Felix Salmon

The WSJ’s Jim Browning has a big story today saying that small investors are “fleeing stocks” and “running for cover”. And interestingly, this is not a particularly new phenomenon, and it predates the big crash of 2008:

After getting hurt in the 2000 tech-stock crunch, individuals came back to U.S.-stock funds in 2003, as stocks were entering a new bull market, ICI data show. But the buying proved tepid and turned to net selling in the latter part of 2006, even before the bull market ended in 2007. Despite occasional periods of inflows to U.S.-stock funds, the selling trend has continued since then.

It’s only natural for buy-side types to look at this data and conclude that this is a great buying opportunity — but I’m not so sure. Browning concentrates on investors who are rotating out of equities by choice, but I suspect that a lot of what’s going on here is a matter of necessity: people are selling their stocks because they have to, not because they want to. After all, they no longer have the ability to take out home equity lines of credit whenever they run into a liquidity crunch.

There’s also a certain amount of delevering going on, which is encouraging: Browning talks of one investor who sold a third of his stocks and used the proceeds to pay down the mortgage on his second home. Sensible.

And while Browning talks of the new conservatism as emblematic of the way in which the stock market is being left to large institutional investors, the fact is that underneath their monolithic exteriors, those big investors are mostly just aggregations of little investments at heart. It’s entirely possible that retail investors are ahead of the curve, here, and that institutions will end up following suit: what are the chances that they will continue to see inflows rather than outflows, over the long run?

What’s undeniable is that it makes a lot of sense for the “comfortably retired” Karen and Roger Potyk to sell their stocks. If you have enough money to live on, why take the risks associated with equities? Especially when doing so makes you feel bad about yourself morally?

“In the military, you learn that you want people you can respect, trust—who have integrity,” Mr. Potyk says. “Over the last five years or so, I find that our financial institutions have no shred of the character I describe.”

The last straw was the May market volatility, accompanied by widespread fears about European government debt. On May 20, the Potyks asked their financial adviser to sell the last of their stock mutual funds.

Now that their portfolio consists entirely of fixed-income investments, “I won’t make 8% on my money. I will make 4% or 5%, but the money will be there,” says Mr. Potyk.

It’s worth noting here that Mr Potyk still thinks of stocks as something which can and should return 8% a year, despite the fact that they’ve done nothing of the sort for the past decade. In that sense, we haven’t had a real capitulation yet. It’s rational to exit the stock market even if you think it’s going to go up, so long as you also think there’s a serious risk it’ll go down, and you can’t afford to lose that hard-earned money. But for the time being, in the public mind, stocks are still things which go up over time. Which says to me that there’s still at least as much downside as there is upside.

Cardiff Garcia pushes back a little at my contention that raising the minimum wage might help the problems of unemployment, underemployment, and bad employment:

How do we know that with a higher minimum wage, employers will “compete on who has the best employees” and “invest significantly in those employees”?

It seems just as possible that employers would react by doing one of the following, or some combination thereof:

• Hiring fewer workers and asking existing workers to do more (a tactic employers are more likely to get away with in an environment of sustained unemployment)

• Investing more in capital (whose price relative to labor obviously declines as the minimum wage increases) to help the company do the same work with fewer people

• Simply continuing to compete on price, even if the prices will be higher across the board as the increased minimum wage affects all employers in the same industry…

I’ve never seen the argument that employers react to higher minimum wages by increasing their investment in human capital.

To Cardiff’s last point first: pretty much by definition, an increase in the minimum wage forces an increase in employers’ investment in human capital. And my point is, at heart, the idea that the more employers spend on human capital, the more they think about it as an investment, as opposed to merely an expense.

To Cardiff’s other points, yes, it’s entirely possible that employers will hire fewer workers to do the same job, if those workers become more expensive. That’s called improving labor productivity, and it’s a good thing, especially when labor is rewarded for its improved productivity in the form of higher wages. Going back to Rich Florida’s original point, America doesn’t just need more jobs, it needs better jobs — especially in the service sector. And in the long term, more productive companies are more successful, and grow more, and end up hiring more people. Higher-productivity jobs are precisely the ones we most want to create.

Finally, Cardiff seems to worry that an increase in the minimum wage would cause price inflation. We should be so lucky. Right now, a bit of wage-driven inflation is exactly what the doctor is ordering. I just don’t see it happening, unfortunately.

Paul Krugman’s column today is devoted to telling off the Fed for not being aggressive enough about deflation:

Conventional monetary policy, in which the Fed drives down short-term interest rates by buying short-term U.S. government debt, has reached its limit: those short-term rates are already near zero, and can’t go significantly lower. (Investors won’t buy bonds that yield negative interest, since they can always hoard cash instead.) But the message of Mr. Bernanke’s 2002 speech was that there are other things the Fed can do. It can buy longer-term government debt. It can buy private-sector debt. It can try to move expectations by announcing that it will keep short-term rates low for a long time. It can raise its long-run inflation target, to help convince the private sector that borrowing is a good idea and hoarding cash a mistake.

Nobody knows how well any one of these actions would work. The point, however, is that there are things the Fed could and should be doing, but isn’t.

In a blog entry, Krugman explains why he’s so convinced that deflation is a real and immediate problem: monthly price inflation has been falling steadily since January 2008, and has now reached the point at which it’s sometimes negative.

Krugman’s argument is certainly defensible. But I do wonder whether he isn’t essentially asking Ben Bernanke to step up and provide the stimulus that Summers and Geithner have rejected:

Washington seems to feel absolutely no sense of urgency. Are hopes being destroyed, small businesses being driven into bankruptcy, lives being blighted? Never mind, let’s talk about the evils of budget deficits.

Still, one might have hoped that the Fed would be different. For one thing, the Fed, unlike the Obama administration, retains considerable freedom of action. It doesn’t need 60 votes in the Senate; the outer limits of its policies aren’t determined by the views of senators from Nebraska and Maine.

This is the point at which I remind myself that Bernanke is a Republican. He’s not a party-political hack, but he never evinced any substantive disagreement with Alan Greenspan when the two of them were on the FOMC together, and his extraordinary interventions into the realm of unprecedented monetary policy nearly all happened while he was working hand-in-glove with a Republican administration. Now, Krugman is asking him not only to break significantly away from Republican party consensus but to go much further than even Democrats seem willing to go.

Bernanke is a consensus builder, as Krugman knows, having been part of the Princeton economics department during Bernanke’s tenure as its head. And it may or may not make sense for the Fed to ease much more aggressively. But so long as that remains outside the general consensus, Bernanke’s not going to do it.

Volcker “lined up public support for a tough crackdown from other well-known financiers who are roughly his age” — NYT

“Crowds of football-mad Polynesians turned away from the World Cup final to look to the skies instead” — BBC

“Toy Story 3″ now the top-grossing film in Pixar’s history — EW

Are government scientists just as frustrated with Obama as they were with Bush? — LAT

Conde Nast subsidiary Reddit launches a pledge drive. Does Si know about this? — Reddit

In Despicable Me, “The Bank of Evil” has a sign that reads “formerly Lehman Brothers” — Jackson

Me, on Marketplace Money, talking about how you can’t trust financial journalism — Marketplace

Evelyn Konrad: A real-world version of Charlotte Graves, in Adam Haslett’s Union Atlantic? — NYT

If Matt Yglesias can wonk out with meditations on the velocity of money, then I can wonk out with a chart:

The red line, here, is the total US money supply, and as you can see it’s started leveling off recently. (Source data here.) In fact, in many months it has actually declined — a rare occurrence, historically speaking. The blue bars are the month-on-month change in M2; it declined as much as 0.65% in January 2010, and in the first five months of this year — all that we have data for so far — it has fallen in three and risen in only two. The money supply in April 2010, at $8.5 trillion, was lower than it was in November 2009: it’s almost unheard-of for the money supply to shrink over so many months.

More generally, I’d take issue with Matt’s assertion that the Fed’s response to the crisis has “involved a sharp increase in the M2 money supply”. Yes, M2 rose in the wake of the crisis. But the sharp rise in M2 dates back much further than that — in fact, you can trace it all the way back to the mid-1990s. The red line doesn’t start rising more sharply when the crisis hits, nor do the blue lines get noticeably larger. There’s one big jump in M2 between August 2008 and January 2009, right at the height of the Lehman collapse, during which it rises from $7.79 trillion to $8.32 trillion, a rise of just under 7%. But we’ve seen that kind of thing before: between November 2000 and May 2001, M2 grew by more than 5%, and then between May 2001 and October 2001, it went on to grow another 4% on top of that.

But I do agree with Matt that we should start publishing M3 data again. If America’s economic statistics are “arguably the most robust in the world”, as Emily Kaiser says, then we should be able to know what’s happening to broad money, without using narrower money as a proxy. These things are very wonky, and only one part of a much bigger puzzle. But they’re still important.

Edward Chancellor’s masterful 10-page essay on sovereign debt crises past and present should be required reading for anybody seriously interested in the “new normal” and the way that sovereign debt dynamics might play out over the medium-to-long term. The whole thing can be found here (warning: 12.2 MB PDF file), or it’s embedded below.

Chancellor does a great job of explaining in a single graph why the PIGS in particular are being singled out for trouble — although in this case the I is very much for Ireland rather than Italy.

What’s more, Chancellor has read his Rogoff and Reinhart thoroughly, and is unafraid to draw smart conclusions from their fantastic trove of data. The main one is that governments nearly always prefer inflation to default — unless and until most of their creditors are foreign, in which case default becomes more attractive. What’s more, the best predictor of future default is simply past default: credit ratios tell you almost nothing. The UK managed to get through debt-to-GDP levels of 240% without defaulting or even inflating the debt away in the early 19th Century, while Russia defaulted in 1998 with a debt-to-GDP ratio of just 12.5%.

More generally, sovereign defaults are by their nature unpredictable. At some point, a country hits a tipping point, and then it’s all over — but no one can tell where that point might be. Greece has already reached its tipping point, which is why it needed the EU bailout; Japan seems as though it might, but it’s not there yet. Notably, the interest rate it’s paying on its debt is lower today than when it was first downgraded in 1998 — despite the fact that the Japanese domestic savings rate has dropped from 9% to 3% over those years, making it harder for Japan to finance its enormous structural deficits.

Chancellor concludes powerfully:

Current yields on government bonds in most advanced economist are at very low levels. Under only one condition – that the world follows Japan’s experience of prolonged deflation – do they offer any chance of a reasonable return. But this is not the only possible future. For other outcomes, long-dated government bonds offer a limited upside with a potentially uncapped downside. As investors, such asymmetric pay-off profiles don’t appeal to us.

There are still trillions of dollars invested around the world on the implicit basis that sovereign debt is risk-free. It isn’t, and as those investors wake up to the new realities, they’re going to do unpredictable things with their money. Which is a good reason to prepare not only for volatility in sovereign debt going forwards, but also for volatility in just about all other asset classes as well. It’s going to be a bumpy, unpredictable ride.

Reflections on the Sovereign Debt Crisis

Rodney Sullivan has a great column which is nominally about “risk parity” strategies, but which in fact applies much more broadly — to anybody, in fact, who buys in to the idea that if you invest in riskier assets, you’ll end up with higher returns.

Of course, high risk sometimes means that returns are much higher than expected. But it can also mean that returns are far lower, perhaps crippled beyond hope of redemption. Given the reality of fat tails, the likelihood of large negative events is also higher than normal. And poor results can persist for long periods. By now, the myth that risk “goes away” over time should be well put away — risk accumulates over time. In short, investors cannot expect to “get” the expected return, but rather a draw from a very wide distribution. And in reaching for high returns by using leverage, investors dwell in the extremes of the return distribution.

The idea behind a “risk parity” strategy is simple. Let’s say you’re 100% invested in equities, because you’re happy with that level of risk. The problem is that you have no diversification: bonds can outperform equities for very long periods of time. So you rotate some of your holdings out of stocks and into bonds. But bonds don’t return as much as stocks, and that can hurt your total returns. So you leverage your bond-market investments, to bring them up to the same riskiness as the stocks.

Sullivan is not impressed. “Using leverage simply to increase the expected return is almost always a bad idea,” he writes, credibly enough. Which makes sense to me: the person lending you the money you’re borrowing expects to make a profit on the deal, which is only going to make it that much harder for you to make a profit as well.

What’s more, you could hardly pick a worse time to start levering up your bond investments than now:

That this leveraged-bond strategy is emerging after a long bond bull run and poor equity performance is curious. This likely hindsight-driven idea runs strikingly close to the frequent overweighting of equities during the late 1990s and the more recent affinity for uncorrelated assets during the early years of this century. Asset allocation decisions should never be made by simply extrapolating the future from the past.

This, of course, doesn’t just apply to bond-market rallies: it can be applied equally to the stocks-for-the-long-run crew. If you’ve got a coherent fundamental reason why stocks should outperform other asset classes, that’s great. But “they always did in the past” is much less convincing.

George Soros on the crisis and the euro — NYRB

Dan Ariely on how people are like wine: describing them is not a very good way of telling whether you’ll like them — Big Think

Who’s pawning $14 billion of gold to the BIS? — Alphaville

Texas Tribune + NYT = NYT Texas edition? Seems like a good idea to me — CJR

David Merkel sets out his own shingle — Aleph

John Paulson’s painful June — Bloomberg

Matt Yglesias is no fan of the distinction between goods and services — Yglesias

Unemployment is tragically, stubbornly high — and that’s going to prove devastating not only for the millions of long-term unemployed but also for the USA as a whole, if it continues indefinitely. And it’s not just the Americans without jobs who need a way out: it’s the ones in bad, underpaid service-industry jobs as well.

I wrote about that problem on Wednesday and got some fantastic comments in response. And a lot of other people are making similar points these days. Mark Thoma picked up on the same Richard Florida piece that I did and noted that improving productivity is not certain to help: since the early 1980s, productivity has fed through into improved pay only once, briefly, during the dot-com boom.

Chrystia Freeland has been attending similar discussions in Aspen:

What frightened me most about today’s discussion was a possibility endorsed by Ron Brownstein, political director of Atlantic Media, that America’s two-speed economy may not be anyone’s fault (as [Arianna] Huffington insisted it was) but might, instead, be the inevitable consequence of the twin revolutions of globalization and technological change.

[Allstate CEO Tom] Wilson was certainly right about one thing: one of the great success stories of our age is how dynamically American companies have adapted to globalization and the technology revolution. But, as Huffington pointed out, the political consequences of a two-speed America might not be pretty: “America cannot be America without a middle class … we will become Brazil and all live behind gates to protect our children.”

There’s a real risk that American companies will thrive on foreign labor, leaving their home nation to slowly devolve into a land of chronic unemployment and widespread lack of skills.

Andy Grove reckons that the solution is for American companies, at the urging of the government, to become more protectionist, putting up trade barriers to create domestic jobs. Like Reihan Salam, I’m unconvinced. But Reihan isn’t particularly constructive himself, saying only that we need “a wrenching series of labor market and entitlement and tax reforms designed to improve work incentives, most of which will prove far less popular than simply bashing China”, which will somehow both raise taxes and foster lots of new employment at the same time. I’ll believe it when I see it.

Michael Hudson is a bit more inventive: he’d like to see a move away from income taxes and towards property taxes. That would help bring property prices down, making housing more affordable, and leaving more money left over for consumption. But that’s a plan designed to work in Eastern Europe, not in the U.S.

Mohamed El-Erian, meanwhile, has a whole laundry list of things he reckons need to be done with some urgency:

Instead of simply debating the case for further government stimulus, policy makers should also come up with a comprehensive strategy that focuses on improving human capital, particularly through a greater emphasis on education and training; expanding infrastructure and technology investments, in part by creating a more friendly tax system; encouraging a bigger translation of scientific advances into economy-wide productivity gains; and better protecting the most vulnerable segments of society.

This is all well and good, but none of it is likely to bear fruit during the presidency of Barack Obama, even if he gets re-elected. And I think it’s fair to say that if he leaves office with unemployment significantly higher than he inherited it, that will be a major blemish on his administration.

But maybe unemployment is simply a problem to which there is no good medium-term solution, let alone any short-term fix. Certainly the government can’t directly employ the unemployed, and although I’m a big fan of arts subsidies as a way of creating jobs, that kind of thing is only ever going to have a marginal effect.

I do think that my first commenter, Harrington, is right that it’s high time to start giving labor unions more recognition and power. That might seem a bit counterintuitive — unions have never been very good at improving employment numbers, as opposed to improving the plight of the employed. But if workers at places like Wal-Mart start being paid a decent living wage, that is surely a significant improvement on where we are now. And if we raise the minimum wage to a point where employees are less likely to quit and more likely to learn reasonably high-level skills, that will help get us to Richard Florida’s promised land. Without unions and minimum-wage laws, corporations compete on who can pay the least. With them, they compete on who has the best employees and they invest significantly in those employees. Which is exactly what we want, especially since raising the minimum wage is unlikely in and of itself to increase unemployment visibly.

My third commenter, billyjoerob, depressingly reckons that reduced immigration will do the trick. It won’t. But immigration is important: if it’s sensibly structured, it can create more jobs more quickly than just about any other low-cost government intervention. Just allow lots of rich and high-skilled immigrants into the country and they will rapidly create businesses which will employ millions. (One prime example: Andy Grove.)

And Dollared notes another important tack: fixing the national health care system so that employers aren’t burdened with enormous healthcare costs and can concentrate instead on what they do best.

But I like HBC’s comment the best:

The prevailing epidemic of bad jobs (formerly known as careers) American workers are having to get used to can be directly attributed to protracted periods of really awful American management, for which there can be no tolerable excuse.

America invented the concept of management as a profession and course of study and in doing so helped to cement the victory of capital over labor. That works until the workforce becomes so demoralized as to be useless — at which point the jolly capitalists just decide to hire foreign workers instead. This is good for investors in the short term, but it’s very bad for the economy in the long term. And I don’t think that anybody believes that the U.S. stock market can rise steadily if the U.S. economy is in a slow and inexorable decline.

At the same time, however, it’s hard to imagine capital giving up its hard-fought gains and becoming much more paternalistic and generous to its employees, hiring more people and paying them better. Which is one reason why I’m a pessimist when it comes to the long-term employment situation.

At the very end of his profile of Henry Blodget, Andrew Goldman drops in a jaw-dropping quote from Gawker founder Nick Denton:

Denton lays out the most optimistic scenario: “This is like the early days of cable,” he says. “High—surprisingly high—startup costs. But eventually advertisers move across and the margins are lavish for the leading players in each category. Jezebel becomes Lifetime, HuffPo becomes MSNBC and Henry becomes CNBC.”

This is by far the most bullish thing I’ve ever heard come from Denton and it makes me wonder whether, finally, he’s beginning to seriously consider — for the first time — selling a large chunk of Gawker Media.

Denton hasn’t launched a new website in a while; in fact, he’s been consolidating his properties, folding the likes of Valleywag and Defamer into Gawker and selling off blogs like Wonkette and Consumerist which he felt he couldn’t make work. Instead, he’s been quietly seeing his empire grow truly enormous: according to Quantcast, he reaches 30 million unique visitors globally every month and 17.3 million in the U.S. That’s 450 million pageviews per month — pretty impressive, although the rate of growth is clearly slowing.

Maybe now is the point at which Denton needs to find an outside investor to shoulder the “surprisingly high” costs of taking a strong online franchise and turning it into the multi-billion-dollar media property of the future. Denton is a serial entrepreneur, having become wealthy by founding and selling First Tuesday and Moreover. He doesn’t need the money from selling Gawker, but at the same time I can’t imagine him just sitting there running it as a going concern, cashing his dividend checks and patting himself on the back for creating a successful company. He needs a challenge, and competing head-on for advertisers with the giants of cable TV is certainly that.

As for Nick being nice about Blodget, that’s classic Denton. Gawker doesn’t do slideshows and listicles and in fact does very little of the aggregation that’s the bread and butter of Blodget’s business. And Denton knows full well that in an apples-to-apples comparison, Blodget is going to make Gawker look almost old-fashioned in its rectitude. If Denton can help give Blodget a certain amount of credibility, that just makes Gawker Media look positively Olympian. Which is maybe exactly what he wants, if he’s finally willing to accept outside investment — at a suitably stratospheric valuation, of course.

David Streitfeld has got his hands on new data from CoreLogic. It’s hard to find actual numbers in the article, or any kind of link to the data, so here’s the accompanying chart:

You can see how this might have blindsided lenders: the richest borrowers, who historically had the lowest default rates, now have the highest.

“The rich are different: they are more ruthless,” said Sam Khater, CoreLogic’s senior economist.

And, they’re disproportionately likely to live in California, or other non-recourse states where you can default on your seven-figure mortgage without any realistic worry that the bank will come after your other assets. That said, there’s a good chance that many of these delinquencies are forced rather than strategic.

Streitfeld’s piece is bylined Los Altos, California, a town where the median home is $1.5 million. In such towns, you don’t need to be a millionaire to find yourself in a multi-million-dollar home. Let’s say you’re a tech geek who found yourself with $200,000 for a downpayment on a house over the course of the dot-com bubble. So you buy a million-dollar home, and then start up a series of companies. You need to live, of course, and you can’t afford to pay yourself a salary, so you do two or three cash-out refinancings on a home which by 2007 was worth $2.5 million. Before you know it, you’ve got a $2 million mortgage, no way of paying it, and a home which is worth significantly less than the mortgage. Realistically, you have no choice but to default.

Even after accounting for your initial $200,000 downpayment and a series of mortgage-interest payments along the way, you still took out of the house much more money than you put in: the cost of living there over the past 10 years has probably been negative to the tune of well over half a million dollars. Essentially, the house has paid you $50,000 a year — money which is easy to spend, and is now long gone.

In any event, these were jumbo mortgages when they were taken out, and they’re jumbo mortgages now — none of this has anything to do with Fannie or Freddie, except insofar as the homeowning majority of the population might yet wake up and, emulating the rich, default on their underwater homes. And so the GSEs are desperately, and unconvincingly, trying to persuade them not to do so:

Knowing the costs and factoring in the time horizon, some borrowers have made the calculation that it is better to purposely default on the mortgage. While I understand how that might well be a good decision for certain borrowers, that doesn’t make it good social policy. That’s because strategic defaults affect many other families and communities. And these costs – or as they are known in economic jargon, externalities – are not factored into the individual borrower’s calculations.

Well, sure, it’s not good social policy to strategically default. Fine. That doesn’t stop the rich, and it shouldn’t stop the rest of us either. I think it’s pretty clear which direction we’re headed in, and moralistic exhortations aren’t going to turn the tide.

Andy Xie on the market for fine wine in China:

Some analysts estimate that 70 percent of China’s Lafite consumption is counterfeit. I personally experienced this on a few occasions. The people who served me fake Lafite didn’t know it, because at the very least, the prices seemed genuine. And the fakes were probably decent wines, possibly some good second growth poured into a Lafite bottle. They just weren’t the real thing. The forgers have targeted the legendary 1982 vintage in particular. Many rich Chinese have bought large stocks of 1982 Lafite. The odds are that these are all fakes. There are very few bottles of the vintage left. It is highly unlikely that one can get several cases of the real thing.

The interesting thing about this is that so long as no one says anything in public, everybody’s happy. Xie explains that Lafite is the drink of choice for buttering up government bureaucrats — not because it tastes good, but just because it’s expensive. If Yellow Tail cost as much, they’d buy that instead. So when you’re served a bottle of 1982 Lafite in China, the important thing is not that it’s 1982 Lafite, but just that it’s expensive.

All of this focus on the brand is great for Lafite, which gets to charge insane prices not only for its flagship wine, but also for its second growth, Carruades de Lafite, as well. It’s great for the forgers, obviously. And it’s great for the purchasers, who otherwise would never be able to get their hands on anything as expensive and special as a bottle of 1982 Lafite.

But Xie sees a dark cloud on the horizon:

A market is efficient when consumers are informed and make rational choices. An efficient market motivates producers to improve quality and control cost. The virtuous cycle leads to great brands that last. The French wine market is like that. I am afraid that Chinese demand is decreasing the market efficiency and may bring down great brands over time. When winemakers see the price a result of propaganda, not quality, they will focus on marketing and decreasing investment for improving quality. It would be a tragedy if Chinese demand, by bringing easy money, brings down a French legacy that has lasted for five centuries.

The wine market in general, and the market in first-growth Bordeaux in particular, has never been efficient. Certainly the big chateaux have never been particularly interested in cost control or in market efficiency, and it’s pretty obvious, as Xie recounts, that the success of Lafite in China is more a matter of dumb luck than it is anything to do with smart marketing. If the price of Lafite goes up, I don’t think that will bring down its quality. No one’s going to mess with a winning formula. Especially when non-Chinese buyers can bid up the price of Petrus to $40,000 a case before it’s even been bottled.

(Incidentally, every time a “br” appears in Xie’s post, it has been replaced with “P”. I’m sure this was an HTML find-and-replace gone rather wrong. Don’t let it put you off.)

Jenn Ablan takes a look at the muni market today, and although inflows have been strong this year, the smart money seems to be moving out of the market, positioning itself for a gruesome second half of the year.

The muni market is a curious beast. Most of it is highly illiquid, with small issuers, buy-and-hold retail investors, and tax-exemption rules which make enormous differences to the value of securities depending on where you live and what your tax rate is. At the same time, some big institutional players like to rotate in and out of the market on a speculative basis, with short time horizons, and when they do, they’re big enough to act as marginal price setters. If they’re moving on to the next thing, then prices are likely to fall a little — which is actually no big deal, for anybody but institutional investors who mark to market. Municipalities will pay a little more to borrow, but rates are still extremely low, and their investors, who are also their voters, will get slightly more attractive rates on their money.

The big danger in most markets when institutional investors leave it for dead is that it closes up entirely, and that borrowers have no market access at any price. That’s less of a worry when it comes to munis because they’re mainly reliant on individuals. At some point, if there’s lots of talk of default, then retail investors might stop buying municipal bonds, but that’s a little bit down the road. First you get the price decline (and CDS spreads widening out further still), then you get the default talk, and only then do you get the retail well drying up.

For institutions who mark to market, then, it makes sense to avoid munis for the time being: they have more downside than upside. But for buy-and-hold individuals, there’s no real reason to panic: you’re going to hold your bonds to maturity anyway, so it doesn’t really matter what happens to their value in the interim. And the chances are that they’re not going to default; what’s more, even if they do, you’ll probably end up getting your money back eventually in any case. And if you’ve lent to a big state-level borrower like California or New York or Illinois, you can be pretty sure that there will be some kind of government bailout too.

The real worry here is with the monoline insurers: municipalities are more likely to default if they know that their voters are still going to receive their coupon payments from an insurance company which provided a wrap for their bonds. But for the time being, at least, I’m not worried about a complete collapse of the muni market, where local governments in need of funds can’t raise the money at any price. That could yet happen, but I doubt it’s going to happen this year.

Amy Shipley has an odd piece today on the economics of signing basketball stars. I know absolutely nothing about basketball, but I do know that Shipley’s story doesn’t convince me that the NBA is suffering the “economic woes” of her headline because “a broken economic system” has resulted in teams spending too much money on players.

For one thing, Shipley never explains the mechanism by which player salaries are being overinflated, beyond waving vaguely in the direction that such salaries constitute “gambling, perhaps foolishly, that the expensive addition of a star player from a historically talented free agent class will generate interest in their franchises and ignite a significant payoff in the box office.” But your foolish gambling is my smart investing, and of course box office revenues are only a fraction of the value that teams extract from players.

What’s more, Shipley concentrates on dubious and vigorously contested cashflow figures, saying that the league will lose about $400 million this year, with the average team losing $13 million. That doesn’t seem like a huge amount of money to me, in a world where players can take home $20 million a year each. Instead, it looks like smart accounting: it’s clearly smart for an owner to lose a modest amount on a cashflow basis, thereby avoiding taxes, and instead build a much higher franchise value for his team, thereby increasing his net worth substantially.

As a datapoint, check out the market capitalization of MSG, the owner of the Knicks, as speculation rises that LeBron James might come to New York. The share price closed at $21.57 yesterday, up a good $2 from a week earlier — that’s an increase in franchise value of $150 million, give or take.

And indeed, as Shipley notes, it’s not the teams paying out monster salaries which are hurting the most:

“The most significant challenge facing the NBA today is the gap between the teams at the top and bottom,” said sports consultant Andy Dolich, a former Capitals executive who has worked for NBA, NFL and Major League Baseball front offices.

Think about it this way: big-name basketball players earn much more in endorsements than they do in salary. It’s reasonable to assume, given how much value they add to the brands they advertise, that they add much more to the teams they play for. And that if smart business owners are competing desperately for the privilege of signing these players, then the chances are that their services are underpriced, not overpriced.

Greg Ip has an interesting argument: if we were really headed for a recession, he says, the yield curve would be inverted. But you can’t have an inverted yield curve when the Fed sets short rates at zero. Therefore, we won’t have a double dip.

Ip concedes that Japan provides an obvious counterexample of a country which had a recession and Zirp at the same time. But he’s convinced that in the US, loose monetary policy will suffice to keep us growing:

Our entire financial system relies on borrowing short and lending long and profiting from the spread. When that spread disappears, sooner or later, so does liquidity. In 2007, that happened in dramatic fashion, partly because we didn’t realise how precarious liquidity was in the vast shadow banking system. Indeed, the more I study the events of the last few years, the more I’m convinced that illiquidity contributed more to the crisis than insolvency.

What all this tells me is that as long as the yield curve remains relatively steep, it is a powerful inducement to credit creation. Credit is currently contracting, but with time the positive lending spread will recapitalise banks and awaken interest in lending. Right now is an excellent time to start a bank: just check out the enthusiasm among private equity funds for buying failed banks from the FDIC.

This is not very convincing: if zero interest rates are so good at fostering new lending, how come credit is currently contracting? After all, we’ve had zero interest rates for a good 18 months now, how long is this supposed to take?

My feeling is that we had a boom and bust in credit, and that most companies — the ones not owned by private equity shops — were sensible enough to avoid levering up during the boom. That’s how they survived the bust so easily, in contrast to banks and homeowners. They’re now sitting on large amounts of cash, and the likelihood that they’re going to start borrowing again in any serious quantity is low. Meanwhile, individuals have embarked upon a long and slow process of saving more and paying down their debts, rather than levering up. In other words, if you’re looking forward to a credit-fueled recovery, you might well be in for disappointment.

At the same time, zero interest rates are still too high: the Taylor Rule would set interest rates in the US at -1.3%. So even a Zirp is restrictive, absent quantitative easing.

None of which means we’re going to enter another recession, of course. And indeed for most people it doesn’t really matter: the key issue facing Americans today is that they can’t find jobs, and it’s increasingly obvious that positive GDP growth isn’t much better when it comes to job creation than negative GDP growth. But it does help a lot on the fiscal side of things. And if you’re worried about government finances, you should be worried sick about the possibility of a double dip. Which is real, zero interest rates notwithstanding.