Monday, October 28, 2013

Austrian Economics, FIRE and America

Bubbles, bubbles everywhere and even the president is against them. Like everything else he says, it is opposite of his administration's policies. We have ZIRP pushing the cost of money down, the government acting as the backer of the home mortgage market as well as the lender of subprime auto and subprime college loans, and a media telling everyone to get back into the game and buy buy buy. It's a world fo credit now, not money, which is why so many of the fools liek Krugman are off in their analysis. If they are telling you to buy, it's already too late. You are the late receiver. You are the late adopter. Wealth flows back to early receivers and asset holders. That is the key to our bubble economy. Credit must always be expanding for economic growth in our FIRE economy.

Credit has been a part of the American economy for over a century but study of how credit would interact in the economy lagged. Murray Rothbard wrote on the evils of credit as monetary expansion would always favor early receivers. Not based on savings but on credit creation, monetary expansion favors those connected to the credit creators. Rothbard explained how this credit expansion and inflation ends up as a redistribution of money from late receivers to early receivers. Hyman Minsky explained it a bit better. Early receivers are hedge borrowers who receive credit first and can make principal and interest payment due to their income or other investment cash flow. Middle receivers are speculative borrowers who receive credit later and can make interest payment but need asset inflation to help refinance their loans. Late receivers are Ponzi borrowers who get credit last, join the asset inflation at the end and cannot make principal or interest payments and only hope to get some form of asset inflation to reap rewards. Oftentimes, late receivers are borrowing and joining the game just to play catch up due to widespread inflation.

Our policymakers find a way to marry the credit expansion to tax policy. Easy money in the '80s was timed with a reduction in top income tax rates, a reduction in the capital gains tax rate, mortgage interest being deductible, depreciation changes and this all made companies more optimistic about opportunities going forward. The '80s witnessed a stock market, residential real estate and commercial real estate bubble, but most importantly it was a corporate debt bubble. The lending to corporations fueled takeover leveraged buyouts, mergers and defensive management buy outs. These all goosed the stock market. A lot of early leveraged buyouts paid handsomely and were winners. Lenders made money, stock holders received a premium, bankers earned fees, and governments received their cut through taxation. As the momentum built, more capital was allocated to leveraged buy outs, the borrowers were of worse quality, valuations rose, and the party ended in tears. It also ended with cash holders and early receivers making the most money to later buy up bubble inflated assets after the crash.

An example from our recent American past is Southland Corp. Southland (operated 7-11 stores) spent $275 million (borrowed throughout the '80s) building up property in Dallas that in 1990 they sold for $24 million to an investment firm (the firm included a Bass billionaire). That was in December 1990 after the credit bubble had popped for junk debt. In December of 1987 with massive investor incentives, Southland could float a multibillion dollar junk bond issue for its own leveraged buyout at roughly 15%. Note that GoldmanSachs, at the time headed up by Robert Rubin, had lent hundreds of millions to Southland for this operation, which they were repaid for handsomely, and then underwrote the junk debt on this final piece. In 1990, a Japanese firm spent $430 million for a controlling interest, and the Bass purchase of 144 acres of downtown Dallas for 10% of what Southland spent building it up was part of the financial restructuring. Minsky and FIRE bubble features were that Southland received easy corporate borrowing for first acquisitions and commercial real estate investing, then in the later stages of the leveraged buyout bubble, they were fearful of a takeover and overborrowed to defend their firm, and the moment sales did not fulfill dreams, they went through a prepackaged bankruptcy. Wall Street received fees, interest, a slice of the capital gains throughout the process. At the end, a billionaire with cash on hand was there to scoop up a $275 investment for $24 million.

This started with corporations and slowly moved to larger realms, affecting more Americans. The FIRE economy just needs to find a new asset, and it will direct lending towards that asset class. America's FIRE economy marries the Minsky-Rothbard early-middle-late receiver model to asset inflation models. Original asset holders and early receivers will benefit from that first inflation, and by the time it gets to you, late receiver, the easy gains have been made. This is why the stock bubble chart looks like the real estate chart. Original asset holders get credit, buy stocks/homes on the cheap, bidding prices up or acquiring assets to monetize (think rentals or land development), middle receivers buy from them or purchase less primo assets within that class, pushing prices up even higher. Middle receivers can make money from stocks or homes. The momentum of rising asset prices cushions lending standards, expanding credit to late receivers who buy at the end, paying off middle receivers and early receivers who held out. 

The '90s was a stock market bubble with real estate benefiting slightly as well. Stocks rose through the early '90s, but you didn't know or had limited means to participate. The media was perplexed in the early '90s why the market moved but the jobs were not growing in synch. NAFTA, the Telecommunications Act of 1996, wider adoption of defined contribution vs. defined benefit retirement plans, reductions in the capital gains tax rate and easy money combined to give us the stock market bubble (often called the NASDAQ bubble). When did you or your parents get the stock buying bug? Was it when Etrade ran Super Bowl ads? That was at the top. All stock transactions have a buyer and a seller, and if you bought in the '99-'00 blow off phase, who do you think sold to you? Who bought it back from those late buyers when they sold during the crash? Thought so.

The housing boom of the '00s technically was a continuation of the '90s home boom as the '00s stock market echo boom followed the '90s crash. It needed easy money and help from the government. Credit scores and down payment requirements limit initial funds to good standing developers and wealthier borrowers. As the assets are bid up, others with worse credit scores and means seek loans. The CRA was renewed under Clinton and a major factor to Democrat support for the Gramm-Leach Bliley Act (repealing Glass-Steagall), and as Steve Sailer pointed out, Bush was instrumental in destroying down payment requirements and barriers to minorities for home ownership. The CRA did reduce lending standards, which helped pull in the late receivers. By the time home loans were being pushed to minority buyers of lower income with little documentation and no down payments, the end of the bubble was in sight. If those policies were enacted to help people who couldn't meet already reduced lendign standards, then that enabled the recruiting of Ponzi borrowers. The blow off top in housing prices happened when the money hit the masses, paying off the original landowners and early receivers. They reaped the asset inflation gains.

Those dead economists described the world we live in before it came into being. Today's American economy needs credit to expand to increase marginal consumption as we do not save anymore. We need to buy on credit to employ the next citizen because our entire political focus is on economic maximization. Our elites want to get paid, and our politicians want to be re-elected. Finance, insurance and real estate have provided ever growing units to GDP, more jobs, and best of all for both left and right, it does not pollute. Asset inflation rewards the original asset holders and early receivers. Even if one never sells, the asset inflation can rationalize lending against that asset. The Frankenstein economy moves on as lenders collect their interest on asset backed lending and originators collect fees. The wealth of the 1% is tied to the very assets that have inflated since the birth of the FIRE economy. In the same time, median wages have been stagnant. Currently the rich are flipping million dollar homes to one another while nearly 50 million receive food stamps. Who donates to politicians or sets up PACs? Not median wage earners, and this is why the system will not change from within. The FIRE economy is a great name because, aside from the men feeding and tending the flames, it burns all in its path.

1 comment:

Anonymous said...

So what are you investing in