…for 2004, nonfinancial executives of publicly traded companies account for less than six percent of the top 0.01% income bracket.  In that same year, the top twenty-five hedge fund managers combined appear to have earned more than all of the CEOs from the entire S&P 500.  The number of Wall Street investors earning over $100 million a year was nine times higher than the public company executives earning that amount.

My first impression is that this fits nicely with the view that, particularly over the past decade, economic growth was tied to activities that were not job-producing or sustainable (i.e. prone to bubbles).  This isn’t to say that people didn’t “earn” their money.  Rather, it points to the fact that much of the wealth that was created was done so in a way that did not strengthen the overall economy over the long term.

Food for thought…

At a time when many economists and financial commentators where underplaying, if not downright ignoring, the looming credit crunch, Roubini was warning of the impending chaos of the markets.  Some may claim that he was simply lucky (even a broken clock is right twice a day), but Roubini’s arguments were always couched in explicit logic and backed by relevant data.  I can remember reading his musings while still in graduate school and hoping that his analysis was flawed.  Unfortunately, it wasn’t.  Lately, he has been warning about the potential problems of sovereign debt and there are signs that once again his perspective should be taken quite seriously.

Even if he never goes on to predict another major economic event he still managed to be on point with the meltdown of 2008, and that is no small accomplishment.

Further confirming this notion is Anna Katherine (A.K.) Barnett-Hart and her brilliant senior thesis from Harvard on the subprime mortgage CDO meltdown.  Her thesis has been getting tons of attention, including praise from leading economists and author Michael Lewis who, in the acknowledgments to his new book, said the thesis was “more interesting than any single piece of Wall Street research on the subject”.  The data collection alone is masterful and a coup given the opaque nature of this market.

Barnett-Hart concludes that the meltdown in the CDO market resulted from “poorly constructed CDOs, irresponsible underwriting practices, and flawed credit rating procedures.”

A pdf  version of her thesis can be found here.

Lewis’ new book, The Big Short, focuses on the instruments of the crisis as well as those few individuals that profited from the crash–those who shorted not a particular company or sector, but the entire system.  On the way back from a meeting today I heard Lewis talk about the book on NPR’s Fresh Air.  His account sounds fascinating, to say the least.  In typical Lewis fashion, he focuses on a few protagonists and uses their stories to explore a larger, more complex story–in this case, how the financial industry become enamored with mortgage-backed securities, the process of selling (through CDO’s) and insuring them (through CDS’s), and how that lead to the exponential increase in systemic risk. In the case of The Big Short, Lewis introduces us to a few of the contrarians who realized early on that the market was set for failure. As Lewis explains:

“Everybody [on Wall Street] was working with the same set of facts about subprime mortgage lending — about how subprime mortgage loans were turned into bonds and repackaged and turned into CDOs and so on and so forth,” Lewis tells Terry Gross. “[And] the vast majority of the people in the markets took those facts and painted one kind of picture with it; it was a very pleasant picture. And a very small handful of people took the same facts and painted a completely different kind of picture with it. [I wanted to find out] ‘What is it that enables [the people who bet against the market] to paint that picture?’ and ‘Why do these people look at the world differently?”

“This is the story of human perception as much as it is anything else. And their attitude toward the financial markets was peculiar,” Lewis says. “It was peculiar to be running around the world looking for unlikely things that might happen. … And it told you something about Wall Street and … the way the markets were functioning when they were dysfunctional. There weren’t enough people thinking this way. There weren’t enough people taking into account the real likelihood of extreme change in the world.”

I’ve got The Big Short on my to-read list (there are currently two books ahead of it in the queue). I’ll be sure to post a review once I’ve finished it.

You can listen to the entire interview here.

If you are looking for a last minute gift, or just something to read over the holidays, you could do much worse.

Happy Holidays!

While it is abundantly clear that companies are near the end of the job downsizing phase, there is scant evidence of any renewal in the pace of new hiring. In fact, it is quite the contrary. This assertion is underscored by the fact that both the median (20.1 weeks) and the average (28.5 weeks) duration of unemployment hit new record highs last month. The share of the unemployed that has been looking for work without success for six months or longer also reached an unprecedented 59% last month. We are fairly certain that these folks will have a slightly different take on today’s employment number than the mainstream economics community. In addition, also keep in mind that the employment diffusion index, while improving in November, was still unacceptably low at 40.6. In other words, roughly 6 out of 10 businesses are still rationalizing their staff loads, even if at a less dramatic rate than in previous months.

The data certainly supports the conclusion that the rate of downsizing has declined dramatically since the bottom fell out of the market in late 2008/early 2009. However, it does not necessarily follow from this that we are about to enter into a period of job growth.

There comes a point at which most employers simply can’t cut anymore more full-time workers–there is only so much they can squeeze out of less employees. One might call this their human capital floor, the point the point at which any further decrease in employees leads to unacceptable decline in performance. One way that businesses are dealing with the trade-off between laying off workers and operational needs is to hire temporary staff. Businesses do not have to make the same kinds of investments (economic, temporal) in temporary workers as compared to full-time employees. Additionally, I can’t think of a time in recent history when you had more highly qualified workers in the temporary pool. One wonders how long businesses could decide to leverage this type of labor before committing to true job creation and growth.

Historically, temporary hires serve as a leading indicator for the hiring of full-time employees. Let’s hope that trend continues.

The first comes via Nathan Yao over at FlowingData, who has put together an interactive data visualization that depicts spending patterns by U.S. consumers over the past 25 years (data courtesty of the Bureau of Labor Statistics).  You can compare spending across the various categories or click on a single category and see how consumers have (or have not) altered their spend.  What’s most interesting is that for many categories, spending patterns have barely shifted since the mid-1980′s.  What isn’t clear is what is actually driving the change in relative spending.  I would suspect that to some extent the data reflects changes in consumer behavior, but it is also likely capturing shifts in the relative cost of various items (e.g. apparel spending decreased, but so did its cost relative to other items).

The second was published by the Wall Street Journal on the heels of the recent jobs report, which showed a drop in unemployment and drastic slow down in the rate of job loss. As a companion to their coverage, the Journal published an interactive chart that plots the monthly U.S. unemployment rate going back to 1948. Scroll over each cell to see the recorded unemployment rate for each month. Additionally, you can choose to view previous recessions overlayed on the data (marked by circles–see below). Two things immediately struck me: 1) it put into perspective how rare an unemployment rate above 10% has been in the U.S. over the past 51 years; and 2) if the current data does indicate that we’ve reached the nadir of unemployment (which I am not convinced we have), we will have only experienced two consecutive months of 10%+ unemployment compared to the recession of the early 1980′s, which experienced 10 consecutive months of 10%+ unemployment.

By delaying payment Dubai has not only created serious doubts about its dedication and ability to repay its loans, but also the credit worthiness and risk-level for other sovereigns.  The price to insure against debt-default by Dubai more than doubled (from $300M to $675M).  Additionally, the price of default insurance rose in general for many sovereigns, including Bulgaria, Abu Dhabi, Hungary, the U.K. and the U.S. (see graphic below).

Graphic Credit: The Wall Street Journal

It’s unclear at this point to what extent concerns for default (or an actual default) by Dubai would act as a contagion, setting off another global financial crisis.  On Friday, global markets took a significant hit based largely on investor reaction to the payment delay.  U.S. and Asian markets took the biggest hits, with European markets managing to close higher on the on the day.

At first glance, the sell-off for firms linked to Dubai World was contained on Friday. Additionally, the amount of risk at stake in this case is minuscule compared to the financial crises of a year ago. The Financial Times notes:

Credit Suisse, for example, assumes that European banks account for half of Dubai’s debt, estimated at about $80bn. If they lost 50 per cent on their exposure, bad loan provisions would rise by 5 per cent next year, equivalent to a €5bn after-tax hit. Compared with the $1,700bn of toxic assets European and US banks have wiped out in the credit crisis, that is a drop in the Burj Al Arab swimming pool.

It would appear at first blush that, financial speaking, there isn’t a great threat of a Dubai default leading to a global financial meltdown (however, I have not seen data on the holders of credit default swaps [cds] and to what extent they’ve assumed too much risk, as AIG did last year). However, I do wonder about the other major variable in financial crises–the psychological risk. Financial crises are the result of both economic and psychological variables interacting in dangerous ways (namely, a positive feedback loop where negative economic conditions feed into negative views on the market which leads to actions that increase negative economics conditions which feed into negative views on the market, etc, etc). As Mark Gongloff notes:

Every episode of sovereign worry raises market fears of contagion, “reminders that pockets of post-credit-excesses are intact and destabilizing,” Gluskin Sheff chief economist David Rosenberg told clients on Friday.

To me, that is the real risk. With states’ balance sheets in total disarray around the globe, investors will not long for worrisome indicators and troublesome cases to analyze (think of the conditions that facilitate brush fires).

We’ll see to what extent this scenario plays out in the coming days. Would love to hear feedback from sovereign debt specialists and global finance experts.

One of the themes of my talk was that it wasn’t an excess of greed and speculation which led to the financial crisis, but rather an excess of overcaution, with an attendant surge in demand for triple-A-rated bonds. Investors didn’t want risk, and investment banks made billions of dollars, during the boom, by waving their magic securitization wands and seemingly making that risk disappear. In Islam, high religious authorities are tasked with looking at complex structures designed to circumvent the prohibition on paying interest; in western finance, the ratings agencies played a similar role, blessing highly complex structures (CPDOs, anyone?) which otherwise investors would never have touched.

Like Noah, I am not an expert in this area.  And while I think this is an interesting viewpoint, my gut tells me it downplays the role that risk-acceptance played in the story.
Let’s grant Salmon the fact that there was an increased demand for AAA-rated bonds. I don’t doubt this (in fact, it seems quite logical), in fact I would be surprised if it wasn’t the case given how market volatility has seemingly increased over the past few decades and investors are always looking to balance their portfolios with low-risk investments.

However, this analysis completely ignores two factors: 1) that someone, somewhere was in fact taking (and, frankly, creating) tremendous risks (i.e. the investment banks that were creating these securities and the agencies that provided the gold-seal ratings) and 2) an over reliance on faith and trust in the ratings agencies and a subsequent lack of due diligence by investors and their brokers.

The fact that these products garnered such a low-level of skepticism and caution is itself proof that risk-aversion was not ruling the decision calculus of all parties. (The term willful blindness comes to mind). Blindly trusting the ratings agencies despite the fact that these offerings where impenetrable for most tells me that people where taking on increased risks and rationalizing it by hanging their investment decisions on a third-party such as Moody’s or S&P.

An increase in demand for low-risk products alone would not cause the financial meltdown we’ve witnessed. You had to combine demand with a supply of flawed products and a large group of (at best) unsophisticated and/or (at worst) willfully blind buyers.