The stymied stimulus

Donald Trump’s executive orders do little for hard-hit Americans

Congressional gridlock prolongs the pain

In late march Congress broke its characteristic gridlock and passed the cares Act, a huge stimulus package. On the day that President Donald Trump signed it into law, around 2,000 Americans had died of the virus. America’s death toll now exceeds 160,000, and its GDP fell by 10% year-on-year in the second quarter of 2020.

The case for further stimulus remains strong, but political will has weakened. Congress adjourned without passing another bill, each party blaming the other. That failure imperils America’s shaky economic recovery, and could presage a brutal end to 2020.

In July America added 1.8m jobs. Such is the scale of the damage caused by the coronavirus that the world’s largest economy needs another seven similarly large jobs increases just to reach its pre-pandemic level of employment. And there is growing evidence that the recovery is losing steam. Almost all economists believe the country needs more fiscal stimulus.

Since the pandemic began Congress has passed some $3trn-worth of fiscal stimulus. It has made grants to small businesses, bumped up unemployment-insurance (UI) payments by $600 a week and sent out cheques worth up to $1,200 per person.

Both in absolute terms and relative to the size of the economy, America’s fiscal stimulus is the world’s largest. But many of the elements of the various packages have now expired, including a federal moratorium on evictions (which ended on July 24th) and the $600-a-week bump to ui (July 31st).

America probably cannot leave it at that. The numbers of infections and deaths from covid-19 remain extraordinarily high. That threatens the economic recovery which began in April, as state lockdowns have been reimposed and consumer confidence has suffered. A closely watched measure of credit-card spending has not grown since mid-June, while the number of small businesses which are open appears to be in decline.

The reduction in fiscal support will be a further drag on growth, not to mention a source of anxiety for many Americans, especially those with less or no work. Worries that investors would balk at another stimulus package have, meanwhile, proved wide of the mark. As talk has swirled of extra borrowing, yields on Treasuries have fallen to new lows.

Moderates on both sides argue in favour of sending extra cheques to households, for more money for bumped-up ui payments, and for extra money for states. But they disagree on how generous these plans should be. The Democrats originally put forward a package worth some $3.5trn (17% of GDP).

The Republicans have proposed their own plan, and the Democrats have since made theirs less generous, but there remains a gap of $1trn between them.

A pen and a pone

With congressional negotiations stalled, on August 8th Mr Trump signed four executive orders that purport to extend ui benefits and the eviction moratorium, and defer student-loan payments and payroll taxes. Democrats howled that these orders were unconstitutional. But except for the ui extension, most appear broadly legal—but ineffective.

The eviction order, for instance, simply asks a few cabinet departments to look for ways to help renters; it does not direct anyone to do anything. Payroll taxes will still come due at year’s end, so businesses may well withhold them from employees anyway rather than scramble to find funds in December.

The ui order provides $400 a week, with states (many of which are cash-strapped, and all of which face stricter borrowing limits than the federal government) responsible for $100 of that.

It provides just $44bn for these payments, enough for perhaps six weeks. By law only Congress can appropriate funds, though federal law allows presidents to provide financial aid during a “major disaster”.

As one conservative legal scholar notes, covid-19 may not qualify: “He can’t call it a disaster just because it’s a disaster for him politically.” But for a court to find it illegal, first someone has to sue, and House Democrats seem an unlikely plaintiff: that would let Mr Trump claim that they are holding up funds to needy people.

Though stubborn partisan disagreement is nothing new, it contrasts sharply with the spirit of co-operation that Republicans and Democrats showed in the early part of the pandemic, when everyone agreed that they needed to get money out as quickly as possible.

In some ways the Republicans’ unwillingness to go along with the Democrats’ spending plans this time around is puzzling, not least since a new stimulus would help the economy and thus Mr Trump’s chance of re-election.

A few things are different now. Back in March many people worried that the economy was going to enter a recession of cataclysmic proportions. Research published by the Federal Reserve Bank of St Louis had suggested that the unemployment rate was going to rise above 30%. In fact it peaked at about 15%, and has since fallen to 10%.

And whereas six months ago double-digit unemployment would have seemed catastrophic, now it seems almost normal, points out Gbenga Ajilore of the Centre for American Progress, a think-tank. So whereas some fiscal hawks may have been bumped into backing fiscal support in March, they now believe the economy does not need it. (Mr Ajilore adds that the evidence that the pandemic has disproportionately affected non-white folk may also explain why some urgency has been lost.)

Politically, too, the ground seems to have shifted. Mark Meadows became Mr Trump’s chief of staff after the cares Act passed. In these negotiations, he has taken a prominent role, and he is a longtime fiscal hawk, as are many Senate Republicans. Five months ago fear of crossing Mr Trump before primary season may have pushed many of them into supporting a stimulus bill that they may otherwise have opposed.

But the primaries are over, and Mr Trump is trailing in the polls. Ben Sasse, for instance, is a generally principled Republican who went quiet during impeachment and won his primary in May; he called Mr Trump’s executive orders “unconstitutional slop”.

Still, that may be the only relief America sees: a substantive congressional deal looks unlikely before the parties’ conventions later this month. For millions of Americans enhanced ui benefits have already ended, and even if no court stops Mr Trump’s extension, implementing it requires states to reconfigure their rickety payment infrastructure and scrounge between sofa cushions to find the money.

Weeks will pass before people see the money. States and cities that need federal aid are similarly left adrift. After the recession of 2008-09, local budgets faced drastic cuts, reducing services and prolonging economic woes. A similarly drawn-out recovery appears far likelier now, unfortunately, than it did just a few weeks ago.

Mortgage Industry in for More Surprises

The new fee from Fannie and Freddie on some mortgage loans is unlikely to be the last change

By Telis Demos

The signs point to more fees ahead. / PHOTO: ANDREW HARRER/BLOOMBERG NEWS

Fannie Mae’s FNMA 5.07% and Freddie Mac’s FMCC 5.36% new fee has roiled the mortgage industry. It could be just a taste of what is to come as the two giants’ role in the housing market evolves.

The 0.5-percentage-point “adverse market” fee approved by their regulator and implemented by Fannie and Freddie last week will be applied to what the government-sponsored entities pay upfront to acquire many refinancing loans.

Though limited—it won’t apply to home purchases, for example—the fee still may hit some mortgage lenders, notably those that have locked in a rate on a loan to a borrower that won’t actually be moved on to Fannie or Freddie until after the fee takes effect in September.

The fee also is likely to be passed through to borrowers, potentially putting pressure on volumes. Since the fee news last week, shares of newly listed Rocket Cos ., the largest U.S. originator, along with those of PennyMac Financial Services and Mr. Cooper Group, are down an average of around 5%.

Criticism of the fee has been swift and loud from lenders, affordable-housing advocates and even the White House. This might give investors a sense that originators, who have had booming business of late, have the upper hand in an environment in which helping people access cash and stay in their homes is politically important.

But even if critics were to win a reversal on this particular issue, there is much more of this type of conflict potentially to come.

Fannie and Freddie and their regulator are in the midst of efforts to raise capital in a quest to become free of government conservatorship. For any additional risk they bear they may need more equity capital as a cushion, which reduces their rates of return and appeal to investors. Potential investors will want to know how Fannie and Freddie can offload risk—or offset it with earnings, including fees.

It’s harder for Fannie and Freddie to offload risk at the moment due to the slowing market for so-called credit-risk transfer securities. There was no issuance at all in the second quarter, according to data tracker Mark Fontanilla & Co.
 So the answer might involve more fees. Fannie and Freddie don’t have a lot of market incentive not to raise them: The pair are no longer locked in a battle for market share with private-label securitizers, as before the financial crisis.

Today that market isn’t what it once was, and it’s still getting smaller: Bank of America estimates that the nonagency residential mortgage-backed security market will issue about $56 billion this year, down from $129 billion in 2019.

Fannie and Freddie cited market and economic uncertainty brought on by the pandemic.

There’s potentially more to that uncertainty than just credit risk, including that they have had to backstop mortgage servicers’ payment obligations due to forbearance programs. This gives Fannie and Freddie all the more incentive to find new sources of income.

Even absent a pandemic, the transition from government conservatorship of Fannie and Freddie was never likely to be cost-free for the broader mortgage industry. Overlaying that process on top of the coronavirus crisis will likely turn up more surprises for investors.

Macroview: Why Soros Just Called The Market A Bubble

Lance Roberts

In a previous post "Market Bubbles," I touched on George Soros' "theory of reflexivity." Interestingly, MarketWatch discussed with George why he no longer participates in the "bubble."
The bigger the "bubble size," the larger the market cap. Not surprisingly, the largest bubbles belong to the "mega-cap" stocks responsible for a majority of the market return.
Can prices remain detached from the fundamentals long enough for the economic/earnings recession to catch up with prices? Maybe. It has just never happened.
This idea was discussed in more depth with members of my private investing community,Real Investment Advice PRO.
In a previous post "Market Bubbles," I touched on George Soros' "theory of reflexivity." Interestingly, MarketWatch discussed with George why he no longer participates in the "bubble." The foundation of his argument comes from his previous work in "Alchemy of Finance." To wit:
"Pivoting to his legendary approach to financial markets, Soros acknowledges that investors are in a bubble fueled by Fed liquidity, which creates a situation that he now avoids. He explained that 'two simple propositions' make up the framework that has historically given him an advantage. However, since he shared it in his book, 'Alchemy of Finance,' the advantage is gone." - MarketWatch
Specifically, he eludes to his "theory of reflexivity."
"One is that in situations that have thinking participants, the participants' view of the world is always incomplete and distorted. That is fallibility. The other is that these distorted views can influence the situation to which they relate, and distorted views lead to inappropriate actions. That is reflexivity."
Before we get into the issue of "reflexivity," let me recap what a "bubble" is.
Bubbles Are About Psychology, Not Metrics
"Market bubbles have NOTHING to do with valuations or fundamentals."
Over the last few weeks, I have touched on the impact of valuations and forward returns. However, it is not just valuations but also the surge in corporate debt and declining profitability resulting from weak economic growth. Historically, such a combination of factors is associated with previous "bear markets."

None of these fundamental concerns are currently a problem. Despite the March selloff, 50-million unemployed, and a deep recession, the markets currently hover near all-time highs.
Such was a point George also confirmed:
"We are in a crisis, the worst crisis in my lifetime since the Second World War. I would describe it as a revolutionary moment when the range of possibilities is much greater than in normal times. What is inconceivable in normal times becomes not only possible but actually happens. People are disoriented and scared. They do things that are bad for them and for the world."- George Soros
As shown in the chart below, the S&P 500 is trading in the upper 90% of its historical valuation levels.
However, since stock market "bubbles" reflect speculation, greed, emotional biases, valuations only reflect those emotions. As such, price becomes more reflective of psychology.
From a "price perspective," the level of "greed" is on full display as the S&P 500 trades at the greatest deviation on record from its long-term exponential trend. (Such is hard to reconcile given a 35% correction just a few months ago.)
In other words, bubbles can exist even at times when valuations and fundamentals might argue otherwise. Notice that except for only 1929, 2000, and 2007, every other major market crash occurred with valuations at levels LOWER than they are currently.
A Basic Disregard
The chart, courtesy of, compares the year-to-date performance of the constituents of the S&P 500. The bigger the "bubble size," the larger the market cap. Not surprisingly, the largest bubbles belong to the "mega-cap" stocks responsible for a majority of the market return. Importantly, notice the vast majority of stocks still sport negative returns.
In other words, investors push valuations simply on "momentum." As shown, since 2018, the increase in stock prices is primarily attributable to "valuation expansion."
The basic disregard by investors over fundamental valuations is a reflection of the "psychological" bias now engulfing market participants. However, being excessively "bullish" is not what causes the eventual reversion. It is just the "fuel" that drives it.

No Bubble Is Ever The Same
Historically, all market crashes have been the result of things unrelated to valuation levels. Issues such as liquidity, government actions, monetary policy mistakes, recessions, or inflationary spikes are the culprits that trigger the "reversion in sentiment."
Importantly, the "bubbles" and "busts" are never the same.
I previously quoted Bob Bronson on this point:
"It can be most reasonably assumed that markets are efficient enough that every bubble is significantly different than the previous one. A new bubble will always be different from the previous one(s). Such is since investors will only bid prices to extreme overvaluation levels if they are sure it is not repeating what led to the previous bubbles. Comparing the current extreme overvaluation to the dotcom is intellectually silly.
I would argue that when comparisons to previous bubbles become most popular, it's a reliable timing marker of the top in a current bubble. As an analogy, no matter how thoroughly a fatal car crash is studied, there will still be other fatal car crashes. Such is true even if we avoid all previous accident-causing mistakes."
Comparing the current market to any previous period in the market is rather pointless. The current market is not like 1995, 1999, or 2007? Valuations, economics, drivers, etc. are all different from cycle to the next.
Most importantly, however, the financial markets adapt to the cause of the previous "fatal crashes." However, that adaptation won't prevent the next one.

Alan Greenspan
Alan Greenspan, former chairman of the Federal Reserve, also noted the importance of investor behavior about both the buildup, and bust, of market bubbles. To wit:
"Thus, this vast increase in asset claims' market value is partly the indirect result of investors accepting lower compensation for risk. Market participants too often view such an increase in market value as structural and permanent.
To some extent, those higher values may be reflecting the increased flexibility and resilience of our economy. But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. Such is why history has not dealt kindly with the aftermath of protracted periods of low-risk premiums."
- Alan Greenspan, August 25th, 2005.

Credit Risk Is The Tell

Just as it was in 2005, we see much of the same behavior in the markets today. One of the "key arguments" for continuing to chase stocks has been that "low rates justifies taking on increased risk." Such was a point Mr. Greenspan obviously disagreed.
"A decline in perceived risk is often self-reinforcing in that it encourages presumptions of prolonged stability and thus a willingness to reach over an ever-more extended period. But, because people are inherently risk-averse, risk premiums cannot decline indefinitely.
Whatever the reason ‎ for narrowing credit spreads, and they differ from episode to episode, history cautions that extended periods of low concern have invariably been followed by a reversal, with an attendant fall in the prices of risky assets. Such developments reflect not only market dynamics but also the all-too-evident alternating and infectious bouts of human euphoria and distress and the instability they engender."
Alan Greenspan, September 27th, 2005.
It's not too hard to remember what happened next. In the short term, investors always believe they can escape the eventual reversions of excess. In reality, they never do.

Soros' Theory Of Reflexivity
With this background, we can better understand Soros' "theory of reflexivity."

"Financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. The degree of distortion may vary from time to time. Sometimes it's quite insignificant, at other times, it is quite pronounced. When there is a significant divergence between market prices and the underlying reality, there is a lack of equilibrium conditions.
I have developed a rudimentary theory of bubbles along these lines.
Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. When a positive feedback develops between the trend and the misconception, it sets a boom-bust process in motion. The process is liable to be tested by negative feedback along the way. If it is strong enough to survive these tests, it reinforces both the trend and the misconception.
Eventually, market expectations become so far removed from reality if forces people to recognize that a misconception is involved. A twilight period ensues during which doubts grow. More and more people lose faith, but the inertia sustains the prevailing trend.
As Chuck Prince, former head of Citigroup, said, 'As long as the music is playing, you've got to get up and dance. We are still dancing.' Eventually, the markets reach a tipping point and the trend reverses; it then becomes self-reinforcing in the opposite direction.
Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions."


The chart below is an example of asymmetric bubbles.
Soros' view on the pattern of bubbles is interesting because it changes the argument from a fundamental view to a technical view. Prices reflect the psychology of the market, creating a feedback loop between the markets and fundamentals. As Soros stated:
"Financial markets do not play a purely passive role; they can also affect the so-called fundamentals they are supposed to reflect. These two functions that financial markets perform, work in opposite directions. In the passive or cognitive function, the fundamentals are supposed to determine market prices. In the active or manipulative function market, prices find ways of influencing the fundamentals. When both functions operate at the same time, they interfere with each other. The supposedly independent variable of one function is the dependent variable, so neither function has a truly independent variable. As a result, neither market prices nor the underlying reality is fully determined. Both suffer from an element of uncertainty that cannot be quantified."
The chart below utilizes Dr. Robert Shiller's stock market data going back to 1900 on an inflation-adjusted basis. I then took a look at the markets before each major market correction and overlaid Soros' asymmetrical bubble shape.


There is currently much debate about the health of financial markets.

Can prices remain detached from the fundamentals long enough for the economic/earnings recession to catch up with prices?
Maybe. It has just never happened.
The speculative appetite for "yield," which has been fostered by the Fed's ongoing interventions and suppressed interest rates, remains a powerful force in the short term. Furthermore, investors have now been successfully "trained" by the markets to "stay invested" for "fear of missing out."
The increase in speculative risks, combined with excess leverage, leave the markets vulnerable to a sizable correction. The only missing ingredient for such a correction currently is simply the catalyst that starts the "panic for the exit."
It is reminiscent of the market peak of 1929 when Dr. Irving Fisher uttered his now-famous words: "Stocks have now reached a permanently high plateau."
Of course, that is most likely why Soros is choosing not to participate. At 90-years of age, these boom cycles are nothing new. However, he also knows how they end.
Have you?

Dollar Sensationalism

The dollar’s fall in July to a two-year low against the euro was the catalyst for sensational headlines shouting that the dollar would soon meet its doom. But too much should not be read into the dollar's recent moves, which reflect readily explicable fluctuations, not the greenback's terminal decline.

Barry Eichengreen

eichengreen144_Tetra ImagesGetty Images_eurodollar

BERKELEY – The dollar is in free-fall! The global greenback is doomed! scream recent headlines. Actually, such sensational headlines are “too sensational,” to echo that noted authority on currencies, Miss Prism, in Oscar Wilde’s “The Importance of Being Ernest.”

The dollar’s fall in July to a two-year low against the euro was the immediate impetus for these stories. In fact, the dollar’s recent slide is one in a series of readily explicable fluctuations.

When the COVID-19 pandemic went global in March, the dollar strengthened on the back of safe-haven flows into US Treasuries, as it does at the start of every crisis. By May, the Federal Reserve, acting as global lender of last resort, had accommodated this mad scramble for dollars by pouring buckets of liquidity into financial markets, and the greenback gave back its early gains.

The dollar’s subsequent depreciation reflects the changing prospects of the US and European economies. With the spread of COVID-19, the US outlook is deteriorating, so investors expect the Fed to keep interest rates low for longer. In the eurozone, the virus is under better control, and data from purchasing managers’ surveys are surprising on the upside.

This improving outlook doesn’t mean that the European Central Bank will start raising its policy rate tomorrow. But it does incline investors to believe that it will start normalizing interest rates earlier.

This relationship – you tell me the outlook for interest rates, and I can tell you the change in the exchange rate – has a name, of course. As Miss Prism will remind you, it’s called “interest parity.” This theory doesn’t work perfectly. But no theory of what determines the exchange rate does. When seeking to understand events, we shouldn’t make the perfect the enemy of the good.

Seeking to explain euro bullishness, some observers, point instead to agreement by European leaders to issue €750 billion ($884 billion) of European Union bonds. This is bullishness without the “ishness.” Seven hundred fifty billion euros is less than 5% of the stock of US government debt held by the public. It’s a drop in the bucket, in other words. And a drop does not a liquid market in safe assets make.

Even if this really is Europe’s “Hamiltonian moment,” ramping up EU issuance by a factor of 20 will take decades. That’s how long Europe will need to create a benchmark asset with the liquidity of US Treasuries. And foreign-exchange markets trade on today’s news, not on something that may or may not happen decades from now.

Indeed, the most striking takeaway from recent experience is the dollar’s resiliency. Normally, investors hold a currency when the issuer’s policies are sound and stable. US policy has been risky and erratic, despite having a “stable genius” at the helm.

Banks and firms hold a currency when it is useful for invoicing and settling trade with the issuing country. But President Donald Trump’s administration has done more than any in living memory to disrupt US trade.

Governments, for their part, hold and use the currencies of their alliance partners. And, under Trump, the United States today is no longer the reliable alliance partner it once was.

Given all this, it would appear that the stars are aligned for banks, firms, and reserve managers to back away from the dollar. But the currency’s international role has not diminished significantly. It has declined only along select dimensions – its share in central banks’ foreign-exchange reserves, for example – and even there only marginally.

The explanation for this stasis, as Margaret Thatcher famously put it, is “TINA”: there is no alternative. The euro is not an alternative. The stock of safe euro assets remains segmented along national lines, and Alexander Hamilton is not coming to the rescue anytime soon.

Nor is the renminbi a viable alternative. Given heightened tensions with China, no Western government will encourage its residents to depend on the People’s Bank of China for liquidity, any more than they will encourage them to depend on Huawei for 5G.

With the Federal Reserve able and willing to act as lender of last resort to the world, the status quo is tolerable. One personnel change at the Fed will not alter how foreign officials view this situation. But one personnel change could augur another, at which point other countries will think twice. At that point, they will realize they have no other option to which to turn.

The only solution to this conundrum is more resources for the International Monetary Fund, so that it can supply countries, in a crisis, with the dollars that a future Fed fails to provide. This of course is the solution that John Maynard Keynes offered already in 1944, albeit by another name.

The 80th anniversary of Keynes’s “bancor” proposal is imminent. What better way to mark the occasion than by implementing it?

Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era.