Heels Dislodged 

Doug Nolan

It was a fascinating set up. 

A pivotal FOMC meeting two days ahead of quarterly “quadruple witch” expiration of options and other derivatives. 

Option expiration-related volatility used to be largely confined to the equities market. 

But with ETFs taking the financial speculation world – certainly including the derivatives universe – by storm, volatility around option expirations now reverberates across markets – equities as well as Treasuries, fixed-income, commodities, currencies and EM. 

Moreover, there were only a couple weeks until quarter-end for a Q2 that had been nicely rewarding for various reflation trades, including commodities and cyclical stocks (i.e. materials, industrials, precious metals). 

Toss into the mix that there had been a bout of risk hedging in May, followed by an unwind of hedges and the reemergence of short squeeze dynamics. 

There were scores of stocks and instruments up on air, vulnerable to sharp reversals. 

And if there wasn’t enough market unease after the Fed’s somewhat surprising meeting outcome, St. Louis Fed president Bullard had to rattle the cages Friday morning with hawkish commentary. 

Let’s take a glance at the equities market week, then circle back to the Fed. 

The week offered hints of how swiftly bull market returns can go up in flames. 

The Banks came into the week with a y-t-d return of 33.5%. 

This week’s 7.8% drop abruptly slashed y-t-d returns by about a third to 23.1%.

Broker/Dealer 2021 returns dropped from 26.5% to 21.2% in five sessions. 

The Midcap Index saw its y-t-d return drop from 19.9% to 13.9%, and small cap Russell 2000 returns fell from 18.7% to 13.8%.

By S&P sector, the Materials Index sank 6.3% this week, Energy 5.2% and the Industrials 3.8%. 

The NYSE Arca Gold BUGS Index sank 11.8%. 

The Philadelphia Oil Services Index fell 6.3%. 

Those betting on a steeper yield curve – a seemingly attractive bet in the current backdrop of mounting inflationary pressures and a Fed “behind the curve” - took one on the chin. 

The spread between two and 30-year Treasury yields closed (pre-meeting) Tuesday’s session at 202 bps. 

In a mad scramble to unwind “curve steepeners,” this spread had contracted 26 bps to 176 bps by Friday’s close. 

The five to 30-year spread sank from 140 to 113 bps.

The dollar shorts were also left bloodied. 

The Dollar Index jumped 1.8% to a two-month high, with technical analysts shouting, “double bottom!” 

Most hot EM currencies reversed sharply lower, with surging EM bond yields inflicting some “carry trade” pain. 

The high-flying commodities market was pummeled. 

Lumber collapsed 15.2% - and is now down almost 50% from May 10th highs (up only 3% y-t-d). 

Dr. Copper was slammed 8.2%, with Zinc down 7.3%, Nickel 5.9% and Tin 5.4%. 

Silver was wacked 7.6%, with Platinum down 9.3%, Palladium 10.9%, and Gold 6.0%. 

The soft commodities were not spared. 

Soybeans were down 7.5%, Sugar 6.3%, Corn 7.1%, and Wheat 2.9%. 

It’s being called a “hawkish tilt.” 

In the post-meeting policy statement, the most significant change was replacing “running” with “having run” in describing inflation persistently below target. 

Markets, though, had their attention elsewhere: the shifting FOMC “dot plot”. 

As a group, individual forecasts on average now signal an expectation to raise rates twice by the end of 2023, versus previous forecasts for increases likely not to commence until 2024. 

This shift caught most analysts by surprise. 

Expectations had been that members would continue to low-ball their rate forecasts, at least until the FOMC had communicated tapering plans. 

Powell suggested taking the dot plot “with a grain of salt.” 

Salty markets weren’t buying it.

Expectations are now for a taper announcement in September, with the first installment of reduced asset purchases commencing late this year. 

The Fed’s median GDP forecast rose to 7% for the year. 

The Unemployment Rate is expected to fall to 3.8%. Core CPI will temporarily rise to 3.0% this year, before (conveniently) returning to just above its 2.0% target level for the next two years. 

In a rather dramatic pivot, the Fed now sees a hot economy.

The Fed “blinked,” suggested Cornerstone Macro’s Roberto Perli. 

I also concur with another analyst’s comment, “The Fed took a step in the direction of reality.” 

In a sign of just how low the bar has dropped, the headline from the Financial Times editorial board’s praise piece read, “The Federal Reserve Deftly Changes Tack.” 

The U.S. economy is booming, inflationary pressures are mounting, and labor markets are rapidly tightening. 

It was past time for our central bank to blink.

It was certainly a rather pronounced change in tone from Powell: 

“If you look at the labor market and you look at the demand for workers and the level of job creation and think ahead, I think it’s clear, and I am confident, that we are on a path to a very strong labor market, a labor market that shows low unemployment, high participation, rising wages for people across the spectrum. 

And as you look through the current time frame and think one and two years out, we’re going to be looking at a very, very strong labor market.”

While it was an initial step toward reality, it’s destined to be a treacherous journey. 

“I think we learned during the course of the last very long expansion, the longest in our history, that labor supply during a long expansion can exceed expectations, can move above its estimated trend. 

And I have no reason to think that won’t happen again.”

It’s worth remembering that we’re now 92 weeks (and $4.23 TN!) into the latest bout of QE, liquidity injections that commenced in the pre-pandemic backdrop of near record stock prices and a multi-decade low unemployment rate. 

Throw unfathomable quantities of liquidity at a system already showing strong inflationary biases in stocks and labor, and one should be prepared for a mania and anomalous wage inflation. 


“We’re all going to be informed by what we saw in the last cycle, which was labor supply outperforming expectations over a long period of time.” 

And I’d like to inform Chair Powell that the Fed will be “fighting the last war.”

Powell somewhat came clean on extraordinarily uncertain economic, inflation and policy backdrops. 

“I think we have to be humble about our ability to understand the data. It’s not a time to try to reach hard conclusions about the labor market, about inflation, about the path of policy.” “The problem now is that demand is very, very strong. Incomes are high. 

People have money on their—in the bank accounts. 

Demand for goods is extremely high and it hasn’t come down. 

We’re seeing the service sector reopening, and so you’re seeing prices are moving back up off their lows there.”

Understandably, markets studied the dots and Powell and concluded a period of policy clarity has been supplanted by significant uncertainty. 

It was as if Powell intimated his heels had been dislodged, and he could no longer guarantee there’d be no surprises. 

And then Bullard beams onto CNBC Friday morning to proclaim surprises start right now. 

“I put us starting in late 2022,” the St. Louis Fed President stated in reference to the “lift off” rate increase. 

Markets came into Wednesday’s session thinking, believing, hoping for 2024.

The world changed this week: Markets can no longer fixate singularly on the salve of massive Federal Reserve stimulus. 

There are major developments in China, for example, that have been easily disregarded in the halcyon environment of $120 billion monthly QE and luminous Fed policy clarity. 

Suddenly, it will matter that Beijing is determined to slow system Credit growth, putting China’s Bubbles in serious jeopardy. 

Chinese Credit stress matters. 

It matters that some of the major apartment developers are facing liquidity challenges. 

Huarong and the other huge asset managers matter. 

The possibility that Beijing may allow a major financial institution to fail matters tremendously. 

Ten-year Treasury yields slipped a basis point this week, not necessarily the reaction one would expect from a “hawkish” Fed pivot. 

Last month’s 5% y-o-y CPI gain was the strongest since June ‘08. 

There are parallels to that pivotal bubble year. 

Recall that crude and commodities went on a speculative moonshot – bolstered by a late-cycle confluence of strong global demand and Fed stimulus measures. 

After peaking at 5.30% in June ‘07, 10-year yields were down to 4% by June ‘08. 

There was this extraordinary dynamic: Year-over-year CPI rose from 2% in August ‘07 to a cycle peak 5.6% about a year later – yet yields sank more than 100 bps.

Why were Treasuries in ‘08 dismissive of the inflationary backdrop? 

Bond market focus was elsewhere - on the faltering credit bubble. 

Treasuries sensed that an unfolding crisis would see the Fed deploy extreme stimulus.

So why did 10-year yields end the week at 1.44% in the face of powerful inflationary pressures, historic Treasury issuance and a less dovish Fed? 

Once again, the bond market is focused on bubble dynamics and the certainty of even greater future stimulus.

June 10 – Reuters (Lusha Zhang and Kevin Yao): 

“China’s new bank loans unexpectedly rose in May from the previous month but broader credit growth continued to slow, as the central bank seeks to contain rising debt in the world’s second-largest economy… 

Growth of outstanding total social financing (TSF), a broad measure of credit and liquidity in the economy, slowed to 11% in May, the weakest pace since February 2020, and compared with 11.7% in April. 

Analysts attributed to the weaker TSF growth to slowing issuance of corporate and government bonds, and a contraction in shadow credit, which could hamper economic growth in the future. 

‘The slowdown in credit growth is happening even faster than we had been anticipating a couple of months ago,’ Julian Evans-Pritchard at Capital Economics said…”

June 16 – Bloomberg (Sofia Horta e Costa):

“China is resorting to increasingly forceful measures to contain risks to the financial system, in moves that threaten to undermine President Xi Jinping’s pledge to give markets greater freedom. 

Authorities have in recent weeks ordered state firms to curb their overseas commodities exposure, forced domestic banks to hold more foreign currencies, considered a cap on thermal coal prices, censored searches for crypto exchanges and effectively banned brokers from publishing bullish equity-index targets. 

A new rule will bar cash management products from holding riskier securities and limit their use of leverage. 

On Thursday, an official said China plans to sell metals from state reserves. 

While the measures fall short of direct intervention, they risk reinforcing the notion of moral hazard.”

June 18 – Bloomberg: 

“Chinese property developers are poised for their worst week since January, on concerns that more bad news could follow the central bank’s announcement last week that wealth-management products have been banned from investing in junk bonds, according to brokerage Zhongtai International. 

A Bloomberg equity gauge tracking the property sector falls as much as 5.7% this week, and is set for its worst performance since the week of January 29.”

The bottom line: global Bubbles are fragile and increasingly vulnerable. 

In particular, China is a Credit accident in the making. 

Fed policy certainty has been the glue holding things together – keeping the mania raging, keeping the leveraged players playing, keeping all the options and derivatives speculators betting on the long side, and keeping the weak dollar supportive of levered “carry trades” the world over. 

Ten-year Treasury yields below 1.50% are sending a signal: there are Bubble fragilities that will impede any effort of policy normalization. 

QE is here to stay. 

And after a week of big commodity price drops, it will be easy for some to now dismiss inflation risk – or even assert yields indicate prospective deflation. 

And while bursting Bubbles would surely exert disparate disinflationary pressures, thinking one step ahead, I ponder the consequences of the Fed’s policy response to the next crisis. 

I actually doubt it will be that far out into the future. 

And there are decent odds Trillions of additional liquidity will hit a system already demonstrating powerful inflationary dynamics. 

Look at Joe not go

After a quick start, Joe Biden’s legislative agenda has hit a wall

Factionalism and the filibuster imperil his ambitions

After his first 100 days in office, Joe Biden looked ruthless and Rooseveltian. 

He had just passed a $1.9trn rescue package despite painfully narrow majorities. 

His administration was triumphantly preparing future plans to spend trillions more on climate, infrastructure and safety-net expansions. 

Since then, however, little has happened, and the prognosis looks murky.

When mathematicians confront a system of equations, they sometimes find that there is no possible solution: the equations are simply inconsistent and cannot be resolved. 

The various constraints on governance—Democratic squabbles over the importance of bipartisanship, the brutal mathematics of thin margins, unrelenting opposition from Republicans—are starting to resemble such a system.

The main constraint on Mr Biden’s ambitions has always been the filibuster, a Senate rule that mandates 60 (out of 100) votes to push through most legislation. 

Democrats hold 50 Senate seats; assuming unanimity among them, the administration thus needs ten Republican votes. 

Mr Biden will be hard-pressed to find them.

That leaves three plausible options. 

The first is to negotiate down his proposals, which risks losing the support of the Democrats’ left flank. 

The second is to squeeze the agenda into a “reconciliation” bill that is primarily budgetary, and immune to a filibuster. 

That would probably require excising some important regulatory provisions, such as a clean-electricity standard or a minimum-wage rise. 

It also risks losing the votes of moderate Democratic senators hopelessly bent on bipartisanship. 

The third option—abolishing the filibuster through a simple majority vote—is hostage to moderates’ unshakeable belief that ending the filibuster would somehow destroy the Senate.

On infrastructure, Mr Biden seems to be pursuing the first path. 

Joe Manchin of West Virginia, the Senate’s most conservative Democrat, insists on a bipartisan deal. 

The White House pursued one, negotiating for weeks with Senator Shelley Moore Capito, the Republican senator from West Virginia. 

Those talks collapsed on June 8th. 

The White House has now pivoted to negotiating with a separate bipartisan group of senators—which may also prove a long slog with little hope of success.

If there were an obvious path to get his full, ambitious package through Congress, the president would already have taken it. 

Mr Biden had little compunction about pushing his rescue package through reconciliation and passing it largely unscathed on a party-line vote in the Senate. 

Moderates acceded during an emergency, but are much less enthusiastic about using reconciliation for ordinary legislating.

Looking at the concessions already forced upon the administration is instructive. 

Ms Capito’s final counter-offer was for $330bn in additional spending—not even 10% of Mr Biden’s $4trn package. 

The president, for his part, had offered to cut proposed spending to $1trn, and suggested taking the corporate-tax rise (from a current rate of 21% to a proposed 28%) off the table. 

The offer being crafted by the new group, which may yet fail to attract ten Republican votes, is said to be $579bn in extra spending, and mainly limited to “hard” infrastructure—roads, bridges and the like—without any of the welfare-state expansion that Mr Biden included in the second half of his plans.

Even if the negotiations yield a compromise, factional forces loom. 

Climate-conscious Democrats seem poised to bolt. (Republicans have been adamant that “core infrastructure” ought not to incorporate greenery.) 

“You can’t hand-wave or spin away the scientific necessity that we have to get our climate emissions down to protect public health,” says an aide to Senator Ed Markey of Massachusetts, who vows to vote against any bill that is “in denial” on climate change. 

Progressives in the House of Representatives, where Democrats have only a bare majority, also have sufficient numbers to torpedo any legislation they deem insufficient.

Much of the rest of Mr Biden’s agenda looks even more endangered. 

The For the People Act, also known as hr1, which Democrats see as their answer to state Republicans’ tightening of voting rules and to the threat to democracy posed by Trumpism, looks dead. 

Mr Manchin will not support it (not because of any of its manifest flaws, but because it was too partisan). 

He also has repeatedly rejected calls to weaken the filibuster. 

Among the ironies engendered by the filibuster is that a simple-majority vote is sufficient to confirm a Supreme Court justice with the power to strike down legislation, but insufficient actually to pass any.

A mausoleum of ambition

Mr Manchin promised instead to whip up support for hr4, the John Lewis Voting Rights Advancement Act, a more limited bill than hr1 (which devoted much of its space to the somewhat ancillary concern of drawing up a public-financing scheme for elections). Even this strategy is suspect. Earlier introductions of the legislation have been co-sponsored by only a single Republican senator, Lisa Murkowski of Alaska—which leaves the administration nine votes short.

Chuck Schumer, the Senate majority leader, has suggested that he will force a series of votes in the coming month. That may yield political benefits for next year’s mid-terms. Substantively, however, he may wind up with little to show for his efforts. Voting-rights legislation is imperilled, and a compromise gun-control bill is looking unlikely after talks broke down between John Cornyn of Texas and Chris Murphy of Connecticut.

That is not to say that nothing will pass. The Senate recently approved a relatively undiscussed $250bn industrial-policy bill aimed at improving competitiveness with China. A $547bn surface-transport bill may soon pass with a smattering of Republican support. Bernie Sanders, who chairs the Senate budget committee, aims to start the reconciliation process soon. But that will get only some of Mr Biden’s agenda through, and nothing at all on voting rights, gun control or immigration.

And this may prove the most favourable legislative environment of Mr Biden’s term. 

Parties in power tend to lose seats in mid-terms, though Mr Biden is proving a slippery target for Republicans, and his signature legislative achievement showered Americans with cheques. 

A successful vaccination campaign and healthy reopened economy may help him when facing that headwind.

But given the Democrats’ narrow margins, even small losses would put Congress in Republican control. 

Herding Democrats is hard enough. 

The Republican congressional leadership could kill Mr Biden’s legislative priorities, leaving him reliant on executive orders, as his two predecessors were in the second halves of their terms. 

That is a long way from Rooseveltian.

The U.S. Averted One Housing Crisis, but Another Is in the Wings

A moratorium on evictions did little to address the bigger problem: The country is running out of affordable places for people to live.

By Conor Dougherty and Glenn Thrush

While pandemic savings are fueling home sales among one group of Americans, rising prices and job losses are putting housing out of reach for many others, an annual Harvard report said on Wednesday.Credit...Jeremy M. Lange for The New York Times

The United States averted the most dire predictions about what the pandemic would do to the housing market. 

An eviction wave never materialized. 

The share of people behind on mortgages, after falling steadily for months, recently hit its prepandemic level.

But a comprehensive report on housing conditions over the past year makes clear that while one crisis is passing, another is growing much worse.

Like the broader economy, the housing market is split on divergent tracks, according to the annual State of the Nation’s Housing Report released on Wednesday by Harvard’s Joint Center for Housing Studies. 

While one group of households is rushing to buy homes with savings built during the pandemic, another is being locked out of ownership as prices march upward — and those who bore the brunt of pandemic job losses remain saddled with debt and in danger of losing their homes.

“Millions of households were financially unscathed coming out of the pandemic,” said Alexander Hermann, senior research analyst at the Joint Center for Housing Studies. 

“But the pandemic has left millions of others struggling to make their housing payments, especially lower-income households and people of color.”

For the past year, lower-income tenants have relied heavily on government support to pay their monthly bills. 

These measures have helped — about a third of renters used unemployment or stimulus payments to pay rent at some point during the pandemic — but the majority of renters still had to borrow or draw on savings to cover bills, leaving them less able to weather future emergencies, much less save for personal investments or a down payment for a home.

The result is that even with a patchwork of federal, state and local eviction moratoriums, and some $5 trillion in federal relief that included expanded unemployment benefits and tens of billions in housing assistance, roughly seven million tenants were behind on rent earlier this year. 

With savings tapped out and unemployment benefits set to lapse, the financial damage to low-income households remains severe enough that they will need more support if they’re to recover with the broader economy, the Harvard report said.

As the U.S. job market recovers and businesses and schools move toward normal operation, political leaders are debating how fast to pull back the emergency supports that helped companies and workers weather the pandemic. 

That includes the various eviction moratoriums that, despite ample loopholes and patchy enforcement, were instrumental in keeping tenants in their homes.

At the peak last year, the majority of states and several large cities including New York, Los Angeles and Seattle had some sort of heightened eviction protection in place, though the degree of protection varied widely. 

Many of those safeguards have expired over the past few months, and the federal eviction moratorium issued by the Centers for Disease Control and Prevention in September is set to lapse at the end of the month.

Placing an eviction notice in December at an apartment in Springfield, Mass.Credit...Bryan Anselm for The New York Times

While a big new wave of evictions seems unlikely, the end of the federal freeze has injected uncertainty into tenants’ lives and tilted the balance of power back in the favor of landlords. 

Tenants’ rights groups have begun pushing the Biden administration for a one- to two-month extension of the freeze to account for widespread delays in the processing and distribution of federal emergency housing aid. 

The administration is weighing an extension but has signaled it would be contingent on public health considerations, not the housing market.

“We’ve avoided some of the worst outcomes so far, but the crisis is not over,” said Diane Yentel, president of the National Low Income Housing Coalition, an advocacy group that has pushed for increased housing assistance. 

“If the Biden administration allows the federal eviction moratorium to expire before states and localities can distribute aid to households in need, millions of households would be at immediate risk of housing instability and, in worst case, homelessness.”

On Friday, 22 Democratic state attorneys general urged the Supreme Court to uphold the moratorium. “An unprecedented wave of mass evictions — amid the embryonic stages of the post-pandemic recovery — would be catastrophic,” they wrote.

The moratorium was never a mandate, and local housing court judges have always had broad latitude. 

As a result, thousands of tenants who were behind in their rents were evicted during the pandemic despite federal and local freezes, often for violations of terms of their leases not directly related to nonpayment.

The federal freeze was further weakened in several states, including Ohio and Texas, when federal courts struck down all or part of the federal moratorium, which allowed landlords to evict tenants for nonpayment of their rents. 

That led to higher eviction rates, but ones that fell far short of the most dire predictions.

For all of its shortcomings, the C.D.C. moratorium helped hold off a wave of evictions. 

And it became a valuable tool after Congress passed more than $40 billion in rental assistance, by buying tenants and their lawyers additional time as they waited for the federal government to review their applications.

“It takes a really long time to process these applications, and a lot of the landlords don’t want to wait six or eight weeks,” said Melissa Dutton, managing director of the Legal Aid Society of Columbus, Ohio, which represents about 2,000 tenants a year in housing court. 

“So the moratorium gave us a little more time, which gave us a little more leverage.”

Tasha N. Temple, 38, a client of Ms. Dutton’s, was able to remain in her two-bedroom apartment after using unemployment assistance to catch up on her overdue rent bill. 

She called the program, and the moratorium, a “lifesaver.”

Of course, by assisting tenants, the government is also assisting landlords. 

Neal Verma, president of Nova Asset Management, a Houston landlord with some 6,000 units, said in an interview that his tally of unpaid rents — $1.4 million just a few months ago — had been whittled to about $400,000 thanks to $1 million in government rental assistance. 

He said he expected to recover even more.

Landlords groups echoed tenant advocates’ frustration with the pace of federal housing aid, and in some cases say they would support a longer moratorium if it meant collecting more rent.

“Getting the funds to landlords has been incredibly slow, and that has impacted those tenants who are truly in need and those landlords who are not getting paid,” said Tom Bannon, president of the California Apartment Association, the state’s biggest trade group for landlords. 

“We could support a limited short extension, but there has to be a way to get the funds out faster.”

But the moratorium was never much more than a stopgap that has done nothing to address a worsening nationwide housing affordability crisis caused by gentrification, the wealth gap and a chronic shortage of housing for the working class and poor. 

Even before the pandemic, one in four rental households was paying more than half its pretax income on rent, while homelessness was on the rise. 

Since then, more than half of renter households lost income, and 17 percent were behind on rent earlier this year, according to the Harvard report.

Moreover, while rents got more affordable last year, the pandemic served to highlight the nation’s longstanding shortage of affordable housing. 

As the economy opens up, renters at the high end of the market are greeting a world of 10 percent vacancy rates and frenzied competition that has buildings offering as much as five months of free rent.

Tenants in search of a moderate or lower-priced unit will find a vacancy rate that is half as high and essentially unchanged from a year ago. 

With competition fierce, rents in lower-end units grew at a faster rate in the first three months of this year than they did in the year before the pandemic.

Judge Sergio L. De Leon, a housing court judge in Fort Worth, has seen a steady rise in evictions since the start of the year. As leases that were locked in during the pandemic begin to expire, he said, landlords are now increasing rents.

“It’s sad,” he said.

Conor Dougherty is an economics reporter and the author of “Golden Gates: Fighting for Housing in America.” His work focuses on the West Coast, real estate and wage stagnation among U.S. workers. @ConorDougherty

A Global Incentive to Reduce Emissions

Proposals for coordinated climate action at the global level all too easily run into free-rider and fairness problems, leaving many of the most popular policy proposals dead on arrival. But a simple framework that gives all countries similar incentives would overcome these problems.

Raghuram G. Rajan

CHICAGO – With President Joe Biden’s administration recommitting the United States to the Paris climate agreement, and with a major United Nations climate-change conference (COP26) coming later this year, there is new hope for meaningful global policies to meet the challenge. 

But while mounting evidence of increasing climate volatility – unprecedented wildfires in Australia, droughts in California and Sub-Saharan Africa, intensifying hurricane and cyclone seasons – suggests that we must move fast in curbing planet-warming greenhouse-gas (GHG) emissions, there are serious impediments to concluding any new global accord.

Economists generally agree that the way to reduce GHG emissions is to tax them. 

But such taxes almost certainly will cause disruptive economic changes in the short run, which is why discussions of imposing them tend to run quickly into free-rider or fairness problems.

For example, industrialized countries such as the US are concerned that while they work hard to reduce emissions, developing countries will keep pumping them out with abandon. 

But at the same time, developing countries like Uganda point out that there is profound inequity in asking a country that emitted just 0.13 tons of carbon dioxide per capita in 2017 to bear the same burden as the US or Saudi Arabia, with their respective per capita emissions of 16 and 17.5 tons.

The least costly way to reduce global emissions would be to give every country similar incentives. 

While India should not keep building more dirty coal plants as it grows, Europe should be closing down the plants it already has. 

But each country will want to reduce emissions in its own way – some through taxation, others through regulation. 

The question, then, is how to balance national-level priorities with global needs so that we can save the one world we have.

The economic solution is simple: a global carbon incentive (GCI). 

Every country that emits more than the global average of around five tons per capita would pay annually into a global incentive fund, with the amount calculated by multiplying the excess emissions per capita by the population and the GCI. 

If the GCI started at $10 per ton, the US would pay around $36 billion, and Saudi Arabia would pay $4.6 billion.

Meanwhile, countries below the global per capita average would receive a commensurate payout (Uganda, for example, would receive around $2.1 billion). 

This way, every country would face an effective loss of $10 per capita for every additional ton that it emits per capita, regardless of whether it started at a high, low, or average level. 

There would no longer be a free-rider problem, because Uganda would have the same incentives to economize on emissions as the US.

The GCI also would address the fairness problem. Low emitters, which are often the poorest countries and the ones most vulnerable to climatic changes they did not cause, would receive a payment with which they could help their people adapt. 

If the GCI is raised over time, the collective sums paid out would approach the $100 billion per year that rich countries promised to poor countries at COP15 in 2009. 

That would far exceed the meager sums that have been made available thus far. 

Better still, the GCI would assign responsibility for payments in a feasible way, because big emitters typically are in the best position to pay.

Moreover, the GCI would not snuff out domestic experimentation. 

It recognizes that what a country does domestically is its own business. 

Instead of levying a politically unpopular carbon tax, one country might impose prohibitive regulations on coal, another might tax energy inputs, and a third might incentivize renewables. 

Each one charts its own course, while the GCI supplements whatever moral incentives are already driving action at the country level.

The beauty of the GCI is its simplicity and self-financing structure. 

But it would require one adjustment in how per capita emissions are computed. 

What is consumed is as important as how it is produced, so there will need to be some accounting for the portion of emissions embedded in imported goods; these will need to be added to the importer’s emissions tally and subtracted from the exporter’s.

Also, most experts would regard a $10 GCI as too low. 

But the point is to start small in order to get the scheme going and iron out the kinks. 

After that, the GCI can easily be raised by common agreement (or reduced, if there were some miraculous breakthrough in emissions-reduction technology). 

But to avoid creating uncertainty after an initial period of calibration, changes might be considered only every five years or so.

What about alternative proposals that have global effects? 

Some industrialized countries plan to impose a domestic carbon tax alongside a border-adjustment tax, effectively applying the same tax rate to goods coming in from countries that do not have a carbon tax. 

The border taxes might push other countries to impose their own carbon taxes, but it certainly would not improve fairness. 

On the contrary, they would let large importing countries impose their tax preferences on poor exporting countries and might serve as a Trojan horse for protectionism.

To be sure, the bureaucrats who dominate international meetings will want to dismiss this proposal as “interesting but simplistic” (or words to that effect). 

The most powerful countries are also the biggest emitters, and few want to pay into a global fund, especially in these times of massive budget overruns.

But a GCI is by far the best option available. 

As rich countries cast about for remedies to domestic inequality, they should spare a thought for inequality between countries, which the pandemic and the unequal vaccine rollout will only worsen. 

Developing countries feel abandoned today. 

A fair proposal for reducing emissions would go some way toward reassuring them that they do not live on another planet. 

And it would give everyone a greater incentive to save this one.

Raghuram G. Rajan, former governor of the Reserve Bank of India, is Professor of Finance at the University of Chicago Booth School of Business and the author, most recently, of The Third Pillar: How Markets and the State Leave the Community Behind

Return of Commuters Is a Wild Card for Downtown Property

Commercial real-estate values are diverging in major cities like London and New York

By Carol Ryan

Long average commutes make London vulnerable to the shift to remote working./ PHOTO: VUK VALCIC/ZUMA PRESS

Downtown offices are just as empty as the clothing stores next door, but real-estate investors much prefer the former. 

Part of the bias may be because the challenges facing offices are newer and less understood.

The centers of major cities like London and New York have been ghost towns during the pandemic as workers have abandoned commuting. 

The West End, one of the U.K. capital’s busiest districts, is currently at 40% of normal footfall, according to local landlord Shaftesbury. 

The hope is that activity will pick up if all U.K. government lockdown restrictions are lifted on June 21, as planned. 

In New York, office occupancy was just 16.8% of precrisis levels by May 19, according to Kastle Systems’ back-to-work barometer. 

Facebook and JP Morgan recently said they would bring staff back to the office from July.

Even with the prospect of more people flowing around urban centers, offices are attracting more optimism than the stores dotted around them. 

Last week, Shaftesbury said the value of its central-London retail stores fell 18% over the six months through March, while another London-focused real-estate investment trust, Great Portland Estates, recently said its stores have lost 27% in value over its latest fiscal year. 

Their offices slipped a more modest 3%, on average.

Stock investors are notably more bearish. 

The big discounts-to-book values at which U.K. office REITs trade imply approximately a 15% fall in property values, according to real-estate research firm Green Street.

The divergence between office and store valuations can also be seen in New York, though office values have come down more sharply than in London. 

A full 16.1% of the U.S. city’s office space is now available to rent, Colliers data shows—higher than during the 2009 financial crisis.

City-center retail probably does face a tougher slog back. Major shopping destinations like Fifth Avenue or Regent’s Street in London depend on overseas visitors for a chunk of sales. 

Even in its most optimistic scenario, the United Nations World Tourism Organization expects global tourism to be 55% below pre-pandemic levels in 2021.

Deserted streets mean flagship stores on these shopping hubs have lost the marketing power that used to justify high rents. 

Out-of-town stores proved more convenient for curbside pickup and dispatching booming online orders during the crisis—flipping the pre-Covid trend that rewarded downtown shops.

Still, London’s resilient office valuations look optimistic. 

Prices are supported by low interest rates and overseas buyers for now: Investors can get an extra percentage point of rental yield on offices in central London compared with other top European cities like Paris. 

However, long average commutes make London more vulnerable to the shift to remote working. 

The trend could reduce demand for office space in the city by 15%, compared with 5% in Berlin, Green Street estimates.

Offices are hard to price at the moment. 

Valuers are trying to understand how the home working trend will play out and what a flood of so-called gray space—excess supply that is sublet by existing tenants—will do to rents. 

A growing preference for environmentally sustainable buildings among corporate tenants also means older offices will need costly green overhauls or become unrentable.

It is hard to square jitters about downtown stores among real-estate buyers with the relative optimism about offices. 

The discounts on property stocks give investors a much-needed margin of safety.

CLOs Join The Everything Bubble


The “Everything Bubble” has jumped from hyperbole to literal truth in just a couple of years, as more and more assets enter “crazy expensive/extremely reckless” territory. 

The latest addition to the list is collateralized loan obligations (CLOs), which are created when a bank lends money to a less-than-creditworthy company and then bundles that loan with a bunch of similar loans into bonds for sale to yield-starved pension funds and bond funds.

There’s a legitimate place in the market for this kind of security, as long as everyone understands the risks. 

But in financial bubbles, banks’ insatiable hunger for fees combines with bond buyers’ desperate need for income to cloud everyone’s judgment. 

Lending standards slip, bond quality declines, credit rating agencies look the other way to keep the deals flowing, and buyers keep buying because they have no choice.

Record year

So far this year, issuance of new CLOs is on pace to easily exceed 2018’s record.

Part of this surge is, like so much else, catch-up from last year’s nationwide lockdown. 

But most is just your typical out-of-control financing fueled by way too much new currency being dumped into the banking system.

So how can bonds made up of below-investment-grade paper be investment grade? Through the magic of securitization. 

As the Wall Street Journal recently quoted CitiGroup:

Because CLOs’ loan holdings are diversified, the bonds can achieve higher credit ratings than the underlying loans, making them popular among institutions restricted to investment-grade debt, such as banks and insurers.

Meanwhile, the combination of a recovering economy and lots of lenders willing to finance pretty much anything is improving the prospects of financially challenged companies. 

Fewer of them are defaulting, which increases the confidence of the people buying CLO bonds. 

Moody’s Investors Service now expects the trailing 12-month default rate on CLOs to fall to 3.9% by the year-end, from 7.5% in March. 

And a growing number of firms are now being reviewed by rating agencies to have their CLOs upgraded.

Meanwhile, spreads relative to risk-free paper are shrinking:

Sounds promising, right? 

And, alas, also familiar. 

Here’s how CDO’s, the previous bubble’s version of CLO’s, worked just before the bottom fell out in 2008.

Perpetual motion machine

Once they really get going, asset-backed securities like CDOs and CLOs take on a kind of perpetual-motion-machine vibe in which easy money begets even easier money. 

To the extremely credulous, such a system looks capable of spinning right along forever. 

Unfortunately, this perception tends to become widespread just as some crucial cog in the machine is about to break.

Which cog will it be? 

Candidates abound. Interest rates might rise, stocks might tank, the government might realize its policies are stoking instability and try to “taper.” 

Some crazy geopolitical thing might happen (DO NOT look closely at Palestine, Ukraine, or Taiwan). 

It doesn’t matter which breaks first, as long as one eventually does.

Then the perpetual motion machine shifts into reverse, with rising defaults causing lower CLO bond ratings causing mass sales by panicked institutions. 

And so on, until whoever had the guts to short this market cashes out with epic gains.