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A Black Hole Engulfing the World's Bond Markets (bloomberg.com)
316 points by igravious on July 28, 2019 | hide | past | favorite | 349 comments



Related story - my first job out of school was in investment banking. My desk worked on some esoteric securitization products (basically bonds backed by aircraft and shipping container leases) where all issuance had basically disappeared when I started, which was right after the 2008-9 crisis. These products generally were in the A/BBB area, and generally had traded like high yield bonds before the crisis. When I first started, we struggled to find investors and were generally seeing 6-8% yields on some small deals. By the time I left three years later, yields were getting down to the 4% area, issuance sizes had tripled and new paper was routinely 3-4x oversubscribed. I have some friends who still work there and tell me not only have yields kept coming down, but lower quality leases are being thrown into securitization pools. I 100% agree on all the comments here saying the big story is lower rates driving people into riskier investments. When the next crisis hits, people will talk about how negative rates forced people to reach for junk companies and questionable securitization paper.


> lower quality leases are being thrown into securitization pools

Shocked, shocked, do you hear me!

Not to snark at this poster, but in general, if we learn anything from experience in markets, we learn:

People want higher returns without higher risks, and other people can profit from convincing buyers that the returns are higher, or the risks are lower.

Also, money is more nimble than legislation. While Congress is trying to outlaw the most recently exposed scam or malfeasance, people are inventing the next several workarounds to existing or upcoming law.


> People want higher returns without higher risks, and other people can profit from convincing buyers that the returns are higher, or the risks are lower.

That does happen, but what may be even more common (and more important is a slightly different form:

People want high returns, and are willing to accept risks, but are required by law to invest in safe securities, and are happy to pay high fees for people who can find a way around this.

A huge driver of this isn't scams or outright fraud, but "regulatory arbitrage". Not saying it's fine, but if your mental model is "how can we protect unsophisticated mom and pop investors from these predators selling exotic asset backed securities", well, they're not the ones buying them. The bigger question is, how can we (or should we?) stop pension funds from knowingly seeking higher risk/higher return investments as part of their ongoing effort to try and reduce their massive unfunded liabilities.


Heck, I think they mostly write the laws for Congress...


> People want higher returns without higher risks

Not only this, but Better, Cheaper, Faster.

I'm in Healthcare and it doesn't work like this.


Reimbursement for work is on a slow decline, and has been for a while (in radiology at least). Hardware vendors and conference talks are often centred around a theme of ‘doing more with less’. This link is an example and discusses revenue declining but the development of new tools might help to get more value out of imaging. https://www.alliancehealthcareservices-us.com/12-imaging-mar...


The average multiple on a healthcare services business is 10x and HCIT assets are trading on revenue multiples. It works exactly like this everywhere. Livongo, Health Catalyst and Phreesia just went public at multiples that didn’t exist 5 years ago


Yes, but... isn’t this basically a bunch or rich folks saying “I was forced to take risks with my money because treasury bonds barely pay anything!”

My gut response is that, yes, if you’re buying risk-free treasuries, why should you get a return above inflation at all? Rewards and risks should be commensurate.


According the Planet Money's Giant Pool of Money, which I've come to realize is a superb postmortem on the 2008 financial crisis, this is exactly what happened:

Adam Davidson: All right. Here's one of his speeches that really drove that army of investment managers crazy.

Alan Greenspan: The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance.

Adam Davidson: You might not believe me, but that little statement, that is central banker's speak for, hey, global pool of money, screw you.

Alex Blumberg: Come on, that's not what he said.

Adam Davidson: It is. I speak central banker. Believe me, that's what he said. What he is technically saying is he's going to keep the fed funds rate-- that's when you hear, the fed interest rate-- at the absurdly low level of 1%.

And that sends a message to every investor in the world, you are not going to make any money at all on US Treasury bonds for a very long time. Go somewhere else. We can't help you.

https://www.thisamericanlife.org/355/transcript

To the question: why should you get a return above inflation at all?

I guess one way of looking at it is: do you want to treat low-risk returns for conservative investors as a sort of public utility guaranteed by the government? Or do you want to put it in the hands of private industry?


What I´ve never understood in all these arguments, is why do economists think that the laws of supply and demand supposedly (given that from this article it´s clear that they´re not), suspended for debt?

If for whatever reason (and having a moderately stable currency is the answer there) there is more demand for bonds than supply, then the price will fall. This has nothing to do with economic reality and everything to do with market pricing mechanisms. Whether it´s good in the long term for the government to increase its lending this way, is a completely separate question.


I can't possibly imagine where you have read/heard that any self respecting Economist thinks that yields (interests, cost of credit/capital) are somehow exempt from supply-and-demand.


If the US can sell treasuries at rates not much above inflation, then it is because they are not loaning enough -- is there really no bridges or other infrastructure that could benefit the economy if they are built?


Check out the price tags on most infrastructure projects these days. As badly needed as they are, the US government currently doesn’t have re ability to execute them for less than the mid-horizon returns, if that.


Much of the infrastructure we need is self-financing. Eg bike lanes, transit etc. increase tax base and keep money in the local economy, while increasing foot traffic and retail sales. There’s no reason curing the 20th century’s car hangover shouldn’t be profitable.


If this were true, they would be easier to get done. Borrowing money to finance is fine, but a lot of these projects have to borrow a vet long way in the future, and the longer the term of the loan, the more interest rates eat into the real return from the project.

Secondarily, many prospective borrowers of these projects are already in debt, and have cash flows which are not growing fast enough to borrow more.


> real return from the project.

why should a gov't project need to have any real returns? Social returns is enough. If the city is nicer to live in, if the businesses thrive because of increaed foot traffic, lower car accident rates, cleaner air etc.


The city has to pay the money back at some point. This either requires higher tax rates, reduced services, or a larger pool of money to tax. The first two are quite unpopular.


No good reason- but like I said, check out the price tag; a mile of subway development in the U.S. can cost billions (with a B!) of dollars. Additional foot traffic along that mile couldn't get you that much back.


I would say most of the solidly profitable infrastructure projects, in the US are gone, combined with pretty much all the state legislatures and Congress being taxation adverse.

We're running our governments like businesses and you're not going to find any nimble or disruptive startups in the mix.


And so we circle back around to, "All socialism is evil except the parts that benefit me."

Which isn't to say that I think the government should do what it do out of spite. Is there any chance of... I dunno, cutting off the public handout and then regulating the private vacuum-fillers sufficiently? Or does the implied drug analogy here reach its logical conclusion (on the black market)?


That "postmortem" explains nothing at all about how real estate factored in. I'd have to be in-the-know enough to understand that people overinvested in real estate partly because they could get loans easily from low interest rates. But even then, doesn't cover how financial markets were repackaging mortgages and hiding or miscalculating the risk.


If you listen to the episode, or even scan the transcript, you'll find that all of this covered. For a one hour show, it does an amazing job of putting everything together.


Ah, I misunderstood because from what I read, it sounded like the part you quoted was supposed to cover all that happened.


> “I was forced to take risks with my money because treasury bonds barely pay anything!”

... is the system working as intended, because the policy rationale behind issuing lots of government bonds is precisely to make investors seek higher risks.

When downturns (like 2008) happen, this is investors fleeing to safe, money-like assets and and so wonks recommend that governments flood the markets with bonds, printed money, whatever to make that unprofitable.

The problem is with trying to fix the economy with policy levers. You can force people towards riskier investments (especially if they can be disguised as safe ones). But investment that is actually productive on average requires conditions where people on the ground can actually build useful stuff at a profit.

But that's an anathema to macro-economists (who want to advise on how use those levers) and also to politicians (who want to be seen to be "doing something").


Why exactly it's an anathema for those groups?

Every state, city, country has a lot of favored sectors and grant opportunities, it's then up to investors to come up with projects that actually turn a profit.

VC/startup investors do this by simply doing a semi-blind search, funding everything they think is at least minimally sound.

If investors are still unable to turn a profit they are not taking on enough risk. (They are not thinking big enough.) And that might be okay. There's no moral imperative to keep every investment fund alive, every investor happy. And the only difference between business as usual periods and now is that the numbers are now scary (negative yields!).

But the fundamentals haven't changed.

Negative yields just mean that too many investors are risk averse, too many people (pension funds, passive funds, low-risk funds, inflation tracking funds, basic savings accounts) just want to park money. And that's okay. Eventually one of the following will happen: the fund managers will take on more risk, the people behind the funds will use the money for something else (eg spend it), or the people behind the funds will pester Congress to spend more and finance it all from debt.


US Treasuries may be the closest thing to 'risk-free' that there is, but isn't 100% risk-free. If the investor does not hold the bond to maturity, then he/she is open to interest rate risk (the risk that rates have changed, and so has the bond's value).

Even if the investor plans to hold the bond to maturity, then the investor is agreeing to lock up that money until maturity. This carries the risk that the investor won't be able to take advantage of an investment opportunity before then. Or, if he decides to sell at that moment, he must accept interest rate risk.

The investor should be compensated for these risks, however small they might be, and that - in my opinion - is why treasuries should yield more than inflation.


I was right there with you until the last three words. Investors ought to be compensated, but there’s no particular reason that compensation should be greater than the inflation rate.


that's not what risk means. no investment considers early exit because of difficulty as a risk. even legislation call that "investor profile" or something meaningless or another.


By selling a bond before maturity, you're open to price fluctuations of the bond. It's not that the investor is exiting early, it's that by exiting early he is no long guaranteed the yield of the bond when he purchased it. Thurs, the yield is not "risk-free", and the risk is that the price moved in the market.


It's not just rich folks. Via pensions funds, this is also about a lot of teachers, social workers, government employees and normal folk.

Pensions were funded (or not) based on assumptions about yields. If actual yields are not hitting those assumptions (and they're not), it's not the rich that'll be eating cat food in their retirement.

(Of course, fixing the funding shortfall by making risky bets on exotic high-yield investments is uh...what's the word? Oh yeah, terrible! But let's not pretend this is strictly a problem for the 1%.)


Because the return on a bond is not just based on the expected risk, but also on the time value of money (generally we prefer consumption now rather than in the future).


The time value of money is the expected risk of inflation. For example, if a lender lends someone $100, then the interest rate is a combination of the risk of not being paid back, and the return that could have been had if the same $100 were invested elsewhere (with the same risk profile of the original investment).


> The time value of money is the expected risk of inflation.

I don't think that's the only source of time value of money.

For example, I'm fairly certain I can buy a car for the same price a year from now, but I am willing to pay a huge premium to have the car now so I don't have to ride the bus for two hours a day while I save up the cash to pay for it.

That is a preference for present consumption over future consumption that has nothing to do with inflation.


Consumption and investment are the same thing in a generalized model when comparing returns and figuring out how much interest to charge to keep up with inflation.


But those two possible uses of money have different profiles. You would have to price in how much it is worth to you to use the car vs the bus, subtract the amortization of the car - and together that's the target rate/yield that you should ask for your money plus risk of default.


Exactly, and the world is awash in goods. The only returns are in some real estate markets, where inflation is called appreciation and is underwritten by “greater fools.”


“Rich folks” include pension funds, insurance companies, and sovereign wealth funds.

The whole thing seems to me like central bankers confusing cause and effect and trying to squeeze a complex system in to linear regressions. Lots and lots of unpredicted consequences to artificially low interest rates, including effects that do the precise opposite of what was predicted.


Not necessarily. With these things there is usually a big belief aggregation going on (some central bankers think this, some that), and we end up with a silly compromise. See Japan, see all the idiotic austerity programs.

So it is very possible that the central bank is not doing enough.


The west's current monetary policy very much hurts retirees living on dwindling fixed incomes. There ought to be at least some reward associated with savings, even without taking a risk to the principal.


Returns need to be associated with value creation. As the world has become more wealthy simply having assets and lending them out stopped creating significant value, thus lowering returns.

My completely unsecured credit card only charges 10%, and that’s before inflation.


Some of the rich folks are pension fund managers. Therein lies the problem.


Why is it that when we see the unintended yet predictable and easily understood consequences of a policy, in this case monetary policy, all the blame goes to those whose decisions were influenced by that ill-advised policy in that predictable and easily understood way? This doesn't strike me as a good way to avoid bad policy in the future.


Agreed a lot of well off people with money don't put in enough thought into this.


Owning negative yield bonds not only you don’t make a return above inflation, but you have to pay for the privilege of owning them. Why do you think that it’s a good thing?


Usually the interpretation is that it is still better than the alternative.

Eg a pension fund has to put money somewhere, but it has to be low-risk. Hence the seemingly absurd demand for negative yields.


In general, it's assumed that it's better for society if you consume later rather than now. Risk-free investment returns are how we incentivize that.


What does your "gut response" tell you about rates on 1 month vs 30 year treasuries? Should they have the same yield?


This is the market signaling that it no longer perceives any value in the maturity value of these bonds. They aren't being purchased for their maturity value; they're liquid assets, traded like any other in a market awash with ultra wealthy institutional investors between whom these securities flow like any other asset.


I just want to know what is "supposed" to happen if we assume bond yields are supposed to be equal to inflation like the parent.

Obviously no one is buying negative yielding bonds for the yields except pension funds, etc who are required to by law or not paying attention.


Isn't inflation simply another cost? As long as the value of these bonds (their low risk, as opposed to their maturity value) is greater than whatever cost you care to consider (inflation, negative interest, opportunity cost, etc.) they will be valued instruments. There is no "what should happen" or what is "supposed" to happen; those are fictions in the minds of spectators and until you're prepared to anger some powerful people and institutions they will remain fictions.


Here is what I was responding to:

> My gut response is that, yes, if you’re buying risk-free treasuries, why should you get a return above inflation at all? Rewards and risks should be commensurate.

The parent has some sort of ad hoc economic theory ("gut response"), and I am asking them to expand on what the theory entails. "Supposed to happen" means it would be predicted by this theory of theirs.


But the nominal yield (to maturity) has to be higher than inflation to keep up because of taxes.


with negative yields you are not even making inflation, you are way below it


This fundamental issue with the economy is driven by a couple of factors. Increases in inequality and wealth concentration means there is more money to loan, and an aging population means there are less young people to borrow the wealthy's money.

We have a couple of levers to increase the interest rate. We could reduce inequality to reduce the supply of loan-able funds, we could allow large amounts of immigration to drive up the demand for loan-able funds, or we could keep interest rates high enough that we have a permanently high unemployment.

However I do have a strong worry that natural interest rates are too low for our current inflation. This gives the fed very little room to deal with the next crises. They should probably be targeting an inflation rate closer to 3-4% so we don't run into zero lower bound problems.


Or, maybe come up with an alternative to making loans? Why is more debt the only answer? People seem not to want it.

The government could spend the money. Or it could give the money to the people (universal basic income) and they could spend it.

This also fixes the inflation problem. Just don't overshoot.


Living in Japan, I feel like they've naturally developed the culture of changing the color of the sky. I mean to say they always find ways of getting the people to blow cash to keep money circulating. Most companies here have like 3x more staff helping me or standing around than in Canada. Consumerism and state marketing is big too.


I'm not any kind of economist, but to me this seems like asking whether the sky really ought to be blue. Reducing the impact of debt (and by extension interest rates) on the economy is every bit as simple as undertaking a massive transforming project to change the color of the sky.


Yes, anything that requires government action is very hard in practice. But rhetorically, we discount that when talking about whether some government action would be a good idea or not.


Who's "we"? I think it's completely reasonable to consider how practical something of this magnitude is. You're not passing a single law; you're talking about fundamentally changing the entire nature of the (US? world?) economy in ways that I find difficult to even comprehend. I'm not even sure any amount of government action would be sufficient to bring it about.


Sorry, I must have given the wrong impression. To be clearer, I was hinting at either more government spending, universal basic income, or "helicopter money," as alternatives to attempting to stimulate the economy by encouraging more loans. These have precedents and it's not particularly difficult for a government to be efficient at giving people money.


> Increases in inequality and wealth concentration means there is more money to loan

Confiscate $3 trillion from the "rich", and give everyone in the US $10k dollars. What percent would end up back in the banking system after 1 year?


This is why you have to do it every year. Which is exactly what a progressive taxation system does (or would do if it was a little more progressive than current systems)


I imagine you would have to "do it" every week to have the claimed effect...

With online banking, etc perhaps once a day.

EDIT:

Actually, if the funds are transferred electronically it would take as long as an ACH transfer takes to get to the new account. The funds are tied up during that but then immediately available to the banking system again.


100%.

Banking system is where money lives.

Value lives outside, but the money represented by the value lives on accounts, in databases.

Even cash is just something tracked by central banks as liability (negative account value - because when someone deposits cash they increase one account, and if the bank then deposits that electronic money at the central bank the total money supply must not change, hence cash is tracked separately).


Wouldn't it be better to have interest rates match the natural interest rate? People paying for loans can't afford the rate payment, so these payments should be lowered to reflect the ability to pay back the loan (including into negative territory). If you're the U.S. Government, you're essentially telling capital surplus holders, "You can keep you large hordes of money here, but it'll cost you 1% a year."

And if you want to take out a loan, it'll still be a risk, since you'll need to make the principle payments, but you'd get a tailwind on the interest paid to you.

I'd be happy to learn where I'm wrong if you have any insight.


Yeah it's always great to have the interest rates match the natural interest rate.

Btw the definition of the natural interest rate is "The natural rate of interest, sometimes called the neutral rate of interest[1], is the interest rate that supports the economy at full employment/maximum output while keeping inflation constant"


> When the next crisis hits, people will talk about how negative rates forced people to reach for junk companies and questionable securitization paper.

There Is No Alternative!


> negative rates forced people to reach for junk companies

Negative rates don’t force junky investment decisions. Inflation does.

Inflation is low. Investors choosing junk yielding 4% are not being forced to do so by negative yields (or, in America, low yields). They’re choosing to reach for yield.


> I 100% agree on all the comments here saying the big story is lower rates driving people into riskier investments.

Yeah but Central Banks that set the interest rates say that too, so this is the worst kept secret known to man

All the comments here and your observation should just be “hey its working”


A famous economist predicted 130 years ago that this would happen.

https://en.wikipedia.org/wiki/Tendency_of_the_rate_of_profit...


Interesting, thanks. Can you expand on the link between government-issued bond interest rates going negative and the tendency for profits to decrease over time in a capitalist system?

Also, the ratio of theoretical to empirical content on that page is ridiculous given the topic is supposedly an empirical phenomenon requiring explanation. What is there is extremely weak as well. Is there better evidence this phenomenon exists?


Until now, technical innovation has been able to stave off that prediction...


I once saw a graph of oil production/consumption over the last 100-150 years. Interestingly the curve is a smooth exponential right up until the late 1960's and then it gets ugly jaggy linear.

Say what you will but I think that's really significant.


And it possibly still can. There is mentioned in that link of the theory being controversial due to automation, where there ends up being less workers and more production.


napkin math. Say we start with economy size A and a year later we have A+P. The profit rate is P/A. Whole economy-wise the P comes from people doing/producing something. Next year same people doing the same would produce the same P. Thus profit rate fell - it is now P/(A+P). As a result we can see that the profit rate can be increased by increasing output - ie. P(next year) > P(this year) due to productivity increase (thus automation) and/or labor force growth (population growth).


You speak as if there is something that can done about it.

There is no way for the government to push rates, especially on exotic collateralized products like you describe. The Fed can play around at the low end and set an overnight rate, but not much else. Historically, the Fed has tried and failed over and over to affect the long end. And it certainly doesn't have the stock to dump long bonds to drive yields up.

Right now, the yield curve is inverted showing how little they actually effect rates. Long run rates are set in the global market.


Unilaterally pushing up nominal interest rates is trivially achieved by rising inflation by devaluing currency by printing lots of it and spending it on pretty much anything. It would pretty much instantly hike up the nominal yields on pretty much everything USD-denominated to match the (now) higher inflation.

It doesn't mean that it's a good thing to do as it has all kinds of other effects, but in general the governments have the ability to do this should they choose to, it's just that they keep pinky-swearing that they won't do it, making legislation that makes it tricky to do without consensus (but they can repeal that if both parties agree that it's the way to go) etc.


Why can't the Fed manipulate long term interest rates?


They don't really have a mechanism, and rates are set in the global market - return on capital is mostly a global issue now and something the fed has no control over.

They can target the overnight rate and buy and sell short term funds because they are the majority player there, but even then the actual Fed Funds rate doesn't always equal the target they are trying to set (and not by a few points either).

On the long end they are more constrained. They can print a ton of money to cause inflation, but going the other way just isn't as easy. They aren't the major player there either. Long term treasuries compete with every other debt instrument out there government and private. Those rates are global for the most part

Just look at the late 90s when the Fed tried to push long term rates up and failed horribly. All they did is invert the curve. It is a repeating scenario.

This same conversation comes up about once a decade it seems.


They can, they just don't have a direct tool for doing it. Long term rates are just an aggregation of short term rates over a given time span. So they can adjust long term rates via promises and hints that they will keep short term rates low for a long time.

There is a ton of interesting monetary theory about how the Fed can do this and issues they run into.


long term rates are more than short term rates added together. while related, short term rates are much more driven by central bank reserve and regulatory policy, and long term rates much more driven bvy return and inflation expectations.

In a real dollar sense, the fed has zero ways to affect long term rates.


Sure there are other factors that affect long term rates. But if the Fed came out tomorrow and said "We promise to keep interest rates at 0 for the next 10 years" long term rates would drop considerably wouldn't you agree?


Not at all. Inflation expectations would soar. A few years ago and there talk was that keeping the overnight rate would lead to huge inflation issues. Now a strange narrative is appearing that nominal interest rates are simultaneously too and inflation going higher.

And there is no way they would be to keep that rate. They can say whatever they want, but that doesn't mean the overnight rate has to oblige them either. They only set a target, the actual rate is still determined in the bank to bank market and historically it does diverge, sometimes strongly.


I'm curious, why can't they manipulate it directly? It seems like if a central bank bought enough long-term bonds, supply would drop enough to raise the price?


The opposite. If they buy every long term bond that means that companies (and the Treasury too), can put them up for any price, let's say zero coupon payment, that's a zero yield bond.

No, to drive up rates would mean to restrict the buyers from buying (either via restricting the money supply - that means a combination of raising the overnight repo rate [FFR - Federal Funds Rate], raising reserve requirements, decreasing interest payment on reserves).

But such a move means slowing down regular lending, VISA/MasterCard and the banks would have to increase consumer facing prices of credit, etc. It would slow down wage growth.

And we are not seeing wage growth, we're not seeing inflation.

To stimulate spending/consumption all the Fed can do is absorb more and more risk (buy bonds/assets - quantitative easing, keepr rates low, encourage lending, encourage the starting of new projects).

Why people are not starting new projects?

Well, for example look at NIMBYs, look at how Congress doesn't want to force mandate better EPA regulations, look at how municipal fiber plans were stopped thanks to Comcast lobbying, etc.

Basically a lot of money goes into "rent" instead of innovation. (Asset bubbles.)


My guess is because the amount of Treasury bonds would dwarf what the fed can buy.

In other words, the Treasury dept is the one that has more power here.


> Right now, the yield curve is inverted showing how little they actually effect rates. Long run rates are set in the global market.

The fed causes the inversions every time by pushing up the short term rates until they are near or above long term... It is ridiculously obvious if you just look at a plot of this.


It's called "Financial repression":

https://www.bbc.com/news/uk-21863295

Paul Mason, from 2013.


I think its driving people into riskier investments that still look like a traditional cash instrument from a bank - instead of looking at say equity / income funds.


The whole world economy makes no sense. The finance and tech industries in particular are a mess; there seems to be no correlation between value creation and profit.

Whenever I hear successful entrepreneurs bash cryptocurrencies, I wonder how they can simultaneously hold the following 3 thoughts inside their heads:

- My company became successful in the last 10 years because it added value to the economy.

- Cryptocurrencies became successful in the last 10 years in spite of subtracting value from the economy; they are the exception to an otherwise efficient market.

- Capitalism works.

If cryptocurrencies were an exception to an otherwise highly efficient and meritocratic economy, could we say the same about bonds which have negative yields?

Maybe the following thoughts are more logically consistent:

- My company became successful in the last 10 years because I exploited a vulnerability in the economy.

- Cryptocurrencies became successful in the last 10 years because they exploited a vulnerability in the economy.

- Capitalism doesn't work because it's vulnerable to hacks.

Also, to explain the current bonds situation:

- Bonds can have positive value in spite of negative yields because some investors believe that the vulnerabilities in the economy can be patched (e.g. it's possible to increase interest rates) and that bonds will eventually return to positive yields.


Cryptocurrencies add value to the economy. At the very least, it is a way for people to hold value into the future and plays a similar role to gold. Other cryptocurrencies can be used to buy/sell stuff.


This story somewhat reminds me of The Giant Pool of Money[1], a landmark This American Life story on the origins of the 2008 financial crisis (remarkably) reported in the early-middle stages of the crisis (May 2008). One of the things it points to as fueling the sub-prime mortgage crisis was an impossible-to-meet demand for mortgages to be bundled in to CDOs which lead to mortgage lenders lowering their standards to increase supply to try to meet the demand. Why was the demand so high? During the early-to-mid 2000s the global money supply had basically doubled (the titular Giant Pool of Money) and that new cash needed somewhere "safe" to be parked and CDOs were the highest-yielding "safe" investments.

That pool of money hasn't gone away and the lesson investors seem to have learned from the financial crisis is that the only truly safe investments are government bonds issued by major governments. The demand that drove mortgage lenders to make (in hindsight) irrational decisions to increase supply seems to have shifted over to those government bonds. Because the supply of bonds is fixed by politicians the market is responding as it needs to match demand with supply: lowering rates (effectively increasing the "price" of the bond), even below 0, to lower demand to meet the available supply.

[1] https://www.thisamericanlife.org/355/the-giant-pool-of-money


Government rates are set by the market at auction. The government does not set the rate of their own bonds, they just offer to sell a certain amount, and the auction determines the rate.

In the US, the Federal Reserve sets the Federal Funds rate, which is (supposed to be) determined independent of the federal government.

The reason rates are low is because there is a lot of demand, and participants are bidding down the price as they compete to acquire the bonds.


Thanks for the correction, fixed.


I think many people don't understand how negative rates are possible because they are used to having FDIC insurance for their bank account. The issue is that an entity with billions of dollars to protect (such as a pension fund) cannot rely on the FDIC because of the $250K insurance limit. There are not enough banks in the US to spread billions of dollars across, $250K at a time, even if an entity was willing to manage 10's of thousands of bank accounts. A government bond is generally the safest alternative. When demand for the safest level of protection is high, an entity might be willing to pay for the protection because market conditions make them unwilling to accept greater risk. Personally, I believe this is the main reason for very low rates right now. The big fixed income entities expect an economic downturn. It's just a question of how many months away it is.


This really helps me understand the institutional desire to purchase bonds even at a negative rate (especially when combined with legal requirements around holding safe asset classes).

It seems relatively obvious in hindsight, but I was still having a little trouble getting my head around it until I read this.

Thanks!


> More than a decade on from the credit crisis, inflation is still scarce, with wages increasing only modestly despite large drops in unemployment. The ECB, for example, isn’t expected to get to its close-to-2% inflation target over the next decade, according to a market-derived measure.

I find it baffling how everyone talks as if inflation is some incomprehensible force of nature out of anyone's control, even though it's actually trivial to cause inflation by printing money and buying assets.

Then the article links to https://www.bloomberg.com/news/articles/2019-07-05/germany-s... which states that Germany is being paid to borrow money but refuses (against the advice of economists) to actually do this and invest in anything? What?

Why does it seem like nobody (with the relevant authority) is willing to do anything but stand around in paralysis worrying?


> I find it baffling how everyone talks as if inflation is some incomprehensible force of nature out of anyone's control, even though it's actually trivial to cause inflation by printing money and buying assets.

But that is literally the mystery about the contemporary economy. The Fed has been printing money like mad with "quantitative easing", with extremely low interest rates, and Congress helping them along with massive tax cuts, but this is having basically 0 impact on inflation rates. We're printing money like mad and it's seemingly having no effect on prices.


Where's that money going though? It can only drive inflation if it's actually increasing demand, and I don't think that's happening. I think there's a fallacy of aggregation required to call it a mystery, if we disaggregate even slightly I think that argument falls apart.

eg, my anecdotal view is that:

1. the rich just put extra money into investment

2. the upper middle-class are just putting any extra money into paying down their debts: housing and student loans.

3. the lower-middle and lower classes are increasingly precarious; and they're not actually seeing any extra money.

4. big business are just doing stock-buybacks, and any profits are just going back into 1

5. small business are struggling because of 2 and 3

What is there in all that to drive inflation?

(edit to fix list)


"But that is literally the mystery about the contemporary economy. The Fed has been printing money like mad with "quantitative easing", with extremely low interest rates, and Congress helping them along with massive tax cuts, but this is having basically 0 impact on inflation rates."

One conclusion that you might draw is that we are in a massively deflationary environment. So much so that all of the inflation tools running at full-tilt only keep us in place.

Among other things, birth rates in rich, developed countries have been dropping for decades and are below replacement rate in many of them. Does that sound inflationary to you ?


It's even worse in Japan. The BOJ is not only buying bonds, it's straight up buying equity ETFs. Still no inflation.


Yeah, except that the Fed has decided to undo all of that by selling off the assets it bought, effectively burning the money it spent so much effort printing. https://www.federalreserve.gov/monetarypolicy/bst_recenttren...


I'm no economist, but shouldn't it work nicely to just print money and pay it out equally to all citizens? Why hasn't anyone tried this yet?


This is called "QE for people", or "helicopter money", and economists know about this idea. It's still deep in the fringes, but in my opinion we can see this happen within our lives.

https://en.m.wikipedia.org/wiki/Helicopter_money


A lot of ideas remain on the fringes for laymen until they are used. Quantitative easing like in 07/08 was discussed during the Great Depression.


The Australian Government's response to the GFC 10 years ago included a $900 payment to most taxpayers.


Ray Dalio calls that "monetary policy 3". (MP1 is lowering interest rates, MP2 is buying financial assets.)

In this article he gives some examples of forms of MP3 in the past: https://www.linkedin.com/pulse/its-time-look-more-carefully-...


Like /u/photojosh mentioned above, it's no good to print money and equally hand over to citizens if most of the citizens don't buy anything :-). Photojosh's comment breaks down how the citizens might be doing it.


> Why does it seem like nobody (with the relevant authority) is willing to do anything but stand around in paralysis worrying?

Maybe because those relevant authorities are more and more not very good at their jobs. It happened a bunch under Bush and his happening way more under our current POTUS. Unqualified people are being put in charge of large portions of our government, and there has to be some consequence. This might just be it.


It’s insane to me that you could buy a 10 year treasury around 1980 that paid 17%.

That’s more than double the long term stock market return, and it’s (basically) risk free.


The 1973 oil crisis (and paying for the Vietnam War, etc) had kicked off a cycle of inflation that didn't really end until after the early 1980's when Paul Volcker (Federal Reserve Chairman) shrunk the money supply and raised interest rates. The prime rate hit 21% in 1982.

Dad was getting phone calls just begging him to refinance his 3.5% mortgage to current rates. "We have a low-low 18.5%!" Nope.


I’m curious what they said in the phone calls? I’m not sure what they could possibly do to sound compelling apart from perhaps just hoping your dad was aggressively financially illiterate?


Lower your interest rate mortgage calls are very poorly targeted. The companies that do this get lists of people with mortgages, which is easy because mortgages need to be publicly recorded to be effective, and call all of those people without any attempt to narrow the field; or maybe they just call everyone they can. They usually call and offer "new lower rates" when the rates have gone down in the last few months, but they probably don't work very hard to estimate the original rate (it's not public record, but you could probably make a good guess based on the lender and the date it was recorded).

I had a mortgage originated in 2009, and then rate adjusted down several times to something in the 3.x range -- and would get calls and mailers promising "historically low" rates of 4.x; which I always found very amusing.


They probably offered to lower his payments.

Sure, the mortgage that would be paid off in 5 years now has another 20 years of payments left, but hey lower monthly payments!


Hello, uh, Mr. Doopler, I see that your current rate is 3.5% on your house. Did you know that at Bank Super Cool we're offering rates as high as 29.7%, and as you know, bigger is always better. PLUS if you refinance today, we're giving away FREE POPTARTS! Whaddya say, Mr. Doopler?


Not sure why you're getting downvoted. They absolutely do that. If you were in person, they would even show you a great chart with their returns and the normal returns so you can see how how much better than the average they are!


Well, if they didn't call, their chance of getting a refinance sale was 0.0% Then, as now, sales is a numbers game.

Dad was very financially literate and would hang up on them after a short "no thank you". If for no other reason than they interrupted the family dinner.


Obviously in exchange they would shave off some part of it?


If a precipitous rise in oil prices caused inflation, why did Paul Volcker cure it, and not the equally-precipitous fall in oil prices that occurred simultaneously with his attempt?

That is, second attempt -- his first attempt, when oil prices were still high, didn't work.


Oh, man, he must have been kissing the ground to have locked in that mortgage rate before the inflation and high rates kicked in!


Boomers often cite the 1970s inflation spike as a terrible time, but the wage inflation eroded their debt, leaving them with high disposable income and the ability to refuse to work if not sufficiently compensated.

The establishment have not made the same mistake again. When you have people in perpetual debt you have them under perpetual control.

Credit can be created at will, but if you accidentally let financial independence break out, it's not easy to put back in the bottle. You have to wait for the next generation.


It benefits those with lots of debt but really hurts those that have worked hard to build up savings, or are on fixed income.


I sometimes wonder if the American healthcare system and the UK housing market aren't deliberately kept expensive for much the same reason.


In the UK there is a lot of rhetoric about "the free market".

When prices looked like they were going to drop, the government stepped in with "help to buy".

The free market rhetoric is just that. It's a complete and utter lie.


Well, it was 1966 and that's what you got back then. :)

He would record every payment on the booklet you got with the mortgage that had the amortization schedule printed in it.


It’s amazing rates lock in for 30 years. Are banks still stuck in the 80s too?


Variable interest rates were a thing in the early-mid oughts. It didn't end well.


Fixed rate mortgages are a uniquely US thing I think - I imagine made possible by government entities securing them. Rest of the world is predominantly on variable rate mortgages - why would a rational lending entity take on the risk of a fixed rate?


AFAIK it's actually the other way around. Banks, hedge funds and other institutions regularly trade "swaps" - instruments that swap variable interest rate for some fixed interest rate - the variable rate is usually "FED rate" or some well-known benchmark, whereas the fixed rate is set to be such that the net present value is zero - so that you can establish such contract without any immediate exchange of money.

If anything, it's a huge anomaly that this facility isn't routinely available to retail customers, and an indication of lack of competition within the banking sector in many countries.


The mortgage market is giant. I don't think there is enough liquidity to remove all the risk off of bank's books from private investors. This is where the government comes in I believe. Freddie Mac/Fannie Mae buy all the loans off of the banks. Many of these are later sold to investors who want to bet on rates - but I imagine Freddie/Fannie still has huge exposure to interest rate moves.


Having personally just purchased a home in the US I can say that a 400 bps increase in a variable interest rate would effectively double my housing cost, and place my home underwater as the Total Cost of Ownership would more than double over 30 years. If the interest rates increased by 600 bps to the maximum of the last 30 years I'd unavoidably default and declare bankruptcy.

On a per consumer level a variable rate is much higher risk, even in countries with highly variable inflation rates some fixed form of incomes will not inflate uniformly with the economy and a variable rate would increase the rate of defaults. On the other hand the loan terms and risks are determined once at loan origination where it's quite feasible for a financial institution to hedge out any long term inflationary risk.


Oh yes, it's a big risk. I think this is at least one reason why policy makers are so hesitant to raise rates. Especially in places like the UK, where many home owners are highly leveraged assuming a low interest rate, yet only have 3-5 year fixed rates. I wouldn't be surprised if there were a large increase in defaults if the interest rates went up here. It would probably bring home prices down to more reasonable levels as well.


What is bps in this context?


Basis points, which are a hundredth of a percent on an interest rate, eg “6% is 200 bps more than 4%.”


Fixed rates are the default in Germany. You would have a hard time trying to find a bank offering a variable rate to a normal customer. They have them, but they are surely not standard and fortunately not offered aggressively. I am unaware of any such regulation, but there probably is one.


In the UK it's mostly fixed for X years (usually a low number 2-5) then variable rate for the remainder.

You can go longer but the bank will factor that with a higher fixed rate to offset variation.


In US lingo, that would be referred to as an adjustable rate, like "5/1 ARM" (fixed for five years, then adjusts each [one] year). When they say "fixed" in the US, they mean fixed for the full term.

I'm honestly surprised that became the standard, it seems like a lot of risks for the banks for what they're getting. I think it has something to do with Fannie Mae and Freddie Mac preferring to buy some mortgages and absorb the risk?

https://www.bankrate.com/glossary/0-9/7-1-arm/


Germany has 5, 10, 15 and 20 year mortgages as the „default“. With the longer ones having a legal exit option (only for the Customer) at the 10 year mark. So in case the interest goes down, you can always refinance after 10 years. Independent of your Bank agreeing to it.


In Italy almost all mortgages used to be on fixed rates until 2000


US inflation has been stable for almost 40 years.


I guess it depends on what you mean by 'stable'. Just eye-balling the data here shows there are historical swings of around ~4-5% on a per-year basis: https://www.usinflationcalculator.com/inflation/historical-i...

And of course the 2008 'financial crisis' didn't really result in 'stable inflation' in the US within the last 40 years.


Interesting how mortages vary so wildly between countries. Here in Denmark the variable loans are all below zero.

You still pay something as the loan has a management fee on top of the interest, so you can end up paying approx 0.6% in interest in the variable loan that can change every 5 years. The mortage loan can only cover up to 80% of the value of the house, with rest being 5% cash and 15% a more normal, higher-interest bank loan.

How much you can loan is based on a multiplier of your household income typically.

The 30-year fixed loan is 2% effective interest. And you can also not pay any interest for up to 10 years.


Variable rate mortgages still are a thing. And it's not like there's anything really wrong with them. You are getting a better rate (compared to the newly issued fixed rates), but also getting some rate exposure over the duration of your mortgage. This exposure could help you, or hurt you, but I would hardly call it a bad thing.

The problem is that most people don't understand these things and are stupid, and decide to buy a house and sign all the paperwork without reading it.


> This exposure could help you, or hurt you, but I would hardly call it a bad thing.

The problem is the amount it can help you and the amount it can hurt you are disproportionate; if the rates fall enough to significantly help you, you could likely have a similar reduction by refinancing a fixed rate mortgage. But, if rates go up, you can't refinance to get a better rate, and you may have trouble selling as you may have planned, because higher interest rates put downward pressure on prices.

For me, it seemed like the risk was not worth the reward; especially given I was borrowing in 2009, and rates had significantly more room to go up than to go down. In the 1980s 20+% interest rate climate, I may have chosen differently.


Can you really just refinance a fixed rate mortgage that's now priced at an above-market interest rate? Surely the bank has you on the hook to pay that higher interest rate for the remainder of your loan term, they're not going to accept an early termination without some kind of penalty. After all, they've presumably backed your loan with some kind of equally long-term security.


> After all, they've presumably backed your loan with some kind of equally long-term security.

See, this is what banks are explicitly NOT in the business of doing. They are in the business of borrowing short and lending long, with a rate spread to make money in the process.

I have had a number of mortgages in the last 10 years in the US (refinanced multiple times), and none of them had any prepayment penalties. I suspect if I looked for one that does I might find it and it might have a slightly lower rate. Maybe. That depends on whether the bank planned to keep it on the books or sell it on; it's easier to sell on standardized mortgages into an MBS than weird ones with bespoke terms.


They are in the business of borrowing short and lending long, with a rate spread to make money in the process.

See that makes sense with variable rates. However if you offer a 30-year fixed rate at 4% because you know that you can currently borrow short at 2.5%, what happens in 20 years time when no-one is willing to lend short to you for less than 6%?


There are two possible options there.

1) The loan is still on your books. In that case, you are in the same situation as an individual who has invested money in a 4% bond and can't withdraw it from there while at the same time paying 6% on a car (or house, or whatever) loan. It's annoying, for sure, but whether it's a serious problem depends on your net assets (which you might draw down to make up the difference) and your net income at that point (which will depend on whether you are still managing to make loans at higher than 6%). Also, 20 * 1.5 - 10 * 2 = 10, so I think you you still come out positive in this scenario, subject to some _really_ simplifying assumptions like the rates being 2.5 and 4 for 2 years and then jumping to 6 and 4, and ignoring the fact that money now is more valuable than money later, etc. But yes, if you keep the loan on your books you do run the risk that rates will go up and the money will not be optimally invested; you presumably try to model that risk and price it into your rates.

2) You sold the loan on to investors in the form of bonds. In that case you really don't care that much, as the loan originator. The investors who bought a 3.25% (or whatever; some loan management fees come off the top) bond now have the problem of having a bond that is paying likely below-inflation rates, and can't be sold, except at a loss, because of that. If the question is why investors would buy such a bond now, it's because they need something to invest in and pickings are pretty slim if they want a risk profile better than stocks (and we can argue whether morgage-backed securities give you that) and they are betting rates won't go up that much.

Now you could ask why people generally buy fixed-yield bonds at all, which is really the same question. My guess would be that partly this is a bet that rates won't rise (partly driven by central banks' commitment to macro stability and therefore not having too-large changes in interest rates). And maybe partly an issue of what time horizon the bond purchasers are operating on...


fixed yield bonds/mortgages also provide an interesting hedge in the current climate against

1) Recession 2) Negative interest rates.

in theory one could make a bet that a recession will occur in X months forcing a rate cut/stock decline and use leverage on fixed rate investments to make an above average return.


You might have to pay a fee to close out the loan early, but mostly the fees are reasonable. If your loan was originated after 2014, prepayment penalties are very limited [1]

My lender had a program where you paid a nominal amount (originally $500, but later $1000) and they'll adjust your rate to their then current rate. If you do a full refi, my understanding is that's going to cost in the neighborhood of $3000, although many lenders will roll that into the loan, or otherwise hide it.

[1] https://www.nolo.com/legal-encyclopedia/when-are-prepayment-...


That still feels sleazy and racketish. I can understand doing that when you take on a new customer, but charging you thousands of dollars just to change the exact same loan to one with a different rate? [1]

Reminds me of the time I bought a package at a pawn shop, but didn't want one of the items in it. They said that to get a discount, I'd have to buy the whole thing as is then pawn back the unwanted item. So far, so good, but then I had to give my ID and attest that I didn't steal that one item ... even though they knew it never came from me to begin with!

[1] The way you said it, thousands sound like the typical case and $500 is a special deal.


If you do a full re-fi; the new lender is going to run your credit, do an appraisal of your home, record the new loan on the title, do a title search, purchase title insurance, pay the broker's commission, etc; that all costs money, and that's where the thousands come from.

Just adjusting the rate in their systems certainly doesn't cost the lender nearly $500 or $1000, but it was still a win-win. They got some money to offset the lower rate, and got to keep servicing the loan, and I got to pay less interest, it's been a while, but I seem to recall my break even was about 3 years each time. I would certainly consider the availability and price of rate modification when considering lenders in the future.


So since it seems like under this system, the lender carries most of the downside risk on interest rate movements while the borrower gets the upside, the lenders must be covering this with a greater spread between their cost of borrowing and the fixed interest rates they charge?


Usually yes; the rate for fixed mortgages tend to be higher than adjustable. Looking at rates today, I'm seeing about 3.75% for a 30-year fixed; 3.125% for 15-year fixed, and 4.25% for a 5/1 ARM; but it's more typical in my experience for an ARM to come in near or below the 15-year fixed rates.


If your original lender were to refuse you could refinance with a different one. Your lender knows this and therefore will let you refinance to keep your business (I'm actually doing this now).

You do have to pay loan original fees again though which can be 1-2% of the balance of the loan so you have to compute when it actually pays off for you and whether it's worth it.


Prepayment fees perhaps?


Agree 100%! But in practice, it doesn’t work like that. In a world where the safe, conservative option, taken by responsible borrowers, is the fixed-rate, then the variable rate takers are dominated by the people who are trying to stretch their finances to the breaking point, and that’s why you should worry when you see variable rate mortgages becoming more common.


They are a thing in New Zealand and have been for a long time. Our rates are a lot higher than the US.


The only reason anyone can get a 30-year fixed-rate is that the government makes it so, by guaranteeing and eventually taking over Fannie Mae and Freddy Mac.


Banks offer both fixed-rate (“locked in”) and floating-rate mortgages (where you pay the prime rate + some fixed number of basis points).


But during that time inflation was in the double digits, and peaked at 14.8%. There was a real risk that inflation would go to 20%, which would wipe you out.


Worse: You got 17%, but inflation was 14%, and you had to pay taxes on the 17%. So even at 17%, you were still losing money.


Inflation was nearly that high, so while the nominal rate was high, in real terms it was more in line with historical returns. Mortgage rates were often in double digits too.


As other have mentioned, it's not "risk free" in a way that makes it "insane".

You could buy a 10-year bond paying 8% in 1970. That's a high yield by 21st-century standards but it performed quite poorly [1]: when you got your principal back ten years later it was worth less than half as much due to inflation (and not even by reinvesting the interests received would you break even).

[1] not worse than stocks, though


> That’s more than double the long term stock market return, and it’s (basically) risk free.

You're comparing nominal and real numbers here. The nominal rate was more than double the long term _real_ stock market return, but the corresponding real rate was 4.5%, as the inflation rate was 13.5% in 1980. That's a more accurate and much less eye-popping number.


It's only 'risk free' in hindsight. Nobody knew what inflation would be and people risked losing value.


I may be wrong but I think when you say risk free you just mean there’s no risk of it not paying out. Inflation is a separate potential threat, for which there are inflation protected treasury assets?


Yes, "risk free" has a technical meaning which doesn't include inflation risk. But it may be misleading when used in a non-technical context. Even if we assume for the sake of the argument that there is no default risk at all in government bonds you have risks linked to inflation and changes in interest rates (they affect the value of your investment before maturity and your ability to reinvest the coupons received according to the initial expectations).


The risk is that it pays out, but what it pays out is less value than you paid in, due to inflation. It's effectively less money you're getting out, even though the number is the same. Sometimes inflation is so high that you would effectively get nothing back. You can't call that 'risk free.'

You also risk that the bond is not honoured - that's a really low risk for the US Government, but it's also not 'risk free.'


“Risk free” refers to default risk, not the risk that you could have gotten a better return elsewhere.


My parents had a mortgage in the 80's at 18%. Yes, those were crazy times.


It didn't seem risk free at the time.


The inflation rate in 1980 was 12.5%.


Contention: The cultural assumption that saving ought to be rewarded is misguided.

Reasoning: When a bank lets you transform production today into future consumption, it's performing a valuable service for you. Storing your value takes work and the bank deserves to be paid for that service. However, historically, they charged a negative price for this service (positive interest rates), because this service allowed them to make even more money letting other people transform their future production into present consumption. But as fewer people need to borrow and as more people want to save, the market clearing price of savings is approaching and in and cases overshooting 0%.

Extrapolation: There's a fair chance this will be a big deal in the history books we write a century from now. Today's bond prices are telling us that the world is changing. We are going from a world of relative growth, where we needed to delay consumption to juice investment, to a world of a relative stasis, where consumption and investment are in equilibrium. Everyone who said interest rates would bounce back to "normal" after the Great Recession has been wrong. This may be the new normal.


Another factor - there are probably a few billion people in Asia in rapidly growing economies who need a hedge against all their savings suddenly becoming worthless due to local instability.

Suppose you are planning your future, and you think there's a small but real (1-5%) chance that sometime over the next decade your local currency will become devalued to zero. Suppose also that you're expecting significant future costs: elder care for your parents, rising costs of living, etc. In those situations, you're likely to have a very high savings rate, and will tolerate guaranteed returns that are near zero (because factoring in the risk of local returns might make them closer to negative double digits).

I'm not a global economist, so I don't know how much this is driving things. But China as a 45% personal savings rate, India is in the 30s, compared to the 6-7% of the US, and anecdotally people have noted significant amounts of foreign investment in "safe" assets. Some of these areas have banks that offer double digit returns for investments, but only on paper - people were talking up the returns from Mongolian savings accounts a few years ago, but then the currency has eroded so quickly that 15-20% returns are actually negative.


> But as fewer people need to borrow

The problem with this theory is that debt is quite high globally and in all sectors (households, corporate, government).


Debt normalized to cash flow or equity is probably the more relevant measure.

If there's cheap government money on the table, everyone would be crazy not to avail themselves, as long as the potential use expands one's business.


Sure, but the point is that money is cheap because government is throwing buckets of it on the table and not because people didn't want money in the first place.


The Fed sets interest rates based on inflation and unemployment (the dual mandate). And what has changed from 20-30 years ago is not that the Fed is extra dovish. If so you would see historically high and accelerating inflation, and incredibly hot job market. So it's not the Fed that has change it's the environment. Due to fundamental changes in the global economy we are living in a world of incredibly low natural interest rates.


Looking at this chart https://www.stlouisfed.org/~/media/Publications/Regional-Eco... it looks like something has changed at the Fed from 15 years ago. I'm not sure one can fully blame the enviromnment.

https://www.stlouisfed.org/publications/regional-economist/j...

Edit: they had started to reduce the size of the balance sheet [1], but who knows how long will it take [2].

[1] https://www.ft.com/content/16649a54-b38a-11e8-bbc3-ccd7de085... [2] https://www.bloomberg.com/news/articles/2019-07-19/the-fed-s...


That looks like a graph of quantitative easing.

To use a car analogy I'm arguing the gas pedal doesn't work as well so the Fed is having to keep their foot to the gas to maintain it's historical speed. Others argue the Fed is has been trying to go faster and that's why their foot is on the gas pedal. The graph seems to support that indeed their foot is on the gas.


Sure, that's quantitative easing. Something that the Fed was not doing in this form before and it's quite controversial whether it has been a success of a failure. In any case, this "temporary" solution is going for over ten years now and the Fed doesn't know how to get out of it.


I think he means fewer people need to borrow relative to giant pool of global money sloshing around.


> Contention: The cultural assumption that saving ought to be rewarded is misguided.

This is an odd contention that I don't agree with entirely based on the usage of "rewarded." Interest isn't a reward, it's simply the price of money, and depending on your personal current values/needs/wants (spend now or save now), it can look either like a reward or a punishment.

So this ends up reading only as a topsy-turvy ex-post-facto justification for central bank policy that favors / provides cover for governments that spend more than they earn, which they all do afaik.

I do agree with some elements of your extrapolation though. It is possible that we are going from a world of relative growth to one of stasis. Or, at least, I don't think it's necessarily a bad thing if economies do not "grow", especially not in cases where population growth is slowing or even reversing.


One of the biggest risks with a natural interest rate of 0 is monetary policy loses all effectiveness. We need to either increase inflation or start playing with other forms of juicing the economy like helicopter drops.


Uhh, there's a practical human problem with that notion and it is that when you're younger if you don't save for when you're older then you'll be destitute. Social Security alone is pretty hard to live on. As for what the bond market is telling us an alternate thesis (supported by the public statements of Trump and the Fed Chairman) is pretty much they don't want a recession in an election year and have eased interest rates not because it's good for the economy but because it's good for the incumbent. In short it's interest rate policy not the market which is setting the price.


I agree with you BUT social security can also be seen as a pay as you go system where the young care for the old. The notion that saving must take place is somewhat tied to American individualism.

If we didn't treat things like wellfare as disdainful and something you could actually rely on, we wouldn't need to worry about personal savings as much.


Not sure who you mean by younger. I'm pushing 40, and I've been aware my entire working life that social security would not be there for our generation when we reach retirement age, but we would still be expected to pay into the system to support our elders and/or their elected officials. The only way we're likely to get any kind of return on that investment is if we become disabled.


This defeatist thinking and odds are its simply wrong for gen X. The Millenial generation is large enough you'll most likely see social security.


I don't know. All my life I thought that way. But I'm 57 now, and it looks like I might get at least something...


Could this actually just be a biproduct of large generations that don't prioritize investment yet?


I don't pay too much attention to this type of thing but I think it might be related to wages not going up but the cost of living skyrocketing.

For example people in their late 50s and early 60s might have been making let's say $30,000 back in the 1980s and 1990s and now today the same exact type of job pays the same 30k salary except the cost of living is crazy high now compared to back then.

Back then they had money to spare for investments but that same salary today means you're probably in debt.


You have it backwards. There are investors (such as banks and pension funds) who want certain very safe investments (government bonds) but governments are unwilling to supply it. So, if anything, this would be too much savings rather than not enough.

But really, it's not about consumers, but about banks not making as many loans as governments want them to. That suggests a lack of safe investment opportunities.

Maybe, instead of pressuring banks to make investments that they don't want to make, governments could stimulate demand in some other way? There are certainly people who, if you give them money, they will spend it.


If that were the case, the people who do take out loans etc should be realizing supernormal returns as they exploit the low-hanging fruit being ignored. Do they?


Check into it and let us know.


The average person is so levered up they cannot afford to invest.


I really don’t think this is true anymore, with regard to the people that are capable of being levered up (ie the top 30% in USA)


Implying that they will in the future?


Except we don't need banks to store money now. We can use math and computer networks aka cryptocurrency.

Personally I think what's missing is a way to holistically track real world resources and consumption and tie them to digital money that can then be regulated in a fine grained way.

I think that is what is needed to change economics from a society of witch doctors into a technical and practical profession.


In other words, billionaires/oligarchs have sequestered so much cash that it has outrun investment opportunities. What does that tell you about the theory that tax reduction spurs investment?


It's more like a heart attack. There's plenty of blood, but the circulation to the heart itself (the people, ie demand side) has stopped. The doctor is pumping ever more blood into the patient without fixing the clogging to the heart itself.

Helicopter money which deletes loans (meaning it would not punish people who did not borrow) would be a far better strategy in this case, and lead to both inflation and deleveraging at the same time, something which is impossible with other methods.


Wait, for those of us who aren't borrowing, how the hell is inflation not a net penalty?


I guess it's not a penalty if you are able to invest the money you get from the helicopter drop in assets, or a sweet gaming rig, while other people are just paying down debt?


On the theory that everyone gets cash, and for those with debt, the cash goes to the debt first, sure. But If I'm reading the proposal correctly, the argument is to just drop money into the debts. Suckers who lived responsible lives up front are left in the dust. This seems ... not healthy for society in the long term.


The overall statement is a fallacy, correlation does not imply causation. There are plenty of good investment opportunities out there, the truth is that you need to find them yourself. The next big companies in the world are purely in their "unfunded idea" stage.

Also the whole tax reduction statement is mostly an opinion. From what I've seen, most companies are almost purely motivated by the risk-adjusted post-tax profit that can be obtained from the investment. Every idea on the drawing board is effectively evaluated meticulously on this basis. If that number isn't to their liking then the research/project simply never gets funded. The company might opt to simply do share buybacks or pay a higher than normal dividend. Plus the overall argument is mostly junk because the United States heavily reduces taxes for companies that perform R&D through the R&D tax credit.


1. “Plenty of good investment opportunities” does not treat their aggregate value compared to cash removed from the economy. I reiterate, in plain English. There is more of that cash, way more, than realistic investment opportunities. Don’t believe me? Look at the crazy vanity projects, either started or under consideration. Settlements on Mars. $500B Saudi cities. 2. “From what I've seen, most companies are almost purely motivated by the risk-adjusted post-tax profit that can be obtained from the investment. Every idea on the drawing board is effectively evaluated meticulously on this basis.” I couldn’t agree with you more, at least when it is done rationally. And precisely because taxation is MULTIPLICATIVE, tax rates have little effect on investment decisions. Look at the 1950’s. Indeed, I suspect, (paradoxically?) that high tax rates encourage investment. The investment cost is effectively discounted by the tax rate.


The interesting part of this story will be looking back on it in ten years. We are either looking at a situation that is surprising but healthy, or a situation that is verging on being a crisis a very long time coming. So far so good, but I don't like it.


The biggest risk with TARP was inflation. You throw that much money into the economy and normally inflation goes up. Some assets have gone up, but generally inflation is low.

So one of two things will likely happen:

1. Economy will go into recession, feds can’t drop interest rates much more (they are already low), so recession hits hard.

2. Inflation skyrockets and the fed starts cranking up interest rates in an effort to control it. Economy stops growing but inflation continues (hi 1970’s!). People bitch because their paycheck stays the same but he price of milk doubles.


> Some assets have gone up,

Land prices are not included in inflation stats. The cost of carry is, as mortgage payments, however that is simply the cost of money. And rates are at all time lows.

The difference between 7% rates where your mortgage takes up most 50% of your wages and 2% rates where your mortgage takes up 50% of your wages is that it's far harder to pay off your mortgage in the latter case.

You cannot attain financial freedom. This means ultimately you cannot refuse to work, even if compensation is poor (low wages, stuck low).

There is inflation. It's being used to force us to work, and the precariat cannot bargain for more of their surplus value.


As I understand it, housing is included as rent or "imputed rent". But, this is the price people actually pay for housing and home owners have it locked in whenever they bought, which could be decades ago. So, inflation lags the market rate for housing.

Or in other words, many people aren't paying market rate and it brings the average down. This isn't what you experience if you need a place now, or bought recently. Inflation is an average and most people aren't average. (Just like nobody has 2.2 kids or whatever.)


No that's just the price it would cost you to rent it back to yourself. It's not the land price. So even if it tracked rent, by being marked to market, it still wouldn't reflect the additional money creation forcing land prices up.


There are lots of smart people worried about a sub 0 percent interest rate, or worry about stagnation. Not to mention my peers in every Industry talking about slowdowns or unprofitable years due to tariffs.

The only people who seem to be enjoying it are exploiting the bubble with high wages and investing companies.

And if you didn't take the investment, your competitors destroyed you.

Fiat currency is a weird thing.


Seems like it comes down to some investors preferring safety so much that they will pay for the privilege?

One possible arbitrage here might be for the governments themselves to issue more debt and invest it? (Essentially, this is a government bank.)

But, the market seems to be saying that there are too few good investment opportunities. Maybe consumption should be higher? A UBI scheme might do it.


Possible but highly unlikely; they could literally keep money in a sack under their bed and get better returns. Not much difference between a sack under the bed and a bank account if you don't tell anyone about the sack.

I'm guessing it probably either speculators buying bonds assuming that they can be onsold to a central bank, or people who are forced to buy for whatever reason (eg, maybe some savings schemes are forced to put x% into government bonds). I've bought bonds exactly once on the assumption that I could on-sell them for a profit when government lowered interest rates. People like me don't have any impact on the market, but if the incentives make sense at the small level maybe it works out the same on the large.


> Not much difference between a sack under the bed and a bank account if you don't tell anyone about the sack.

They could hardly be any more different. If one person beyond yourself knows about it, then you're in trouble. One fire or disaster and it's all gone. If it's a smaller sum, you're FDIC insured against loss in a bank account, which again makes the point about just how different the scenarios are. If I feel like it I can safely protect $1 million via four distinct accounts under the FDIC at no cost. The Fed will go back to zero rates at some point to stimulate the US economy. Even when that happens, I'm essentially paying a small insurance fee (inflation vs zero rates) per year to guarantee the safety of the $1 million. That is ultimately far safer than managing it under my mattress. And cheaper, if I need any guaranteed security for the mattress. It's also easier to move at low concern (whether that's to shift it into an investment account or move it to another bank). If it's under your mattress, every move is a high risk for exposure; every person you let deep into your life creates some risk of theft (eg non-malicious gossip).


Why not just put it into a bank deposit then? This has positive rate and won't burn as well.


> Not much difference between a sack under the bed and a bank account if you don't tell anyone about the sack.

Burglary isn't the only danger. Paper money can be eaten by moths, so you probably want to vacuum seal it. That still won't keep out rats. You could lose it all in a flood, landslide, tornado, fire, or earthquake.

The individual probabilities of all these events are quite low but multiplied with your all your liquid cash, the cost is unacceptably high for most people.


You're also likely to be charged for taking your money out in paper form and depositing it back later. Not much, especially if you're going to keep it under your matress for a long period, but everying adds up.


Actually, large amount of cash instruments are pretty unweildy things. And you still have to pay to secure it in the meanwhile.


This assumes that cash or bank money has the same counyerparty risk as a government bond. That is not the case. Negative interest rates essentially signal that everybody is short on the future overall.


Literal cash under a mattress is not a good option for a pension fund.


The logistics alone are kind of alarming. That's a huge mattress, for starters.


Depends on the currency. If you can get hold of €500 notes, you can fit quite a lot of money in a small space:

> Tests by the Serious Organised Crime Agency found it was possible to carry €25,000 in €500 notes in a cigarette packet, €300,000 in a cereal box – £1 million in banknotes weighed 50kg while its equivalent in €500 notes only 2kg.

https://www.irishtimes.com/news/world/europe/the-500-note-a-...

Note that having that much in €500s may raise some questions.


You'd be surprised at how much cash you can fit into small spaces.

Someone once proved in court you could fit 7,400 bills into a normal shoe box. Filled with $100 bills that's $740,000.


Most (all?) of the Federal Reserve banks have a money museum attached to them, and they will generally have a few stacks of money in various denominations that total $1,000,000.

1 million $1 bills is really large. The $20 bills would fit in a suitcase. The $100 bills fit into a briefcase, which will have a clear plastic cover over it so you can take pictures of yourself holding a million dollars in a briefcase.

FYI: They also give away bags of shredded cash, which you can then use as baller confetti at your kids' birthday parties.


Kill the Messenger (1) has a bit about this where the CIA was funding the Contras by pushing cocaine through the US. One of Oscar Blandon's minions describes hotel rooms full of cash and they had to have people circulate the money from the top to the bottom to prevent mold.

(1) https://en.wikipedia.org/wiki/Kill_the_Messenger_(2014_film)


Central banks are trying to tell investors to go throw their money at random unproven CEOs

Investors are saying they’ll pay for the privilege not to, and some also started buying tiny amounts of bitcoin.

Economics consistently fails to predict actual human behavior.


> But, the market seems to be saying that there are too few good investment opportunities. Maybe consumption should be higher?

The market has very little say in the matter when the central banks force interest rates to near (or equal to) zero -- somewhat ironically to increase consumption by de-incentivising saving.


Central banks control the supply of some very safe investments and usually that determines the price. But, someone still needs to own government debt and that depends on demand.

There are plenty of other choices for investors, like the stock market or real estate. So, you could either spend the money or choose a riskier investment.


Do you blame a certain class of investor for being extremely risk-averse?

Imagine if you're managing people's retirement money. How would you invest it? People's nest eggs.

To put it into computer-nerd context; remember the saying, "nobody ever got fired for buying IBM".

Isn't this the same kind of thinking?

By the way, what do you think about the idea some are proposing that crypto-currencies are more solid than a gold standard?

Instead of transitioning from this central bank backed fiat currency malarkey (which in theory ought to work just fine but doesn't because of greed, collusion, corruption, hubris – i.e., human weakness) back to the gold standard, some say we should move to crypto-currrency standards. I'm not at all versed enough in the tech and theory to know if this is a good idea or not.


I'm not blaming anyone for wanting very safe, secure investments. What I'm saying is that, if people want safety, maybe the government should provide it?

Cryptocurrency is high risk, with both dramatic changes in price and insecure exchanges, so I'm not sure why you bring that up in this context?


With negative interest rates, it truly will make financial sense to put all of your money under the mattress, so to speak.

In reality, keeping liquid cash will no longer make any sense whatsoever, and further push all other assets up in value, property and equities for example.


Keep in mind Modern Portfolio Theory, in which we measure the total return of a portfolio, not just the individual components.

A huge number of retirement plans and endowments and pension programs will still hold negative yielding bonds, because they need to diversify their assets.

In theory those safe government bonds will shoot up in price just as equities crash. Because these assets aren’t correlated, your long term return will actually be higher. So, yes, that is probably worth paying a bit of money for.


Is that really true when the yield is negative though? Wont investors just, like, go into checking accounts or safe deposit boxes when they need to flee to safety?


For large institutional investors, government-backed securities can be safer than bank accounts, given that they need to invest sums that are much larger than deposit insurance (e.g. FDIC) limits.


Recent related story titled:

Safe Deposit Boxes Aren't Safe (nytimes.com)

https://news.ycombinator.com/item?id=20545276


Holding cash almost always has a pretty bad negative rate, i.e inflation. Real rates of bonds might be negative, but they should always be bigger than inflation.


The "real rate" is the rate after inflation. It can't be both negative and bigger than inflation.


The idea is that for cash, the nominal rate is zero, so the real rate is (-inflation). Whereas for negative-real-rate bonds, the real rate is (r - inflation). Since r < inflation this is negative, but since r > 0, the magnitude is still below inflation.

The parent comment was maybe being slightly imprecise, but his core point isn't wrong that positive nominal rates means that your losses are less than inflation (whereas for cash they're equal to inflation).


But that misses the point that one can have negative (nominal) yields which give you very negative (real) yields. So it's not true that "they should always be bigger than inflation."


Right, it requires nominal r > 0. I think the parent comment point was that violating that condition is rare, but as you point out below, apparently it isn't.


What's the notional value of all negative nominal yield bonds? Surely it can't be that much? Though, if you expect rates to go ever lower, I guess you could argue that a negative nominal yield bond could be a good investment.


$13 trillions. I don't know if that's "much" for you, though.

https://www.bloomberg.com/graphics/2019-negative-yield-debt/


I still don't fully understand negative interest rates. So banks then have a negative penalty for holding cash?


When sums of money are sufficiently large (millions or billions of USD), it sometimes makes sense to secure a very small loss (0.5% per year) than to park it in an account or fund or etc which could have a positive or negative yield (maybe you win maybe you lose).

Also, to the original commenter, I will never put all my cash under the mattress. One break in and it's all gone.

I currently have all my cash parked in a 1% interest checking account with strong protections and fringe perks.

I am content with taking an extremely small loss on inflation while I wait for the market to eventually tank. It's been longer than I expected (2 years already), but I do not ever shed a tear over the what, $16,000 in pretax capital gains I theoretically could have made?


I have spoken with several people recently who tried to time the market by selling their equities, then lost out on these recent all-time-highs.

I don’t know what the answers are and no one does. In my opinion there has been a global phenomena of easy money in various ways for a decade, and it has filtered out in all sorts ways, from the premium in equities, the absurd rise in housing prices, the art market, basically anything that can eat excess cash has been eating it. A crash and hangover is coming but it will primarily affect richer people though it will bleed out to the non-monied classes via job losses and retirement accounts falling in value.

But when this will happen? It could be next year or in 50 years! The governments of the world have so many options to keep the party going.


Yes I agree with you, it's been a very interesting decade where we went from "the sky is falling" to "let the good times roll"!

However at least for me, my current earning potential in my job is not that high, and my cost of living therefore has been what I've sought to optimize instead of capital gains.

For people who have lots of taxable income, lots of asset exposure, and a high cost of living, then a mixed bag of investments is definitely crucial to preventing those people from going bankrupt.

But for me, as long as I find ways to continue to live healthy, have a good network of friends, a job, money in my main bank accounts in case I need to put up a security deposit or take an extended vacation, then I am very happy. I therefore would never want to keep $40,000 or something in a market account when I really do need all of that money at any time.


while your point about negative interest rates is valid, note that your conservative investment strategy is misguided (as you've already noted in foregone gains). there is no way to time the entire market, going up or down, without vast and extreme insider information.

so the safe strategy is to make sure you have an appropriately balanced portfolio (among cashlike securities, equities, bonds, etc.) and to leave your equity investment in place while riding out the downturn.


If you are riding out the downturn there's little need for diversification. Sure don't keep your portfolio in a single stock but the S&P500 is sufficient diversification. You don't need cash likes or bonds. Equities have the highest rates of return and that's what you should be having.


it really depends on your risk appetite. the conservative investor will want downside protection against rare market collapses that last for decades (e.g., 1929).

investors typically get more conservative as they get older, so your advice might be ok for most 25 year olds, but not for most 65 year olds. the conventional wisdom then is to hold increasing proportions of weakly/negatively correlated securities like bonds in your portfolio as you get older, particularly through downturns.

and the s&p500 is a reasonable basket of equities, but it's not perfectly representative of the asset class either, since it's composed of primarily large cap domestic stocks. it doesn't include any startup equities, for instance.


Why not at least buy a 1yr CD? Rates were around 2.5% last I checked.


My money market account pays 2.5% interest. SoFi Money is at 2.25%.

https://www.doctorofcredit.com/high-interest-savings-to-get/


Goldman is offering 2.25 percent on a basic savings account as well.


Supply and demand, and fear. Imagine a customer who needs safety more than a return. They are willing to put down $1 now in exchange for a GUARANTEE they will get 0.99 in 10 years.


It might help to think of it as going beyond zero interest rates to the point of intentionally punishing traditional savings to try to force consumer spending (if you hold onto it, we'll devalue it), entice borrowing (we'll essentially pay you to buy a house [1]), etc. There are various approaches to pushing rates below zero. Japan and the ECB have done a lot of experimenting, the US will probably take some notes from them when it comes time to push US rates below zero persistently.

[1] https://www.wsj.com/articles/the-upside-down-world-of-negati...


That would just further press housing prices up, and push people into bitcoin.


But then people move to safe long holds, and out of Fiat.

This is how we revert back to a barter economy, or one that uses gold/Bitcoin/etc... Since the Fiat currency is rapidly inflating.


Some institutions are bound (legally and/or contractually) to hold (a certain percentage of) their assets in government bonds. So they don't really have a choice. Also, their performance isn't measured in absolute percentage terms, but only as relative to the benchmark - so if the benchmark goes just as negative as the fund, they didn't actually "underperform".


What if you cannot withdraw it because we move to digital only "cash"?


Time to gamble on bitcoin.


Interest rates are always positive. You are referring to yields which are part interest rate and part trading issues. Yields can and do go negtaive from time to time from the trading issues around the products. The interest rate (as shown on the coupon payment on the bond) will always be positive.

edit: let me add, I mean the consumer space. There can be some oddity in the bank-to-bank market because of various technical reasons, but it is extremely rare.


There are mortgages in Europe which are indexed to Euribors, which have been negative for a while, and you have been able to end up having a mortgage where index + margin is below zero. Obviously banks argue that actually mathematics is wrong and negative numbers do not exist, so customer needs to pay more than what was originally agreed, and I am not sure if that issue has been sorted out in courts.

What comes to interbank markets, it is far from rare and far from only technicalities, it is nowadays pretty normal that the floating leg of the swap pays negative interest rate. (In Euro, that is, USD has higher rates)


Euribor rates are just short end bank-to-bank reference pts. The interbank markets are mostly technically driven on the short end. Central bank policies (eg reserve requirements) play the largest role.

And can you show me euribor-based long-term loan where the interest rate is negative? For the most part, banks have no need to loan unless compelled, so maybe where is some policy forcing them to? I would call those extremely strange technical factors.


> And can you show me euribor-based longe-term loan where the interest rate is negative?

My old mortgage would have become technically negative a couple of years ago, but I was forced to prepay it due to selling my apartment before the rates went that far down. As I said, my understanding is that my bank would have refused to honor our contract, though, and insist there is a zero floor in my mortgage even if nothing like that was agreed when I took the loan, so in that sense you are right.


> The interest rate (as shown on the coupon payment on the bond) will always be positive.

Negative coupons would be quite difficult to implement but having a positive coupon doesn't really mean anything: bonds are not necessarily sold at the nominal price even when they are initially issued.

"Henkel and Sanofi sell first negative yielding euro corporate bonds"

https://www.ft.com/content/6fdfeee8-2045-3452-a55d-3744a9091...


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