Universal Translator

Monday, April 18, 2011

The Financial Press (and the Fed) Doesn't Work for You

One of the things that really bugs me about this country is our (relatively) new fascination with financial news.  What bugs me about it is that you can tell from the way in which the news is reported that the American system isn’t really working for the benefit of all of us.  It is really working for the benefit of those of us whom it already has rewarded.

For example, pretty much on an hourly basis NPR will give you an update of what “the market” is doing today.  Stocks are always up or down, but they never, never stay the same.  Except, you know, they do.  If the DOW starts at 12,500, and ends at 12,515, then nothing much has happened.  15 points out of 12,500 is an increase of about 1/10th of a percent.  It is basically statistical noise.  Nothing really has occurred, it was a slow day on Wall Street.

But that isn’t how it is reported.  It is reported as good news:  the market was up today.

And that is another thing that bugs me about our financial reporting, the fact that having the market go up is always considered to be good, while if it goes down, that is always considered to be bad.  This is how reporting on stocks is presented, this is how reporting on housing is presented.  Just 3 weeks ago I was listening to the radio and the announcer exclaimed dolefully that housing prices for the past month were weaker than expected.  As if higher housing prices were automatically understood to be good news, and lower housing prices were equally automatically understood to portend badly for the economy, and you would be a fool and a communist not to instinctively know that.

Except this is insane.

Look . . . the value of a market – any market – is the degree to which it can price goods, services, investments, etc., accurately.  Whether the market goes up (goods, services, or investments are now considered to be worth more) or down (goods, services, or investments are not considered to be worth as much) is basically irrelevant.  What is relevant is whether the new price of the goods/services/investments does or does not more accurately reflect the real value of the goods/services/investments.

Five years or so ago, the housing market was going great guns.  House prices kept marching higher and higher, and people actually thought that they could retire and live the good life merely by purchasing real estate.  Cable TeeVee shows like Flip This House were all the rage, as people tuned in to vicariously experience the thrill of making money buying and selling property.

But, of course, buying and selling real estate doesn’t contribute any real productive power to the economy, and most of these housing increases – we now know – resulted from really, really bad decisions made by investment banks on Wall Street, which were flooding the market with cheap and easy money because they had discovered how to bundle and monetize mortgages so as to sell them on to other investors.  There was no real economic activity, no real productive activity, but the moving about of money allowed us all to pretend that money was actually being made.
As with any type of phantom economic activity, it could not be sustained and eventually came crashing down.  But think about what else was going on while the real estate bubble was being inflated.  A lot of people who may have wanted to buy a home, not as an investment but because they needed a place to live, were inevitably priced out of the market.  So long as housing prices kept going up and up and up, these people were unable to buy and had to continue to rent their housing.  What makes it worse is that there was literally no reason for house prices to get as high as they did.  The market was not accurately reflecting the value of real estate, and because the actual value of real estate was not accurately reflected a ton of people found themselves unable to buy property – it was just too expensive.

The same thing happened a few years before with the stock market.  Remember the tech stock boom?  Remember how the NASDAQ was growing by leaps and bounds every single day?  Remember how people thought they could get rich by quitting their jobs and becoming day traders?  Remember the ubiquitous E*Trade ads, with that annoying Gen X guy giving helpful tips to tired and stolid white collar workers who weren’t hip enough to grasp the magical wealth creating possibilities of the stock market?

Once again, it was a bubble and once again that bubble had to burst.  And, once again, the market – which had been climbing for years, and the climb had been universally lauded as good for America – was based on very little.  The market had failed to accurately reflect the real underlying value of the investments being traded.

(My favorite story from this time involves the Initial Public Offering of a company named “J.com.”  J.com had issued a prospectus in connection with its IPO that announced that the company had no assets, no management and no business plan, but that it anticipated “doing something with the internet.”  Now, it was a penny stock and was initially offered at 25 cents a share.  By the end of the day, shares were trading at about $1.17.  Based on nothing.)

But, while this was ongoing, people who wanted to start investing in the market were being priced out of it.  I know, because I was one of those people.  I had just started my professional career and was beginning to make a decent salary, and as a former finance major (undergrad) I was heavily into the idea of putting money into the stock market on a long-term basis.  But I had been paying attention for a few years, and I was convinced that the market was overpriced.  P/E ratios were so far off their historical scale that I could not conceive that putting my money into the market wouldn’t result in an inevitable loss.

So I waited and waited and waited for the market to correct itself.  And while I waited, the market kept climbing.  So I kept socking my money away in CDs and other instruments that did not give a great rate of return, and I felt increasingly foolish.  But I would eventually be vindicated when the tech boom burst and then – finally – I could start investing for myself.  Still, I would have preferred to have had a couple of additional years where I was making a realistic return on stock investments, rather than the paltry return bank CDs gave me.

* * *

Now, if our financial press was at all self-aware, it would not continue to report markets going up as good news, and markets going down as bad news.  Whether it is good or bad news depends on whether the market is accurate or not.  If – as was the case during the tech boom – the market does not reflect the actual value of the instrument being traded, then even if the market goes down that should be considered good news:  the market is correcting itself to more accurately reflect the real value of what is being measured, which means people can more legitimately decide where they should put their money.

But that is not at all how the financial press reports matters.  And the reason for this is simple:  the financial press is not interested in those of us who are not already rich enough to be investors.  The financial press is interested only in what I call “the Creditor Class.”

Here is how it works.  If you are not wealthy enough yet to have a stock/bond/security portfolio, then you are largely uninteresting.  However, if you are wealthy enough to already have a stock/bond/security portfolio, then your interest is necessarily to see that portfolio increase in value.  Which means that every time the market goes up, you can consider this to be good news.

But this is a lazy way of presenting information.  Seriously, if the financial press were doing its job at all well you might expect CNBC reporters to point out that the market might not be working properly, that perhaps the securities being traded are overpriced, and perhaps smart investors should think about getting out of the market until it had a chance to regain some sanity.  But CNBC reporters never report this.  So long as the market is “up” – for whatever reason, no matter how insane it is – that is and always will be “good news.”

Like I said, the financial press is interested only in those among us who already have accumulated wealth.  If you are like I was 15 years ago, just starting out and trying to figure out how, when and what to invest in . . .  well screw you, kid, you aren’t already rich and so we just don’t care.

* * *

Finally, it should be noted that this concern for the already monied among us isn’t just restricted to the financial press.  It also explains the Fed’s actions.

The Federal Reserve has two somewhat conflicting goals in its charter:  keep a rein on inflation, and keep unemployment down.  The reason these two goals are conflicting is because when you have full employment, you have higher wages.  Which is great for the employees, but it also means that some of these higher labor costs get passed on in the form of higher prices for the goods and services those employees are producing.  The Fed’s job is to try and use monetary policy to balance these two (semi-)competing interests.

Except the Fed doesn’t really do that.  There was an article a few weeks ago in the New York Times by David Leonhardt that pointed out that – time after time after time – when the Fed has been forced to make monetary decisions and to choose between reining in inflation or boosting employment, the Fed always – always – chooses to keep inflation down.  Right now we’re at about 9% unemployment nationwide, and yet the Fed is making decisions as if inflation is the biggest threat we face.

At first blush that doesn’t seem to make a lot of sense, but if you think about it the rationale for the Fed’s actions is very simple:  the Fed, like the financial press, is not concerned with those of us who are not already wealthy.

If you are wealthy enough to be among the Creditor Class, than you already have loaned your money to others – individuals, corporations, governments – who are supposed to return that money to you, with interest.  So if, say, you’ve leant out $100 million dollars to the government, and the government’s bonds are paying you back 5% annual interest, than you can expect to clear $5 million per year.  Simple.

But inflation affects the real rate of return here.  If inflation is 3%, then 60% of your nominal return is going to just keep you treading water in terms of real purchasing power.  What used to cost you $100 is now – a year later – going to cost you $103.  But if you are making a 5% rate of return, you will at least have an extra $2 left over as a real increase in your wealth.  That’s not bad.

But suppose inflation goes up to 7%.  Now that 5% nominal return looks pretty lousy.  What used to cost you $100 now costs you – a year later - $107, but you only have $105 . . . .  you’ve lost money and are just a little bit poorer.  This sucks.

Now most – in fact, the great, great majority – of Americans are not among the Creditor Class.  Sure, a lot of us have investments, 401ks, CDs, etc., but we are still debtors overall.  Think about what you owe in credit cards, student loans, car loans, mortgages . . . and tell me whether you owe more or are owed more.  Almost all of us are debtors.  Only a small percentage of Americans are truly among the Creditor Class, the people who make their money by loaning money to others.

Yet these are the people for whom the Fed works, and these are the people to whom the financial press is talking when it provides news.  This small sliver of the population is who our politicians listen to and who they think about when they are crafting policy.  The rest of us are just along for the ride.

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