Even Minsky Would be Shocked at This “Moment”

Good Evening: U.S. stocks rose today, as some well spun economic data and an upward reversal in Treasury securities combined to support the major averages. Though durable goods orders and jobless claims came in “better than expected”, the news behind the headlines was less than reassuring. And though it didn’t seem to affect the bank stocks today, word from the Mortgage Bankers Association that more than 10% of U.S. mortgages are now either delinquent or in foreclosure indicates that forecasts for a bottom in housing next month are more than a bit premature. To better understand just how so many borrowers wound up in the soup during this cycle, let’s journey back a decade or two and examine what Hyman Minsky and Jim Grant had to say about how economic stability itself would have a hand in today’s Great Recession.

Up, but loitering not far from yesterday’s close, U.S. stock index futures began to rally this morning in the wake of the first economic reports. First out of the chute came jobless claims, of which the widely watched initial claims ticked down a bit. But continuing claims, a decent indicator of whether or not those who’ve lost a job can now find another one, rose more than 100K to a new record. By my unscientific reckoning, this certainly is a jobless non-recovery. Also sporting a nifty headline that obscured the warts beneath was the durable goods release for April. Across the screens rolled “Up 1.9%”, but the 1.3% downward revision to the March figures was given short shrift. The headlines won out and stocks popped 1% once the opening bell rang.

The strength was short-lived once the new home sales figures for April were reported thirty minutes into the session. Coming in at 352K versus expectations of 360K, these figures gave little comfort to those trying to spot a bottom in U.S. housing. Close on its heels came word from the Mortgage Bankers Association that mortgage delinquency and foreclosure rates on U.S. mortgages was not falling, but inconveniently rising (see below). 9.12% of all mortgages were delinquent in the first quarter of 2009, a sharp rise from Q4’s 7.88%. Mortgages in the process of foreclosure rose to 1.37%, meaning that more than one in ten borrowers are in some sort of financial distress. Let’s remember that delinquencies are a leading indicator of future distress, so the needle for housing is still pointing south. This news caused the major averages to slip back until they were all down on the day.

But that was it. The lows were in and stocks began a slow and relentless climb right then and there. Helping boost equity prices along the way was a reversal in the Treasury market (see below). After yields set a new high in the morning, an O.K. 7 year note auction and some short covering pushed yields lower in the afternoon. Whether this temporary reprieve for Treasurys actually aided the stock market rally, I have no idea, but new highs for the year in crude oil certainly boosted energy shares. At the bell, the averages posted gains ranging from 0.5% for the Russell 2000 to 1.5% for the S&P 500. Yields on shorter dated Treasurys were a little lower, but those on the long end declined between 12 and 14 bps as the curve flattened. The happy TBT holders I mentioned last night went home 2.4% poorer this afternoon. The dollar was mixed, climbing against the yen and falling against the euro, but commodities once again went their own way. Lower than expected crude oil inventories sparked a rally in the energy complex, and precious metals were firm. The CRB index rose 1.5% today.

Those who two years ago predicted the housing bubble would end in tears were not bearish enough. That a large rise in delinquencies and foreclosures would be accompanied by falling home prices and economic distress was fairly easy to foresee, but what now looks like a bubble in mortgage trouble was a tougher call to make. Attempting to explain how this whole process unfolded, PIMCO’s Paul McCulley turns to the late Hyman Minsky’s theory of economic stability leading to instability (see below). “The Shadow Banking System and Hyman Minsky’s Economic Journey” is a thoughtful essay that tries to explain how mortgage lending practices in the U.S. went from a responsible form of “hedge finance” to the completely irresponsible practices of “ponzi finance”.

I think if he was alive today, Hyman Minsky would be shocked by how far into the ponzi realm U.S. finance wandered during the late housing bubble, and we’ve certainly had our “Minsky moment”. Mr. McCulley mostly succeeds in reducing into 12 pages what could easily fill an entire book. Minsky’s theory of stability breeding instability fits nicely, though I wish Mr. McCulley had mentioned the Fed’s role in this process. I was also disappointed that he took only a vague and half-hearted swipe at Alan Greenspan’s shameful stewardship as during the bubble years, but I guess he’s showing Sir Alan what I’ll kindly call “professional courtesy” (The Maestro is a consultant to PIMCO).

As with Keynes before him, Hyman Minsky’s contribution to economic theory is undeniable. Minsky first published his views on what would later cripple our financial markets way back in 1986, but the Austrian school of economics merits mention on this topic, too. Jim Grant called upon the Austrians for help and went on to add his own penetrating insights in his 1996 book, “The Trouble With Prosperity”. In Jim’s view, booms and busts are natural parts of capitalism, that each leads to the other as night follows day. As he states in the Introduction:

“Booms do not merely precede busts. In some important sense, they cause them. This idea, on which so much of the analysis of these pages rests, is borrowed from the Austrian School of economics. It was the Austrians who observed that people in markets periodically miscalculate together.”

One of his main points is that, by intervening to prevent the pain of economic downturns, we can hinder the upside (or, worse, allow imbalances to build up until they reach the catastrophic proportions that wreaked so much havoc in 2008). Creative destruction and the healthy clearing away of the cyclical debris shouldn’t be stymied. Japan’s post-bubble malaise during the 1990’s is a prominently cited example of this short-sighted tinkering, but Jim took the Alan Greenspan Fed to task on this very subject in both the book and subsequent essays. Jim turned out to be so spectacularly right on this subject that he can be forgiven for being more than a decade too early in worrying about the U.S. financial system. In closing let me say that the published works of both Minsky and Grant should be required reading for any new Fed governor. It’s more than a shame these foresightful insights were ignored by the Maestro; it’s appalling.

— Jack McHugh

U.S. Stocks Rise, Led by Banking, Energy Shares as Bonds Gain
Treasuries Rise as Yields, ‘Difficult’ Economy Bolster Demand
Mortgage Delinquencies Rise to Record on Job Losses
The Shadow Banking System and Hyman Minsky’s Economic Journey, by PIMCO’s Paul McCulley

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