A Bright Golden Haze
There's a bright golden haze on the meadow,
There's a bright golden haze on the meadow.
The Dow is as high as an elephant's eye,
An' it looks like it's climbin' clear up to the sky.
Oh what a beautiful morning!
Oh what a beautiful day.
It's far too pretty for trading,
So why don't we play golf today.
With apologies to Rodgers and Hammerstein, it appeared as if the lovely spring day in the Northeast took its toll on market activity today. It has always been the case that good weather tended to cause trading to slow, but as trader bonuses have gradually disconnected from performance over the last few years it seems as if the pattern has been accentuated. True, there wasn't much to trade on today...but in the past that didn't seem to matter quite so much.
That said, I won't stop at merely butchering show tunes as there are one or two recent stories I'd like to address from yesterday that I didn't broach in that somewhat-lengthy article. The first is the news that President Obama's latest tax plan includes a provision to cap IRAs at $3 million. To most of us, that's a lot of money, although the article points out rightly that if you are a business owner who has contributed to a retirement plan as long as it has been available, it is fairly easy to get numbers above that level without needing extraordinary returns. Thrift, and compound returns, are two of the only three investing miracles that can produce great wealth with little effort (the third is rebalancing - look for my book "Only Three Miracles," due out in roughly 2023).
But more disturbing is the fact that the White House has not said whether this $3mm level would be indexed for inflation (or, for that matter, whether it would affect defined benefit plans or Roth IRAs on which you've already paid taxes). If it is not indexed for inflation, then any readers of this column could be 'capped out' of tax-advantaged structures with sufficient inflation. And, since there is no reason that inflation could not reach scary levels, given the right circumstances, this is something that every investor should be aware of.
It is also disturbing to me, personally, that according to the story:
"The White House said in an April 5 statement that under current law 'some wealthy individuals' can accumulate 'substantially more than is needed to fund reasonable levels of retirement saving.'"
Maybe I am the only person who is concerned about the use of the word "reasonable" here, as if my decision for what amount of savings I want to accumulate, rather than spend, is open to someone else's validation of whether my savings is "reasonable." But I suspect not. This statement isn't part of the law, but it is part of the context under which laws are being proposed, and I think this means that we investors (including unreasonable ones, who should be spending much more and saving less, darn it) ought to be paying attention.
The other topic I want to include concerns the remarks of Chairman Bernanke yesterday at a conference in Georgia. I've previously pointed out in this space that selling assets from SOMA or letting those bonds run off are not feasible approaches for the Fed to take when it comes time to tighten. Apparently, the Fed now agrees, after having previously discussed (publicly) these options. Bernanke remarked in his response to audience questions that "asset sales are late in the process and not meant to be the principal tool of policy normalization" and that rather the Fed prefers to adjust the interest rate paid on excess reserves (IOER) as its main policy tool.
My main complaint about the IOER tool is that we have no idea how it is calibrated, and whether a small adjustment can cause important amounts of liquidity to be pulled back from the market. Moreover, I think this is a defensive tool - the Fed needs to keep the Excess Reserves from becoming Required Reserves by having banks expand lending too quickly. But consider the difficulty: if a bank has $1bln in excess reserves and $50mm in required reserves (for example), and increases lending by 50% so that required reserves rise to $75mm and excess reserves fall to $975mm, then by how much does the Fed need to raise IOER, currently at 25bps, to induce the bank to hold $1bln rather than $975mm in excess reserves? This is the problem - the Fed isn't operating on the variable that they actually want to control.
The picture below is a slide from the presentation I will be delivering this month at the Inside Indexing event in Boston. Notice the relative sizes of the excess and required reserves slices. The Fed needs to take big swipes at the excess reserves piece without damaging the required reserves piece too much. This strikes me as being somewhat more challenging than the Federal Reserve currently seems to believe.
I continue to think that the best solution for the Fed, and also the one least likely to be deployed, is to raise margin requirements to make official the unofficial policy of de-leveraging banks. By doing that, they will with one wave of the magic monetary wand cause excess reserves to vanish and they can operate again on required reserves.
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