vinod1
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Posts posted by vinod1
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Vinod, instead of worrying about what the float will earn why don't you look at the float as a liability?
Then you can go about valuing the insurance business this way:
Investments + capitalized underwriting profits - PV of float liability - Goodwill.
rb,
We can do BRK valuation different ways and I do that too. However, the only valuation approach on which I have confidence is one based on owners earnings. When shit hits the fan, it is the only thing that gives me enough conviction on an investment. Nearly every investment mistake I made is because I misjudged earnings. I see that pattern among Buffett and other greats as well.
So my strong bias is to look at the earnings an investment can generate. Above, I am basically looking at all the earnings that BRK can generate (even though some are just look through) that accrue to the owners.
Coming back to float, you need to make some assumptions about it. Almost all the other parts of BRK are pretty simple to value. We can nit pick about the multiples a bit here and there, but there is not much ambiguity in most of the business. The thing that drives uncertainty in BRK valuation is float and its reinvestment opportunity. Even if you do not explicitly value float, you are basically making some assumption implicitly about its value. Better separate it out, that way you can change its value if something changes related to it.
Vinod
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At the end of 2019 my model assumed "normal" BRK.B look through earnings of $12 to $16 per share, and a growth rate of 6% to 8% (a base case of $14 per share look through earnings and 7% growth).
Since then I've impaired my estimates to incorporate post-covid margin compression for financials, and more modest growth expectations.
I now model for look through earnings of $8 to $12 per share, and growth of 5% to 7% (a base case of $10 per share and 6% growth).
For me, intrinsic value falls somewhere in the neighborhood of $240 per B share. I'm perfectly comfortable owning the stock at the current price, and would happily buy more below $160 per share.
Thanks for laying out the assumptions. Without knowing one's estimates of earnings, growth rate of earnings and discount rate, it is difficult to know where there is disagreement if any.
In the base case as of Q1, 2020, I have normalized earnings as $12.5 per share, excluding any earnings from float. Growth rate of 8.5%.
To me, it looks like any differences in IV estimates for BRK really boil down to
1) The value of float. This is harder to assess as it is dependent on interest rates and investment opportunities. One simple and likely very conservative way is to assume that $60-80 billion would always remain in cash and as long term interest rates may remain low for a long time, essentially are not worth much. So we end up valuing the rest of the float or about $50 billion.
Or assume it is going to earn some low rate on the total float and it ends up adding $0.5 to $1 per share.
2) The discount rate.
So you have ROE of about 8.5% which is consistent with the growth rate assumption as well with 100% earnings retention.
If you pick a discount rate of 7%, you have to have to look through 30 years to make it worth 1.5x book value.
The question I have for you is, if you assume a growth rate of 6%, why would it be worth even book value unless your discount rate is less than 6%?
Vinod
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Neil Ferguson is a charlatan. Injecting bleach is genius! Trump supporters at their best.
I can see why college educated women would not date Trump supporters!
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I agree with educating children on finances. But would even go further. Just like you have a driving test before you drive, have a test with basic information about stocks, biases, etc. and only if they pass they should be able to open a trading account for stocks and options. Else they would only be limited to broad index or active funds.
Vinod
This is an excellent idea. While maybe annoying, is there any reason at all it doesnt make sense to mandate an individual with limited investing experience take a brief online tutorial/course prior to being permitted to open a trading account? Doesnt even have to be pass/fail, just a basic intro of "hey this is what you're getting in to".
I think the best argument against it is empirical rather than philosophical -- it wouldn't actually do anything to change people's behavior, but it would allow those who wish to do so to say that appropriate steps were taken and "You were warned. It's on you." In short, it seems to be a symbolic act, rather than a real effort to solve a problem.
That being said, my objection could be tested by some type of randomized trial to see if the proposal has any effects. If it actually does change outcomes in a good way, then I see no reason not to do it.
You might be right.
My thought process is to view it as similar to driving. You can just say people drive the way they want to drive and that self interest should ensure that they would try to minimize accidents. So there is no need for a driving test.
I think that making people aware of basic signs, yield, right of way, double yellow line, etc. they become more likely to follow rules than if they have never even been made to go through that written and a driving test.
I would think that something similar is likely. Just like we do not eliminate drunk driving or reckless driving completely, we could reduce it.
In 1999 I bought two stocks about $1000 each. I think after reading an article on each. :) They went to $6800 before going to nearly zero. I had no idea if I lost money because stock market is a giant gambling machine and I just got the wrong cards, or if there is some approach that I am supposed to follow and did not know about it or something else.
That curiosity led me down the path of my interest in investing. Went through all the books of the investing section of the local library twice over the next couple of years.
Assuming I am not a complete idiot (may not be a safe assumption), many people new to investing might be similar to me and do not really know much about the stock market. By making them aware of very simple investing knowledge they would be less inclined to do what I did.
We are not going to avoid it completely but I would think it would diminish some of errors people make. Just by putting this kind of gate, we can reduce the number of people who get into trouble with single stocks and options.
Imagine you set this kind of test at some threshold that requires some basic numerical literacy and understanding of financial concepts, I think that might say not allow some x% who do not meet that standard from being able to even get into trouble as they would be unable to open an account for individual stocks or options.
Of course, the remaining 100% - x%, might feel like geniuses for passing the test and trade even more recklessly :) so you might end up being right.
Vinod
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I agree with educating children on finances. But would even go further. Just like you have a driving test before you drive, have a test with basic information about stocks, biases, etc. and only if they pass they should be able to open a trading account for stocks and options. Else they would only be limited to broad index or active funds.
Vinod
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Likewise, we expect recent high school graduates who join the Army to obey the laws of war despite extreme conditions. We expect police in their early 20's to exercise restraint and good judgment at all times, even under duress, under penalty of jail if they don't meet that standard.
OT? I am afraid that our expectations in both of these cases are too high. In fact, I am afraid that our expectations of human behavior in general are too high. Whether applied to young people in their 20s, or people in general, or "highly rational" investment professionals frequenting certain investment forums, or even people at the highest levels of business or politics.
Yeah, that makes me a misanthrope. :-\
Also see my signature.
This is nonsense....I’ve seen children (first hand) in third world countries have more responsibility and act more “adult like” than your average millennial. Notice the more laws we create to coddle individuals, the softer society becomes and the more coddling it needs. If you have low expectations of society and individuals (and let them know it), you’re pretty much guaranteed to get poor results.
I’m a firm believer in the saying “Hard times create strong men. Strong men create good times. Good times create weak men. And, weak men create hard times.” If I had to pick a point as to where modern society is, I would say somewhere in the bottom of the “good” inning.
Do not mean to argue with you. It is something, if I remember correctly, Billy Bryson wrote about. He talks about how while he was talking with a parent from some tribe that has not yet been introduced to modern world, the 2 or 3 year old child keeps playing with a very sharp knife and every time the kids drops the knife, the parent keeps handing it back to the child. I am sure by the time the kid grows up to 7 or 8 he becomes an expert at it. But there is a downside to it.
Do you know how many children in those countries do not have arms, legs, one or both eyes damaged? Yes it teaches responsibility but you need to be willing to live with the pain, which means you need to be able to say I am fine if my child loses an arm or a leg or his eye. In a rich developed country, your tolerance for that would be low.
I grew up in India, so I am well aware of what you are saying. Just pointing what you need to be willing to give up as well.
Vinod
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cherzeca - Fantastic advice to all parents. Noted down all your comments. Thank you!
rkbabang & SharperDingaan - Great advice! Thank you!
It is always surprising to me how much good non-investing advice there is on this forum from fellow board members.
Vinod
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Common sense to a Trump supporter - Injecting with bleach :)
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Wow! that is some of the DUMBEST stuff I have heard in my life. And I've heard some whoppers.
I know I'm gonna be sorry for it, but I must still ask, if he's so busy causing covid? Why is he planting bricks?
Yup, I know it is absolutely crazy but something like 44% of republicans have been found to believe Bill Gates is planning to implant microchips in everyone via vaccines. Don't know whether to laugh or cry at that one. See https://www.bbc.com/news/52847648 and https://www.businessinsider.com/bill-gates-vaccine-conspiracy-theories-are-stupid-2020-6 for some of the craziness.
The bricks come in within all these theories because Bill Gates apparently hates and is scared of Trump (who might expose and counter him as the story goes) and wants to damage him by making the protests violent. That is about as far as I can figure out since they don't make much sense overall (some claim that Bill Gates wants to kill 15% of all people via vaccinations but some don't so there is quite a bit of variation to this nonsense).
Pity them. Imagine if someone believes these kinds of things. How are their relationships going to be with their family members? How effective would they be at work? How much anger and frustration must be boiling over in their minds?
They are likely frustrated every waking minute. This frustration oozes out of every post they make for example.
Count your blessings that you are not them.
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In a way, - I don't know which - the current line of posting in this topic has to stop.
For those interested, here is a distilled list of best-evidence that has built up over the last few weeks versus prevention of transmission.
https://academic.oup.com/jid/advance-article/doi/10.1093/infdis/jiaa189/5820886
https://www.thelancet.com/journals/lancet/article/PIIS0140-6736(20)31142-9/fulltext
From a humble perspective, a detached and rational approach tends to avoid running into sterile debates and tribal drift but i often feel like an idiot.
It's fascinating that this virus, which is somewhat benign from an evolutionary standpoint, stirs so much reptilian instincts and one has to wonder about the host (and its institutions).
Maybe i focus too much on governance issues.
Here is another one :
https://wwwnc.cdc.gov/eid/article/26/9/20-2272_article
Runs a bit against my hypothesis that truly asymptomatic (And those that never show symptoms) younger people aren’t likely superspreaders. Well, it seem they can be.
Whether one is truly asymptomatic or get some mild symptoms later is not that important. Its been clear for a while that there is asymptomatic transmission, which happens while talking. To some extent masks help but not eliminate small tiny droplets floating in air and its difficult to wear masks continuously.
That is why Japanese say "ventilation is key". That makes everyone life easier. And now we know it works. I think we should copy what works. That is not to say not to use masks or stop washing hands or stop safe distance. But no need for enforced lockdowns.
About that mask thing...
https://www.washingtonpost.com/nation/2020/06/17/pelosi-masks-house-rule-jordan/
You can't even get the leadership of the country to put on a mask.
From the linked article:
“Can you smell through that mask? Then you’re not stopping any sort of a virus,” Rep. Clay Higgins (R-La.) told CNN last month, an argument not supported by science about the disease’s spread. “It’s part of the dehumanization of the children of God. You’re participating in it by wearing a mask.”
To the Russian backed Trump's supporters, this all makes sense along with injecting bleach.
Trump, the only American President to run away and hide from people in a bunker, it is a way of making up for his cowardliness.
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WSJ article by Peggy Noonan
https://www.wsj.com/articles/on-some-things-americans-can-agree-11591313189?mod=hp_opin_pos_1
As to the president, this week he altered his position in the political landscape. Something broke. He is no longer the force he was and no longer lucky. In some new and indelible way his essential nature was revealed.
It got out that faced with protests around the White House, he hid. Or perhaps let the Secret Service, which might have struggled with realistic threat assessment, talk him into going into the White House bunker. (Mr. Trump later said he was simply “inspecting” it.) He tweeted that he was protected by the “most vicious dogs” and “ominous weapons.”
On Monday, he spoke in the Rose Garden. “I will fight to protect you,” he said. “I am your president of law and order.” This was unsubtle, and seemed more aimed at protecting his political prospects than your safety and property.
Then, upset that people might be getting the impression he was a physical coward, he set out to prove he is brave. Protected by a phalanx of police, Secret Service, sharpshooters and what looked like a Praetorian Guard with shields, he marched to St John’s, the church of the presidents. Aides said it was a Churchill moment. And it was just like Churchill during the blitz, if Churchill secretly loved rubble. Upon arrival with his friends, the people who work for him, he brandished a Bible like—who in history?—the devil?
In all this he gave up the game and explicitly patronized his own followers. It was as if he was saying: I’m going to show you how stupid I know you are. I’ll give you crude and gross imagery and you’ll love it because you’re crude and gross people.
And some would love it. But not all. Not most, I think.
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Holy shit! Everyone in the US needs to read and reflect deeply on what Mattis wrote. Mattis is a Republican, a professional soldier, a patriot and has intimate knowledge of who Donald Trump really is as a person and how he thinks and acts as President. This message is not from a partisan Democrat hack. Mattis’ is very clear in his assessment of the situation and the President. Donald Trump is clearly not fit for office (and it is not even close). How anyone with a working brain can continue to support this man completely boggles my mind. No, the alternative is NOT worse. That is a false choice. Read the underlined section below if you still do not understand why he must be defeated at the polls in November.
“...Donald Trump is the first president in my lifetime who does not try to unite the American people—does not even pretend to try. Instead he tries to divide us. We are witnessing the consequences of three years of this deliberate effort. We are witnessing the consequences of three years without mature leadership. We can unite without him, drawing on the strengths inherent in our civil society. This will not be easy, as the past few days have shown, but we owe it to our fellow citizens; to past generations that bled to defend our promise; and to our children.“
Dont expect his supporters to change though.
They were brain washed to believe that the lockdown is a liberal effort to bring down the president by hurting the economy. By the same standards, Trump supporters must be cheering the violent way in which Floyd was killed and the ensuring riots. Since this is likely to increase support for the Trump just as it did for Nixon in 1968.
Trump would be hands down winner for Osama Bin Laden's lifetime achievement award for causing the greatest damage to US by anyone in living memory.
Vinod
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The U.S. government literally ran out of cash dollar lenders for their Treasury securities; both domestic and foreign. In reality, the root cause was that the U.S. government ran out of lenders. Foreigners, pensions, insurance companies, retail investors, and finally large banks and hedge funds, simply weren't buying enough Treasuries at that point compared to how many Treasuries the government was issuing, at over $1 trillion annualized. They had no excess dollars from which to lend to the U.S. government at those rates.
Vinod - her explanation of the Sept repo crisis is just goofy....and wrong. I don't think she totally understands how any of this works.
In order to understand the Sept repo "crisis' - you have to understand that this was the Federal Reserve causing a self-inflicted wound to itself by not keeping its eye on the ball when it comes to its most important function - running the US payment clearing system between banks.
US PAYMENT CLEARING SYSTEM:
The Federal Reserve manages the US payment clearing, netting and settlement process between federally-chartered banks and thrifts (also includes a few other financial firms but also the US Treasury, of course). Banks have checking accounts at the Fed and those balances (reserves) are used to make sure all inter-bank payments clear and no bank overdraws its account during daylight hours. Despite all the focus on FOMC meetings, etc - this is the single most important reason why the Federal Reserve system exists.
So what is the sum total of financial transactions processed in a day, a week, a year? The Fed provides this data for the two major payment clearing systems (Fedwire - which is run by the Fed) and (CHiPS - which is run by ~50 big US banks and the US subs of foreign banks but does the final settlement with the Fed). Here are their transaction volume summaries:
FEDWIRE:
https://www.frbservices.org/resources/financial-services/wires/volume-value-stats/monthly-stats.html
CHIPS:
In 2019, Fedwire processed $696t in US payments while CHIPS processed $417t in US payments. That's a total of $1.13 quadrillion in annual financial payments cleared (vs $21t US GDP) There are also a small amount of transactions settled in cash but we can ignore those. That's over $3.1t per day. But I do like to say "$1 Quadrillion Dollars!"
ROLE OF BANK RESERVES IN PAYMENT CLEARING:
All inter-bank payment clearing happens at the Fed. To participate in this activity, banks have "checking accounts" at the Federal Reserve. The key question is what is the right amount to keep at the Fed given the very high transaction amounts. What governs the amounts banks have to have there is the Federal Reserve itself (including its regulations and practices). Let's use our own experience with a checking account and how we would manage our finances - one with overdraft protection and one without. Since we are all investors, we would prefer to keep the minimum possible in this checking account because there is an opportunity cost to keep large balances vs holding stocks, etc.
So on a particular day, we have a large bill payment to make but we are also expecting our bi-weekly pay via direct deposit to come in that day as well. What we don't know is the order in which these transactions will hit our account (plus there could be a surprise outflow we forgot about). If we keep the balance low and the bill payment goes out before the pay comes in, we'll go into a daylight overdraft and get hit with large overdraft fees by the bank. But if we have overdraft protection from the bank, we don't care what the order of transactions is, because the bank will cover us for any short-term negative balances.
Banks manage their reserves with the same thought process - do they lend out reserves to other banks for some income or do they play it safe. This is where the Fed, its interest rate management policy and its regulatory rules come in. Pre-GFC, the Federal Reserve would allow banks to run negative reserve balances intra-day (which the Fed would cover) so long as they ended up at the end of each day with a positive reserve balance. If some bank looked like it was going to be short, it would try to borrow reserves from banks that would be over. This might cause interest rates for Fed funds (reserve balances) to increase. If this was threatening to make the Fed funds rate to rise above the target of the Fed, the Fed would come in with a repo operation - supplying reserves for Treasuries to get the interest rate back to target. This Fed interest rate targetting is called a corridor system (ie, the interest rate on fed funds stays within a band target set by the Fed and the Fed intervenes when it threatens to break above or below the band - thus the "corridor")
But back then, the total excess reserves at the Fed were less than $10B - to clear daily payments of $2-3t per day. Just like us with overdraft protection at the bank, the banks had daily overdraft protection at the Fed and ran with extremely low reserve balances.
After the GFC, the Fed changed the rules for banks. Daylight overdrafts were no longer permitted (the Fed would cover in an emergency because the Fed must ensure no payment ever fails to clear, but basically the bank CEO would lose his/her job), In addition, there were other rules imposed - there were "living will" requirements that forced banks to hold reserves to cover a certain number of days of payment clearing, etc.. In addition, the Fed expanded its balance sheet to force reserves to expand in size. (remember its the Fed, and not the banks, that control the size of total bank reserves). Now the Fed changed its interest rate management strategy. It no longer needed a corridor, since there were more reserves than banks needed - it went to a "floor" system and paid an interest rate on excess reserves. Fed repo operations basically ceased. The problem for the Fed is no one really knew where the 'floor' was anymore. I mean when you have trillions in excess reserves - how can any payments not be cleared?
JPM MORGAN CHASE & RESERVES/REPO:
JPMorgan is the biggest and most important bank in the US. It also has the largest amount of bank reserves since the GFC and thus is, at the margin, the lender of last resort to other banks who need reserves. Here is a chart that shows quarterly bank reserves for JPM since the GFC (these are from the FFIEC's quarterly bank Call Reports).
So a few things to note about this chart. Prior to the GFC, JPM managed its payment clearing at the Fed with only $2-4B in reserves. Payment clearing volumes have not changed much over that time - total payments grow in line with GDP growth. Then when the Fed started doing all of its QE, JPM's reserves grew to a peak of $450B (over 100x pre-GFC) in March, 2015. As the Fed began to shrink its balance sheet in 2016-2019, total bank reserves began to shrink (and JPMs reserves shrink too). But where is the redline? Especially under the new regulations? At what point do individual banks like JPM think - I don't feel that I have any excess reserves to lend because of the new rules and regulations?
Well - it turns out that point was reached in mid-Sept 2019! All it took was three days (Sept 13, 16, 17th, 2019) of large tax payments by the US private sector to the US Treasury (in excess of Treasury daily spending) that moved a net $125B from bank reserves to the US Treasury's general account at the Fed (data from the US Treasury Daily Statements for that period). On Sept. 11, 2019 - total bank reserves per the Fed H.4.1 report stood at $1.458T. Normally (125/1458 =) a 8.6% short-term reduction of bank reserves shouldn't push the payment system from Defcon 5 to Defcon 1 in the space of a few days. But unbeknownst to the Federal Reserve, the regulations and rules imposed on the banks limited their ability to deploy their excess reserves to help each other square up at the end of each of those days. JPM's reserves stood at ~$119b at June 30 and Sep 30, 2019 (which were their lowest levels since the GFC). The signs were there, though, at previous quarter-ends there were very brief spikes in fed funds rates but nowhere near what happened on Monday and Tuesday Sept 16 and 17.
Here's JPM's Jamie Dimon on his Sept 30 earnings conference call:
..we [JPMorgan Chase] have a checking account at the Fed with a certain amount of cash in it. Last year, we had more cash than we needed for regulatory requirements. ... But now the cash in the account, which is still huge. It's $120 billion in the morning, and it goes down to $60 billion during the course of the day and back to $120 billion at the end of the day. That cash, we believe, is required under resolution and recovery and liquidity stress testing. And therefore, we could not redeploy it into repo market, which we'd have been happy to do."“... we believe the requirement under CLAR and resolution recovery is that we need enough in that account such that if there’s extreme stress, during the course of the day, it doesn’t go below zero. You go back to before the crisis, you’d go below zero all the time during the day. So the question is, how far is that as a red line? Was the intent to regulate it between CLAR resolution to lock up that much of reserves in account at the Fed. And that will be up to regulators to decide. But right now, we have to meet those rules. And we don’t want to violate anything we told them we’re going to do."
So there you have it. This was a bureaucratic and regulatory FUBAR that forced the Fed to resume its repo operations (and thus go back to a 'corridor' system from a 'floor' system in terms of controlling the fed funds rate). Nothing more or less than that. It wasn't because the US Treasury was issuing too much debt -- quite the contrary, the cause was actually the opposite - i.e, the US Treasury running a small 3-day surplus. I'm not a conspiracy theorist - but as the biggest bank, did JPM force the Fed's hand here? Was Jamie Dimon chafing at holding too much cash at the Fed and wanted a little loosening of the regulations? I would never want to accuse Jamie Dimon of anything here, but nor would I want to play poker with him. But if I had to bet between the bureaucrats at the Fed vs Jamie Dimon, I know who I would bet on.
Once again, sorry for the long-winded response but my wife always jokes that she doesn't want to ask me the time, because I go into explaining how the watch is made.
wabuffo
This is immensely helpful! Thank you very much.
Vinod
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This is by far the best explanation of how QE works and its effects on inflation/deflation.
Pretty long article, but well worth the effort.
https://seekingalpha.com/article/4343574-qe-mmt-and-inflation-deflation
It even goes into the Repo spike in 2019 and explains why it happened. Good stuff.
An Example of Running Out of Real Borrowers
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But by September 2019, foreigners stopped buying Treasuries again, and became net sellers of them instead. At the same time, most domestic lenders weren't able to buy more Treasuries either. Corporations weren't buying. Pensions weren't buying. Insurance companies weren't buying. Traders and mutual funds were only buying a little bit. Model 1 of domestic government financing started to run out of lenders.
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The U.S. government literally ran out of cash dollar lenders for their Treasury securities; both domestic and foreign. In reality, the root cause was that the U.S. government ran out of lenders. Foreigners, pensions, insurance companies, retail investors, and finally large banks and hedge funds, simply weren't buying enough Treasuries at that point compared to how many Treasuries the government was issuing, at over $1 trillion annualized. They had no excess dollars from which to lend to the U.S. government at those rates.
In one alternative world, the repo rate would have remained very elevated, and repo borrowers like hedge funds basically would have had to stop buying Treasuries and even start outright selling them (you can't borrow at a 7% repo rate to hold 2%-yielding Treasuries on a sustained basis). The interest rates on Treasury securities would have had to rise considerably to attract a totally new pool of buyers (such as foreign pension funds), and even that would have probably been insufficient. With interest rates much higher, that would have put massive downward pressure on equity prices and other risk assets, and would have put immense pressure on the U.S. government budget due to higher interest expense and lower capital gains tax revenue.
In the real world, since the U.S. is a monetary sovereign, the Federal Reserve stepped in with newly-printed dollars out of thin air, and started buying Treasury securities, due to a lack of any more real buyers at those low rates. For the first two weeks starting the day after the repo spike, the Fed lent newly-created dollars to other institutions to buy Treasuries with (basically nationalizing the repo market to reduce the interest rates), but when that quickly proved insufficient, the Federal Reserve began outright buying Treasury bills with newly-created dollars. In other words, the Federal Reserve allowed the U.S. government to keep funding its domestic spending plans at current interest rates, without finding new real lenders for their rising deficits. They just created new dollars to buy Treasury bills and fill the difference between what the government wanted/needed to borrow, and the dollars that real lenders were able to lend.
....
When banks ran out of cash to buy more Treasuries, the Federal Reserve printed up some digital cash and took their place as the primary accumulator of Treasuries. Months before the economic crisis from COVID-19, the Federal Reserve began accumulating Treasuries at basically the same rate they were issued, meaning it was monetizing virtually all net new government debt.
...
Imagine, for example, that the Treasury (authorized by Congress and the President) decides to spend a trillion dollars to send every American $3,000 in the next round as a stimulus. The Treasury would issue Treasury bonds to pay for it, primary dealer banks would buy them at auction, and the Federal Reserve would create new digital dollars to buy them from the primary dealer banks and accumulate them on their central bank balance sheet. If we follow the flow from beginning to end, new dollars were created at the Federal Reserve, sent to primary dealer banks, sent to the Treasury Department, and sent to the public, which get deposited in their accounts via direct deposit or mailed checks (which directly increases broad M2 money supply). The Treasury security moves the other direction, from the Treasury Department to the banks and then ultimately to the Federal Reserve's balance sheet. This is an example of QE truly "printing money" and getting that money to the public.
Similar capital flow models apply for corporate bonds, mortgage-backed securities, or other securities. If they wind up on the central bank balance sheet, bought with newly-created dollars, it effectively means that money was created from thin air to provide capital funding for a company or the mortgage market, rather than extracted from elsewhere in the economy. New money entered the system. This set of funding doesn't really reach Main Street like it does when QE is used to fund Treasury securities, but it does enter the financial system as it relates to asset prices.
So, "does QE money make it to Main Street?" is not the main question because it depends specifically on what securities are bought with QE. When QE is used to buy mortgage-backed securities, corporate bonds, stocks, or other things, it mainly goes to financial markets rather than Main Street. When QE is used to buy Treasuries in a normal sense, it makes it to Main Street in the form of supporting existing government spending (much of it on Social Security, Medicare, and military) that isn't fully supported by taxation or real lenders. If QE is used to buy Treasuries for crisis-level helicopter money (checks in the mail, direct deposits, extra unemployment benefits, negative payroll taxes, or whatever the case may be), then it gets to Main Street more obviously.
Vinod
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I would imagine most of the COBF board members would not be changing their spending habits if interest rates on savings are 1 or 2% higher, if they notice them at all.
Macro forces are powerful and sometimes you can't feel them as they move slowly. But as I showed earlier the numbers are quite large.
Ok - let's try this a different way. Think of it from a pension perspective - similar to a defined benefit pension plan.
Lower rates increase the future liabilities in present value terms due to the effects on discount rates.
Lower rates also affect expected returns on current assets. They are lower.
The effect of lower returns on assets and higher present value of liabilities for a pension (or for someone trying to save for retirement) is the requirement for more cash to be put into the retirement plan. This diverts from consumption.
Again I point to how as the Fed was raising rates in 2018 led to higher quarterly GDP prints (3-3.5% per Q). After the Fed did a U-turn and starting dropping rates in 2019, quarterly GDP fell to the 2-2.1% per Q range. No doubt, the US economy is complex and subject to a multitude of forces - but I am convinced that lower rates hurt the economy more than they help.
We can agree to disagree. Its an interesting question, though, to ponder that the Federal Reserve could be hurting the US economy when it thinks its helping by lowering rates. This is different than its effect when it is acting as a lender-of-last-resort (which has nothing to do with rates) as it has been in this crisis.
wabuffo
Thanks for taking the time to help me understand. Appreciate your thoughtful response. I need to think some more about this.
Vinod
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This is helpful to the economy the way I see it. With QE, Treasury is not borrowing money from the public to pay the interest. So how is the public missing out on the interest income? Public did not lend money and they are not getting interest. So no effect in that regard.
The US Federal Govt spends first, then borrows. If not, how does the private sector ever get the govt's money? Taxation and other forms of payment to the US government create the private sector's need for the government's money which the govt provides via spending. It then borrows to remove the reserves it has created in the banking system.
States and municipalities can't do this since they are not allowed to issue their own currencies. This is why the Eurozone has so many problems - nations like Greece and France can no longer issue their own currency and must balance their budgets. Even here it is interesting to watch states like Illinois and California sometimes get into severe budget crises and then issue IOUs which they give value to (in order for vendors to accept) by allowing these IOUs to extinguish state tax and fee obligations.
This proves the model that US Federal govt's money is basically an IOU that the private sector needs to extinguish its tax liabilities - except its more formal and systematized such that we don't even think about it at all. It follows that the Federal govt (after creating the tax obligations, must spend first in order for the private sector to be able to pay its taxes - just like a municipal bus system must issue tokens first, so that riders can exchange them for bus rides).
Now, instead of borrowing from the public (via selling of Treasuries), it gets money from the Federal Reserve (indirectly via the Banks) and what does it do with the money? It spending it on the public. Especially all the COVID programs. They are spending it without either taxing the money from the public or borrowing from the public.
So why is that not massively helping the economy? Yes, the concerns about this seemingly easy way to fund the Government programs are valid, but we cannot say it is not helping the economy.
I'm not following what you are saying here. Could you re-phrase?
wabuffo
The way I see it, a Government can generate money in 3 ways to fund its expenses
1. Taxes
2. Debt
3. Direct debt monetization (Printing money). I understand the US has legal protections where it cannot do that directly. Treasury sells bonds to primary dealer banks, then the Fed Reserve buys the bonds from the primary dealer banks. Because the Fed intention is that they would only be holding these bonds "temporarily" and would sell the bonds to the public later on, we can go with the assumption and/or pretension that debt is not being monetized.
When Govt does #1 and #2, it is taking away money from the public to fund its expenses. So the public has less to spend on other things.
QE is helping fund US Govt at lower rates than would otherwise be the case. In addition, to the extent that Fed does not sell the bonds to public at a later time, that part of the debt is directly being monetized. So instead of some other entity (US Citizens, other countries, etc) buying the US Treasuries, it is Fed that is ending up owning these US Treasuries.
Point being, this is money that is not being "extracted" from anyone. It is being generated out of nowhere. As to the risks of this, that is a separate discussion. But if you can do this, why would it not be helpful to the economy? At least in the short term.
Vinod
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Take a simplistic case of savers being all billionaires and debtors being all poor households.
Vinod1 - let's move from the hypothetical and go right to the film. From the Fed's Z.1 report:
https://www.federalreserve.gov/releases/z1/20200312/z1.pdf Cop a squint at p.152
From that page, here's a high-level balance sheet for US households (Q4, 2019 - $billions):
ASSETS:
04. Real Estate (households - owner-occupied).....$29,326
11. Time and Savings Deposits...........................$10,163
12. Money-Market Fund Shares...........................$ 2,148
LIABILITIES:
33. One-to-Four-Family Residential Mortgages.....$10,610
34: Consumer Credit........................................$ 4,191
So let's ignore the effect of low rates on pensions and post-retirement benefits. This household balance sheet snapshot at the end of last-year shows about $12.2 trillion held in short‐term rate‐sensitive instruments like savings accounts and money market funds.
On the liability side, most household liabilities are fixed‐rate mortgages, where payments are unaffected by rate changes. Consumer credit is made up of credit card debt and car lease payments and totals $4.2 trillion, most of which is also fixed. But let's assume that 25% of the household debt can be made variable interest.
Net, net - (assuming 75% of the liabilities are fixed rate) we can estimate that households have about $8.6 trillion in exposure to short‐term interest rates, so a 1% change in rates adds about $86 billion to annual income. Thus, I maintain that lowering rates punishes households more than it helps them. Its not a coincidence, IMHO, that GDP growth took off in 2017 and 2018 when the Fed started to raise rates and slowed down in 2019 when they started to lower them again.
wabuffo
Thank you for the explanation and the link to data.
My point is that it ignores the distribution of wealth and income across the population. I am not sure about the numbers, but from what I remember the bottom 50% of the population have very little savings. Much of the savings are likely in the top 25% of the population with top 10% owning a lot of these savings.
To those in the top 10%, the interest income is unlikely to make any difference to their propensity to spend. Older retirees with modest portfolios would be most impacted, I concede.
I would imagine most of the COBF board members would not be changing their spending habits if interest rates on savings are 1 or 2% higher, if they notice them at all.
Vinod
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I think he used a poor choice of words - instead of deflationary, I think he's not talking about a monetary vector, but an economic one. He means slower growth - and not monetary deflation such as occurs in a financial debt panic.
The reason for QE being an economic growth suppressant, in my view, is for two reasons:
1) QE tries to push rates down. But, low interest rates punish savers more than they help debtors. The low rates force savers to save even more, thus cutting consumption, which slows economic growth.
2) QE replaces interest expense from the US Treasury - which flows to the private sector as income. The Fed swaps Treasury debt held by the private sector with reserves held by the banks. While the Fed pays the banks interest on their excess reserves, it stays in the reserve accounts at the Fed and does not flow to the private sector. So QE takes interest income away from the broader economy and doesn't replace it with any other forms of income for the private sector - so its a net loss of income
Both of these factors hurt the economy - despite the intention by the Federal Reserve to try to stimulate it.
wabuffo
QE replaces interest expense from the US Treasury - which flows to the private sector as income. The Fed swaps Treasury debt held by the private sector with reserves held by the banks. While the Fed pays the banks interest on their excess reserves, it stays in the reserve accounts at the Fed and does not flow to the private sector. So QE takes interest income away from the broader economy and doesn't replace it with any other forms of income for the private sector - so its a net loss of income
Hi wabuffo,
I have limited understanding and hope you would correct me on this, but I think the above might not be true.
This is helpful to the economy the way I see it. With QE, Treasury is not borrowing money from the public to pay the interest. So how is the public missing out on the interest income? Public did not lend money and they are not getting interest. So no effect in that regard.
Now, instead of borrowing from the public (via selling of Treasuries), it gets money from the Federal Reserve (indirectly via the Banks) and what does it do with the money? It spending it on the public. Especially all the COVID programs. They are spending it without either taxing the money from the public or borrowing from the public.
So why is that not massively helping the economy? Yes, the concerns about this seemingly easy way to fund the Government programs are valid, but we cannot say it is not helping the economy.
Vinod
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I think he used a poor choice of words - instead of deflationary, I think he's not talking about a monetary vector, but an economic one. He means slower growth - and not monetary deflation such as occurs in a financial debt panic.
The reason for QE being an economic growth suppressant, in my view, is for two reasons:
1) QE tries to push rates down. But, low interest rates punish savers more than they help debtors. The low rates force savers to save even more, thus cutting consumption, which slows economic growth.
2) QE replaces interest expense from the US Treasury - which flows to the private sector as income. The Fed swaps Treasury debt held by the private sector with reserves held by the banks. While the Fed pays the banks interest on their excess reserves, it stays in the reserve accounts at the Fed and does not flow to the private sector. So QE takes interest income away from the broader economy and doesn't replace it with any other forms of income for the private sector - so its a net loss of income
Both of these factors hurt the economy - despite the intention by the Federal Reserve to try to stimulate it.
wabuffo
I have limited understanding, but I think this might not be right.
But, low interest rates punish savers more than they help debtors.
How? What is the reasoning behind this to say low interest punish savers more than debtors?
I would argue that it could be either way. It might help debtors more than savers and it depends on who is in the most need or the most vulnerable.
Take a simplistic case of savers being all billionaires and debtors being all poor households. In this case low interest rates would be of immense help to the overall economy.
Take a more realistic case of debtors being more economically vulnerable and savers less so, then it seems more likely that low interest rates help rather than hurt the overall economy.
The low rates force savers to save even more, thus cutting consumption, which slows economic growth
Again in depends and there is no logical reason to believe that this is true.
If savings are concentrated among the higher income population, changes in interest income is not going to drive their consumption behavior.
Vinod
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Its all intentional. As I said in the other thread, the left has gotten so mad and full of TDS that they are full throttle trying to destroy the economy just to get rid of Trump. Of course, most of them are in cash and bonds...preserving "their" interests while doing everything they can to destroy those of the American people, and further, making a full wave of new generations likely dependent upon the government. Its disgusting
I hope you really do not believe what you are writing. You are far too thoughtful and intelligent person for that.
I am sure they are nut jobs on both left and the right, but the vast majority of the people of either party just want to do what is best for economy. They are just coming from different angles and I can see the logic in both. For these vast majority if you give them an option of getting rid of the virus and economy getting back to normal on the condition that the party they oppose would win the elections for President, Congress and Senate, they would take that option in a heartbeat.
I was in the camp of leaning to vote for Trump (60/40) by end of January. Because on the whole, despite so many negative things, he did get one major critical priority right: confronting China, trying to get back some of the manufacturing back to US, etc.
To me his actions since start of March are absolutely unacceptable. I can see both views of keeping an economy open and shutting down. And neither is a simple obvious choice. Pros and cons to both. But once you make a decision, you should proceed forward with that.
Look at what Trump has done. He is both for and against lockdowns. What kind of message does that send to people?
Fed should have been the primary entity in trying to get PPE and other medical equipment and then distributing to the states. It makes so much sense.
We should have had a massive program like the Apollo mission to try to produce PPE in massive quantities once he declared an emergency on March 13. Say being able to deliver a bunch of masks for every family every week. Sanitizing stations every street corner, testing at a massive scale, etc.
He defanged CDC and drug approvals at FDA are politicized.
It is not that Trump is evil, he is just plain incompetent for this situation. Almost any past President of either party would have done so much better. Just look at Amazon. Read the annual letter if you have not. That is how competent people with power would behave.
There are lots of things which are shades of grey and it is difficult to say right or wrong except in hindsight. This is not the case with Trump's actions during the Covid period. They are simply idiotic. People who cannot see that are being blinded by hate towards the other party. It is precisely what you are complaining about with TDS.
Vinod
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Practical-side observations/thoughts of masks:
I and my wife wear masks to stores and anywhere we have to interact closely with people. We wear masks at home when someone comes from outside - e.g. we had a chimney sweep come recently.
Since mask wearing sucks (I cannot wear a mask and eyeglasses - they fog over), and IMO the infection risk outdoors is very low, we don't wear masks outdoors when we go for walks. I guess this is being bad role model though. ::)
It would be nice to be able to buy N95 masks for store visits, but AFAIK they are not reliably available. (Feel free to post pointers if you think they are).
I thought about buying face shields for going to stores, but still not sure it's worth it. It's additional hassle, you still have to wear mask underneath and supply is unreliable. (Feel free to post pointers if you have pointers for good supply.)
It sucks when a neighbor comes over without a mask and starts talking to you. First, no mask - bad. Second, talking - also bad (worse than just walking by or standing closely and not talking). I don't have a good way to tell them not to do it without them being offended. ::)
Most asian stores (Chinese or Indian) have KN95 masks, which I am told are quite similar if not same as N95. Bought a few myself. There are kids versions of those masks too. That one I do not trust as much but still likely better than cloth I think.
This also has the added benefit that you are not taking away N95 masks from the front line workers.
Vinod
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fareastwarriors - it is a upper middle class neighborhood. I pick pennies all the time too. Just the virus makes us a bit more cautious.
Midas79 - We had a good laugh as well.
Jurgis - I was thinking the same. How can I call myself value investor if I do not even pick dollar bills from the street.
Vinod
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Retail is still - price, selection, convenience.
Those that are doing well, Costco, Walmart, Target, TJ Maxx, Ross Stores, Burlington, Five Below all provide goods at very low prices for those particular segments.
Amazon wins on all three respects on many items.
Macy's, JCP, Bed Bath and Beyond, J Crew, Abercrombie, are not doing well in any one these respects. Previously for some mid-quality brands these used to offer a good combination of price and selection in a reasonable convenient way (mall). Now all that is gone.
Employee pay, ambiance, etc I think are more of secondary effects.
Vinod
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The size of the Fed balance sheet is irrelevant - we're already at zero rates.
The Fed typically owns ~10-20% of the net debt issued to the public by the US Treasury (BTW this is a normal range for the Fed). Per the May 6th Fed H.4.1 report, the Fed owns $4t of US Treasury debt out of $19.2t total US Treasury debt o/s. (you can find this number on the US Treasury Daily Report for May 6th).
But even if it bought 100% of all the US Treasury debt outstanding that it didn't already own (19.3t - 4.0t = $15.2t), the only impact would be to increase the size of reserves held by the banking sector. Essentially the Fed would buy $15.2t of Treasury debt in exchange for $15.2t of new bank reserves via the US banks as intermediaries (as it must - since only federally-chartered banks, a few other financial companies and the US Treasury have accounts at the Fed). Those bank reserves are deposits in accounts at F.R banks and can't circulate outside the Federal inter-bank clearing system. They are really check and e-payment clearing accounts.
So the net effect would be to consume the balance sheets of US banks with reserves and drive all interest rates to whatever the Fed pays on excess reserves (currently zero). US bank reserves on May 6th were $3.2t which corresponds to "Cash Assets" of $3.2t in the Fed's H8 report - "Assets and Liabilities of Commercial Banks in the United States".
US banks total assets on May 6th were $20.3t. Thus the Fed would force US banking sector cash balances to go to $3.T + $15.3t = $18.3t This would essentially liquidate the entire US banking sector and turn it into a huge cash box ($18.3t/20.3t = 90% of bank assets would turn into cash on deposit at F.R. banks).
I think in this hypothetical environment, what would the economy look like with a zombified banking sector and no available US Treasuries for anyone, anywhere? It basically demonstrates that the Fed can buy anything it wants, but its only currency is a very specific one that you and I can't access. Therefore, it is taking out liquid assets (Treasuries, IG bonds, stocks?, baseball cards?) and replacing them with illiquid assets that must sit as a cash asset in the banking sector via a contra-liability account at the Fed. The more the Fed balance sheet grows, the less safe, liquid assets exist for the rest of us. I don't see how that helps the private sector and I think it actually hurts it.
The reality is that the Fed isn't the major factor in money creation since it can only lend via swapping assets for bank reserves. It is the US treasury and its deficit spending that is the major money creator. All of the attention on the Federal Reserve is misdirected.
It also shows how disjointed monetary operations are when you have two players (the Fed and the US Treasury) that often work at cross-purposes and neutralize each other.
wabuffo
I quite did not follow how the last statement (in bold) follows from the rest of your message. Could you please eloborate?
To me it looks like Fed and Treasury seems to be working very well together. Fed is indirectly funding the Treasury. Since Treasury cannot all the bonds that it wants to sell without higher yields, Fed is buying them.
My understanding is quite limited, so please excuse my ignorance if something I say above makes no sense.
Vinod
BRK Valuation
in Berkshire Hathaway
Posted
Thanks for the detailed response. Lots of good points.
What I am asking is what is your expected long term expected return on BRK? This is what people would call "required return". If I understand it correctly, you seem to be saying you would be happy with 5%.
Vinod