“We need a Volcker moment,” Zoltan Pozsar declared, in a positively rollicking note published February 16.
I scaled back my coverage of Pozsar’s missives around the time he started releasing what certainly felt like more of them. That may be my imagination, but what I can say definitively is that he moved away from the intricately-crafted masterpieces that made him pseudo-famous in some circles in favor of short one-pagers which, while useful, didn’t quite pack the same punch.
That’s certainly not to diminish the “legend,” as it were. It’s just to say that Pozsar’s “dispatches” started to feel more like bulletins, and although I still read them, I’m inundated with bulletins. I get more bulletins every day than I could read in a month.
In any event, Pozsar managed to capture some headlines Thursday by employing the same strategy everyone else uses in 2022 to garner media attention: He conjured Paul Volcker.
“A Volcker moment, where Vol stands for ‘vol’,” Pozsar explained. “As in volatility.”
Got that? Are you still with him? “V” is for “Volcker” and “Vol” is for… well, vol, which is shorthand for volatility.
With that somewhat cumbersome lead-in out of the way, Pozsar endeavored to explain, starting with the novel observation that, “The FOMC has one big problem: Inflation.”
From there, Zoltan delivered what one has to imagine was a deliberately provocative essay, the gist of which was conveyed in the very first full paragraph which read,
Historically, the Fed used rate hikes to engineer recessions that generated the slack needed to keep inflation in check (“opportunistic disinflation”). With the Fed’s “updated dual mandate” of inclusive low unemployment and the political imperative of redistribution through firmer wage growth at the bottom of the income distribution, the Fed aiming to slow inflation via a recession is unimaginable. Hikes today then are meant to slow inflation without a recession which is not something that the Fed has ever managed to achieve before.
Pozsar’s argument was (very) straightforward. The current political environment rules out engineering demand destruction (i.e., a recession) in order to bring down goods inflation. So, the Fed needs to act against the services side.
How would that work? Well, first, the Fed needs to get a handle on shelter inflation, which is rising on a lag (figure on the right, below) following the pandemic-era surge in home prices, turbocharged as it was by Fed MBS-buying (figure on the left).
Mortgage rates, Pozsar said, “need to get higher.” And home prices need to be flat or “outright lower,” he wrote.
As far as other services, Pozsar reiterated that working to reduce the demand for labor isn’t an option, and neither is it feasible to target lower wages. “Inclusive low unemployment is a political imperative and, by extension, so is redistribution via stronger wage growth,” he said, on the way to arguing that what’s needed is more labor supply in order to reduce pressure on wage growth without “killing it.”
None of that is particularly controversial. What Pozsar wrote next, though, raised eyebrows. Essentially, he argued that the Fed should deliberately crash markets. He didn’t put it that way. Or, actually, he did. Only not initially. First, he wrote that,
Just as your correspondent is not an expert on inflation, neither is he an expert on labor matters, but growing up in Hungary, his common sense whispers that if the post -Communist government response of generous transfer payments and early retirement sapped labor force participation and hurt the real growth prospects of Hungary and other economies, the capitalist market response to low interest rates and QE through sky-high equity valuations, house prices, and the rise of Bitcoin probably does the same: If the young feeling Bitcoin-rich are less inclined to work and the old feeling mass affluent are eager to retire early, labor force participation drops to the detriment of real growth prospects. If early retirement wasn’t good for Hungary, it won’t be good for the US either. Maybe the path to slower services inflation – OER and all other services – is through lower asset prices. We recognize that what we are saying is extreme, but we think the Fed will soon incorporate some version of this thought process.
So, no more socialism for the rich. And no more artificially inflated home equity. And no more minting of crypto millionaires either.
You’re (gently) reminded that not everyone participated in the ~$34 trillion wealth bonanza that accompanied the Fed’s pandemic response.
To benefit from rising home prices and surging stocks, you need a home and a portfolio (see the familiar figures above).
“No, lower risk assets won’t kill growth,” Pozsar remarked, implicitly chiding those inclined to suggest that the economy may not be able to handle a severe correction in asset prices. “This is not a balance sheet recovery, and no, higher mortgage rates won’t kill growth either [because] wage growth at 5% can absorb higher monthly payments,” he added.
Having taken it that far, Pozsar apparently saw no utility in obfuscation. There was no going back, and thus no need to enlist any euphemisms. Instead, he just came right out and said it. All of it.
“Volatility is the best policeman of risk appetite and risk assets. To improve labor supply, the Fed might try to put volatility in its service to engineer a correction in house prices and risk assets – equities, credit, and Bitcoin too,” he wrote, adding that the surest way to achieve such an (un)controlled demolition is to withdraw transparency, a concept I’ve covered extensively in these pages for years.
“Maybe the Fed should hike 50bps in March, put an end to press conferences and sell $50 billion of 10-year notes the next day,” Pozsar mused. “Maybe FOMC members talk too much. They don’t keep the market guessing.”
On a roll, Pozsar concluded with an epic flourish, noting that central bank decisions have “always” been redistributive, traditionally from “labor to capital.”
“Maybe it’s time to go the other way next,” he modestly suggested, before asking, “What to curb? Wage growth? Or stock prices? What would Paul Volcker do?”
Amen
Agree with Pozsar’s prescription 100%. Time to end the transparency regime at the Fed and wring some of the speculative excess out of the markets (equity, housing, etc.).
Well, there’s at least one pundit who does not dodge the issue!
Definitely faster and more blunt than taxing wealth. Asset price volatility taxes wealth indirectly: with falling prices the asset-rich may want to or be forced to sell. Higher interest rates will make it harder to use assets as collateral for low interest loans. But to get there, interest rates should compete with taxes. If the tax rate on income is 37%, then interest rates should be around 7% for getting a loan against the asset over 5 years to be equivalent to being taxed; around 3.5% if the time horizon is 10 years.
The Stock Market is viewed as an indicator of the health of the economy, so in this light it should move with the ups and downs of the economy itself. In other words, changes in the share market should roughly track changes in GDP. This has been the case since 1950. Then in 1995 it starts to diverge. From its nadir in March 2009, the stock market has risen over sixfold—but the economy has risen only by a factor of 1.5.
Then there is the margin debt. It is now the highest it has been since legislation limited margin lending to 50% of a portfolio and is now at a record of over 4% of GDP.
In the words of Herb Stein: “If something cannot go on forever, it will stop”.
The Stein quote is terrific. I told my students for decades the future is about inevitability and there are just two kinds of inevitability. The first is the inevitability associated with things that cannot change (everybody needs to eat everyday so more people means more food is needed; why I own K, GIS, KHC shares). The second is associated with things that must change (the burning of carbon fuels, population growth).
What’s interesting in Mr Pozsar’s market update is the basic math and mechanics attached to Volcker Shock.
Of all analysts, it’s surprising that Zoltan is not addressing the invisible elephant of Fed/Treasury selling things like MBS at losses. In order to shock the market by raising rates over 3 percent or imagining rates over 6 percent is absurd. How likely is it that the Biden administration will drastically cut their budgets in order to partner with the Treasury in an effort to flood the market with almost 15 years worth of QE related boondoggles?
Congress cuts or raises budgets, not the White House.
A 20% decline in stock prices will have little impact on the vitality of businesses, even those whose stock price declines. Sure, it imposes some incremental financial discipline, but 113% SGA/revenue when revenue is >$1BN deserves some disciplining (looking at you, PLTR). Even with many early-clinical-stage biotechs down 70%, capital continues to flow into the industry, there is merely a shift in the mix of VC vs M&A.
Housing is a tougher call. Houses are bought with massive leverage – the lower-income the buyer, the more leverage – and there is so much institutional money in single-family rentals that a 20% decline in house prices will simply shift even more of this asset class from Average Joe to Big Investment Fund. Housing is the last major asset class that is predominantly owned by the not-rich. Absent restrictions on institutional rental fleets, each house price crash will simply erode that further.
Agreed, a 20% decline in stock prices that are up several hundred percentages already isn’t going to impact either business or labor. Large corps will reverse their trend of stock buybacks and create new issuances to account for losses which will doubly benefit asset prices and lower the barrier to entry for lower income investors.
Housing prices do impact lower income buyers but right now there are massive amounts of investor owned properties because of the price and rents boom. In order to get them out of the market and get housing to people who actually need to live in them the market must be shocked into a reversal. Economists need to decide their money could be invested better elsewhere. This is also a problem in the used vehicle market.
All of this seems to highlight the flaws of QE. While it does boost the economy, it seems to generate toxic asset bubbles more than it promotes economic growth. That is to say it creates inflation at a greater rate than it does promote economic growth. These bubbles are toxic to our currency and will eventually destabilize it. Targeted QE would be a better approach to the problem of keeping the economy stimulated. Helicopter money is just going to those that already have a lot.
A housing price reversal will not get investor funds out of single family houses. It will draw more funds into the asset class.
Remember how this got started: Blackrock and other PE funds scooping up foreclosed houses in the GFC. When Covid hit, these funds and other institutions were looking for another foreclosure opportunity. They didn’t get it, but cheap financing, iBuyers, and surging rents were just as good.
An institutional investor will always be willing to pay more for an average, standard house than an owner-occupant aka family. The investor has ample cash, lower financing and transaction cost, can securitize its debt, has lower operating cost, extracts the highest possible rent with 3 year turnovers, and by owning 10s of 1000s of houses, doesn’t need to worry about any individual’s income. The individual has limited savings, borrows from banks with points and PMI and credit scores, uses a broker, doesn’t have plumbers and electricians on payroll, has only his own income which probably isn’t growing as fast as rents are rising, and needs to hold back some financial capacity in case he loses his job or has big medical bills. If an INVH renter loses his job, simply replace him with the next renter, and raise the rent (currently about +15% increase on turnover).
Institutional investors can always outcompete families for houses. Look up % of sales to investors in various housing markets.
So if Fed tanks housing prices and triggers a lot of house sales, those houses will disproportionately be bought by investors. That’s what they’ve been waiting for. That’s why all that money has been raised (over a trillion $ in just one list of deals I saw).
Need to make huge fleets of rental houses less financially attractive. Unless we want the US to bring a nation of renters. Which I think would be a very bad idea. Not only is home ownership an ingrained part of the “American dream” but it is the main retirement savings for many.
“Unless we want the US to bring a nation of renters. Which I think would be a very bad idea.”
I’m in the deep minority here, but why is that a bad thing. We have had federal policies for decades and even centuries revolving around the importance of home ownership being a vehicle of wealth. Homeowners vastly underestimate the amount of time and money involved in ownership that eats away at this “wealth.” I think it’s time we, at the very least, analyze the idea that home ownership is the best way for the working and middle class to build wealth considering a lot has changed in the last 100 years (and even the last two).
At the end of the day, housing is still a commodity
And all that housing leverage eventually ends up in MBSs, in which I have a large interest. Come on rates.
I don’t know if Pozsar was serious about increasing the labor supply by crashing assets, but I don’t think the numbers work even if the sentiment does. There are only 10M or so Americans in the $1M-$5M asset range, some fraction of whom might find themselves dunked unceremoniously back into the labor pool of 164M post Fed-crash. Those richer than that aren’t likely in play; those below that range are still working. Millionaires average 62 years old; only the younger ones will still have relevant skills, which reduces the numbers. You might solve leisure and hospitality with ex-millionaires, with a smattering of professionals thrown in. Vaporizing 50-60% of equity wealth (which is the decline in their net worth that would be necessary to motivate them to take the only jobs they were now qualified for), in order to achieve that modest result may, just possibly, have undesirable side effects.
I’ve seen the related arguments that subsidy payments have suppressed the labor force, but I suspect that 2021 argument is rapidly growing stale.
And those BTC millionaires? All, what, twenty thousand or so of them? Piffle. They’re already running scared, anyway.
Raising immigration from its somnolent state would be far more effective if Congress could see its way to putting the culture wars on hold long enough to do something useful.
I think you raise an important point about addressing labor shortages with immigration. Hasn’t immigration always been a prime input into American growth. And then the Trumpettes slammed on the brakes – except for the 5 Norwegians who wanted to come here.
Jyl nailed the housing problem. Since GFC the financial engineers have and will always run circles around regulators in our housing markets. It is not even a contest anymore. The only solution left is legislative. Draconian caps on the number of single-family homes and duplexes and similar small multi-family structures that can be owned per income tax ID, etc. IDK, 100 units max sounds about right. Just as US healthcare via insurance companies is an abysmal failure for all but the employed corporate droids in, or under the wing of, the C-suite, just like Big-Tech has repeatedly disqualified itself from owning citizen’s data, housing is a basic human need to vital to be controlled by any other than those that live in the homes…. If your first objection is something like, ‘we live in a capitalist system and that will never happen cuz who else can we get to turn the hamster wheels of profit for the shareholders and other private equity rent-seekers… blah blah blah’, then welcome to the hell of your own making the rest of us have to live in. Until we won’t. I suppose it will be up to the States to fire the fuses.
We definitely need the Fed to stop suppressing mortgage rates. A spread of 250 bps or more and no Fed vacuum cleaner will take the wind out of the sales. Also, limit the dollar ammount of long term capital gains per year: everybody gets first before you get seconds. Limit the amount as a percentage of free cash flow for dividends and buybacks. Revamp the rules for private equity- not just carried interest. How about a limit on how much thaey can borrow to fay fees and dividends. Redo the bankruptcy code.