Friday Night Reading

A reader sent me this link a week or so ago after I mentioned Krugman. It's a long article, but very, very interesting. This is the kind of article that goes nicely on the iPad and then you lay in bed and read it until you fall asleep. In the morning, when you wake up, you finish the article. There is much more to the article, but this, near the beginning, caught my attention:

His proposal is so simple you could write it on the back of a napkin: raise margin requirements on any financial asset – stocks, real estate or whatever – as its price goes up beyond its mean-reverting (average historical) valuation.  Reduce the amount of permissible leverage in proportion to the degree of deviation from the mean.  "If housing prices go up, then you would have to keep putting more and more money down, which would kill the psychology of the bubble," Brock said. 

The same requirement would, of course, prevent Wall Street from leveraging its collective balance sheets by a 50-1 margin leading into the next financial crisis.  "On Wall Street, the objection you hear is: oh, we can't tell when we're in a bubble," Brock argued.  "I say, who cares?  What you do know is that theoretically and in the data, the average PE is 15 for the stock markets of the 10 largest countries for the past century.  So if a PE of 15 is the norm," Brock continued, "and the market goes to 20, then you have to put more down if you want to buy stocks.  When the PE goes up to 34, as it did in 2000, you bloody well better be putting 95% down, and in doing that, you deflate the tech bubble."

You might be surprised to learn that this proposal has historical precedent.  A review of margin requirements  shows that investors who could put virtually nothing down to buy shares of stocks before the 1929 crash were later required to limit their margin accounts as low as 0% and as high as 55%, with the figures moving around as the markets did.  Brock pointed out that in January, 1958, when the Dow was at 440, a person could buy stock with 50% down.  By August, when the Dow had breached 510, the investor had to put down 70%, and by December, when the Dow was trading around 580, the requirement had grown to 90%.  "When everybody has to put 90% down," said Brock, "You no longer have a bubble."

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Economists come and go, but this song will never go old:

Phantom 309, Red Sovine

Years ago when I did a lot of hitchhiking, I got a lot of truck rides -- never with Phantom 309, sad to say. Back in the early 70's. Truckers won't pick up hitchhikers any more: liability issues. Sad.