Welcome to the Capital Note, a newsletter about business, finance and economics. On the menu today: state-and-local assistance, central bankers tackling climate change, and a look at New York’s near-bankruptcy in 1975.
State-and-local assistance has emerged as the main sticking point in Congress’s negotiations over another round of coronavirus relief. Democrats have requested $500 billion for states and cities as well as an additional $225 billion for public schools, roughly double the amount that Republicans are willing to provide.
Whatever its merits, the Democratic proposal effectively attempts to use pandemic relief as a backdoor bailout for states and cities with Democratic constituencies. Kevin Hassett — a senior advisor to National Review’s Capital Matters and former chairman of the White House Council of Economic Advisors — says assistance on that scale is off the table. He estimates that Pelosi’s requested state-and-local assistance amounts to five times their revenue loss from the COVID recession.
Now that both political parties appear to agree broadly on the need for sizeable fiscal stimulus, federal transfers to states and cities are becoming the most consequential economic policy question. A Trump victory would close the door on state-and-local bailouts, potentially accelerating the outflow of residents from New York, California, and Illinois.
States and cities are already starting to feel the pain. Last week, Moody’s downgraded bonds issued by New York State and City, citing revenue shortfalls from the pandemic:
The lasting economic consequences…will likely be amongst the most severe in the nation and require significant fiscal adjustments. The city regularly identifies and closes future year budget gaps, but has delayed implementing more recurring savings and relied primarily on reserves, the possibility of direct federal fiscal aid, and a request for deficit financing authority from the state. The current budget assumes $1 billion in savings will come from labor concessions or headcount reductions but those savings have not been formalized.
If the city fails to make necessary budget cuts, it will have to issue long-term debt to meet operating costs — a fraught practice to which Governor Andrew Cuomo has expressed opposition. But a successful fiscal consolidation means cuts to the police and other public services at a time when social unrest has already led to a spike in crime. Out west, California’s pension system is seeing mounting shortfalls as the state’s revenues decline by more than $30 billion. Judging by Governor Gavin Newsom’s statements, the state is banking on a blue wave in November to plug the holes in its budget.
Despite large budget deficits, investors are still willing to lend to states and cities. The Federal Reserve’s municipal-liquidity facility shored up the municipal-bond market earlier this year, but that backstop is limited to relatively short-term loans and expires at the end of 2020. Should Republicans hold onto the Senate, municipal bondholders may want out.
Central Banks & Climate Change
In a Capital Note back in August, I noted with concern efforts to push the Fed into a more activist role on climate change. This was triggered by a report that, in the view of the Senate Democrats’ Special Committee on the Climate Crisis, “the Fed appears to be evolving on the issue of climate risks.”
At the time I mentioned my rule of thumb: When a political entity is described as “evolving,” that is a bad sign.
On the other hand, I looked at what the Fed has been doing in this area and didn’t find too much cause for concern.
How long that will last, I don’t know. Meanwhile, other central banks in the West have been taking a more activist line, including, notably, the Bank of England and the European Central Bank (ECB).
Regarding the latter, in a Corner post earlier this summer, I quoted from a story on Christine Lagarde, the ECB’s president, in the Financial Times. She was described as having “opened the door to using [the bank’s] €2.8tn asset purchase scheme to pursue green objectives, promising to examine changes to all of its operations in the fight against climate change.”
The report also included this:
Asked whether the pandemic could dilute the importance of green issues, the ECB president said that “those who would be tempted by that option would live to regret it”. She added: “I have children, I have grandchildren. I just don’t want to face those beautiful eyes, asking me and others: ‘What have you done?’”
Perhaps it’s superfluous to add that, prior to joining the ECB, Lagarde had no experience in central banking, but plenty of experience as a politician.
Two or three weeks ago, Bloomberg ran this story (my emphasis added):
The pandemic could easily have derailed Christine Lagarde’s plan to enlist the European Central Bank in the fight against climate change. Only she won’t let it…
Lagarde made battling global warming a defining feature of her eight-years as managing director of the International Monetary Fund, warning that humanity would be “roasted, toasted, fried and grilled” if it failed to act.
Instead of allowing the Covid-19 recession to bump climate off her agenda, Lagarde has used it to try to persuade skeptics that phenomena such as global warming are well within the remit of monetary policy, a notion that some of her European peers, notably Bundesbank President Jens Weidmann, have resisted. Across the Atlantic, the chairman of the U.S. Federal Reserve has also been lukewarm on the idea. “Society’s overall response to climate change needs to be decided by elected officials and not by the Fed”…
Prior to her confirmation, Lagarde floated several ideas for how the ECB could take steps to help alleviate global warming. The most radical involved greening the bank’s massive quantitative easing program (QE), in which it buys bonds from banks to lower interest rates. Lagarde suggested the bank should prioritize purchases of environmentally friendly securities…
Her comments met with resistance from inside and outside the institution. The most frequently invoked objection against what Lagarde was proposing is that the ECB must strive always to be market-neutral. If the bank were to favor debt issued by makers of wind turbines over that of oil majors, it would open itself up to accusations that it was charting its own industrial policy.
“Central bankers are not elected officials and they should not replace or bypass the necessary debates in civil society,” the Bank for International Settlements wrote earlier this year. “Mitigating climate change requires a combination of fiscal, industrial and land planning policies (to name just a few) on which central banks have no experience.”
Powell and the Bank of International Settlements get it. These sorts of decisions are the responsibility of democratically elected governments, not technocrats. But, as we are increasingly seeing with efforts such as those to institutionalize “socially responsible” investing, bypassing the democratic process is part of the plan.
And, so far as central banks are concerned, the activist agenda doesn’t stop with climate change.
From IMF bloggers Niels-Jakob Hansen, Alessandro Lin, and Rui C. Mano last week:
In new IMF staff research, we find a case for central bankers to take inequality specifically into account when conducting monetary policy.
Even though inequality remains outside central banks’ mandates, major central bankers are increasingly discussing distributional issues. At the same time, recent advances in economic theory shed new light on the interplay of monetary policy and inequality.
Some of the arguments (or, rather, justifications) that they put forward are interesting, and I would recommend reading what they have to say.
Nevertheless, the inconvenient truth remains unchanged. What they are advocating would represent a technocratic intrusion into what should be a political space. That’s hard to reconcile with basic democratic principles, and, like the greening of the central banks, should be resisted.
Central banks should stick to their basic job, which is to act as custodians of the currency (and, in effect, financial markets) and to provide, in essence, some macroeconomic steering. They have already pushed that mandate as far as they should, and, arguably, further.
But enough is enough.
Around the Web
The Capital Note is not a forum for theological debate, but when Pope Francis wades into economics, well…
“Pope Francis says the coronavirus pandemic has proven that the “magic theories” of market capitalism have failed,” reads a story in Time magazine. Leaving aside the little matter that the virus appears to have originated in a country not normally known for its attachment to market capitalism, and that that country’s reluctance to be open about COVID-19’s capabilities and spread contributed to the extent of the catastrophe, Francis’s claims do not stand up when considering the response to the coronavirus in the West. Essentially, the failures on both sides of the Atlantic have been those of governments, not the free market—and they have been compounded by the way that governments have got in the way of the creativity and adaptability of free enterprise in the face of crisis. . .
Populyst (Sami Karam) from September 30:
Last week, the market value of Zoom Video Communications exceeded that of Exxon, an unimaginable feat by a company that was an unknown until recently. Exxon reigned for a long time as the most highly valued company on the US stock market until it was dethroned by Apple several years ago. Since then, it has fallen further out of favor due to a decline in the price of oil and investors looking at fossil fuel companies with an increasingly critical eye….
There seems to be no upward limit to the valuation of the “right” companies and no downward limit to the valuation of the “wrong” companies. Of course, due to the pandemic, Zoom is riding an unprecedented demand wave while Exxon is hit hard by the economic slowdown. But if we look dispassionately at profits past the pandemic, what should we make of Zoom’s PE of 175x expected 2021 earnings compared to Exxon’s 20x (and Exxon’s 10% dividend yield)? In addition to fundamentals, these valuations result from a double squeeze, one upward on Zoom resulting from the massive pandemic-related stimulus pumped into the market, the other downward on Exxon resulting from its excommunication by scores of politically-minded investors.
This momentum on one hand and self-censoring on the other explain why some companies are very overvalued and others undervalued. Peer pressure also plays a role in chronically pushing stocks outside of their reasonable valuation ranges.
Zeitgeist investing has come of age in 2020. The last time that we saw this on this scale was in 1990-2000, a period that celebrated “new economy” companies but that was followed by a decade-long resurgence of the old guard sectors. But who today is willing to bet on the next reversal, and more to the point, when? There will be a time.
Magnus Carlsen’s latest first move:
Magnus Carlsen has won yet another speed chess final, defeating Wesley So 5.5-3.5 after the world champion won the first game with the bizarre opening 1 f3 and 2 Kf2.
Meanwhile, the Play Magnus Group, a tech company which incorporates the chess24.com website, the Chessable learning platform and the Play Magnus chess app, will start trading on the Oslo stock exchange on Thursday. Its $42m initial offering has already been subscribed. The largest investment in chess has been backed by respected New York financial institutions.
In 1975, New York City went to the brink of default. First as comptroller and then as mayor, Abraham Beame spent years borrowing against the city’s pension funds to paper over gaping holes in the budget. But after Beame was forced to turn to the state for relief in 1975, the city’s teacher’s union refused to purchase more municipal bonds. The city’s lawyers prepared bankruptcy filings, only to be bailed out by the teacher’s union in the 11th hour. Jeff Nussbaum wrote a play-by-play in the New Yorker a few years back:
At the Waldorf-Astoria, in Midtown, seventeen hundred guests were gathering for the Alfred E. Smith Memorial Foundation benefit dinner, a white-tie fund-raiser for the Catholic charities named in honor of Al Smith, a former governor and the first Catholic candidate on a major-party Presidential ticket. As day turned to night, the bad news continued to come in. Banks were refusing to market the city’s debt, which left New York unable to borrow. Federal help was repeatedly refused by President Gerald Ford and his advisers. The only hope left was pension funds. And the only one that had committed to buying the city’s bonds—the Teachers’ Retirement System—was now pulling back…
Felix Rohatyn, a well-known investment banker running the newly formed Municipal Assistance Corporation, was charged with persuading union officials to change course:
The Teachers’ trustee, Reuben Mitchell, said, “We must watch that investments are properly diversified, that all our eggs aren’t put in one basket.” Governor Carey left the dinner and phoned state and federal leaders with a simple message: Default was imminent…
The teachers’ union was in a bind. Shanker later called it blackmail. If the city went bankrupt, a judge could order thousands of teacher dismissals, undo the raises the teachers had recently negotiated, and override any pension laws, stripping retirees of their pension checks.
After the union reversed course, the city, still in need of help from Washington, was roundly rebuked by President Ford, inspiring the infamous Daily News headline, “Ford to City: Drop Dead.” The city tightened its belt, and Ford eventually relented, signing legislation that gave New York $2.3 billion in federal loans.
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