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Discussion: (7 comments)

  1. As the housing prices declined through 2006, so did the stress indexes. The first indications of trouble in the subprime market appeared in February 2007 (I believe that’s the little blip in the first part of 2007 on those charts). The market then continued on its merry way right into the summer of 2007. Strangely, I remember the first day I noticed craziness in fixed income was 26 June 2007 when high yield debt sold off, then the volatility spiked in both equity and fixed income markets.

    The graphs show stress as it became apparent to all of us. I don’t see where they predicted in a previous period what a tick up in stress in the next period. Unlike the VIX, which uses implied vol (the expected standard deviation of price in the underlying), these statistical measures use historical data, so they aren’t looking forward. I’m just unclear what the takeaway is here. Markets haven’t seized up and credit spreads are tightening. This is pretty well known. These models would be more useful if they were predictive, but even the one meant to be predictive doesn’t seem to be predicting anything.

  2. morganovich

    a question:

    at a time when interest rates and rates spreads, which are the key components of these indexes , are being deliberately manipulated by literally unprecedented central bank manipulation, why would we expect any sort of meaningful result from these “stress indexes”?

    that seems like cargo cult thinking.

    it seems akin to claiming at a patient is health because his fever has gone down and ignoring that you have him in an ice bath.

    the issue that such indexes ignore is that leverage at banks does not look good.

    if you own us treasuries at 10 or 15 to 1 gearing, the end of twist and zirp will lead to massive capital hits.

    consider what happens to the value of a bond portfolio at 10:1 leverage if rates go back to even historically low values like 2%.

    that’s a crisis in the making and one that these sorts of indexes will completely miss.

    1. Morganovich,

      I don’t think you have to worry about ZIRP going away any time soon. It’s the only thing keeping TBTF crony banks profitable.

      Plus, there’s lots of government debt to inflate away. Of all the options available to the government, inflation is the easiest to implement. All they have to do is pray that they lose control of it.

      1. morganovich


        it will be interesting to see what helicopter ben does at year end when twist expires.

        that will drop purchases from about $85bn a month to about $45bn.

        will he increase the size of qe3? extend twist? actually let purchases drop?

        going to be a key issue.

        what are you hearing on his likely replacement in 2014? (ben seems to have enough sense to get out of dodge before this totally blows up. he likely learned that trick from greenspan.)


        1. Morganovich,

          Oh, I think the Fed will be torturing the curve for the foreseeable future. I’m pretty sure they’ll find an excuse to extend the twist or some version of it.

          what are you hearing on his likely replacement in 2014?

          Gideon Gono.

          What other living banker has the steady hand and experience to get this job done?

        2. I bet I’ll be borrowing at 50bps until the end of my career.

    2. morganovich

      that’s a very interesting chart. the divergence of this very fundamental and tangible index with the rate spread based ones is extreme.

      i’m more inclined to trust an index like this at the moment given how manipulated rates are.

      it does not look like it generally gives much warning in advance, but current levels certainly seem worrying.

      this gels with what we just saw from earnings.

      for Q3 we saw revenues for the S+P 500 drop 0.9 % yoy in nominal terms (which is close to a 3% drop in real terms using cpi) earnings dropped by 0.6% nominally as well.

      those are numbers consistent with recession (though they do not prove it). q4 guidance got slashed and a great many companies spoke of strong negative linearity in the q with September much weaker than the prior months.

      q3 GDP was reported as higher that q2, but that was all an increase of government spend. gdp-d also looked quite low again, even compared to cpi.

      use cpi and private gdp was stall speed.

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