What is the meaning of this ‘reaching for yield’ discussion?
February 1, 2013 1 Comment
There seems to be a discussion of ‘reaching for yield’ bubbling around the blogotwitosphere. Unfortunately, I haven’t been able to follow most of it. Which is just as well, since once I did finally tune in, I couldn’t understand it.
This guy Miles Kimball who started it seems to be denying that reaching for yield exists. But he’s really not. Or says he’s not. It’s not clear to me, then, what he’s denying. Hence why this discussion exists. Do people want more yield or less? And is that so hard to ‘model’? I wouldn’t think so. Is any of this even controversial? I wouldn’t have thought so. From the start this discussion seems laden with some sort of desire to deny obvious things.
One thing he’s too focused on is fraud. As in, ‘reaching for yield’ necessarily means fraud, so unless there’s fraud, we shouldn’t worry about reaching for yield. But not all risk is fraud. So I don’t get it. There were plenty of non-’fraudulent’ CDOs. Whether they were actually ‘fraud’ is just not really the main point about them.
Another odd aspect to his argument is a denial (?) that low rates create low risk premia: “If “reaching for yield” when interest rates are low is a strong enough phenomenon, it should show up as a reduction in risk premia.” Um, look at credit indices at the height of the bubble. Or, after a bunch of QEs. Look at what high-yield credit has done in the past year or two. Again, is this something that can even be possibly denied? Or am I missing something? Then there’s this:
It is a much bigger step to say they are taking on too much risk, than just to say that they are taking on more risk as a result of low interest rates.
Um ok, it’s a much bigger step. But what does ‘reaching for yield’ mean? It means the latter right? So once again he’s arguing with something he doesn’t actually argue with. (Or, turning it into an extreme straw-man for the purpose of arguing with, or denying, or quibbling with it or something.) He goes on:
This is an important challenge to those arguing that low interest rates cause people to make mistakes in their decisions about which assets to invest in.
Did you catch the straw man? Who said anything about ‘mistakes’? Since when does ‘reaching’ imply making, and only exist in the presence of, investment ‘mistakes’? It just implies, well, reaching. As in: ‘If the benchmark yield goes down, I want to reach for more yield, even if it comes at the expense of more risk.’
Again: does anyone deny that investors do this? Why on earth why? And if not then why bring any of this up at all?
Here’s a model that then got linked in various places, claiming to be a simple model of reaching for yield, making me hopeful that this discussion could be closed (in the – obviously – affirmative). Unfortunately it’s really a model of moral hazard:
The government has one role in this model and that is to provide a “safety net”…If the consumer’s combined labor and investment income is less than one, the government provides a transfer of the difference from 1.
In other words the government socializes your losses in that model. So yes that incentivizes extra risk-taking but has nothing to do with reaching for yield. Which – again – is a totally obvious and unremarkable phenomenon to me. But what do I know.
They’re all reacting to this article by John Taylor. I haven’t read it yet, but boy, it must have hit some sore spots! By inference, I’m going to say I agree with it. Remind me to read it some day.