The Bubble Question

>>> investors would rather hold scarce assets such as equities and real estate.

Real Estate is not the investment it once was and homes have yet to recover their initial value since the crash in 2006. I doubt this is something people would be actively investing in like they used to.

Be wary of conflating corporate cash with the LP cash backing VC companies. Companies are holding record amounts of cash because (1) it is seen as insurance for financial shock-event; and (2) low interest rates do not penalize them for holding it.

If interest rates were 7%, shareholders would be demanding minimal cash on balance sheets. But with money @ 0.25%, the BOD is telling investors the "option value" is worth the minimal carry cost to the company in terms of FCF and/or NI.

On the other hand, the sources of VC (LP) have excess liquidity they do not want to hold as cash. If they had 7% on cash they would hold some cash as insurance; but with 0.25% (6.75% forgone) the cost of this insurancs is too high. This is exactly opposite dynamic of the corporate case.

So, you see companies hoarding cash and LPs trying to get rid of it. But for VCs and valuations, it is the LP's dynamics (excess liquidity) which are relevant. The corporate cash piles have second-order effects (via M&A), but the central source of liquidity is driven by LPs wanting to be fully invested.

(There is also the issue of spread/total rate which pushes LPs deeper into the risk spectrum to meet threshold returns. This effect drives allocation to equity vs bonds, and equity market liquidity has carry-through for VC exits both at the iPo and m&a level.)

"In order to raise rates, the US would probably have to either confiscate a lot of assets (which would harm its international status as the cleanest dirty shirt), raise taxes, raise retirement ages, implement means testing on medicare + social security, and cut military pensions/VA expenses. There is no real solution that does not involve provoking some sort of major crisis, so it is much easier for everyone to keep the carnival going as long as possible until something snaps internationally. The federal government can't afford even a slight rise in rates without having an immediate cash flow crisis."

They could demand immediate taxes(30 years retroactive) on all those offshore banks that slick corporations and rich boys like to hide money. If the banks hesitate; send in the the Boys. It might be the first honest war we have had in awhile? Oh yea, and immediately default on the Chinese debt. Wow--I sound like my father? I am ashamed of wealthy Americans who skip out on taxes though. They like to blame the poor, but it's the guy's who don't get a regular check who hide money. I remember this Harris dude who bragged about his Caymen Island trips in the 80's.

Banks are hoding cash for the same reason as corporates. The cash is cheaply financed by low-cost debt and it has utility as an insurance-liquidity-pool-of-last resort in the case of a policy reversal by the Fed.

For argument's sake, assume debt is mis-priced right now relative to equity. If you believe that, and you are a bank, what you do is increase ROE through increasing leverage (shor debt markets+long equity). So, if you are a bank you borrow and buy back shares. Or, you borrow and keep shares at a minimum/flat.

On the other side of your ledger, if you are a bank and you believe debt is mis-priced, the last thing you want to be doing is going long credit (to customers). So, what you should expect is increasing debt/equity ratio and flat/decreasing proportion of long-credit/total assets.

The "stingy credit" allegation is perfectly rational if you make the assumption that debt is fundamentally mis-priced as an asset class. That is the essential assuption Wilson is making to explain why money is chasing equity/pe/vc.

The only open issue is whether or not the assumption is correct.

If we look at policy, when regulators ring-fence reserve and increase the reserve level, they are forcing the banks to sell-equity. The reason they are doing this is because--assuming equity is mis-priced--they understand that banks will leverage up. The problem with banks leveraging up increasingly over time is policy hysterisis.

If the fed policy results in increasing bank leverage, the baking system will become increasing more "brittle". This tie the hands of the Fed--when they move to revert policy--they will risk creating a problem due to having added "brittleness" to the financial system.

So, even the fed is acting as if the assumption about debt pricing is true.

That being said, it is a more difficult case to explain from first principles whether or not debt is truly mis-priced as an asset class. But the analysis can be followed as far as I can tell simpley based on the binary assimpyion (yes/no). And one of those assumptinos seems to explain alot, while the other faces a harder time making sense of the data we are seeing.

From your piece:

The hope is that the lower interest rates will encourage people and businesses to take out more loans and thereby start spending again.

What we are seeing is opportunistic borrowing for financial engineering. We are not seeing 1:1 borrowing to spending on operating expenses or PPE. We are seeing borrowing that is being spent on share-buy-backs and/or cash-stockpiles that maked increasing leverage ratios more operationally risk-tolerant. (And it seems this is true for corporates and financials, at least to a first order approximation.)

I second the EconTalk podcasts. I've been listening to them for over 5 years. They are hour long interviews on a wide variety of subjects. The host, Russ Roberts, does a great job of letting the guest get his or her point across even when you suspect he disagrees. The tone is polite and non-confrontational. It is more about accurately presenting a position than debating, although there is some point/counter-point.

I cannot exaggerate how much I've learned from EconTalk. Plus, there's even an episode with Paul Graham about ycombinator and startups:

http://www.econtalk.org/archives/2009/08/graham_on_start.htm...