The Fallout Edition

Summary

Slate Money — The Fallout Edition (July 9, 2016)

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Episode Overview

This episode of Slate Money, hosted by Felix Salmon with regulars Jordan Weissman and Cathy O’Neill, is the "Brexit Fallout" edition. The hosts revisit the financial and economic repercussions of the UK's Brexit vote, examining both immediate chaos and longer-term consequences in global finance. Specific attention is paid to the frozen UK property funds, the world of negative interest rates, and the precarious state of Italy’s banks, all positioned within the shifting backdrop of European and international financial policy.

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Key Discussion Points and Insights

1. Brexit’s Impact on UK Property Funds

• Commercial Real Estate Illiquidity:
  • Several UK commercial property mutual funds, holding around $25 billion in assets, have "closed their gates," suspending redemptions due to massive uncertainty and an absence of buyers post-Brexit ([03:01]–[05:56]):
    • “They’re not letting anyone take out their money.” — Kathy O’Neill [03:15]
    • “The fact is, no one knows what's happened to the value of this commercial property because no deals have got done in the UK since the Brexit vote. Literally zero.” — Felix Salmon [03:48]
• Frozen Markets as Panic Barometers:
  • Discussion over whether these funds now function as ‘fear indexes.’ Felix argues the banking sector and the pound are more indicative, with property fund freezes highlighting just how abnormal the period is ([05:56]–[06:53]).
    • “The last time we all remember funds closing was Soc Gen and Bear Stearns at the end of 2007, the beginning of the credit crisis. And that was a harbinger, as we know, of much, much worse things.” — Felix Salmon [06:33]
• On Suspending Redeemability:
  • Consensus that suspending redemptions, while potentially ‘postponing bad news,’ is rational because forced fire sales would be even more destructive ([07:46]–[09:47]):
    • “If a property fund has a lot of redemptions, the only way it can meet those redemptions is by selling property. Yes, you can't sell property. No one benefits if you sell property in a fire sale.” — Felix Salmon [07:46]
    • “Many of them had 20% cash on hand...but when 40% of people wanted their money back… they’re like, screw this, we can’t actually do this.” — Kathy O’Neill [09:22]

2. Uncertainty and “Confidence Fairies”

• Economic Paralyzation Due to Uncertainty:
  • The episode echoes the psychological cloud blanketing British business, with actors ‘waiting to see’ and economic activity grinding to a halt ([10:34]–[11:30]).
    • “What we’re seeing right now with these property funds and across Britain is a response to… uncertainty. We really do not know what's going to happen.” — Jordan Weissman [10:34]
• Paul Krugman & “Confidence Fairies”:
  • Contrasts the post-2008 US “confidence fairies” debate with post-Brexit Britain, arguing that—this time—lack of confidence itself is a destructive economic force ([11:30]–[12:51]).
    • “In the UK, you're absolutely right, they do exist. They are real. We're seeing them in the way that people are trying to get out of their exposure to commercial property and not being able to.” — Felix Salmon [12:10]
    • “It's not just a question of confidence, although confidence is certainly making things worse.” — Felix Salmon [13:10]
• Not Just About Confidence:
  • Kathy O’Neill’s skepticism of magical thinking: “It's not normal. It's going to be different.” [13:08]

3. Global Flight to Safety and Negative Interest Rates

• Bond Market as Fear Index:
  • With Brexit, there’s a ‘flight to quality’—investors pile into safe government bonds, even at negative yields ([13:10]–[15:05]).
    • “When people are afraid, you get this thing called flight to quality… you wind up buying bonds in euros, dollars, Japanese yen, and Swiss francs and you pay whatever it takes.” — Felix Salmon [13:10]
    • “If you invested in government bonds at the beginning of the year, right now you're sitting on a 25% annualized.” — Felix Salmon [14:22]
• Explaining Bonds in Uncertain Times:
  • Bonds serve as both a counterweight to falling stocks and as a guarantee of capital, even if yields are negative, thanks to associated currency moves and deflation expectations ([15:05]–[16:45]).
    • “Bonds have a guaranteed return of capital…even with negative yield… it's inherently a much safer place to put your money.” — Felix Salmon [15:40]
    • “If you think there's deflation coming… you can actually also make money off of a negative yield… in real terms you're making money.” — Jordan Weissman [16:09]
• Negative Yield Mania:
  • Dramatic stats: $13 trillion in negative-yielding bonds; 659 global rate cuts since Lehman Brothers; Switzerland and Germany issuing 10-year bonds at negative rates, with Japan following ([17:07]–[19:53]).
    • “We live in a world of zero interest rates... the entire world is becoming Japan.” — Felix Salmon [19:53]
• Central Banks in a Trap:
  • The global move to zero/negative rates constrains central banks—raising rates in one major economy causes damaging currency appreciation ([20:24]–[20:43]).
    • “When bonds everywhere around the world go to zero, it in turn becomes incredibly hard for a central bank to raise rates.” — Jordan Weissman [20:24]

4. Italy’s Shaky Banks: The Next Domino?

• High Levels of Bad Loans:
  • Italian banks have roughly 17% non-performing loans—massively larger than seen in the US during the financial crisis ([22:23]–[23:09]).
    • “About 17% of the loans on their books have gone bad, are sour. Italy's banks are not in a good place financially.” — Jordan Weissman [22:23]
    • “It's like 10 times what's normal in the US now.” — Jordan Weissman [23:09]
• EU Bailout Rules & Political Toxicity:
  • EU’s 2014 banking rules prevent Italy from giving a blanket bailout without imposing losses on equity and bond holders. But many holders of Italian bank bonds are retail investors—making “bail-in” politically toxic ([24:49]–[26:47]).
    • “A lot of the bondholders of these banks’ debts are retail investors, which is really unusual…so this is politically toxic there.” — Jordan Weissman [25:25]
    • “If you have a bank CD, which is a big thing in Italy, then you’re a bail-inable bondholder rather than a depositor who’s protected.” — Felix Salmon [25:42]
• Structural Flaws in EU Banking Union:
  • The EU’s drive for banking union clashes with the vastly different structures of national banking systems:
    • “That’s really hard when you have national banking systems that don’t mesh, that don’t fundamentally work the same ways.” — Jordan Weissman [27:02]
• No Good Solutions—Kick the Can Down the Road:
  • Italian banks are forced to ‘wait out the credit cycle,’ but with unemployment still high and little sign of recovery, there’s no guarantee relief will come ([28:00]–[29:15]).
    • “Is this like sort of the first of many? Is this like Portugal and Spain?” — Kathy O’Neill [29:29]
    • “Southern European banks…have been in crisis for five years now and we’ve had a system of rolling bailouts.” — Felix Salmon [29:35]
• Bailouts Are Inevitable, Despite the Rules:
  • “Ultimately, when a country's banks get into trouble, that country does need to bail out the banks. We discovered that in the US in 2008…in Greece in 2012. We've discovered that in so many countries when push comes to shove, these banks are going to have to get bailed out. It's just part of how a modern economy works.” — Felix Salmon [30:02]
• Zero Interest Rates & Political Will:
  • The irony: governments can borrow at or below zero to bail out banks, but lack the political will or legal framework to act decisively ([32:14]–[33:00]).
    • “The cost to the government of borrowing the money to bail out the banks is zero.” — Felix Salmon [32:15]
    • “Anything that might get the economy going at this point, they [Germany, Switzerland] are being paid…are being paid to borrow and try to save the world.” — Jordan Weissman [32:48]
• EU at a Crossroads:
  • Resistance to change and inflexible rules threaten the EU’s stability:
    • “If these rules really get in the way of everything, this is gonna be terrible.” — Kathy O’Neill [31:55]

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Notable Quotes & Memorable Moments

• On the Illusion of Liquidity in Property Funds:
  “It makes sense if you are offering exposure to a fundamentally illiquid asset class that at times like this, you basically suspend the fiction that the investment is liquid.”
  — Felix Salmon [09:47]

• On the Difference Between Bond Yields and Borrowing Costs:
  “Almost none [of the negative-yielding bonds] were issued at negative yields…When Jordan is saying you’re paying to lend money to Switzerland, that’s not true. What you’re paying for is an asset, a bond, which is owned by someone else.”
  — Felix Salmon [17:29]

• On Southern European Bank Bailouts:
  “We've had a system of rolling bailouts. One of the reasons for these 2014 rules is precisely that the European Union got sick of all of these government bailouts and said stop bailing out your banks…but ultimately, when a country's banks get into trouble, that country does need to bail out the banks.”
  — Felix Salmon [29:35 & 30:02]

• On Data Randomness and Jobs Reports:
  “What we are finally seeing is the kind of natural randomness in data series that you should…expect in all natural data series and we shouldn’t get alarmed by.”
  — Felix Salmon [35:50]

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Timeline of Important Segments

| Timestamp | Segment | |:-------------:|--------------------------------------------------------------------| | 00:08 | Introduction; Brexit focus and “We need to return to Brexit.” | | 03:01 | UK property funds freeze; deep dive into commercial property risk | | 05:56 | Are funds now “fear indexes”? Panic in financial markets | | 10:34 | Uncertainty & behavioral economics: confidence, paralysis, risk | | 13:10 | Bond markets, negative yields, flight to quality | | 17:07 | Negative yield bonds and central banking conundrums | | 22:17 | The Italian banking crisis explained; the problem of bad loans | | 24:49 | The fraught politics of bailouts and EU banking union | | 29:29 | Comparison to Southern Europe, cyclical crisis and bailouts | | 32:14 | Zero borrowing costs vs. political will—EU at a crossroads | | 34:23 | Numbers round (Theranos, Jobs Data randomness, Moving averages) |

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Tone and Approach

The tone is sharp, irreverent, and laced with skepticism:

• “Fuck that. Like this is not normal. It’s going to be different.” (Kathy O’Neill, [13:08])
• “Is no one in charge better than Boris Johnson in charge, though?” (Jordan Weissman, [12:38])
• The banter is lively, and each segment is framed with clear frustration at both market panic and political inaction.

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Conclusion

This episode elegantly ties together the array of financial repercussions from Brexit, from the concrete (frozen UK property funds) to the abstract (shifting financial sentiment), to structural problems in Italy and the wider EU. The recurring theme: when confidence evaporates and rules get rigid, the financial system creaks—and policy paralysis can make everything worse.

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Memorable Final Thoughts

• “The entire world is becoming Japan.” — Felix Salmon [20:17]
• “They are being paid to borrow and try to save the world.” — Jordan Weissman [32:48]
• “We shouldn’t get alarmed by [randomness in data], and this kind of large fluctuation is what I kind of feel the jobs report series should do.” — Felix Salmon [35:50]

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Transcript

[Jordan Weissman]

The following podcast contains explicit language.

[Felix Salmon]

Hello, and welcome to the Brexit Fallout edition of Slate Money, your guide to the business and finance news of the Brexit. Because we had an entire Brexit edition the day after Brexit happened, but frankly, there's just so much Brexiting going on. We need to return to Brexit. And thank you for all of your emails about the various different podcasts you listen to. I know. It turns out that top of the list is the Slate Political Gabfest. Who'd a thunk? So I guess you can all listen to the Slate Political Gabfest for everything you need to know about Michael Gove and Nigel Farage and Andrea Leadsom and all of these loathsome British politicians. So we are gonna stick to the financial repercussions of Brexit here because they are enormous and not necessarily or entirely confined to the uk we're gonna talk about what's happening to the Italian banks. They are looking shaky. We are gonna talk about interest rates all over the world in Switzerland and Japan, which are going even more negative than they were before. But first. Oh, wait, hang on a sec. Who's we?

[Kathy O'Neill]

You never introduced us.

[Felix Salmon]

Who's we? We is.

[Jordan Weissman]

That's the question these days.

[Felix Salmon]

The standard. The state. Well, okay, so the first bit of good news is that Jordan Weissman, the Slate Money Box columnist, has been let out of his cage, where he was literally just feet away from the Brexit discussion that we had last time round, but was somehow recused himself from participating.

[Jordan Weissman]

Well, last time, yeah, I was called upon to do my regular job, which was put words on the Internet, but I was.

[Felix Salmon]

I feel like putting your voice into the podcaster sphere is at least as valuable and important as putting words on the Internet.

[Jordan Weissman]

It's much more enjoyable.

[Kathy O'Neill]

I feel a little superior here because I don't have a regular job, so.

[Felix Salmon]

So we have Jordan Weisman. We also have the woman without a regular job. That's me, Kathy O'. Neill.

[Kathy O'Neill]

Hi.

[Felix Salmon]

But you do have a blog called mathbabe.org I do. And, yeah. Kathy, tell us about property funds in the uk yeah.

[Kathy O'Neill]

So this is actually a direct continuation of our conversation without Jordan, which was very sad to not have him, but we did have that really wonderful guy, Leo Carey. Yeah, he was great.

[Felix Salmon]

Leo was great. He used words like phthonic.

[Kathy O'Neill]

He was so, you know, articulate. I was. I was really.

[Jordan Weissman]

Okay, guys.

[Felix Salmon]

He had a great English accent.

[Kathy O'Neill]

We love you, though, Jordan.

[Jordan Weissman]

Anyway, this is the classic lineup.

[Felix Salmon]

We love Paul Ford. We love Leo Carey, we love our guests, however, we love our guests.

[Jordan Weissman]

We love each other, too. Let's continue.

[Felix Salmon]

And Jordan Weissman is not bad in the pin.

[Kathy O'Neill]

He's wonderful.

[Felix Salmon]

Yeah.

[Kathy O'Neill]

So anyway, we talked about the possible repercussions of Brexit on the day after, and one of the things we thought about was finance moving out of the City of London. And what would that mean to real estate prices? And guess what, it means a lot to real estate prices. In the last few days, a bunch of different things called commercial property mutual funds in the uk, which center on basically investing in UK commercial property, like stores and buildings, have announced that they are closing their gates. They're not letting anyone take out their money.

[Felix Salmon]

So there's a few of these funds and basically, as we know, buildings are illiquid assets. And so these funds are traded on the stock market and they're mutual funds. And you can just say, look at the price at which the fund closed on any given day and say, I want to buy at that price or sell at that price, bid offer spread notwithstanding. And they have now decided. Well, a few of them, like three or four of them at least, have decided, maybe five have decided that they're not even going to make a market. You just can't sell at any price. Because what's happened to commercial property is that, as Kathy says, well, Kathy says it's gone down in value. The fact is, no one knows what's happened to the value of this commercial property because no deals have got done in the UK since the Brexit vote. Literally zero. And I was at a conference in London last week and there was this sort of show of hands of, like, who among you has postponed making a major decision which you would otherwise have made because of Brexit? And like, the entire room, all hands just shot up. And this is why Britain is going into a recession. It's because a recession is just when economic activity slows down and economic activity is clearly slowing down because people are just not doing shit for the time being.

[Kathy O'Neill]

Yeah, sorry. There's like a $25 billion commercial property market of this type in the UK, and 8 of the funds, which represents more than half the market, have officially frozen transactions on their funds.

[Felix Salmon]

So nobody can take that. One of them, though, has done something a bit more interesting. Aberdeen, I believe it is, has said, yeah, if you want to leave, we'll give you a super lowball price.

[Kathy O'Neill]

You can leave at they mark down by 17%.

[Felix Salmon]

By 17%. So if you want to take a 17% discount and leave at a 17% loss, you can do that. And that way they're providing liquidity to people who really want to leave and to people who are scared. But what you can't do is basically just give yourself liquidity at no cost. Because the one thing which doesn't exist right now in UK property market is liquidity at no cost. In fact, there's no liquidity basically at all.

[Jordan Weissman]

So I first have a question and then I have a comment. The question is, do you think it's fair to basically just look at these funds now going forward? Is kind of like fear indexes for the state of the, you know, of London's financial market or London's financial sector. I mean, is this going to be kind of thing we can just look at these funds and say, okay, this is where people think the winds are.

[Felix Salmon]

Blowing or no, I mean, the financial sector is the banks.

[Jordan Weissman]

Yeah.

[Felix Salmon]

And you can look at the share price of Barclays as a good fear index for London's financial sector. And I think that's a much better index, frankly. The pound is a much better index than looking to see whether a bunch of commercial real estate funds are open or closed. I think this is basically a sign that we are in a very abnormal time because the last time we can all remember funds closing was Soc Gen and Bear Stearns at the end of 2007 at the beginning of the credit crisis. And that was a harbinger, as we know of much, much worse things to say.

[Kathy O'Neill]

Yes, and thanks for bringing that up because it did happen in 2008, this very same kind of thing. And in fact, D.E. shaw closed their gates in 2008. But one thing I remember is that near the beginning of the financial crisis, a friend of mine who is a quantitative hedge fund guy, estimated what the markets were saying if you pretended everything was normal and you were just saying, what does the market think that the housing prices are going to be in three years? Because there's various ways to look. And it ended up being relatively accurate three years later. Which is to say people, when there's something going on in the market, there's a crisis of panic. They always say, close the gates. We don't want to sell at fire for fire sales. We don't want to lose too much money. But I think part of it is just that they don't want to admit that things are worth a lot less than they want them to be worth. So it's in some sense it's just like postponing bad news.

[Felix Salmon]

Well, I mean, maybe it's postponing bad news. But on the other hand, it makes sense because if a property fund has a lot of redemptions, the only way it can meet those redemptions is by selling property. Yes, you can't sell property. No one benefits if you sell property in a fire sale. And you couldn't anyway, like there are no sort of fire sale buyers of London property right now. Everyone is waiting to see.

[Kathy O'Neill]

That's where I would. Here's like just devil's advocate on that. There's going to be someone who's going to buy it if the price is low enough. Right. People are just not willing to put the price low enough for those buyers. Right. That's what it really is.

[Felix Salmon]

Now, I feel like that's generally true in the securities market, but in the commercial property market it's less true. I feel like the commercial property market is an incredibly illiquid market at the best of times. That even in a booming market where everyone is super bullish, you can't do a fire sale. The sales of commercial property take sometimes years to negotiate, even in the best of times. And the idea that you can just sort of say, oh, well, I'll take a discount and sell more quickly. I don't think it works like that.

[Kathy O'Neill]

Well, I'm not saying it works perfectly like that. I'm just saying that this notion that we literally there are no buyers out there and we can't possibly sell is just a little bit of a fabrication.

[Felix Salmon]

Well, it's an empirical fact.

[Jordan Weissman]

Yeah. Certainly selling building does take a lot. I mean, it just, it does take time. This was, you know, the industry my dad was in. Like, it just takes a long time.

[Kathy O'Neill]

It does take a long time. And it's a weird market.

[Jordan Weissman]

It's not instantaneous.

[Kathy O'Neill]

It's a slow, it's a sticky market. And these funds are definitely like facing a completely unexpected situation where they had 20%. Many of them had 20% cash on hand. So that meant if like 20% of the people wanted their money back, they could just literally hand them cash. But the other 80% was actually invested in actual commercial real estate. So when 40% of people wanted their money back immediately, suddenly they're like, screw this, we can't actually do this.

[Felix Salmon]

Well, it's not. You don't even need. It doesn't even need to be 40%. It's just that if it makes sense to have 20% cash, it doesn't make sense to give all of that cash to exiting unitholders and have no cash left on hand. A lot of these commercial property funds I'm sure are to use some of that cash to start buying property at lower prices. But for the time, if they give all of their cash to departing unitholders, they can't do that. It makes sense if you are offering exposure to a fundamentally illiquid asset class that at times like this, you basically suspend the fiction that the investment is liquid. That makes sense to me.

[Kathy O'Neill]

I mean, it's part of the contract, so people sign up for that when they invest in this.

[Jordan Weissman]

I just want to also come back to the observation I was going to try to make before, which is slightly tangential, but I think important, which is that what we're seeing right now with these property funds and across Britain is a response to, like you said, uncertainty. We really do not know what's going to happen. And to me, that brings back memories, actually, of the US in the early Obama years, where you would hear politicians talking about, oh, President Obama, the Democrats are creating uncertainty by, you know, passing Obamacare or by proposing to raise taxes. And it was always kind of fuzzy. And I think that you're getting actually a really clear illustration of first the fact that uncertainty really can be damaging. But what uncertainty actually looks like where there's a paralyzing fear of we do not, do not know what the whole system is going to be anymore. It's not just a matter of, oh, we might pay a little bit more taxes or we might have to give health care or not. It's, we do not know how to our economy is based, what the rules of the economy are going to be.

[Felix Salmon]

And this is what Paul Krugman has been sort of twisting himself up in knots about when it comes to Brexit, is that Krugman is famously scathing about these things called confidence fairies, where he's like, everyone was talking, as you say, Jordan, during the early Obama years about, well, confidence is going to evaporate and that's going to be bad for the economy. And of course, it didn't work out that way at all. And Krugman was right that these confidence fairies didn't exist really, in 2009, 2010. And so now he's being a little bit skeptical about the existence of confidence fairies in the uk. But I think in the uk, you're absolutely right, they do exist. They are real. We're seeing them in the way that people are trying to get out of their exposure to commercial property and not being able to. We're seeing them in the value of the pound. We're seeing them in the fact that Britain is almost certainly Going to have a recession. And we're seeing them frankly. I mean, we're not gonna spend too much time talking about British politics. We're seeing them in the fact that there is no leadership in Britain anymore. Like, you know, there's no one in charge. And that's just. That can't be good for the country.

[Jordan Weissman]

Is no one in charge better than Boris Johnson in charge though?

[Felix Salmon]

Yeah, no, Boris Johnson would have actually. He was the Brexiteer, he was the leave guy who was most likely to not leave and to just leave things in limbo.

[Kathy O'Neill]

Can I just make one comment about confidence fairies though? Cuz I heard a lot about confidence fairies working finance during the crisis. And I always got annoyed by the concept of a confidence vary because it seemed like people used that concept as if all we needed was confidence. Like the underlyings were all good and we would go back to normal and fuck that. Like this is. This is not normal. It's going to be different.

[Felix Salmon]

You're absolutely right, Kathy, this is bad in the uk. It's not just a question of confidence, although confidence is certainly making things worse. So let's pick up this conversation about confidence and fear with my favorite fear index, which is the price of government bonds. When people are afraid, you get this thing called flight equality. And you want very safe bonds without any credit risk, and you want bonds in very safe currencies which you think aren't going to implode like the pound just did. So what that means in practice, it turns out, means that you, you wind up buying bonds in euros and dollars and Japanese yen and Swiss francs and you pay whatever it takes. And then on top of that, what you do, what you see is a bunch of bond traders who are seeing which way the wind is blowing. And I have one of my favorite stats about the bond market is that if you look at government bonds over 2016, if you just invested in government bonds at the beginning of the year, right now you're sitting on a 25% annualized.

[Jordan Weissman]

Jesus Christ.

[Felix Salmon]

So bond traders are just making huge amounts of money by going long government bonds, no matter what the yield. And so where we are now is this situation where there are $13 billion of bonds with negative yields. People get very excited about negative yields because zero is an important number. But it's symptomatic of those two things. Number one is fear, and number two is just momentum trading because you can make money on bonds with negative yields by buying them expensive and then selling them even more expensive to a greater fool.

[Kathy O'Neill]

I just want to Back up one second. Why do people put money into bonds when they're afraid? I think, I mean, tell me if you disagree, but my theory is that it's because mostly people ride the stock market and the stock market goes up a lot of the time. But then when stock markets go down, the bond market goes up. Like they're anti correlated. So if you are very long in the stock market, you're like, oh shit, we have no idea what's going to happen in the world economy. The stocks might really drop down. So I'm going to hedge by getting a bunch of bonds that might go up.

[Felix Salmon]

Bonds have a guaranteed return of capital. That's the other thing. They might have a negative yield. So you might get back a little bit less than you invested, but ultimately you will get back your money. And if you're investing in a foreign currency like Swiss francs or Japanese yen, if that currency goes up, then you make money regardless of negative yield. So it's inherently just a much safer place to put your money than the stock market where you can lose everything.

[Jordan Weissman]

I mean, there's another aspect of this which is if you're, it's a little bit scary, which is that if you think there's deflation coming, right, if you think prices are going to fall in a country, you can actually also make money off of a negative yield.

[Felix Salmon]

Because how do you make money?

[Jordan Weissman]

Because defi. I mean, you're in real terms. You're making money because you can make.

[Felix Salmon]

Money in real terms.

[Jordan Weissman]

Exactly.

[Felix Salmon]

So, so, so that's, that's the other thing is that you have to differentiate between nominal prices and real prices. And economists like Jordan love to talk about real prices. And they're like, well, if, if your, if your money went down, but the cost of goods went down even more, then really you made money. Which is an argument which only an economist could really love.

[Jordan Weissman]

That's, and that's how we actually, it's.

[Kathy O'Neill]

Not such a bad argument. Like according to anybody I've read recently, there's no expectation of a strong inflation at the very least. And there's some fear of. Real fear of deflation.

[Jordan Weissman]

Yeah, exactly. That's how a lot of, a lot of macro people are looking at the state of the bond market. That's a sign that people just don't think inflation, I mean, don't think inflation is coming anytime soon. Deflation could be coming. To give you a sense of the timeline, we're looking at the piece of news that everyone kind of latched on to late last week and this week was that all of Switzerland's bonds went negative all the way out to 50 years. You literally have to pay to lend Money. Switzerland for 50 years at a time.

[Kathy O'Neill]

Now that's not, that's not necessarily like a strong vote in favor of deflation into the Swiss franc.

[Jordan Weissman]

No, but it's a combination.

[Felix Salmon]

Can I, can I. I want to make one distinction which I think I've made on this show before, but it's an important one, is that people allied the two slightly different things. There's an important difference between number one, the yield on the bond and number two, how much Switzerland is paying to borrow money. And so when Jordan is saying that you're paying to lend money to Switzerland, that's not true. What you're paying for is an asset, a bond which is owned by someone else and the person you're paying is the, the previous holder of the bond. It is not a loan to Switzerland. The Switzerland loan borrowed the money at whatever interest rate ages ago. The vast majority for all the 29% of government bonds out there are trading at negative yields. Almost none of them were issued at negative yields.

[Jordan Weissman]

Countries like Germany are issuing bonds at negative yields. I mean there are countries now putting them in.

[Felix Salmon]

Well, they're issuing notes, they're issuing very short term debt yields, negative yield.

[Jordan Weissman]

Switzerland issued one five year bond.

[Felix Salmon]

Switzerland issued one 10 year bond at negative yield of -0.055%. Japan has issued one, I think proper like long term bond. But what we're talking about is a tiny fraction of all of the negative yields that's actually been issued.

[Kathy O'Neill]

The contracts themselves are the things that are being sold.

[Jordan Weissman]

You're buying the security because it's gone up in price and so the yield goes down. But I'm just saying these countries literally are actually now issuing these bonds at negative yields. And I'm sure that's happen more in the future given where we are now.

[Felix Salmon]

That's true. And the one interesting thing I'll note is that this 10 year bond which was issued at a yield of minus 0.055% still was issued with a 1.5% coupon. It had a nice relatively hefty 1.5% coupon which you get every year. The price you're paying for that bond upfront is so high that even with all of those coupons you won't get all of your money back. So yeah, that. I'm just gonna throw in another couple numbers here because I love numbers. And this is A number podcast one is that there have been 659 rate cuts since the Lehman crisis around the world. Wow, that's a lot of rate cuts.

[Kathy O'Neill]

What does that say about the world economy?

[Felix Salmon]

And this is ultimately the real reason why there are so many negative yielding bonds. It's just because we live in a world of zero interest rates. And when we're talking about negative, we're just talk. A third of the bonds at zero interest rates are below zero and two thirds are above zero and it averages out to slightly above zero, but we're in the zero.

[Kathy O'Neill]

So the entire world is becoming Japan.

[Jordan Weissman]

Yeah, that's my friend Matt's favorite thing to say. The whole world is turning Japanese because.

[Kathy O'Neill]

Japan started this 20 years before anyone else.

[Jordan Weissman]

But the problem is also, it's self reinforcing. When bonds everywhere around the world go to zero, it in turn becomes incredibly hard for a central bank to raise rates because if, say the Fed wants to raise interest rates, everyone's going to flood into treasury bonds, dollar denominate assets. All of a sudden the US dollar is going to go up and that's really bad for our economy. It can push us into deflation.

[Felix Salmon]

So strong dollar is in the national interest. Haven't you heard every single treasury secretary for the past 50 years. But we're not going to get into that.

[Kathy O'Neill]

That's actually interesting.

[Jordan Weissman]

I'm.

[Felix Salmon]

The little data point which I want to throw in here is about the high yield leveraged loan market. Larry Summers, our favorite person, wrote a column this week about how when his parents had a 4.5% mortgage, he would look on that and go, wow. See, in days we will never see again. The opposite of a safe borrowing mortgage is this thing called leveraged loans, which is super high risk loans with massive credit risk. Embedded Uber, our favorite company, just came to the market with $1.15 billion of leveraged loans. High yield loans. What was the coupon? What was the yield on these things? 5%. Wow, that's, that's, that's what counts as high yield.

[Kathy O'Neill]

These people are so desperate.

[Felix Salmon]

5%, okay.

[Kathy O'Neill]

Plus people love Uber. It's like its own thing, but not.

[Felix Salmon]

I mean, it doesn't matter how much you love it, like you still only get 5%.

[Jordan Weissman]

It's like owning a piece of the Green Bay Packers.

[Kathy O'Neill]

Yeah, it's like owning a seat from Yankee Stadium.

[Felix Salmon]

All right, on which note, we should, we should tie all of this up, Jordan, with I think the classic case of confidence and illiquidity and zero interest rates. All sort of conspiring to create what I believe is known as an omnishamble it's an omni.

[Jordan Weissman]

I wonder what the Italian word for that is.

[Felix Salmon]

What's the Italian word for omnishamishambles?

[Kathy O'Neill]

Listeners, we are relying on you.

[Jordan Weissman]

Yeah. Please let us know if any of you are fluent in Italian. So, yeah, Italy's banks are not looking too good. And it's sort of that their problems kind of combine all the things we've just been discussing specifically. People are starting to freak out that about 17% of the loans on their books have gone bad, are sour. Italy's banks are not in a good place financially. And it's gotten to the point, and that's being kind of reinforced now by Brexit. That's kind of creating more fear, more panic about what's going to happen in Europe and of course in Italy too, everywhere around.

[Kathy O'Neill]

What's that 17% compared to what we saw in the US during the financial crisis?

[Jordan Weissman]

It's like 10 times or something.

[Kathy O'Neill]

I thought it was more like three times, but a lot worse.

[Jordan Weissman]

I think it's 10 times what's normal in the US now.

[Felix Salmon]

But these comparisons are dangerous to make. Italian banks, and Italy in general is much more built on small and medium sized enterprises which borrow money. Much less built on financial markets and loan markets and bond market. The problem with the Italian banks is that there is no secondary market for loans. The banks, what they do is they make these loans and then they sit on them to maturity. Any bank in any country at the low point of a credit cycle, if you force it to market, loans to market, is going to look pretty insolvent. And also it has to be said that no one is saying that the Italian banks are insolvent. They're saying that their capital ratios are low, but they're still solvent. And indeed, even the worst ones, like, you know, that ancient bank in Siena is still profitable, it's still making money, but people are worried because their capital ratios are too low. And historically the Italian bankers had a. And they have seen this a million times. This is Italy. This is not exactly the world's most stable country. Italian bankers have seen this a million times. What they do is they just sit on their loans until the credit cycle comes out the other side and then everything's fine. The problem is that under European banking regulations, they need to start marking all of these bad loans to market and they need to worry about their solvency and they need to recapitalize themselves. And no one has any interest in recapitalizing them.

[Jordan Weissman]

Yeah. So Italy's very good looking. Prime Minister Matteo Renzi Essentially wanted to give them a bailout, wanted to give them a approximately €40 billion influx of capital. And Europe looked at this and said no, that this would violate our new anti bailout rules that went in Place in 2014. And the idea is that Europe's rules, the conflict is that Europe's rules say that if you're going to do any kind of attempt to save the bank bondholders, equity holders have to take some kind of losses. You have to force losses on the owners of the bank and the people and the people who own the bank's debt. And so, and the problem in Italy with that is that a lot of the bondholders of these banks debts are retail investors, which is really unusual. It's kind of a symptom of Italy's mom and pop economy that the people who own bank debt for whatever reason are retiree, like random retirees. So this is politically toxic there.

[Felix Salmon]

Let's be clear about this. Normal mom and pop people own bank debt again in every country in the world they're called depositors. So the difference between Italian banks and other banks in other places is that depositors treated differently, they are sort of bail inable bondholders. Basically. If you have a bank cd, which is a big thing in Italy, then you're a bail inable bondholder rather than a depositor who's protected. And so there are huge riots anytime anyone wants to bail in bondholders of Italian banks. So I feel like this is going to get solved, that there is going to be an Italian government bailout and that the Europeans are going to hold their nose and allow it. Just because the Italian banking system is so unlike the Dutch banking system or the German banking system. The laws which were passed to deal with those banking systems just don't really apply very well to Italy.

[Jordan Weissman]

Yeah, I mean this is I guess coming back to the kind of contradictions inherent in the eu. They're trying to move towards banking union, you know, along with monetary union. And that's really hard when you have national banking systems that don't mesh, that don't fundamentally work the same ways. You know, this wouldn't be a problem in the US when you're, if you're comparing banks in New York and Mississippi necessarily.

[Kathy O'Neill]

So why did Italy agree to those rules?

[Jordan Weissman]

It's a good question. They're 2014 rules. They probably didn't have a lot of say is my guess.

[Kathy O'Neill]

Yeah, so the people whose, whose systems worked with these rules decided.

[Felix Salmon]

Well, I mean like it doesn't. There's no such thing as a system which works with the rules. But the idea in general is that bondholders should be bailed in. And in principle everyone is in favor of this idea that if you're going to bail out banks, yeah, you hit the stockholders, but you should also hit some of the what's known as loss absorbing capital and that the bondholders should be counted among loss absorbing capital. The problem is that the smaller the bondholders get, the less capacity those people have to absorb losses.

[Jordan Weissman]

Yeah. And I mean this is, it's a devious sense. Like there are stories in Italy about people committing suicide because they were bailed in on when a bank was bailed out.

[Kathy O'Neill]

Can we go back to the 17% losses? Does this mean like that the actual economy of Italy is sucking? And like, is it going to get worse?

[Jordan Weissman]

I mean Italy's economy's not.

[Felix Salmon]

Well, it's not 17% losses, it's 17% non performing loans. Okay. And who knows what the value of those non performing loans is?

[Kathy O'Neill]

I mean, but you mentioned that, you.

[Felix Salmon]

Know, it's not zero. The Italian banks are valuing their non performing loans for about 43 cents on the dollar. If they try and sell them, they're being offered about 20 cents on the dollar. So that's why they're not selling them. Honestly, I feel like 43 cents is probably not a bad valuation for them. That most of them are collateralized by some kind of property or other. And here we get back to the whole question of the UK property market and stuff like that. There is a collateral, there are businesses here. Eventually the businesses will probably turn around. Some of them will start being able to repay those debts. It's not like just because these loans are not performing that they will never perform.

[Kathy O'Neill]

Yeah. But when you talk about waiting out the credit cycle, it sort of gives you the impression that there's a sine wave and you're at the hump and it's going to come back down and we're going to be okay. I'm just wondering if we have that reason to think that this is going to end anytime soon.

[Jordan Weissman]

I mean for Italy, I don't think there's no, I don't think there's any. I mean their unemployment rate, last I looked was still in the teens. Their economy has not substantially rebounded from.

[Kathy O'Neill]

Is this like sort of the first of many. Is this like Portugal and Spain? Are there.

[Jordan Weissman]

People are worried about that?

[Felix Salmon]

Yeah, we've already had a major bank failure in Portugal. So yeah. Southern European banks are, have been in crisis for five years now and we've had a system of rolling bailouts. One of the reasons for these 2014 rules is precisely that the European Union got sick of all of these government bailouts and said stop bailing out your banks because it's screwing up our internal EU finances in ways that the Germans don't like. But ultimately, when a country's banks get into trouble, that country does need to bail out the banks. We discovered that in the US in 2008, we discovered that in SP 2011, we discovered that in Greece in 2012. We've discovered that in so many countries when push comes to shove, these banks are going to have to get bailed out. It's just part of how a modern economy works.

[Jordan Weissman]

It's just also just half measures, kind of kicking the can, half bailing them out, sort of saying, okay, well these banks are okay now, but Italy's are sort of teetering, but we'll let them try to handle it for a while. It doesn't work. I mean, the U.S. the bailout was pretty swift and done with overpowering force and that's why the banks recovered as quickly as they did. So I think you're seeing Europe's hesitancy come back to haunt it.

[Felix Salmon]

And the other thing that's really important to mention is precisely because there's much less of a securities market in Italy. The economy which should come back, will only come back if the banks are lending. So if the banks are spending all of their profits recapitalizing themselves and paying back bailout loans instead of actually lending to small and medium sized businesses, which is what they exist to do, then that's just going to make the Italian economy worse. And this is true in all of Europe, that if you look at bank stock prices in Europe, across Europe, not just in Italy, but in Germany and Holland and France and Spain, they've been plunging since Brexit. And there is an unbelievably strong correlation between bank stock prices and the amount that they lend a year later. So if that happens this time and the lending goes down in line with the stock prices, that basically means that all of Europe is going to have a Brexit induced recession, not just the.

[Kathy O'Neill]

Uk For God's sakes. This is incredibly depressing, the third European.

[Felix Salmon]

Recession in a decade.

[Kathy O'Neill]

But I mean, it really sounds like the real problem here is the economy. The banking system absolutely needs to be healthy to sustain a good economy, to revive an economy or sustain a good economy. And there are these silly rules that are preventing what needs to happen from happening. If these rules really get in the way of everything. This is gonna be terrible.

[Felix Salmon]

Just to close the circle on the way all of these things are connected. We have zero interest rates in Europe, which means that the cost to the government of borrowing the money to bail out the banks is zero.

[Jordan Weissman]

Germany.

[Kathy O'Neill]

So it's just like a principle.

[Jordan Weissman]

I've been saying that Germany should literally just be borrowing money and rocketing bonobos into space, just spending it however they can at this point.

[Kathy O'Neill]

Bonobos do not deserve that.

[Jordan Weissman]

Anything, whatever. They just don't like, just burn money however you.

[Kathy O'Neill]

How about you give it to the Italian small and medium businesses that need it all.

[Felix Salmon]

Universal basic income.

[Jordan Weissman]

Yeah, anything. Anything that might get the economy going at this point, they are being paid. Germany specifically and Switzerland now, it seems, are being paid to borrow and try to save the world. And yet I feel like the EU.

[Kathy O'Neill]

Really has to go down. Sorry.

[Felix Salmon]

I mean, I know Kathy's a Brexiteer. She's a secret.

[Kathy O'Neill]

I really. I really think.

[Felix Salmon]

Are you a believer?

[Kathy O'Neill]

I really think that they need to adjust their thinking if they want to be attractive to their members, they can't just be attractive to Germany.

[Jordan Weissman]

Here's the thing I'm a little surprised about here because bailing in bondholders is the kind of thing that I would think you would be a fan of because it is sort of creating. It should create a little bit more moral hazard. It should try to make the banking system a little bit safer, if anything, or less risky. That's the idea behind it, partly.

[Kathy O'Neill]

So I agree that I think people who are just speculating on this bank. I'm going to lend my money to this bank because I think it's going to get bailed out. That's not a great thing. Right, but it's also not a great thing to starve a country of the basic investments that. I mean, banking systems do things. I'm not like a nihilist.

[Felix Salmon]

And when you look at bank bonds in virtually all countries in the world, it's people, sophisticated institutional investors making calculations of credit risk and saying, well, there's a certain risk of default and we're going to charge this much extra yield in order to make up for it. In Italy, it's like I'm putting my money in the bank. It's not that kind of thinking. And it's a different investor base. Okay, numbers round.

[Kathy O'Neill]

I have a number. It's two. It's very simple.

[Jordan Weissman]

Oh, no, I think you took my number.

[Kathy O'Neill]

Oh, shit. That's why I said it first. It's the number of years.

[Jordan Weissman]

God damn.

[Kathy O'Neill]

It, Kathy, that Elizabeth Holmes is not allowed to own a medical facility. A blood testing facility.

[Jordan Weissman]

Yeah. They've slaughtered this unicorn.

[Felix Salmon]

Oh, my God.

[Kathy O'Neill]

I have to say, it's like, pretty satisfying to someone who actually cares about science. And we've talked about this many times, but Elizabeth Holmes was, like, basically just pretending that she had invented a new kind of blood test. They did 81. They finally did, like, this criminal investigation. They did 81 tests, patient result tests. All of them were inaccurate.

[Felix Salmon]

81 of 81.

[Kathy O'Neill]

It was like 0% accuracy, statistically speaking.

[Felix Salmon]

You would think that just randomly one or two would be correct.

[Kathy O'Neill]

Yes. 81 out of 81 were wrong. And I'm like, yes, shut that stuff down right now.

[Jordan Weissman]

I mean, yeah, I mean, like the punishment, like, there was more. Like that was only the beginning of Theranos punishment. It was like.

[Kathy O'Neill]

Do you have another number coming up into it?

[Felix Salmon]

Jordan, come up with another number.

[Kathy O'Neill]

This is the first time this has ever happened, people.

[Felix Salmon]

We've managed to fudge it before. My number is 276,000, which is. It's a jobs report number. So this month, the US economy gained 287,000 jobs. The previous month, the US economy gained 11,000 jobs.

[Kathy O'Neill]

Not good.

[Felix Salmon]

So my point is that 11,000 is a low number, which is bad, and 287,000 is a high number, which is good. But my bigger point is that what we are finally seeing is the kind of natural randomness in data series that you should. That we should expect in all natural data series and we shouldn't get alarmed by, and that this kind of large fluctuation is what I kind of feel the jobs report series should do, and for many, many years has not been doing. It's been suspiciously steady month to month, given the margin of error on the numbers, which is plus or minus like 150,000.

[Kathy O'Neill]

Is it really that big?

[Felix Salmon]

Yeah, it's huge. It's that big.

[Jordan Weissman]

That's why you should never, ever trust, like, the first, the one that comes out on that Friday. Don't trust it until the.

[Kathy O'Neill]

I mean, you do seasonal adjustment, so that makes it a little smoother. But yeah, you're right. If it's. If the error bars are that big.

[Felix Salmon]

If the error bars are that big, you would not expect the numbers to be as smooth as they are. And so now, finally, maybe just randomly, we are seeing the kind of month to month fluctuation, which just goes to prove that, you know, stochastic data series are stochastic.

[Kathy O'Neill]

That's so sweet.

[Jordan Weissman]

Jesus. So you know what? I'm just going to go with to since my number was viciously taken away from me.

[Kathy O'Neill]

You got to go first, man.

[Jordan Weissman]

I'm just going to go. Yeah, right. I'm just going to go with three as my number going off of Felix. If you are interested in following the jobs report, my preferred measure is always to look at the 3 month rolling average on jobs because that just gives you a slightly, slightly more realistic sense of the longer or the midterm trend, which is what people are really interested in.

[Kathy O'Neill]

So it's always a balancing balance between smoothness and timeliness that.

[Jordan Weissman]

But I feel the rolling average is usually a little bit more indicative of what's going on.

[Felix Salmon]

I have a side gig, an unpaid side gig as a weight loss coach.

[Kathy O'Neill]

Oh, you do?

[Felix Salmon]

To a guy with a former guest of Slate money actually who I shall not name who has a Withing scale, one of his lovely Withing scales. And the thing I love about Withings.

[Kathy O'Neill]

Is it brand Withing.

[Felix Salmon]

Yeah, it's like WI fi connected brand bathroom scale you've mentioned.

[Jordan Weissman]

Oh no, you've rhapsodized about this before.

[Felix Salmon]

And the reason I like the Withings WI Fi connected bathroom scale is that it encourages you to ignore a lot of that stochastic randomness in data series and it will show you your long term moving average which is a much better indication of how well you know what's happening to your weight over time rather than get standing on the scale and getting a single database.

[Kathy O'Neill]

Yeah, I have a feeling some people are going to call in and ask you to be their life coach. Weight loss coach. I don't know.

[Felix Salmon]

Don't do that, don't do that. Do write in. The email address is slatemoneylate.com don't ask me to be your weight loss coach because honestly I'm not very good at that. But yeah, give us whatever feedback. Thank you for all of your feedback. By the way, on last week's Religion episode, it turns out a lot of you are are theologically sophisticated. Who knew? So that was good to learn. And come back next week. I have some sad news.

[Kathy O'Neill]

What? Oh yeah.

[Jordan Weissman]

Moment of silence.

[Felix Salmon]

This was the very last Slate Money to be produced by the one and only Audrey Quinn. Audrey will miss you, Audrey, we will miss you. Thank you very much to Audrey for producing this weekend. For countless weeks in the past, you've been amazing. Thank you too to the executive producers who do much less work. They are Steve Lichti and Andy Bowers. They have names. This is what we know about them. They run this thing called Panoply. You can check out all of the Panoply [e-mail] Panoply find us in itunes. Leave reviews there and we will talk to you next week on Slate Money.