MONEY Obamacare

The Real Reason Obamacare Is Now In Trouble

Tangle of colored wires
PM Images—Getty Images

Here's why we're still arguing over how the health care law is supposed to work.

The legal struggles over health care reform have taken yet another odd turn.

Last week a decision by a federal appeals courts put into doubt a key feature of the Affordable Care Act, a.k.a. Obamacare. In particular it ruled that residents in the 36 states that have not set up their own insurance “exchanges” aren’t eligible for tax credits when they buy coverage. Those credits are crucial to making the law work because they make insurance plans affordable. (The ruling may not stand; another court the same day made the opposite call.)

I wrote at the time that the court’s reading of the intent of the law seemed implausible. Why would Congress have allowed states to so easily opt out of such a hard-fought law? And why did no one mention this at the time? The theory that Congress meant for the law to work this way seemed to be news to everyone until Obamacare opponents came up with it for the lawsuit.

However, late last week opponents of Obamacare found video of a prominent, well-connected Obamacare adviser, M.I.T. economist Jonathan Gruber, saying that states should really set up exchanges because otherwise their residents wouldn’t get the federal money. Those remarks (and these too) were in 2012, two years after the law passed but before the court case. Gruber says his remarks were a mistake.

What Gruber said in 2012 doesn’t really prove much about what Congress was thinking in 2010. (More here from’s Sarah Kliff on how none of this came up during the actual debate). But I have to admit, it’s somewhat harder to argue that the D.C. circuit’s reading is a craaaaazy idea because, well, one architect of the law apparently once understood it that way, too.

That said, let’s look beyond the controversy of the moment, and even beyond the ACA, at the real reason Democrats have found themselves in this tight spot: Congress tried to squeeze a big social program through the tax code. No wonder things got complicated.

Remember what people were talking about in 2010? It was mandatemandatemandate. Tax credits and subsidies weren’t much on the minds of anyone but real health care wonks. Yet they are essential to making the ACA what it really is: A social insurance program, not unlike Social Security or Medicare, that raises some taxes (chiefly Medicare taxes on higher earners) to pay for a safety net for low and middle-income people.

But the subsidies are indirect: Instead of having a public insurance program, we have money running through private insurance. Which runs through state-run exchanges. Or sometimes federal exchanges. Through which run tax credits via the IRS. With another chunk of money going through states via the the Medicaid system.

That complexity is why the roll-out was such a mess. It’s why the Supreme Court has already reduced the law’s reach by striking down part of its Medicaid provision, allowing some states to opt-out of coverage for many low-income people. And it’s why it now matters so much how a judge chooses to interpret the language of section 1311(d)(1) of the legislation.

But of course the ACA isn’t the only example of the government using indirect means to put money into people’s pockets to achieve a social goal. There’s the Earned Income Tax Credit, an important anti-poverty program. But there’s also lots for the middle-class (and above): Medicare drug plans administered by private companies, longstanding tax incentives for employers to offer health insurance, and the 529 tax break for college savings. And, for homeowners, of course, the mortgage interest deduction.

Political scientist Suzanne Mettler calls these partly hidden benefits the “submerged state.” The government is still spending money–it’s just not always obvious how. Such programs have become become the center of gravity in the Washington’s approach to domestic spending. Republicans frequently try to make direct spending programs less direct. (Think Mitt Romney’s plan to turn Medicare into something like a voucher to buy coverage.) And Democrats proposing new programs go the indirect route. (Obamacare is basically a voucher to buy coverage.)

This has political advantage for both sides. Conservatives like that it leaves people less attached to the idea that government can help them, because the programs are harder to see, even if the money going to constituents is real. Liberals like that indirect programs are a lot easier to get passed.

The cost, though, is that indirect programs are hard to design well. They create a lot of complexity for users—these programs are a big part of why doing your taxes is such a pain. And they sometimes fail to get dollars where they are most needed.

That doesn’t mean indirect programs aren’t worth doing—the Affordable Care Act has achieved one of its key goals by adding millions to the insurance rolls. But if the D.C. circuit decision prevails (I’m still guessing it won’t) supporters of health-care reform are going to need to do some rethinking. They might consider pushing something like Medicare, except for people under 65. That wouldn’t be an easy political argument to win, of course. But at least you wouldn’t have to be a wonk to understand how it works.


Mark Cuban to Investors: Get Out Of U.S. Companies That Run Overseas

Mark Cuban
Hey, you! Get back here! Mpu Dinani—Getty Images

Companies are merging with foreign competitors to get tax breaks. Here's what the notorious Mavs owner thinks of that.

Dallas Mavericks owner and investor Mark Cuban has taken to Twitter this morning with some big thoughts about the U.S. companies changing to foreign addresses to get tax breaks.

Such corporate relocations, known as inversions, have become a hot-button issue in recent days after several major corporations pulled the tax maneuver and President Obama began calling for Congress to block this virtual corporate exodus.

Cuban starts with what sounds like your basic economic patriotism argument:


And then things get more interesting.


By PE, Cuban means price-earnings ratio, the standard way investors value a stock. He means that if companies take the tax break, investors ultimately benefit because it raises earnings. (We recently discussed who really benefits here. Short answer: That’s true mostly for wealthy investors like Cuban.) And he says he’s wiling to live with lower earnings. But what does “risk doesn’t leave the system” mean?



Of course, he adds, if you sell to punish a company for cutting its taxes, make sure it doesn’t mean you pay a bunch of taxes.


Activism has its limits, amirite?


This Hedge Fund’s $6.8 Billion Tax Break Is Going to Enrage You

If it looks like a loophole... Jupiterimages—Getty Images

Short-term trades are usually taxed like regular income. But not if you are a hedge fund with a helpful banker.

If you invest or do any stock trading outside of a 401(k) or IRA account, you know that how long you hold your stocks can make a big difference at tax time.

If you buy and then hold an investment for at least a year, your profits will be taxed at the long-term capital gains rate — 15% for people in most tax brackets and 20% for those in the very top one. Fast in-and-out trades, on the other hand, face a much bigger tax bite because they are taxed as ordinary income. What’s more, you can be hit with those higher rates even if you aren’t a day trader: For example, if you own an aggressively managed mutual fund that does a lot of trading, you may get capital gains distributions you have to pay tax on.

Now it appears that some high-powered hedge funds found a clever way around those higher rates, basically by turning short-term trading gains—often really short-term, as in minutes—into long-term ones. According to a report issued this week by a the Senate subcommittee on investigations, that move might have netted one fund managed by Renaissance Technologies a tax saving of $6.8 billion over several years. That billion with a B.

By what magic does a trade of a minutes become a long-term, buy-and-hold investment eligible for lower taxes? Well, it appears you just had to find a bank that will wrap your trading into something called a ” basket option.”

Here’s how it worked: Instead of buying and selling the stocks directly, hedge funds would go to a bank—the Senate report singled out Barclays and Deutsche Bank—and buy an options contract linked to the value of a basket of securities. Think of the basket of securities as being like a stock fund; and just like a stock fund you might have in your 401(k), the composition of that basket is constantly changing. In the Renaissance case, the basket changed based on computer algorithms looking for tiny inefficiencies in asset prices, which meant constant buying and selling.

At some future date, the hedge fund could exercise the option and get back the amount it paid for the option plus or minus any returns on investments in the basket. And here’s where the tax break happened: If the hedge fund waited at least year to exercise the option, all those quick in-an-out trades inside the basket got wrapped up in one big long-term trade.

The really clever (or, some might say, devious) part is that the basket of securities was all along actually still managed by the hedge fund. Technically, the banks hired Renaissance managers to run the basket backing the options that they sold to Renaissance. Did you catch that?

In Senate testimony this week, execs from the banks and Renaissance offered their side. They say that while it’s true there were tax advantages to this set-up, it wasn’t only a tax shelter. For example, in addition to changing the tax treatment, using an options contract also gave Renaissance a lot of leverage, since they only put in part of the money to buy the basket. That amplified their wins as well as losses. (The Senate’s not too happy about that part, either, though. Since 2008, big investors using borrowed money looks more like a bug than a feature.) It also limited Renaissance’s exposure to catastrophic losses, since they couldn’t lose more than they paid for the option, giving the banks some skin in the game on the portfolios. In tax law, something that works like a tax shelter can still be okay if it has another economic purpose.

The Internal Revenue Service, though, indicated in 2010 that moves like this don’t pass the smell test.

Howard Gleckman of the Tax Policy Center explains here why it is that the IRS might not yet have clamped down on this particular maneuver. Short answer: It’s tough for the IRS to go after big hedge funds and their investors. They are outgunned. Gleckman wonders if we have a “two-tiered” tax system, one for the rich and another for the rest of us.

At the subcommittee hearing, there were really two arguments in play. One was whether the tax law technically allows quick trades to be turned into long-term investments in this way.

The other was whether it should. That doesn’t seem like a hard question.

MONEY Health Care

4 Really Weird Things About the Latest Obamacare Ruling

U.S. President Barack Obama (L) walks out next to Vice President Joseph Biden
Obama's signature health-care law faces a new court challenge. Larry Downing—Reuters

An appeals court says Congress must have meant to make the health care law even more complicated than we thought.

Today two separate appeals courts handed down decisions on challenges to the Affordable Care Act, known popularly as Obamacare. One of those courts, a three-judge panel of the U.S. Court of Appeals for the D.C. Circuit, ruled that the federal government can’t provide insurance premium subsidies to people in states that haven’t set up their own insurance exchanges. The other court rejected that argument.

The D.C. circuit’s opinion, which would invalidate the subsidies paid to about 5 million people, will be a huge, huge deal if it holds up. Much of the early debate and legal wrangling over the ACA focused on the “individual mandate,” the part of law that fines you if you don’t have health coverage. But the subsidies are even more important because they make the required coverage affordable for moderate- to middle-income families. (The subsidies are available to a family of four earning up to $95,400.) The law says you don’t have to pay the fine if insurance isn’t affordable, so without the subsidies the mandate doesn’t apply to so many people.

The ruling could very well be overturned on appeal, and in the meantime the subsidies remain in place. (You can read more on what happens next in this report by Time’s Kate Pickert.) But as a reporter who has covered health care reform closely since the George W. Bush administration, I have to say this ruling just doesn’t make much sense to me. In particular, four very odd things stand out.

1. The court’s interpretation seems implausible.

Quick background: Obamacare subsidies are issued when you buy insurance on an online marketplace called an exchange. Some states set up their own exchanges, but 36 states didn’t, leaving the federal government to do the job instead. The D.C. Circuit ruled that the law authorizes the subsidies to be paid only through state-run exchanges.

This ruling hinges on a close reading of the law, a purported effort to figure out what Congress truly intended. The government, defending Obamacare, argued that because the law can’t work without the premium subsidies, Congress must have meant them to apply regardless of who ran the exchange.

But the court offered another theory: Maybe Congress meant the subsidies to be an incentive for states to set up their own exchanges.

That sounds like a implausibly flexible approach to what was meant to be a sweeping national health care law. After all, it essentially gives any state whose governor or legislature opposes the ACA a chance to opt out of some its biggest provisions—not just the subsidies, but the individual mandate, too.

Cast your mind back to the debate in 2009 and 2010. What I remember was conservatives denying the ACA a single Republican vote and arguing that Democrats would brook no compromise. Democrats, meanwhile, were pointing out that Obamacare looked a lot like the Massachusetts law signed by Republican governor Mitt Romney.

It seems to me that in a long argument over whether Obama and Nancy Pelosi and Max Baucus were tyrants, or just sweetly reasonable splitters-of-the-difference, someone might have said: “Hey, if Republican-led states don’t like the individual mandate, they can always opt out of the exchanges.”

That did not happen.

2. If the ruling stands, this messes up the insurance markets in 36 states.

If there are no subsidies, that doesn’t only mean that many people won’t get help from the government to buy coverage. Even those who didn’t get the subsidies in the first place could face higher prices.

That’s because the law requires the exchanges to sell insurance to everyone who applies, charge them the same rates (based on age) regardless of health, and offer a minimum package of benefits. The problem is that if you don’t have to buy insurance, many people will do so only when they know they need coverage—i.e., when they are sick. And if too few healthy people and too many sick people sign up, insurers have to raise prices to cover the costs. That then means you have to really sick to want to sign up, and that jacks up rates more, and so on. This is known in insurance as adverse selection, or a “death spiral.”

So the federal exchanges could stop working pretty quickly if this ruling stands. In fact, according to the briefs filed by the insurance industry and a group of economists who support the ACA, the adverse selection problem in the exchanges could spill over into the market for private individual plans outside the exchange too, since the law links the two markets in various way. How this would actually play out is unclear, but suffice it say, it’s a major rug-pulling.

Setting up federal exchanges that can’t work seems pretty dumb. Now, as Michael Cannon of the libertarian Cato Institute says, it’s not like lawmakers never make bad laws. States have tried to regulate insurance coverage the way the ACA does, without subsidies, and they’ve run into all these adverse selection problems. The thing is, people in Washington knew this when the ACA was being debated and written. It’s why the subsidies and the individual mandate—a wildly controversial, politically costly provision that many members of Congress wished would go away—were in the law in the first place.

3. This somehow involves the Northern Mariana Islands.

The D.C. Circuit panel notes that the ACA in fact did trigger the “death spiral” problem in this U.S. overseas territory in the Pacific. That’s because the Northern Mariana Islands were subject to the new rules about health coverage but left out of the subsidies. That, says the court, means that maybe Congress really could have meant to regulate the insurance market without subsidizing it too.

I can think of some other reasons why Congress might have klutzed up the part the law that applies to U.S. territories. Like the fact that people in those places have no voting representation in Congress.

4. Congress really isn’t very good at crafting laws

I don’t mean it’s not good at making laws (views may vary on that). I’m talking about the actual writing-it-down part. The court’s lead opinion is devastating in showing how badly written parts of the law are. If these were comments from the professor in a course titled “Lawmaking 101: Making a Bill a Law,” you’d expect to see a big fat red “D” at the bottom of Congress’ term paper. The bill was pushed through hastily after Republican Scott Brown unexpectedly won the late Ted Kennedy’s seat in the Senate, depriving the Democrats of a filibuster-proof majority. The craziness of the legislative process shows in the text.

But its not just a craft problem. The legal vulnerability of the ACA goes hand-in-hand with how politically vulnerable it is. The law makes sense in a basic way and seems to be helping more people get coverage. And polls say people like many of the provisions of the law. But it is also complicated, and hinges on many different players (states, employers, private insurers, Medicare, Medicaid, you and me…) interacting in predictable and not-so-predictable ways. From the beginning, many people have really struggled to get how the law fits together. Turns out that may have included some people in Congress.

MONEY real estate

NYC Apartment Building Will Have Separate Door for Lower Rent Tenants. What’s Up With That?

Rich door and poor door
New Yorkers are calling it the "poor door." Sarina Finkelstein—Marcus Lindström/Bronxgebiet/Getty Images

A new luxury high-rise on the Upper West Side of Manhattan will include a separate entrance for tenants in "affordable" housing units.

New York City has approved plans for a new luxury high-rise on the Upper West Side of Manhattan that will include a separate entrance for tenants in “affordable” housing, reports the New York Post. Even the conservative Post manages to see the class angle, calling this a plan for a “poor door.” (The quotation marks are the Post‘s.)

This controversy has been roiling in New York for a while. The Daily Mail unearths a 2013 quotation in a real-estate trade paper from the developer of another project (not the one on the West Side) defending separate entrances. It’s one for the ages:

‘No one ever said that the goal was full integration of these populations,’ said David Von Spreckelsen, senior vice president at Toll Brothers. ‘So now you have politicians talking about that, saying how horrible those back doors are. I think it’s unfair to expect very high-income homeowners who paid a fortune to live in their building to have to be in the same boat as low-income renters, who are very fortunate to live in a new building in a great neighborhood.’

Let’s keep the rich and not-so-rich in separate boats. Nice. You can make arguments for what the developers are doing here—here’s one—but, wow, that’s not it.

If you don’t live in New York and you aren’t familiar with the crazy real estate market here, this story might need a little translation. Your questions answered:

If the developers don’t want to mix different tenants, why include “affordable” units at all?

Because they are getting subsidies—pretty valuable ones—to build them.

There is not enough of any kind of housing in NYC, but housing for people with low-to-middle incomes is especially scarce. The long-term answer to that is to build lots more housing, and there’s a case to be made that building in NYC should just be a lot easier than it is. The fear on the other side is that new construction will mostly go to the luxury end of the market.

One stop-gap has been to encourage developers to encourage builders to include various kinds of affordable units in their projects. There may be tax benefits passed on to buyers of condos in buildings with affordable units, for example. The Upper West Side project, developed by a group called Extell, got zoning rights to build more units, says the blog West Side Rag, and Extell can sell those rights to other nearby developers.

West Side Rag also says the developer argues that, since the affordable units are in a separate part of the building, it legally must have its own entrance. That could have been avoided had the affordable units been mixed throughout the building. But this particular high-rise offers coveted views, including of the Hudson River. Spreading the units around would presumably have meant giving up some prime spots to affordable units, cutting profits for the developer.

What’s “affordable”?

To qualify for these units, a tenant would need to earn less than 60% of the area’s median income, adjusted for family size, says West Side Rag. For a family of four, that’s about $52,ooo a year. That’s twice the Federal poverty line and above the median U.S. household income, though making ends meet in NYC on that much, with a couple of kids, isn’t easy. That family could rent a two bedroom under this program for about $1,100 a month. So yeah, New York’s version of affordable is different than in other places.


Hey, If Companies Can Change Their Citizenship To Get a Tax Break, Why Can’t I?

Getty Images/age fotostock

A big merger turns an American company into a foreign one, and cuts its taxes. Nice trick if you can pull it off.

This morning AbbVie, a big pharmaceutical company based near Chicago, announced it agreed to acquire Shire, another drug maker that is often described as being based in Ireland. It’s actually incorporated on the small island of Jersey, a British Crown dependency. As part of the deal, AbbVie will incorporate in Jersey too, and as a result get what looks to be a pretty sweet tax break. The company’s “effective” tax rate, reports USA Today citing regulatory filings, would fall to 13% in 2016, compared to 22% last year.

And the great part is, the people who run the new company will get to stay in Chicago. Jersey’s nice, but with a population of about 90,000, and the English Channel on all sides, it’s a little inconvenient. For everything besides taxes, that is.

Allan Sloan just wrote an epic cover story for Fortune (which like is owned by Time Inc.) about the growing trend of companies switching their on-paper country of residence to avoid paying U.S. corporate taxes. Recently, the Obama administration has called on Congress to find a way to crack down on the practice, known as “inversion.”

So here’s a question: How is it that corporations can so easily change their legal address to get a tax break, but the rest of us can’t? (Not that we want to. We’re patriotic, fair-share-paying Americans… but still.)

The simple answer is that corporations are legalistic fictions. You could theoretically move and switch passports, but you’d miss your family and your favorite baseball team, and your employer might wonder why you’re not at your desk. Besides, explains Eric Toder of the Tax Policy Center in Washington, D.C., to do a inversion you need to find an overseas company to merge with, such that 20% of the new combined entity is held abroad. Sort of hard to slice-and-dice yourself that way. A company can go “live” in Jersey and still visit its U.S. customers every day, still employ people here, and still let the CEO keep his season tickets to the opera in New York or Chicago or Boston.

Corporations may be people these days, as the Supreme Court would have it, but they are magically incorporeal ones.

Behind the ghost-like corporate entity that lives abroad, of course, there are lots of actual flesh-and-blood people who live right here in the U.S. of A. So one answer to the question “Why can’t I get this tax break?” is that you can: Just own shares of a company like AbbVie that’s a good candidate for inversion. When corporations pay lower taxes, most of the value of that accrues to the shareholders, says Toder. So if you own some stocks, you get a piece of the action when corporations invert. But it’s probably a very small piece because you have to own a lot of stock to be paying much in the way of corporate taxes.

In other words, inversion isn’t a tax break for “corporations.” It’s a tax break largely enjoyed by wealthy households. Here is how much the Tax Policy Center estimates people pay in corporate taxes, based on income.

SOURCE: Tax Policy Center

You need to get to people earning over $100,000 per year before corporate taxes start taking more than a 1% bite, and the really noticeable burden of the corporate tax falls on people above the $500,000 level. They pay more because they’re the ones who own shares. (How do people earning less that $10,000 end up with some corporate tax? TPC attributes some of the cost of corporate taxes to workers getting lower pay than they would otherwise.)

When companies find tax loopholes, it effectively lowers tax revenues from higher earners, and means the government has to find other ways to raise money instead.

One way to stop companies from “inverting” is to lower U.S. corporate rates, which are high compared to the rest of the world, perhaps paying for it by closing tax preference enjoyed by some but not all companies. (Many companies are good enough at working the tax code that the “effective” taxes that are actually paid by U.S. firms is more in line with international averages.) And that’s part of the long-term solution even the White House says it wants.

But Congress moves slowly, while corporations are light on their disembodied feet. Too bad the rest of us can’t move that fast.

MONEY Markets

Markets React to Malaysian Jet Crash and Gaza Invasion

A part of the wreckage of a Malaysia Airlines Boeing 777 plane
A part of the wreckage of a Malaysia Airlines Boeing 777 plane is seen after it crashed near the settlement of Grabovo in the Donetsk region, July 17, 2014. Maxim Zmeyev—Reuters

Investors sold off stocks in response to news that a Malaysian Airlines jet had crashed in eastern Ukraine today, reportedly killing 295 people. Ukrainian government officials said the plane may have been shot down; pro-Russian separatist fighters in the region denied responsibility. Then late in the trading day came reports that Israeli forces had begun a ground invasion of Gaza.

The S&P 500 index of large cap stocks fell more than 1% for the day. The Dow Jones Insutrial Average also declined, closing at 16,977, back below the 17,000 milestone it first crossed earlier this month.


Investors in general moved away from risky to safer assets. The 10-year Treasury bond yield fell below 2.5%, down from 2.55% yesterday. A fall in bond yields means a rise in price, and reflects investors being willing to accept a low return in exchange for the safety of U.S. government-backed securities.


Janet Yellen’s Guide to Investing

U.S. Federal Reserve Chair Janet Yellen adjusts her glasses
Kevin Lamarque—Reuters

The Fed says stocks in general aren't overpriced, but watch out for bubbles in social media and biotech.

Janet Yellen, chair of the Federal Reserve, is testifying before the House of Representatives today. Yesterday, she spoke to the Senate. Her testimony is accompanied by a deeper-dive document called “The Monetary Policy Report.”

One snippet caused a stir yesterday, because the Fed lays out a fairly detailed view of valuations in the markets. The Reformed Broker blog quipped that it sounded like a report from a portfolio manager at “Yellen Capital Partners”. The big news was that the Fed thinks prices for some biotech, social media, and other small companies look “stretched.” That’s a polite way of telling investors: watch out.

But the Fed’s full take on the markets is worth a look. Here’s what the bank says — feel free to skip ahead if you prefer to read Fedspeak in translation — and what it means.

“Some broad equity price indexes have increased to all-time highs in nominal terms since the end of 2013. However, valuation measures for the overall market in early July were generally at levels not far above their historical averages, suggesting that, in aggregate, investors are not excessively optimistic regarding equities.”

A standard way to look at whether stocks are cheap or expensive is to compare prices on the S&P 500 index to companies’ earnings. If you use the profits Wall Street analyst’s estimate for the coming year, prices look high relative to the past decade, but a long way from the tippy-top prices of the late-1990s bubble.

SOURCE: Factset

People with a more bearish take on the market prefer to look at stocks relative to the past 10 years of actual earnings. This smooths out times when earnings are unusually high, and cuts out Wall Street analysts’ optimism. It also allows you take a longer view. Again, stocks look expensive compared with recent years, less so compared with the peak… but quite high relative to a longer history.

SOURCE: Rober Shiller

The Fed’s saying stocks are on the expensive side, but not crazily so.

“Valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries.”

There was much talk of a biotech bubble earlier this year, and those stocks have been volatile ever since. They’re still way ahead of the S&P’s big gains in recent years. As Business Insider noted back in March, new biotech IPOs are popping up all over. There were 24 in the first quarter of this year and 37 least year, compared with just 11 in 2012. That can be a sign that investors are throwing their money at anything in hopes of getting that one big lottery ticket stock.


As for social media: This.

“Credit spreads in the corporate sector have also declined, on balance, in recent months… Credit spreads on high-yield corporate bonds are near the bottom of their range over the past decade.”

We’re talking about bonds here. High-yield is the nice way of saying junk bonds with poor credit quality and a higher risk of default. I bet if Janet Yellen is worried about anything, it’s bonds more than weird social media IPOs. Investors who take a plunge on small companies with a new app usually know going in that they could lose money fast.

That’s not always the case with bonds. As investors have searched for more ways to get yield, they’ve been pouring money into “unconstrained” and “nontraditional” bond funds, many of which hold lower grade debt. That may help investors if interest rates go up, but it also means taking on other kinds of risks. Some analysts, like Eric Jabcobson at Morningstar, worry that not all fund investors know the risk they are taking on. Unpleasantly surprised bond-fund investors can make a lot of trouble: In a worst-case scenario, if they all run for the exits at once, fund managers may end up having to fire-sale less-liquid bonds, or sell their higher quality bonds to meet redemptions. That would amplify a bond bear market, which in turn would mean tighter lending conditions all around.

But the Fed isn’t painting a worst-case scenario here. They’re just saying they are watching this data point.

The big question: What business is it of the Fed’s what people invest in?

Like it or not, communicating with markets is a big part of what central banks do. It used to be said that British banks were regulated merely by a raised eyebrow from the governor of the Bank of England. Janet Yellen is giving the markets a little bit of an eyebrow raise here. The Fed’s main jobs are getting unemployment down and keeping prices stable, but especially after 2008, it worries about asset bubbles too.

Yellen may also be shaking the tree a little. The Fed doesn’t see a whole lot of bubbly behavior, but it also knows it can’t see everything that’s going on in every corner of the financial system. Blogging economist Tyler Cowen has a theory that Yellen’s talk about certain investors getting kinda complacent is really a way of finding out if that’s true. If the Fed says biotech stocks are a little high, and then investors take a closer look at their biotech stocks and decide to run away… well, maybe biotech stocks really were getting too high.

But let’s not forget the context in which Yellen is raising her eyebrow: Her Fed is still doing Quantitative Easing, though it’s likely to end this fall, and still holding short-term interest rates near zero. In other words, she’s still telling the financial markets that the Fed will keep stoking economic growth; the report just tempers that message a bit.

Yellen is saying, in effect, “We’ve still got your back — but don’t come crying to us if you go making crazy bets.”

MONEY The Economy

WATCH: Why You Should Care About the $7 Billion Citigroup Mortgage Settlement

Citigroup paid $7 billion as part of a settlement with the Justice Department, but homeowners affected by toxic mortgages are still struggling.

MONEY Citigroup

Here’s Why Citigroup Is Shelling Out $7 Billion

It wasn't just investors who were hurt when banks turned lousy mortgages into toxic bonds


You could be forgiven for not caring — or perhaps not even noticing — that Citigroup agreed yesterday to pony up $7 billion to settle a Justice department inquiry into its mortgage business. More than five years after the financial crisis, the legal process of holding banks accountable can feel about as urgent as a rerun of Law & Order.

But it’s worth spending a few minutes remembering what actually happened — and who got hurt.

The government’s case against Citigroup is about harms to investors who bought pieces of mortgage “pools” that Citi created. But since investors who buy mortgage securities aren’t exactly Joe and Jane Mainstreet, the whole thing can seem almost victimless. The financial press also tends to overlook the human costs and focus on the money: What does the $7 billion hit mean for Citigroup’s share price? (So far, investors seem happy to at least know the bill.) Who gets the money? (Mostly the government, but $2.5 billion will go to consumer relief, like mortgage modifications.) And who is paying? (Shareholders, basically. No individuals from the banks are paying up—at least in this settlement.)

So it’s easy to forget that actual homeowners were hurt, too. Citigroup was one link in a chain that turned home loans into investment products. At one end, there were the original mortgage lenders (including such fine operation as Countrywide). Citigroup would buy mortgages from the originators and then pool the loans together to create securities that other investors could buy. One of the bank’s jobs was to make sure that the mortgages in the pool were up to snuff.

Citigroup hired outside companies to check on this. The companies would look at a sample of the loans and see if any of them didn’t fit guidelines, or if valuations of the homes the mortgages backed looked squishy. The news Citigroup got back wasn’t pretty. One Citigroup trader looked at the reports produced and wrote in an email (one for the ages) that “we should start praying… I would not be surprised if half of these loans went down.” Nevertheless, Citigroup went ahead and created securities out of the loans. These securities went south, touching off the Great Recession.

But things didn’t work out terribly well for the individual borrowers, either. Citigroup and institutions like it helped stoke mortgage originators’ appetite to lend to just about anybody and everybody, in many cases based on unrealistic valuations. The damage from this includes borrowers who ended up overstretched and put on the road to foreclosure, and more broadly any home buyer who bought into a increasingly inflated market.

Let’s not forget that part.

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