Photographer: Andrew Harrer/Bloomberg

An anti-foreclosure demonstration outside Fannie Mae headquarters.

Update: Fannie Mae today reported a record 17.2 billion profit for 2012, underlining the dilemma Clea Benson explained in yesterday’s story.

If there’s such a thing as too big to fail, no one qualifies more clearly than Fannie Mae and Freddie Mac. Together the two agencies own or guarantee more than $5 trillion in mortgages. After they were taken over by the government, the consensus was that we’re certainly not going to let the government take the risk of losses on the entire mortgage market again.

Not so fast. Bloomberg’s Clea Benson today reports that the government is trying to figure out what to do with the substantial profits collected by Fannie and Freddie. The two have now given back $50 billion to the government out of $187.5 billion in bailout costs. The question is how the government plans to run a profitable business that it never wanted to be in.

From the beginning, discussions of what to do with Fannie and Freddie have focused on getting the government out of the business of unlimited guarantees. A Treasury report on reforming the housing market two years ago outlined the problems with the agencies succinctly, noting their “profit-maximizing structure undermined their public mission.” Telling the agencies to do anything they could to make a profit, while also asking them to avoid irresponsible risks, plainly didn’t work.

What would be better? As yet, there’s no really good answer. One option is just to split up Fannie and Freddie into smaller pieces. That won’t be enough. It’s often claimed that lenders act recklessly when they’re too big to fail and can count on the government to step in when they get in trouble. The evidence for that is slim: the mass of smaller companies in the subprime industry happily drove themselves into oblivion with no expectations of government help (Roger Lowenstein has made a similar point). The problem with smaller financial companies, whether you talk about subprime lenders or, to go back in history, savings-and-loans, is that most of them make similar mistakes at the same time. When they fail, they all fail at once.

The invisible hand of the market alone isn’t going to fix that. Benson writes that proposals now focus on developing a private mortgage market, with a final backstop of direct government guarantees. Like it or not, some version of that last part is always going to be in play.

Photographer: Scott Eells/Bloomberg

Steven “Steve” Cohen, chairman and chief executive officer of SAC Captial Advisors LP

A version of this was originally posted to the TMN newsletter in December, after insider trading charges were filed against former SAC Capital fund manager Matthew Martoma. The same points are relevant now, in the wake of the latest SAC-related charges.

Why is Steven A. Cohen’s SAC such a tempting target for prosecutors? Despite a great deal of effort, prosecutors haven’t found evidence linking Cohen directly to insider trading.

So why do they deem to be looking so hard? Yes, Cohen is well known and successful; so are other fund managers. The difference is that we have a pretty good idea of roughly what other successful fund managers do. There are a few approaches that seem to account for outsized returns:

* Work off an understanding of macro-economic trends that is simply consistently correct than that of other investors. This is what George Soros did for many years, and what John Paulson does, not always successfully.

* Invest with a long time horizon, finding value that other investors miss. This is what Bruce Berkowitz has done with the Fairholme Fund (if you missed this Bloomberg story about Berkowitz, go back and read it right now). There may be a few efficient-markets zealots who will say this is theoretically impossible. It’s not.

* Model the market with algorithms better than other investors to take advantage of price discrepancies. Some variation of this probably drives the returns of Jim Simons’s Renaissance Technologies LLC.

* Trade with borrowed money to boost your returns. Almost every hedge fund does this to some degree. This will always work as long as the market moves with you; without another edge, it will also eventually make you blow up.

Cohen has certainly tried all these approaches. What his fund is best known for, however, is stock picking. As this 2010 Bloomberg story describes, Cohen’s main business is trading stocks (in 2008 he shut down efforts in other classes) and holding them for periods of 2 to 30 days.

With other top investors, the outside world has some sense of what makes their strategy different from everyone else’s. Not so with Cohen. There may be a general explanation for why he outperforms his peers. Cohen and his staff may have a markedly better understanding of the market’s psychology, for instance. Or a better framework to evaluate the quality of publicly available information.

The difficulty here is that in other hands the approach of guessing which stocks will go up in the next week or month reliably fails to beat the market.  So far, Cohen has never really articulated what makes his firm different from all the other stock pickers out there. That may be one way to dissolve the cloud of doubt that has settled over SAC.

Postscript: One data point worth noting, for those who want to dive deeper, is that the latest SEC filings for Berkowitz’s Fairholme Capital Management show investments in just 15 companies. That’s it. Picking just a few stocks that will beat the market is hard enough; any strategy that picks hundreds of winners will raise questions. Also, one approach not mentioned here that has been in the news a lot lately is Carl Icahn’s investor activist approach. Clearly that’s another strategy that works, but again, very different from the kind of stock picking that SAC does.

Photographer: Chris Ratcliffe/Bloomberg

Cyprus in April, 2012. Looks like everyone’s already left to line up at the ATM.

Update: Boom! With 36 votes against, the Cypriot legislature nixed the deposit tax. Let’s see if the alternative is any kinder to ordinary Cypriots. And if foreigners take out their cash anyway when banks reopen.

Every nation, no matter how small, eventually gets a minute in the spotlight. Usually it’s not for good news. So it with Cyprus, where the plan to pay for a bailout by taxing bank deposits has elicited outrage among everyone from Cypriot citizens to Vladimir Putin to kibitzers who could barely find Cyprus on a map.

The photos of long lines at empty ATMs haven’t been great PR for the government of Cyprus or for European policy-makers. Nothing says Coming Depression as crisply as a bank run. The early consensus is that taxing bank deposits shakes the very core of the financial system.

Economist Tyler Cowen says this could go down as a blunder of historic proportions. At Reuters, Felix Salmon notes that the vow that your bank deposits are safe is one of a government’s most important promises. “Botched and improvised,” is how one expert characterized the plan to Bloomberg’s James G. Neuger. The only people who don’t seem to hate the plan are those who are just left speechless. The New York Times’s Paul Krugman confesses he didn’t see it coming — a moment for the record books.

This wasn’t a well-thought-out plan. Nonetheless, it’s worth considering whether what Cyprus is doing is worse than what other governments have done in similar circumstances. There’s a case to be made that (a) for most Cypriots it beats the alternatives and (b) a devastating run on the banks as soon as they reopen isn’t the sure thing many commentators assume.

Ultimately, taxing bank deposits (or, as Caroline Baum at Bloomberg View says, “confiscating” them) has many of the same effects as a currency devaluation. Whether the devaluation happens overnight, as it did in Argentina in 2002, or over an extended period of inflation, the ultimate hit to savers of all kinds is the same as a tax on deposits.

Devaluation has always been the final, and often not-so-final, resort of governments unable to pay their debts. In the euro zone, it’s no longer an option. But a deposit tax punishes savers just as a devaluation would. By taking money out of the economy, it makes Cypriots relatively poorer, and less able to afford goods from abroad, (eventually pushing the balance of payments in favor of domestic industry: the upside of devaluation).

These are the same effects as Cyprus would face if it left the euro zone — except that would be a much, much bigger and more sudden shock. Citigroup estimated last year that Greece would face the equivalent of a 60 percent currency devaluation if it got kicked out of the zone. You can assume that the consequences for Cyprus would be similar. By that standard, the deposit levies that Cyprus is considering — whether 9.9 percent or 6.75 percent — are a bargain.

So why the outrage? I would venture to say that the real difference between the bank levy and other solutions is that the levy is transparent and obvious, while the wealth effects of devaluation or inflation are hidden.

That would seem to be an argument for the levy, except that optics do matter in these cases, and, as Cowen notes, there seems to be great resistance to a transparent wealth tax. It’s possible that cutting the rate on smaller deposits, something that Cyprus is already contemplating, could remedy that.

That finally brings us to point (b): An immediate general run on the banks isn’t the certainty the empty ATMs might suggest. Of the 40.1 billion euros in deposits at Cyprus’s banks, 8.8 billion euros — about 21 percent — are immediately redeemable. If you look only at the 30 billion euros in household (ie. non-business) accounts, the share is even lower. The rest is tied up in time deposits of up to two years.

That means that if Cyprus goes through with the tax on deposits, there’s plenty of opportunity to cool off before every penny gets pulled out of the banks. Yes, foreign depositors, including the oft-mentioned Russian oligarchs, will pull out their money. But with the shakiness of the Cypriot financial system, you can bet that was going to happen anyway.

Given the choice of a tax on wealth or half-baked European austerity measures to achieve raise the same 5.8 billion euros, TMN would be inclined to go with the deposit tax. At Marginal Revolution, Tyler Cowen says the tax reflects the deeply anti-democratic impulses of European policy-makers. It doesn’t take a Machiavellian command of politics to see that taxing bank deposits isn’t an easy sell to voters anywhere. Fair enough.

But at least with a bank deposit tax, Cypriots get to see exactly what money is getting taken from them and where it’s going. That’s more than can be said for most other austerity plans.

Update, March 19: The bank levy now looks like it won’t pass the Cypriot legislature, even with the sweetener of exempting deposits under 20,000 euros. That would mean no deposit tax revenue — while very likely still leaving plenty of foreign depositors jittery enough to withdraw their money at the first opportunity. It seems to me that means much of the pain, and none of the benefit. That’s happening just as a few commentators seem to be turning around on the plan. Andrew Ross Sorkin at the New York Times also defends it, and points out that despite dire predictions, there’s certainly no Europe-wide bank run. That said, if you want to recap all the mistakes that policy makers have made in the last days getting to this point, and all the ways this makes Cypriots feel their national policy has been hijacked by Germany, make sure to read James G. Neuger’s masterful story about the negotiations.

The National Council Chamber in the Federal Palace, Bern. Swiss legislators now must work out how to implement the ‘rip-off’ resolution.

In his new book Thinking, Fast and Slow, the Nobel-winning psychologist Daniel Kahneman, demonstrates how when people are confronted with difficult questions, they tend to get around them by answering easier ones. You can’t find a better example than the just-passed Swiss referendum on abusive pay.

The ‘rip-off’ initiative–yes, that’s the official name of the voter proposal–garnered an overwhelming 68 percent support among Swiss voters. Driven by a series of corporate scandals and outsized pay packages, the Swiss approved a requirement for shareholder votes on pay and bans signing bonuses and golden parachutes. The news that pushed the proposal over the top, according to most accounts, was Novartis AG agreeing to pay outgoing chief Daniel Vasella $78 million in a non-compete agreement.

So what did the vote actually accomplish? That’s where the hard question/easy question part comes in.

The complicated question underlying the executive pay debate is “What do 21st century economies do about the startling growth of inequality?” Think about that one for a couple of seconds. Have an answer in mind? No? Well, that’s why it’s a complicated question.

The easier question here: “Do you think a chief executive should be paid $78 million to get lost, or just to show up?” That’s the one that Swiss voters answered. The outcry over Vasella’s exit package had already killed the Novartis deal. The voter initiative codifies the public’s anger at this deal and kills similar ones in the future.

Does this do anything to deal with the complicated question? Not really. What the Swiss vote amounts to is a shareholder protection measure. Except that it’s a shareholder protection measure that (as Dealbreaker’s Matt Levine has also pointed out) most shareholders weren’t asking for. Overall it might mean that top executives get fewer outsized payouts. It could also mean that mediocre and entrenched executives stay on longer. There are sometimes good reasons to pay signing bonuses, though probably fewer good reasons for golden parachutes.

In the debate over the Minder initiative, Swiss Justice minister Simonetta Sommaruga said that giant pay packages do “enormous damage to social cohesion in our country.” That the growth of inequality damages social cohesion is almost inarguable: the greater the differences in income, the greater the gap in outlook.

The real gap in income to worry about, though, isn’t between ultra-rich chief executives and the merely rich tier below them. It’s between the wealthy and everybody else. To be clear: that doesn’t mean that a sweetheart $78 million golden parachute payment is defensible. It means that getting rid of such payments for corporate officers doesn’t address the social cohesion problem.

Like many other efforts to rein in bonuses and executive pay, the Swiss initiative, if it succeeds at all, will succeed in shifting some money from executives to shareholders. There’s just no reason to think that this will shift any more money into the hands of those shouldering the biggest burders of inequality — ordinary workers.

An earlier version of this post appeared in the Market Now daily email. Click here to register and subscribe.

Photograph by Christian Heeb/laif/Redux

The San Remo apartment building, on New York’s Upper West Side.

The most expensive apartment in the twin towered Art Deco masterpiece looking out over Central Park, the San Remo, rented for $900 a month. The tenant was a stockbroker named Meno Henschel who, according to what he told the Census Bureau, lived in his apartment together with his wife, a cook and two maids. Henschel had one of only two apartments that rented for more than $600. Another, with room for a family of five, plus the requisite cook, butler and maid, rented for $540.

The year was 1940, and that $540 is what would now generally be referred to as about $8,850 in today’s dollars. Except it’s  almost impossible to find an apartment like that to rent today. Like most  of the great prewar luxury Manhattan buildings, the San Remo has long since been converted into a co-op, owned by the residents.

Very rarely an apartment there will come up for a short-term rental. There is one listed now. The asking price is $29,750 a month.

At first glance, this may strike you as the kind of problem that rich people file under “even richer people’s problems.” So the price of Central Park views has gone up? Feh, probably you can find yourself another park to look at. You might assume that the price of living in one of New York’s most expensive buildings tells us nothing of value to most Americans, who (a) don’t live in New York, (b) don’t live in rentals, and (c) couldn’t come close to affording that kind of price.

In fact, it tells us a lot. Extraordinary as a rent of $29,750 a month may seem, the rise in the price of a rental at the San Remo is not exceptional. You can find similar or even bigger increases at every level of the market, down to the most ordinary middle-class apartments. Looking closely at rents at the San Remo and other places in New York opens up questions about whether we’re measuring inflation accurately. And those questions, in turn, have big implications for how we understand the cost of living and quality of life—not only of those who live in the San Remo, but of the middle class.

Nationally, according to U.S. inflation data, since 1940 rents have risen 1,014 percent, so they have gone up about 11-fold. For the New York area alone, the increase is a little higher, 1,250 percent. Though those are big numbers, they’re actually lower than the overall 1,536 percent rise in prices reported by the Bureau of Labor Statistics, the agency that gauges inflation.

Most New Yorkers, however, would guess that the price of housing has risen much faster. Diving deep into old records bears that out. The 1940 census found the median rent in New York City to be $38.10. In 2011, that was $1,100. That’s an increase of 2,787 percent—close to twice the rate of inflation. And when you start comparing specific apartments, delving into the newly released 1940 census forms in which I found how much Meno Henschel paid for his apartment, the differences are even starker.

At the San Remo the price increase is greater than 50 times. It’s a good example, because the San Remo is one of very few buildings not to have changed in character over 70 years. It was, as Dennis Hughes, the real estate agent handling the listing puts it, an “iconic” building then, and it remains so now. It’s a time capsule of luxury living. But that kind of increase hasn’t happened just at the top. You can see the same pattern in much more modest places.

One is the one-bedroom apartment I lived in from 2004 through 2009 in Williamsburg, Brooklyn. Back in 1940, as I found from the handwritten (and recently digitized) census forms, most of the tenants were Italian. Several were truck drivers; it’s not hard to imagine that one settled there and his friends followed. The rent was $18 to $24 a month. The upper end of that is $369 in current dollars. When I moved in late in 2004, the real estate broker cautioned me that it “wasn’t a luxury building.” Indeed, it wasn’t, as the broken front door lock suggested and the heat inspectors could confirm, but the rent was $1,500 a month, and later it rose to $1,615.

So what’s happening here? Most conventional stories of inflation hold that the consumer price index tends to overestimate how much prices rise. For a long time, the index, the government’s main inflation yardstick, didn’t adjust for changes in quality, and many economists believe that it still doesn’t do it enough.

With rent, it’s a different story. Rent is a particularly important piece of the consumer price index. The government uses data on rents not only to estimate inflation for those who actually rent their homes, but also to separate out the investment value of homes and derive a measure of how much homeowners pay to keep a roof over their heads. Together, “rent” and “owner’s equivalent rent” make up about 30 percent of the inflation measure.

Changes in rent, though, are not easy to measure. Rents tend to rise slowly over time, and a lot of what makes a home desirable changes, too—think “location, location, location.” Those difficuties have led to some awkward results. Mike Shedlock, a well-regarded blogger who looks at economic trends, has tracked how the rents the government measured barely budged during the housing boom and rose afterwards even as real estate agents wrung their hands over falling prices.

Perceptive recent work on rent comes from three economists who worked together at the Philadelphia Federal Reserve, Theodore Crone, Leonard Nakamura, and Richard Voith (Nakamura is a vice president of the Philadelphia Fed). Their research makes a good starting point for figuring out the rent puzzle.

The most important insight in their work is that for decades the inflation measures skipped over the cases in which a tenant moves out. Think about that for a second: A landlord avoids raising the rent for a decade for a good tenant, then when the tenant moves, ups the rent to a market rate. Or, as is common in New York, rent regulations keep rent from rising until a tenant moves out. Those are precisely the units in which the rent is most likely to rise, and for some four decades they weren’t counted in inflation.

Crone, Nakamura and Voith estimate that this and other problems bring down the government’s measure of rent increases by about 1.4 percent a year for the whole period that runs from 1942 to 1985. Nakamura outlines these findings in a very readable paper published by the Philadelphia Fed. Over such a long period, 1.4 percent into a really big number. Add that in, and instead of falling 20 percent in real-dollar terms over six decades, rents rise 50 percent.

Think about what that means for the middle class. Since 1970, the average hourly earnings of American workers (excluding managers) have stayed almost exactly flat by the official inflation measure. If, however, the cost of housing has risen faster than those measures say, then that means that many folks are actually worse off than they were then. You can see how that matters, and not just to the people in the San Remo with Central Park views.

Source: Google Street View

The building in Brooklyn I lived in from 2004 to 2009. Not exactly a model of luxury.

The reason I started with the San Remo wasn’t just to get you to marvel at how much a fancy apartment in New York costs these days. OK, that was part of it; it’s not an accident that Robin Leach’s show wasn’t called “Lifestyles of the Average to Upper Middle Class.” The other reason for focusing on the San Remo, though, is that in most buildings and neighborhoods, so much changes that it’s hard to compare prices over extremely long periods of time.

Often when you read stories about the economy they’ll translate a price from decades ago into “today’s dollars.” By that measure, the $540 that a San Remo apartment rented for in 1940 is $8,856 in today’s dollars. Except that it’s clearly not: If you’re talking about rent, it’s $29,750 in today’s dollars. We know that because that’s what a San Remo apartment rents for today.

If we work off that $540 price for a San Remo apartment (one of the more expensive ones then; many rented for less than $400), that’s an increase of 5,409 percent.

Notably, that number is a lot higher the calculations of Leonard Nakamura and his collaborators. By their measure, rents from 1940 to 2000 increased about 15-fold. That would make the increase in rent higher than the overall inflation rate—but still well below the change in median New York City rents. Even with this effort to fix the data, we still don’t get close to the kind of inflation you see for many New York apartments, those long turquoise and magenta lines at the bottom of the chart.

So what else is at play here? We just don’t know. It’s tempting to explain the San Remo by looking at the rise in income at the top. That’s the market for four bedroom apartments with park views. Strangely, however, the change in the price of a fancy Manhattan apartment is actually lower than the 67-fold increase in the price of the underheated Brooklyn walkup I lived in for five years.

It’s difficult to judge the degree to which that Brooklyn apartment—unlike the four-bedroom in the San Remo—is “the same” as it  was in 1940. The heat may have worked more reliably then, and the building had not yet been blessed with its current asbestos-shingled facade. On the other hand, it wasn’t within throwing distance of about half a million trendy restaurants, as it is now. How do you calculate the value of those kinds of changes and plug them into the inflation model?

“The main thing we cannot take into account [in measuring inflation],” says Leonard Nakamura, “is how a city changes over time.” That’s certainly part of the rent puzzle. In the post-war years there has been a major national transition from renting to home ownership. In New York, as in many parts of the country, many of the most desirable properties in most desirable neighborhoods can no longer be rented at all. This is essentially the case with the San Remo. As the San Remo and buildings like it turned owner-occupied, they’ve dropped out of the inflation measure.

That may have pushed down measured rent in New York and many other places as well. As the upper and middle class have moved to home ownership over the last decades, it’s possible that the the homes and neighborhoods that have stayed rentals are the ones that have been less desirable in hard-to-measure ways. That might help explain the enormous divergence between New York rents and the inflation yardstick, but it’s hard to test without a much deeper dive into real estate records.

1940 census forms from tenants at the San Remo. You can see Meno Henschel’s $900 rent at the left, the highest at the time.

Complaining about inflation can seem like an old person’s diversion; yes, at some point a steak dinner did cost three bucks and penny candy was a penny. So what?

With rent, however, the intuition that prices have risen faster than the inflation data appears very robust not only to laypeople, but to professional economists as well. Robert Gordon is an economist known for his pioneering work on how we’ve overstated inflation in durable goods, such as cars, which have improved over time. He suspects that housing may be different. As Gordon writes in an e-mail, ”the low prices my parents paid in the 1950s for a lot, a house, my Harvard education … seem unbelievably cheap by today’s standards.”

If rent has indeed risen more than the usual inflation measures indicate, it would help explain why many families have the sense that they are working ever harder to afford to live in what they think of as a nice neighborhood. More generally, understanding what’s happened to the price of shelter is key to the current debate on inequality and how we answer the question that gets asked (rightly) in every election year: “Are we better off?”

The other takeway from New York rents is that when you think about inflation, you may consider asking “inflation in what?” and “inflation for whom?” We are so used to talking about the headline inflation number that comes out each month that we tend to forget it includes changes in literally thousands of prices. The increase in rent at the San Remo is not the same as the increase at a new college grad’s shared apartment across the river in Brooklyn, or at a public housing complex in the Rockaways—or in a different city. Nor is it the same as the change in the price of steak or childrens’ clothes.

And because inflation isn’t the same for different items in the consumer basket, it’s not the same for different people, either. It may, for instance, be higher for the wealthy, who are competing for the same few ultraluxury properties. It may be lower for older people, who don’t worry about moving. And it may be higher for those who have to move often. Measuring inflation accurately is a hard problem, and over the years economists both inside and outside the government have made great efforts (and strides) to get it right. The evidence of New York is that we’re not there yet.

Already the national discussion has turned from talking about inflation in general to focusing on specifics, like the costs of education and health care. It may be time to start cutting up the data in even more granular ways to get more specific answer to those questions of “inflation in what?” and “for whom?” That may pose some questions for government policies. In return, it’s likely to offer up some answers to why we live the way we do up and down the economic ladder.

Photograph by American Stock/Getty Images

Deflation isn’t always accompanied by Depression-style soup lines.

“Deflationary spirals” have been a major subject on the economics agenda since the financial crisis hit. While the theory here is clear — falling prices lead consumers and businesses to hoard cash — there are few actual examples of deflation to study. The Great Depression in the United States is one, and the current long period of slow deflation in Japan is another.

In a surprising article, Bloomberg’s Toru Fujioka reports on the response of Japanese consumers and businesses to deflation, finding a startling face: many of them like it. The elderly benefit from savings and pensions that go further. And while deflation may harm the young by keeping wages stagnant in the long term, it’s also the only de facto wage increase they’ll see with businesses unwilling to raise salaries. Economist Tyler Cowen notes that though the Japanese economy has been stagnant, the unemployment rate is still 4.1 percent, a number that other countries must find enviable.

Over the past decade, Japan has seen the consumer price index for most periods hover just below the zero-percent inflation line (chart’s above). The notable exceptions were in 2008, when inflation rose as high as 2 percent, and late 2009, when prices fell at close to a 2 percent rate. The rise in inflation coincided a crash in capital spending. The worst period of deflation preceded an upturn.

This isn’t enough data to infer causal effects. It does seem, though, that the relationship between growth and Japan’s mild deflation may be more complicated than the Great Depression-inspired deflationary spiral narrative suggests.

A version of this post appeared in the Market Now newsletter. Click here to register at Bloomberg.com and subscribe to The Market Now daily email.

Photographer: Gianluca Colla/Bloomberg

In the mortgage bond boom, banks and hedge funds, not homeowners and debtors, stand to gain most.

The new issue of Bloomberg Markets magazine looks at the year’s best-performing hedge funds. Topping the list are several that have invested in mortgages, led by the 38 percent return at Deepak Narula’s Metacapital. Within this winning category there are funds that invest in Fannie and Freddie-backed mortgages, and (believe it or not) in subprime. For everything there is a price and a time.

Housing has risen this year, with a 4.3 percent gain in the S&P/Case-Shiller home price index. As is usually the case with housing, it doesn’t take much for the word “recovery” to start getting tossed around. Don’t confuse mortgage bonds with housing. The Big Picture’s Barry Ritholtz has several times charted the long run view of home prices, and they’re still above the historical average relative to household income. (Standard & Poor’s Co.’s David Blitzer shows them slipping below historical norms compared to per capita income; with changing family sizes, that’s  the wrong measure.)

Narula gives some detailed insight into his strategy, and it’s worth reading for the view it affords not only into his fund, but into the housing economy. He’s gained with bets that mortgages would rise relative to Treasury bonds, and that fewer debtors would be able to refinance than the U.S. government hoped.

That reveals some painful truths about the housing recovery. Low rates have made housing relatively more affordable … for those who haven’t been locked out of the market by credit standards that are much tighter than they were even before the housing boom. The winners in a concerted Federal effort to keep housing afloat are banks, investors, and the limited group of homeowners who’ve been able to finance purchases at low rates.

The losers, on the other hand, are those who have cash but little creditworthiness, or those who buy homes expecting they will steadily gain value over the next decades. In the short term, the government has given banks and mortgage investors a comfortable cushion. For housing over the long term, it looks like less of a soft landing than a long slow descent.

Hedge Fund Bonus Round: Hey, where’s James Simons’s Renaissance Technologies? Bloomberg’s rankings editor Laurie Meisler says that the Renaissance Institutional Equities Fund just missed the list, with a gain through October of 8.7%, and Renaissance’s Institutional Futures Fund had negative returns. Simons’s longtime flagship, Medallion, is now run almost exclusively for employees, as last year’s story notes, and excluded from the rankings. How the Medallion fund achieved decades of outsized returns, and why other RenTec funds (update: to be clear, funds with very different strategies) don’t seem to be able to match it, are two of the most interesting questions in hedge fund world.

Photographer: Davis Turner/Bloomberg

The 1998 multi-state tobacco settlement was a landmark example of multi-billion dollar corporate punishment. It was also a massive moneymaker for the states. Bloomberg’s Martin Braun today reports on how that money is still rolling in — and has put bonds backed by tobacco settlement money in the top ranks of state bond returns.

A bit of history is worthwhile here: When tobacco companies agreed to pay billions to settle claims, many states decided to take the money upfront and issue bonds backed by years of future payments. Most bondholders have gotten back years of payments.  Still, with cigarette sales and annual payments from tobacco companies falling, some of those bonds have drifted closer to default.

Last week, though, cigarette companies agreed to ante up another $4 billion of disputed payments. So now that stream, which recently appeared threatened, now looks like it’s  still not close to running dry after all. How much longer can it last? Maybe longer than you think; take a look at the chart below, which shows U.S. government data on rates of smoking in the U.S. broken down by age group.

In 2009, smoking fell, especially among the young, after cigarettes got hit with a 62-cent-a-pack federal tax. The big surprise here, however, may be that since then smoking rates have actually climbed a bit for some age groups. That’s not at all what The Market Now would have expected to see in the data.

Raising revenue from sin taxes is very much in vogue now in economics circles. In theory, the problem here is that if you cut the sin, the revenues fall too. Turns out, though, that smoking is an awfully resilient sin — an encouraging data point for state revenues and holders of tobacco bonds, but a discouraging one for public health.

A version of this post appeared earlier in the Market Now newsletter. Click here to register at Bloomberg.com and subscribe to The Market Now daily email.

Photographer: Daniel Acker/Bloomberg

John Stucker, a Purdue University student must pay back $80,000 he borrowed.

What’s going to be the bigger drag on the economy over the next years: the overhang of unpaid mortgages or the burden of student loans? At Bloomberg today, some unexpected answers.

First, the mortgage front. Yesterday Bloomberg’s Dan Levy reported on the upswing in property values in Las Vegas. The Market Now speculated that some of the shift has come from banks cutting down on foreclosures that dumped properties on the market at rock-bottom prices.

Today John Gittelsohn and Prashant Gopal take a deep dive into the national real estate market, finding that the foreclosure flood has ebbed nationwide. Banks, as one analyst puts it, have managed to “slow walk” the process, and “bleed through” the overhang of defaults over a long time. That’s limited the damage to the economy.

Compare that to what’s happening with student loans. Above, a chart from Bloomberg’s David Wilson shows that as mortgage delinquencies have fallen to near the 6 percent mark, student loan delinquencies have risen sharply. Eleven percent of student loans are now 90 days late or more; that number is now higher for student loans than for credit cards, reversing a pattern that has held for years.

Wilson points out that the delinquency number understate the share of borrowers who are drowning in debt because it doesn’t include the nearly half of student loans that aren’t due for repayment. For-profit schools, it’s worth noting, have been especially adept at making sure that students who can’t pay their bills get postponements that keep those numbers down. Eventually these borrowers, too, will default on their loans.

As the mortgage crisis diminishes, the student loan crisis builds. As one report that Wilson cites puts it, “student loan debt crowds out other consumption.” So the damage here hits the whole economy, not just overburdened students and grads. Unlike other debt, student loans don’t get erased in bankrupty; the unpaid debt lurks in the wings of the economy more or less forever. The Market Now is betting that eventually there will some sort of student loan bailout plan; it won’t happen, though, before there’s a lot more pain.

A version of this post appeared earlier in the Market Now newsletter. Click here to register at Bloomberg.com and subscribe to The Market Now daily email.

Photographer: Tim Boyle/Bloomberg

It has become the strangest yet most predictable move in this economy: The worse it gets, the higher the market goes. When the economic numbers are bad, the Fed moves in and the markets shoot up. On Thursday we saw this happen right on cue as the Fed announced itslatest asset purchase program, aka QE3, as the econosphere calls it.

Bernanke might now be a bogeyman for Ron Paul and other critics of easy monetary policy (a bandwagon Mitt Romney seems to have jumped on), but for the stock market, his policies have worked. Bernanke speaks, and markets go up, in what you might think of as a “Bernanke Rally.”

It makes sense that the stock market would react well to the new asset-purchase policy. The effect is to lower the returns on long-term Treasuries and mortgage-backed bonds and push investors into the stock market. What’s not to like? The question, though, is how long the market can go up even as key economic indicators, such as joblessness, point down.

On this, looking at Japan’s experience is valuable. The term “quantitative easing” comes from Japan, where the central bank increased the money supply by buying up longer-term government bonds—an earlier, less aggressive variant of what the Fed is doing now. From March 2001, when the Bank of Japan put the strategy in place, until March 2006, when it ended, the Nikkei 225 Index rose from 13,000 to 17,059. This wasn’t an uninterrupted rise, but the overall effect on the market seems to have been substantial. That’s especially evident if you start looking from 2003, when Japan strengthened its commitment to the policy.

That’s the markets. For the underlying economy, it’s a different picture. Take a look at this chart, which maps the end-of-year close of the Nikkei 225 to Japan’s national output, or gross domestic product. Even after the market started shooting upward, Japan’s GDP growth was essentially nil.

That the economy should be stagnant during this time isn’t a big surprise: If it weren’t, the Bank of Japan wouldn’t have pursued the quantitative easing policy in the first place. You can blame the policy for the bad economy. You can’t blame the stimulus for this.

The bad news for the markets comes afterward. In retrospect, it’s clear that the markets overshot the real growth. After Japan ceased the policy in March 2006 (whether it was a success is now debated), the Nikkei 225 plummeted. Investors may have gotten a little too used to the central bank’s nectar.

In the U.S., similarly, the stock markets are going up as the rest of the economic data look stagnant, at best. The Fed is letting the markets cash in now on the promise of growth in the future. As Marketplace reporter Heidi N. Moore puts it, the Fed is “giving the markets a sugar rush.” The experience of Japan indicates that this can go on for a while, but the markets that are reaping the fruits of the stimulus now could wind up paying for it later.

A version of this post appeared earlier in the Market Now newsletter and at Businessweek.com. Click here to register at Bloomberg.com and subscribe to The Market Now daily email.