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CiteThe Fed cut policy interest rates to zero, more or less. And it signaled that it hasn’t run out of ammunition even if it cannot cut rates further.
Not so long as there are still financial assets that it is willing to purchase. The Fed:
The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.
The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity. (emphasis added)
Over the last few months, the Fed has more or less taken over a slew of functions previously performed by the private financial system.
Banks with spare cash (more deposits than loans) used to lend to banks that were short of cash (more loans than deposits). Now they lend to the Fed, and the Fed lends to the banks that are short on cash. That way no bank risks taking losses lending to a bad bank ….
Money market funds used to lend both to the financial sector and to firms with short-term financing needs. Now they (to simplify a bit) just buy Treasuries. The Treasury met this demand by increasing its issuance, and (to simplify a bit) putting the cash it raised on deposit with the Fed. That in turn allowed the Fed to lend to institutions in the US and abroad that previously relied on money market funds for financing.
Foreign central banks used to buy rather significant sums of Agency bonds, and in the process finance (indirectly) the extension of credit to American households. Now foreign central banks just want Treasuries. The Fed now plans to purchase rather significant quantities of Agencies, in effect making up for the fall off in demand from other central banks.
As Dr. Krugman notes, “we are in very deep trouble” —and it isn’t clear if the Fed’s various initiatives will be sufficient to pull the US economy out of its current tailspin. But the Fed can hardly be accused of not trying. It isn’t the ECB.
The real criticism of the Fed is that it – for a host of reasons – didn’t try very hard to limit the build up of financial vulnerabilities that generated the current mess.
UPDATE: Yves Smith isn’t at all convinced the Fed’s approach will work. John Jansen highlights the obvious risk of a debtor cutting interest rates to near zero, namely no one will want to finance its deficits. I am less worried, if only because I suspect a host of emerging market central banks will resist any pressure for the dollar to depreciate against their currencies when their exports are shrinking (see China) and in the process support the dollar and finance a (smaller, due to falling oil prices) current account deficit. Remember, more of the fiscal deficit will be financed domestically, as Americans start savings and stop investing ….
Is the Fed trying to engineer dollar depreciation as a substitute for protectionist measures?
There are two possibilities…
either it doesn’t work or it does work
Since everyone is in a gloom and doom work, everyone thinks is thinking about the situations in which it doesn’t work. I think people should start thinking about the situation in which everything does work according to plan.
Suppose in six months, it looks like we are out of a recession, and unemployment and economic growth are moving in the right direction. What happens next?
What worries me a little is the possibility of “catastrophic success”
Brad, this is my take: the drop in the dollar is so rapid that it will force other central banks to take steps to devalue or watch their export industries fold. Intervening in the currency markets is almost always a losing strategy, and I can’t see them running expansionary fiscal policy, so logically they will follow the Fed and engage in “quantitative easing.”
What the investment banks will do with their nice shiny balance sheets is anyone’s guess, but a round of M&A seems likely, as well as the start to inflation of a new asset bubble.
Is that how you read it?
Brad, thanks again for sharing your thoughts.
There are indications that banks are now using their excess reserves to purchase hedge fund assets at distressed prices from which the banks could derive net interest margin in the teens. David Goldman put it this way:
“1) The Fed borrows at 0% from the world ($286 billion in short term inflows during October alone)
2) The Fed lends at 0.5% (or whatever the funds rate is after today’s announcement)
3) Hedge funds are liquidated and sell structured product at pennies on the dollar to banks
4) Banks finance structured product taken from hedge funds at 0.5% and earn double digits
5) Very high earnings from very high-yielding assets compensate the banks for continued losses in the rest of their portfolios”
http://blog.atimes.net/?p=332
Unlike the Japanese banks in the 90s that could never earn enough interest to recapitalize themselves, the banks now can do so at the expense of hedge fund write-downs.
The only truly catastrophic scenario in my opinion would be for the US fiscal authorities to use the borrowings improperly to fund projects for which the public have no demand. I’m talking about the possibility of setting a portion of this borrowing aside to cover Health care costs down the road.
If they really wanted to unfreeze the credit markets, why not just systematically place different levels of guarantees on all corporate and consumer debt?
im pretty confident this move will work. and like twofish, i think the danger is overshooting, which historically, is usually the case. so what happens next after the massive asset deflationary phase? hyperinflation because of the loose monetary conditions?
adiemuso, you don’t go from deflation to hyperinflation in a short period of time. If inflation picks up, then you stop and reverse course if needed. It is as simple as that.
You shouldn’t say hyperinflation. The US has never seen hyperinflation, not even in the 70s. That was just high inflation and they can certainly stop it before it gets to double digits. The only countries that see hyperinflation are those that want hyperinflation. If the US sees say 10% inflation for a few years (including wages), that will not do any harm. It might actually be a good thing if it reduces the real value of household debt just as it did in the 70s.
Finally we are at ZIRP and QE(aka many printing)
The hyperactive FED is on its way to destroy reserve currency of the world. As Mises observed to prevent an unsustainable debt level from natural adjustment will lead to the collapse of the currency itself.
Since USD cannot depreciate much further against other majors it looks like another round of commodity inflation after the exhaustion of the current deleveraging process is in the cards.
We must have arrived at step 7
http://rebalancing.blogspot.com/ (written March 2008)
But it looked like a coordinated action as the same day Trichet announced that the ECB would pause in January. Does it signal the acceptance of a lower dollar? Why?
Maybe the ECB is more scared about a financial armageddon in the US than a recession in Europe.
“Since everyone is in a gloom and doom work, everyone thinks is thinking about the situations in which it doesn’t work.”
Actually, I think most people trust things will work out. There are job losses, but so far limited. Maybe you’re spending too much time on the wrong forums in the blogosphere…
“I think people should start thinking about the situation in which everything does work according to plan.”
*Is* there a plan? I don’t see one, other than rolling out more and more schemes with a different abbreviation, to correct the failings of the last scheme. I guess there’s an *aim*: to pull the U.S. out of recession if not depression. But that’s different from having a plan.
“Suppose in six months, it looks like we are out of a recession, and unemployment and economic growth are moving in the right direction. What happens next?” Either they continue moving in the right direction, or they turn around and start moving in the wrong direction. I guess that means I don’t understand the point of your question. Do you really think prognostication, which is usually dubious at best, should be made even more precise so that it becomes path-specific? (In 6 months we will be here, and in twelve months we will be here, and in 18 months we will be here…)
Brad wrote: “As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.”
This won’t reverse the housing bubble for several reasons:
1. A look at Robert Shiller’s graphs shows that house prices still have a lot further to fall before they reach their fundamental values. There’s a bubble popping out there.
2. The United States is experiencing deflation, which means that house prices will likely fall, other things being equal.
3. The US government is still letting the mercantilist countries manipulate their currencies during this depression, which will accelerate the job losses and bankruptcies in the US productive sectors. This means that middle class Americans will have even less income to spend on house payments.
4. Many foreclosed homeowners have already lost their life savings due to the falling house prices. They will prefer renting to buying. Rental costs will have to exceed mortgage plus property tax payments before they’ll come back into the market.
In other words, the result of the Fed’s attempt to bet against the risk premium paid by Fanny Mae and Freddie Mac is predictable. They will lose their bet! They will take a huge financial loss which they will have to stick to the taxpayers, probably through money creation, which will probably cause inflation since the US economy is not growing.
In September 2005, the chief economist at the NY Fed, Charles Himmelberg co-authored a foolish NBER working paper which claimed that there was no house price bubble as of the end of 2004. In June 2006, that non-existent bubble burst, and sent the national economy into a financial crisis.
Based upon this new action of the Fed, I believe that they still believe exactly what Himmelberg wrote in that working paper. Is there nobody at the Fed who understands economics?
Howard Richman
http://www.tradeandtaxes.blogspot.com
whoops, I identified Himmelberg as the chief economist at the New York Fed. He was just a “senior economist.” His working paper can be read here: http://www.newyorkfed.org/research/staff_reports/sr218.pdf
“As Dr. Krugman notes, “we are in very deep trouble” —and it isn’t clear if the Fed’s various initiatives will be sufficient to pull the US economy out of its current tailspin. But the Fed can hardly be accused of not trying. It isn’t the ECB.
Well, that is what the Fed told us in 2001. In six years, they brought about a situation that is far worse than 2001. So, obviously, there is something wrong with their approach that then brings forth a crisis and something more wrong with their cure that brings about an even bigger crisis six years later.
Pl. spare ECB. They may have their hearts and heads in the right place but when the international reserve currency operating in a world of de facto dollar standard decides to unilaterally debases its currency twice in a decade, they have no choice but to follow suit.
they will; don’t worry. the Fed will drag all to the lowest common denominator.
that is why the world had ultra-low real rates for three to four years in the first half of this millennium. easy money and abundant liquidity was initiated by the Fed. Others had to follow suit, willingly or otherwise. Else, their currencies will have shot through the roof, especially since the mercantilist decided to fund the US private consumption and to support the US war effort in Iraq through its purchase of US Treasuries and agency debt.
“if only because I suspect a host of emerging market central banks will resist any pressure for the dollar to depreciate against their currencies when their exports are shrinking (see China) and in the process support the dollar and finance …”
If all central banks again finance the US deficit – assuming that they do at these ultra-low interest rates and after finding out what AAA really means, then what will have changed, Brad?
So, is a multi-trillion dollar crisis is about debtors and creditors behaving as though nothing has changed and going back to creating the next unsustainable boom and surely another more unmanageable bust?
Which one is a bigger worry now? Financial bankruptcy or intellectual complacency?
China warns US Treasury Dept that future bond purchases will not be unlimited
http://www.google.com/hostednews/afp/article/ALeqM5ggAdj8G1CX8w3yNIWRYUCORxYuQw
BEIJING (AFP) — China warned Wednesday it would not keep lending money to the US economy indefinitely, even as new data showed it had consolidated its position as the top buyer of American government bonds.
“China’s increased purchase of US Treasury securities should not be interpreted as an endorsement of the assumption that the US can borrow its way out of the current financial crisis,” the China Daily said in an editorial.
However, as China and other nations help prop up the US economy, the United States should use the window of opportunity to undertake necessary financial reforms, the China Daily said.
“The current strong foreign appetite should not be taken by the US government as solid proof of the long-term value of its Treasury bonds,” it said.
“Instead, it should race against time to undertake painful but critical reforms to revive its economy before such demand peaks any time soon.”
Quantitative Easing American Style: Free Helicopter Money from Bernanke
http://globaleconomicanalysis.blogspot.com/2008/12/quantitative-easing-american-style-free.html
The Fed is looking at the “benefits” of purchasing longer-term Treasury securities. The benefit is to banks who are front running the trade. Banks can now borrow from the Fed at the discount rate of .5% and invest somewhere out on the yield curve at a higher rate.
And as long as the Fed is not going to contract credit, banks can hold to maturity and pocket “free money”. The odds of Bernanke contracting credit any time soon are essentially zero.
Bernanke hopes ZIRP will spur lending. But why lend in the middle of a recession with credit spreads blowing sky high and consumers walking away from mortgages, when you can borrow from the Fed at .5% and have guaranteed free money?
There is infinite demand for free money. But note that only banks can get it. Citigroup is not going to get a margin call from the Fed no matter how many treasuries it buys.
Yes, this is artificial demand. And no, this is not going to help the economy. The availability of Fed credit will deter private credit. The lender of last resort becomes the lender of only resort. Bernanke wants to drive long term rates lower, but there is no incentive for banks to lend at lower rates.
This is starting to get real.
Serious fear is next.
Reality 1: We now have a nationalized banking system. How that plays out will be a very interesting story. If times get very bad, the nationalization may become more clear.
Reality 2: This latest step, which is a declaration of War, is essentially a demand on the President and Congress to match. Expect the kitchen sink.
Reality 3: Congratulations economists! You now have something to argue about for the next 50 years.
The effective Funds rate was already 1/4 percent, so changing the target doesn’t do anything. They reaffirmed their intention to continue balance sheet operations, but we knew they would, and no new specifics were announced. It seems to me that the most important line was the last one:
“The Board also established interest rates on required and excess reserve balances of 1/4 percent.”
So the Fed is reducing the return that banks can get for hoarding cash, and simultaneously talking up its intention to intervene in the Agency and long-term Treasury markets. That looks like a two-fold push to get banks to buy Agencies/Treasuries as well. Is that the point, to try to bring down long-term rates?
Can someone answer this:
Will the Fed force the foreign CB’s BACK into agencies again?
The Fed is doing a lot of damage by misdirecting funds that should instead be used as stimulus dollars toward real, bankable, projects rather than going to banks that simply ride on the back of the real economy.
To Observer: The hedge fund scenario makes no sense to me. If the structured note has a long term return the hedge fund can keep it.
The only way a bank can force the hedge fund to liquidate is if the hedge fund had a loan that was paid against the note, and the price of the note has dropped enough so that the bank calls the loan. The trouble with this is that at this point the bank may be looking at a loss.
Also there is a reason that those structured notes are worth very little. If the economy improves then someone will make huge amounts of money from buying mortgage securities. If not, then someone is going to lose a lot of money. Right now people aren’t in a risk-taking mode.
The Bernanke Fed is attempting to engineer a “Bond Bubble” to bailout the Housing Bubble which bailed out the Dot-con Bubble
http://www.cnbc.com/id/28274210
The dollar dropped to an 11-week low and government bonds rose Wednesday after the Federal Reserve cut its base rate to a range of zero to 0.25 percent. The central bank said it would employ “all available tools” to battle a year-long recession.
There are severe dangers in the Fed’s new course of action, says Uwe Parpart, chief economist & strategist, Asia at Cantor Fitzgerald. He tells CNBC it could undermine the value of the dollar and creates a bond market bubble.
“Remember, more of the fiscal deficit will be financed domestically, as Americans start savings and stop investing ….”
I certainly hope so. Otherwise, the government’s largess will go entirely to prop up foreign exports and the U.S. will merely end up with a bigger debt load for its efforts.
Twofish: The hedge fund scenario makes no sense to me. If the structured note has a long term return the hedge fund can keep it.
There have been massive runs on hedge funds, which have prompted distressed selling to meet redemption demands. Disclosure that certain hedge funds have temporarily suspended redemption may have meant that distressed selling has been going on for a while now.
Today’s report from Bloomberg:
Pickens’s BP Capital Says Equity Fund Withdrawal Rate at 65%
Also, as you mentioned, banks can call their loans or raise the margin requirements, which may prompt further liquidation. Banks are paying for assets in pennies on the dollar; what do they have to lose, a .5% funding cost from the Fed?
http://biz.yahoo.com/tm/081217/18576.html?.v=2
The Fed continues to create and print new money in order to buy long term bonds…AFTER the bonds are already way up and rates are way down. This same Fed who has been wrong 100% of the time is now making these big bets into a bond bubble.
So, what are they going to do when the bond bubble breaks and the bond market croaks? I want to know…who is going to bail the Fed out of their bad bets?
I know everyone is giving the Fed a hand for their “creative” ways. I think they are nuts and I think the Fed is insane. Imagine…we are in this position because of the ridiculously easy money several years back…implemented by Mr. Bubble Greenspan. We get into this problem because of the easy money…and what is the answer? Even easier money than what Greenspan ever had. I do not have enough 4 letter words for Bernanke and Paulson here as they have been wrong 100% of the time and continue to be wrong in their decisions.
They are destroying this nation’s longer term potential by printing and spending money that will come out of the economy in the future – while potentially creating severe inflation down the road. Imagine, they are now conjuring up money to buy treasuries – and are being applauded by the same people who applauded Greenspan.
A few notes:
CHINA is back to leading as a country as it moved out to the upside first.
GOLD is now in play and buyable on any pullback as the FED goes out of its way to destroy our currency.
Lastly and off the beaten path, I run a much smaller management business than this Madoff guy supposedly did. My smaller business is not even a one man job. There is no way this puke Madoff could accomplish such a scam by himself. Expect more arrests.
i posted a reference to an article about japan being prepared to put up with the pain from a rising yen / falling dollar . . .
today an item in bloomberg suggests that the opposite is now the case.
“Japan’s Finance Minister Shoichi Nakagawa said the government is ready to take steps in the currency market to help the economy, Dow Jones reported.”
who said : ‘believe nothing until you hear it denied.’ (!)
New U.S. Government Regulations to further restrict most high-tech U.S. exports to China
http://www.washingtontimes.com/news/2008/dec/17/us-to-tighten-export-rules-on-5-firms-in-china/
The Commerce Department’s Bureau of Industry and Security recently drafted a new regulation, obtained by The Washington Times, that would suspend the so-called Validated End-User program. Since October 2007, the program has granted “trusted status” to select companies doing business in China.
The program allowed the companies to obtain dual-use technologies without the formal security checks required for an export license. Congressional investigators recently raised concerns that the program lacked safeguards, and that the Beijing government is refusing to allow U.S. officials to conduct full inspections at Chinese facilities to see whether companies are diverting U.S. high technology to the military.
A Commerce Department official, who spoke on the condition of anonymity because of ongoing diplomatic negotiations, told The Times that the Bush administration plans to suspend the program before laeving office.
China generally favors looser export controls in the interest of expanding trade cooperation with the United States.
“We believe that the U.S. releasing controls on exports to China conforms with the common interests of the two sides, particularly against the backdrop of the deepening and extending international financial crisis and the slowdown of the world economy,” Chinese Embassy spokesman Wang Baodong said in an e-mail.
“Anantha Nageswaran responds: “As Dr. Krugman notes, “we are in very deep trouble” —and it isn’t clear if the Fed’s various initiatives”
My utter respect to you, sir.
japan seemingly failed to reflate its economy over the ‘lost decade.’ we use the term ‘failed’ and yet i am still tempted to think that japan dealt with the aftermath of its property bubble quite well.
the british pound on the other hand is nose diving. will this solve – or create problems ?
so does the paulson / bernanke policy set out to follow japan – or follow britain ?
gillies, Japan was made miserable by the correction. Young people in particular lost faith in society. One hears enormous pessimism from Japanese about the future.
But now they have an opportunity. They can match the Fed’s quantitative easing and it will drive down the yen, which their export industries like. The same is true across Asia. If they can let go of their squabbles and distrust, this could be a great decade for the region.
Bernanke hopes ZIRP will spur lending.
But who will the borrowers be?
Consumers credit capability is all tapped out, those with house equity see it decline each month, the future of their jobs hangs by a thread for many and therefore consumer confidence is extremely low. Conversely, with consumer ability to borrow low and demand in the tank, what reason do businesses have to borrow for expansion if there isn’t anyone to buy their products?
Meanwhile, while the FED lowers targeted interest rates to ZERO, the credit card companies raise the rates they charge while cutting consumers credit lines!
As long as the unemployment numbers continue to trend up, spending will remain weak and the economy is not going to be able to climb out of the hole it is in.
Instead of giving money freely to anyone who is or can become a “bank”, the government/FED should have been focusing on ensuring that government money is spent to create GOOD long-term jobs in new, innovative industries (alternative energy, fusion power, nano technology, medical research for cancer cures, stem cells, etc.) and help get people into these jobs.
Instead, the government lacks vision and is hell bent on short-term solutions, attempting to recreate the bubble.
The Bernanke Fed is attempting to engineer a “Bond Bubble” to bailout the Housing Bubble which bailed out the Dot-con Bubble
http://www.cnbc.com/id/28274210
The dollar dropped to an 11-week low and government bonds rose Wednesday after the Federal Reserve cut its base rate to a range of zero to 0.25 percent. The central bank said it would employ “all available tools” to battle a year-long recession.
There are severe dangers in the Fed’s new course of action, says Uwe Parpart, chief economist & strategist, Asia at Cantor Fitzgerald. He tells CNBC it could undermine the value of the dollar and creates a bond market bubble.
Gillies,
No doubt the plunging pound will mitigate the bust for us in the UK as it did in 1992, but at the expense of other countries in the EU. Not that that stops Gordon Brown criticising the Germans for not pulling their weight of fiscal stimulus.
Can someone who knows something answer my question on the agencies, or will I just get more editorials?
Isn’t the crucial question, “What was Japan’s unemployment rate during the lost decade?”
As debtors, Japan and the US are somewhat different.
credulous_prole ask: Will the Fed force the foreign CB’s BACK into agencies again?
I don’t see how they can. If a foreign central bank doesn’t want to buy agencies, there is nothing that the Fed can do to force them to.
And I don’t think that foreign CB’s will *EVER* buy agencies ever again. They were sold as being just as good as Treasuries but with more interest. No one believes that now, so there is no point for anyone to buy them.
This has some enormous consequences. I don’t know what they are, but they are enormous.
Twofish:
Does China care about getting paid back on their agencies? The Fed is giving China a way out of its current crisis, and all the Chinese have to do is grin and bear buying agencies again. Then, the markets will recover and we’ll have S&P > 1200 in no time.
Or, PBoC can refuse to do so, and they whole vendor finance ponzi scheme collapses…
JoJo: Instead of giving money freely to anyone who is or can become a “bank”, the government/FED should have been focusing on ensuring that government money is spent to create GOOD long-term jobs in new, innovative industries (alternative energy, fusion power, nano technology, medical research for cancer cures, stem cells, etc.) and help get people into these jobs.
I see the “money fairy” strikes again. We hate banks, because banks are evil and serve no social purpose. Instead of giving money to banks, we give them directly to great companies.
How do we decide what those companies are? Well there are “money fairies” that magically take money and deliver them to people that deserve it. These “money fairies” work for free, are totally non-corrupt, and magically know who to give money to and how much. Because we have money fairies, we don’t have to actually find humans to make decisions about who to lend money to and how much to lend, because if we had human beings do it, pretty soon they would end up looking like a bank which we all know are evil entities with no redeeming social value.
credulous_prole: Does China care about getting paid back on their agencies?
Yes. Any particular reason why you think they won’t be?
credulous_prole: The Fed is giving China a way out of its current crisis, and all the Chinese have to do is grin and bear buying agencies again.
And what possible reason would China have for buying agencies rather than Treasuries? More to the point, what is the Fed supposed to do if China doesn’t buy agencies? Bomb Shanghai?
You are missing the creditor/debtor relationship. If you are dependent on someone continuing to lend you money, then you aren’t in a very strong position to make any demands.
If the Fed wants agencies to be bought, then the Fed can and should buy them. The rest of the world is buying lots of treasuries. If the Fed things that agencies are as good as treasuries, it can take that money and buy agencies. If the Fed is unwilling to do this, then the PBC really will be asking why.
credulous_prole: Or, PBoC can refuse to do so, and they whole vendor finance ponzi scheme collapses…
First rule. If you find yourself in a hole, stop digging. If the US economy is really built on a Ponzi scheme then how is having China continue to pump money into this good for anyone?
PBC is perfectly willing to buy Treasuries. If the Fed wants agencies bought, then it should buy it. This means of course that if it really is a Ponzi scheme then when the whole thing falls part, the Fed will be holding the trash.
(I don’t think that the US economy is a Ponzi scheme, but I don’t see why the PBC should take any risk that it is.)
China buying agencies directly will have a huge multiplier effect that will give them more “bang for buck” than just buying t-bills.
China is trying to sustain its trade surplus any way possible, and Bernanke is trying to force the Chinese BACK into the agency market.
I personally think he may succeed.
charles : “But now they have an opportunity. They can match the Fed’s quantitative easing and it will drive down the yen, which their export industries like. The same is true across Asia. If they can let go of their squabbles and distrust, this could be a great decade for the region.”
that is what i would have thought, but not everyone agrees.
and a global tendency to zero interest rate policies, plus competitive devaluations, achieves what ? such a combination is massively tilted towards debtors.
at the climax of the tulip madness the dutch simply made all debts unenforcible, other than 10% of the agreed contract. is this where we are headed ? world wide debt cancellation ?
back in the black but afraid to trade ?
so ‘this sucker’ is going down ?
credulous_prole responds: China buying agencies directly will have a huge multiplier effect that will give them more “bang for buck” than just buying t-bills.
At the cost of possibly losing their investment if Fannie or Freddie default again. Besides, what’s the point of China buying agencies, when the Fed is going to end taking Chinese money to buy agencies, anyway.
credulous_prole responds: China is trying to sustain its trade surplus any way possible,
No they aren’t. China doesn’t really care whether it has a trade surplus or not. It’s main concern is the Chinese economy. If expanding the Chinese economy creates a huge trade surplus, so be it. If it doesn’t, so be it.
credulous_prole responds: Bernanke is trying to force the Chinese BACK into the agency market.
If that’s what Bernanke wants to do, then he better come up with plan B. The only way any foreign investor is going to buy agencies is if they have the “full faith and credit” guarantee attached to it. If the United States isn’t willing to buy agencies, then I see no reason why China would want to touch them. It’s one of those “what kind of idiot do you think I am” and “put your money where your mouth is” moments.
Don’t worry though. If buying agencies is essential to recovery, people will find a way of doing it. In the end China probably will end up funding agencies. It will just be set up so that if the agencies go bust, then China won’t lose any money from it.
@DJC: “The Fed continues to create and print new money in order to buy long term bonds…AFTER the bonds are already way up and rates are way down. This same Fed who has been wrong 100% of the time is now making these big bets into a bond bubble. So, what are they going to do when the bond bubble breaks and the bond market croaks? I want to know…who is going to bail the Fed out of their bad bets?”
You ask an excellent question. He will be known to history as “Bailout Bernanke,” and we’ll all wish we had parachutes when he is done. Here are the latest money supply statistics for December 11 from the Fed, seasonally adjusted:
M1: 25.3% growth rate in last 13 weeks
M2: 10.5% growth rate in last 13 weeks
Let us assume that the US deflation is being imported from the rest of the world. Then, if the dollar falls, what will be the impact of these monetary supply figures? INFLATION!
There is an alternative to this seat-of-the-pants flying without instruments by Bernanke: Balanced Trade Monetarism. The tennets are:
1. Balanced Monetary Growth
2. Balanced Budgets
3. Balanced Trade
Howard Richman
http://www.tradeandtaxes.blogspot.com
gillies asks, “and a global tendency to zero interest rate policies, plus competitive devaluations, achieves what ? such a combination is massively tilted towards debtors.”
Nouriel Roubini pegged it. The debt overhang is killing economic growth. We have to find some way to forgive debt to restore growth, which will benefit everyone. If done by inflation, it will erode the wealth of bond holders, as happened in the 1980s. That can lead to punitively high rates on lending and weak growth. Inflation also tends to get out of hand and wipe out small savers. Therefore, a better, though more complicated means of achieving debt reduction is directly.
I have proposed to do it in the United States by selecting those mortgages which will default only because mortgage rates reset and splitting the reset payment between the borrower, the lender, and the taxpayer. To this group, I would add mortgages where there was clear evidence of fraud by the lender or any other mortgage where it looks likely that the borrower could keep up payments. It’s very clear that resolving the problem at the level of the mortgage is vastly cheaper than resolving it at the level of CDOs.
But more has to be done, both here and abroad. Africa is in tumult because of resource wars. Ecuador has defaulted. Bolivia is on edge because of falling gas prices and withholding of US aid. Argentina has been skirting default for years. The UK is threatening Iceland. All of this debt-related turmoil hurts economic growth. Better to make an agreement by the creditor nations to fully forgive debt and make available development aid under scrutiny to prevent corruption as well as scrutiny to prevent the kind of hijacking of development aid by corporations that has undermined so many well-intentioned efforts in the past.
So, yes, I think and hope we are headed toward worldwide debt forgiveness. It’s probably the only way to keep capitalism alive.
Charles: The debt overhang is killing economic growth. We have to find some way to forgive debt to restore growth, which will benefit everyone.
Debt forgiveness is exactly what bankruptcy is for, and one of the big mistakes I think was a series of laws that made it much harder to declare personal bankruptcy. This causes a problem because….
Charles: I have proposed to do it in the United States by selecting those mortgages which will default only because mortgage rates reset and splitting the reset payment between the borrower, the lender, and the taxpayer.
There are three problems:
1) there isn’t “a” borrower and “a” lender. Typically mortgages are sold, resold, split into pieces, those pieces are put back into batches. It’s like taking an rotten egg, making a cake, and trying to get the rotten egg back out.
2) if you do get rid of the bad loan, you end up with lots of domino effects which could easily spin out of control
3) if you to forgive a mortgage, but the person who you forgive losses their job, you are right bad to where you started. One set of statistics that is both alarming and depressing is how quickly people that have mortgage relief get back into trouble again.
Charles: So, yes, I think and hope we are headed toward worldwide debt forgiveness. It’s probably the only way to keep capitalism alive.
You run into the very tricky and very messy problem of what debts to forgive. For example, your checking account. It’s a debt. It’s a debt from the bank to you. The bank owes you money. You probably wouldn’t be too happy if that debt was “forgiven.”
David:
“adiemuso, you don’t go from deflation to hyperinflation in a short period of time. If inflation picks up, then you stop and reverse course if needed. It is as simple as that.”
Firstly i have to agree to disagree. Trends take a while to change, however when it changes it turns abruptly. We went from boom to bust, the peak in DOw was in Nov 07. I believe most on this forum are macro guys, our timeframe isnt a day or a month, we are looking at quarters or years. Trends do not change overnite.
Secondly, its not as simple as you chose to believe. Monetary effects are not that easy to reverse. Its not a simple case of buy or sell. Its a multivariate equation. You cannot just hike rates once you see price levels going higher. it doesnt work that way.
“You shouldn’t say hyperinflation. The US has never seen hyperinflation, not even in the 70s.”
one of the most expensive 4 words ever. “it will not happen” a lot of the mess that we are currently in was thought to be minutely probable. inflation figures could be much higher. it really depends on your parameters. i believe there are a lot of researchers who can give you different figures from the official ones.
Try this on for size: when banks get an interest rate deal, like after 9-11, they can accept loans at the lower rate in return for given up some balance sheet transparency for the loans in question. If I’m a central banker seeking stimulus, instead of creating a bubble for tommorrow’s central bank and tomorrows taxpayers and the kiddies, I offer the option for stimulus at a lower rate in return for making the borrowing details completely public.
Say the fed funds rate is 2%, and I want more interbank loans or more industrial payroll loans or whatever. If I’m the CB, I keep the rate at 2%, and offer a 1% financial-trade-secret-tattle loan rate for anyone who doesn’t mind making some coarse details of the contract public. It doesn’t help now, but if this were done in 2001 instead of no strings attached cheap interest rates, I’m guessing people taking massive financial positions based on sub-prime mortgage collateral would consider a housing bubble and second guess Moody’s.
I also think both Republican and Democrats, and maybe even Greens and Libertopians should be given a sliver of public dollars to each establish credit rating agencies to compete with Moody’s. A mosiac of conflict-of-interests if you will.
Huggan: Say the fed funds rate is 2%, and I want more interbank loans or more industrial payroll loans or whatever. If I’m the CB, I keep the rate at 2%, and offer a 1% financial-trade-secret-tattle loan rate for anyone who doesn’t mind making some coarse details of the contract public.
The contracts that are used in these sorts of transactions tend to be very standard. You can contact the ISDA for the terms of the contracts used. Also lending aggregate numbers such as how many contracts are of what type also tend to be rather transparent.
I really don’t think that transparency is the problem, since it wasn’t as if someone woke up one morning and said “oh my God, banks have been making massive subprime mortgage loans!!!!” The problem is suppose you have this information. What do you do with it?
Huggan: I also think both Republican and Democrats, and maybe even Greens and Libertopians should be given a sliver of public dollars to each establish credit rating agencies to compete with Moody’s. A mosiac of conflict-of-interests if you will.
Stepping back, I’m not exactly what a credit agency is for anyway. Presumably if you are lending money, you should be doing your own research.
@credu: I think the Fed’s objective is to arrest the downward spiral starting with lower home prices and end with more and more unemployment. They know that monetary easing by itself won’t stimulate demand. There’s a fiscal stimulus coming.
Plus there’s a supply side problem in EM infrastrcutre. Re balacing of current accounts is going to be gradual with the EM infrastructure sector emerging as the next boom sector. Hang on for the CDO financed bubbly new highways, airports, bridges, etc in unpronounceable places. and that’s where our export is going to come from.
We should think of beating Volvo to the EM demand game instead of wasting time arguing about the Fed’s intentions.
Twofish, you overestimate the difficulty of dealing with CDOs and CDO-squareds. A poster at Econobrowser convinced me that it is possible to find out, easily and quickly, exactly what mortgages are held within a derivative. Similarly, finding the owners isn’t difficult, since if the mortgages did pay off, the owners left a forwarding address for where to send the cash. I don’t think it would be difficult to persuade someone whose investment is frozen to accept a slight haircut.
And certainly they have no trouble dealing with defaults below a certain level. It’s only when defaults exceed a certain point that there’s a problem.
As for re-default, that is a serious issue. However, the problem is mostly because the terms negotiated have been too severe. I think the terms I have suggested are painful for all, but feasible. As a longer-term issue, if we could get health care reform, it would help a lot. Most bankruptcies are caused by illness or job loss. If we keep the economy from tanking and keep people healthy, it will prevent most bankruptcies.
There’s no one other than Bernanke that I would want running the “show”.
The significant economic purposes for which debt was contracted, or the manner in which it was financed, is of inestimatable value in evaluating it’s impact.
For example if the debt was acquired to finance the acquisition of a (1) (new-security), the proceeds of which are used to finance plant and equipment expansion, or the construction of a new house, rather than the purchase of an (2) (existing-security) to finance the purchase of an existing house (read bailout), or to finance (1) (inventory-expansion), rather than refinance (2) (existing-inventories).
The former types of investment are designated as “real” as contrasted to the latter, which constitute “financial” investment (existing homes).
Financial investment provides a relatively insignificant demand for labor and materials and in some instances the over-all effects may actually be retarding to the economy.
Compared to real investment,it is rather inconsequential as a contributor to employment and production.
Only debt growing out of real investment or consumption makes an actual direct demand for labor and materials.
Charles: A poster at Econobrowser convinced me that it is possible to find out, easily and quickly, exactly what mortgages are held within a derivative.
It’s possible to find out easily and quickly what mortgages are held in a standard pass through mortgage-backed security. The trouble is that when that that MBS is packaged and repacked, you end up with layers and layers of indirection, at which point it’s hard to find out who owes what to whom.
Also you run into a problem that typically, A owes B, B owes C, C owes D. B might want to renegotiate with B, but if things get written down, B will owes C full value.
Charles: Similarly, finding the owners isn’t difficult, since if the mortgages did pay off, the owners left a forwarding address for where to send the cash.
No. When you send cash to pay a mortgage, that goes to a mortgage servicer who takes a fraction of the money, but really doesn’t own the mortgage at all. The servicer then sends off the money to some people that send it off to other people that send it off to other people.
Charles: I don’t think it would be difficult to persuade someone whose investment is frozen to accept a slight haircut.
That’s not the problem. The trouble is that you have 100 people. If you persuade 99 of those people to take a haircut, all the money goes to the 100th person that didn’t.
The way that the bankruptcy process deals with this is that you have a judge that issues an order that anyone that cares about getting paid needs to send a lawyer to this time and this place, and if you don’t send anyone you get whatever everyone else agreed to. But there is no bankruptcy here.
Also what happens in a lot of situations, is that the mortgage holder just stops paying, and in a lot of cases that’s actually the most logical and financially sane thing for the holder to do. There are lots of laws on the books that limit what a person can do to collect a bill.
Charles: As for re-default, that is a serious issue. However, the problem is mostly because the terms negotiated have been too severe.
It’s a deeper problem. If someone loses their job, then they aren’t going to be able to pay their mortgage no matter what the terms are.
Charles: Most bankruptcies are caused by illness or job loss. If we keep the economy from tanking and keep people healthy, it will prevent most bankruptcies.
The trouble is that the economy *will* tank from time to time and people do get sick.
People mistake the process of dying and the process of burying a body. Bankruptcy is the process of burying a body. It’s unpleasant, but you do don’t go through with it, then what happens is that you end up with a lot of corpses and zombies floating around, and that does no one any good.
@Twofish – thanks for your clarification on an earlier post/my comments on the change in TARP. Also, I’m a recent graduate with an advanced degree in science and am facing a similar decision that you appeared to have made (between research and finance). I’d love to pick your brain offline about that – please send me an email (on my blog site) if you’ve got the time and inclination.
@Brad – As usual, an excellent post. I depend on this blog as much as I depend upon Bloomberg. Any word yet if you’ll be headed to DC?
“It’s possible to find out easily and quickly what mortgages are held in a standard pass through mortgage-backed security. The trouble is that when that that MBS is packaged and repacked, you end up with layers and layers of indirection, at which point it’s hard to find out who owes what to whom.”
Twofish this doesn’t change my prescription. If contracts are as transparent as you say it transfers the unintelligibility down to determining an asset’s ownership as it filters down the repackaging chain, and its risks/beta/leverage.
It just means instead of hiring accountants to make the contracts transparent, as I though they weren’t, you just hire more expensive “financial Private Eyes” to determine who owns what, and some “Portfolio actuaries” to determine true risk levels caused by leverage that appears to be hidden. If this info were transparently available to investors that didn’t have the time/skill to do it themselves; if a bond issue is backed by overpriced Tulips and these regulators warn that might be a bubble, maybe no one buys them.