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MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

Archive for December, 2009

Monetary Policy and the Housing Bubble

Posted by WARREN MOSLER on 29th December 2009

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>   (email exchange)
>   On Tue, Dec 29, 2009 at 8:55 AM, wrote:
>   Do you agree with their conclusion that monetary policy (low rates) didn’t affect housing
>   prices?

Yes, seems that way to me, too.

>   I guess they did raise rates from 2003-06.
>   Seems the very low short rates DID contribute to the ability to buy “more house” or qualify for
>   any house.

Maybe some.

>   For me it was the bush 2003 fiscal adjustment- spending increases, retro tax cuts, etc. that got
>   the deficit up to 200 billion by q303 which was about 8% of gdp annual. Then after a few years
>   the sub prime housing fraud started with loan officers on commission pushing fraudulent
>   appraisals and fraudulent income statements that turned the recovery into a mini boom that
>   actually didn’t get all that large before it crashed when the $trillion fraud was discovered.

Fed: “Monetary Policy and the Housing Bubble”

Our findings are both clear and limited in scope.

We find little evidence that the setting of U.S. monetary policy could have directly accounted for a substantial share of the strength in U.S. housing markets between 2003 and 2006. In particular, the rise in house prices or housing activity during this period was much faster than the pace consistent with the overall macroeconomic environment at that time.

But we also find that housing-specific developments were unusual in this period—and not only with respect to prices and activity. The form of mortgage finance—the prevalence and nature of mortgages with adjustable rates versus fixed rates, the role of other “new” or exotic mortgage features, and the role of different types of lenders and securitization paths—all shifted during this period. These shifts undoubtedly fed on each other, with strong demand for housing and rising house prices spurring unsustainable evolution in the nature and perceived risks associated with mortgage innovations and vice versa. This finding is quite limited in that it describes developments but does not explain why such developments occurred.

Nonetheless, our clear finding that traditional channels of monetary policy accounted for little of the rise in housing markets and that housing-specific factors involved the interaction of shifts in demand and mortgage finance suggest two important lessons for policy and certainly for subsequent research. In particular, our discussion connects to the questions of whether monetary policy should “lean against the wind” in the face of asset price bubbles and of how complimentary financial policies (for example, macroprudential regulation) may interact with monetary policy.”


Posted in Fed, Housing, Inflation, Interest Rates | 24 Comments »

Why health care will keep us ill

Posted by WARREN MOSLER on 29th December 2009

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The flaw in the annointment is that our out of paradigm legislators and administration have apparently agreed that whatever healthcare they pass will be a ‘tax now, spend later’ arrangement.

This will only serve to reduce aggregate for the time leading up to the additional spending, which looks to be, perhaps, three years.

While it may not be enough to throw us back to negative growth, it will work against any transition back towards full employment we might have had otherwise.


Posted in Employment, GDP | 18 Comments »

Iron ore in China

Posted by WARREN MOSLER on 29th December 2009

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Yes, China is very large and in many ways ‘untouched’ and will most likely continue to find its own resources, rather than cause world wide shortages.

China says it may have 10bln tonnes of iron ore reserves in Hebei

Dec 26 (Reuters) — The eastern region of China’s northern Hebei Province may hold iron ore reserves of more than 10 billion tonnes according to exploration work done in the area, reported the official Xinhua news agency on Saturday.

The China Metallurgical Geology Bureau said a total of 3.44 billion tonnes of iron ore has been verified in five mines in the province.

The discovery of the deposits would ease the shortfall in China’s domestic iron ore supplies and contribute to the sustainable development of China’s steel industry, Yan Xueyi, director with the bureau, was quoted as saying.

Spot iron ore prices have recently fallen from three-month highs struck in late November, and some analysts said China, the world’s biggest iron ore consumer, may seek to put pressure on prices to win more favourable terms in annual talks with global miners.

China reported on Friday that iron ore production in November rose 3.5 percent from October even as total crude steel output dropped 8.7 percent. China’s iron ore imports in November rose 12.3 percent from October.

(Reporting by Melanie Lee)


Posted in China, Comodities | No Comments »

Fixing the small banks

Posted by WARREN MOSLER on 26th December 2009

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Fixing the Small Banks

The Obama administration has been preaching the importance of fixing the small banks and getting them lending again. This will review what I see as the critical issue and how to fix it.

First, the answer:

1. The Fed should loan fed funds (unsecured) in unlimited quantities to all member banks.

2. The regulators should then drop all requirements that a % of bank funding be ‘retail’ deposits.

Yes, it is that simple. This simple, easly to implement ‘fix’ will immediately work to restore small bank lending from the bottom up by removing unnecessary costs imposed by current government policy.

The current problem with small banks is their too high marginal cost of funds. The only reason the Fed hasn’t expressed an interest in ‘opening the spigot’ and supplying unlimited funding at its target interest rate to any member bank to bring down this elevated cost of funds has to be a lack of understanding of our banking system.

Currently the true marginal cost of funds to small banks is probably at least 2% over the fed funds rate. This is keeping their minimum lending rates at least that much higher, which also works to exclude borrowers who need that much more income to service their borrowings, all else equal.

The primary reason for the high cost of funds is the requirement for ‘retail deposits’ that causes the banks to compete for a finite amount of available deposits in this ‘category.’ While, operationally, loans create deposits, and there are always exactly enough deposits to fund all loans, there are some leakages. These include cash in circulation, the fact that some banks, particularly large, money center banks, have excess retail deposits, and a few other ‘operating factors.’ This causes small banks to bid up the price of retail deposits in the broker CD markets and raise the cost of funds for all of them, with any bank considered even remotely ‘weak’ paying even higher rates, even though its deposits are fully FDIC insured. Additionally, small banks are driven to open expensive branches that can add over 1% to a bank’s true marginal cost of funds, to attempt to attract retail deposits. So by driving small banks to compete for a limited and difficult to access source of funding the regulators have effectively raised the cost of funds for small banks.

It should be clear my solution would immediately lower the marginal cost of funds for small banks. I’ll now attempt to address the usual host of objections to my proposal.

There are always two fundamentals to keep in mind when contemplating banking with a non convertible currency and floating exchange rate:

1. The liability side of banking is not the place for market discipline.

2. The Fed and monetary policy in general is about prices (interest rates) and not quantities.

Disciplining banks on the liability side has been tried repeatedly and always and necessarily fails. First, it’s fundamentally impractical to the point of ridiculous to expect anyone looking to open a checking account or savings account, for example, to be responsible for analyzing the finances of competing banks for solvency, when even Wall Street analysts can’t reliably do this. The US leaned this the hard way when the banking system was closed in 1934, reopening with Federal deposit insurance for bank deposits for the sole purpose of removing this responsibility from the market place. Regulation and supervision on the asset side then became the imperative. And while we have seen periodic failures due to lax regulation and supervision of the asset side of the US banking system, and it’s a work in progress, the alternative of using the liability side of banking for market discipline exposes the real economy to far more disruptions and far more destructive systemic risk.

Those who understand reserve accounting and monetary operations, including those directly involved in monetary operations at the world’s central banks, have known for decades that in banking, causation runs from loans to deposits, with reserve requirements, if any, being merely a ‘residual overdraft’ at the central bank and not a control variable. This includes Professor Charles Goodhart at the Bank of England, who has written extensively on this subject for roughly half a century, endlessly debating the ‘monetarist’ academic economists who spew gold standard and fixed exchange rate rhetoric, and who are unaware of how monetary operations are altered when there is no legal convertibility of a currency. Recall the ‘500 billion euro day’ back in 2008 when the ECB added that many euro in reserves to its banking system, and a week later the monetarists pouring over the data ‘couldn’t find it.’ The fact that they even looked was evidence enough they had no actual knowledge of reserve accounting and monetary operations. And, more recently, the notion that ‘quantitative easing’ makes any difference at all apart from changes in interest rates (it’s always about price and not quantity) reinforces the point that there is very little understanding of monetary operations and reserve accounting. While Professor Goodhart did declare quantitative easing in the UK a ‘success’ he did so on the basis of how it restored ‘confidence,’ making it clear that there was no actual monetary channel of causation from excess reserves to lending. Banks do not ‘lend out’ reserves. Loans create their own deposits. Total reserves are not diminished by lending. This is operational and accounting fact, and not theory or philosophy.

What this means in relation to my proposal of unlimited lending by the Fed to small banks at its target rate, is that any lending by the Fed will not alter anything regarding lending and the ‘real economy’ in any other regard, apart from the resulting term structure of interests per se. (Also, and not that it matters in any event, total lending by the Fed won’t exceed funds ‘hoarded’ by some banks along with the usual operating factors that routinely ‘drain’ reserves.)

In other words, the notion that this policy will somehow result in some inflationary monetarist type expansion is entirely inapplicable with a non convertible currency and floating exchange rate policy.

The other common concern is the risk to the Fed of lending unsecured to its member banks. However, there is none, if you look at government from the macro level. All bank assets are already regulated and supervised, and the banks are continually subjected to solvency tests. This means government has already deemed to the banks ‘safe to lend to.’ Furthermore, functionally, the fact that banks can indeed fund themselves in unlimited size with FDIC insured deposits means the government already lends to banks in unlimited quantities, protecting itself by regulating and supervising the assets, including asset quality, capital requirements, etc. Therefore, the Fed asking for collateral from its member banks is entirely redundant, as well as disruptive and a cause of increased rates to borrowers.

Conclusion: If the Obama administration had the knowledge, they would immediately move to implement my proposals to support small banking.


Posted in Banking, Obama | 27 Comments »

more on the man of the year

Posted by WARREN MOSLER on 24th December 2009

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More on the Bernanke testimony:

Shortly after the failure of Lehman Brothers, I was in Brazil at an international meeting, and I had a meeting there with bankers, and I asked them how the Brazilian economy was doing. And they said well, it had been doing fine, but within a week after Lehman Brothers collapsed, it was like a frigid wind descended on the economy in Brazil. And there was an enormous impact almost immediately on their economy, on their ability to raise funds and make loans.

In dollars, I’m sure.

And it’s astonishing how quickly that one failure spread throughout the world, and created a very severe recession, not just in the U.S., but around the world.

The Federal Reserve, by making a large loan under very tough terms to AIG,

But allowing those funds to be used to meet margin calls on CDS and probably other related market losses. That’s perhaps the most controversial part. Those payments to creditors perhaps could have been labeled ‘loans from the Fed’ subject to AIG ultimate solvency rather than payments from the Fed.

prevented the failure of that institution, and, therefore, tried to contain the impact of the Lehman Brothers failure on the rest of the global financial system. I’ll come back and talk more about AIG, and those things later, but that was just the first step of many that we took to try to stop the crisis.

Subsequently, again, very concerned with the possibility of a global financial meltdown, we worked with Treasury and the Congress to develop a bill that would provide funding that the Fed, the Treasury and other agencies could use to stabilize the financial system, to prevent collapse of the financial system.

This immediately became relevant, because in mid-October, the crisis heated up again to the point that we thought that we were again within days or hours of a collapse of many of the largest financial firms in the world. It was a dramatic weekend. It was Oct. 10 or 11, Columbus Day weekend, when the Finance Ministers and the central bankers of seven of the largest industrial economies had a meeting here in Washington, which, of course, I attended. Usually, those meetings are very scripted and very dry. In this case, there was palpable concern among the participants that the collapse of their financial system might be just days away, and there was a great deal of discussion about how we, collectively, as the policy makers leading those countries could stop the collapse.

In the days that followed, countries all over the world, particularly the advanced industrial countries, took strong measures to prevent the collapse of the financial systems. That included putting capital into banks;

Obviously they didn’t know it was nothing more than regulatory forbearance.

it included preventing the failure of large financial firms; it included guaranteeing the debts of financial firms so they could borrow and keep themselves afloat; it included making short-term loans to firms so that they would have the short-term credit they needed to pay off lenders who were withdrawing their funding. And, again, this was the U.S. doing this, but also many of the most important industrial countries around the world simultaneously, including the U.K., Germany, France, Switzerland and others.

Again, many of those creditors ‘bailed out’ by the Fed’s liquidity provisions could have had those funds labeled ‘loans from the Fed’ rather than simply receiving payments from the Fed.

The result of this collective global effort over that week was essentially to succeed in stabilizing the global banking system, in that subsequent to that week the fears of utter collapse were largely overcome.

Now, in the following months after that, there were still many, many great difficulties in the financial markets. And the Fed, and other central banks and Treasuries around the world, worked very hard to restore the normal functioning of those markets. For example, following the Lehman failure, there was a run where ordinary investors went as quick as they could to pull their money out of money market mutual funds, which are a common investment vehicle for many Americans. It was very analogous to 100 years ago when a bank was about to fail, and the depositors would go to the bank, they would run and pull their money out as quickly as possible, and then the bank would fail. The money market mutual funds were experiencing exactly the same phenomenon.

The Fed and the Treasury working together provided short-term loans to these funds. The Treasury provided some insurance to depositors, or to investors so they would know they wouldn’t lose their money. We stopped the run on the money market mutual funds, and that was an example of how we helped stabilize the situation.

Not sure why that was critical?

There were many other steps we had to take helping individual institutions, and providing programs for backstop lending to make sure that the key markets in the financial system were functioning again, because for months after Lehman Brothers, the amount of fear and uncertainty in the financial markets was so elevated that these markets were, essentially, not functioning properly, and it took really many months until we had reached the point that these markets had begun to approach a normal state.

Doesn’t mention the dollar swap lines to foreign CB’s???

But bank lending is still weak. The banks had a near-death experience, they are now lending in a difficult economic environment. We are strongly encouraging them to lend. We have taken a lot of steps to help them raise new capital, so they’ll have a basis on which to make new loans. And we are taking a number of steps to try to open up markets through which investors invest directly in various forms of credit, like auto loans and credit card loans. All of these steps are improving the financial situation, but particularly the banking sector, we’re still in the convalescent stage.

They only bought AAA traunches which didn’t address the credit issues. They were more worried about taking losses than restoring auto credit, but wanted to give the appearance they were doing something.

As I said, I was a professor. I never worked for Wall Street. I have no connections on Wall Street. In fact, when I first became chairman, I was criticized in some quarters for not being close enough, or knowing enough about Wall Street. So, why did I take these actions?

I didn’t take these actions, or the Federal Reserve didn’t take these actions because we were trying to help bankers, or trying to help Wall Street. What I understood, and what knowledgeable people all around the world understood, is that the financial system is essential to the functioning of any economy. And that if the financial system had collapsed to the extent to which we believed was very likely in September and October 2008, then no force on earth, no policy, could have prevented the collapse of the entire U.S. economy with long-lasting and extreme consequences for every American.

How about a proportionate fiscal response, like a payroll tax holiday and per capita revenue distributions to the States? Instead, he continues to preach ‘fiscal responsibility.’

It was because we were concerned about jobs and incomes and the economic well-being of every American that we intervened to prevent the collapse of the financial system.

Now, going forward, we have a lot to do to get the economy back to stability, get jobs created. You can talk as much as you like about the things we’re doing there, but we’re also going to have to take some very strong steps to make sure that the crisis doesn’t ever happen again.

There were, certainly, weaknesses in our financial regulatory system. There were weaknesses in the way that financial regulators supervised the banks and other financial institutions. And the financial institutions themselves made lots of mistakes in terms of their ability to measure the risks that they were taking, and to control them properly. And to make sure we don’t ever have a crisis like this again, we need to have extensive reform in the private sector, in the public sector, to eliminate these risks in the future.

You had said that the banks were convalescent still, Mr. Chairman. Can you talk to us a little bit more about what that means?

Well, the banks have been stabilized. They’ve raised a good deal of capital, so they’re in much better shape than they were. They are lending, but they are not lending enough to support a healthy recovery. One important reason for that, is that given their losses, given what they’ve been through, they’re being very conservative in the face of what is still a very weak economy; and, therefore, a sense that many borrowers are quite risky.

As bank supervisors, we have a difficult challenge. We have told the banks very clearly that we want them to make loans to credit-worthy borrowers, where there are borrowers who can repay the loans. It’s in the interest of the banks, it’s in the interest of the economy, and, of course, it’s in the interest of the borrowers for those loans to get made.

But the problem is, of course, that we got into trouble in the first place by banks making loans that couldn’t be repaid, so we don’t want banks to make bad loans. Therefore, we are trying to work with banks to make sure that they are, in fact, able to make as many good loans as possible, that they have enough capital, that they have enough short-term funding, and that the examiners and the regulators who work with the banks are not unduly restricting the loans that they make. We want to work with the banks to make sure that they balance the appropriate prudence and caution against the need to make good loans for the economy, and for their own profits.

Banks and the entire private sector is necessarily procyclical.

Only govt via fiscal policy can be countercyclical.

So, what this means is that economic policy, and financial oversight have to take into account all the international dimensions of that. So, for example, on the monetary policy side, we have worked carefully and closely with other central banks to talk about monetary policy in different parts of the world. In fact, during the heat of the crisis in October 2008, the Federal Reserve and five other major central banks cut interest rates together on the same day, as a sign of how committed we were to cooperating on monetary policy.

Doesn’t seem concerned that interest rate cuts may in fact be deflationary as he knows they remove interest income for the private sectors (Bernanke, Sacks, Reinhart, 2004 Fed paper- see ‘the fiscal channel’)

The system worked.

It did work. It was an important first step. I mean, even after we took those steps, the financial markets were in a great deal of stress, and credit at all levels was very much constrained. But it stabilized the situation, and from there, we were able to take a number of steps to – both we, and our partners in other countries – to get the key markets working again, to get the banks stabilized, and to begin the very difficult process of getting the financial system back on its feet.

Never realizing that all the alphabet soup measures to get liquidity going missed the point that all the Fed had to do was lend fed funds to member banks without limit, as the ECB effectively did by immediately accepting any and all bank collateral, to immediately restore bank liquidity.

So, while it’s difficult to know exactly what the outcome would have been, certainly, just judging on what happened after the failure of a single firm, the collapse of the global financial system would surely have led to a far deeper recession, higher unemployment, much greater fiscal cost to the taxpayer, and to rebuild the financial system, and to get the economy moving again. And almost certainly, [we would have had] many, many years of subnormal – substandard – performance by the U.S. economy, and by other industrial economies, as well. Again, we can’t know precisely, but I think if anything, the financial crisis last fall was as severe, and as dangerous as anything we’ve ever seen, including the 1930s.

The whole point of going off the gold standard in 1934 was to be able to provide liquidity without limit to the banking system, so the fact that he did that, however belatedly, is nothing to brag about. It also allowed for unlimited fiscal responses, which he still seems to not fathom.

There is an irony here that’s literary, that here’s this man who spends his life distinguishing himself studying economic history. And then one day you wake up and realize that you’re at the center of economic history in this really unusual chapter. How do you process that personally? I mean, how does that change how you go from being the academic expert to you are in the arena?

Well, I certainly didn’t anticipate when I came to Washington in 2002, I certainly didn’t anticipate these events, or how things would evolve. No question about it. And when I became chairman in 2006, I thought that – I hoped that my main objectives would be improving the management, communication and monitoring policy.

We were certainly attentive to the risks of financial crisis. Secretary Paulson and I talk frequently to people on Wall Street, and we secured the Federal Reserve. We set up a team of staff drawn from different disciplines to try to identify problems and weaknesses in the financial sector. So, we were certainly aware of the risks of financial crisis, but one as large and as dangerous as this one, I certainly did not anticipate. I wish I had, but I didn’t.

Then when the crisis came, you know, rather unexpectedly, a different part of my training and research became relevant, which was to work on financial crises generally, and also on the Great Depression. And I believe very much that that experience, and that knowledge, was very helpful to me in many dimensions of this effort, ranging from – I think the most important lesson, there are many lessons, but I think the most important lesson was that we were not going to have a healthy stable economy with a completely dysfunctional financial system. We had to take strong measures to prevent that from happening.

And in the 1930s, the Federal Reserve was quite passive, and allowed the banks to fail, and we know the result of that. So, we were determined that that wasn’t going to happen on my watch, on our watch, so we were prepared to take very strong actions to avoid that.

That was under the gold standard. Nothing could be done without losing the nation’s gold supply. It was only after the banks reopened in 1934 with a non convertible currency could there be credible deposit insurance unlimited Fed provision of liquidity. Clearly he doesn’t understand that or a) he’d be stating it b) I don’t want to say…

You’ve been quite forthcoming, I think, in your testimony about saying, there’s a lot of things you didn’t see, there’s some things that we didn’t do. If I gave you a kind of do-over to go back as long as you want to say you know what, if we’d seen this, if we’d looked at the sub-prime mortgage crisis. I mean, how could you have handled it, and the Fed handled it better to have a different outcome?

Well, we have, based on the experience of the crisis, we – the Treasury and others – have made proposals for how the financial regulatory system ought to be reformed and restructured. I’ll say a word about that. If we had been in that forum, I think we would have avoided the crisis. So, there were some important lessons.

One was that our regulatory system was too myopic. It was too focused on individual firms, or individual markets, and there was nobody paying attention to the broad overall financial system. So, the Federal Reserve was not entrusted with looking at the whole financial system. We were – we had very specific assignments. We were supposed to look at specific institutions. Those institutions did not include many of the firms that had severe problems, like Lehman Brothers or Bear Stearns or AIG. Those were outside of our purview, and since they were outside of our purview, we didn’t look at them.

They missed one critical factor- allowing bank loan officers to work on a commission basis. Nor, did the regulators look into actual loan files to check for fraudulent appraisals and income statements promoted by loan officers working on a commission basis. Regulation is necessarily a work in progress. Mistakes will be made, including mistakes of this scale. Critical to our well being is the knowledge of how to keep these errors in the financial sector from damaging the real economy. And that requires appropriate fiscal responses to sustain aggregate demand, preferably in an equitable manner.

But there were many situations where there was really nobody who was looking carefully at what was going on, and nobody who was looking at how the parts of the system fit together. So, a very important recommendation that we have made is that there be a more systemic approach – that is, have some arrangement whereby a regulator, or a group of regulators, has responsibility to look at the system as a whole, and try to identify emerging problems, or gaps in the regulatory apparatus, or weaknesses in individual institutions, as they relate to other institutions, that threaten the integrity of the system as a whole.

Better still, most of the issues came from allowing banking activities that in fact served no further public purpose. That includes any bank participation in secondary markets, loaning against financial assets, using LIBOR as an index, and many others.

We didn’t have that. Therefore, nobody paid enough attention to AIG, nobody paid enough to attention to credit and call swaps, nobody paid enough attention to some of the activities of investment banks. You go on, and on, and on. Again, if we had had a more comprehensive overview approach that would have been helpful.

A second key element is the problem too big to fail, and how to address that. So, I just want to be very, very clear that even though the Federal Reserve was involved in rescuing Bear Stearns and AIG, we did that extremely reluctantly, and with – it was a very distasteful thing for us to do. We did not do it – we were not set up to do it. We were – it was very difficult for us to do, but we did it because there was no appropriate mechanism, there was no set of laws that would allow the government to intervene in a situation like that in a way that would allow the firm to fail, but would not have all the negative consequences for the financial system and the economy.

So, we had a situation where there were firms who were literally too big to fail, or too complex to fail, or too interconnected to fail. When they came to the edge of collapsing, we had only two very, very bad choices: we either bailed them out, put taxpayer money at risk, put the Federal Reserve at risk in terms of our lending, or we could let them collapse and have all the hugely negative consequences for the financial system and for the economy.

So, what we did not have, and what we very much need going forward, is a third option, and that option should be a legal framework which allows the government – and I think that means, in practice, the Treasury and Federal Deposit Insurance Corporation – to intervene when a large complex systemically critical firm is about to fail, and to allow the firm to fail, impose losses on the lenders, the creditors of the firm, the shareholders, fire the management, protect the taxpayer, but be able to do that in a way that protects the system, so that the financial system is protected from the immediate impact of that collapse.

I submit we already have that for the large banks, and the others as well. He just didn’t grasp how to use it. The receivership they did set up did not have to pay off all the creditors, and if there were issues, it would have been a relatively simple matter to petition congress for an ‘emergency’ alteration of current law. They didn’t even try.

We did not have a system like that in place. I think if we had, we could have dealt with Lehman Brothers and AIG in a much more satisfactory way. We would have avoided many of the problems. And, most importantly, we would have not, in some sense, rewarded failure, which is what happened. In the future, it’s important that firms be allowed to fail if they, in fact, take excessive risks, and make bad gambles.

But that mechanism is not in place now.

The mechanism is not in place, and we have asked Congress to address it, and I believe that they will. But until they do, we are really still in a situation where we don’t have good options in dealing with potential collapse of a global financial firm.

It isn’t that hard to do.

Right now people are sort of looking to you, and to Congress, to kind of break the back of unemployment. And you’ve talked about how that is really our biggest challenge right now. Do you feel there is anything else that can be done, or has the Fed shot all its bullets, and has Congress shot all its bullets?

Well, the Federal Reserve has been very aggressive on the unemployment side. So, let me just first say that even though the recession may be technically over., in a sense that the economy is growing, it’s going to feel like a recession for some time, because unemployment remains very high, about 10%. And even people who have jobs, there are many people who are on short hours, that are in voluntary part-time, or maybe people who are not technically unemployed, only because they stopped looking. So, the labor market is in very weak condition, and we’re not going to see a healthy, vibrant economy again until the labor market – the job market – has recovered. So, that is really an extraordinarily important objective for policy going forward. And, certainly, our job won’t be done until the economy is growing again, and jobs are being created.

The Federal Reserve’s attempts to address employment issues, we’ve done several things. Certainly, one of the things is we’re using our monetary policy. In December 2008, while the crisis was still in an intense phase, we cut the short-term interest rate that is the measure of our monetary policy almost to zero. The first time that had ever been the case, the Fed had ever done that, in order to provide the maximum amount of support to the economy, and it remains close to zero today. So, that is a very powerful measure.

Again, he gives no weight to the possibility that the interest income he removed from ‘savers’ is weighing on the economy, even though it’s in his own paper from 2004.

Having used that tool to its maximum extent, we have then turned to new and innovative tools, things that have never been done before in the Federal Reserve. I’ll give you two examples. One, we’ve purchased about $1 trillion worth of mortgages that are guaranteed by Fannie Mae and Freddie Mac, and the U.S. Treasury. And in doing those purchases, we have succeeded in reducing the national 30-year fixed-rate mortgage rate from about 6-1/2% to about 4.8%. By lowering mortgage rates that way, we have helped to stabilize the housing sector, to help stabilize the housing crisis, and allow people to refinance, to buy homes. And that, obviously, should get construction started again and house prices stabilizing, and people being able to meet their mortgages. That’s obviously going to be helpful.

The far more effective way would be to directly fund the agencies at the fixed rate the Fed wanted for mortgages and allow that funding to be prepaid without penalty if the mortgages prepaid. But that was never even a consideration.

We’ve also created a program that helps bring credit from Wall Street to support a wide variety of consumer and small-business loans. So, for example, our program allows Wall Street money to come in and support auto loans, credit card loans, student loans, small business loans, commercial real estate loans. By providing that conduit, we are supporting what the banks are doing to get credit flowing into those important sectors.

But only the AAA pieces, as previously discussed.

And I guess a third thing, an additional thing I would mention is that we serve not only as monetary policy makers, but also as bank supervisors. And there we’ve been sparing no effort, as I talked about earlier, to get the banks able and willing to lend again, to create – particularly the small businesses – to create the credit that’s needed to create new jobs and get employment back on track.

I would mention, in particular, our leadership of the stress tests. In the spring, the Federal Reserve led an effort to evaluate the balance sheets of 19 of the largest banking companies in the U.S., and our report on those balance sheets, along with the FDIC, the OCC, to other banking agencies, our reports on those balance sheets is public, greatly increased the confidence in the banking system, which meant that they were able to go out and raise new capital in the stock market, and many of them have paid back the capital to the government.

Still no clue it was only regulatory forbearance.

But by raising new capital, they increased their own capacity to lend. And, as conditions improve, they’ll be able to make new loans as well.

So, by keeping interest rates low, including both short-term rates and long-term rates, like mortgage rates, by supporting a flow of credit to small businesses, consumers and the like, that is our primary effort. Those are the tools that we have. We can always do more, if necessary, but those are the tools that we are applying trying to get job growth going again.

They have more tools but aren’t using them? Unless this is a bluff, what are they waiting for? This is an extraordinary statement.

And we have seen, obviously, the labor market is still very weak, but the last report we saw shows that we’re now coming closer to the point where we’ll stop seeing job losses and start seeing job gains.

We’ve talked about a lot of those extraordinary things you’ve done. But is that it? Like now do we have to – because there’s still really bad numbers, even your forecasts are like what, 10% [unemployment] this year, 9% going forward, I think like 8% in 2012. Do we just have to kind of now sit back and take it?

Well, the Federal Reserve will continue to see what other policy actions we can take. And we’ve really been very aggressive, thus far. And the additional steps aren’t as obvious or clear as the ones that we’ve already taken.

Right, they don’t have any actual ideas.

A lot of the scope now is on the fiscal side of the house. As you know, the government passed a major fiscal program earlier this year, and I think it was just today the President announced a number of individual – a package of programs to try to address unemployment. So, [there are] a lot of new initiatives probably coming from the fiscal side.

While he preaches fiscal responsibility. See below.

Did they ask you for your opinion of those before…

Well, our staffs confer frequently with the Treasury and other parts of the Economic Advisory Groups that advise the President. And we often give our views. Our views are solicited. But, of course, they are responsible for their policy choices.

Have you said before, or are you prepared to say now, that a second stimulus, a round of incentives, is a good idea, on the fiscal side?

So, my domain is monetary policy and financial stability. And we have done, of course, a lot of aggressive things to try to support the economy, try to support job creation. I generally leave the details of fiscal programs to the Administration and Congress. That’s really their area of authority and responsibility, and I don’t think it’s appropriate for me to second guess.

You have said that there’s a long-term deficit program that needs to be dealt with. You said health care costs ought to be cut back, so it’s not like you won’t talk at all about the fiscal situation. Regardless of the details, which I understand that you don’t want to tell them how to do it, do you think that the fiscal side ought to do something?

Well, let me say this, I think that it’s very important that whatever actions that Congress and Administration take on the fiscal side, that they begin soon, or even sooner, to develop a credible medium-term interest strategy for fiscal policy, one that will persuade the markets and the public that over the medium term, the next few years, we will – we, as government, we, as a country – will be able to bring our deficits down to a level that could be sustained over a period of time.

Yes, he’s clearly part of the problem, not part of the answer. He’s failed to realize the ramifications of lifting convertibility in 1934 (and 1971 internationally) and is one of the leading deficit terrorists.

If we can do that, which will increase the confidence of the markets in American fiscal policy, that would give us more scope to take action today, because, again, there would be confidence that we have a way out, a way back towards sustainability.

There is no sustainability issue and he should know that. But he doesn’t even fully understand monetary operations of the Fed itself.

In your testimony the other day, one Senator talked about here’s the money that the federal government takes in, here’s what we spend on entitlements. It’s basically the same. Everything else we have to borrow for. I mean, there are a lot of people saying that it’s not sustainable, as you have said. And they said one of the only solutions is some kind of tax, a sales tax, value-added tax, something other than an income tax. But would you be in favor of any of those alternatives?

So, the way I put this before Congress before is that the one law that I strongly advocate is the law of arithmetic. (Laughter.) That law of arithmetic says that if you are a low-tax person, then you have to – you are responsible for finding ways on saving on expenditure, so that you don’t have enormous imbalances between revenues and spending. And by the same law of arithmetic, if you were somebody who believes that government spending is important, and you are for bigger and more spending, and bigger programs, then it’s incumbent upon you to figure out where the revenues are going to come from to meet that spending. So, again, I think that’s, again, Congress’ main responsibility.

I have spoken about deficit, and I think deficits are important, because they address broad economic and financial stability. We need to talk about that. But in terms of the specifics about how to get to fiscal balance, that’s the elected officials’ responsibility.

He sees spending as revenue constrained where that concept is entirely inapplicable to non convertible currency and floating fx policy.

Do you think Congress is fiscally illiterate? Economically illiterate?

No, of course not. But what they have to deal with is not just a question of understanding. It’s a question of making very, very tough choices, and in a political environment, where people understandably are resistant to cuts in programs or benefits, or increases of taxes. So, there needs to be tough choices made, there needs to be leadership. And I don’t envy Congress those choices, because they’re very difficult ones to make.

Are you saying that time for fiscal and monetary stimulus is over? And, if so, what’s the downside of pushing even harder?

There are not easy solutions. It’s an enormous problem. I think the Federal Reserve – one direction that we can go is to continue to encourage the extension of credit, small businesses, in particular, create a lot of jobs, particularly during economic recoveries. And we have lots and lots of evidence and anecdotes suggesting that small businesses are particularly harmed by the tightness of the bank lending standards and unavailability of credit. So, everything we can do, and that the Administration and Congress can do, to support credit extension to all business, but primarily small business, would be a very powerful.

You don’t think it’s a liquidity problem?

Well, I mean, interest rates are very low, so I think it’s going to be a question, first of all, of getting credit flowing again. And the Federal Reserve has got a role to play there. And then, Congress and the Administration will consider possible programs and fiscal policies.

You’re definitely not okay with long-term profligacy, but are you okay with them doing something in the short-term?

I think if they do that, it’s critically important they clarify the longer-term plan for establishing sustainable fiscal [policy].

Again ducking the question. But it’s clear he is not a supporter of using fiscal adjustments to sustain aggregate demand.

Adair Turner, the chief British [financial services] regulator, said that we’ve learned that much of what the financial services sector did in the past 10 years has no economic or social value. Do you agree? Did the financial services sector just get too big, and should it be smaller?

Okay. Well, a strong financial system is very important. It allocates capital to new businesses and new industries. It allows for people to invest in a wide range of activities, so it’s critically important to have a good financial system. And the evidence for that is that when the financial system breaks down, the system just doesn’t function.

That is not evidence for that. Seems a breakdown of logic???

You see what the impact has had on the economy. With that being said, the financial system is unique to the extent, first, that it is so critical to the economy, and, secondly, to the very, very old tendency to succumb to booms and busts.

Again, this is too confused to not be an insight into his basic sense of logic.

And, therefore, we do need to have an effective comprehensive financial regulatory system that will essentially allow us to tame the beast so that it provides the benefits, the growth and development without creating these kinds of crisis.

And then this says it all regarding his understanding of monetary operations:

Okay. When the Federal Reserve buys mortgages, it pays for them by creating reserves the banks hold in Federal Reserve. So, as we purchase $1 trillion of mortgages, we’ve created roughly $1 trillion of reserves that banks hold at the Federal Reserve. The banks, at this point, are just willing to hold those reserves with the Fed, and not do anything with them.

Banks don’t ‘do anything’ with reserves.

Ultimately, if the economy normalized, and the Fed took no action, the banks would take those reserves, try to lend them out, and they would begin to circulate, and the money supply would start to grow.

Banks don’t ‘lend out’ reserves.

And then, ultimately, that would create an inflationary risk.

This is not how it works.

So, therefore, as the economy begins to recover, and as we move away from this very weak economic environment, the Federal Reserve is going to have to pull those reserves out of the system.

We have a number of means for doing that, which we have explained to the markets, and the public, and everyone is confident we can do that. And we will do that over time, in order to make sure that as we come out of this crisis, we don’t generate inflation at the end.

Reserve management has nothing to do with inflation with a non convertible currency and floating fx. This is ancient gold standard rhetoric.

So, the reserves can be pulled out through various mechanisms or can mobilize. And we don’t have to do that yet, but when the time comes, we have tools to do that.

And are there lurking dangers in those mortgages that you purchased that we don’t even know about now?

Well, the mortgages are guaranteed. The credit, even if they go bad, Fannie and Freddie with the backing of the U.S. Treasury will pay them off, so the Fed is not taking any credit risk by holding these mortgages.

It’s comforting for you, but not for the taxpayers. Right?

Well, on the other hand, what’s happening is that we earn the interest from those mortgages, and then we remit that interest back to the Treasury, so the money finds its way back to the taxpayer.

That’s exactly how the Fed’s portfolio removes interest income from the private sectors.

And, indeed, the Federal Reserve will be paying the Treasury a good bit more money the next few years than it has in the past, because of the interest we’re earning on these mortgages we acquired.

On that note, this week we did learn the TARP is going to pay back nearly all of what it was required to from the taxpayer. Looking back a year later, are surprised by that?

Well, we said at the beginning that the TARP money was an investment. It was going to acquire assets, and that most or all might come back to the taxpayer. Right now, if you look at all these repayments from banks, and the fact that the government is sitting on capital gains, as well as other investments, I think it’s a reasonable probability that the TARP money invested in financial institutions, that the great majority of it will come back to the taxpayer. So, in the end, we will have stabilized the financial system and avoided this global crisis at not a small amount of money, but relative to the alternative, a quite small amount of money.

Were there days where you woke up and you thought, what am I not thinking of that we could be doing?

We had a philosophy right here, which was what we called blue-sky thinking. And what blue-sky thinking was, was we have a problem, I want everybody to give me just three associations. What can you think of? How can we approach this, what can we do? And we’ll worry about getting rid of the silly answers later. So, there’s been a lot of creativity here, and I give credit to terrific staff . I think one of the lessons of the depression, and this is something that Franklin Roosevelt demonstrated, was that when orthodoxy fails, then you need to try new things. And he was very willing to try unorthodox approaches when the orthodox approach had shown that it was not adequate.


Posted in Banking, CBs, Congress, ECB, Employment, Fed, GDP, Government Spending, Inflation, Interest Rates, Political, Recession, USA | 24 Comments »

Schwarzenegger Seeks Obama’s Help

Posted by WARREN MOSLER on 24th December 2009

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Still haven’t seen any discussion of a per capita revenue distribution to all the States?

$500 per capita would give California maybe $19 billion and be ‘fair’ to all the States.

It would also support aggregate demand (spending power) output and employment, which presumably is a national priority?

Feel free to send this suggestion to your representatives!

Schwarzenegger Seeks Obama’s Help as Budget Gap Defies Solution

By Michael B. Marois and William Selway

Dec. 24 (Bloomberg) — CaliforniaGovernor Arnold Schwarzenegger wants President Barack Obama to help ease large- scale cuts to the most populous U.S. state’s already diminished social programs amid a $21 billion anticipated deficit.

Schwarzenegger, a Republican, plans to ask for relief totaling as much as $8 billion, according to a California official who asked not to be identified because details haven’t been resolved. Instead of seeking one-time stimulus money or a bailout, the state wants the U.S. to reduce mandates and waive rules stipulating minimum expenditures on programs such as indigent health care, the official said.

California has been among the states most affected by the economic recession. It has the lowest credit rating and recorded the nation’s second-highest rate of home foreclosures, trailing only Nevada. Unemployment peaked at 12.5 percent in October amid the loss of 687,700 jobs from the year before, when the jobless figure was 8 percent. Wealth declined as the stock marketlost 40 percent of its value in 2008.


Posted in Government Spending, Political, States | No Comments »

fixing the economy

Posted by WARREN MOSLER on 24th December 2009

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I was asked by a reporter to state how I’d fix the economy in 500 words and replied:

Fixing the Economy

1. A full ‘payroll tax holiday’ where the US Treasury makes all FICA payments for us (15.3%). This will restore ‘spending power’ allowing households to make their mortgage payments, which ‘fixes the banks’ from the ‘bottom up.’ It also helps keep prices down as competitive pressures will cause many businesses to lower prices due to the tax savings even as sales increase.

2. A $500 per capita Federal distribution to all the States to sustain employment in essential services, service debt, and reduce the need for State tax hikes. This can be repeated at perhaps 6 month intervals until GDP surpasses previous high levels at which point state revenues that depend on GDP are restored.

3. A Federally funded $8/hr job for anyone willing and able to work that includes healthcare. The economy will improve rapidly with my first two proposals and the private sector far more readily hires people already working vs people idle and unemployed.
In 2001 Argentina, population 34 million, implemented this proposal, putting to work 2 million people who had never held a ‘real’ job. Within 2 years 750,000 were employed by the private sector.

4. Returning banking to public purpose. The following are disruptive and do not serve no public purpose:
a. No secondary market transactions
b. No proprietary trading
c. No lending vs financial assets
d. No business activities beyond approved lending and providing banking accounts and related services.
e. No contracting in LIBOR, only fed funds.
f. No subsidiaries of any kind.
g. No offshore lending.
h. No contracting in credit default insurance.
5. Federal Reserve- The liability side of banking is not the place for market discipline. The Fed should lend in the fed funds
market to all member banks to ensure permanent liquidity. Demanding collateral from banks is disruptive and redundant, as
the FDIC already regulates and supervises all bank assets.
6. The Treasury should issue nothing longer than 3 month bills. Longer term securities serve to keep long term rates higher than
a. Remove the $250,000 cap on deposit insurance. Liquidity is no longer an issue when fed funds are available from the Fed.
b. Don’t tax the good banks for losses by bad banks. All that does is raise interest rates.
8. The Treasury should directly fund the housing agencies to eliminate hedging needs and directly target mortgage rates at
desired levels.
9. Homeowners being foreclosed should have the option to stay in their homes at fair market rents with ownership going to the
government at the lower of the mortgage balance or fair market value of the home.
10. Remove the ‘self imposed constraints’ that are disruptive to operations and serve no public purpose.
a. Treasury debt ceiling- Congress already voted for the spending and taxes
b. Allow Treasury ‘overdrafts’ at the Fed. This is left over from the gold standard days and is currently inapplicable.
11. Federal taxes function to regulate aggregate demand, not to raise revenue per se, and therefore should be increased only
to cool down an overheating economy, and not to ‘pay for’ anything.


Posted in Banking, CBs, Congress, Fed, GDP, Government Spending, Inflation, Interest Rates, Political, Proposal | 7 Comments »

Fed reverse repo tests

Posted by WARREN MOSLER on 24th December 2009

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Repo testing???

This is downright embarrassing:

Fed’s Reverse Repo Tests Going Well, Industry Group Head Says

By Liz Capo McCormick

Dec. 23 (Bloomberg) — Federal Reservetests of tri-party reverse repurchase agreements have “gone extremely well,” according to the head of the industry group working with the central bank on the transactions.

The Federal Reserve Bank of New York has drained $990 million in reserves from the banking system through five trials this month as part of its “tri-party reverse repo operational readiness program” announced Nov. 30. The central bank stressed at that time that the tests don’t represent a change in policy and were one tool at its disposal for the eventual withdrawal of the unprecedented monetary stimulus added to the economy.


Posted in Fed | 23 Comments »

more from Geithner and Obama

Posted by WARREN MOSLER on 23rd December 2009

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Geithner: Tight Lending Threatens US Recovery

Dec. 22 (Reuters) —U.S. Treasury Secretary Timothy Geithner expressed confidence on Tuesday that the U.S. economy was on a solid recovery path, but said tight lending practices by banks still pose a risk.

He said the Treasury “will do what is necessary” to prevent another severe downturn. “We cannot afford to let the country live again with a risk that we’re going to have another series of events like we had last year,” Geithner said.

So how about a payroll tax holiday, revenue sharing for the states, and funding an $8/hr job for anyone willing and able to work? Maybe this is why:

On December 16, Mr. Obama told a television audience that if his “health care bill” doesn’t pass, “the federal government will go bankrupt” and that “health care costs are going to consume the entire federal budget.”

Someone needs to remind them how, operationally, the federal government actually does spend and lend:

(PELLEY) Is that tax money that the Fed is spending?

(BERNANKE) It’s not tax money. The banks have– accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.


Posted in Government Spending, Obama | 3 Comments »

Hedge funds bet on rising yields

Posted by WARREN MOSLER on 23rd December 2009

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Yet another legend (or two) slips into the ‘better lucky than good’ category.

They may be right, but it will be for a different reason:

Top hedge funds bet on big yields rise

By Henry Sender

Dec. 22 (FT) —The recent rise in long-term US interest rates comes as good news for several leading hedge fund managers, including John Paulson, who have positioned their trading books to benefit from higher yields on US Treasury securities.

Mr Paulson, who made big gains earlier this decade by betting against the subprime mortgage market and whose firm, Paulson & Co, manages $33bn, has said he believes government stimulus efforts will inevitably lead to higher inflation and a corresponding rise in rates.

“It will be difficult for the government to withdraw the economic stimulus,” Mr Paulson said in a speech. “An increase in the monetary base leads to an increase in the money supply, which leads to inflation.”

Bond prices fall as yields rise, and Mr Paulson told the Financial Times last week that he has been hoping to benefit in the Treasury market by buying options that would become profitable if rates headed higher. TPG-Axon’s Dinakar Singh has been making similar options trades, according to a person familiar with the matter.

Julian Robertson, the hedge fund manager, has pursued a related strategy, hoping to benefit from a bigger difference between short-term and long-term interest rates, known as a steeper yield curve, a person familiar with his trades said.

The yield on the 10-year Treasury, which hit a crisis low of 2.055 per cent last year, has moved from 3.2 per cent last month to 3.75 per cent on Tuesday.

Hedge fund managers, however, have been hesitant to engage in short sales of Treasury bonds to profit from the rising yields – and falling prices – because of the Federal Reserve’s heavy involvement in the market. This has led some to buy options – dubbed “high strike receivers” – that would enable them to profit from sharply higher Treasury yields, hedge fund managers say. These trades, which are relatively cheap to execute because they are so out of the money, are based on the thesis that yields could hit 7 or 8 per cent.

“If they are right, and the world ends, they will make a fortune,” said one fund manager who is sceptical of the idea. “If they are wrong, they haven’t lost much.”

Some traders are cautious because many peers lost large sums betting that rates would rise in Japan in the 1990s – as yields fell to less than half a percentage point. The trade was termed the “black widow” because it left so many victims.

“Nobody understood the extent of deflation and economic weakness in Japan,” said Dino Kos of Portales Partners, a research consultancy, who was then a Fed official. “More money was lost on that trade than on any other single trade. Everyone piled in when rates were at 3 per cent and then at 2.5 per cent and then at 2 per cent.”


Posted in Financial Times, Inflation, Interest Rates | No Comments »

Auerback Critiques Bernanke

Posted by Sada Mosler on 21st December 2009

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Well stated!!

Bernanke doesn’t understand the basic economics of central banking

By Marshall Auerback

Dec 19 — I would like to incorporate a critique of quantitative easing based on Bernanke’s comments in Ed’s post “Quantitative easing and inflation expectations.”

You’ve got to focus on improving the conditions for potential borrowers, not on the banks’ balance sheets. Banks are never reserve constrained. Even the BIS, the central banks’ central bank, understands this. In a recent report, the BIS said the following:

In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. The aggregate availability of bank reserves does not constrain the expansion directly.

It is obvious why this is the case. Loans create deposits which can then be drawn upon by the borrower. No reserves are needed at that stage. Then, as the BIS paper says:

in order to avoid extreme volatility in the interest rate, central banks supply reserves as demanded by the system.

The loan desk of commercial banks have no interaction with the reserve operations of the monetary system as part of their daily tasks. They just take applications from credit worthy customers who seek loans and assess them accordingly and then approve or reject the loans. In approving a loan they instantly create a deposit (a zero net financial asset transaction).

The only thing that constrains the bank loan desks from expanding credit is a lack of credit-worthy applicants, which can originate from the supply side if banks adopt pessimistic assessments or the demand side if credit-worthy customers are loathe to seek loans. Banks are never reserve constrained, so this comment below from Bernanke is either ignorant or deliberately misrepresents the actual operations of the banking system (as opposed to the nonsensical Economics 101 version).

Ultimately, if the economy normalized, and the Fed took no action, the banks would take those reserves, try to lend them out, and they would begin to circulate, and the money supply would start to grow. And then, ultimately, that would create an inflationary risk. So, therefore, as the economy begins to recover, and as we move away from this very weak economic environment, the Federal Reserve is going to have to pull those reserves out of the system.

The mainstream belief is that quantitative easing will stimulate the economy sufficiently to put a brake on the downward spiral of lost production and the increasing unemployment. Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts. It is commonly claimed that it involves “printing money” to ease a “cash-starved” system, and based on the erroneous belief that the banks need reserves before they can lend and that quantitative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates.

Bank lending is not “reserve constrained.” Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterward. Even the BIS recognizes this. In reality, if the banks are short of reserves then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost). But the reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep.

The current incoherence of our economic policy making could diminish if we had a Fed chairman who understood how the banking system genuinely operated, as well as one who would understanding the linkages between banking lending and fiscal policy, which he persistently downplays (or even worse when he starts calling for long term reforms to balance the Federal government’s budget). It is a national tragedy that this man is being given the chance at another term in office.


Posted in Uncategorized | 21 Comments »

Stiglitz Warns US Economy May Contract Next Year

Posted by Sada Mosler on 21st December 2009

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Unfortunately, he and all the other deficit doves still can’t refute, and thereby tacitly support, the notions that include ‘we have to borrow money from China to pay for it.

So, while probably right on the prognosis, he remains part of the problem rather than part of the answer as The 7 Deadly Innocent Frauds continue to take their toll.

Stiglitz Warns US Economy May Contract Next Year

Nobel Prize-winning economist Joseph Stiglitz warned there’s a “significant” chance the U.S. economy will contract in the second half of next year, and urged the government to prepare a second stimulus package to spur job creation.


Posted in 7DIF | No Comments »

Bernanke statements to TIME editor

Posted by WARREN MOSLER on 18th December 2009

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This is a recent statement by Chairman Bernanke regarding the ‘exit strategy:’

Federal Reserve Chairman Ben Bernanke sat down on Dec. 8, 2009 with TIME managing editor Richard Stengel, Time Inc. editor-in-chief John Huey, TIME assistant managing editor Michael Duffy, and TIME senior correspondent Michael Grunwald for a conversation on everything from the state of the economy to the contents of his wallet. Here is an extended, edited transcript of the interview:

Ultimately, if the economy normalized, and the Fed took no action, the banks would take those reserves, try to lend them out, and they would begin to circulate, and the money supply would start to grow. And then, ultimately, that would create an inflationary risk. So, therefore, as the economy begins to recover, and as we move away from this very weak economic environment, the Federal Reserve is going to have to pull those reserves out of the system.

In fact, the causation is that loans create deposits in the banking system. Reserves are not involved. So even if the banks advanced $2T in loans tomorrow, excess reserves of $2T would still be there. Sadly, it seems to be a case of senior Fed officials who no doubt more than understand this obvious point not feeling comfortable enough to discuss it with the Chairman in casual conversation and bring him up to speed on banking and reserve accounting.

He also made the following statements, indicating he had no idea that, functionally, ‘putting capital into banks’ is nothing more than regulatory forbearance, and that the banking system- the some 8,000 regulated and supervised public/private partnerships already in place to do the bidding of the Fed- could have just as easily been used to make the loans and buy the securities in question. Instead, the Fed has burdened itself with the logistics of accounting for the multi thousands of individual mortgage backed securities it currently has in its Maiden Lane and other portfolios that are also currently removing over $50 billion in income from the ‘non govt.’ sectors:

This immediately became relevant, because in mid-October, the crisis heated up again to the point that we thought that we were again within days or hours of a collapse of many of the largest financial firms in the world. It was a dramatic weekend. It was Oct. 10 or 11, Columbus Day weekend, when the Finance Ministers and the central bankers of seven of the largest industrial economies had a meeting here in Washington, which, of course, I attended. Usually, those meetings are very scripted and very dry. In this case, there was palpable concern among the participants that the collapse of their financial system might be just days away, and there was a great deal of discussion about how we, collectively, as the policy makers leading those countries could stop the collapse.

In the days that followed, countries all over the world, particularly the advanced industrial countries, took strong measures to prevent the collapse of the financial systems. That included putting capital into banks; it included preventing the failure of large financial firms; it included guaranteeing the debts of financial firms so they could borrow and keep themselves afloat; it included making short-term loans to firms so that they would have the short-term credit they needed to pay off lenders who were withdrawing their funding. And, again, this was the U.S. doing this, but also many of the most important industrial countries around the world simultaneously, including the U.K., Germany, France, Switzerland and others.


Posted in CBs, Fed | 7 Comments »

US Government will go “bankrupt” if health care bill doesn’t pass

Posted by WARREN MOSLER on 18th December 2009

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The stupidity of the rhetoric (from both sides) just keeps getting worse:

President Obama: Federal Government ‘Will Go Bankrupt’ if Health Care Costs Are Not Reined In

President Obama told ABC News’ Charles Gibson in an interview that if Congress does not pass health care legislation that will bring down costs, the federal government “will go bankrupt.”

The president laid out a dire scenario of what will happen if his health care reform effort fails.

Gibson Obama“If we don’t pass it, here’s the guarantee….your premiums will go up, your employers are going to load up more costs on you,” he said. “Potentially they’re going to drop your coverage, because they just can’t afford an increase of 25 percent, 30 percent in terms of the costs of providing health care to employees each and every year. “

The president said that the costs of Medicare and Medicaid are on an “unsustainable” trajectory and if there is no action taken to bring them down, “the federal government will go bankrupt.”


Posted in Congress, Government Spending, Political | 3 Comments »

FDIC Postpones Capital Requirements

Posted by WARREN MOSLER on 18th December 2009

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I’m guessing the govt saw how this made the bank stocks in Japan go up, and wants to make a profit on their remaining bank shares in the US banks?

FDIC Postpones Capital Requirements for Wells Fargo (NYSE:WFC), Citigroup Inc. (NYSE:C), Bank of America Corp. (NYSE:BAC) and JPMorgan Chase & Co. (NYSE:JPM)


Posted in Banking | No Comments »

Man of the year

Posted by WARREN MOSLER on 17th December 2009

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I’m perhaps a bit harsher and more direct in my criticisms than Time Magazine when they named Chairman Bernanke their
Man of the Year:

His latest speech shows he’s got ‘quantitative easing’ and monetary operations completely wrong as he believes the banks lend out reserves.

His alphabet soup of programs for the interbank lending freeze up completely missed the
point that all the fed has to do is lend in the fed funds market which would have immediately solved the problem that never should have happened, and lingered for over 6 months and contributed to the last leg of the collapse.
He’s on the wrong side of fiscal policy, urging the Congress to balance the budget, at least longer term.

He’s on the wrong side of the trade issue, trying to engineer exports at the expense of domestic consumption,
which is indeed happening, and causing our real terms of trade and standard of living to deteriorate.

He hasn’t even begun to consider the evidence that is showing lower rates to be deflationary rather than inflationary.

He still adheres to inflations expectations theory.

His unlimited dollar swapline program was an extraordinarily high risk policy that fortunately worked out,
but never should have been done without discussion with Congress. In fact, last I read he still thinks it was low risk,
not understanding that fx deposits at the foreign CB are not actual collateral.

If I had to select someone from outside the Fed for the next chairman Vince Reinhart is the only one I can think of that at least thoroughly understands monetary ops and reserve accounting, though we do have our differences on theory and policy .


Posted in CBs, Fed, Government Spending, Inflation | 1 Comment »

Banks Given 10 Years To Meet Tougher Capital Rules – Tokyo

Posted by WARREN MOSLER on 16th December 2009

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Capital ratios control permissible leverage which initially appear to control bank returns on equity, but longer term spreads adjust and the roe gravitates to a bank’s cost of capital.

And since higher leverage increases risk to investors, the cost of capital eventually adjusts to the capital ratios, so over time- in the long run when we’re all dead to quote Keynes- it all comes down to about the same thing.

With markets discounting the near term a lot more than the long term it makes sense lower capital ratios will help bank equities.

>   FYI – FSA just stated no agreement has been reached yet.


By Shingo Kawamoto
Dec. 16 (Bloomberg) — Japan’s Financial Services Agency
says no agreement has been reached on delaying new rules on
capital adequacy for banks. Motoyuki Yufu, a spokesman for the
regulator, spoke after the Nikkei newspaper reported
international banking authorities agreed to start introducing
new capital adequacy rules from 2012, giving lenders a
transition period of 10 to 20 years to implement the

>   Based on article below this transition period could potentially apply to
>   all banks and not just Japanese banks

Banks Given 10 Years To Meet Tougher Capital Rules

TOKYO (Nikkei)- Global banking regulators have agreed to effectively delay the enforcement of new capital adequacy rules for large banks, opting to create a transition period of at least 10 years, The Nikkei learned Tuesday. The Basel Committee on Banking Supervision, made up of the banking authorities of major countries, has been discussing introducing stricter capital requirements since September 2008 in an effort to prevent a recurrence of the global financial crisis.

The proposed changes include raising the 8% minimum capital ratio banks are currently required to maintain and focusing on a narrower definition of core capital. The committee will stick to its plan to gradually introduce the new rules starting in 2012, but will establish a transition period of 10-20 years. This means that the rules will not be fully implemented until at least the early 2020s.

Banking authorities have apparently determined that a rush to adopt stricter requirements might deter lending by major banks and hurt the chances of a recovery in the global economy. “The Basel Committee has turned to a more cautious approach,” says a financial regulatory official in Japan. The committee will also consider allowing banking regulators in each country or region to decide when to fully adopt the new requirements. The slow phasing in of new capital rules will come as good news to Japanese banks, which had faced the prospect of being forced to bolster their capital through the issuance of common shares.

The Basel Committee plans to compile an outline of its proposals before the end of this year and roll out a concrete plan sometime next year.
(The Nikkei Dec. 16 morning edition)


Posted in Banking, Japan | No Comments »

China News

Posted by WARREN MOSLER on 16th December 2009

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China Won’t ‘Explicitly’ Exit Stimulus Next Year
More residents upset over prices: PBOC survey

People don’t like inflation.

China grants zero-tariff to 90% of ASEAN imports

China trying to reduce costs to fight inflation, rather than support domestic jobs.

Must be a serious inflation problem?


Posted in China, Inflation | 3 Comments »

Greece Sells 2 Billion Euros of 2015 Debt to Banks

Posted by WARREN MOSLER on 16th December 2009

[Skip to the end]

That spread for its own banks that it guarantees shows a serious funding issue.

During a period of euro weakness funding problems could become worse and spread to other euro nations.

When foreign govts. buy euros for their portfolio of fx reserves, they have to hold them in some kind of account or security. Most probably opt for eurozone national govt paper. Same with international institutional investors.

When they stop adding to their euro portfolios and/or reduce them, they stop buying and/or sell that paper.

The new holders of euro (those who buy the euros when portfolios sell them) may or may not buy that same govt paper, and the euros may instead wind up as excess reserves at the ECB in a member bank account, or even as cash in circulation as individuals who don’t trust the banks turn to actual cash. The banks with the excess reserves may or may not buy the National govt paper or even accept it as repo collateral, to keep their risk down, and instead simply hold excess reserves at the ECB.

Markets will clear via ever widening funding spreads as national govt paper competes for euros that are otherwise held as ‘cash reserves.’ The amount of reserves held at the ECB doesn’t actually change, apart from some going to actual cash.

What changes are the ‘indifference levels’- yield spreads- between having cash on your books and holding national govt paper risk. And the ability to repo national govt paper at the ECB doesn’t help much.

Would you buy Greek paper today if you were concerned it might default just because you could repo it at the ECB, for example?

Also, while Americans go to insured banks and Tsy secs when they get scared, Europeans exit the currency as they have a lot more history of hyper inflation.

That means a non virtuous cycle can set in with a falling euro making National govt funding problematic, which makes the euro continue to fall.

This happened a little over a year ago due to a dollar funding liquidity squeeze.

The Fed bailed them out with unlimited dollar swap lines and the euro bottomed at something less than 130 to the dollar.

This time it’s not about dollars so the Fed can’t help even if it wanted to.

And the ‘remedies’ of tax hikes and/or spending cuts Greece intends to pursue will only make it all worse, especially if undertaken by the rest of the eurozone as well. Fiscal tightening will only slow the economy and cause national govt. revenues to fall further, unless the taxes are on those taxpayers who will not reduce their spending (no marginal propensity to spend) and the spending cuts don’t reduce the spending of those who were receiving those funds.

And the treaty prevents ECB bailouts of the national govts. so any bailout from the ECB would require a unified Fin Min action and an abrupt ideological reversal of the core monetary values of the union towards a central fiscal authority.

This is somewhat analgous to what happened to the US when the original articles of confederation gave way to the current constitution in the late 1700′s..

Greece Sells 2 Billion Euros of 2015 Debt to Banks, Bankers Say

By Anna Rascouet and Christos Ziotis

Dec. 16 (Bloomberg) — Greece sold 2 billion euros ($2.9 billion) of floating-rate notes privately to banks, eight days after Fitch Ratings downgraded the nation’s debt as the government struggles to cut the European Union’s largest budget deficit, two bankers familiar with the transaction said.

The securities, which mature in February 2015, will yield 250 basis points, or 2.5 percentage points, more than the six- month euro interbank offered rate, or Euribor, they said. That’s 30 basis points higher than a similar-maturity Greek fixed-rate bond when converted into a floating rate of interest, according to data compiled by Bloomberg.

Greek bonds have fallen in the past week, with two-year note yields rising by the most in more than a decade on Dec. 8, when Fitch cut the nation’s credit rating to BBB+, the lowest in the euro region, citing the “vulnerability” of the nation’s finances. Prime Minister George Papandreou has been unable to convince investors he can reduce a deficit the government says will rise to 12.7 percent of gross domestic product this year, after the economy shrank 1.7 percent in the third quarter.

“Selling bonds via a private placement can be a double- edged sword at this point,” said Luca Cazzulani, a fixed-income strategist in Milan at UniCredit Markets & Investment Banking. “On the one hand, it shows that Greece can always find buyers for their bonds. But the market might take it as a sign that they only have this channel left.”

Widening Spread

Greek bonds rose snapped two days of declines today, with the yield on the 10-year note dropping 11 basis points to 5.62 percent as of 10:26 a.m. in London. It rose as much as 29 basis points yesterday to 5.76 percent, the highest since April 3.

Concern some countries may struggle to pay their debt was reignited after Dubai’s state-owned Dubai World said on Dec. 1 it wanted to restructure $26 billion of debt. The premium, or spread, investors demand to hold Greek 10-year bonds instead of German bunds, Europe’s benchmark government securities, rose as high as 250 basis points yesterday, the highest closing level since April 2. It narrowed to 239 basis points today.

The participating banks in yesterday’s private placement were National Bank of Greece SA, Alpha Bank AE, EFG Eurobank Ergasias SA, Piraeus Bank SA and Banca IMI SpA, the bankers familiar with the transaction said. Italy’s Banca IMI was the only foreign-based in the group.

Worst Performers

The government paid “generous” terms, said Wilson Chin, a fixed-income strategist in Amsterdam at ING Groep NV.

“I guess you have to pay some liquidity premium, given the sale was done at the end of the year,” he said. “I would be very surprised if they continue to use this method into the first quarter of next year. That would probably be taken as a sign the market isn’t working for them.”

Greek bonds are the worst performers after Ireland among the debt of so-called peripheral euro-region countries this year, handing investors a 3.5 percent return, according to Bloomberg/EFFAS indexes.

In a private placement, issuers offer securities directly to chosen private investors as opposed to selling them through an auction or via a group of banks.

Papandreou pledged in a speech two days ago to begin reducing the nation’s debt, set to exceed 100 percent of GDP this year, from 2012. The European Commission estimates the ratio at 112.6 percent of GDP this year, second only to Italy.

‘Painful Decisions’

“In the next three months we will take those decisions which weren’t taken for decades,” Papandreou said in Athens. He said many choices will be “painful,” though he promised to protect poorer and middle-income Greeks.

Credit-default swaps on Greece rose 1 basis point to 238.5, according to CMA DataVision, after surging 25.5 basis points yesterday. Such swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should an issuer fail to adhere to its debt agreements. A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.


Posted in Currencies, ECB, EU, Government Spending | 4 Comments »


Posted by WARREN MOSLER on 15th December 2009

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Karim writes:


  • Headline CPI +0.4% and core +0.034%
  • OER -0.1% and volatile items largely offsetting (lodging away from home -1.5% vs tobacco +1% and vehicles +0.8% (after +1.7% prior month))
  • Favorable base effects for core coming in H1 2010 should see y/y drift to 1% from current 1.7%


  • Starts up 8.9%; largely payback from weak October and driven by multi-family
  • Single family up 2.1% (-7.1% prior) and multi-family up 67.3% (after down cumulative 51% prior 2mths)
  • Permits +6% (versus prior -4.2%)
  • Net/Net housing component of GDP likely to remain flat/slightly positive for next 2-3 quarters


Posted in Housing, Inflation | No Comments »