From: Fed Weighs ‘Sterilized’ Bond Buying if It Act
Many Fed officials believe strongly the bank reserves it has created as part of this money creation aren’t an inflation threat. But they are acutely aware of a popular perception, also held by a few inside the Fed itself, that the money the Fed has created could cause an inflation problem down the road.
Karim writes:
Dealing with perceptions not reality.
Karim writes:
Bernanke gives his latest Congressional testimony and takes Q&A at 10am tomorrow.
He’s unlikely to diverge much from the recent narrative and I expect him to focus more on the changes they made at the last FOMC meeting (easing via extending conditional commitment and new set of forecasts) than highlight more policy changes (QE3 or Twist 2). March/April a more likely time frame for next set of policy changes.
Today’s data backs up the view stated by the Fed in January and recent speeches:
Fits in with the following from their last Statement (where they eased):
While indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but growth in business fixed investment has slowed, and the housing sector remains depressed.
Feel free to forward to your local Fed President, to remind them that rate cuts do remove income from savers and from the economy in general, as the economy is a net saver to the tune of the cumulative govt debt (to the penny). (And not to forget the $80 billion or so per year of lost income due to QE.)
Lower rates remove income from ‘savers,’ with everyone who works for a living and contributes to any kind of retirement plan a ‘saver.’
Yes, with most major corporations, the additional contributions come from earnings, which reduces shareholder incomes rather than employee earnings.
But in any case, contributions to retirement funds are ‘demand leakages’ that directly or indirectly reduce income and, to some degree, reduce spending.
The obvious fiscal response should be along the lines of a FICA suspension to sustain sales, output, and employment…
GE to 3M Pension Pain Mounts as Rates Boost Liabilities
By Thomas Black
February 28 (Bloomberg) — General Electric Co. (GE), Boeing Co. (BA) and 3M Co. (MMM) will join big U.S. employers in making a record $100 billion in 2012 pension contributions, 67 percent more than two years ago, as low interest rates boost companies’ liabilities.
Payments may total $400 billion from 2011 through 2015 to ease underfunding at the 100 largest defined-benefit programs, according to consultant Milliman Inc., which estimated that assets in January were enough to cover less than three-fourths of projected payouts.
“It’s been called the wall of contributions,” said Alan Glickstein, a senior retirement consultant at Towers Watson & Co. (TW) in New York. “All of a sudden this thing jumps up and stays there for a few years. That’s what it looks like — a wall.”
Companies from defense contractor Lockheed Martin Corp. (LMT) to aviation-electronics maker Honeywell International Inc. are caught in a vise: the Federal Reserve Board’s vow to keep rates at current levels until 2014 means pension plans’ fixed-income investments are stagnating just as new rules shorten the time available to shore up funding.
“They’re going to have to kick money in,” said John Ehrhardt, a consulting actuary at Seattle-based Milliman. “We’re basically seeing historically low interest rates driving historically high employer contribution requirements.”
That’s money that won’t go back to shareholders through dividends or buybacks, or toward expansion, said Kevin McLaughlin, a pension risk management specialist with consultant Mercer in New York.
Seven Years
Under the federal Pension Protection Act, which was passed in 2006 and mostly took effect in 2008, tighter accounting rules gave employers seven years to fully fund their retirement plans and required them to use a specified, market-based rate of return to compute liabilities instead of a company estimate.
Those liabilities are calculated by projecting future payments and discounting to the present based on interest rates pegged to a basket of corporate bonds. Liabilities rise when rates fall — and the Fed has held its discount rate at 0.75 percent since February 2010, down from as high as 6.25 percent in June 2007. The Fed said Jan. 25 it expected rates to stay at current levels until 2014.
3M’s pension plan in the U.S., which started 2011 with assets of $11.6 billion, shows the challenge for employers.
Assets rose to $12.1 billion by year’s end because of investments and contributions, even after payments of $680 million, according to a Feb. 16 filing. At the same time, the funding shortfall more than tripled, to $2.4 billion, because projected benefit obligations rose 18 percent to $14.5 billion.
‘Liabilities Did Increase’
“With the declining interest rates here in 2011, our liabilities did increase,” 3M Chief Financial Officer David Meline said Feb. 23 at a Barclays Plc industrial conference.
While 401(k) savings accounts are more common at younger companies, traditional manufacturers such are among the employers most affected by the pension pinch because they’re still making payments under defined-benefit plans. St. Paul, Minnesota-based 3M’s 2012 pension contribution will almost double to as much as $1 billion.
Pension expense is “a variable that we consider among many when we look at a company and what it could mean to their profitability,” said Mark Luschini, chief investment strategist at Philadelphia-based Janney Montgomery Scott LLC, which manages $54 billion. “If that were something that we said we wouldn’t want to own, we’d probably have a fairly limited universe of companies we could buy.”
S&P Industrials
The Standard & Poor’s 500 Industrials Index (S5INDU), whose 61 companies include manufacturers such as Boeing with defined- benefit programs, climbed 10 percent this year through yesterday, topping the S&P 500’s 8.7 percent gain.
Boeing’s pension cost will jump to $2.6 billion, 63 percent more than a year earlier, the company said in January. GE told investors in December it plans to add $1 billion, the first contribution since 1987, and expects to add about $2.1 billion in 2013. The Fairfield, Connecticut-based company closed its U.S. defined-benefits pension plan to all new hires this year.
Honeywell (HON) probably will make a contribution of as much as $1 billion, after low interest rates dashed a goal of full funding in four years, CFO Dave Anderson said. The plan was 83 percent funded at the end of 2011.
‘Little Bit Longer’
“I’d hoped to be there by 2015 to have more of a full resolution of that issue, but it’s going to take a little bit longer probably,” Anderson said in an interview. “Interest rates are at historic low levels and there’s no change in sight for that.”
Pension sponsors usually average rates over 24 months, so 2012 may be the peak year for companies’ pension contributions, said Glickstein of Towers Watson.
“We have a very unusual governmental intervention in the wake of a financial crisis,” he said. “Whatever other merits it may have, it’s clearly distorting the measures of pension obligations and putting a lot of extra pressure on plan sponsors.”
Lockheed Martin anticipated the rise in liabilities by pumping $6 billion into its plan over the last three years, curbing the projected 2012 contribution to $1.1 billion, according to a company filing.
Many pension plans, including GE’s, were overfunded before the December 2007 onset of the worst recession since World War II. Then pension assets began shriveling as stocks slumped, and lower interest rates increased liabilities.
Funding Levels
For the 100 largest defined-benefit plans, average funding levels sank to 74 percent in January from 105 percent in 2007, according to Milliman. Some companies may need to funnel cash to their pension plans for years.
Pension plan assets at Atlanta-based Delta Air Lines Inc. (DAL) covered only about 40 percent of obligations at the end of 2011, down from 47 percent the previous year, according to the carrier’s latest annual report. The funding shortfall widened to $11.5 billion from $9.3 billion in 2010, the filing showed.
Even after Delta ended pilots’ pensions before its 2007 bankruptcy exit and closed other plans to new hires, CFO Hank Halter said Jan. 25 that the airline still expects to contribute as much as $675 million in 2012. Defined-benefit programs taking new employees fell 26 percent in six years to 20,381 in 2009, according to the latest U.S. Pension Benefit Guaranty Corp. figures for plans with 25 or more workers.
The threat of future contributions is driving many sponsors of defined-benefit plans to seek ways to blunt risk, said Jeffrey Saef, chief of Bank of New York Mellon Corp. (BK)’s investment strategy and solutions group in Boston. That often means using more fixed-income investments to help match pension assets more closely to liabilities, he said in an interview.
Clients struggling with the cash drain from pensions have a universal query, Saef said: “‘When will it go away?’”
With Fed Chairman Ben S. Bernanke’s thumb on interest rates, that won’t be any time soon, said McLaughlin, the Mercer consultant.
“Right now, everybody is hoping for the best, which is equity markets performing and interest rates not falling any lower,” he said.
So look what slipped into a Fed statement:
*DJ Fed’s Williams: Current Economic Conditions Call For Strong Fed Response
*DJ Williams: Weak Total Demand Calls Supports Fed Policy Action
*DJ Williams: Sees Value In Targeted Stimulus Actions
*DJ Williams: Mortgage Bond Buying Has Helped Housing Market
*DJ Williams: Fiscal Actions May Also Help Revive Housing, Aid Economy
*DJ Williams: Fiscal Stimulus May Be More Potent Than Monetary Policy Now
*DJ Williams: Housing Has Hurt Economy, Not Sole Cause Of Slow Recovery
From the NY Fed:
Deficits, Public Debt Dynamics, and Tax and Spending Multipliers
Cutting government spending on goods and services increases the budget deficit if the nominal interest rate is close to zero. This is the message of a simple but standard New Keynesian DSGE model calibrated with Bayesian methods. The cut in spending reduces output and thus—holding rates for labor and sales taxes constant—reduces revenues by even more than what is saved by the spending cut. Similarly, increasing sales taxes can increase the budget deficit rather than reduce it. Both results suggest limitations of “austerity measures” in low interest rate economies to cut budget deficits. Running budget deficits can by itself be either expansionary or contractionary for output, depending on how deficits interact with expectations about the long run in the model. If deficits trigger expectations of i) lower long-run government spending, ii) higher long-run sales taxes, or iii) higher future inflation, they are expansionary. If deficits trigger expectations of higher long-run labor taxes or lower long-run productivity, they are contractionary.
*DJ Fed’s Plosser:’Monetary Policy Has Exposed Us To Substantial Inflation Risk’
Maybe it’s a learning disability…
Not much progress here:
Rising Deficits Pose Major Threat to Economy: Bernanke
By Jeff Cox
Feb 2 (CNBC) — Rising federal budget deficits are posing a significant threat to the U.S. economy and are likely to cause a crisis if not brought under control, Federal Reserve Chairman Ben Bernanke told Congress Thursday.
Calling the situation “unsustainable,” the central bank leader pointed out that surging health-care costs, along with the high level of government spending used to pull the economy out of recession, are creating fiscal hazard.
“Having a large and increasing level of government debt relative to national income runs the risk of serious economic consequences,” Bernanke told the House Budget Committee. “Over the longer term, the current trajectory of federal debt threatens to crowd out private capital formation and thus reduce productivity growth.”
At the same time, he also warned Congress not to pull the reins too tightly so as to threaten growth.
Evidence of real progress will be a statement like:
‘Draghi sees no evidence of any possible channel from ECB loans to the economy’
Bank liquidity is something like wheels on a car.
Without wheels the car won’t function, but neither are wheels alone enough to make it go.
Banks are public/private partnerships, with govt’s role being liquidity provider, as private capital in the first loss position prices risk. And with unlimited liquidity provision comes the necessity of full regulation and supervision of the asset/capital side.
In the US the unlimited liquidity provision comes mainly via FDIC insured deposits, supplemented by funding from the Fed. The Fed is the liquidity provider of last resort for its member banks, while at the same time it uses the banking system’s cost of funds as its instrument of monetary policy.
The euro zone hasn’t figured this out yet.
The liquidity provider of last resort is the ECB, as it’s the ‘issuer of the currency’, and as such not itself liquidity constrained. The member nations are like the US states, and are necessarily liquidity constrained, and therefore not ’empowered’ to be liquidity providers of last resort to their member banks.
So in that sense, as the bank funding by the ECB grows, it’s all gravitating towards what all other nations have in place. The problem is the euro zone leaders don’t understand that aspect of banking, as evidenced by the way they are resisting the shift to ECB funding, and, in fact, working towards moving banks away from ECB funding.
Draghi Sees No Evidence ECB Loans Are Financing Economy Yet
By Jana Randow and Simone Meier
Jan 28 (Bloomberg) — “Do we know that actually this money is going to finance the real economy? We don’t have evidence of this kind yet,” ECB President Mario Draghi told Davos. “There is a lag. We will have to see.” “We know for sure we have avoided a major, major credit crunch, a major funding crisis,” he said today. “You have parts of the euro area where credit is more or less normal, but you have other parts where credit is seriously contracting.” “If you take 0.5 trillion euros and then you take off the reimbursement of other short-term facilities by the banking system in December, you get a figure of roughly 220 billion euros, which is exactly the amount of bank bonds that were to come due in this period of time,” he said.
