Category Archives: USA

Fed regs with comments

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Note they’ve also added the international arrangements as per my discussion earlier today.

The same recommendations suggested in August.

7 Lending by the Federal Reserve

The Federal Reserve’s authority to extend loans is a potentially powerful tool with

which it can stimulate aggregate demand. Loans to depository institutions can help spur credit extensions to households and firms. If depository institutions are unwilling or unable to lend to firms and households, direct loans by the Federal Reserve to firms and households could provide the financing needed for economic recovery- although such lending is subject to the restrictions discussed below.

The above has the causation backwards. In the banking system, loans ‘create’ deposits, which many incur reserve requirements.

In the first instance, new reserve requirements are functionally an ‘overdraft’ in the bank’s reserve account at the fed. Since an overdraft *is* a loan, as a matter of accounting loans create both deposits and any resulting new required reserves. What the fed does is set the price of the reserves (the rate of interest), which influences bank lending decisions, but doesn’t directly control bank lending.

Therefore, all fed lending to member banks is generally to replace ‘overdrafts’ in reserve accounts. At the end of each statement period, overdrafts are booked as loans from the fed’s discount window, which are 50 bp over the fed fund rate and also carry a ‘stigma’ of implying the bank is having financial difficulties. That’s why banks are willing to bid up funds above the discount rate when trading each other,

7.1 Lending to Depository Institutions

As shown in table 7.1, lending to depositories is authorized under several sections of the Federal Reserve Act: Advances are authorized under sections 10B, 13(8) and 13(13), while discounts are authorized under sections 13(2), 13(3), 13(4), 13(6) and13A.78 In recent decades, the Federal Reserve has extended credit to depositories only through advances (under sections 10B and 13(8)) and has not made any discounts. The broadest and most flexible authority under which the Federal Reserve can extend loans to depositories is Section 10B, under which the restriction on collateral is only that the Reserve Bank making the advance deems the collateral to be “satisfactory”.

Yes, and this makes perfect sense. All bank collateral is limited to what the federal regulators deem ‘legal’ along with regulated concentration and gap limits. Also, banks can issue federally guaranteed liabilities; so, functionally the government is already funding what they deem legal assets. So, for the fed to provide another channel for this process, to assist ‘market functioning’, changes nothing of substance regarding risk for the government.

The collateral can be promissory notes, such as corporate bonds and commercial paper- instruments that cannot be purchased by the Federal Reserve.

But, as above, instruments that are categorized as bank legal by federal regulation, and can already be funded via government insured deposits.

Currently, Reserve Banks accept as collateral various types of promissory notes of acceptable quality including state and local government securities, mortgages covering one- to four-family residences, credit-card receivables, other customer notes, commercial mortgages, and business loans. Apparently, even equity shares would be legally acceptable as collateral if a Reserve Bank found them to be acceptable as collateral.

78The differences between discounts and advances are discussed briefly below and in more detail

in Section 2.1 of Small and Clouse (2000).

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Table 7.1

Credit Instruments Used in Discounts or Advances

Borrower Credit Instrument

Depositories

10B Advances* Depository’s time and demand notes secured \to the

satisfaction of [the] Reserve Bank.” * *

13(8) Advances Depository’s promissory note secured by U.S Treasury,

U.S.-guaranteed, U.S. agency, or U.S. agency-guaranteed

securities, or by credit instruments eligible for discount or purchase.

13(2) Discounts * * * Notes, drafts and bills of exchange meeting \real bills” criteria.

13(4) Discounts * * * Bills of exchange payable on sight or demand which grow out of the shipment of agricultural goods.

13(6) Discounts * * * Acceptances which grow out of the shipment of goods

(section 13(7)) or for the purpose of furnishing dollar exchange as required by the usages of trade (section 13(12)).

13A Discounts * * * Notes, drafts, and bills of exchange secured by agricultural paper.

IPCs * * * *

13(13) Advances IPC’s promissory notes secured by U.S. Treasury, U.S. Agency or U.S. agency-guaranteed obligations.

13(3) Discounts Notes, drafts, and bills of exchange endorsed or otherwise secured to the satisfaction of the Reserve Bank, in unusual and exigent circumstances”, and provided the IPC cannot secure adequate credit elsewhere or is in a class for which this determination has been made.

Notes: All advances and the financial instruments used as collateral in all discounts except section 13(discounts are subject to maturity limitations. Section 13(14) authorizes discounts and advances to branches and agencies of foreign branches, subject to limitations.

*Section 10A provides for advances to groups of member banks.

* * Advances to undercapitalized and critically undercapitalized institutions are subject to limitations listed in section 10B.

* * * Must be endorsed by a depository institution.

* * * * Depository institutions are corporations and thus qualify for lending authorized for IPCs.

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Even though the Federal Reserve can extend credit to depositories through advances secured by a wide array of instruments, there may be limitations regarding the extent to which the Federal Reserve can take onto its balance sheet the credit risk of a private-sector security pledged as collateral{whether the security is pledged as part of an advance or a discount. With an advance, the loan is extended on the basis of a promissory note issued by the depository. During the course of the advance, should the ability of the depository to repay the advance come under question (for example, because the collateral is in default) the Federal Reserve would look to the depository first for repayment: The credit risk of the collateral therefore remains with the depository.79 In a discount, the depository does not issue its own note to the Federal Reserve, but the depository must endorse the security that is discounted (as indicated by the triple asterisks in table 7.1). Again, the credit risk of the underlying collateral stays with the depository institution, and the only risk the Federal Reserve takes onto its balance sheet is the risk that the depository will default.80

79In a similar vein, the Bank of Japan recently has undertaken repurchase agreements in commercial paper but has acted to protect its balance sheet from the credit risk of the issuer of the commercial paper:

The Bank recommends commercial paper (CP) operations (purchase of CP with resale agreements) in order to ensure smooth market operations.

CP will be purchased from financial institutions, securities companies, and tanshi companies (money market dealers) which hold accounts with the Bank. The CP is to be endorsed by the seller, and to have a maturity of 3 months or less from the day of the Bank’s purchase. Purchase is to be made under competitive bidding, and the period of the purchase is to be 3 months or less. (See Quarterly Bulletin (1996), page 100.)

In September of 1998, the Bank of Japan held, through repurchase agreements, about 35 percent of the outstanding stock of commercial paper in Japan. See Table VII in Economic Statistics Monthly

(See various dates).

80Discounts under sections 13(2), 13(4) or 13A for a bank require a \waiver of demand, notice and protest by such bank as to its own endorsement exclusively”, which is discussed by Hackley (1973)

(pp. 22). The effect of this waiver is to make the endorsing bank primarily liable because the Reserve Bank would not have to demand payment by the issuer of the discounted paper before proceeding against the bank. To further limit its credit-risk exposure, the Federal Reserve presumably would also take a \haircut” on the discount by extending funds that are significantly less than the value of the discounted instrument. Additionally, the Federal Deposit Insurance Corporation Improvement

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To the extent the credit risk of the collateral remains with the depository, lending to depositories may do very little to lower the credit-risk premiums charged by depositories in making new loans to private-sector borrowers. Credit risk premiums could be a major factor holding down credit expansion and economic recovery should nominal rates on Treasury bills be at or near zero and should the economy be weak.

In private-sector markets, credit risk can be managed through the use of credit- risk options. And, in some circumstances, the Federal Reserve’s incidental powers clause is consistent with the Federal Reserve using options.81 However, the view that the Federal Reserve could not accept the credit risk of the collateral used in discount window loans may leave little scope for the Federal Reserve to write credit-risk options in order to take that credit risk of the balance sheets of depositories and onto its balance sheet.

But even if Federal Reserve loans to depositories leave credit-risk premiums unchanged, such loans may provide some liquidity for the financial instruments used as collateral helping to lowering private-sector interest rates by reducing implicit liquidity premiums.

7.2 Lending to Individuals, Partnerships, and Corporations

Although the Federal Reserve currently does not make loans to individuals, partnerships, and corporations (IPCs), the Federal Reserve has the authorization to bypass depositories and make such loans under sections 13(3) and 13(13) of the Federal Reserve Act- as shown in table 7.1. However, lending under these authorities is subject to very stringent criteria in law and regulation, and such lending has not taken place since the Great Depression. For example, advances, under section 13(13), are limited

Act of 1991 (FDICIA), through its \prompt corrective action” provisions has imposed restrictions on depository institutions in weak capital condition. Among those restrictions are limitations on access to the Federal Reserve’s discount window.

81See footnote 46 for a discussion of the Federal Reserve’s recent use of options, and see Section 4 of Small and Clouse (2000) for a discussion of the Federal Reserve’s authority to engage in options.

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to those “secured by direct obligations of the United States or by any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, an agency of the United States.”

Because IPCs with such collateral could easily sell it in the open market, section 13(13) advances may not have much effect(unless done at subsidized rates) in stimulating aggregate demand.

In contrast, private-sector instruments may lack the liquidity of Treasury debt and, therefore, Federal Reserve loans that use them as collateral may provide liquidity and help stimulate the economy. Also, in a \credit crunch”, such direct loans would circumvent depository institutions and the \non-price” terms of credit imposed by them. Hence, we shall focus on section 13(3) discounts of:

“notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are endorsed or otherwise secured to the satisfaction of the Federal Reserve bank: … ”

Because notes, drafts, and bills of exchange include most forms of written credit instruments, section 13(3) provides virtually no restrictions on the form a credit instrument must take in order to be eligible for discount.82 And by merely requiring that the discount be \secured to the satisfaction of the Federal Reserve bank …”, there is no restriction on the use of funds (such as for \real bills” purposes) for which the discounted security was originally issued.

However, in making section 13(3) loans directly to IPCs, the Federal Reserve must impose standards that are much more stringent in comparison to those used in lending to a depository. Such lending to IPCs is authorized only in “unusual and exigent circumstances.” In particular, the statute requires that a loan can be extended only to IPCs for which credit is not available from other banking institutions.83 Activation

82The distinctions between notes, drafts, and bills of exchange are discussed in detail in Small and Clouse (2000).

83The Federal Reserve’s Regulation A (Section 201.3(d): Emergency credit for others) species that advances to IPCs would be contemplated only in situations in which failure to advance credit would adversely affect the economy.

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of this authority requires the affirmative vote of five of the seven governors of the Federal Reserve Board.

Section 13(3) further requires that the collateral be “endorsed or otherwise secured to the satisfaction of the Federal Reserve bank …” As interpreted by Hackley (1973):

… it seems clear that it was the intent of Congress that loans should be made only to credit-worthy borrowers; in other words, the Reserve Bank should be satisfied that a loan made under this authority would be repaid in due course, either by the borrower or by resort to security or the endorsement of a third party.84

If binding, this restriction could seriously curtail the effectiveness of such loans in stimulating aggregate demand in an environment of elevated credit risk and risk aversion.

But even if the Federal Reserve were able to accept private-sector credit risk onto its balance sheet, any social benefits to the Federal Reserve lending directly to the private sector would need to be balanced against the potentially serious drawbacks associated with placing the Federal Reserve squarely in the process allocating credit within the private sector. The information available to the Federal Reserve about nonbank credit would in many cases be inadequate to reliably assess credit risks{ and there is little reason to believe the Federal Reserve could assess credit risks more accurately than do private intermediaries. Problems with adverse-selection could lead to the Federal Reserve lending to precisely those credit risks that it most severely underestimates. After the credit is extended, the Federal Reserve may not be well situated to monitor the ongoing activities of the recipients of the funds to ensure the activities are consistent with the terms of the contract. Some of these problems might be addressed through the Federal Reserve using credit-ratings from private sector firms.

Moreover, such programs could develop important political constituencies that might make the programs difficult to dismantle once the immediate aim of policy|

84Hackley (1973), page 129.

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namely providing a short-run economic stimulus- had been achieved.

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UST ASW update

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(an interoffice email)

>
>
> 16bp day for 2yr spreads today:
>
>
>
> The market went into the fed announcement expecting perfection
>
> 25-50bp cut and 50bps on the discount window.
>
>
>
> Spreads were 6 lower on the day in the 2yr sprds and 3 lower in tens before
> the Fed.
>
> Needless to say the market was disappointed…
>
> Spreads moved back to the wides in the front end
>
> and now are repricing an expectation of extended financial market /
> financing turmoil

Hi,

Looked to me like the post fed moves were unwinds of all sorts, and didn’t fit any other theme, so I’ll be watching for reversals after things settle down tomorrow am.

Interesting that the markets were shocked that the Fed cared about inflation. I read the speeches as saying they do care a lot, but the media glossed over those parts and didn’t even report those references.

And also interesting that interest rates went lower in response to the Fed caring about inflation.

Also, the strong yen vs the pound and euro, for example, was the reaction to ‘stress’ type of move we saw beginning in August.

While the FOMC didn’t do much to alleviate stress per se, they didn’t actually *do* anything to make it worse, either, and there were signs it was running its course, with the year end issue the remaining
hurdle. I’ll be looking for signs the NY Fed is working on that tomorrow and watching to see if 3 mo libor comes back down over the next few days.

The CPI and PPI are expected to be off the charts Thursday and Friday, and the media could start harping on inflation, blame the Fed for high oil prices, questioning whether a half point in the funds rate over the last few months was worth a $20 increase in the price of crude, and continue pushing that theme if crude goes up as I expect it will, as Saudis continue to (irregularly to hide what they are doing) hike posted prices and let the quantity they pump vary. (and Russia
probably doing same as well.) At 120 crude, retail gasoline should be pushing $4 and food up as well via the biofuel connection, and the media attack on the Fed for letting the inflation cat get out of the bag can elevate expectations rapidly, with tips breakevens and Michigan expectations numbers elevating rapidly.

So far, higher crude means lower yields, as it is anticipated the economy will weaken and the Fed doesn’t care about inflation. If/when that changes- as evidenced by higher crude causing higher interest rates even with risk to gdp- tensions and stresses move up several notches, as anyone working through the 70’s and 80’s should recall.

Given the coming inflation numbers, a segment of the mainstream will start to point out that the ‘correct’ fed funds rate is about 7% with inflation at about 4. To them a neutral real rate would put the ff rate at 6, so it will take 7 to be restrictive. They will argue headline cpi is the rate to use, as food and energy are trending and sustaining the higher levels, along with import and export prices rising at more than 5% rates, and therefore this group will give greater weight to core moving up to headline as happened in the 70’s when crude trended upwards for an extended period of time. And should crude continue to move up, this initially small group of mainstream economists will grow, and CNBC will help promote this ‘scare story’ as it attracts more and more viewers.

Hoping things don’t go that way but concerned they will. Looking forward to reactions to the data later this week and what commodity prices do from here.

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Manpower survey better than expected

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Bernanke stated he was watching the labor markets closely, right up to the meeting, and the latest survey further confirms its holding up at least as well as expected, if not quite a bit better.

The headline and lead in, however, continue to indicate a reporting bias toward a slowdown:

U.S. Employers Trim First-Quarter Hiring Plans, Manpower Says

By Bob Willis

Dec. 11 (Bloomberg) — Employers in the U.S. trimmed hiring plans for the first quarter of 2008 as the economy cools, according to a private survey released today.

Manpower Inc., the world’s second-largest provider of temporary workers, said its employment index for January through March fell to 17, the lowest since the first three months of 2004, after holding at 18 for the three prior quarters.

The decline wasn’t large enough to signal employment would slump, suggesting the labor market is holding up enough to sustain consumer spending. Federal Reserve policy makers, who are forecast to lower interest rates later today, are counting on rising wages to help Americans weather the housing recession.

“We’ve kind of pointed down a little, but we didn’t fall off a cliff like we did in other downturns,” Jeffrey Joerres, chief executive officer of Milwaukee-based Manpower, said in an interview. “Companies may not be euphoric about hiring, but they are still hiring.”

Right, so why wasn’t the headline ‘survey doesn’t signal a slump’? The reporting bias has been as strong as I’ve ever seen it.

The survey was in line with the Labor Department’s monthly jobs report issued last week. Employers added a greater-than- forecast 94,000 workers to payrolls in November and the unemployment rate held at 4.7 percent. The economy has created an average 118,000 jobs a month so far this year, compared with 189,000 a month in 2006.

These are not rate cut numbers.

Manpower’s index slumped 8 points in the second quarter of 2001, at the start of the last recession.

Before adjusting for seasonal variations, 22 percent of the roughly 14,000 companies surveyed said they will boost payrolls in the first quarter, down from 27 percent in the previous three months.

Little Change

Twelve percent said they’d trim hiring in the coming quarter, and 60 percent anticipated no change, the survey showed.

The overall index subtracts the percentage of employers planning to cut jobs from those who plan to add workers and adjusts the results for seasonal variations.

The world’s largest economy will expand at a 1 percent annual pace this quarter, bringing 2007’s growth rate to 2.2 percent, according to the median estimate of economists surveyed this month by Bloomberg
News. It grew at a 4.9 percent annual pace in the third quarter and 2.9 percent for all of 2006.

That’s a two quarter average of 3%, as actual employment and output grew modestly and inventory in Q3 borrowed some GDP from Q4. And the fed knows that if recent history is any guide, there is a good chance net exports were higher than expected in Q4 and it could be revised up.

The Fed will probably lower its target lending rate by a quarter point to 4.25 percent later today, its third consecutive reduction, according to a separate Bloomberg survey.

That’s the consensus, and the fed may do it out of fear that if they do not accomodate what markets have priced in, the sky will fall.

Half Limit Hiring

Employers in five of 10 industries polled by Manpower planned to limit hiring next quarter compared with the previous three months. Manpower’s measure of hiring intentions was weakest for construction companies. The index for government agency hiring showed the biggest drop.

And the risks are to the upside, as construction is already near zero. There is no where to go but unchanged or up.

Hiring plans at all but one of the industries were lower than year-ago levels, the report showed. Manufacturers of long- lasting goods, such as computers and appliances, projected little change from the first quarter of 2007.

The hiring outlook is strongest at mining companies, followed by service industries and wholesalers.

Regionally, employers in the Northeast, South and West predict no change in hiring, while employers in the Midwest anticipate a slowdown in activity.

Globally, hiring plans in Peru, Singapore, India, Argentina, South Africa, Australia and Japan were among the strongest, while employers in Ireland reported the weakest hiring plans.

The Manpower survey is conducted quarterly and has a margin of error of plus or minus 0.8 percentage point in the U.S. and no more than plus or minus 3.9 percentage points for national, regional and global
data.

To contact the reporter on this story:Bob Willis in Washington
bwillis@bloomberg.net .

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Fed expected to lower rates despite raging inflation – MarketWatch

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And the risk is headlines could get much worse after they cut.

For example:

‘Oil prices rise as Fed rate cuts drive down the dollar’

‘Fed cuts rates, driving up gas prices, to bail out banks’

MarketWatch article – Fed expected to lower rates despite raging inflation

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Washington Mutual to take writedown, cut jobs

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Yet another shoe that didn’t fall. No business interruption, no change to aggregate demand, a relatively few layoffs over time, and this is a major California lender where housing is hurting perhaps the most of any state.

Washington Mutual to Take Writedown, Cut Jobs (Update1)

2007-12-10 17:00 (New York)

(Adds writedown in the first paragraph and downgrade in the third paragraph.)
By Elizabeth Hester

Dec. 10 (Bloomberg) — Washington Mutual Inc., the largest U.S. savings and loan, will write down the value of its home lending unit by $1.6 billion in the fourth quarter and cut 3,150 jobs as losses in the mortgage market increase.

Washington Mutual also will cut its quarterly dividend to 15 cents a share from 56 cents and close 190 of 336 home loan centers, the Seattle-based bank said in a statement today. The company said provisions for loan losses in the quarter will be $1.5 billion to $1.6 billion, about twice as much as it previously expected.

Fitch Ratings downgraded the firm’s rating to “A-” from “A,” citing “worsening asset quality,” and “extremely challenging conditions in the U.S. residential mortgage market.” Washington Mutual said it plans to raise $2.5 billion to shore up its capital by selling convertible stock.

Industry-wide mortgage originations will probably shrink 40 percent in 2008 to $1.5 trillion, down from about $2.4 trillion this year, Washington Mutual said in the statement. The firm plans to cease lending through its subprime mortgage channel.

The company said it would cut 2,600 jobs in its home loans unit, or about 22 percent of that division. The remaining job cuts will come from corporate and support staff, the statement said.

–Editor: Otis Bilodeau.

To contact the reporter on this story:
Elizabeth Hester in New York at +1-212-617-3549 or ehester@bloomberg.net.

To contact the editor responsible for this story:
Otis Bilodeau at +1-212-617-3921 or obilodeau@bloomberg.net.

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Bowling alley to run out of points!

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National Debt Grows $1 Million a Minute

The Associated Press
Monday 03 December 2007

Washington – Like a ticking time bomb, the national debt is an explosion waiting to happen. It’s expanding by about $1.4 billion a day – or nearly $1 million a minute.

What’s that mean to you?

It means net financial assets are growing by only that much. 1.5% of GDP isn’t enough to support our credit structure needed to sustain aggregate demand over time.

It means almost $30,000 in debt for each man, woman, child and infant in the United States.

No, it means 30,000 in net financial assets for each.

Even if you’ve escaped the recent housing and credit crunches and are coping with rising fuel prices, you may still be headed for economic misery, along with the rest of the country.

Yes!

That’s because the government is fast straining resources needed to meet interest payments on the national debt, which stands at a mind-numbing $9.13 trillion.

No, it’s because the deficit is too small to supply the net financial assets we need to sustain demand, given the institutional structure that removes demand via tax advantage savings programs.

And like homeowners who took out adjustable-rate mortgages, the government faces the prospect of seeing this debt – now at relatively low interest rates – rolling over to higher rates, multiplying the financial pain.

Only if the fed hikes rates.

So long as somebody is willing to keep loaning the U.S. government money, the debt is largely out of sight, out of mind.

Government securities offer us interest bearing alternative to non interest bearing reserve accounts.

But the interest payments keep compounding, and could in time squeeze out most other government spending –

Operationally, spending is totally independent of revenues. The only constraints are self imposed.

leading to sharply higher taxes or a cut in basic services like Social Security and other government benefit programs. Or all of the above.

Only if congress votes that way..

A major economic slowdown, as some economists suggest may be looming, could hasten the day of reckoning.

The national debt – the total accumulation of annual budget deficits – is up from $5.7 trillion when President Bush took office in January 2001 and it will top $10 trillion sometime right before or right after he leaves in January 2009.

Too small as it is the equity behind our credit structure.

That’s $10,000,000,000,000.00, or one digit more than an odometer-style “national debt clock” near New York’s Times Square can handle. When the privately owned automated clock was activated in 1989, the national debt was $2.7 trillion.

It is also the national ‘savings’ clock as government deficit = non government accumulation of net financial dollar assets.

It only gets worse.

So does this article.

:(

Over the next 25 years, the number of Americans aged 65 and up is expected to almost double. The work population will shrink and more and more baby boomers will be drawing Social Security and Medicare benefits, putting new demands on the government’s resources.

The government spends by changing the number in someone’s bank account. Spending puts the same demands on government resources as running up the score at a football game puts strain on the stadium’s resources needed to post the score.

These guaranteed retirement and health benefit programs now make up the largest component of federal spending. Defense is next. And moving up fast in third place is interest on the national debt, which totaled $430 billion last year.

All interest expense is net income to the non government sectors.

Aggravating the debt picture: the wars in Iraq and Afghanistan, which the nonpartisan Congressional Budget Office estimates could cost $2.4 trillion over the next decade

That will be an aggregate demand add. What are the subtractions going to be? Increased pension funds assets, IRA’s, insurance reserves, and all of the other tax advantage ‘savings incentives’. To date, these have dwarfed government deficit spending and resulted in a chronic shortage of aggregate demand and massive economic under performance.

Despite vows in both parties to restrain federal spending, the national debt as a percentage of the U.S. Gross Domestic Product has grown from about 35 percent in 1975 to around 65 percent today.

Last I heard it was still 35%? But, as above, whatever it is, it is still not sufficient to support demand at ‘full employment’ levels. Our employment rate assumes large chunks of the population aren’t working because they don’t want to and wouldn’t work if desirable jobs were offered to them. The experience of the lat 90’s shows this isn’t true. With the right paid jobs available, employment could increase perhaps by 10%.

By historical standards, it’s not proportionately as high as during World War II – when it briefly rose to 120 percent of GDP, but it’s a big chunk of liability.

Didn’t seem to hurt war output!

“The problem is going forward,” said David Wyss, chief economist at Standard and Poors, a major credit-rating agency.

“Our estimate is that the national debt will hit 350 percent of the GDP by 2050 under unchanged policy. Something has to change, because if you look at what’s going to happen to expenditures for entitlement programs after us baby boomers start to retire, at the current tax rates, it doesn’t work,” Wyss said.

The only thing that ‘doesn’t work’ is the 10% of the work force that is kept on the sidelines by too tight fiscal policy.

With national elections approaching, candidates of both parties are talking about fiscal discipline and reducing the deficit and accusing the other of irresponsible spending.

Yes, and that is the biggest continuing systemic risk to the real economy – not a bunch of write downs in the financial sector.

But the national debt itself – a legacy of overspending dating back to the American Revolution – receives only occasional mention.

Who is loaning Washington all this money?

Who has all the money looking to buy government securities is the right question. And it’s the same funds that come from deficit spending. Deficit spending is best thought of as government first spending, then selling securities to provide those funds with a place to earn interest. The fed calls that process ‘offsetting operating factors’.

Ordinary investors who buy Treasury bills, notes and U.S. savings bonds, for one. Also it is banks, pension funds, mutual fund companies and state, local and increasingly foreign governments. This accounts for about $5.1 trillion of the total and is called the “publicly held” debt.

It’s also called the total net financial assets of non government sectors when you add cash in circulation and reserve balances kept at the fed.

The remaining $4 trillion is owed to Social Security and other government accounts, according to the Treasury Department, which keeps figures on the national debt down to the penny on its Web site.

Intergovernment transfers have no effect on the non government sectors’ aggregate demand.

Some economists liken the government’s plight to consumers who spent like there was no tomorrow – only to find themselves maxed out on credit cards and having a hard time keeping up with rising interest payments.

Those economist have it totally backwards and are a disgrace to the profession.

“The government is in the same predicament as the average homeowner who took out an adjustable mortgage,” said Stanley Collender, a former congressional budget analyst and now managing director at Qorvis Communications, a business consulting firm.

Wrong.

Much of the recent borrowing has been accomplished through the selling of shorter-term Treasury bills. If these loans roll over to higher rates, interest payments on the national debt could soar.

Wrong. The fed sets short term rates, not markets, and long term rates as well if it wants to.

Furthermore, the decline of the dollar against other major currencies is making Treasury securities less attractive to foreigners – even if they remain one of the world’s safest investments.

For now, large U.S. trade deficits with much of the rest of the world work in favor of continued foreign investment in Treasuries and dollar-denominated securities. After all, the vast sums Americans pay – in dollars – for imported goods has to go somewhere.

He’s getting warmer with that last bit!

But that dynamic could change.

“The first day the Chinese or the Japanese or the Saudis say, `we’ve bought enough of your paper,’ then the debt – whatever level it is at that point – becomes unmanageable,” said Collender.

Define ‘unmanageable’ please.

A recent comment by a Chinese lawmaker suggesting the country should buy more euros instead of dollars helped send the Dow Jones plunging more than 300 points.

Ok.

The dollar is down about 35 percent since the end of 2001 against a basket of major currencies.

Ok. Is that all there is to ‘unmanageable’? How about 10 year treasuries coming down below 4% as the dollar went down? How does he reconcile that?

Foreign governments and investors now hold some $2.23 trillion – or about 44 percent – of all publicly held U.S. debt. That’s up 9.5 percent from a year earlier.

Point?

Japan is first with $586 billion, followed by China ($400 billion) and Britain ($244 billion). Saudi Arabia and other oil-exporting countries account for $123 billion, according to the Treasury.

“Borrowing hundreds of billions of dollars from China and OPEC puts not only our future economy, but also our national security, at risk.

In what way? This is nonsense.

It is critical that we ensure that countries that control our debt do not control our future,” said Sen. George Voinovich of Ohio, a Republican budget hawk.

They already don’t. We control their future. Their accumulated funds are only worth what we want them to be. We control the price level. They are the ones at risk.

Of all federal budget categories, interest on the national debt is the one the president and Congress have the least control over. Cutting payments would amount to default, something Washington has never done.

Why would they? Functionally that’s a tax, and there are sufficient legal tax channels. So why use an illegal one?

Congress must from time to time raise the debt limit – sort of like a credit card maximum – or the government would be unable to borrow any further to keep it operating and to pay additional debt obligations.

Yes, that is a self-imposed constraint, not inherent in the monetary system that needs to go. If congress has approved the spending, that is sufficient.

The Democratic-led Congress recently did just that, raising the ceiling to $9.82 trillion as the former $8.97 trillion maximum was about to be exceeded. It was the fifth debt-ceiling increase since Bush became president in 2001.

Democrats are blaming the runup in deficit spending on Bush and his Republican allies who controlled Congress for the first six years of his presidency.

Not that I approve of the specifics of his tax cuts and spending increase, but good thing he did run up the deficit or we would be in the middle of a much worse economy.

They criticize him for resisting improvements in health care, education and other vital areas while seeking nearly $200 billion in new Iraq and Afghanistan war spending.

Different point.

“We pay in interest four times more than we spend on education and four times what it will cost to cover 10 million children with health insurance for five years,” said House Speaker Nancy Pelosi, D-Calif. “That’s fiscal irresponsibility.”

She is way out of paradigm. We can ‘afford’ both if the real excess capacity is there without raising taxes.

Republicans insist congressional Democrats are the irresponsible ones. Bush has reinforced his call for deficit reduction with vetoes and veto threats and cites a looming “train wreck” if entitlement programs are not reined in.

Both sides are pathetic.

Yet his efforts two years ago to overhaul Social Security had little support, even among fellow Republicans.

It was ridiculous. There is no solvency risk with social security or any other government spending requirement. Only a potential inflation risk. And the total lack of discussion regarding that is testimony to the total lack of understanding of public finance.

The deficit only reflects the gap between government spending and tax revenues for one year. Not exactly how a family or a business keeps its books.

Even during the four most recent years when there was a budget surplus, 1998-2001, the national debt ranged between $5.5 trillion and $5.8 trillion.

As in trying to pay off a large credit-card balance by only making minimum payments, the overall debt might be next to impossible to chisel down appreciably, regardless of who is in the White House or which party controls Congress, without major spending cuts, tax increases or both.

“The basic facts are a matter of arithmetic, not ideology,” said Robert L. Bixby, executive director of the Concord Coalition, a bipartisan group that advocates eliminating federal deficits.

Deficit terrorists.

There’s little dispute that current fiscal policies are unsustainable, he said.

Sad but true.

“Yet too few of our elected leaders in Washington are willing to acknowledge the seriousness of the long-term fiscal problem and even fewer are willing to put it on the political agenda.”

Fortunately!!!

Polls show people don’t like the idea of saddling future generations with debt, but proposing to pay down the national debt itself doesn’t move the needle much.

Our poor kids are going to have to send the real goods and services back in time to pay off the debt???? WRONG! Each generation gets to consume the output they produce. None gets sent back in time to pay off previous generations.

“People have a tendency to put some of these longer term problems out of their minds because they’re so pressed with more imminent worries, such as wages and jobs and income inequality,” said pollster Andrew Kohut of the nonpartisan Pew Research Center.

Good!

Texas billionaire Ross Perot made paying down the national debt a central element of his quixotic third-party presidential bid in 1992. The national debt then stood at $4 trillion and Perot displayed charts showing it would soar to $8 trillion by 2007 if left unchecked. He was about a trillion low.

Fortunately!

Not long ago, it actually looked like the national debt could be paid off – in full. In the late 1990s, the bipartisan Congressional Budget Office projected a surplus of a $5.6 trillion over ten years – and calculated the debt would be paid off as early as 2006.

That therefore projected net financial assets for the non government sectors would fall that much. Not possible!!! Causes recession long before that and the countercyclical tax structure fortunately builds up deficit spending (unfortunately via falling government revenue due to unemployment and lower profits) sufficiently to ‘automatically’ trigger a recovery.

Former Fed chairman Alan Greenspan recently wrote that he was “stunned” and even troubled by such a prospect. Among other things, he worried about where the government would park its surplus if Treasury bonds went out of existence because they were no longer needed.

Not to worry. That surplus quickly evaporated.

As above.

Mark Zandi, chief economist at Moody’s Economy.com, said he’s more concerned that interest on the national debt will become unsustainable than he is that foreign countries will dump their dollar holdings – something that would undermine the value of their own vast holdings. “We’re going to have to shell out a lot of resources to make those interest payments.

Interest payments do not involve government ‘shelling out resources’ but only changing numbers in bank accounts. ‘Unsustainable’ is not applicable.

There’s a very strong argument as to why it’s vital that we address our budget issues before they get measurably worse,” Zandi said.

“Of course, that’s not going to happen until after the next president is in the White House,” he added.

Might be longer than that.

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Another shoe doesn’t fall

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Profitable business plans are finding support from savvy investors profiting from ‘the great repricing of risk’.

I call it the ‘too profitable to fail’ club, and it seems to include most of the big names in sectors the media deemed hopeless.

MBIA To Get $1 Billion from Warburg Pincus Buyout firm Warburg Pincus has agreed to invest $1 billion in MBIA, bolstering the finances of the world’s largest bond insurer amid concern about its ability to pay claims on faltering mortgage-backed bonds.

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Fed’s best move

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From the Fed’s theoretical framework, their best move is:

♦ Cut the discount rate to 4.5

♦  Leave fed funds at 4.5

♦ Remove the stigma from the window

♦ Allow term window borrowing over the turn

♦ Accept any ‘legal’ bank assets as collateral from member banks in good standing

♦ Allow member banks to fully fund their own siv’s

♦ Do not allow banks to do any new sivs or add to existing siv assets, and let the existing assets run off over time.

This would:

♦ Close the FF/LIBOR spread stress for member banks

♦ Support market functioning

♦ Support portfolio shifts to the $

♦ Temper inflation pressures

♦ Restore confidence in the economy

♦ Regain Fed credibility

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Paulson on the dollar

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Maybe he knows the fed won’t cut the fed funds rate….

Paulson says economy healthy

updated 10:33 p.m. ET, Fri., Dec. 7,2007
SOURCE: Reuters

Treasury Secretary Henry Paulson said on Friday Washington was following a strong dollar policy and indicated he expected it to rebound, emphasizing the U.S. economy’s long-term strength should help the currency.

But Paulson warned in a radio interview in Cape Town that some aspects of the U.S. subprime mortgage crisis would become worse before getting better.

Paulson is in South Africa partly for a weekend meeting of finance chiefs from the Group of 20 economies, some of whom have expressed concern that the dollar’s falling value is putting strain on their ability to export.

“We have very much a strong dollar policy … that’s in our nation’s interest. Our economy, like any other, goes through its ups and downs but I believe the U.S. economy will continue to grow and its long-term strength will be reflected in our currency markets,” Paulson told 567 Cape Talk radio.

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Feds’ budget tricks hide trillions in debt

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Feds’ Budget Tricks Hide Trillions in Debt

-Scott Burns
Every year, tens or even hundreds of billions of dollars are quietly added to the national debt — on top of the deficits that we hear about. What’s going on here?

Burns doesn’t get it.

When it comes to financial magic, the government of the United States takes the prize. Sleights of hand and clever distractions by purveyors of line-of-credit mortgages, living-benefit variable annuities and equity-indexed life insurance are clumsy parlor tricks compared with the Big Magic of American politicians.Consider the proud trumpeting that came from Washington at the close of fiscal 2007. The deficit for the unified budget was, politicians crowed, down to a mere $162.8 billion.

In fact, our government is overspending at a far greater rate. The total federal debt actually increased by $497.1 billion over the same period.

But politicians of both parties use happy numbers to distract us. Democrats routinely criticize the Republican administration for crippling deficits, but they politely use the least-damaging figure, the $162.8 billion. Why? Because references to more-realistic accounting would reveal vastly greater numbers and implicate both parties.

No, because they are right and Burns is wrong.

You can understand how this is done by taking a close look at a single statement on federal finance from the president’s Council of Economic Advisers. The September statement shows that the “on-budget” numbers produced a deficit of $344.3 billion in fiscal 2007. The “off-budget”> numbers had a surplus of $181.5 billion. (The off-budget figures are dominated by Social Security, Medicare and other programs with trust funds.)

Correct. Net government spending in the non government sectors is what ‘counts’. Intergovernment transfers of anything are of no economic consequence to the rest of us. They have no current year impact on aggregate demand.

Combine those two figures and you get the unified budget, that $162.8 billion. In the past eight years we’ve had two years of reported surpluses and six years of reported deficits. Altogether, the total reported deficit has run $1.3 trillion.But if you examine another figure, the gross federal debt, you’ll see something strange. First, the debt has increased in each of the past eight years, even in the two years when surpluses were reported. Second, the gross federal debt, which includes the obligations held by the Social Security and Medicare trust funds, has increased much faster than the deficits — about $3.3 trillion over the same eight years.

They are correct, as above, by not including transfers of securities from one government agency to another.

That’s $2 trillion more than the reported $1.3 trillion in deficits over the period. Can you spell “Enron”?

Pass on the comebacks and go on to the text.

In other words, while our reported deficits averaged $164 billion over the past eight years, government debt increased an average of $418 billion a year. That’s a lot more than twice as much. How could this happen?

How can a responsible new sight publish this nonsense???

Easy. The Treasury Department simply credits the Social Security, Medicare and other trust funds with interest payments in the form of new Treasury obligations. No cash is actually paid.

Why should it be???

The trust funds magically increase in value with a bookkeeping entry.

That’s all the $ is in any case – a bookkeeping entry. Get over it!

It represents money the government owes itself.

Right, which has no current year effect on the real economy. It changes buys or sells of real goods and services.

So what happens if we take out the funny money?

What does ‘take out’ mean? Simply transferring from one account at the the fed to another. More entries. Can’t be anything more. That’s all the $ is.

When the imaginary interest payments are included, Social Security and Medicare are running at a tranquilizing surplus (that $181.5 billion mentioned earlier). But measure actual cash, and the surplus disappears.

What is ‘actual cash’???

In 2005, for instance, the Social Security Disability Income program started to run at a cash loss. 2007 is the first year that Medicare Part A (the hospital insurance program) benefits exceeded income.

The same thing will happen to the Social Security retirement-income program in six to nine years, depending on which of the trustees’ estimates you use. During the same period, the expenses of Medicare Part B and Part D, which are paid out of general tax revenue, will rise rapidly.

Point???

Despite this, the Social Security Administration writes workers every year advising them that the program will have a problem 34 years from now, not six or nine years. In fact, the real problem is already here. It will be a big-time problem in less than a decade.

Define ‘big time’. Government going to bounce checks? If the government runs deficits in the out year that are ‘too large’ the evidence will be inflation, not solvency. If he thinks there’s a potential inflation issue, fine, but he doesn’t or he would have said it.

Count on it.

Count on more of this nonsense.

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