Tag Archives: Fed

Proposal

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The short version of my current alternative proposal to the TARP remains:

  1. Normalize bank liquidity by allowing Fed member banks to borrow unsecured from the Fed in unlimited quantities.
  2. Have the Fed set term lending rates out to 3 months in addition to the Fed funds rate.
  3. Extend FDIC insurance to Fed deposits at member banks to keep any insolvency losses at the FDIC.
  4. Remove the cap on FDIC insurance to eliminate the need for money market funds.
  5. Declare a ‘payroll tax holiday’ and reduce social security and medicare payroll deduction rates to 0% until aggregate demand is sufficiently restored.

This would immediately end the current crisis.

Remaining issues include the increased demand for energy consumption as the economy recovers, and associated price pressures.

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Re: Mosler plan, short version

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>   
>   Warren,
>   I like adding the tax holiday.
>   

Thanks, we were all pushing that as a better alternative than the Bush tax cut plan 5 or so years ago.

While not as constructive as, for example, an infrastructure project, and likely to drive up energy consumption, it will get immediate results, ‘cure’ the financial crisis (people will better afford their mortgage payments) and the ‘recession,’ and is far better than what they are proposing which does little or nothing.

>   
>   Why do you want the Fed to establish 1 month, 2 month, and 3 month rates?
>   

To eliminate interbank markets domestically at least out that far. Six months would be even better, and 30 years even better, but at some point it gets beyond political understanding, and most of the benefit comes from the very front of the curve where most of the interbank lending takes place, or tries to!


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Equity prices dropping to takeover levels

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A while back I wrote about how shareholders were at risk of management selling them up the river with dilutive converts and the like.

But if a someone buys all the shares in a takeover they don’t have that risk.

Therefore, I concluded, equities would get cheap enough for a massive round of takeovers.

Now a different risk has presented itself. Seems when the Fed or the Treasury decides to step in and help they take 79.9% of the equity.

So when the stock of a too-big-to-fail prospect starts going down, the incentives are in place for it going down further/faster as the risk of government intervention increases.

Lower prices make takeovers even more attractive.

Once they get going, look for record takeover volume.


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FOMC

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Wonder if Fisher cut a deal not to dissent for the hawkish inflation language?

Karim writes:

Decision (no cut) may be hawkish relative to expectations, but wording mostly dovish.

1st paragraph-all changes highlight downside risks to gwth; slowing export gwth a new wrinkle in addition to the usual financial market strains, labor market weakness and housing.

2nd paragraph-identical to prior except mention of inflation expectations has been dropped; so a downgrading of concern over inflation.

3rd paragraph-‘stand ready to act’ but no mention of ‘in a timely manner’.

Fisher dropped his dissent

NEW

Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

OLD

Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.


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2008-09-16 JN Highlights

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Highlights:

Aug Consumer Sentiment Hits Record Low For 3rd Month
Govt Panel To Call For Cutting Corporate Tax To 30% By FY15
Ota Reelected As New Komeito Leader For Another 2 Years
Extra Budget To Total 1.81tn Yen, Govt Eyes 400bn Yen Bonds
Lehman Failure Not To Mar Japan Financial System: Ibuki
BOJ Injects Y1.5tln To Calm Markets
New-Condo Offerings Tumble 38% In Tokyo, Rise 7% In Osaka For Aug
Forex Focus: Yen To Benefit From Banking Woes
Stocks: Slide To 3-Year Low As Banks, Insurers Tumble
Bonds: Surge After Lehman Bankruptcy, Market Turmoil

 

Note Japan’s proposed fiscal responses: cutting corp tax and extra budget, while the proposed increased consumption tax has been delayed.

Same in most nations around the world.

Fiscal responses ‘work’ while interest rate cuts don’t.

The US tax rebates worked while there is no econometric evidence the rate cuts did anything, except maybe make things worse as they reduced personal income and contributed psychologically to a USD sell off and spike in import prices that probably hurt consumers at least as much as it helped exporters.

The Fed could to anything today from unchanged to a 50 cut.

They seemed to have decided to use interest rates for ‘monetary policy’ and other tools for ‘market functioning’.

So for market functioning they just expanded the scope of the TAF and the Treasury lending facility, and may do more of that type of thing at today’s meeting, including adjusting the terms of the discount rate.

The question is whether falling commodities and the stronger USD will lead to a further rate cut.

What the Fed knows and has recognized since the Bear Stearns episode is that markets are going to open every day and do their thing, as the last week’s activity has demonstrated.

The Fed’s perceived risk of markets simply not opening and not trading has subsided.

Also, with the Treasury take over of the agencies mtg rates have dropped over 50 bp and availability of mortgage funding has been sustained.

The Fed considers this an ‘easing of financial conditions’ and is the move they’ve wanted to see to support housing, which has shown signs of stabilizing.

And the Treasury has shown it’s there to ‘write the check’ as it sees the need to prevent systemic risk.

So from that point of view there has already been a substantial ease in ‘financial conditions’, and the Fed may not see a need for further immediate ease.

Their forecasts will continue to show ‘moderating inflation and continued downside risks to growth’.

It all depends on their fear factor. They could leave fed funds unchanged or cut up to 50, depending on their concern regarding systemic risk.


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AS: Fed moves

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I’ve been recommending the following for the Fed for quite a while (see Proposals for the Fed):

  1. Lower the discount rate the Fed Funds rate and:
    1. Accept a pledge of any bank legal collateral from any member bank.
    2. Impose no restriction on quantity borrowed.
    3. Impose no restriction on the duration of any member bank borrowing.
  1. Likewise, remove collateral restrictions on the TAF operations.
    1. Set the maturity and interest rate for each TAF operation.
    2. Leave demand open-ended, rather than the current policy of limiting quantity.

Failure to implement the above shows a failure to understand fundamental monetary operations.

These policy changes would alleviate critical liquidity issues, and not, per se, alter net bank reserve demand (not that the size of the bank reserve ‘matters’).

Part of the current crisis is due to the failure to implement the above changes that would have:

  1. Normalized bank liquidity.
  2. Prevented the forced sales of investment grade, unimpaired, bank legal assets.
  3. Allowed banks to finance bank legal assets for third parties.
  4. Allowed markets to function to deleverage impaired assets.

The Fed is slowly moving in that direction, but, unfortunately, not proactively to ‘fix’ a flawed institutional structure, but reactively as things fall apart in no small part due to lack of action:

Federal Reserve lowers standards for collateral from primary dealers

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.

The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.

These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.

Also, Schedule 2 TSLF auctions will be conducted each week; previously, Schedule 2 auctions had been conducted every two weeks. In addition, the amounts offered under Schedule 2 auctions will be increased to a total of $150 billion, from a total of $125 billion. Amounts offered in Schedule 1 auctions will remain at a total of $50 billion. Thus, the total amount offered in the TSLF program will rise to $200 billion from $175 billion.

The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market. This exception expires on January 30, 2009, unless extended by the Board, and is subject to various conditions to promote safety and soundness.


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Thoughts on the bailout of Freddie Mac and Fannie Mae

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It comes down to public purpose.

The agencies were set up to provide low cost funding for moderate income home buyers.

They have done that reasonably well.

However, for probably 20 years I’ve been saying the agencies should fund themselves directly with the Treasury or Fed financing bank (same as Treasury). This both lowers their cost of funds, which would get passed through to the home mortgages they originate, and eliminates the possibility of a liquidity crisis.

Market discipline should not be on the liability side. It subjects them to risk of a ‘liquidity crisis’ where those funding you can decide to go play golf one day and cut you off for no reason and put you out of business. (And any entity subject to private sector funding to continue operations is subject to this kind of liquidity risk.) Regulation should focus instead on the asset side with assets and capital fully regulated.

This was done for the most part, and this is the same as the general banking model which works reasonably well. Yes, it blows up now and then as banks find flaws in the regulations, but the losses are taken, regulations adjusted, and life goes on.

The agencies made some loans to lower income borrowers as that went bad.

Even with this, most calculations show that at today’s rates of mortgage default they still have adequate capital to squeak by – the cash flow from the remaining mortgages and their capital is pretty much adequate to pay off their lenders (those who hold their securities).

But if defaults increase their ‘cash flow net worth’ could turn negative; hence, it would currently not be prudent for the private sector to fund them.

Paulson has now moved funding to the Treasury where it should have been in the first place.

This removes the possibility of a liquidity crisis and allows the agencies to continue to meet their congressional charge of providing home mortgages for moderate and lower income borrowers at low rates.

There was no operational reason for Paulson to do more than that, only political reasons.

The agencies could then have continued to function as charged by Congress.

If there were any long-term cash flow deficiencies, they would be ‘absorbed’ by the Treasury as that would have meant some of the funding for new loans was in fact a Treasury expense as it transferred some funds to borrowers who defaulted.

Congress has always been free to change underwriting standards.

In fact, the program was all about easier underwriting for targeted borrowers.

If there were any ultimate losses, that was the cost of serving those borrowers.

To date there have been only profits, and the program has ‘cost’ the government nothing.

With Treasury funding and a review of underwriting standards the program could have continued as before, which it might still do.

The entire episode was a panic over a possible liquidity crisis due to the possibility of the Treasury not doing what it did, and what should have been done at inception.

I don’t think the Treasury getting 79.1% of the equity after making sure it took no losses and got a premium on any ‘investment’ it made served any non-political purpose.

There was no reason current equity holders could not have gotten the ‘leftovers’ after the government got its funds and a premium also determined by the government.

Equity IS the leftovers and could have been left alone. (It wouldn’t surprise me if some of the shareholders challenge this aspect of the move.)

Yes, holders of direct agency securities were ‘rescued’, but they were taking a below market rate to buy those securities due to the implied government backing and lines of credit to the government.

I don’t see it as a case of ‘market failure’ but instead poorly designed institutional structure with a major flaw that forced a change of structure.

It’s a failure of government to do it right the first time, probably due to politics, and much like the flaw in the eurozone financial architecture (no credible deposit insurance – another form of allowing the liability side of the banking system to be subject to market discipline), also due to politics.

As for compensation, that too was ultimately under the control of Congress, directly or indirectly.

Lastly, in the early 1970s, with only 215 million people, housing starts peaked at 2.6 million per year.

Today, with over 300 million people we consider 2 million starts ‘gangbusters’ and a ‘speculative boom’.

And in the early 1970s, all there were was bunch of passive S&Ls making home loans – no secondary markets, no agencies, etc.

Point is, we don’t need any of this ‘financial innovation’ to further the real economy.

Rather, the financial sector preys on they real sectors, in both financial terms and real terms via the massive brain drain from the real sectors to the financial sector.

At the macro level, we’d be better off without 90% or more of the financial sector.


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Fed senior loan officer survey charts

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On Mon, Aug 11, 2008 at 1:25 PM, Karim writes:

  • Both lending standards and spds move up from cycle highs; appears defining aspect of the current episode may be the duration of tighter lending conditions (prior episodes approached current levels of tightness but were relatively short-lived).
  • Also of concern to Fed is chart on page 3 showing significant tightening of standards for prime residential mortgage loans (though all types of loans showed a deterioration)

http://www.federalreserve.gov/boarddocs/SnLoanSurvey/200808/charts.pdf

Yes, and note how housing showing strong signs of bottoming and GDP moving up at the same time.

Interesting to watch the blood flowing around the clot, as it necessarily does.

Though not without difficulty.


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Bloomberg: Fed can’t reduce LIBOR

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I could fix this in twenty minutes…

Money Market `Plagued’ by Libor That Fed Can’t Reduce

by Gavin Finch

(Bloomberg) A year after central banks started to pump trillions of dollars into the financial system to end a seizure in credit markets caused by subprime mortgages, cash is about as tight as it’s ever been.

The U.S. market for commercial paper, or short-term IOUs, backed by assets such as mortgages has shrunk 40 percent from its peak in July 2007. The amount borrowed in pounds between banks in the U.K. fell by 70 percent in June from a record in February 2007. The European Central Bank received $100 billion of bids for the $25 billion it offered to financial institutions on July 29, the most since the sales began in December.

Efforts by the Federal Reserve, ECB and Swiss National Bank to shore up the world’s biggest banks and promote lending have had limited success.

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2008-08-07 UK News Highlights

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Highlights:

ECB Leaves Interest Rates at Seven-Year High to Fight Inflation
German industrial orders drop
Western European Car Sales Fall by 6.7% in July, JD Power Says
German June Exports Rise the Most in Nearly Two Years
German Economy Contracted as Much as 1.5% in 2Q
French Trade Deficit Expands to Record as Euro Curbs Exports
Italian June Production Stalls as Record Oil Prices Damp Growth
Fall in output fuels Spanish recession fears

 
 
 
Article snip:

ECB Leaves Interest Rates at Seven-Year High to Fight Inflation (Bloomberg) – The ECBkept interest rates at a seven-year high to fight inflation even as evidence of an economic slump mounts. ECB policy makers meeting in Frankfurt left the benchmark lending rate at 4.25 %, as predicted by all 60 economists in a Bloomberg News survey. The bank, which raised rates last month, will wait until the second quarter of next year to cut borrowing costs, a separate survey shows. The ECB is concerned that the fastest inflation in 16 years will help unions push through demands for higher wages and prompt companies to lift prices. At the same time, record energy costs and the stronger euro are strangling growth. Economic confidence dropped the most since the Sept. 11 terrorist attacks in July and Europe’s manufacturing and service industries contracted for a second month. ECB President Jean-Claude Trichet will hold a press conference 2:30 p.m. to explain today’s decision.

Same as UK, less costly to address inflation now rather than support growth and address inflation later if it gets worse.

It’s been said in the US that the Fed needs to firm up the economy first, and then address inflation. To most Central Bankers this makes no sense, as they use weakness to bring inflation down.

In their view that means the Fed wants to get the economy strong enough to then weaken it.

The Fed majority sees it differently.

They agree with the above.

However, for the last year they have been forecasting lower inflation and lower growth were willing to take the chance that supporting growth would not result in higher inflation.

Now, a year later, the FOMC is faced with higher inflation and more growth than the UK and Eurozone, and systemic ‘market functioning’ risk remains.

The FOMC continues to give the latter priority as they struggle with fundamental liquidity issues that stem from a continuing lack of understanding of monetary operations.


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