Echo

The effective funds rate will ALWAYS trade below the FOMC target

Friday, October 31, 2008

The path of the effective funds rate – the rate at which U.S. banks loan excess reserves to each other - has eluded me since October, when it deviated sharply from the federal funds target – the target rate that the Federal Open Market Committee sets every six weeks or so. I finally figured it out: a new monetary policy initiated by the Fed early in October creates a wedge between the effective rate and its target, so that the effective federal funds rate will always trade around 0.35% below the federal funds target.

As part of the Emergency Economic Stabilization Act of 2008 , the Fed is now able to pay interest on total reserves held by banking institutions – required reserves plus excess reserves. I imagine that the rationale is to reduce the banks' inefficient use of resources to minimize the profit losses of holding reserves (since they earned no income on reserves). Now, banks – just like everybody else – earns income on reserves (deposits), changing the opportunity cost of holding reserves. The outcome is hopefully a more efficient level of bank reserves held with the Fed. The market rate, however, is set by the Fed – kind of funny because then it ceases to be a market rate.

The Fed initially set the interest rate paid on required reserves equal to the average federal funds target over 14 days (the reserve period) less 10 bps, currently about 0.9%. And the interest paid on excess reserves –reserves held by bank above what is required by the Fed – was the lowest federal funds target minus 75 bps, currently 0.25%. On October 22, the Fed changed the excess reserve interest rate to the lowest target minus 35 bps, currently 0.65%.

Going forward, this new policy (paying interest on excess reserves) creates a wedge between the federal funds target and the effective federal funds rate equal to 0.35%. Think about it, if I am Bank of America and I am looking to loan my excess reserves at a market interest rate equal to 0.60%, why would I do that if the Fed is paying 0.65% for the same funds? I take my funds out of the market – and so do other banks – which drives down the supply of loanable funds, and the interest rate rises. If the market rate exceeds 0.65%, let’s say 0.70%, then banks increase loan activity rather than earning the Fed’s 0.65% interest payment, and the interest rate falls. Arbitrage pushes the interest rate to 0.65%, which is 0.35% below the target (1%). Therefore, the federal funds target will never meet the effective funds rate again, and the difference between the two will be 0.35% (provided the Fed doesn't change the formula again).

Therefore, there is no correlation between the $900 billion in new liquidity that the Fed has injected since last year (most of it in September and October) and the effective funds rate trading below its target (see chart).

Here’s a little math: Since October 1, the average federal funds target rate is 1.60%, the average effective federal funds rate is 1.08%, and the average payment on reserves is 0.55%. Therefore, the difference between the average federal funds target and effective federal funds rate is:

1.60% - 1.08% = 0.52%, which is the average payment on reserves, 0.55%.

I apologize for my previous posts, where I suggested here that the Fed is unable to properly target the effective rate and here where I suggested that the Fed would cut its target because the effective funds rate is already below the target rate. But I was partially correct since the deviations started before the new policy (see September data in the chart). The mass amounts of liquidity that the Fed injected starting in the middle of September did push the effective rate well below its target (2% at the time). The Fed could not raise the effective rate closer to its target without extracting precious liquidity, which would have done more harm than good in the middle of a banking crisis. Further, it doesn’t seem like many other people/bloggers have a firm grip on this, so I will just leave it at that.

Rebecca Wilder

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Super-cool dynamic map of credit card delinquencies

Thursday, October 30, 2008

Last month I wrote a piece that was highlighted in Paul Krugman’s NY Times The Conscience of a Liberal blog, where I argued that overly run-up lines of revolving credit will be the next shoe to drop in the credit crunch.

Well, clearly the Fed is worried about this because they published a super-cool dynamic map of credit card delinquency rates on the NY Fed’s website.

According to the map, in Suffolk County, Massachusetts – where I live – 2.48% of all credit card loans are 60+ days delinquent. Fortunately that is not me, but obviously this is a problem when the labor market is expected to post its tenth month of decline in October. The top delinquency rate is Shannon, South Dakota, where 11.19% of all credit card loans are 60+ days delinquent. This data is current as of the first quarter, and I expect that these delinquency rates have changed a bit (probably risen).

Here are the top 25 U.S. counties in terms of credit card delinquency rates:


The bad news just keeps on coming. What does your county look like?

Rebecca Wilder

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The King $US prolongs the global credit crisis; Fed opens at least $600 b in currency swaps

The U.S. dollar ($US) continues to gain ground, approaching its 2002 peak level against major currencies and on a broader basis. This hurts global economies that rely on $US to finance portfolio holdings, as well as U.S. exporters.

When dollar funding runs dry with tight interbank lending, firms and central banks go to the open market to buy up the difference; that is very expensive right now. In order to alleviate the pressures on demand for $US, the Fed continues to open up currency swap lines, effectively fanning out a supply of $US around the world. Hopefully, these swap lines will continue to stabilize the global credit crunch and also the value of the $US.

A timeline of recent swap lines in addition to the $67 billion already in place. If you want a nice discussion of what is a swap line, visit the macroblog here:
  • $180 billion September 18: Swap lines announced with major central banks: The Bank of Canada, the Bank of England, the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank
  • $30 billion on September 24: Swap lines announced with the Federal Reserve, the Reserve Bank of Australia, the Danmarks Nationalbank, the Norges Bank, and the Sveriges Riksbank.
  • $13 billion on September 26: Extending already-in-place lines with the Bank of England, the European Central Bank (ECB), and the Swiss National Bank.
  • $330 billion on September 29: Extended swap lines available to key central banks (developed World).
  • $Unlimited on October 13: Swap lines enough to “meet demand” with the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank
  • $15 billion on October 28: Swap line opened with the Bank of New Zealand
  • $120 billion on October 29: Swap lines opened with emerging economies: the Banco Central do Brasil, the Banco de Mexico, the Bank of Korea, and the Monetary Authority of Singapore.
Total: At least $688 billion.

Although the Swap lines are simply “lines of $US credit,” foreign central banks are drawing on these lines. As of October 22, the Fed had issued roughly $520 billion in $US to foreign central banks. Although these lines of credit are helping to heal international credit markets, the value of the $US is still at record levels. As the credit crisis filters into emerging markets, the developing world seeks $US funding.

Brad Sester was rather prescient to the Fed’s actions on October 29. He reported – on October 18 - on the emerging economies’ envy of the Fed’s unlimited $US funding with developed foreign central banks. Emerging economies can access $US through the IMF, but with economic strings attached. An excerpt from Brad Sester’s post:


“There is another key difference between European banks’ need for dollars and many emerging markets’ need for dollars. European banks need dollars to finance their holdings of US mortgages and other US securities. If they didn’t have access to dollar financing, they would either have to borrow euros and buy dollars – pushing the dollar up (and hurting US exporters) or they would have to dump their US assets (hurting US banks holding similar assets). By lending to European central banks who then lent to their own banks, the US kept some European banks from being forced sellers of risky US assets – and in the process putting pressure on US banks. The US wasn’t acting entirely altruistically.

Emerging market banking systems by contrast often need dollar financing not to support their portfolios of US assets but to support their domestic dollar lending.

And it is now clear that a broad range of emerging economies do need access to the international banking system to continue the kind of breakneck growth that they have experienced recently — and have been caught up in the recent “deleveraging” of the global financial system. The FT’s Garnham again:

Analysts said emerging market currencies were being hit as foreign investors pulled money out of developing regions, driven by liquidity pressures from the credit crisis. “There seems little now that the authorities can do to reverse the process of deleveraging that is taking place with financial institutions all contracting their balance sheets at the same time,” said Derek Halpenny, at Bank of Tokyo-Mitsubishi.”

Obviously, the swap lines have not stabilized the $US, but have helped (slightly) to calm credit markets. But the $US strength cripples US exports. In the second quarter of this year (third quarter to be released today), export spending contributed 1.5% to the 2.8% of recorded economic growth, and with domestic consumption sliding, export strength is needed to keep the U.S. afloat. Thus, the $US strength hurts the American economy as well as global economies.

The fact that the Fed continues to open up currency swap lines re-iterates the severity of the financial crisis that is both global and ongoing. One can only hope that these measures – with economic costs that are yet to be determined – will calm global capital markets enough to allow each economy to heal on its own accord.

Rebecca Wilder

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The economic impact of various stimulus packages; Why isn't the precipitous decline in gas prices included?

Wednesday, October 29, 2008

Here's an interesting piece on the economic impact of various stimulus packages. Part of Congress' proposed $300 billion package will likely include several of these features (extended unemployment benefits). From the Economic Policy Institute (via Moody's):

"As money is spent, it creates beneficial ripples through the entire economy. The evidence is that most of the money from the recent tax rebate was saved rather than spent, thus blunting its stimulative benefit.1 By comparison, other options—such as infrastructure spending, aid to states, food stamps, and unemployment insurance (UI) benefits—are much more cost-effective because they target the needs most likely to channel money back into the economy. Mark Zandi from Moody’s Economy.com estimates that each dollar of refundable tax rebates only boosts GDP by about $1.26, while each dollar of infrastructure spending could provide a $1.59 boost. Not only are many of these stimulus options more effective, but they also have the added benefit of assisting those hardest hit by the downturn and tackling long-standing infrastructure needs that would lower transportation costs, decrease traffic, and increase business productivity."
RW: I am surprised that a decrease in gas prices is not included on this chart. I read that (Deutsche Bank probably) for each 10 cent decrease in the price of gasoline, $1 billion in annual energy consumption dollars are added back to GDP. Therefore, the $1 decline in the price of gas since last month to $2.66/gallon translates into roughly $10 billion more on consumer energy spending (at an annualized rate). Now that's an economic stimulus, and the taxpayer doesn't even have to pay for it!

Rebecca Wilder

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ECB still has wage pressures to contend with

The U.S. and Eurozone central banks meet this week and next, and markets are expecting rate cuts from both. However, the Eurozone still has wage pressures to contend with, while the U.S. does not.

Today the Federal Open Market Committee (FOMC) announces their decision for key interest rate targets, including the famous federal funds rate – the Fed’s target interbank loan rate. I believe that the market's expected 50 bps rate cut (yes a cut) is just a simple way to get the target down to the level of current effective federal funds rate (the actual interbank lending rate). I discuss this here. The Fed has introduced a plethora of liquidity into the banking system, liquidity that has driven the effective funds rate well below 1%, where the Fed's target is/was 1.5%.

Next week the European Central Bank will meet, and President Jean-Claude Trichet has indicated that a rate cut is on the horizon. From Bloomberg:

"European Central Bank President Jean-Claude Trichet said Oct. 27 he may reduce interest rates next week, citing ebbing inflation and ``weakening demand.'' The ECB, Fed and four other central banks trimmed rates by a half point on Oct. 8 in an unprecedented coordinated move.”
Compared to the Fed, the ECB has less wiggle room for its expansionary policy. First, it has an explicit inflation target equal to 2%. But second, and more importantly, the ECB is the central bank for 15 sovereign countries.

There is a short list of requirements that must be fulfilled in order for an EU member country to adopt the euro - including criteria over inflation, government finance, currency management, and long term interest rates - but that list does not include wage cost pressures. Certain countries – Germany, Spain, Belgium – have strong tendencies to index wages to the inflation rate, and in spite of strong wage pressures in key economies, the ECB must adhere to its 2.0% target.

The chart illustrates quarterly labor costs across the Eurozone spanning the years 2003-2008. Labor costs remain above the inflation target, 2.0%, and recently have risen with inflation pressures. Labor cost growth hit a peak in the first quarter of 3.5% and fell to 2.7% in the second quarter. With inflation receding on oil, wage pressures should subside a bit, but with inflation elevated, wage costs will be, too.

In Germany, where the labor market is strong and the unemployment rate is still falling (click here for chart), wage pressures are strong. Unions have bargaining power, and pressure firms to raise wages to meet elevated inflation, which is 3.6% in the Eurozone and 3.0% in Germany.

The chart illustrates monthly labor costs in Germany spanning the years 2003-2008. Labor costs in Germany are extremely volatile and fluctuate with inflation. Spanning 2006 and 2007, when inflation was falling, labor costs fell, while recently labor costs have grown with the surge in inflation. Inflation pressures are receding, but the headline rate sits at 3.0%, and strong labor conditions will likely drive labor costs upward to meet or exceed 3.0%.

Wage pressures that are stronger across Europe than in the U.S.

The chart illustrates U.S. quarterly labor costs in the U.S. spanning the years 2003-2008. Although unit labor costs in the U.S. do fluctuate with inflation, there is a stronger tendency for weak labor market conditions to keep wage pressures at bay. For example, current U.S. inflation sits at 4.9% and labor cost growth in the second quarter of 2008 was just 2.4%. On the other hand, Eurozone inflation is currently 1.3% lower than in the U.S., 3.6%, and labor cost growth exceeds that in the U.S., 2.7%.

Conclusions

Trichet will likely reduce the ECB’s target rate, but he needs to be careful - more careful than his counterpart Ben Bernanke must be. Wage pressures are strong in Europe, stronger than in the U.S., and the infamous cost-push spiral (wages pushing up prices) is an an ongoing risk for the Eurozone.

Rebecca Wilder

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My faves for the day

Tuesday, October 28, 2008

The Financial Crisis and Short-Run Stabilization Policy

“I've been wondering if the current crisis will change our attitude about paying for stabilization policy, i.e. if it will make us more willing to raise taxes and cut spending when times are good. One of the problems with the last two boom-bust cycles was unchecked exuberance. Any calls to raise taxes or interest rates were met with howls about how it would cut off the boom, and who would want to do that? But tempering the boom might have helped to reduce the size of the meltdown we are experiencing now and left us much better off.”

RW: If we don’t pay off government debt, the next bust will likely be worse than the current one (currently -42% loss in the DOW since 10/2007). Thanks, Mark, for a nice article.

The soaring yen

“There was a reason why Asian exports to Europe were growing so rapidly. The euro’s strength v most Asian currencies was the most obvious currency misalignment in the world for the past several years. It just took a long time to correct.”

A Yen for Yen

“It’s a weird world indeed when capital is fleeing into the Japanese yen instead of away from it. The Japanese currency has appreciated dramatically against other currencies in the last couple of weeks and hit a 13-year high against the dollar Friday, as the dollar fell to 90.87.”

With Rate Cuts, FOMC Returns to Scene of the Crime

“If, as widely expected by financial markets and Fed watchers, the Federal Open Market Committee lowers the target federal funds rate for interbank lending by 0.50 percentage point at the conclusion of its Tuesday-Wednesday meeting, it would leave the funds rate at just 1%.

Ironically that same ultra-low rate in 2003 and 2004, and the slow pace of tightening after, has been blamed in some circles for the housing bubble that led to the economic and financial storm gripping the world right now.”

Tips for savers, as another Fed rate cut looms

“But here’s some good news: Even as the Fed gets ready to cut its benchmark rate again this week, you still have time to lock in CD yields. Many banks haven’t been moving very fast recently, if at all, to reduce what they pay depositors.”

RW: Good advice, unless you’re money is in an online saving account that takes 3 business days to transfer.

(Update1) TARP: Troubled Automaker Relief Program?

“The Treasury Department confirmed this week that no money would be diverted from TARP funds; that money had been designated solely for capital infusions to banks and insurance companies only.”

RW: Come on guys, share and share alike…..

RW: A nice discussion of the yen carry trade: Carry Trade Carnage

Helicopter Ben makes good on nickname

A Poem, by yours truly:

Real estate was
The way to get rich.
Just buy a home
And give it a flip.

If you bought more house
Than you can afford,
Helicopter BenWill dump cash your door.

He's Helicopter, Helicopter,
Helicopter Ben,
The money-throwing man
Who works at the Fed.

Money from the clouds,
Money from the sky,
Manna from heaven,
Thank that helicopter guy.

RW: Very cute, James!

Led Zeppelin Will Tour Without Plant

“Led Zeppelin are planning to tour and record with a replacement for frontman Robert Plant. "We are trying out a couple of singers," said bassist John Paul Jones.”

RW: Just not seeing how that could work. Would U2 go on stage without Bono? I don’t think so..

Stars Turn Out for Paul Newman Benefit

RW: Yup, FOX actually thinks that is news. Duh, I love that movie: Butch Cassidy and the Sundance Kid, but not b/c Paul Newman is in it….oh yeah, the young days of Robert Redford.

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A 50bps cut is just for show

Tomorrow the Federal Open Market Committee (FOMC) – the group in charge of the Fed's open market operations – meets to set the new federal funds rate target. The federal funds rate target is the rate that the FOMC controls by adding or extracting money from bank reserves in order to push the interest rate that banks pay on overnight loans between each other (the effective federal funds rate) either up or down.

Outcomes of the FOMC meeting are:

(1) Leave the target at 1.5% - unlikely
(2) Raise the target rate – epsilon possibility (really, really small)
(3) Lower the target rate – likely outcome.

The market believes a rate cut is all-but a certain outcome – with 50bps to 1.0% being the expected target. From Reuters :
”U.S. short-term interest rate futures were higher on Tuesday, underlining expectations for an aggressive rate cut from the Federal Reserve this week, after a severe drop in consumer confidence.”
This is a good idea, but not because the Fed will actually increase the monetary base - because the effective rate is already at or below 1%.

The effective rate has been trading well below the Fed’s target – currently at 1.5% - since 10/10/2008. The Fed has increased interbank liquidity in order to jumpstart lending (the size of the Fed’s balance sheet is almost $1 trillion larger than it was just one year ago), and without counteracting the positive effects of the liquidity measures, the Fed is allowing the effective rate to run below its target. Thus, a 50bps cut is just for show. However, the effective funds rate will always trade at least 35 bps lower than the target rate for as long as the Fed pays interest on excess reserves.

However, I don’t believe that if the Fed targets 1% that it will let the effective rate fall to zero; that is not credible. All a 50bps cut would do is to give the Fed a little credibility back, and push the differential between the target federal funds rate effective federal funds rate back to 35 bps (it is currently at 0.58%).

Rebecca Wilder

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This cycle may get to 1980s low; unlikely according to cyclical unemployment

I received some comments regarding different measures of unemployment when I predicted that the unemployment rate would not rise above 10% in this cycle; specifically, how some measures are already reporting 11%. However, these measures do not give any new information. The best measure to identify the depths of the recession is cyclical unemployment. At 10%, the cyclical unemployment rate implies a recession that tops the 1980s, and since growth is not forecasted to reach such lows, 10% is an upper bound.

Admittedly, there are huge risks that the unemployment rate actually reaches this level, and the biggest being the failure of the Fed’s and Treasury’s measures to instill confidence in the banking sector. However, assuming that they do, 10% implies high excess unemployment (cyclical), surpassing that following the 1980-1982 recessions when the unemployment rate reached 10.7% in January of 1983.
The chart illustrates quarterly cyclical unemployment spanning the years 1975, quarter 1 to 2008, quarter 3. Cyclical unemployment is the difference between the current unemployment rate and the non-accelerating inflation rate of unemployment (NAIRU), or the natural rate of unemployment. The current unemployment rate, 6.0% in the third quarter (average over July, Aug, and September), is 1.2% higher than NAIRU, 4.8%. Thus, the cyclical unemployment rate is 1.2%.

The current cyclical unemployment implies that this recession may be more severe than that in 1990-1991. The recession likely started in July 2008 (third quarter) and cyclical unemployment was 1.2%, which is higher than cyclical unemployment entering the recession of 1990, -0.1% (the current rate of unemployment was slightly lower than the NAIRU level).

If the cycle peaks at 10%, the current recession may be just as, if not more, severe compared to the recessions in 1980-1982. During 1980-1982, when economic growth hit a cyclical low of -7.8% in 1980, and the cyclical unemployment rate hit 4.58%. If unemployment hit 10% during this cycle, then the implied cyclical unemployment is, 5.22% = 10% - 4.8%, which exceeds the 1980-1982 cycle high.

I have not seen a forecast where growth approaches the levels implied by the 1980-1982 recession. Thus, 10% is likely too high for this cycle, and a worst-case scenario because growth is just not expected to be -7.8% for any quarter in the near term.

I am sure that some are going to refer to the U-6 measure of unemployment, which is currently 11% and already exceeds my forecasted peak of 10%. This measure estimates the unemployment rate, calculated as unemployed plus part-time for economic reasons plus marginally-attached workers all divided by the labor force plus marginally-attached workers. This level is higher than the headline unemployment rate at any given time and adds no new information to the severity of this cycle.

The best way to assess the severity of a recession is to use cyclical unemployment because NAIRU changes over time. And if we do reach 10% unemployment, the U.S. economy is looking at a nasty recession – worse that the 1980-1982 cycle. The risks that this recession does reach such lows are ubiquitous, but venerable forecasters (like Macro Advisers) do not see the U.S. economy reaching such depths.

Rebecca Wilder

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How can a 4-yr low of the $C not bolster Canadian exports?

Monday, October 27, 2008

From Bloomberg:

”Former Canadian Finance Minister John Manley said exporters may not benefit from a weaker currency because of a lack of consumer confidence in the U.S., Canada's main market.

``The lower dollar helps, but if the U.S. consumer is staying home, it doesn't really matter,'' Manley told reporters after a speech today in Ottawa. ``If they aren't buying anything it doesn't really matter what our exchange rate is.''

The Canadian currency is headed for its worst monthly drop since at least 1950, depreciating 17 percent since Sept. 30, as prices of exported commodities have declined. The Bank of Canada on Oct. 23 forecast ``sluggish'
' economic growth over the next few quarters because of the U.S. recession and the global credit crisis.”
RW: It seems like a bit of a stretch to say that lack of consumer confidence will offset this:

Canada’s exports will surely boom if the $USD maintained these levels. It’s not like we are buying mostly jewels from Canada – we are buying energy, car parts, tourism (skiing), or timber. Those goods are bound to sell well in spite of low consumer confidence, which consequently, was already low before the exchange rate surged.

Rebecca Wilder

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You think this is bad? Wait another 10 or 20 years!

As you all well know, I do not believe that the current U.S. recession is ever going to be named the Great Depression 2. Growth is likely to be negative for at least two consecutive quarters (third quarter GDP is released this Thursday), the labor market is sure to post its tenth consecutive month of job loss in October, weekly data indicate that lending to consumers and firms is declining, but that is all regular recessionary activity. Eventually, and especially with the massive amounts of liquidity and spending that the Fed and the Treasury are pumping into the economy, economic growth will turn around with some force.

I have to concur with Ben Bernanke:
"But I strongly believe that the application of these tools, together with the underlying vitality and resilience of the American economy, will help to restore confidence to our financial system and place our economy back on a path to vigorous, healthy growth.”

However, the sizable fiscal stimulus policies undertaken over the last year (really over the last decade) give me much more angst about the future of the U.S. economy than do the near-term risks (current recession). Provided that the banking sector does not crash, households and firms will be forced to delever in the near term – they almost always do in a recession – but what happens when our government is forced to delever in 10 or 20 years? Or worse, if it does not pay down its debt and weakness in the financial markets is again realized, and another asset blowout occurs? According to Aruthur Laffer in the Wall Street Journal's The Age of Prosperit is Over, that will hurt much more than our current economic suffering.

From the Wall Street Journal:
"About a year ago Stephen Moore, Peter Tanous and I set about writing a book about our vision for the future entitled "The End of Prosperity." Little did we know then how appropriate its release would be earlier this month.

Financial panics, if left alone, rarely cause much damage to the real economy, output, employment or production. Asset values fall sharply and wipe out those who borrowed and lent too much, thereby redistributing wealth from the foolish to the prudent. This process is the topic of Nassim Nicholas Taleb's book "Fooled by Randomness."

David GothardWhen markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses.

No one likes to see people lose their homes when housing prices fall and they can't afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction. If the house's value had appreciated, believe you me the overleveraged homeowner and the overly aggressive bank would never have shared their gain with taxpayers. Housing price declines and their consequences are signals to the market to stop building so many houses, pure and simple.

But here's the rub. Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and inject capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy. And the government doesn't create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved.

If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street.

Some 14 months ago, the projected deficit for the 2008 fiscal year was about 0.6% of GDP. With the $170 billion stimulus package last March, the add-ons to housing and agriculture bills, and the slowdown in tax receipts, the deficit for 2008 actually came in at 3.2% of GDP, with the 2009 deficit projected at 3.8% of GDP. And this is just the beginning.

The net national debt in 2001 was at a 20-year low of about 35% of GDP, and today it stands at 50% of GDP. But this 50% number makes no allowance for anything resulting from the over $5.2 trillion guarantee of Fannie Mae and Freddie Mac assets, or the $700 billion Troubled Assets Relief Program (TARP). Nor does the 50% number include any of the asset swaps done by the Federal Reserve when they bailed out Bear Stearns, AIG and others.

But the government isn't finished. House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid -- and yes, even Fed Chairman Ben Bernanke -- are preparing for a new $300 billion stimulus package in the next Congress. Each of these actions separately increases the tax burden on the economy and does nothing to encourage economic growth. Giving more money to people when they fail and taking more money away from people when they work doesn't increase work. And the stock market knows it.

The stock market is forward looking, reflecting the current value of future expected after-tax profits. An improving economy carries with it the prospects of enhanced profitability as well as higher employment, higher wages, more productivity and more output. Just look at the era beginning with President Reagan's tax cuts, Paul Volcker's sound money, and all the other pro-growth, supply-side policies.

Bill Clinton and Alan Greenspan added their efforts to strengthen what had begun under President Reagan. President Clinton signed into law welfare reform, so people actually have to look for a job before being eligible for welfare. He ended the "retirement test" for Social Security benefits (a huge tax cut for elderly workers), pushed the North American Free Trade Agreement through Congress against his union supporters and many of his own party members, signed the largest capital gains tax cut ever (which exempted owner-occupied homes from capital gains taxes), and finally reduced government spending as a share of GDP by an amazing three percentage points (more than the next four best presidents combined). The stock market loved Mr. Clinton as it had loved Reagan, and for good reasons.

The stock market is obviously no fan of second-term George W. Bush, Nancy Pelosi, Harry Reid, Ben Bernanke, Barack Obama or John McCain, and again for good reasons.

These issues aren't Republican or Democrat, left or right, liberal or conservative. They are simply economics, and wish as you might, bad economics will sink any economy no matter how much they believe this time things are different. They aren't.

I was on the White House staff as George Shultz's economist in the Office of Management and Budget when Richard Nixon imposed wage and price controls, the dollar was taken off gold, import surcharges were implemented, and other similar measures were enacted from a panicked decision made in August of 1971 at Camp David.

I witnessed, like everyone else, the consequences of another panicked decision to cover up the Watergate break-in. I saw up close and personal Presidents Gerald Ford and George H.W. Bush succumb to panicked decisions to raise taxes, as well as Jimmy Carter's emergency energy plan, which included wellhead price controls, excess profits taxes on oil companies, and gasoline price controls at the pump.

The consequences of these actions were disastrous. Just look at the stock market from the post-Kennedy high in early 1966 to the pre-Reagan low in August of 1982. The average annual real return for U.S. assets compounded annually was -6% per year for 16 years. That, ladies and gentlemen, is a bear market. And it is something that you may well experience again. Yikes!

Then we have this administration's panicked Sarbanes-Oxley legislation, and of course the deer-in-the-headlights Mr. Bernanke in his bungling of monetary policy.

There are many more examples, but none hold a candle to what's happening right now. Twenty-five years down the line, what this administration and Congress have done will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932. Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity."
Rebecca Wilder

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Consumption back to 62% of GDP?

The primary argument supporting the worst recession since the Great Depression is that U.S. households are horribly overly leveraged, and will soon be forced to reduce their debt burden. In the second quarter, the average household debt service payment was 6.12% of GDP, down from an unsustainable 6.33% in the first quarter.

In this case, reduced consumption – increased saving - will result in several negative quarters of growth, but following an arduous transition, growth will eventually resume. The dollars used to consume are transferred to the investment or export sectors – expanding businesses, infrastructure, roads – and eventually GDP growth rebounds. The economic transition, however, is arduous.

So will we return to 1960s-style consumption rates, or 62% of GDP?


Because asset prices and home values are falling?

I suspect that yes, saving will rise for many consumers, but the aggregate effect depends on whose saving is rising. In the 1990s - when household consumption as a share of GDP rose substantially with a surge in equity values - personal saving fell, but only for about 20% of the income distribution. Studies show that in the 1990s, 40% of the income distribution actually increased saving rates, while the aggregate personal saving rate fell. So as long as the top households in the income distribution do not significantly reduce saving, and even though saving will rise for the majority of the population, aggregate personal saving rate should not rise substantially.

However, record losses in wealth are bound to pass through to consumption even for the wealthy, and consumption growth is likely to be negative in the third and fourth quarter. So the real question is the following: Does one expect aggregate consumption to fall back sharply, and for those who are calling the worst recession since the Great Depression, back to its level in 1960s when it was just 62% of GDP? I suspect not. Even reducing consumption back to levels in the 1980s – consumption at 64% of GDP – implies saving would be in the 5%-10% range (see this post).

The risks are severe, with the credit markets still in disarray and the next shoe getting ready to drop on consumer credit, and my scenario depends on the stabilization of the credit markets. But don’t forget about the recent sharp drop in gas prices. This is good news, especially heading into winter. Consumption suffers like it has in every recession, but this time around some of the consumption loss will be offset by gas prices that are back to one penny cheaper than year.

Finally, many are barking at how saving is going to rise, but would it be so bad if saving did rise back to 1980s ? Economic growth suffers in the short term, but going forward, the economy sits on a more solid foundation – with strong investment spending and a financial focus on the future (a transition to investment spending).

Rebecca Wilder

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Beware: Current government mortgage relief efforts may be much costlier compared to similar efforts in the Great Depression

Saturday, October 25, 2008

Great paper by David Wheelock (2008) at the St. Louis Federal Reserve Bank, Government Response to Home Mortgage Distress: Lessons from the Great Depression. Wheelock provides a detailed analysis of the housing market crash during the Great Depression, with a focus on the governments’ – state and federal – responses to the housing downturn.

He concludes that the unmeasured costs of government actions are important: state foreclosure moratoria reduced the aggregate supply of loans, while the federal response - purchasing delinquent mortgages - may have encouraged risky lending. The U.S. economy does not mimic the days of the Great Depression, but nevertheless, the government is moving forward (it has already started) with its response to the housing market crash, and economic costs will result. I suspect that following the election, there will be a more microeconomic response involving similar policies to those taken in the Great Depression to aid delinquent mortgage loans directly. But remember, there are always winners and losers, and as Wheelock (2008) suggests, there may be more losers this time around.

I will highlight some of the points here of Wheelock’s paper, but it is definitely worth a read. Housing market statistics in the Great Depression:
  • Home values peaked in 1926 (well before the 1929 crash).
  • Between 1929 and 1933, foreclosures rose from 134,900 to 252,400 – almost double.
  • Foreclosure rates rose to 13.3% of every 1,000 mortgages in 1933; in 1933, about 1,000 foreclosures occurred every day.
  • Between 1929 and 1933, personal income fell 41%, wealth declined 25.7%, and with declining home values, mortgage debt was difficult to pay off and foreclosure rates soared.

Government responses to rising foreclosure rates:

  • The first response included encouraging parties involved (borrowers and lenders) to reassess the terms of the loan, but when that didn’t work, the governments stepped in.
  • State-level responses included the modification of foreclosure laws and 27 states offered explicit foreclosure moratoria; Iowa was the first to enact a mortgage moratorium.
  • Foreclosure rates fell immediately – the desired benefit - and many argue that the social benefit outweighed the economic costs, which include:
  • A short-term redistribution of wealth from the lender to the borrower.
  • Longer term, lenders restricted loan availability, and mortgage loans became more difficult to obtain at higher rates.
  • Among other programs, the federal response to the housing crash was the creation of the Home Owners’ Loan Corporation (HOLC); it was established in 1933 and eventually purchased and/or refinanced 1 million loans during the great depression.
  • By 1935, the HOLC held nearly 19% of all mortgage debt on single to multi family homes.
  • 20% of the 1 million refinanced mortgages by the HOLC ended in foreclosure, and relative to other lenders at the time, this rate was low.
  • The HOLC was initially capitalized by $200 million and turned a profit thereafter.
  • There is evidence that the enactment of the HOLC encouraged risky lending, but overall, the program likely improved housing market conditions, although some evidence suggests otherwise.

And finally, a quote from the article:

“However, the Great Depression experience may not be especially relevant for addressing how a taxpayer bailout of delinquent borrowers and their lenders would affect behavior today because of differences in the underlying causes of mortgage distress during the two periods. Conceivably, a bailout would more likely encourage risky behavior in the present situation [2008] (in which lax underwriting was an important cause of the increase in defaults) than during the Depression (when a sharp decline in economic activity was the main cause of defaults). Thus, while the federal response to mortgage distress during the Great Depression provides insights about how the government might respond to the current wave of defaults, the very different conditions underlying mortgage distress during the two periods warns against drawing strong conclusions from the historical experience for the current episode.”

RW: Point: the implicit economic costs associated with a bailout of foreclosures in response to the recent housing downturn may be huge, larger than those of the Great Depression. Beware, because our Democratic Congress is on fire: second stimulus plan, new banking regulation, talk of foreclosure moratoria, buying mortgages at risk of foreclosure, and more.

Wheelock (2008) further reiterates how far from the Great Depression is the current macroeconomy. The stock market crash in 2007/2008 is similar to that in 1929 and serious – second only to the crash that preceded the Great Depression – but the macroeconomy does not incorporate the same stress signals as were present in previous crash environments. The unemployment rate is just 6.1% (it grew to 25% in the Great Depression) and real personal income grew 0.3% over the year (compared to a 41% decline from 1929-1933).

There’s a lot of spare capacity building in the U.S. economy – with more to come in the fourth quarter – and once the labor and housing markets starts to stabilize, the economy will take off. Further, with the help of the Fed and the Treasury to mitigate the near-term recession, when the U.S. economy starts to expand again in 2009 (provided the banking sector continues to stabilize in the near term), the recovery will be quicker than most are speculating because there will be a lot of labor and firm investment just sitting around, ready to produce again.

Rebecca Wilder

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America’s worst market crashes: 2008 is number 9 but economy is much stronger than that

U.S. and global equity indices are low – the Dow closed at 8,379 on Friday, marking its lowest point in 5.5 years. What many do not know, is the recent crash – a high of 14,164 on 10/9/07 to a low on Friday 10/25/08 of 8,379 – marks a 41% drop over the year. And that is the ninth biggest crash since 1901 (click on chart to enlarge).

Although the crash has been significant, I do not believe that the U.S. economy is going to sink into a 43 month recession (the Great Depression). First, Congress, the current Administration, and the next Administration will do everything in their power to prevent a crash of the U.S. banking system and economy. The U.S. Treasury – backed by Congress and President Bush – have initiated recapitalization and spending efforts that are unmatched in U.S. history and slowly melting the ice in the credit markets. The next Administration – Obama or McCain – is certain to approve a second stimulus plan, designed (hopefully more intelligently than the rebate program) to jumpstart the U.S. economy. In this light alone, I cannot imagine a workable scenario where unemployment rises above 10%.

Second, the Fed is taking its own unprecedented measures to tackle the banking crisis. As it acquires an ever-growing stock of illiquid assets – it’s balance sheet has doubled over the last month – the banking system is breathing a very slight, but nevertheless positive, sigh of relief. There is so much liquidity in the banking system that the effective federal funds rate (the interest rate that banks pay when they loan to each other) is down to 0.93%, which is 0.57% below the Fed’s 1.5% target. That money will eventually flow through to consumers and businesses; however, loan growth will slow as is the usual case in a recession.

I know that I sound particularly sanguine about the future of the U.S. economy – especially against a backdrop of negative outlooks, but that is just what I believe about the foundation on which the U.S. economy is built. Our labor market is solid - adding jobs in sectors with high productivity, our current policy makers are credible – initiating expansionary measures when needed, foreigners continue to flock to our asset markets – the $US is off-the-charts strong, and inflation has remained stable over the last 20 years.

There’s a lot of spare capacity building in the U.S. economy – with more to come in the fourth quarter – and once the labor and housing markets stabilize, the economy will take off.

Rebecca Wilder

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Chinese exports to the U.S. set to remain strong

Friday, October 24, 2008

China slowed to 9% annual growth in the third quarter of 2008, but I expect China to be more resilient to the global slowdown than is commonly reported. Some are predicting a hard landing – 7.5% annual growth – but I expect China to survive just fine because U.S. import demand is set to remain strong.

The Yuan is appreciating against a broader basket of currencies, but remains depreciated against the U.S. dollar ($US).


As the world flocks to the safety of the popular $US, it is appreciating relative it’s other trading partners. This is going to serve as a backstop in the near term for exports to its most precious export market…the United States of America. Chinese exports to the U.S. will fall slightly with reduced U.S. income, but the reduction in growth will be mitigated by the surging $US.

U.S. import demand for Chinese goods is resilient during a recession.

In spite of an 8-month recession in 2001 and a deteriorating labor market through 2003, U.S. demand for Chinese imports remained strong. Further, and in spite of record import prices 2008, annual U.S. imports of Chinese goods surged since April 2008 to a huge 8.1% annual growth ending in August 2008.

Exports will certainly slow, as key countries – Japan, U.K., Eurozone – experience reduced growth. However, China’s export revenues coming from its golden market – the U.S.A. – are likely to remain strong. Along with new expansionary policies already being put in place.

Rebecca Wilder

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Real estate to rebound in 10 markets

Thursday, October 23, 2008

I am not the only one who is more sanguine on the outlook for the housing market. This is from Forbes:

Believe it or not, in the future people will be buying and selling homes. Some of them will even make a profit.

It's not so crazy an idea. Consider Albuquerque, N.M. The mid-sized Southwestern city has experienced housing price declines since a peak in the third quarter of 2007, job growth has been flat, and housing starts are expected to fade by 45% through the end of 2008. Nevertheless, it's a city that home builders and economists are bullish about for 2010 and beyond.

According to analysts at Moody's Economy.com, Albuquerque's job growth through 2012 is projected at an average annual rate of 1.6%, fueled in large part by its low costs and local business expansion. Housing starts in the city are expected to reverse course in 2009, growing by 26.6%, according to the National Association of Home Builders (NAHB). This means builders have high hopes for 2010 and 2011, when those homes will be completed and on the market.

It's the same story in several other cities: more tough times to come in the short term, but potential for a recovery and a rise in prices in the long term.”
RW: Being bullish about a recovery means that prices had already stabilized by 2010 and are rising amid a stronger housing marker – a.k.a., a healthier market. All we need is a stabilization of home values prices, which are likely to occur mid 2009 or at least, “many months in the future,” from now (which could certainly be mid 2009) according to Alan Greenspan.

Forbes highlights bull opportunities for home building in 10 markets. If they are bullish about 10, then eventually, they will be bullish about 20, and then 30, etc. Housing will rebound, and there are signs out there that a stabilization will happen sooner than the well-reported later, 2010.

The 10 markets where home prices are likely to rise:

1. Albuquerque, New Mexico
2. Charlotte, North Carolina
3. San Antonio, Texas
4. Portland, Oregon
5. Austin, Texas
6. Salt Lake City, Utah
7. Colorado Springs, Colorado
8. Minneapolis, Minnesota
9. Atlanta, Georgia
10. Oklahoma City, Oklahoma

Rebecca Wilder

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Home sales may have already bottomed

The housing market continues to haunt the economy and the banking sector, with foreclosure filings up 71% over the year. Consumer wealth is and has been declining substantially, with home values and equity values in a free fall, job losses mount, and the economic downturn is now showing its ugly face in the hard economic data. Going forward, the housing market faces stronger headwinds with falling incomes and stressed credit conditions, but it will recover.


With Fannie Mae and Freddie Mac now explicitly backed by the U.S. government, there is no reason that this market will not “stabilize.” Eventually, home buying will be so affordable that resisting would be futile.

On Friday we get another piece of the housing market puzzle, September existing home sales, which are expected to post positive monthly growth with the leading indicator - pending home sales - posting a 7.4% surge in August. You know my thoughts on the pending home sales report, so I look at high frequency data for better clues.

Mortgage Rates were declining quickly in August

The chart illustrates the weekly 30-year fixed conventional mortgage rate – in levels and the 4-wk. moving average – since the beginning of the year. Mortgage rates fell in August and September, increasing the affordability of a home buying. Provided that lending standards are not too tight, home buying should rise with demand.

Mortgage Applications were rising in August

The chart illustrates the weekly change in the number of mortgage applications – in levels and the 4-wk. moving average – since the beginning of the year. Mortgage applications rose through September 12, indicating that consumers are jumping on the increased affordability. Provided that applicants with proper income credentials are approved, home buying should rise.

On Friday, I expect that the existing home sales will post a slight increase, perhaps as much as 1-2% since August. However, for the same reasons that I argue that existing home sales will post a September increase, October and/or November existing home sales may decline. In the charts above, mortgage rates started to ascend October and applications declined. This is slightly disconcerting when the entire U.S. economy is looking for signs of stabilization in the housing market.

I believe that the sales market has already bottomed

The chart illustrates the percentage change in existing home sales over the month and since last year. Monthly existing home sales have been extremely volatile since the beginning of the year. Potential homebuyers are slightly confused – reacting to any market shift in prices, interest rates, or lending standards. However, on an annual basis, existing home sales are slowly ebbing back from a decline over the year (sales got as low as -23% over the year in February) to simply no growth (sales were down -10% over the year in August). And at some point – likely late next year – growth will likely be slightly above zero.

The longer-term trend indicates that sales have already bottomed. On a monthly basis, October and November may post negative numbers, but that will probably be an aberration in the data. Credit conditions are slowly stabilizing, and when the banking sector does initiate a more normal business environment (however, slight that may be), bankers will make mortgage loans.

However, huge risks abound. This morning, Bloomberg reports that foreclosure filings are still increasing sharply – up 71% in the third quarter of 2008 since last year, and there is still a lot of supply to work off. Just because existing home sales are slowly ebbing back to “no growth” over the year, doesn’t mean the market is healthy.

The bigger they come the harder they fall, and the housing monster was big. However, it is nice to see baby steps toward a recovery in sales, which by the way, is just the first step.

Rebecca Wilder

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OPEC: To cheat or not to cheat....

Wednesday, October 22, 2008

The Organization of Petroleum Exporting Countries (OPEC) meets on Friday in Vienna. What are they fighting? An oil bear market, where prices fell to their lowest levels in over a year; the oil Czars are nervous.

From CNNMoney:
"When the Organization of Petroleum Exporting Countries meets at its Vienna headquarters on Friday it will be reminded of just how slippery oil prices can be, and how little control the cartel has over the price of oil.


Faced with a the possibility of a global recession and a sharp decline in energy demand, OPEC will discuss slashing oil production in an emergency meeting.

OPEC president Chakib Khelil, Algeria's oil minister, said there could be a "significant" reduction in the organization's daily output of 29 million barrels.

The organization considers the market to be oversupplied by two million barrels a day, but it has yet to agree on the size of the cut. This lack of agreement could hinder its efforts to control prices.

"Two million barrels a day is a very big number and it's not that easy to do," said Joseph Stanislaw, an energy expert and independent senior advisor at the consultancy Deloitte & Touche. "It's possible. It's doable. But the question is how long it takes them to agree."
And later in the article:
"Most [OPEC] members have planned massive infrastructure projects on the assumption that high oil prices will continue," wrote Anas Alhajji, chief economist for NGP Energy Capital Management, in an email to CNNMoney.com. "If they cut production in the current environment, revenues will decline and they might not be able to finish these projects."

One of OPEC's biggest hurdles as it tries to stem the fall in oil prices is getting all its members to agree to a plan and to stick to it, said Alhajji."
RW: Expect a production cut, but also expect member countries to cheat. With spending projects in the pipeline, there is a strong incentive - especially coming from the smaller countries - to raise production slightly and attempt to steal market share from the remaining OPEC countries.

Rebecca Wilder

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The effective fed funds rate is getting close to 0%; the Fed raises interest on reserves

Today, the Federal Reserve announced that it would increase the interest paid on bank excess reserves that are held on the Fed's balance sheet. The rate rises from the lowest FOMC target rate minus 0.75% to the lowest FOMC target rate minus 0.35% (target minus 0.35%, which is 1.15%), an increase of 40 basis points.

The Federal Reserve began paying interest on excess reserve balances on October 6 in an effort to maintain a lower bound on the effective federal funds rate, which was trading well below target following the Fed’s unprecedented liquidity measures over the last month.

By paying interest on excess reserves, the Fed increases the incentive for a bank to hold excess reserves with the Fed. This reduces the amount of interbank lending, and and increases the effective federal funds rate. The move, in theory, sets a lower bound on the effective federal funds rate.

Apparently the Fed was not paying enough reserve interest because the effective rate has been trading low, 0.67%, which is well-below the Fed’s target, currently 1.5%. The increased interest payments on excess reserves should increase the reserves held with the Fed, and drive up the effective federal funds rate. However, this is a new policy tool, and the correct rate still needs to be hammered out by the FOMC.

According to Bloomberg, Ben Bernanke said this about the policy measure:
“We're not quite sure what we have to pay in order to get the market rate, which includes some credit risk, up to the target,'' Bernanke told economists Oct. 7. ``We're going to experiment with this and try to find what the right spread is.'
RW: Hopefully they get it right because the current level of the effective rate doesn't leave a lot of room for an expansionary rate cut at the FOMC's next meeting.

Rebecca Wilder

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TAF vs. Discount Window

The Federal Reserve announced $600 billion in new TAF funds on October 7, 2008 to be auctioned in four increments throughout the rest of the year. The Term Auction Facility (TAF) is a new Fed policy tool – one of the 6 added since December 2007, totaling 9 policy tools – and is the Fed’s favorite liquidity measure. Going forward, the TAF is probably here to stay, whereas other new lending facilities – e.g., the Primary Dealer Credit Facility – will be repealed once the credit markets have stabilized. However, I am slightly perplexed by the TAF. On average, it’s terms do not appear to be any more attractive than those at the discount window, so I must conclude that the discount window still has the stigma of “lender of last resort” attached to it.

Why would a bank participate in the TAF auction, rather than borrowing at the discount window?


According to the Fed, here are the stipulations of TAF:
1. The auction allows the Fed to offer funds through a broader range of counterparties (the regional banks, I suppose), while accepting a broader range of collateral (anything other than T bills).
2. The loan matures in either 28 days or 84 (85) days.
3. The stop rate (the interest on the loan) is determined through an auction process.
4. Only banks eligible for primary credit qualify to bid.

The loan terms at the primary discount window and through the TAF auctions are very similar. The primary discount window makes loans (primary getting the better rate) for a term of up to 90 days – same as the TAF in some cases. Only primary credit banks can participate in the TAF auction, where most of the loans made at the discount window are to primary credit banks.

Relative to the size of the discount window ($100 billion as of 10/15/08), TAF lending is massive ($438 billion), and the difference must be accounted for by one of two things: (1) the interest rate for TAF loans must be lower than at the discount window, or (2) the discount window still has the pejorative meaning of “lender of last resort.”

Recently, the Fed took actions to purge discount lending of its negative meaning, so it must be the interest rate.

The chart illustrates the stop-out rate (interest rate on the loan) for the TAF funds and the primary discount rate since the beginning of the year. Since the beginning of the year, there have been 23 TAF auctions with funds ranging from $25 billion to $150 billion, and only 9 times have the auctions resulted in a lower rate than the discount window. And sometimes – 9/22/08 - the auction results in a 150bps spread between the TAF lending rate and the Fed discount rate. The numbers do not indicate that the TAF funds offer a better “deal” than does the discount window

(click to enlarge on image below; Source: Federal Reserve).

I can only conclude that the auction-style of the TAF window offers two incentives over the discount window: (1) the expected stop rate faced by the depository institution is lower than the discount window, and (2) the pejorative “lender of last resort” meaning is not attached to the TAF auction.

Rebecca Wilder

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Pelosi and Bernanke do not support the same stimulus package

Tuesday, October 21, 2008

Ben Bernanke said this on a second fiscal stimulus:

“Finally, in the ideal case, a fiscal package would not only boost overall spending and economic activity but would also be aimed at redressing specific factors that have the potential to extend or deepen the economic slowdown. As I discussed earlier, the extraordinary tightening in credit conditions has played a central role in the slowdown thus far and could be an important factor delaying the recovery. If the Congress proceeds with a fiscal package, it should consider including measures to help improve access to credit by consumers, homebuyers, businesses, and other borrowers. Such actions might be particularly effective at promoting economic growth and job creation.”
Pelosi said this on her stimulus package:
“In September, the House passed an economic recovery package that would create and save jobs by building a 21st century infrastructure, extend unemployment assistance and protect health care services for working families. Unfortunately, President Bush threatened to veto the recovery legislation and Senate Republicans blocked it.

Congress must try again. That is why I have asked the chairs of relevant committees to schedule hearings in the coming weeks on the key provisions of a fiscally responsible recovery package to get our economy moving again."
RW: I am not seeing how the two jive…at all. Bernanke calls on the house to consider a targeted package that includes responsible fiscal spending, especially in the area of job creation, and the promotion credit flow to consumers and firms. Pelosi’s approach is not targeted – she wants to create and save jobs with new infrastructure (??), extend unemployment assistance (which, by the way does not, in any way, create jobs), and protect health care services for working families – nor does it address spending to promote new credit for businesses and consumers.

Bernanke must be champing at the bit right now because Pelosi came out with this statement yesterday:
Chairman Bernanke made it clear that a new economic recovery package is critical to boost our weakening economy. In testimony today before the House Budget Committee, Chairman Bernanke added his voice to the chorus of economists, experts and policymakers who insist that America needs a job-creating recovery package to get our economy back on track and to restore consumer and investor confidence."
RW: Bernanke supports a new economic recovery package, but not her economic recovery package.

Rebecca Wilder

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The paradox: Interbank credit showed only minimal signs of stress

Yesterday, 10/20/08, credit markets breathed a big sigh of relief, but U.S. interbank lending never froze up - at least in the data. I will let John Jansen at Across the Curve explain the financial indicators:

”Prices or Treasury coupon securities posted bifurcated results today as the return to normalcy continued with a vengeance. I have chronicled in other postings the improvement in the corporate bond market as well as in mortgages and agencies. The price action in the Treasury market echoes those results. One bill trader with whom I just spoke made the comment that the market is “doing the thing that hurts the most people. In his market that means higher bill rates. Three month bill and six month bill rates climbed over 30 basis points today and everyone is now a seller….

The yield on the benchmark 2 year note jumped 10 basis points to 1.71 percent. Other benchmark securities experienced declining yields. The yield on the 5 year note slipped 2 basis points to 2.81 percent. The yield on the benchmark 10 year note declined 7 basis points to 3.86 percent and the yield on the 30 year bond decreased 7 basis points to 4.25 percent.

The 2year /10 year spread is about 215 basis points after trading as wide as 240 basis points last week.

The 2year/5year/30 year butterfly moved to 33 basis points from 27 basis points Friday. That indicates the richening of the 5 year note against the wings of the butterfly.

The significant flattening of the yield curve and the decline and fall of the 2 year note reflects participants shifting views that tr
ades premised on a view that financial Armageddon is nigh now lack profit potential. The entire student body is racing to the other side of the bus."
Point: Bond market jargon with the following point: Generally, credit conditions are improving. Two illustrations of credit markets conditions (click on graph to enlarge):

andBut what I am wondering is: Did interbank lending show the stress implied by the financial indicators? According to the Fed's data, not really.

The chart illustrates weekly growth in commercial interbank lending in the U.S. over the year. I expected lending to show significant signs of stress - given the recent banking crisis - where the series would generally decline since September (money markets froze the week ending 9/19/08).

However, interbank lending only declined for two weeks (so far, the last data point is 10/8). Interbank lending declined sharply in the week ending 9/24/08 and falling further the week ending 10/1/08. This correlates with high stress in the banking system when the House voted down the first draft of TARP.

But interbank lending recovered precipitously in the week ending 10/8/08. If anything, I would describe interbank lending as only slightly stressed during the heat of the crisis. This is truly amazing, given the sharp increase in bank reserves (see chart from last week's post).

The financial indicators are coming back in line with interbank loan data that never showed the extreme duress implied by the credit markets – only for two weeks did the loan data start to trend downward. I conclude that the biggest credit problems was not present in the interbank lending market (at least in this U.S. data), but with lending outside of the banking system: the money market and all loans tied to the Libor rate.

Rebecca Wilder

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My faves for the day

Monday, October 20, 2008

Despite Early OPEC Meeting, Some See Even Lower Oil Price Near Term

“A perennial problem is diverging interests among OPEC members. iran and Venezuela need high oil prices to make their sulfurous, heavy crude economically viable and are calling for cuts deep enough to keep oil prices above $80 a barrel; Saudi Arabia, which has far and away the most clout by virtue of the size of its reserves, also has far and away the lowest production costs and thus is less affected than other producers by price declines.”

Economists React: China’s Growth Is Slowing, Not Slumping

“The GDP figure isn’t particularly useful. It offers little granularity and is best used as a lagging indicator on the ‘direction’ of growth. It is also unclear to what extent Olympic-related factory closures and transport disruptions depressed the [year-to-year] growth rate. Moreover, there is tension in the monthly data. September’s PMI, fixed investment, and iron ore import growth all rose. But industrial production and steel production growth fell. The latter two may be signaling problems specific to the steel sector rather than the broader economy. … The upshot is that growth is slowing, but not yet slumping. – Ben Simpfendorfer, Royal Bank of Scotland"

RW: I was unaware that 9% annual growth was anywhere near slumping. Hasn’t Ben (the media) heard of the rule of 72? With 9% annual growth, income will double in 8 years!

Paulson: Bank capital plan is 'investment, not expenditure'

“This is an investment, not an expenditure, and there is no reason to expect this program will cost taxpayers anything. They will not only own shares that should be paid back with a reasonable return, but also will receive warrants for common shares in participating institutions.”

RW: At least Bernanke’s honest – he says that he cannot assure the profits will be made.

Agency Agony

“The agency market continues to be a vale of tears in search of buyers. Agency spreads are wider today despite improvement in other spread markets and improvement in funding markets. FNMA had scheduled an announcement of a benchmark note but decided to pass on the opportunity.”

RW: Payback’s a b- - ch!

Do Not Pass Go. Do Not Collect $200.

“Confused about how the crisis happened? Start by getting out your old Monopoly set, Tim Harford advises:
The game is one big property boom, funded by an overly generous central banker – a diagnosis many economists would also apply to the sub-prime crisis. Alan Greenspan, the Fed chairman who presided over the boom, was nine when Monopoly was widely published. It is not known whether he played the game as a child, but he seems to have taken inspiration from it somehow.
Maybe that's why I always ended up depressed after playing as a kid ...”

RW: I knew that there was a reason why I liked to play Monopoly. The rule: if you suck at Monopoly, then don't buy real estate! Remember the McDonald’s Monopoly game? Never won that either.

A Damascene Moment

“Tomorrow's Lehman CDS settlement remains one prominent possible thorn in the side of policy normalization. So risky markets may struggle to tack on much more upside until tomorrow's settlement is successfully resolved.

Assuming that does come to pass, Macro Man would not be surprised to see a decent rally in risky stuff. The combination of an easing of the worst of the crisis and the impending US election could give markets all the excuse they need to rally.”

RW: Kind of wish that he would explain the problem with Lehman’s CDS settlement, but at any rate, Macro Man is the best – super informative, and always refers to himself (could be a girl) in the third tense. Macro Man, if you’re out there, will you please explain the title? Damascus? Syria? What? I am sure that I am totally stupid by not knowing this.

And I knew that FOX would not let me down! Here is the classy news for the day:

Report: Halle Berry Says She Takes Control in Bed

Ttfn, Rebecca

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