Living La Vida Nada

cautionFrom the Federal Open Market Committee’s (FOMC) policy statement earlier today:

Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract.  Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending.  Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment.  U.S. exports have slumped as a number of major trading partners have also fallen into recession.  Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued.  Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability.  The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

It goes on to state that its goal is to bring long term rates down farther by buying “up to an additional $750 billion of agency mortgage-backed securities”, “$300 billion of longer-term Treasury securities over the next six months” and  “agency debt this year by up to $100 billion”.  The Fed is aggressively using its balance sheet to inject liquidity into the financial system since the already low fed funds rate target is technically as low as it can get now.  The Fed is hinting that we may be looking at the recession’s trough soon.  Given the release of today’s 1st Quarter GDP, we can only hope and pray.

From Market Watch:

The central bank’s Federal Open Market Committee said that spending has stabilized and that the pace of the downturn appeared to be somewhat slower. The economy could remain weak in coming month but policy actions and “market forces” were aligned to create a gradual upturn, the statement said.

Fed watchers saw little drama in today’s announcement.

“The only major difference between today’s statement and the previous one on March 18 is that today’s cited the fact that most evidence points to a slowing rate of economic decline. Anyone with two eyes and a brain knows this to be the case,” wrote Josh Shapiro, chief U.S. economist at MFR Inc. in a note to clients.

Economists had expected the policy-setting panel to maintain the status quo. The FOMC kept its target interest rate unchanged at an ultra-low 0%-to-0.25% range.

The economy has fared dismally over the past six months — collapsing by the sharpest rate in more than 50 years. The unemployment rate has spiked and business investment has slowed.

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The Chicago School v. The Rest of Us

skateThere’s a very big debate between economists that’s beginning to spill on to the pages of major newspapers.  Suddenly, people that I usually only read in scholarly articles are attending conferences where they give papers in what passes off more as the lessons of theory and empirical evidence instead of the theory and evidence itself.   So many folks are coming down out of the ivory towers these days that I think some kind of tipping point about the financial crisis has been reached.  The only thing I can think that may have caused this escalation is the back and forth that is now the blogosphere and the financial crisis which is making a lot of folks defend their models.

Many, many academic economists keep blogs now.  The readership of these blogs was originally every one’s students or the adopters of your textbook.  It then became a way to pass your working papers and pubs back and forth to avoid the journals.  Even a few folks have actually put their databases up for use by doctorate students.  Believe me, both a blessing and a curse having been in the position of having to reproduce a bunch of stuff I’d rather have not.  Many finance folks keep blogs because they make money giving advice to Wall Street Types and investors.  But their blogs have taken an interesting twist too.   Maybe it’s because I live blocks from the Mississippi and a few miles from a salt water lake but watching this back and forth is like watching the world’s longest intellectual and philosophical tennis match.  Do we really have to repeat the Great Depression for the Chicago School to get it this time?

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Yesterday, Teabagging, Today Sandbagging

nancy-pI can’t tell you how disappointed I am that America’s first woman Speaker of the House has turned into a player for all seasons.  First, we find out exactly how much she knew about the torture methods of the Bush Administration and when she knew about it.  Then she tells a big lie about it.  Rumors still abound that she was wanted Obama as POTUS because she could be the Queen Bee of Capitol Hill.  His lack of knowledge and experience was certain to put her in a position of power.  Too bad she is more of a demagogue than a democrat because if there was ever a chance to be the Queen of the Hill, it would’ve been with reform of the financial system.

Instead, we’re seeing her go after yet another woman who has tried to champion the voters/taxpayers over big party money.  A head line from Yves Smith at Naked Capitalism says it all for you: “On Pelosi’s Duplicity and Apparent Sandbagging of Elizabeth Warren, watch dog of the TARP”.  It’s a typical Capitol Hill soap opera if there ever was pelosiboarding01-copyone.  As appears customary with everything economic coming out of the democratic wing of our congressional whores,  Pelosi is siding with the financial services industry over the voters/taxpayers. Yves first reminds us of the strange dance surrounding the birth of TARP.  Remember, life was supposed to be different once the Democrats retook the Congress.

Recall how instrumental Pelosi was in getting the TARP passed. The widely mentioned gambit of Paulson getting on bended knee to plead for her support was a nice bit of theater to cover how readily she fell into line. The other justification for the Democratic leadership support was the claim that Treasury had given a closed door briefing to Senate and House leadership telling them the world would end if the TARP was not passed yesterday.

Some have suggested that Treasury provided data on the potentially disastrous money market fund withdrawals around the time of the Lehman failure (recall the death of Lehman led Reserve to break the buck). but that problem had already been addressed in September in part via the Fed providing non-recourse loans to purchase asset backed commercial paper, and more fully in October via yet another Fed facility. In other words, if the money market fund panic was indeed the scare tactic, the TARP was not the remedy.

But even if we give the devil its due, the performance of the Democratic leadership was pathetic. The most heinous aspect of the bill, putting the Treasury secretary outside the reach of law, was never cut back. The first draft, a doodle on a napkin, was offensive to democratic processes, the second draft added a lot more words but was still way too thin on basics, like objectives, criteria, procedures, and the final draft loaded tons of pork in to assure passage. And the ironies kept multiplying. The bill was wildly unpopular even with the media falling into line (and in the later stages, a clearly orchestrated campaign to have financial services industry employees contact legislators to counter the groundswell of opposition). And it was Senate Republicans who were the last holdouts.

Here’s the soap opera, errr, money line.

So why are we pointing a finger at Pelosi in particular? The next chapter is her appointment of one Richard Nieman to the Congressional Oversight Panel. Under the TARP rules, the House Majority leader selects one of the oversight panel members, so this choice was completely under her control.

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Looking for the Copper Lining

I’ve been earning my creds as a dismal scientist lately.  However, it’s spring, it’s sunny here in the Big Easy where Jazz chile-torresdelpaineFest season is rocking on and I’d just like to share an example of an administration somewhere in the world that’s done the right thing.   I’d like to introduce you to a dismal scientist that’s doing the right thing for his country.  I found the news at Dani Rodrik’s weblog Unconventional thoughts on economic development and globalization and it’s about Chile and the Minister of Finance, Andres Velasco.

When macroeconomists talk about Keynesian policy, politicians only like the one side.  That would be the side where they get to cut taxes and increase spending.  This usually leads to re-election.  However, that’s the one side of fiscal policy.  You get to deficit spend, throw every one tax cuts, and run up your budget when the economy is in a recession.  The other side is that the government should restrain itself and run a surplus during the good times.  We had that after Bill Clinton left office.  Dubya blew it with his rebates for every one.  Then he started a war and kept spending and giving tax cuts when the economy was recovering.  This is a classic no-no because it leaves you very little wiggle room when you need to take care of a recession.  This is especially true when it’s as bad as it is now.  The U.S. generally has a larger national credit card than most countries so we might not hit our limit any time soon although China and taxpayers have been grumbling recently as well as Republicans for whom bellicose grumbling is a fine art.  However, small countries, especially those in Latin America, don’t have the national credibility of European countries or North America.  They can only borrow so much.

Enter Chile, it’s nationally owned copper industry, and its finance minister, a macroeconomist, Andres Velasco.   He andres_velascoactually did the politically unpopular thing of not increasing Chile’s spending or decreasing its taxes during the good times and because of this huge surplus Chile now enjoys, Chile’s in excellent shape to weather the current global economic crisis.

So, here’s Dani’s bragging on his friend and colleague who deserves the accolades and popularity he now enjoys.

Until the current crisis hit, Chile’s economy was booming, fueled in part by high world prices for copper, its leading export.  The government’s coffers were flush with cash.  (Chile’s main copper company is state-owned, which may be a surprise to those who think Chile runs on a free-market model!)  Students demanded more money for education, civil servants higher salaries, and politicians clamored for more spending on all kinds of social programs.

Being fully aware of Latin America’s commodity boom-and-bust-cycles and recognizing that high copper prices were temporary, Velasco stood his ground and decided to do what any good macroeconomist would do:  smooth intertemporal consumption by saving most of the copper surplus.  He ran up the largest fiscal surpluses Chile has seen in modern times.

This didn’t make Velasco very popular.  Last November, public sector workers marched in downtown Santiago, burning an effigy of Velasco.

But by the time the financial crisis hit Chile, Velasco (and the Central Bank governor Jose de Gregorio, another fine macroeconomist) had accumulated a war chest equal to a stupendous 30% of GDP.

The price of copper plummeted 52 percent from Sept. 30 to year-end, and Velasco dusted off his checkbook. In the first week of January, he and Bachelet unveiled a $4 billion package of tax cuts and subsidies…  Velasco’s stimulus spending, includ[ed] 40,000-peso ($68.41) handouts to 1.7 million poor families…

The surpluses accumulated during the good years has given the Chilean government unusual latitude in responding to the crisis.  As a result, the economy is doing much better than its peers.  As Bloomberg reports, “the country’s economy is expected to grow 0.1 percent in 2009, as the region contracts 1.5 percent, according to the International Monetary Fund.”

And does good economics pay off politically?  Eventually, yes.  Five months after being burned in effigy, Velasco is currently President Bachelet’s most popular minister.

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James K. Galbraith and the Sorceror’s Stone

morganaForecasts of economic activity are always a mixture of alchemy and bias.  You always have to check the assumptions before you evaluate the output.  Assumptions can turn a model up side down or inside out.  Economist James K. Galbraith gave a speech this month at the Minsky Conference.  His speech included terse evaluations of some of the biggest baseline forecasting models including one used by the Congressional Budget office.  He found some of the rationale  “purely mystical”.  He’s currently questioning what some folks see as a future “Obamaboom” that assumes a really quick turnaround in the economy followed by manic expansion.  (This scenario is actually coming out of bank economists and you know how well they’ve been assessing things recently.)

Galbraith looks at this giddy scenario skeptically, and rightly so.  I want to discuss his caveats.  He has reservations about this overly optimistic scenario similar to mine.  Yesterday, during discussion of my post, I was asked about the L shaped recovery scenario.  This is something I find likel, although I’m not using sophisticated models to wank out numbers.  I mentioned that I thought it likely because of some structural changes going on in the underlying economy.  Laurie asked me if I could elucidate further.  I did a little of that yesterday.  I’ll continue it today.

Basically, I see the households and their relationship to debt and their assets undergoing some fundamental changes.  House values are way down and unlikely to escalate to bubble levels again which is going to deprive households of their big cash cow.  Also, I don’t really see the credit markets churning out the kinds of expedient loans they did in the past.  If anything, I see banks becoming overly prudent in their underwriting practices–a sort’ve over reaction to the subprime toxins.  Because household spending represents about 67% of our overall economy’s spending, any significant drawback of consumer spending, or the relationship between what they spend, save, pay in taxes and buy in imports is going to have a significant impact on the multiplier process.

I just see a new American thrift paradigm.  I don’t think that households will be enabled by banks any more.  I think their wealth (primarily houses and retirement savings) will not recover to levels that will make the feel secure about their futures.  I think the uncertainty of the job market will make them spooked for some time.  All of this means, to me, a  very long drawn out slow, scuttling along the bottom, L shaped recovery.

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W(h)ither Geithner and his TALF

timmy-beavisNeil Irwin of WAPO reported today that the TALF is not having the results trumpeted by the Obama administration. This is leading, again, to speculation about the relevancy of most of these plans and, of course, job security of Treasury Secretary Timothy Geithner.

In its first two months, the government’s signature initiative to support consumer lending has fallen well short of expectations, deploying only a fraction of the amount officials had hoped to extend to stimulate auto loans, student loans and credit card lending.

The slow rollout of the program has frustrated staff at government agencies working on the effort and diminished hopes that they could engineer a rapid return to healthy lending levels, according to interviews with government and industry sources. The initiative also serves as a window into the complexities of designing a giant rescue of the financial system.

The TALF is the private-public partnership that couples the funds of private investors, like hedge funds, and the FED.  The hedge funds invest small amounts that are matched by much larger amounts that would presumably come from the Treasury and Tax Payers if they wind up being nonprofitable.   The combined funds  will supposedly purchase non-toxic, virgin, high rated rated securities to fund everything from student loans and car loans to inventory and capital loans for business. As of yet, they really have failed to do so.

Officials envisioned TALF supporting tens of billions of dollars a month in new lending, saying it could eventually total $1 trillion. But in March, when it was launched, it backed only $4.7 billion in auto loans and credit cards. For April, it logged only $1.7 billion.

Sources involved in the program said private investors have been reluctant to work with the government, which they view as an unreliable business partner. Separately, the brokerage houses that are crucial intermediaries are being exceptionally cautious in the contracts they draw up with participants in the program, in part out of wariness that any mistakes could draw the ire of Congress or the media.

In congressional testimony on Tuesday, Treasury Secretary Timothy F. Geithner said that overall progress is “pretty good” for a program in its early days. Still, he acknowledged that participation was “lower than expected” because of “concern about the conditions that come with the assistance in the program . . . and uncertainty about whether they may change in the future.”

Meanwhile, on the bank front, stupid accounting tricks abound!    Which begs the question is any one stupid enough to believe the numbers?  Every large financial institution appears to be jumping on the band wagon of conveniently forgetting the month of December.  What does this say about the state of public accounting today and Wall Street’s gulliblity?

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Irrational numbers

maskI’ve sat in two doctoral level investment classes for my degree. It’s not one of my fields because I just don’t want to take the derivatives seminar.  I actually have a lot of disdain for the field now that I’ve done the proofs on the major models.  My ex husband worked 20 years for an insurance company in their investment department doing the real thing.  It was one of the reasons I actually left him.  I find the entire field pretty insufferable.  Unfortunately, it’s also one of the highest paying fields you can have as an academic.  It’s much easier to get big publications in Finance than Economics. That’s basically because there really isn’t an awful lot of theory in finance.  It’s mostly data mining looking for some kind of theory.   As you can  probably tell by now, I’m not really popular with the Investment professors.  They don’t understand me primarily because I’m not out to make money. (Well, that and I refuse to call Eugene Fama God)  My research is always based on contrariness about the current asset pricing models we teach.  I especially disdain the ones that we teach to MBAs and Finance majors.

A lot of Finance is based on two assumptions that I can’t buy. One is that the market follows a random walk.  (This is Fama’s big contribution for which he expects to get a Nobel, but hasn’t managed to date.)  A lot of time is spent looking at the equity markets saying you can’t beat the market or really forecast it because it’s a completely random series.  The second is that the investor is a rational being.  Most of the field total ignores the old Keynesian idea of ‘animal spirits’.  That’s the idea that the market can get a herd mentality and spook at various events and move like a bunch of scared cows.

There’s a field in Finance that’s beginning to get a little bit of respect but still is considered a little out there. That’s probably, why it’s the only parts of Finance and Investment theory that intrigues me.  It’s called Behavioral Finance.  It looks for anomalies in the market and tries to find the reasons for them based more on human psychology rather than trying to just call them odd events.  That’s why I was happy to read this account,  Irrational everything,  written by Guy Rolnik on  Prof. Daniel Kahneman.  Kahneman’s a collector of stories of irrational behavior when it comes to people and finance decisions.  His voice would really add some flavor to the current collapse of modern finance.  Here’s a non finance example that just tickles me every time I read it.

But the story Kahneman recalls when asked about the economic models at the root of the current financial crisis is actually taken from history, not an experiment. It concerns a group of Swiss soldiers who set out on a long navigation exercise in the Alps. The weather was severe and they got lost. After several days, with their desperation mounting, one of the men suddenly realized he had a map of the region.

They followed the map and managed to reach a town. When they returned to base and their commanding officer asked how they had made their way back, they replied, “We suddenly found a map.” The officer looked at the map and said, “You found a map, all right, but it’s not of the Alps, it’s of the Pyrenees.”

According to Kahneman, the moral of the story is that some of our economic models, perhaps those of the investment world, are worthless. But individual investors need security – maps of the Pyrenees – even if they are, in effect, worthless.

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