All Eyes on Ben

bernakelargeI’ve been Fed watching again. That’s something of both an occupational hazard and a weirdish hobby for me. Usually, Fed chairs stay off the lecture circuit until they retire and write their biographies. Ben Bernanke, however, is not your usual Fed Chair and these are not usual times. I think you may recall that part of his observations with being in charge of monetary policy when there’s no room drop interest rates (ZIRP) has to do with communicating future Fed actions to a nervous public. This continues.

Bernanke was in Kansas City over the weekend speaking to normal people and Jim Lehr of the PBS program News Hour. There were several things from this exchange worth mentioning. The first is a response to the meme circulating around the libertarian circuit that there is no accountability between the FED and any one in Washington. That is untrue for several reasons. First, because the majority of appointments (including the Fed Chair) to the FOMC are made by POTUS and approved by the Senate. Second, the Fed Chair makes biannual trips to the Hill to speak with both houses of Congress and take questions. Third, they publish their internal records as well as their research continually. It’s a matter of public record. The only thing Congress doesn’t get to see is the rationale behind monetary policy which is perfectly in keeping with the idea of independence supported overwhelmingly by evidence and theory. They have to the right to see the Fed balance sheet and items now. What they do not have is the right to ‘audit’ monetary policy. Something that would be a disaster.

“The Federal Reserve, in collaboration with the giant banks, has created the greatest financial crisis the world has ever seen,” Representative Ron Paul, Republican of Texas, said at a House hearing last week in which Mr. Bernanke testified about the state of the economy.

Republican lawmakers portray the Fed as the embodiment of heavy-handed big government, and have called for scaling back the central bank’s regulatory powers. But liberal Democrats, like Representative Dennis J. Kucinich of Ohio, have accused the Federal Reserve of caving in to demands by banks for huge bailouts, for failing to protect consumers against dangerous financial products and for being too secretive about its emergency rescue programs.

More than 250 lawmakers have signed a bill sponsored by Mr. Paul that would allow the Government Accountability Office to “audit” the Fed’s decisions on monetary policy — a move that Fed officials see as a direct threat to their political independence in carrying out their central mission of setting interest rates.

A lot of the complaints at the appearance came from the audience who basically aired Kucinich’s view that the Fed appeared all too willing to bail out the reckless big guys while letting the little guys go belly under. Bernanke did not shy away from the questions at all.

When a small-business owner asked Mr. Bernanke why the Fed helped rescue big banks while “short-changing” small companies, Mr. Bernanke answered that he had decided to “hold my nose” because he was afraid the entire financial system would collapse.

“I’m as disgusted by it as you are,” he told the audience of 190 people. “Nothing made me more angry than having to intervene, particularly in a few cases where companies took wild bets.”

He used a most interesting metaphor when explaining why he had to hold his nose and bail out the gamblers. He basically said, if an elephant falls it crushes the grass beneath it. Wow, a zen moment from a Fed Chair. Who’d have thought that was possible? He also said that the main reason he did it was because he didn’t not want to be the Fed Chair at the time of the second Great Depression. I’d say that was succinct enough.

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Subprime Mortgage Myths

Yuliya Demyanyk, a senior research economist at the Cleveland Fed, has done a fascinating job debunking some of the bigger memes floating around main stream media outlets about the Subprime Mortgage Market. Her Economic Commentary piece here distills the more germane information found in the research published here. Her bottom line is that it was not so much the meltdown of the subprime market with its components of interest rate resets, declining underwriting standards, and declining home values that contributed to the systemic problems creating the big financial meltdown. She argues that it was the interplay between that market and the securitization process, lending and housing booms, and leveraging

One of the biggest myths surrounding the subprime market is that subprime mortgages are given solely to borrowers with impaired right-wingcredit. Demyank and her fellow reseacher Van Hemmert found that many folks actually wound up in certain subprime loans not because of their credit history (which was not impaired) but the fact that certain loans were only available in the subprime market because that was the type of loan demanded by the securitization market.

But mortgages could also be labeled subprime if they were originated by a lender specializing in high-cost loans—although not all high-cost loans are subprime. Also, unusual types of mortgages generally not available in the prime market, such as “2/28 hybrids,” which switch to an adjustable interest rate after only two years of a fixed rate, would be labeled subprime even if they were given to borrowers with credit scores that were sufficiently high to qualify for prime mortgage loans. This is very good for a credit repair company with money-back guarantee because they get clients that are above prime for subprime rates.

The process of securitizing a loan could also affect its subprime designation. Many subprime mortgages were securitized and sold on the secondary market. Securitizers rank ordered pools of mortgages from the most to the least risky at the time of securitization, basing the ranking on a combination of several risk factors, such as credit score, loan-to-value and debt-to-income ratios, etc. The most risky pools would become a part of a subprime security. All the loans in that security would be labeled subprime, regardless of the borrowers’ credit score.

Mortgage originators may have directed some folks to these loans based on the characteristics of the loan, not necessarily the characteristics of the buyer.

A second myth debunked by the research is the idea that subprime mortgages were used to promote home ownership. By slicing and dicing the lending data base, the two researchers found some interesting numbers as they relate to overall homeownership statistics.

The availability of subprime mortgages in the United States did not facilitate increased homeownership. Between 2000 and 2006, approximately one million borrowers took subprime mortgages to finance the purchase of their first home. These subprime loans did contribute to an increased level of homeownership in the country—at the time of mortgage origination. Unfortunately, many homebuyers with subprime loans defaulted within a couple of years of origination. The number of such defaults outweighs the number of first-time homebuyers with subprime mortgages.

Given that there were more defaults among all (not just first-time) homebuyers with subprime loans than there were first-time homebuyers with subprime loans, it is impossible to conclude that subprime mortgages promoted homeownership.

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Monetary Policy at the Zero Bound

monetary-man-001 I am a financial economist and I’ve been through most phases of my career one that applies the trade in banking. That’s because my first economics specialty was monetary economics. I still have my original copy of Patinkin’s Money, Interest and Price sitting next to my dad’s original copy of Keyne’s The General Theory of Employment, Interest and Money. My grandfather was one of the first Fed lifer’s having been in charge of the bond area in the Kansas City District for both world wars. My ex-husband’s first job out of college was with that Fed. I worked for the Atlanta District Fed before retreating back to academia. So, in this day and age, with all the unpopularity that entails, I have to confess to being a banker of sorts. I hope you won’t hold that against me.

Today, there is more evidence that this is not my Grandfather’s Fed and it’s not completely the Fed I worked for either during the Greenspan years. When I was there, the emphasis was consolidating functions to various branches and realizing that check clearing and wire transfers, the main source of revenues for the branches, were being taken up by big money center banks and clearing houses. Clinton was President and the economy was good so there wasn’t much dithering about the technical things done up there at the desk in NYC. I just had my staff transmit the bond sells every Tuesday (even on Mardi Gras) dutifully.

Much consolidation has taken place and many traditional Fed services have been privatized. Oh, and then there’s that one other difference, Ben Bernanke and his realization that traditional monetary policy is pretty useless when interest rates are close to zero. Welcome to the world of Monetary Policy at the Zero Bound which is actually something we talked about last fall. I’m going to point you again to Ben Bernanke’s treatise again because it explains a lot of what we’re going to discuss. It’s written for wonks, but if you read the first few pages, you’ll get the basic idea.

The Fed’s upcoming retreat from its current position has been a topic of much discussion and speculation. That’s because every one has some concern that they will be accommodating for way too long and it may lead to another Bubble or to general inflation (instead of price increases in a specific market like housing). That’s pretty much the consensus of what happened post 9/11 when Greenspan left interest rates extremely low and we developed a speculation crazed housing market. For some reason, he popped the bubble of excessive exuberance during the Clinton years and the Tech stock run-ups, but let the mortgage market baste in low interest rates for way too long. My guess is that he was more accommodating to Republicans because he himself was one of them, but that’s a discussion for his biographer and just a source of speculation for me.

So, Ben used his platform as the second most powerful man in the US today to reduce the information asymmetry surrounding the Fed’s exit strategy. Again, if you check the link to his academic paper above, you’ll see that’s one of the things he believes is necessary when monetary policy hits the zero bound. He basically calls this “using communications policies to shape public expectations about the future course of interest rates” and that’s exactly what he’s doing in today’s Op-Ed piece in the WSJ.

I’m not sure how many people wrote and edited this piece, but it is a brilliant discourse that explains in a very succinct and clear way what the FED will do in the coming recovery to ensure that we won’t get inflation. He also reassures that they won’t reverse the course of any improvement either as was done in 1937 to cause a double dip depression. This Op-ed is historic in nature, although I’m sure only those of us steeped in Fed lore, culture and history will realize what’s going on here. Ben is opening up the some what secret world of the Federal Open Market Committee (FOMC) to those with the need to know.

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MacroEconomic Malpractice

If the U.S. economy was a patient, I’m sure we all would be talking medical malpractice by now. After having 8 years of nothing to lecture on during the Clinton years other than, yes Keynesian economics works, we are now on our 9th year of wtf? (Feel sorry for my poor undergrads.) We’re still dealing with the spinning of the complete failure of Voodoo Economics, Trickle-down economics, Reaganomics or Supply Side economics from the free spending, tax dollar giveaway as success story with no real point other than supporting faith based economic hypotheses and the rights of the ultrarich to stay that way in to something it was not. I simply cannot believe that any REAL democratic administration with some roots in the Clinton years could possibly be choosing to continue the failed policies of the right.

So, since I’ve been on a populist rant over Wall Street Bonuses, let me just fuel the fire some more with this little piece in the Washington Post website today with the unsurprising title “Bailout Overseer Says Banks Misused TARP Funds”. No kidding cupcake. Why do you suppose the same risk happy folks that got their bonuses last year are getting big ones this year? We might as well funded a national road trip to Vegas.

Many of the banks that got federal aid to support increased lending have instead used some of the money to make investments, repay debts or buy other banks, according to a new report from the special inspector general overseeing the government’s financial rescue program.

The report, which will be published Monday, surveyed 360 banks that got money through the end of January and found that 110 had invested at least some of it, that 52 had repaid debts and that 15 had used funds to buy other banks.

logo-mr-monopolySo, we’re basically funding a real time game of monopoly. Okay, Republicans, let me just explain this to you ONE more time. MONOPOLY is the antithesis of market capitalism. It isn’t Socialism. Socialism is NOT an economic concept any more than GOD is a Buddhist one. It’s the difference between, I buy houses in Houston and I buy All the houses in Houston. We actually prove markets are efficiently working by comparing competitive markets to centrally planned ones and find the same result when they are. However, that’s IFF (if and only if) things in both circumstances are perfect (which they NEVER are). We live in a land of frictions and 30 years of research shows that we’ve just about got as much chance of having the Pure Capitalist dream as we do the Pure Marxist dream. Zip, Zilch, nada, no way! Our lives our lived in imperfect markets where government sometimes steps in to make things worse, and some times steps in to make things better. We’re basically in the search for the middle path.

Right now, we’re funding and sustaining a financial market structure that perpetuates extraordinary profits for the capital owners, less products available to the market, and higher prices for every one. It is also well-researched that bigger institutions do not bring efficiencies of scale to the market so how is this a good thing? Just pick up any basic microeconomics book and study market structures. The bottom line is a welfare loss for the market as resources will be inefficiently used, quantities will be reduced, prices will be higher, and the demand side of the market will experience a loss of welfare. (Sorry, I keep having to remind myself I have the summer away from theory, but I’m an old dog and that’s a new trick for me.) The empirics on this have supported these theories for hundreds of years!

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When Will They Ever Learn?

The Blogging Econ heads are still news makers today as we have more and more reports of record profits at Goldman pigs-playing-poker1Sachs and examples of blatant corportist propaganda at CNBC. I learned yesterday that many folks are listening, it just isn’t necessarily the ones shaping and setting policy. We also see a completely unsustainable budget coming down the pipe per the Director of the CBO. Why is it that policy makers seem to want us in dire straights? Are their sources of campaign funds so sacred that they’re willing to bring down the U.S. economy? Where does a Cassandra start?

Matt Taibbi and Paul Krugman focus in on the GS profits. So, I’m all for making a decent rate of return, that’s necessary to keep a company in business and it’s required to attract capital to grow a market. However, record setting, extraordinary profits are symptoms of a market out-of-whack. In the most simplest of analysis it could mean there are minimally too few providers of a service which can also lead to some form of market manipulation, information hiding, or information asymmetry allowing them to reap extraordinary profits. I basically think we’re seeing GS game the market based on raiding underpriced AIG assets with a free source of capital. This means the profits are straight from taxpayer funding. No wonder these guys don’t want to pony up any equity to us based on profitability and want to dump TARP funds (with their compensation restrictions) as quickly as possible. How can Washington miss that they’re back at their same old games?

This is from Taibbi who basically lays it out. They’re taking our tax dollars and buying assets with tax dollar in government-selected subsidized fire sales, creating arbitrage profits (some through their own huge market shares now that much of their competition is gone) and churning themselves some nice bonuses. In music, that’s called riding the gravy train. It’s a no risk, no brainer, no lose situation. Why would that require bonuses? [You can mark my words on this. They looted (with government enabling) AIG and the next one up will be CIT.]

So what’s wrong with Goldman posting $3.44 billion in second-quarter profits, what’s wrong with the company so far earmarking $11.4 billion in compensation for its employees? What’s wrong is that this is not free-market earnings but an almost pure state subsidy.

Krugman, a microeconomist with specializations in trade theory, sees it too.

The American economy remains in dire straits, with one worker in six unemployed or underemployed. Yet Goldman Sachs just reported record quarterly profits — and it’s preparing to hand out huge bonuses, comparable to what it was paying before the crisis. What does this contrast tell us?

First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.

Second, it shows that Wall Street’s bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away.

Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely.

Meanwhile, back in the Main Stream Media, also known as the Wall Street and K Street propaganda factory, CNBC has tired to rosy up Dr. Doom’s forecasts to enable its masters arbitrage profits. Roubini made it clear that his views on the economy have remained unchanged despite the attempts to make it look otherwise.

Nouriel Roubini, the economist whose dire forecasts earned him the nickname “Doctor Doom,” said after markets closed Thursday that earlier reports claiming he sees an end to the recession this year were “taken out of context.”

“It has been widely reported today that I have stated that the recession will be over ‘this year’ and that I have ‘improved’ my economic outlook,” Roubini said in a prepared statement. “Despite those reports … my views expressed today are no different than the views I have expressed previously. If anything my views were taken out of context.”

Several business news outlets, picking up on a report initially from Reuters, earlier Thursday cited Roubini as saying that the worst of the economic financial crisis may be over.

The New York University professor was quoted by Reuters as saying that the economy would emerge from the recession toward the end of 2009.

Reports of his comments helped trigger a late rally in the stock market.

Did you read that bit about triggering a late rally in the stock market? Pity the poor suckers that believed CNBC and of course, watch the deposits grow of the folks that placed the offsetting market transactions. And, let’s see, which market insiders would probably know that was BS? I don’t think you have to be Ms. Marple or an SEC investigator to figure that one out. It was just a simple mistake, wasn’t it?

Factors Explaining Future Federal Spending on Medicare, Medicaid, and Social Security (Percentage of GDP)
Factors Explaining Future Federal Spending on Medicare, Medicaid, and Social Security (Percentage of GDP)

Another thing that really has sugared my cookies is this report coming out of the Congressional Budget Office (CBO) one of the few bastions of economic thought in the beltway that tries to look out for the real constituents of Washington D.C.. The Director of the CBO,Doug Elmendorf, had this to say to a Senate Committee followed by a post to his blog.

The current recession and policy responses have little effect on long-term projections of noninterest spending and revenues. But CBO estimates that in fiscal years 2009 and 2010, the federal government will record its largest budget deficits as a share of GDP since shortly after World War II. As a result of those deficits, federal debt held by the public will soar from 41 percent of GDP at the end of fiscal year 2008 to 60 percent at the end of fiscal year 2010. This higher debt results in permanently higher spending to pay interest on that debt. Federal interest payments already amount to more than 1 percent of GDP; unless current law changes, that share would rise to 2.5 percent by 2020.

There’s also his bottom line.

Under current law, the federal budget is on an unsustainable path, because federal debt will continue to grow much faster than the economy over the long run. Although great uncertainty surrounds long-term fiscal projections, rising costs for health care and the aging of the population will cause federal spending to increase rapidly under any plausible scenario for current law. Unless revenues increase just as rapidly, the rise in spending will produce growing budget deficits. Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress economic growth in the United States. Over time, accumulating debt would cause substantial harm to the economy.

Okay, am I just being a little too wonky here or are these three things perfectly clear to any one who has the audacity to be informed?

Norway, anyone?
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