I am the first to say that I do not understand the whims of the market, but today we saw a pretty schizophrenic display. Attention in the US focused on the Fed’s Open Market Committee statement. Earlier this week, not much was expected, since the Fed is somewhat constrained by fact that the Obama team has not come forth with plan for the banking industry. But then rumors started circulating that the Fed would commit to buying long-dated Treasuries to lower interest rates (30 year bond rates had risen nearly a percent from their lows last month, and of more immediate concern to the Fed, fixed mortgages rates, which had blipped down, had risen as well).
The 30 year bond rose prior to the announcement, as did gold (not necessarily contradictory, if you are buying gold out of a worry about the long-term health of fiat currencies). Similarly, stocks gapped up at open, since if the Fed engineers lower rates, that would help housing, banks, and make equities look more attractive relative to bonds.
The key section of the Fed statement was weaker than what was hoped for.
The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. The focus of the Committee’s policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve’s balance sheet at a high level. The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.
So the Fed reaffirmed its commitment to buying mortgage paper in size, and said it would buy Treasuries IF it would help “private markets”. That is as clear as mud.
Now there has been an assumption among most observers that the reason that the Fed is contemplating buying Treasuries is to drive rates down. Bernanke has discussed this idea in papers and presentations on deflation before he became the Fed chair. However, as Fedwatcher Tim Duy points out, it might be worth reading what the Fed actually said, since these statements are crafted carefully:
Conventional wisdom has that any Fed action to purchase longer-term Treasuries would be done with the intent of holding interest rates low, thereby stimulating economic activity. That, however, is not the implication of this sentence. Instead, the Fed views Treasury purchases only as a mechanism to support effective functioning of credit markets, which suggest that the Fed is not worried about controlling the level of longer term interest rates, but the spread between Treasuries and other assets.
This also suggests that the Fed is not particularly interested in expanding the balance sheet further via Treasury purchases. They may be willing to, but I am not sure how Treasury purchases will improve market functioning. To date, improving credit market efficiency has meant purchasing or holding as collateral risky assets, or even safe assets that the market currently shuns, not riskless Treasuries. What factors would cause a reversal of that position?
Moreover, one should also question the willingness of the Fed to fight against rising interest rates if those rising rates were the result of a shift to riskier assets and credit spreads fell to more normal levels. Presumably, this would correspond to a loosening of credit conditions, which in and of itself would be stimulative even if rates edged upward.
This distinction, and the Fed’s apparent reluctance to balloon its balance sheet unduly is telling. Some commentators (most notably John Hempton) have argued that Bernanke NEEDS to have the appearance of being reckless, that the debt deflation vortex is so powerful that he needs to do something to jolt consumers who are not at the end of their rope to spend more. Thus, while helicopter drops of cash may be out, letting the Fed balance sheet grow in the next year to, say $5 to $7 trillion would certainly focus the mind.
However, this may all be moot. If mortgage rates continue to rise despite the Fed’s efforts to contain them by lowering spreads, then the Fed will presumably buy Treasuries. But it is odd that the statement (in effect) renounced the approach that Bernanke advocated in his academic work, of driving down long Treasury interest rates to combat deflation.
Maybe bond market investors are better readers, or are simply more skeptical. 30 year Treasuries promptly retreated, as did gold, while stocks faded a wee bit from pre-announcement levels and averages continued upwards to the close. Financials in particular showed big gains. Technicians would stress that the market broke through an important resistance level, and if you are of that school of thinking, you would expect some follow through.
The FOMC annoucement overshadoved (at least in the US) other economic news. An EIA report showing a bigger than expected increase in inventories was shrugged. off. And perhaps more telling, the outlook is becoming sufficiently grim that international economic agencies are slashing their forecasts (mind you, they are about as likely as the sell side to tell you that things will be bad).
Last night, we reported that the International Institute of Finance was calling for a global GDP contraction for 2009. The IMF today, while not going as far as the IIF, got about as downbeat as one could expect them to be, predicting a marked contraction in advanced economies. From the Financial Times:
[T]he International Monetary Fund increased its estimate of credit losses on US-based assets from $1,400bn to $2,200bn. It also said world output, measured at market exchange rates, would fall in 2009 for the first time since the second world war. Weighted by purchasing power, growth would be very slightly positive.
The new growth forecasts mark a huge revision – down by more than 1.5 percentage points – from the IMF’s previous forecast for the year in spite of the inclusion of the fiscal stimulus efforts by governments into its predictions for the first time. Advanced economies, the IMF predicted, would contract 2 per cent in 2009 with the UK hit hardest.
In Geneva, the International Labour Organization said the global recession would lead to a “dramatic increase” in unemployment this year, which would certainly lead to 18m-30m additional unemployed and more than 50m “if the situation continues to deteriorate”.
28 comments
Comments are closed.
Let’s call this Phase II.
Phase I is the popping of the bubble and resulting crash of the financial system, which results in contraction of the real economy.
Phase II is the contraction of the real economy begins to further impact the foundations of financial markets, that is below the bubble.
How low does that go? Well place your bets, but one thing for sure, if the TARP was an failed answer to Phase I, what passed in the House today can be considered the fiscal equivalent of the TARP to Phase II, and we should expect about the same results.
And the optimists out there can be reminded, we still haven’t come close to addressing the problems of Phase I.
Two things:
1. "controlling the level of longer term interest rates, but the spread between Treasuries and other assets.
Yah, that is correct IMHO and that s what will drive Das Boat and grease the wheel of fortune and create future value. I'd give an example, but frankly my dear I don't give a damn, and I have no visual aids or fun stuff to add here.
2. Re: A jolt to the system, IMHO would be to fire Bernanke ASAP and place someone at the helm of Das Boat that is more unpredictable and in theory, insane enough to put the fear of GOD into FRIGGN Wall Street and someone that is not connected to the mess that has been made by the udders and teats at The Fed & Treasury, during the last three years!!!!!!!!!!!!!!!! Look at the BOOBS we have had in there like Warsh …. America needs leadership not nepotism from The Bush Legacy or The Clinton Legacy …. please, God help us, there are too many boobs in Das Boat!
If Fed starts buying unlimited supply of long dates treasuries then it will give China a chance to diversify its savings into other currencies. They won’t be worried about the prices going down because own sweet Ben is standing with a plane load of dollars to exchange them for long treasuries.
Yves,
Don’t forget the rumors swirling around the creation of a bad bank/good bank structure for toxic debt. That had to have a “stimulating” effect on stocks, especially financials. Thoughts?
No way Ben. My wallet is closd – we aren’t buying any cars, any houses, and plasma screens, we aren’t buying shit for now.
I don’t care WTF you do with your balance sheet. I’m not spending again until you start the Helicopter drops.
You want people to spend? Put one million dollars into every single mailbox in the United States and see what happens!
about the stimulus:
“Also missing from the dialogue is the concern for our children and the unconscionable debt burden we are leaving them. Keynesians, what value do you add? Your insane belief in the power of government spending is nothing but entertainment for the rest of us who can smell bullshit the minute you hit town. Where again is your grand, coherent vision for a vital infrastructure buildout? Tell us why you want this money from their future. Explain how every project will further our national interest. Convince us first, and then you may have more of their money. But show us some respect; don’t waste your breath trying to convince us that this $1 trillion error in judgement will substantially boost the economy. Call it what it is, generational rape with a shovel, and it’s an extremely bad sign as we continue on the path to federal bankruptcy.”
“I am the first to say that I do not understand the whims of the market, but today we saw a pretty schizophrenic display”
Eh, Bad Bank= City and BOA shares will rise as the taxpayers provide the necessary serum for a resurrection of more serial financial abuse to come. Obama’s failure is already cast in granite. Imagine him in black in white, grainy film from a distance of 100 years. Geithner sealed the deal.
Game over. Only thing that can save America is isolationism and all out global war.
Anon 12:01
“give China a chance to diversify its savings”
Let’s look at the other bubble that has been popped – the globalization myth. The idea of Chinese economic power was always extrapolated into the future. Right now its a fast declining economy, of 1.2 billion people, over 2/3 of whom are subsistence farmers.
Which get’s us to Phase III and why we should have never quit calling it political economy, because we’ve barely scratched the surface of the global political implications of all this.
Somebody help me out here. What are the possible mechanisms by which the Fed can expand the money supply — ie, “print money”? I guess I should go back and consult my old Samuelson textbook.
And relatedly: does the federal government seriously expect to be able to borrow a trillion dollars (sell a trillion dollars of bonds) to the rest of the world at this point in time? I find that difficult to believe.
More nonsense about the Fed’s “balance sheet”. As if that’s actually something real and consequential, or there’s some kind of limitation on it.
Somebody help me out here. What are the possible mechanisms by which the Fed can expand the money supply — ie, “print money”? I guess I should go back and consult my old Samuelson textbook.
Buiter has a very comprehensive treatment for you, Born Again.
I think projection of unrealistic inflation expectations is silly. If anything, it would seem to drive interest rates up or limit lending because a credulous lender should demand higher interest rates to compensate for the anticipated inflation. It still seems counter-productive to me today.
Recent market action appears to me to be gearing up again for another round of disinflation. I’m much less sanguine of the prospects current resuscitation plans will work, but still worry about the ramifications if they do.
‘Treasury purchases only as a mechanism to support effective functioning of credit markets, which suggest that the Fed is not worried about controlling the level of longer term interest rates, but the spread between Treasuries and other assets.’
this Tim Duy guy seems seriously confused and flawed in his thinking.
firstly, by having an irregular and big player that only buys from time to time, we will hardly see an effectively functioning market. quite the opposite: a distorted market where everyone frontruns the fed and then screams for a bailout if the fed does not come to pay a higher price.
secondly, if the spread is of concern, the credit risk of the borrower should be improved. the fed will detriment the credit rating of the taxpayer by creating higher tax liabilities down the road, and here we are talking about 30 year maturities. again quite the opposite will happend of what the Duy guy says.
thirdly, we have huge allocations into treasuries and corp bonds by pension funds. if the fed lets those fall in value by raising interest rates anytime soon, portfolios will be severly hit. as we have already seen, this leads to rebalancing aka selloffs of other assets like stocks, private equity, futures etc. this will certainly negate all their efforts so far of cutting the fed funds rate. another no-go.
ahh, and since securitization is dead (60 times lower volumes in 2008 than 2007) this means banks will have to hold on the ridiculously low interest rate loans in order not to incur significant charge offs. we are destined for decades of low interest rates if the fed really succeeds in kickstarting the economy again with those 0% rates.
the problem here is the fed heads are really not thinking beyond the most immediate impact of their decisions and this is why we will not see the end of this crisis anytime soon. another folly of benny himself is that he may still be reelected.
Come on fools, go back and look at Sweden! You can’t fight city hall and this is not gonna hurt a bit, just close your eyes and wait for Santa!
Day to day stock levels are guided by people measuring the sentiment of day to day stock levels. Of course the news can guide that sentiment, but we should not expect to explain why people overreacting to an overreaction isn’t an a valid overreaction.
Volatility is the markets response to unknowns. And volatility creates its own weather systems. We can’t have the markets quckly drop in half, and that rest for an extended period at 800. The very act of resting will tire the bears and encourage the bulls which will cause a rally. Because of the volatility trading is good this past year, and I agree that the short term is likely up. but the bears will roar back in after the traders tick it up a notch or two.
Irrational volatility is going to be with us for a while until we know where our companies stand.
The moment that the Fed starts buying Treasuries the foreign governments are going to start dumping them. If I were a foreign country in this situation, that is what I would do.
Watch it happen.
The Fed buying treasuries is printing, inflating the money supply. When, if, a few years down the line – the economy is in recovery – that massive infusion in money supply will be inflationary.
The Fed plans to sterilise this by withdrawing money from circulation. How? By selling treasuries. Problem. The prices fall, yields will rise – and oh oh. The government will not have enough revenue to afford the interest payments on the treasuries. Solution – leave inflation in the system. A dollar in 2020 worth 50% or less than a dollar now. Too bad for all savers and 401k holders…
Actually the Federal Reserve is acting as the ‘bad bank’ (buying/holding toxic waste) but also as the ‘good bank’ at the same time which convolutes the pictures since they won’t release what debt was acquired.
Endowing a truly new bank with new currency and lets say 0% loans to spur the economy leaving the Federal Reserve to continue soaking up waste still won’t balance out until we have a number representing the total debt to cover.
I’m think’in, before inflation arrives in earnest, enough currency /credit (pick one) has to be available (future timetable works) to not only cover the outstanding (unknown) debt but exceed it past the previous bubble numbers……Good luck on that one but doesn’t mean they won’t try.
Fixes so far have only kept cash available at your local bank. That’s nice but world is melting down around you.
More layoffs coming, I think you can see where this is headed. When will a significant fix be put in place or is there even one to be had? So far a bad dream is reality.
Wintermute: “A dollar in 2020 worth 50% or less than a dollar now.” Appreciably less than 50%, if the Fed and the Trez seriously opt for monetization. If the Fed does _not_ opt for monetization, than 50% or more, nominally, but economic conditions will be recessionary or worse over the coming decade, and so what’s the point of a bitty-monetization? It would be ineffectual.
There are many problems from monetization. But one that has received little discussion, even in the blogosphere, is that any serious monetization will effectively vaporize public, private, and Federal dedicated pension plans. Now, that might be a solvable problem; might be. But it will be a political problem on a scale that the American ‘dealership’ (don’t call these schmoes leaders) will be unable to think coherently as they approach such an event horizon. So I suspect we’ll get all cranked up for monetization, at which point some key players inside the Beltway lose their nerve and try to penny ante that approach.
Just my guess.
Thanks Richard for the further info. I agree that the decimation of pensions in an effort to save the housing market and debt-fuelled economy – is yet another major problem for the future.
And yes the “dealership” will have cashed out long before, still enjoying 5-star hotels, limos, art collections, foreign holidays in retirement – that the rest of the boomers will only dream about…
Another 800 billion and you have to ask how long will it last? Another 3 months before we need the next 800 billion?70000 job loses announced in one day so how many for the week? I doubt whether the FED will be buying treasuries at this point, but what we do know is that they are committing 300 billion to buying Agency debt. I guess this is to try to push mortgage prices down at a time when the Chinese are turning their noses up at this debt. Who can blame them when you read about how the agencies are encouraged by the treasury to allow fantasy property valuations. Just how much money will agency debt buyers loose when the fantasy property prices have to be realised. By my back of the cigarette packet reckoning 100 billion a month is required to keep mortgages at current levels and there is no exit strategy in site.
Having scanned quickly the IMF report, it looks to be out of date already. Which of the BRIC countries is really going to have growth this year and how much? As for the UK being worse off then I am not so sure. The UK is clearly gaining economic impetus from the devalued pound at the expense of its European neighbours. The UK is now one of the cheapest place in Europe to manufacture those BMW’s, Nissan’s, Toyotas and although many of its prestige brands and banks have suffered set backs, they still have Pharmaceuticals, Telephony, Cigarettes, Scotch, Guns and Aircraft Engines which have not really been that much affected as yet.
Most of the politicians are still burying their heads in the sand with pensions. Whether it is Gordon Brown pretending unfunded pension liabilities are not government debt, Companies having to make more unemployed so they can put more into their pension funds which have been decimated, individuals who need to put more of their income into pensions and so are spending less in the economy, or government who will need to put away or borrow even more money to fund the lack of pension provisions in the private sector and to subsidize all those who no longer get an income from their savings. Trying to save the economy in this way could bankrupt the consumer and have a counterintuitive affect.
How can stocks go up when the worldwide financial system is bankrupt? The Fed is insolvent on a static basis and the whole financial system is bankrupt. Why don’t the accounting firms who audit the bankrupt financial institutions listen to Roubini? Roubini has been right about this whole mess going back to 2005 and made public his analysis, this is not a case of not being able to know the unknown. How can accounting firms like KPMG continue to issue fraudulent financials for Banks like Citi, the math is there for all to see.
………………………………………………………………………………………………
Nouriel Roubini and Elisa Parisi-Capone of RGE Monitor release new estimates for expected loan losses and writedowns on U.S. originated securitizations:
• Loan losses on a total of $12.37 trillion unsecuritized loans are expected to reach $1.6 trillion. Of these, U.S. banks and brokers are expected to incur $1.1 trillion.
• Mark-to-market writedowns based on derivatives prices and cash bond indices on a further $10.84 trillion in securities reached about $2 trillion ($1.92 trillion.) About 40% of these securities (and losses) are held abroad according to flow-of-funds data. U.S. banks and broker dealers are assumed to incur a share of 30-35%, or $600-700 billion in securities writedowns.
• Total loan losses and securities writedowns on U.S. originated assets are expected to reach about $3.6 trillion. The U.S. banking sector is exposed to half of this figure, or $1.8 trillion (i.e. $1.1 trillion loan losses + $700bn writedowns.)
• FDIC-insured banks’ capitalization is $1.3 trillion as of Q3 2008; investment banks had $110bn in equity capital as of Q3 2008. Past recapitalization via TARP 1 funds of $230bn and private capital of $200bn still leaves the U.S. banking system borderline insolvent if our loss estimates materialize.
………………………………………………………………………………………………
If Professor Roubini is correct and I fear he is, why don’t any of the accounting firms listen to him? What about starting with the accounting firms and perhaps, one of the worst offenders KPMG.
KPMG audits Citi, how can anyone trust their financial statements? Why does anyone even care what KPMG has to say? Why does anyone want to work at KPMG? KPMG audits a disproportionate percentage of financials yet totally missed the banking collapse. Exactly what is KPMG expert at and why would anyone listen to them after all their failed audits of failed institutions? Many as early as 2005 predicted the financial meltdown and the unsustainable lending pattern of the financials including Dr. Roubini of the Stern School of economics, why didn’t KPMG listen. If I were a partner or employee at KPMG I would be extremely concerned about all the pending lawsuits and potential criminal liability of KPMG. You know for a fact that Tim Flynn the CEO and Joe Loonan the head lawyer will not stand behind the partners as evidenced by the tax partners KPMG threw under the bus when the DOJ came a calling. In fact, Flynn, completely reneged on the former O’Kelley’s promise to support the tax partners (after he got brain cancer) and lied to the tax partners by pulling the carpet out from under the them by hiring Bennett and Holmes to not only lie about the tax partners to the DOJ but deny them legal fees for defense at the DOJ’s request. Loonan, Holmes and Flynn, totally screwed the tax partners and an email exists wherein Loonan specifically states that in the KPMG tax settlement with the DOJ he has no idea if any of the facts are correct but KPMG better sign or the DOJ will put them out of business and ends the email by saying: “freedom is just another word for nothing left to lose”. The point of course is those that run KPMG have no honor, are lying scum and if you are employed by KPMG and something bad happens, KPMG will do everything it can to ensure it survives at your expense. Of course something bad has happened, the banking collapse was a no brainer, predicted by many and most of the KPMG audits of the financials are riddled with fraud. The lawsuits and criminal investigations are coming, no doubt. All KPMG partners and employees should be very concerned as KPMG has no problem throwing them under the bus for a life of ass raping if it will save KPMG a nickel. Why any clients would accept advice or rely on KPMG for anything shows a total lack of due diligence and perhaps, negligence by those clients choosing to use KPMG. Of course, the last sentence does not apply to those clients that are actually consensually engaging in fraud with KPMG. The firm of KPMG has no honor or expertise in any matter just self interested thieves like Flynn, Holmes and Loonan attempting to make as much money as possible for themselves before the firm implodes. Many emails exist concerning KPMG’s malevolence and will be disseminated over time. Thoreau has a great quote, “no one can associate themselves with the U.S. Government without disgrace”, the same applies to KPMG, no one can associate themselves with KPMG without disgrace.
I’ll tell you why th stock market especially banks rallied. The bad bank idea has certainly changed the outlook of financial stocks – the Obama people are going to finally socialise ALL the toxic=asset losses. And geitner is going to make sure taxpayers pay a small premium over their current book value. Hence there would be no nationalization of banks, not even dilution of existing capital base. Obama’s team would out-do Bush and Paulson by finally following through on the original TARP idea to buy toxic assets at premium. Thanks in no small measure to Mr Buffett’s advice; same Buffett who owns Wells Fargo (American cronysm at work). Frankly I think the banks’ balance sheets would look quite impressive after selling the toxic wastes for $2 trillion or whatever trillions to US taxpayers. So why shouldn’t financial stocks go up? Even the dollar rallied. But US treasuries fell. If Americans are smart enough (and I doubt it very much) connect the dots and you know who has been selling your treasuries and who has been buying the beaten down financial stocks.
ANNOUNCER TWO: Ladies and gentlemen, I have just been handed a message that came in from Grovers Mill by telephone. Just a moment. At least forty people, including six state troopers lie dead in a field east of the village of Grovers Mill, their bodies burned and distorted beyond all possible recognition. The next voice you hear will be that of Brigadier General Montgomery Smith, commander of the state militia at Trenton, New Jersey.
SMITH: I have been requested by the governor of New Jersey to place the counties of Mercer and Middlesex as far west as Princeton, and east to Jamesburg, under martial law. No one will be permitted to enter this area except by special pass issued by state or military authorities. Four companies of state militia are proceeding from Trenton to Grovers Mill, and will aid in the evacuation of homes within the range of military operations. Thank you.
ANNOUNCER TWO: You have just been listening to General Montgomery Smith commanding the state militia at Trenton. In the meantime, further details of the catastrophe at Grovers Mill are coming in. The strange creatures after unleashing their deadly assault, crawled back into their pit and made no attempt to prevent the efforts of the firemen to recover the bodies and extinguish the fire. Combined fire departments of Mercer County are fighting the flames which menace the entire countryside. We have been unable to establish any contact with our mobile unit at Grovers Mill, but we hope to be able to return you there at the earliest possible moment. In the meantime we take you — just one moment please.
2020 outlook for a dollar worth 40 cents doesn’t consider a spiral out of control scenario in the next couple of years.
OTC contracts are only voluntarily reported. The debt numbers being bantered about do not include the unreported worth of OTC contracts, mainly derivatives. Banks have an inkling of the numbers hence they won’t loan to each other.
I believe the current plan before Congress is estimated to take on full effect in 18 months after passage.
The US could be a pile of smoldering ruin by then.
Regarding the stimulus. I do hope Obama would just forget about schools, kindergartens, infrastructure, and tax breaks for corrupt Republicans, and just send the whole thing in checks for the masses. I could use a little cash just about now. My yacht needs painting, my Rolex needs a polishing, the Michelins on my Porsche are 6 months old, and my private French cook needs to take new continuing education classes in Paris.
Looking forward to receiving my $2730 check (819 billion fiat dollars divided by 300 million proud Americans),
Sincerely yours,
Vinny Goldberg – yet another victim of this downturn.
Anon. 8:12 AM,
As for the UK being worse off then I am not so sure. The UK is clearly gaining economic impetus from the devalued pound at the expense of its European neighbours. The UK is now one of the cheapest place in Europe to manufacture those BMW’s, Nissan’s, Toyotas and although many of its prestige brands and banks have suffered set backs, they still have Pharmaceuticals, Telephony, Cigarettes, Scotch, Guns and Aircraft Engines which have not really been that much affected as yet.
Indeed. Additionally, the UK is now quite an affordable country, so expect tourism to rise. At 34 pounds per night in a brand new 3 star London hotel and 2 pounds per cappuccino at Starbucks (versus at least 90 euros per night and 4 euros per cup of coffee in continental Europe), the UK is now even cheaper than the US.
Vinny Goldberg — a proud American on temporary business exile in the UK.
I agree with the earlier comment that the IMF estimate of 2009 world economic growth is already out of date. Several things are wrong with the forecast. Growth estimates keep surprising on the downside, which means that forecasts are based on outdated views of the baseline. Also, export-oriented emerging economies like China are especially vulnerable to surprising on the downside, as has been noted elsewhere. They already face severe difficulties creating enough jobs, and we have yet to see how well they will be able to manage the political, social, and economic difficulties of the worldwide downturn, which is just beginning.
Any check for $2730 will be immediately followed by a bill for $2730 plus 20%. Even without receiving the $2730 check you’ll get the bill anyway.