Tuesday, January 26, 2016

Fox Business News Tobak Continues Media Blitz Against Millennials

 This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/financial/fox-business-news-tobak-continues-media-blitz-against-millennials?post=83154&uid=4798

Steve Tobak, noted technology writer, has piled on the media bandwagon bashing millennials. His is one of the most offensive articles yet. He calls millennials "special little snowflakes" and "entitled narcissistic brats" in a way that sounds as if he wants to not call them those names, but hold them accountable as individuals.

If Tobak wanted them held accountable as individuals, instead of insulting them, why did he have to call them those names first?  

And he doesn't go into detail about how their parents are coddling them. Perhaps he wants them to build a nest, haul their children up into that nest, and boot them out. They live at home because wages are not keeping pace with real estate. That is coddling? No, Steve, that is survival. Just kidding about the nest thing.

Steve Tobak fears that millennials are not pulling their own weight. And maybe they are not. But who shaped them Steve? The bankers and their bad loans, and the elusiveness of the American dream for their parents, have shaped them, Steve. Many of their parents failed, while trusting the financial sector.

The cost of living and diminished wages, as the Fed destroys the stickiness of wages, have put millennials in survival mode.

So, when we see them not adding to aggregate GDP, Steve, we can't place the blame entirely on the millennials. Most of the problem rests with the financial system that cannot be trusted. Yes, it could end up hurting the entire nation for millennials to fail to rise up, as entrepreneurs. But you need to call out the greedy financiers, starting with the Fed, Steve. The conspiracy to diminish wages is hardly without proof.

If some of the millennials drive for Uber or Lyft, that is a good thing, Steve. And you, sir, certainly get paid for contributing poor quality online content (at least in the article in review), so why can't they do the same?

And readers, what gets me most about Tobak's article, is that we know small and medium businesses create most of the jobs. Climbing up the corporate ladder, which is what Tobak wants from millennials, is not so easy, as those jobs with large corporations are hard to find.

But Tobak needs to come clean about his real motives for bashing millennials. Banks can't make money if these millennials don't borrow. The article appears on Fox Business News and that isn't by accident, in my opinion.  The bashing continues and the millennials will dig in their horns if this bashing does not stop.

Will Rogers would have approved of the millennials, at least for this:

You see in the old days there was mighty few things bought on credit. Your taste had to be in harmony with your income, for it had never been any other way. I think buying autos on credit has driven more folks to (rob banks) as a regular means of livelihood than any other contributing cause... I don't reckon there has ever been a time in American homes when there was as much junk in 'em as there is today. Even our own old shack has got more junk in it that has never been used, or looked at than a storage place. Most everybody has got more than they used to have, but they haven't got as much as they thought they ought to have. So it's all a disappointment more than a catastrophe. If we could just call back the last two or three years and do our buying a little more carefully why we would be O.K." WA #419, January 4, 1931
However, Will Rogers, not unlike Steve Tobak (who runs a consulting firm that supplies speakers for businesses), was an after dinner speaker among many other accomplishments. Rogers was willing to go voluntarily, but perhaps Tobak is not. Here is Rogers on after dinner speaking:

"You can't break a man that don't borrow; he may not have anything, but Boy! he can look the World in the face and say, "I don't owe you Birds a nickel." You will say, (if everyone stops borrowing) what will all the Bankers do? I don't care what they do. Let 'em go to work, if there is any job any of them could earn a living at. Banking and After-Dinner Speaking are two of the most Non-essential industries we have in this country. I am ready to reform if they are." WA #14, March 18, 1923
Will Rogers looked at his after dinner speaking business, and would have looked at Steve Tobak's business, as being non essential. And he considered bankers as being non essential as well.  After dinner speaking sure has changed. It has gone from Will Rogers' criticism of banking and borrowing, to Steve Tobak's criticism of millennial's frugal risk aversion!

Millennials think, I think, like Will Rogers. Was Will Rogers right for the aggregate? Probably not. Was he right for the individual? Well, you be the judge. "You can't break a man who don't borrow." 

And readers, note that Rogers lived through a short depression, in 1921. It was caused mostly by retooling industry from World War 1. Then he lived through the Great Depression. By that time, he had certainly come to have no trust in bankers. Can anyone blame him?





 

Sunday, January 24, 2016

LIBOR Destroyed Subprime. But The Fed Deepened the Great Recession

 This article was first published by me on Talkmarkets: www.talkmarkets.com/content/us-markets/libor-destroyed-subprime-but-the-fed-deepened-the-great-recession?post=82947&uid=4798

It is clear now that the Federal Reserve Bank deepened the recession in 2008. I have written that a  motive for this dampening of the American economy was sticky wage creep, that had pushed American wages up. The need to make America more competitive could have been a major goal behind the decision to let the recession deepen. Stopping the housing bubble, that the Fed caused by mispricing risk, was clearly a motive for Fed inaction. Ben Bernanke practically said so himself:
"My mentor, Dale Jorgenson [of Harvard], used to say — and Larry Summers used to say this, too — that, ‘If you never miss a plane, you’re spending too much time in airports.’ If you absolutely rule out any possibility of any kind of financial crisis, then probably you’re reducing risk too much, in terms of the growth and innovation in the economy.”
Since the risk was mispriced, thanks to the Fed (Basel 2) adopting suspect copulas, there was something not moral happening on both ends of the housing bubble.

Because the subprime paper market froze up, as explained below, any financial engineering or inaction on the part of the Fed, that tightened the money supply, also had unforeseen consequences that weakened the banks more than planned. I had written that interbank lending was affected by the LIBOR rate explosion as well as subprime lending. However, as chart 3 below will show, that there was a delay in interbank lending decline, as it did not significantly decline until the Lehman failure and again with the advent of interest on reserves for the big banks.  

There is a timeline offered here that may add to a reasonable explanation of the unfolding of the Great Recession. There are three charts below, making a timeline of sorts that shows a possible deliberate deepening of recession. I explain the charts in detail below. The Fed ignored data, or actively tightened for two whole years, including implementation of interest on reserves (IOR).

Chart 1

Chart 2

Chart 3

Chart 1 refers to the GDP decline, starting in 2004-2005 but really picking up in early 2007, compared to inflation, which kept steady until late 2008. Massive layoffs also occurred in late 2008. Was that not a random coincidence? Chart 1 shows Fed inaction in the face of a major NGDP crisis.

Chart 2 refers to LIBOR interest rate exploding and crossing the Swaps rate, the blue line, making swaps unprofitable for banks, causing bank subprime lending to slow. Swaps were insurance against bad real estate loans. And when that insurance was no longer safe for the banks, lending slowed. Also, when LIBOR rose, adjustable mortgages became unprofitable. Bernanke speaks of this 2007 LIBOR explosion as if it caused the decline of interbank lending. So it is necessary to look at chart 3 to show that was not quite true.

Chart 3 refers to interest on reserves paid to the banks by the Fed. The interbank lending started to dive in late 2008 as the crisis hit, and Lehman failed September 15th, which is the first vertical line, but rebounded slightly until Bernanke started paying IOR.

George Selgin quotes Bernanke as saying:

The skyrocketing cost of unsecured bank-to-bank loans mirrored the course of the crisis. Usually, a bank borrowing from another bank will pay only a little more (between a fifth and a half of a percentage point) than the U.S. government, the safest of all borrowers, has to pay on short-term Treasury securities. The spread between the interest rate on short-term bank-to-bank lending and the interest rate on comparable Treasury securities (known as the TED spread) remained in the normal range until the summer of 2007, showing that general confidence in banks remained strong despite the bad news about subprime mortgages. However, the spread jumped to nearly 2-1/2 percentage points in mid-August 2007 as the first signs of panic roiled financial markets. It soared again in March (corresponding to the Bear Stearns rescue), declined modestly over the summer, then showed up when Lehman failed, topping out at more than 4-1/2 percentage points in mid-October 2008 (pp. 404-5).
But if you look at interbank lending in the third chart, it continued despite the high cost, even increasing in August and September, 2008 prior to Lehman! LIBOR cost increases in 2007 did not slow interbank lending down at all for the big banks between each other, until Lehman!

What really slowed with the LIBOR explosion in chart 2 was subprime to the public. According to Investopedia, the most common subprime loan was an ARM, which started out with a low fixed rate and then converted to a floating rate based on LIBOR plus a margin. When LIBOR rose, that margin was undone. That could explain why banks like Barclays were desperate for LIBOR to decline back below the Swap line.

So, Selgin, who may not view all this as part of a master plan, (you have to ask him), clearly catches Ben Bernanke in a strange statement that clearly is diversion from actual events. Again, the third chart clearly shows that the first vertical line, September 15th, 2008, Lehman's collapse, was the start of interbank lending collapse.

The second vertical line, October 15th, shows small banks beginning to receive interest on reserves. Small banks receiving IOR did not destroy interbank lending.

In fact, interbank lending did not fall off the cliff until the third vertical line, October 22, when the big banks began receiving interest on reserves! IOR for the TBTF banks was the main factor in the destruction of interbank lending.


It is clear that the interbank lending decline, (chart 3) was not in the mirror of the LIBOR explosion timeline, chart 2, until the collapse of Lehman almost 2 years later. The explanation by Bernanke is factually incorrect. But it is true that toxic CDOs and CDSs based on subprime lending, destroyed by LIBOR's push upward, lead to Lehman's collapse. The destruction of interbank lending due to toxic subprime paper, exposed by Lehman's demise, was a delayed reaction.

Bernanke's Fed is almost rewriting history, it seems. But their own chart 3 refutes that "history". And if you extend chart 3 back to 2006-2007 you will see that interbank lending was increasing in 2007.

The Fed should have intervened much sooner in the process. If the Fed shared Henry Paulson's concept that subprime was contained as he stated in 2007, that was either a mistake or fraud. With LIBOR exploding at that time, was nothing was contained.  

IOR for the big banks, coupled with lack of responsible actions for at least two years prior, increased the intensity of the Great Recession, first by ignoring NGDP, second by ignoring the LIBOR explosion, and third by the combination of the Lehman collapse coupled with the implementation of IOR for the big banks.


Bernanke made the crisis worse by inaction and IOR which was a tightening of the money supply, and then failed to explain it correctly.

And was it necessary to halt interbank lending by implementation of IOR (chart 3) in order to drop LIBOR below the Swap Line in chart 2? That drop in LIBOR didn't restore trust or interbank lending, and included bank manipulation of the rate. That became known as the LIBOR scandal, a fraud upon the counterparties of the banks.

London, the seat of world finance, controls that system by controlling LIBOR. That fact certainly should not be taken lightly by US regulators going forward.

Thursday, January 21, 2016

Fed Monetary Errors Could Have Made The Great Recession Much Worse

This article was first published by me on Talkmarkets:  www.talkmarkets.com/content/us-markets/fed-monetary-errors-could-have-made-the-great-recession-much-worse?post=82876&uid=4798

The Federal Reserve ignored its own data when it came to the percentage drop off in growth in the Great Recession. The Fed targeted inflation, which seemed to be humming along, and yet, GDP, the Nominal GDP, was dropping way before inflation dropped. This chart tells it all:


The Fed was looking at inflation, the red line, when it should have been looking at the percentage change of (N)GDP, the blue line.

NGDP was dropping by percentage in early 2007, actually starting in 2005, while inflation did not drop until nearly 2009. Of course we have to look at sticky wages for the private sector and we see the greatest percentage drop is attributed to the Great Recession, as many well paying jobs were lost in fall of 2008, leading to the greatest percentage of hourly earnings drop in 2009.


The "sticky wage" concept is that wages, in normal times, tend to creep up. They may even put businesses into a noncompetitive global position. Business had been offshoring jobs, in the process of hollowing out manufacturing in America, even before the Great Recession. The New York Times showed that in early 2008, prior to the mass layoffs at the end of the year, there were real problems growing in the treatment of workers. 

According to the Times, productivity grew 60 percent between 1979 and 2007, yet wages stagnated. While I ignore the average wage figures in the article, they could have been higher according to this chart, the productivity clearly has not been rewarded for workers.

The Great Recession unstuck sticky wages. Layoffs were massive in late 2008 as companies are not keen to drop wages, as was done to my father in the Great Depression of the last century. His wages were dropped substantially, but workers were still needed in a developing nation, especially in the oil patch. He kept his job. My father knew an oil worker who worked for an oil company called Superior Oil. He was paid in stock rather than in wages, because the company could not pay wages. He saved the stock and became a millionaire after the Great Depression, while still wearing overalls.

We saw a combination of furloughs, and layoffs and cuts in wages in the Great Recession. And people feared quitting, putting the  classical economists' concept that people would just quit because of lower wages into hibernation!  And wages are so sticky they are not going up to reflect productivity gains, after the Great Recession, either. The combination of slowing wage growth and labor participation being low can be attributed to the credit crisis and Fed policy in the aftermath.

Wages are quite sticky until growth is hindered for some time. The first chart above shows that GDP was dropping even during the house bubble in 2005. Wage creep could have motivated the Fed to look the other way as warning signs signaled the Great Recession and it could have made the recession much worse.

With the Great Recession, the Fed may have tried to make the US more competitive, and yet, because of the damage to the American consumer, the worker, the whole world has slowed down. 

NGDP targeting, which takes into account what was seen on the first chart above, would simply interfere with plans to deepen recessions going forward, in order to force Americans to accept lower wages still. That is not the reason given by central banks for not applying that targeting. Keep in mind that wages in private manufacturing are where the biggest hit took place. Most public service jobs, though thinned out, kept wages very sticky. Many in the private sector have given up looking for work.

Regarding recovery, perhaps the central banks were counting on China to boost or stabilize asset inflation and middle class spending among a large, growing middle class. That could prove to be a damaging central bank miscalculation as China is slowing and its asset purchases have slowed. 

Americans buy the world's excess goods, until they don't. The Fed believed that the recovery would be faster. Bernanke said there would be bull markets somewhere, growth somewhere. Perhaps sticky low wages kept his visible hand from a successful reflation. 

This plan to slow the growth of wages, especially in manufacturing, to reduced house prices from bubble territory, to weaken the middle class wealth and worker wages, and cause banks to continually profit from low interest rates "succeeded". But what will be the cost of this decimation of America's working class going forward?  Will recessions deepen going forward because of monetary policy decisions?

Perhaps a strong middle class in America is essential to the strength of the world economy. Central banks, with the Fed in the lead, could have tried to preserve many of these well paying jobs by targeting NGDP. They are now being replaced by lower paying jobs. 

In the Great Recession, the banks got houses back, received guaranteed mortgages if they didn't short sell, and bailout money. The banks won in major fashion on bets on low interest rates in the swaps markets as rates continued to drop even further. There are new demands for bonds as collateral, that constrain interest rates, even when growth occurs.

And, if something doesn't change, in order to establish a successful and healthy reflation, we could be facing cashless societies and negative interest rates. I wrote about those here and here and here.

Tuesday, January 19, 2016

NGDP Targeting and Market Monetarism Made Easy with Graphs

 This article was first published by me on Talkmarkets: www.talkmarkets.com/content/us-markets/nominal-gdp-targeting-and-market-monetarism-made-easy-with-graphs?post=82536&uid=4798

NGDP Targeting is an easy concept to understand and so I will try to share it here. I am sharing this as a layman, a financial contributor, not as an economist. I have not made a judgement about the merit of the system, only that it makes perfect sense and that monetary policy has been unnecessarily blind to the reality on the ground.

The economists who target NGDP are known as market monetarists. Sharing this relatively new school of economics on a basic level has to then be, a sharing by example, not by abstract academic thinking.

I have written a little article showing the terms involved in a more thorough understanding of the subject, and why I think it could work except for the problem of recent bond behavior. And of course, serious students can learn from the many blogs that exist teaching the abstract details of what the school stands for. But here is a simple approach for those who are not economists.

Simply put, Nominal GDP is growth plus inflation. Targeting NGDP, then, becomes an option to central bank targeting of inflation, which, according to the market monetarists, does not show the entire picture. The MMers like to target 4-5 percent, as it is a natural rate based on Wicksell's study. So, if inflation is only at 1 percent, but growth is at 3-4 percent, all is stable in this system. If growth is 1 percent, inflation should be bumped up to 3-4 percent. But that rate of inflation should only be higher when growth is lower.

Real GDP is growth minus inflation. If only inflation is targeted as is done now, and growth happens to be strong, inflation becomes too high and prices are distorted. But if inflation is stable and NGDP is dropping, the nation could be plunged into turmoil as we see by the following chart. [Nominal GDP is also known as the chained dollar GDP or the current dollar GDP.]






[Note: As you can see, for FRED, the Nominal GDP graph is simply the GDP graph as distinguished from the Real GDP graph.]


Nominal GDP started falling precipitously in early 2007 and, as a result, many people were laid off, and many corporate bankruptcies occurred. The argument of the MMers is that this fall off could have been leveled out had the Fed been paying attention to proper targeting.

You can see by the next graph that the inflation rate (breakeven used here), was humming along and had not dropped in early 2008, while NGDP had already been dropping. Therefore, the Fed, if it were only looking at inflation, did not see any threat to money supply that was really occurring. Again, was it a mistake or done on purpose? Only the Fed knows that.

But this truth is a strong argument for targeting NGDP. Inflation targeting works fine when things are doing ok, but the Fed is blind when NGDP is falling off the cliff, and inflation is stable at the same time, for awhile at least:



Also, I have argued that the Fed ignored the LIBOR interest rise taking place as NGDP dropped. My argument is a second proof that the Fed saw a crisis in data and did nothing. The MMers' argument that the Fed was too tight as to monetary policy at that time carries a lot of weight. The Fed was sleeping, and you wonder if it was done by accident or on purpose.

Another example example of failure to target nominal GDP is now most acute in the Eurozone, where systemic unemployment is massive, especially in the periphery nations, like Spain, and Greece.

NGDP Targeting is a process, and the measurements determining how to apply the process are complex. For non economists, the measurements may turn out to be something not worth trying to understand. But there are important things to understand.

For example, NGDP Targeting would not save the economy from itself, but rather from monetary policies that could make downturns and upswings more unstable. NGDP is a method for wanting monetary policy to stay out of the way of the economy. The housing crash, if the MMers are right, would not have been as severe had the Fed been paying attention to the NGDP in 2007 and 2008, which simply crashed horribly during that time.

Some NGDP Targeting advocates like Scott Sumner say they are libertarians. But they will certainly not be accepted as such by most libertarians, who live in a fantasy world of free markets anyway. But, again, a policy that suggests a way for the Fed to get out of the way of the economy may appeal to libertarians and non libertarians alike.

Because of the complexity of applying the simple notion of growth plus inflation, these economists tend to be very grumpy. They have bitten off a lot to chew on, because of the complexity of it all. And they have been abused, from time to time by other schools of economic thought. But I think that is what economists do and could lead to some grumpiness.

One terrific idea from NGDP targeting is that the central bank does not have to fear failure in targeting inflation, if the economy is growing enough to make that inflation less needed. As it is, the Fed targets inflation at 2 percent, and they are timid about it. The MMers accuse the Fed of using 2 percent as a ceiling. With growth really slow in the next recession, say at 1 percent, this could be a problem for the economy. Knowing this could happen, people hoard money and bonds.

The MMers think less hoarding would take place if NGDP were targeted instead of inflation.

I hope this article has helped some understand that the Fed was flying blind, and data existed from two sources, NGDP and LIBOR, that told of a crisis brewing.




Monday, January 18, 2016

MM Boys and Tight Money. Market Monetarist Terms Listed for You

 This article was first published by me on Talkmarkets: www.talkmarkets.com/content/us-markets/mm-boys-and-tight-money-market-monetarist-terms-listed-for-you?post=82308&uid=4798

The New MM Boys are attempting to aim for the fences, and develop a new economic school of thought that will cause the economy to prosper through stabilizaton of Nominal GDP. But so far they are just hitting singles and doubles. Before I continue, here are a list of terms that apply to the New MM bloggers:

Terms Market Monetarists are most interested in. Google them if you are not familiar with them:

Phillips Curve broken down
Nominal GDP (NGDP)
NGDP Targeting and Inflation Targeting
ZIRP and NIRP
Money Illusion
Rational Expectations
NGDP Futures
Nominal Income Target
Monetary Disequilibrium Theory
Sticky Wages/Sticky Prices
Hot Potato Effect
Wicksellian Dilemma
Wicksellian Natural Rate of Interest
Keynesian Liquidity Trap
Interest on Reserves (IOR)
Aggregate Demand Determined by Future Path of NGDP
Base Money
Excess Reserve Interest As a Monetary Tool
Velocity of Money
Decline of M1 Money Multiplier
PT or PY?


Turns out, the demand for bonds I have written about here at Talkmarkets could be preventing GDP targeting as the Fed only seems to want to buy bonds or MBSs and can't hoard long bonds forever, which are in great demand. The Fed doesn't seem to want to buy shopping centers (although it was stuck with one), or,  gold or stocks or other assets like land to use as collateral, at this point. Some market monetarists want the Fed to branch out for collateral.

One problem is that market monetarists expect bond yields to rise when the Fed purchases those assets. But that may not be proven true.

Now, when I was a young child, around 12 years old, my father took me to watch the original MM Boys from the New York Yankees. It was at the old Wrigley Field in Los Angeles, first home of the California Angels baseball team.

Wrigley Field had a ramp where players walked to the field. I managed to see the real MM Boys up close, a childhood dream. There stood Mickey Mantle and Roger Maris, and I got Mickey Mantle's autograph that day. Maris watched, smoking a cigarette. Can you imagine if those guys had taken care of themselves?

That year Maris would hit 61 home runs, and Mantle 55 home runs, steroid free. I was also a fan of the great Willie Mays.

The New MM Boys, the Market Monetarists, have not hit any home runs. Scott Sumner hit a double, likely influencing the Federal Reserve to extend QE although it isn't his favorite vehicle for targeting.  But that QE drug has now turned banks into QE addicts. So he hit a double, in getting a little growth and stability in the economy, but then the bankers' addiction left Sumner stuck on second base. The banks fear lending and would rather suck at the teat of Interest on Reserves (IOR).

But you have to know that I had great hopes for the New MM Boys. They have a similar view to mine, that negative interest rates, secular stagnation and a cashless society are all bad things. They see the direction Europe is going and fear the world will adopt that plan. They are right that the Fed was too tight during the credit crisis, probably making things worse for the economy.

So, while I commend them on their intentions to prevent busts and rekindle prosperity, they face resistance for their solutions to prevent the slide past the zero bound. The don't want Negative Interest Rates, or NIRP (coined by Kevin Dowd I think), but they have unusual solutions to the problem of negative rates.

My concern is that the Fed buying up other assets would not necessarily boost wages but rather only boost speculation in those assets by the private sector. Some people think that the market monetarists are just banker shills.

But I believe they are more substance than that. For example, they deny the Keynesian argument of liquidity trap. They believe that money printing can increase interest rates. Again, I would caution that demand for bonds as collateral can interfere with that. But historically, that has been true.

Don't be fooled, the MM Boys know an increase in new money will devalue money. A tool for devaluation is printing money. American's need a little purchasing power, though, don't they? Austrians watch the MM Boys in horror, not even wanting a central bank, while other economic schools are skeptical as well.

One complex solution is that Scott Sumner advocates negative interest rates on IOR. But he does not advocate negative nominal interest rates in the economy.  I can't see where he would accept negative interest rates in the economy although you have to realize, economists can change their minds. Look at Krugman, who was classical and became Keynesian.

And Bill Woolsey, a market monetarist, sees nothing wrong with banks passing a negative IOR onto customers of the bank. That seems to contradict other market monetarists and sort of defeats the purpose of the New MM Boys altogether. But all Market Monetarists don't think alike on everything.

But for now, it appears most of the New MM Boys want stimulus to put us above the zero lower bound. Interest rates have not fallen to lows we see now for 5000 years, so the New MM Boys wonder why now. We have negative real rates and are headed to negative nominal rates if other economists have their way.

So, Market Monetarists seem to want much higher targets for pricing of commodities and things produced through seeking from the Fed a commitment to maintain or restore wages. But central bankers tend to shy away because the measurements for GDP can be revised, meaning they can be in error when first measured.

Certainly if central banks do decide to buy a lot of different assets, as the MM Boys want, they will set prices for those assets and we know they have secretly mispriced risk in the past to do so. Now at least, price fixing by the Fed would be out in the open.

Market Monetarists say that economic shocks are handled in more stable fashion if NGDP is targeted. They say that if money is too tight it will show in the falling of NGDP.

Lars Christensen, whose pdf link is provided at the end of this article has said that if money is loose, long bond yields should rise. But that was then and this is now and I would caution about this not happening due to the fact that long bonds are in massive demand for collateral. I don't think that the market monetarists have factored Fed market manipulation into their observations.

But I am still rooting for them to figure something out, because it seems like interest rates floating at a more positive level have been a normal occurrence in the course of human history. Civilizations didn't worry about negative rates. Derivatives and collateral may well one day be the destruction of historical economic thought, taking down the Classicals, Keynesians, Austrians and Market Monetarists!

Still, I hold out hope for some solution that would return us to the old economics. Banning derivatives may be the only, ultimate, answer. Certainly, the MM Boys, must try to convey their understanding of their positions to the rest of us. Some sincerely do, and some could care less about anyone not in the profession. The Fed may be powerless to stop a credit crisis, or maybe the MM Boys are right, that it is all about base money and velocity of money.

If they can prove they can overcome the new normal of low interest rates, they will illustrate genius. We can only hope.

For further study, see Lars Christensen's working paper, the "Bible" of the New MM Boys:
Market Monetarism

See also:
PT VS PY

See also:
Could the Fed Have Prevented the Financial Crisis?

See also:

The Fed Knew LIBOR Was Exploding in 2007 and Did Nothing








Monday, January 11, 2016

Sumner and His Market Monetarists Compared to Mish, Libertarians and Keynesians

 This article was first published by me on Talkmarkets: www.talkmarkets.com/content/us-markets/sumner-and-his-market-monetarists-compared-to-mish-libertarians-and-keynesians?post=81981&uid=4798 

Scott Sumner and his market monetarist buddies have made a name for themselves. All the way back to articles on Business Insider, mostly written by Joe Weisenthal, they have maintained that the Fed was too tight in late 2007, leading to the Great Recession. They say that the cause of the Great Recession was tight money, including Interest On Reserves, IOR paid to keep banks from lending.

Now, please note, they do not deny a housing recession. But they say what happened was much deeper than that. The argument is compelling. They are opposed by Keynesians, Mish Shedlock, and Mises (Austrian economists). Please bear with me as I attempt to sort this out for you.

This accusation of tightening on the part of the Fed has become a hot economic topic because of  Ted Cruz's comments about the Fed showing a disposition to tighten prior to the deep crash in 2008. Mises would not accept this and says that blowing the bubble in the first place was the real evil of the Fed.

That has some truth to it as well, because many, including myself, believe that the Fed did misprice risk of the faulty MBSs in order to allow them to be used as collateral in the money markets. They broke one money market and were exposed after that. Confidence in the markets was damaged by the bubble and crash of MBSs.

But Mises and the Austrians say that easy money was the fault, while the monetarists say tight money after the crash began was at fault. Sumner and his friends have an agenda to print more money, but some of what they say makes perfect sense. Benjamin Cole and all the market monetarists want money printing and Ben freely admits it. I am no fan of Ted Cruz, but could he be latching on to some valid arguments?

Mises.org (Austrians), and their buddies like Peter Schiff, want money tightening in place of printing.
What I think is that the Fed tightens when it should loosen and loosens when it should tighten. What works one time does not necessarily work another time. But that is a layman's opinion. I just think there is not enough flexibility in the system to do what needs to be done,when it needs to be done.

Now, I believe that Keynesians like Roger Farmer and non Keynesian Mish would say the tightening by the Fed was a result of the credit crisis, and that the credit crisis, not tight money, was the cause of massive layoffs. That isn't so far different than the Austrians.

There are compelling arguments on all sides. For example, the Keynesians would say that massive unemployment cannot be solved by monetarism. Roger Farmer calls for fiscal solutions. But Sumner would say, print money and unemployment will decline.

But the monetarists call for unlimited growth and think a bunch of easy money loans are just fine and won't cause a Great Depression if the Fed is there to keep NGDP on track. More on that later. But, they aren't good for the people who take out the loans and I oppose predatory loans. But are they good for the economy that is heading for deflation, negative interest rates, economic despair, and a cashless society? That is a tough question. 

I have written against the cashless society and demand deflation. Those aren't any good, but we could be headed to those results if we don't loosen up lending for productive gains. Giving a small stipend to each citizen may be the only real answer, but could big finance blow a worse bubble with all that money?

And what collateral would the Fed take in in order to print all that money? Would they be owning malls and power plants? Questions abound. And I think we have a bigger shortage of bonds than we do of money. 

You could say that there is truth to Sumner's position on the crash of the economy, as well. I observed and reported that watching LIBOR explode and doing nothing was clearly a tightening.  That happened in mid to late 2007. Add to this inaction, the implementation of IOR, and you can see it clearly was a tightening for a whole year. It was a result of the Fed's fear to act, but could it have been the cause of a deeper recession?

It is time that the Fed members be held responsible for their actions. After all, it does seem that paying interest on reserves in October, 2008, really hurt the economy. Maybe it saved the banks, and that is an argument to consider. But, saving the banks should be secondary to saving the economy.

I remember the late Bill Seidman going on CNBC every day saying that you just needed to put the banks into something like the Resolution Trust Corporation that he applied to the Savings and Loan crisis banks. Could Seidman have saved the economy and wound down the banks at the same time? He seemed to think it could be done, even with the mountain of derivatives that existed.

But the Fed exists to save the big banks no matter what happens to the economy. They proved it beyond a reasonable doubt.

This is my take, if you are going to try the Sumner experiment and print away, you have to do two things. You have to tie fixed income to whatever inflation results. Sumner doesn't believe in targeting inflation, but rather targeting Nominal Gross Domestic Product or NGDP. But that could result in inflation so you have to protect fixed income.

And you have to repeal recourse lending. You must allow non recourse loans only if you try Sumner's way. That way, if the house crashes, and you mail in the keys, you won't be liable for any other charges. And that could include HELOC  liability, which made even a non recourse loan into a recourse loan.
If society is not willing to do those things, then Scott should never have the opportunity to apply his experiment to the world economy.  Putting citizens through what they went through in the last Great Recession is simply unacceptable.

I know in my bones that Fed tightening contributed to the Great Recession, but I don't know if I could stomach the solutions of the market monetarists. And who could trust the Fed to have their backs?
I partly believe the market monetarists when they say raising interest rates is not tightening. Seems like the banks make more money on loans that have a higher interest rate, plus house prices are cheaper so it helps the consumer. But when the Fed raises the IOR along with raising interest rates, it could be another tightening.

Yes, big business and big banks benefited from low interest rates, and bought up many assets while improving balance sheets. But this has not helped the economy, because small business creates most of the jobs. The Fed has simply been a zero interest rate failure. It was OK for awhile, but failure is the massive amount of people not looking for work. Do not think that is success when big business has billions of dollars on their balance sheets.

I don't think a low interest rate regime of years was called for by Keynes himself. However, Keynes has said that people will borrow less if interest rates rise. While that seems logical and applies to big business, what really happens is that as interest rates rise, prices for things come down, and more importantly, banks are more willing to lend. At rock bottom interest rates, banks are afraid to lend. 

The market monetarists are onto something here. But as we can see, the macro battles wage on. For example, while there is a shortage of bonds, there certainly is enough money at the top. There is not enough money at the bottom.

The answers on how to solve the dilemma require honest people putting a damper on greed long enough to establish a greater good. Certainly, we have been disappointed by the Austrian economists' invisible hand of self interest, since all we got from that was bank deregulation and massive housing speculation and closed access cities with all the high paying jobs.

Market monetarists and the Austrians agree that bank deregulation was no big deal. They are wrong about that, in my opinion, because speculation drove up the price of houses in certain markets, causing the crash in house prices. When they all say that the house bubble would have been a run of the mill recession but for Fed tightening, things get murky. Certainly, the Fed did nothing while LIBOR exploded. And they did nothing for the year after that.

But the Austrians and market monetarists must realize that the Fed cares about the banks and not about the society, if it has to choose. And it did have to choose, or at least thought it had to in the Great Recession.

So, as long as the Fed has interests opposite the Austrians and market monetarists, deregulating the banks only plays into the hands of the Fed, and does not give the Austrians and market monetarists what they want, lending into society, private stimulation of the real economy. Both camps simply trust banks too much.

The market monetarist supply side increases of production morph into supply side increases in unproductive lending for speculation, the way the system is devised now.

Yet the Keynesians have been wrong too, trying to stimulate a banking system that would rather speculate and take IOR than take an active role in helping society. Keynes' ideas worked in the Great Depression because there were rules in place to stop speculation. Perhaps that should be the first rule applied before any economic theory is applied going forward.

After all, people hoard if they don't trust that the financial system is fair.

The Dollar Is Not Redeemable In Gold But It Is Backed by Collateral

This is what the Fed says about the dollar, about our money:
http://www.federalreserve.gov/faqs/currency_12770.htm

Is U.S. currency still backed by gold?

Federal Reserve notes are not redeemable in gold, silver, or any other commodity. Federal Reserve notes have not been redeemable in gold since January 30, 1934, when the Congress amended Section 16 of the Federal Reserve Act to read: "The said [Federal Reserve] notes shall be obligations of the United States….They shall be redeemed in lawful money on demand at the Treasury Department of the United States, in the city of Washington, District of Columbia, or at any Federal Reserve bank." Federal Reserve notes have not been redeemable in silver since the 1960s.
The Congress has specified that Federal Reserve Banks must hold collateral equal in value to the Federal Reserve notes that the Federal Reserve Bank puts in to circulation. This collateral is chiefly held in the form of U.S. Treasury, federal agency, and government-sponsored enterprise securities.

Keep in mind that this is base money that the Federal Reserve bank puts into circulation, not all money,  that is backed by collateral. Of course, the quality of collateral is important. Treasuries have good quality because the US government has never defaulted and because the demand for treasuries is immense as I wrote at Talkmarkets:

Future Insatiable Bond Demand

However, one must understand that bond demand is greater than it should be even when the economy is expanding and that may affect the willingness of banks to lend. They may not lend when they don't have to do so. Certainly the Fed does not want the bank excess reserves to get out into the public because demand for bonds would have to be even stronger. This demand is distorting the behavior of the long bond.

Perhaps an audit of the Fed would allow us to see if this rule is being followed properly. 

Friday, January 8, 2016

Fed Premeditated Mispricing of Risk in Housing, Oil, junk bonds and other Markets

This article was first published by me on Talkmarkets:  http://www.talkmarkets.com/content/us-markets/fed-premeditated-mispricing-of-risk-in-housing-oil-junk-bonds-and-other-markets?post=81636

I have written that skeptics of Wall Street view the housing bubble of the mid 2000's as a premeditated mispricing of risk. More on that at the end of this article. Now that we have Bank of America coming out and saying that stocks and other assets are mispriced regarding risk and the Fed is behind it, so we have to wonder what else is mispriced regarding risk.

It looks as though investors may be buying financial assets that were meant to fail, but are inflated for a time before failure, due to this mispricing. This allowed assets to reach pricing heights not possible had the risk been priced correctly and crashes to be delayed. To a certain extent, we often see what finance wants us to see, and we don't see the big picture until after the fact. But Bank of America has put the blame for bubbles and busts squarely upon the shoulders of the Federal Reserve Bank.

In the private sector the continual application of fraud looks like racketeering, and one could say that there should be RICO laws opposing the behavior. The Fed is more private than most people think.
In one case, pricing of oil, it appears that there could be political motivation for asset price declines and the duration of those declines. However, most of the asset manipulation is inflated, which results in speculation that allows bankers to make some money.

That is exactly what Will Rogers said prior to, and during the Great Depression. He believed that speculation was premeditated and made statements in jest about how bankers claim they don't know much about their business. He accused them of criminal behavior to their faces. Rogers said this to the bankers at the American Bankers Association in NYC:
 "You have a wonderful organization. I understand you have ten thousand here. And if you count the ones in the various federal prisons, it brings your total membership up to around thirty thousand." 1923
However, apparently they do understand their business, especially when the manipulation of speculation, through mispricing of risk, comes from the top.

So, what could be mispriced now? Maybe oil is mispriced, as the drop in production that is coming could one day cause a severe bounce back. I don't have an opinion, but you wonder if strings are being pulled to keep oil prices low, as a political attack on Putin's Russia? Certainly, keeping oil too low for too long could destroy production and cause a massive bounce back of prices.

In fact, the author of this article claims that the mispricing of oil is by traders and is deliberate. The central bankers just may have something to do with it and the longer oil is mispriced, the worse the bounce back will become in the future.

High yield bonds could be mispriced, since the highest, safest tranches are trading at levels showing a lot of risk. Michael Snyder has reported that this market could have destructive results. If that is the case, it is because, again, risk was mispriced on purpose.

Why would anyone want to misprice high yield "junk" bonds on purpose. Well, it is because they are used as collateral for capital intensive industries such as oil and telecommunications. As long as those industries are humming along, the mispricing doesn't hurt anything, until they don't hum along. Oil isn't humming much these days.

Exotic assets could all be mispriced, including high end fine art, and Los Angeles upper end housing.

Turns out that the threat of deflation could also be mispriced, as the Fed thinks inflation will run at 2.5 percent over 30 years. Treasury bonds could be the best deal in history if inflation runs below that number. But that is not advice from an investment pro, just an observation. The Fed has done a great job, if you can call it that, of keeping core inflation low while ripping food and energy costs upward. That slowed when it was determined that oversupplying the world in oil would hurt Russia. At least that is my take.

It does not seem like it would be in the interest of the Fed to allow rates on the long bonds to rise significantly. I wrote about that here and here.

With regard to the housing bubble, the risk that all mortgages could not go bad at the same time was not adequately factored into the formulas, the Gaussian Copulas, used to weigh the risk of the mortgage backed securities (MBSs), sold to investors. Mispricing these MBSs was fraud, plain and simple.
The  mispricing of MBS risk lead to the failure of the bonds, which were used as collateral in the money markets. And even central bank credit must be properly collateralized. But the central banks accepted the faulty Gaussian Copula which resulted in MBSs being mispriced.

David Li's Gaussian Copula was adopted by Basel 2 as revealed by Susan Lee, and it ruined the financial system. Basel 2, meaning the Fed and the central banks associated with the BIS, is responsible. Then regulation of the banks failed when the off balance sheet hiding of assets resulted in banks being able to look solvent when their capital ratios were totally out of whack. Huge transfers of wealth went from the middle class to the wealthiest among us when the securitization machine broke. The Fed even let crash that occur. 

And here is the problem, if the government was lying, you could say it is sovereign and can do what it wants. But the Fed is not part of the government. It is a private organization made to look like a government organization. It has, after all, the name, Federal Reserve Bank. That sounds very federal.
Janet Yellen receives a cabinet level salary, set by congress. That looks like government in action. But then we learn the Fed employees are paid by the securities they own. 

If anyone doubts this, you can look at the 1982 Ninth Circuit Court case, Lewis vs. the USA, where a Fed employee crashed into Lewis. The court rules that the Fed employee was not a government employee and Lewis could not sue the US government for the damages! If Janet Yellen runs you over in her car, you won't be able to get government relief.

The Fed is private, and its real mandates is to make money for and protect the big banks. That makes the mispricing of risk a criminal behavior, in my opinion. The Fed does not exist to make money for American citizens. It exists to make money for the banks.

The Fed hides its private nature, and the government assists in that endeavor. CNBC also assists, and I have personally never heard CNBC, which I watch often, ever say the Fed is a private bank. Even Larry Summers adds to the confusion, saying the Fed is a public institution that should not have big banks owning shares.

It is very disturbing that Larry Summers is debating Bernie Sanders on the Fed and on what Sanders gets right or gets wrong, when Summers is fooling us as to the public or private nature of the Fed. Summers clearly stated the Fed was a public entity. I got the feeling from reading the article by Summers in the Washington Post that he wanted the banks to relinquish shares in the Fed to make the Fed look even more public than it already isn't. And that "isn't" isn't a typo.

Andrew Jackson chased one central bank from America's shores at extreme peril to his own life. So, you wonder how much more manipulative corruption of assets and resulting damage to our economy can be tolerated before it will finally force the government either to bid adieu to our own Federal Reserve Bank or nationalize it with rigid control over its behavior.

Further reading:
The Federal Reserve Knew LIBOR Was Exploding in 2007 and Did Nothing

and:

A Whole Lot of Gold Hoarding Going On

and here is a well known pundit unfortunately defending the practice of price manipulation:

Jim Grant on CNBC Discusses Mispricing of Assets 




Monday, January 4, 2016

The Federal Reserve Knew LIBOR Was Exploding in 2007 and Did Nothing

 This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/bonds/the-federal-reserve-knew-libor-was-exploding-in-2007-and-did-nothing?post=81296

The Federal Reserve did nothing when LIBOR exploded in 2007 (chart at the end of this article). But since then, the Fed has taken the four steps listed below. The result of these steps will be a slow economy going forward.

Jeffrey Rogers Hummel recently posted an article spelling out the relationship of the Fed to banks and the government. I have no clue whether his main argument is valid although we know the Fed is paying banks 12 billion dollars in 2016 in interest on reserves (IOR). That seems like real money to me.

But the most interesting aspect of the article for me is Mr. Hummel stated that the big banks who are members of the Fed get few perks from that position. I think the big banks get massive perks from the Fed. I want to share again what I posted on Talkmarkets. I said:

So, we need to look at the ways in which the Fed has set things up to predispose it to keep rates low.
1. Grumpy's (Grumpy is John Cochrane) friend says the Fed can't afford to pay the treasury interest if rates are significantly raised. That is almost a hostage situation.
2. The banks have bet on low rates, taking the floating low side of the swaps bet when they issue loans.
3. The Fed pays interest on the excess reserves in order to restrain lending.
4. Long bonds are in massive demand as collateral, the new gold, and there are shortages, even with BRICS nations selling into a deep market.
Clearly, the Fed does not want to repeat the explosion of LIBOR, ever again. The chart at the end of this article shows that LIBOR was on a collision course with the Swaps Rate in September, 2007. The Fed could have lowered interest rates before that LIBOR line crossed the Swaps line.

Once LIBOR and Swaps crossed, it was curtains for interbank lending.  And swaps were placed at risk that were based on the banks taking floating LIBOR and the counterparties taking fixed high rate.

Sumner and his friends believe the Fed was too tight during that time. There could be some truth to that, knowing that the Fed paid IOR (interest on reserves), which slowed the money supply and growth, to be sure. But one wonders why the Fed did not attempt to reduce the LIBOR explosion that predated those reserves being put into place?

Turns out, based on the chart again, the Fed was way too tight even though it knew that the economy was at risk by simply watching the explosion of the LIBOR rate in 2007. I think the Fed wanted to experiment with the economy and this crash was done on purpose. That is my opinion only. 

Yet, economists don't take into account that decisions by the Fed protect the banks first and economy second. And they don't take into account that the Fed keeps rates low to protect the banks, even more so as the new clearing houses for derivatives requires even more bonds as collateral than ever before!

Economists think that the Fed wants banks to make money on higher interest. That used to be true, but it may no longer be central to bank stability.

The Fed clearly has the dual mandate to 1. protect the banks and 2. to create demand for bonds no matter what the impact on main street.

So, I found myself saying this again to Mr. Hummel, in a way that would move economists to take on the subject of the supply and demand for long bonds:

...Those (treasury) bonds are being hoarded and long bond yields will be pushed down forever by this plan, or conspiracy or whatever you want to call it. Long bonds no longer react to expected measurements. CATO and most economists are blind to this new reality. Supply and demand of bonds in those markets is a worthy topic for economic study yet none of you seem to want to do it. I am not an economist so you are going to have to do it. If you never do it it makes people like me question the veracity of your profession.
It has been said that a nearly a trillion to 4 trillion dollars worth of bonds are needed in the clearing houses for collateral. And then consider that if bonds were to go up in yield  there would be margin calls on the collateral, and even more bonds would have to be hoarded.
The firms who are counter parties don't know interest rates won't likely go up by much, because of actions by the Fed and the demand created for bonds, so they buy extra bonds. The Fed really did it this time. The Fed is (also) in the business of keeping interest rates low, by backing the banks as they bet on low floating LIBOR and pass the fixed swaps rate to the counter parties. Put the two together and you wonder why we will never see strong growth in the economy for as long as we are alive!
Perhaps I exaggerated there. But it would be interesting to see growth going forward for the next 20 years. The way things are set up now, it seems as though major growth in the economy is going to be difficult. And it seems that as the crash was allowed to happen, with the full knowledge of the Fed, a slow economy is being set up with the full knowledge of the Fed!

One more related issue regards the Sumner/CATO cabal and its desire for rapid economic growth. These economists spend a lot of time blogging about the need for easier loans and easier zoning, in order for growth to take place. But those loans hurt a lot of people. Germany grows without allowing toxic loans for its people. German home ownership is below 45 percent and rent controls are in place. Of course, as I wrote on Business Insider a long time ago, the German banks loaned money to the periphery with easy terms. Must be nice to be in the protected group.

Here is the chart showing that at the exact time when LIBOR crossed the Swaps rate, the financial crisis began the recession. By the way, you always have to keep in mind that the Fed had access to this Swaps and LIBOR data. One wonders why it didn't act to lower interest rates much sooner.