Friday, January 13, 2017

Pros and Cons of Attacking the Federal Reserve Bank

This article was first published by me on Talkmarkets

It would seem that the attacks on the Fed are increasing. Most people have lots of reasons, legitimate reasons, for attacking the Fed. Now, a presidential candidate, Donald Trump, has chimed in with his improper attacks on the Fed.

Trump is partly right, as most people who are all things to all people appear to be right. But his attacks require multiple universes. We, unfortunately, live in only one universe, and are relegated to the earth, home of Hotel Structured Finance, where we have all checked in.

But more about all that in the cons.  Here are the pros first.

So, what are the pros of attacking the Fed? Well, I have attacked the Fed on five issues:

First is the issue of mispricing risk. I think it is proven that the Fed mispriced risk in the housing bubble and in other markets as well, causing banks and other financial institutions to buy unsafe bonds that were less than sound, putting the economy in jeopardy.

Second is the issue of taking down the economy in the Great Recession. I believe that the Fed took down the economy to slow wage growth and get houses back for the uber rich. The Fed would say it was just all to protect the banks. Maybe that is why so many people hate banks.

So, the housing crash was bad, but the resulting tightening of credit, mark to market, etc, made things much worse for main street. The Fed made things so bad that companies could not borrow, sending many workers to a life of misery, unemployment and even death, with most of the unemployed having little opportunity to rebound for years.

Third is the issue of creating fairness in society. I have advocated helicopter money, because all other stimulus from the Fed goes to making an even greater financial divide than has existed in this nation for decades. Helicopter money done correctly, would give us some inflation, but controlled in a way that would cause everyone to benefit.

As it is now, even the local 1 percent people are being left behind compared to the national 1 percent. In certain states, 1 percenters make millions. In other state their incomes are relatively paltry. There is not only a financial divide in America, but also a geographical/financial divide.  Helicopter money would be dispersed equally among all Americans. It would likely benefit geographical areas that are falling behind too.

Fourth is the issue of the Fed creating structured finance in the first place. Derivatives, tools of the false economy, are simply crushing main street, or at least enough of mainstreet that the Fed cannot raise rates quickly, to control a boom. No, now the Fed simply cannot allow a boom. The collateral of bonds cannot spike in yield, or counterparty destruction could undermine big finance altogether.

While most people do not understand that much about derivatives, or the new clearinghouses that increase demand for bonds as collateral in derivatives, they know that something is different this time. This is not like America of the past. As in the words of the song, we just don't have a peaceful, easy feeling about our financial system.

Fifth is the issue of the havoc the Fed is exacting on savers, pension plans, insurance companies and all those who rely on a reasonable return to survive. The damage is great, and getting more pronounced. This is an attack on main street for sure, even if that is not the intent.

I think it is a legitimate criticism of the Fed to discuss those issues. This is true in the light of an article on CNBC based on Boston Fed President Eric Rosengren's comments. Rosengren has said that the Fed should start raising rates, because if it doesn't people will simply make too much money. While he didn't say exactly that, clearly he believes that the labor market will tighten, and the recovery will stagnate? Say what? 

The liquidation of wages contributed massively to the stagnation of the recovery after 2008. It appears that Rosengren, focusing on the unemployment rate, is only interested in the continued recovery of the 1 percent, or maybe a small percentage of the 1 percent. The Fed finds itself in a sweet spot, it thinks, but main street is restless, seeking off the wall candidates for office. You can be an unstable soul, and if you run against the Fed, you will get a lot of votes even if you behave in an abusive and belligerent manner.

Perhaps the Fed should take note and at least watch what it says. It sounds really bad to seek the increase in interest rates only because everyone is working and prospering! We know, of course, that it is partly about wages and partly that the boom cannot be permitted. That new reality goes against the grain of most voters.

So, now we can look at the cons regarding Fed attacks:

This effort to attack the Fed is not as simple as it looks. Attacking is a whole lot easier than fixing. Scott Sumner summed it up best when he said this about Donald Trump:

So what are Trump’s views?  Very simple.  For elderly savers, Trump favors higher interest rates.  For big developers, he favors low rates.  For consumers, he wants a strong dollar.  For exporters, he wants a weaker dollar.  Each group will get what they want, but not all in the same universe. You see, Trump’s monetary views are best described as a wave function, which will collapse to a single outcome on January 20th. Trump is the first post-modern candidate, the first to understand that truth is what the voters let you get always with, and that the multiverse offers the possibility of achieving seemingly irreconcilable aims.
For Sumner, Trump wants multiple universes, or multiple realities existing at the same time. It just isn't possible to please everyone at the same time.

So, while Rosengren hints at the unpopular act of tamping down wages, there are good arguments for raising interest rates that have nothing to do with wage destruction in a tight labor market situation.

One such reason is that banks could make more money if interest rates go up a bit. Jamie Dimon says that would be the case. That means they may be willing to lend to people who need housing and have less than perfect credit or make it easier for those that do have decent credit.

I am not talking about banks extending exotic, massively risky, loans that result in not paying your mortgage, like pay option arms and the like. And, we know interest rates cannot spike too high, in this age of derivatives. But small increases could motivate banks to offer reasonable loans to a greater portion of society.

Another con of attacking the Fed is that the need to raise interest rates will help escape the ZIRP and NIRP. NIRP has not hit home, at least in nominal interest rates in the USA, but low and negative rates make it dangerous to enter into another recession. If that were to happen, rates would go deeply negative. Hats off to the Fed, at least so far being unlike other central banks, for at least trying to get rates up so the cushion against negative will be in place.

And finally, a con of attacking the Fed is that it just isn't free to do much anymore. As the song says, the Fed has checked in, along with all of us, and can never leave. It isn't Hotel California. It is more like Hotel Structured Finance. If anyone saw the movie Independence Day, with Will Smith, you can be sure that Hotel Structured Finance floats in the sky, taking up all of the horizon. It is ship run by aliens, the globalists, but the rates are low and you have a lot of choices as to rooms. Don't plan on leaving, though.

So, here is what constrains the Fed, and all of us, from the booming times we so want to have return to our nation:

Structured finance products are usually include derivatives and securitized and collateralized debt instruments like syndicated loans, collateralized mortgage obligation mortgage obligations, collaterized bond obligations (CBOs), collaterized debt obligations (CDOs), credit default swaps (CDSs) and hybrid securities.

Structured finance helps larger businesses get large capital injections, while loans to main street businesses are hard to come by. So, we will see going forward if criticism of the Fed can bring any prosperity. At least people need to get it right. Donald Trump doesn't quite get it, thinking incorrectly that bond yields on the long end are controlled by the Fed rather than by supply and demand. That is a grave error on his part.

Just don't bet the farm that Happy Days Are Here Again.  After all the 1929 song was written by a Yellen. His name was Jack Yellen. I am just kidding about any connection with Janet Yellen, but perhaps she will sing it one day for us, even if happy days aren't quite attainable for many on main street.

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