Friday, February 3, 2012

Weekend links

1--Treasury Ponders Negative Interest Rates, NY Times

Excerpt: A curious tidbit from a Treasury release this morning:

The question was asked if it made sense for Treasury to permit bids and awards at negative interest rates in marketable Treasury bill auctions. [A Treasury employee] noted that there were operational issues associated with such a rule change, but that the hurdles were not insurmountable. It was the unanimous view of the committee that Treasury should modify auction regulations to permit negative rate bidding and awards in Treasury bill auctions as soon as feasible.

Put simply, the Treasury Borrowing Advisory Committee, composed mostly of Wall Street types, is urging that investors be allowed to pay the government for the privilege of lending it money. For example, an investor would be able to bid and then pay the government $101 for a $100 Treasury bill.

It sounds a bit crazy. After all, a dollar bill is a perfect substitute for a zero-interest Treasury security. But Treasury bills have occasionally traded in the secondary market at negative yields, most recently in December. And at last month’s auction of 10-year Treasury inflation-protected bonds, investors accepted a real yield of negative 0.046 percent. If there is inflation over the period, however, those investors will get back more dollars than they invested. Those who buy a normal Treasury bill at a negative rate, on the other hand, would be assured of getting back less than they paid for it — unless they sell it to someone else for more, of course.

Chalk it all up to the extraordinary demand for and very high prices of United States government debt, driven by investors’ concerns about the economy, a flight to dollar-denominated assets and foreign governments’ insatiable appetite for American bonds, among other trends.

2--Bernanke Sees Improvement in Economy, Bloomberg

Excerpt: Federal Reserve Chairman Ben S. Bernanke said the economy has shown signs of improvement while remaining vulnerable to shocks, and he called on lawmakers to reduce the long-term U.S. budget deficit.

“Fortunately, over the past few months, indicators of spending, production, and job-market activity have shown some signs of improvement,” Bernanke said today in testimony to the House Budget Committee in Washington. “The outlook remains uncertain, however, and close monitoring of economic developments will remain necessary.”...

Bernanke devoted half of his speech to discussion of the U.S. budget deficit.

“To achieve economic and financial stability, U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time,” Bernanke said. “Achieving this goal should be a top priority.”

At the same time, Congress should “take care not to unnecessarily impede the current economic recovery,” Bernanke said.

3--Fannie and Freddie don’t deserve blame for bubble, Wa Post

Excerpt: There is plenty of blame to go around for the U.S. housing bubble, but not much of it belongs to Fannie Mae and Freddie Mac. The two giant housing-finance institutions made many mistakes over the decades, some of them real whoppers, but causing house prices to soar and then crater during the past decade weren’t among them.

The biggest culprits in the housing fiasco came from the private sector, and more specifically from a mortgage industry that was out of control. These included lenders who originated home loans, investment bankers who packaged them into securities, rating agencies that misjudged these securities, and global investors who bought them without much, if any, study.

In other words, America’s mortgage securitization machine was fundamentally broken. It created millions of mortgage loans that, even under reasonable economic assumptions, stood little chance of being repaid — and were not. As a result, hundreds of billions of dollars were lost as defaults and write-downs brought the financial system, and the wider economy, to the brink, requiring a massive government bailout....

Between 2004 and 2007, private lenders originated three quarters of all subprime and alt-A mortgage loans. These were loans to financially fragile homeowners with credit scores under 660, well below the U.S. average, which is closer to 700. But only a fourth of such loans were originated by government agencies, including Fannie, Freddie and the Federal Housing Administration.

The dollar amount of subprime and alt-A loans made during this period by the private sector was jaw-dropping, reaching nearly $600 billion at the height of the lending frenzy in 2006. For context, this is about equal to the total amount Americans currently owe on bank credit cards. By contrast, government lenders made just over $100 billion in subprime and alt-A loans in 2006. Even in 2007, when the housing market was beginning its free fall, private lenders still handed out more than $300 billion via these very shaky mortgage loans...

All this can be seen in the share of total residential mortgage debt insured or owned by Fannie Mae and Freddie Mac. At the start of 2002, before the housing boom got going, the two agencies’ market share accounted for almost 54 percent of all mortgage debt. By summer 2006, the bubble’s apex, their share had fallen to only 40 percent. It is difficult to see how the agencies could have been responsible for inflating the housing bubble at a time when they were losing a full 14 percentage points of market share. Indeed, the opposite was true, as their position in the housing market rapidly diminished....

Securitization was in full swing, enabling private lenders to offer low rates and increasingly aggressive terms to borrowers. In 2006, almost half the loans made by private lenders required no down payment and no documentation. Fannie and Freddie simply couldn’t play in that league, even though Congress had given them aggressive lending targets to help boost homeownership among lower-income and minority households....

Fannie’s and Freddie’s originations of sketchy loans actually peaked near $160 billion in 2008, the year regulators placed them into conservatorship. The two agencies had jumped back into the housing market at precisely the wrong time.

4--United Kingdom Shows That Austerity Does Not Grow the Economy, CEPR

Excerpt: The Federal Reserve Board issued new projections for the economy last week, and they are not pretty. It projects the unemployment rate will still be 8.2 percent at the end of this year, 7.4 percent at the end of 2013, and 6.7 percent at the end of 2014. To put this in context, the unemployment rate peaked at 7.6 percent in the 1990-91 recession and never got above 6.3 percent in the 2001 recession. The Fed is projecting that seven years after the onset of the current recession, the unemployment rate will still be higher than at any point in the last recession.

This should have people alarmed and angry since it means that millions of lives will be ruined. Workers who are unable to find jobs will not be able to support families, contributing to stress and breakups.

The reason the economy is not creating jobs is simply that there is no source of demand to replace the demand created by the housing bubble. With nothing to replace this lost demand, companies see little reason to expand production and hiring.

Government spending is an obvious source of demand. However this spigot has been closed due to concerns over deficits. We have thousands of people in Washington who seem convinced that if the government would just stop spending money and lay off more employees then the private sector would respond with increased output and hiring.

While this might seem implausible on its face (what business hires people because the government has laid off school teachers or firefighters?), we no longer have to speculate about the impact of budget cuts and government layoffs, the United Kingdom is showing us.

The government elected last spring in the United Kingdom committed itself to rapidly reducing the size of its deficit. This government austerity was supposed to give a big boost to the private sector. It actually did the opposite. Growth has fallen to a near standstill. The IMF projects that the U.K. economy will grow by just 0.6 percent this year and an only slighter better 1.6 percent in 2013. This pace is not even fast enough to keep up with the growth of the U.K.'s labor market.

It would be good if the politicians in Washington could learn these basic facts about the British economy. They might then realize that deficit reduction destroys jobs, it doesn't create them. There are times when we should be worried about the size of the deficit, but this is not one of them.

5--Treasury’s 2008 Financial Rescue Could Last Until 2017, WSJ

Excerpt: The U.S. government’s rescue of the financial system could last for five more years as the Treasury Department unwinds its investments in hundreds of banks and other companies propped up in the aftermath of the 2008 financial crisis, a government watchdog said Thursday.

The Bush administration launched the financial rescue plan in the autumn of 2008 at the height of the financial crisis. At its launch, Congress authorized spending $700 billion on the bailout known as the Troubled Asset Relief Program, or TARP. The Treasury Department currently estimates that the final cost for TARP will be $68 billion.

As of the end of last year, about $414 billion had been spent through 13 programs, while $278 billion had been repaid and $51 billion was still available to be spent, according to a quarterly report to Congress by the special inspector general for the TARP program. The remaining institutions in the program include 455 banks and thrifts, plus insurer American International Group Inc., General Motors and Ally Financial Inc.

“TARP is not over,” said Christy Romero, the acting TARP special inspector general. “Some TARP programs last until 2017, and market volatility has slowed Treasury’s progress in unwinding its investments.”

6--Working Poor: Almost Half Of U.S. Households Live One Crisis From The Bread Line, Huff Post

Excerpt: What does it mean to be poor?

If it means living at or below the poverty line, then 15 percent of Americans -- some 46 million people -- qualify. But if it means living with a decent income and hardly any savings -- so that one piece of bad luck, one major financial blow, could land you in serious, lasting trouble -- then it's a much larger number. In fact, it's almost half the country.

"The resources that people have -- they are using up those resources," said Jennifer Brooks, director of state and local policy at the Corporation for Enterprise Development, a Washington, D.C., advocacy group. "They're living off their savings. They're at the end of their rope."

The group issued a report today examining so-called liquid asset poverty households -- the people who aren't living below the poverty line, but don't have enough money saved to weather a significant emergency.

According to the report, 43 percent of households in America -- some 127.5 million people -- are liquid-asset poor. If one of these households experiences a sudden loss of income, caused, for example, by a layoff or a medical emergency, it will fall below the poverty line within three months. People in these households simply don't have enough cash to make it for very long in a crisis.

7--Home prices drop, consumers turn gloomier, Reuters

Excerpt: Home prices fell more steeply than expected in November, and consumers turned less optimistic in January, highlighting the hurdles still facing the bumpy economic recovery.

After accelerating at its fastest pace in 1-1/2 years at the end of 2011, the U.S. economy is expected slow in early 2012.

The S&P/Case-Shiller composite index of single-family home prices in 20 metropolitan areas, released on Tuesday, declined 0.7 percent on a seasonally adjusted basis, a bigger drop than the 0.5 percent economists expected.

The decrease added on to the 0.7 percent decline in October from September.

Separately, an index of consumer attitudes fell to 61.1 in January from 64.8 the month before, as Americans turned gloomy about the job market and income prospects, said the Conference Board, representing private companies.

The data frustrated expectations for an increase after sharp gains in consumer confidence in November and December.

"We are braced for a more bumpy picture over the next few months. A lot of expectations probably ran away or got a little too lofty coming into the end of the year," said Sean Incremona, economist at 4Cast Ltd in New York.

8--That Eurozone repo contraction, charted, FT Alphaville

Excerpt: We’ve had the results of ICMA’s European repo survey, but the following chart — by way of the ECB’s statistical data warehouse — offers a much more contemporaneous view thanks to data collected by the ECB via its MFI balance sheet reporting regulation . More…

We’ve had the results of ICMA’s European repo survey, but the following chart — by way of the ECB’s statistical data warehouse — offers a much more contemporaneous view thanks to data collected by the ECB via its MFI balance sheet reporting regulation . (H/T to Lorcan Roche Kelly of Trend Macro, by way of Alea.)

Shown in the following chart are the outstanding amounts of repurchase agreements in the Eurozone as of the end of December between MFIs, excluding ESCB, and other financial institutions (excluding insurance corporations and pension funds (see chart)

The sudden drop-off at the end of 2011 is *we think* linked to the scarcity of collateral referenced by the ECB’s Mario Draghi in December — which may, or may not, have prompted the ECB’s decision to conduct three-year LTROs.

The scale of the reversal, registering as it does a contraction of some $100bn, is actually quite spectacular.

9--(From the archives) Fed's Bullard: Best To Leave Economic Stimulus To Fed, WSJ

Excerpt: The Federal Reserve's ability to generate stimulus even when interest rates are at 0% negates the need for the government to step in an provide additional stimulus to the economy, a top central banker said Friday.


Federal Reserve Bank of St. Louis President James Bullard argued in a paper he was to present that his observation was mostly theoretical in nature. He declined to offer an evaluation of the spending and taxation decisions made by political leaders since the start of the financial crisis.

Bullard instead argued the crisis and resulting recession has shown the Fed can still offer plenty of stimulus on its own even when it can't cut its traditional policy tool, the overnight fed funds rate, any further. He was referring to the various balance sheet actions undertaken by the central bank, which have bought Treasury and mortgage bonds in a bid to push up overall economic activity.

Because the central bank can still affect the economy, theory suggests the government can stand aside and leave the act of stabilizing the economy to the central bank. The experience of recent years shows "the Fed was not out of bullets.... We've been able to react fairly effectively" over the course of the last three years, Bullard told reporters in a conference call.

The paper he was presenting was called "Death of a Theory." Bullard, who will be a nonvoting member of the Federal Open Market Committee for 2012, made no forward-looking comments about monetary policy, although he did say central bank policy has been "appropriate" over the last three years. He also warned the very low borrowing rates currently enjoyed by the Treasury Department could quickly end, suggesting an additional aspect of danger to the U.S.'s high borrowing levels.

"The typical assumption is that governments can borrow unlimited amounts on international markets," Bullard said, with low borrowing rates serving as "an indication that more debt can be taken on safely." He warned "the U.S. has low borrowing rates today, but when a crisis occurs, rates will rise rapidly.

Bullard argued his view on what part of the government is the best source of economic stabilization represents a return to the consensus that existed before the financial crisis. Then, the official said, the conventional wisdom held fiscal stimulus actions, be they in the form of stimulus spending or special tax cuts, would be too late or ineffective due to the nature of the political process.

Bullard said that consensus was tested by events that have happened since 2008, which included unprecedented central bank action and huge amounts of fiscal stimulus spending.

In materials supplementing his paper, Bullard said "the turn toward fiscal approaches to stabilization policy has run its course."

"Stabilization policy should be left to the monetary authority, which can operate effectively even at the zero lower bound," the official said, adding "Unconventional monetary stabilization policy has been quite effective over the last three years, making fiscal action redundant."

When it comes to government spending, Bullard said theory suggests "tax and spending policy should be set for the medium and longer term."

Bullard's low opinion of government stimulus is not new. He noted in remarks he gave in St. Louis in November that when it comes to Keynesian economic thought--it holds government deficit spending can offset a drop in private activity and restart growth--"we are witnessing the death of a theory." It prompted him to say "I love Hayek," in a nod to Friedrich Hayek, who saw government as a problem and not a solution when it comes to the economy.

10--(From the archives) The General Theory of Employment, Interest and Money, John Maynard Keynes, Chapter 12---The State of Long-Term Expectation




Excerpt: ...The state of long-term expectation, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast — on how highly we rate the likelihood of our best forecast turning out quite wrong. If we expect large changes but are very uncertain as to what precise form these changes will take, then our confidence will be weak.


The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention. But economists have not analysed it carefully and have been content, as a rule, to discuss it in general terms. In particular it has not been made clear that its relevance to economic problems comes in through its important influence on the schedule of the marginal efficiency of capital. There are not two separate factors affecting the rate of investment, namely, the schedule of the marginal efficiency of capital and the state of confidence. The state of confidence is relevant because it is one of the major factors determining the former, which is the same thing as the investment demand-schedule....

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; — though fears of loss may have a basis no more reasonable than hopes of profit had before.


It is safe to say that enterprise which depends on hopes stretching into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death.

This means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man. If the fear of a Labour Government or a New Deal depresses enterprise, this need not be the result either of a reasonable calculation or of a plot with political intent; — it is the mere consequence of upsetting the delicate balance of spontaneous optimism. In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends....

Only experience, however, can show how far management of the rate of interest is capable of continuously stimulating the appropriate volume of investment.


For my own part I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest.

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