Monday, October 31, 2011

Business Lending is Increasing, Especially at the Largest US Banks

Business lending continues to accelerate in US commercial banking system according to the latest data released by the Federal Reserve System.  Although overall lending has not increased by much in the commercial banks, only about $27 billion year-over-year at all domestic and foreign-related institutions, business loans (commercial and industrial loans) rose by more than $95 billion. 

True, many of these loans have gone to support acquisitions and other uses that are not directly related to expanding economic expansion.  Still, it is good to see more life in this particular area of bank lending.

Most of the increase in business lending came from the largest twenty-five banks in the country and foreign-related financial institutions.  Business loans did increase modestly at the small- and medium-sized banks, but not by much.

Commercial banks continued to allow their real estate and consumer loans to run off, the largest declines coming in the commercial real estate area.  All real estate loans at commercial banks decreased by almost $160 billion, year-over-year, with $86 billion of the decline coming at the largest twenty-five commercial banks and almost $70 billion coming in the rest of the domestically chartered banks.  The largest proportion of these declines came in the commercial real estate area. 

Consumer loans declined by about $41 billion in the whole banking system, year-over-year, with $38 billion of the decline coming in the largest 25 banks.

On another note, one can still see how the Federal Reserve is helping to finance banks in the eurozone.  Cash assets in the whole commercial banking system rose by almost $620 billion, year-over-year, with the rise at the foreign-related financial institutions absorbing almost $490 billion of the total.  At the same time the net deposits to foreign offices at these foreign-related financial institutions rose by more than $590 billion.  The average increase in these net deposits to foreign offices over the past month was another $50 billion. 

The Federal Reserve has done what it can to supply liquidity to European-related financial institutions to help them through the recent financial crisis.

I still have substantial concern about the smaller commercial banks in the United States.  The statistics still do not look good to me.  The total assets at the “smaller” banks rose by about $58 billion over the last year, but over $39 billion of that increase came in the cash assets of these institutions.  Although business loans at these institutions rose modestly, as mentioned above, total loans at these “smaller” banks dropped by almost $60 billion.  These “smaller” banks are just not growing.

A very large number of these smaller banks are just “sitting on their hands” hoping to survive.  These banks are doing everything they can to work out their loan portfolios and to become more liquid.  The reserves for bad assets have declined, but these declines are coming at the healthier banks.  And, given the low interest rates that can be earned on securities, the profits of many of these smaller banks are not sufficient to help them recover from the bad assets that are still on their balance sheets.  It is just amazing the numbers related to bad commercial real estate loans that are on these balance sheets. 

One could say that the good news is still related to the fact that there are not major disruptions occurring in the commercial banking sector.  This “peace and quiet” allows the FDIC to close as many banks as need to be closed without a big fuss.  This year 85 banks have been closed, just under 2 per week.  This figure, however, does not include the decline in the number of banks still open due to acquisitions.  I am still expecting some 2,000 or so commercial banks to drop out of the banking system over the next five years or so. 

It is hard to imagine that bank lending will grow much in the future given all the vacant residential real estate and commercial real estate that is around and all the foreclosures that are still to come.  An examination of the commercial banking sector does not give us much hope about the possibility of a more rapid expansion of the economy. 

Sunday, October 30, 2011

Super Mario and the European Central Bank

Tuesday, a new player moves into the top rung of European officials dealing with the European financial crisis. 

Mario Draghi is not “new” to the European scene, but on Tuesday he takes over as the president of the European Central Bank replacing Jean-Claude Trichet, and so is “new” in this important position.

A new head of a central bank is generally “known” but, not having ever been in the position before, he (when are we going to get a woman head of a central bank?) is untested and it is uncertain how he will really act under pressure. 

There is an interesting article in the Sunday New York Times about Mr. Draghi titled “Can Super Mario Save the Day for Europe?” that gives us some background on this “new” leader: (

In this article Mr. Draghi is cited as vowing “that there would be no surprises on his watch.”

Vintage Draghi seems to provide a “performance so subtle and politic that it seem(s) to please everyone.  Which, it turns out, is the Draghi way: people often seem to see what they want to see in him.” 

Yet, Mr. Draghi seems to produce.  Although having sterling academic credentials, he in not some academic that gained his laurels by writing about historical events.  He has actually been in “real” administrative positions that have required tough decisions to be made and leadership to be shown.  In these positions he has shown well. 

He has been in the private sector and, although this is the place where people seem to question some of what he has done, he performed well in his role as a vice chairman of Goldman Sachs in Europe.  

He seems to be a person that let’s his actions define his positions and does not get all “hung up” about how best to communicate with investors and markets as does the current Federal Reserve System. 

I particularly like the description of Mr. Draghi given by Francesco Giavazzi, who worked for Mr. Draghi at the Italian treasury.  Mr. Giavazzi, a classmate of his at M. I. T., states that Draghi learned a very important lesson in his efforts to bring Italy’s fiscal problems under control so that Italy could join the new common monetary zone that was being created for Europe.  At that time Italy was dealing with “high levels of debt” and “runaway deficits” which led to Italy being expelled from the European Exchange Rate Mechanism, the European currency system that preceded the formation of the eurozone. 

The efforts of Mr. Draghi and his team brought things under control so that Italy avoided bankruptcy and could become a founding member of the new currency union.

Mr. Giavazzi states that the lesson that Mr. Draghi learned through this experience “is that rather than waiting for help, you need to regain the confidence of the markets through your own actions, and that if you do not do the right thing, no outside help is enough—you will have a solvency problem.” 


Furthermore, people that have worked with Mr. Draghi claim that even though he is an economist he “put aside models and theories for what actually works.”  Mr. Draghi seems to be a pragmatist. 

So, Mr. Draghi appears to be an experienced, pragmatic leader who is confident enough in his abilities that he can let his actions speak for themselves.

Sounds too good to be true!

Best wishes, Mr. Draghi, we all wish you the greatest success!        

Friday, October 28, 2011

Second European Market Response: Italian Borrowing Costs Surge

The first response of world financial markets to the eurozone package produced early Thursday morning was positive. 

The second response…

Italy issued 10-year debt on Friday but paid the highest price since joining the euro as investors demonstrated skepticism over the center-right government’s economic reform program in the first bond auction in the region since new steps were agreed to tackle the eurozone debt crisis.

The auction served to underline Italy’s current dependence on purchases of its bonds on the open market by the European Central Bank in a program that began on August 8 as yields rose above 6 per cent.” (

The underlying concern with the new eurozone package is that the officials in Europe still believe that the problem is one of liquidity, a crisis in confidence, which can be resolved by more bailout gimmicks.  As a consequence, these officials have, once again, avoided the fact that the problems they are facing are solvency problems and that eventually someone will have to bear losses.  The solvency issue has not been resolved since little or no new money is being put on the table.

Yes, there is an agreement for a 50 percent write down of “private” holdings of Greek debt.  But, note, that “public” holdings of Greek debt amount to about 40 percent of the total Greek debt outstanding.  These “public” holdings will not be subject to the haircut reducing the debt. 

The “public” holdings include the Greek securities held by the European Central Bank, the International Monetary Fund, and eurozone governments. 

Furthermore, the “haircut” is a “voluntary” write down in the hopes that a payout on Credit Default Swaps will not be triggered.  European leaders feared that if a “non-voluntary” event occurred, a CDS payment would be kicked off and this might cause a “Lehman Brothers affect” which would create more funding problems for banking institutions throughout the continent.

Also, this funding problem might expose other countries…like Italy, Spain, Portugal and France…in their efforts to place their sovereign debt.

The difficulty Italy had in placing its debt on Friday might be an indication that this effect is already at work.

 And what additional pressure does this put on the European Central Bank?

The ECB remained firmly in crisis management mode following the marathon Brussels summit to stem the sovereign debt crisis.

Within hours of the meeting, traders reported that the ECB was intervening again in the Italian government bond market – a clear sign that its controversial purchases were far from being wound down. “ (

Included in the plan was a proposal for the recapitalization of European banks.  But, the question is, will these new requirements actually provide the protection needed.  In the recent failure of the Dexia bank, the bank met the initial requirements for capital.  It seems as if the regulators of the European financial system are still reluctant to admit the serious needs of the banking system to add capital…a shortcoming that is related to the “joke” these regulators perpetrated in the two applications of “stress tests” to the banks of Europe. 

But, the European officials also included in their bank recapitalization plan a proposal that the national governments in Europe would increase guarantees of their banks.  This just increases the specter that these national governments will have additional liabilities adding to their already heavy debt loads. 

Finally, there is the European Financial Stability Facility (EFSF).  This is the last resort lender in which everyone in Europe commits to bailing out everyone else in Europe.  That is, the EFSF is a scheme that says that “Europe is Solvent”…even though individual nations within the eurozone are not solvent.

Whether or not “Europe is Solvent” depends on the willingness of the solvent countries within the EU to continue to pay for the shortcomings of those countries that are not solvent.  The success of this depends upon whether or not the existing problems are “liquidity” problems or “solvency” problems.  “Liquidity” problems relate to a lack of confidence and a lack of confidence can only be a short-term phenomenon. 

Officials hope that by “re-arranging the chairs” once again that the crisis of confidence will come to an end.  The thing these European officials fail to understand that in the game of “musical chairs”, every time the music begins to play again another chair is taken from the game.  At some point, the fact that the eurozone does not have sufficient capital to cover its outstanding debt will become evident.

The efforts to bring money in from China, Japan, or elsewhere, seem like a desperate move.   

Again, it seems as if Europe has come up short again. 

Wednesday, October 26, 2011

News From Italy: A Bargain is Struck?

The news out of Rome:

Silvio Berlusconi has salvaged a compromise agreement on economic reforms with his coalition partners that commentators said lacks specifics and risks falling short of what eurozone leaders have demanded ahead of Wednesday’s summit in Brussels.” (

The crucial point…the plan “lacks specifics and risks falling short”…

Prime minister Berlusconi and the head of his coalition partner, the Northern League, Umberto Bossi, negotiated the new compromise package to submit to other eurozone leaders.  Other than reaching some kind of agreement, the alternative is for Mr. Berlusconi to resign.

The prospects do not seem to be encouraging:

“Newspaper editorials on Wednesday said Mr. Berlusconi and Mr. Bossi may have staved off a collapse of their coalition for the time being, but at the risk of undermining a critical summit and failing to deliver the reforms Italy needs to lift an economy on the edge of a renewed recession.”

Mr. Bossi is not a fan of the European arrangement…a euro-skeptic.  Hence, his tradeoffs are substantially different from those of Berlusconi.  And, Mr. Berlusconi does not have much personal credibility…and little or no moral stature…to trade on.

In fact, Beppe Severginini in a Financial Post op-ed piece goes even further:

“How can the world’s eighth largest economy go on with a delusional prime minister, a weak government, an impotent opposition and its finances in disarray?” (

How did someone like Berlusconi become prime minister in the first place?  Well, as one person commentated on my earlier post this week, Mr. Berlusconi became prime minister of Italy because everyone else running for the position was worse than he was.  Encouraging…

So where does that leave Europe?

Mr. Sarkozy and Ms. Merkel appeared to be applying the pressure to Mr. Berlusconi over the weekend.  This precipitated the efforts of the past two days. 

If the reports of the reform plan concocted by Berlusconi and his coalition are true and the plan really does fall short of what is necessary, the question becomes, will Sarkozy and Merkel “stick to their guns” and hold Italy’s “feet to the fire”?  Or, will the French and German officials back off and attempt to get by with something less than they stated was necessary. 

The crucial thing here, to me, is that the pressure on Italy was applied because several eurozone officials believed that the problems they faced were deep enough that an attempt needed to be made to “encircle” the major problems and not just work on individual nations on a case-by-case basis. (See my post “Italy is the Key to Solving the Euro Debt Crisis”,  Whereas in the past, the European Union began with the smallest, weakest link in the chain and then moved up to the next, larger, crisis, the current move was to include the third largest economy in the EU along with the weakest, Greece, and this, then, would include all that was in-between, like Spain and Portugal. 

Now, this may not be achieved.  We wait to see how Mr. Sarkozy and Ms. Merkel respond to the new Italian proposal.

But, this is not all.  The banking situation in Europe still lingers. ( European banks are balking over the proposed debt “haircuts” and the new proposed capital requirements. 

It would seem that if Sarkozy and Merkel “back off” any on the Italy effort, given the pressure put on Italy over the weekend, that the banks will smell the weakness and put up even more resistance to the effort to write down the debt issues under consideration as far as needed. 

This, of course, puts the eurozone in a more tenuous position because lack of cooperation by the banks on the write-downs has implications that relate to a “triggering event” which might set off “bankruptcy” questions leading to payoffs on Credit Default Swaps.  The possibility of this occurring raises the specter of contagion in the financial sector, ala’ the Lehman Brothers affair, something eurozone officials sincerely want to avoid.

It seems as if European officials are running out of choices.  Yet, as we have seen in the past, European officials are masters of the art of squirming out of difficult spots and postponing solutions for another time. 

The betting still seems to be on the conclusion that no real leaders will arise in Europe to resolve the problems that Europe faces.  We can only hope for a better outcome

Monday, October 24, 2011

Can Berlusconi Pull It Off?

In my last post I wrote about the role that Italy might play in any solution to the European sovereign debt crisis. (See

It seems as if the pressure applied on the Italian prime minister might be paying off.
“Silvio Berlusconi has called a cabinet meeting for Monday evening to consider new economic reform proposals after the prime minister returned to Italy following his humiliation at the eurozone leaders’ summit in Brussels.

The emergency meeting was called in response to demands by the summit that Italy prepare legislation on structural reforms before the next meeting of eurozone leaders on Wednesday.” (

Mr. Berlusconi, in the face of political pressure and financial market pressure, is going to propose some “tough” measures to his coalition cabinet.  But, his Northern League coalition allies are flat out against some of the things he has presented.  Others in the coalition are seen as too divided internally to “agree on tough reforms”.

Still, Mr. Berlusconi is giving it a try.  His embarrassment in front of European Union members has been substantial.  It appears that he is attempting to “save face” before the eurozone officials assemble again on Wednesday.  An alternative, given that Berlusconi has been regularly losing support, is for him to resign in the face of too much opposition within the ruling coalition. 

Financial markets have also not been kind.  On Monday, the spread between the 10-year Italian BTP benchmark bond and the equivalent German issue jumped to 388 basis points.  The near term high for this spread is slightly more than 400 basis points.

Moody’s dropped the rating on Italian bonds three notches on October 4: Standard & Poor’s downgraded the Italian debt about a month before.  The rating agencies are poised for another possible lowering of the rating. 

Mario Calabresi, editor of Turin’s La Stampa newspaper stated the “we (Italians) are the sick man of Europe…”  As I stated in my last blogpost, the situation in Italy is comparable to the situation in Greece.  This can be seen as the cause of the current hostile focus on Italy by others in the eurozone. 

In this previous post, I argued that officials of the EU may finally be accepting the seriousness of the problem they face; that the issues now faced by the eurozone are solvency issues and not liquidity issues; and that the problem cannot be solved just on a state-by-state basis. 

Can Berlusconi bring this off?

I’m not sure he can.  But, this latest humiliation may really bring home to some Italians that they are not going to get “off the hook” this time.  Like Greece, efforts to bring on the reforms in Italy will result in more protests and riots like the ones seen in Greece and elsewhere in Europe. 
The times they are a changin’…

I’m not sure that the changes that are coming are the ones imagined by Bob Dylan when he wrote this line.  But, times have changed and societies and cultures are going to have to adapt.  Not everything is happening in “the Arab Spring.”       

European officials really seem to be getting serious now.

European negotiators have asked Greek debt holders to accept a 60 per cent cut in the face value of their bonds, a hardline stance that far exceeds losses agreed in a deal between private investors and eurozone authorities three months ago.“ (See but also see my post of October 23,
I am thinking that many European officials are tired, tired of going over the same thing month after month after month.  Maybe, just maybe they are realizing that unless they really get their “arms around the problems” that the difficulties will just continue to march along.  In essence, maybe, just maybe, they are coming to the conclusion that “kicking the can down the road” doesn’t work. 
Let’s hope Mr. Berlusconi sticks to his guns and is able to pull off the reforms needed to allow Europe to move ahead.  Time really seems to be running out.    

Italy is the Key in Europe

It seems to be boiling down to this.  Italy and its prime minister Silvio Berlusconi are the evolving focus of any acceptable solution to the European sovereign debt crisis. 

There are, I believe, two reasons for this focus.  First, Italy is the third largest economy in the European Union.  Thus, moving it into the spotlight leapfrogs the problems of Spain and Portugal and others in terms of impact.  If Italy can be “tamed” then Spain, Portugal, and others will have to fall in line.

Second, Italy, within the European Union, is most like Greece in terms of fiscal irresponsibility, governmental patronization, and lackluster economy.  If both Greece and Italy take steps to correct their situations, then other troubled countries can justify stronger efforts to straighten out their problems as well. 

Another factor is that Silvio Berlusconi has become a characterization of European leadership…or the lack thereof…given his personal as well as his public tribulations.  And, this does not include his recent disputes with others, like that with French president Nicolas Sarkozy, over the makeup of the board of the European Central Bank.  Berlusconi, it seems, must be brought into line...even though he is just barely hanging onto power now.  

By focusing on Italy, the European Union is, in a sense, attempting to “get its arms around” the problem.  The EU efforts of the past have started with the smaller countries with the idea of working up the ladder as the need arose to deal with larger and larger countries.

By bringing Italy in at this time, the EU seems to be admitting that the problem is more fundamental than it had assumed in the past and that the problem is one of solvency and not the liquidity of the sovereign debt.  

Furthermore, the EU seems to be saying that more fiscal coordination needs to be achieved within the European Union itself and to gain this coordination, even the larger countries, like Italy, must submit to greater oversight and community discipline than had originally been built into the organization.    

With the crisis, it has become more and more obvious that for the countries of the European Union to really benefit from the creation of a common currency, greater fiscal union must be achieved as well.  Painful as it may be to some to accept this reality, I don’t believe that there is really much support anywhere for the breaking up of the currency union.

The European Union may finally be getting someplace, although I don’t want to be too optimistic.  Up to this point, the EU has just been “kicking the can” down the road.  It has continually avoided the seriousness of the situation; it has not accepted the reality of the solvency issue; and it has attempted to deal with problems piecemeal. 

As a consequence, many analysts have claimed that it would be better for some nations to leave the currency union or for the Euro to be eliminated all together. 

The fact is, the benefits of the currency union have been sufficiently great that the members of the EU really don’t want to see it go away. 

The “big bump in the road”, however, has been the need for sovereign nations to give up some of their sovereignty on the fiscal front, something they have, understandably, been reluctant to give up.  As a consequence, the path to greater fiscal union has been winding and painful.  No one, willingly, wants to look like the pansy.

By putting the pressure on Italy, the European Union is accepting the seriousness of the situation; it is accepting that the primary issue is one of solvency and not liquidity; and it is finally trying to encircle the problems that exist, not deal with them one-by-one.

This does not mean that the crisis in Europe is over.  There are still many “bumps in the road” that must be smoothed over. 

However, to me, putting Italy into the spotlight raises some hope that the officials in Europe (I am not willing to call them “leaders” yet) may finally be moving in the right direction.

Friday, October 21, 2011

Europeans Facing More of a "Haircut" Than Preciously Thought

News is leaking out that the “haircuts” on European Sovereign debt are going to be greater than imagined just several weeks ago!  “EU looks at 60% haircuts for Greek debt.” (
Three months ago European officials agreed to a 21 percent haircut.  Then, in the last several weeks, the figure moved to around 50 percent.
And, still officials are dawdling.
European banks are troubled, and we hear about how the “French Banks Fought Oversight.“  Seems as if French banks and French regulators consistently ignored the reality of the situation within the banks claiming that no problems ever existed. 
Of course, bankers are notorious for claiming that problems do not exist on their balance sheets!  But, this is not new. (See my  The bankers’ denial of any problems on their balance sheets is maintained right up to the time hey begin to argue that “It was not our fault!”
The problem I have with all this is that attention is being deflected from the real issues while blame is being diverted from the real culprit.
The real culprit, to me, is the post-World War II attitude in America, the UK, and Western Europe that the creation of debt, especially by governments, could keep unemployment at low levels and this would end the possibility of social unrest caused by masses of unemployed persons.  The result was that the latter half of the twentieth century became the “poster child” for the benefits of what can be called credit inflation. 
Creating debt, especially government debt, was not just a policy of the left, but it was also the policy of the right.  The creation of debt would resolve almost all social issues since it kept people at work.  This would also help politicians get re-elected.
In the 1960s we added to the goal of keeping people working the goal of seeing to it that every family owned their own home.  This was especially the case in the United States.  I was working for a cabinet secretary in the early 1970s in a “conservative” administration, and one of the major goals of this administration was the development of mortgage-backed securities.
The reason for the development of this instrument was certainly not an economic one.  The reason for the development of the mortgage-backed security was to get politicians re-elected.  The argument was that if more Americans owned their own home, the more willing they would be to re-elect those Senators, Representatives, and Presidents that supported this goal. 
The government’s development of the mortgage-backed security, of course, brought several new things to the financial markets, like ‘slicing and dicing’ cash flows, that paved the way for the financial innovation that was to take place later in the century.
Of course, the major driver behind all of this was the continual efforts of the national governments to create credit through deficit spending to hire large numbers of people themselves, to almost continuously stimulate the economy to keep unemployment low, and to continue to find ways to put more and more people into their own homes. 
This is the essence of credit inflation!  And, the central banks, fundamentally, helped the national governments to write the checks.
The undisciplined creation of debt, however, does not end well.  This is the story that Carmen Reinhart and Kenneth Rogoff tell in their book “This Time is Different.”  And, for the United States, the UK, and Western Europe, this time was not different and financial crisis arose.
The point I am getting at is that the resolution of a financial crisis is not a unique action.  However, many of those in authority are crying out “This time is different”!
One of the boldest “criers” is Fed Chairman Ben Bernanke.  I have written my opinion of him in an earlier post. (  But, Mr. Bernanke is not the only authority at the central bank that is searching for a new or better way to conduct monetary policy. (
Gillian Tett also writes in the Financial Times that “Central Bankers must update outdated analytical toolkit.” (  
Let me just say in answer to this situation we are in: This time is not different!
The problem is too much debt!  The cause of the problem was 50 years of credit inflation in the United States, the UK, and Western Europe.  This debt must be worked off and it takes time to work off excessive amounts of debt.  Again, I recommend you check the Reinhart and Rogoff book.  I have also just written a post on this:
And, the lessons from this experience are not new.  Don’t issue too much debt!  Don’t just focus on short-run goals…like fiscally stimulated low unemployment, like everyone owning their own home, like governments hiring all their own supporters…and so on and so forth.
The problem is not financial innovation or greed or speculators.  These things will never go away. 
The problem has been that the credit inflation created in the last 50 years has created huge incentives to develop financial innovation, to exercise greed, and to benefit from speculation.  And, in the frenzy, things got out-of-control.
That is where we are today.  The haircuts that are now necessary are large and if something is not done about them soon, the haircuts will get even larger!  What if the write-down on Greek bonds were 90 percent?  What if the write-down on the bonds of Italy were 50 percent?  Portugal…60 percent? Spain…?  And, France…?
Over the last fifty years or so, people in the United States, the UK, and Western Europe have been living pretty well.  They can live well again.  But, we need to get away from Keynesian policies that promise something for nothing and return to some fundamentals that have played well over the years.
This time is not different!  Discipline and integrity are winners and have always been winners.  But, in a state of chaos, returning to discipline and integrity is difficult and painful.  The historical lesson, however, is that if people do not return to a condition of discipline and integrity the pain and suffering does not end…and in many cases it will only get worse!   

Wednesday, October 19, 2011

Oh, My Gosh! We Now Need "Forward Guidance"!

Poor Ben Bernanke. 

To me, the kindest thing that can be said about him is that he is suffering the fate of those who are in charge of large institutions with little or no practical experience in administering any other organization of consequence.  He just does not seem to understand how to lead such an organization and he does not seem to have the capacity to adapt how he does things so as to achieve a better performance. 

Where one can criticize Mr. Bernanke and the Fed, as I have done in the past, for claiming that solvency problems are just liquidity problems, one can also criticize Mr. Bernanke and the Fed for claiming that their problems with the market are ones of the appropriate information flow and not one of credibility.

Now we are presented with the specter of something called “Forward Guidance.”  To quote Mr. Bernanke, “forward guidance and other forms of communication about policy can be valuable even when the zero lower bound is not relevant (short-term rates are not around zero).  I expect to see increasing use of such tools in the future.” (

Mr. Bernanke came into the position of Chairman of the Board of Governors of the Federal Reserve System promising to provide greater openness and transparency to what the Federal Reserve is doing.  He has been consistently more available to the press and others than any previous Fed Chairman.  His latest effort has been to talk directly with the press after four regularly held meetings of the Federal Reserve Open Market Committee to explain what the Fed is doing.  The first such meeting was less than rousing. 

Yet, apparently, Mr. Bernanke is unsatisfied with the results of this accessibility.  Why else would we need to have something dangled in front of us like this so-called “Forward Guidance.”

Roughly, “Forward Guidance” provides banks and financial markets with an explicit idea of what the Federal Reserve is attempting to achieve in the future in much the way that the August 2011 statement that the Fed would keep short-term interest rates low until mid-2013.

And, there are other forms the “Guidance” could take.  For example, Mr. Bernanke has been an advocate of “inflation targeting” something other central banks in the world have adopted.  For example, the Fed, during the regime of Mr. Bernanke, has had an informal target for inflation of 2 percent.  Under the new effort to keep the public better informed, this policy effort, tying interest rate levels to an inflation target, would be made more formal and explicit.

One could also do the same thing with respect to an unemployment goal. 

When this effort of communication does not work, I wonder what Mr. Bernanke will try next.  His increasing attempts to inform the public about how the Fed will operate given the policy parameters it is watching seems to be constantly falling short of what Mr. Bernanke and the Fed have expected.  Hence, the need to try different things.

In my mind, Mr. Bernanke and the Federal Reserve have followed one basic policy since late 2007.  This policy can be described as throwing as much “stuff” as possible against the wall to see how much of the “stuff” can stick to the wall.

The term “stuff” can apply to many things.  An early example of “stuff” was the Term Auction Credit (TAC), which first showed up on the Fed’s balance sheet on December 26, 2007.  During 2008, the Fed became the banker to the world lending to the European Central Bank and the Swiss National Bank, among others, through swap lines of credit.  The Fed’s line item, Other Federal Reserve Assets, which includes these central bank transactions, rose from about $56 billion on December 26, 2007 to $105 billion on August 27, 2008.  Added to this was the Fed’s assumption of assets from the Bear Stearns transaction, which first showed up on July 2, 2008.  Then in the fall of 2008, the door swung wide open. 

Whereas the earlier efforts did not expand Federal Reserve credit appreciably during most of 2008 (this measure rose from about $874 billion on December 26, 2007 to $884 billion on August 27, 2008 as the Fed reduced other categories of assets to expand credit where it seemed to be needed) by December 31, 2008, Federal Reserve credit reached $2.250 trillion!

On October 12, 2011, Federal Reserve credit stands at almost $2.845 trillion!

We have had QE1, and QE2, and now we have “Operation Twist.”  Excess reserves in the commercial banking system have risen from less than $2.0 billion in December 2007 to about $770 billion in December 2008 to over $1.550 trillion in September 2011.

Bank lending remains anemic, at best, and economic growth stays modest. 

What is the Fed’s monetary policy?  The Fed’s monetary policy is to flood the banking system with “cash”.  What else needs to be explained? 

“Operation Twist” and “Forward Guidance” and “QE2” and whatever do not change the general thrust of the Fed’s monetary policy.  The Fed is throwing as much “stuff” against the wall as it possibly can.  And, it will continue to do so for as long as Mr. Bernanke and the Fed feel that it is necessary.

But, Mr. Bernanke does not feel that this is enough.  And, so he tries this and tries that to increase the “openness and transparency” of the Fed to the rest of the world.  I believe that he is concerned about this more to calm his own mind than to calm the mind of the banking system and the financial markets.

The problem is that people are attempting to reduce their debt loads.  The fifty years or so of credit inflation released on American families and businesses by the United States government since the early 1960s has resulted in a situation where these same families and businesses feel that they are burdened by too much debt.  Consequently, they are attempting to reduce their debt loads. (See my post, “The US economy will continue to grow”:

However, de-leveraging takes time.  Unfortunately, given the current circumstances, the only thing that would stop the de-leveraging is a rapid build-up of inflation making debt “economically valuable” again.  In one sense, this is what it looks as if Mr. Bernanke and the Fed are trying to do.

But, with modest economic growth and tepid inflation, families and small- and medium-sized businesses will continue to reduce the amount of debt on their balance sheets.  These people will not come back into the debt market for some time.  This is  consistent with the research published by Reinhart and Rogoff in their book, “This Time is Different.” 

Even if this is true, Mr. Bernanke and the Fed, for the history books, do not want to look as if they did not do everything in their power to combat a second Great Recession…a double dip, if you will.  Consequently, they will stand ready to throw as much “stuff” as they feel they need to against the wall and will continue, in an open and transparent way, to tell the world that they are doing everything within their power to get the economy moving again.  To me, this is a lack of confidence that does not enhance their credibility.

Tuesday, October 18, 2011

The United States Economy Will Continue to Grow

I believe, as I have written before, that the United States economy is recovering and will continue to recover. 

However, I also believe that “financial crises are protracted affairs.” (Reinhart and Rogoff, “This Time is Different”, page 224.)

Why don’t I believe that there will be a “double dip” recession, a 1937-38 depression like the one following the 1929-33 Great Depression?

In the case of the 1930s, there were policy errors committed that resulted in the 1937-38 depression: the most prominent one being the effort of the Federal Reserve to eliminate all the excess reserves being held by the commercial banks at that time so that the Fed would have more “control” over the money markets.

Unfortunately, the banks wanted those excess reserves around even though they were not in the mood to expand their lending activities.  As a consequence, when the Fed attempted to remove those excess reserves by raising reserve requirements, the banks cut back even more on their lending activities in an effort to achieve the financial protection they believed those excess reserves brought them.    

This has not happened in the current situation because Fed Chairman Ben Bernanke (a student of the Great Depression era) and the Fed have done just about everything possible to make sure that the banking system is flooded with excess reserves so that a similar contraction of the banking system does not occur.  There are questions about what this means for the future, but we are not at that future yet.

So, I believe that the economic recovery will continue.

The economic recovery, however, will not be robust.  One reason for this is the debt overhang that exists in the private sector.  David Brooks speaks to this point in his Tuesday morning column in the New York Times. (

“Quietly but decisively, Americans are trying to restore the moral norms that undergird our economic system.

The first norm is that you shouldn’t spend more than you take in. After an explosion of debt over the past few decades, Americans are now reacting strongly against the debt culture. According to the latest Allstate/National Journal Heartland Monitor poll, three-quarters of Americans said they’d be better off if they carried no debt whatsoever. Not long ago, most people saw debt as a useful tool for consumption and enjoyment. Now they see it as a seduction and an obstacle.
By choice or necessity, eight million Americans have stopped using bank-issued credit cards, according to The National Journal. The average credit card balance has fallen 10 percent this year from 2010. Banks, households and businesses are all reducing their debt levels.”

This same phenomenon is occurring in the world of state and local governments, and the non-profit world.

How is spending going to expand within the context of this kind of behavior?

The general fundamentalist Keynesian response to this is that the federal government needs to do more to stimulate the economy.  The argument is that government spending actually needs to be much greater than is being proposed at the present time.  The people that are making this argument also state that the economic recovery in the 1930s was as slow as it was because the government did not spend as much as it should have back then.  Government expenditures will never be large enough for these people. 

But, how is more government debt going to change the picture?  As Reinhart and Rogoff state in their book, “the value of government debt tends to explode” (page 224) in the aftermath of any severe financial crisis anyway.   

The reason is that as incomes drop, tax revenues decline and the government deficit increases. 
But, greater deficits mean greater interest and principal payments in the future, and someone like Robert Barro argues that this will mean more taxes for the private sector in the future so that current savings will increase even further to offset this future obligation.     

Even if the private sector does not fully discount future taxes into their current spending plans, people may just accelerate their efforts to save to provide themselves with more flexibility to manage their financial affairs in an uncertain future world dominated by huge government debts. 

The problem that results from this scenario, in my mind, is that given the behavior of the Federal Reserve System there is lots and lots of cash floating around in the economy, but this cash is not in the hands of those people and businesses that are trying to restructure their balance sheets.  Because, this cash is not in the hands of those people and those businesses that are trying to restructure their balance sheets, the fundamental economic recovery will continue to be modest. 

Thus, you have lots and lost of cash looking for places to invest where there are very few “productive” places for the money to go.  So, money seems to be chasing assets.  However, the uncertainty seems to be causing other problems and this is resulting in increased market volatility. (

“The problem is a lack of liquidity—a term that refers to the ease of getting a trade done at an acceptable price.

Markets depend on there being many offers to buy and sell a particular stock, across a range of prices. But as investors have gotten nervous, many of those offers have dried up. That is causing wider-than-normal gaps between prices showing where stocks can be bought and where they can be sold—the difference between the "bid" price and the "ask" price.

Many big investors, such as hedge funds and mutual funds, which at times can act as shock absorbers for trading because they tend to trade large chunks of stocks, have been on the sidelines. Some hedge funds, for example, say they're not trading as much until they know how much money their clients will withdraw at the end of October, a deadline some clients have to inform funds of intentions to redeem money at year-end. “

In my mind, the economic recovery is going to continue on its slow path.  But, given all the money around and given the general impatience that is attached to this money, wide swings in asset prices are going to continue well into the future, especially if the Federal Reserve really keeps interest rates as low as they are into the middle of 2013.

Patience is not an attribute of traders…and of politicians…but that is another story.