Due to the great concern over how the Federal Reserve plans to reduce its balance sheet from $2.2 trillion to something comparable to the level it was at in August 2008, something around $900 billion, I will be posting on a regular basis my analysis of how the Fed is withdrawing funds from the banking system and the financial markets.
The concern about having put too many funds into the banking system is one about future inflation. The argument here is that it takes a while for inflation to build up. But, as the credit bubble earlier created by the Fed earlier this decade ended up in the financial collapse of 2008-2009, the fear is that if all the reserves the Federal Reserve has put into the banking system remain there, inflation will become a factor in 2010 and beyond.
The concern about removing the funds from the banking system too quickly comes from the 1937-1938 experience where commercial banks had a large quantity of excess reserves on their balance sheets. The Federal Reserve, at that time, raised reserve requirements to establish “tighter control” over the bank activity. However, the large amount of excess reserves on hand was consistent with the conservative behavior of the banks. The increase in reserve requirement caused banks to be even more conservative resulting in a substantial decline in the money stock. The result was the depression of 1937-1938.
For the two weeks ending September 9, 2009, depository institutions held $823 billion of excess reserves. Cash assets in the commercial banking system totaled slightly less than $1.0 trillion. In August 2008 these figures totaled less than $2.0 billion for excess reserves and around $300 billion for cash assets. Reserve balances with the Federal Reserve totaled about $860 billion on September 16, 2009; and this figure was about $50 billion on September 17, 2008.
It is an understatement to say that a lot of liquidity has been injected into the banking system!
Over the past 13 weeks ending on Wednesday September 16, 2009, reserve balances with Federal Reserve Banks increased by almost $120 billion. This increase alone represented a jump of about 13% of the Fed’s balance sheet one year earlier, so one cannot deny that the rise in reserve balances is not insignificant. The Federal Reserve is still acting in BIG NUMBERS, the size of which would have been incomprehensible 18 months ago!
Dissecting what took place during this time, however, is crucial to an understanding of how the Fed is trying to extricate itself from the situation it now finds itself in without setting off another panic in the financial markets. There were three basic changes in the Fed’s balance sheet over this time. The first change was operational in a seasonal sense and hence not crucial to the reduction in the Fed’s balance sheet. The second change is important because it relates to what is happening to all the special assets and facilities that the Fed set up to combat the financial crisis. These accounts appear to be phasing out. The third change relates to how the Fed is replacing the reserves draining out of the banking system because of the second change. Here the Federal Reserve is getting back into open market operations, something it abandoned in December 2007 as it created the Term Auction Facility (TAF).
The first major change in the balance sheet over the last 13 weeks was the swing in the general deposits the U. S. Treasury holds with the Fed. The movements here were seasonal and therefore solely of an operational nature. This swing has to do with tax receipts and the Treasury writing checks. The Treasury and the Fed have worked out operations so that tax collections and government expenditures do not disrupt the banking system any more than necessary. As a consequence you can get some pretty large swings in the balances that the Treasury holds at the Fed in this account without these movements causing large swings in the reserves that are in the banking system. Over the 13 weeks ending September 16, 2009, Treasury deposits declined by over $60 billion: however, in the last 4 weeks ending on the same date these balances increased by $32 billion. All this was handled smoothly.
It is the second of these factors that is vitally important for the exit strategy of the Fed. Accounts that can be associated with the “unusual” activities engaged in by the Fed over the last 21 months declined by over $300 billion over the last 13 weeks. The amount of funds supplied through the TAF dropped by over $140 billion. The net portfolio holdings of Commercial Paper Funding Facility LLC fell by almost $90 billion. Funding supplied through central bank liquidity swaps declined by more than $87 billion. The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility fell by about $19 billion.
In other words, the Federal Reserve is letting these facilities decline at their own pace as the need for them recedes. Even with all these reductions, however, one can still account for almost $600 billion of the Fed balance sheet being associated with assets created for the specific needs that officials perceived were necessary to keep the banking and financial system from collapsing. So there is still a ways to go to return to normalcy.
The Fed is replacing these assets that are running off with the purchases of various kinds of open market securities. Over the past 13 weeks, the Fed has increased its portfolio of securities held by about $385 billion. (One should note that in the first week of September 2008 the Fed held “total” less than $800 billion in securities. Again the magnitudes are staggering!) Of this increase, $121 billion was in Treasury securities, $35 billion was in Federal Agency securities, and $229 billion were in Mortgage Backed securities. (Note that on September 16, 2009, the Federal Reserve held $685 billion in Mortgage Backed securities, about 88% of the “total” securities held by the Federal Reserve in the first week of September 2008.)
My best guess about how the Fed will reduce its balance sheet is as follows. (Note that I am not including in this analysis any effort on the part of the Fed to support the massive amounts of debt that will be created through the deficits of the federal government in the future.) The portfolio of Treasury securities and Federal Agency securities will not be an active part of the Federal Reserve exit strategy. In my mind, what the Fed would like to see happen is that the roughly $600 billion is “special” assets would “run off” over time without major difficulty. Then, as the market for Mortgage Backed securities stabilizes and then returns to a more normal pattern of activity, the Fed will either allow its portfolio of Mortgage Backed securities to run off or will sell them into a strengthening market and significantly reduce the size of its holdings of these securities. As mentioned above, the Fed’s portfolio of Mortgage Backed securities totaled $685 billion on September 16.
Thus, assuming the best of all worlds, if these two items on the Fed’s balance sheet were eliminated, this would account for almost $1.3 trillion. Take away $1.3 trillion from the $2.2 trillion of assets on the Federal Reserve balance sheet September 16 and you get roughly $900 billion. On September 10, 2008 the Federal Reserve balance sheet totaled a little more than $900 billion in assets!
Can the Fed do it? We’ll just have to wait and see. It is important for us to see that there is a logical path out of the dilemma the Federal Reserve is facing. However, there are many potential bumps along the path. The health of the economy is one. The ever increasing federal debt is another. Recovery around that world is also a factor. And so on and so on. We will continue to watch!
Showing posts with label depression. Show all posts
Showing posts with label depression. Show all posts
Friday, September 18, 2009
Sunday, June 21, 2009
A Walk on the Supply Side
Keynesian demand-side economics still rules the minds of the policy makers in Washington, D. C. Their actions and their analysis continually point to their focus on aggregate demand and the “green shoots” that are expected to accompany an economic recovery based on the stimulus of spending.
For over a year I have been arguing that more attention needs to be given to the supply side of the equation. Yes, the growth rate of real GDP has been going down and the rate of employment has been going up. But, the rate of inflation, as measured by the rate of increase of the GDP price deflator has not declined since the fourth quarter of 2007. If it were just a demand side problem, this would not be the case.
I focus on the rate of increase in the GDP implicit deflator because of some of the measurement problems associated with the Consumer Price Index, such as the treatment of housing expenses and energy. Certainly, the CPI should be watched, but in dealing with economic aggregates, I prefer the former.
My point has been that if the problems in the economy were all tied to a substantial fall in aggregate demand, then there should have been a more substantial lessening in the rate of price increases. Consequently, my argument has been that something has happened on the supply side of the economy for the numbers to have been reported as they have been.
I would like to point to two areas of the United States economy that indicates that the problems of recovery may be more difficult to overcome than if the dislocation in the economy were just one of inadequate aggregate demand. The first area is that of industrial output; the second area is the labor market.
In terms of the industrial base of the economy I would like to focus upon industrial production and the industrial utilization of capacity. Industrial production has been declining steadily since the start of the recession in December 2007. At that time, industrial production was growing at about a 2.0% year-over-year rate of growth. By April 2008 the year-over-year rate of growth had become negative. The figures for 2009 are
January -10.8
February -11.3
March -12.6
April -12.7
May -13.4
This certainly shows a continuing weakening in the economy. However, taken by itself I don’t think that it carries more meaning than does the decline in the rate of growth of real GDP which has been declining as well.
Combine this performance with the figures on capacity utilization and one gets a different picture. As expected, total industry capacity utilization has dropped substantially in this recession. In December 2007, the figure stood at a little over 80.0%. In May 2009, capacity utilization had fallen to about 68.0%. This is the largest 18 month decline in the post-World War II period.
But, this is not all. The peak in capacity utilization in the past ten years was only slightly more than the December 2007 figure. But, this peak of the last ten years was substantially below the level of capacity utilization for most of the 1990s which was below the peak utilization in the 1970s which was below the peak utilization in the 1960s. That is, it appears as if we have been using less and less of our capacity on a regular basis since the 1960s.
The structure of our industrial base is changing. We can see that in autos, in steel, and in many other parts of our manufacturing base. It appears as if the weakness in our economy is composed of two things: first the cyclical swing in business; but this weakness is on top of a secular decline in our productive ability. The economy is in the process of restructuring!
This shift is also showing up in labor markets. The civilian participation rate in the labor force for the United States rose from the late 1960s into the 1990s when it peaked a little above 67.0%. The civilian participation rate has declined since late 2000 and has remained below 66.2% since 2004. In terms of the number of people who are not participating in the labor market any more, this represents a large number. People have left the labor force in the last five or six years and this trend has, of course, been exacerbated by the recession. Over the past forty years the rise in the participation rate has slowed down or stopped during recessions, but at no time did it decline as it did in the in the past six years.
Of further interest, the Labor Department reported that separations from jobs in April remained relatively constant as they have for the past two years, but the rate of hiring continued to be quite low. In early 2008 the percentage of the labor force that were separated from their jobs was about equal to the percentage that were being hired. Since then separations have exceeded hirings, as might be expected, causing the unemployment rate to rise.
In terms of those that were separated from their jobs, there was a dramatic shift between those that quit their jobs and those that were laid off or discharged from their jobs. The percentage of layoffs and discharges rose dramatically from April 2008 to April 2009 whereas quit levels dropped substantially. That is, although separation rates did not change much at all during this time, the composition of those being separated from their positions experienced a tremendous shift. This is an indication that there is a structural shift in what is happening in the labor markets.
This information leads me to believe that there is a substantial restructuring taking place in the United States economy. And, a structural shift is a supply side issue and not a demand side issue. In fact, demand side responses can just make a bad situation worse by trying to force people back into positions that companies and industries are attempting to eliminate because the world has changed.
The figures on industrial production and capacity utilization seem to indicate that industry is changing and the numbers from the labor market reinforce that conclusion. Pumping up aggregate demand is an attempt to stop this restructuring or, at least, slow it down.
The problem that policymakers’ face is that they, or we, do not know what the new industrial structure is going to look like. It is impossible for anyone to know. People can make guesses, but that is all they are—guesses. And, in situations like this, it is more likely that the guesses will be wrong rather than being right. It’s just that the future is unknown. The need for the United States economy to restructure just adds another “unknown, unknown” to our list of “known unknowns” and “unknown, unknowns.” My guess is that this restructuring is going to take some time and could be sidetracked by huge government deficits and a supportive monetary policy.
For over a year I have been arguing that more attention needs to be given to the supply side of the equation. Yes, the growth rate of real GDP has been going down and the rate of employment has been going up. But, the rate of inflation, as measured by the rate of increase of the GDP price deflator has not declined since the fourth quarter of 2007. If it were just a demand side problem, this would not be the case.
I focus on the rate of increase in the GDP implicit deflator because of some of the measurement problems associated with the Consumer Price Index, such as the treatment of housing expenses and energy. Certainly, the CPI should be watched, but in dealing with economic aggregates, I prefer the former.
My point has been that if the problems in the economy were all tied to a substantial fall in aggregate demand, then there should have been a more substantial lessening in the rate of price increases. Consequently, my argument has been that something has happened on the supply side of the economy for the numbers to have been reported as they have been.
I would like to point to two areas of the United States economy that indicates that the problems of recovery may be more difficult to overcome than if the dislocation in the economy were just one of inadequate aggregate demand. The first area is that of industrial output; the second area is the labor market.
In terms of the industrial base of the economy I would like to focus upon industrial production and the industrial utilization of capacity. Industrial production has been declining steadily since the start of the recession in December 2007. At that time, industrial production was growing at about a 2.0% year-over-year rate of growth. By April 2008 the year-over-year rate of growth had become negative. The figures for 2009 are
January -10.8
February -11.3
March -12.6
April -12.7
May -13.4
This certainly shows a continuing weakening in the economy. However, taken by itself I don’t think that it carries more meaning than does the decline in the rate of growth of real GDP which has been declining as well.
Combine this performance with the figures on capacity utilization and one gets a different picture. As expected, total industry capacity utilization has dropped substantially in this recession. In December 2007, the figure stood at a little over 80.0%. In May 2009, capacity utilization had fallen to about 68.0%. This is the largest 18 month decline in the post-World War II period.
But, this is not all. The peak in capacity utilization in the past ten years was only slightly more than the December 2007 figure. But, this peak of the last ten years was substantially below the level of capacity utilization for most of the 1990s which was below the peak utilization in the 1970s which was below the peak utilization in the 1960s. That is, it appears as if we have been using less and less of our capacity on a regular basis since the 1960s.
The structure of our industrial base is changing. We can see that in autos, in steel, and in many other parts of our manufacturing base. It appears as if the weakness in our economy is composed of two things: first the cyclical swing in business; but this weakness is on top of a secular decline in our productive ability. The economy is in the process of restructuring!
This shift is also showing up in labor markets. The civilian participation rate in the labor force for the United States rose from the late 1960s into the 1990s when it peaked a little above 67.0%. The civilian participation rate has declined since late 2000 and has remained below 66.2% since 2004. In terms of the number of people who are not participating in the labor market any more, this represents a large number. People have left the labor force in the last five or six years and this trend has, of course, been exacerbated by the recession. Over the past forty years the rise in the participation rate has slowed down or stopped during recessions, but at no time did it decline as it did in the in the past six years.
Of further interest, the Labor Department reported that separations from jobs in April remained relatively constant as they have for the past two years, but the rate of hiring continued to be quite low. In early 2008 the percentage of the labor force that were separated from their jobs was about equal to the percentage that were being hired. Since then separations have exceeded hirings, as might be expected, causing the unemployment rate to rise.
In terms of those that were separated from their jobs, there was a dramatic shift between those that quit their jobs and those that were laid off or discharged from their jobs. The percentage of layoffs and discharges rose dramatically from April 2008 to April 2009 whereas quit levels dropped substantially. That is, although separation rates did not change much at all during this time, the composition of those being separated from their positions experienced a tremendous shift. This is an indication that there is a structural shift in what is happening in the labor markets.
This information leads me to believe that there is a substantial restructuring taking place in the United States economy. And, a structural shift is a supply side issue and not a demand side issue. In fact, demand side responses can just make a bad situation worse by trying to force people back into positions that companies and industries are attempting to eliminate because the world has changed.
The figures on industrial production and capacity utilization seem to indicate that industry is changing and the numbers from the labor market reinforce that conclusion. Pumping up aggregate demand is an attempt to stop this restructuring or, at least, slow it down.
The problem that policymakers’ face is that they, or we, do not know what the new industrial structure is going to look like. It is impossible for anyone to know. People can make guesses, but that is all they are—guesses. And, in situations like this, it is more likely that the guesses will be wrong rather than being right. It’s just that the future is unknown. The need for the United States economy to restructure just adds another “unknown, unknown” to our list of “known unknowns” and “unknown, unknowns.” My guess is that this restructuring is going to take some time and could be sidetracked by huge government deficits and a supportive monetary policy.
Sunday, January 25, 2009
How Effective Might the Stimulus Plan Be?
The Obama stimulus plan totals $825 billion. This plan is a combination of spending plans and tax relief. The dollar amount needed to be large, we are told, because the American economy is tanking and a lot of effort needs to be exerted to stop the decline and re-establish positive growth once again. Of course, we were told similar things when the legislation relating to the TARP was introduced. We have also been told that the number needs to be large because we don’t really know how much stimulus will be needed to jump-start the economy so we need to throw a lot of cash at the problem in hopes that the effort will be large enough to do the job.
The problem is…how much extra spending will $825 billion of stimulus create in the economy. In the simple Keynesian model this $825 billion will generate something more than $825 billion as new investment and new spending is created from the initial stimulus. The word going around is that the Obama economists are using a “multiplier” of 1.5. Thus, $825 billion in new spending and tax cuts will actually result in another $412.5 billion in spending raising the total affect on the economy to $1.2375 trillion…a hefty sum.
On Thursday, the Wall Street Journal printed an opinion piece by Harvard economics professor Bob Barro (http://online.wsj.com/article/SB123258618204604599.html?mod=todays_us_opinion)
who argued that the “multiplier” might be something different from 1.5 and might even be as low as zero! Barro contended, supported by his research, that even in times that are most favorable for the multiplier to be toward the higher end of this range, war times, the multiplier comes out to be no higher than 0.8. That is a stimulus plan that totaled $825 billion, could only expect to produce about $660 of real Gross Domestic Product not $1.2375 trillion. But, he adds, this estimate of 0.8 is probably optimistic.
Why would the final impact of the stimulus package be less than the amount of the stimulus package itself? There are several reasons. For one, the government expenditures could be expected to be a substitute for private investment or other private expenditures. Furthermore, whether or not the tax cuts are spent is another question. In the recent Bush43 tax rebate program much of the rebate money either went into savings or it went to pay off existing debt. In a poll released in the middle of last week, pollsters found that, on average, people would apply 70% to 75% of any tax relief from the stimulus plan to savings or to paying off existing debt. So there are arguments…and empirical support…for the contention that the “multiplier” may not be as high as 1.5 and might realistically be below 1.0.
The threat to save or pay back debt is real…not only for consumers…but also for businesses. Some economists who have studied recessions and depressions talk about a period of time called a debt/deflation. In periods like these the future looks bleak…and economic units…consumers and businesses…try to pull back and restructure themselves on a sounder financial basis. That is, they want to reduce the leverage that is on their balance sheet and get away from owing money. The first concern has to do with being unemployed or faced with going out of business…economic units want cash or, at least, near-cash items so as to be able to bridge a period when cash inflows might be low. And, if there is a possibility of deflation, people want to reduce the amount of debt on their balance sheets because the real value of debt and debt payments increase when prices are falling.
Some “Keynesians” have tried to incorporate these ideas about debt/deflation into their economic models. Hyman Minsky was one of the most prominent economists to explicitly discuss the impact of the capital markets on economic expansions and contractions. However, most of the empirical models used by policy makers do not take account of capital market effects on economic activity. (For a discussion of the economic model used for policy forecasting in the Federal Reserve see “Ben Bernanke’s Fed: The Federal Reserve After Greenspan” by Ethan S. Harris, Harvard Business School Press.) It is hard to contemplate “multipliers” as high as 1.5 if one considers these capital market issues.
For people to spend or borrow (if they could borrow) they need to have at least a somewhat optimistic view of the future (even for the possibility of inflation) to maintain or increase spending by either reducing savings or by borrowing. The obvious psychological impact hoped for from the stimulus package is that economic units will have enough confidence in the future or will even be willing to borrow and pay back loans with cheaper real dollars to keep spending or even increase spending. The Obama team is intending to use the rest of the TARP funds released by the Congress ($350 billion) to get people borrowing again.
Of course the concern about achieving this latter effect is the concern over the creation or the re-enforcement of moral hazard in the economy. If the government continues to “bail out” not only financial institutions but businesses, families, and other economic units, these economic units will continue to take on more and more risk in the future because they know that the government will supply a safety net to protect people from their foolish bets. The economists who argue from the viewpoint of the debt/deflation hypothesis contend that sooner or later the economy will take on so much debt that the debt/deflation cannot stop until people finally work off their extreme financial imbalances and return to more normal debt loads and positive amounts of saving. Some of these economists believe that this time has arrived and the economy cannot be turned around until economic units have worked off their excessive debt burdens and taken on a more conservative view of their economic future.
To get a zero multiplier (see the Barro article and Barro’s textbook “Macroeconomics: A Modern Approach” published by Thomson South-Western) one must argue that economic units will anticipate the increased real economic costs, real future taxes, or inflation that result from the way in which the stimulus package is financed and re-arrange their economic and financial activities to be able to cover the future government levies. A zero multiplier means that for every $1.00 the government puts into the stimulus plan, economic units will remove $1.00 from the spending stream. Thus, the $825 billion stimulus plan would increase real Gross Domestic Product by…ZERO DOLLARS!
What is the alternative to the type of stimulus plan proposed by the Obama administration? Barro argues that things must be done to encourage business commitment and innovation. His favorite idea is to eliminate the federal corporate income tax. If people are to be put back to work again…businesses must be hiring. In order to do this the energy and the foresight of the American business community must be put back to work again. The concern with massive public-works programs is that they will just substitute for the innovation and entrepreneurial leadership that still exists in the country and could produce real growth but needs to have the appropriate incentives.
So, what will be the impact of the Obama stimulus plan? You take your guess…I’ll take mine. My guess is that the multiplier is less than 1.0 and is maybe as low as 0.4. A reason for this pessimistic view of the multiplier is that we are at the stage where people/families and businesses finally have to fully restructure their finances to get balance sheets back into some form of conservative position. After many, many years of chasing dreams through betting on rising inflation with increased leverage and new financial instruments…the economy finally needs a break…needs to catch its breath and settle down for awhile.
I could be wrong. The American government could throw so much money at the economy that rising inflation and increased leverage becomes “the thing” again. If such is the case…then we are just postponing for another time, dealing with the monster that the government has created in the first place.
The problem is…how much extra spending will $825 billion of stimulus create in the economy. In the simple Keynesian model this $825 billion will generate something more than $825 billion as new investment and new spending is created from the initial stimulus. The word going around is that the Obama economists are using a “multiplier” of 1.5. Thus, $825 billion in new spending and tax cuts will actually result in another $412.5 billion in spending raising the total affect on the economy to $1.2375 trillion…a hefty sum.
On Thursday, the Wall Street Journal printed an opinion piece by Harvard economics professor Bob Barro (http://online.wsj.com/article/SB123258618204604599.html?mod=todays_us_opinion)
who argued that the “multiplier” might be something different from 1.5 and might even be as low as zero! Barro contended, supported by his research, that even in times that are most favorable for the multiplier to be toward the higher end of this range, war times, the multiplier comes out to be no higher than 0.8. That is a stimulus plan that totaled $825 billion, could only expect to produce about $660 of real Gross Domestic Product not $1.2375 trillion. But, he adds, this estimate of 0.8 is probably optimistic.
Why would the final impact of the stimulus package be less than the amount of the stimulus package itself? There are several reasons. For one, the government expenditures could be expected to be a substitute for private investment or other private expenditures. Furthermore, whether or not the tax cuts are spent is another question. In the recent Bush43 tax rebate program much of the rebate money either went into savings or it went to pay off existing debt. In a poll released in the middle of last week, pollsters found that, on average, people would apply 70% to 75% of any tax relief from the stimulus plan to savings or to paying off existing debt. So there are arguments…and empirical support…for the contention that the “multiplier” may not be as high as 1.5 and might realistically be below 1.0.
The threat to save or pay back debt is real…not only for consumers…but also for businesses. Some economists who have studied recessions and depressions talk about a period of time called a debt/deflation. In periods like these the future looks bleak…and economic units…consumers and businesses…try to pull back and restructure themselves on a sounder financial basis. That is, they want to reduce the leverage that is on their balance sheet and get away from owing money. The first concern has to do with being unemployed or faced with going out of business…economic units want cash or, at least, near-cash items so as to be able to bridge a period when cash inflows might be low. And, if there is a possibility of deflation, people want to reduce the amount of debt on their balance sheets because the real value of debt and debt payments increase when prices are falling.
Some “Keynesians” have tried to incorporate these ideas about debt/deflation into their economic models. Hyman Minsky was one of the most prominent economists to explicitly discuss the impact of the capital markets on economic expansions and contractions. However, most of the empirical models used by policy makers do not take account of capital market effects on economic activity. (For a discussion of the economic model used for policy forecasting in the Federal Reserve see “Ben Bernanke’s Fed: The Federal Reserve After Greenspan” by Ethan S. Harris, Harvard Business School Press.) It is hard to contemplate “multipliers” as high as 1.5 if one considers these capital market issues.
For people to spend or borrow (if they could borrow) they need to have at least a somewhat optimistic view of the future (even for the possibility of inflation) to maintain or increase spending by either reducing savings or by borrowing. The obvious psychological impact hoped for from the stimulus package is that economic units will have enough confidence in the future or will even be willing to borrow and pay back loans with cheaper real dollars to keep spending or even increase spending. The Obama team is intending to use the rest of the TARP funds released by the Congress ($350 billion) to get people borrowing again.
Of course the concern about achieving this latter effect is the concern over the creation or the re-enforcement of moral hazard in the economy. If the government continues to “bail out” not only financial institutions but businesses, families, and other economic units, these economic units will continue to take on more and more risk in the future because they know that the government will supply a safety net to protect people from their foolish bets. The economists who argue from the viewpoint of the debt/deflation hypothesis contend that sooner or later the economy will take on so much debt that the debt/deflation cannot stop until people finally work off their extreme financial imbalances and return to more normal debt loads and positive amounts of saving. Some of these economists believe that this time has arrived and the economy cannot be turned around until economic units have worked off their excessive debt burdens and taken on a more conservative view of their economic future.
To get a zero multiplier (see the Barro article and Barro’s textbook “Macroeconomics: A Modern Approach” published by Thomson South-Western) one must argue that economic units will anticipate the increased real economic costs, real future taxes, or inflation that result from the way in which the stimulus package is financed and re-arrange their economic and financial activities to be able to cover the future government levies. A zero multiplier means that for every $1.00 the government puts into the stimulus plan, economic units will remove $1.00 from the spending stream. Thus, the $825 billion stimulus plan would increase real Gross Domestic Product by…ZERO DOLLARS!
What is the alternative to the type of stimulus plan proposed by the Obama administration? Barro argues that things must be done to encourage business commitment and innovation. His favorite idea is to eliminate the federal corporate income tax. If people are to be put back to work again…businesses must be hiring. In order to do this the energy and the foresight of the American business community must be put back to work again. The concern with massive public-works programs is that they will just substitute for the innovation and entrepreneurial leadership that still exists in the country and could produce real growth but needs to have the appropriate incentives.
So, what will be the impact of the Obama stimulus plan? You take your guess…I’ll take mine. My guess is that the multiplier is less than 1.0 and is maybe as low as 0.4. A reason for this pessimistic view of the multiplier is that we are at the stage where people/families and businesses finally have to fully restructure their finances to get balance sheets back into some form of conservative position. After many, many years of chasing dreams through betting on rising inflation with increased leverage and new financial instruments…the economy finally needs a break…needs to catch its breath and settle down for awhile.
I could be wrong. The American government could throw so much money at the economy that rising inflation and increased leverage becomes “the thing” again. If such is the case…then we are just postponing for another time, dealing with the monster that the government has created in the first place.
Wednesday, January 14, 2009
The Collapse of Citi
Banking is a commodity business. Banking deals with information…I am holding $100.00of yours in something called a transaction account…I am holding your IOU for $1,000,000.00. Whereas, historically, these sums had to do with a physical quantity…something like gold…now all banking is basically conducted in 0’s and 1’s.
Banking is just information and the movement of information. Banking is a commodity business.
Yes, there are some other products and services connected with the banking business. There is safe keeping…you can get coin and currency back from you transaction account. We will clear payments for you though the banking system so that you can pay people from your account without the use of coin and currency and you can receive payments from other which will be put into your account. That is, we clear transactions through the banking system. We will do your accounting for you and send you a monthly statement. We will make loans to you and provide many different kinds of services for you connected with your loan. And there are many other products and services that banks provide their customers…individuals, businesses, and governments.
Banks used to get paid for these services primarily in interest payments or in deposit balances that were kept at the bank. In the 1980s, however, we got another idea. We can isolate these products and services, account for them, and then charge the customer fees for these particular products and services they use and then we, the banks, won’t have to build in payment for them in the interest rates charged on the loans or by means of the deposit balances that the customer had been required to keep at the bank.
Fees are good because they don’t depend upon loan or deposit balances, but depend upon other products or services rendered.
In the 1980s depository institutions found another way to generate fee income. In the 1970s the government had invented a new financial instrument called a mortgage-backed security that could help financial institutions make more money available to people who wanted to own homes and the depository institution could make these mortgage loans, securitize them so they could sell them and not hold them on their balance sheets, and collect fees for originating and, possibly servicing them. Furthermore, the banks would not have to worry about the interest rate risk that came from holding assets with long term maturities like mortgages and support them with deposits that were available on demand or had short-term maturities.
Banks liked fees and started to build businesses based on fee income. They looked farther and farther in an effort to find more sources of fee income. They built or acquired subsidiaries that generated fee income. And banking companies grew and became diversified…even conglomerate in nature.
But, the banks saw that more than just mortgages could be securitized and they saw that these securitized loans could be traded and in so doing more and more fees could be generated, but they also found that they could make trading profits from dealing in these securitized loans. And so banks began trading in securitized loans…otherwise called derivatives…and developing arbitrage strategies to take advantage of market discrepancies. But, to take advantage of market discrepancies they had to increase the amount of leverage they used so as to earn competitive returns.
Yet, the nature of banking did not change. Banking is a commodity business.
Not only is the business of borrowing money in the form of deposits and lending that money out to businesses and consumers in different kinds of loans a commodity business, the banks found that competition made all the products and services they offered into commodities as well. And, trading…well no one makes money over the longer haul on trading…because it, too, is composed of transactions in commodities.
Banks can earn a return on capital that is equal to what the capital can earn elsewhere given the normal risk a bank assumes. But, banks cannot mold themselves into institutions that can produce and sustain competitive advantages over other firms and industries. The business model they tried did not work. Yet, like other firms and other industries that come to believe in a business model that doesn’t work, their continued efforts to make the business model work only exacerbated the problem. Generally, this extra effort meant taking more and more risks and then even using extra-legal means to produce the results wanted.
I am not saying that banks committed fraud, but I have very serious concerns about the off-balance sheet practices along with other accounting efforts that the banks used in an attempt to generate the higher returns they felt they had to earn. However, the competitive pressure to perform does push people and organizations to walk the edge of ethical practices.
Citi…whatever…had a business model that did not work. And, this model was tested over about a decade…and it never worked. The investment community realized this and was only luke-warm about the company’s stock. Yet, management stuck with the model and tried all the tricks to make its business model work. They were true believers.
No one stood up, however, and mentioned that the emperor didn’t have on any clothes.
Banking is a commodity business. Citi…whatever…is said to be cutting back its organization by a third…and this is from the reduction in size that had already been achieved. They are supposedly getting back to fundamentals…into areas in which they have a core competency. Supposedly, its management has a better appreciation of the markets it will be working in. Let’s hope so.
And so the debt deflation goes on. The example of the banks…and of Citi-whatever…shows why it is so difficult to achieve a turnaround in the financial system and the economy during a time such as this. In the previous forty years or so, many companies, like Citi-whatever, took advantage of the almost continuous expansion of the economy and the government support of that expansion. Now the re-construction of these companies must take place.
The big question on the table right now concerns the stimulus plan being put together by President-elect Obama and his team. With companies…like Citi-whatever…drawing back and restructuring, how much effect can the stimulus plan have on the economy? The stimulus plan must not only attempt to reverse the economic down-term but must overcome the impact of the companies that are deleveraging their financial structure or are withdrawing from markets. The administration is shooting at a target that is moving away from it.
Banking is just information and the movement of information. Banking is a commodity business.
Yes, there are some other products and services connected with the banking business. There is safe keeping…you can get coin and currency back from you transaction account. We will clear payments for you though the banking system so that you can pay people from your account without the use of coin and currency and you can receive payments from other which will be put into your account. That is, we clear transactions through the banking system. We will do your accounting for you and send you a monthly statement. We will make loans to you and provide many different kinds of services for you connected with your loan. And there are many other products and services that banks provide their customers…individuals, businesses, and governments.
Banks used to get paid for these services primarily in interest payments or in deposit balances that were kept at the bank. In the 1980s, however, we got another idea. We can isolate these products and services, account for them, and then charge the customer fees for these particular products and services they use and then we, the banks, won’t have to build in payment for them in the interest rates charged on the loans or by means of the deposit balances that the customer had been required to keep at the bank.
Fees are good because they don’t depend upon loan or deposit balances, but depend upon other products or services rendered.
In the 1980s depository institutions found another way to generate fee income. In the 1970s the government had invented a new financial instrument called a mortgage-backed security that could help financial institutions make more money available to people who wanted to own homes and the depository institution could make these mortgage loans, securitize them so they could sell them and not hold them on their balance sheets, and collect fees for originating and, possibly servicing them. Furthermore, the banks would not have to worry about the interest rate risk that came from holding assets with long term maturities like mortgages and support them with deposits that were available on demand or had short-term maturities.
Banks liked fees and started to build businesses based on fee income. They looked farther and farther in an effort to find more sources of fee income. They built or acquired subsidiaries that generated fee income. And banking companies grew and became diversified…even conglomerate in nature.
But, the banks saw that more than just mortgages could be securitized and they saw that these securitized loans could be traded and in so doing more and more fees could be generated, but they also found that they could make trading profits from dealing in these securitized loans. And so banks began trading in securitized loans…otherwise called derivatives…and developing arbitrage strategies to take advantage of market discrepancies. But, to take advantage of market discrepancies they had to increase the amount of leverage they used so as to earn competitive returns.
Yet, the nature of banking did not change. Banking is a commodity business.
Not only is the business of borrowing money in the form of deposits and lending that money out to businesses and consumers in different kinds of loans a commodity business, the banks found that competition made all the products and services they offered into commodities as well. And, trading…well no one makes money over the longer haul on trading…because it, too, is composed of transactions in commodities.
Banks can earn a return on capital that is equal to what the capital can earn elsewhere given the normal risk a bank assumes. But, banks cannot mold themselves into institutions that can produce and sustain competitive advantages over other firms and industries. The business model they tried did not work. Yet, like other firms and other industries that come to believe in a business model that doesn’t work, their continued efforts to make the business model work only exacerbated the problem. Generally, this extra effort meant taking more and more risks and then even using extra-legal means to produce the results wanted.
I am not saying that banks committed fraud, but I have very serious concerns about the off-balance sheet practices along with other accounting efforts that the banks used in an attempt to generate the higher returns they felt they had to earn. However, the competitive pressure to perform does push people and organizations to walk the edge of ethical practices.
Citi…whatever…had a business model that did not work. And, this model was tested over about a decade…and it never worked. The investment community realized this and was only luke-warm about the company’s stock. Yet, management stuck with the model and tried all the tricks to make its business model work. They were true believers.
No one stood up, however, and mentioned that the emperor didn’t have on any clothes.
Banking is a commodity business. Citi…whatever…is said to be cutting back its organization by a third…and this is from the reduction in size that had already been achieved. They are supposedly getting back to fundamentals…into areas in which they have a core competency. Supposedly, its management has a better appreciation of the markets it will be working in. Let’s hope so.
And so the debt deflation goes on. The example of the banks…and of Citi-whatever…shows why it is so difficult to achieve a turnaround in the financial system and the economy during a time such as this. In the previous forty years or so, many companies, like Citi-whatever, took advantage of the almost continuous expansion of the economy and the government support of that expansion. Now the re-construction of these companies must take place.
The big question on the table right now concerns the stimulus plan being put together by President-elect Obama and his team. With companies…like Citi-whatever…drawing back and restructuring, how much effect can the stimulus plan have on the economy? The stimulus plan must not only attempt to reverse the economic down-term but must overcome the impact of the companies that are deleveraging their financial structure or are withdrawing from markets. The administration is shooting at a target that is moving away from it.
Monday, January 5, 2009
When Will Banks Begin Lending Again?
Commercial banks have always played and, as far as I can see, will always play a role in the health of the economy. Commercial banks represent a kind of fulcrum of economic activity. If commercial banks are not lending at all or are not moving toward an acceleration of lending…then one can bet that the economy will not be moving ahead in the near future. If commercial banks are lending modestly or are accelerating their lending…then it can be anticipated that the economy will be expanding or even over-heating.
Right now, the commercial banks are not lending…and there doesn’t seem to be much reason to believe that they will pick up their lending any time soon.
The Federal Reserve is doing all that it can to infuse liquidity into short term and long term financial markets, but the banks are doing little or nothing in the way of expanding credit. There are two major reasons for this: first, the quality of the assets the banks are holding; and, second, the quality of potential borrowers.
In the first case, I am not convinced that banks have finally gotten their hands around the quality of their assets. There is still too much uncertainty in financial markets…as well as real markets…for banks to fully understand their position. Some financial assets, still, cannot be valued. Assets in foreclosure present an uncertain asset value to the banks. Credit card losses are mounting. Auto loan losses are mounting. And, so on and so on…
We continue to receive news that does not bode well for the value of the assets of banks. For example, the front page article in the New York Times trumpets on page one, ”As Vacant Office Space Grows, So Does Lender’s Crisis” (see http://www.nytimes.com/2009/01/05/business/05real.html?_r=1&hp). We have not yet seen the bankruptcies that will follow the miserable holiday season and this will lead to vacancies in the major malls as well as in strip malls. This will lead to further foreclosures and financial stress in real estate where there are already a lot of empty stores. We still have a wave or two to go through in the residential real estate market as the various ‘no doc-no down payment” loans re-price. And, although unemployment began to rise throughout the fall, many expect this trend to accelerate early in 2009 as the business failures and cutbacks start to add up. These movements and others not mentioned will only exacerbate the uncertainty surrounding the value of the asset portfolios of banks.
Banks will continue to be reluctant to lend if they don’t have a good idea of what the asset side of their balance sheet looks like.
As far as potential borrowers. There used to be a saying in the banking community that banks will not lend to anyone unless they don’t need to borrow any money.
My guess is that this will be the major lending rule that most financial institutions will follow in the near and intermediate future. On the upside, financial institutions stretch and stretch their lending standards to earn extra basis points returns so as to outdo their competition. On the downside, banks focus on the quality of credit because charge-offs dominate bank performance. In the past, banks have not moved into riskier borrowers until other banks have moved and it becomes necessary to compete in lesser credits in order to maintain a competitive position. Here the question becomes…who wants to move first?
My answer is that bankers feel very defensive about their behavior in the recent past…they will not want to be the leader in a new round of stupidity!
And, what of the Obama administration and the new plans for fiscal stimulus?
First of all there are rumors that any stimulus package proposed will not be enacted by January 20, 2009 let alone early in the spring. The Obama team has already responded to this by proposing, as a part of any stimulus program, a substantial package of tax cuts. The reasoning behind this is that it will draw bi-partisan support of the Republicans in Congress, something felt to be desirable to help achieve as much effectiveness for the economic program as possible.
An economic stimulus package, however, will not result in an immediate stimulation of bank lending. So, on top of when the economic program is passed…partially or in full…banks must still solve their own difficulties, as described above, before much real lending takes place.
Secondly, there is the international situation. The world economy is worse than anyone thought it was and is declining from there. The United States is part of this world economy…it cannot act independently of what is going on elsewhere in the world. Almost all of the nations of the world face similar situations and each faces the uncertainties mentioned above. But, how much is the rest of the world going to suffer from the continued decline in the United States economy and how much the United States is going to suffer from the decline in the rest of the world is unknown. The Obama administration must act more responsibly toward the rest of the world than did the administration that left office earlier this past fall.
And, we now have another uncertainty…the events in the Middle East present us with another unknown. War is uncertainty itself! What impact this will have on the rest of the world and how it will work itself out cannot be predicted with any degree of precision. But, it is in the mix now and must be taken into consideration is our potential scenarios for the year.
To summarize these comments: the economy will not begin to turn around until the banks are in a position to start lending again. My expectation for this turnaround is beyond the middle of 2009. And, this might be delayed even further if there is a rash of bank failures during the year. There are still too many uncertainties to be more definite and, as a consequence, the prediction for financial markets will still be…a downward drift…with lots and lots of volatility!
Right now, the commercial banks are not lending…and there doesn’t seem to be much reason to believe that they will pick up their lending any time soon.
The Federal Reserve is doing all that it can to infuse liquidity into short term and long term financial markets, but the banks are doing little or nothing in the way of expanding credit. There are two major reasons for this: first, the quality of the assets the banks are holding; and, second, the quality of potential borrowers.
In the first case, I am not convinced that banks have finally gotten their hands around the quality of their assets. There is still too much uncertainty in financial markets…as well as real markets…for banks to fully understand their position. Some financial assets, still, cannot be valued. Assets in foreclosure present an uncertain asset value to the banks. Credit card losses are mounting. Auto loan losses are mounting. And, so on and so on…
We continue to receive news that does not bode well for the value of the assets of banks. For example, the front page article in the New York Times trumpets on page one, ”As Vacant Office Space Grows, So Does Lender’s Crisis” (see http://www.nytimes.com/2009/01/05/business/05real.html?_r=1&hp). We have not yet seen the bankruptcies that will follow the miserable holiday season and this will lead to vacancies in the major malls as well as in strip malls. This will lead to further foreclosures and financial stress in real estate where there are already a lot of empty stores. We still have a wave or two to go through in the residential real estate market as the various ‘no doc-no down payment” loans re-price. And, although unemployment began to rise throughout the fall, many expect this trend to accelerate early in 2009 as the business failures and cutbacks start to add up. These movements and others not mentioned will only exacerbate the uncertainty surrounding the value of the asset portfolios of banks.
Banks will continue to be reluctant to lend if they don’t have a good idea of what the asset side of their balance sheet looks like.
As far as potential borrowers. There used to be a saying in the banking community that banks will not lend to anyone unless they don’t need to borrow any money.
My guess is that this will be the major lending rule that most financial institutions will follow in the near and intermediate future. On the upside, financial institutions stretch and stretch their lending standards to earn extra basis points returns so as to outdo their competition. On the downside, banks focus on the quality of credit because charge-offs dominate bank performance. In the past, banks have not moved into riskier borrowers until other banks have moved and it becomes necessary to compete in lesser credits in order to maintain a competitive position. Here the question becomes…who wants to move first?
My answer is that bankers feel very defensive about their behavior in the recent past…they will not want to be the leader in a new round of stupidity!
And, what of the Obama administration and the new plans for fiscal stimulus?
First of all there are rumors that any stimulus package proposed will not be enacted by January 20, 2009 let alone early in the spring. The Obama team has already responded to this by proposing, as a part of any stimulus program, a substantial package of tax cuts. The reasoning behind this is that it will draw bi-partisan support of the Republicans in Congress, something felt to be desirable to help achieve as much effectiveness for the economic program as possible.
An economic stimulus package, however, will not result in an immediate stimulation of bank lending. So, on top of when the economic program is passed…partially or in full…banks must still solve their own difficulties, as described above, before much real lending takes place.
Secondly, there is the international situation. The world economy is worse than anyone thought it was and is declining from there. The United States is part of this world economy…it cannot act independently of what is going on elsewhere in the world. Almost all of the nations of the world face similar situations and each faces the uncertainties mentioned above. But, how much is the rest of the world going to suffer from the continued decline in the United States economy and how much the United States is going to suffer from the decline in the rest of the world is unknown. The Obama administration must act more responsibly toward the rest of the world than did the administration that left office earlier this past fall.
And, we now have another uncertainty…the events in the Middle East present us with another unknown. War is uncertainty itself! What impact this will have on the rest of the world and how it will work itself out cannot be predicted with any degree of precision. But, it is in the mix now and must be taken into consideration is our potential scenarios for the year.
To summarize these comments: the economy will not begin to turn around until the banks are in a position to start lending again. My expectation for this turnaround is beyond the middle of 2009. And, this might be delayed even further if there is a rash of bank failures during the year. There are still too many uncertainties to be more definite and, as a consequence, the prediction for financial markets will still be…a downward drift…with lots and lots of volatility!
Wednesday, October 22, 2008
Accounting Losses Represent the Past...Layoffs Represent the Future
Accounting losses report on what has been done and the consequences of those actions. The announced layoffs, in the thousands, give us an indication of what is in store for us in the future. The announced layoffs mean that retail sales will continue to be soft…goodbye Christmas volume, hello special sales even before Thanksgiving…industrial production will continue to decline…will all cars in America be produced by foreign companies…and continued declines in housing prices and increases in foreclosures…the American dream is on hold. So the wealth of Americans will continue to decline which will mean…more layoffs.
Not only is Ben Bernanke speaking gloom and doom…Hank Paulson is also now on record for a long and difficult period of economic retrenchment. The amazing thing to me is how Paulson seems to carry out what ever seems to be on Bernanke’s mind.
Remember there was a time when Paulson was letting Lehman Brothers go, implying that the rescues were over. And, then Bernanke had a meltdown…called Paulson…who arranged a meeting with congressional leaders…a meeting in which Bernanke is reported to have scared the daylights out of all present. Since then, Paulson…the free-market Paulson…has been bailing out everyone he can…while Bernanke is flooding the world with billions and billions of dollars. We should have Carl Sagan reciting these numbers to the world!
The bottom line…the Bush administration will be remembered…not exactly fondly…for a long time. The team that wanted to get out-of-town before the roof fell in didn’t make it. January 20, 2009, now, seems such a long time away.
Most of the responses we are seeing to the financial and economic crisis seem to postpone real action so that the in-coming administration will have to make the hard decisions as to what the new world of finance and economics is going to look like. And, this seems to be across the board…Iraq, Guantanamo, education, justice, health, and so on and so on. The President has all but disappeared!
According to the Wall Street Journal the only person lobbying for a position in the new (Obama) administration is Ben Bernanke. Yesterday the Journal argued that Bernanke all but submitted his resume to the Democrats by coming out in favor of the new stimulus plan being offered by the Democrats in Congress which has been supported by Obama. (See “Bernanke Endorses Obama”, http://online.wsj.com/article/SB122455027730552509.html?mod=todays_us_opinion.) Everyone else wants out.
So, we are going to have a sustained period of economic stagnation or decline. Layoffs are going to increase for a while rather than decline. How bad the economic conditions are going to get is still anyone’s guess, but the extent of the financial dislocation certainly carries with it an ominous black cloud. And little is being done about it. It is the future we have yet to see.
The financial guys have thrown about everything they have at the problem because they do not want to be accused of not providing enough “stuff” to keep the financial markets going. Now, we move to the real economy…output, employment, and dislocation! This is raising the cries for a fiscal response.
Here is where the other side of the frivolous and undisciplined behavior of the Bush administration comes home to haunt all of us. Since it has been in office, the monetary authorities kept interest rates exceedingly low while at the same time ignoring the housing bubble. When things seemed to get a little tough, the Fed drastically lowered its target interest rate. In effect, it shot off almost all of its ammunition. Not having much else it could do, the Federal Reserve flooded the world with liquidity. The monetary authority expended its resources before the battle really began and has little more it can do except direct intervention in institutions…not markets…with newly printed money.
In terms of fiscal policy the irresponsibility of this administration was also present. The problem now is how to add additional stimulus upon an already mammoth budget deficit. No one really knows whether or not a new stimulus program will do anything toward reducing the severity of the economic decline. Again, it is a case that the ammunition was basically used up before it was really needed.
This is where the lack of discipline kills you. When you really need something, you find that what you need is not there and this leaves you with little you can do going forward. The “free market” tools that could have been used to speed about a recovery have been frittered away in easy living. Now, the only recourse is greater direct government intervention into the economy in an effort to prevent the worst.
One final note: one of the implicit assumptions connected with the free market model is that there is a moral structure in the society which underlies behavior and allows the free market to be free. This moral structure leads to people acting responsibly with respect to commitments and relationships.
What we have seen in the last seven and one-half years is an administration that has underwritten fiscal prodigality and monetary laxity, behavior that has been emulated throughout the economy. In effect, the administration has undermined the moral fabric of economic prudence. Now the administration is washing its hands of its waywardness and scurrying for the door. It is someone else’s problem.
And the layoffs will grow.
I believe that a lot of the uncertainty is over. The future is not going to be pleasant. The question is…how unpleasant will it get? Not only does the economy need to be rebuilt but the moral fiber of the markets need to be reconstituted.
Not only is Ben Bernanke speaking gloom and doom…Hank Paulson is also now on record for a long and difficult period of economic retrenchment. The amazing thing to me is how Paulson seems to carry out what ever seems to be on Bernanke’s mind.
Remember there was a time when Paulson was letting Lehman Brothers go, implying that the rescues were over. And, then Bernanke had a meltdown…called Paulson…who arranged a meeting with congressional leaders…a meeting in which Bernanke is reported to have scared the daylights out of all present. Since then, Paulson…the free-market Paulson…has been bailing out everyone he can…while Bernanke is flooding the world with billions and billions of dollars. We should have Carl Sagan reciting these numbers to the world!
The bottom line…the Bush administration will be remembered…not exactly fondly…for a long time. The team that wanted to get out-of-town before the roof fell in didn’t make it. January 20, 2009, now, seems such a long time away.
Most of the responses we are seeing to the financial and economic crisis seem to postpone real action so that the in-coming administration will have to make the hard decisions as to what the new world of finance and economics is going to look like. And, this seems to be across the board…Iraq, Guantanamo, education, justice, health, and so on and so on. The President has all but disappeared!
According to the Wall Street Journal the only person lobbying for a position in the new (Obama) administration is Ben Bernanke. Yesterday the Journal argued that Bernanke all but submitted his resume to the Democrats by coming out in favor of the new stimulus plan being offered by the Democrats in Congress which has been supported by Obama. (See “Bernanke Endorses Obama”, http://online.wsj.com/article/SB122455027730552509.html?mod=todays_us_opinion.) Everyone else wants out.
So, we are going to have a sustained period of economic stagnation or decline. Layoffs are going to increase for a while rather than decline. How bad the economic conditions are going to get is still anyone’s guess, but the extent of the financial dislocation certainly carries with it an ominous black cloud. And little is being done about it. It is the future we have yet to see.
The financial guys have thrown about everything they have at the problem because they do not want to be accused of not providing enough “stuff” to keep the financial markets going. Now, we move to the real economy…output, employment, and dislocation! This is raising the cries for a fiscal response.
Here is where the other side of the frivolous and undisciplined behavior of the Bush administration comes home to haunt all of us. Since it has been in office, the monetary authorities kept interest rates exceedingly low while at the same time ignoring the housing bubble. When things seemed to get a little tough, the Fed drastically lowered its target interest rate. In effect, it shot off almost all of its ammunition. Not having much else it could do, the Federal Reserve flooded the world with liquidity. The monetary authority expended its resources before the battle really began and has little more it can do except direct intervention in institutions…not markets…with newly printed money.
In terms of fiscal policy the irresponsibility of this administration was also present. The problem now is how to add additional stimulus upon an already mammoth budget deficit. No one really knows whether or not a new stimulus program will do anything toward reducing the severity of the economic decline. Again, it is a case that the ammunition was basically used up before it was really needed.
This is where the lack of discipline kills you. When you really need something, you find that what you need is not there and this leaves you with little you can do going forward. The “free market” tools that could have been used to speed about a recovery have been frittered away in easy living. Now, the only recourse is greater direct government intervention into the economy in an effort to prevent the worst.
One final note: one of the implicit assumptions connected with the free market model is that there is a moral structure in the society which underlies behavior and allows the free market to be free. This moral structure leads to people acting responsibly with respect to commitments and relationships.
What we have seen in the last seven and one-half years is an administration that has underwritten fiscal prodigality and monetary laxity, behavior that has been emulated throughout the economy. In effect, the administration has undermined the moral fabric of economic prudence. Now the administration is washing its hands of its waywardness and scurrying for the door. It is someone else’s problem.
And the layoffs will grow.
I believe that a lot of the uncertainty is over. The future is not going to be pleasant. The question is…how unpleasant will it get? Not only does the economy need to be rebuilt but the moral fiber of the markets need to be reconstituted.
Wednesday, October 8, 2008
A Liquidity Trap?
Is this what a liquidity trap looks like?
A liquidity trap gives one the feeling that the monetary authorities are pushing on a string. The amount of liquidity the Federal Reserve and other central banks around the world have provided for the financial markets has been huge. The Paulson Plan was supposed to create confidence that illiquid assets would now have some liquidity. The Fed Plan to purchase commercial paper was supposed to create confidence that illiquid assets would now have some liquidity.
Yet, the financial markets remain silent.
Seemingly, no one wants to commit because no one is sure about the solvency of other participants in the financial markets.
Bernanke spooked the financial markets again yesterday as he talked about a possible cut in interest targets…which he did follow through on. The speech was to the National Association for Business Economists at their 50th anniversary get-together in Washington, D. C.
The message the market heard, however, was how dire things were.
And, the market asked…what does Bernanke know that we don’t?
The absence of leadership seems to reach new heights daily. (See Mase: Economics and Finance for October 7, 2008.)
But, now we are apparently in a liquidity trap. Consumers are pulling back their spending…the latest figures out on consumer credit even show a decline. Businesses are consolidating and cutting spending and hiring plans. State and Local governments are going to the Federal Government to get cash to help them meet payrolls. And, then the Federal Government…
Get out your old copy of Keynes’ General Theory.
A liquidity trap gives one the feeling that the monetary authorities are pushing on a string. The amount of liquidity the Federal Reserve and other central banks around the world have provided for the financial markets has been huge. The Paulson Plan was supposed to create confidence that illiquid assets would now have some liquidity. The Fed Plan to purchase commercial paper was supposed to create confidence that illiquid assets would now have some liquidity.
Yet, the financial markets remain silent.
Seemingly, no one wants to commit because no one is sure about the solvency of other participants in the financial markets.
Bernanke spooked the financial markets again yesterday as he talked about a possible cut in interest targets…which he did follow through on. The speech was to the National Association for Business Economists at their 50th anniversary get-together in Washington, D. C.
The message the market heard, however, was how dire things were.
And, the market asked…what does Bernanke know that we don’t?
The absence of leadership seems to reach new heights daily. (See Mase: Economics and Finance for October 7, 2008.)
But, now we are apparently in a liquidity trap. Consumers are pulling back their spending…the latest figures out on consumer credit even show a decline. Businesses are consolidating and cutting spending and hiring plans. State and Local governments are going to the Federal Government to get cash to help them meet payrolls. And, then the Federal Government…
Get out your old copy of Keynes’ General Theory.
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