An ongoing snapshot of the national and world ecomony. Designed for the busy professional who requires more than soundbites and taglines, but does not have time to read it all.
Showing posts with label Federal Reserve System. Show all posts
Showing posts with label Federal Reserve System. Show all posts
Here is a great article from Slate written by Daniel Gross, a writer from Newsweek. Definitely worth a read.
A quick except:
"When you look at the financial markets as a whole, the post-crisis bailout efforts have worked out better than expected. Many of the financial market guarantees were lifted without having been used, and the Treasury is turning a profit on the central component of the TARP. But AIG has so far loomed as a gigantic rebuttal to the optimists, a symbol of everything that went wrong.
But it turns out that the efforts to prop up AIG are also working out much better than expected. AIG still owes the Fed and the Treasury a combined $127 billion. But—surprise!—AIG is paying a lot of its debts back. And there's a not too far-fetched scenario in which we come close to breaking on our reluctant investment in the company."
Siegel: Inflation is going to be under control this year and probably into 2011. However, we will have an upward tilt to inflation, which means the longer-run trends point to a 2%-to-4% range of inflation rather than zero to two, which unofficially is what most central banks and the Fed have targeted.
The scaremongers, who worry that the ton of money the Fed created to fight off the crisis is going to fuel the next [period of] inflation, are wrong.
Knowledge@Wharton: But the 2%-to-4% range is standard over the long run, right?
Siegel: It's not. I remember when I was studying economics, we talked about what a victory it would be if we could get down to between 2% and 4%. We've been spoiled with very low rates. Most central banks use zero to two. They come closer to two.
We'll move closer to between 2% and 4%, particularly in the United States, given the large deficits that we have and the liquidity that was created. But just as Bernanke acted very responsibly in providing the liquidity necessary to prevent [a repeat of] the Great Depression, he is also an excellent enough economist to know that money is what fuels inflation. The Fed is really solely responsible for inflation. He will not let it go above five, and probably not even four. He will raise interest rates to whatever level is necessary if inflation starts running into the mid-single digits or higher.
Knowledge@Wharton: When we talk about inflation, we also often talk about commodities. There has been a pretty good run in some commodities, especially gold. What do you see happening there?
Siegel: The commodities cycle has followed the world economy. It had hit its low very close to the same time the stock market did. Now that the world markets have recovered, we see oil has recovered. I would love to see it in the 70-to-80 range.
Commodities are fully priced. Gold ... is priced for an inflationary scenario that is much worse than will be realized. Gold is a risky investment now.... That is not going to be a good investment throughout 2010 and the longer term.
Confused? We all are. Read this to learn what Financial Derivatives are.
Severe valuation losses on the super senior multi-sector credit default swap portfolio of AIG Financial Products Corp. (AIGFP) triggered collateral provisions in the swap contracts, creating a liquidity crisis for AIG in September 2008. The Federal Reserve Bank of New York (FRBNY) provided an emergency $85 billion loan to AIG to meet short-term cash needs. The aid received by AIG helped avoid severe financial disruptions by providing liquidity to important financial institutions and municipalities.
Using funds from the emergency loan, financial counterparties listed on Attachment A (all attachments are posted online at http://www.aig.com/Related-Resources_385_136430.html ) received a total of $22.4 billion in collateral relating to CDS transactions from AIGFP between September 16, 2008 and December 31, 2008. This amount represents funds provided to such counterparties after the date on which AIG began receiving government assistance. The counterparties received additional collateral from AIG prior to September 16, 2008.
PIMCO - IO Feb 2009 Gross Beep Beep: "The simplicity of the solution, however, is not easily achieved once deflationary momentum takes hold. Animal spirits, once dampened, are hard to reignite; “fear of fear itself” dominates greed. Under such circumstances, the benevolent hand of government is required and Keynes is reincarnated in an attempt to plug the dike via fiscal spending and imaginative monetary policies that support asset prices. PIMCO has recently been contracted to assist in several publically announced programs which have helped in that effort: the CPFF, which has benefitted commercial paper yields, and the Federal Reserve’s purchase program for agency-backed mortgage loans, which has lowered 30-year mortgage rates to 4.5% and fostered the affordability of new and secondary housing prices. These two programs, in our opinion, have been the major policy successes to date – not because of our involvement – but because they have supported and increased asset prices whose decline has been the major deflationary thrust behind the real economy. Stop asset prices from going down and with a 12-month lag, unemployment will stop going up, and President Obama’s targeted three million new jobs will have a fighting chance of being achieved."
PIMCO - IO Feb 2009 Gross Beep Beep: "Example: CMBS or commercial real estate mortgage-backed securities are now priced to yield over 12% vs. 5% in recent years. As real estate financing comes due and rolls over in the next few years, it is imperative these yields return to mid-single digits if shopping centers, retail malls, and office buildings are to remain viable. How best to bring those yields down is debatable: another CPFF-like structure with self-insurance and contributed fees as its equity backstop? A generous portion of remaining TARP billions providing a reserve cushion for Federal Reserve funding? A good bank, bad (aggregator) bank structure? All three are being debated by policymakers and we should have clarity within a week’s time. But one thing is certain: an economic recovery is dependent upon commercial real estate prices stabilizing and most retail stores staying open for business in the months and years ahead."
Zero Hedge: How The World Almost Came To An End At 2PM On September 18: "On Thursday (Sept 18), at 11am the Federal Reserve noticed a tremendous draw-down of money market accounts in the U.S., to the tune of $550 billion was being drawn out in the matter of an hour or two. The Treasury opened up its window to help and pumped a $105 billion in the system and quickly realized that they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts and announce a guarantee of $250,000 per account so there wouldn't be further panic out there.
If they had not done that, their estimation is that by 2pm that afternoon, $5.5 trillion would have been drawn out of the money market system of the U.S., would have collapsed the entire economy of the U.S., and within 24 hours the world economy would have collapsed. It would have been the end of our economic system and our political system as we know it."
Allowing Lehman Brothers to collapse had such severe systemic effects that the global financial system went into cardiac arrest and is still dealing with the aftermath.
How do we set up a sytem to eliminate the risk of (another) global financial meltdown? In their FT.com article'A proposal to prevent wholesale financial failure', NYU Stern students Lasse Pedersen and Nouriel Roubini have devised a way to avoid the "worst financial crisis since the Great Depression."
Bail-outs of major financial institutions are based on a fear that their collapse would cause havoc, with collateral damage to the real economy. Examples include the Bear Stearns, Fannie, Freddie, AIG, and Citigroup.
The current system is "vulnerable to financial contagion when big banks (or many small ones) go bust. This is the systemic risk. The root of this problem is that "banks have little incentive to take into account the costs they impose on the wider economy" if their failure prompts a liquidity crisis.
"This is akin to when a company pollutes as part of its production without incurring the full costs of this pollution. To prevent this, pollution is regulated and taxed."
How do we reduce both the moral hazard and the cost of bail-outs in the event of a liquidity crisis? Impose a new systemic capital requirement and systemic insurance program. Once systemic risk can be measured, it can be managed.
Banks already use standard risk-management techniques internally to weigh how much each trading desk or division contributes to the overall risk of a bank. But the authors suggest that these same ideas should be used to evaluate the banks themselves. They set out their ideas in an NYU Stern project on restoring financial stability.
"First, the regulator would assess each bank’s systemic risk. The higher it is, the more capital the bank should hold. This would seek to ensure that the banking system as a whole had sufficient capital relative to the system-wide risk. This is just like the headquarters of a bank charging each trading desk or division for use of economic capital measured by its contribution to overall firm risk.
Second, each institution would be required to buy insurance against its systemic risk – that is, against its own losses in a scenario in which the whole financial sector is doing poorly. In the event of a pay-off on the insurance, the payment should not go to the company, but to the regulator in charge of stabilising the financial sector."
What happens then? A market-based estimate of the risk the develops (the amount of theinsurance premiums). Second, each bank would have an incentive to limit systemic risk (via lower insurance premiums). Finally, it would reduce the fiscal costs and the moral hazard of government bail-outs (because the company does not get the insurance pay-off).
Since the private sector may not be able to put aside enough capital for all the systemic risk insurance, government could provide part of it. Government already provides such partnership on insurance with the private sector in terrorism insurance.
"Unfortunately bank regulation, such as the Basel accord, ignores systemic risk since it analyses the risk of failure of each bank in isolation. It seeks to limit the probability of failure by each bank, treating isolated failures and systemic ones in the same way (and also ignoring how much a bank loses if it fails). However the move by many large banks to lever their balance sheets with similar mortgage-backed securities is more dangerous than if they had made loans to diverse borrowers."
More broadly, a systemic crisis that feeds on itself is more dangerous than the isolated failure of smaller banks. A small bank will probably be taken over with a smooth transition of operations – it does not bring down the economy.
"We believe our proposal offers several advantages by explicitly addressing systemic risk based on tools already in use by private companies to manage internal risks. Our proposal is a better way to deal with the trade-off between letting a large institution go bust (Lehman, for example) and causing a global cardiac arrest of the financial system or being forced to spend trillions of dollars of taxpayers’ money to bail out such systemically critical institutions."
The writers are professors at NYU Stern School of Business and the proposed regulation of systemic risk is part of the NYU Stern project Restoring Financial Stability: How to Repair a Failed System (John Wiley & Sons, 2009)
Image via WikipediaBarclays Capital lays out a primer for what the Fed is really doing for monetary policy. The Fed can't drop interest rates below 0%, but there are other weapons in the Fed arsenal. Barclays Capital in their most recent Weekly Market Monitor talks in depth about the current Fed policy called Quantitative Easing. (See Help! What is Quantitative Easing?)
"Without making a formal announcement, the Fed has already moved to a policy that is effectively QE. While its policy objective is still the fed funds rate, the Fed's balance sheet has more than doubled over the past three months to over $2 Trillion as it has expanded its emergency lending programs, foreign currency swap lines, and open market purchases. When the Fed began creating new lending facilities last year, it financed them by selling Treasuries, thereby keeping its balance sheet from expanding.
A few months ago, the Fed ran low on Treasuries it could sell and began to expand its balance sheet; however, it sought to soak up or sterilize this expansion through the use of a special Treasury bill program. The Treasury sold bills and deposited the proceeds in its account with the Fed, and the Fed used the proceeds to extend loans to banks based on illiquid collateral. While the Fed's balance sheet was being grossed up, the Treasury was soaking up cash through bill issuance and systemwide liquidity was unchanged.
The Treasury program is being wound down and the expansion of Fed programs is being financed through increases in excess bank reserves. In this case, the Fed is extending the same collateralized loans, generating excess reserves, and grossing up its balance sheet without sterilizing the transaction through the Treasury facility. Thus, the Fed is currently "printing money" and the over-provision of reserves to the banking system is far beyond what would be required to meet the FOMC's target funds rate."
According to the Barclays Capital Weekly Economic Monitor, there "is little immediate risk of deflation." The report goes on to say that although headline inflation will fall into negative territory (yr to yr) heading into fall 2009, this is primarily due to falling in energy prices. Once energy prices "find a bottom, inflation will naturally rise back to the level of core inflation. This is a case of a big fall in one relative price, not a broad-based deflation."
The report goes on to say that the real risk of deflation comes in 2010. If the unemployment rate does not come down quickly from the presumed 8% peak, core inflation will drop steadily and could pierce the lower end of the 1-2% Bernanke bands in 2010. This risk argues for continued very accommodative monetary policy for a long time to come. Presumably, the Fed will want to exit from its aggressive market interventions as quickly as the capital markets safely allow. These programs distort the capital markets, put tax dollars at risk, and should be phased out as soon as it is safe.
Image by imageining via FlickrBloomberg.com: Exclusive: Nov. 24 -- "The U.S. government is prepared to provide more than $7.76 trillion on behalf of American taxpayers after guaranteeing $306 billion of Citigroup Inc. debt yesterday. The pledges, amounting to half the value of everything produced in the nation last year, are intended to rescue the financial system after the credit markets seized up 15 months ago.
The unprecedented pledge of funds includes $3.18 trillion already tapped by financial institutions in the biggest response to an economic emergency since the New Deal of the 1930s, according to data compiled by Bloomberg. The commitment dwarfs the plan approved by lawmakers, the Treasury Department’s $700 billion Troubled Asset Relief Program. Federal Reserve lending last week was 1,900 times the weekly average for the three years before the crisis."
The important thing to note at this time is that the $700B TARP bailout is just the tip of the iceberg. Keep an eye on this story updates. The writers, Bloomberg's Mark Pittman and Bob Ivry, seem to have a good feel for these complex issues.
In an all-out assault on capitalism’s worst crisis since the Great Depression, the U.S. is taking on the role of both lender and borrower of last resort for the global economy.
The Federal Reserve, which has already pumped out hundreds of billions of dollars, might formally adopt a policy of flooding the world financial system with even more money. The Treasury, on course to borrow some $1.5 trillion this fiscal year, may tap global capital markets for even more to finance a fiscal stimulus package of as much as $700 billion and provide additional bailout money for banks.
“You want to do everything you can when you’re facing the threat of a deflationary breakdown of the economy,” says Michael Feroli, a former Fed official who is now an economist at JPMorgan Chase & Co. in New York."
Bloomberg.com: Economy: "Oct. 15 (Bloomberg) -- The Bank of Japan said it will offer lenders as many dollars as they want, joining European counterparts in attempting to lower borrowing costs in money markets and freeing up credit worldwide.
The central bank will provide dollars at fixed interest rates for an ``unlimited amount against pooled collateral,'' it said in a statement late yesterday. It also announced measures to improve companies' access to cash, expanded the range of Japanese government bonds it accepts from lenders, and suspended a program of selling shares it bought from banks between 2002 and 2004.
The Bank of Japan's supply of dollars comes from a swap agreement with the U.S. Federal Reserve. Last month the two central banks agreed to swap as much as $120 billion for yen. The increase to unlimited dollar supply came a day after the Fed removed caps on swap lines with the European Central Bank, Bank of England and Swiss National Bank."
``The headline in the local paper that everybody's going to read is, `Local Bank Seeks Government Assistance,''' Fine said in an interview. ``That doesn't look real good to the folks in the local towns.''"
Bloomberg.com: Economy: "The Fed said in a separate statement that its previously announced program to buy commercial paper will start on Oct. 27. Officials haven't indicated a limit for the total size of the fund."
Monday, October 13, 2008
Oct. 13 (Bloomberg) -- The world may be heading for its worst recession in a quarter of a century -- if it's lucky.
A steep slump looks likely as the credit squeeze crunches economies from the U.S. to Singapore and panic engulfs global financial markets.
``It's certainly going to be the worst since the 1980s,'' says Bradford DeLong, an economics professor at the University of California at Berkeley who worked at the U.S. Treasury Department from 1993 to 1995. ``The hope is that it won't become the worst unemployment business cycle since the Great Depression.''
The Reckoning - Taking Hard New Look at a Greenspan Legacy - Series - NYTimes.com: "George Soros, the prominent financier, avoids using the financial contracts known as derivatives “because we don’t really understand how they work.” Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential “hydrogen bombs.”
And Warren E. Buffett presciently observed five years ago that derivatives were “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”
One prominent financial figure, however, has long thought otherwise. And his views held the greatest sway in debates about the regulation and use of derivatives — exotic contracts that promised to protect investors from losses, thereby stimulating riskier practices that led to the financial crisis. For more than a decade, the former Federal Reserve Chairman Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street. “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,” Mr. Greenspan told the Senate Banking Committee in 2003.
“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.” — Alan Greenspan in 2004
Dividend Stocks - The Dividend Daily » Blog Archive » The Bailout Precedent was Set in 1998, but That’s Not the Point: "It has become abundantly clear that no one learned a single thing from the collapse of Long-Term Capital Management. Every single entity involved in our current crisis should be absolutely ashamed of themselves, from the Fed that insisted on a record number of consecutive interest rate cuts, to the mortgage lenders who forgot the most basic rule of lending, to the investment banks that used huge leverage with derivatives schemes to game a clearly inflated housing market, to the insurers like AIG who backed the mortgage products that weren’t worth the paper they were printed on.
The precedent of government intervention had already been set, but the most egregious part of this situation is that no one learned their lesson afterward."
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