A provocative Wall Street Journal OpEd by Donald Luskin and Lorcan Kelly gives me hope for Europe.
No, I'm not talking about Greece, and the latest bailout deal. That's more of the usual charade. But in the end Greece is small. Europe can bail Greece out if they feel like it; or let it default.Or let it rot, which seems where they are headed.
Italy and Spain are where the real issue lies. Italy and Spain are too big to bail.
Growth is the only hope for paying back large government debts. "Growth" to an economist means long-run growth, growth that lasts decades. Even the most hard-bitten Keynesian, if honest, has to admit that "stimulus" does not produce long-run "growth." Growth comes from more people or more productivity. Period. Italy and Spain can only grow if they free up their markets, clean up their tax systems, put themselves quite a few notches higher on the list of good places to do business.
Growth is also essential for solving the more immediate debt problems. Italy and Spain need to roll over debts. Markets can be quick to do that, and even lend more, if they see countries have good long-run growth prospects. Markets will stay away as long as they do not see a coherent plan for long-term growth. ("Growth" is distinct from "austerity." "Austerity" means high and distorting taxes, spending cuts but no liberalization of the economy. This quickly runs the economy into a death spiral as people and money leave.)
I had long thought that like the Greeks -- or, increasingly, like the Americans -- Italy, Spain and the rest of Europe (Belgium? France?) simply did not have the will to free their economies. If so, Europe seemed to me destined for a huge bout of inflation. The ECB is basically buying up the debt (via the banks); if the debt can't be bailed out, defaulted on, or repaid, it must end up with inflation.
But, as Luskin and Kelly point out, I may have for once been too Grumpy. Mario Monti, Italy's prime minister, is on a rampage of liberalization. They quote him, growth "will have to come from structural reforms or supply-side measures." Spain's prime minister Mariano Rajoy is headed in the same direction. Monti and Rajoy recognize that companies will only hire people if they can later fire them; that barriers to entry for all the professions ("from pharmacy and baking to taxi-driving") just drag down the economy, that state industries don't provide "jobs," but instead suck the lifeblood out of growth.
Will they get there? Will they reestablish growth soon enough to get the bond markets to roll over debt, or pay back the ECB before it needs to unwind its purchases to avoid inflation? It will be dicey. There is a lot of entrenched opposition to liberalization -- which is why obviously good ideas have such a hard time being implemented for decades. But, as my mayor once said, a crisis is a terrible thing to waste. Maybe Monti and Rajoy can achieve the needed "grand bargains."
What is remarkable -- what gives me hope -- is that they are even talking about "supply side" growth measures and liberalization at all!
The Conventional Wisdom makes no connection between stifling labor market regulations and a debt crisis. The debt crisis is about "confidence" and "contagion," to be met with bailout funds, "firewalls," financial engineering, and ECB debt schemes.
For example, in her most recent speech, IMF Director Christiane Lagarde recommends that "stronger growth" come first of all from "additional and timely monetary easing." Then, "raising [bank] capital levels" (Note the usual passive policy voice -- who does this raising and how? Translation: taxpayers give money to banks.) Then, "maintaining orderly funding conditions" whatever that means. (Watch your wallet.)
She warns that " On fiscal policy, resorting to.. budgetary cuts will only add to recessionary pressures...those with fiscal space should support the common effort by reconsidering the pace of adjustment planned for this year." Translation: Economies with stratospheric debt/GDP ratios need just a little more fiscal stimulus. As St. Augustine lamented, Lord give me frugality, but not quite yet.
The bond market? She wants a "larger firewall.... Adding substantial real resources..folding the EFSF into the ESM, increasing the size of the ESM,.." Then, "Action by the ECB to provide the necessary liquidity support to stabilize bank funding and sovereign debt markets would also be essential." Translation: ECB to buy debt with printed Euros.
Eventually, yes, "some countries still have much to do to boost their competitiveness and growth potential." Some? What, most of Europe is right on its "growth potential? And finally, at the very end, "..structural reforms are critical, however medium or long-term their impact might be. ... fiscal sustainability depends, ultimately, on generating long-term growth." Four or five years down the line, maybe, meekly approach Italy's unions and government-run industries with a request for "structural reforms." Sure, that's going to work.
I don't mean to pick on Lagarde. Her speech is just a good example of global bien-pensant policy Conventional Wisdom. I'm sure everyone murmurs this sort of thing at Davos. Grumpy's favorite columnist, Paul Krugman is, believe it or not, arguing for more spending and stimulus across Europe. I'm not exactly clear how he wants Italy, Spain, Portugal or Greece to borrow more money to spend it. Budget constraints are never the forte of Keynesian economics. He seems to saying that multipliers are so large that spending is self-financing: "Because spending cuts have deeply depressed their economies, undermining their tax bases to such an extent that the ratio of debt to G.D.P." It's either that or the Easter bunny: I don't see bond markets ponying up more stimulus. But "growth," tackling absurd regulations, unions, labor market rigidity denying employment to a generation of Italians and Spaniards... that' s not even on his agenda.
In this noxious intellectual environment, it is remarkable and praiseworthy that Monti and Rajoy are putting "supply side growth" on the front burner at all; that they make a connection between a debt crisis and sclerotic microeconomics. This is a Reagan / Thatcher moment, when courageous politicians may seize the moment of crisis to jump to the long run; let their economies grow and pay off a mountain of debt, ignoring the Conventional Wisdom. It could happen. Or not, but at least there finally is hope.
In bocca al lupo ("good luck" in Italian -- and, literally, "into the mouth of the wolf," an unusually apt expression) Signor Monti!
Wednesday, February 22, 2012
Are We There Yet ? Part 2
The ever so slow trend change is yet to be confirmed. The Advance Decline line is sitting just above the 13 DMA.
After that it seems to have lost its MOJO and like the cardiogram of a dying patient, it is losing momentum. Sooner rather than later, gravity will pull it down. Its counterpart, USD has surprisingly come back to life.
From FXCM: "The dollar breached key resistance at the confluence of the 100-day moving average, former channel resistance dating back to January 13th, and the 50% Fibonacci extension taken from the August 1st and October 27th troughs at 9850. The index encountered resistance at the 50-day moving average at 9884 before closing just lower at 9880. Note that the daily relative strength index broke above former RSI support dating back to the October 27th low suggesting further dollar advances may be in the cards in the days to come."
AUD is on a sell signal and a comparison of SPX vs AUD shows that SPX has some catching up to do:
After a long time today all the three indexes were in various shades of red, none severe.
DeMark set-up gave a Trap Sell confirmation on SPX today. It is not one of the strongest of signals but taken with everything else, it does increase the chances of a correction. In the absence of any other trigger let us look at the FX today.
After the Greek drama, there is nothing much left for EURO to move higher. From a low of 1.2975, it spiked to 1.3291 on the news that Europe has been fixed.
AUD is on a sell signal and a comparison of SPX vs AUD shows that SPX has some catching up to do:
But if AUD cannot break down 1.06 level, then we may see it run above 1.0840 and SPX runs higher along with it.
While all these points to further downside in the short term, LTRO-2 will commence by end of the month and more liquidity will be pumped in. So unless we see some big drop in the next four trading days, we can kiss the correction goodbye for another two weeks.
Thank you for visiting http://bbfinance.blogspot.com/ and following me in Twitter.(@BBFinanceblog).
Taylor on Lehman and TARP
John Taylor took the trouble to respond to Paul Krugman's latest outrage on the sources of the financial crisis. Taylor's post -- along with the deeper analysis he points to -- is well worth reading.
Krugman's calumnies are so nonsensical I generally do not find it worth responding.
The idea that I now like stimulus is simply preposterous if you bother to read what I write about it. (Here, here and here.) The idea that I or John Taylor don't think there was a run is even more preposterous. (One of many examples here, p. 7: "Why was there such a large fall in output? For once in macroeconomics we actually have a good idea what the shock was—there was a ‘‘run’’ in the shadow banking system.")
To top it off, Krugman writes "Anyone else have the impression that something happened in the second half of September 2008?" I mean really, accusing Taylor and myself of thinking that nothing happened in September 2008? Are Krugman's readers such simpletons that they fall for such unvarnished falsehoods?
Taylor did us a service by taking the time to straighten this one out.
Yes there was a run.
Taylor's detailed work shows what many of us sensed: That the run was not triggered by Lehman's bankruptcy. Instead a good part of the run can be laid at the feet of Treasury Secretary Paulson, who showed up on national TV asking for 700 billion dollars, with three sheets of paper in front of him, no clear explanation of what he wanted to do with the money, and with a hastily-imposed short-sale ban on bank stocks. How to Cause A Run 101.
More importantly, Taylor's work also puts to rest Krugman's idea (last sentence) that Lehman caused or threatened a chain of bankruptcies. Ed Lazear puts it nicely: it wasn't dominoes, it was popcorn.
That's what a run is. When a piece of news comes out that banks may be in trouble, people pull their money out of all the banks at the same time. Krugman is being simply incoherent in first calling it a run and then a threatened chain of bankruptcies only saved by further bailouts.
In fact, the run is central to my view of the crisis and its lessons. I doubt Krugman has thought through the implications carefully, along with the distinction between dominoes and popcorn, as they run directly counter to his worldview.
Runs don't have a single cause, they have a straw that broke the camel's back. Ask yourself, would simply bailing out Lehman have avoided this whole mess? Obviously not. People saw Lehman go under -- and Paulson's speech, plus short-sale ban, plus everything else going on at the time -- and asked themselves, "gee, my bank was investing in the same things Lehman was. I wonder how they're doing? I'd better pull my money out just to be safe." ("People" here means institutional investors in the shadow-banking system, i.e. prime-brokerage customers, repo investors, derivatives counterparties, asset-backed security investors.)
In the circumstances of Fall 2008, suppose that the government had announced a big Lehman bailout, especially along with Paulson's speech. Well, you come to just about the same worries about your own bank, as if Lehman had not been rescued, don't you? If they had to rescue Lehman, they must have been in real trouble. I wonder if my bank is in similar trouble?
Actually it would have been worse. such a bailout would have also come with a howl of protest, and it was clear that the bailouts would have to end somewhere, and the next one would be bigger. AIG? Citigroup? Hmm, let's take our money out extra special fast as a big blowup is coming this way.
The insight that it was a run is central to my view of how to fix things. If it was a run, echoing, as Krugman says, Friedman and Schwartz's view of the Great Depression, then some of Friedman and Schwartz's conclusions are surely warranted! No, this was not some mysterious failure of capitalism and we need to have the Fed run everything under Dodd-Frank. No, this does not require that we save every big institution and protect them from competition and failure forever. This was one run very like the many runs and panics we've seen throughout history.
Our run was in the shadow-banking system. I recommend Darrel Duffie's "Failure mechanics of dealer banks," the article and the book Once you read these, you naturally see simple ways in which we can fix bankruptcy law and run-prone assets in place of Dodd-Frank. How, exactly? That's a subject for another post -- actually a long series -- coming up.
Yes it was a run. And that fact leads directly to some very un-Krugmanlike conclusions.
(If you want to read what I actually have written so far about this issue it's all here. I'm teaching a class this week on financial crisis -- we're going to spend a lot of time on Duffie and Gary Gorton's analysis of the run in repo markets.)
Krugman's calumnies are so nonsensical I generally do not find it worth responding.
The idea that I now like stimulus is simply preposterous if you bother to read what I write about it. (Here, here and here.) The idea that I or John Taylor don't think there was a run is even more preposterous. (One of many examples here, p. 7: "Why was there such a large fall in output? For once in macroeconomics we actually have a good idea what the shock was—there was a ‘‘run’’ in the shadow banking system.")
To top it off, Krugman writes "Anyone else have the impression that something happened in the second half of September 2008?" I mean really, accusing Taylor and myself of thinking that nothing happened in September 2008? Are Krugman's readers such simpletons that they fall for such unvarnished falsehoods?
Taylor did us a service by taking the time to straighten this one out.
Yes there was a run.
Taylor's detailed work shows what many of us sensed: That the run was not triggered by Lehman's bankruptcy. Instead a good part of the run can be laid at the feet of Treasury Secretary Paulson, who showed up on national TV asking for 700 billion dollars, with three sheets of paper in front of him, no clear explanation of what he wanted to do with the money, and with a hastily-imposed short-sale ban on bank stocks. How to Cause A Run 101.
More importantly, Taylor's work also puts to rest Krugman's idea (last sentence) that Lehman caused or threatened a chain of bankruptcies. Ed Lazear puts it nicely: it wasn't dominoes, it was popcorn.
That's what a run is. When a piece of news comes out that banks may be in trouble, people pull their money out of all the banks at the same time. Krugman is being simply incoherent in first calling it a run and then a threatened chain of bankruptcies only saved by further bailouts.
In fact, the run is central to my view of the crisis and its lessons. I doubt Krugman has thought through the implications carefully, along with the distinction between dominoes and popcorn, as they run directly counter to his worldview.
Runs don't have a single cause, they have a straw that broke the camel's back. Ask yourself, would simply bailing out Lehman have avoided this whole mess? Obviously not. People saw Lehman go under -- and Paulson's speech, plus short-sale ban, plus everything else going on at the time -- and asked themselves, "gee, my bank was investing in the same things Lehman was. I wonder how they're doing? I'd better pull my money out just to be safe." ("People" here means institutional investors in the shadow-banking system, i.e. prime-brokerage customers, repo investors, derivatives counterparties, asset-backed security investors.)
In the circumstances of Fall 2008, suppose that the government had announced a big Lehman bailout, especially along with Paulson's speech. Well, you come to just about the same worries about your own bank, as if Lehman had not been rescued, don't you? If they had to rescue Lehman, they must have been in real trouble. I wonder if my bank is in similar trouble?
Actually it would have been worse. such a bailout would have also come with a howl of protest, and it was clear that the bailouts would have to end somewhere, and the next one would be bigger. AIG? Citigroup? Hmm, let's take our money out extra special fast as a big blowup is coming this way.
The insight that it was a run is central to my view of how to fix things. If it was a run, echoing, as Krugman says, Friedman and Schwartz's view of the Great Depression, then some of Friedman and Schwartz's conclusions are surely warranted! No, this was not some mysterious failure of capitalism and we need to have the Fed run everything under Dodd-Frank. No, this does not require that we save every big institution and protect them from competition and failure forever. This was one run very like the many runs and panics we've seen throughout history.
Our run was in the shadow-banking system. I recommend Darrel Duffie's "Failure mechanics of dealer banks," the article and the book Once you read these, you naturally see simple ways in which we can fix bankruptcy law and run-prone assets in place of Dodd-Frank. How, exactly? That's a subject for another post -- actually a long series -- coming up.
Yes it was a run. And that fact leads directly to some very un-Krugmanlike conclusions.
(If you want to read what I actually have written so far about this issue it's all here. I'm teaching a class this week on financial crisis -- we're going to spend a lot of time on Duffie and Gary Gorton's analysis of the run in repo markets.)
"The Rich are Bulletproof"
So spoke Meredith Whitney, bank analyst of some note this morning on CNBC. As Ms. Whitney described our current economic plight, she marched through one set of new regulations after another that are roadblocks set up to thwart the economic future of middle and lower income Americans, while noting that the rich are unaffected by all of the new Obama Regulatory regime.
Dodd-Frank and the Consumer Protection Agency are open assaults on the American middle class. It has now become much, much harder to get any kind of credit -- be it a mortgage, a home equity loan, a credit card, a pay day loan, whatever. The nanny state has decided that middle and low income Americans should take their business to the loan shark community. We've seen all of this before.
In the name of protecting middle and low income Americans, the Obama Administration has put middle America into an economic straight-jacket. Credit is the life blood of any economy, but by declaring war on those who issue credit to middle America, the Obama Administration is laying waste to the hopes and dreams of the average American.
It is a mistake to blame lenders when folks get in debt over their heads. Let people do whatever they want. People will learn. By declaring war on those who provide credit, American policy is making sure that people who need credit won't be able to get it when they need it.
This is one of the many terrible consequences of our new over-regulated economy.
Dodd-Frank and the Consumer Protection Agency are open assaults on the American middle class. It has now become much, much harder to get any kind of credit -- be it a mortgage, a home equity loan, a credit card, a pay day loan, whatever. The nanny state has decided that middle and low income Americans should take their business to the loan shark community. We've seen all of this before.
In the name of protecting middle and low income Americans, the Obama Administration has put middle America into an economic straight-jacket. Credit is the life blood of any economy, but by declaring war on those who issue credit to middle America, the Obama Administration is laying waste to the hopes and dreams of the average American.
It is a mistake to blame lenders when folks get in debt over their heads. Let people do whatever they want. People will learn. By declaring war on those who provide credit, American policy is making sure that people who need credit won't be able to get it when they need it.
This is one of the many terrible consequences of our new over-regulated economy.
Tuesday, February 21, 2012
Are we there yet?
We had lots of comments from the readers regarding the debt ceiling and thereafter. It seems that it will be one of those "buy the rumour, sell the news" type of things. Nobody believes that Greece has been saved and everyone is just buying time. I do not think the other EZ countries will pay even one cent. The editorial in "The Guardian," UK, says it all: http://www.guardian.co.uk/commentisfree/2012/feb/21/eurozone-greece-deal-debt-editorial
If anyone was hoping for a run-off rally after Europe had been fixed, they were surely disappointed. Question now is, are we done with this rally? Let us be very clear about the rally. This is not a fundamental driven rally. This is all about liquidity pumped by ECB and the FED in the form of LTRO. The 2nd phase of LTRO does not start till the end of February and the FED will be selling lots of bonds here in USA. This will drain out some of the excess liquidity and may cause the expected pull back in the stock markets.
In terms of market internals, breadth is becoming weak. Various summation indexes measure the market indexes and all things being equal, when the summation indexes turn down, that increases the odds of market correction. Let us look at NYSI first:
Parabolic Sar is giving a sell signal as well.
Let us look at BPSPX or SP 500 bullish percentage index, which is another breadth indicator.
As you can see on the weekly chart, it is as high as you can imagine and way over bought. Normally there is not much scope of further advance in prices from this level and more often than not, this level signify correction.
Of course there are many divergences and in the normal course of things we would have a correction long time back. But this is not a normal market.
However, we have to wait for the change of trend and my simple measure of change of trend is the AD line. Till AD line does not convincingly break through the 13 DMA, I would not consider it a valid trend change.
I would be very worried to front run even with all technical indicators screaming trend change because external forces like the FED or ECB can and do distort the market big time.
For the sake of information, you might be interested in the latest from Tom Demark:
http://www.bloomberg.com/video/86842200/
Thank you for reading http://bbfinance.blogspot.com/. Join me in Twitter (@BBFinanceblog ) and share it with your friends.
If anyone was hoping for a run-off rally after Europe had been fixed, they were surely disappointed. Question now is, are we done with this rally? Let us be very clear about the rally. This is not a fundamental driven rally. This is all about liquidity pumped by ECB and the FED in the form of LTRO. The 2nd phase of LTRO does not start till the end of February and the FED will be selling lots of bonds here in USA. This will drain out some of the excess liquidity and may cause the expected pull back in the stock markets.
In terms of market internals, breadth is becoming weak. Various summation indexes measure the market indexes and all things being equal, when the summation indexes turn down, that increases the odds of market correction. Let us look at NYSI first:
Let us look at BPSPX or SP 500 bullish percentage index, which is another breadth indicator.
Of course there are many divergences and in the normal course of things we would have a correction long time back. But this is not a normal market.
However, we have to wait for the change of trend and my simple measure of change of trend is the AD line. Till AD line does not convincingly break through the 13 DMA, I would not consider it a valid trend change.
For the sake of information, you might be interested in the latest from Tom Demark:
http://www.bloomberg.com/video/86842200/
Thank you for reading http://bbfinance.blogspot.com/. Join me in Twitter (@BBFinanceblog ) and share it with your friends.
A Silly Deal
The Greek bailout announced overnight is ridiculous and will not avert plunging the Greek economy into chaos. It will only be a matter of a few months until this deal will create political conditions in Greece that will shake up the Eurozone. There is simply no way the Greek citizenry will abide this deal.
Meanwhile Merkel and Sarcozy will take a victory lap for nothing. Note that on the bailing side is the IMF, of which the biggest single donor is the US taxpayer. So, Obama has stepped the US into this quicksand and dragged the US taxpayer in with him.
No one wins with this outcome. But, it will look like a win to the politicians ... for a while.
The only apparent winners are the French and German banks. But, their victory is only temporary until this deal unravels as it smacks up against reality.
Meanwhile Merkel and Sarcozy will take a victory lap for nothing. Note that on the bailing side is the IMF, of which the biggest single donor is the US taxpayer. So, Obama has stepped the US into this quicksand and dragged the US taxpayer in with him.
No one wins with this outcome. But, it will look like a win to the politicians ... for a while.
The only apparent winners are the French and German banks. But, their victory is only temporary until this deal unravels as it smacks up against reality.
Sunday, February 19, 2012
Fed Independence 2025
Headline: The Fed just forced mortgage servicers that got caught submitting "documents that were not properly notarized," among other sins, to cough up money towards principal reduction, for people unaffected by the notarization scandal, as well as to fund "nonprofit housing counseling organizations" and other policy objectives.
Deeper question: What will the Fed look like in 2025? How long can it stay independent as it takes on more and more power, and uses that power for these kinds of political policy actions?
Act 1: Three recent news items add up to a scary picture.
Item 1: Led by the White House, the state Attorneys General announced their "settlement" with banks.
Here's what happened. Suzie, Bob, and Joe each bought $300,000 houses, that are now worth $200,000. Suzie stopped paying, and was foreclosed. Bob borrowed $280,000, so he's "underwater," but he likes his house, doesn't want to ruin his credit, and is still paying his mortgage. Joe only borrowed $200,000 and is also still paying.
The banks got caught robo-signing Suzie's paper work. The Administration and Attorneys General (with the laudable exception of Oklahoma) used the threat of prosecution to get the banks to lower Bob's principal by $20,000. Suzie might get a small check. Joe gets nothing.
There is a story for doing this. Bob might decide to stop paying his mortgage, forcing the bank to foreclose. The foreclosure might lower the value of his neighbor's property.
There are also costs. This money comes from somewhere -- the mortgage investors, the bank equity holders, or eventually the taxpayers. Maybe they had better things to do with $20,000. Maybe banks and investors, seeing their contracts torn up ex-post by the government, are going to be a whole lot more careful about who they lend to in the future. We live in a time of 3.5% mortgages that nobody can seem to get. To say nothing of the blatant unfairness, and moral hazard, of giving Bob this little present for taking out a huge loan, or the larger moral hazard of using the threat of prosecution for procedural errors to force anyone to cough up money towards unrelated policy goals.
As you can guess, I think it's a rotten idea. The Fed's own White Paper on Housing puts the ineffectiveness of the policy and its costs better than I can, citing the relevant research. Look at the top of p. 21.
But that's not important here. Even if you think it was a great idea, you have to admit it is a controversial policy, one on which there is likely a strong partisan divide. You also have to admit that the Administration threatened the banks with prosecutions to force them to finance a policy goal having nothing to do with the actual legal case.
Ok, that's the kind of tough hardball that the executive branch plays. Which is why, in our society, they have to face the voters.
Item 2: The Federal Reserve thinks foreclosures and underwater mortgages are a big problem too, and has been cheering the Administration's various mortgage-modification programs. See Governor Elizabeth Duke's Speech on September 1, or Ben Bernanke speech on February 10, titled "Rebalancing the Housing Market" -- a new job for the Fed -- or the Fed's extensive White Paper on Housing. (Actually, reading this stuff, the Fed seems much more keen on "government-facilitated rent-to-own programs," but that's an intervention for another day.)
Item 3: In case you missed it, the Federal Reserve is taking on regulation of financial institutions at a very detailed level. I reviewed its massive plan to regulate large banks in an earlier oped and blog post The Fed just announced its plans to actually go forward and "designate" non-banks as "systemically important" and subject to its mercies as well. Together with the new "Consumer Financial Protection" bureau, located in the Fed, the Fed can and will tell large banks what to do at an amazingly detailed level.
Let's put two and two together. How long will it be until the Fed starts acting like the Administration. "Nice bank you have there. Wouldn't want anything to happen to it. Those consumer financial protection nerds can be a real pain in the butt, can't they? To say nothing of those wonks down in the systemic risk department. Say, we notice you're still sitting on a lot of reserves, and nobody's lending to support the housing market in Detroit. Sure would be nice if you pitched in and helped a bit. And why aren't you writing down mortgages instead of foreclosing on all those houses?"
I don't mean to ascribe any bad motives here. The people I know at the Fed are all well-meaning and really smart. The problem is the power. If you really believe that "the market is not functioning as it should." (Elizabeth Duke, Sept 1), i.e. that the housing markets are impeding recovery, and that banks could do a lot about it; if your institutional mandate includes micromanaging the state of the economy by watching individual markets, and detailed regulation of bank's activities, the outcome is inevitable: You will soon be using your regulatory power to force the banks to accomplish policy goals.
Act 2: It's already happening
As I was writing this, I thought I was writing one of my usual doom-and-gloom worries about the far-off future. Browsing the Fed's website, it turns out it's already happening. For the Fed is a party to the Administration's deal, and is using its banking supervision powers to force mortgage reductions.
The Fed announced its actions in a February 9 press release
1) The Fed is using its banking supervision powers, to call the robosigning scandals "unsafe and unsound" banking practices.
2) The Fed is acting in conjunction with the Administration -- so much for independence and standing outside of politics.
3) The Fed is forcing the banks to write down mortgages and provide other "assistance," policy goals unrelated to the actual "unsound processes and practices."
The details, in the followup Feburary 13 press release are even more astonishing. Reading from the Ally Financial settlement,
1) Ally is to provide "relief" to borrowers, not victims of the lack of notarization.
2) They're doing it to avoid the threat of huge legal bills.
3) Legally, the Fed can't tell Ally to write people checks. So, the Fed is going to levy a $207 million penalty because Ally's lack of notarization is an "unsafe and unsound" practice. Then the Fed will "reduce the penalty" by exactly the amount that Ally spends on "borrower assistance."
4) It's not just writedowns, but all the hilarious stuff in the last paragraph -- "funding for nonprofit housing counseling organizations!" Stuff that the Administration wouldn't dare put in a budget it sent to Congress.
It's a bit puzzling that the Fed signed on to this agreement, actually. As above, the White Paper on Housing and Fed official's speeches are pretty negative on mortgage writedowns. One sniffs a lot of pressure coming form the White House.
Which is the danger, for the Fed, of getting involved in these policies at all: Who knows what great ideas the Santorum Administration will have for the Fed to "support manufacturing," or the Romney Administration will have for its idiotic "day 1" currency war with China? Now we know what the Fed is, it is only a matter of the price. It would be have been far better for the Fed to say, "as the price of our independence, we're not allowed to do things like this."
Act 3: Independence
The Fed is set up to be politically independent, and central bank independence is a cherished principle of monetary economists.
Academics typically think the Fed's main job is to control short-term interest rates: too high and we get unemployment, too low and we get inflation. Fed "independence" helps it to make this decision without too much political interference. Such interference might skew the decision to temporary stimulus at the expense of long-term inflation.
Before the financial crisis, thinking around the world was moving towards the idea that the central bank's job is really just to control inflation. Efforts to micromanage the economy were largely seen as illusory. This view was embodied in the ECB's mandate and many "inflation-targeting" regimes. The whole banking supervision part of the Fed was a separate backwater, unrelated to the Fed's macroeconomic policy roles.
That all seems so quaint now. The Fed is now the Gargantuan Financial Regulator, as well as Controller and Stimulator of the Macroeconomy. Its macroeconomic role is increasingly the Supporter of Particular Markets and the Allocator of Credit. It's also getting in to the business of running whole markets, i.e. the details of how mortgages are written and serviced. And it's loudly cheering for particular Administration policies such as mortgage modifications. Monetary policy is way down the list.
The price of independence is limited power. Central banks that only try to control inflation, and only using one tool, such as purchases and sales of Treasury debt, can be walled off from the political process. As a country, we can decide that the price level will not be used for political purposes and assign its maintenance to technocrats.
The Fed was assigned great power after the financial crisis. It's more competent than most of the other agencies, and as a result of its historic independence can act with great power. But this situation cannot last. The Federal Reserve cannot command that one group of voters cough up $20,000 checks to another group of voters, and not expect those voters to want a say in the matter. Locating financial regulation in the Fed may turn out to have been a terrible idea.
What to do? Good question. My preferred answer would be to save the independence, competence, and a-political nature of the Federal Reserve. That means breaking up its functions. Focus monetary policy on the price level, and stop pretending to micromanage activity. In any case, separate monetary policy from financial regulation -- break the institution up so that financial regulation tools cannot be used to promote macroeconomic policy goals, except by direct political intervention, by politically accountable officials.
The alternative is to bring the whole of the Federal Reserve's activities under much more direct control and accountability to elected officials. I have no more faith in the wisdom of elected officials than the next person, so I foresee a politicized Fed will be disastrous. But our society is not built on faith in the wisdom of an unaccountable aristocracy with huge power and no supervision. That will be even more disastrous. That's where the Fed is going, and it cannot last.
Deeper question: What will the Fed look like in 2025? How long can it stay independent as it takes on more and more power, and uses that power for these kinds of political policy actions?
Act 1: Three recent news items add up to a scary picture.
Item 1: Led by the White House, the state Attorneys General announced their "settlement" with banks.
Here's what happened. Suzie, Bob, and Joe each bought $300,000 houses, that are now worth $200,000. Suzie stopped paying, and was foreclosed. Bob borrowed $280,000, so he's "underwater," but he likes his house, doesn't want to ruin his credit, and is still paying his mortgage. Joe only borrowed $200,000 and is also still paying.
The banks got caught robo-signing Suzie's paper work. The Administration and Attorneys General (with the laudable exception of Oklahoma) used the threat of prosecution to get the banks to lower Bob's principal by $20,000. Suzie might get a small check. Joe gets nothing.
There is a story for doing this. Bob might decide to stop paying his mortgage, forcing the bank to foreclose. The foreclosure might lower the value of his neighbor's property.
There are also costs. This money comes from somewhere -- the mortgage investors, the bank equity holders, or eventually the taxpayers. Maybe they had better things to do with $20,000. Maybe banks and investors, seeing their contracts torn up ex-post by the government, are going to be a whole lot more careful about who they lend to in the future. We live in a time of 3.5% mortgages that nobody can seem to get. To say nothing of the blatant unfairness, and moral hazard, of giving Bob this little present for taking out a huge loan, or the larger moral hazard of using the threat of prosecution for procedural errors to force anyone to cough up money towards unrelated policy goals.
As you can guess, I think it's a rotten idea. The Fed's own White Paper on Housing puts the ineffectiveness of the policy and its costs better than I can, citing the relevant research. Look at the top of p. 21.
But that's not important here. Even if you think it was a great idea, you have to admit it is a controversial policy, one on which there is likely a strong partisan divide. You also have to admit that the Administration threatened the banks with prosecutions to force them to finance a policy goal having nothing to do with the actual legal case.
Ok, that's the kind of tough hardball that the executive branch plays. Which is why, in our society, they have to face the voters.
Item 2: The Federal Reserve thinks foreclosures and underwater mortgages are a big problem too, and has been cheering the Administration's various mortgage-modification programs. See Governor Elizabeth Duke's Speech on September 1, or Ben Bernanke speech on February 10, titled "Rebalancing the Housing Market" -- a new job for the Fed -- or the Fed's extensive White Paper on Housing. (Actually, reading this stuff, the Fed seems much more keen on "government-facilitated rent-to-own programs," but that's an intervention for another day.)
Item 3: In case you missed it, the Federal Reserve is taking on regulation of financial institutions at a very detailed level. I reviewed its massive plan to regulate large banks in an earlier oped and blog post The Fed just announced its plans to actually go forward and "designate" non-banks as "systemically important" and subject to its mercies as well. Together with the new "Consumer Financial Protection" bureau, located in the Fed, the Fed can and will tell large banks what to do at an amazingly detailed level.
Let's put two and two together. How long will it be until the Fed starts acting like the Administration. "Nice bank you have there. Wouldn't want anything to happen to it. Those consumer financial protection nerds can be a real pain in the butt, can't they? To say nothing of those wonks down in the systemic risk department. Say, we notice you're still sitting on a lot of reserves, and nobody's lending to support the housing market in Detroit. Sure would be nice if you pitched in and helped a bit. And why aren't you writing down mortgages instead of foreclosing on all those houses?"
I don't mean to ascribe any bad motives here. The people I know at the Fed are all well-meaning and really smart. The problem is the power. If you really believe that "the market is not functioning as it should." (Elizabeth Duke, Sept 1), i.e. that the housing markets are impeding recovery, and that banks could do a lot about it; if your institutional mandate includes micromanaging the state of the economy by watching individual markets, and detailed regulation of bank's activities, the outcome is inevitable: You will soon be using your regulatory power to force the banks to accomplish policy goals.
Act 2: It's already happening
As I was writing this, I thought I was writing one of my usual doom-and-gloom worries about the far-off future. Browsing the Fed's website, it turns out it's already happening. For the Fed is a party to the Administration's deal, and is using its banking supervision powers to force mortgage reductions.
The Fed announced its actions in a February 9 press release
The Federal Reserve Board ...has reached an agreement in principle with five banking organizations regarding the issuance of monetary sanctions against the organizations totaling $766.5 million. The monetary sanctions would be assessed for unsafe and unsound processes and practices in residential mortgage loans servicing and foreclosure processing.It's right there in print:
... the Board is acting in conjunction with a comprehensive settlement agreed in principle between the five banking organizations, the state Attorneys General, and the Department of Justice on February 9, 2012 ("Settlement Agreement"). The Settlement Agreement requires these organizations to provide $25 billion in payments and other designated types of monetary assistance and remediation to residential mortgage borrowers.
1) The Fed is using its banking supervision powers, to call the robosigning scandals "unsafe and unsound" banking practices.
2) The Fed is acting in conjunction with the Administration -- so much for independence and standing outside of politics.
3) The Fed is forcing the banks to write down mortgages and provide other "assistance," policy goals unrelated to the actual "unsound processes and practices."
The details, in the followup Feburary 13 press release are even more astonishing. Reading from the Ally Financial settlement,
WHEREAS, the Mortgage Servicing Companies [Ally Financial Subsidiaries], ... allegedly:Heavens, what a scandal...Documents not properly notarized! Notice it does not even "allege" that anyone was actually kicked out of a house who was paying their mortgage.
(a) Filed or caused to be filed...numerous affidavits.. making various assertions, such as the ownership of the mortgage note and mortgage, the amount of principal and interest due, and the fees and expenses chargeable to the borrower, in which the affiant represented that the assertions in the affidavit were made based on personal knowledge or based on a review by the affiant of the relevant books and records, when, in many cases, they were not based on such knowledge or review;
(b) Filed or caused to be filed in courts... numerous affidavits and other mortgage-related documents that were not properly notarized,..
(c) Litigated foreclosure and bankruptcy proceedings... without always confirming that documentation of ownership was in order at the appropriate time, including confirming that the promissory note and mortgage document were properly endorsed or assigned and, if necessary, in the possession of the appropriate party...
WHEREAS, as part of the Settlement Agreement the Ally Parties agreed to provide consumer relief, which may include mortgage principal reductions or refinancing, and other assistance to certain residential mortgage borrowers (the “Borrower Assistance”)Again, right there in print:
NOW, THEREFORE, ..and solely for the purpose of settling this matter without a formal proceeding being filed and without the necessity for protracted or extended hearings or testimony, it is hereby ORDERED by the Board of Governors,... that:
1. Ally Financial, ResCap, and the Mortgage Servicing Companies are hereby jointly and severally assessed a CMP [civil monetary penalty] in the amount of $207,000,000...
2. ...the Board of Governors shall remit up to $207,000,000 of the CMP by an amount equivalent to the aggregate dollar value of the Borrower Assistance provided....
3. .. the Board of Governors shall also remit up to $207,000,000 of the CMP... by an amount equivalent to the aggregate amount funds expended by Ally Financial, ResCap, and the Mortgage Servicing Companies on funding for nonprofit housing counseling organizations, approved by the U.S. Department of Housing and Urban Development, to provide counseling to borrowers who are at risk of or are in default or foreclosure, or to provide assistance to borrowers in connection with the independent foreclosure reviews required by the Consent Order...
1) Ally is to provide "relief" to borrowers, not victims of the lack of notarization.
2) They're doing it to avoid the threat of huge legal bills.
3) Legally, the Fed can't tell Ally to write people checks. So, the Fed is going to levy a $207 million penalty because Ally's lack of notarization is an "unsafe and unsound" practice. Then the Fed will "reduce the penalty" by exactly the amount that Ally spends on "borrower assistance."
4) It's not just writedowns, but all the hilarious stuff in the last paragraph -- "funding for nonprofit housing counseling organizations!" Stuff that the Administration wouldn't dare put in a budget it sent to Congress.
It's a bit puzzling that the Fed signed on to this agreement, actually. As above, the White Paper on Housing and Fed official's speeches are pretty negative on mortgage writedowns. One sniffs a lot of pressure coming form the White House.
Which is the danger, for the Fed, of getting involved in these policies at all: Who knows what great ideas the Santorum Administration will have for the Fed to "support manufacturing," or the Romney Administration will have for its idiotic "day 1" currency war with China? Now we know what the Fed is, it is only a matter of the price. It would be have been far better for the Fed to say, "as the price of our independence, we're not allowed to do things like this."
Act 3: Independence
The Fed is set up to be politically independent, and central bank independence is a cherished principle of monetary economists.
Academics typically think the Fed's main job is to control short-term interest rates: too high and we get unemployment, too low and we get inflation. Fed "independence" helps it to make this decision without too much political interference. Such interference might skew the decision to temporary stimulus at the expense of long-term inflation.
Before the financial crisis, thinking around the world was moving towards the idea that the central bank's job is really just to control inflation. Efforts to micromanage the economy were largely seen as illusory. This view was embodied in the ECB's mandate and many "inflation-targeting" regimes. The whole banking supervision part of the Fed was a separate backwater, unrelated to the Fed's macroeconomic policy roles.
That all seems so quaint now. The Fed is now the Gargantuan Financial Regulator, as well as Controller and Stimulator of the Macroeconomy. Its macroeconomic role is increasingly the Supporter of Particular Markets and the Allocator of Credit. It's also getting in to the business of running whole markets, i.e. the details of how mortgages are written and serviced. And it's loudly cheering for particular Administration policies such as mortgage modifications. Monetary policy is way down the list.
The price of independence is limited power. Central banks that only try to control inflation, and only using one tool, such as purchases and sales of Treasury debt, can be walled off from the political process. As a country, we can decide that the price level will not be used for political purposes and assign its maintenance to technocrats.
The Fed was assigned great power after the financial crisis. It's more competent than most of the other agencies, and as a result of its historic independence can act with great power. But this situation cannot last. The Federal Reserve cannot command that one group of voters cough up $20,000 checks to another group of voters, and not expect those voters to want a say in the matter. Locating financial regulation in the Fed may turn out to have been a terrible idea.
What to do? Good question. My preferred answer would be to save the independence, competence, and a-political nature of the Federal Reserve. That means breaking up its functions. Focus monetary policy on the price level, and stop pretending to micromanage activity. In any case, separate monetary policy from financial regulation -- break the institution up so that financial regulation tools cannot be used to promote macroeconomic policy goals, except by direct political intervention, by politically accountable officials.
The alternative is to bring the whole of the Federal Reserve's activities under much more direct control and accountability to elected officials. I have no more faith in the wisdom of elected officials than the next person, so I foresee a politicized Fed will be disastrous. But our society is not built on faith in the wisdom of an unaccountable aristocracy with huge power and no supervision. That will be even more disastrous. That's where the Fed is going, and it cannot last.
Subscribe to:
Posts (Atom)