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March 31, 2008
Back to the blog
With no major meltdowns in the financial markets in the last couple weeks, I have been trying to catch up on other things. Trying.
But here are a couple of things that caught my attention lately.
Tim Schilling writes a nice essay on the economic way of thinking about Romeo and Juliet. This post is just about Act I. Looking forward to the rest.
Professors who teach principles of micro... bookmark these articles for the next time you do supply and demand. Both the NY Times and WSJ describe how farmers will be planting less corn and more soybeans this year. Cost increases and relative price changes are the reasons given. The exam questions practically write themselves.
Sticking with the agricultural theme, this article on the lack of convergence in futures and spot prices is beyond the principles level. Give it to your grad students.
Give this one to your students who are going on the market soon. The FDIC is hiring. No need to guess why.
David Tufte links to this interview with Ed Begley Jr. At about the same time that this came out, Begley visited WIU and gave the same message.
It's a busy week ahead. The final push to the end of the semester is about to begin.
Posted by William Polley at 01:50 PM | Comments (0) | TrackBack
March 19, 2008
Useful information if you use Gmail
How to make a local backup of your Gmail
Posted by William Polley at 09:02 PM | Comments (0) | TrackBack
Belly up to the bar: Investment banks are using the new facility
From Reuters:
Goldman Sachs plans to test the program sometime this week, a spokesman said. Morgan Stanley Chief Financial Officer Colm Kelleher said his bank has already tested the program, and a spokeswoman for Lehman said the investment bank has also done so.
The Wall Street Journal reports that there still might be some stigma attached to borrowing from the Fed, but that the banks "viewed the new funding source positively".
Posted by William Polley at 01:26 PM | Comments (0) | TrackBack
Funny they didn't mention anything about tightening credit markets
The Real Time Economics Blog collected some reactions from Wall Street concerning the rate cut. One firm chose to emphasize their concerns about inflation.
These actions were taken despite rising inflation pressures. The Fed expects these pressures will subside as energy and other commodity prices flatten out, and as unused resources rise. Our take, however, is that commodity price strength is in part a function of the easy stance of monetary policy and that inflation is headed higher. –Bear Stearns
Contrast this with what they said in December, also from the pages of the Real Time Economics Blog:
The Fed continues to couch its policy actions in terms of their impact on economic growth rather than admit that the primary motivation for Fed action is the turmoil in the financing market — turmoil which may become worse as a result of the miserly action on the discount rate. –Bear Stearns
I guess it's all a matter of your perspective at the time.
Posted by William Polley at 03:08 AM | Comments (0) | TrackBack
Arthur C. Clarke, visionary and author 1917-2008
From the NY Times:
Arthur C. Clarke, a writer whose seamless blend of scientific expertise and poetic imagination helped usher in the space age, died early Wednesday in Colombo, Sri Lanka, where he had lived since 1956. He was 90.
...
Among his legacies are Clarke’s Three Laws, provocative observations on science, science fiction and society that were published in his “Profiles of the Future” (1962):
¶“When a distinguished but elderly scientist states that something is possible, he is almost certainly right. When he states that something is impossible, he is very probably wrong.”
¶“The only way of discovering the limits of the possible is to venture a little way past them into the impossible.”
¶“Any sufficiently advanced technology is indistinguishable from magic.”
The last of those I have heard quoted a lot. And did you know that geosynchronous orbits are called Clarke orbits? He dreamed of things that some thought impossible, and some of those dreams have come true.
Posted by William Polley at 12:55 AM | Comments (2) | TrackBack
March 18, 2008
Quote of the day
From Felix Salmon:
I'm similarly skeptical about the idea that the Fed is "propping up" Bear Stearns. For a couple of months until it can be deleveraged and subsumed into JP Morgan, perhaps. But that's a world away from allowing banks to operate for years while marking distressed assets on their balance sheets at par, which is what happened in Japan. The Fed was happy leaving the carcass of Bear Stearns to the wolves at 270 Park: this was anything but a "propping up" operation.
Posted by William Polley at 05:23 PM | Comments (0) | TrackBack
FOMC cuts by 75 basis points
Here's the statement.
The Federal Open Market Committee decided today to lower its target for the federal funds rate 75 basis points to 2-1/4 percent.
Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.
Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.
Today’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred less aggressive action at this meeting.
In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 2-1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, and San Francisco.
I wonder what Fisher and Plosser would have preferred. 50? 25? 0? Maybe the minutes will tell us in a few weeks.
Parse it word by word if you want. Given the way that the last few days have gone, I'm not sure how much good it will do.
Judging by the way that Wall Street jumped in the first few minutes after, I would say that it was a little more than necessary. They could have gotten by with 50.
Anyway... got to run to class.
Posted by William Polley at 01:27 PM | Comments (0) | TrackBack
March 17, 2008
FOMC meeting tomorrow
Anyone care to hazard a guess as to what they will do tomorrow?
The Cleveland Fed shows the above graph with the probabilities based on the fed funds futures. 75 basis points is the leader right now with 50, 100, and 125 (!) basis points all getting votes. The futures market is predicting a 50% probability of 1.5% by the next meeting. Clearly there are two likely ways that could happen--either 75 bp twice or 100 tomorrow and 50 next month. I'm not saying it can't happen.
But let's look at this coldly and rationally as we always do. What in the world would a 100 bp cut do to help the liquidity crisis (and the solvency crisis) that was at the root of this weekend's troubles? Nada. The announcement of the new lending facility did much more to steady everyone's nerves than a full percentage point cut ever will. Let's see if that works before spending more interest rate ammunition. How about 75 bp? Again, I'm hard pressed to say it will help the ways that are necessary. The market expects it, and as much as I'd like to say that the Fed should have the guts to disappoint the market, I'm sensitive to the counterargument. This is a likely outcome.
How about 50? It's less likely, but more desirable in my view. It wouldn't drastically undercut the market. This was the expected outcome for all but the last couple days. It would probably contain the fall of the dollar (somewhat) and signal that the Fed expects a more stable environment going forward. I would applaud this choice.
How about 25? A bit risky from the Fed's point of view, I think. It would undercut the market more than is necessary on this given day. I'm sympathetic to the hawks, but given the totality of the situation, 50 is probably the better choice.
Going to be a fun day of class tomorrow! Until then...
Posted by William Polley at 08:45 PM | Comments (0) | TrackBack
Some thoughts on the day after: Bring back Glass-Stegall?
I couldn't resist watching a little CNBC tonight. Kudlow was talking about how the Fed should have opened the discount window up to investment banks sooner. After all, Glass-Stegall was repealed in 1999. Since then, the role of investment banks in the financial system has expanded, and they have become intertwined with commercial banks (i.e. depository institutions). But all this time, houses like Bear Stearns have been working without a net. They've been unable to tap the discount window.
So the Kudlows of the world would like to have seen the Fed open the discount window to investment banks sooner. That way, maybe they could have survived this crisis. Hmm... maybe... maybe not. It might have prolonged the agony and the result would have looked more like Continental Illinois which although it came to a head in a day, took weeks for the FDIC to finally take the assets. All the while, they had access to the window and to a number of other banks (who were presumably willing to lend to CI because it had access to the window) to help them liquidate. In terms of restoring confidence to the system, it was probably better this way. Here's the deal. Take it or leave it. They had no choice but to take it.
If it turns out that there is another Bear Stearns out there waiting to happen, you can bet that it will unfold differently now that investment banks have access to the discount window. Should this change be made permanent? Should investment banks have access to the discount window at all times?
That's a tougher question. First, look at the way the Fed's announcement actually reads. They aren't lending directly to the investment banks... they are going through the primary dealers. (It happens that Bear Stearns was a primary dealer so in that case it would have been direct, but it would not necessarily be so in every case.)
First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets.... Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities.
The fact of the matter is that now that this is out there it will be tough to put the genie back in the bottle. It's definitely a good idea in times of crisis. It is probably also a good thing to have on the books so that you don't get caught off-guard in the future. I would only amend it so that the credit is available at a penalty rate. Read Bagehot for the reason why.
Is it necessary to open the window directly to investment banks who are not primary dealers? No, and probably not a good idea either--except as already provided under statute in exigent circumstances. Let's see how this works, and if it works, just keep it on the books as it was announced yesterday.
Now let's look at the other end of the spectrum. For each person like Kudlow who would want to open the discount window to investment banks directly, there is probably a person who would want to reinstate Glass-Stegall and put the wall of separation between investment banks and commercial banks back up again.
But I don't see that as being the problem.
Glass-Stegall was meant to keep the commercial banks from engaging in speculative investment activities that would put customer deposits at risk. That's not what happened here, nor is it likely to be a big issue. The problem is that investment banks dependent on short term repos for daily financing are now as critical (if not more critical) for the stability of the system than the commercial banks of old. They also seem to be as prone (if not more prone) to the kinds of lapses in judgment that led to what we saw this weekend. But walling them off, even if it were realistic to do so now, would not make them go away, get smaller, or suddenly get better judgment.
So how do you get them to behave? Act as their lender of last resort? Lots of moral hazard, not enough moral authority. But perhaps by allowing their peers (here I am referring to the primary dealers) to be their lender (or buyer) of last resort you enforce a kind of market discipline that the Fed alone would have trouble enforcing. Was Bear Stearns a sacrificial lamb on this altar, as many are suggesting? Perhaps. And although I cannot do anything other than speculate as to whether that was the intent, it certainly was the way it worked out. It's too late to do anything about that now, and perhaps it was too late even last week. We'll never know.
But now that a mechanism is in place, I would simply prefer that next time it be done by lending to them at a penalty rate instead of buying at a discount.
Posted by William Polley at 07:29 PM | Comments (0) | TrackBack
Welcome new readers
Welcome to listeners of Ed Morrissey's show on BlogTalkRadio. I had the honor of visiting with Ed on the air today about the Fed and Bear Stearns. Thanks for dropping by.
Posted by William Polley at 03:20 PM | Comments (0) | TrackBack
A little ironic that this deal was inked today
On this day when the perils of largely unregulated markets are all to clear comes news of a merger that will in all likelihood mean better diversification of risk in a regulated market. CME Signs Deal for Nymex (Wall Street Journal)
Posted by William Polley at 01:06 PM | Comments (2) | TrackBack
If you read one article today...
...about the Fed's role in the buyout of Bear Stearns by JPMorgan, let it be this article by Greg Ip in the Wall Street Journal. An excerpt:
In some ways, the initiatives better equip the Fed to help a financial system that has changed drastically from one based on banks for most of its 95-year existence. It took a unanimous vote by the Fed's five governors yesterday to invoke a Depression-era clause in the Federal Reserve Act to waive the usual prohibition on Fed loans to nonbanks. A Fed official told reporters today's circumstances couldn't have been envisioned when the Fed was created, and noted newer central banks like Europe's have many of these powers. But these steps also take the central bank into uncharted territory with new and potentially troublesome risks.
Those risks include the possibility that with the credit crunch showing no sign of lifting, the Fed will be called on to lend to other troubled firms and end up a major creditor of Wall Street, even if at present the risk of any substantial loss appears small. Another risk is that while the Fed used a loophole yesterday in the Federal Reserve Act to expand its lending to nonbanks in "unusual and exigent" circumstances, it has in effect expanded the federal safety net with no political debate. However, the Fed sought and received agreement over the $30 billion loan from Treasury Secretary Henry Paulson, who informed President Bush.
Also check out the Real Time Economics Blog.
Posted by William Polley at 12:12 PM | Comments (0) | TrackBack
Link roundup
Some assorted links that didn't make their way into my previous three posts on tonight's events.
Felix Salmon is optimistic about the effect of the sale of Bear Stearns on the financial markets.
John Jansen has some comments and links on the overnight happenings.
The WSJ Real Time Economics Blog has an absolutely excellent post. Choice quotes:
Fed officials went out of their way to say Bear Stearns was unique in the problems it faced. No other major securities firms are in a similar situation, an official said.
and...
So how much has the financial system changed? Consider securities repo, an essential grease that enables dealers to make markets in a wide variety of credit instruments. In 1990, securities repo credit, at $372 billion was about 13% the size of federally insured bank deposits, at $2.8 trillion.
By last year, securities repo credit had ballooned to $2.6 trillion, 60% of the value of federally insured deposits at $4.3 trillion.
Gross repo among the primary dealers alone (that is, excluding banks but including loans among dealers) was $4.5 trillion on March 5, according to the New York Fed.
How secure is that funding base? Well, consider that two-thirds of repo loans mature or must be rolled over each day. And there is no government guarantee behind them (although Treasurys often collateralize them.) No wonder the Fed worried about a run on the repo market if Bear failed.
They also link to this article from 1992 by Anna Schwartz on "The Misuse of the Fed's Discount Window." That brought back memories for me. The article was required reading in my Money and Banking class back in college.
Calculated Risk links to CBOT Dow Futures. Look out below.
I could paraphrase Paul Krugman thusly: You ain't seen nothin' yet.
Reuters reports that Bear Stearns executives won't be getting any golden parachutes. Good.
Tim Duy expects a big fed funds move (75 or 100 basis points) on Tuesday and worries about a destabilizing fall of the dollar. He uses the word "monetization." Let's hope it doesn't come to that. Check back with me on Tuesday.
Posted by William Polley at 02:59 AM | Comments (0) | TrackBack
March 16, 2008
Whatever happens in the morning, we'll still be writing about this twenty years from now
This is part three in a series of posts relating to this weekend's sale of Bear Stearns to JPMorgan and the Fed's role in the matter. (First post, second post)
The previous post highlighted a few of the reasons that some will be cynical about what happened tonight. The cynics make some relevant points. Moral hazard is a concern. Some will say that the Fed's role in backing JPMorgan is troubling. Similar points were made during the LTCM debacle. And yes, there might be other episodes like this. All true, and yet....
When I take my students up to Chicago to tour places like the Chicago Fed and the Board of Trade, I make sure to give them a little history lesson. At the corner of Jackson and LaSalle stands a reminder of another financial crisis with particular relevance to today--the old Continental Illinois building. Bank of America now occupies the space, but the name remains carved in stone as a mute testimony to what once was. The name faces out over LaSalle St. directly across from the main entrance to the Chicago Fed building. I have often thought, as I enter the Fed building, that having that name as a constant presence across the street must give anyone who works at the bank a sense of purpose. The Fed's very existence (and that of other regulators) is meant to prevent such bank failures and when prevention fails, to cushion the greater economy from the effects.
To be sure, there are some similarities as well as many striking differences between the Bear Stearns situation and that of Continental Illinois over twenty years ago. Continental Illinois was a commercial bank. Deposits were at risk. In that way, it was quite different from the situation we see today.
Despite these differences, one similarity between Continental Illinois and Bear Stearns is that they will both go down in the history books as a milestone in the Fed's evolution as a lender of last resort. For a great recounting of the Continental Illinois collapse, check out this document on the FDIC website: "History of the Eighties--Lessons for the Future." In particular, look at chapter 7, which details how the events unfolded and what was learned. This passage from page 249 is the appropriate text for today.
As has been noted, however, [Too Big To Fail] was an inaccurate term: too big to liquidate would have been more appropriate. Large banks did fail during the period, with shareholders losing their investments and managements being removed. In significant ways, Continental failed. But as one regulator observed, the banking agencies were reluctant to tolerate the sudden and uncontrolled failure of large institutions and therefore generally opt[ed] for managed shrinkage, merger, or recapitalization. There were several reasons for adopting such an attitude, the most important of which was systemic risk. This rubric covered potential spillover effects leading to widespread depositor runs, impairment of public confidence in the broader financial system, or serious disruptions in domestic and international payment and settlement systems. In addition to systemic risk, the logistical difficulties and potential expense of liquidating a large bank also contributed to regulatory reluctance to close such a bank and pay off insured depositors. Moreover, liquidation would mean tying up uninsured depositors funds during the lengthy proceedings, a situation that could have a very disruptive effect on a banks community. For all these reasons combined, the larger the bank, the more likely it was that bank regulators would look for alternatives to closing the bank and paying off the insured depositors.
Except for the part about depositors, it could have been written about this weekend. Indeed, Bear Stearns failed. But it proved too big to liquidate without assistance. Continental Illinois essentially did go into receivership. The FDIC guaranteed everything, even beyond the $100,000/deposit limit. The Fed provided the backstop liquidity. It was not without controversy. And it took months to come to a head, and months to finally work out.
How things have changed. When this story first broke, the NY Times reported:
The developments may only postpone the eventual sale of all or part of Bear Stearns, which has had crippling losses on mortgage-linked investments. To keep the 85-year-old firm solvent, JPMorgan, backed by the New York Fed, extended a secured line of credit that gives Bear Stearns at least 28 days to shore up its finances or, more likely, to find a buyer.
One day, folks. One day and the deal was done. Would the markets have gone into a tailspin if it didn't get done that fast? Hard to say. What is not hard to say is that no one wanted to take that chance. You know that everyone involved at the Fed knows that they are doing something that will be scrutinized and criticized. They know about the moral hazard problem. They know that this could have negative consequences. They know that there is only one reason to do it--and that is that the consequences of not doing it are potentially much worse. Mr. Bernanke, scholar of the Great Depression, knows that better than most.
By pulling out all the stops the way that he has, Mr. Bernanke is probably already the most innovative Fed chair in history. I'm sure he would rather not have that distinction, but there are worse ways to distinguish oneself. And so in the final analysis (at least for tonight) I have to applaud Mr. Bernanke and the Fed for taking the steps to allow for an orderly liquidation of a failed institution--a very different thing from a bailout (Ritholtz agrees). JPMorgan can probably liquidate the assets more efficiently than the government could in a short amount of time. With the way that financial markets are connected and positions are so heavily leveraged they could not afford to shop Bear Stearns around the way that they did Continental Illinois. If we are to believe what we're hearing, the wheels were about to come off. The "repo" market moves too quickly and is less forgiving than a depositor in a commercial bank. Undoubtedly banks and other institutions had loaned Bear Stearns large amounts in the repo market and if they didn't get paid, well, that would indeed be the sort of thing that causes the whole market to seize up very suddenly, perhaps catastrophically. Not a slow motion deposit-driven meltdown.
Kind of makes Continental Illinois look like a minor hiccup in comparison. And yet here we are twenty-some years later talking about that event--its aftermath coloring our perception of today's events.
The Fed was presented with a tough choice and probably made a good call. And while some of the critics objections are reasoned (Buiter), some just don't get it. Today's public flogging of the MSM is outsourced to Brad DeLong.
As Buce of Underbelly puts it, Gretchen Morgenson fails to understand the distinction between preserving the lines of business that are the enterprise and rescuing the holders of the equity in the firm:
Rescue Me: A Fed Bailout Crosses a Line: WHAT are the consequences of a world in which regulators rescue even the financial institutions whose recklessness and greed helped create the titanic credit mess we are in? Will the consequences be an even weaker currency, rampant inflation, a continuation of the slow bleed that we have witnessed at banks and brokerage firms for the past year?
Or all of the above?
Stick around, because we'll soon find out. And it's not going to be pretty.
Agreeing to guarantee a 28-day credit line to Bear Stearns, by way of JPMorgan Chase, the Federal Reserve Bank of New York conceded last Friday that no sizable firm with a book of mortgage securities or loans out to mortgage issuers could be allowed to fail right now.... But why save Bear Stearns? The beneficiary of this bailout, remember, has often operated in the gray areas of Wall Street and with an aggressive, brass-knuckles approach.... Let's not forget that Bear Stearns lost billions for its clients last summer, when two hedge funds investing heavily in mortgage securities collapsed. And the firm tried to dump toxic mortgage securities it held in its own vaults onto the public last summer in an initial public offering of a financial company called Everquest Financial. Thankfully, that deal never got done.... And so, Bear Stearns, a firm that some say is this decade's version of Drexel Burnham Lambert, the anything-goes, 1980s junk-bond shop dominated by Michael Milken, is rescued. Almost two decades ago, Drexel was left to die...
It does not seem that she gets it.
I have to agree with DeLong. This is far a desirable outcome, but the consequences of inaction were worse. I admit to being uncomfortable with the Fed as a backstop and I worry about the precedent this sets. Tell me who is comfortable with it? It should make one very uncomfortable, and I'm sure that a lot of folks at the Fed are not sleeping well tonight. But sometimes you need to make the uncomfortable choice.
And so now we'll just have to wait and see how much the new lending facility gets used.
I didn't even get to talking about the discount rate. In light of everything else going on, it's a minor part of the story, and the fact that they lowered it is maybe a little bit of overkill. If someone can explain why an extra quarter point today as opposed to Tuesday is going to help the liquidity issues, I'm all ears.
Posted by William Polley at 11:10 PM | Comments (0) | TrackBack
How tonight's Fed announcement paves the way for more emergency financing of investment banks
This post continues the discussion from here. The immediate question is, of course, whether the Fed's facilitation of JPMorgan's rescue of Bear Stearns was a good idea. Here is a "no" vote from Willem Buiter (via Felix Salmon)
The Federal Reserve Act (1913) allows the Federal Reserve to lend, in a crisis, to just about any institution, organisation or individual, and against any collateral the Fed deems fit. Specifically, if the Board of Governors of the Federal Reserve System determines that there are “unusual and exigent circumstances” and at least five (out of seven) governors vote to authorize lending under Section 13(3) of the Federal Reserve Act, the Federal Reserve can discount for individuals, partnerships and corporations (IPCs) “notes, drafts and bills of exchange indorsed or otherwise secured to the satisfaction of the Federal Reserve bank…”.
The combination of the restriction of “unusual and exigent circumstances” and the further restriction that the Federal Reserve can discount only to IPCs “unable to secure adequate credit accommodations from other banking institutions”, fits the description of a credit crunch/liquidity crisis like a glove. So why hasn’t the Fed declared “unusual and exigent circumstances” yet, so non-deposit-taking financial and other institutions in need of liquidity and blessed with eligible collateral can go directly to the discount window? When in doubt, leave the middleman out.
...
Since Bear Stearns is not a deposit-taking institution, and appears to be of no other systemic significance, there is no need for a special resolution regime of the kind managed by the FDIC for troubled deposit-taking institutions. The firm could have been left to go into receivership.
If the Fed fears the risk of contagion effects and financial panic, it could have requested the nationalisation of the investment bank. This should have been done at a zero price. The existing shareholders could, if the US government were feeling generous, be granted the privilige of claim on whatever value is left after all other creditors have been paid off.
But the shareholders of Bear Stearns are eating their cake and having it. Shares may have dropped 43 percent in value, but what is left still beats nothing. And nothing seems the only possible fair value for what Bear Stearns would be worth without Fed assistance. Why was Bear Stearns not taken into public ownership, preferably at a zero price?
One would hope that, as soon as the rescue was announced, the existing management and board of Bear Stearns would have resigned en-masse, and without any golden handshakes of the CEO of Citigroup and Merrill Lynch -variety. This should have been a condition of the loan being made. The argument that only the existing management understands the business well enough to see it through the storm is unconvincing, as these are the very people that screwed it up in the first place. Why are the old top management and board members still in their jobs?
Another key issue concerns the terms on which Bear Stearns now borrows. I have always considered the Fed’s decision to lower the spread between the discount rate and the Federal Funds target rate to be a mistake - an inframarginal subsidy to those lucky enough to have access to the facility. Now we see why. If Bear Stearns can borrow at 50 bps over the 28-day OIS rate, or anything in that ballpark, it would be scandal.
Good points. And the first of those points (unusual and exigent circumstances) is what tonight's announcement by the Fed addresses--in a new and innovative way. From the press release,
First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York.
So there it is. A new lending facility which appears to be inspired by the spirit of the "unusual and exigent circumstances" clause to which Buiter refers. But as path-breaking as this is, it is not quite as drastic as if the Fed had invoked that phrase and opened the door even wider. It is limited to primary dealers, which are listed here. These are the institutions that the New York Fed works with on a daily basis in the conduct of open market operations. One could argue that the Fed already uses them as a conduit for routine monetary policy, so they are the natural choice for facilitating these emergency actions.
If they are simply acting as a conduit for loans, that would be odd--sort of a regulatory quirk reflecting a holdover of the post-Depression wall that has now fallen between deposit institutions and investment institutions. It's a patch rather than a permanent fix while we try to figure out how to keep this from happening again and how to address it more effectively if it does. Not what I would suggest if I were designing the system de novo, but an understandable thing to do in the heat of battle.
But if it leads to the primary dealers swallowing up troubled institutions, then it does raise some issues of the sort that Buiter outlines in the second part of the quote. Why not take Bear Stearns (and whoever may be next in line) into public receivership directly?
Such questions are all the more relevant tonight as news comes of the sale of Bear Stearns to JPMorgan for $2 a share.
Reflecting Bear Stearns’s dire straits, JPMorgan agreed to pay just $236 million for the firm, a figure that includes the price of Bear’s soaring headquarters on Madison Avenue in Manhattan. At $2 a share, JPMorgan is buying Bear Stearns for a third of the price at which the troubled firm went public in 1985. Only a year ago, Bear’s shares fetched $170. The cut-rate price reflects deep misgivings about the firm’s prospects.
JPMorgan said it was guaranteeing the trading obligations of Bear Stearns and its subsidiaries, effective immediately. “JPMorgan Chase stands behind Bear Stearns,” Jamie Dimon, JPMorgan’s chief executive, said in a statement. “Bear Stearns’s clients and counterparties should feel secure that JPMorgan is guaranteeing Bear Stearns’s counterparty risk.”
The companies said that the Federal Reserve would provide special financing in connection with the transaction and that the Fed had agreed to fund up to $30 billion of Bear Stearns’s “less-liquid assets.”
If you're a fan of the movie It's a Wonderful Life, this is where George Bailey says "Potter's not selling. Potter's buying!" I mean, the Bear Stearns building alone must be worth....
But it's the last paragraph I quoted that leads to headlines like this, from a blog on the L.A. Times: "With Fed financing, JP Morgan buys Bear Stearns".
I suspect that's not how Mr. Bernanke wants this to be viewed.
But the cynic who has moral hazard on his mind can't help but ask... If they do it once like this, what if it happens again? What if another entity considered too big to fail gets special financing from one of the primary dealers through this new facility? As we saw tonight, it is but a small step from a loan guarantee to a fire sale.
This is a good time to link to Brad DeLong's excellent post in which he tells us what Bernanke, Paulson, et al. should have done this weekend. He would have the Treasury set a (discounted) price for mortgages that look a little shaky, buy them, push the market back to equilibrium, and make money for the taxpayer in the process.
If I were working for the Treasury right now, I would be saying: make this happen on Monday. There isn't time to set up a new bureaucrtacy--a HOLC, which is what Alan Blinder wanted to do as of three weeks ago. So use an existing bureaucracy: Fannie Mae. If I were Treasury Secretary Hank Paulson, I would spend the weekend building a legislative vehicle to introduce Monday morning on an emergency basis to give Fannie Mae the resources and the mission to undertake this mortgage rescue operation, and I think Fannie Mae is the right institution for the task: why does it have its government-sponsored status and guarantee if not to be used for purposes like these at times like these?
And if I were Ben Bernanke and Tim Geithner, I would be spending this weekend thinking about how to first thing Monday morning punish bear speculators on Bear Stearns, Lehman, and others by pushing their CDS spreads back to more normal levels. It seems to me that people on Wall Street need to be taught that betting that the Fed will not intervene to stabilize or that its interventions to stabilize will be unsuccessful is an unhealthy thing to do.
The Bear Stearns sale notwithstanding, it's not too late to do something approximating DeLong's (and Blinder's) suggestions to head off future episodes. (Who thinks that this is the end?)
Whether $2 a share is sufficient punishment for the speculators is left to the reader.
Some closing thoughts (at least for tonight) in the next post.
Posted by William Polley at 09:33 PM | Comments (0) | TrackBack
When was the last time the Fed made a policy announcement on a Sunday?
I do not know the answer to my title question, but if anyone does, I am curious. Anyway, here is the announcement from the Fed, and this is the first in what will be at least two posts on the subject by me tonight. If it were just one post, it would be far too long. So let's get started.
This story starts as a bank run... not like the one in It's a Wonderful Life, but a run on an investment bank. Less of a public spectacle, but just as nerve-wracking. (NY Times)
Just three days ago, the head of Bear Stearns, the beleaguered investment bank, sought to assure Wall Street that his firm was safe.
But those assurances were blown away in what amounted to a bank run at Bear Stearns, prompting JPMorgan Chase and the Federal Reserve Bank of New York to step in on Friday with a financial rescue package intended to keep the firm afloat.
...
The developments may only postpone the eventual sale of all or part of Bear Stearns, which has had crippling losses on mortgage-linked investments. To keep the 85-year-old firm solvent, JPMorgan, backed by the New York Fed, extended a secured line of credit that gives Bear Stearns at least 28 days to shore up its finances or, more likely, to find a buyer.
Comment #1: This article is from yesterday--March 15. The sale of Bear Stearns will probably be consummated tonight. That is an indication of just how quickly these things are moving. So quickly that the financial reporters who spend their days enmeshed in these stories are underestimating how rapidly the events will unfold.
News of the bailout ignited fears that other big banks remain vulnerable to the continuing credit crisis, and stocks tumbled in another rocky day for the markets. Financial shares led the way, with shares of Bear Stearns plunging 47 percent. Hours after the rescue was announced, another Wall Street firm, Lehman Brothers, said it had secured a three-year credit line from banks. Its stock fell 15 percent.
Comment #2: Counterparty risk and systemic risk--look them up.
The Fed’s intervention highlights the problems regulators face as they contemplate the prospect that investment banks, saddled with toxic securities tied to subprime mortgages, are losing the trust of their lenders and clients — the kiss of death on Wall Street, where confidence has always been the most precious asset of all.
Traditionally regulators have helped commercial banks in financial panics, but not investment banks, which do not hold customer deposits. But the 1999 repeal of the Glass-Steagall Act, the Depression-era law that separated investment banks and commercial banks, led to consolidation within the financial industry that has made such distinctions harder to make.
“I don’t remember a Fed action aimed at a noncommercial bank; this is the kind of thing you see in this post-regulatory environment,” said Charles Geisst, a Wall Street historian at Manhattan College.
Comment #3: Indeed this is a sign of our times. The consequences of investment bank versus commercial bank failure are different and so are the reasons for rescuing them. In the movie It's a Wonderful Life, when the Bailey Building and Loan faces a bank run, the deposits of the townspeople (the "little guys", if you will) are directly at risk. But when Bear Stearns cannot meet its obligations to its creditors (who are anything but "little guys"), it means that those creditors may face difficulty in meeting their obligations. Eventually, as the crisis deepens, it will begin to threaten commercial banks that do have more of a connection to "real people" with deposits that FDIC will make sure are protected. Certainly that is the worst-case scenario that everyone wants to avoid.
So did the Fed do the right thing by intervening? There are many reasons to say yes, but not everyone thinks so. This post is getting long, and a full answer to this question deserves it's own. To be continued...
UPDATE: John Jansen informs us that October 6, 1979 was a Saturday. Close enough. Students of monetary policy need only read the date to know what that was about.
Posted by William Polley at 07:53 PM | Comments (3) | TrackBack
March 12, 2008
How much more can the Fed do?
I'm in the middle of a few things that are keeping me from blogging an extended analysis of the Fed's recent actions. But I did come across something today that will interest my readers. The WSJ Real Time Economics Blog opens a post with this:
Back in 2003, when the Federal Reserve cut interest rates to 1%, the world worried that the Fed was running out of ammunition and would soon have to turn to unconventional tools.
Now, in 2008, it’s worth asking if the Fed could run out of unconventional ammunition. Tuesday’s offer to lend $200 billion of its Treasury holdings to primary dealers in return for mortgage-backed securities both guaranteed by the government-sponsored enterprises (Fannie Mae and Freddie Mac) and not (private-label MBS) means it will have eventually sold or pledged half of its Treasurys, limiting how many more of these tricks it can pull off.
My first thought when I heard about this innovative move the Fed was that it would take the pressure off for a few days--maybe a week or two. And what then?
Posted by William Polley at 06:02 PM | Comments (2) | TrackBack
Chinese inflation still on the rise
Meanwhile, on the other side of the Pacific...
From Reuters:
BEIJING (Reuters) - China's high January and February readings for inflation have increased the pressure on the government to take action to counter price rises, Commerce Minister Chen Deming said on Wednesday.
Annual consumer inflation jumped to 8.7 percent in February after hitting 7.1 percent in January, the worst in more than 11 years.
Posted by William Polley at 05:33 PM | Comments (2) | TrackBack
March 05, 2008
Beige Book.... now available as a PDF
Here's a link to the new PDF version of the Beige Book. Here's the old html version.
The Wall Street Journal headline is "Beige Book Hints at Stagflation Amid Slow Growth, Prices Pressures"
I'm heading out the door, but I know what I'll be reading tonight.
Posted by William Polley at 02:35 PM | Comments (2) | TrackBack
ADP payroll report posts a decline
The Automatic Data Processing (ADP) employment report shows a loss of 23,000 jobs in February. I would look for Friday's BLS payroll survey to be pretty flat--maybe 50K in either direction. We shall see.
Tomorrow, I'm in the Quad Cities for an economic outlook breakfast. William Strauss from the Chicago Fed is the keynote speaker. I may have more to say after that.
Posted by William Polley at 11:51 AM | Comments (0) | TrackBack
March 03, 2008
Today's required reading...
... is from the Wall Street Journal's Greg Ip. In today's piece, "For the Fed, a Recession -- Not Inflation -- Poses Greater Threat", he writes:
So why is the Fed more worried about growth than inflation? First, it thinks run-ups in commodity prices explain the increases, not only in overall inflation but also in core inflation: higher energy costs have "passed through" to other goods and services. Core inflation rose and fell with energy inflation between early 2006 and mid-2007, and the Fed thinks the same thing is probably happening now. If energy and food prices stop rising -- they don't have to actually fall -- both overall and core inflation should recede.
...
For the current high inflation rates to become permanent, the Fed believes it has to become embedded in how workers and businesses set wages and prices. So far, surveys suggest consumers haven't raised their expectations of inflation much. In last year's fourth quarter, hourly wages and benefits were up just 3% from a year earlier, a slowdown from 2006, even though unemployment was below 5% for almost all that period. A wage-price spiral requires wages to cooperate.
Wages are even less likely to accelerate if unemployment, now 4.9%, rises to 5.25% this year and falls only gradually to 5% by 2010, as the Fed's Federal Open Market Committee forecasts. That implies three years with the unemployment rate above the FOMC's estimated "natural" rate of about 4.9%, and thus steady downward pressure on inflation.
The notion that higher unemployment reduces inflation has its skeptics, even at the Fed. "All you have to do is recall the 1970s, when we experienced both high unemployment and high inflation, to appreciate that slow economic growth and lower inflation don't necessarily go hand in hand," Federal Reserve Bank of Philadelphia President Charles Plosser said last month.
I must say that I get a little nervous about pinning my hopes for inflation reduction on a forecast that unemployment will be a couple tenths of a percent over the supposed "natural" rate. Even if you believe in some kind of an expectations augmented Phillips curve, you have to wonder about what has been happening in recent weeks. The genie may not be out of the bottle yet, but it's beginning to look like someone popped the cork.
Ip continues,
Critics say the Fed also took too long to reverse the ultralow rates of 2001-2003, thereby fueling the housing bubble -- if not rampant inflation -- whose collapse now threatens the economy. Federal Reserve Bank of St. Louis President William Poole became one of the first people who participated in that decision to repudiate it. "With the benefit of hindsight...it is not hard to argue that the [Fed] was too slow to raise the federal-funds target after taking the target down to 1% in 2003," he said at a conference on Friday.
Even Fed officials who don't share that view agree that both that episode and the 1970s experience argue for promptly reversing rate cuts once the current crisis passes.
That's easier said than done. The Fed is unlikely to face an outlook so unambiguously positive anytime soon that such a reversal will be a slam-dunk, and during an election year, it will face intense political pressure not to raise rates.
Whether the Fed reverses course "on an appropriate schedule" will be clear in five years or so, Mr. Poole said.
This is not the first place I've seen this sentiment (of rate hikes as soon as this crisis passes) expressed recently. That makes me think that there is a concerted effort to manage expectations here. At this point, I'd say the most likely time for the Fed to want to begin tightening again (barring any unforeseen developments) will probably be very close to election time. It will be a tough sell. Better start paving the way soon.
And Poole's final comment is very much on the money.
Posted by William Polley at 01:39 PM | Comments (4) | TrackBack
One student's view on why she wants to be an economist
Via Newmark's Door comes this from the Richmond Fed "Why I Want To Be An Economist". Read it. Many of us have had students who would tell similar stories.
Posted by William Polley at 01:34 PM | Comments (0) | TrackBack
Women's college basketball notes
This blog is mostly dedicated to economics, but it can be hard to resist an occasional digression into the world of sports. In that vein, a couple of things caught my eye today.
First, the WIU women's basketball team is waiting to see if they will be the #1 or #2 seed in the conference tournament. Their regular season is finished. They missed the opportunity to decide their own fate with a win this weekend. So now it's up to Southern Utah. (Incidentally, SUU is the academic home of David Tufte of the voluntaryXchange blog.) With a win over the other contender for the #1 seed, Oakland University, SUU could propel WIU into the top spot. If Oakland wins, they and WIU would have identical conference records, but Oakland swept the regular season series and would win the tiebreaker. Let's hope that SUU can pull off the upset.
The other women's basketball story getting my attention is the retirement of NDSU coach Amy Ruley (registration may be required for the article). Ruley has coached the Bison since 1979 and led the team to five Division II national championships--four of them consecutive from 1993 to 1996. Tonight will be her last regular season game. Bison basketball will just not seem the same for many fans of the game. Nearly 30 years at one school is an incredible run--that just doesn't happen anymore. She's a graduate of Purdue and has her master's degree from Western Illinois. (The latter I only found out recently after coming to WIU myself.) After coaching, she's expected to do some fundraising for NDSU athletics. As someone who grew up and went to college near Fargo in the '80s and '90s when she and the Bison were making their way to the pinnacle of D-II, I'd love to see her go out with a win. Go Bison!
Posted by William Polley at 12:51 PM | Comments (3) | TrackBack