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February 12, 2014
Even if we used a 10:1 fractional reserve ratio, the Fed’s $85 billion per month QE was creating $10 trillion per year in liquidity.
The point to understanding the Status Quo financial system is doomed is not to revel in the doom but to understand why we have to look past the current corrupt, predatory, parasitic system to a better arrangement. That’s positive.
Longtime correspondent Harun I. submitted this quote from John Ing and a commentary on simple arithmetic. In “We Are Nowhere Near The Chaos That I Expect”, John Ing observes the consequences of deleveraging a highly leveraged system:
“We have already had $3 trillion in stock market capitalization wiped out. It is amazing that just a $20 billion tapering has been enough to cause all of this chaos around the globe.”
Harun then explained why it isn’t amazing at all–it’s entirely predictable:
Simple arithmetic will do. The Fed is leveraged 72:1. For every dollar it removes, it actually removes 72. The product of 72 and 20 is 1,440. The Fed has actually removed nearly $1.5 trillion of liquidity with its $20 billion tapering.It is a mathematical certainty that this geometric progression of debt growth will end (remember, for everything that is growing geometrically, that upon which the growth is dependent is contracting at the same rate). The contraction (deleveraging) must necessarily be as geometric as the expansion (leveraging).
The Fed can try to keep interest rates at zero but there will be dire consequences. The Fed can try to “taper” but there will be dire consequences.
What I find amazing is that even if we used a 10:1 fractional reserve ratio, the Fed’s $85 billion per month QE was creating $10 trillion per year in liquidity.
The World Economic Forum reported in 2011 that $100 trillion in new credit would be needed for world growth going forward. How long does anyone think tapering will last?
Over US$ 100 Trillion Additional Credit Needed to Support Global Growth(World Economic Forum)
Trying to force simplistic results out of complex systems inevitably generates unintended consequences. Liquidity and credit expansion act like pressure in a closed system; central planners look at the site of the last financial break and see no leaks, so they assume they’ve got the system under control.
But the next failure in the system will occur where no one is looking–the points in the system that everyone assumes are “safe.”
The system is doomed if central banks continue creating trillions of dollars in new leveraged credit and liquidity to keep the system from imploding, and it is also doomed if they cease creating new leveraged credit (i.e. taper their geometric expansion of credit). Doomed if you do taper, doomed if you don’t taper.
Here’s the Fed balance sheet. If you get a magnifying glass, you might discern some tapering.
Geometric expansion of credit is visible throughout the system. Never mind the infamous shadow banking system–look at the insane expansion of credit/debt in student loans:
Of related interest:
Resolution #1: Let’s Call Things What They Really Are in 2014 (January 15, 2014)
The Federal Reserve’s Nuclear Option: A One-Way Street to Oblivion (February 5, 2014)
Volatility will rise toward its long-term average and that means an increase in risk premiums, said Philip Moffitt, head of fixed income in Sydney for Asia and the Pacific at Goldman Sachs Asset Management, which had $991 billion of assets under supervision worldwide as of September. The risks for different emerging economies will become more idiosyncratic and Mexico presents a buying opportunity following the rout, he said.
Markets from Turkey to South Africa and Argentina were roiled during the past month as investors sold off emerging-economy currencies, stocks and bonds, prompting emergency measures from governments and central banks. The bout of risk aversion follows the Fed’s decision to scale back asset purchases and China’s pledge to rein in leverage and give market forces a more decisive role in allocating resources.
“The selloff in emerging markets has much more to do with China than with Fed tapering,” Moffitt said yesterday in an interview in Sydney. “China’s such a big source of global demand, in particular for other emerging markets, uncertainty’s going to stay high and risk premiums should be expanding.”
The worst isn’t over for emerging markets, Mark Mobius, who oversees more than $50 billion in developing nations as an executive chairman at Templeton Emerging Markets Group, said in an interview. Prices can decline further or take time to stabilize, he said.
China’s policy makers have attempted to rein in the unprecedented credit boom they unleashed in 2008-2009 amid the global financial crisis. Money market rates in China have surged, the cost of insuring against credit default by banks has increased and payment difficulties are emerging in the country’s $6 trillion shadow-banking industry.
“They’re looking to create a market that prices credit risk, rather than having prices imposed,” Moffitt said. “In the absence of a strong mechanism for pricing credit risk, there’s likely to be a lot of uncertainty and volatility.”
The world’s second-largest economy is predicted to expand by 7.4 percent this year, the slowest pace since 1990, according to the median estimate in a Bloomberg News survey.
The slowdown in China comes as the U.S. economy is showing signs of a pickup, allowing the Fed to trim its monthly bond purchases to $65 billion from $85 billion. U.S. growth is expected to accelerate to 2.8 percent in 2014 from 1.9 percent last year, according to a another Bloomberg poll.
Moffitt said investing in Mexico would be his top trade at the moment because the country’s fundamental outlook is strong even though it has been affected by the global selloff.
“There’s been outflow from emerging-market assets and when you get that kind of flow people sell what they can sell, often high-quality assets,” he said. “It will benefit from the strong U.S. growth we’re expecting and there’s the prospect for rate cuts, so Mexico stands out to us on both value and fundamentals.”
By Chris Andrew and Mustafa Zaidi at Clarmond
The concept of continuously doubling down in order to achieve financial and economic goals is now a respectable and established norm. Takahashi’s Wager of 1930s Japan shows that such a policy, while initially successful, can remove all sensible restraints
For a gambler on a losing streak the classic trap is to borrow money, trying to break even. Doubling down, time and time again, becomes routine as all caution is discarded; this does not make for sound financial planning.
In ‘Resurrecting Reflation’ (November 2012) we highlighted when this policy was first attempted; in 1931 Finance Minister of Japan, Takahashi Korekiyo, paid for Japan’s invasion of Manchuria whilst countering the collapse of capitalism around Japan with unorthodox measures of massive QE and deficit spending. These twin policies were heralded as a great success 70 years later by Governor Ben Bernanke and a decade after that by Prime Minister Abe.
‘Takahashi’s Wager’ led to a tripling of the Japanese stock market, a 40% currency devaluation and warfare spending that rose from 30% to 70% of the national budget. Having taken the gamble to reflate, the octogenarian established the principle that capital is costless and unlimited; doubling down had become routine.
This band-aid boom ended in a calamitous collapse years later; by then Takahashi was long gone…literally, as he had belatedly tried to slow the handout-hooked warfare train. In 1937 another ‘routine’ incident occurred at the Marco Polo Bridge, which gave Japan the excuse to invade the rest of China. This was, in effect another ‘doubling down’, but by this time Japanese economic statistics had plateaued, war casualties had hit a 100,000 and warfare spending comprised nearly the entire government budget. But the unorthodox ‘policy genie’ was out of the bottle, as Takahashi had demonstrated, one could double down again and again, as the goalposts for success were simply moved and all gambles appeared sane.
Modern day Japan finds itself in a similar predicament, but instead of warfare the Japanese leadership is confronting the dual burdens of welfare spending and interest payments, which, at current interest rates, now account for 60% of the budget.
The Bank of Japan’s unconventional policy of massive QE, which is nearly 18% of GDP, is intended to ignite inflation and break the twenty-year deflationary cycle. This scheme, put in place by the current Prime Minister, has been dubbed ‘Abenomics’. Given zero interest rates for last 15 years, and the occasional bout of QE, ‘Abenomics’ is another ‘doubling down’ but, this time, it has staked everything on this one final throw of the financial dice. Perhaps ‘Gamblernomics’ may be a more reasonable nomenclature.
On the surface ‘Gamblernomics’, like the ‘Takahashi Wager’, appears successful – the equity market has risen substantially, the currency has fallen, and government bond yields remain low. So far, so good.
How is the government gauging the success of this dice roll? They are looking for two percent inflation, a positive growth number, and have committed to two years of massive QE to achieve these goals. As time passes and these targets are not met, the policy makers will double down again, by which point interest payments and welfare spending are likely to comprise most of the budget. Emergency shall have become routine and all further gambles shall appear sane.
All gamblers are aware of their accumulated losses, in economic parlance this means their ‘sunk costs.’ Today’s adherents of ‘Gamblernomics’ are not only found in Tokyo, but also reign in all major financial capitals, each playing their own version of a similar wager. All believe that doubling down is a sober strategy given the sunk costs of lost growth. As a new generation of gamblers sit at the table, ghosts of gamblers past whisper – “Place your bets.”
The report from RealtyTrac last week proves beyond the shadow of a doubt the supposed housing market recovery is a complete and utter fraud. The corporate mainstream media did their usual spin job on the report by focusing on the fact foreclosure starts in 2013 were the lowest since 2007. Focusing on this meaningless fact (because the Too Big To Trust Wall Street Criminal Banks have delayed foreclosure starts as part of their conspiracy to keep prices rising) is supposed to convince the willfully ignorant masses the housing market is back to normal. It’s always the best time to buy!!!
The talking heads reading their teleprompter propaganda machines failed to mention that distressed sales (short sales & foreclosure sales) rose to a three year high of 16.2% of all U.S. residential sales, up from 14.5% in 2012. The economy has been supposedly advancing for over four years and sales of distressed homes are at 16.2% and rising. The bubble headed bimbos on CNBC don’t find it worthwhile to mention that prior to 2007 the normal percentage of distressed home sales was less than 3%. Yeah, we’re back to normal alright. We are five years into a supposed economic recovery and distressed home sales account for 1 out of 6 all home sales and is still 500% higher than normal.
The distressed sales aren’t even close to the biggest distortion of this housing market. The RealtyTrac report reveals that all-cash purchases accounted for 42% of all U.S. residential sales in December, up from 38% in November, and up from 18% in December 2012. Does that sound like a trend of normalization? There were five states where all-cash transactions accounted for more than 50% of sales in December – Florida (62.5%), Wisconsin (59.8%), Alabama (55.7%), South Carolina (51.3%), and Georgia (51.3%). In the pre-crisis days before 2008, all-cash sales NEVER accounted for more than 10% of all home sales. NEVER. This is all being driven by hot Wall Street money, aided and abetted by Bernanke, Yellen and the rest of the Fed fiat heroine dealers.
The fact that Wall Street is running this housing show is borne out by mortgage applications languishing at 1997 levels, down 65% from the 2005 highs. Real people in the real world need a mortgage to buy a house. If mortgage applications are near 16 year lows, how could home prices be ascending as if there is a frenzy of demand? Besides enriching the financial class, the contrived elevation of home prices and the QE induced mortgage rate increase has driven housing affordability into the ground. First time home buyers account for a record low percentage of 27%. In a normal non-manipulated market, first time home buyers account for 40% of home purchases.
Price increases that rival the peak insanity of 2005 have been manufactured by Wall Street shysters and the Federal Reserve commissars. Doctor Housing Bubble sums up the absurdity of this housing market quite well.
The all-cash segment of buyers has typically been a tiny portion of the overall sales pool. The fact that so many sales are occurring off the typical radar suggests that the Fed’s easy money eco-system has created a ravenous hunger with investors to buy up real estate. Why? The rentier class is chasing yields in every nook and cranny of the economy. This helps to explain why we have such a twisted system where home ownership is declining yet prices are soaring. What do we expect when nearly half of sales are going to investors? The all-cash locusts flood is still ravaging the housing market.
The Case-Shiller Index has shown price surges over the last two years that exceed the Fed induced bubble years of 2001 through 2006. Does that make sense, when new homes sales are at levels seen during recessions over the last 50 years, and down 70% from the 2005 highs? Even with this Fed/Wall Street induced levitation, existing home sales are at 1999 levels and down 30% from the 2005 highs. So how and why have national home prices skyrocketed by 14% in 2013 after a 9% rise in 2012? Why are the former bubble markets of Las Vegas, Los Angeles, San Diego, San Francisco and Phoenix seeing 17% to 27% one year price increases? How could the bankrupt paradise of Detroit see a 17.3% increase in prices in one year? In a normal free market where individuals buy houses from other individuals, this does not happen. Over the long term, home prices rise at the rate of inflation. According to the government drones at the BLS, inflation has risen by 3.6% over the last two years. Looks like we have a slight disconnect.
This entire contrived episode has been designed to lure dupes back into the market, artificially inflate the insolvent balance sheets of the Too Big To Trust banks, enrich the feudal overlords who have easy preferred access to the Federal Reserve easy money, and provide the propaganda peddling legacy media with a recovery storyline to flog to the willingly ignorant public. The masses desperately want a feel good story they can believe. The ruling class has a thorough understanding of Edward Bernays’ propaganda techniques.
“The conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in democratic society. Those who manipulate this unseen mechanism of society constitute an invisible government which is the true ruling power of our country. …We are governed, our minds are molded, our tastes formed, our ideas suggested, largely by men we have never heard of.”
Ben Bernanke increased his balance sheet by $3.2 trillion (450%) since 2008, and it had to go somewhere. We know it didn’t trickle down to the 99%. It was placed in the firm clutches of the .1% billionaire club. Bernanke sold his QE schemes as methods to benefit Main Street Americans, when his true purpose was to benefit Wall Street crooks. 30 year mortgage rates were 4.25% before QE2. 30 year mortgage rates were 3.5% before QE3. Today they stand at 4.5%. QE has not benefited average Americans. They are getting 0% on their savings, mortgage rates are higher, and their real household income has fallen and continues to fall.
But you’ll be happy to know banking profits are at all-time highs, Blackrock and the rest of the Wall Street Fed front running crowd have made a killing in the buy and rent ruse, and record bonuses are being doled out to the men who have wrecked our financial system in their gluttonous plundering of the once prosperous nation. Their felonious machinations have added zero value to society, while impoverishing a wide swath of America. Bernanke, Yellen and their owners have used their control of the currency, interest rates, and regulatory agencies to create the widest wealth disparity between the haves and have-nots in world history. Their depraved actions on behalf of the .1% will mean blood.
Just as Greenspan’s easy money policies of the early 2000’s created a housing bubble, inspiring low IQ wannabes to play flip that house, Bernanke’s mal-investment inducing QEternity has lured the get rich quick crowd back into the flipping business. The re-propagation of Flip that House shows on cable is like a rerun of the pre-bubble bursting frenzy in 2005. RealtyTrac’s recent report details the disturbing lemming like trend among greedy institutions and dullard brother-in-laws across the land.
- 156,862 single family home flips — where a home is purchased and subsequently sold again within six months — in 2013, up 16% from 2012 and up 114% from 2011.
- Homes flipped in 2013 accounted for 4.6% of all U.S. single family home sales during the year, up from 4.2% in 2012 and up from 2.6% in 2011
The easy profits just keep flowing when the Fed provides the easy money. What could possibly go wrong? Home prices never fall. A brilliant Ivy League economist said so in 2005. The easy profits have been reaped by the early players. Wall Street hedge funds don’t really want to be landlords. Flippers need to make a quick buck or their creditors pull the plug. Home prices peaked in mid-2013. They have begun to fall. The 35% increase in mortgage rates has removed the punchbowl from the party. Anyone who claims housing will improve in 2014 is either talking their book, owns a boatload of vacant rental properties, teaches at Princeton, or gets paid to peddle the Wall Street propaganda on CNBC.
Reality will reassert itself in 2014, with lemmings, flippers, and hedgies getting slaughtered as the housing market comes back to earth with a thud. The continued tapering by the Fed will remove the marginal dollars used by Wall Street to fund this housing Ponzi. The Wall Street lemmings all follow the same MBA created financial models. They will all attempt to exit the market simultaneously when their models all say sell. If the economy improves, interest rates will rise and kill the housing market. If the economy tanks, the stock market will plunge, creating fear and killing the housing market. Once it becomes clear that prices have begun to fall, the flippers will panic and start dumping, exacerbating the price declines. This scenario never grows old.
Real household income continues to fall and nearly 25% of all households with a mortgage are still underwater. Young people are saddled with $1 trillion of government peddled student loan debt and will not be buying homes in the foreseeable future. Dodd-Frank rules will result in fewer people qualifying for mortgages. Mortgage insurance is increasing. Obamacare premium increases are sucking the life out of potential middle class home buyers. Retailers have begun firing thousands. The financial class had a good run. They were able to re-inflate the bubble for two years, but the third year won’t be a charm. In a normal housing market 85% of home sales would be between individuals using a mortgage, 10% would be all cash transactions, less than 5% of sales would be distressed, and 40% would be first time buyers. In this warped market only 40% of home sales are between individuals using a mortgage, 42% are all cash transactions, 16% are distressed sales, 5% are flipped, and only 27% are first time buyers. The return to normalcy will be painful for shysters, gamblers, believers, paid off economists, Larry Yun, and CNBC bimbos.
The gap between the rich and poor continues to grow. The wealthiest 1 percent held 8 percent of the economic pie in 1975 but now hold over 20 percent. This is a striking change from the 1950s and 1960s when their share of all incomes was slightly over 10 percent. A study by Emmanuel Saez found that between 2009 and 2012 the real incomes of the top 1 percent jumped 31.4 percent. The richest 10 percent now receive 50.5 percent of all incomes, the largest share since data was first recorded in 1917. The wealthiest are becoming disproportionally wealthier at an ever increasing rate.
Most of the literature on income inequalities is written by professors from the sociology departments of universities. They have identified factors such as technology, the reduced role of labor unions, the decline in the real value of the minimum wage, and, everyone’s favorite scapegoat, the growing importance of China.
Those factors may have played a role, but there are really two overriding factors that are the real cause of income differentials. One is desirable and justified while the other is the exact opposite.
In a capitalist economy, prices and profit play a critical role in ensuring resources are allocated where they are most needed and used to produce goods and services that best meets society’s needs. When Apple took the risk of producing the iPad, many commentators expected it to flop. Its success brought profits while at the same time sent a signal to all other producers that society wanted more of this product. The profits were a reward for the risks taken. It is the profit motive that has given us a multitude of new products and an ever-increasing standard of living. Yet, profits and income inequalities go hand in hand. We cannot have one without the other, and if we try to eliminate one, we will eliminate, or significantly reduce, the other. Income inequalities are an integral outcome of the profit-and-loss characteristic of capitalism; they cannot be divorced.
Prime Minister Margaret Thatcher understood this inseparability well. She once said it is better to have large income inequalities and have everyone near the top of the ladder, than have little income differences and have everyone closer to the bottom of the ladder.
Yet, the middle class has been sinking toward poverty: that is not climbing the ladder. Over the period between 1979 and 2007, incomes for the middle 60 percent increased less than 40 percent while inflation was 186 percent. According to the Saez study, the remaining 99 percent saw their real incomes increase a mere .4 percent between 2009 and 2012. However, this does not come close to recovering the loss of 11.6 percent suffered between 2007 and 2009, the largest two-year decline since the Great Depression. When adjusted for inflation, low-wage workers are actually making less now than they did 50 years ago.
This brings us to the second undesirable and unjustified source of income inequalities, i.e., the creation of money out of thin air, or legal counterfeiting, by central banks. It should be no surprise the growing gap in income inequalities has coincided with the adoption of fiat currencies worldwide. Every dollar the central bank creates benefits the early recipients of the money—the government and the banking sector — at the expense of the late recipients of the money, the wage earners, and the poor. Since the creation of a fiat currency system in 1971, the dollar has lost 82 percent of its value while the banking sector has gone from 4 percent of GDP to well over 10 percent today.
The central bank does not create anything real; neither resources nor goods and services. When it creates money it causes the price of transactions to increase. The original quantity theory of money clearly related money to the price of anything money can buy, including assets. When the central bank creates money, traders, hedge funds and banks — being first in line — benefit from the increased variability and upward trend in asset prices. Also, future contracts and other derivative products on exchange rates or interest rates were unnecessary prior to 1971, since hedging activity was mostly unnecessary. The central bank is responsible for this added risk, variability, and surge in asset prices unjustified by fundamentals.
The banking sector has been able to significantly increase its profits or claims on goods and services. However, more claims held by one sector, which essentially does not create anything of real value, means less claims on real goods and services for everyone else. This is why counterfeiting is illegal. Hence, the central bank has been playing a central role as a “reverse Robin Hood” by increasing the economic pie going to the rich and by slowly sinking the middle class toward poverty.
Janet Yellen recently said “I am hopeful that … inflation will move back toward our longer-run goal of 2 percent,” demonstrating her commitment to an institutionalized policy of theft and wealth redistribution. The European central bank is no better. Its LTRO strategy was to give longer term loans to banks on dodgy collateral to buy government bonds which they promptly turned around and deposited with the central bank for more cheap loans for more government bonds. This has nothing to do with liquidity and everything to do with boosting bank profits. Yet, every euro the central bank creates is a tax on everyone that uses the euro. It is a tax on cash balances. It is taking from the working man to give to the rich European bankers. This is clearly a back door monetization of the debt with the banking sector acting as a middle man and taking a nice juicy cut. The same logic applies to the redistribution created by paying interest on reserves to U.S. banks.
Concerned with income inequalities, President Obama and democrats have suggested even higher taxes on the rich and boosting the minimum wage. They are wrongly focusing on the results instead of the causes of income inequalities. If they succeed, they will be throwing the baby out with the bathwater. If they are serious about reducing income inequalities, they should focus on its main cause, the central bank.
In 1923, Germany returned to its pre-war currency and the gold standard with essentially no gold. It did it by pledging never to print again. We should do the same.
Note: The views expressed in Daily Articles on Mises.org are not necessarily those of the Mises Institute.
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Frank Hollenbeck teaches finance and economics at the International University of Geneva. He has previously held positions as a Senior Economist at the State Department, Chief Economist at Caterpillar Overseas, and as an Associate Director of a Swiss private bank. See Frank Hollenbeck’s article archives.
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Too late. I already opted for the first option years ago. It was a choice between a low return on capital or no return of capital, so I chose the former. Everyone thinks that they will be that one guy who gets out at the very top – you know, like Alan Greenspan. Fortunately, you don’t have to be a retiring Central Bankster to realize that a set of widely ignored factors have coalesced to make meltdown inevitable.
Capitalism taken to the logical extent possible will inevitably self-implode with extreme dislocation.
Carry Trades Unwinding
First off, carry trade unwind risk was always the greatest risk created by Quantitative Easing and despite the rolling dislocations in Emerging Markets, it’s still being ignored. These various high risk Emerging Market countries were primary beneficiaries of Fed largesse as it temporarily propped up their currencies and their debt markets. Now during the unwind phase, the currencies are collapsing and interest rates are rising. Meanwhile, investors are just starting to realize that these trade deficits (current account balances) are totally unsustainable. In a desperate attempt to stabilize its currency, Turkey raised interest rates by 4% overnight which of course will kill the economy. This is all just deja vu of the 1997 currency crisis which started in Thailand and spread throughout Asia.
Don’t Worry. Be Happy
“China is being engulfed in a financial crisis that might end up in its own version of the credit crunch. There are running battles on the streets on Bangkok and Kiev as authoritarian regimes totter. Turkey is sinking, and may soon not be able to fund its current account deficit. Argentina is going through another currency crisis. There is no shortage of drama coming out of the emerging markets. And there is no shortage of reasons for the markets to work them themselves up into a panic.” (“Why An Emerging Markets Crash Wouldn’t Matter”)
Key Stock Market Risks
“A Funny Old World” – The EM Carry Trade Collapse ‘Deja Vu, All Over Again’ From Citigroup | Zero Hedge
Spot the similarities.
From CitiFX Technicals: It’s a funny old World
- 1989-1991: Housing and savings and loan crisis: Fed eases aggressively as economy enters deep recession
- 1992-1994: Existing financial architecture in Europe (ERM) blows apart
- 1995-1998: European convergence trade in both FX and Bond spreads keeps European currencies relatively stable vis a vis the USD with a good rally in 1998.By 1996 BUBA has lowered the discount rate to 2.5% while US rates remain well below the pre-crisis highs of 9.75% in 1989.
- The carry trade and capital flow into emerging markets (Asia in particular) is center stage
- March 1997: In a seemingly “innocuous” move the Fed “tinkers” by raising rates 25 basis points.
- April 1997: Japan raises its consumption tax as USDJPY has rallied from a post Kobe Earthquake low of 79.7 to 127.50 . USDJPY collapse to 111 by June
- June 1997-Jan 1998: Severe reaction in Asian currencies as “hot money flees”
- August-October 1998: Russia defaults, Long term capital folds and the Fed eases aggressively as the Equity market drops 22% (S&P)
History may not repeat…..but it sure RHYMES
As Federal Reserve Chairman Ben S. Bernanke shuts the door to his office for a final time in two days, he can say he took actions that were the first or the biggest of their kind in the central bank’s 100-year history. Some will probably also be the last.
Bernanke was the first to devise a monetary policy that focused on lowering credit costs by suppressing longer-terminterest rates after the short-term policyrate hit zero. His strategy, involving direct purchases of agency mortgage-backed securities and longer-term Treasury debt, left the Fed with the biggest balance sheet in its history, $4.1 trillion.
He was the first chairman since the Great Depression to use emergency lending powers to rescue businesses in almost every corner of the financial system — from banks, to corporations, to bond dealers. And he might be the last: Congress, leery of the Fed’s sweeping powers, removed the central bank’s ability to loan to individuals, partnerships and non-bank companies.
“He was incredibly creative in the different steps and programs he took to prevent a free fall of the global economy,” said Kristin Forbes, a professor at Massachusetts Institute of Technology’s Sloan School of Management in Cambridge and a member of the White House Council of Economic Advisers under President George W. Bush. “During a crisis, you have to make decisions with highly imperfect information. He was willing to do that.”
The 60-year-old Bernanke leaves a Fed vastly different from the institution he took charge of on Feb. 1, 2006. At that time, the former Princeton University professor had a few goals. He said naming an inflation target would help boost accountability and policy effectiveness. He also wanted to push power out of the chairman’s office down into the policy-making Federal Open Market Committee, in effect, to dilute some of the mystique his predecessor Alan Greenspan created.
Eight years later, Bernanke achieved those goals. The Feddeclared an inflation target of 2 percent in 2012, and the FOMC is more democratic. The Fed chairman encouraged more open debate at policy meetings, allowing colleagues to interrupt the format if they wanted to make a point. Unlike Greenspan, Bernanke voices his policy view last.
Among other Bernanke innovations, central bankers publish their economic forecasts, including their outlook for the policy interest rate they set, four times a year. The chairman holds a press conference quarterly.
The crisis response also transformed the institution in ways that defy any near-term conclusion because nobody knows whether extraordinary actions, like purchasing $1.5 trillion in mortgage debt or creating $2.4 trillion in excess bank reserves, can be retracted, shrunk and unwound successfully.
The Fed is more extended politically as it engages in policies such as suppressing mortgage rates, and the size and influence of its open-market operations have involved it in financial markets as never before.
“The legacy is still open,” said Vincent Reinhart, a former top Fed official and now chief U.S. economist at Morgan Stanley in New York. “We survived. The question is what are the consequences?”
U.S. central bankers meeting today will probably announce a second $10 billion reduction in the pace of monthly bond purchases, bringing them down to $65 billion from an original $85 billion. That means Bernanke’s successor, current Fed vice chairman Janet Yellen, will inherit a balance sheet that is still growing.
Those purchases from Wall Street dealers add to the level of reserves in the banking system, requiring the Fed to plant a huge footprint in money markets to manage them. Yellen’s Fed will need to use new tools such as paying interest on these reserves or pulling them out of the banking system with reverse repurchase agreements. Otherwise, the central bank would have a difficult time stabilizing its policy interest rate as banks dumped reserves into the overnight market. That could lead to higher inflation.
“I think it is very intrusive,” Tad Rivelle, who oversees about $84 billion as chief investment officer for U.S. fixed-income securities at TCW Group in Los Angeles, said of the Fed’s operations under Bernanke. The outgoing chairman’s legacy “will ultimately be negative” as policies used during the crisis and slow recovery lead to future instability, he said.
That instability may be social and political as well as financial, he said. Banks are still wary lenders, so the Fed’s low-rate policies are providing what Rivelle calls “preferential access” to a privileged group of borrowers: the government, corporations and consumers with the highest credit scores.
The bond-buying policy, known as quantitative easing, has helped boost asset prices. The Standard and Poor’s 500 stock index rose 30 percent last year, and home prices rose a projected 11.5 percent in 2013, according to an index tracked by CoreLogic, an Irvine, California, data and analytics company. Yet earnings per hour for private-sector workers have climbed just 2 percent a year on average since 2011 compared with a 3.2 percent gain in 2007, the last year of the previous expansion. Adjusted for inflation, they’ve barely grown at all.
Meanwhile, the Fed’s retreat from quantitative easing is slowing capital flows to emerging markets, roiling local stock markets. The MSCI Emerging Markets Index is down 6.8 percent year-to-date.
The Fed’s rescues under Bernanke also left an expanded safety net around financial institutions and markets that Congress and regulators are busily trying to shrink.
Fed officials, such as Richmond Fed president Jeffrey Lacker, warn that if the perception of government guarantees against financial risk isn’t reduced, it will set the stage for another crisis. Richmond Fed economists estimate that the proportion of the total liabilities of U.S. financial firms covered by an implicit or explicit federal safety net increased by 27 percent over the past 12 years.
Bernanke helped increase the perception of government support by rescuing Bear Stearns Cos. and American International Group Inc. during the crisis. He further contributed to that notion when Goldman Sachs Group Inc. and Morgan Stanley came under speculative attack and he let them convert into banks, which granted them access to backstop credit from the Fed.
The bailouts triggered a backlash, stiffening resolve on Capitol Hill to prevent taxpayer support from helping Wall Street again.
Even one of Bernanke’s predecessors, former Chairman Paul Volcker, was surprised by the actions, which, he said in an April 8, 2008, speech before economists in New York, took the Fed “to the very edge of its lawful and implied powers.”
The 2010 Dodd-Frank Act, the most sweeping rewrite of financial rules since the 1930s, contains the phrase “to end too-big-to-fail” in its preamble, a message to regulators that no bank should be so big and risky that it would have to be saved again. To put a point on it, Congress limited the Fed’s power to lend emergency funds to non-bank corporations to a broad-based facility that could only be accessed by several institutions. The message was that singular bailouts of firms such as Bear Stearns were over.
Bernanke said in a hearing in February that regulators were “moving in the right direction” to end too-big-to-fail with the new tools given to them by the Dodd-Frank Act.
Phillip Swagel, who helped manage the government’s bank bailout fund known as the Troubled Asset Relief Program during the George W. Bush administration, said legislation is only part of the solution.
“We won’t know if too-big-to-fail has been solved until the next crisis,” said Swagel, now an economist at the University of Maryland in College Park. “The tools are there” to take down a troubled bank, he added. “The unknown is the will of the government.”
Among the unresolved questions as Bernanke exits: Can the Fed operate indefinitely with a multi-trillion-dollar balance sheet? Is the flow of credit to the economy constricted with the banking system under intense regulatory scrutiny? Has the economy downshifted to some slower pace of growth that the Fed can’t change?
“This is a Fed that’s intervening in the yield curve, it’s intervening in liquidity markets, it’s intervening in many asset classes,” said Julia Coronado, a former Fed board staff economist who is now chief economist for North America at BNP Paribas in New York.
“The book is still open, the last chapters have yet to be written, and it’s way too soon to say, ‘Ah, this is his legacy,’ because history is the judge, and there’s still a lot of risk.”
To contact the reporter on this story: Craig Torres in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Chris Wellisz at email@example.com
Is this how it starts?
The third great market crash of the 21st century?
At Ben Bernanke’s perhaps final public appearance at the Brookings Institution on January 16th, the beginnings of the 2008-2009 financial crisis were linked to the issues of a French bank in the summer of 2007, an incident little noticed at that point in time.
This time around will it be the currency problems of frontier and emerging markets? The default of a Chinese trust fund, discussed in some detail here atForbes? Or something else altogether, totally hidden at the moment? Or nothing at all?
With U.S. equity markets suffering their deepest losses since 2012, there were plenty of disparate concerns to go around this past week.
These included the fear of the Fed’s tapering ultimate timing and impact, weakening China growth, those currency devaluation jitters, a lackluster U.S. earnings season, perceived overheated equity market valuations, and that China trust fund, to mention a few. There was also the end of week concern that the selling could feed upon itself, as those market-makers selling puts on indices and calls on the VIX could get squeezed and have to hedge next week with more S&P futures selling.
On the week, the Dow gave up -3.5%, finishing below 16,000 for the first time since mid-December. The S&P 500 lost -2.6%, closing below the key 1800 level at 1790. And the NASDAQ fared the best, down “only” -1.7%, helped by the relative strength of some of its high-fliers. Notably, the VIX popped close to +46%, ending the week just above 18, although still far below panic levels.
It is a bit iffy to reconstruct the true narrative of the week, as things seemed to get rolling to the downside on Monday evening. Influential Fed watcher Jon Hilsenrath of the WSJ wrote of January FOMC tapering possibilities:
A reduction in the program to $65 billion a month from the current $75 billion could be announced at the end of the Jan. 28-29 meeting, which would be the last meeting for outgoing Chairman Ben Bernanke.
Coincidence or not, the next four trading days were all on the negative side of the ledger for the Dow, although the S&P hung in decently on Tuesday and Wednesday. But then China’s HSBC PMI numbers hit, indicating a drop in January to 49.6 from December’s final reading of 50.5, moving “below the 50 line which separates expansion of activity from contraction.” (Reuters).
This, combined with the currency devaluation news, with Venezuela, Argentina, and Turkey leading the headlines, seemed to fuel the overall“emerging market risk” theme which overwhelmed markets on Friday.
Not helping were some comments coming out of Davos. Larry Fink ofBlackRock BLK -3.95% said there was “too much optimism” in the markets. He added, according to Bloomberg , “The experience of the marketplace this past week is going to be indicative of this entire year. We’re going to be in a world of much greater volatility.”
This came on the heels of Goldman’s chief strategist, David Kostin, saying two weeks ago that market valuations are “lofty by almost any measure.”
But the real outlier came from Dr. Doom himself, NYU professor and head of Roubini Global Economics, Nouriel Roubini. Roubini seized on yet another global issue, tweeting:
@ Nouriel: “Japan-China war of words goes ballistic in Davos” and “A black swan in the form of a war between China & Japan?” along with various comments on the emerging market issues, saying, “Argentina currency crisis & contagion to other EM – on top of weak China PMI – suggests that some emerging markets are still fragile.”
The China/Japan “conflict” story was the shocker, and apparently goes back to some comments allegedly made by Japanese Prime Minister Shinzo Abewhich compared China/Japan tensions to those found between Germany and Britain prior to World War I. (CNBC) In an interview with Business Insider, Roubini called the events of last week “a mini perfect storm,” alluding to“weak data in China, fresh currency market turmoil in Argentina, and a worsening chaotic situation in the Ukraine.”
It is a bit amusing to note that while Mr. Roubini was serving on several panels at Davos, giving press interviews, and tweeting non-stop, he also found time (or one of his associates did) to post a ranking of “top Tweeters” from the World Economic Forum, showing himself in 5th place. (See Twitter imagehere.)
Let’s take a very quick look at a few of the other notable quotes from newsmakers this week:
–“I don’t think it (marijuana) is more dangerous than alcohol.” –President Obama in a New Yorker interview published last Sunday. The remark created a firestorm of controversy, including reportedly negative feedback from DEA Administrator Michele M. Leonhart and many others. (Huffington Post)
–Apple is “one of the biggest ‘no-brainers’ we have seen in five decades of successful investing.” –Fund manager and legendary investor Carl Icahn, in continuing to tout AAPL’s undervaluation and push for stock buybacks by the company. Forbes also noted that Icahn grabbed headlines last week for now getting involved with eBay and urging a spinoff of its PayPal holding.
–“Gross: PIMCO’s fully engaged. Batteries 110% charged. I’m ready to go for another 40 years” –PIMCO’s Bill Gross tweeting after the highly visible and speculation-provoking departure of Mohamed El-Erian. Mr. El-Erian reportedly said in a letter to PIMCO employees, “The decision to step down from PIMCO was not an easy one.”
–“It’s a very juicy target.” –Andrew Kuchins, Russia Program Director for CSIS, in commenting on the terrorist threats at the Sochi Olympics and the need for extensive security and preparedness planning. (USA Today)
–“It’s so easy to enter, a caveman could do it.” –Warren Buffett, a bit jokingly, in announcing his company’s sponsorship of a $1 billion March Madness challenge along with Quicken. (Fox Sports) The simple idea is that an absolutely perfect bracket will produce the billion-dollar winner, but the offer includes also some twenty $100,000 winners for the best, if imperfect, brackets. There is also a charity angle, but at something like 1 in 9.2 quintillion odds (we have seen varying estimates all over the place) Berkshire is likely not facing too much risk here.
–“A lot of people got dead in that one.” –retired NYC detective and now security consultant/media celebrity Bo Dietl on the Don Imus program, commenting on the history of the Lufthansa “Goodfellas” robbery and this week’s arrests in the case.
–And in another high profile criminal case, famed lawyer Roy Black said of client Justin Bieber, “I’m not going to make any comments about the case except to say Mr. Bieber has been released on bond and we agreed that the standard bail would apply in this case.” (CBS Miami)
–“We’ve lost some of our consumer relevance.” –McDonald’s CEO Don Thompson in a call after client traffic comps greatly disappointed in the recent earnings release. This was the flipside of Netflix, which surged dramatically after their latest numbers and user figures, with NFLX stock up some 17% despite the terrible market week.
–“We believe POS malware will continue to grow.”–The FBI in a statement on the troubling hacking of Target and other retailers, which was revealed in far greater detail this week, including the hacking intrusion of Neiman Marcus. (Yahoo)
–“It was so awesome!” –ESPN reporter Erin Andrews, in a slightly hard to believe remark on the antics of Seattle defensive back Richard Sherman after last week’s NFC title game. Her initial real-time reaction to the interview seemed at odds with that statement, as she stood in utter disbelief in the post-game situation. (seattlepi.com)
Let’s close it out there, as all eyes will be on the opening of foreign equity markets tonight and the U.S. futures trading. Well, maybe not all eyes, as the Grammy Awards also kicks off this evening. But the really big event of the week will be President Obama’s State of the Union address Tuesday evening. Presidential senior adviser Dan Pfeiffer predicted in an email of the upcoming SOTU address, according to Bloomberg:
Pfeiffer: ‘Three words sum up the president’s message on Tuesday night: opportunity, action, and optimism. The core idea is as American as they come: If you work hard and play by the rules, you should have the opportunity to succeed.’ While Obama ‘will seek out as many opportunities as possible to work with Congress in a bipartisan way,’ Pfeiffer said he ‘will not wait for Congress’ to act on some of his goals.’
Have a good week!
I want to apologize for this space being blank for quite some time. I actually spent the bulk of the last two days on a long blog post about the “Dr. V.” story in Grantland. But then I got all the way to the end, and realized I was completely wrong about the entire thing.
So, I spiked my own piece. Now I’ve been in Talk Radio-style “This is totally dead air, Barry” territory for about two weeks. I could swear I saw a cobweb when I logged on this morning.
So thank God for Neel Kashkari, and the news that this goofball footnote caricature of the bailout era has decided to run for Governor of California. Never in history has there been an easier subject for a blog post.
If you don’t remember Kashkari’s name, you might be excused – he was actually better known, in his 15 minutes of fame five years ago, as “The 35 year-old dingbat from Goldman someone put in charge of handing out $700 billion bailout dollars.”
Now you remember. That guy! Neel Kashkari when he first entered the world of politics was a line item, usually the last entry in a list of ex-Goldman employees handed prominent government and/or regulatory positions, as in, “. . . and, lastly, Neel Kashkari, the heretofore unknown Goldman banker put in charge of the TARP bailout program . . .”
Kashkari was not just a former Goldman banker handed a high government post – he was a former Goldman banker handed a high government post by a former Goldman banker, in this case former Goldman CEO and then-Treasury Secretary Hank Paulson.
Neel was also the human parallel to the original TARP proposal written by Paulson, which was famously just three pages long.
Paulson’s TARP proposal was essentially the last, unaired episode of Beavis and Butthead,with the three pages of script just containing a single scene in which Butthead walks into the U.S. Senate and says, “Can you, uh, like, give us 700 billion dollars? Uh-huh-huh.”
Kashkari then was more or less an equally blank slate, a little-known tech banker from Goldman’s San Francisco office who somehow ended up being Paulson’s choice to administer a bailout that Paulson wanted to feature no oversight whatsoever. The original three-page proposal specified no review “by any court of law or any administrative agency.”
It never came to that, not exactly – Paulson had to expand his three-page proposal – but it’s worth remembering now that the Treasury’s original plan for the bailout was to give literally unlimited powers to distribute $700 billion of taxpayer money to a low-level banker that prior to 2006, even Hank Paulson had never heard of.
So Kashkari takes the job as bailout czar and starts hurling fistfuls of cash at the banks, in a fashion that turned out later to have been beyond haphazard. Critically, even though the Treasury promised only to give out TARP funds to institutions that were “healthy” and “viable,” Kashkari had no protocol in place to even decide whether a bailout recipient was solvent or not.
They forked over billions in cash to failing institutions and then failed to enforce crucial provisions, like for instance measures put in place to prevent executives from bailout-out companies from giving themselves huge bonuses.
This latter failure was what led to one of Kashkari’s more infamous public appearances, in which Maryland congressman Elijah Cummings raked Kashkari over the coals for allowing AIG executives to give themselves $503 million in bonuses. “I wouldn’t want to be asking my friend for some money to stay afloat,” hissed Cummings. “Then my friend, who can barely afford to go to McDonald’s, sees me in a restaurant costing $150 a meal. There’s absolutely something wrong with that picture!” He added:
I’m just wondering how you feel about an AIG giving $503 million worth of bonuses on the one hand, and accepting $154 billion from hard-working taxpayers. You know, because I’m trying to make sure you get it. What really bothers me is all these other people who are lined up. They say, well, is Kashkari a chump?
After this “chump” episode, and others, Kashkari apparently became despondent. He and his wife reportedly were particularly upset by a snickering item in Gawker. The item read, “Financial Crisis Taking a Toll on Our Favorite Asshole Banker,” and made the neatly cruel observation that that Kashkari, who was a fit/lean/bald banker of Paulsonian persuasion when he arrived in Washington, had begun “putting on classic stress-related weight under his chin.”
The item featured before and after photos. The “after” photo was shot from just below chin level. It was brutal.
Now, a lot of people have been ripped in Gawker. I think everyone with a Q rating above 0.00003 has been ripped in Gawker. I personally remember having to Google-image Peter Beinart because Gawker described me as looking like the computer-generated love child of Beinart and Ashton Kutcher. It’s an Internet-age rite of passage and they give great service – I mean, Gawker’s insults are almost always really good. Probably most people who get ripped on the site flip out at first, and then laugh about it later.
Not Kashkari. He was so mortified by items like the Gawker bit that he literally disappeared into the woods like Ted Kaczynski and committed himself to a vengefully ascetic fitness regimen, apparently determined to return someday to society and have the last word.
This is not a joke. The Washington Post actually tracked Kashkari down in the woods after the bailouts. They photographed the tiny shed he’d built for himself in Nevada County, California. They were shown the incredible list-of-things-to-do he’d written on his way out of Washington. I have to keep repeating this, but this isn’t a joke:
1. buy shed
2. chop wood
3. lose twenty pounds
4. help with Hank’s book
The Post was then invited to watch as Kashkari lived out his hilarious homage to Rocky IV,getting in shape by his lonesome in the woods, fiercely splitting log after log with an ax, recalling a past slight with each blow:
Kashkari raises his ax.
“It felt like I got jumped.”
“Like three guys beat the crap out of me.”
The massive block of sugar pine breaks, the crack bouncing off the mountain.
Kashkari is recalling his testimony before Congress, while splitting logs to feed the stove for the winter. He is down to his last two chain-sawed trees.
“Members of Congress will tell you they agree with you, and then in public they blast you. I understand their anger, but the playing at politics when so much was at stake — ”
Whack. The ax blade flies off its wooden handle.
After enough of this, there was no more stress-related neck-jelly, no sir!
Kashkari, in shape again, soon-re-entered the finance world, taking a high-profile job with the bond fund PIMCO, run by notorious Wall Street insider Bill Gross.
The new choice of employer was significant because as numerous critics havesubsequently pointed out, PIMCO was one of the major beneficiaries of the government’s rescue of Wall Street. In December 2008, the Fed hired PIMCO to be one of four investment firms put in charge of managing a Fed program to buy up the toxic mortgage-backed securities that were threatening to tank the economy at the time.
Gross, at the time, warned that the government would have to “open up the balance sheet of the U.S. Treasury” (i.e. the state would need to cough up taxpayer money) in order to prevent “continuing asset and debt liquidation” (to prevent Wall Street jerks from being blown up by their own bad bets). Conveniently, Bill Gross and PIMCO happened to be sitting on $500 million of mortgage-backed holdings at the time. Which meant, as Babson College professor Peter Cohan put it:
Bill Gross, who manages $830 billion, has convinced the U.S. Treasury to use your taxpayer dollars to bail him out of his bad investments.
So Neel Kashkari was the administrator of the biggest corporate welfare program in history, took shit for it (“Beating on the Hill,” he would pencil for certain times in his calendar), went into the wilderness to get his mind and body right after the experience, then re-emerged to take a high-paying job with a company that was a significant beneficiary of government largesse.
While at PIMCO, Kashkari dipped a little toe in the lake of politics once again by penning aneditorial for the Post (“No more me-first mentality on entitlements,” July, 2010) denouncing government aid programs. He argued – and again, this is no more a joke than the Rocky-IV-cabin-in-the-woods thing was – that even though we have an economy successfully founded on self-interest, accepting government benefits, by which one assumes he means things like Medicare, is the wrong kind of selfish:
Our belief in free markets is founded on the idea that each individual acting in his or her self-interest will lead to a superior outcome for the whole. The financial crisis has reminded us that free markets are not perfect — but they do allocate capital better than any other system we know. A “me first” mentality usually makes markets more efficient.
But this “me first” mentality can also lead to shortsighted political decision making . . .
Kashkari’s solution? People who accept government benefits should take the long view and just say no:
Cutting entitlement spending requires us to think beyond what is in our own immediate self-interest. But it also runs against our sense of fairness: We have, after all, paid for entitlements for earlier generations. Is it now fair to cut my benefits? No, it isn’t. But if we don’t focus on our collective good, all of us will suffer.
Again, this came from a guy who handed out hundreds of billions of dollars of welfare to Wall Street companies, effectively subsidizing the massive compensation packages of Wall Street executives. This same person then went to work for a company that got a fat government contract to help other Wall Street investors unload their bonehead investments on the taxpayer.
Then, after all that rescue money disappeared, Kashkari made the interesting observation that there was not enough left over to pay benefits for other people. So, he effectively said to Americans on benefits, stop being so selfish. Tighten your belts. All of us will suffer otherwise.
This is the person who has now decided to run for Governor of California. It seems Jerry Brown has become his own personal Dolph Lundgren. A friend of mine sent me the news by email and suggested I say nothing at all about his decision, other than to post the headline above the following clip:
Kashkari’s platform seems to be centered around restoring jobs and schools, but also seems targeted at waste – he called Jerry Brown’s $68 billion high-speed rail project a “crazy train” and said it reflected “misplaced priorities.”
Humorously, and predictably, Kashkari’s campaign has already sprouted serious leaks. It turns out he has a somewhat spotty voting record (I do, too, to be honest, but I’m not running for governor), and he’s already had to acknowledge publicly that he has not always voted – although, he says, “I believe voting is very important.”
The Kashkari story is a perfect little allegory about the arrogance and cluelessness of the people who run the American economy. Kashkari talks passionately about free markets, forgetting that he was the individual who was actually in charge of the biggest-in-American-history government program to subvert the free market, bailing out countless institutions that should otherwise have gone out of business due to their own incompetence and corruption.
He talks about how the “free markets” allocate capital better than any system we have, but then again he was the person who had to step in when that system failed and institute a different system of capital allocation, one in which public treasure was unorganically re-allocated from taxpayers to private companies. His complaints about “misplaced priorities” are almost beneath comment – there’s just not much to say about someone who committed public funds to million-dollar bonuses but believes regular people accepting government benefits have a “me-first” mentality.
Anyway, having this guy run for public office is like a gift from the blogging gods. How funny will this get? Will this one go to 11? I’m taking the over.