Streetwise Professor

October 22, 2011

No Panaceas

Filed under: Economics,Financial crisis,Financial Crisis II,Politics — The Professor @ 2:22 pm

If you were wondering whether the Fed has run out of ideas, wonder no longer:

Federal Reserve officials are starting to build a case for a new program of buying mortgage-backed securities to boost the ailing economy, though they appear unlikely to move swiftly.

The idea would be to target any new efforts by the central bank at the parts of the economy that are most severely impeding a recovery—the housing and mortgage markets—by working to push down mortgage rates.

Lower mortgage rates, in turn, could encourage more home buying and mortgage-refinancing, and help the economy by freeing up cash for consumers to spend on other goods and services. Mortgage rates are already very low, but some Fed officials believe they might be pushed lower. Moreover, Fed officials believe their past purchase programs helped to lift stock markets, by driving investors from low-risk investments toward riskier investments.

What is it that Einstein said about doing the same thing repeatedly, and expecting a different result?  Now I remember: insanity is what he called it.  The emphasized paragraph suggests that the Fed is ready for the rubber room.

OK.  Don’t look for help from monetary policy.  What about fiscal policy?  Well, today’s WSJ presents a Keynesian lament that Americans’ saving is impeding a recovery:

Since the financial crisis erupted, millions of Americans have ditched their credit cards, accelerated mortgage payments and cut off credit lines that during the good times were used like a bottomless piggybank. Many have resorted to a practice once thought old-fashioned—delaying purchases until they have the cash.

As a result, total household debt—through payment or default—fell by $1.1 trillion, or 8.6%, from mid-2008 through the first half of 2011, according to the Federal Reserve Bank of New York. Auto loan and credit-card balances in August had their biggest drop since April 2010, the Federal Reserve said.

The national belt-tightening, known as deleveraging, comes as the U.S. economy struggles to fend off a double-dip recession. Paying off bills slows consumer spending on appliances, travel and a slew of other products and services. Home sales, the engine of past economic recoveries, remain depressed.

Is it somehow shocking that Americans are trying to rebuild ravaged balance sheets?  Is it shocking that they realized they were overleveraged prior to the financial crisis, and are trying to achieve a more sane level of debt?

This also means that Krugmanesque, Old School Keynesian borrowing solutions are unlikely to work either.  Those solutions depend on leveraging up on behalf of households, but those households can undo–and are likely to undo, given their recent behavior–most of all of that by reducing private leverage in response.  Hair of the leverage dog will not cure the hangover.

Which all means that both fiscal and monetary policies are at dead ends.  There are no quick policy fixes.  Indeed, frenetic attempts to find and implement such fixes are likely to make things worse, not better.

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  1. You are absolutely right that we are not going to lever up and “getting the game going” as per usual. It isn’t gong to happen for many reasons but you are far too kind to the Fed, and our leaders.

    The cyclical swings and expansions under Greenspan (aka WrongWay) brought on the inevitable crash, and the grotesque M1 printings of Bernanke (aka MaxiMe)and the spending by the corruptocrats in Congress followed their Eco 101 rolls to perfection. Now it isn’t working and they haven’t a clue.

    Out of ideas is one thing, but I believe they are failing to recognize a dramatically changed economy in the last year is another.

    A brief history: We seem to be in a pay down mode as far as consumer credit is concerned, but a lot of it in 2009-10 was actually the effect of net charge offs- the monthly charge off numbers were often much larger than the declines in outstanding balances, even after adjusting them for a more normalized rates. And please remember, servicers can lie!

    As regards to “helping” the economy with lower interest rates the help was to the Banks, at least in 2009-10. Essentially there was a race between growing net interest margins due to lower funding costs versus increasing default costs, and the NIM won, barely. Remember this was also a time when something like 800 MM to 1000 MM dollars of CP and MTN’s could not be issued by SIV’s, conduits and the like. and all those smelly assets had to be brought back on balance sheet, along with the fictions needed to support the illusion that we weren’t broke (Level 3 pricing from FASB 157, anyone?). While it was a race that the Banks largely won, now we have moved into a different phase beginning in 2011.

    We have entered into a less dramatic (ex the Eurotards) but more painful period – the time when some good loans begin to go bad, good loans get lower rates, the consumer is adverse or unable to lever and companies have adjusted to lower volume levels and will not hire the incremental worker or buy that asset if they can avoid it. In the CRE market there is not a drip but flood of loans coming due that can only be rewritten on a cash flow basis – at lower rates the loan may be serviced but the LTV isn’t there unless one screws with the cap rate- see the prior sentence. Rental markets are tight in a lot of markets – e.g. NYC where I live – while cap rates of 8-9% are available in the second tier coop market, when evaluated as an alternative to renting. Cap rates on most Multifamily loans are lower. This sort of thing happened a lot in the early Thirties.

    The most telling sign of change is that almost all large bank profit growth this Quarter has come from manipulating Loan loss reserves, asset and debt revaluations and other legerdemain. Spreads are shrinking,Trading volumes are dropping, Dodd Frank is costing, and we have a lot of pressure for the Banks to be more virtuous (don’t charge fees), looser with their lending standards, profitable, conservative, stable and generous: self contradictory goals that we would expect a politician or an OWS clown.

    Recession, great of small, is a stupid way to describe what we are in. We are facing a demographic time bomb when the promises made cannot be paid, and there is no growth to hide it. In other words this is the great liquidation of obligations, rebuilding of balance sheets, de levering, or whatever you wish to call it.

    In honor of the late Alfred Kahn, let’s call what we are in the Great Banana . it will only end when four things happen:

    1. There are no precipitating panics from overseas that scare everyone, and we stop injecting uncertainty into the markets – someone should explain why volatility costs to Barney Frank if they can corner him somewhere – I suggest the Men’s room.
    2. We give up ideas like operation Twist and instead focus on rebuilding personal savings and net worth (as was done in WWII). This also means liquidating the “obligations” we cannot afford.
    3. We try, try to give up the idea of legislating for a “new” problem – in other words constantly injecting uncertainty into an already fraught economy aint helping anyone, and we already have plenty of laws that cover most of the problems we inflicted on ourselves. For example don’t commit a fraud on the Court (robo signing), don’t file a fraudulent loan application, etc. All this does is complicate an already too confusing economy*
    4. Become anti- Keynesian to the point where we shrink the Government or actually get something productive out of it, not just noise and roadblocks. Personal productivity, and human skill sets need to be boosted for things that are actually used – e.g. NOT solar jobs. This means breaking the hold of municipal unions, which are not unions at all but political pressure groups.

    Failure is an option, but not pre ordained.

    * Has anyone here actually read Reg Z or other housing disclosures? They make a red herring prospectus seem lucid.

    Comment by Sotos — October 22, 2011 @ 4:45 pm

  2. Meanwhile, I am getting an average of a credit card offer per week from Citi. What does that say about regulation?

    Comment by Nina — October 22, 2011 @ 8:58 pm

  3. It says nothing about regulation, but it says a lot about the banks’ desperately trolling for assets that earn money. Credit cards are particularly valuable since they escaped the debit card transaction fee fiasco part of FrankenDodd (GREAT NAME SWP!)

    Comment by Sotos — October 23, 2011 @ 10:38 am

  4. “eanwhile, I am getting an average of a credit card offer per week from Citi. What does that say about regulation?” Senor Equis is too, but guaran-dang-tee you they’re all with $1,000 limits, with the idea that they want you to load up 4 or 5 cards with them at 0% instead of just getting one card at a low interest rate with a $10,000-$20,000 limit like in the pre-crash days.

    Comment by Mr. X — October 23, 2011 @ 6:42 pm

  5. “NYC where I live” Sotos, do you know David P. Goldman aka Spengler?

    Comment by Mr. X — October 23, 2011 @ 6:52 pm

  6. @Sotos–I am completely with you on the policy uncertainty issue. The sorcerer’s apprentices run amok, sowing confusion. Ditto the Keynesian stuff (which is a big source of the policy uncertainty). Realistic restructuring of entitlements. But I am pessimistic that the political system will do any of that.

    The ProfessorComment by The Professor — October 23, 2011 @ 9:22 pm

  7. Mr. X, I really can’t believe you asked somebody from NY “do you know so & so?”

    The ProfessorComment by The Professor — October 23, 2011 @ 9:34 pm

  8. Mr. X,

    No, but I would probably like to.

    Comment by Sotos — October 24, 2011 @ 6:27 am

  9. “@Sotos–I am completely with you on the policy uncertainty issue.”


    For instance, the 2008 crash was caused by policy uncertainty created when Obama was a candidate for the presidency. A Democrat competing for political office is simply intolerable to the Market, so it crashed.

    Just like Roosevelt prolonged the Great Depression. The US GNP grew less than 20% between 1933 and 1934. I’m sure the US GNP grew more every single year reagan was in office.

    The length of the Great Depression had nothing to do with the fact that the US GNP dropped fro $103 billion to %56 billion between 1929 and 1933.

    Comment by a — October 24, 2011 @ 6:29 am

  10. Well at least he doesn’t know Phobie (I think). And Moscow is already bigger than NYC and a lot of people know people there. 🙂

    And if you’re reading ZH SWP, I can only imagine that SG Frenchman’s reaction if you’d told him you’re a Ron Paul supporter who wants to End the Fed…

    Comment by Mr. X — October 24, 2011 @ 11:59 am

  11. @a The crash of 2008-10 was the final of a series of escalating crashes going at least as far back as 1994. It wasn’t caused by uncertainty – it was caused by the certainty that a lot of crap in place was not working. The reason we did not enter the great depression is that 1. we didn’t shrink the money supply by 30%, 2. destroy world trade balances with a new Smoot-Hawley, 3. shoved liquidity into the system till it chocked and 4 had a new driver of growth in China that covers about 1/5 of the entire world’s population.

    Actually we are 60% of the way there if we make an honest count of the unemployed – 19 versus 30. Look at the numbers employed versus working age population. But don’t despair, our leaders are working on it and no doubt another crisis will come! Seriously, that is the issue: we are not in a position to take too much more damage and you cannot believe the stupidities being inflicted on us by the Accountant racket via FASB 115, IFRS compliance, etc.

    p.s. if you think uncertainty doesn’t have a cost – explain insurance. Or better yet read up on how volatility (the result of uncertainty) affects option pricing.

    Comment by Sotos — October 24, 2011 @ 2:29 pm

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