Wednesday, January 28, 2009

Mini max mini max mini max mini max


When it is hard to decide what to do, studies find that businesses often pursue what is called a mini-max strategy. While economics looks at transactors as maximizing agents that maximize things (income, output, utility, etc), min-max refers to a totally different way of acting. It refers to businesses making decisions under uncertainty so that if they make the wrong decision they minimize the damage that would come from that. Hence the term mini-max.

With that as background we can look at the Fed statement with what I believe is a fresh eye. The Fed does not simply do things based on forecasts. The Fed has to weigh and balance risks and scenarios as well. It is further aware that what it does today will affect events down the road since monetary policy works with a lag. It is also aware that what it does as well as what it says it does and how it says it will do it all have some impact on the markets. Welcome to the land of sophistication, if not sophistry.

The Fed undoubtedly uses the mini-max strategy too, since it may have a forecast but it can't be sure it is right. The Fed statement had several examples of that sort of complexity. The Fed noted that there were significant risks. It said that inflation may be too low for the needs of long term price stability and growth (..." the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term"... ). Yet it also said it expected growth to begin before the end of the year. So the Fed's statement seemed to emphasize certain aspects of its worry but in the end the Fed is forecasting growth.

Its policy statement had references to a lot of remedies. The Fed may be 'forecasting growth' before the end of the year but it is not going to sit back and wait. It is going to implement asset-backed lending. It is going to continue to buy mortgage-backed paper in the markets. And it sounds a bit more serious about buying treasury securities to try to lower long term rates (although I seriously doubt if that would have much impact).

So what we see is the Fed trying to guide our expectations to see growth while doing what it can to help ignite activity. Yet the Fed is still issuing warnings about deflation. I do not fear deflation that much. A lot of fiscal stimulus is on the way and the Fed has cut rates savagely. Its special lending can be augmented whenever it chooses. It seems to have mechanisms in place to spur growth in various ways. Existing home sales did re-start by themselves out West after house prices fell by enough. We have some reason to think that the economy still will work if given the right motivations.

Beyond the Fed
One loose end is the bad bank - and it's a big loose end. There have already been a lot of capital infusions into organizations that took the money and did things the authorities did not like, such as paying retention bonuses, paying ordinary bonuses, spending on CEO office redecoration, and buying new and fancy corporate jets. One problem with the bad bank is that once the government removes the bad assets it losses its ability to influence any decision at that institution. As things stand, if the bank has to continue to work out its problems it is always in the lap of the regulators. And that is one thing banks are trying to avoid. Yet they have not shown much restraint when they have gotten even a modicum of financial freedom.

The bad bank is a final solution of sorts for the assets that the bad bank consumes. But at what price? How many of them does it take? And what subsequent leverage do the authorities have over the bank it has liberated from such an affliction? I think that also needs to be a question that is addressed since this will not be a normal market transaction with both parties mutually satisfied and agreed on a price. This is still a bailout of sorts. We just must make sure that the bad bank does not become the foundation of bad policy.

1 comment:


A lot of m's in the title of the post.