Thursday, June 25, 2009


In the heat of battle
It seems that everyone has forgotten how weak and troubled the economy was at the time Bernanke was active in this BofA-Merrill Lynch deal. Concerns by the Fed that you can't wind the clock back and that invoking MAC ( Material Adverse Clause) to kill the ML deal are prescient points that the Fed clearly understood even in the heat of the crisis.

Conditional 'threats'
A conditional threat from the Fed that if Lewis invoked MAC and got in trouble he would be dispatched along with his board does not seem very controversial to me. If invoking the MAC destabilized BofA after the Fed warned it not to do that, the Fed would be remiss to do anything less than to remove Lewis and his board. Lewis may not have thought the 'conditional part' of that 'threat' was important and may have been threatened by that statement, thinking it meant more than it did.

Speculation about truth and motive
That, of course, is speculation. But we can spend time asking 'who is lying' or in trying to understand if the things that were said were misunderstood or taken out of context. Congress is not trying to understand but it is trying to use any inconsistency or seeming inconsistency that it can find to justify the belief of a cover up or of malfeasance. This is largely because much of the public is angry over the money spent and Congress approved TARP whose funds were disbursed by treasury, not by the Fed. One way for Congress to protect itself is to show that THE FED or someone else hid its actions or helped TARP funds to be used in a manner that seems inappropriate.

Shoo-bee-do diligence
It was CLEAR to outsiders at the time that BofA did not have time for any thorough due diligence ahead of its offer for ML Without knowing any details it is clear that given the complexity of ML and its assets there was not time for any appropriate detailed due diligence by BoA in the time it took to say 'yes' to ML. In short Lewis jumped the gun on his ML offer and then had buyer's remorse. That remorse would have had clear severe market consequences had it invoked MAC. Moreover, there is a lot of controversy about whether the grounds to invoke MAC were really in existence.

Witch hunt meets selective recall
While Congressmen are hopped up about this I don't see the issue other than their being on witch hunt to find that someone is lying. It is possible that no one is lying but that the issues were so complex and tempers so high at points that people distorted the important details of the things that they heard and did not like.

Be careful what you EMAIL!!!
If it was never clear to you before it should be clear to you (and Jeff Lacker) that you should be very careful about what you put in an email. Lacker's recounting of a conversation he had with Bernanke (which may not be perfect recall) has become allowable information even though, in law, hearsay is not allowed. Lacker's recollection is now an email and has its own standing.

Bernanke never has been a Chairman who has ruled with ego. He is not Allan Greenspan. He is not Larry Summers. We could NOT have had a better chairman for these times. He has been collegial and inclusive. The sorts of actions Congressmen are grilling him about refer to the kinds of characteristics we have never seen from him.

Japanese lunch box regulation
It is clear in listening closely to Bernanke that one of the issues is that different regulators had different issues. The FDIC did not like the ML/BoA combination because it did not want to be on the hook for any of Merrill's assets that might yet go bad after the combination. There also are some questions about the Fed and its timing in providing information to the SEC. It is not surprising that the Fed did want the SEC any more inside the loop than it had to be since it would be one more complication in an already tangled situation. For its part Bernanke says it did obey the law in terms of releasing information in the timely manner the statures require.

The beat goes on...and on...and on
As I post this, the beat (or beating) goes on. If ever there was a reason to see why a new master regulator is required it is the revelation of all this internecine fighting or positioning in the midst of a real crisis. It does not seem that it was fighting by dueling egos but by regulators protecting and pursuing their different mandates. At one point a Congresswoman said to Bernanke you are all one government... But the FBI and CIA and local law enforcement do not always cooperate. Why should bank regulators? We need to change the laws and make someone responsible.

Monday, June 22, 2009

What not to expect from the Fed

About two weeks ago there were concerns of too much growth in the US coming on stream too fast. Stock prices were up sharply and on a tear. Oil was moving up over $70/bbl and, as the Fed meeting approached, bond yields had spiked up. In looking for a way to stop the rise in long term yields and the threat they posed to the burgeoning recovery, some have suggested that the Fed would add some language to its statement at the meeting this week suggesting it would be some time before its rates would rise in order to calm markets.

But would that calm markets?

One thing we can be sure of is that the Fed will make no promise it can't keep. The Fed will not make any promises on how long it will be before it hikes rates.

The Fed might state that because of the size of the GDP gap it will be able to keep rates accommodative (or low) for a long time. But there will be no pledge not to hike rates.

The Fed knows it must implement a correct monetary policy and on top of that it might have to take some steps to salve the bond market. Ironically the Fed may have to raise the Fed funds rate before it wants in order to keep long term rates in check if the bond market is spooked by stronger than expected growth in the economy. That is a major complication.

But more to the point is the new development in markets: the factors that set all of this speculation in train have diminished and reversed in the past two weeks. US equity market indices are falling. US treasury yields have declined. Oil prices have tumbled back below $70/bbl. Economic data continue to show progress. But the sense of emergency is past.

It would not be surprising for the Fed to just put that tempest in a tea pot behind it and do nothing new at the upcoming meeting. No longer are any Fed words of solace needed.

Wednesday, June 17, 2009


The new sexy bet in financial market is on inflation, but I don't get it.

Neither will we.

The bond market vigilantes are back. They will send rates spiking if inflation rises and that will stop growth cold. I'm not arguing that infation can't start, but it certainly can't flourish. It's a new world.

Bettors on inflation need to to explain to me how the rate of change in prices can sneak past the bond market. I don't think it can be done. Markets are vigilent. Inflation is not just about the Fed.

To get inflation you need more than just the Fed making mistakes and that is an important new ingredient.

Inflation: you can't get there from here.

Tuesday, June 16, 2009

Meltzer in the WSJ on the Fed as regulator and more

Meltzer Article

In his WSJ commentary Allan Metlter mostly is critical of the Fed and of its performance as a regulator. He is clearly in that group that is not happy to see the Fed emerge from the New Obama plan with more powers, as seems to be the case.

Meltzer is critical of the Fed on the record. Others are critical of the fact that should the Fed get this job its mission will be diverted and its attention will be split between regulating and making monetary policy. Still others argue that the Fed did not see this coming and should not be rewarded with more power. But no regulator did see it coming. By that standard the comprehensive regulator should be something altogether new. Having an untested agency does seem like a good idea to me.

Meltzer is critical of the past. Under Alan Greenspan the Fed was not aggressive. But that was Greenspan's leadership, not the Fed bureaucracy. Greenspan was the classic regulator who did not believe in regulating. He was the problem, not the Fed. The Fed, viewed as an institution, spotted some of the bank problems and sent requests for action up the line. Greenspan blocked the Fed from taking action. That's a personality/ideology problem not an institutional problem. . To me it suggests that the Fed has hope. Obviously having a leader with the right instinct matters. Under Greenspan, the Fed did not. But the SEC did not get it and neither did other regulators. The Fed at least comes close. Politics intervened, rearing its ugly head in the the house financial services committee. There members urged more of the sort practices that ultimately became toxic in an effort to spread the housing miracle to everyone. That is an argument for keeping the politicians out of it. I still am not sure if some of the state/federal conflicts are being handled. Some mortgage brokers used to engage in illegal activities then fall back across state lines and open for business again. Has this loop-hole been closed?

Meltzer blames the Fed for dawdling and for the $150 bln in losses in the thrift crisis in 1980-1982. That seems disingenuous. Those losses came about because of monetary policy mistakes coupled with interest rate ceilings. When those rate ceilings were taken off banks and thrifts had low yield assets on their books. When the Fed shftied to new operating procedures in October of 1979, that drove rates to 20%. Banks were caught in a no-win situation. If that was the Fed's fault it was not the fault of the Fed as regulator. For a bank that thought an 8% yielding asset was a good one, the Fed's monetary policy move was a disaster as rates moved up and stayed up.
The thrift crisis was compounded by the Fed as regulator when it gave thrifts powers to execute C&I loans when even though they had no experience with that sort of lending. Banks that already were on death's doorstep were all but encouraged to play the game of moral hazard otherwise known as double or nothing.

Meltzer also is concerned and critical of teh Fed for not having a policy on closing banks. When banks get in trouble they do not know what to expect. The Fed in fact does not close many of them. Small banks are closed all the time by the FDIC. The Fed is more reluctant. It is good about enforcing the rules but bad at deciding what to do when a large bank is tottering. More often than not the Fed's prescription is that its Merger Time.

Even so I don't think any of that history disqualifies the Fed. Large banks are not small bank sand they bring different problems to the table. The failure of the investment bank Lehman Bros. must have made that clear.

There is no panacea to this problem. There may not be a 'right' answer as much as there are different ways to play it and different risks to take. The Fed proved itself historically to have been a bit lenient toward banks. But it's not clear that the Fed, armed with a broader mandate would be the same sort of regulator as it once was. Some politicians have a preference for putting the risk assessment center at Treasury directly where there is both political accountability and the greater potential for political meddling.

As a matter of logic it seems to me that someone will do this job. If the job is put under the Fed's purview is it any different than if it is put anywhere else? Could Bernanke have a second under him who is mainly concerned with matters of regulation? Why would such a thing have to interfere with making monetary policy? Arguably, knowing more about the regulatory picture could make the Fed better at monetary policy. But heaping more duties on a quasi-governmental organization has its costs and risks too. While many like the Fed for its independence, when it starts shutting banks down, the first to squeal are the politicians themselves. Does than man that they would have meddled?

The whole thing is a slippery slope. Whoever becomes the super regulator he will need to close the loopholes and the gaps between regulators that used to exist and deal with the threat from derivatives. We need to get away from regulatory competition. And we need to do better job than we have to date. That is true of the banking committees with their oversight responsibilities and all regulators of any sort. It would help if financial managers did a better job too.

Sunday, June 14, 2009

Could it be inflation??? Or, are the vigilantes vigilant?

This week puts the BIG monthly inflation reports on tap. Do we care?

The answer is yes we do since oil prices are flaring and in the U of M report inflation began to raise people's hackles a tad. And if we care about markets we care about inflation now. But is it possible that we will get inflation or will we just worry about it?

Ken Rogoff and Greg Mankiw think we should have some inflation: inflation is your friend (a little inflation is your friend anyway). In late May these economists suggested that a little bit of inflation is just what the economy needed. The trouble is, as you can tell from the reaction in the treasury market, you can't get there from here. see number 22 for the 'inflation is our friend' skit.

Academics have the wrong model for interest rate determination in the economy. It may have worked the way they think at one point, but not any more. The market determines long term rates and while those rates are affected by short terms rates it is better to think of market expectations as setting long rates than to think of long rates as cozying up from some Fed funds rate target.

Under the belief that the Fed sets the level of rates it is possible to get the central bank purposefully or through an error in judgment creating inflation as markets, too, dumbly go along and don't spread long rates high enough over a too-low too long funds rate to forestall inflation. Models based on that sort of process are the main models for interest rate determination.

But once we admit that the market controls long rates the Fed's ability to create inflation is called to question. This is the reality I see and why I think Rogoff and Mankiw are promoting an idea whose time will never come: you can't get there from here. Oh the Fed can expand reserves and money supply can grow like crazy but if markets see it happening (and they would, of course), long yields would rise and that would choke off any growth sending the economy into recession instead of into inflation.

Of course, the bond market isn't perfect, either. But it is a second independent check on the inflation process. Of course we have had inflation even with the bond market and the Fed. But since the late 1970s and the removal of interest rate ceilings and since the experience with inflation in the 1970s and with stopping it in the 1980s markets have come alive with inflation fear. Sine then we have not seen inflation- real core inflation- get any traction. We have seen oil pump up the headline but nothing more.

In the 1980s this fear was called the reaction of the bond market vigilantes. A vigilante is someone who takes the law into his own hands and that is exactly what the bond market has done. But in this case the action implies no lawlessness. The bond market does not do this by wresting control of the printing presses from Fed but by autonomously setting the level for long term rates- without regard for the level of the Fed funds rate. The bond market has not let the Fed be solely responsible for inflation for some time. If the Fed's policies get to be what the bond market considers to be namby-pamby the vigilantes take over.

Of course it is not exactly correct to say that the bond market puts the long rates where it wants them regardless of the Fed funds rate. Rather the market assess if the Funds rate is too high or too long and deviates from its preferred level accordingly.

In any event my view is that inflation is just not happening. Markets are too wary, too closely watching the Fed, and in this environment the idea of having a little more inflation just is not going to fly.

This week's inflation reports are important but no one I know is betting on core inflation doing much of anything. We have seen oil prices spurt and jump-start headline inflation and we know where that goes. It doesn't mean the core goes along. So remember that the thing to watch is not the headline unless you want to bet on some short term market overreaction.

We know that markets are good at that. They can overreact like no nobody's business. I don't think that means we will see $150/bbl oil again soon but we could see something uncomfortable to start the inflation headline going and to spur the bond market on to higher yields. That is the real risk. That's much more real that than the risk of a lasting inflation.

Sunday, June 7, 2009

Reply to inquiry...

I received the email  below in reference to a quote of mine, not to a posting on this site. Still, it is a question of some common import I believe, so let me respond:

Mr Brusca you are quoted in the BCC as refering to the latest labor figures as the "Jolly Green Giant". I am wondering if you have looked at the report in detail as my brief analysis, considering only NFP total employed and average work week indicates that the May figures are worse than April's, which was a blip and also worse than March. In other words the May figures indicate a return to the earlier trend and do not even indicate a flattening of the decrease. The reduced drop in job loss is more than compensated for by the reduced average working week i.e. companies are reducing the working week rather than laying off people but the overall situation is still getting worse ? 

Several points are germane. 

First, I always look at report in detail before I comment on it. I look at the employment report each month in uncommon detail. So please... my comment is not uninformed just because it seems curious to you... I have processed the data through about six spread sheets with more charts tables and analytics than you can shake a stick at.  Let's see what's there: 

First let me point out that the FACTS: nonfarm job losses were 345K in May, 504K in April and 652K in March. Since these are job losses, employment LEVELS are progressively declining. I do not know what the emailer means when He/She says the pace of decline is slowing since the change in the change (345K-504K) in May was 159K compared to 148K for the month before. That shows that the pace of job loss is slowing. So I think our emailer has at least one critical fact wrong. It is true that in the household survey jobs actually ROSE in April then FELL in May but that is a very volatile survey (about 50% MORE volatile than the payroll survey month-to-month)  and if we smooth it, the Household survey is showing the same trends -almost exactly -- as the nonfarm report. So, let's set aside the household report, that is just plain confusing.   

The economy
Think of the economy as a car. If you miss your turn you will continue on the wrong path until you realize it. When you realize it, you will not change directions instantly or you will be part of a multi-car pile up. You will slow your progress in the wrong direction, stop and turn around to re-trace your steps to get back to where you should be. Correction is a process.  

Once you realize your error you actually are on the path to correcting your problem even if for a few blocks you continue to go 'the wrong way.' The same is true of the economy.  

Once the economy begins to shift gears, to reverse from recessionary decline to recovery, it will continue to shed jobs for a time. But it will shed them at a slower pace. Eventually it will stop shedding them and start adding them. We will not call recession over until ECONOMIC GROWTH IS POSITIVE but in the past that has sometimes happened with JOBS still declining. 

When economists look at the May jobs report, we look at the change in jobs created/lost not at the level of employment. Yes May shed nonfarm jobs and employment levels in May were 'worse than'  in April, where 'worse' means 'lower'. But the month to month decline was less in May than in April and tha is very, very good.  Indeed, the pace of job loss in May was half that in January. This is very GOOD NEWS.  

Economics is not tennis you do not take a ball going 100MPH in one direction and switch it to 100MPH in the other direction in the blink of an eye. 

As to the monthly job numbers, you must look at job changes by month, not at levels of employment or you are getting the wrong picture. Are we still in recession? Yes. But we can see the extent of repair and that is progress. That's the point.  

As to the drop in hours-worked: 'hours-worked' is not the best cyclical diagnostic for the economy. Hours are very flexible but hiring people represents a commitment. Since 1969 hours-worked (the effect of people at work plus the length of the work week, sometimes called man-hours) declined at the end of recession (long recessions or or short recessions , all mixed together) at an average of 6.6% counting from the start of the recession. Job losses alone averaged a decline of 3.3%.  That means in the average recession losses in hours-worked are more or less equally shared between job reduction and a reduction in the length of the work week. But, in this recession, counting from the recession start, jobs have fallen by 5.4% and hours worked have contracted by 'just' 7.5%. So the length of the work week did not fall by as much jobs did. Employment (unemployment) bore more of the brunt of cut backs than what is normal: nearly three quarters as much (72%) instead of half (50%). In the severe recession of 1981-82 jobs fell by 3.5% accounting for 60% of the hours-worked decline. So this isn't simply a feature of severe recessions.  

In this recession/recovery we would expect jobs to come back first since they have declined by so much more. In fact the jobs signal is a very reliable signal for when recessions start and end. The coincident economic index, after all, uses JOBS not hours-worked as its current job market measure. 

Also note that the rise in the rate of unemployment increased as job losses lessened. That is 'peculiar.' The unemployment rate is rising now MORE because of an expansion of the labor force than because of more people getting laid off. That is a good sign because people coming into the labor force are looking for jobs and typically they don't look if prospects are grim (remember these are the folks we called 'discouraged workers' in the pit of the recession.) Now they see that job hunting might pay off so they are spending time looking. Even though jobs are declining on a net basis, remember that the job market is very dynamic and in fact there is a lot of hiring/firing each month. So while people are still getting let go on a net basis it seems that hiring has picked up- but we do not yet have data to know if that is true. That sort of report lags. 

But do note that the improvement month to month in job losses was about 150K with losses trimmed to about 350K per month. If the pace of loss abates by 150K per month, after two months job loses will be down to nearly zero and after one more month we will have gains - that means we could ahve job gains in THREE month's time or by  by AUGUST!  

So when you take in the economic data be careful to look at the TRENDS. If May is really worse than April why would we be looking to job gains by August? The headlines -unfortunately -often are written by people with a political purposes or naive in their economic training. I don't want anyone to think recession is recovery nor do I want anyone to by-pass the sense of STRONG PROGRESS in the past two jobs reports.   

Unfortunately since we have two job reports, a household and payroll report, some cut through the 'confusion' to look at the rate of unemployment which seems straight-forward.  Unfortuantely it is not. Sometimes a higher rate of unemployment is the result of more economic activty, as is true this month. Labor force participation rates are rising and that is good even if it leaves more people unemployed at first. That's because a person looking for a job is more likely to get one than one who does not look. 

I was and am critical of the stimulus package adopted so don't take this note as cheerleading for Team Obama..  That package with its stimulus back-loaded is totally different from what the economy is doing. I'm not sure the stimulus package has much to do with this economic improvement but you can bet dollars to donuts who will take credit. That's the way politics work.

This is a typical end of recession dynamic. Deep long recessions tend to produce strong initial recoveries. We seem to be headed there.

Although economists do think that 'hours worked' is the superior statistic to jobs alone in order to gauge economic activity it is not the best statistic at all times.  At the end of recession you look for the best 'indicator' for growth per se and that is jobs, not hours-worked.

So I say there is a sighting of not just green shoots but of the Jolly Green Giant because he plants and grows things on a widespread basis. We are headed for recovery and headed there pretty fast. Typically in recoveries the pace of progress steps up sharply. We are getting beyond simple 'green shoots.'

That is my response. I hope the anonymous emailer and others find the reply useful.


Saturday, June 6, 2009

Six degrees of separation...or less


Epilogue on interest rate paths, possibilities & consequences

So where should rates be? The Fed has Fed funds pinned near zero. The 10-Year note has a one-way ticket to 4%. But pushing term rates up will push mortgage rates up and the housing sector down and, well, there we go again. This is the ‘everything is connected to everything else’ view or the ‘six degrees of separation’ rule of economics. Bonds are close to being oversold. They probably are above ‘true value’ but not far enough to create a backlash. That will happen above 4%.  We are getting there. The debt levels in his economy and mortgage financing needs of this economy simply will not let rates drift much higher and that is the problem for those with inflationist beliefs. Were the Fed to mis-step and were inflation to rise, TERM interest rates would rise (as they are now without the Fed moving) and that would eventually choke-off inflation EVEN IF THE FED DID NOTHING by crashing the economy first. The issue to wrap your mind around here is that the economy’s structure with so much debt and so much financial fragility will not let inflation rise. So many argue the opposite that there is an incentive to inflate debt away. There is that incentive; there always is. But there is no way to do it. The bond market would not stand for it. The economy would crash first.  Because we have a vigilant bond market, inflation is a false worry. Insufficient growth is a real worry. And this analysis is from a guy who thinks the economy is about to grow strongly over the next four quarters or so. The problem is four quarters will not be enough… and if the reality of some strong growth spooks bonds too badly we might not even get four.