Bernanke Obama and Yo’ Mama

Bernanke Obama and Yo’ Mama

This recovery has been very iffy. When times are hard you naturally ask what can the Fed do? What can government do? What about my family? (hence, the title Bernanke, Obama and yo’ Mama).

Out of options? In this cycle I think the Fed is tapped out. The government has fumbled the ball and then, to mix the metaphor, painted itself into a corner. Now it proposes an alternative to a Republican idea, an alternative that even after some thought seems pretty lame. No wonder confidence is slow in forming. It seems pretty clear when all is said and done that policy is dueling it out on a political battlefield not on an economic one. That means the economy is sure to lose out... again.

Why is confidence dropping? Ask yourself this: after everything the Fed and the Administration have done, why is sentiment sinking even as current conditions are improving? Therein lies a story of government that has lost its way and lost control and of a central bank with too much on its plate.

Obama hits rock bottom with Summers:

I recently saw Larry Summers on TV. It’s a bad sign, since Mr Summers is no pitchman. He stood there telling us, or trying to tell us, how much better investment expensing would be than making the Republican tax cuts stick for 10 years when they would send $750bln to the richest of Americans.

Republicans bad! Well, that’s one way to tell the story. But when Larry is talking we know to check our back pockets for our wallets. As usual he has presented us with a glaring and biased view of the trade-offs. Where has intellectual honesty gone? Is anybody stupid enough to believe what he said and take it at face value? I think even partisan Democrats must have choked as they chortled and listened to Larry.

The real deal - In the first place what most people seem to have put on the table is extending the Bush tax cuts for a couple of years not for the ten year period Summers used to inflate the cost. The idea is to extend the cuts until the economy gets on its feet.

The ‘why’ behind extending tax benefits - The reason for this idea is to shield small business from tax hikes. Many small businesses are not incorporated so their owners pay the personal tax rate. This means that if the personal tax rate goes up, the tax on business goes up and that will restrict activity. Congress has known about this for some time and has done nothing to solve the problem. It’s back! A tax hike on high wage earners is one thing; a tax on business is something else. That is what is really at stake and Mr Summers wants to hide that and prefers to sell policy on the basis of ideas rooted in class warfare which can never be good but do get the blood flowing. Summers is a much better economist than political spin-meister but his foray into politics via economics makes him look foolish.

Behind the tax deal - What’s worse is the idea that Summers proposes which is to make all investment spending tax deductible immediately. That would provide tax breaks for investment that responds to a tax incentive plan as well to all the investment that would have occurred anyway. That is a big giveaway. If the plan stimulates a 10% increase in investment spending then 90% of the break is a giveaway. But I guess giving money to big business is more palatable than giving it to ‘rich Americans’ even if some of them are small business owners. When it comes down to it I guess Summers likes capital better than labor. Did capital vote for Obama?

Small help for small business- This investment plan will not help small businesses since they do not invest to get tax breaks if they don’t have business. Large businesses can and do take advantage of such things. In addition there is the problem that a lot of capital investment is labor saving. So what Summers is doing is subsidizing the implementation of capital investment that will substitute for labor. That does not sound very helpful in creating jobs. Moreover, capital equipment is usually very capital intensive in its production. So even if capital goods output is stimulated it will not spur much hiring. The more you look into Summers’ idea, the less attractive it gets.

THE REAL TRADE-OFF- It comes down to this: Give money to rich firms to invest in high-end capital equipment and hope for a trickle of stimulus that will dominate the negative impact of this tax break, or give the tax break to the ‘rich’ knowing some of them are business owners and that a lower tax rate will impact how they manage their firm and deal with issues of economic expansion and hiring.

Different strokes for different folks - Stimulus plans for large well capitalized, well-lawyered up, and fully bureaucratized corporations Vs those for small business are very different things. The Administration does not seem to understand that after all this time. Small business will go with the flow. Large incorporated firms can swim against the current.

Interest rate distortion - Look at Microsoft. This week it announced a bond offering. Why? This firm is loaded with capital, and in the form of extra cash, too. Yet, it has a bond offering. It finds money so cheap it just had to stockpile more. It has no good use for it, but if money is almost free I may as well get some- that’s what they think at Microsoft. If a corporation is huge it can do stock buy backs or something else. At this cost large firms will find some use for the cheap money. A small business never would do that. Not all the corporate borrowing will stimulate jobs some will just dress up the balance sheet.

Rate incentives - More to the point, this behavior shifts our focus to monetary policy. Microsoft, certainly, is not the only firm that finds long term rates very low and very attractive. So if you are on the other side of that trade, say a bank, are you very eager to lend at these rates? I’d say no. It’s one of the reasons I think the Fed is tapped out on policy. Rates are already so low bankers probably do not really want to pile on any more long term fixed rate assets.

Rate disincentives - If a banker makes a 30-Yr loan at a 30-yr fixed rate two ‘bad’ things can happen. The loan can default causing the bank to incur loss. Or, the loan can remain on its books for 30-Yrs causing its investments to underperform. Few expect long term rates to stay this low. All this makes a mockery of the economic theory of the determination of long term interest rates. Banks are dragging their feet in mortgage lending precisely because they are skeptical that rates can stay here for very long. They are being picky about documentation and are setting high standards in terms of credit scores for access to the best rates for mortgage borrowers. In short, they act like they really do not want to do this business. They don’t.

The Truth - Rates that are ‘too low’ will not stimulate the economy, to the extent that demand increases supply pulls back. Low rates may have the opposite impact form what’s intended. As for the Fed’s quantitative easing, if it does not work through interest rates, how does it work? Do we really want another round of the Fed sloshing in reserves hoping they will have some impact on market rates or market spreads? Worsening the excess reserve situation will only make unwinding the process all the harder. If the idea is to stimulate the economy by shifting expectations to see more inflation I’m not sure that is a good route to go. Indeed, at some point too much bloating of the Fed’s balance sheet is not good for the Fed’s reputation or for the dollar. We do not want to flirt with that route. That would be the biggest mistake of all. We did not have such a thing to worry about in the Great Depression Bernanke studied. The dollar is now the principle international reserve asset; it changes the game.

Policy will reveal the Fed’s preferences - What the Fed chooses to do will tell us a lot about what it really thinks. When times get tough, when it is hard to do what is best, it is often best to avoid doing what’s worst. This is the mini-max approach. The aim under this doctrine is to take the path which, if it is wrong, will do the least damage. So what will the Fed do? That will tell us what it really fears. The Fed claims to see the economy doing better. It has cut its outlook but it still sees growth. If the Fed engages in another round of Q-easing we can only conclude that it sees a slippage into a double dip as the most severe risk. If it avoids a second Q–easing we can conclude it believes its own forecast for growth and sees excessive stimulus as the biggest risk. Ironically the more aggressively the Fed behaves the more pessimistic it should make us feel. Since the Fed’s ability to stimulate with quantitative easing is so suspect, it should be reticent about doing something that will trigger negative feedback.

What transparency does - Basically the Fed is stuck making policy in a fish bowl. We can all see what it is doing. We also can assess the impact of what it is doing. When the feedback effect might dominate the stimulus effect, something I believe is true, the Fed should very wary of adopting a new round of stimulus.

Summing up - To sum up, the economy is in recovery. The Fed has cut its view of recovery. Private sector economists have just cut their outlook. Yet, recent economic data have just been showing a bit more upside. We do not know what the Fed thinks will happen or how seriously it fears what ‘might happen.’ But we can infer these thoughts from the Fed’s next move.

The Fork in the road - We do know that there is a deep schism within the Fed. Some members feel their view has been ridden over roughshod. Bernanke keeps testifying that the Fed can do more and is not out of bullets. This is exactly what he should do/say if the Fed is out of bullets and cannot do any more. But at some point we will leave this world of posturing and the Fed will do something. Will it do more stimulus? Or will it try to convince us that it believes the economy really is on the road to recovery? It can’t have it both ways. Its forecast of recovery is undermined by its actions if we get a new Q-easing plan. Withholding a new plan gives the Fed’s forecast of continued growth more credibility. The Fed has reached the fork in the road. It’s time for it to take it.

But which one Yogi?

Goldman Again - a post to please no-one

As I watch the senators grill the Goldman folk I have to say that I am both impressed with the way they have gotten up to speed on the industry and yet displeased about how much they seem yet not to understand. Their lack of understanding is their undoing. I have been listening to this testimony today for over nine hours and I would not describe the questions as targeting the key issues like a laser.

Levin is compulsive about Goldman's large - HUGE short (the absolute size of the short); he is also compulsive about the idea that Goldman 'should' be an advocate of the assets Goldman sells to customers. These are two misguided positions by Senator Levin. Sorry, Carl, my fellow Michigander.

If the raw size of Goldman's 'short' in the mortgage market is an issue because it can impact the whole market then the issue should be one of governing market positions in instruments:instrument by instrument. Goldman had a huge short FOR THE PURPOSE OF hedging its huge 'long' in a weak and declining market. I don't think that is/was Carl's point. I don;t think Carl ever really made a damaging point on this subject. Testimonies began at 10AM and this point emerged early on; Yet it took us until Blankfein's commentary late in the day for it to be explained to Levin that the act of being a principle necessarily puts the dealer and his customer on different sides of the trade and with completely opposite risks, at least initially.

If a dealer is selling to a customer in a rising market or buying securities from customers in a falling market both circumstances put the dealer firm at great risk to 'service' the desires of his customer. These risks or interests cannot be 'aligned'. But that IS the business of the securities firm. Hedging that risk and managing it is the crux of the business. If firms sought out clients with the same market views it had, it would never do business with them!

As for transparency, a friend of mine who has been a trader on Wall Street for a long time says the best skill l to being a trader is to play poker. If you played poker would you want your opponent to know what you held in your hand? Of course not. Dealers can't (read that as meaning 'ought not be required to'...) disclose their positions. Some of their customers are very sophisticated and would use that information against a dealer. Senators need to know that. Markets are adversarial. Each transactor needs to look after his or her own interests. Buyer beware! At the same time there are rules to promote fair play. That is the complication of markets; that the point the Senators are missing. 'Caveat emptor', yes, but seller be fair.

There are other business in in which firms undertake a true fiduciary responsibility for their clients. And Goldman is in some of those businesses. But those businesses are not about the deals the that the senators were taking about today.

Now all of this is very different from the charge that Goldman did not just trade securities but it created a security for a client that wanted the price of that security to fall. Now let's point out that while that is peculiar and seems reprehensible, if the deal is properly described there is nothing 'wrong' with it (it's not illegal).

Abacus 2007-AC1 (maybe they should have called it 'Icarus')

Goldman is accused in this one deal (Abacus) of not making a material disclosure related to the deal. Two aspects of this have emerged. Not only does Goldman argue that the role of Paulson need not be revealed- it was material. It was also said by Blankfein today said that he thinks ACA knew what Paulson was doing. We have earlier testimony that points out that Paulson was not in the end listed as being in the equity part of the deal something ACA would have known as it underwrote a good portion of the deal for which it had the responsibility for asset selection and which it insured. Even though there are allegations that Paulson had been originally represented as being an equity player in the end he was not there. Most of the discussion today has not been about that at all.

This Abacus structure is allegedly a security formed with the objective of having it fall in value. This conclusion about the intended performance of the security follows from the fact that the deal was being designed for a Goldman client who wanted to bet against the housing market. A Goldman committee described the deal as being like Goldman 'working an order' for their client, Paulson. The telling aspect of that phrase is that we know the client wanted to short the housing market and that when Goldman works an order it does so without putting it's capital at risk. So Goldman wanted to sell it all.

Yet Goldman operatives deny that the deal was designed to produce a weak security that would fail, although Goldman operatives admit that the firm did not plan to own any of it- it did get stuck with a piece it could not sell. That fact does not allow Goldman to say it was blameless.

When Goldman put Abacus together, the developing information from todays testimonies suggests, it sought a novice firm to insure the deal and to pick the securities, a firm that may have felt 'honored' to have been chosen to do a deal with Goldman. The real client, the Paulson-run hedge fund , the intended short-seller who wanted the deal to fail, was put in meetings with the asset insurer who wanted the deal to succeed. Germane to the case, we have seen documents leading us to believe that the Insurer for Abacus, ACA, thought Goldman's customer, Paulson had a equity position - not that he was a short-seller. Though Goldman puts this allegation in dispute.

We now have for the first time in today's testimony an allegation by the 'Fabulous Fab' that he told ACA that Paulson would be short. We also, interestingly have had a case of the 'fab fab' making errors in statements possibly because of his less-than-stellar grasp of English. He also has described some of his emails as inaccurate because he was in a hurry and being less than completely 'accurate' in his haste. These are two possible lines of defense he can use later on.

Various background documents produced, have quoted Goldman operatives as saying that Goldman did not want to do more business with sophisticated customers but that it wanted to transact more with others since the sophisticated customers were more likely to be on the same side of the trade as what Goldman wanted. That's a nice revelation.

Beyond Abacus

Goldman is confusing the issues in the case and so are the senators by not getting to the facts of the deal that has prompted this investigation and the charges by the SEC about Goldman's wrong-doing. The Senators are going beyond this deal and getting tripped up by confusing Goldman's role in this transaction with the idea of what a dealer does. There is no fiduciary responsibility for a dealer per-se, but there are securities laws. Goldman only has fiduciary responsibility when its firm undertakes that in some of the roles it does play apart from its role as dealer. But in the role of dealer it does not have its client's interests at heart. It is trying to trade and make money, but it still has rules it must follow. On the other hand when it underwrites or originates securities its participation is controlled by other securities laws. Being a dealer is not a license to engage in a free-for-all. The rules depend on whether the firm is trading listed securities or originating new paper or being an investment advisor, and so on.

Goldman is a complicated firm-as are most securities firms. Securities laws are complex. Derivative products are a rat's nest of troubles. Goldman had a number of emails whose contents once disclosed reflected badly on it. Some of this is just the stuff of securities markets and people who are under pressure and letting their guard down, blowing off steam, more than being underhanded. The talk about Goldman selling 'crap' is talk you'll find in every shop in Wall Street, as well as in used car lots and elsewhere. And... one man's crap is another man's fertilizer. It's hard to tell in these emails what is truth and what is just blowing off steam.

No trader thinks he is holding crap but he might call a security that after he sells it, especially if it falls in price. 'Crap' is often made obvious only after the fact. Salesman often have views that differ from that of the firm. Salesmen often think a company has underwritten or has created a security his customers don't want to buy and as a consequence, he does not want to be pushed to sell them. Sometimes the salesmen are right. Sometimes they are not.

The question is - in the case of Abacus - not was there 'pro and con' chatter nor 'did Goldman salesmen ever call it 'crap' (or a more vulgar term),' but was something illegal done? The senators lost their way. Michael Lewis's "Liar's Poker" would be a good book for the senators to read to get some perspective on how salesman work with customers and how they talk. I have worked on the assembly lines in Detroit and on Wall Street at a bank and at a securities firm as well as at the central bank, the Fed. I find the language used in on Wall Street as well as on Detroit's assembly lines has a lot in common.

The key here should be for the senators to pursue those charges that have to do with securities law violations or that have real moral character problems. They seem to have lost their way although they did score some points today.

One of the keys here is to poke through the complications to get at the real issues. The more we get into the complications of the industry, complications of the securities and complications of 'the deal' the more likely it is that Goldman wins. Complication works in Goldman's favor. When things are complex other things go wrong and sometimes that is seen as a result of the complication itself instead of being viewed as being the fault of those who were the transactors or deal architects who may have well understood the complex structure and used it to do no good and shield themselves.

Most disturbing to me is that Blankfein said he heard nothing today that makes him think that Goldman did anything wrong- really? Was he listening to the same stuff I was listening to? Or does he just have lower standards?

END

GOLDMAN...

Several disparate and conflicting thoughts come to mind over he the SEC allegations against Goldman Sachs.

First, is this the best that the SEC could do? After all this time is this their flagship prosecution? It is essentially a case about improper disclosure.

Second, While Goldman makes a number of statements about how it did nothing wrong and that shielding the counter party identities is par for the course, this is the sort of partial-truth blather that makes them seem more culpable, at least to me.

Third, what it is: What Goldman did, as far as I know, is a first in markets. It set out to design a security that would fall in value almost from Day One and it got investors to buy it. We have seen high-risk initial securities offerings before (interestingly, Michael Milken pioneered original issue junk bonds), but in the past the risk was fully disclosed and was reflected in a higher yield and/or an initially discounted issue price. How do you sell such a thing that is not discounted? Goldman apparently intended to make the issue viable by mining the fact that market participants had vastly different views of the market's path and by not making that facet clear. Goldman's internal meeting describes this deal as accommodating a trade for hedge fund investor, Paulson (aspiring short-seller). An internal memo says that Goldman was effectively working an order for Paulson to buy protection on specific layers of the deal's capital structure.

Red badge of innocence, isn't -- While Goldman lost money in the deal, something it now wears as a red badge of innocence, the wound was self inflicted. Goldman seems to have been bearish on housing at the time it arranged the deal. It may have used securities it already had on its books it wanted to hedge or it just may have been caught holding the deal it could not sell. None of that adds to its 'innocence.' Some old expression about playing with fire comes to mind.

Goldman selected ACA, the credit expert company with a low credit rating itself (the smallest and weakest in its country) to be the independent analyst and selector of assets for the deal. ACA was a self-described expert that seems to have lacked a strong market profile despite describing itself as 'expert.' Arguably Goldman picked a weak 'expert' that could be pushed around. ACA would also insure the $909mln of the deal. But ACA collaborated on asset selection, nonetheless, with Paulson for whom the deal was arranged and intended as a short. ACA did not know that. The trader who arranged the ACA Paulson meeting left the meeting between the two calling it 'surreal.' IKB Deutsche industriebank AG bought a $150 mln slice of the deal it said it would only buy if an independent body picked the assets for it. So ACA's participation and control was crucial, at least to IKB. But due to ACA's weakness when the deal went sour its backing was insufficient as a backstop. Only Paulson seems to have gotten what he wanted, despite being described as being not the party with the authority to pick the assets. No wonder the young Goldman trader Fabbrice Tourre described the ACA-Paulson meeting as 'surreal'. One wonders what else that meeting could have been, given the very different objectives of these two participants one of whom did not know that the other was the enemy.

What ever really happened, whatever people were told or not told, it is pretty clear that Goldman put two adversaries together and did not disclose that to one of them. Two of the main parties to the transaction that worked on it together had very different interests in the design of this product and even though 'only one' had the mandate to select assets, as the other would be involved, it's possible that that ACA felt that some accommodation was called for to placate the other, Paulson. It was a sort of kabuki in which nothing was at it seemed.

One thing seems clear, this was not a normal above the board deal. There was a a lot of surreptitiousness here. While Goldman may have buried everyone with technical details on the securities involved and may wish to wash its hands of any further obligation, there seems to have been an underlying objective that was hidden from some of the key participants that Goldman herded together and some had mis-information about the goals of the others. The case in a legal sense will turn on the issue of, was there a material omission or not.

This deal is very tangled. As we learn more, it may not become that much clearer. One thing we know is the that the very complicated structure of theses deals, from the complex roles of the various counter parties, to the math that defines the security itself, gives all participants some degree of cover. But this is hardly the kind of deal we'd expect an expert market maker like Goldman to have championed. One could have looked at theses participants and at this deal and seen that this was not going to turn out well right from the start. But Wall Street is about doing the deal and raking in the commission. At the end of the day that is what Goldman did. What it took to get them there -guilty verdict, plea bargain, or 'vindication'- it does not matter, it has damaged the Goldman reputation. One thing Goldman has been very good at has been protecting itself. That skill is about to be tested.

Europe grows but still lags

The monthly indicators from the EU Commission showed a sharp jump in the index of sentiment for the region. But even with the sharp monthly jump in March - a jump that is in the top ten percentile of all monthly jumps in the index - the indices remain at very weak levels.

The EU index remains in the the 41st percentile of its queue implying that it is stronger than its current level nearly 60% of the time.

Despite the good performance in the monthly EU indices the situation there is is still troubled. While there was a large jump in the EU/EMU index for the month there had also been bad weather in Europe early in the year. This report could reflect some bad weather catch-up of the sort we are looking for in the US data for March. We should not conclude that Europe is authentically carrying so much momentum in March. We should bear in mind the still low readings of the EU indices as well. Europe's recovery is still a long way off.

Greek lesson and impact from the eZone to the US

Riots in Greece. Citizens in a country strapped for funds wrecking the public infrastructure that it will not really be able to afford to repair. Priceless. MasterCard.

Whole industries on strike. Critical businesses like banks operating on skeleton crews.

Protesters are saying that the average man can't pay anything more, get it from the rich.

Ah, yes it should be a familiar theme to Americans where the solution to everything is to tax the rich theses days. But the rich are rich. The rich are mobile. The rich own the businesses that create the wealth and provide employment. Scare them off and you are left with the poor. Try taxing them - alone.

In the late 1960s riots in America decimated Watts in California, Newark, New Jersey and Detroit, Michigan. The reaction was by not just the rich but any middle class person who could afford it; that reaction was to leave. The riots were race-based. But the flight of the 'wealthy' was not. By the way the definition of 'wealthy' is anyone who has more money than you. These three cites were forever marked by these riots and the flight of their tax base. Newark is only just getting itself rebuilt. Detroit is a shadow of its former self and is now being decimated by a new challenge to its key industry, autos.

Rest assured that taxing The Rich is a slogan that like any other seemingly good intention is destined to help pave the road to hell. It may be a great slogan but as a policy it just won't fly.

Greece has overspent in a way that probably benefited public servants the most! But this is the hardest cost to trim from a budget especially in a social welfare state. In New York City as Mayor Bloomberg ran for another term he 'gifted' the MTA with a huge contract. After a transit strike in the late 1970s, the NY unions still got rich contracts. They own the city, almost literally the same way investment bankers 'own,' control or hold hostage their firms and their compensation polices. The municipal unions have power and tend to vote in a block- for you or against you. So politicians cave in to their demands. Municipal unions are powerful forces and all states will have a hard time reining in what has been expanded. Greece - socialist leanings or not - is no different.

Greece's people are rejecting the idea that they have done anything wrong. In their eye, someone else is at fault, call them 'the rich' although everybody who can in Greece hides income and avoids taxes. It's still someone else's fault.

What about the government that hid the country's excesses and did not face the music sooner? Are they at fault? What about hiding the excesses and at the same time not trying hard to compress expenditures so someday Greece could comply with The Rules? What were Greek leaders thinking? Did they think they could roll their ever-growing derivatives contracts forever? Are the people angry? yes! But these were their elected leaders and the people are responsible for their leader's actions.

Beware of Greeks bearing debt and/or protest placards. We already have seen what Icelanders have done when it comes time to pay the piper. What is the new modern legacy Greece will make for itself? Austerity, it's not my job? And if Greece can't get rich Greeks to pay what about the Rich countries of the e-Zone? Isn't that the next most logical step? If there is no need for austerity then everything in Greece must be fine except for the tax revenues to pay for it all. If you can't tax the rich or the poor or the middle class then you need an inflow from outside the country. QED.

Where Greece is heading with this logic is a very bad place. The unwillingness by Greeks to take their medicine is bad sign for all of Europe not just Greece. At some point soon Greek bond debt will be due and given this tilt on the part of Greeks no one will roll that debt over let alone contract for new debt. A country that wont' knuckle down to pay its debts puts itself in a real jam.

Pay what you owe? It's Greek to me. Maybe the Greeks can restore the good name of the Welsh or give Icelanders a run for their money as nonpayers. The trend is unsettling.

Meanwhile the US budget deficit gets bigger and the Administration wants to add another trillion to that load for healthcare coverage (not reform). And big challenges for medical costs and social security costs still lie ahead. Maybe Greece's troubles came just in time to give the US a wake up call. Even the RICH United Sates cannot afford to go off on trillion dollar spending programs- again (Iraq war) and again (Economic stimulus) and again (health care) . A penny spent must be a penny earned. The era of deficit financing in the US must be brought to a close and yes we ALL WE ALL WILL PAY MORE TAXES TO DO THIS. It's not just a vague prescription for Greece.

US debt levels? They are not Greek to me.

Fed's Move in a broader context

The markets seem to have untangled the mystery of the Fed's move that isn't a move.

The Fed's discount rate (or primary credit rate) is not a mainstay for bank funding so hiking that rate is not going to have any clear impact on a bank's cost of funds. Banks try to avoid the discount window.

While markets sold off in the wake of the Fed's announced discount rate hike late yesterday, after some reflection US markets have righted themselves. So we cannot even argue that market rates have been pushed up or equity prices pushed down in reaction to the Fed's move of a largely inconsequential rate- a rate used for leverage in implementing monetary policy.

The fact of the matter is that the Fed is paving the way for a rate hike. It has to get markets back to normal conditions before it can do that. But it will not necessarily hike rates quickly once normal interbank market rate relationships are re-established. But it's fair to say it is unlikely that the Fed would hike rates until it had removed the special facilities and rate arrangements it had put in place to deal with the crisis. In that respect we are now closer to a rate hike than we were before.

The release of the CPI on Friday underscores the subtlety of that message. The CPI headline was up but the core CPI fell leaving inflation really very tame for right now. GDP growth has been strong mostly on technicalities. Job growth has yet to check in and without job growth the recovery does not look solid. There is no reason to expect that the Fed is already trying maneuver to a rate hike even though we can argue that in some ways we are closer to having one.

Markets seem to have sorted this out. It is the situation as it was presented to us by Fed Chairman Bernanke in a statement made about one week ago. While markets were confused by his statement then, that has changed.

Still, with the rate hike the world has changed, too. We can see that the Fed wants to be prepared to hike rates if conditions warrant and that is different from saying that it plans to hike rates soon. Still the Fed's move carries a message. That is that the need for the emergency tactics is over. The Fed is betting on a continued recovery.

While it is possible for the Fed to use a wider spread to the discount rate to pressure the Fed funds rate higher that would take repeated efforts and a consistent strategy. There is no evidence that the Fed is trying to use the discount rate in that fashion. It is more obviously true that the Fed is trying to restore a normal Fed fund to discount rate spread as it claims.

There is some complaining about the Fed hiking rates in a post-FOMC meeting, making its move more of a surprise. But it is also true that making the move in that way made it look less like a move at an FOMC meeting that has monetary policy implications. Moreover, it was not a true surprise since Bernanke had just told us he wanted to do just that.

All in all it is hard to be critical of the what the Fed has done or how it has done it.

Still the new weakness in the CPI and the weakness in Europe's service sector revealed by its flash PMI for the service sector in February gives us some reason to wonder about not just the US but the global expansion. In some ways the timing of the Fed move is peculiar since growth is not exactly building in a clear way. We can understand the Fed wanting to get the interbank market and official rate structure back to normal as soon as possible. But the economy has been so weak for so long that if there is backsliding the possibility that economic weakness turns to financial catastrophe again is quite high.

So it is in that respect that markets were cheered by the Fed's move to normalize the discount rate. That move told the market that the Fed, at least, thinks the banking sector is more sold and that it can stand up by itself without special facilities or rate configurations. The Fed also is betting on growth. We can all hope that the Fed is right on this one.

Markets sell off on good news again

A week ago the market went down after GDP rose at a 5.7% pace in 2009-Q4 This past week markets shrugged off a drop in the rate of unemployment to 9.7% from 10%.

Why all the pessimism? Why ignore such good news?

The ISMs cooked up improved numbers this past week and showed improvements their respective employment components as well. The MFG report was especially strong. Challenger's announced corporate layoffs remained low for January.

There are lingering financial sector concerns since Greece got in fiscal trouble. Often when something like happens there is thematic selling across the spectrum that sorts itself out in subsequent weeks. It's like Hells's Angels saying, 'Kill 'em all and let God sort 'em out'. OK we've killed them all, isn't it time for the sorting out?

The US jobs picture is much brighter now. We have gains in services jobs. We have gains in manufacturing jobs. Losses in the tiny construction sector - likely the result of harsh winter weather- swamped gains in the two main job sectors of the economy. This month is a good lesson about looking into the details of the report. The unemployment rate fell, average hourly earnings rose and the work week expanded. The economy improved in just about every major labor market respect.

It's time for some optimism to appear.