Tag: Federal Reserve

If Not Fannie, then Who?

A common defense offered for keeping Fannie Mae and Freddie Mac, or something like them, is that the market simply cannot absorb the same level of mortgage lending without them.  The central flaw in this argument is that Fannie and Freddie themselves must be funded by the market.  So if the financial markets can absorb X in GSE debt, then the financial markets can absorb X in mortgages.

Different market participants currently face different capital requirements for the same assets.  To some extent, Fannie and Freddie were a vehicle for shifting mortgage risk from higher capitalized institutions to less capitalized.  If the Obama administration and bank regulators are serious about closing “regulatory gaps” then all entities backed by the govt, implicit or otherwise, should hold the same capital against the same risks.  In the following I will thus assume that differences in capital requirements behind mortgages are irrelevant.

So to determine who could absorb the GSEs’ buying of mortgages, let’s look at who holds GSE debt.  Of the approximately $5 trillion in GSE debt and mortgage backed securities (MBS), about a trillion is held by commercial banks and thrifts.  Another trillion is held by insurance companies and pension funds.  Close to a trillion is held by mutual funds.  That quickly gets one to 3 trillion.  Households and state/local governments also hold close to a trillion.  That leaves us with about a trillion left, held mostly by foreign governments (usually central banks).  For this analysis, I am using data pre-Federal Reserve purchases of GSE debt/MBS.

Given that banks hold about a trillion in excess reserves and over 9 trillion in deposits, I think its fair to assume commercial banks could easily absorb another $1 trillion in mortgages, as represented by foreign holders.   Some holders of GSE debt are legally prohibited from holding mortgages.  These entities can generally hold bank commercial paper (think mutual funds) which could then fund the same level of mortgages.  

The point here should be clear, by swapping out GSE debt for mortgages, our financial markets have sufficient capacity to replace Fannie and Freddie.  In fact, we are the only advanced country that does not fund our mortgage market primarily or exclusively with bank deposits.  This analysis also does not assume any reduction in the size of our mortgage market, which should actually be an objective of reform.  We devote too much capital to mortgages, at the expense of more productive sectors of our economy.

Bernanke on Monetary Policy

Every August, the Federal Reserve Bank of Kansas City sponsors a conference on monetary policy. It is the most valued invitation of the year for central bankers and Fed watchers. The Fed Chairman typically presents his views on monetary policy and the economy, and his talk inevitably makes headlines. (A select few reporters are invited.)

This year, Ben Bernanke promised the Fed will do whatever it takes to aid the faltering U.S. recovery, and most of all to prevent deflation. The problem for the Fed Chairman is that the central bank is plainly running out of options, as some had the cheek to observe. He suggested the Fed could do more of the same (purchase long-term securities), or try something new and untested (tweak the interest rate it pays on bank reserves).

Bernanke also suggested a third option, plus offered some professorial speculation on another. Taken together, these suggest the Fed may be prepared to chart a dangerous course.

In its policy statement, the Federal Open Market Committee has promised to keep interest rates low “for an extended period.” Bernanke suggested (as the third option) that the FOMC might make it clear that rates will remain low for an even longer period than markets are currently expecting. Within the Committee, there have been calls for caution and to remove the “extended period” language from the statement. These have been led by Thomas Hoenig, president of the KC Fed and host of the conference. By suggesting the only option was lengthening the period of low interest rates, Bernanke delivered the back of his hand to his host and the other inflation hawks on the FOMC.

Bernanke then mused about suggestions by some economists that perhaps the Fed should set an inflation target – that is, promise to deliver higher inflation rates to stimulate the economy. Fed chairmen do not engage in abstract speculation about policy, and to raise the inflationary option gave it place above all other possibilities. Bernanke hastened to add that there was at present no support for such a policy within the FOMC, and it “is inappropriate for the United States in current circumstances.”

In other words, the Fed chairman is thinking about an inflationary policy and, if circumstances change and he can build support within the FOMC, he is willing to implement it. When central bankers speculate in public about the possibility of an inflationary monetary policy, the currency is in jeopardy and the country in peril.

Biden’s Fatal Conceit

The White House’s misbegotten “Summer of Recovery” continued today with the release of another administration “analysis” that purportedly demonstrates the stimulus’s success in “transforming” the economy.

Vice President Joe Biden unveiled the report alongside Energy secretary Steven Chu and numerous businesses officials willing to serve as political props in return for Uncle Sam’s free candy. Biden bemoaned the nefarious “special interests” that were coddled by the previous administration. What does the vice president think those subsidized business officials attending his speech are called?

The money the White House has lavished on these privileged businesses isn’t free. The money comes from taxpayers—including businesses that do not enjoy the favor of the White House—who consequently have $100 billion (plus interest) less to spend or invest. Therefore, the fundamental question is: Are Joe Biden — an individual who has spent his entire career in government— and the Washington political class better at directing economic activity than the private sector?

Biden repeatedly stated that the “government plants the seed and the private sector makes it grow.” Because the government possesses no “seeds” that it didn’t first confiscate from the private sector, what the vice president is advocating is the redistribution of capital according to the dictates of the Beltway. This mindset exemplifies the arrogance of the political class, which at its core believes that free individuals are incapable of making the “right” decision without the guiding hand of the state.

Unfortunately for Joe Biden, the state’s hand guided the private sector into the economic downturn that the administration and its apologists would have us believe was a consequence of imaginary laissez faire policies. From the housing market planners at HUD to the money planners at the Federal Reserve, government interventions led to the economic turmoil that the perpetrating political class now claims it can fix.

Enough already.

The following are Cato resources that challenge the vice president’s breezy rhetoric on the ability of the federal government to direct economic growth:

  • Energy Subsidies: The government has spent billions of dollars over the decades on dead-end schemes and dubious projects that have often had large cost overruns.
  • Energy Regulations: Most federal intrusions into energy markets have been serious mistakes. They have destabilized markets, reduced domestic output, and decreased consumer welfare.
  • Energy Interventions: The current arguments for energy intervention and energy subsidies fall short.
  • High-Speed Rail: Policymakers are dumping billions of dollars into high-speed rail, even though foreign systems are money losers and carry only a small share of intercity passengers.
  • Special-Interest Spending: Many federal programs deliver subsidies to particular groups of individuals and businesses while harming taxpayers and damaging the overall economy.

Does High Unemployment Make Inflation Impossible?

Benn Steil and Paul Swartz wrote a technically brilliant yet readable Wall Street Journal tutorial explaining why “the Fed’s exit strategy is not credible, and that means a serious risk of high inflation down the road.” 

They are sure to be ignored by those of the Keynesian faith who have repeatedly assured us that inflation cannot possibly be a problem for many, many years.  Why not?  Because there is so much “slack” in the economy—a euphemism for high unemployment.
If this “slack theory” of inflation makes you too sanguine about future inflation, recall that it is the same theory that predicted stagflation would be impossible in 1973–75 and 1979–81.

Figures from The Economist, August 21, raise some doubts.  The latest unemployment rate in Argentina is 8.3%, but CPI inflation over the past year was 12.2%. Unemployment in Venezuela is 8.2%, but inflation is 13.3%. Unemployment in Egypt is 9.1%, but inflation is 10.7%.  Unemployment in India is 10.7%, but inflation is 13.7%.  Unemployment in Turkey is 11%, but inflation is 7.6%.   Wasn’t high unemployment supposed to make high inflation impossible

Perhaps Slack Theorists might take comfort from the fact that inflation is “only” 4.2% in South Africa, where unemployment is 25.3%.  But that is not exactly solid proof.

Whenever Keynesian dogma proves so completely at odds with the facts, there is a powerful inclination among true believers and their herd of media apostles to cling to the theory and diregard the facts. 

Some volatile economists who previously worried about near-term U.S. inflation have switched to assuming (as they did in 2003) that high unemployment will produce deflation.  Yet that is obviously not happening in the countries listed above.  The only country with falling prices is Japan, with an unemployment rate of 5.3% (and foolishly high tax rates and decades of wasteful ”fiscal stimulus”).

File the Steil-Swartz article away for future reference. 

And remember Reynolds’ Second Law: “Inflation is always lower before it moves higher.”

State Debt Doubles

CNNMoney.com reports on how state governments are digging themselves deep into debt. The story points to Moody’s Investor Service data on “tax-supported” debt, which is bond debt that state taxpayers will ultimately have to pay back.

The article shows the large variations in government debt across the states, and notes that “not every state is ratcheting up its borrowing. Many states have strict laws governing their debt issuance. Some places, such as Nebraska and Wyoming, have virtually no debt.”

I’ve argued that all state governments ought to follow the no-debt approach to state finance. With good planning, capital expenditures can be financed “pay-as-you-go” or out of current revenues. Debt creates bad incentives for politicians and makes it harder for citizens to understand complex state budgets.

The CNNMoney.com story notes that state debt soared 10.3 percent in 2009 as the economy struggled. But I’ve noted that Federal Reserve data shows that debt has soared in good times and bad over the last decade. The Moody’s data tells the same story, as shown below.

State debt outstanding doubled from $230 billion to $460 billion in just nine years, 2000 to 2009.

Even Keynesian Accounting Can’t Find All That ‘Stimulus’

From January 2009 to the present, President Obama and his team have repeatedly made grandiose claims about the economic benefits of shoveling money at shovel-ready projects or green jobs.  “It is largely thanks to the Recovery Act that a second Depression is no longer a possibility,” said the President.   He also claimed that lavish spending alone (not Federal Reserve actions or bank bailouts) is what prevented the unemployment rate from “getting up to … 15%.”

If any of that were remotely close to being true then, as a matter of simple accounting, rising federal spending would have shown up as a huge offset to falling GDP in 2009, and also as a major component of the modest increase in GDP growth in early 2010.   On the contrary, the table below shows that the increase in federal nondefense spending contributed only two-tenths of one percent (0.2) to the change in GDP in 2009.  That was no better than 2008 when the Recovery Act did not exist.  If nondefense spending had not increased at all in 2009 (unlike 2008) then GDP would have fallen 2.8% rather than 2.6% — scarcely the difference between a recession and a “second Depression.”  If nondefense federal spending had not increased at all in 2010, the economy still would have grown at a 3.6% pace in the first quarter, 2.1% in the second.  Cutbacks in state and local spending were a trivial damper on GDP growth last year, contrary to recent speculation, and real state and local spending rose significantly in this year’s second quarter (unlike the first).

This is just an exercise in crude Keynesian accounting, not economics.  Yet it nonetheless makes the stimulus bill look like a huge waste of money.  The reason Keynesian accounting is no substitute for economics is that governments can only spend other peoples’ money.  To claim that such spending is a net addition to “aggregate demand” is to ignore those other people — namely, current and future taxpayers.

Nobel Laureate Robert Lucas put it this way:

If the government builds a bridge … by taking tax money away from somebody else, and using that to pay the bridge builder — the guys who work on the bridge — then it’s just a wash.  It has no first-starter effect.  There’s no reason to expect any stimulation.  And, in some sense, there’s nothing to apply a multiplier to.  You apply a multiplier to the bridge builders, then you’ve got to apply the same multiplier with a minus sign to the people you taxed to build the bridge.  And then taxing them later isn’t going to help, we know that.

Show Me the Money

A number of economists have been warning about the Federal Reserve’s easy-money policy, but defenders of the central bank often ask, “if there’s an easy money policy, why isn’t that showing up in the form of higher prices?” Thomas Sowell has an answer to this question, explaining that people and businesses are sitting on cash because anti-business policies have dampened economic activity.

Not only has all the runaway spending and rapid escalation of the deficit to record levels failed to make any real headway in reducing unemployment, all this money pumped into the economy has also failed to produce inflation. The latter is a good thing in itself but its implications are sobering. How can you pour trillions of dollars into the economy and not even see the price level go up significantly? Economists have long known that it is not just the amount of money, but also the speed with which it circulates, that affects the price level. Last year the Wall Street Journal reported that the velocity of circulation of money in the American economy has plummeted to its lowest level in half a century. Money that people don’t spend does not cause inflation. It also does not stimulate the economy. …Banks have cut back on lending, despite all the billions of dollars that were dumped into them in the name of “stimulus.” Consumers have also cut back on spending. For the first time, more gold is being bought as an investment to be held as a hedge against a currently non-existent inflation than is being bought by the makers of jewelry. There may not be any inflation now, but eventually that money is going to start moving, and so will the price level.

I do my best to avoid monetary policy issues and certainly am not an expert on the subject, so I asked a few people for their thoughts and was told that perhaps the strongest evidence for Sowell’s hypothesis comes from the Federal Reserve’s data on “Aggregate Reserves of Depository Institutions” - specifically the figures on excess reserves. This is the money that banks keep at the Federal Reserve voluntarily because they don’t have any better options. As you can see from the chart, excess reserves shot up during the financial crisis. But what’s important is that they did not come back down afterwards. Some people refer to this as “money on the sidelines” and Sowell clearly is worried that it will have an impact on the price level if banks start circulating it. That doesn’t sound like good news. On the other hand, it’s not exactly good news that banks are holding money at the Fed because there are not enough profitable opportunities.

What this really tells us is that the combination of easy money and big government isn’t working any better today than it did in the 1970s.