I don't think the Fed is dimwitted. But the data lags make it very hard to confidently change policy without an obvious event. And the impact lags make it nearly impossible to avoid staying in a policy position too long. So by the time they change direction they need a strong action to more quickly counteract the previous overshoot. Then they get painted into a corner by concerns about market psychology, and are loath to fine tune back to a moderate position.
BTW, I think the Fed is having some trouble keeping the target up at 5.25%. It traded at 5.0% weds, and 4.75% for a while yesterday. It has been all over the map on some days in the last two weeks.
It will only prolong the agony of the “debt slave” to an overpriced asset. So I just say… whatever.
I think this is an important observation. Ultimately, some FBs will elect to be debt slaves for at least a few more years. But many more will simply walk away--with or without a bailout.
My hope is that any federal loans given to FBs will be (1) nondischargeable in bankruptcy; (2) subject to typical federal government collection tactics (withholding tax refunds, wage garnishments, etc...) Just like taxes and federally guaranteed student loans.
Let's say you owe $500K on a $400K house. The Feds could offer to refinance your $500K debt at a fixed "affordable" rate. But hopefully they will not do so without extracting their (taxpayers') pound of flesh. Make the FB pay the balance in full or else sic the IRS on them.
But maybe I'm just bitter because I still rent and I'm still paying off my student loans.
I disagree that the Fed Funds rate has been artificially high. As Randy H states, I think it has been artificially too low for most of the decade, heck, for most of Greenspan's term. The fallout we are seeing today is not a consequence of the recent tightening, but the effects of getting the "Masters of the Universe" on Wall Street, who have been so used to easy credit, used to "more normal" credit conditions.
What does it say about the American economy that we can't stomach a 5.25% Federal Funds rate?
Precisely! What's left to demolish? The "2nd home/vacation home" market? Toast. Condo "specuflipping"? Toast. Other than remote enclaves hunkerd down in the rural areas of the midwest there's nothing left worth bombing!
In naval terms this would be referred to as "making the rubble bounce" (sending in a second missile just for a sh@ts and grins).
Oh and my youngest daughter had a great term for the ultra hip 20 something MEW moms commanding their world from a cell phone and a stroller. "New and Improved Soccer Mom". I kind of like it.
Of course, the big economic news of the day is Bendover Ben's speech in Jackson Hole. As I'm sure many of you have noticed, the markets have reacted favorably to it, which by implication suggests it is being interpreted as a signal for a rate cut. Now, this may be well and true, but I think the comments are being taken out of context. Here is the pertinent section of the speech:
The purpose of the discount window actions was to assure depositories of the ready availability of a backstop source of liquidity. Even if banks find that borrowing from the discount window is not immediately necessary, the knowledge that liquidity is available should help alleviate concerns about funding that might otherwise constrain depositories from extending credit or making markets.
The Federal Reserve stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets.
It is not the responsibility of the Federal Reserve - nor would it be appropriate - to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.
In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.
The incoming data indicate that the economy continued to expand at a moderate pace into the summer, despite the sharp correction in the housing sector. However, in light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country. Inevitably, the uncertainty surrounding the outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives. The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.
The sentence that the markets seem to be creaming over is how, "(t)he Federal Reserve stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets." Seems to me that in the context above, this doesn't necessarily mean a rate cut is a given. Ben seems to imply that the discount window is the preferred tool in this liquidity crisis, but the Fed Funds rate could be used if there are any "early" indications of impact on the broader economy. IE, Wall Street shouldn't expect a "Bernanke Put."
Maybe I'm being hopeful, but that seems reasonable to me. Alternatively, this is just lip service and indeed rate cuts galore are coming...
The Fed Funds rate has been artificially too low for a long time -- until recently. The normal position for the fed funds rate is about 100 bps or more below the 10 year treasury.
The normal position for all rates is to be higher as the duration is longer. Overnight is the shortest duration, and should have the lowest rate. The fact that the fed funds rate is higher than all the other rates on the yield curve makes it clear that it is being artificially pushed to be so high. If the rate were allowed to float freely in the market it would drop by at least 100 bps.
I think we discussed this before, but the "normal" calculus of using the 10y treasury as a benchmark comparison for the "normal" fed funds rate seems to me not applicable. The Fed itself has acknowledged "artificially" low long-term treasury yields due to foreign money parked in these securities. Perhaps this underlying cause doesn't matter in the end, but it seems that the Fed has at least taken it into account in determining what they think the rate should be.
Of course treasury rates are market-driven, but my point (not clearly made) was that compared historically, the current situation is unusual in that "saver nations" have dumped tons of cash into long-term treasuries in a situation not seen previously.
Yield inversions are also "natural forces of the market". Zephyr is correct as a static analysis. But as skibum pointed out, the market structure of Treasuries have changed quite significantly over the same period.
If the "natural" Fed target is 100bp below the 10yr Treasury in 1990, then it would need to be more like 250bp below the 10yr in 2007 in order to match the effect of nominal versus real interest rates vis-a-vis inflation. The US has progressively been *losing* nominal rate power as an effect of foreign capital flows.
This is the primary argument against just using a simple, automated or semi-automated, transparent Fed inflation target. Such a target would have to be infinitely complex and is probably impossible to achieve without simply resulting in nominal-rate gaming.
As to the Fed's overshooting, I still disagree. If "Zephyr" is smart enough to see the overshoot, so are the hundreds of brilliant economists, econometricists, and statisticians working for the Fed. They know quite well how long it takes for rate moves to work into the economy, and they know the nature of their own historical data better than any of us armchair policy wonks.
The only folks deluded enough to think they could do the job better are global macro hedge fund managers and autistic fools.
True re: savers. Moving on, the other thing that's been irking me while following the latest developments is that everyone (talking heads, economists, etc etc) are pushing/expecting the Fed to lower its funds rate to avoid recession, as the "downside risks have increased substantially." Fair enough. Then these folks usually go on to say that a big part of the economy is the consumer. Fair enough. It may not be pretty, but yes, we are a nation of fat, lazy, SUV driving, McMansion-living consumers. Then they all invariably go on to say how the tight credit market and the tight mortgage market leads to lower refi's, less cash-out for consumers to spend.
This is where the argument pisses me off. So, it's now a foregone conclusion that cash-out refi's as a way to keep the economy going is a GOOD thing? Are economists really truly advocating for a return to those times? God help us all!
I think the problem is that there are no real conservatives left in the republican party, and I'm also not that convinced that there have been for a long time. Real conservative *voters*, sure, but they seem to prefer voting for conservative rhetoric rather than realizing the true nature of the semi-fascist bandits that are really running the party, and turning the other way.
I think that the case-in-point is the fact that the Fed has yet to cut the Fed funds rate as Wall Street Titans have been begging for recently. The Fed sees "downside risks" present, but if they were to overreact, they risk moving when they didn't need to. I see BenB as consciously trying to make moves as slowly as possible. It's like a very slowly responsive, nonlinear and very complex feedback system, but there is only one feedback loop (two if you count the discount rate) that can be manipulated easily. So, you want to manipulate it only when you are fairly certain the effects will be necessary, and perhaps as importantly, predictable.
Randy, I agree that the Fed does have an army of experts and great resources to evaluate the markets and the economy(far more than I or anyone else could ever have). However, it does not follow that all those experts have the same opinion of what the best policy is. And the implemented policy need not be the technically correct policy, as politics do exist.
For all that resource they have sure been far from the mark as far as perfect policy is concerned.
I agree that changes in the yield curve are natural to the market. But the actions of the Fed unnaturally exacerbate those changes.
As far as being delusional in thinking we could do better than the fed, that has good logical basis given the resources of the fed. However, many people (including me) thoughtthat lowering the fed funds rate to 1% was a mistake at the time it was done. In fact, I thought 2% was too low. And whatever artificially low rate would have been best, it should have been used for only a few months. Instead we got the credit bubble. I am not embsarrassed to be among the many "fools" who thought they knew better than the fed back then. And we "fools" were right.
But, in the end, while I objected to the policies, there was no harm to me from it. This is because I knew what economic craziness would come of their moves and I made piles of mony betting on it.
The zero interest rate policy (ZIRP) is a Keynesian macroeconomics scheme for economies exhibiting slow growth with a very low interest rate, such as contemporary Japan. The Keynesian (and neo-Keynesian) thesis is that these countries are in the so-called liquidity trap, an assessment with which neoclassical economics disagrees.
Under ZIRP, the central bank maintains a 0% nominal interest rate, and then maintains inflation of the currency to make the value of otherwise stable investments, such as real estate, rise over time. It is effectively a way of imposing a negative real interest rate.
For instance, if an investment earns 0% interest and there exists a 4% inflation rate, a house or commercial property will appreciate in value by 4% a year. This means that the return on the investment is calculated as if the interest rate is actually -4%.
The effect of a ZIRP policy is to encourage investment throughout the economy by making capital purchases more financially attractive. Whether ZIRP succeeds in achieving this goal is a matter of much debate.
Bush said the Federal Housing Administration, a government agency that provides mortgage insurance to borrowers through lenders in the private sector, would launch in coming days a program called FHA Secure. The program would let homeowners who have good credit histories but can't afford their current mortgage payments to refinance into mortgages insured by the FHA.
"This means that many families who are struggling now will be able to refinance their loans, meet their monthly payments and keep their homes," Bush said.
Bush also urged Congress to modernize and improve the FHA so more homeowners could qualify for the mortgage insurance provided by the agency. Last year the House passed legislation to modernize FHA, but Congress has not yet sent a bill to the White House. "I look forward to signing a bill as quickly as possible," Bush said.
Bush also pledged to work with Congress to reform a key housing provision of the federal tax code, which will make it easier for homeowners to refinance their mortgages.
"Let's say the value of your house declines by $20,000 and your adjustable rate mortgage payments have grown to a level you cannot afford," Bush said. "If the bank modifies your mortgage and forgives $20,000 of your loan, the tax code treats that $20,000 as taxable income. When your home is losing value and your family is under financial stress, the last thing you need to do is to be hit with higher taxes."
Bush also said the administration would launch a new foreclosure avoidance initiative to help homeowners figure out a way to refinance. He said Housing Secretary Alphonso Jackson and Treasury Secretary Henry Paulson would reach out to groups that offer foreclosure counseling and refinancing assistance for homeowners.
Bush is going to guarantee a bunch of people who got in over their head and can't refi, by using FHA loan programs. He is also going to modify the tax code, so that forgiven debt won't be counted as taxable income.
Bush has been the banner carrier for the Republican Party and the Conservative movement for over seven years now. It is amusing to watch all those who cheered his so loudly when he played "dress-up hero" in his flight suit abandon him now.
ZIRP can be very effective if applied to a country not subject to a liquidity trap. There is no reason to believe the US would suffer from the same liquidity trappings as Japan. The US reacts quite well to monetary inflation based growth -- we are a consumer society.
The problem with ZIRP in relation to US policy is that it is a draconian measure, to say the least. It effectively translates into a subversive default on US foreign debts, and a subversive subsidy for US exports. It also shifts even more US inflation oversees. The reaction of foreign debt holders will be to either eat it, or to fight back. Fighting back would cause US hyperinflation, except for two saving reasons that is all but impossible: 1) by fighting back they will suffer worse than we do simply due to their low percentage domestically derived GDPs; 2) the US won't hyperinflate because no country willingly hyperinflates, and all countries with credible, projectable military forces escape hyperinflation without exception.