The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

November 24, 2009

Interest rates at center stage

In case you were just yesterday wondering if interest rates could get any lower, the answer was "yes":

"The Treasury sold $44 billion of two-year notes at a yield of 0.802 percent, the lowest on record, as demand for the safety of U.S. government securities surges going into year-end."

"Demand for safety" is not the most bullish sounding phrase, and it is not intended to be. It does, in fact, reflect an important but oft-neglected interest rate fundamental: Adjusting for inflation and risk, interest rates are low when times are tough. A bit more precisely, the levels of real interest rates are tied to the growth rate of the economy. When growth is slow, rates are low.

The intuition behind this point really is pretty simple. When the economy is struggling along—when consumer spending is muted and businesses' taste for acquiring investment goods is restrained—the demand for loans sags. All else equal, interest rates fall. In the current environment, of course, that "all else equal" bit is tricky, but the latest from the Federal Reserve's Senior Loan Officer Opinion Survey is informative:

"In the October survey, domestic banks indicated that they continued to tighten standards and terms over the past three months on all major types of loans to businesses and households. However, the net percentages of banks that tightened standards and terms for most loan categories continued to decline from the peaks reached late last year."

Demand also appears to be quite weak:

"Demand for most major categories of loans at domestic banks reportedly continued to weaken, on balance, over the past three months."

This economic fundamental is, in my opinion, a good way to make sense of the FOMC's most recent statement:

"The Committee… continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

Not everyone is buying my story, of course, and there is a growing global chorus of folk who see a policy mistake at hand:

"Germany's new finance minister has echoed Chinese warnings about the growing threat of fresh global asset price bubbles, fuelled by low US interest rates and a weak dollar.

"Wolfgang Schäuble's comments highlight official concern in Europe that the risk of further financial market turbulence has been exacerbated by the exceptional steps taken by central banks and governments to combat the crisis.

"Last weekend, Liu Mingkang, China's banking regulator, criticised the US Federal Reserve for fuelling the 'dollar carry-trade', in which investors borrow dollars at ultra-low interest rates and invest in higher-yielding assets abroad."

The fact that there is a lot of available liquidity is undeniable—the quantity of bank reserves remain on the rise:


But the quantity of bank lending is decidedly not on the rise:


There are policy options at the central bank's disposal, including raising short-term interest rates, which in current circumstances implies raising the interest paid on bank reserves. That approach would solve the problem of… what? Banks taking excess reserves and converting them into loans? That process provides the channel through which monetary policy works, and it hardly seems to be the problem. In raising interest rates paid on reserves the Fed, in my view, would risk a further slowdown in loan credit expansion and a further weakening of the economy. I suppose this slowdown would ultimately manifest itself in further downward pressure on yields across the financial asset landscape, but is this really what people want to do at this point in time?

If you ask me, it's time to get "real," pun intended—that is to ask questions about the fundamental sources of persistent low inflation and risk-adjusted interest rates (a phrase for which you may as well substitute U.S. Treasury yields). To be sure, the causes behind low Treasury rates are complex, and no responsible monetary policymaker would avoid examining the role of central bank rate decisions. But the road is going to eventually wind around to the point where we are confronted with the very basic issue that remains unresolved: Why is the global demand for real physical investment apparently out of line with patterns of global saving?

By David Altig, senior vice president and research director at the Atlanta Fed

November 24, 2009 in Federal Reserve and Monetary Policy, Interest Rates, Monetary Policy, Saving, Capital, and Investment | Permalink


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Can you say what you mean? (when you work as a public servant)

Bankers make more money investing in totally risk free, highly liquid earning assets, mis-named excess reserves @.25% rather than zero percent t-bills. Not too complex.

Banks are unencumbered in their lending operations(except the venerated, & capricious, 10% bank capital ratios).

Again, whether it's dis-intermedition (contraction or outflow of funds), from the non-banks, or financial intermediaries (e.g., hedge funds, investment banks, finance companies, insurance companies, mortgage companies, pension funds, etc.),

c. 80% of the lending market,

or IMPOUNDING savings within the commercial banking system, both are contractionary (the source of savings deposits within the monetary system is other bank deposits, directly or indirectly via currency, or the bank's undivided profits accounts).

Lower the remuneration rate on excess reserves. Then get the member banks out of the savings business. I.e., money flowing “to” the intermediaries never leaves the monetary system as anyone who has applied double-entry bookkeeping on a national scale should know. And why should the member banks pay for something they already own (interest). The member banks would be smaller, and more profitable, if they did not (1966 proved that, Dr. Alton Gilbert wasn't an expert: "Requiem for Regulation Q: What It Did and Why It Passed Away").

Monetary savings are LOST TO INVESTMENT (bottled up), within the banking and monetary system. I.e., savings held within the monetary system have a transactions velocity of zero, and are a leakage in the Keynesian national income concept of savings.

IOR's are not offsetting when the system's expansion coefficient varies widely

On IORs: Banks create new loans-deposits. The bankers are getting paid twice, for new, free, and additional earning assets (regardless of the expansion coefficient). Interest on reserves is a fraud and deceit upon the American people.

Posted by: Spencer Bradley Hall | November 26, 2009 at 07:59 PM

Thanks for doing this blog. I'll try to keep my comments to a technical nature.

On one hand, I agree that there has been some flight to safety in recent weeks, which I think reflects concerns about the economy's dependence on monetary stimulus, and the sustainability of the stimulus.

On the other hand, I also see indications that the recent retreat in Treasury rates is due also to an increase in the scale of monetary stimulus. The federal funds rate has fallen in recent weeks to around 12 bips, after hovering around 20 bips for most of the year.

This decline roughly coincided with the recent redemption of $185 billion from Treasury's supplementary financing account, which boosted the pace of the increase in excess reserves.

Also, for most of this year the Fed had been able to restrain the stimulus effect of its asset purchase programs by reducing borrowing from the Fed - in essence, replacing the large borrowed reserves built up in 2008 with non-borrowed reserves. But there seems to be little borrowed reserves left that the Fed can reduce, and so its asset purchases seem recently to be translated practically 1:1 into additional excess reserves.

Or this could perhaps be a case of steady monetary stimulus having partly delayed, and thus accelerating effects.

In a different time in a different country, a central banker once explained to me how he would know when monetary stimulus had surpassed its usefulness. He said it's like trying to pour coffee while blindfolded: the only way you know the cup is full is when you can feel the coffee spilling across the table. By that he meant when CPI accelerates.

But this is a novel situation, in which the scale of monetary stimulus is very large and yet the deflationary forces from deleveraging are very powerful. So perhaps the coffee is spilling out, but the table is tilted enough that the Fed isn't feeling any where it has its hand.

Posted by: Tom | November 27, 2009 at 01:23 AM

The Fed is in a box. Raising short term rates now would be bad policy. Perhaps being more stringent on the type of collateral that they take would be a step toward signaling to the market that they are ever vigilant, and are not encouraging bubbles.

Saving is up because people are scared (in the US). Bankers have told me they cannot find good credit risks to lend to. Plus, their existing loans are being paid off as quickly as possible. They are forced to buy treasuries to put their money to work.

The propensity to save in Asia is high. There seems to be a cultural bias toward saving versus spending. The Chinese populace has become richer, but they have not spent those riches and are saving them.

It would be interesting to look at the savings rate of the US from the late 1880's to 1920 to see how it compares. Maybe there is a correlation with saving and development?

Secondly, the economic environment is so uncertain. Business is terrified of the coming actions of the Obama administration. Cap and trade, higher taxes, health care regulations and taxes, pro union actions, and more regulation in general are troubling to any business. The costs of all these actions are not easily quantified into any model-so it's hard to make a decision. The result, is no action. Cash piles up.

Posted by: Jeff | November 27, 2009 at 08:58 AM

In regard to the final question, why is the demand to borrow seemingly lower than the supply of capital, I wonder if it is some combination of:

A. Demographic changes - if young people generally borrow and take risks, and older people generally save (lend), perhaps the baby boom retirement is causing too much savings to chase too few risk takers?

B. Business changes - in the past, the hottest areas of the economy (say railroads) required large amounts of capital investment. Increasingly, the hottest areas (the internet/google) use relatively little capital, and are largely self-financing. Perhaps this shift implies that the same amount of savings is now chasing fewer opportunities for capital investment.

C. Changes in retirement expectations - in the early 1900s, I think many people never expected to retire, and consequently never saved. Now, most expect to retire and most save to attempt to fund that retirement. That increases the number of people looking to save/lend.

I wonder if A, B and C are large enough to cause macroeconomic impacts. I think they could amplify each other, in the sense that there are both fewer risk-taking borrowers per retiree/lender, and each risk-taker needs less capital investment than before.

Posted by: Chris | November 30, 2009 at 06:50 PM

I'd like to play devils' advocate with regard to the fear of rampant inflation that is expected.

True, the money supply has expanded enormously in the credit crisis. It is mind boggling to think about. How could it not lead to rampant inflation?

First, the money isn't in the economy. It is on bank balance sheets.
They are reinvesting it in government treasuries. They are not lending it. As a matter of fact, their credit standards are so high they won't lend it. Furthermore, their outstanding loans are being repaid-so this cash is being reinvested in treasuries as well.

Once the Fed sees that money is being lent out-and the velocity of money picks up-they undertake open market operations aggressively to sop up cash. They raise discount rates by a little-and change the collateral that they take to make it tougher for prime brokers to get cash from the Fed.

If they are fast enough, we will have limited inflation in the overall economy.

Posted by: jeff | December 04, 2009 at 01:14 PM

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September 01, 2009

Us and them: Reviewing central bank actions in the financial crisis

With all the focus on the financial crisis in the United States, folks in this country might sometimes lose sight of the fact that this crisis has been global in nature. To provide some perspective on the global dimensions of the crisis, we are providing a few summary indicators of financial sector performance and central bank policy responses in the United States, the United Kingdom, the Euro Area, and Canada. Based on this general review, we surmise that some of the experiences have been remarkably similar, while others appear to be quite different. To pre-empt the question: Why these four regions? The reason is simply that the data were readily available. We encourage readers to use data from other areas, and let us know what you find.

The first chart compares relative changes in monthly stock market price indices for 2005 through the end of August. During the crisis, market participants significantly reduced their exposure to risky assets, which helped push equities lower. All indices peaked in 2007, except Canada, which technically peaked in May 2008. Canada outperformed relative to the others in early 2008 but suffered proportionally similar losses thereafter. The United Kingdom, Euro Area, and Canada bottomed in February 2009 while the United States bottomed in March 2009. The Euro Area to date has experienced the strongest rebound in equities, increasing by almost 40 percent since the trough in February. However, Europe also had the largest peak-to-trough decline, almost 60 percent. Canada and the United States have jumped by about 33 percent since their respective lows in February and March, while U.K. stock prices have risen by about 30 percent since February.


The second chart compares long-term government yields. As the crisis unfolded in late 2007, yields on 10-year U.S. Treasuries sank as global flight to quality helped push yields lower. Yields on U.S., U.K., and Canadian bonds have all moved lower than they were prior to the onset of the crisis. Interestingly, in the Euro Area, prior to the crisis, sovereign yields were at or below bond yields in the other countries but are now slightly above those. In fact, Euro Area yields haven't moved much since the beginning of the crisis in late 2007.


The third chart contrasts monetary policy rates in the four regions. The chart shows that all the central banks lowered rates aggressively, but there are some subtle differences in the timing. For the United Kingdom, Euro Area, and Canada, the bulk of policy rate cuts came after the financial market turmoil accelerated in the fall of 2008, whereas in the United States the majority of the cuts came earlier.

The Fed was the first to lower rates, cutting the fed funds rate by 50 basis points in September 2007 at the onset of the crisis. The Fed continued to lower rates pretty aggressively through April 2008, with a cumulative reduction of 325 basis points. Once the financial turmoil accelerated again in the fall of 2008 the Fed cut rates again by another 200 basis points.

The Bank of Canada's cuts followed a generally similar timing pattern to the Fed but with differences in the relative magnitude of the cuts. In particular, the Bank of Canada rate lowered rates by 150 basis points through April 2008 and then by another 275 basis points since September 2008.

Similarly, the Bank of England cut rates three times in late 2007/early 2008, totaling 75 basis points. But like the Bank of Canada, the bulk of their policy rate cuts didn't come until the increased financial turmoil in the fall of 2008. Between September 2008 and March 2009, the Bank of England cut the policy rate by 450 basis points.

Unlike the other central banks, the European Central Bank (ECB) did not initially adjust policy rates down as the crisis emerged in late 2007. In fact, after holding rates steady for several months it increased its rate from 4 percent to 4.25 percent in July 2008. It started cutting rates in October 2008, and from October 2008 to May 2009 the ECB reduced its refinancing rate by 325 basis points. Of the four regions, the ECB currently has the highest policy rate at 1 percent. For some speculation about the future of monetary policy rates for a broader set of countries, see this recent article from The Economist.


The final chart compares relative changes in the size of balance sheets across the four central banks. The balance sheet changes might be viewed as an indication of the relative aggressiveness of nonstandard policy actions by the central banks, noting that some of the increases can be attributed to quantitative easing monetary policy actions, some to central bank lender-of-last-resort functions, and some to targeted asset purchases.

The sharpest increases in the central bank balance sheets came in the wake of the most intense part of the financial crisis, in the fall of 2008. There had been relatively little balance sheet expansion until the fall 2008. Prior to that, the action was focused mostly on changing the composition of the asset side of the balance sheet rather than increasing its size. The size of both U.S. and U.K. balance sheets has more than doubled since before September 2008, although both are now below their peaks from late 2008. Note that in the case of the Bank of England, quantitative easing didn't begin until March 2009, and the subsequent run-up in the size of the balance sheet is much more significant than in the United States. Prior to that, the increase in the Bank of England balance sheet was associated with (sterilized) expansion of its lending facilities.

In contrast, the Bank of Canada and ECB increased their balance sheets by about 50 percent—much less than in the United Kingdom or United States. By this metric, nonstandard policy actions have been less aggressive in Canada and the Euro Area. Why these differences? This recent Reuters article provides a hypothesis that focuses on institutional differences between the Bank of England and the ECB. In a related piece, this IMF article compares the ECB and the Bank of England nonstandard policy actions.


Note: The Bank of England introduced reforms to its money market operations in May 2006, which changed the way it reports the bank's balance sheet data (see BOE note).

By John Robertson, vice president and senior economist, and Mike Hammill and Courtney Nosal, both economic policy analysts, at the Atlanta Fed

September 1, 2009 in Europe, Financial System, Interest Rates, Monetary Policy | Permalink


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Re : "Of the four regions, the ECB currently has the highest policy rate at 1 percent."

Please, this is the kind of "analysis" we all could do without. You are comparing apples and pears. If you want to compare the US policy rate, i.e. an interbank overnight rate target, to something relevant in the Eurozone, then pick a euro overnight rate. Eonia has been at around 0.35% since June, not 1%, which is currently used as the very long term tender rate. As to 1 month Euribor, it is currently 0.48% while 1 month USD Libor is 0.28%.

Posted by: Henri Tournyol du Clos | September 01, 2009 at 07:12 PM

Yeah, but this analysis is accurate with the situation and the subject "Bank Actions".

Posted by: Andrew | September 08, 2009 at 04:46 AM

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July 14, 2009

A funny thing happened update

More than a week has passed since the Regulation D changes went into effect, and it appears that the changes are having a noticeable, if not dramatic, impact on pricing in the funds market—see the updated effective funds rate chart below.


The funds rate did fall last week, and it is possible that the softening was related to an increased supply of fed funds by Federal Home Loan Banks as they sought to reduce their excess reserve balances because they no longer earned interest on those balances. But if that is in fact the explanation, the effect was not large: Fed funds are still trading in a relatively narrow range between about 5 and 40 basis points each day. Though, as the chart shows, the effective fed funds rate has drifted lower so far in July—it was at 15 basis points on Friday, July 10, down from 20 basis points on July 1. The current rate is well above the January low of 8 basis points.

Despite the large increase in supply of funds in the market that might have resulted from the Reg D change, it seems to me that the opportunity for arbitrage profits is helping keep the effective funds rate hovering in the neighborhood of the interest rate paid by the Fed to eligible institutions on their reserve balances.

By John Robertson, vice president in research at the Atlanta Fed

July 14, 2009 in Interest Rates, Monetary Policy | Permalink


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Trivia. If the FOMC wanted rates to fall, and insured member banks to lend, the policy makers would lower the renumeration rate on excess reserves. It's too high relative to the target FFR.

Posted by: flow5 | July 14, 2009 at 06:43 PM

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July 03, 2009

A funny thing happened on the way to the federal funds market

Since the beginning of this year, the effective funds rate in the market for reserve balances has varied between zero and about 15 basis points below the interest rate the Federal Reserve pays on those reserve balances (see chart below, which runs through July 2). A vexing issue has been the fact that the interest paid on reserve balances at the Fed has not set a floor on the funds rate traded in the funds market, but rather it has acted more like a magnet (see, for example, this PrefBlog post from early this year).


On July 2, the Federal Reserve Board’s latest amendments to Regulation D (Reserve Requirement of Depository Institutions) went into effect. Included in these changes are two that could materially affect the fed funds market and that vexing gap between the fed funds market rate and the deposit rate.

The first is the authorization for correspondent banks to create Excess Balance Account (EBA) programs on behalf of their respondent financial institution clients. The second is the nullification of an exemption that allowed ineligible institutions (such as the Federal Home Loan Banks) to earn interest on their reserve balances as a result of providing reserve management services for banks.

This change is good news for the 20 or so bankers' banks that provide respondent banks, usually community banks, with services, such as managing the respondent’s reserve balances at the Fed. Prior to the change in Regulation D, a bankers' bank was required to pool all the respondent’s reserve deposits into its own reserve account. This task is a bit of a problem when excess reserves are at high levels because reserves are a bank asset that counts against regulatory capital-to-asset ratios. Partly because of this financial leverage concern, bankers’ banks have had to sell some of their respondent excess reserves into the fed funds market and earn less than the 25 basis points offered for reserve balances at the Fed. But with the change in Reg. D, they will be able to deposit respondent balances at the Fed in the EBAs, and this approach will alleviate their balance sheet pressure.

What does this change mean for the funds market? Well, one source of supply of funds will be reduced, and that should put upward pressure on the fed funds rate. That’s good news for closing the deposit/market rate spread, although it should be said that bankers’ banks represent only a small fraction (about 5 percent) of daily fed funds market activity, so the impact will probably be equally small.

The second change could be a more significant one and will tend to put downward pressure on the effective funds rate. Nine of the 12 Federal Home Loan Banks (FHLBs) provide respondent banking services (like bankers’ banks) for some of their member institutions. These FHLBs had been pooling their own reserve balances with their respondents’ balances, thus earning interest on their own reserves as well. Technically, the FHLBs, like other government-sponsored enterprises, are ineligible to earn interest on their own reserve balances held at the Fed, but the FHLBs were given an exemption under the interim rule published last year, which did not distinguish between an FHLB’s own reserve balances and those of their respondents. With the amended Reg. D, the pooling of reserves will no longer be allowed. Thus, the FHLBs will not be able to earn interest on their own reserve balances.

Will this change matter to them? A look at the FHLB consolidated balance sheet suggests it could. For instance, as of Sept. 30, 2008, the FHLBs were sellers of some $94 billion of fed funds and held zero on deposit at the Fed. But as of Dec. 31, 2008, after the Fed started paying interest on reserves, the FHLBs sold only $40 billion of fed funds and held $47 billion on deposit at the Fed. In a funds market that has been experiencing relatively light volumes in 2009 year to date, the potential additional supply of dollar reserves by the FHLBs could materially affect rates in the fed funds market.

What happened when the regulation changes took effect yesterday? Well, the fed funds effective rate yesterday declined from 20 to 17 basis points. Thus, it appears the softer funding conditions expected as a result of the changes generally failed to materialize. But it still may be too early to determine the full impact of the regulation changes, and more definitive changes in trading could materialize in coming days. Fed funds market nerds stay tuned.

By John Robertson, vice president in research at the Atlanta Fed

July 3, 2009 in Interest Rates, Monetary Policy | Permalink


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Why have a peer-to-peer inter-bank market at all? Why not redesign the system using a hub-and-spoke model with the Fed being intermediary to overnight unsecured lending. The whole reserve ratio requirement is obsolete in the current system.

Posted by: Zaid | July 05, 2009 at 05:35 AM

This was an obvious gap. It should have been dealt with 29 years ago - with the DIDMCA of March 31st 1980.

Zaid is exactly right. Pass-thru's should be eliminated.

Posted by: flow5 | July 06, 2009 at 04:18 PM

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November 25, 2008

How should we think about the monetary transmission mechanism?

That’s always a relevant question, but it takes on some added importance in times like these when the federal funds rate—the standard policy target for the Federal Open Market Committee—approaches its lower bound of zero. The recent introduction of a policy to pay banks interest on the reserves they hold on account with the Federal Reserve—which presumably (though puzzlingly not yet operationally) puts a floor on the federal funds rate independent of how much liquidity the central banks pumps into the economy— raises the question afresh.

A week or so back, Glenn Rudebusch, associate research director at the San Francisco Fed, offered his view on this topic:

“Although the funds rate target cannot be lowered much further—and certainly not below zero—it is not the case that the Federal Reserve is necessarily 'on hold.' Indeed, the Fed has already started to employ alternative means for conducting monetary policy in order to stimulate the economy.

“There are three key strategies for a central bank to stimulate the economy when short-term interest rates are fixed at zero or near zero. The first is to attempt to lower longer-term interest rates and boost other asset prices by managing market expectations of future policy actions. Specifically, a credible public commitment to keep the funds rates low for a sustained period of time can push down expectations of future short-term interest rates and lower long-term interest rates and boost other asset prices. Such a public commitment could be unconditional, such as 'maintained for a considerable period' or it could be conditional, such as 'until financial conditions stabilize.' The FOMC made such a commitment in 2003 after the funds rate was lowered to 1 percent and the economy remained weak. With the funds rate currently quite low, the Fed may revisit this strategy. If so, there would appear to be considerable scope for such a strategy to work, as the 10-year U.S. Treasury bond yield remains around 4 percent. When the Bank of Japan promised in 2001 to keep its policy rate near zero as long as consumer prices fell, it was able to help push the rate on 10-year government securities down below 1 percent.”

Rudebusch goes on to discuss the other two strategies—worth reading and examining here at a later time—but I think it is interesting to contrast this first statement of strategy with the following, from Tobias Adrian and Hyun Song Shin (of the Federal Reserve Bank of New York and Princeton University, respectively):

“We find that the level of the Fed funds target is key. The Fed funds target determines other relevant short term interest rates, such as repo rates and interbank lending rates through arbitrage in the money market. As such, we may expect the Fed funds rate to be pivotal in setting short-term interest rates more generally. We find that low short-term rates are conducive to expanding balance sheets. In addition, a steeper yield curve, larger credit spreads, and lower measures of financial market volatility are conducive to expanding balance sheets. In particular, an inverted yield curve is a harbinger of a slowdown in balance sheet growth, shedding light on the empirical feature that an inverted yield curve forecasts recessions.”

That empirical feature is in fact documented by Rudebusch and John Williams. Adrian and Shin continue:

“These findings reflect the economics of financial intermediation, since the business of banking is to borrow short and lend long…

“… our results suggest that the target rate itself matters for the real economy through its role in the supply of credit and funding conditions in the capital market. As such, the target rate may have a role in the transmission of monetary policy in its own right, independent of changes in long rates.”

Interestingly, the “considerable period of time” episode referred to in the Rudebusch excerpt above coincided with an increase in long-term interest rates and a steepening of the yield curve:

Interest Rates: 2002-2004

So, if stimulative monetary policy is what we are after, should we be looking for lower long-term rates or higher long-term rates? Discuss.

By David Altig, senior vice president and director of research at the Atlanta Fed

Because of the Thanksgiving holiday, today’s posting will be the only macroblog posting for this week.

November 25, 2008 in Federal Reserve and Monetary Policy, Interest Rates | Permalink


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I think there is much validity to the argument that a steepening yield curve is a key ingredient to jumpstarting economic activity. Ideally, 300 basis points or more between the 30-yr bond and 3-mo T-bill is enough to encourage lenders to borrow short and lend long in a risky environment. I think the lack of a clear policy commitment is having a negative impact in this panic-driven environment. I am looking for the Fed to lay out in clear terms how they intend to loosen policy going forward given the real limitations of impending ZIRP.

Once a clear monetary policy is established, participants will be able to take actions without fearing unanticipated Fed (re)actions to market conditions could hurt them. The more transparency and clear direction, the better if we expect lenders to take risk.

best wishes,

Posted by: Bob Brinker | November 25, 2008 at 07:23 PM

If we are trying to increase bank capital, higher long term interest rates would allow banks to borrow short and lend long with a larger net interest margin.

If we are trying to stimulate investment, lower long term interest rates would encourage companies to borrow to increase productive capacity.

Given the dangers of deflation and the fact that we are not using the productive capacity we have, we should adopt the first policy. Until banks have the confidence to lend to companies and individuals with good credit ratings, the level of short term interest rates will have no effect on economic performance.

Posted by: Rajesh Raut | November 25, 2008 at 09:45 PM

First, Happy Thanksgiving and keep blogging.

I think at this time, it is critical that the Fed keep rates low. Once the economy shows signs of life, they can begin ratcheting them up. The last chart is interesting. If you think about the explosion of leverage in the market, it may account for the steepening of the curve. Because hedge funds, and investment funds could get better returns in the market, they were voracious borrowers to get more cash to get more return.

The amount of subprime/alt-a activity also increased significantly from 2001-2007, and I believe the velocity of that increase was steeper from 04-07 (would have to check) This could also account for the steepening.

As an aside, there was a trade in the 30 year bond option last week. An out of the money strike traded for half a tick-effectively pricing the 30 year at 0%. That should give anyone a shudder.

Posted by: Jeff | November 25, 2008 at 10:58 PM

My concern with this post is the following:

We know how the Fed used to run monetary policy and we know how short-term interest rates used to work. But I don't think the past should be treated as a good indicator of the future in the current environment. I think the Fed should be preparing for the possibility that changes in the target rate have a minimal effect on any interest rates of more than one year duration.

Of course, by all means try Rudebusch's public commitment method -- just make sure you have a plan B in case it doesn't work.

Posted by: Anonymous | November 26, 2008 at 12:52 PM

"The 10-year U.S. Treasury bond yield remains around 4 percent."

Bloomberg quotes 2.98, close to historical lows.

Posted by: rogier kamerling | November 26, 2008 at 01:44 PM

It's supply and demand, innit? Cause and consequence?

An increased SUPPLY of long loans (from the Fed) will lower long rates, increase investment, and help CAUSE a recovery.

When recovery starts, the increased investment, and increased DEMAND for long loans (from firms and households), will raise long rates, and will be a CONSEQUENCE of the recovery.

Posted by: Nick Rowe | November 27, 2008 at 03:53 PM


the fed cannot engineer a recovery by itself. it can pursue an easy money policy, but until actual business gets going (not by a boost from the government), GDP will continue to wane.

Posted by: Jeff | December 01, 2008 at 09:31 PM

We want LOWER longer term interest rates. I'm perplexed that you should ask.

Preventable foreclosures are a key issue we are addressing. To the extent they are tied to 10-year Treasury rates, lower rates obviously help keep people in their homes.

In a time of massive deflation that will be caused by extraordinary debt overhangs and a worldwide COLLAPSE in consumer demand, to argue whether higher longer term rates would exacerbate or ameliorate the situation poses serious questions about the fundamental grasp of the problem.

Posted by: Matt Dubuque | December 02, 2008 at 03:39 PM

As previously stated two months ago in this forum, the Fed needs to IMMEDIATELY buy long term securities and SELL short term Treasuries, a reprise of Operation Twist from the 1960s.

Doing so will lengthen the time horizon of actors and yet support the dollar at the same time.

Posted by: Matt Dubuque | December 02, 2008 at 03:41 PM

Lower long-term interest rates. From a spending perspective, the last thing we need now, with inflation falling, is long-term interest rates rising. In other words, we want the real interest rate to fall not rise.

Isn't this the idea behind the Taylor principle? As inflation falls, lower real interest rates will help stimulate spending, which, in turn, enables the economy's readjustment back towards potential?

In fact, isn't the likelihood that the Taylor Principle may not be operable (by reaching the zero interest floor) a major reason why this recession is different from all of the other post WWII recession?

Posted by: SMG | December 04, 2008 at 08:51 PM

Given the dangers of deflation and the fact that we are not using the productive capacity we have, we should adopt the first policy. Until banks have the confidence to lend to companies and individuals with good credit ratings, the level of short term interest rates will have no effect on economic performance.


I couldn't disagree more. The issue here isn't the cost of the debt. It is the fact the sheer size of debt in this country is overwhelming. This is the reason you will see deflation, (then inflation). The debt load is suffocating every asset class, especially those tied to the use of leverage. We don't need to lower the cost of the leverage artificially, in my opinion, that will not work. Debt needs to be paid down or wiped out. That is the only solution. You can take rates to zero or 1 percent Fed Funds, I don't think it will help. Corporate issuers are paying north of 10% to access the credit markets, when Fed Funds is 1.00%

I don't think taking the Funds rate to zero and keeping it there is going to change the rate corporate issuers are paying in the capital markets. Risk is finally being priced into these credits.

Posted by: Irish | December 06, 2008 at 10:44 PM

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September 16, 2008

The left and right of it all

What a wild day it was on Monday in U.S. and global financial markets. We heard it quipped that the problem with financial institution balance sheets is that “on the left hand side nothing is right and on the right hand side nothing is left.” This is clearly an exaggeration, but it does raise the question: What do people look at when gauging the rightness or leftness of balance sheets?

A lot of the discussion about asset quality has focused on mortgage backed securities (MBS). The size of the MBS market has experienced phenomenal growth over the last decade or so—MBS issuance grew from around $500 billion in 1997 to over $2 trillion in 2007. As the name suggests, an MBS is a bond that is backed by the collateral of mortgages—either by mortgages guaranteed by Freddie Mac or similar institutions or other pools of mortgages. The MBS, or pieces of it, are then sold to investors, with the principal and interest payments on the individual mortgages used to pay investors.

Underlying the performance of MBS is the performance of mortgages themselves. Mortgage delinquency has been rising for some time, and especially for subprime mortgages.

Figure 2

At the same time, the value of the mortgages, as indicated by home prices have been falling.

Figure 2

One of the features of the U.S. financial system is that the debt of financial institutions tends to be weighted toward long-term obligations while the financing has been predominately from short-term borrowing. As the performance of the assets has deteriorated the need for liquidity has risen sharply.

The demand for cash was especially acute on Monday, as can be seen in the large intra-day variability in the federal funds market. Federal funds are the reserve balances of depository institutions held at the Federal Reserve. At times on Monday the federal funds rate traded well above the target of 2 percent before the New York desk intervened with an additional $50 billion injection of reserves. This Bloomberg news story describes Monday’s large movements in the federal funds market.

Figure 2

The demand for liquidity at 1 and 3 month horizons also surged, as indicated by the dollar LIBOR spread over OIS at 1 and 3 month horizons. LIBOR (the London Inter-Bank Offered Rate) is the interest rate at which banks in London are prepared to lend unsecured funds to first-class banks. As such it is a guide world-wide for the rate banks use to lend to each other. In the U.S., it is usually not far off from the fed funds rate. But after the emergence of the financial turmoil last fall the LIBOR has risen relative to the fed funds rate. The OIS (Overnight Index Swap) rate is a measure of the expected overnight fed funds rate for a specified term (1 or 3 months, for example). The LIBOR/OIS spread can be used as measure of the amount of liquidity or stress in short-term unsecured cash markets.

Figure 2

LIBOR spreads edged higher last week amid uncertainty about financial firms, and both spreads jumped higher on Monday and Tuesday, with both at or close to new highs.

Tuesday is another day, but some things will remain the same, including the focus of attention on the left and right of financial institution balance sheets, and the debate about the appropriate role of government in all this.

By John Robertson and Mike Hammill in the Atlanta Fed’s research department

September 16, 2008 in Capital Markets, Interest Rates | Permalink


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I think Geithner is doing a great job under impossible circumstances.

The only failure of the Federal Reserve here is in public relations.

The financial press (save the Financial Times) and the blogosphere are absolutely clueless as to why the Federal Reserve is proceeding as it is.

The level of ignorance in the American public about what the Fed does is terrifying. The "conspiracy theorists" are absolutely out of control and dominating the discussion.

This web site is a good beginning. I would like to see ALL Federal Reserve branches have such a blog and this would help. Kansas City should definitely be next in line; Sellon, Hakkio and Hoenig are true stars, as was the great Wayne Angell.

Matt Dubuque

Posted by: Matt Dubuque | September 16, 2008 at 08:42 PM

Matt - I wholeheartedly agree and third your motion. In fact so much so that I've been posting on my own blog numerous times trying to throw some starfish back in the sea. Apparently good conspiracy theories are too much fun no matter what the facts are; e.g. the willful distortion of CPI, the whole GDP deflator tempest, etc. If you've any interest there's a whole archive of my views on Fed policy and another on the credit contagions, for what the views of an amateur are worth.

Posted by: dblwyo | September 17, 2008 at 10:37 AM

Nice post guys. Glad to see some discussion on the underlying problems facing financials and the economy. There are bad assets hiding on banks' books. And now banks are hoarding cash.

Will be interesting to see how things shake out over the next couple weeks. Please keep putting up these kinds of posts. Very helpful and much appreciated.

Posted by: The Street | September 17, 2008 at 08:05 PM

I liked the content on this site. Would like to visit again.

Posted by: Shirin Jindal | September 18, 2008 at 02:59 AM

What Matt Dubuque Said, but...

"Mortgage delinquency has been rising for some time, and especially for subprime mortgages."

Uh, NO, on that "especially." The Fed knows better, and so do you. The "especially" at this point is the PRIME mortgages.

Posted by: Ken Houghton | September 23, 2008 at 07:15 PM

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August 26, 2008

Deep questions from Jackson Hole

If one were to judge importance by press attention, the key events of this past weekend’s annual Jackson Hole economic symposium hosted by the Federal Reserve Bank of Kansas City would be the bookend contributions of Fed Chairman Ben Bernanke’s opening address and Willem Buiter’s 141 pages worth of Fed criticism. Understandable, in the former case for obvious reasons and in the latter for the grand theoretical pleasure of Buiter’s (shall we say) forthright critique and discussant Alan Blinder’s equally forthright (and witty) defense of the Fed. (The session’s tone is nicely captured in the reports of Sudeep Reddy from the Wall Street Journal and Bloomberg’s John Fraher and Scott Lanman.) [Broken link to the Bloomberg article fixed.]

Though Professor Buiter’s (of the London School of Economics and Political Science) assertions were certainly provocative, for me the truly thought-provoking aspect of the symposium was the collective effort to address some deep questions that still seek answers. There are a lot of them, but here are a few at the top of my list.

How do you know “loose” monetary policy when you see it?
Charles Calomiris—whose paper received attention at Free exchange, and is summarized by the author himself at Vox—says it is the real (or inflation-expectations adjusted) federal funds rate. I suspect that conforms to the definition favored by many, but the significance of defining the stance of monetary policy in this way was hammered home by Tobias Adrian and Hyun Song Shin:

…some key tenets of current central bank thinking [have] emphasized the importance of managing expectations of future short rates, rather than the current level of the target rate per se. In contrast, our results suggest that the target rate itself matters for the real economy through its role in the supply of credit and funding conditions in the capital market.

There is a fair amount at stake in understanding which of these views is correct:

Chart of Interest Rate Spreads

Are longer-term interest rates relatively high while the real federal funds rate is so low because policy is quite loose and inflation expectations are rising? Or are the elevated long-term rates a sign that policy is really restrictive? Or is the picture just a symptom of a combination of currently weak returns to capital (keeping short-term rates low), the prospect of better times ahead (and higher long-run returns to capital), and a return to more realistic pricing of risk, all of which would be consistent with the proposition current policy is neither too easy nor too tight? The question is not academic.

Is there crisis after subprime?
A primary component of Calomiris’ thesis is (in the words of his Vox piece) “loose monetary policy, which generated a global saving glut.” That global saving glut connection would come up again, most prominently in MIT professor Bengt Holmstrom’s discussion of the contribution by Gary Gorton (itself an essential read if you have any questions at all about the way subprime markets work, or what they have to do with SIVs, CDOs, and ABXs).   The starting point of Holmstrom’s argument—a variation on earlier themes from Ben Bernanke (for the general audience) and Ricardo Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas (for the economists in the crowd)—goes something like this: Surplus saving in emerging economies has driven up the demand for liquid assets. Liquidity being a specialty of the United  States in particular, the excess demand drives down interest rates here, stimulates spending, and expands deficits on the country’s current account.

The story, I believe, goes back to the late 1990s. One important difference between then and now is that the liquid assets most in demand at the close of the past decade were highly concentrated in long-term Treasury securities. Another is the fact that the related private-asset appreciation in the late 1990s was manifested in equity markets. After the tech-stock bust, however, the fundamental global imbalances remained and found a new home in debt created by the subprime housing market. As Professor Holmstrom and others noted, collateralized debt markets, based as they are on leverage and low levels of information flows, are much more complicated animals than equity markets.

The question that remains is obvious. What is there to stop the next crisis if global imbalances persist? And if they do, is “better” monetary policy—whatever that might be —a sufficient condition for avoiding future problems?

Which leads me to…

Is there a better way to prepare for future bouts of financial market turmoil?
One answer—shared by many at the symposium—is that we can do so imperfectly at best, and that ultimately governments or markets or both just have to clean up the mess afterward. That approach feels a bit costly at the moment, so it seems a prudent thing to explore proactive measures that may at least mitigate the impact when problems arise. On this front, the biggest buzz of the symposium was probably generated by Anil Kashyap, Jerome Stein, and Raghuram Rajan, who proposed the development of “insurance policies” that would infuse the banking sector with fresh capital when they need it most. I’ve run on too long now, so for further elaboration I will refer you again to Sudeep Reddy – or to the paper itself.

A related reading PS: You will find more on the Chairman’s speech at Free exchange, at Calculated Risk (here and here), and at the William J. Polley blog. On Professor Buiter’s session you will find no shortage of commentary. The Daily Reckoning, naked capitalism, Economic Policy Journal, and Equity Check provide what I am sure is just a sampling.

August 26, 2008 in Federal Reserve and Monetary Policy, Interest Rates | Permalink


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{the biggest buzz of the symposium was...“insurance policies” that would infuse the banking sector with fresh capital when they need it most.}

David --- such 'options on contingent capital' were proposed by [Myron] Scholes shortly after the LTCM crisis. I will look for the reference, but I believe it was an interview in Risk magazine.

Posted by: MW | August 26, 2008 at 02:06 PM

I have a question of my own. Why is the Fed holding the discount rate so low (i.e., making medium-term ultra-low-interest loans) that banks can perform arbitrage with GSE debt for zero-risk profits?

See http://dealbreaker.com/2008/08/trade_of_the_day_buy_freddie_p.php

Posted by: Nemo | August 26, 2008 at 02:24 PM

Deep questions from Jackson Hole

I am just a Ph.D. chemist, but I believe that this question is unasked because the answer is a YES that's too hot to touch!

In your opinion,
will asset-market extreme mispricing be well-deterred,
if and when
real inflation-corrected asset-market price histories are well-apparent to the people?

Exampling such histories, please see first and last charts here:
“Real Dow & Real Homes & Personal Saving &
Debt Burden” at

Posted by: Ed | August 26, 2008 at 05:24 PM

The subprime risk problem resulted from the banking sector’s lack of macroeconomic imagination, in filtering the interpretation of “risk statistics” for a product with little economic history.

The Fed has done a good job of responding to the crisis, after a not so great job of assessing the risk ex ante, although in the latter matter it was constrained by a dysfunctional alignment of related regulatory responsibility, beyond its own scope at the time.

The current Treasury yield curve is quite reasonable, even healthy. What is obviously not healthy in the same context are credit spreads, including mortgage spreads, which is why the combination of the treasury curve and credit spreads make monetary policy meaningfully tighter than indicated by the funds rate on its own.

The global savings glut is a bad, distractive economic paradigm. It explains nothing because it is not meaningful. It matters not whether the explanation for the imbalances is that China has not purchased enough imports (savings glut), or the US has purchase too many (expenditure glut). The result is the same. Foreign surpluses fund US deficits, and wouldn’t exist without them. The two are co-dependent, rather than causal, in either direction. Sub-prime was created by an aggressive domestic intermediation machine, and sold to a foreign one – not vice versa. Foreign surpluses did not cause the US to go and buy more houses.

Posted by: JKH | August 26, 2008 at 08:40 PM

All insurance schemes are subject to agency problems. They are either solved through a combination of risk premia/underwriting standards, or by regulation.

So the introduction of an "insurance capital" scheme would hardly present a solution to the current problem. What its proponents miss is that, the more insurance, the more asymmetric the returns, the more risk the banks will want to take.

The Fed tends to see "moral hazard" as a problem to be addressed in the future. And yet, as any market participant will tell you, the belief in a "Fed Put" created moral hazard that landed us in the present crisis, and that the cost of each successive hazard-generated crisis is higher.

The credit crisis is part of a continuum that began with the 1998 LTCM rescue. What's clear is that this is still very much a minority view among Jackson Hole participants and Fed Governors.

Posted by: David Pearson | August 27, 2008 at 10:17 AM

As the finanical industry loses public support for bailouts, we will continue the approach towards the zero bound.

While many may see this as a bad thing as it requires fiscal policy stimulus and therefore politically guided spending, they should be reminded that 'nonpolitical' monetary policy got us here.

It appears the financial infrastructure may have shot itself in the foot this time (as it did in Japan) and is making itself irrelevent as people start to realize the financial drain banks attach to the economy.

Posted by: Winslow R. | August 27, 2008 at 12:55 PM

JKH -- I am not sure your argument fully address Bernanke's argument, which is explicitly casual. He claims that if an expenditure glut drove the US deficit, it should have manifest itself in higher us and global rates -- with the high rates needed to pull funds into the US. Conversely, if high savings abroad drove deficits elsewhere (whether in the US or increasingly in europe), rates would be expected to be low both in the US and globally, with the low rates inducing more borrowing. In effect, Bernanke argues that US market rates tell you whether there is an expenditure glut or a savings glut.

In that sense, a rise in savings v investment in the emerging world (a fact shown in the IMF's WEO data) would induce lower rates, and lower rates could reasonably be expected to push up home prices and encourage non-residential investment. Perhaps not to the extent that they did -- the internal dynamics of the US credit market played a role -- but certainly directionally it would tend to work in that way. Some part of the US and European economy would need to borrow at the low rates and run a deficit that is the counterpart to the emerging world's surplus.

Dr. Altig -- I will confess I always find the academic discussion of "liquidity" as a speciality of the US rather frustrating. After all recently the US seems to have produced an enormous quantity of highly illiquid assets(which are causing a bit of trouble in the banks, last i checked). Even some Agency bonds i suspect are increasingly illiquid. Setting aside the fact that Europe's government bond market isn't as homogenous as the US bond market (a function of a single issuer v multiple issuers), I am not sure there is a meaningful difference in Europe's ability to create safe and liquid assets v the United States ability to do so. I certainly would have accepted a slight loss of liquidity by holding bunds rather than treasuries in exchange for an asset that has held its external purchasing power better over the last five years. And I don't think that there is strong evidence that the US is all that much better at Europe at creating "liquid" assets that private investors want to hold -- I would note that all net foreign purchases of Treasuries and Agencies (from june 06 to june 07 -- the last data points based on the survey data) came from the official sector.

It often seems to me that the United States comparative advantage at supplying liquidity is asserted rather than proven. Are Fannie and Freddie pass-throughs (China holds a lot of them) significantly more liquid than Italian treasury bonds, and held by the PBoC for that reason?

It seems like the most parsimonious explanation for large central bank inflows into the US is not the intrinsic quality of the US market but rather policy decisions on the part of key emerging economies to peg their currencies primarily to the dollar.

Finally, I don't find a story that argues that there has been one continuous deterioration in the US external deficit since 1997 all that compelling. It glosses over two facts: over that time the sources of funding changed from private investors to official investors and the sectors running the deficit in the US changed from the corporate sector to the household and government sectors. Understanding the sources of that shift strike me as important -- afterall one potential result of the end of .com driven investment (and the associated fall in private demand for US assets, net of US demand for foreign assets) would have been smaller deficits -- not bigger deficits combined with bigger net official flows.

Did Holmstrom's comment (which i need to read) or the discussion that followed recognize the enormous role the official sector now plays in the financing of the US deficit -- and the possibility that central banks might be buying dollar assets not because of the intrinsic desirability of dollar asset but rather becuase of a policy decision to peg to the dollar? Caballero, Farhi and Gourinchas do not, and as a result their paper never struck me as offering a useful model of the world we currently live in. Central banks -- not private investors -- are the ones buying us assets right now, and domestic savers in the emerging world increasingly have wanted to hold their own assets not foreign assets (see all the hot money moving into China. Both Dr. Feldstein and Dr. Summers understand the role the official sector now plays in financing the US well (total official asset growth is running at about two times the size of the US deficit), so i would expect the issue came up -- though it doesn't appear in your (quite useful) summary.

Posted by: bsetser | August 27, 2008 at 01:23 PM

While I like the paper on insurance policies, it seems that the authors are ignoring major parties who should buy the insurance. The FDIC is one regulatory authority which should own such insurance, as long as it isn't perceived as weekening their incentive to regulate properly.

Posted by: some investor guy | August 27, 2008 at 04:29 PM

bsetser – I was perhaps unnecessarily excessive in my characterization of the savings glut thesis, although I think you would acknowledge it is a debatable subject that indeed has been debated vigorously at times. The level of interest rates certainly fits well with the savings glut thesis, and taken as evidence it certainly suggests a savings glut rather than an expenditure glut. Nevertheless, I keep doubting that the savings glut is the critical explanation for low rates per se. My own preferred explanation is that the expected path of the funds rate, given the level of inflation and inflation expectations, has weighed heavily in the outcome. E.g. I think this factor was largely overlooked as an explanation for the yield curve “conundrum”. The yield curve was historically steep when the funds rate started its historic ascent from the low level of 1 per cent. The curve at the start discounted a substantial cyclical increase in the funds rate, arguably including the actual extent of the ensuing funds rate increase. Considered on that basis, there was little reason for treasury yields to move higher from the start, notwithstanding the unusual departure from the yield pattern of the typical tightening cycle. And I would add that the expected path of the funds rate is a valuation input that can be considered by foreign as well as domestic investors in the process of bidding on treasury bonds.

Posted by: JKH | August 27, 2008 at 05:01 PM

Contingent capital options:
Scholes, M., (1999), "Liquidity options: Scholes explains", Risk, Volume 12, Number 11, November, pp. 6

Posted by: MW | August 27, 2008 at 08:14 PM

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July 03, 2007

The World According To Goldman Sachs (And Almost Everyone Else)

From my email, "A Tale of Two Tail Risks," from Goldman Sachs' Michael Vaknin:

  • Sub-prime mortgage woes still hold centre-stage as housing fundamentals deteriorate further.
  • A full-blown spillover from credit markets to other asset classes is unlikely as corporate sector and global macro fundamentals remain strong.
  • Rather, credit market will feature less leverage, more convents, elevated volatility and gradual supply absorption.
  • Upward risks to global inflation also remain high on the list of what investors worry about currently.
  • On our baseline case, prudent monetary policy should limit a build-up of inflationary pressures.

Some details:

From a fundamental standpoint, there are two conflicting forces to consider. First, the ongoing deterioration in the residential housing market will continue to weigh on the mortgage market. Recent housing market data point to further inventory accumulation, while price indicators suggest the deceleration in house prices has gained more traction recently. The Case-Shiller 10- and 20-city composite indexes have declined sharply in April (7?% on annualized basis). The resulting decline in housing equity, along with the recent widening of mortgage rates and tightening of contractual mortgage conditions are all likely to keep credit investors on high alert.

On the bright side, corporate fundamentals remain fairly robust. Corporate default fundamentals are in good health, and from a macro perspective, corporate earnings are still supported by broadly favourable global demand conditions. While measures of industrial activity (including our Global Leading Indicator) have been somewhat softer than expected recently, from a level perspective the global manufacturing cycle remains comparatively strong, and a more broad-based weakness in the data is needed to shift this perception. Today's US ISM and the upcoming US payroll data are highly important in this respect.

That ISM report was, of course, a good one, although today's news on pending home sales failed to break the string of lousy housing data and factory orders for May were primarily lauded for being less bad than expected.  But put it together and the consensus seems to be that it all adds up to the Goldman Sachs story.  That's what came through in yesterday's round-up of forecasts from the Wall Street Journal, and the story that we're sticking to appeared again today in Bloomberg's coverage of the housing sales and orders reports:

Economists and the Federal Reserve predict growth will accelerate from its first quarter pace, the weakest since 2002, even as housing remains a burden. Fed Chairman Ben S. Bernanke said last month there was no sign of "major spillovers'' from the housing slide. Industry reports for June show manufacturers are raising production as businesses spend on investment.

"The second half is coming together almost perfectly according to the Fed's plan,'' said Mark Vitner, senior economist at Wachovia Corp. in Charlotte, North Carolina. "Housing is going to be a drag but if we get some strength in business spending then the economy will be able to handle it.''

Though some of the forecasters in that Wall Street Journal survey -- about 20 percent --- put inflationary risks at the top of their wish-not list, GS's Vaknin wants to ease their minds:

As global activity continues to grow at an above-trend rate and commodity prices remain elevated, a re-acceleration in consumer price inflation, particularly in the major markets, remains a clear risk to the outlook for financial asset returns. Consider that, on a year-on-year basis, headline inflation in advanced economies has accelerated from 1.7% in Q4:06 to around 2.0% currently, driven largely by higher food and energy prices. Such acceleration comes on the back of extended tightness in production capacity: According to the OECD, the output gap in this group of countries is about to move into a positive territory by year-end after hovering in negative levels since mid-2001.

Despite these seemingly worrying observations, we that think inflation, particularly in the G-7, should accelerate only moderately before stabilizing at benign levels early next year. Granted, elevated food and energy prices may keep headline inflation above core measures for a bit longer. But this should be seen in the context of two important developments: (1) US core inflation is on a genuine deceleration path, and (2) Monetary policy stance remains prudent in other major economies where upside inflation risks are clearly higher.

The "monetary policy stance" is key, and it probably explains why so many commentators are taking their predictions of a policy-rate cut off the table for the time being.

July 3, 2007 in Forecasts, Housing, Interest Rates | Permalink


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June 26, 2007

What's That Unpleasant Sound?

According to Lombard Street Research, it's a credit crunch.  From the U.K. Telegraph (hat tip, Action Economics):

The United States faces a severe credit crunch as mounting losses on risky forms of debt catch up with the banks and force them to curb lending and call in existing loans, according to a report by Lombard Street Research.

The group said the fast-moving crisis at two Bear Stearns hedge funds had exposed the underlying rot in the US sub-prime mortgage market, and the vast nexus of collateralised debt obligations known as CDOs.

"Excess liquidity in the global system will be slashed," it said. "Banks' capital is about to be decimated, which will require calling in a swathe of loans. This is going to aggravate the US hard landing."...

Lombard Street’s warning comes as fresh data from the US National Association of Realtors shows that the glut of unsold homes reached a record of 8.9 months supply in May. Sales of existing homes slid to an annual rate of 5.99m.

The median price fell for the 10th month in a row to $223,700, down almost 14pc from its peak in April 2006. This is the steepest drop since the 1930s.

The Mortgage Lender Implode-Meter that tracks the US housing markets claims that 86 major lenders have gone bankrupt or shut their doors since the crash began.

The latest are Aegis Lending, Oak Street Mortgage and The Mortgage Warehouse.

It is worth noting that those are specifically mortgage-lending corporations not commercial banks, so I am not clear on the basis of this claim:

Lombard Street said the Bear Stearns fiasco was the tip of the iceberg. The greatest risk lies in the “toxic tranches” of lower grade securities held by the banks.

Much-trumpeted claims that banks had shifted off the riskiest credit exposure on to the asset markets was “largely a fiction”, said [Charles Dumas, the group's global strategist].

In fact, the article contains more assertions than facts.  But I think it is agreed that if there is going to be a really big spillover effect from ongoing housing woes, this is where we'll find it.   

June 26, 2007 in Housing, Interest Rates | Permalink


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I'm highly skeptical of Lombard's position. Banks have used CDOs to lay off credit risk moreso than the other way around. And I don't see the link between poor performance on sub-prime MBS pools and bank loan pools.

I really think the CDO market will prevent a generalized credit crunch, rather than cause it. This is because the risk of poor performing loans is more spread out today than at any time in the past. If many banks/investors suffer small losses, the impact on liquidty system wide will be less than the classic case, where a few banks suffered large losses.

Posted by: TDDG | June 26, 2007 at 12:41 PM


Mortgage-lending companies are dying off because they cannot sell the subprime loans they are originating. With the credit well drying up---and refis becoming a distant memory---, subprime mortgage defaults will inevitably increase, creating large losses for the owners of the lower tranches of MBS and CMOs (hedge funds and banks; what is the difference between a hedge fund and a bank's trading desk these days anyway?).

As losses mount, banks will become ever more cautious, starving even the more creditworthy borrowers (typical credit crunch story). Note that lending standards have recently been tightening even on the prime borrowers. In April Senior Loan Officer Survey, a net 15% of lenders said they have tightened their standards for prime borrower (48% for nontraditional, 56% for subprime borrowers). The tighter standards hurt not only the shaky borrowers but also those who cannot sell their homes due to a dearth of buyers.

We could easily see the problems spread from the toxic products to more traditional loans and higher quality MBS/CMO tranches. If that turns out to be the case, I'd say Lombard is underestimating the problem.

P.S.: Commercial bank/investment bank distinction is no longer all that relevant. Lombard is talking about banks in general, not commercial banks per se.

Posted by: Oracle of Cleveland | June 26, 2007 at 02:41 PM

The article makes it sound like this isn't just subprime: a credit crunch like that would mean it would be difficult for even high FICO borrowers to get a mortgage. If you think housing is in bad shape now, just imagine what that would (will?) be like.

Posted by: TiP | June 26, 2007 at 05:38 PM

I also doubt that banks are big holders of CDO equity tranches. On the other hand: Bloomberg reported this weekend that junk bond buyers are getting pickier about accepting new paper that is very highly levered and/or with weak covenants. And today (June 26) the WSJ discussed the possibility that leveraged loans might become harder to place in CLOs (collateralized loan oblidgations).

Put it all together and we are seeing indications that lenders' appetite for risky paper -- be it from private equity borrowers to finance LBOs (with the hope that the loans be placed in junk debt or CLOs) or from laxly underwritten mortgages (to be repackaged as CDOs) may be on the wane.

At the top of each economic cycle we learn that excess liquidity eventually dries up. I wouldn't be surprised if that is what is starting to occur.

Posted by: JB | June 26, 2007 at 11:04 PM

I see no basis for TDDG's assertion that, "If many banks/investors suffer small losses, the impact on liquidty [sic] system wide will be less than the classic case, where a few banks suffered large losses."

Even if the individual losses experienced by the "many investors" are small relative to those suffered by the "few banks" in the classic case, those losses will not necessarily be small from the viewpoint of those investors, and the degree to which those investors retreat from lending as a result of those losses may be much greater. After all, as they are not banks, they are not "to big to fail", and not supported by the FRB commitments to guaranteed banks profitability by reducing short-term rates below long rates whenever they need to repair their balance sheets.

The dispersal of risk is more likely to increase the impact on liquidity than to decrease it.

Posted by: jm | June 27, 2007 at 03:30 AM

When I said "large" I meant proportionally not absolutely.

Let's say that a large corporation has loans with only 2 banks. If that corporation fails, those two banks may be in trouble. A bank failure surely decreases system-wide liquidity.

Alternatively, let's say that the banks securitized that loan and is now owned in a CDO structure, which is held by dozens of hedge funds. The loss is absorbed by the CDO structure and spread around many investors. Something like that doesn't sour investor appetite for credit risk.

You also have to ask yourself, where is all the liquidity going to go? Drastic oversavings by non-US investors will be invested somehow.

Posted by: TDDG | June 27, 2007 at 11:39 AM

I suspect that we are living in a rather different world of credit intermediation now than in the past. The focus on banks assumes that the risk of financial disintermediation depends on whether banks are will and able to continue lending, A lot larger share of credit flow now goes through non-bank institutions than in the past. If those institutions crack up, then disintermediation becomes a problem even with banks relatively unscathed. Having a sound banking sector means there would be a credit channel to fall back on, but the transition would be painful, if a transition is necessary.

Posted by: kharris | June 27, 2007 at 12:01 PM

One answer, TDDG, is that some of this liquidity will disappear once hundreds of billions of instruments currently carried at face value of the books of many banks and funds are marked to their true values close to zero.

You had better believe that the margin calls on bear's hedge funds will not be the last. The major ratings agencies are finally being forced to revisit their pie-in-the-sky ratings on may such securities, as press reports this week made clear.

No collateral, no loan, goodbye liquidity.

Posted by: Gary | June 27, 2007 at 12:03 PM

That assumes that the problems in sub-prime MBS will leak into other credit products.

Maybe we're arguing semantics, but I wouldn't say that sub-prime consumers experiencing decreased access to funding is tantamount to a liquidity crisis.

Posted by: TDDG | June 27, 2007 at 03:16 PM

One view among the causes of the great depression was a general loss in confidence with the financial system.

The scorecard on the sub-prime meltdown is unsettling. The fact that both the credit ratings given these instruments and the current price are complete fabrications is a much bigger problem.

Should the entities that own this phony paper be allowed to continue the sham ? Or, in the interest of free markets, should they be ordered to revalue immediately ?

What other so called financial markets have been undermined by wall street. Equities ?

This is not just an isolated incident in an obscure security. The problem has ramifications across all free financial markets.

What a dilemna.

Posted by: zinc | June 27, 2007 at 10:55 PM

TDDG replies to mine of 03:30AM, "The loss is absorbed by the CDO structure and spread around many investors. Something like that doesn't sour investor appetite for credit risk."

From the looks of things, rather than being spread around and diluted, the risk is being distilled and concentrated to 200 proof by leverage as the hedge fund managers swing for the fences with other people's money.

"You also have to ask yourself, where is all the liquidity going to go? Drastic oversavings by non-US investors will be invested somehow."

As Gary writes above, some of the liquidity is going to disappear as it becomes undeniably clear that many of these loans will never be repaid. Still more of it will disappear as falling home prices annihilate illusory wealth and reduce consumption -- the Asians can't recycle dollars we don't send them, and as their overbuilt export industries are forced to cut wages and employment, political unrest may exacerbate conditions.

Posted by: jm | June 28, 2007 at 01:15 AM

It used to be that money supply multiplication through the fractional reserve banking mechanism was limited by the reserve requirements. The classic description was that $1000 of deposits into Bank A funded $900 of loans, which became deposits at other banks and funded $810 of loans, and so on in decreasing amounts (assuming a 10% reserve requirement). But some time ago the FRB reduced bank reserve requirements to zero for time deposits (presumably because the banks otherwise couldn't compete with non-bank lenders who were unencumbered with any reserve requirement).

It is interesting to contemplate what will happen if a consensus forms that the problem of banks being unable to compete with other entities that have no reserve requirements would be better dealt with by imposing reserve requirements on those other entities, rather than by removing them from the banks.

Posted by: jm | June 28, 2007 at 01:33 AM

I disagree with the assertion that we are hearing an "unpleasant sound." On the contrary, I think we are observing and hearing a truly robust open market system as it reasonably "adjusts" to changes in "perceived" values of assets and instruments. This is what a *dynamic* system is *supposed* to be like.

On Monday, the entire first half of 2007 will be completely behind us, and without even a hint of any "systemic" crisis. Sure, we do not know what the final haircut will be for the markdown of mortgage-related assets and instruments, but the simply fact is that everybody has had more than enough time to fiddle with their portfolios to make sure that they can "handle" this "crisis." Sure, we will continue to see failures and bailouts here and there in various niches for a bit longer, but there doesn't seem to be *any* "pressure" building up that would cause a true "systemic" problem.

Geez, all this whining about the "subprime crisis" is making Paris Hilton, Chicken Little, Nervous Nellie, and The Boy Who Cried Wolf look like paragons of backbone.

Most of what is going on right now is simply the flip side of "talking up your book", where the circling vultures are trying to talk down the value of mortgage-related assets and instruments so that the harcut fire sale prices are as "sweet" as possible. That, plus the players who bailed out LTCM while Bear Stearns refused to participate in that bailout are now enjoying the "payback" of letting Bear twist slowly in the wind.

Rest assured, the system *is* working. It is a truly amazing thing to behold. Sure, it is not as smooth-running as a watch, but this is America where risk is *supposed* to be the heart and soul of our lives.

-- Jack Krupansky

Posted by: Jack Krupansky | June 28, 2007 at 01:57 PM

... without even a hint of any "systemic" crisis ...

I'd opine there are numerous hints of systemic crisis. And the fallout from ludicrously loose mortgage lending -- of which subprime is just the first component to surface, and probably not as large as the Alt-A component waiting in the wings -- has only just begun.

What we're seeing now is just the leading edge of the mortgage default wave, and foreclosures are not yet impacting market prices in most areas. But the supply glut alone is forcing prices down, such that as the still-to-come ARM resets hit home, more and more will be owing more than their home is worth and unable either to refinance or to sell without bringing money they don't have to the closing.

In Arlington Heights, IL there are now 34 homes listed at prices over $1 million, with five more at $999k or $995k. And the number of sales recorded as of May 11 in that price range? Just one. Between $900k and a million? Three. The corresponding numbers for all of 2006? Six and eleven.

Shall we do a little gedanken experiment?
Suppose the Top 40 listings on the MLS do finally sell this year, for the same prices as the Top 40 actual sales of 2006 (though it's clear even that would be optimistic). Let's line them up below and see the deltas line by line. We find that the average haircut off the asking price would be $350k, and is $250k even down at the 40th line -- one of the $995k homes would have to go for $750k. The average price drop is 28%

And this would be just the impact of oversupply -- foreclosures aren't even in the picture yet.

Top 40s
2007 Asking 2006 Sale Delta
$2,199,000 $2,478,000 ($279,000)
$1,899,900 $1,160,000 $739,900
$1,690,000 $1,100,000 $590,000
$1,580,872 $1,100,000 $480,872
$1,549,000 $1,040,000 $509,000
$1,499,000 $1,040,000 $459,000
$1,499,000 $994,000 $505,000
$1,490,000 $992,500 $497,500
$1,449,000 $955,000 $494,000
$1,425,000 $950,000 $475,000
$1,350,000 $950,000 $400,000
$1,350,000 $930,000 $420,000
$1,299,900 $915,000 $384,900
$1,299,000 $905,000 $394,000
$1,290,000 $900,500 $389,500
$1,274,900 $900,000 $374,900
$1,250,000 $900,000 $350,000
$1,250,000 $889,000 $361,000
$1,249,000 $880,000 $369,000
$1,229,000 $880,000 $349,000
$1,199,900 $875,000 $324,900
$1,199,000 $871,500 $327,500
$1,198,872 $865,000 $333,872
$1,195,000 $860,000 $335,000
$1,185,000 $855,000 $330,000
$1,185,000 $850,000 $335,000
$1,175,000 $850,000 $325,000
$1,149,000 $835,000 $314,000
$1,149,000 $825,000 $324,000
$1,125,000 $825,000 $300,000
$1,099,000 $810,000 $289,000
$1,089,000 $805,000 $284,000
$1,059,900 $797,500 $262,400
$1,049,000 $796,000 $253,000
$1,025,900 $787,500 $238,400
$999,000 $775,000 $224,000
$999,000 $774,000 $225,000
$999,000 $772,000 $227,000
$995,000 $762,500 $232,500
$995,000 $750,000 $245,000

Sum of deltas: $13,993,144
Average delta: $349,829

If someone's about to contend that these homes are owned by rich people who will be able to wait forever to get their wishing price, note that the MLS photos show more than 70% of these homes to be vacant, and most are new construction on teardown lots.

Posted by: jm | June 29, 2007 at 01:50 AM

jm: Even if all of your numbers and inferences were 100% correct, *none* of that would establish even the proverbial "hint" of a *systemic* crisis.

Your "experiment" is micro-economic in nature, whereas any "systemic" crisis would have to be macro-economic in nature. Micro vs. macro is never simply a matter of scaling up by multiplying by a large number.

Anecdotes are wonderful for illustrating issues, but they never "prove" a thesis, nor are they ever particularly useful when searching for "hints" about systemic risks.

There are still plenty of investors with huge amounts of money in liquid, low-yield financial instruments waiting anxiously for new opportunities for higher rates of return. Haircuts, the more dramatic the better, are a *good* thing in terms of opening up new investment opportunities in a low-yield "flat" world.

As far as your vacant homes, what fraction of them are "spec" homes? Add another column for the cost or "investment" that the builders/speculators have tied up in these properties. The big, open question is what hind of investment losses such "investors" can take before those losses might somehow have an impact on the big-picture "real" economy and not simply the profit picture for a narrow niche of speculative activity. I suspect that even in a worst-case scenario the big-picture impact as well as the "systemic" impact are likely to be barely noticable and lost in the noise of overall economic activity, probably even significantly less than the organic demographic growth that the U.S. domestic economy is experiencing every year.

If you actually have "hints" of *systemic* crisis... "Bring 'em on!"

-- Jack Krupansky

Posted by: Jack Krupansky | June 29, 2007 at 11:45 AM

The vacant homes are almost all spec homes, Jack, but the point is not that the builders' losses are going to cause a systemic crisis -- indeed, if their true out-of-pocket construction costs were under $100/sqft, which they may well be, then even though the teardowns probably cost them about $300k, they'll only suffer decreased profits, not losses.

The point is that these houses aren't going to sell until they cut the prices 30+%, and those price cuts are going to crush the price structure of the entire market below. When million-plus homes are selling for $750k, the people who thought they owned $750k homes, and either paid $750k for them, or refinanced out equity based on that belief, or even just were expecting to cash out for retirement at that price, are going to have a rude awakening, most especially so because nearly the entire populace has come to believe that real estate is an absolutely sure-fire investment that can never go down.

If the builders have such huge margins they can cut their million-plus McMansions 30% and still make money, the carnage down below will be even worse -- because they'll keep on building even more!

A major factor fueling the recent bubble was that young people who formerly would not have bought homes until much later in life,and then would have bought them with 10% or 20% down using fixed-rate loans at prices that would have put their payments well under 40% of income, have been lured/ panicked by the sure-thing/priced-out-forever mantras into paying ridiculous prices with toxic ARMs and nearly nothing down, with payments far above 40% of income. Not only has this pulled forward demand -- they're not going to be first-time buyers in their 30s, as they've already got a home -- many will lose those homes to foreclosure or short sale and be so damaged financially they'll not be able to buy again for a decade; and they'll be pushing homes back into the glutted market, not taking them out. As those forced sales and foreclosures hit the market, prices will fall even further.

Most important, the beliefs that real estate can only go up, and that you must buy as much as can as soon as you can, with as much leverage as you can possibly get, is going to be totally destroyed -- just as it was in Japan.

I'll never forget the day in the late 90s when some young Japanese friends came out to Narita to give me a ride into Tokyo, and along the way mentioned that they were thinking of buying a condo, but had decided to wait a few years, "because prices will be even lower then."

Once bubble psychology starts to disintegrate in the face of a glut, the process is regenerative and can't be stopped.

A 30% average fall in the US housing price level will destroy $6 trillion of illusory wealth that most people thought was completely secure, and which fueled much more leveraged buying and borrowing than the dot-com bubble. Margin debt in the dot-com era peaked around $250 billion, only a fraction of the current margin debt equivalent in mortgages (and they only let you use 2:1 leverage in stocks).

When the baby boomers realize that the wealth they thought they had in their homes was never really there, and that they're going to have to save for retirement rather than fund it by cashing out of their home (and that that sure-thing-investment second home they bought is an albatross), consumption spending is going to take a nasty hit. This will be exacerbated by the fact that pension funds are significantly exposed to a real estate bust. The savings rate is going to go back to 8+%. Think about what that means not just to US business, but also to the export-dependent economies of Asia.

But of course you won't even see a hint of systemic crisis in this, right, Jack?

Posted by: jm | June 29, 2007 at 05:27 PM

jm: Hmmm... "But of course you won't even see a hint of systemic crisis in this, right,"

That's correct. Nothing in your *hypothetical* scenario is *real* *evidence* of a "systemic" crisis. Hypothetical versus real... you do understand the difference? Of course you do, but for reasons unknown to me, you defer to hypothetical over real. Why is that?

I'm always willing to consider alternative points of view and certainly always willing to look at hard *data*, but when you've had an opportunity to come up with *real* evidence, all you come up with is a hypothetical story of a hypothetical chain of events cthat is completely divorced from reality.

So, do you have any actual, real, live evidence of any hint of systemic crisis? Not hypotheticals, but real evidence?

From all the hard evidence I have been able to access, it still appears that the overall financial "system" is humming along quite well and not showing *any* signs of a "systemic crisis" approaching the level of the S&L or LTCM crises.

You are of course certainly free to contrive any and all hypotheticals (where would the dismal science be without hyptheticals), but I would suggest that you refrain from claiming or suggesting that any hypothetical constitutes evidence (or even a hint) of a likely outcome.

-- Jack Krupansky

Posted by: Jack Krupansky | July 02, 2007 at 11:41 AM


So you consider my Arlington Heights Top 40 data above "hypothetical"? I don't think you can get more real than actual 2007 listings versus actual 2006 sales, and the actual fact that 70+% of the listings are vacant, and that as of May 11 there had been only one, repeat one, sale in the town in the asking price range of the Top 40, and only three more even down to $900k.

What matters is not whether a prediction is "hypothetical", all predictions, including that "the sun will rise tomorrow" are "hypothetical". What matters is the degree to which a prediction is based on relevant historical experience, and we know from experience that when loose lending allows assets to be bid up to prices far out of line with historical levels and other price levels (e.g., wages), a crash and severe systemic strain nearly always follow.

You wrote, "all you come up with is a hypothetical story of a hypothetical chain of events that is completely divorced from reality."

Neither the Top 40, nor the pulling forward of demand among under-30s, nor the beginning of the end of abusive mortgage lending is divorced from reality.

"From all the hard evidence I have been able to access, it still appears that the overall financial 'system' is humming along quite well and not showing *any* signs of a 'systemic crisis' approaching the level of the S&L or LTCM crises."

If you review the history of the S&L and the LTCM crises, you will see that were no "signs" at all before the latter, and that the numerous signs preceding the former were all of exactly the same nature as those I described.

In 1929 in the US, 1989 in Tokyo, and again in 2000 in the US, the overall financial systems were, at least judging by the sort of "hard data" you demand, humming along quite well right up to the point of crash, with no "hints of systemic crisis" other than numerous variations on the theme of loose-lending-fueled asset pricing excess -- and predictable disintegration thereof -- that we see around us today.

I must add that it's also a bit odd that you seem to consider the S&L and LTCM debacles as "systemic crises", and that there is no hint of problems as large as them. Relative to the crises now approaching, they were small potatoes.

Posted by: jm | July 03, 2007 at 01:27 AM

I must add that I am not one of those who believes there is going to be any complete collapse of the financial system. There was no complete collapse of the financial system even during the Great Depression (except perhaps in Germany). I do believe we are going to have a long "period of adjustment" that will be quite painful to a significant fraction of the population.

Posted by: jm | July 03, 2007 at 01:45 AM

jm: I'm sorry you misinterpreted my point that was not a reference to your specific anecdotal evidence (specific housing prices), but was a reference to the long chain of inferences that you drew about the future from that one anecdote.

As far as "relevant historical experience", I do hope that you will acknowledge the distinction between corelation and causation and acknowledge that history does tell us that we need to consider all factors and not a cherry-picked set of factors when considering any situation, and most importantly, that the future can *never* be so mechanically predicted from cherry-picked data in the manner that you have suggested. Sure, the your outcome *might* transpire, just as any other outcome *might* hypothetically transpire, but you seem to be claiming that it *will* transpire, which is a strong claim that doesn't seem justified given the nature of the financial system and economic scenario we have with us at present, in particular, the *huge* levels of liquidity combined with stubbornly low interest rates and stubbornly low inflation expectations.

If LTCM showed us one thing, it is what the Fed can do without actually doing anything.

I should acknowledge that there are a range of interpretations for the term "crisis" and it is possible that you simply interpret the term differently than I. To me, a crisis is when life comes to a screeching halt and everybody stands still with their mouths open looking at each other wondering what to do. I gather that for you a "crisis" is simply an issue that pops up and must be dealt with that even hints about a change in the status quo.

So, when you say "the crises now approaching", should I simply interpret that as "the issues and tough decisions now approaching"?

-- Jack Krupansky

Posted by: Jack Krupansky | July 03, 2007 at 11:02 AM

The less didactic tone of your response is most welcome. Regret I cannot respond in any detail until tomorrow. See you then (if not, have a good 4th).

Posted by: jm | July 03, 2007 at 04:11 PM

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June 13, 2007

Still The Place To Run

Just when you think you have it figured out.  From Bloomberg:

Treasurys rallied Wednesday, after recent sell-offs in bond prices sent the benchmark yield to a five-year high, attracting money from investors amid speculation the economy will continue to grow at moderate levels.

The buying spree occurred despite news of a jump in May retail sales, higher- than-expected import prices and a Federal Reserve Beige Book survey of regional economies that depicted an economy with tame inflation and moderate growth.

One explanation for the sudden reversal in the Treasury-yield trend is that there is no explanation required: On a day-to-day basis asset prices rise and asset prices fall.  Unless you are one of the relatively few who makes his or her fortune vacuuming up the arbitrage pennies, it really is of no consequence.  Still, it's fun (if not particularly productive) to speculate.  One line of argument might be that the strong retail sales were really not quite as strong as they seem.  From the Wall Street Journal Online:

We do not advise looking at either the very weak April or the robust May result alone, as neither is an accurate representation of underlying consumer spending… While May saw a bounce, the two months together don’t paint a particularly ebullient picture, particularly when looked at excluding large, price-related gains in gasoline purchases. –Joshua Shapiro, MFR, Inc.

But if you don't like that one, the Bloomberg article has plenty more:

"There are lots of rumors out there" to explain the unexpected rally, said T.J. Marta, fixed income strategist at RBC Capital Markets. "Our rumor is that there was a huge purchase of 30-year notes by an Asian buyer."

After the purchase "a sheep-like mentality" set in, inspiring more buyers to return to the market, Marta said...

Kim Rupert, fixed-income strategist at Action Economics, attributed the day's gains to "an oversold condition."

"We've come a long way in a short time," she said.

Renewed concerns about the deteriorating subprime mortgage market may have spurred some safe-haven buying. BusinessWeek online Wednesday reported that a 10-month-old Bear Stearns Companies Inc. (BSC) hedge fund is down 23% for the year largely due to subprime problems.

That last one is the one that catches my eye, as it reflects a point that seems to prove itself over and over again: When the players get nervous, it's still to the U.S. Treasury market they run.

June 13, 2007 in Data Releases, Interest Rates | Permalink


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It has been a long time since I felt that securities markets were efficient markets or, for that matter, markets at all.

Any movement, especially sudden movement, always appears to me to be coordinated and planned, with the objective of short term profit for a segment of the financial community or industrial oligopoly. Witness the coordinated surge in crude oil refinery "maintenance" driving the price of gasoline.

The depressed interest rates over the past three years of inflation is much more suprising than the recent snapback. Some overleveraged, market manipulator probably just lost his grip on the market or is making a short term run. Probably a speculative bank with tentacles into the Fed.

Why has the carry trade continued without correction, even though financial theorey has predicted an adjustment for over three years. It sure ain't market efficiency.

Posted by: zinc | June 14, 2007 at 11:02 PM

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