A year ago Friday the Federal Reserve cut its benchmark interest rate to 4.5% and signaled that further cuts were unlikely. The thought at the time:
“Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets,” the Federal Open Market Committee said in a statement after meeting today in Washington. “After this action, the upside risks to inflation roughly balance the downside risks to growth.”
This morning, the Federal Reserve cut its benchmark interest rate to 1 percent, “matching a half-century low, in an effort to avert the worst U.S. economic downturn in the postwar era.” And with that, the rate kegs have nearly run dry.
∙ Fed Cuts Rate to 1% to Avert Prolonged Recession [Bloomberg]
∙ The Federal Reserve Cuts Benchmark/Discount Rates By 0.25% [SocketSite]
Hey, it’s working! 😉
[Editor’s Note: Or perhaps not: U.S. Stocks Decline as Fed Fails to Ease Concern About Economy.]
So the feds cut the interest rates, and the rates on mortgages inch ever higher?
Is it me or are the banks pocketing the difference while raising rates?
Yawn. At least there’s only 2-3 more of these until we’re at zero.
Hey, anyone else see the latest epiphany from Comrade Bair? Your tax dollars used to restructure and then guarantee bad mortgages:
http://www.bloomberg.com/apps/news?pid=20601068&sid=asOlfO5uPwIY&refer=economy
Almost makes me wish I had a mortgage I could stop paying.
@editor: That was the joke! (note post date after the market close) 🙂
As for the banks, why can’t I do business directly with the treasury? What do I need the banks for, given this outrageous level of intervention? Heck, my company’s checks might even clear faster…
If the Treasury directly competed with banks, they’d have to start lending again, or go belly up.
Love to hear feedback on my half-baked plan 🙂
Is it me or are the banks pocketing the difference while raising rates?
(snarky me):
It’s just you. now get back to work! we need your taxpayer money so that we can “help” you “afford” your home! NOW!
even worse, they’re using your taxpayer money to pay themselves big bonuses. $70 billion of the $750 billion bailout package will go to bonuses and executive compensation. they will also use your taxpayer money to buy out their rivals. this will garner them even more money and create an oligopoly so that they can crowd out competition and charge you MORE money!.
what do you expect when 4 of the key players in this game came from Goldman Sachs!
Lowering the Fed Funds Rate was never about helping the homeowner (ok, that’s what the lipservice was about). It is about lowering the cost of money to the banks so that the banks can “recapitalize” saving the banks. Oh, and in theory then the recapitalized banks will lend to us joes. good luck with that.
by the time it “trickles” to us we will have an inflation problem! hooray!
(serious me:)
that’s not entirely true of course… anybody who has debt tied to the Fed Funds rate will benefit immediately as well… credit card debt, student debt, some of the mortgages/loans etc
(unsure if I’m snarky me or serious me):
I’m watching and waiting, and will soon take out tons and tons of debt. not yet… right now I’m in all cash. that is what our govt is telling us. Saving is for suckers! Drop the rates people can get on their savings so low that they are FORCED to invest in risky things like banks! Force people to gamble with their retirement money!
(somewhat serious me):
it’s the so called “Ka-POOM” theory. First we have deflation. Then the govt tries to fight inflation by creating a lot of money… but it’s not enough to overcome destruction of credit so we have deflation… (called the “ka”). but they overshoot causing inflation. (the “POOM!”)
The inflation will likely show up in a bubble again. the Fed hopes the new bubble will be in Real Estate or Stocks… but they can’t control where the bubble will be… I’m not sure where the bubble will be either. I’m watching oil and gold closely though as well as a few commodities.
Disclosure: I am invested almost entirely in Treasuries and cash. I own no stocks except for oil stocks and CEF which is an silver/gold stock. I may or may not change these positions at any time. i do not recommend investing in anything based on what I’m saying, because we do not have rational free markets. we have crony capitalism with a pseudo-governmentally controlled market system that doles out arbitrary “gifts” to connected businesses. anybody trying to “trade” this is a fool IMO, including Satchel. (if he’s doing it). that said, I am very rarely occasionally foolish with small amounts of cash.
It’s shocking how easy the solutions looked from afar when Japan had it’s real estate bubble pop. It’s amazingly more complex when it happens in your own back yard. The good news is we are doing exactly what Japan did, so you can see how the story ends.
And if memory serves, dropping interest rates to zero did not stop the decline of Japanese real estate. Instead, the money just flew out of the country. Real estate declined for years. Stocks occasionally went up, in the hope that yet another intervention would make everything all better, but over the long run, stocks dropped and employment was stagnant.
But the temperature of the water in the pot was increased slowly, so the frog didn’t jump out. The populace won’t be mad at the politicians when the value of their homes and the number of jobs declines over a long period as they would be if the same (or even lesser) drop is quick.
Great posts ex SF-er and tipster. I wish that there were at least a few members of congress with enough honesty and integrity to stop what is going on. Of course, it’s not going to happen. Our next treasury secretary will no doubt have a Goldman Sachs connection. Ron Paul is no longer running – maybe I’ll vote for Nader.
Actually, I think it’s a lot more complicated than that. Ignoring for a moment the incredible chutzpah of rewarding executives who led their companies to financial ruin, we have an over-leveraged system at almost every level. Individuals and corporations took on more debt than they could realistically handle in all but a minor downturn. Banks don’t lend their money, they lend other peoples money. In the old days this was from depositors but that wasn’t enough to keep up with demand. So we ended up with CDOs and other financial instruments which could be sold off to investors.
At the moment, no one will touch a mortgage except the US govt or with very high interests rates to justify the risk. So the banks can’t just sell off your new loan and doesn’t actually have the capital to eat all the losses. You’re not going to see low rates unless the govt offers them. And of course, the taxpayer will be on the hook for the 20-40% fail rate on this toxic junk.
Keep in mind the minute the govt argued for the ability to modify the loans they became essentially high risk. The housing market hasn’t reached bottom. The average American bought more than he could afford on credit cards and on their houses. So who would lend to them except with the promise of high returns. That’s why people with bad credit who need it most have the most difficulty getting credit and at a reasonable interest rate.
We are facing a global meltdown of historic proportions because this is all starting to unwind. Don’t expect some miracle on rates. Our politicians are almost certainly going to go for the deficit spending fix. The next generation isn’t voting at the moment, so it’s safe to ignore them. Did I mention the US govt is also over leveraged? But when you guarantee everything with an IOU, is anything really guaranteed?
Good summary.
And as people in the US become aware of the indebtedness that the government is creating, they will begin to go into hunker down mode. The government will absorb whatever excess “savings” it can, thereby depriving the real economy of access to funds. This will create a positive feedback (ie, self-reinforcing) loop, as dimming economic prospects in the real economy will dim any desire to invest/lend in the US.
Japan opted for the Keynesian route. In the early 1990s, Japan deficit spent on the order of 4-5% of GDP (on average). By the late 1990s/early 2000s, the deficits reached 6-7% (with 10%+ in 1998). BTW, they also “printed” huge quantities of money, starting in 1994 with effectively the ZIRP, 1997 through direct BOJ purchases of JGBs and the early 2000s through so-called “quantitative” easing.
Despite all this, Japanese property prices are back to where they were (on average) in 1980-82. Their stock market is similarly back to where it was in 1982-83. All of in nominal terms. In real terms of course, less, as Japan had pretty high inflation through the 1980s, declining into 1994 or so, after which they experienced tiny bits of deflation/inflation (at least as measured by Japanese CPI).
Good luck to all who now own leveraged assets in the US!
Of course the difference between us and Japan is that if you give a dollar to an American consumer, he will go spend it, while if you give a dollar to Japanese consumer, he will put it in the bank. This is why fiscal stimulus did not work very well in Japan.
You can add to that the fact that they spent too much time and money propping up zombie banks and also wasted a bunch of money on really dumb “Bridge to Nowhere” type infrastructure projects, which made no economic sense.
We actually have a bunch of infrastructure projects that make sense economically. It will be important in the coming decade to make sure that our money is spent wisely, on things like rapid transit infrastructure, which will pay itself back many times, and not on things like freeways to exurban areas.
NoeValleyJim,
I believe that I will vote “yea” on Proposition 1A.
Signed,
NewBuyer
Well the rate cuts will help buyers. That is, unless Wells Fargo raised Jumbo rates to 10.2%.
https://www.wellsfargo.com/mortgage/rates/
Never underestimate the will of people to inflate money.
I’m buying stocks, but only I’m buying Berkshire Hathaway.
Is that the real Eisaku “Mr. Yen” Sakakibara, as in the former Japanese finance minister?
If so, wow. If not, great handle.
NewBuyer, since we are clearly constructing a road to hell, it might as well be high-speed rail.
tipster, Wells Fargo is getting $25B from the TARP and they will reap as much as $20B in illegal tax benefits from the Wachovia deal. And now they are raising their borrowing rates. No doubt their bonus pool will be flush. Must be nice to be a friend of Hank.
You can add to that the fact that they spent too much time and money propping up zombie banks and also wasted a bunch of money on really dumb “Bridge to Nowhere” type infrastructure projects, which made no economic sense.
NVJ: I agree with you… however to date we are following the Japanese model. We are propping up Zombie banks (our banking system isn’t illiquid, it’s insolvent). Morgan Stanley, Goldman Sachs are insolvent. Bank of America plus Countrywide is insolvent. Wells Fargo plus Wachovia is insolvent. Citibank is insolvent. these are all zombie banks. Just look at their Level 3 “assets”
we also have our bridges to nowhere, but in different husks (AIG, financing GM/Chrysler bailout)
we will have to see going forward what happens under a new administration. However Hank Paulson has clearly shown his hand. Feed the banks and the bankers and the well-connected. Throw the rest of the economy under the bus.
we could have deviated from the Japanese model. It would have been “easy”. Force the banks to mark their holdings in a transparent manner. Create a central clearing house for ALL derivatives. most of the banks would have been immediately insolvent and our banking system would have crashed. Much/most of the shadow banking system as well (hedge funds, etc). The govt would then nationalize some of those banks or create new banks and keep them functioning for day to day operations for “main street”. the rest go. this of course would have been extraordinarily difficult on the US and the world. however it would have cut the rot out of the system, if it survived. we would have been left devastated, but with a very different and likely healthier economic model. it is what “needed” to be done, but sometimes it’s too hard to choose what “needs” to be done so we do the less scary option. FWIW: I too am afraid to do what “needed” to be done. That said, Mr. Paulson chose the EXACT wrong plan for our economy’s long term health all in my opinion of course.
I also agree with you that the US can only be compared to Japan in so many ways. There are huge differences. (some of them encouraging for the US, some discouraging for the US). Among them:
-the Japanese save and the American consumes. This is a big difference. (so monetary policy has greater chance of working)
-Another big difference is that… uh… the Japanese had savings and we have consumption! (this is bad, as we rely on foreign savings to fund our increasing debt)
-the Yen was not the reserve currency whereas the USD is (at least for now) This is huge in our favor.
-starting Federal debt of Japan on its downturn was much lower than US on our downturn This is bad for us.
-the Japanese went through their downturn while most of the world was largely unaffected (mild recession in late 80’s only), and then the world boomed. this was helpful to them.
-the US looks to go into its recession during worldwide recession. this is harmful for us.
in sum: we will not be Japan. We might fare worse, we might fare better.
I’d be interested to see if Satchel agrees now (I’m sure he does) but the Fed is now “printing” and we are increasing govt debt at a staggering pace. I think our govt debt went up $1 Trillion in the last month! staggering! And now the Fed is monetizing the Treasury’s debt. Not unheard of, but certainly a bad harbinger. They are decreasing (on a net basis) their sterilization techniques over the last few weeks as well.
the only question is whether or not the govt can create money faster than credit deflation destroys credit WITHOUT causing severe inflation/hyperinflation or a severe tertiary bubble. we will see. I am guessing that we will see overall monetary deflation the next quarter or two, and then significant inflation (not hyperinflation) and we will see a bubble somewhere. I’m guessing a commodity like gold or oil. Gold and oil seem to be the ONLY things stopping outright currency destruction right now.
trying to decide which is worse. deflationary recession or inflationary recession… hmmm… both seem like they’ll suck.
ex SF-er – I would be interested on your take of what Roubini says about inflation, he disagrees with what you posit. I have also been on the side of thinking that inflation was a likely (and possibly necessary) outcome, was surprised to see Roubini disagrees.
http://www.forbes.com/home/2008/10/29/stagnation-recession-deflation-oped-cx_nr_1030roubini.html
They are decreasing (on a net basis) their sterilization techniques over the last few weeks as well.
Where do you see this? Admittedly, I’m no expert on reading the Fed’s balance sheet and it’s gotten a bit more complicated the past couple of weeks. Is this assessment a reflection of, from what I can see, Bank credit expanding faster than the injections from the Treasury (supplementary financing account)?
I’m sure whatever happens will be unlike anything that’s ever happened before.
It will, however, spawn another economic school or two (the first of the 21st century!), so that will be fun…
The Bunk:
Roubini is very smart, and I agree with most everything he writes. I would never be dumb enough to challenge him. However that is not to say that he is infallible. If you read my posts above I hope it becomes clear that I am not sure if we’ll have long term deflation or inflation. Hence my line: “deflationary recession or inflationary recession… hmmm… both seem like they’ll suck.”
Roubini and I both agree that short term monetary DEFLATION will be (no, IS) the problem. That is happening now. That is why I am in cash.
where we (only partially) disagree is whether or not the Fed/Govt will monetize debt in an attempt to avoid deflationary recession/depression.
I agree with all of his points as to why we SHOULD NOT monetize the debt. I do not agree that they WILL NOT monetize the debt.
I am actually 100% unsure if they will or will not monetize but I do lean towards long term (>1 year) inflation. There’s over 100 years of data to support my claim on what the US favors. The US fears DEFLATION because that’s what we had in the Great Depression. Contrast this to the Europeans who fear INFLATION because that’s what they had under Weimar Germany.
Thus, I am basically in 100% cash and watching. The INSTANT that I feel that we are monetizing I will dump my dollars and buy assets by the wheelbarrowfull. I do not trust our Fed or Govt with one cent of my money.
That’s why I said that we should watch Oil and Gold. I know the Fed is watching them. They will try to stealthily inflate (without “printing”) so long as they can do it without commodity price appreciation. That right now is the ONLY check against them.
but the temptation is LARGE. And I don’t respect their self control.
Where Roubini fails (all in my opinion) is that he overestimates the foolishness of our leaders, and he fails to realize that right now these decisions are being made by maybe 10 people (bernanke, paulson, bush, cheney, reid, pelosi, schumer, maybe 2-3 more people). So it all hinges on how foolish 10 people are. Thus far I’d consider all but two of those people on that list to be a fool. One is a genius but doesn’t know how to play the game (Bernanke). one is very smart but his allegiance is elsewhere, and not with the american people (Paulson).
so what decision will 5 fools, a genius out of his element, and a slimey crony capitalist make? I dunno. So I’ll watch gold and oil and commodities and the Fed Balance sheet (until they stop printing it becuase of some dumb reason)
EBGuy:
Sorry, I need to actually work now (ack). So I’ll just give you one article to read.
Bob McTeer is an ex Fed official. I agree with his article except he made an error reading the Fed Balance sheet (unbelievably). The Fed balance sheet rose $294 Billion this year, most of that recently. The rest I agree with, and it gives good background.
About the Fed Balance Sheet, From Forbes
I’ll try to comment for real later but I doubt anybody will go back to this thread!
ex SF-er… You can be sure many people are following this thread… I am. I hope this discussion will continue for next many months.
I always find the balance sheet discussions esoteric when it comes to the inflation/deflation arguements. I always ask myself, “Who is having money put into their hands and what are they likely to spend it on?”
In the 2001-2006 period people had money put into their hands as long as they agreed to spend it on a house and so we had a major inflation in house prices. That’s no longer there and the price inflation in houses has reversed.
There may be a lot of “printing” going on but whose hands is the money going in and what are they spending it on? The banks are getting money but they are hoarding it to repair their balance sheets (and because there’s no one who isn’t already up to their nostrils in unpayable debt to loan it to). Probably some financial institution are getting money and are speculating on the stock market but J6P isn’t really getting any of it and so we’re seeing a consumer led recession.
@diemos — respectfully, your claim “there’s no one who isn’t already up to their nostrils in unpayable debt to loan it to” is ridiculous.
This is like claiming our tax system is fair because the bottom half pays only 3% of the federal income tax (2006 data). This “macro” fact neither proves nor disproves the claim.
I can name a dozen small unlevered businesses among our customers/vendors who’ve had lines summarily reduced because of “the economy”. This interferes with operations the same way unexpectedly changing the locks on your house would.
It also causes them to use cash, freaks them out (why did they change my locks?), and feeds on itself. These are profitable, unlevered businesses, not .com fluff-pieces fueled by loose credit. You’ve probably never heard of any of them.
At first, I thought it was orchestrated by the government for reasons we don’t know yet. It’s more likely that lenders are being as stupidly conservative now as they were loose/easy before (pendulum swinging the other way, etc).
If there’s no “secret reason”, Obama’s treasury should nationalize one of the banks (pick something ironic like Goldman Sachs), and have it compete directly with the ones that are left.
The silver lining is we are still early in this crisis, and I expect we will work it out, but my definition of success assumes the evisceration of the credit industrial complex.
But this is great fodder for the armchair economists! Everyone’s out of their bomb shelter, waving their arms, offering advice on their blog. The good news is if Paul Krugman can win a nobel prize, there’s hope for anyone here 🙂
Great point diemos… explains Roubini’s bias. Bears watching going forward.
I am interested in this discussion because I want to understand the real cost of money. Specifically, 30 year fixed rates versus inflation/deflation. If 30 year fixed is 5% and long term inflation expectation is 4-5%, the money is essentially free (actually you’re getting paid to take money when coupled with income tax deduction). On the other hand, if long term expectation is deflation, that money is very expensive.
chuckie,
the price of the money is relative to what use you put it to.
looking over the history of man i still believe we are in an ultra low cost of capital era.
In the 2001-2006 period people had money put into their hands as long as they agreed to spend it on a house and so we had a major inflation in house prices
Diemos: I think that the money was more pervasive than that. the money was put into anybody’s hands for almost any reason.
Money for houses? check
money for cars? (8 year car loans!) chck
money for students? check
money for leveraged buy outs? check
money for hostile takeovers? check
money for VC funds? check
money for leveraged hedge funds? check
money for SPE’s/off balance entities? check
money for credit cards? check.
the financial system (banks plus investment banks plus shadow banking system plus Sovereign nations and pension funds etc) went through an impressive and possibly unprecedented credit boom. that is now contracting.
The Fed has tried to patch the contracting credit problem with localized injections, but has “sterilized” these injections. (see Bob McTeer’s article above). There was no so-called “printing” the last year. (this is what Satchel often railed about, that there was no “printing” and thus the Fed’s actions were therefore deflationary… and I agreed with him).
But there seems to have been a change of late, specifically with the special Treasury account and also perhaps with the Fed bearing interest on overnight deposits. The treasury account plus ballooning Fed Balance sheet is the first signal that we’ve gotten that the Fed is monetizing debt without sterilization. hence their rapid balance sheet expansion.
it is of course more convoluted than that, specifically because some of the Fed’s balance sheet is LOSING value, since for the first time in quite some time the Fed has crap on their books.
(this next paragraph is pure speculation. give it no weight)
it is possible IMO that the recent Treasury account was not an attempt to save the banks per se… rather an attempt to save the FED!!!!! the Fed may have for a short time been technically insolvent given the “assets” (cough!) that they have on their books.
The Fed is in trouble because it took on more responsibility than it should. (it did things that FDIC should have, that congress should have, that Treasury should have, and that nobody should have done).
Agreed with paco that rates have been forced down to artificially low levels.
But I also agree with ex SF-er that, while we’re seeing deflation today, massive inflation is on the horizon. It just has to be – how else can we (we meaning the American consumer and the federal government) ever pay off all this debt? Consumer debt is at record levels with virtually no savings, and federal debt has exploded under Bush and is now going higher to finance all our new acronyms.
So the trick will be timing the move from cash and treasuries to stocks and real estate as inflation hedges. Just my opinion.
“your claim “there’s no one who isn’t already up to their nostrils in unpayable debt to loan it to” is ridiculous.”
Busted. That’s hyperbole of course. I can name you at least one person who has no debts at all. Me.
But trying to solve a problem of over-indebtedness by loaning people even more money they can’t pay back is not the way the current situation is going to be resolved.
“It also causes them to use cash, freaks them out (why did they change my locks?), and feeds on itself.”
Agree. But my take-away is that it’s stupid to have your business at the mercy of some bank’s credit decision. If you’re profitable then keep cash on hand to fund operations.
“But this is great fodder for the armchair economists!”
What a time to be alive if you have an interest in economics. Although it would be a lot more fun if one could be up in the stands waving a pennant instead of down on the track dodging cars.
“Diemos: I think that the money was more pervasive than that. the money was put into anybody’s hands for almost any reason.”
Agree. Which is why there will be a broad based slowdown.
“it is possible IMO that the recent Treasury account was not an attempt to save the banks per se… rather an attempt to save the FED!!!!!”
Ya know, I just can’t get spun up about analyzing these artificial constructs like the Fed, banks, FDIC etc. In the end it always reminds me of medieval monks argueing about how many angels can dance on the head of a pin. I prefer to think about things that are more fundamentally real. Who has money in their hands, what are they spending it on, do the necessary real resources exist to support that economic activity. The gov can print up enough money to make the financial system’s boo-boos go away tomorrow. Just not without destroying the ability to trade existing dollars for real goods and services. In the end the financial system is just a complicated way of keeping score with the gov as the corrupt referee running the game. The ref has decided that it’s unacceptable that his cronies are losing the game and has decided to change the score so that they win. It’s just a question of structuring it so that the other team doesn’t realize they’re getting screwed over.
ex SF-er, thanks for the informative posts and the link to McTeer’s article. It’s all very helpful. Regarding McTeer’s point on focusing on bank reserves, I understand that as their reserves increase the banks have the capacity to increase their lending by 10X (and that increases the money supply). But what if they don’t increase lending? Isn’t that what Barney Frank (the big bailout cheerleader) is now complaining about? The banks are sitting on the funds (or getting ready to pay bonuses or whatever) but not lending. Is there a metric for this?
I agree with all of your points (except perhaps that Bernanke is a genius – I think of him being more at the Chauncey Gardner end of the spectrum rather than the Einstein end). On investment strategy, if deflation persists, what are alternatives to staying in cash?
good question fsbo,
housing rental income in metro areas that still have a relatively strong employment market will continue to perform.
very selective corporate credits might be worth a little nibbling too.