Tag: economics

Confessions of a Credit Easer

A mea culpa from the manager of the Federal Reserve’s mortgage-backed security purchase program:

Confessions of a Quantitative Easer

We went on a bond-buying spree that was supposed to help Main Street. Instead, it was a feast for Wall Street.

I can only say: I’m sorry, America. As a former Federal Reserve official, I was responsible for executing the centerpiece program of the Fed’s first plunge into the bond-buying experiment known as quantitative easing. The central bank continues to spin QE as a tool for helping Main Street. But I’ve come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time.

Five years ago this month, on Black Friday, the Fed launched an unprecedented shopping spree. By that point in the financial crisis, Congress had already passed legislation, the Troubled Asset Relief Program, to halt the U.S. banking system’s free fall. Beyond Wall Street, though, the economic pain was still soaring. In the last three months of 2008 alone, almost two million Americans would lose their jobs.

The Fed said it wanted to help—through a new program of massive bond purchases. There were secondary goals, but Chairman Ben Bernanke made clear that the Fed’s central motivation was to “affect credit conditions for households and businesses”: to drive down the cost of credit so that more Americans hurting from the tanking economy could use it to weather the downturn. For this reason, he originally called the initiative “credit easing.”

My part of the story began a few months later. Having been at the Fed for seven years, until early 2008, I was working on Wall Street in spring 2009 when I got an unexpected phone call. Would I come back to work on the Fed’s trading floor? The job: managing what was at the heart of QE’s bond-buying spree—a wild attempt to buy $1.25 trillion in mortgage bonds in 12 months. Incredibly, the Fed was calling to ask if I wanted to quarterback the largest economic stimulus in U.S. history.

This was a dream job, but I hesitated. And it wasn’t just nervousness about taking on such responsibility. I had left the Fed out of frustration, having witnessed the institution deferring more and more to Wall Street. Independence is at the heart of any central bank’s credibility, and I had come to believe that the Fed’s independence was eroding. Senior Fed officials, though, were publicly acknowledging mistakes and several of those officials emphasized to me how committed they were to a major Wall Street revamp. I could also see that they desperately needed reinforcements. I took a leap of faith.

In its almost 100-year history, the Fed had never bought one mortgage bond. Now my program was buying so many each day through active, unscripted trading that we constantly risked driving bond prices too high and crashing global confidence in key financial markets. We were working feverishly to preserve the impression that the Fed knew what it was doing.

It wasn’t long before my old doubts resurfaced. Despite the Fed’s rhetoric, my program wasn’t helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn’t getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.

If you’ve read RGD, (published in 2009), then you are aware that even at the time it was obvious that the neither the Fed nor the White House was trying to help home buyers. They could have simply written off the debts owed by mortgage holders, but instead, they funneled trillions to Wall Street.

This proves, once more, that the Federal Reserve has zero interest in fixing, saving, or otherwise improving the US economy. It has other objectives, other goals, and it is a category error to even discuss the Fed’s future actions in terms of whether they will be good for the economy or not.

To do so is like discussing whether the future run/pass ratio of the New England Patriots will be good for the New York Yankees. It’s not even relevant to the discussion except perhaps as an unintended consequence.  And notice that they changed the name from credit easing to quantitative easing just to make the concept harder to grasp for the average American. Simple, but effective, because MPAI.

Obama’s economic end game

Post-Obamacare, it is only a matter of time before other American industries eventually go the way of electronics retail in Venezuela. But it could work! Just think about how many plasma TVs Best Buy could sell if every American under the age of thirty was compelled to buy one on pain of a substantial fine!

Thousands of Venezuelans lined up outside the country’s equivalent of Best Buy, a chain of electronics stores known as Daka, hoping for a bargain after the socialist government forced the company to charge customers “fair” prices.

President Nicolás Maduro ordered a military “occupation” of the company’s five stores as he continues the government’s crackdown on an “economic war” it says is being waged against the country, with the help of Washington.

Members of Venezuela’s National Guard, some of whom carried assault rifles, kept order at the stores as bargain hunters rushed to get inside.

“I want a Sony plasma television for the house,” said Amanda Lisboa, 34, a business administrator, who had waited seven hours already outside one Caracas store. “It’s going to be so cheap!”

It’s a one-track road downhill once the government embarks upon the road of “fixing” the economy. Of course, the wealthier the society is when the process begins, the longer it takes to break the economy and the fewer people understand what is happening as they live through it.

Most people still don’t realize that America is considerably less wealthy than it was in 1990, because the illusion of being permitted to spend someone else’s money leads them to believe that they genuinely have more wealth. It’s like watching a child running around with Daddy’s credit card, thinking he’s rich, only on a national scale.

Explaining the college bubble

Richard Cantillon explains some of the effects of the college bubble in An Essay on Economic Theory… in 1730.

The Labor of the Plowman is of Less Value than that of the Artisan

A LABORER’S SON, AT SEVEN to twelve years of age, begins to help his father either in keeping the herds, digging the ground, or in other sorts of country labor that require no art or skill.

If his father has him taught a trade, he loses his assistance during the time of his apprenticeship and is obligated to clothe him and to pay the expenses of his apprenticeship for many years. The son is thus dependent on his father and his labor brings in no advantage for several years. The [working] life of man is estimated at only 10 or 12 years, and as several are lost in learning a trade, most of which in England require seven years of apprenticeship, a plowman would never be willing to have a trade taught to his son if the artisans did not earn more than the plowmen.

Therefore, those who employ artisans or professionals must pay for their labor at a higher rate than for that of a plowman or common laborer. Their labor will necessarily be expensive in proportion to the time lost in learning the trade, and the cost and risk incurred in becoming proficient.

The professionals themselves do not make all their children learn their own trade: there would be too many of them for the needs of a city or a state and many would not find enough work. However, the work is naturally better paid than that of plowmen.

The key is in the second to last sentence. The problem that the USA and many other countries are facing is that they have encouraged too many young men, and far too many young women, to pursue college degrees, so there is now a massive surplus of degree-holders for the needs of the various nations where academic credentials have been subsidized and fetishized.

In a free and sustainable economy, the number of college students would be significantly reduced due to the combination of the cost and opportunity cost of a college education. But because demand has been artificially inflated by student loans, government grants, and the willingness of parents to go into debt on behalf of their children, the level of current malinvestment  in college education is extraordinarily high. The fact that student loan debt can no longer be legally discharged was the first indication that the education bubble had reached its terminal point of expansion.

Longer lifespans and longer working lives justify spending more time and money in acquiring professional skills than in Cantillon’s day, but not indefinite amounts of either. And unless the student acquires skills that increase the value of his labor during that time, the entire process is a waste of both.

The irony is that the average college student is probably less valuable than the unskilled plowman now, because while he still lacks any useful skills, he also is unwilling to work hard at anything he is actually capable of doing.

UPDATE: “In 2008 there was $730 billion of student loan debt outstanding, of
which the Federal government was responsible for $120 billion. Five
short years later there is $1.2 trillion of student loan debt outstanding
and the Federal government (aka YOU the taxpayer) is responsible for
$716 billion. Using my top notch math skills, I’ve determined that
student loan debt has risen by $470 billion, while Federal government
issuance of student loan debt has expanded by $600 billion.”

No reason

The Fed is testing susceptibility to counterparty credit risk in 2014. Just to, you know, be on the safe side. Nothing to worry about here. No problems are anticipated. Hey, look there, green shoots!

Lenders including JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C) will have to show they can survive the demise of a trading partner or a plunge in value of high-risk business loans in the 2014 version of U.S. stress tests.

The scenarios for the annual tests, outlined by the Federal Reserve in a statement yesterday, reflect some of the most pressing threats seen by regulators as they gauge the ability of the U.S. financial system to withstand economic shocks. Bankers will have to show what would happen to the value of leveraged loans they hold, the impact of another housing bust and how they’d fare if a firm that owes them substantial sums collapses.

The test was designed in part to build resiliency against what some see as emerging asset bubbles, said a Fed official who spoke on a conference call with reporters. The counterparty failure test aims to prevent a repeat of the 2008 crisis, when distress at Lehman Brothers Holdings Inc. and American International Group Inc. threatened to destroy their biggest trading partners.

Of course, regular readers here know another way to spell “a plunge in value of high-risk business loans”. C-R-E-D-I-T-D-E-F-L-A-T-I-O-N.

Mailvox: the Fed imbalance

JD asks about the Fed’s balance sheet:

Fed balance sheet may not return to normal until 2019?  What does this mean to lay people?  Would you enlighten The Dread Ilk, please?

The short version is that quantitative easing, which is the Federal Reserve’s euphemism for “printing money” under the current monetary regime, is not working in terms of returning the economy to full employment or stimulating economic growth. However, the Fed doesn’t dare stop QEn because doing so would almost instantly crash the stock market and hurl the global financial system into crisis, if not collapse. So, the program is going to continue indefinitely, which we already know due to the appointment of Janet Yellen, who is even more expansionary-minded than the man named Helicopter Ben.

Wikipedia has a good definition of quantitative easing: “Quantitative easing (QE) is an unconventional monetary policy used by central banks to prevent the money supply falling when standard monetary policy has become ineffective. A central bank implements quantitative easing by buying specified amounts of financial assets from commercial banks and other private institutions, thus increasing the monetary base. This is distinguished from the more usual policy of buying or selling government bonds in order to keep market interest rates at a specified target value.

“Expansionary monetary policy typically involves the central bank buying short-term government bonds in order to lower short-term market interest rates. However, when short-term interest rates are at or close to zero, normal monetary policy can no longer lower interest rates. Quantitative easing may then be used by monetary authorities to further stimulate the economy by purchasing assets of longer maturity than short-term government bonds, and thereby lowering longer-term interest rates further out on the yield curve. Quantitative easing raises the prices of the financial assets bought, which lowers their yield.”

This is why the stock market is up considerably since early 2009 and why corporate borrowing is up when the other private borrowing sectors are down. The reason that the QE program has continued for nearly five years now is that it hasn’t had the triggering effect that it was supposed to have in 2009 or any subsequent year. This is exactly what I have been talking about for years, in pointing out that the Fed cannot expand the money supply in the same way that was done in Weimar Germany and in Zimbabwe, because there are material and significant differences in the way the Fed “prints” money and the way past governments have printed money.

The Fed won’t simply print money in the traditional manner because the coterie of investment institutions they serve can’t profit that way; it is all inflationary downside without a leveraging upside. The US government could certainly do it, of course, and all it would have to do is completely shake off the chains of Wall Street first. So, needless to say, printing trillions of dollars and distributing them to the citizenry is not going to happen.

Given that they STILL haven’t taken the simple step of forgiving mortgage debt to free up disposable income, it should be obvious that they’re not going to indiscriminately hand out cash to everyone either.

My case for debt-deflation doesn’t rest on the physical impossibility of money printing, but on the improbability of Wall Street voluntarily giving up the goose that has laid so many dollar-filled eggs for 100 years. I think they will kill the economy before they give up control, especially since widespread bankruptcies and foreclosures taking place under the present regime would put huge swaths of U.S. property in their hands. It is very much a heads they win, tails you lose situation.

As for 2019, they might as reasonably have given a date of fiver. If you look at L1, it is very clear that all QE has done for the last five years is prevent the bottom from falling out completely while encouraging an astonishing amount of malinvestment via the corporate and federal sectors. So, I anticipate more of the same until the household sector defaults begin, which should set off the third, and more serious, stage of the financial crisis.

Timing? I don’t do timing. How will the crisis be resolved? I don’t know. These things cannot be known until they happen. All we can know for certain is that the present course of credit disinflation and substitution of private debt for public debt is not going to continue indefinitely, since it would result in the complete socialization of the national economy by 2030.

The MIN campaign

From Wikipedia circa 2023:

Moar Inflation Now (MIN) was an attempt to spur a grassroots movement to stoke inflation, by encouraging personal borrowing and unrestrained spending habits in combination with expansionary public measures, urged by Fed Chairwoman Janet Yellen and Secretary of the Treasury Paul Krugman. People who supported the mandatory and voluntary measures were encouraged to wear “MIN” buttons, perhaps in hope of evoking in peacetime the kind of solidarity and voluntarism symbolized by the V-campaign during World War II.

The campaign began in earnest with the establishment by the Federal Reserve, of the National Commission on Inflation, which Yellen closed with an address to the American people at Jackson Hole, asking them to send her a list of ten inflation-increasing ideas. Ten days later, Krugman declared deflation “public enemy number one” before Congress on October 13, 2017, in a speech entitled “Moar Inflation Now”, announcing a series of proposals for public and private steps intended to directly affect supply and demand, in order to increase inflation to the desired rate of 10 percent per annum. “MIN” buttons immediately became objects of ridicule; skeptics wore the buttons upside down, explaining that “NIW” stood for “No I Won’t,” or “Not In Weimar,” or “Need Immediate Wank.”

In his book What the Fucking Fuck Was I Thinking?, Ben Bernanke admitted that the thought “This is unbelievably stupid” crossed his mind when Moar Inflation Now was first presented to the Clinton administration by his successor at the Federal Reserve. However, according to revisionist self-historian Paul Krugman, increasing the money and credit supplies was never meant to be the centerpiece of the pro-inflation program and the mass corporate bankruptcies, collapse of the US debt markets, and subsequent catastrophic failure of the global financial system only prove how much worse the economic situation would have been without the triumphant success of the MIN campaign.

Debt-deflation in action

Detroit pensioners will receive 16 cents on their expected retirement dollar:

On Friday, city financial consultant Kenneth Buckfire said he did not have to recommend to Orr that pensions for the city’s retirees be cut as a way to help Detroit navigate through debts and liabilities that total $18.5 billion. Buckfire said it was clear that the city did not have the funds to pay the unsecured pension payouts without cutting them.

“It was a function of the mathematics,” said Buckfire, who said he did not think it was necessary for him or anyone else to recommend pension cuts to Orr.

Are you saying it was so self-evident that no one had to say it?” asked Claude Montgomery, attorney for a committee of retirees that was created by Rhodes.

“Yes,” Buckfire answered. Buckfire, a Detroit native and investment banker with restructuring experience, later told the court the city plans to pay unsecured creditors, including the city’s pensioners, 16 cents on the dollar. There are about 23,500 city retirees.

The secured creditors, by which is meant the banks, received 75 cents on their dollar. In light of this, you may wish to keep in mind that as a bank depositor, you are a similarly unsecured creditor who is loaning money to institutions that no longer have to mark their assets to market. I estimate that the average bank assets are 40 percent lower than recorded, so you should understand that the amount of money you have in the bank is likely 60 percent of what you see on your statement.

At best.

The Detroit pensioners are fortunate the banks were willing to take a 25 percent haircut. If not, they would have received even less, perhaps even nothing.

This is why we are seeing the likes of Paul Krugman waxing increasingly hysterical as they call for More Inflation Now! With the Federal sector finding it increasingly difficult to prop up Z1/L1, (L1-G actually fell for the first time since Q2 2008), and the three main private sectors average 1.1 percent quarterly growth between them, the economic winds are blowing rather cold again.

Anti-Americanism in Europe

It’s completely understandable why average Europeans are beginning to turn anti-American:

US intelligence has been operating a global network of 80 eavesdropping centres, including 19 European listening posts in cities such as Paris, Berlin, Rome and Madrid, the German magazine Spiegel has reported.

The new revelations, which Spiegel said were based on leaked American intelligence documents, are certain to fuel international outrage at the sweeping scale of US international surveillance operations.

Spiegel also reported that the telephone number of Angela Merkel, the German chancellor, has been a target of US surveillance since 2002, when she was leader of the opposition.

Mrs Merkel, who telephoned President Barack Obama on Wednesday to express her anger at reports that her phone had been hacked, was still under surveillance until a few weeks before the US leader Berlin in June, Spiegel said.

Even before the latest reports, Germany said that it would send a high-level delegation to the US this week to demand answer s at the White House and National Security Agency (NSA) about the reports that Mrs Merkel’s phone was tapped. The team will include spy chiefs, German media reported.

I had an interesting experience this weekend that exposed how many Europeans feel about the NSA revelations. My team was playing an away game and I got a little lost trying to find a soccer field. Most villages have signs clearly marking where their main field is, but this one didn’t, so I stopped at a small restaurant where several people were hanging out on the deck, smoking and drinking.

They were obviously locals, so I parked the car, got out, and asked them where the field was. I was wearing my team’s jacket, and as we are known to have a few Portuguese players, one of the men asked me if I was Portuguese, most likely because of my accent. The two women both laughed at that and said: “but come on, look at him, he’s clearly not Portuguese.”

When I explained I was originally from America, the man made a face, held his hand up to his ear like a telephone, and said, “USA? Why are you listening to my mobile phone? Why are you listening to my phone calls?” He was joking, of course, as he promptly laughed, slapped me on the shoulder, and provided directions to the field, but it really startled me to discover that in a tiny village in the middle of nowhere, the immediate reaction to an American would be to bring up the NSA.

And the more elite Europeans aren’t blind to the opportunities presented by the scandal either. I spoke to several high-level investment executives over the last few weeks, and to a man, they see the scandal as being a reason for Europe to make a serious effort to break away from the technology chains of Google, Microsoft, Oracle, Twitter, Facebook, and other American companies that have dominated the world. The larger the corporation, the more determined they are to keep the US out of their emails and servers.

As more and more revelations of tech-enabled spying come out, it wouldn’t surprise me to see nations deciding to subsidize national alternatives and perhaps even eventually banning the use of American software. And why shouldn’t they? How can they possibly accept the status quo? It’s not inconceivable that the long-term result of using the NSA to spy on everyone through international business and the consequential shattering of trust may be a factor in the material reduction of transnational trade.

This isn’t merely a diplomatic or political scandal, it is probably an economic one as well.

Everything is fine, the Krugman promised

And those four horsemen you see riding this way, they’re just out for an afternoon canter. Keep in mind these soothing assurances come from the same Nobel prize winner who, contra his ex post facto self-congratulatory posturing, didn’t see the 2008 financial crisis coming:

Once upon a time, walking around shouting “The end is nigh” got you labeled a kook, someone not to be taken seriously. These days, however, all the best people go around warning of looming disaster. In fact, you more or less have to subscribe to fantasies of fiscal apocalypse to be considered respectable.

And I do mean fantasies. Washington has spent the past three-plus years in terror of a debt crisis that keeps not happening, and, in fact, can’t happen to a country like the United States, which has its own currency and borrows in that currency. Yet the scaremongers can’t bring themselves to let go….

Look at Japan, a country that, like America, has its own currency and borrows in that currency, and has much higher debt relative to G.D.P. than we do. Since taking office, Prime Minister Shinzo Abe has, in effect, engineered exactly the kind of loss of confidence the debt worriers fear — that is, he has persuaded investors that deflation is over and inflation lies ahead, which reduces the attractiveness of Japanese bonds. And the effects on the Japanese economy have been entirely positive! Interest rates are still low, because people expect the Bank of Japan (the equivalent of our Federal Reserve) to keep them low; the yen has fallen, which is a good thing, because it make Japanese exports more competitive. And Japanese economic growth has actually accelerated.

Why, then, should we fear a debt apocalypse here? Surely, you may think, someone in the debt-apocalypse community has offered a clear explanation. But nobody has.

So the next time you see some serious-looking man in a suit declaring that we’re teetering on the precipice of fiscal doom, don’t be afraid. He and his friends have been wrong about everything so far, and they literally have no idea what they’re talking about. 

First, numerous clear explanations have been offered. It is well-known that Paul Krugman does literally no reading of economics outside his Neo-Keynesian paradigm, as evidenced by his disastrous attempt to criticize Austrian economic theory I addressed in RGD. His grasp on it wasn’t quite as bad as the guy who didn’t understand why such a small country’s economy was so important, but it wasn’t much better.

Second, if there isn’t a potential debt apocalypse on the horizon, then how does Mr. Krugman explain the 5-year anomaly in a 65-year period shown to the left?  I’m not going to bother producing a new graph, because the picture looks exactly the same from 1948 to 2013.

Total Credit (Z1) rose at a very steady rate from 1948 to 2008. Like clockwork, the 60-year quarterly growth rate averaged around 2.3 percent per quarter. In the 22 quarters since Q1 2008, the average quarterly Z1 growth rate has been 0.6 percent, leading to a current credit demand gap of $26 trillion with Zn, which is where Z1 would be now if it had simply continued to grow at its normal 60-year rate over the last five years.

And that $26 trillion gap is despite the Federal sector increasing its outstanding debt from $5.1 trillion to $11.9 trillion during those 22 quarters. The Federal sector now accounts for 20.7 percent of all outstanding debt, more than double its percentage in 2008.  Without the orgy of Federal borrowing and spending, (or in other words, if outstanding Federal debt was still only 10.24 percent of Z1) we would still be in credit deflation rather than the ongoing state of credit disinflation.

So what we are seeing is the gradual socialization of the credit markets. At this rate, if the Federal sector continues to double its share of Z1 every 16 quarters, 100 percent of the outstanding debt in the entire economy will be owed by the Federal government in the year 2023. This may not matter from the Neo-Keynesian perspective, where debt does not enter into the equations, and all spending counts the same and is equally efficient no matter the source or the recipient. But for those who understand the Austrian concept of malinvestment or are cognizant of the history of fully socialized economies, it should be troubling news indeed.

We are already in a state of debt deflation in the private economy. In Q4 2007, the private sector’s share of Z1 was $42.7 trillion. In Q2 2013, that share was $42.6 trillion. (NB: this does not count the large quantity of bad debt assets that have not yet been booked, which I estimate to be around 40 percent based on reported FDIC losses.) That is evidence that there has been no real growth in the economy despite the GDP numbers and the massive government attempts to kickstart it. One cannot push on a string, and as Ben Bernanke belatedly discovered, one cannot print private sector borrowers either.

Krugman is like a man standing in the rain on the banks of a flooding river, ignoring the frantic efforts of thousands of men piling sandbags higher and higher, calmly assuring everyone that no one has to worry about getting their feet wet. I have very little doubt that this is a column Krugman is going to regret having written in the future and very much look forward to reading his attempts to disavow it or otherwise explain it away.

Ask yourself this question

If credit isn’t money and cannot affect prices, then why is managing the growth of credit a specified aspect of the Fed’s monetary policy? From the Federal Reserve charter:

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

The reason the Fed tracks the various components of Z1 in the first place is that they know perfectly well that M2+credit is the effective money supply. Which means that they already know their can-kicking can’t possibly work indefinitely. Karl Denninger has more thoughts on this as well as Alan Greenspan’s Mr. Magoo Problem.