Tag Archives: Fed

The Fed Has To Be The Strict Parent

Thesis: The Fed has to be strict with the banks.

The Fed conducted annual stress tests on the 31 largest U.S. financial institutions this week. The purpose of the test is measure two things: “Whether banks can weather a hypothetical recession, and whether they have good processes for identifying and preparing for risks.” The first measure is a quantitative assessment of how well capitalized the bank is; that is, how much capital they will have available to smoothly continue their lending operations in significant economic downturns. This is a relatively straightforward measurement that yields a simple yes or no answer.

The second aspect of the test is a lot more interesting; it is a qualitative assessment of a bank’s internal processes of identifying and managing risk. The reason this is the more interesting component is because it defines the conduct and culture that the Fed deems appropriate on Wall Street.

In a Bloomberg View editorial, David Shipley writes:

“Better regulation is essential. Particular attention has to be paid to the dangers of excessive systemwide leverage, and banks and other financial instructions need to be better capitalized. In this and other respects, aligning tax and regulatory incentives with the public interest is no simple task. But the guiding principle in this work shouldn’t be the idea that finance is a fraud on the public and Wall Street a nest of vipers. The purpose of regulatory reform shouldn’t be punishment.

Rather, the aim should be to promote prosperity. A vibrant, innovative financial sector is a vital economic resource. Talented and hard-working people are well deployed in such an industry, and deserve to be well-rewarded. Anger has had its day, and it’s time to move on.”

The first part of Shipley’s argument concerns the first aspect of the Fed’s stress test – the quantitative assessment of capital levels that is relatively easy to monitor. However, the second part of Shipley’s argument concerns the Fed’s qualitative assessment. In Shipley’s view, the Fed should promote prosperity, and encourage a culture on Wall Street that creates new financial instruments, and rewards themselves for it. But isn’t that exactly what led to the sub-prime mortgage crisis? Bankers created new financial instruments called mortgage-backed securities, and didn’t fully understand how they worked. That was a huge factor in the financial meltdown. While I am not suggesting the Fed to discourage innovation, as the sole regulatory body the Fed has to use punishment to keep the banks in check.

It is almost like Shipley is suggesting the Fed to be the “fun parent,” but doesn’t it seem like those are the kids that always end up in trouble?

 

 

New York Fed Should Not Regulate Wall Street Investment Banks

Federal Reserve Bank of Dallas President Richard Fisher, in an article on the Wall Street Journal, is arguing for power to be shifted away from the Federal Bank of New York. Community bankers also support this weakening of the New York Fed. In a letter to the U.S. Senate by president of the ICBA (Independent Community Bankers of America, an organization representing over 6,500 community banks), one of Fisher’s main points in his proposal is that financial institutions should be supervised by Federal Reserve Banks from districts other than the ones in which they are headquartered. This is all to promote transparency and avoid regulatory capture. I believe this is an important step in increasing the efficiency of the Federal Reserve system.

I hate to be one of the naysayers of the Federal Reserve because I believe in that they are a necessary entity for a better financial sector. This is why I think Fisher’s most important point is for the regulation of financial institutions to be conducted by Federal Reserve Banks other than their region. The current president of the New York Fed, William Dudley, was formerly Goldman Sachs’s chief economist. And of course, he oversees the regulation of Wall Street banks, including Goldman Sachs. This makes room for regulatory capture to occur. In fact, Carmen Segarra’s story paints a very suspicious image of the New York Fed.

In an article on Bloomberg View by Michael Lewis (whose books have been required reading for some economics classes here at University of Michigan), Carmen Segarra was the New York Fed regulator inside Goldman Sachs who had been fired because she called out suspicious activities conducted by Goldman Sachs. A segment from his article includes the following, expressed by Carmen Segarra, “In one meeting, a Goldman employee expressed the view that ‘once clients are wealthy enough certain consumer laws don’t apply to them.’ After that meeting, Segarra turned to a fellow Fed regulator and said how surprised she was by that statement — to which the regulator replied, ‘You didn’t hear that.'” Apparently, the culture in the New York Fed is such that most employees are deferential to the banks they supervised, and unpopular opinions are hushed (ProPublica, David Beim). And Goldman Sachs is not the only case, similar events are happening at JP Morgan as well.

The cause of this culture, I would guess, is because many employees of the New York Fed will eventually seek employment in some of these investment banks, and they do want to tarnish their chances by making enemies with these companies. That’s why, in order to avoid regulatory capture, Wall Street should not be supervised by the New York Fed.

The Fed might be ambiguous, but at least they’re honest

In their initial statement from the January 27-28 policy meeting, the Fed hinted at a midyear rate hike. However, the minutes from the meeting were far less convincing, as there was much difference in opinion about the timing of a rates hike amongst Fed officials. “’It was suggested that the [Fed] should communicate clearly that policy decisions will be data-dependent, and that unanticipated economic developments could therefore warrant a path of the federal funds rate different from that currently expected by investors or policy makers,’ the minutes said. In other words, the Fed could move faster or slower on rate increases depending on the economy’s performance,” according to the WSJ.

In the Wall Street Journal, Charles Calomiris and Peter Ireland crafted a response to the Fed, entitled “A Muddle of Mixed Messages from the Fed.” In the article, they lay out some instructions for the Fed:

“First, stop giving mixed signals reacting to each day’s data dump. The Feb. 6 jobs report, for example, confirmed the positive outlook for “solid” economic growth and “strong” job gains that was described in the Jan. 27-28 FOMC policy statement. Yet recent speeches and media appearances by Fed Chair Janet Yellen and Federal Reserve Bank Presidents Charles Evans and Narayana Kocherlakota convey an impression that the economy and labor markets may not be healthy enough for a midyear rate hike.

Their statements may be part of an effort to maintain Fed flexibility, but they confuse markets. Far better to emphasize the compelling indicators that point to sustained economic growth. For example, while the GDP report for the fourth quarter of 2014—2.6% annual growth—was slower than the previous two quarters, it was still solid. The job market is stronger than it has been in years, and so are the data for consumption and housing starts.”

Yes, the Fed’s statements are ambiguous, and they do maintain flexibility, but what Calomiris and Ireland don’t address is that they actually have some validity! If the Fed came out and said that the labor market was great and everything is peachy, that would just be irresponsible. If the Fed only addressed the positive gains in unemployment, they would only be reporting half the story. What do Calomiris and Ireland have to say about wage growth? Is the Fed supposed to ignore those concerns, and allow the markets to react under false pretenses? What they are suggesting is false advertising, and that cannot be the backbone of any good product.

Fed Stalls Raising the Short Term Interest Rate

Today at the FOMC meeting, the Federal Reserve released statements that were more dovish than analysts had expected regarding the short term interest rate. On February 7, I posted a blog highlighting my analysis and contrarian view that the Fed would stay patient in raising the short term interest rate despite popular beliefs it would come sooner rather than later. Now I am not saying that I have achieved victory in my prediction, but it is one step closer in the right direction. My prediction came at a point after a point when the most recent U.S. economic data was strong. The Fed minutes suggested that U.S. data was weak according to a report by the Wall Street Journal: “The action followed a round of soft economic data and signs from the minutes of January’s Fed meeting that the central bank is grappling with how to lift U.S. rates for the first time since 2006.” That is a long time period since the Fed last raised interest rates, and there are many new factors in play considering we have experienced the Great Recession and experimented with new forms of monetary policy.

Raising interest rates has many negative implications. Domestically, it makes it harder to borrow in the sense that debt is relatively more expensive. Say you have a floating rate mortgage and today your payment is 4%, your payment might go up substantially if the mortgage rate moves to 6%. Also, there are more first time home buyers that may not be able to afford a house if their mortgage payment is higher due to the rise in interest rates. These are only a few sheltered examples related to one industry that would be negatively affected by a rise in interest rates. An interest rate increase also has some positive effects, too. Another Wall Street Journal article highlighted the market effects due to interest rates being held lower. “The yield on the two-year U.S. Treasury note fell by about 0.07 percentage point Wednesday to 0.605%, the biggest one-day decline since August 2011. The yield, which falls as prices rise, is among the most sensitive to changes in the Fed’s interest-rate outlook.” Essentially, investors earn less return on their money when interest rates are low.

Another negative of raising the interest rate arises in international finance. When the Fed raises the interest rate, that will lead to a decrease in net capital outflows, and an increase in the U.S. dollar exchange rate. The increased exchange rate can be viewed as a positive since it signals a strong economy, but will ultimately hurt net exports. This dilemma can also be viewed from the net capital outflows decreasing according to the equation NCO=NX. Essentially, net capital outflows are equal to net exports and boost a country’s GDP. So when net capital outflows fall due to an increase in the interest rate, the U.S. GDP is also expected to be weakened.

 

If it Isn’t Broken, Don’t Try to Fix It

Last month, Republican senator Rand Paul introduced a bill that would expand Congressional oversight over the Federal Reserve and used it to spearhead a self-proclaimed “Audit the Fed” movement.  In an op-ed on Breitbart written by the senator himself, Rand cites the Fed’s massive balance sheet leverage being composed of faulty loans, long-term dollar dilution, and expanded powers from the Dodd-Frank Act as being the driving forces behind the movement.  Many journalists seem to be missing the underlying implications of the proposed bill.  Neil Irwin of the New York Times delves into a description of how the Fed is actually quite transparent and argues that its financial statements are indeed already audited yearly, then goes on to claim that experts say the bill is really about “unveiling the secrets of the temple, exposing the perfidy that these secretive central bankers are surely engaged in”.  He counters that issue by going into detail about the Fed’s communication with the public, but what his analysis is missing is the fact that Congress having even the slightest input on the Fed’s decisions is a terrible idea.  A writer for the Wall Street Journal glanced over that notion as well, providing an explanation of the Fed’s balance sheet and Paul’s claims, adding a mere sentence about how Fed officials think the bill would limit their independence with no elaboration beyond that.  Journalists are missing the real story here.  While some are acknowledging the fact that the Fed is adamantly against the issue, as this WSJ article does, they are simply quoting statements from Fed officials and leaving the meaty story on the table, opting instead for the side-salad.

Nobody should be surprised that the Fed is against expanding Congressional oversight – it goes against everything they stand for as independent, “private” bankers.  The issue at hand here is not about a lousy financial audit, nor is it about tapping into the minds of the Fed’s Board of Governors.  It is about Congress, a radically political being, wanting to interrupt a monetary system that has a solid track record.  It is about lawmakers diverting their efforts towards a matter of policy where there is little room for improvement.  Since the peak of the global recession, the United States has had the best recovery out of the five countries with the biggest central banks, as demonstrated by this data from the World Bank.

 

gdpgrowthperformance

 

This was largely due to the Fed’s quick response of buying up toxic assets, a response which may have taken years (and which would have been far too late) if it involved some sort of Congressional vote or approval.  Critics of the Fed claim that purchasing these assets was a mistake, reasoning that there is risk inherent to increasing the size of the Fed’s liabilities.  In reality, the asset purchase program was well-implemented, likely saved Americans years of economic stagnation, and carried less risk than what was perceived.  It is only natural that it will take a while for the Fed’s balance sheet to shrink, just as Fed officials claim, since it must space out the asset sales at a reasonable rate (and its asset sales have been accelerating, as noted in CNBC).  The Fed has been wise in its handling of these assets, opting to hold on mortgage-backed securities that it had previously intended to sell in 2013, waiting for the right time so as to avoid losses, as described by this Bloomberg article.  Those who claim that the Fed has not been transparent enough seem to be overlooking the fact that Ben Bernanke provided plenty of guidance to the market with respect to the Fed’s goals.  The Fed as we know it is working perfectly fine as it is: a board of apolitical experts who are free to make decisions without worrying about public or political input that is often misguided, as Rand Paul’s is.  To insert any sort of Congressional control would jeopardize a system that has worked perfectly fine as is.

 

Fed’s Dilemma in Low Inflation and Job Gains

Feb 9th 2015

 Federal Reserve Announces End of Quantitative Easing

(http://nypost.com/2014/11/05/gop-should-start-fixing-the-fed/)

Nowadays, the Fed faces with the severe dilemma between low inflation and job gains. The unemployment rate has fallen to 5.7% from 6.6% a year ago and 8% two years ago while the inflation rate is still below the target 2% rate. According to Wall Street Journal, the stronger job market provides reason of raising short-term interest rates to prevent the overheating market while low wage growth and inflation show the signal that overheating problem wouldn’t be in the near future.

Officially, the Fed already said a high possibility of raising short-term interest rate around the midyear. However, many Fed officials worry about the market situation although net hiring increases during the November-to-January by more than 1 million. Their worries come from the inflation which is still below the Fed’s 2% objective and little wage growth. Why does low inflation matter? It is a simple economic theory called Phillips curve. Basically, it phillipsis a historic inverse relationship between unemployment rates and inflation rates in the economy. In theory, there is a point where the long-run Phillips curve meets the short-run Phillips curve, where the Fed and other governments target on.

 

(http://en.wikipedia.org/wiki/Phillips_curve)

“Economists call this cutoff point a non-accelerating inflation rate of unemployment, or Nairu, and also point to a “natural rate” of unemployment where inflation is stable in the longer-run. The problem is nobody knows the cutoff point. Economists merely estimate it” (Wall Street Journal). Because of uncertainty in estimating the point, it is hard to set the interest rate at the right time. Both Fed officials and policy makers want to see the obvious sign to make sure that the economy is close to the full employment, but not as much as to the overheating point.

There are two options for Fed; it can be patient until the market shows a clearer sign or take an action by increasing short-term interest rate. Personally, I am in the position that Fed should wait because I think raising the interest rate is too risky. As Rosengren said, “Low level of inflation in most developed economies meant the U.S. central bank shouldn’t hurry to raise interest rates.” Furthermore, still the economic measures are not fully recovered as before the sub-prime mortgage. For example, many people point out involuntarily part-time workers, which make “job gains” doubtful. “There are still almost 7 million workers counted as employed who say they are working part-time involuntarily” (Wall Street Journal). Fed should be more careful about its increasing interest rate unless the whole economy falls into the deep recession again.

Fed Stands Pat on Interest Rates

In a recent Federal Open Market Committee meeting, the Federal Reserve issued its latest statements regarding the status of the U.S. economy and where it sees the future of interest rates. An article published by the Wall Street Journal outlines the FOMC minutes and the Fed’s current stance on monetary policy. The Federal Reserve had announced at earlier meetings that it had intended to raise interest rates in 2015. Some analysts predicted it would be early 2015, while others viewed a potential rate hike as late as Q4 2015 or even early 2016. The Fed reiterated its stance that they seek to raise interest rates around mid-year 2015. So at the earliest, we would expect the Fed to raise interest rates at their June meeting. The FOMC minutes was also comprised of language that indicated the Fed was open to being patient and seeing how global economic events panned out prior to raising rates. The Wall Street Journal coined this as a “wait-and-see” approached.

There are many recent global events to be considered for the Fed to raise the interest rate. Over the past few months, the U.S. dollar has been surging against other currencies due to the strength of the U.S. economic recovery, end of quantitative easing, and hawkish comments made on raising the interest rate. At the same time, other countries including Japan and the Eurozone have embarked on further quantitative easing programs of great magnitude. The combination of strong U.S. dollar and quantitative easing in foreign nations make U.S. exports look relatively more expensive which could put a damper on the U.S. economic recovery. Raising the interest rate would only make the U.S. dollar even stronger relative to its peers, which could have a snowball effect on U.S. exports. Furthermore, the Eurozone was hawkish last year and raised their short-term interest rate as leaders of the European Central Bank viewed the European recovery as solid and were afraid of rising inflation. Now, the bloc of countries is at risk of falling into another recession and has launched another quantitative easing program.

There are risks outside of the monetary policy of other nations, as well. Raising interest rates is a way to combat rising inflation. According to the Bureau of Labor Statistics, the Consumer Price index ex food and energy is at 1.6% which is below the 2% target inflation rate set by the Fed. If the Fed did take the stance to raise interest rates, we would expect to see the CPI drop even further and not be at an optimal inflation rate. I agree with the Fed’s stance to take a ‘wait-and-see” approach. I do think however, that the Fed will remain dovish and that we will not see interest rates raised until the end of the year. There are too many variables that side against increasing the short-term interest rate right now or even in the coming months.

Get Zero Interest Rates Till June!

The Fed held its FOMC meeting this past Tuesday and Wednesday, January 27th to the 28th of 2015, discussing several different aspects of monetary policy to “foster maximum employment and price stability.” Lately, there has been a lot of talk about a rumored interest rate increase that is forecasted to occur sometime this year. Fortunately, the Fed has decided to leave interest rates where they are on account of the falling inflation rates throughout the US, for which they listed several reasons. They spoke on the falling oil prices, the ECB’s decision to buy over a trillion Euros worth of bonds, and the dollar’s appreciating value. Ultimately, interest rates are still expected to increase in June of this year, and many still fear this day.

A USA Today article titled “Fed likely to continue to signal mid-2015 rate hike” states “The Fed typically raises interest rates to keep inflation from spiraling too high as the economy and labor market heat up and lowers rates to spur growth. The unemployment rate has fallen from 6.7% to a near-normal 5.6% over the past year, providing support for adhering to Fed policymakers’ forecast for the first rate hike in June.” Should the Fed increase interest rates, many negative events may occur. The most likely result of this increase would be an immediate shock to the stock market. Investors like conditions where money is cheap, and higher interest rates mean it is effectively more expensive to borrow. The same goes for mortgages, loans, and credit. People would ultimately see a decrease in the purchasing power of their dollars, and a rise in prices everywhere. Historically, higher interest rates have been signs of an economic recession, however the Fed doesn’t have much of a choice.

Some expect that the Fed shall continue printing money and buying securities to keep interest rates artificially low. That is entirely within the realm of possibility, however eventually the Fed has to raise interest rates or inflation will devalue the dollar to a worthless status. It’s going to be a risky decision for the Fed, and had they raised interest rates a long time ago, it may have been a smarter move. Economic crashes have always occurred cyclically. Never for the same exact reason, always the same way. As with the 2008 subprime mortgage bubble, we are now faced with an even greater bubble that must be deflated. What remains to be seen is which needle the Fed chooses to use this time.

The Waiting Game

“The Federal Reserve signaled this past week that it is unlikely to raise short-term interest rates until at least June” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

This came as a surprise to most people, it seems, but I am not completely surprised based on the underlying motivation of the Fed.

“…The Fed will raise interest rates only when it is confident that the economic recovery is robust and companies have regained the ability to raise prices” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

Although it seems that the Fed is not in touch with everyday citizens, like you and I, I believe their decision to delay the rise of interest rates is in tune with the best interests of everyday citizens. Although we have been told for a while that the recession is over, it seems that from the perspective of everyday people that is not necessarily the case. It seems like the wealth of the upper class has been rising since post recession, but the middle class and below has not had the same fortune.

The Federal Reserve clearly believes that the economy is not in full rebound yet, hence the delay of raising rates until mid summer. I am happy with the decision the Federal Reserve made, their focus seems to be more on the well being of everyday Americans, rather than worrying about creating high returns for investors. This is not really the common perception of the Federal Reserve; most people seem to think they do not have to best interest of the people in mind. There seems to be this notion or belief that the Federal Reserve is just a group of wealthy bankers in an ivory tower playing with everyone’s money, acting according to the best interest of a few. Their recent decision, however, points to the opposite.

“…Investors seemed mildly disappointed when the Fed reiterated on Wednesday that it would remain “patient”” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

Although investors seem to be upset with the Federal Reserve’s decision. Most people are not investors so this decision by the Fed to not act does not affect them in the same way as those who speculate based on the Fed’s actions.

“More than three-quarters of Americans say the five-year bull market in U.S. stocks has had little or no effect on their financial well-being, according to a Bloomberg National Poll” (http://www.bloomberg.com/news/articles/2014-03-12/stock-market-surge-bypasses-most-americans-poll-shows).

Bull market is a term used to signal positive beliefs about the market, while bear market is used to signal the exact opposite, pessimism towards the market. Although the stock market, like explained above has been labeled a bull market for the past five years, this has not improved the financial well being of everyday Americans, most who do not own stocks, or at least not a significant amount anyways. With the lower and middle class of America still struggling, it seems that the fed made the appropriate decision to delay raising interest rates.

“Don’t worry about the Fed; be happy” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

You can be happy; the Fed seems to be thinking about you and I, not just the wealthy elite.