On the Peterson Institute for International Economics Monitor, Mohsin S. Khan sits down with Steve Weisman and argues that both India and Pakistan have much to gain by putting aside their hostilities and increasing economic cooperation and trade. Please read Benefits of More Trade Between South Asian Rivals.
On the U.S. EconoMonitor, Robert Reich looks at the composition of the Senate Finance Committee and questions why so much power for deciding the future of health care is concentrated in six senators (three Republican and three Democrat) hands. See Why the Gang of Six is Deciding Health Care for Three Hundred Million of Us .
Aug 292009
“When an unprecedented amount of taxpayer dollars were lent to financial institutions in unprecedented ways and the Federal Reserve refused to make public any of the details of its extraordinary lending, Bloomberg News asked the court why U.S. citizens don’t have the right to know”
-Matthew Winkler, the editor-in-chief of Bloomberg News.
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I would have been surprised if it went the opposite way.
“Federal Reserve must make records about emergency lending to financial institutions public within five days because it failed to convince a judge the documents should be exempt from the Freedom of Information Act.
Manhattan Chief U.S. District Judge Loretta Preska rejected the central bank’s argument that the records aren’t covered by the law because their disclosure would harm borrowers’ competitive positions. The collateral lists “are central to understanding and assessing the government’s response to the most cataclysmic financial crisis in America since the Great Depression,” according to the lawsuit that led to yesterday’s ruling.
The Fed has refused to name the borrowers, the amounts of loans or the assets put up as collateral under 11 programs, saying that doing so might set off a run by depositors and unsettle shareholders. Bloomberg LP, the New York-based company majority-owned by Mayor Michael Bloomberg, sued Nov. 7 on behalf of its Bloomberg News unit.”
The only way this has been historically been allowed is when it imoacts National Security . . .
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Source:
Fed Must Release Reports on Emergency Bank Loans, Judge Says
Mark Pittman and Karen Gullo
Bloomberg, Aug. 25 2009
http://www.bloombergs.com/apps/news?pid=20601087&sid=afi7TJiJFys0
Stanford Professor John Taylor has suggested that monetary policy could be summarized in terms of a simple rule, lowering interest rates when output is too low and raising them when inflation is too high. A number of academic papers have investigated this rule from the perspective of describing what the Federal Reserve has historically done. In a new paper co-authored with Federal Reserve economist Seth Pruitt and Office of Immigration Statistics economist Scott Borger, I take a look at what monetary policy rule the market perceived the Fed to be following over different historical periods.
Our basic idea is that, back in the days before we ran into the zero lower bound on interest rates, if there was a major surprise in a macroeconomic news release, you would see a big change in fed funds futures prices. For example, when the BLS announced on March 8, 1996 that nonfarm payrolls increased by 705,000 workers in February (wouldn’t we love to see another report like that one about now!), the interest rate associated with the August fed funds futures contract jumped from 5.01% to 5.25%. That response reflected a market belief that the development would cause the Fed to choose a higher interest rate than it otherwise would have.
We then built simple forecasting models for how news like this would alter a rational forecast of future inflation and output growth and ask, if market participants were revising their expectations in a way consistent with those forecasting relations, and if they thought that the Fed would respond to those future fundamentals according to a Taylor Rule, what parameters for the Taylor Rule are most consistent with the observed response of fed funds futures prices?
Our estimates are similar to those derived from more conventional econometrics, and suggest that, since 1994, the market believed that monetary policy was consistent with the Taylor Principle, raising the nominal interest rate more than 1-for-1 with an increase in inflation. Output targeting, particularly over the 2000-2007 period, appears to have been assigned secondary importance by the market.
One of the advantages of our approach is that we are also able to come up with estimates for the degree of inertia in perceived monetary policy. For example, while the August 1996 contract experienced a 24-basis-point jump on March 8, the May contract only moved 10 basis points. Since we can describe how the March 8 news should have altered a forecast for both May and August inflation, we can come up with direct measures for how long the market expected it would take the Fed to adjust interest rates fully in response to the news.
We document two important changes in the perceived policy rule over time. After 2000, the market believed that the Fed would eventually have a stronger response to inflation than it had prior to 2000, but also that the Fed would take longer to implement those changes, responding to news more sluggishly than it had before 2000.
We study the consequences of these changes using a simple new-Keynesian model. We find that the first change (a stronger long-run response to inflation) would be something that would have made output less variable, whereas the second change (a smaller immediate response) would have made output more variable. According to these simulations, increased Fed inertia undid some of the benefits it could have otherwise obtained with its anti-inflation policies.
Our conclusion is that the measured pace at which Greenspan increased interest rates over 2004-2005 may have been counterproductive, and that economic performance might have been improved if the Fed instead had raised interest rates more quickly to the higher warranted levels.
The Market-Perceived Monetary Policy Rule by James Hamilton
Fresh off my vacation, I have jury duty tomorrow, but today I got a jump on my fun reading for the courthouse – Traders, Guns, & Money, the anecdote-packed overview of derivatives by Satyajit Das, a prolific consultant, author, and commentator on the topic. Das says that his book “does not attempt to make a case for and against derivatives” (p. xiii), and it’s true that he does point out some of the useful, value-creating functions of derivatives. But this passage (p. 41) is probably more typical, and one I thought deserved being typed out:
We needed ‘innovation’, we were told. We created increasingly odd products. These obscure structures allowed us to earn higher margins than the cutthroat vanilla business. The structured business also provided flow for our trading desks. The more complex products were stripped down into simpler components that traders hedged. …
New structures that clients actually wanted were not that easy to create. Even if somebody came up with something, everybody learned about it almost instantaneously. They reverse-engineered the structure and then launched identical products.
In Das’s account, derivatives can be used to unbundle risk – but market competition makes unbundled risks look an awful lot like commodities. So the answer instead is bundle those risks back together into complex products that (a) customers can’t understand and (b) can earn high margins, at least temporarily. Das concludes his tutorial on inverse floaters this way (p. 50): “Greenspan had been right – risk had truly been unbundled. We had just packaged it right back up and shoved it down the eager throats of the wealthy taxpayers of Orange County.”
Which brings me back to something Mike Konczal (last week’s guest blogger – as my daughter would say, “Round of applause!”) discussed a while back – why do so many “innovative” financial products included embedded options? In Mike’s words, “When I was discussing this prepayment penalty theory with a very smart person from a hedge fund, he told me that selling people embedded options is always deviously clever because people don’t understand that they are buying them, and often don’t understand their value.” That sounds to me like the same thing Das is saying.
By James Kwak
Fun with Derivatives by James Kwak
by Bill Bonner at the Daily Reckoning
Ouzilly, France
Damned if he does; damned if he doesn’t
This week, Ben Bernanke got the nod for another stint as head of the world’s most important central bank. Yes, he completely misunderstood the implications of the hugely negative US trade balance, believing that America did the world a favor by spending its “global saving glut.” And, yes, he missed the approach of the biggest financial disaster in three generations. Then, when it arrived, he mistook it for a routine recession, until finally, panicked by the collapse of Lehman Bros., he insisted that Congress pass a $750 billion spending bill – or “we may not have an economy on Monday.”
But except for things that really matter, he’s been a pretty good Fed chief. Besides, he has the right credentials. He was a professor of economics at Princeton and holds a Ph.D. from MIT – just like the most recent Nobel Prize winner in economics, Paul Krugman.
The United States has just averted the Second Great Depression, say the papers. “What saved us?” asks Krugman in a recent New York Times editorial. “Big government,” is his answer. Specifically, the big government of Ben Bernanke.
But the ghost of Milton Friedman haunts the central bank. Bernanke borrowed a phrase from Friedman, saying he’d even “drop money from helicopters,’ if necessary, to prevent deflation. This led to one of the surest trades of the Bubble Era was the so-called on the ‘Bernanke Put.’ Investors thought they could count on him. Buy stocks. If they went down, Ben Bernanke would make sure you didn’t lose. He’d add liquidity until the market bounced back. But the Bernanke Put trade went bad in ’07. The market fell. Ben Bernanke added liquidity. But so far, stocks have yet to regain 50% of what they lost. Meanwhile, consumer prices are falling. And yet, he does not drop money from helicopters. Why not?
Few people would have more authority on the subject than the group gathered at the Beverly Hilton in Los Angeles earlier this year. Michael Milken, the Junk Bond King, gathered them thither and picked up the tab for Gary Becker, Myron Scholes, and Roger Myerson…each of their names is preceded by ‘Nobel Prize winner.’ With that kind of brainpower on hand, you’d think you could come up with a good explanation. But the best they could do was a simple analogy. Gary Becker (Nobel awarded ’92) took the Friedman line; he argued that by putting out the little forest fires, the recessions of the ’90s and the early ’00s, the feds inadvertently created the conditions for an even greater conflagration. Instead of burning off the underbrush, the tinder built up until a huge blaze was inevitable. And in a speech honoring Friedman, Bernanke accepted Friedman’s criticism of the Fed in the ’30s. Yes, Bernanke admitted, the Fed made mistakes; but we won’t do it again, he said. The burden of today’s rumination is that he was wrong; he will do it again.
“Inflation is always and everywhere a monetary phenomenon,” said Friedman. But deflation doesn’t seem to be a monetary phenomenon at all. Despite huge inputs of new money from the Fed, prices are still going down. The Fed’s balance sheet more than doubled in the last 18 months. It will probably double again – to $4 trillion – before Bernanke’s next term is over.
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Friedman won a Nobel Prize for his work. And he drew around him a community of scholars that won so many Nobel Prizes they ran out of room in the University of Chicago trophy cabinet. But it only makes you wonder about the Nobel committee. Friedman’s acolytes won their prizes for elaborating a series of mathematical proofs for things that were either self-evident or self-evidently absurd. Most of them were later shown to be wrong, irrelevant or misleading. Modern Portfolio Theory, Black-Scholes Option Pricing Model, Dynamic Hedging – the farther afield the scholars went, the more they lost touch with home. The more scientific their work became, the more it resembled alchemy or phrenology.
Friedman’s work itself was flawed in the same way. The general principle was correct – that the government that governs the markets least governs best. But when he got into the mechanics of ‘monetarism,’ he got lost. He believed that if the Fed kept its eye on the money supply; the free market would take care of everything else. But the free market didn’t take of everything, at least not as people hoped. Economist Murray Rothbard explained why in 1971. You cannot expect the free market to function perfectly if you leave in the hands of the government the power to control money. Either markets are free or they aren’t, was Rothbard’s point. If they’re not free, you can’t blame freedom when they fail.
But free market economists are now blamed for everything. The free- market Chicago boys are out. The MIT crowd is in. And investors are buying the Bernanke Put again, confident that the Fed chief will keep pushing money into the system and stocks will continue rising. But Ben Bernanke, for all his bluster, is a victim of the trade. Everyone knows what he is up to. They can’t help but look ahead and see where it leads.
As soon as Bernanke starts his helicopter engines, bond buyers get out their missiles; the Chinese – the biggest single customer for US debt – have warned that they will shoot him down. What can Bernanke do? He is damned if he doesn’t. But even more damned if he does. He can’t guarantee increases in either CPI or stocks. All he guarantees is that Big Government will play a larger role in the economy…and that Milton Friedman’s history of the Great Depression will turn out to be prophecy:
“The Fed was largely responsible for converting what might have been a garden-variety recession… into a major catastrophe…”
Ultimately, Bernanke does what his predecessors at the Fed did in the ’30s…and what the Japanese did in the ’90s. He hesitates. He makes mistakes.
And he wonders why he took the damned job in the first place.
