The FOMC as a Social Institution
There are many crying for the FOMC to cut rates, and soon. I will use Babak’s unusual endorsement of Cramer as an example. (I like both of them, but I disagree here.)
Because of the unusual structure of the FOMC, it is difficult to bring change rapidly. The regional banks governors represent their areas, and if no one is hurting, they are unlikely to suggest loosening. Those appointed by President Bush are moderate inflation hawks, and will need to hear how the real economy is suffering before they decide to act. A mere financial crisis where we aren’t even in a bear market yet is not enough to goad action, particularly when none of the major commercial (not investment) banks are under threat yet.
Tell me, what regulated depositary institution is under threat at present? Those are what the Fed cares about. They could care less if hedge funds and non-bank lenders go under, so long as the banks aren’t affected. Failures of non-bank lenders help the Fed in monetary policy, as less lending is outside of their control.
I don’t see the FOMC loosening in 2007. That was a non-consensus view in December 2006, when I first said it, which became consensus (and I worried), and is now no longer consensus any more. Inflation is still a threat, the real economy is not weak, but the FOMC does not want to tighten, because of risks in the financial markets. We stay on hold, though the FOMC may soften language, as a sop to the financial markets.
August 4th, 200711:50 am at
Hi David, I really enjoy reading your blog. I had not realised that you were a value investor as many of your posts are about the health of the market generally. If you have time in future posts, it would be good to hear more about your approach to value investing. Thanks
August 4th, 20072:29 pm at
Hi David…
Bill Luby introduced me to your blog, and It has become part of my daily reading habit. Very thoughtful, well-written posts. Your VIX argument was particularly well-reasoned, and I indeed hope the SPX proves to be 30% undervalued! - lol. Thanks.
I too have contended since last year that the FOMC would remain neutral for quite a while. Currently, the Fed isn’t a methadone clinic, and it’s not going to provide liquidity to a problem that has its roots in excess liquidity. What the FOMC has repeatedly implied is that the best hope for easing is a significant uptick in unemployment (an ease in “resource utilization”). Shy of that, expect neutrality.
I suspect the market will hate that next week, and stocks will continue to slide. Thanks again for the great stuff…..dk
August 7th, 20074:02 pm at
Have you ever heard of the concept of moral hazard? Have you read the article in today’s WSJ (http://online.wsj.com/article/SB118643226865289581.html)?
If the Fed steps in to bail out investors/banks/funds who took on more leverage than was appropriate and, worse yet, created a liquidity/duration mis-match between their assets (MBS, CDOs, CLOs) and liabilities (investor assets, margin, repo agreements) then the message is that you can go ahead and take on too much risk and if you get in trouble you’ll get bailed out.
Market participants must know that they will be the ones to own both the upside and the downside risk of the investment decisions they make. If funds blow up so be it. If Bear Stearns goes bust, so be it. If Countrywide ends up in Chapter 11, that’s their problem and their shareholder’s problem.
The discount window is for true systemic crises that surpass rationality, such as providing liquidity following the 23% drop in equity markets on 10/19/87 or offering liquidity after 9/11/01. The events of the past few weeks have been completely predictable. In fact, many funds have predicted them — Paulson Credit Opportunities ( 40% in June and 129% YTD (no June info yet)) and BlueCorr ( 17% in July and 34% YTD) for example were created to profit from just these sorts of events.
August 8th, 200712:04 pm at
Wise words from Europe’s central bankers:
“Interest rates aren’t a policy instrument to protect unwise lenders from the consequences of their unwise decisions,” Bank of England Governor Mervyn King said today at a press conference unveiling the bank’s latest Inflation Report.
In fact, while noting the bank would continue to monitor markets closely, Mr. King said the turmoil heralded “a more realistic appreciation of risk, which we should welcome.” He also contends there’s no evidence, yet, that the U.S. subprime turmoil has spread across the pond to Europe: “I don’t think there is much evidence of a major change in loan performance in other markets.”
European markets have gyrated recently along with global exchanges, but so far the impact of the U.S. subprime crisis on Europe does seem limited. Germany’s taken the hardest hit, with a Frankfurt-based asset management firm closing one of its funds on Monday and a government-backed group last week providing $4.8 billion to bail out another German bank whose subprime investments went bad.
Mr. King’s comments today echo similarly sanguine ones made last week by his continental European colleagues. At a press conference following the European Central Bank’s decision to keep its key interest rate at 4%, ECB President Jean-Claude Trichet said: “I would qualify this episode as a process of re-appreciation of risks which can be interpreted as a phenomenon of normalization of risk pricing in a number of markets.” Mr. Trichet had warned for months that investors were under-pricing risk.
Mr. Trichet, declining to comment on whether the ECB would consider coming to the market’s rescue in the event of a banking crisis, referred reporters to comments made by the head of Germany’s central bank, Axel Weber. Mr Weber’s take: “Fears of a banking crisis in Germany lack foundation.”