15 December 2010 – The Aleph Blog

Redacted Version of the December 2010 FOMC Statement

Posted on 15 December 2010 by David Merkel

Comments

They highlight that they have a ?statutory? mandate, and a ?dual? mandate.? They are trying to say that they are required by Congress to do these things, and that it is a tough job.? The flip side is that they admit the Congress has the right to tell them what to do, which Ron Paul may make clear as the Chair of the House?s subcommittee on Monetary Policy.
The question is this: will the mechanisms of credit transmit inflation to goods and services?? So far, it has not.? Lowering the policy rate does little to incent borrowing when enough people and financial institutions are worried about their solvency.
Beyond that, if they succeed, how will it be received on Main Street, especially if price inflation is not accompanied by increases in employment, or is accompanied by higher interest rates or lower stock prices?? Stagflation is not popular.
That said the economy is not that strong.? In my opinion, policy should be tightened, but only because I think quantitative easing actually depresses an economy.? It does the opposite of stimulate; it helps make the banks lazy, and just lend to the government.
The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
They have no idea why their policy is not working, and they don?t know what to do about it.? Monetary policy works with long and variable lags, so they won?t say that their policy isn?t working.? It?s just slow in taking effect.

Flavors of Insurance, Part X (Conglomerates)

Posted on 15 December 2010 by David Merkel

One major trend that has existed in the insurance industry over the past several decades is increased specialization. This is true globally, but is most true in the US. In general, being good at one area of the insurance business does not confer significant advantages in other areas. This is true in underwriting, which is a specialized talent in each area of insurance. It is also true in market. Cross-selling opportunities across lines of business are not great enough to justify the effort. There are small consolidation advantages in shared corporate staff, and it may be cheaper to finance a large organization than two smaller ones, but those are slim advantages to conglomerate over. In general, we do not expect an increase in the number of major conglomerates; rather, the trend is toward increasing specialization, with increasing scale within a company’s area of specialization.

The most successful conglomerates have tended to be holding companies that allow individual operating companies to act with little coordination. They require results from the subsidiaries, and intervene when the holding company does not get results. The holding company directs the allocation of capital to the businesses that offer the best prospective returns. In one sense, some insurance conglomerates invert the insurance model; they are essentially investment companies, with insurance liabilities issued to provide funds to invest in favored projects. With ordinary insurers liability issuance leads the process.

The excellent performance of the conglomerates group is unique to two companies that are large and do it particularly well: AIG and Berkshire Hathaway. As these companies get larger, it will be increasingly difficult for them to achieve above average performance. It will also be more difficult to do as well without their unique current leaders.

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Bringing it to the Present

Well, when I wrote about this in 2004, I had not yet focused on the growth of debt inside AIG.? The firm I was with owned AIG, and sold into the flood of buying that occured when AIG was added to the Dow.

But I can adjust my views.? Before the time Greenberg was being shown the door, I was bearish on AIG because I thought that leverage was too high, far greater than the rating agencies should allow, which explained why AIG credit traded more like a single-A credit.? I also reflected on my prior days at AIG with more insight than when I was younger, and wondered if it might not be possible that the accounting at AIG was very liberal.? While working there, I was involved with uncovering five reserving errors, each of which should have led to a hiccup in earnings, and in one case, a severe loss.? But the earnings kept going up.

When I have written things like this, I have never gotten flak from people inside AIG; rather, I get e-mails from people inside AIG that have had similar experiences.? Part of the problem was the culture of fear.? When telling the truth is initially derided with force, even if it is eventually accepted if you are strong enough, you will get few people taking the risk to tell the truth.

But without Greenberg, AIG was doomed in the short run.? No one else could manage it, even if it was crooked in some ways.? The truth withheld re-emerged, and those in charge got whupped for the sins of Greenberg.

But what of insurance conglomerates generally?? I don’t recommend them, because synergies are few, and focus is necessary for most effective insurance companies.

November 2010	December 2010	Comments
Information received since the Federal Open Market Committee met in September confirms that the pace of recovery in output and employment continues to be slow.	Information received since the Federal Open Market Committee met in November confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.	No real change. Unemployment is not easily affected when interest rates are so low.
Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.	Household spending is increasing at a moderate pace, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.	Little change.
Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls.	Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls.	No change.
Housing starts continue to be depressed.	The housing sector continues to be depressed.	No real change.
Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters.	Longer-term inflation expectations have remained stable, but measures of underlying inflation have continued to trend downward.	No real change.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.	Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.	No change.
Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.	Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.	Translation: we have no idea why our policy is not working, and we don?t know what to do about it.? Monetary policy works with long and variable lags, so we won?t say that our policy isn?t working.? It?s just slow in taking effect.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities.	To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.	No real change.
The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.	The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.	They will stealth-fund the US Government to the tune of $600 Billion.
The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.	The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.	Meaningless sentence. What? You would do otherwise?
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.	The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.	No change.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.	The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.	Meaningless sentence.? Would you do otherwise?? If we know that the opposite is impossible, why have the sentence at all?
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Sarah Bloom Raskin; Eric S. Rosengren; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.	Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Sarah Bloom Raskin; Eric S. Rosengren; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.	No change.
Voting against the policy was Thomas M. Hoenig. Mr. Hoenig believed the risks of additional securities purchases outweighed the benefits. Mr. Hoenig also was concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.	Voting against the policy was Thomas M. Hoenig. In light of the improving economy, Mr. Hoenig was concerned that a continued high level of monetary accommodation would increase the risks of future economic and financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.	No real change.