25 January 2012 – The Aleph Blog

Redacted Version of the January 2012 FOMC Statement

Posted on 25 January 2012 by David Merkel

Comments

So they extend the period of accommodation by a little more than a year.? Sends financial markets flying, and especially TIPS prices, but will have little impact on the economy.? (Do they want the yield on 30 year TIPS to go negative?? Looks that way.)
GDP growth is not improving much if at all, and the unemployment rate improvement comes more from discouraged workers.? Inflation has moderated, but whether it will stay that way is another question.
In my opinion, I don?t think holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy finances itself.
Also, the reinvestment in Agency MBS should have limited impact because so many owners are inverted, or ineligible for financing backed by the GSEs, and implicitly the government, even with the recently announced refinancing changes.
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.
The Fed is out of good policy tools, so it will use bad policy tools instead, and for longer than before.

Questions for Dr. Bernanke:

Why do think extending the period of accommodation by a little more than a year will have any significant effect on the economy, aside from stock and bond prices?
Is it possible that you don?t really know what would have worked to solve the Great Depression, and you are just committing an entirely new error that will result in a larger problem for us later?
Discouraged workers are a large factor in the falling unemployment rate. Why do you think the economy is doing so well at present?
Why do you think that holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy finances itself?
Why will reinvestment in Agency MBS help the economy significantly?? Doesn?t that only help solvent borrowers on the low end of housing, who don?t really need the help?
Couldn?t increased unemployment be structural, after all, there is a lot more competition from labor in emerging markets?
Isn?t stagflation a possibility here?? I mean, no one expected it in the ?70s either.
Could we end up with another debt bubble from keeping short rates so low?
If the Fed ever does shrink its balance sheet, what effect will it have on the banks?

Recent Tweets

Posted on 25 January 2012 by David Merkel

They may not have meant to publish it, but the results don’t seem too earthshattering — … http://t.co/MkmCtxnJ Jan 25, 2012
@Convertbond He was 1 of my professors @ Hopkins, & the only 1 w/a consistently free market viewpoint; Talked w/him @ http://t.co/k4mL15rp Jan 25, 2012
India to pay gold instead of dollars for Iranian oil. Oil and gold markets stunned http://t.co/ZRmnIjOz @JamesGRickards sounds like Ch 1 $$ Jan 25, 2012
Bears gone wild! http://t.co/s0mvx9LK What does it mean when bears get less pessimistic? Do we rally, or do things fall apart? Or both? $$ Jan 25, 2012
Retail in the Age of the Internet http://t.co/4wovantW Difficult 2c how the internet doesn’t change retail; has changed so many things $$ Jan 25, 2012
What Makes FPA Crescent Tick? http://t.co/ngisagdY A lot to learn from businesslike clever managers who insist on a margin of safety $$ Jan 25, 2012
You don?t WANT to be making iPhones, really http://t.co/cvG1rVqJ Baruach of Ultimi Barbarorum sets the record straight on manufacturing $$ Jan 25, 2012
The end of mutual funds is coming http://t.co/V9FhizVt @reformedbroker on the coming dominance of ETFs in 2022. My take in a comment below. Jan 25, 2012
The Pimco Premium?Totally Gross? http://t.co/QXBqRSpH Amazing what premiums to NAV some junk CEFs run by Pimco get up to. $$ >+70% Jan 25, 2012
Mitt Romney’s SOTU Challenge on the Mortgage Crisis http://t.co/xeTaeswA “u recognize the distress, u take the loss & let people reset.” $$ Jan 25, 2012
@MebFaber @onetwoko @The_Analyst Good stuff. I’ve written similar from both equity and debt perspectives. Alternative: NGDP growth+1% $$ Jan 24, 2012
@valuewalk yeh, especially for the highly compensated in private DB plans, b/c the PBGC limits the coverage any one person gets. $$ #ouch Jan 24, 2012
Examples: Autos and Telecom Bonds back in 2000, MBS (Esp non-GSE), GSEs, CDOs and finance 2007. Today? Governments. The poison of AAA/AA $$ Jan 24, 2012
It is usually wise to avoid investing in the largest or fastest growing sectors and subsectors in debt markets; boom presages a bust $$ Jan 24, 2012
@valuewalk Yes, that’s right, and the standards for that are squishy. Funny that life co acctg has 2b conservative, but not DB pensions $$ Jan 24, 2012
@The_Analyst Been writing about this off and on for the last 20 years in various forms. Sadly, doesn’t get traction because it’s complex $$ Jan 24, 2012
@The_Analyst yeh, especially since ERISA doesn’t apply to state & local DB plans; beneficiaries have 2 rely on protection from local laws $$ Jan 24, 2012
@The_Analyst There are no actuarial assumptions police for DB plans. W/private corps, the auditors can object (though they rarely do) $$ Jan 24, 2012
The Real Problem With the Global Bond Markets http://t.co/rYHw673u Catch my comment here: http://t.co/UCkhtXZx $$ Jan 24, 2012
CalPERS 2011 return below its assumed rate by 6.65 percentage points http://t.co/GDoBD6H2 Gets worse when you count in the fall in int rates Jan 24, 2012
Rob Arnott is doing enhanced indexing. So do most bond indexers; they match broad characteristics of the index, and … Jan 24, 2012
RE: @valuewalk Someone send the memo to Soros: http://t.co/ShMY4LWN http://t.co/6oA7kfMR Jan 24, 2012
New from Aleph Blog Against Simple Valuation Metrics: There have been a lot of articles dealing with use of corp… http://t.co/PaZElTUQ Jan 24, 2012
The new American divide http://t.co/lOmLT2xs Working class falls further away from marriage & religion & upper class becomes more isolated Jan 23, 2012
We Found Bin Laden So Now We?re In Search of Yield http://t.co/4veqJ6xB Y Buffett likes consistent $$ to flow from subs, but he pays no div Jan 23, 2012
The biggest Mark to Model error in the country http://t.co/Tgi5DVx7 ?Price indexes are more an art than a science.? Manipulable indeed. $$ Jan 23, 2012
How executives spend their company?s cash http://t.co/4xadWZqy Buybacks tend 2b procyclical; economically rational w/b countercyclical $$ Jan 23, 2012
Europe Stocks Cheapest to US Since ?04 as Net Rises Amid Recession Worry http://t.co/54ajiIQD Worth kicking the tires on nonfinancials $$ Jan 23, 2012
Generals have led the US three times already — Washington, Grant, and Eisenhower. That i… http://t.co/9w9C3AM2 Jan 23, 2012

On Financial Intermediation

Posted on 25 January 2012 by David Merkel

I appreciate Steve Randy Waldman, who writes the excellent blog Interfluidity.? Even before I started blogging, while I was at RealMoney, we interacted over CPDOs, along with Alea, and several others that were onto the scam.? That was a fun time, because aside from the Canadian rating agency Dominion, there was no one else questioning the idiocy of the AAA ratings aside from a few bloggers — we are the conscience of Wall Street, but that doesn’t mean that we get any pay as a result.? We write these things as a public service.

Recently, he wrote two? articles on financial intermediation.? Now I’d like to try my own thoughts on the topic.

Financial intermediation has two purposes: transactions and safety.? People want to buy and sell, but don’t want to have a currency where its value shifts radically day-to-day, which would complicate their decisions considerably.? They want a stable unit of account, and don’t want the possibility that they lose a lot of money as a result.? (Yes, during conditions of hyperinflation that boundary disappears, but that’s because they are already losing value already each day from holding the formerly “safe” transactional asset.? They get more careless on the intermediary, because of the risks of holding the safe asset.)

The second goal is safety/preservation/growth of purchasing power.? Can I park money or a short to long amount of time and be assured that when the term is up, I will:

Receive receive back as much or more in purchasing power terms.
Reduce my risks or the risks of those I care for from death and other calamities.

Financial intermediation leaves money on the table.? It does not seek the best investment outcome, but takes a lesser return, so that goals can be achieved with greater certainty.

Now, that provides an advantage to the financial intermediaries.? It means that they get cheap funding under most conditions.? Now, can they invest it over the likely lifetime of the funding and not lose money?? That’s a lot of what solvency regulation is about in banks and insurers.?? Because financial promises made can’t be easily analyzed for quality by those that offer money, there are two responses by the government:

Capital rules (which vary by liability and investments)
Insurance, so that users don’t have to worry about loss.

And, for what it is worth, 12 years ago I played a large role in setting the rules for Maryland life insurers in place, both writing the law, and explaining to the legislators how it protected the public interest.? (Hey! Passed unanimously on the first try, and with the d-word! (Derivatives)? My bill allowed risk mitigation but not risk taking with derivatives.)? The then-governor dressed like a mafia don at the bill signing, for what it is worth… My boss and I and our external and internal legal counsels spent a lot of time on this, but I was the prime mover on getting it done.

As an aside, sitting around in hearings in Annapolis, not knowing when your bill will come up is a chore.? If you know me well, you know I brought work to do, and if that wore out, good books to read.? I was never sitting there with nothing, bored. In the process I learned that Johns Hopkins owns Maryland, but declines from making that public, except when they care. 😉 When they spoke up, the legislature rolls over and asks for a scratch on the tummy. Arf!

Sorry, got lost in reminiscing.? Can I say that it was weird?? (I will leave out my dealings with the Department of Insurance, which were surreal.)? I’m not political for the most part, but in the end, the Maryland life insurance investment code is one of the best of the 50 states.? Kind of sad that we don’t have more life insurers here.

The last three paragraphs were quite a detour.? Let me take a different tack.? Yes, intermediation is opaque; that is true by necessity.? Depositors and insureds do not know how their money is invested.? I am here to tell you that that is a feature and not a bug, because the regulators know you can’t analyze the safety of your deposited assets.

In most things, I am a libertarian, but in areas where average people can’t ascertain truth or or falsehood, I support some form of regulation.? Financial promises fall under that rubric, because they are hard to discern.

To close this off, my main point is this: people want financial intermediation, particularly during the bear phases of the financial cycle.? They want to be protected, and transact, and save.? It is reasonable that the government regulates this, because the ability to make future promises that people rely on is valuable to society as a whole.

December 2011	January 2012	Comments
Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth.	Information received since the Federal Open Market Committee met in December suggests that the economy has been expanding moderately, notwithstanding some slowing in global growth.	No change.
While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated.	While indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated.	The unemployment rate is down, but few jobs are being created, and people are dropping out of the labor force.? This is improvement?
Household spending has continued to advance, but business fixed investment appears to be increasing less rapidly and the housing sector remains depressed.	Household spending has continued to advance, but growth in business fixed investment has slowed, and the housing sector remains depressed.	Shades down their view on business investment.
Inflation has moderated since earlier in the year, and longer-term inflation expectations have remained stable.	Inflation has been subdued in recent months, and longer-term inflation expectations have remained stable.	True for the last few months for goods & services prices, but past isn?t prologue.? TIPS are showing higher inflation expectations.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	No change.? Mentions of the statutory mandate are always meant to hide the distasteful aspects of what they do.
The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.	The Committee expects economic growth over coming quarters to be modest and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.	No change.
Strains in global financial markets continue to pose significant downside risks to the economic outlook.	Strains in global financial markets continue to pose significant downside risks to the economic outlook.	No change.
The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee?s dual mandate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.	The Committee also anticipates that over coming quarters, inflation will run at levels at or below those consistent with the Committee’s dual mandate.	Drops language inflation and inflation expectations.
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate,	To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy.	Adds that the FOMC will be highly accommodative, if it hasn?t been so already.
The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.	In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.	Extends the period of high accommodation for another 15-18 months. They moved this paragraph up from last time.
the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.	The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.	No real change.? Central bank asset policy does not have that big of an impact on economic activity. They moved this paragraph down from last time.
The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability.		Deletes meaningless sentence.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.	Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Sarah Bloom Raskin; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen.	Three new regional Fed presidents.? Storm and fury, signifying nothing.
Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.	Voting against the action was Jeffrey M. Lacker, who preferred to omit the description of the time period over which economic conditions are likely to warrant exceptionally low levels of the federal funds rate.	Make that four, with a dissent from Mr. Lacker, who is likely the only one to dissent in 2012.? Talked with him at the Cato Monetary Conference ? he is skeptical of the asset policy at the Fed.? This dissent disagrees with the Fed trying to give a time period for how long the Fed funds rate will remain low.