Banks – Page 21 – The Aleph Blog

The War Against Savers

Posted on 24 June 2011 by David Merkel

Today, Charles Rotblut, CFA who is the AAII Journal Editor wrote:

Federal Reserve Chairman Ben Bernanke continues to be the enemy of savers. Yesterday, the Boston Red Sox fan reiterated his belief that interest rates should be kept at rock-bottom levels for an extended period of time. He views this as necessary in order to keep the economy growing.

When you run an investment group that is largely composed of retirees and near-retirees, it is reasonable to call Bernanke the enemy of savers, because he is the enemy of savers.? When one can’t earn anything over one year without risk, something is wrong.? Better that the economy grow more slowly, than that savers not get their due for not consuming.

Saving deserves a return.? Let the Fed raise the Fed funds rate by 1%, and they will see that there is no harm to the banks, and little harm to the economy.? Once you have 1% slope between twos and tens you have more than enough oomph to make the economy move.? What, does the AARP have to bring a age discrimination lawsuit against the Federal Reserve to make this happen?? The Fed is discriminating against the elderly.

But now consider another issue — money market funds.? I consider them to be superior to banks because their asset-liability mismatch is so small, and they have generated small losses relative to banks and other depositary institutions.

Prime money market funds in the US have been investing 50% of their assets in the Commercial Paper [CP] of Core Eurozone Banks.? Well guess what?? If the Greeks and other fringe members of the Eurozone default, and the core governments don’t bail the situation out, those holding? CP of core Eurozone banks may take a loss.? And this is at a time where French and German Banks are facing liquidity issues.? Take time to review your money market funds.

The problems of the US and China are significant, but the problems of the Eurozone are pressing.?? The endgame there will arrive more rapidly because the underlying structure is unstable.? One currency can’t serve multiple cultures.? Also, there should have been an Eurozone exit plan designed in from the beginning.? It was hubris to think it would never need that level of adjustment.

It seems like the ECB is becoming a repository of euro-fringe debt, and perhaps the IMF as well.? After all, it doesn’t cost the ECB anything to absorb those debts, but it indirectly spreads the risk to the euro-core nations if there is ever a default or unfavorable restructuring.? A central bank can’t go broke, but it can impose problems on those that use the currency if defending the central bank exacerbates other problems in the economy.? (E.g., printing money to cover over bad debts absorbed by the bank, while inflation rolls on.)

On a slightly different level, I’m not sure that the banking regulators in the US or Europe really got the main lesson from the crisis.? Risk management is liquidity management.? I still think that banks rely too much on short liabilities to finance illiquid, longer assets.? One advantage of mark-to-market accounting is that it can reveal those mismatches to investors, or perhaps, to regulators.?? Extra capital can help, but it is usually not enough when there is a run on short-term liquidity, particularly because capital is the excess of assets over liabilities.? If there are not enough liquid assets to meet the redemption of liquid liabilities, the result is insolvency.

“But that’s a liquidity problem, not a solvency problem — just give it time and the market will normalize, the assets are worth more than the liabilities anyway.”? But at such a time, no one wants to buy the longer, less liquid, lower quality assets.? If the bank could raise liquidity, it would.? It can’t, so it is not only illiquid, but insolvent.? It’s always cheaper to issue liquid liabilities, because those are attractive to savers and investors, but they a poison in a crisis.

My fear here is that there may be another call on liquidity that forces the Fed or the ECB to backstop banks.? Not sure what would cause it; it’s always hard to pick which straw will break the camel’s back.

Thus I say be cautious at present; have some safe assets available in case we have a panic that emanates out of Europe, and has second-order effects on the US.

Redacted Version of the June 2011 FOMC Statement

Posted on 22 June 2011 by David Merkel

April 2011	June 2011	Comments
Information received since the Federal Open Market Committee met in March indicates that the economic recovery is proceeding at a moderate pace	Information received since the Federal Open Market Committee met in April indicates that the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.	Shades down their view of GDP.? (finally!)
and overall conditions in the labor market are improving gradually.	Also, recent labor market indicators have been weaker than anticipated.? The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan.	Shades down their view of employment.? Wishful thinking regarding transitory factors? Japan does not have that big of an impact on US employment, nor do food and energy prices, which have been going up for some time.
Household spending and business investment in equipment and software continue to expand.	Household spending and business investment in equipment and software continue to expand.	No change.
However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed.	However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed.	No change.
Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the Committee met in March.		Sentence dropped, as have commodities dropped.
Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued.	Inflation has picked up in recent months, mainly reflecting higher prices for some commodities and imported goods, as well as the recent supply chain disruptions.? However, longer-term inflation expectations have remained stable.	Shades inflation view up a little, but argues that it is transitory.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.? The unemployment rate remains elevated, and measures of underlying inflation continue to be 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.? The unemployment rate remains elevated; however, the Committee expects the pace of recovery to pick up over coming quarters and the unemployment rate to resume its gradual decline toward levels that the Committee judges to be consistent with its dual mandate.	FOMC expresses additional optimism regarding recovery.? Every bad thing is transitory, every good thing is continuing, except housing.
	Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate	New sentence.? Again, inflation transitory.
Increases in the prices of energy and other commodities have pushed up inflation in recent months.? The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations.	as the effects of past energy and other commodity price increases dissipate. ?However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.	Sees effect of rise in commodity prices fading.
The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.		Sentence dropped.
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.	To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent.	Reemphasizes the Fed funds rate, brings it up higher in the document, now that QE2 is waning.
	The Committee continues to anticipate 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 for an extended period.	Moved up from below. ?exceptionally low levels for the federal funds rate for an extended period? means that the short end of the yield curve will stay flat as a pancake.
In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter.	The Committee will complete its purchases of $600 billion of longer-term Treasury securities by the end of this month and will maintain its existing policy of reinvesting principal payments from its securities holdings.	No real change. They will stealth-fund the US Government to the tune of $600 Billion.
The Committee will regularly review the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability.	The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.	They see the end of QE2 coming, and will manage their bloated balance sheet as best they can.
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.		Moved higher in the document.
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 monitor the economic outlook and financial developments and will act as needed to best foster maximum employment and price stability.	Little real change.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; 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; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.	No dissent.? Where are the so-called hawks?

Comments

Given that the effects of QE2 are subsiding, the FOMC moves the Fed funds sentence up higher in the document and moves up the language that ?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 for an extended period.? Means the front end of the yield curve will hug zero for some time, absent a crisis in inflation or credit.
In one sense, the FOMC is emphasizing what they can do in the future, not what is in the past.
The FOMC is a lot more bullish on the strength of the economy than the general public.? Aside from housing, every good thing is continuing, and every bad thing is transitory.
The Fed engages in wishful thinking regarding transitory employment factors? Japan does not have that big of an impact on US employment, nor do food and energy prices, which have been going up for some time.
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.
Where are the hawks?? This report does not give a fair rendering of the rising risks of inflation, driven by commodity, agriculture, and energy costs.
The Fed is not shrinking its balance sheet anytime soon.

Questions for Dr. Bernanke:

How big is the effect on employment from higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan?
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?
Could we have more economic historians on the FOMC, and fewer neoclassical economists?? Perhaps we could end the intellectual monoculture there?? (Even I wouldn’t ask this… I know the answer.)

Book Review: Reckless Endangerment

Posted on 16 June 2011 by David Merkel

This book on the crisis is different for two reasons:

1) It focuses on the causes of the financial failure, and the history behind them.? It spends relatively little time on the failure in 2008.

2) It spends almost all of its time on the GSEs, Fannie Mae and Freddie Mac.? They were big contributors to the crisis, but they weren’t the majority of the crisis.

This book chronicles the growth of the housing bubble, which was a financing bubble, as most bubbles are.? How did financing for housing get so cheap?

Low interest rates from the Fed.
Lower underwriting standards from Fannie, Freddie, and independent lenders.
Trickery from lenders offering a low initial rate.
Pressure from Congress to make more loans to low-income borrowers who should have been renters.
A mistaken idea that more housing owned by residents was good social policy.

It also describes many of the people who disproportionate benefited from the bubble, and what their motives were for helping to expand the bubble.? It also mentions many who tried to fight the bubble unsuccessfully.? It does *not* mention the “Fannie Fraud Patrol,” who helped to uncover Fannie Mae’s errors in 2003-2004.? It was a loose group of analysts who found inconsistencies in Fannie’s financial statements… we fed OFHEO.? I was one of them, and I have the T-shirt to prove it, even though my contributions were the least of the group.

One? more note: consider Walker Todd, reprimanded by the Fed in 1993 for suggesting that the Fed should not be allowed to bail out non-banks.? Prescient guy, punished of course.? He was one of many who took the chance and fought the Fed or the GSEs.? Almost no one comes out the better for that effort.

Quibbles

The authors blame the rating agencies rather than the regulators that demanded that ratings be used, even if the agencies were less than certain about their models.? Real bond investors never look at the ratings, except as investment policy constraints.

Who would benefit from this book:

It’s an easy read.? This book benefits from having a good writer, and someone who actually knows that markets.? Great combination.? Most people would benefit from this book, because it would disabuse them of the notion that the actions of the government are for the good of the nation.? Special interests won, and many average people lost.

If you want to, you can buy it here: Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon.

Full disclosure: The publisher asked me if I wanted the book and I said “yes.”

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.

Industry Ranks June 2011

Posted on 10 June 201110 June 2011 by David Merkel

I?m working on my quarterly reshaping ? where I choose new companies to enter my portfolio.? The first part of this is industry analysis.

My main industry model is illustrated in the graphic.? Green industries are cold.? Red industries are hot.? If you like to play momentum, look at the red zone, and ask the question, ?Where are trends under-discounted??? Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted.? Yes, things are bad, but are they all that bad?? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

If you use any of this, choose what you use off of your own trading style.? If you trade frequently, stay in the red zone.? Trading infrequently, play in the green zone ? don?t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh?? Why change if things are working well?? I?m not saying to change if things are working well.? I?m saying don?t change if things are working badly.? Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes.? Maximum pain drives changes for most people, which is why average investors don?t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy ? no one thinks of changing then.? This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year.? It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy some healthcare-related names, P&C Insurance and to a lesser extent Reinsurance, particularly those that are strongly capitalized.? I?m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

A word about reinsurance: I suspect this year will have yet more property catastrophes, particularly from hurricanes.? A lot of flexible capital has rolled into Bermuda over the last few months, so I would be disinclined to play too heavily there until late in the year.? There’s too many financial players that think there is easy money to be made in reinsurance after the recent spate of catastrophes, but that added capital is eliminating any hard pricing environment that might have emerged.? Maybe if they take losses later this year, capital won’t flow so freely for a while… I can dream.

A word on banks and REITs: the credit cycle has not been repealed, and there are still issues unresolved from the last cycle — I am not interested there even at present levels.? The modest unwind currently happening in the credit markets, if it expands, would imply significant issues for banks and their “regulators.”

I?m looking for undervalued and stable industries.? I?m not saying that there is always a bull market out there, and I will find it for you.? But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive.? I don?t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.? The red zone is pretty cyclical at present.? I will be very happy hanging out in dull stocks for a while.

That?s why I?m not digging through any red zone stocks this time.? I don?t see the value, especially if we have a slowdown globally, and/or in the US.? I don?t trust this economy.

Regulate Banks More Tightly, not Money Market Funds

Posted on 3 June 2011 by David Merkel

I think that the powers that be do not like a low-cost superior source of liquidity that is outside of the banking system.? Why else would there be such regulatory pressure against money market funds, when their losses over their existence would be less than .o1% of yield?? Let the banks compete there… they have lost far, far more.? Which is more badly regulated?

Besides there are simpler ways to fix the problem without adding new charges or bureaucracy.? Let money funds invest as they will, and loosen their credit and maturity constraints.? They would earn better yields on average, and credit events would become a normal aspect of money market funds.? That would bring discipline to the market in a way that regulators rarely bring.? Funds that have credit events would be avoided by investors, but there would be no death spirals, because a run on the fund would improve the NAV.

Money market funds have several advantages over banks:

Their assets are short, like their liabilities.? Unlike banks the cash flow mismatch is small.
Their assets are high-quality.
Their assets are liquid.

As far as depositors go, it would be reasonable to abolish banks, and replace them with money market funds.? Wait, what will happen to the lending market?? That would be replaced by new institutions that borrow longer-term to finance longer-term loans.? It wold be similar to having a small bank sector and a huge REIT sector.? We wouldn’t care if these institutions went bust — they don’t take deposits.? What is better, by separating long-term finance from deposits, we would eliminate that source of most panics, because they occur when short-term liabilities finance long-term assets.? Solve the mismatch, and crises diminish.? Growth may be slower in the short run, but should be the same in the long run.

Forget deposit insurance for money market funds.? My solution is cheaper, simpler, and would allow for greater flexibility of fund management.? Let the banks justify their existence, and raise their FDIC premiums to a fair level.? After that, let the criticisms of money market funds begin.

Articles not cited: Should Investors Worry About Money Funds?

Why Investors Should Worry About Money Funds

Why Investors Shouldn’t Worry About Money Funds (good article, but ignore the dumb idea of insuring money market funds, they are safe enough already)

PS — the banking lobby is so much more powerful than the money market funds — it is no surprise that the banks win here.? We would all be better off if we eliminated the power of banks to take deposits, and handed it over to money market funds.? Of course the Fed would scream, because their power would be emasculated.? All the better. 😀

Inflation Speculation

Posted on 13 May 2011 by David Merkel

When currencies do not serve as a long-term store of value, economic actors search for ways to preserve future purchasing power, which often mean purchasing commodities. But most commodities are not cheaply storable over long periods, so actors get forced into the few that do: gold, silver, etc. There is a problem here, stemming from dumb money. When dumb money shows up for purchase of generic “commodities” distortions follow: backwardation, large storage demand, and warped market incentives.

Eventually overproduction catches up, but the volatility when it breaks can be huge and self-reinforcing, with c0unterparties raising margin to protect themselves.? Extreme volatility causes exchanges to raise margin requirements substantially, which reveals which side of the trade is inadequately financed, which typically is the side that was winning, which leads to a reversal in price action.? The dumb money is revealed.

Now after a washout, the dumb money often assumes that powerful entrenched interests colluded against them to deny them their long-deserved free ride to prosperity through speculation.? The exchanges are in cahoots with the other side.? Well, no, the exchanges have two interests, which are solvency and transaction volume, which drives their profits.? Solvency is a more primary goal for an exchange, because the second goal can’t exist without it, and exchanges are not thickly capitalized.

Many different types of financial systems are subject to these risks.? Think of AIG: they were rendered insolvent by rising margin requirements as their creditworthiness was downgraded, largely because the rating agencies concluded they were going to lose a lot of money off of their many bets on subprime residential credit.? Think of all of the mortgage REITs that got killed as repo haircuts rose on all manner of mortgage-backed securities at the time that values for the securities were depressed.? Alternatively, think of Buffett, who entered into derivative trades where he received money and bore the risk, but his agreements limited the margin that he would have to post.

Commodity-linked exchange traded products serve four functions:

Allow sponsoring financial institutions to get cheap financing through exchange traded notes.
Allow sponsoring financial institutions to inexpensively hedge their commodity risks.
Allow commodity producers to have cheap financing of their inventories via backwardation.? (And indirectly allow more clever speculators to earn extra profits from gaming the rolling of futures contracts.)
Allow retail speculators who cannot access the futures market to make or lose money.? Scratch? that, that should probably read “lose money in aggregate.”

Wall Street does not exist to do small investors/speculators a favor.? It exists to make money off of the issuance of securities, and their trading in secondary markets.

As Buffett put it, “What the wise man does in the beginning, the fool does in the end.”? Yes, there is monetary debasement going on.? We should expect gold, crude oil, and other commodity prices to rise to reflect that.? But rises can overshoot, particularly in smaller markets like gasoline and silver.

So in answer to the question, “Which came first ? the margin call or the commodities mayhem?” my answer is simple: The cause of the bust is found in the boom, not in the bust.? The boom happened because of loose monetary policy, which led many people to adjust their risk posture up, whether in commodity speculation, or in high yield debts.? (Oh wait, there are ETFs for that now too.)? Eventually self-reinforcing booms have self-reinforcing busts.? The elites think they can tame this, but they can’t, because you can’t change human nature, which means you can’t change the boom-bust cycle.

James Grant, at a recent meeting of the Baltimore CFA Society said that we had exchanged a “gold standard” for “Ph. D. economist standard.”? And indeed, the value of our currency is manipulated by that intellectual monoculture at the Fed, who pass Einstein’s test of insanity: doing the same thing over and over again and expecting different results.? I say that because the Fed thinks that it can produce prosperity by reducing interest rates.? All that their policy does is produce an asset bubble, or price inflation in goods and services.

The Fed drove us into this liquidity trap through increasing application of an easy money policy.? It will take different ideas and different people, and a lot of pain to get us out, because the Fed is blinded by their bankrupt theories.

On Systemic Risk

Posted on 5 May 2011 by David Merkel

There are five factors for systemic risk.? Here they are:

Asset size of the institution, including synthetic exposures.
Degree of leverage of the institution, including synthetic exposures.
Asset-Liability mismatch, particularly financing long assets with short liabilities (including derivatives and margin agreements — think of AIG, or mortgage REITs on repo).
Degree to which the institutions owns financial companies equity or debt, or vice-versa, where other financial companies have claims on the institution in question.
Riskiness of the assets owned by the institution in question.

Contributing to the risks include easy monetary policy, which can lead/has led? to the neglect of risk control.? Personally, if I were a regulator of systemic risk, I would throw my effort at companies that fit factors 1 and 2, and analyze them for the other three factors.

Systemic risk is layered levered credit risk. A lent to B, who lent to C, who lent to D, who financed a bunch of bad mortgages.

#5 is underwriting risk

#4 is connectedness risk

#3 is liquidity risk

#2 is financial risk

#1 is risk to the economy as a whole.

So when I read articles like this, or books about systemic risk by academics that are so bad that I don’t want to review them (set them to work picking fruit, it would be more valuable than what they currently do), I simply say systemic risk is easy.? Look at my five points.? You can eliminate systemic risk by:

Breaking up the big banks. (1)
Disallowing banks from owning the equity of other financials and vice-versa. (4)
Forcing strict asset-liability matching at banks, and? (3)
Sizing capital to the riskiness of loans made. (2,5)
Move to double liability on banks — they can’t be limited liability corporations.? Investors and managers must have their net worth on the line for any losses.

This isn’t hard, but the banks will scream.? Let them scream, and let the stocks of the banks fall.? Banks take risks beyond what they ought to because of poor regulation.? They should be regulated well, and have lower returns on equity as a group.

Redacted Version of the April 2011 FOMC Statement

Posted on 27 April 2011 by David Merkel

March 2011	April 2011	Comments
Information received since the Federal Open Market Committee met in January suggests that the economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually.	Information received since the Federal Open Market Committee met in March indicates that the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually.	Shades up their view of GDP and employment.
Household spending and business investment in equipment and software continue to expand.	Household spending and business investment in equipment and software continue to expand.	No change.
However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed.	However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed.	No change.
Commodity prices have risen significantly since the summer, and concerns about global supplies of crude oil have contributed to a sharp run-up in oil prices in recent weeks. Nonetheless, longer-term inflation expectations have remained stable, and measures of underlying inflation have been subdued.	Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the Committee met in March. Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued.	They say, ??measures of underlying inflation are still subdued.? which conflicts with their other statement below, ?Increases in the prices of energy and other commodities have pushed up inflation in recent months.?? Which is it?
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate remains elevated, and measures of underlying inflation continue to be 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.? The unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.	No change.
The recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations.	Increases in the prices of energy and other commodities have pushed up inflation in recent months. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations.	Perhaps it should read, ?Yes, we see inflation in the recent past, but we don?t think that there is any trend to higher inflation.?
The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.	The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.	No change.
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.	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 change.
In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.	In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter.	No real change. 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 size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability.	They see the end of QE2 coming, and will manage their bloated balance sheet as best they can.
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.	No change to this 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; Elizabeth A. Duke; Charles L. Evans; 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; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.	No dissent.? Where are the so-called hawks?

Comments

The FOMC is a lot more bullish on the strength of the economy than the general public.
They say, ??measures of underlying inflation are still subdued.? which conflicts with their other statement below, ?Increases in the prices of energy and other commodities have pushed up inflation in recent months.?? Which is it?? Perhaps it should read, ?Yes, we see inflation in the recent past, but we don?t think that there is any trend to higher inflation.?
To me, without much evidence, the Fed is hoping that the economy is strong, and that inflation moves back down.
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.
Where are the hawks?? This report does not give a fair rendering of the rising risks of inflation, driven by commodity, agriculture, and energy costs.
The next real set of events is how the Fed shrinks its balance sheet, and how they preview it to the market.

Book Review: Essentials of the Dodd-Frank Act

Posted on 6 April 2011 by David Merkel

Before I start this evening, I just want to say that as a day progresses, if I find a good topic, I prepare for it. If I don’t, I plan on doing a book review. As it is, I have 15 books that I have read and not reviewed. The majority of them are poor. It is tough to do a bad book review, but I guess I will do a bunch of them.

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My review of this book was shaped by its coverage of my own industry.? I am an investment advisor, and a small one.? I learned far more from other sources regarding what I needed to do to comply with Dodd-Frank than this book did.? If I had had only this book to help guide me in my regulatory work, I would have been sunk.

Now, as I read through the book it struck me as being a perfunctory summary of the law, without a lot of insight.

The structure of the book is this:

Introduce the Act
Explain the history and main goals
Go through the Titles (main divisions) of the Act, and give brief explanations of the main points.
Explain how various institutions are affected at a high level.
Then talk about how the various studies that the Act demands will be done, and how regulatory rules will be created.
How it affects all existing agencies, and the new agencies that are created by the Act.
What impact it has globally (not much)
How it affects various financial professions
How it interacts with SOX and Basel (not much)

I found the book to be weak, given what I know about my industry, and other financial industries.? It read like someone went through the Act and excerpted it.

Quibbles

I have no quibbles, I only have objections.? This book was put out too fast, and with too little thought.

Who would benefit from this book:

Better you should read the act; it is bad, but not that bad, as Washington goes.? The act is long, so if you are looking for an easy introduction to the act this book could be helpful, but you could probably clip the highlights of the act yourself.? It is only a question of the value of your time.

If you want to, you can buy it here: Essentials of the Dodd-Frank Act (Essentials Series).

Full disclosure: They asked me if I would like to get this book, and I said yes.? What a disappointment.

Book Review: Boombustology

Posted on 1 April 20112 April 2011 by David Merkel

For those that have read me for years at The Aleph Blog, this book will impart little that is new.? But, you get a set of powerful arguments in one integrated slim package.

I really liked this book.? The author took a broad view of bubbles, and developed five lenses through which to analyze them:

Microeconomics
Macroeconomics
Psychology
Politics
Biological (contagion) analogies

This picks up the growth in debt, the misaligned short-term versus long-term incentives, crowd behavior, imitation, political agreement with booms, finger-pointing during busts, etc.

This book integrates the ideas of Keynes, Minsky, the Austrian economists, Soros (reflexivity), and others.? The author was very willing to interact with the view of those that might not fully agree with him, and yet bring out the areas where they do agree.

And the author tests the five lenses on five bubbles:

The tulip bubble
The Great Depression
Japan in the late 80s
The Asian crisis in 1997
The US Housing Crisis 2006-?

Not surprisingly the crises chosen support the theory.? It would be interesting to see what the author would say on other bubbles, like the South Sea Bubble, the Tech Bubble, etc.

And so the author summarizes his case, and I think he does it well. But then he takes it a step further, and effectively says, “Well, is there an obvious bubble to point out now?”? And so he points out China.? The debts, the manipulation, malinvestment, bad incentives, etc.? You can read it for yourself and draw your own conclusions.

My main verdict on this book is that it provides a firm basis for evaluating bubbles.? I place it behind “Manias, Panics, and Crashes,” and “Devil Take the Hindmost,” but not by much.? To the author: Great job.

Quibbles

I disagree with the idea that booms and busts are a capitalist phenomenon.? Command-and-control economies do have booms and busts — the Great Leap Forward was a boom followed by a tremendous bust.? The effort to plant cotton in the Soviet Union was short-lived, leading to declining yields and destruction of the ecology of the Aral Sea.? There are more examples than this; at least in capitalism, the boom yields some decent rewards.

Who would benefit from this book:

Anyone who wants a better understanding of the boom-bust cycle will benefit from this book.? The author has nailed it in my opinion.? This book will help you to properly skeptical in the next unsustainable boom, and minimize your exposure to the bust.

If you want to, you can buy it here: Boombustology: Spotting Financial Bubbles Before They Burst.

Full disclosure: I asked the publisher for the book, and they sent it to me.