What is the Fed doing
now? Few claim to know. And those who claim to know donâ€™t seem to
agree. I donâ€™t pretend to know what the Fed is doing with monetary policy
apart from being the bank of first and last resort â€“ all doors are open for
nearly all comers carrying a bank holding company license and one very large
insurance firm wrapped inside in even larger shadow hedge fund.
But when Bill Gross the Bond
King says the Fed is now targeting the 10-year yield under 3.10% and street
economists at highly respected institutions say the Fed is following monetary
conditions of which the 10-year yield is one among a number of components it
suggests the Fedâ€™s pledge to be transparent and keep the public much less
markets informed is a bit disingenuous. If PIMCO and top US investment bank canâ€™t agree on what the Fed is up
to, Houston we have a problem.
Okay I give the Fed credit
for telling us its policy tactics from TALF to bond buying operations â€“ we know
what the Fed does (to execute monetary policy) but we do not know anything
about the current framework for policy. At first the Fedâ€™s expansion of
its balance sheet along with measures to support the flow of credit was called
â€ścredit easingâ€ť as opposed to â€śquantitative easing.â€ť Then the Fed at the
March FOMC meeting announced it would buy US government debt outright as well as a lot more MBS
issued by the agencies which seemed to some to cross the line to â€śquantitative
easing.â€ť But without a quantitative target is it really quantitative
easing or simply debt monetization?
Then we learned from FOMC minutes
that the Fed is knocking around the idea of targeting inflation â€“ something
Bernanke has favored since he first served as a Governor of the FRB. At a
monetary policy conference In Tennessee a few weeks back, where Don Kohn and
Bill Dudley dutifully made the case for an inflation target Paul Volcker
essentially went postal at the idea and suggested if there is any lesson of the
current crisis is that monetary policy should not be shackled by an inflation
target that may or may not be relevant for smoothing business cycles and is
subject to change in the face of real world financial and real stability
Does a more formal inflation
target in the midst of unconventional monetary policy meet the standard of
And then there is the larger
question. Is the Fed independent in light of its heavy hand in fiscal
policy (like buying Treasuries outright, picking winners and losers in the
banking and financial sector alongside the White House or embracing massive
While no central bank has a
complete playbook or much history to draw upon on how to conduct unconventional
monetary policy, one would think that at this late stage of the crisis and
policy response if the Fed was the least interested in communicating its policy
framework and approach we would not be hearing such divergent points of view on
what is happening with monetary policy. Nor would we need to wait for the
next insider financial journalist to have a one on one with Bernanke or Kohn to
find out what the Fed is thinking.
It may be too much to ask
but how about the Fed end Wednesdayâ€™s FOMC meeting with a press conference and
come clean on what it is doing â€“ and not simply details on the components of
unconventional or credit-flow-related policies. It might help
sentiment and confidence if the guessing games and veil of uncertainty is
lifted. The Fed policy burka needs to be removed.
I suspect it might help some
members of the FOMC better understand what the Fed is doing as well â€“ not all attending
the inner sanctum board meetings are much more aware of the policy approach
than the rest of us.
I thought the Bernanke 60
Minutes segment was a good first step to real policy transparency. But
the 60 Minutes frankness in hindsight looks more like an anomaly than a new
I watched Greg Ip of the
Economist and Neil Irwin of the Washington Post on CNBC earlier today and they
were clearly briefed in recent days by senior Fed officials on what the Fed is
thinking. Nothing against Greg or Neil, but deep background is not an
acceptable substitute for policy transparency. Fed needs to move to a BOE
standard on transparency and disclosure and the sooner the better. On the
question of independence, well that is a problem the BOE shares and I see no
way around itâ€¦time heals everything.
Frankly I am skeptical that
the Fed is ready to disclose more. Instead Wednesdayâ€™s markets will be
trading on the degree of optimism on the economy the Fed has signaled in the
statement (in its assessment of economic conditions). Based on Ip and
Irwin today, the Fed is extremely cautious about being early on calling a
bottom and recovery. Maybe this reluctance has something to do with the
Fedâ€™s abysmal track record in forecasting the real economy in the last 24
Count on the Fed remaining
Bank Stress Tests - No
Bank Left Behind
When President Bush and
Senator Kennedy came together early in 2001 to pass the No Child Left Behind
legislation to restore the health of public education (and public trust on the
issue of a first rate education for a first world nation), there was some sense
that at last something constructive would be done to close the educational
quality gap in the country. However, what ended up happening was that
schools who did not measure up to the standardized tests began teaching the
test so as to remain a credited school. Teaching to the test yielded many
passes when in reality schools should have failed and should have been
It reminds me of the bank
stress tests the US government is conducting (not sure who â€“ the Fed is involved, but who
else? FDIC? SEC?) - a failing school spending the year to
teach the test for a pass and remain open. Treasury and Fed officials
said even before the tests started that none of the 19 large banks tested was
insolvent. Moreover none would be allowed to fail if found
insolvent. The stress tests are pretty meaningless if there is no
pass-fail outcome. Instead we are expected to be told who needs capital
on May 04. Well banks were notified last Friday and by Monday evening the
WSJ learned that BAC and C need capital (it did not say the others do not need
capital). So much for May 04 (who knows this could be deliberate to ease
the blow on markets of more capital needy firms next week â€“ get the two most
needy out of the way with a deliberate leak).
Banks that need capital will
have 6 months to raise it, presumably privately if possible, or face the wrath
of government scrutiny â€“ conversion of government held preferred to common,
replacement of bank leadership and the old fois gras force feed if
And yes Goldman raised $5bln
in a rights issue this month and successfully. But is this really a clean
private capital raising effort when the firm benefits from billions of dollars
of FDIC backed debt (at a huge discount to market price) or $10bln in TARP
funds? And of the remaining 19 there are only a few that could follow
Goldmanâ€™ lead with a stock offering.
It is also clear that the
Obama administration canâ€™t go back to the TARP well again â€“ Congress, short of
another off the charts financial crisis, will not authorize more federal
dollars (taxpayer liabilities) to the banks. So the $700bln is it and
this means most banks that need significant capital infusions and canâ€™t raise
capital privately at a reasonable cost will see US government warrants on convertible preferred shares
exercised and converted to common equity (boost TCE). But this is an
exercise in buying time â€“ for PPIP to get going (good luck â€“ supposed to start
up in May), bank â€śrisk freeâ€ť interest income from a steep curve to grow, to
allow time for Congress to pass legislation creating a large financial firm
wind-up authority/mechanism and maybe for Congress to forget about the $700bln
authorized in 2008 to buy toxic assets from the banks (but used instead as
direct capital infusions). This unavailability of new TARP funds
may pressure the government into accepting TARP funds back from stronger banks
like Goldman and Northern Trust before the crisis has passed and before flow of
credit is fully restored.
Which leads me to GM
restructuringâ€¦why is what is good for GM is not good for US banks? If the
GM restructuring works (de facto bankruptcy and government restructuring) just
maybe the White House will decide that the zombie banking model currently in
place will get shelved for the GM model.
Lastly the worst case
scenario in the current stress tests rest on the assumption that the economy is
indeed no longer falling off a cliff nor will it again ahead. In this
environment I think any stress test that does not include at least one more
cliff dive is no stress test at all but more like the consensus forecast.
And what charge-off rates are in the stress tests for credit cards?
HELOCs? Commercial real estate? Commercial loans? Student loans?
Auto loans? Household deleveraging is just beginning. Capex
outlook? Who wants to expand capacity when the outlook for demand is so
uncertain? Moreover, the fiscal stimulus bill ($787bln) is not being
spent quickly (hard to do) and not filling the hole left by the private sector
and may not until much later this year. The massive budget in the
legislative process does not go into effect until October.
I donâ€™t see an early end to
the financial or economic crises on the horizon despite the green shoots (all
of which indicate a slowing in the rate of decline or inflexion point, which is
no turning point). Not suggesting selling the rally in risk assets now â€“
loads of pent up bottom pickers around from real and spec communities to drive
risk assets up more. But how sustainable is the rally in risk assets
without a supportive real economic recovery and there is no sustainable real
recovery when banks everywhere and US households have much more deleveraging
ahead? I am skeptical, very skeptical.
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