10 Tuesday PM Reads

My aftyernoon train reads:

• Big Banks Lack Convincing Business Model (American Banker)
• MF Global: A Despicable State of Affairs (Jesse’s Café Américain)
• The waffle paradox: Nuance loses to erroneous certainty (Seth’s Blog)
• Is Facebook Killing Google? No, But… (Jeff Matthews Is Not Making This Up)
• Are there any good arguments against the EMH? (The Money Illusion)
• Federal Pay vs. Private Sector Compensation (Economix) see also Which federal worker job pays better: Government or private? (Yahoo Finance)
• How to Prioritize When Everything Is Important (Lifehacker)
• Pythons Are Wiping Out Mammals in the Everglades (The Atlantic)
• No seriously, I’m dead. (Scientific American)
• Traffic Jam Economics (Economix)

What are you reading?

Fannie Mae Serious Delinquency rate declines, Freddie Mac rate increases

Fannie Mae reported that the Single-Family Serious Delinquency rate declined in December to 3.91%, down from 4.0% in November. This is down from 4.48% in December 2010. The Fannie Mae serious delinquency rate peaked in February 2010 at 5.59%.

Freddie Mac reported that the Single-Family serious delinquency rate increased to 3.58% in December, up from 3.57% in November. This is the fourth month in a row with a small increase in the delinquency rate. Freddie's rate is down from 3.84% in December 2010. Freddie's serious delinquency rate peaked in February 2010 at 4.20%.

These are loans that are "three monthly payments or more past due or in foreclosure".

Fannie Freddie Seriously Delinquent RateClick on graph for larger image

The serious delinquency rate has been declining, but declining very slowly (Freddie's decline seems to have stalled). The reason for the slow decline is most likely the backlog of homes in the foreclosure process due to processing issues (aka robo-signing).

I expect a mortgage servicer settlement agreement to be reached very soon, and that will probably lead to more modifications and foreclosures - so the delinquency rate should start to decline faster.

The "normal" serious delinquency rate is under 1%, so there is a long way to go.
All current mortgage delinquency graphs

Earlier on House Prices:
Case Shiller: House Prices fall to new post-bubble lows in November (seasonally adjusted)
Real House Prices and House Price-to-Rent
All current house price graphs

Privatizing of Gains and Socializing of Losses; You Want the News? From Where?

I am a fan of Michael Hudson. I was pleasantly surprised to see him on Capital Accounts with Lauren Lyster a few days ago.

Capital Account is produced by RT. That stands for Russia Today. I have numerous emails criticizing me for being on "Russia TV".

Let's take a look at what Wikepedia says about RT.
RT is the second most-watched foreign news channel in the United States, after BBC News. By March 2010, its videos had garnered more than 83 million views on YouTube and has also set a TV News Channel record after exceeding a view count on YouTube of half a billion.

RT broadcasts from its headquarters in Moscow and its studio in Washington, DC, and also has bureaux in Miami, Los Angeles, London, Paris, Delhi and Tel Aviv.

In the United States, the channel is available to digital customers of Time-Warner Cable in New York and New Jersey on channel 135 (channel 196 in upstate New York), in Los Angeles and the desert cities on channel 236, and in San Diego and North County on channel 222. Digital customers of Comcast can receive the channel in Chicago on channel 103, and in Washington, D.C. on channel 274. Digital subscribers to Buckeye CableSystem can receive the channel in Northwest Ohio and Southeast Michigan on channel 266. The channel is also available in the Washington, D.C. area via Cox (channel 474), RCN (channel 33), and Verizon FIOS (channel 455).
Last week RT interviewed Mohamed A. El-Erian, the CEO of PIMCO. They also interviewed me. More recently they interviewed Michael Hudson.

Alternate Sites vs. Mainstream Media

Most of the mainstream sites do one of three things (over and over and over).

  1. Interview those who manage the most money
  2. Interview those with bullish forecasts
  3. Interview those with the latest "hot hand" about to flame out

Reflection on News vs. Opinions

Please consider Rupert Murdoch
In an era of media empires, Rupert Murdoch, the Australian-born chairman and controlling shareholder of News Corporation, is perhaps the preeminent global media magnate.

The company, which owns Fox News, The Wall Street Journal, The New York Post and the 20th Century Fox film studio, among other assets, is one of the world’s largest media conglomerates.

In the worlds of politics as well as media, Mr. Murdoch has been one of the most influential figures of our time, and nowhere more so than in Britain, where he made his mark in newspapers.

But in July 2011, he and his company were engulfed in an explosive scandal involving the hacking of public figures’ telephone messages by journalists at News of the World, another British newspaper owned by News Corporation. The firestorm was set off by the revelation that the paper had deleted voice mail messages from the cellphone of a 13-year-old girl who was abducted and murdered in 2002, a move that had added to vain hopes that she was still alive.

In the wake of the furor, Mr. Murdoch closed down News of the World, saw two former editors of the paper arrested, accepted the resignation of Les Hinton, one of his closest associates, and abandoned what would have been the biggest deal of his career, the $12 billion takeover of Britain’s biggest pay television company, British Sky Broadcasting (BSkyB). He also bore the brunt of an outcry from the public and Parliament, as politicians of all parties who had long chafed under the need to win his support lashed out.

On July 19, Mr. Murdoch was questioned by a Parliamentary committee. In his testimony, he said that he was deeply sorry about the revelations of widespread unethical practices at his British newspapers, that he knew little or nothing about them and that he had not tried to cover them up. While defending his company against the accusations accompanying the scandal, Mr. Murdoch insisted that he had the backing of News Corporation’s board and would stay on as its chief executive for the foreseeable future.
News vs. Opinion

If you watch Fox News, rest assured it has a general overall spin that is approved by Rupert Murdoch.

Fox News will toss an occasional bone to Ron Paul, primarily from Judge Napolitano. I suspect it is out of necessity of hoping to appear balanced.

Much of what appears on Fox News belongs on "Reality TV" not news stations.

Understanding Bias

When someone reads my blog they understand what they see is "my opinion". When someone listens to Fox News many do not realize they are not getting facts, they are getting "political opinions" disguised as the news.

The Fox news slant is Republican, anti-Paul, pro-warmongering.
The Financial news sites are very biased towards "economic cheerleading".

Those who want something else turn to blogs like Calculated Risk, the Big Picture, Zero Hedge, Max Keiser etc.

Please see CNBC's Best Alternative Financial Websites; Strategist News' Best Business Blogs 2011; Business Blogs vs. Financial Blogs for further discussion of alternative sites.

Impossible Not to be Biased

It is impossible to not be biased, but as least everyone understands the alternative sites generally offer commentary that comes from the heart, not from robots hired to say and do exactly what the media giants want.

Mike "Mish" Shedlock
Click Here To Scroll Thru My Recent Post List

Euro Chicken Scratch

As a companion to my posting yesterday of the GDX chicken-scratch, here's another poultry-created masterpiece: a trio of Euro drawings with my best attempt at marking the "matched" points of this analog. The charts speak for themselves. Whether or not this pans out a third time remains to be seen. So far, so good, though.....



Why is the Normally Astute Taibbi Sounding Like a Hopey Dopey Liberal on the Mortgage Settlement?

I hate taking issue with Matt Taibbi. I’m a huge fan of his writing and think he has done more to cause the big bd banks discomfort than any single writer.

But even someone as skilled as Taibbi occasionally has the writing equivalent of a bad hair day. And his post, “A Victory for the Public on Foreclosures?” is an example. And his misreading matters precisely because he has so much cred with the public that is unhappy with Big Finance.

Taibbi has taken up cheerleading the Schneiderman involvement in a Federal investigation committee as major progress and also amplified the messaging that the current version of the release in the mortgage settlement deal (which by the way is still more of a mystery than it ought to be) is a good deal. As we will discuss in due course, even a narrow deal around robosigning is in fact NOT a good deal.

I need to get a bit granular since quite a few folks on what passes for the left have gone into hopey dopey liberal mode. This is EXACTLY what the Administration wanted. A mere gesture, appointing Schneiderman to a part time job co-chairing an under-staffed investigation, when the committee members who are likely not to be on the same page as him have the advantage of being in DC where the troops will be located and knowing their way around the relevant bureaucracies. The ONLY hope Schneiderman has of pulling this off is lots of very noisy, sustained pressure, NOT going all gooey-eyed at a blast of Administration PR.

This isn’t the first time that Taibbi has had a lapse of judgment. He bought the unadulterated Obama spin, as this this 2007 piece and this 2008 article attest. An extract from the latter:

We’ve become trained to look for the man behind the mask…

But I’m not sure there is a mask when it comes to Barack Obama…

I hear Obama tell audiences about his grandmother and her time working on a bomber assembly line during World War II. Intellectually I know it’s the same thing — but when you actually watch him in person, you get this crazy sense that these schlock ready-for-paperback patriotic tales really are a big part of his emotional makeup. You listen to him talking about his grandfather waving a little American flag on the Hawaiian beach as he watched the astronauts come in to shore, and you can almost see that these moments actually have some kind of poetic meaning for him, and that he views his own already-historic run as a continuation of that pat-but-inspirational childhood story — putting a man on the moon then, putting a black man in the White House now.

The beginning of Taibbi’s post excerpts a list in a Huffington Post story that was cribbed and somewhat edited from a post by Mike Lux on Daily Kos. But Lux regularly does messaging for the Administration. It would have been a good precaution to verify his account.

Now, alert NC readers, notice how effective this propaganda technique is from the original Lux post:

1. No release on any fair housing, fair lending, or civil rights claims.
2. No release on any Federal Housing Finance Agency or Government-Sponsored Enterprise claims.
3. No release on any Consumer Financial Protection Bureau claims (which would admittedly be modest, since the Bureau was only established in July 2011).
4. No release on tax liability claims.
5. No release on criminal liability claims.
6. No release on SEC claims.
7. No release on National Credit Union Association claims.
8. No release on FDIC claims.
9. No release on Federal Reserve claims.
10. No release on the “vast majority” of origination claims.
11. No release on the “vast majority” of securitization claims, including all claims of state pension funds.
12. No release on legal liability surrounding Mortgage Electronic Registration Systems (MERS).

Look impressive, no? You’ve been three card Monted. Nearly all of the items on the list are NOT what the worries about the release are over. Some examples: No one ever thought there would be a waiver on putbacks, which are claims being made now by the FHFA. The IRS has made it abundantly clear that that it is not going to go after REMICs (if they did, they’d cause big losses to every RMBS investor in the US, which in turn would set off an avalanche of litigation). It’s an extremely useful threat, but since no one in the Administration is interested in threatening the banks as a way to bring them to heel, there is no real need to provide a waiver. And SEC liability? Schneiderman was willing to trade that away because it is pretty meaningless on mortgage originations. The subprime party ended by June 2007, and the statute of limitations is effectively five years. The 2006 originations are fee and clear (note there IS ongoing liability, as we have stressed, for annual trustee certifications, but no one seems very interested in that). And in earlier posts I’ve discussed how I never thought MERS was on the table (as in MERS liability sits with MERS).

Put it another way, if the list has read something like:

1. No release for selling purple cows to Martians
2. No release for operating a perpetual motion machine without a license
3. No release for jaywalking in Manhattan
4. No release for going back in time and killing Shakespeare

it might have been easier to catch the ones that no one thought were germane to the negotiations.

Now, let’s play “gotcha.” I have not idea what is in or not in the release (and as we will discuss shortly, the AGs themselves seem to be not so clear on this matter). But notice how FTC claims are not on the list. They are picked up only as of when they were transferred to the CFPB. Yet the FTC was THE central actor in busting the last outbreak of servicer bad behavior, by Fairbanks in 2003. As Tom Adams wrote:

Back in 2003, Fairbanks Capital billed itself as the largest servicer of subprime mortgages. It was also a stand alone servicer, in that it was not in the business of lending.

In a high profile case within the mortgage industry, the Federal Trade Commission brought an action against Fairbanks for violating the FTC Act, the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, and the Real Estate Settlement Procedures Act (RESPA) . Fairbanks was accused of a host of improper servicing activities that will sound remarkably familiar to anyone following the foreclosure and servicing issues in today’s mortgage markets. Among the transgressions, Fairbanks was alleged to have:

-failed to post payments in a timely manner, resulting in additional late fees or interest,
-charging for forced place insurance,
-assessed improper fees, such as for attorneys, service, appraisals, FedEx,
-misrepresented the amounts owed by borrowers,
-submitted misleading or false information to credit reporting agencies,
-failed to report disputed charges to credit reporting agencies,
-failed to respond to borrowers written requests for information or investigation into charges, and
-failed to make timely payments of escrow funds for insurance and taxes.

Similarly, I see no mention on this widely-touted list of where consumer fraud claims stand. HAMP fraud was widespread and Attorney General Catherine Cortez Masto is including HAMP consumer fraud in her expanded lawsuit against Countrywide for violations of its consent decree.

I sincerely doubt that consumer fraud claims and FTC claims are being included in the proposed waiver. I’m just using that to illustrate you can’t take that list at face value.

And that’s before we get to the issue that we still don’t know what “vast majority” of origination and securitization claims mean. As anyone who has worked on contracts can tell you, seemingly innocuous language can often be very powerful.

Far more important, even if you accept this messaging at face value, the deal is NOT a good deal. Taibbi acts as if the BANKS will be paying the $25 billion bandied about as a settlement number. Earth to base, this is yet another three card Monte trick. The number to keep your eye on is the cash portion. That’s a moving target, but it is clearly under $5 billion.

In fact, what everyone keeps skipping over is that the bulk of the value of the deal is in principal mods, and the deal is set up so that mods on mortgages that the banks don’t own will count at a 50% rate. Guess what, other people’s money is ALWAYS preferable to your own money, so the only mods the banks will do on their own mortgages are ones they would have done anyhow.

So the effect of this deal is:

1. To have MBS bondholders (pensions funds, 401 (k)s, insurers) pay for liability that belongs to the banks

2. To transfer from those investors to banks as second lien holders. The big four banks still have hundreds of billions of dollars of second liens, mainly home equity loans. If you write down the first lien, it makes the second lien more valuable.

Let’s look at how this might work in practice. Say you have a borrower that has a first lien that is now worth 120% of his house at current market prices and a second lien worth and additional 15%. He gets his first lien written down to 105% of his home value. Guess what, he is still seriously underwater but he now has more cash to pay his bank-held second. How much has he been helped, really? If he can afford the hit to his credit score, he really ought to ditch the house. The mod only serves to make that a tougher call.

Now a letter by Nevada AG Masto raising questions about the deal, and it appears second liens are being addressed to a degree, but I don’t find the bits I see very encouraging. For instance, she mentions that banks get a credit for extinguishing a second lien that is over 180 days delinquent. She isn’t sure what that means. And more important, this is not as big a concession as it might sound. Banks historically have not pursued deficiency judgments on primary mortgages, let alone seconds. They have started of late, but even that probably means less than their PR would have you believe. The US has had very lax enforcement of debt collection laws, but that is being tightened up both via the CFPB starting up and some new Administration initiatives. I suspect what we will see is a year or two of efforts and scary stories (meant to deter those thinking of defaulting). It’s a good bet that the banks will go back to their former practice of rarely going after these borrowers because you seldom get much from people who are under financial stress, and it costs real money to pursue them.

In addition, the consensus view among the boosters is that robosigining is not such a big deal, so we ought to be happy to waive that in isolation. But look at how Catherine Cortez Masto is using that abuse to go in a very systematic manner up the servicing ladder, from managers of robosigners that she is prosecuting criminally to Lender Processing Services. As we have argued repeatedly, LPS served as a liability shield for the major servicers. If Masto gets to discovery on LPS, the odds are high that she will be able to establish that servicers were well aware of the abuses that LPS was engaged in as their agent and the banks were effectively colluding with LPS.

In other words, clear cut, institutionalized abuses are a great way to engage in the classic mob prosecution strategy of targeting the foot soldiers to get them to give you the dirt on the entire network. Why would you give up such a valuable chip when you don’t know the extent of the abuses? But ex Masto, there is a remarkable lack of willingness among attorneys general and regulators to dig hard into what the banks are doing and see where that leads. For instance, Richard Cordray, newly appointed head of the CFPB, said that he is not going to pursue bank violations of the Servicemembers Civil Relief Act because it looked like mistakes and the banks said they had stopped doing that. Huh? How do you know it was a mistake unless you investigate? The fact that Jamie Dimon was so eager to make this problem go away quickly suggests otherwise.

The other bizarre element of this cheerleading is that the current deal stinks for any state ex maybe California. Why should ANY state participate when they have no idea how much they will be getting, and $15 billion of $25 billion earmarked for California? The fact that Republican Pam Bondi of Florida, a state hit even worse by the aftermath of the bubble than California, is hectoring California’s Kamala Harris to sign on says clearly that Bondi is more concerned about protecting the banks than about her state’s citizens. That can be the ONLY conclusion you can reach for any state that joins this lopsided pact.

If the Administration had really changed its stance on bank misdeeds, you’d see it putting the settlement on hold until the investigations led by Schneiderman had been concluded. The fact that they mortgage settlement is proceeding on schedule says this the Administration is, as before, trying to cover up its bank-favoring actions with better propaganda.

Michael Hudson: The Man Who Fired Greenspan

This is the transcript of an interview with Michael Hudson in an Australian film, discussing a 1966 incident:

MH: They increased it largely by having Alan Greenspan create the Greenspan Commission to look at social security and pushing the myth that social security had to be funded out of pre savings, so American labour was essentially taxed 11% between itself and the employers to pay social security and this vast increase in social security taxes was used to lend to the Government(US) to provide it with enough money to slash taxes on the rich and that was Greenspan’s ploy.

He was rewarded by being made head of the Federal Reserve for his actual hatred of labour and his desire that you had to reduce living standards in order to increase the profits of capital.

And so Greenspan was sort of the hack that was hired.

When I was on Wall Street, Greenspan was hired as part of a study I was doing on the balance of payments of the Oil Industry. And one day my boss, John Deaver came into my office and said he really worried about Greenspan being a part of this report because he was known as a hack that always gave …his clients what they wanted instead of something actual.

So he (JD) gave me Greenspan’s figures on depreciation of oil producing refinery assets in Europe and asked me to find out where the faking is? He said he couldn’t believe that Greenspan by himself wouldn’t of just faked the figures and it took me about a week to figure out where the faking of the figures came out (from) and that was Greenspan had simply picked up depreciation rates relative to output for the United States and projected them onto Europe.

So I went over and talked to his assistant Lucille Woo and she said “it’s all implicit, all implicit” and I confronted her with it and she said “Yes that’s what we did”!

And so, Greenspan was indeed ‘talked off the study’ and we met… John Deaver, David Rockefeller and myself and I was told…Greenspan was such a little bastard that if they fired him, he’d hold a grudge against Chase Manhattan for years and they told me to be the guy to give him the news that we couldn’t use his (laughs) statistics on it and I was a 25 year old economist at the time and he hardly new me at all, so I was the guy that…subsequently became known as ‘the man who fired Alan Greenspan’.

House Prices Still Under Water

Data released today shows that house prices fell from the prior month's level and still remain in negative territory, as shown on the graph below. Since it's a "leading indicator of the housing industry's health because rising house prices attract investors and spur industry activity," the weak price levels just confirm the depressed state of new home sales, as mentioned in my post of January 26th.

The Daily chart below of the Homebuilders ETF, XHB, shows negative Stochastics and MACD divergence and that a topping process may be underway. Near-term support sits, first, at the confluence level of monthly Volume Profile POC and monthly VWAP of 18.58, and then at the -2 monthly VWAP level of 17.65. Near-term resistance is at the +2 monthly VWAP level of 19.50.

As this ETF has had a strong run from its October 2011 lows, it remains to be seen as to whether it runs out of favour on the buying side any time soon.

The Monthly chart below shows that this ETF has been slow to recover from highs made in 2006, and has made a rough triple top formation, beginning from the April 2010 highs. Resistance on this timeframe sits at a Fibonacci confluence of level of 20.00...a very important level for the bulls to break above and hold. However, with data like we've seen of late, it makes such a bull case very weak, in my opinion, and I would not look to this sector to lead the general markets higher.





On the Fed’s Policy of Quantitative Easing Coupled with Promises Not to Let Prices Recover Any of the Ground Relative to Trend They Lost in the Recession…

The conventional Fisher-Friedman approach to the determination of nominal spending and income focuses on the equilibrium demand and supply of money through the quantity theory:

(1) PY = MV(i)

If the economy’s money-supply process has produced “too little” money for the current level of spending, businesses and households attempt to shift their portfolios and accumulate more money by (i) trying to sell some of their other financial assets for cash, and (ii) cutting back on their spending. Thus the flow of spending—and income, and production—falls until PY has fallen by enough to make households and businesses no longer seek to increase their money holdings. Combine this focus on money supply and money demand equilibrium with some model of price theory and price adjustment, and the result is a theory of the monetary business cycle.

At the zero-interest rate lower nominal bound, this Fisher-Friedman framework breaks down. With no opportunity cost to holding wealth in money rather than in other short-duration safe nominal assets, there is no reason for changes in the money stock to induce any changes in the flow of spending at all. Anybody seeking to model nominal and real income determination must then find another, alternative equilibrium condition to focus on.

The conventional theoretical macroeconomic step to take is to focus on the intertemporal Euler equation of a representative household with rational expectations: is it on an optimal consumption-savings path? But focusing on the Euler equation requires that there be (a) no disagreements between investors, and (b) a meaningful representative household, with (c ) correct rational expectations. If we are unwilling to make those assumptions, we are then driven back to the equilibrium condition from which, given the existence of no disagreements, a representative household, and rational expectations, the Euler equation was derived.

This equilibrium condition--appropriate for a more general theory—-is the Wicksell-Hicks flow-of-funds through financial markets condition: the supply of savings vehicles must be equal to the demand for savings vehicles. If the demand for savings vehicles is greater than the supply, people will cut back on spending their savings on currently-produced goods and services as they try to boost their holdings of savings vehicles. Spending, production, and incomes will fall until people feel so poor that they no longer wish to boost their holdings of savings vehicles. When the supply of savings vehicles is greater than demand, people will increase their spending as they try to turn their excess asset holdings into current consumption. Spending, production, and incomes will rise until the richer society is happy holding the existing supply of savings vehicles.

Thus theories about the effectiveness or ineffectiveness of any kind of policy—monetary, fiscal, banking, whatever—at the zero nominal interest rate lower bound are ways of deploying Wicksell-Hicks flow-of-funds equilibrium condition. They are theories about:

(2) B + S = B + I + (G - T)

about the demand for savings vehicles—the sum of the current stock of financial assets in the economy B and desired additions to that stock through savings S—and the supply of savings vehicles—the sum of the current supply of financial assets B plus business investment I plus government debt issuance G - T.

Note that if you wish to assume a (a) representative agent with (b) rational expectations you are still committed to an analysis via (2). It is a consequence of your intertemporal Euler equation. If and only if (2) holds, then your representative agent with rational expectations is on its optimal consumption-savings path.

Equation (2) gives us insight into the potential effectiveness of monetary policy at the zero lower bound. Such non-fiscal policies do not, by definition, change the supply of savings vehicles: they simply swap one savings vehicle in private portfolios for another—cash for Treasuries, short Treasuries for GSEs, private obligations subject to bankruptcy risk for private obligations backstopped by a government guarantee. For them to boost the economy therefore, they too must work via their effects on reducing private savings S or boosting private investment I.

How can they do this?

Mostly, they do this by convincing financiers that the path of real interest rates will be lower in the future than they had expected. Even though at the zero nominal lower bound the current size of the money stock is irrelevant because the opportunity cost of holding money is zero, this will not always be the case. Someday the size of the money stock will matter again. And if the central bank now takes steps that credibly promise such a larger money stock in the future when it matters, then expectations of lower nominal interest rates and higher price levels in the future which should boost investment and other real interest-sensitive components of spending now.

What are these policies?

Jawboning to reduce anticipated real interest rates: The central bank can claim that it will maintain interest rates in the future at a lower level and the money stock at a higher level than that of its normal policy reaction function. Thus, the central bank would claim, inflation will be higher in the future than forecasts based on normal reaction functions would allow. That means that real interest rates will be lower—and that would push down savings and push up investment.

The potential difficulty is that open-market operations can be unwound. That the Federal Reserve has raised the money stock this year does not necessarily mean that it will keep the money stock five years hence above the level called for by its standard reaction function. Pure jawboning is the ultimate in cheap talk. Jawboning backed by quantitative easing at the short end of the term structure is not quite pure cheap talk: the central bank is taking action. The problem is that the action is easily reversible.

Quantitative easing at the short end to reduce anticipated real interest rates: The central bank can claim that it will maintain interest rates in the future at a lower level and the money stock at a higher level than that of its normal policy reaction function—and back up those claims by expanding the money stock now by continuing to buy short-term government bonds for cash even though this is simply a swap of one zero-yielding short term safe nominal asset for another. The idea is that the Federal Reserve is not just claiming it will expand the money stock in the future—it has already expanded the money stock.

The potential difficulty is that open-market operations can be unwound. That the Federal Reserve has raised the money stock this year does not necessarily mean that it will keep the money stock five years hence above the level called for by its standard reaction function. Pure jawboning is the ultimate in cheap talk. Jawboning backed by quantitative easing at the short end of the term structure is not quite pure cheap talk: the central bank is taking action. The problem is that the action is easily reversible.

Quantitative easing at the long end to reduce anticipated real interest rates: The central bank can claim that it will maintain interest rates in the future at a lower level and the money stock at a higher level than that of its normal policy reaction function—and back up those claims by expanding the money stock now by to buying long-term government, agency, and private bonds for cash and committing to holding them to maturity. The idea is that the Federal Reserve is not just claiming it will expand the money stock in the future—it has already expanded the money stock. And such transactions are not or at least are not as easily unwound. Price pressure effects mean that the Federal Reserve will, embarrassingly, probably lose money on the round trip if it breaks its commitment to hold its purchased securities to maturity.

Quantitative easing at the long end may have another significant effect as well. By taking duration and, in the case of private bonds, default risk onto its balance sheet the Federal Reserve transfers that risk from the marginal investor to the marginal taxpayer. If the marginal taxpayer is at a corner solution in their financial market holdings or has a higher rate of time discount than the marginal investor or simply does not see through the government’s balance sheet, one consequence of quantitative easing at the long end is that investors will then have unused risk-bearing capacity. Duration and default risk spreads should then fall, and this fall in spreads should turn more investment projects into positive NPV ones. Quantitative easing at the long end thus has not only its potential principle effect on private investment and other forms of interest-sensitive spending via expectations of inflation and thus of real safe interest rates but also a secondary effect on investment via the government’s assumption of a role as a risk-bearing partner in private enterprise.

Back-of-the-envelope calculations based on standard finance principles suggest that this portfolio-composition effect should be insignificantly small. But similar arguments based on standard finance principles have long suggested that standard open-market operations in normal times should not be able to shake the intertemporal price system out for thirty years either, and there is a lot of evidence that standard open market operations in normal times do in fact have substantial effects.

Quantitative easing accompanied by declarations that the central bank has not changed its long-run inflation and price level targets: I do not understand why a central ban would pursue such a policy.

But that is the policy that the Federal Reserve appears to have decided to pursue.

Ryan Avent:

Monetary policy The Fed s communications problem | The Economist

Monetary policy: The Fed's communications problem: As I've written before, the commitment to allow higher inflation in the future is one of the key methods through which the central bank can have a positive effect on an economy stuck at the zero lower bound. The Fed's efforts to clarify and push out the date at which it is likely to raise rates strikes me as a means to try and commit itself to higher inflation in the future. But the Fed's communications efforts in this regard run up against a serious obstacle in the form of the Fed's long-term inflation forecast, which is 2%. The Fed can't force future central banks to keep to any policy path. If the Fed were to project a long-run inflation rate above 2% then, as Mr Bini Smaghi says, markets might suppose that monetary tightening lay ahead, whatever the fine print says.

This is not an unsolvable problem but is, I think, one of the tight spots in which the Fed finds itself as it transitions from a framework that wasn't very good at boosting the economy at the ZLB to one that might be. One way to get around the problem would be to change the target, to 3% inflation or to something else, like a price or nominal GDP level, that implies future inflation above currently acceptable levels. The Fed may get there eventually, but probably not soon enough to have a meaningful impact on this recovery. 

An alternative might be to bring the point at which future inflation is tolerated a bit closer to the present. That is, the Fed doesn't necessarily run into problems of inconsistency if it projects inflation above 2% 1 or 2 years from now—a timeframe over which markets readily understand this group of policymakers to have control—while maintaining the long-run 2% goal. Achieving that would require the Fed to give itself a framework within which it's acceptable to have inflation above 2% (and even to try to generate inflation above 2%), and as I wrote last week, I thought the Fed took a big step in that direction at its latest meeting. But one then has to choose to act within that framework. I suspect that what that will take is a near-term projection of inflation above 2% combined with action—asset purchases—designed to demonstrate that, yes, the Fed is actually trying to create a little catch-up inflation. At the last press conference, Ben Bernanke all but admitted that that would be a sensible thing to do. Now we just need to excise the "all but".

Fracking IPOs This Week

A couple of interesting fracking IPOs this week. First, US Silica (SLCA) mines the sand for the fracking market. Second, Platinum Energy Solutions (FRAC) is a contract fracking service provider. Both companies have interesting futures, but they are coming public when oil service companies are beaten down due to low natural gas prices. This video from theSteet.com shows just how bearish the
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