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Dollar Is Dirt, Treasuries Are Toast, AAA Is Gone

by Mark Gilbert

May 21 (Bloomberg) —

The odds on the dollar, Treasury
bonds and the U.S. government’s AAA grade all heading for the
dumpster are shortening.

True, but for the wrong reason. There is no solvency issue, but markets are pricing it in anyway.

While currency forecasting is a mug’s game and bond yields
can’t quite decide whether to dive toward deflation or surge in
anticipation of inflation, every time I think about that credit
rating, I hear what Agent Smith in the “Matrix” movies called
“the sound of inevitability.”

Several policy missteps suggest that investors should stop
trusting — and lending to — the U.S. government. These include
the state’s pressure on Bank of America Corp. to buy Merrill
Lynch & Co.; the priority given to Chrysler LLC’s unions over
the automaker’s secured creditors; and the freedom that some
banks will regain to supersize executive bonuses by giving back
part of the government money bolstering their balance sheets.

When you buy treasury securities the government debits your transaction account and credits your securities account at the Fed.

When those securities mature the government debits your securities account and credits your transaction account. That is all there is too it.

There is no solvency issue at the operational level

Currency markets have been in a weird state of what looks
almost like equilibrium for the past couple of months. What’s
really going on is something akin to an evenly matched tug of
war that fails to move the ribbon tied around the center of the
rope, giving the impression of harmony while powerful forces do
silent battle until someone slips.

“All currencies are being debased dramatically by their
central banks at extraordinary speeds and so in relative terms
it appears there is no currency problem,” Lee Quaintance and
Paul Brodsky of QB Asset Management said in a research note
earlier this month. “In reality, however, paper money is highly
vulnerable to a public catalyst that serves to acknowledge it is
all merely vapor money.”

The ‘value’ is the purchasing power of real goods and services.
The largest and deepest thing for sale is labor.
Seems like currency still buys labor at pretty much the same price as the recent past,
And maybe even a bit more.

In fact, it may buy a bit more of just about everything vs a year ago. Particularly houses and land.

But yes, next year can always bring a different story.

Flesh Wounds

Why pick on the dollar, though? Well, not necessarily
because the U.S. economy is in worse shape than those of the
euro area, the U.K. or Japan. The biggest problem is that
external investors — particularly China — have more skin in
the dollar game than in euros, yen or pounds, which makes the
U.S. currency the most likely candidate to meet the cleaver in a
crisis of confidence about post-crunch government finances.

China owns about $744 billion of U.S. Treasury bonds in its
$2 trillion of foreign-exchange reserves.

Chinese exports, though, are dropping as the global economy
weakens, with overseas shipments declining 23 percent in
April from a year earlier, leaving a nation that has already
expressed concern about its U.S. investments with less to spend
in future.

China doesn’t ’spend’ it’s dollars on real goods and services which is why they
Have a trade surplus in the first place.

They sold things in exchange for ‘dollar balances’ which are financial assets and
then exchanged some of those balances for alternative USD financial assets as they
accumulated $744 billion of financial assets.

‘Heavy Hand of Government’

Those kinds of concerns are starting to surface in a
steepening of the U.S. yield curve, driven by an increase in 10-
and 30-year U.S. Treasury yields.

True, though there is no economic imperative for the treasury to issue a 30 year security in the first place.

In fact, the treasury issuing securities and the Fed later buying them is functionally identical to the treasury never issuing them in the first place.

(note that Charles Goodhart of the Bank of England has recently been proposing the UK do exactly that- cease issuing long securities rather than issuing them and having the BOE buy them.)

The 10-year note currently
yields 3.23 percent, about 235 basis points more than the two-
year security, which marks a near doubling of the spread since
the end of last year.

Yes, though from very low flight to quality yields at the height of the fear of oblivion.

“When the government parks its tanks on capitalism’s
lawns, that spells trouble for those who invest, add value and
create jobs,” says Tim Price, director of investments at PFP
Wealth Management in London. “Trillion-dollar bailouts do not
only leave massive public-sector deficits in their wake, they
also leave the presence of the heavy hand of government all over
industry and markets, so the outlook for government bonds is
less promising than the economic textbooks on deflation would
have us believe.”

A totally confused chain of logic, though government does often reduce shareholder value when it intervenes. But that’s a different point.

Earlier this month, the U.S. reported the first budget
deficit for April in 26 years, with spending exceeding revenue
by $20.9 billion, even though that’s the month when taxpayers
have to stump up to the Internal Revenue Service and the
government’s coffers should be overflowing. So far this fiscal
year, the U.S. shortfall is $802.3 billion, more than five times
the $153.5 billion gap in the year-earlier period.

Those are the ‘automatic stabilizers’ at work, which, fortunately, are out of the hands of
Congress. While they work the ugly way- falling employment and rising transfer payments- they do work to restore net financial assets to the private, non government sectors and thereby reverse the contraction.

Budget deficits = non govt ’savings’ of financial assets
To the penny
It’s even an accounting identity. Not theory. Ask anyone at the CBO.

Deathly Deficit

For the fiscal year ending Sept. 30, the Congressional
Budget Office forecasts a record deficit of $1.75 trillion,

That includes the purchase of financial assets which doesn’t add to aggregate demand.

Up until now the fed has always bought the financial assets when government wanted to do that and that hasn’t ‘counted’ as deficit spending for exactly that reason.

This time around the treasury bought financial assets and confused things, much like 1936 when social security first started and was accounted for off budget rather than consolidated as we quickly figured out was the right way to do it and it’s fortunately been done that way ever since.

almost four times the previous year’s $454.8 billion shortfall
and about 13 percent of gross domestic product. Bear in mind
that the target demanded of European nations wanting to join the
euro was a deficit no greater than 3 percent of GDP.

Yes, which is responsible for their poor economic performance as well.

David Walker, a former U.S. comptroller general,

And foremost US deficit terrorist

wrote in
the Financial Times on May 12 that the U.S.’s top credit rating
looks incompatible with “an accumulated negative net worth” of
more than $11 trillion and “additional off-balance-sheet
obligations” of $45 trillion. “One could even argue that our
government does not deserve a triple A credit rating based on
our current financial condition, structural fiscal imbalances
and political stalemate,” he wrote.

As if government payments are operationally constrained by revenues.

They are not, as chairman Bernanke made clear a few weeks ago
when he explained how he makes payments by changing numbers in bank accounts.

That is the only way there is for government to spend in its own currency, which
is nothing more than the process of making spread sheet entries on its own books.

Any constraints on the US ability to make payments in dollars is necessarily self imposed (and
can just as readily be removed by those wanting to spend the money.)

Said another way, government checks don’t bounce unless government decides to bounce its own checks.

If you want to claim govt won’t pay because it will vote not to pay, fine.

But not because ‘deficits can’t be financed’ or any other nonsense like that.

No Default

It is undeniable that the U.S. government’s ability to
finance its borrowing commitments has deteriorated as its
deficit has ballooned.

The ability to deficit spend is the ability to make entries on its own spreadsheets.
Nothing more.
The idea that that can ‘deteriorate’ indicates a fundamental lack of understanding of monetary operations.

Dropping the U.S. from the top rating
grade, though, wouldn’t mean the nation is about to default on
its debt obligations; there’s a subtle distinction between
ability to pay and propensity to fail to pay.

And a less subtle distinction between knowing how it works and not knowing how it works.

There’s also a
compelling argument that no government should be enjoying the
benefits of a top credit grade in the current financial climate.

There’s nothing to ‘enjoy’ or even care about.

Note Japan was heavily downgraded with a debt to GDP ratio triple the US,
With no ill effects as three month rates remained near 0 for the last
15 years and 10 year Japanese govt bonds fluctuated between .5 and 1.5%

Using the definitions outlined by Standard & Poor’s, a one-
step cut into the AA rated category would nudge the U.S.’s
creditworthiness into a “very strong” capacity to fulfill its
commitments, just weaker than the “extremely strong”
capabilities demanded of AAA rated borrowers.

S&P cannot change the actual creditworthiness of the US, or any other
issuer of its own currency. There can be no solvency issue no matter what they do.

That seems an
appropriately nuanced sanction — albeit one that the rating
companies might turn out to be too cowardly to impose.

(Mark Gilbert is a Bloomberg News columnist. The opinions
expressed are his own.)

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• Producer Price Index MoM (Released 8;30 EST)
• Producer Price Index YoY (Released 8:30 EST)
• PPI Ex Food & Energy MoM (Released 8:30 EST)
• PPI Ex Food & Energy YoY (Released 8:30 EST)
• Initial Jobless Claims (Released 8:30 EST)
• Continuing Claims (Released 8:30 EST)
• Jobless Claims ALLX (Released 8:30 EST)

Producer Price Index MoM (Mar)

Karim writes:

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Producer Price Index YoY (Mar)

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PPI Ex Food & Energy MoM (Mar)

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PPI Ex Food & Energy YoY (Mar)

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Initial Jobless Claims (May 1)

Karim writes:

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Continuing Claims (May 1)

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Jobless Claims ALLX (May 1)

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UN Panel says world should ditch dollar

by Jeremy Gaunt

Mar 18 (Reuters) — A United Nations panel of experts

Who don’t understand how monetary systems work….

will recommend next week that the world move away from using the dollar as a reserve currency and adopt a shared basket of currencies instead, one of its members said on Wednesday.

Avinash Persaud, chairman of consultants Intelligence Capital and a former currency chief at JPMorgan, said the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket.

“It is a good moment to move to a shared reserve currency,” he told the Reuters Funds Summit in Luxembourg.

He doesn’t either.

The United States, he said, was finding it hard to manage policy while remaining the reserve currency and the rest of world was also unhappy with the generally declining dollar.

Persaud said the recommendation would be one of a number delivered to the United Nations on March 25 by the U.N. Commission of Experts on International Financial Reform.

More of the blind leading the blind.

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It all still looks very, very weak. But so low that even small improvements will show high % gains.

• MBA Mortgage Applications (Released 7:00 EST)
• MBA Purchasing Applications (Released 7:00 EST)
• MBA Refinancing Applications (Released 7:00 EST)
• Challenger Job Cuts YoY (Released 7:30 EST)
• Challenger Job Cuts TABLE 1 (Released 7:30 EST)
• Challenger Job Cuts TABLE 2 (Released 7:30 EST)
• Challenger Job Cuts TABLE 3 (Released 7:30 EST)
• Challenger Job Cuts TABLE 4 (Released 7:30 EST)
• ADP Employment Change (Released 8:15 EST)
• ADP ALLX (Released 8:15 EST)
• RPX Composite 28dy Index (Released 9:00 EST)
• RPX Composite 28dy YoY (Released 9:00 EST)
• ISM Non Manufacturing Composite (Released 10:00 EST)

MBA Mortgage Applications (Feb 27)

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MBA Purchasing Applications (Feb 27)

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MBA Refinancing Applications (Feb 27)

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Challenger Job Cuts YoY (Feb)

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Challenger Job Cuts TABLE 1 (Feb)

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Challenger Job Cuts TABLE 2 (Feb)

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Challenger Job Cuts TABLE 3 (Feb)

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Challenger Job Cuts TABLE 4 (Feb)

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ADP Employment Change (Feb)

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ADP ALLX (Feb)

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RPX Composite 28dy Index (Dec)

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RPX Composite 28dy YoY (Dec)

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ISM Non Manufacturing Composite (Feb)

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The World Won’t Buy Unlimited US Debt

by Peter Schiff

Jan 23 (Wall Street Journal) — Barack Obama has spoken often of sacrifice. And as recently as a week ago, he said that to stave off the deepening recession Americans should be prepared to face “trillion dollar deficits for years to come.”
But apart from a stirring call for volunteerism in his inaugural address, the only specific sacrifices the president has outlined thus far include lower taxes, millions of federally funded jobs, expanded corporate bailouts, and direct stimulus checks to consumers. Could this be described as sacrificial?

No. Good point! Why should utilizing idle resources be sacrificial?

It’s only during times of scarcity does ’sacrifice’ come into play.

What he might have said was that the nations funding the majority of America’s public debt — most notably the Chinese, Japanese and the Saudis — need to be prepared to sacrifice.

They already have been and want to continue net exporting to the US.

That is true sacrifice, and they are begging to be allowed to continue doing it.

They have to fund America’s annual trillion-dollar deficits for the foreseeable future.

No, we have funded their savings.

These creditor nations, who already own trillions of dollars of U.S. government debt, are the only entities capable of underwriting the spending that Mr. Obama envisions and that U.S. citizens demand.

No, they push to get to the front of the line to accumulate USD financial assets as part of their desire to net export (sacrifice) to the US.

These nations, in other words, must never use the money to buy other assets or fund domestic spending initiatives for their own people.

Yes, it’s better for us if they don’t. But they can at any time. And lucky for us they don’t want to.

When the old Treasury bills mature, they can do nothing with the money except buy new ones. To do otherwise would implode the market for U.S. Treasurys (sending U.S. interest rates much higher)

Maybe.

and start a run on the dollar. (If foreign central banks become net sellers of Treasurys, the demand for dollars needed to buy them would plummet.)

Only if they sell USD for other currencies, or spend those USD here.

And if the dollar goes down, so what? While it’s not my first choice to enact policy that causes the dollar to go down for other reasons, it does not alter the real wealth of the US.

Real wealth= everything produced domestically plus everything imported minus everything exported.

Exports are always a cost, imports a benefit.

In sum, our creditors must give up all hope of accessing the principal, and may be compensated only by the paltry 2%-3% yield our bonds currently deliver.

And if they never spend the USD interest earned is of no real consequence either.

As absurd as this may appear on the surface, it seems inconceivable to President Obama, or any respected economist for that matter, that our creditors may decline to sign on.

You would think they would have realized net exports hurt them long ago. But as of today they are still clawing and biting to increase net exports.

And, worse yet, our fearless leaders are trying to reverse that and balance of trade account.

Their confidence is derived from the fact that the arrangement has gone on for some time, and that our creditors would be unwilling to face the economic turbulence that would result from an interruption of the status quo.

No, they do it to support their export industries that have disproportionate political clout, supported by international mainstream economics that praises exports and condemns imports.

But just because the game has lasted thus far does not mean that they will continue playing it indefinitely.

Agreed! But we should strive to continue it, not strive to end it.

Thanks to projected huge deficits, the U.S. government is severely raising the stakes. At the same time, the global economic contraction will make larger Treasury purchases by foreign central banks both economically and politically more difficult.

No, it makes it more urgent, as they have no instinct to increase their domestic demand, but instead focus on supporting their exports.

The root problem is not that America may have difficulty borrowing enough from abroad to maintain our GDP, but that our economy was too large in the first place. America’s GDP is composed of more than 70% consumer spending.

Pretty normal. The entire point of any economy is consumption. The rest is investment which represents a down payment on future consumption.

For many years, much of that spending has been a function of voracious consumer borrowing through home equity extractions (averaging more than $850 billion annually in 2005 and 2006, according to the Federal Reserve) and rapid expansion of credit card and other consumer debt. Now that credit is scarce, it is inevitable that GDP will fall.

Yes, but because government doesn’t understand its role in sustaining domestic demand.

Neither the left nor the right of the American political spectrum has shown any willingness to tolerate such a contraction. Recently, for example, Nobel Prize-winning economist Paul Krugman estimated that a 6.8% contraction in GDP will result in $2.1 trillion in “lost output,” which the government should redeem through fiscal stimulation. In his view, the $775 billion announced in Mr. Obama’s plan is two-thirds too small.

Agreed!

Although Mr. Krugman may not get all that he wishes, it is clear that Mr. Obama’s opening bid will likely move north considerably before any legislation is passed. It is also clear from the political chatter that the policies most favored will be those that encourage rapid consumer spending, not lasting or sustainable economic change. So when the effects of this stimulus dissipate, the same unbalanced economy will remain — only now with a far higher debt load.

There is no reason for fiscal balance to ‘dissipate’ but instead can be continually altered to support aggregate demand/output/employment.

Currently, U.S. citizens comprise less than 5% of world population, but account for more than 25% of global GDP. Given our debts and weakening economy, this disproportionate advantage should narrow. Yet the U.S. is asking much poorer foreign nations to maintain the status quo, and incredibly, they are complying. At least for now.

We aren’t asking them to export to us, they are demanding the right to export to us.

You can’t blame the Obama administration for choosing to go down this path. If these other nations are giving, it becomes very easy to take.

In fact, foolish not to.

However, given his supposedly post-ideological pragmatic gifts, one would hope that Mr. Obama can see that, just like all other bubbles in world history, the U.S. debt bubble will end badly. Taking on more debt to maintain spending is neither sacrificial nor beneficial.

He misses the point. There is no financial risk to government ‘debt’, only the risk of inflation.

Government continuously has the option to sustain domestic demand and no reason not to do so apart from deficit myths and a lack of understanding of our monetary system.

Mr. Schiff is president of Euro Pacific Capital and author of “The Little Book of Bull Moves in Bear Markets” (Wiley, 2008).

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• Euro Area Sector Analysis (Released n/a EST)
• US Sector Analysis (Released n/a EST)
• Japan Fiscal Balance as % of GDP (Released n/a EST)

Euro Area Sector Analysis (Dec 17)

 
Karim writes:
Euro-middle of historical range. But with government deficits nearing Maastricht limits (though those limits will be bent, it will be grudging), not much chance for large enough fiscal stimulus to make a difference to private demand.

Yes, deficits seem too small to support higher levels of output and employment.

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US Sector Analysis (Dec 17)

 
Karim writes:
U.S.-still far below peak of early 90s. Nearing levels of earlier this decade, but much private demand growth in recent years fueled by credit (unlikely to be repeated, certainly not to same extent).

Yes, we are still paying the price for allowing the budget to go into surplus. The deficit needs to be substantially higher to restore output and employment, to ‘make up’ for the surplus years that drained the financial equity needed to support the credit structure.

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Japan Fiscal Balance as % of GDP (Dec 17)

 
Karim writes:
Japan-well off recent peaks, in some part due to some fiscal tightening in recent years. Fiscal policy starting to be loosened, but private savings still have ways to go to get back to levels that were associated with the moderate period of domestic demand growth from 2003-2006.

Yes, and with their higher propensity to not spend income they require a higher deficit to sustain output and employment.

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Securitized Products Weekly Update: 12/22/08

Overview

Securitized products continued to have a positive tone last week assisted by momentum from FOMC announcements. The RMBS sector benefited the most in hopes that aggressive downward pressure on mortgage rates will increase prepay speeds (thus enhancing yields in a deeply discounted market). CMBS shorter pays and junior AAAs firmed on the week along with more seasoned super dupers.

CMBS/X

• CMBS cash continued to stabilize (from violent Nov swings) last week on lighter flows, with shorter pay A1-A3 supers and AM/AJ classes tightening the most and LCF’s (Last Cash Flow classes) firm but generally unchanged
• LCF’s trading around +950 (~$70 price; 12% yield) although the market is becoming more bifurcated between deals considered to be safer and those perceived to have real credit risk; the trading range between the most/least desirable ‘07 LCF’s is now in the 350bps range
• Non-super AAAs seeing renewed buying interest; AMs were up another 5-6 pts week-over-week now trading in hi 40s
• The market is taking increased note of relative value in shorter pay A1-A3 classes, as those classes tightened 50-75bps on the week
• CMBX.AAA.4 tightened 77 bps on the week on relatively light flows and profit taking
• The street reports spending increasing efforts to educate opportunity funds interested in CMBS; appx 25% have started buying and 75% still completing due diligence
• Fitch reports that CRE loan delinquencies (held in CRE CDOs) declined from Oct to Nov from 3.1% to 2.8% as a result of increasing loan extensions being granted
• Centro, distressed Australian retail REIT who levered up to buy U.S. shopping centers, averted bankruptcy by transferring 90% ownership control to lenders in exchange for loan extensions on maturing debt
• GGP, a major U.S. mall REIT, was able to extend maturing secured loans in exchange for lender concessions
• Both the Centro and GGP situations reflect lenders reluctance to foreclose/liquidate in this market and indicate that more extensions/modifications are likely for maturing CRE (commercial real estate) loans that cannot be refinanced
• Market chatter about the Federal Reserve possibly buying CMBS directly in secondary markets continues to get some press
• JPM liquidated a portfolio of CMBS securities on margin from Guggenheim, a levered CRE strategy fund and large TRS player
• CMBS market tone improving and feels like it will be better bid after the turn, although the fact that new loan origination remains in a deep freeze is of concern

RMBS

• RMBS continued to rally this week, Jumbo and Alt A super seniors were up 3-5 pts and Option ARMs were up 2 points
• ABX 06 AAAs were up 2-4 pts and 07 AAAs were up 4-5 post FOMC moves and the government’s stated objective of driving down mortgage rates
• Optimism in RMBS was sparked by hopes that lower mortgage rates will drive faster prepay speeds as the non-agency market presently prices to rock-bottom CPR assumptions
• Both ML and JPM announced buy recommendations on non-agency AAA MBS based upon assessments that increasing traction from aggressive federal actions will accelerate the bottoming of the housing market and mitigate the risk of an over-correction on the downside
• Affordability in a number of MSAs has now fully corrected to pre-bubble levels and lower mortgage rates will speed up the process across all markets
• Although affordability metrics have improved and will further benefit from lower mortgage rates, rising unemployment will be a major headwind
• Although mortgage modification efforts have yet to show results, the market senses a growing conviction on the part of the new administration to aggressively pursue mortgage modifications that will entail removing loans from securitized pools and encouraging principal reductions
• JPM expects bottoming of house pricing to now occur in mid-09, escalating this timeframe from a prior expectation of 1H10
• Citi is aggressively buying Option ARM super seniors and effectively setting market levels for this sector
• Housing starts dropped to the lowest level in 50 years
• JPM is advocating buying RMBS AAA Mezz trading in the $30s as it has the greatest convexity upside to increased mods/prepays
• ML/Citi issued buy recommendations on super senior Option ARMs and certain Alt A AAA structures
• Although most government actions have been initially directed towards improving conforming mortgage markets, non-agency RMBS is expected to become the beneficiary of 2009 actions expected to focus on foreclosure forbearance and more aggressive modification/principal writedowns

Credit Cards/Autos

• Better tone to ABS market at higher-end of credit stack although flows were generally light and domestic Auto ABS continues to struggle
• New Unfair or Deceptive Acts or Practices (”UDAP”) legislation passed will increase regulatory cost to card issuers but will have no significant adverse impact on profitability or trading levels
• Some additional TALF details were announced including a term extension from one to three years; since TALF will only apply to newly issued ABS, it is likely to create a bifurcated market between TALF eligible and non-eligible ABS; TALF rate and haircut terms have yet to be announced
• The BACCT (BofA) Credit Card Master Trust began trapping excess spread at the C class (BBB) level, prompting Card mezz classes to widen 50-75bps on the week
• JPM significantly enhanced the WAMU Credit Card Master Trust by swapping out $6B of weaker accounts for stronger accounts
• Although Nov results showed card charge-offs increased ~20bps to 6.7%, this was more than offset by margin improvement from declining Libor which boosted overall excess spread to 6.0%, up from 4.3% in Oct
• Many synthetic CDOs invest note issuance proceeds in AAA credit card ABS due to cards historic ratings stability and available liquidity; liquidations of synthetic CDOs continues to adversely impact AAA card technicals as more AAA classes are forced back into the market
• Auto ABS was buffeted by news highlighting rapid deterioration at GM and Chrysler and culminated with an announced bridge loan to get them over the turn
• Independents and foreign issuer shelves continue to outperform domestic Auto ABS
• Volkswagen was able to issue a new $1B ABS transaction last week; 1 year AAAs came at L+350

CDO/CLO

• Little trading activity last week. BWIC with a AAA CRE CDO bond was talked in single digits (although didn’t trade) reflecting the rating agencies unwillingness to downgrade AAA CRE CDO paper. Market consensus on the bond was that there was little likelihood for any return of principal
• Moody’s cautioned today that it will be reviewing their ratings on 109 CRE CDOs. AAAs may be downgraded 2-6 notches (4-8 notches on lower rated tranches). Moody’s expects to complete their review by Feb 09
• JPM has been a large buyer of super senior AAA CLO paper the last few weeks. Huge OWICs over the last few weeks in 450a for high quality managers, which is about 100bps tighter than where BWICs had been trading. Current count has JPM adding $1.1BN to their $14BN AAA CLO exposure
• A large wave of S&P downgrades on high yield loans last week threaten to trigger OC test failures in CLOs. Failure of OC tests results in cash flows being redirected from mezz class to senior note holders
• S&P announced that they are reviewing the assumptions used to model CLOs and placed many mezz classes on negative watch over the last few weeks. BBB/BB classes are expected to be most impacted

Securitized Products

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FACTBOX: What is quantitative easing?

Tue Dec 16, 2008 3:30pm EST

NEW YORK (Reuters) - The Federal Reserve on Tuesday cut its target for overnight interest rates to zero to 0.25 percent, bringing it closer to unconventional action to lift the economy out of a year-long recession.

“The message is they’re instituting quantitative easing on a fairly large scale,” said Doug Roberts, chief investment strategist at Channel Capital Research.com.

Under quantitative easing, central banks flood the banking system with masses of money to promote lending.

Central banks exchange non or low interest bearing assets- reserve balances- for longer term higher yielding securities.

Since lending is in no case ‘reserve constrained’, the ‘extra’ reserves do nothing for lending.

The purchase of the longer dated securities results in lower longer term rates than otherwise. The lower borrowing rates may or may not alter aggregate demand.

The lower rates for savers definitely lowers aggregate demand.

They usually do this when lowering official interest rates no longer is effective because they already are at or near zero.

True!

The central banks add cash by buying up large quantities of securities — government debt, mortgages, commercial loans, even stocks — from banks’ balance sheets,

Yes.

giving them plenty of new money to lend.

No, they already and always have infinite ‘money to lend’.

Available funds are not a constraint for the banking system.

The constraints are regulated asset quality and capital requirements that are expressed in the rates bank charge.

Not the total quantity of funds available.

It is a tool used by Japan earlier this decade to combat deflation and stimulate the economy.

Didn’t work then either. It was fiscal policy that kept them afloat, though not a large enough deficit to sustain output at full employment levels.

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Karim writes:

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(email exchange)

Thanks, this is yet another example of the WSJ publishing and thereby promoting authors with no understanding of monetary operations, which means the WSJ editors don’t have any either.

Feel free to send this along the the WSJ with your own introductory comments as well!

>   
>   This is a well written piece, by Mr. Wood of CLSA.
>   

I respectfully don’t agree.

>   
>   He has long maintained a bearish bias which comes through in the
>   article. The points he raises I believe are cogent and logical and ones I
>   have addressed as well over recent days and months.
>   

It doesn’t seem you understand monetary operations either.

>   
>   The end of the article discussing gold I found to be particularly of
>   interest.
>   

The Fed Is Out of Ammunition: A Discredited Dollar Is a Likely Outcome of the Current Crisis

By Christopher Wood

With an estimated $4 trillion in housing wealth and $9 trillion in stock-market wealth destroyed so far in the United States, there is little doubt that we are witnessing a classic debt-deflation bust at work, characterized by falling prices, frozen credit markets and plummeting asset values.

Yes, as well as fiscal automatic stabilizers working their way to the rescue as always.

Those who want to understand the mechanism might ponder Irving Fisher’s comment in 1933: When it comes to booms gone bust, “over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money.”

Irv was writing in the context of the gold standard of the time, and that did very well.

But it’s inapplicable with today’s non convertible currency and floating FX.

The growing risk of falling prices raises a challenge for one of the conventional wisdoms of the modern economics profession, and indeed modern central banking: the belief that it is impossible to have deflation in a fiat paper-money system.

You can easily have deflation if the deficit is allowed to get and remain too small.

Yet U.S. core CPI fell by 0.1% month-on-month in October, the first such decline since December 1982.

Pull back in commodity prices mainly, after a long run up, but yes, for now the moment the outlook is deflationary.

The origins of the modern conventional wisdom lies in the simplistic monetarist interpretation of the Great Depression popularized by Milton Friedman and taught to generations of economics students ever since. This argued that the Great Depression could have been avoided if the Federal Reserve had been more proactive about printing money.

On the gold standard this might have worked, though it would have meant the need to rapidly devalue the conversion rate which would have considered a government default. And this did happen.

Today it is inapplicable with non convertible currency and floating FX.

Yet the Japanese experience of the 1990s — persistent deflationary malaise unresponsive to near zero-percent interest rates — shows that it is not so easy to inflate one’s way out of a debt bust.

Doesn’t show that at all. Just shows the depth of their reluctance to use sufficient deficit spending to restore output and employment via increased domestic demand. They want to be export driven and have paid the price for a long time.

In the U.S., the Fed can only control the supply of money;

No, it only can control the term structure of risk free interest rates.

it cannot control the velocity of money or the rate at which it turns over.

True.

The dramatic collapse in securitization over the past 18 months reflects the continuing collapse in velocity as financial engineering goes into reverse.

By identity.

True, this will change one day. But for now, the issuance of nonagency mortgage-backed securities (MBS) in America has plunged by 98% year-on-year to a monthly average of $0.82 billion in the past four months, down from a peak of $136 billion in June 2006. There has been no new issuance in commercial MBS since July. This collapse in securitization is intensely deflationary.

Yes, though offset by increased government deficit spending, increased export revenues (for a while), and increased direct lending by banks to hold in portfolio (which is how it was all done in not so distant past cycles).

It is also true that under Chairman Ben Bernanke, the Federal Reserve balance sheet continues to expand at a frantic rate, as do commercial-bank total reserves in an effort to counter credit contraction.

In an effort to lower rates and thereby counter credit contraction.

Thus, the Federal Reserve banks’ total assets have increased by $1.28 trillion since early September to $2.19 trillion on Nov. 19. Likewise, the aggregate reserves of U.S. depository institutions have surged nearly 14-fold in the past two months to $653 billion in the week ended Nov. 19 from $47 billion at the beginning of September.

So??? Just entries on a government spread sheet with no further ramifications.

But the growth of excess reserves also reflects bank disinterest in lending the money.

So?

This suggests the banks only want to finance existing positions, such as where they have already made credit-line commitments.

Banking is necessarily pro cyclical- get over it!

Monetarist Bernanke and others blame Japan’s postbubble deflationary downturn on policy errors by the Bank of Japan.

Not me. It was the lack of sufficient deficit spending, as above.

But he and others are about to find out that monetary gymnastics are not as effective as they would like to think. So too will the Keynesians who view an aggressive fiscal policy as the best way to counter a deflationary slump. While public-works spending can blunt the downside and provide jobs, it remains the case that FDR’s New Deal did not end the Great Depression.

Mixing metaphors. The New Deal’s deficit spending was far too small to restore output and employment.

There are no easy policy answers to the current credit convulsion and intensifying financial panic — not as long as politicians and central bankers are determined not to let financial institutions fail, and so prevent the market from correcting the excesses.

Yes there is an easy answer- make a sufficiently large fiscal adjustment.

This is why this writer has a certain sympathy for Treasury Secretary Henry Paulson, even if nobody else seems to. The securitized nature of this credit cycle, combined with the nightmare levels of leverage embedded in the products dreamt up by the quantitative geeks, means this is a horribly difficult issue to solve.

Couldn’t be easier. Start with a payroll tax holiday where the treasury makes all FICA payments for employees and employers.

The spread around a few hundred billion in revenue sharing to the states for operations and infrastructure.

Crisis over.

Virtually everybody blames Mr. Paulson for the decision to let Lehman Brothers go. But this decision should be applauded for precipitating the deflationary unwind that was going to come sooner or later anyway.

The Japanese precedent also remains important because the efforts in the West to prevent the market from disciplining excesses will have, as in Japan, unintended, adverse, long-term consequences.

Doesn’t even mention output and employment.

In Japan, one legacy is the continuing existence of a large number of uncompetitive companies which have caused profit margins to fall for their more productive competitors.

Who cares?

Another consequence has been a long-term deflationary malaise, which has kept yen interest rates ridiculously low to the detriment of savers.

Interesting bit of logic!

Meanwhile, the most recent Fed survey of loan officers provides hard evidence of the intensifying credit crunch in America. A net 83.6% of domestic banks reported having tightened lending standards on commercial and industrial loans to large and midsize firms over the past three months, the highest since the data series began in 1990. A net 47% of banks also indicated that they had become less willing to make consumer installment loans over the past three months.

Banks are necessarily pro cyclical- get over it!

Consumers are also more reluctant to borrow. A net 48% of respondents indicated that they had experienced weaker demand for consumer loans of all types over the past quarter, up from 30% in the July survey. This hints at the Japanese outcome of “pushing on a string” — i.e., the banks can make credit available but cannot force people to borrow.

Good! Lower taxes for any given amount of government spending. Bring it on! Now!

The Fed Is Out of Ammunition

With a fed-funds rate at 0.5% or lower in coming months, it is fast becoming time for investors to read again Mr. Bernanke’s speeches in 2002 and 2003 on the subject of combating falling inflation. In these speeches, the Fed chairman outlined how policy could evolve once short-term interest rates get to near zero. A key focus in such an environment will be to bring down long-term interest rates, which help determine the rates of mortgages and other debt instruments. This would likely involve in practice the Fed buying longer-term Treasury bonds.

Yes. And not do a lot for output and employment until fiscal adjustment takes hold.

And do we really want to encourage an increase in private leverage? Been there done that, right?

It would seem fair to conclude that a Bernanke-led Fed will follow through on such policies in coming months if, as is likely, the U.S. economy continues to suffer and if inflationary pressures continue to collapse. Such actions will not solve the problem but will merely compound it, by adding debt to debt.

I think he’s got it right there.

In this respect the present crisis in the West will ultimately end up discrediting mechanical monetarism —

Hope so. It flies in the face of theory and reality.

and with it the fiat paper-money system in general — as the U.S. paper-dollar standard, in place since Richard Nixon broke the link with gold in 1971, finally disintegrates.

Why??? Deflation as above? Deflation is the increase in value of a currency. Disintegration is via inflation???

The catalyst will be foreign creditors fleeing the dollar for gold. That will in turn lead to global recognition of the need for a vastly more disciplined global financial system and one where gold, the “barbarous relic” scorned by most modern central bankers, may well play a part.

Fleeing the dollar for gold means inflation. He’s been preaching deflation for this whole piece. Can’t have it both ways.

Mr. Wood, equity strategist for CLSA Ltd. in Hong Kong, is the author of “The Bubble Economy: Japan’s Extraordinary Speculative Boom of the ’80s and the Dramatic Bust of the ’90s” (Solstice Publishing, 2005).

Aha! Hong Kong has a fixed FX policy, much like a gold standard. He’s applying fixed FX analysis to the us which has a floating FX policy.

The WSJ should have told him this and rejected this op-ed piece.

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Germany Retains `Stable’ Rating Outlook at Moody’s Amid Crisis

By Rainer Buergin

Nov. 24 (Bloomberg) — Germany retained a “stable” outlook at Moody’s Investors Service on its Aaa government bond ratings even as the financial crisis puts strains on public coffers, the rating company said today in an e-mailed report.

Moody’s, in a regular credit analysis, kept the “Aaa - stable” rating for Germany’s government bonds, the country ceiling and the bank deposit ceiling, both in foreign and local currency.

“Germany’s public debt payment capacity is strong and Moody’s anticipates no problems with regard to affordability or adverse debt dynamics, even with the impact of the economic slowdown likely to be felt on both sides of the government balance sheet,” said Moody’s analyst Alexander Kockerbeck.

Chancellor Angela Merkel’s government faces revenue shortfalls this year and will have to expand net borrowing in 2009 as the worst economic recession in at least 12 years takes its toll on the budget. Lawmakers last week authorized higher net federal borrowing in 2009 compared with 2008, the first increase since Merkel came to office three years ago.

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(email exchange)

>   
>   On Wed, Nov 12, 2008 at 11:37 PM, Morris wrote:
>   
>   The Muni stuff is more interesting… See the data…if the USA loses AAA.,
>   what does that make states with Budget Gaps of over 10pct of GDP and
>   NO capability for a funding mechanism to print money????
>   

Dependent on the US government/banks for credit, like the rest of us- (we may now need both a payroll tax holiday and a trillion or so of revenue sharing for the states).

And restoring growth and employment is no big deal, actually, if government sustains demand at reasonable levels, which it always, readily, can do.

We sent men to the moon 40 years ago, cram mind boggling technology into cell phones, do robotic surgery, and don’t understand how a simple spreadsheet called the monetary system works.

Remarkable!

US May Lose Its ‘AAA’ Rating

The United States may be on course to lose its ‘AAA’ rating due to the large amount of debt it has accumulated, according to Martin Hennecke, senior manager of private clients at Tyche.

Yes, that may happen, as ratings agencies have no clue how it all actually works.

“The U.S. might really have to look at a default on the bankruptcy reorganization of the present financial system” and the bankruptcy of the government is not out of the realm of possibility, Hennecke said.

With government spending not constrained by revenue, any such event would be an unnecessary political response.

“In the United States there is already a funding crisis,

Not for government.

And a close look at actual monetary operations shows government best thought of as spending first and then borrowing or collecting taxes. Any constraints are necessarily self imposed (debt ceilings, no overdraft at Fed provisions, paygo policy).

and they will have to sell a lot more bonds next year to fund the bailout packages that have already been signed off,” Hennecke told CNBC.

No, the Fed government sells bonds after they spend, not in order to spend.

In order to solve or stem the economic slowdown, Hennecke suggested the US would have to radically reduce spending across all sectors and recall all its troops from around the world.

No, to stem the slowdown the US has to increase its deficit- increase spending and/or cut taxes.

Fortunately, this is already underway via the ‘automatic stabilizers’ as tax revenue slows and transfer payments increase.

Unfortunately we still don’t have the good sense to do this proactively.

>   
>   On Thu, Nov 13, 2008 at 6:53 AM, Morris wrote:
>   
>   Your theories are quite interesting- why wouldn’t the G20 announce
>   this sort of massive WW stimulus package of say, 10 trillion dollars to
>   restart all local economies?
>   

They might.

Two points:

1. Deficits need to be ongoing to sustain the financial equity that supports credit structures. It’s not just a matter of ‘jump starting’ though that certainly doesn’t hurt.
We got into this mess by letting deficits get too low. We have yet to recover from the surplus years of the late 90’s that reduced private sector financial equity by maybe a trillion USD, back when that was a lot of money.

2. Any nation is better off by doing it unilaterally in sufficient quantity to restore output and employment. The last thing anyone needs is foreign consumers competing for scarce resources.

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Doesn’t look as bad as many would expect.

Maybe it’s being supported by lower fuel prices.

TABLE-US chain store sales fell 1.0 pct last week-ICSC

(Reuters) The International Council of Shopping Centers and Goldman Sachs on Tuesday released the following seasonally adjusted weekly data on U.S. chain store retail sales.
 

WEEK ENDING	INDEX 1977=100	YEAR/YEAR CHANGE	WEEKLY CHANGE
		(percent)	(percent)
Nov 8	477.2	0.4	-1.0
Nov 1	482.0	0.9	0.6
Oct 25	479.3	1.3	0.5
Oct 18	477.0	0.9	-1.6

 
The ICSC weekly U.S. retail chain store sales index is a joint publication between ICSC and Goldman Sachs Group Inc. It measures nominal same-store sales, excluding restaurant and vehicle demand, and represents about 75 retail chain stores.

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Here’s my take on the events of the last year:

Paulson/Bush/Bernanke pressed a ‘weak dollar’ policy to use exports to sustain GDP, rather than a fiscal package to support domestic demand.

This kept the US muddling through but took demand from the rest of world.

The rest of world had become ‘leveraged’ to their exports to the US.

As US imports fell and US exports accelerated, the rest of world economies slowed and support was removed for their credit structures.

No government moved to support domestic demand until the modest US fiscal package of a few months ago. It was too little too late.

None of the credit based economies have the institutional structure to sustain growth and employment with soft asset/collateral prices.

No private sector loans are ’safe’ when collateral values and income are falling.

The lesson of Japan is that with a general deflation of collateral values it took a federal deficit of at least 8% of GDP just to stay out of recession.

Not sure what it will take here.

The payroll tax holiday would be a good start and probably sufficient to reverse the shortfall of demand.

The US, UK, Japan, etc. will survive a slowdown due to their ‘automatic stabilizers’ that will rapidly increase deficits until they are sufficiently large to turn things around.

The eurozone doesn’t have the institutional structure that will allow this process to work as it does in the other nations with non-convertible currencies.

The eurozone can only hope the rest of world recovers quickly and supports eurozone exports.

Without a US fiscal package US domestic demand will remain weak until the deficit gets large enough via falling tax revenue and rising transfer payments.

Without foreign CB buying of USD, US imports will not increase enough to support rest of world demand.

All this means a decisive US fiscal response, such as the payroll tax holiday, will support:

• Both US and rest of world aggregate demand.
• Support the financial sectors from the bottom up.
• Increase US real terms of trade.

(Not to forget the need for an energy package to keep higher crude prices from hurting our real terms of trade and reducing our standard of living.)

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Saved by the Deficit?

by Robert B. Reich

BOTH presidential candidates have been criticized for failing — at Tuesday’s debate and previously — to name any promises or plans they’re going to have to scrap because of the bailout and the failing economy. That criticism is unwarranted. The assumption that we are about to have a rerun of 1993 — when Bill Clinton, newly installed as president, was forced to jettison much of his agenda because of a surging budget deficit — may well be mistaken.

No, it’s ridiculous! Cutting back is for times of excess aggregate demand - hardly the case today.

At first glance, January 2009 is starting to look a lot like January 1993. Then, the federal deficit was running at roughly $300 billion a year, or about 5 percent of gross domestic product, way too high for comfort.

Why?

By contrast, the deficit for the 2009 fiscal year is now projected to be $410 billion, or about 3.3 percent of gross domestic product. That’s not too worrying.

No number per se is worrying. It’s things like output, employment, and maybe inflation that are worrying.

But if the Treasury shovels out the full $700 billion of bailout money next year, the deficit could balloon to more than 6 percent of gross domestic product, the highest since 1983. And if the nation plunges into a deeper recession, with tax revenues dropping and domestic product shrinking, the deficit will be even larger as a proportion of the economy.

True, as a matter of accounting. But none of the above is symptomatic of excess aggregate demand.

Yet all is not what it seems. First, the $700 billion bailout is less like an additional government expense than a temporary loan or investment.

It’s an exchange of financial assets, much like the Fed does continuously, with no effect on demand.

The Treasury will take on Wall Street’s bad debts — mostly mortgage-backed securities for which there’s no market right now — and will raise the $700 billion by issuing additional government debt,

No, the government first pays for the mortgage securities and then offers Treasury securities (or now, interest-bearing reserves, which are functionally the same as Treasury securities) to support the overnight rate that the Fed’s target rate.

much of it to global lenders and foreign governments.

They exchange real goods and services for balances at the Fed because they want to. We then offer them alternative financial assets in the form of Treasury securities via an auction process that is bought at necessarily attractive levels.

As America’s housing stock regains value, as we all hope it will,

Yes, deep down we all hope for ‘inflation’…

bad debts become better debts, and the Treasury will be able to resell the securities for at least as much as it paid, if not for a profit.

And that would drain aggregate demand and be contradictionary, just like a tax.

And if there is a shortfall, the bailout bill allows the president to impose a fee on Wall Street to fill it.

Also draining aggregate demand.

Another difference is that in 1993, the nation was emerging from a recession.

Yes, because the deficit was allowed to get up to 5% of GDP.

Government deficit = Non-government accumulation of net financial assets, etc.

Although jobs were slow to return, factory orders were up and the economy was growing. This meant growing demand for private capital.

If so, loans create deposits: loanable funds went out with the gold standard.

Under these circumstances, the deficit Bill Clinton inherited threatened to overheat the economy.

I don’t recall any evidence of an overheating economy back then?

He had no choice but to trim it, a point that the Federal Reserve chairman, Alan Greenspan, was not reluctant to emphasize. Unless President Clinton cut the deficit and abandoned much of his agenda, interest rates would rise and the economic recovery would be anemic.

Interest rates would rise only if Greenspan, not market forces, raised them, which he may have threatened to do.

Next year, however, is likely to be quite different. All economic indicators are now pointing toward a deepening recession. Unemployment is already high, and the trend is not encouraging. Factory orders are down. Worried about their jobs and rising costs of fuel, food and health insurance, middle-class Americans are unable or unwilling to spend on much other than necessities.

Under these circumstances, deficit spending is not unwelcome. Indeed, as spender of last resort, the government will probably have to run deficits to keep the economy going anywhere near capacity, a lesson the nation learned when mobilization for World War II finally lifted us out of the Great Depression.

Agreed!!!

Finally, not all deficits are equal. As every family knows, going into debt in order to send a child to college is fundamentally different from going into debt to take an ocean cruise. Deficits that finance investments in the nation’s future are not the same as deficits that maintain the current standard of living.

Agreed!

Here again, there’s marked difference between 1993 and 2009. Then, some of our highways, bridges, levees and transit systems needed repair. Today, they are crumbling. In 1993, some of our children were in classrooms too crowded to learn in, and some districts were shutting preschool and after-school programs. Today, such inadequacies are endemic.

Yes, trillions of USD could be spent on infrastructure. But the key to ‘affordability’ at the macro level is unemployment and excess capital in general.

In 1993, some 35 million Americans had no health insurance and millions more were barely able to afford it. Today, 50 million are without insurance, and a large swath of the middle class is barely holding on.

Insurance is an entirely different issue than whether people are getting health care or not. He should make that point and then address the real issue (distribution of health care and other real goods and services) and not miss the financial for the real issues.

In 1993, climate change was a problem. Now, it’s an emergency.

Moreover, without adequate public investment, the vast majority of Americans will be condemned to a lower standard of living for themselves and their children. The top 1 percent now takes home about 20 percent of total national income. As recently as 1980, it took home 8 percent. Although the economy has grown considerably since 1980, the middle class’s share has shrunk. That’s a problem not just because it strikes so many as being unfair, but also because it’s starting to limit the capacity of most Americans to buy the goods and services we produce without going deep into debt.

That’s because incomes are too low, the largest taxes are the regressive payroll deductions, and the deficit is too small.

Time for a payroll tax holiday.

The last time the top 1 percent took home 20 percent of national income, not incidentally, was 1928.

Good statistic!

Perhaps it should not be surprising, then, that the Wall Street bailout has generated so much anger among middle-class Americans. Let’s not compound the problem by needlessly letting it prevent the government from spending what it must to lift the prospects of Main Street.

Agreed, but not by writing this type of thing.

Feel free to distribute.

Robert B. Reich, a secretary of labor under President Bill Clinton and a professor at the University of California, Berkeley, is the author of “Supercapitalism.”

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Things have come apart very quickly as government officials have demonstrated they are in this way over their heads.

Especially as it becomes clear the enormous efforts expended to get the TARP passed will do little if anything to address any of the current woes.

Government, including the Fed, has lost what little credibility it may have had.

While they have the ’silver bullet’ at hand with fiscal policy, they are reluctant to use it due to deficit myths left over from the gold standard that are no longer applicable.

Note earnings growth has moderated but not yet gone negative, ex financials.

Not reported is that core earnings for financials (ex writeoffs) are probably reasonably strong.

Q3 Earnings: Not So Pretty

by Juan Aruego

This earnings season is looking ugly and there hasn’t been much talk about which sectors are bringing the pain.

What’s different this quarter is that expectations for everyone are falling.

Until now, the weakness has been concentrated in banks. But this quarter, the consumer discretionary sector is getting crushed. Estimates have plunged from +15% on July 1st to -9% today.

Other depressing factoids:

• Four sectors are now expected to see earnings fall. Together they make up 27% of all earnings

• Only one sector, energy, is looking at growth above seven percent. Oh, for the days when double-digit growth was de rigueur.

• Can you believe that just three months ago, analysts thought Q3 financials’ earnings would be nearly unchanged from last year? How times have changed.

Amazingly, the ex-financials growth rate is still in the double digits, but it has fallen from 16.7% on July 1st to 11.3% now. As good as that sounds, excluding financials from the overall number is starting to feel a lot like paying attention to core CPI because it’s not as bad as overall CPI… especially since most of the upward drive is coming from the energy sector. Pull out the energy sector and the “growth” consensus plunges to -14.7%.

Here are all the numbers for you earnings wonks out there:

Q3 2008 Earnings Growth Estimates

Sector	Today	July 1st
Consumer Discretionary	-9%	15%
Consumer Staples	-1%	1%
Energy	53%	58%
Financials	-67%	-4%
Health Care	6%	8%
Industrials	3%	6%
Materials	5%	11%
Information Technology	7%	12%
Telecomm. Services	-5%	-4%
Utilities	3%	7%
S&P 500 Overall	-4.3%	12.6%
Without Energy Firms	-14.7%	4.7%
Without Financials	11.3%	16.7%

 
Special thanks to Thomson Reuters and its earnings gurus for the data to back up this story.

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1. Money fund issue:

   Remove the $100,000 cap on insured bank deposits. This adds no risk to government. And it will eliminate the need for money funds which the cap created in the first place.

2. Broker/dealers:

   Let them go. If they don’t survive, at worst their assets will be distributed by the bankruptcy court if it goes that far. They do nothing that I know of that serves public purpose and/or the real economy that banks can’t do. And the banks are already regulated and supervised.

3. Insurance companies:

   Policy holders should be government insured and insurance company assets, and capital regulation should be updated. You will know insurance regulation doesn’t go far enough if there are too many government losses to make policy holders whole.

   AIG got short credit (sold insurance on securities at low prices) and lost all their capital as risk and the price of insurance went up. Looks to me like a failure of regulation that allowed that much risk.

4. Home ownership:

   Continue to fund the agencies via the Treasury to keep costs of funds at a minimum.

   Have the agencies ‘buy and hold’ new originations, and thereby eliminate that portion of the secondary markets. The secondary markets serve no public purpose, beyond working past flaws in the institutional structure that should instead be addressed.

   Increase and enforce criminal penalties for mortgage application fraud. Its functionally the same as robbing a bank.

5. Banks:

   Lower the discount rate to the fed funds target rate and eliminate the need for collateral. This is how it should have been anyway.

   Bank assets and solvency are already highly regulated, and how they are funded doesn’t alter the risk of loss due to insolvency for the government.

   An interbank market serves no public purpose. Eliminate it out to six months by offering discount lending out to 6 months.

   In addition to the FOMC setting the fed funds rate target, it can also set the rate for 3 and 6 month borrowing at the discount window. This both gets the job done and also replaces the TAF and TSLF type of experiments.

6. Growth and employment:

   Offer (directly or indirectly) a Federally funded $8 per hour full time job to anyone willing and able to work that includes health care benefits. An employed buffer stock is a more effective stabilizer and price anchor. It’s also less costly in real terms, than the unemployed buffer stock we currently maintain.

   Eliminate the various payroll taxes as needed to sustain demand.

   Implement needed infrastructure upgrades and repairs.

   Eliminate health care as a marginal cost of production. People aren’t more likely to get ill if they are employed; in fact, the opposite is likely the case.

   The current system distorts pricing, and results in a suboptimal outcome for the economy’s ability to sustain prosperity.

If you in general agree with the above, please forward this to all your contacts in high places asap, thanks.

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My take is an RTC type solution only works when the government owns the institutions, so this will probably be different.

I suspect it will be more like Japan, where the government bought a new class of preferred stock in the banks to add capital.

Whatever they will do will cause credit spreads to come in, which will make the assets of AIG far more valuable and probably result in a ‘profit’ for the government.

Unsold Lehman assets will also appreciate.

More comments below:

Paulson, Bernanke Push New Plan to Cleanse Books

by Alison Vekshin and Dawn Kopecki

Government Options
Options that U.S. officials are considering include establishing an $800 billion fund to purchase so-called failed assets

I see this as problematic as above and as below.

and a separate $400 billion pool at the Federal Deposit Insurance Corp. to insure investors in money-market funds, said two people briefed by congressional staff. They spoke on condition of anonymity because the plans may change.

This puts money funds on par with insured bank deposits. Seems no need for both.

Instead, better to remove the $100,000 cap on bank deposit insurance to allow large investors use bank deposits safely. There is no economic reason for the low cap in any case.

Another possibility is using Fannie and Freddie, the federally chartered mortgage-finance companies seized by the government last week, to buy assets, one of the people said.

That’s already in place. They already have treasury funding to buy mortgages.

“We will try to put a bill together and do it fairly quickly,” House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, said after the meeting. “We are not in a position to give you any specifics right now” on the proposals, he said when asked about the potential cost.

The likelihood of the government taking on yet more devalued assets, after the seizures of Fannie, Freddie and AIG and the earlier assumption by the Fed of $29 billion of Bear Stearns Cos. investments, may spur concern about its own balance sheet.

We need to get past this concern about government solvency. It’s simply not an operational issue.

Debt Concern
The Treasury has pledged to buy up to $200 billion of Fannie and Freddie stock to keep them solvent, while the Fed agreed Sept. 16 to an $85 billion bridge loan to AIG. The Treasury also plans to buy $5 billion of mortgage-backed debt this month under an emergency program.

“It sounds like there’s going to be a giant dumpster for illiquid assets,” said Mirko Mikelic, senior portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan, which oversees $22 billion in assets. “It brings up the more troubling question of whether the U.S. government is big enough to take on this whole problem, relative” to the size of the American economy, he said.

This is ridiculous and part of the problem that got us to this point.

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The JG is job guarantee, and it’s identical to ELR which is simply offering a national service job to anyone willing and able to work.

Bill is based in Australia, and his book can be ordered from this website.

He is one of the few who is ‘in paradigm’.

Excerpts from Bill’s email to me:

>   
>   I have been in South Africa and now in Europe. Today I gave workshops to
>   senior policy managers at the ILO in Geneva on employment guarantees. I have
>   some further meetings tomorrow with managers of ILO programs in Nepal and
>   Mozambique and they are keen to map out an agenda to introduce JGs in those
>   countries.
>   

Well done!

>   
>   I will provide a full report about all the workshops and meetings I have had in
>   the last 3 weeks when I get back home on Tuesday.
>   
>   Hope all is getting back to normal. The financial markets certainly are going
>   crazy. No-one has really said that the US government cannot afford to pump 82
>   billion here and some more there etc into defending financial capital. That issue
>   - of financial solvency and capacity of the Govt hasn’t come up. interesting.
>   

There have those giving warnings about solvency, and that the US will get downgraded if it goes too far.

And there are those that say ‘pumping in all that money’ is inflationary.
 
 
All the best!,
Warren

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>   
>   On Thu, Sep 18, 2008 at 4:21 PM, Eric Tymoigne wrote:
>   
>   One former FOMC member at least gets it (From the NYT) (well, at least if you
>   replace “can create money” by “can create reserve”):
>   

I’ve heard him before, and he definately doesn’t quite get it. See my comments below:

September 18, 2008, 3:15 pm

Will Government Bailouts Lead to Inflation?

by Catherine Rampell

A reader asks about inflation concerns, and finds a divided response from our panel:

I’m worried about how much the government is intervening. It appears that the last remaining weapon the government will have is printing more money. Is hyperinflation a real concern down the road? — Geoffrey Bell

The question is about hyperinflation.

From Bob McTeer of the National Center for Policy Analysis:

All the offsets do is to alter the resulting interest rate. The offsets have nothing to do with inflation. Fed operations are about pricing, not about inflation per se. The only connection Fed policy has regarding inflation is the further effect of the interest rate they select. It has nothing to do with quantity.

The Fed’s ability to lend is limitless because it can create money.

All Fed lending is ‘creating money’ (changing a number in a member bank’s reserve account).

So it’s not that it’s limitless because it ‘can’ ‘create money,’ it’s limitless because it always/only does ‘create money’.

Its ability to offset the lending is limited by its portfolio. Hence, its request to the Treasury to sell some extra Treasury bills. — Bob McTeer

Yes, and this is a self imposed constraint put on by government.

Functionally and operationally, a treasury security is nothing more than a credit balance in a security account.

Current law doesn’t allow the Fed to take funds into a securities account of its own creation.

This is one of many self-imposed constraints by government that are contributing to ‘the problem’.

warren

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