Posts Tagged ‘federal reserve’

Federal Reserve’s Scary Math

Thursday, December 10th, 2009

In the early 1980’s mortgage rates where above 14% and other debt carried an even higher rates of interest. During the early 1980’s, banks required most home buyers to put down 20% and have spotless credit. For example if a buyer purchased a home for $125,000 he or she would more than likely need to put $25,000 down (20%) and the monthly principle and interest payment at 14% would be $1184.87.

Over the past 25 plus years, rates on mortgages and most debt have fallen considerably. The cause of this decrease in rates is mostly attributed to the Federal Reserve’s action of lowering rates and raising rates to control inflation in the US economy. Clearly the Federal Reserve has viewed the past 2 plus decades as having relatively low inflation thereby lowing more than raising rates (Fed Funds Rate).

Lowering rates more than raising them creates cheaper costs of borrowing thereby making room for more. This cheap money also creates more of a demand for credit. This excessive credit demand led to fierce competition among banks. Competition is definitely a good thing until demand starts to wane. As soon as the credit demand let up this led to banks acting as their own Federal Reserves by creating products that artificially lowered the cost of lending thereby stimulating borrowing.

Most home buyers view a home purchase not by the sales price, but by the down payment and monthly obligation. Now let’s look at the buyer from the early 1980’s with he or she’s $25,000 to put down and the ability to afford $1184.87 monthly payment. This buyer today could afford a $225,000 home with $25,000 down with $1183.08 monthly principle and interest payment with an interest rate of 5.875% and relaxed down payment restrictions. Identical down payments and same monthly, but twice the debt, was the growth in value or debt?

This rather rapid reduction in the cost of money over the past two plus decades has led to an equal increase in the price of cars, education, utilities, etc. Inflation seems to have been masked in credit. The credit markets in the US and around the world nearly collapsed because they had “maxed out their credit”. With the rapid expansion of debt at the end of the road with the Fed Funds rate at 0 to .25% target and lending rates increasing because of diminishing credit quality (except for mortgages because the Federal Reserve is supporting the rates), what’s next? Deflation?

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Ben Bernanke and The Federal Reserve Money Factory

Thursday, December 3rd, 2009

golden-ticketOver the past few weeks Republican Congressman Ron Paul out of Texas has been making a noticeable push to get more transparency out of the Federal Reserve. The Federal Reserve members and its Chairman (Ben Bernanke) have been verbally opposed to the measures that the Congressman is attempting to have enacted. The proposal Congressman Ron Paul is pushing for would allow for an independent audit to be called for following any decisions on monetary policy by the Federal Reserve.

Currently the Federal Reserve keeps most of its dealings a secret. The Federal Reserve believes that by keeping politics and the public view out of monetary policy they will be able to act more prudently and timely without influence. They believe that this independence is crucial to maintaining their objectives.

Some believe that many of the problems today are caused by their objectives. The Federal Reserve’s deliberate reactions to economic events creates a relatively predictable cycle. When the economy contracts, the Federal Reserve lowers rates to expand credit to spur growth with cheap money. When the economy is growing too fast they raise interest rates to slow the growth. Unfortunately, it is much easier to indentify contraction than over expansion, which typically results in a late raising of rates which can result in a bubble.

For the past 25 years the Federal Reserve has lowered rates more than raising them and now is faced with a very troubling 0 to .25% Fed Funds Rate. Interest rates as a whole should be falling, but for credit that is not supported by the government, rates are rising. One can only assume that with banks profit margins so high that the rising rates are being caused by falling credit quality and defaults. The Federal Reserve has resorted to another avenue in attempts to promote lending with “quantitative easing”. Quantitative easing is essentially when the Federal Reserve becomes the lender of last resort. This form of injecting money into the economy can have adverse and unknown consequences, since much of the money is created out of thin air in the form of credit.

Who, what and how they are supporting these institutions seems to be behind Congressman Ron Paul’s motivation. Over this historical Financial Crisis the Federal Reserve’s political powers have been weakened. We will see if this weakness will lead to the Congressman getting his golden ticket.

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Federal Reserve Statement

Wednesday, May 20th, 2009

Judge for yourself, but it looks like according to the US Federal Reserve the outlook has not improved. The economy has continued to “contract” and their hope is resting on the stimulus and the Federal Reserve’s steps it has already taken. They cite household spending has seen signs of stabilizing, “but” with continued job loss, declining housing wealth and tight credit, it still is “constrained. There has never been a time in history where fighting a credit crisis with credit has ever won. Maybe it isn’t a lack of credit, but too much credit in the system.

Here is a copy of their statement released today at 2:00 PM EST:

Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower. Household spending has shown signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Weak sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories, fixed investment, and staffing. Although the economic outlook has improved modestly since the March meeting, partly reflecting some easing of financial market conditions, economic activity is likely to remain weak for a time. Nonetheless, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is facilitating the extension of credit to households and businesses and supporting the functioning of financial markets through a range of liquidity programs. The Committee will continue to carefully monitor the size and composition of the Federal Reserve’s balance sheet in light of financial and economic developments.

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Bank Stress Test – Possible Train Wreck?

Friday, May 8th, 2009

File:Train wreck at Montparnasse 1895.jpgSince the announcement of the Bank Stress Test the US Government has been promising a level of transparency that was suppose to shed light on the real condition of the largest banks in the USA. The official results were announced at 5:00 PM EST but the actual results had been leaked to the press over that past two weeks.

With the test scores in, Wall Street seems unsurprised by the results. The US Government seems to have spent more effort on releasing the information so as not to disrupt the markets, than realistically testing the banks. This test was supposed to see if banks could handle another future financial earthquake. Instead it seems to have tested if they could handle what may be a best case scenario.

The US government used both a worst case scenario and a more “probable case” to test the possible financial needs of Americas 19 largest banks. The “probable case” unemployment for this year has already been met. The Federal Reserve Chairman during his last testimony to congress stressed the increasingly concerning commercial real estate industry, but the test puts little weight to it. The Bank Stress test seemed to be more political propaganda to spur optimism than a true test of structural integrity.

Consumer credit was released today showing consumers paid down debt $11.1 billion in April instead of the forecasted reduction of $4.2 billion. The consumer still appears to be concerned about debt reduction than expansion. The backbone of the US governments recovery plan is to expand lending and spur consumer spending.

United States Railroad freight traffic was down 23 percent in April and 18.2% year to date. Railroads move raw goods around America. The Association of American Railroads Senior Vice President John T. Gray was quoted in a released statement “Unfortunately, it’s hard to find much in rail traffic data in April to support the idea that the economy is starting to see ‘green shoots’ … it may still just be weeds”. How can manufacturing be recovering without the raw goods to make products?

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Banks Profitable – That was Easy

Thursday, April 16th, 2009

Okay so here we are again, it is earning season and to the market’s surprise banks are showing some profits. When I make the above statement I can’t help to picture a older man in a suit riding a bike with training wheels saying “Mom look, I can ride a bike”.


All it took was nearly a trillion dollars to suppress mortgage rates; billions of dollars of direct aid, small change to Market to Market accounting and a commitment from the US government indicating they will not them fail.

Meanwhile earnings of companies who do not have the favor of the government are falling rapidly. Housing starts again appear to be retrenching (remember this was a pillar which Wall Street put such angst on citing recovery). A large commercial real estate firm (holds over 200 malls across America) filed for bankruptcy protection today with a disclosed $29.6 billion in assets and $27 billion in liabilities. What banks are on the hook for that?

The US economy cycles through expansion and contraction of credit. This process has occurred for centuries. Since the Federal Reserve started to maintain control of the overnight bank rate the cycles have become somewhat more predictable. This predictability occurs because as the Federal Reserve identifies where the US economy is in a cycle it responds with a rather predictable action. This action has a somewhat predictable response.

When the economy approaches over expansion of credit the Federal Reserve raises the overnight bank rate to raise the cost of lending, which theoretically should slow growth. When the economy starts to contract credit, the Federal Reserve lowers the overnight bank rate to lower the cost of lending, which theoretically should spur growth.

The actions to save banks over the past year are meant to contribute to the above mentioned goal. The US Government and Federal Reserve are attempting to reduce the cost of lending to spur growth. The dilemma that is facing the United States is that currently its citizens are contracting out of fear. The average US citizens’ mindset has changed from over consumption to conservation. Since US consumers makes up about 70% of GDP, growth cannot occur without them.

To stabilize the US consumer you most likely need to improve unemployment to reduce this fear. This week showed an improvement in claims (attributed to the holiday week) but continued claims are still rising (over 6 million). This indicates that finding a job is still a challenge. For job growth to resume, someone needs to start hiring. The US government is attempting to take this role artificially with their behemoth stimulus they passed.

It appears the US government is attempting to put training wheels on its economy by trying to shoulder the weight on their own. These banks that have already had the training wheels attached are profitable off the actions of the US government, at the expense of the US taxpayer. I was under the impression that companies went out of business because not enough business to support them. What happens when (if?) the US government takes off the training wheels? Will the economy ride on its own or break a leg?

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Is Deflation the Problem or the Solution?

Saturday, April 4th, 2009

Over the past year the US government has taken large steps to ward off the destructive forces of deflation. Deflation takes much of the blame for the financial crisis during the depression of the 1930’s.

Instead of following in the monetary footsteps of the Federal Reserve during the depression, the current US Federal Reserve is attempting to monetize their way out of the problem by flooding the system with money.

One thing is for sure, the Federal Reserve of the 1930’s was successful in the long run. The United States emerged as the power house economy of the world. During the 1930’s prices came down and leverage was reduced through the process of deflation.

The current policy of the United States is to attempt to re inflate the US economy at all costs. This policy reflects a belief that deflation is worse than inflation. The Federal Reserve believes that they can control inflation through the control of the overnight bank rate.

If they can control inflation, than why has debt grown significantly (historically) faster than income over the last 30 years? Stable growth, in my opinion, should be complimented by salary growth and not expanded credit. Unfortunately complex financial instruments have fooled our Federal Reserve into believing we have had very tame inflation over the past 30 years. How do you bring debt back into balance with income? Deflation?

Couple relevant quotes:

“I place economy among the first and most important of republican virtues, and debt as the greatest of the dangers to be feared.” -Thomas Jefferson -1816

“I have sufficiently urged that all suggestions as to financial innovation be regarded with extreme skepticism” John Kenneth Galbraith from “A Short History of Financial Euphoria”

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Are Bank’s Balance Sheets going Green on the Taxpayers Back?

Thursday, March 26th, 2009

The Federal Reserve and the US Treasury Department have made dramatic moves (at a heavy taxpayer cost) over the past few months to artificially suppress rates to reduce the cost of lending. Unfortunately these actions also reduce money market yields.


Recently large banks have been revealing their surprisingly profitable beginning of the year. I would note that these so-called profits are actually not including further write downs on bad loans they have made.

Are credit card rates at all time lows? Interestingly the other day I received a notice in the mail from a credit card indicating that they were raising their profit margin (prime plus their margin). My credit rating has not changed. Are they raising their profit margins on their good standings customers to help pay for the bad ones? Am I paying for their credit rating being reduced?

So even though prime is at a very low at 3.25% it seems as though credit card rates have managed to stay the same. Could mortgage rates actually be lower than they are now? Are banks gouging us to claw back from the grave?

Consumer spending is down and savings rates are on the rise. It seems to me that the people would rather make more money on their savings than letting banks make more money off of us.

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Worried about Inflation? What!

Thursday, March 19th, 2009

Are they serious? The US Federal Reserve yesterday took significant action to promote lending and restore growth to the US economy. The Federal Reserve cited the following reason for the dramatic action:

Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession.

Inflation will be an issue in the USA when it actually starts growing instead of contracting. Read the above statement from the Federal Reserve, does this seem like growth is around the corner? If growth is so close, then why has the Federal Reserve taken made such a bold move? I think that Deflation is the real concern here. Remember that we can stop inflation; Deflation is the real scary one, especially since the Federal Reserve has already thrown the kitchen sink at the problem. It is funny how the stock market always seems to be so ahead of the news without actually thinking about the now. It is true, low rates makes growth easier because of the cheaper cost of money, but to get to the ending you have read the whole book.

Annual inflation rates in the United States from 1666 to 2004

Annual inflation rates in the United States from 1666 to 2004

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