Why the Fed's Rate Cut Was a Mistake
Yesterday, the Federal Reserve cut interest rates by 75 basis points, or .75 of a percentage point. There has been a lot of commentary about what this move means and what it signals. I fall into the camp of "this won't do a damn bit of good" and below I'll explain why. This is a compilation of posts from my blog yesterday.
Interest rates aren't that high right now.
To listen to the rate cutting crowd, you would think that interest rates were at godawful levels that prevented lending. Nothing could be further from the truth.
Above is a chart of the effective Fed funds rate. I eyeballed a line from current rates back through the history of previous rates. Notice today's rates aren't that high, especially in a historical context. In other words, money isn't that expensive right now.
Above is a chart of th constantly maturing 10-year Treasury. Note that rates have been declining for nearly 20 years.
Above is a chart of AAA corporate paper. Notice the highest rates have been during this expansion corresponds to the low point of the previous cycle. Simply eyeballing the chart, it looks like AAA corporate paper is about 5.25%. That's not expensive at all.
The same analysis goes for BBB paper -- it's just not that expensive to borrow right now, even for a riskier corporate credit.
So -- interest rates just aren't that high right now.
Inflation is on the horizon
You've seen them before and you'll see them again. I should probably start asking regular readers to draw these graphs from memory. But --
Agricultural prices are in the middle of a three year bull run
And oil prices are in the middle of a year long bull run -- although they may be forming a double top here. But either way -- oil prices have increased smartly over the last year.
So -- we may have a really ugly inflation picture emerging.
Let's look at what got us into this mess.
Look specifically at the rates from the early 2000s. I drew a line from those levels all the way back to the beginning of the chart. Notice that rates were not that low for about 40 years.
Let's look at what else happened during that time. Here is a chart of total household debt outstanding:
And here is a chart of the last 10 years of total household outstanding:
Notice the mammoth increase? Total household debt outstanding went form about $8 trillion to a little under $14 trillion, or an increase of about 75%.
All of that debt has to go somewhere -- it doesn't exist in a financial netherworld. It has to become an asset to somebody. And it has -- in the form of a massive amount of securitizations which are currently being written down by literally every financial name in the business. So far we've seen about $100 billion or writedowns in the financial markets and we are going to see more. That's the central problem right now; it's not interest rates but the amount of crap on the books of various financial players (hell -- all the financial players).
In other words, the problem isn't the need too underwrite more consumer debt -- we are already choking on consumer debt. The problem is the system made too many loans that are now going bad. And the only way to wean us off of that problem (easy money) is to feel the pain so we don't do it again.
Let's take a look at money supply. I'll be using MZM which is:
A measure of the liquid money supply within an economy. MZM represents all money in M2 less the time deposits, plus all money market funds.
Here is a chart from the St. Louis Federal Reserve of the total MZM money supply:
Notice that starting in late 2005 the total started increasing and has been increasing ever since. Let's see what the percentage change chart looks like:
This number has been increasing for the last year and a half, indicating money supply is increasing.
And then there is M3, which the government no longer publishes but which is available from the website shadowstats:
That's a huge increase.
So -- the issue isn't money supply. The facts show there is ample money in the system. The basic problem is no one wants to lend right now.
The glum news from U.S. banks continued with steep declines in fourth-quarter profit at five large lenders, led by Bank of America Corp. and Wachovia Corp., while mortgage-related woes plunged regional bank National City Corp. to a steep loss......
The results capped a miserable earnings season for the banking industry, which was riding high until the mortgage meltdown triggered huge write-downs on investments, forced banks to begin hastily rebuilding loan-loss reserves, and exposed how far many lenders strayed from their roots during the housing boom. "It is back to basics," Bank of America Chief Financial Officer Joe Price told analysts in a conference call yesterday.
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Despite saving $500 million a year with the dividend cut, Jeff Kelly, National City's chief financial officer, said the Cleveland bank still is considering "a number of options for nondilutive...capital issuance this quarter."
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At Regions Financial Corp., Birmingham, Ala., which has a major presence in Florida and other parts of the Southeast being clobbered by the housing downturn, profit tumbled 80%. KeyCorp, of Cleveland, reported an 83% profit decline. Fifth Third Bancorp of Cincinnati saw its fourth-quarter net income slide 39%. National City swung to a loss of $333 million, or 53 cents a share, from a year-earlier profit of $842 million, or $1.36 a share.
While all six banks said the performance of many businesses remains at least decent overall despite the weakening economy, deteriorating credit quality is causing loan-loss reserves to balloon in anticipation of further trouble. The six banks reported a combined loan-loss provision of $6.22 billion in the fourth quarter, up 181% from $2.21 billion a year earlier.
The financial sector is really sick right now. And it's not just one player -- it's everybody in the system. Loan loss reserves are increasing, banks are looking at ways to increase capital, writedowns are hammering earnings.
The underlying hope of a rate cut is it will encourage financial players to make new loans and thereby stimulate the economy. But what banks are looking to repair the damage of previously made poor lending decisions, making new loans is far from their minds.
The facts are clear:
1.) Interest rates aren't high right now. In fact, they are downright inexpensive.
2.) Debt levels are high right now. More loans aren't the answer -- paying off some of that debt is.
3.) Money supply has been increasing at decent rates, indicating there is plenty of cash in the market.
4.) The financial sector is sick as a dog and has to heal itself. That's going to take time and prevent them from doing what the Fed wants them to do, which is make loans.
I will admit that I have a great deal of sympathy for Bernanke. Greenspan inflated the last asset he could (housing), waited until the market topped and then handed the keys of the economy over to Ben and said, "Good luck (you're really going to need it.)" Essentially, Ben is between a rock and a hard place with no good options available.
However, the main problem of the US economy is we are literally choking on debt right now -- and some of that debt is really bad debt meaning it won't get paid off. So the economy has to go through a period of de-leveraging -- getting rid of some of that debt. And that will take time and be painful. And frankly, there really isn't a way around it right now.
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No one has mentioned the new Bankruptcy laws in all of this. Considering the high rate of foreclosures, where does this new law rear it's ugly head and what does it mean for the "middle income" American with a home he may lose to the banks? Who does the law protect, the "people" or corporatio
Your graphs and charts are most interesting, but unfortunately, not worth a hill of beans if you're trying to sell your house today. Whether you bought your home three or thirty years ago..do or don't have a subprime mortgage..
Ye gods! All you have to do is count the number of "payday" check cashing stores popping up on every corner (even in those "better" neighborhoods) to get the hint! Speculators have bought and sold and bought and sold..pric
Those who are old enough to have been watching Saturday morning cartoons back in the early 70's may recall a series of ABC animated shorts called "Schoolhouse Rock" i.e. "Multiplication Rock", "Grammar Rock", and "America Rock", the last about US history. In the last group there was one short that I never saw in the original run, possibly because it never was run, possibly because it was considered too disturbing for kids. It was called "Debtosaurus", and was about the history of national debt, represented as a steadily growing Godzilla-type monster. Perhaps it's time ABC shows a new primetime version that includes corporate and consumer debt, for the edification of adults as well as kids.
The economy will not flourish until the people do. Many of the lending practices used by banks are inherently unfair/deceitful, and this is going to take more than a rate cut to sort out. And the national debt? Well, maybe it's real after all (we'll see.) The economy will bounce back to a degree, but it will not flourish until the people who make up that economy do.
What a relief! Someone else out there GETS this! PAY ATTENTION, folks! Here are the new 10 economic commandments.
1. Thou shalt not spend more than thou earnst. Otherwise, thou shalt never own a home outright!
2. Thou shalt never sign an adjustable rate mortgage. They are for suckers! Save enough for the down-payment you need for a fixed-rate!
3. Thou shalt never even consider a sub-prime loan. It will eat you alive!
4. Thou shalt not enter a mall more than once a month. It will scalp your paycheck!
5. Thou shalt limit thy credit-card use to emergencies only and pay it off ASAP.
6. Thou shalt deposit thy paycheck into a savings account and transfer only what thou needst to pay monthly bills to thy checking account.
7. When thy savings account hits $10,000, thou shalt open an investment account and contribute to it whatever exceeds that amount at the end of each month.
8. Thou shalt listen to economic news instead of American Idol; it will save your sorry butt!
9. When thou goest to the gas pump, don't blame the Saudis for the cost. Our dollar is no longer worth the paper it's printed on. Their costs keep going up. Do you expect them to eat the difference?
10. The next time the president says: "Go to the mall and spend!", politely suggest to him where he should go.
What about an economics of not increasing DEBT but restructuring debt at lower interest rates (consolidation) the way INTERNATIONAL debt crises have been addressed in the past (admittedly a very vague analogy). But specifically helping out homeowners who face foreclosures and job-creation ALSO mitigate debt problems -- indeed limiting indebtedness might be part of the deal for individuals being bailed out by the federal government from "foreclosure situations" as well as foreclosures per se.
bonddad is a respite of intelligent insight in the noise of the drekkosphere.
otherwise, all i can say is--wow. the reason more people don't get any of this is because they don't have maps, and, they should have maps because, like, south africa and the war in iraq, we should be supporting america because china knows that, like, iraq and south africa, more people want to, like, bring love and peace to mankind, with maps.
By now, anything George W. Bush is for, I'm against.
His only accomplishment in the last seven years has been amping up relief for African AIDS victims.
Every other initiative, decision or action on his part has been DEAD WRONG.
There is very little left in this country to invest money in these days. The money that is created with the rate cut will go off shore and the dollar will continue to decline. There is no way left to channel the money into the pockets of the American public which is what is needed for a recovery. Tax cuts will result in a short spending spurt and everyone will say that things are getting better until they get worse again. Too much money has been created and too much has been loaned.
Too many got greedy.
Money markets aren't so much driven by reality as the perception of some part of the reality of what happens next. Maybe it's all smoke and mirrors, but it worked for today. Tommorow is another day.
Almost makes you want to tie the dollar, one-to-one, to the Chinese yuan.
The secret is to have the fed print more money,print up a couple of million for each and every congressmen,and senator, then maybe the earmark bullshit will stop and we can get on with our failing economy. i'm sure that would get congress to ok that!
The real truth is that there is hundreds of TRILLIONS of dollars of debt worldwide in the form of CDO's, SIV's and other arcane instruments of debt understood by only a handful of people on the planet. These obligations exist as ones and zeroes on computers and move around the world at the speed of light in a giant shell game. What happened was the shell game was stopped due to a lack of confidence that the game would be solvent, if to many players was asked to retrive some ones and zeroes to pay off debt.
The Fed rate cuts were a mistake, but putting out a slight decline in rates from the absurdly high Volker rates in the early 1980s isn't the reason.
The Federal government has been driving the US into deeper and deeper debt since Reagan. The 1990s boom and responsible fiscal management gave us our first surpluses in years, and then Bush lied to Americans that you can have tax cuts and endless wars at no costs. The result has been a massive loss of competitiveness, a dollar cut in half, spiking oil prices, and dramatic increases in consumer debt. The house is about to fall apart, and any attempts to alleviate it by encouraging more debt, on the personal or public level, only worsens the long-range issue.
By cutting rates, the Fed is inviting more inflation, and further kneecaps the dollar. Further falls in the dollar will cause oil and other imports to rise in price, thus creating more inflation. Inflation is what causes recessions, and the Fed and Bush are encouraging inflation with their short-term fixes. This is more like giving chocolate bars to an obese, type II diabetic than giving medicine to someone with a cold.
It seems to me the fed in collusion with congress is the problem in the first place. First of all they create inflation and devaluation of the dollar, which is really the same thing, simply by putting more into circulation. The congress wants to spend money, but dont want to raise taxes, so they kindly ask the fed to print it up (a lot of the time it's not actually printed just moved around on computers with the same effect) and spend it and give a few pennies back to the serfs who vote them in and everybody wins right? People we allow a banking cartel in collusion with the government (which only helps the fed) to have a monopoly on creating our money....h
If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them (around the banks), will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered.
“I sincerely believe … that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale.” jefferson
“All the perplexities, confusion and distresses in America arise not from defects in the constitution or confederation, nor from want of honor or virtue, as much from downright ignorance of the nature of coin, credit, and circulatio
The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves…. [This] is the shabby secret of the welfare statist’s tirades against gold. Deficit spending is simply a scheme for the ‘hidden’ confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.” alan greenspan
"Vote ron paul and take back our money and the rest will follow" - me
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Posted January 23, 2008 | 08:36 AM (EST)