A House Divided: A Synopsis of Bernanke's Speech at Jackson Hole, and What It Means

When listening to a speech like this, one has to remember who is speaking and under what conditions. A Fed Chairman has a thousand watt megaphone attached to his chest, and so he must speak quietly and calmly, in order not to disrupt markets and place the Fed in the middle of political controversies. Unless you have actually been close to or in a position of power, where your words carry great significance, it is all too easy to forget this.

Bernanke addressed his problem with the dysfunctional Congress, gridlocked by luddites and libertines, and the serpentine leadership style of Obama.  He is trying to stand his monetary policy on a two legged stool, and it is not working.  The all important fiscal side of economic governance is broken.  Not so much that it is doing the wrong things.  Rather, the process itself is broken, hopelessly frozen by ideological warfare and implacable extremes.

He reiterated that the Fed has the additional policy tools to deal with the situation, in addition to the unprecedented actions they have taken already, although there is a lack of consensus on his own Fed. It is significant that they have expanded their September meeting from one to two days in order to discuss this more fully.

Bernanke gave a particularly sharp rebuke to the Congress, at least by Fed Chairman standards, for the debt ceiling deadlock and discussions that recently shook confidence in the markets.

There is little doubt in my mind that the Fed will put some additional scalable programs in place before the end of the year. The introduction of new programs during a Presidential election year is typically considered to be only acceptable at extreme risks to the banking system and obvious duress to the economy.

As a reminder, there will be another Non-Farm Payrolls number out next week.

There are forces in the US that are on the offensive, and pushing for a crisis in order to better obtain their objectives. What Bernanke is doing is positioning the Fed on the sidelines as best he can, while signaling that they will act once again, overtly or quietly, to prevent a major financial breakdown.

But he is stressing that the Fed has done quite a bit already, and they cannot do it alone. The monetary actions are ineffective without a fiscal counterpart. Like most observers, the Fed sees a broken governance process, and the new super-committee is likely destined to fail in more gridlock. The Fed will not act again except under the duress of an approaching crisis, although they will have the programs in place in anticipation of that crisis.

The US is a house divided against itself. Until the system of governance is repaired, the Fed cannot be reasonably expected to take up the burden of the nation's problems on its own.

So for the future, listen to what the Fed says, but more importantly, watch what the Fed does. And some of that may be opaque, at least for the time being.

This is not necessarily what I think, or what I would do if, God forbid, I was the Fed Chairman. This is what Bernanke is thinking in his own words, and what I believe he is doing, and to some extent, why he is doing it.

Fri Aug 26, 2011 10:00am EDT

JACKSON HOLE, Wyoming, Aug 26 (Reuters) - The following are highlights of Federal Reserve Chairman Ben Bernanke's speech on Friday to a central bank conference sponsored by the Kansas City Federal Reserve Bank.

On economic growth, inflation outlook:

"The recent data have indicated that economic growth during the first half of this year was considerably slower than the Federal Open Market Committee had been expecting, and that temporary factors can account for only a portion of the economic weakness that we have observed.   Consequently, although we expect a moderate recovery to continue and indeed to strengthen over time, the Committee has marked down its outlook for the likely pace of growth over coming quarters.

"With commodity prices and other import prices moderating and with longer-term inflation expectations remaining stable, we expect inflation to settle, over coming quarters, at levels at or below the rate of 2 percent, or a bit less, that most Committee participants view as being consistent with our dual mandate."

On what the Fed's recent policy decision means:

"We indicated that economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. That is, in what the Committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years."

On what other tools the Fed has:

"In addition to refining our forward guidance, the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. We will continue to consider those and other pertinent issues, including of course economic and financial developments, at our meeting in September, which has been scheduled for two days (the 20th and the 21st) instead of one to allow a fuller discussion. The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability."

On market volatility:

"Financial stress has been and continues to be a significant drag on the recovery, both here and abroad. Bouts of sharp volatility and risk aversion in markets have recently reemerged in reaction to concerns about both European sovereign debts and developments related to the U.S. fiscal situation, including the recent downgrade of the U.S. long-term credit rating by one of the major rating agencies and the controversy concerning the raising of the U.S. federal debt ceiling. It is difficult to judge by how much these developments have affected economic activity thus far, but there seems little doubt that they have hurt household and business confidence and that they pose ongoing risks to growth. The Federal Reserve continues to monitor developments in financial markets and institutions closely and is in frequent contact with policymakers in Europe and elsewhere."

On long-term economic growth prospects:

"It may take some time, but we can reasonably expect to see a return to growth rates and employment levels consistent with those underlying fundamentals ... Notwithstanding the severe difficulties we currently face, I do not expect the long-run growth potential of the U.S. economy to be materially affected by the crisis and the recession if -- and I stress if -- our country takes the necessary steps to secure that outcome."

On the impact of monetary and fiscal policy:

"Normally, monetary or fiscal policies aimed primarily at promoting a faster pace of economic recovery in the near term would not be expected to significantly affect the longer-term performance of the economy. However, current circumstances may be an exception to that standard view ... The quality of economic policymaking in the United States will heavily influence the nation's longer-term prospects. To allow the economy to grow at its full potential, policymakers must work to promote macroeconomic and financial stability; adopt effective tax, trade, and regulatory policies; foster the development of a skilled workforce; encourage productive investment, both private and public; and provide appropriate support for research and development and for the adoption of new technologies."

The Banking Crisis: Obama's Iraq Part 2

It is hard to assess who among the current DC crew are more limp when it comes to addressing the banking crisis in a meaningful and effective manner: Geithner, Summers or Bernanke.

They are all the very picture of the bureaucrat, which is a nice way of saying "systemic hacks." Have Timmy and Ben have reached their level of incompetency? Larry Summers has far exceededed his some years ago at Harvard.

It is difficult ground when one speculates on motives, but these are all rather bright fellows, albeit creatures nurtured by the system that they serve. It is hard to accept that their inability to address our financial crisis is sheer incompetency. But for now they obtain the benefit of doubt and the CEO's defense made so popular by the Enron crowd.

We wonder how bad it will get before Obama understands that his team is not working, that they have no actionable vision among them for whatever combination of reasons, and that the corruption being perpetuated is starting to stick rather handily to the Democrats.

The banking crisis is starting to look like Obama's Iraq.


Bloomberg
Hoenig Says Treasury Failed to Take ‘Decisive’ Action on Banks
By Steve Matthews and Vivien Lou Chen

March 6 (Bloomberg) -- The U.S. Treasury has failed to take “decisive” action to address the bank crisis, pursuing an ad- hoc approach that leaves management in place and avoids necessary asset writedowns, a veteran Federal Reserve official said.

“If an institution’s management has failed the test of the marketplace, these managers should be replaced,” Fed Bank of Kansas City President Thomas Hoenig said in prepared remarks for a speech in Omaha, Nebraska. “They should not be given public funds and then micro-managed, as we are now doing” with “a set of political strings attached.”

Hoenig’s comments are the most detailed criticism of the Treasury’s actions by a Fed official since the financial crisis began. By contrast, Fed Chairman Ben S. Bernanke has endorsed the approaches taken by Treasury Secretary Timothy Geithner and his predecessor.

Geithner is requiring a “stress test” for the largest 19 U.S. banks to determine if they need more capital. He has stressed that nationalization isn’t the goal.

Last week, the U.S. government moved to convert some of the preferred stock it owned in Citigroup Inc. to common shares, gaining a 36 percent stake in the company and boosting Citigroup’s buffer against future losses. While authorities pushed for changes to the makeup of Citigroup’s board, Chief Executive Officer Vikram Pandit remains at the helm.

Hoenig said while policy makers “understandably” want to avoid nationalizing banks, “We nevertheless are drifting into a situation where institutions are being nationalized piecemeal with no resolution of the crisis.”

The Treasury’s $700 billion Troubled Asset Relief Program “began without a clear set of principles and has proceeded with what seems to be an ad-hoc and less-than-transparent approach,” Hoenig said today.

Banking regulators need to be willing to write down losses, bring in new managers and sell off businesses if institutions can’t survive on their own, “no matter what their size,” said Hoenig, the second-longest serving of the Fed district bank presidents, after Minneapolis’s Gary Stern.

The Fed's Balance Sheet Strategy to Support Qualitative Easing: A Synopsis

“They [the Fed's financial crisis programs] all make use of the asset side of
the Federal Reserve’s balance sheet. That is, each involves the Fed’s
authorities to extend credit or purchase securities.”

Ben Bernanke, London School of Economics, January 13, 2009

The Fed's strategy is to expand Balance Sheet and to change the mix of the financial assets it holds to stimulate specific troubled markets.

As you will recall, the Fed's Balance Sheet provides the backing for the US Dollar currency among other things, and traditionally has consisted of gold, US Treasury Debt, and the explicitly guaranteed debt of agencies like Ginnie Mae.

What the Fed is doing is expanding the assets on its Balance Sheet, which is quantitative easing, but is doing it by adding specifically targeted non-traditional assets.

The Bernake Fed distinguishes its own approach from the "quantitative easing" of the Bank of Japan. It is an expansion of the central bank's balance sheet, but in the case of the Fed, with a bias. Bernanke calls it 'credit easing' while we prefer to call it 'qualitative easing.'

The Fed is deciding specifically where and to whom to apply its qualitative easing.

This is the controversial part of the program, because the Fed no longer manages the money supply and interest rates, and the general health of the banking system, but targets specific markets and companies for its monetization efforts.

In effect, one might say that the Fed has begun to assume a central planning role for the economy that decides, with specifics, who fails and who survives to succeed. What is troubling in particular is that so far the Fed has retained the perogative to do this without disclosure of the specifics even to Congress.

Bernanke divides the use of balance sheet assets into three groups:

1. lending to financial institutions,

2. providing liquidity to key credit markets, and

3. purchasing longer-term securities.

What does "Buying Longer Term Securities" mean?

In November 2008, the Federal Reserve announced plans to purchase the direct
obligations of the housing-related government-sponsored enterprises (GSEs),
specifically Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. In
principle, the extra demand for these obligations is designed to increase the
price of the securities and thereby lower rates paid for mortgages.
Additionally, the Fed outlined plans to purchase mortgage-backed securities
backed by Fannie Mae, Freddie Mac, and Ginnie Mae. These actions were designed
to improve the availability of credit for the purchase of houses, therefore
supporting the housing markets and financial markets in general.

Source: The Federal Reserve

Coming Next Week to an Imploding Economy Near You...

Without serious reform we will repeat the cycle of bubble, boom, and bust until the economy is shaken apart into civil disorder and re-emerges in proto-fascism.

Bernanke's Gamble on the Dollar

There are several things of interest this week. The first and foremost is the Fed's FOMC two day meeting with their announcement on Wednesday at 2:15.

It is important despite the fact that rates are effectively at zero, and the Fed has declared for 'quantitative easing.'

How does the Fed intend to implement this quantitative easing? Another way to ask this is to say, "What is the next bubble?"

Quantitative easing implies market distortion, and traders will be keen to understand where and how that distortion will play, because they are still geared for supercharged returns in an environment where fewer and fewer opportunities exist.

The Treasuries seem like a safer place, because lower interest rates are to the economy's benefit. Foreign entities may not like the monetization aspect, but we wonder how many real 'investors' are left in the bonds? Most in there are domestic parties seeking safe havens with any sort of return, and foreign central banks supporting political and industrial agendas.

So the focus will be on the wording of the Fed's statement once again, looking for clues with regard to the Fed's easing implementation and potential distortions that provide market inefficiencies.


Bloomberg
Bernanke Risks "Very Unstable" Markets as He Weighs Buying Bonds
By Rich Miller
January 25, 2009 19:01 EST

Jan. 26 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke and his colleagues may try once again to cure the aftermath of a bubble in one kind of asset by overheating the market for another.

Fed policy makers meeting tomorrow and the day after are exploring the purchase of longer-dated Treasury securities in an effort to push up their price and bring down their yield. Behind the potential move: a desire to reduce long-term borrowing costs at a time when the Fed can’t lower short-term interest rates any further because they are effectively at zero.

The risk is that central bankers will end up distorting the Treasury market, triggering wild swings in prices -- and long-term interest rates -- as investors react to what they say and do. “It sets forth a speculative dynamic that is very unstable,” says William Poole, former president of the Federal Reserve Bank of St. Louis and now a senior fellow at the Cato Institute in Washington....

Inflated Prices

Recent history shows the economic danger of inflating asset prices. After a stock-market bubble burst in 2000, the Fed slashed interest rates to as low as 1 percent and in the process helped inflate the housing market. The collapse of that bubble is what eventually helped drive the U.S. into the current recession, the worst in a generation.

Faced with the danger of a deflationary decline in output, prices and wages, the Fed is considering steps to revive the moribund economy. On the table besides bond purchases: firming up a pledge to keep short-term interest rates low for an extended period and adopting some type of inflation target to underscore the Fed’s determination to avoid deflation.

The central bank has been buying long-term Treasury debt off and on for years as part of its day-to-day management of reserves in the banking system. Yet it has always gone out of its way to avoid influencing prices. What it’s discussing now, says former Fed Governor Laurence Meyer, is deliberately trying to push long rates below where they otherwise might be.

Fed Purchases

Bernanke raised this possibility in a speech on Dec. 1. While he didn’t specify what maturities the Fed might buy, in the past he has suggested that purchases might include securities with three- to six-year terms. (This is around the sweet spot for foreign Central Banks - Jesse)

Investors immediately took notice, with the yield on the 10-year note falling to 2.73 percent from 2.92 percent the day before. Yields fell further on Dec. 16, dropping to 2.26 percent from 2.51 percent the previous day, after the central bank’s policy-making Federal Open Market Committee said it was studying the issue....

Yields have since risen, with the 10-year note ending last week at 2.62 percent. Behind the reversal: expectations of massive fresh supplies of Treasuries as the government is forced to finance an $825 billion economic-stimulus package and a possible new bank-bailout plan. This week alone, the Treasury is scheduled to auction $135 billion worth of securities.

Jump in Yields

David Rosenberg, chief North American economist for Merrill Lynch in New York, says the jump in yields may prompt the Fed to go ahead with Treasury purchases.

This isn’t the first time Bernanke and the Fed have discussed buying longer-dated securities and ended up roiling the market. Bernanke touted the idea as a tool to fight deflation in speeches in November 2002 and May 2003.

Egged on by his comments -- and later remarks by then-Fed Chairman Alan Greenspan that the central bank needed to build a “firewall” against deflation -- many investors became convinced the central bank was poised to buy bonds. The yield on the 10-year Treasury note fell to 3.11 percent in June 2003 from 3.81 percent at the start of the year.

Traders quickly reversed course as it became clear the Fed had no such intentions, sending the 10-year Treasury yield soaring to 4.6 percent just three months later, on Sept. 2.

‘Miscommunication’

Poole, who was then at the St. Louis Fed, was critical at the time of what he called the central bank’s “miscommunication.” He now sees the Fed making the same mistake with its latest suggestions that it might buy longer- dated securities.

“If they do it, it’s going to be disruptive to the market,” says Poole, who is a contributor to Bloomberg News. “If they don’t do it, it will impair the Fed’s credibility and erode the confidence the market has in the statements that the Fed makes.”

Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers, says the Fed should, and probably will, go ahead with purchases as a way to lower borrowing costs. “The story is stop talking and start buying,” he says.

Still, he notes that not everyone at the Fed is enthusiastic about the idea. One concern: Foreign central banks and sovereign-wealth funds, which are big holders of Treasuries, might cool to buying many more if they believe prices are artificially high. (The buyers of our debt now are supporting their own industrial policy we would hope. Any other reason borders on mismanagement of funds while anyone in their country is hungry or unemployed - Jesse)

Undermine the Dollar

That may undermine the dollar. “There’s no guarantee that international investors would switch to other dollar- denominated debt if flushed from the Treasury market,” says Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. in New York, says foreign investors might also get spooked if they conclude that the Fed is monetizing the government’s debt -- in effect, printing money -- by buying Treasuries. (They already are, and they already are - Jesse)

Bernanke himself, in his 2003 speech, said monetization of the debt risked faster inflation -- something bond investors, foreign or domestic, wouldn’t like.

Some economists argue the Fed would help the economy more if it bought other types of debt. (Such as corporate bond - Jesse) Even after their recent rise, 10-year Treasury yields are still well below the 4.02 percent level at the start of last year....

Hawks at the Fed wouldn’t welcome such purchases. They are already uneasy that some of the central bank’s programs are effectively allocating credit to one part of the economy rather than others. Case in point: the Fed’s ongoing program to buy $500 billion of mortgage-backed securities, which Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, has called “credit policy” rather than monetary policy. (Its nice to see that someone else is noticing that the Fed has crossed the Rubicon from central bank to central economic planner in the worst sense of the description - Jesse)

The Fed's Game Plan: What Ben Bernanke Is Thinking

Bernanke's game plan is becoming more apparent. Based on a reading of his papers and his public statements, here is a distilled view of what we think is his game plan.

1. Grow the money supply quickly and abundantly

2. Stabilize the Banking System to avoid destructive banking failures

3. Do not withdraw the monetary stimulus prematurely to fight inflation.

4. Manage 'confidence' aggressively to dampen the expectation of inflation later, and a panic liquidation now.

Each of these legs of his policy is a reaction to lessons he believes the Fed learned from the Great Depression.

As you consider the specific things he is doing, it is likely that they will fit very nicely into this framework.

He is obviously fighting the 'last war,' the last great battle that the Fed is known to have waged, and lost. For it did lose, as there was no lasting recovery until the world suffered through the Second World War.

Whether he will be successful or not remains to be seen. It is important to bear in mind that the Fed is absolutely confident that they know how to stop inflation once it gets started, even if it becomes rather serious.

The over-arching theme is that this is an emergency, and so long term niceties like moral hazard and systemic reform will be left for later: the ends justify the means.

William Poole says that this is a dangerous approach, because longer term consequences like inflation appear with a one to two year lag after a significant monetary stimulus such as we have just seen.

The timing of the Fed's dampening of inflation will be critical, and perhaps constrained by the real economy. How can the Fed tighten sufficiently if the real economy remains sluggish?

Bernanke is determined to err on the side of too much stimulus, given the trauma of the Fed's experience in the Great Depression. Coupled with the Fed's confidence in their ability to stop any monetary inflation, this raises a higher level of probability in the most likely outcome of the Fed's latest and greatest monetary experiment.

We cannot help but wonder what he thinks the Fed will be doing this time that will be different than 2003-2007 when they reflated the financial system after a market crash the last time without meaningful reforms, resulting in the stock market and housing bubbles.

Whatever happens, it will certainly provide the raw material for economic papers yet unwritten.

Bill Poole: The Fed is Now Expanding Its Balance Sheet by Printing Money

We have long held Paul Volcker, William Poole and Jerry Jordan in high respect as former Fed governors. When they speak we listen, although Jerry seems to be more reticent, enjoying his retirement these days.

In a discussion with Kathleen Hays this afternoon during her "On the Economy" show on Bloomberg Television, Bill Poole took uncharacteristically sharp exception to the latest decisions by the Bernanke FOMC from their December Meeting minutes.

"The Fed is now expanding its balance sheet by printing money."

He was also visibly perturbed that the FOMC appears to no longer be stepping up to managing the money supply which is its mandate, but rather is allowing the Board of Governors to expand the money supply 'willy-nilly' with no eye to targets, just an uncoordinated roll out of special facilities.

For a minute we had to make sure this was Bill Poole speaking and not Willem Buiter, who delivered a round house commentary at Jackson Hole on the Bernanke Fed.

Yes, this is not the first time you have heard this, that the Fed is now printing money, monetizing the debt, especially if you are a regular reader here.

But it was unmistakable that in Bill Poole's mind the FOMC has now "crossed the Rubicon" and "will greatly regret their recent decisions in the future."

Jimmy Rogers has it right. "Bernanke’s going to keep printing money until they run out of trees."

The Fed is confident that they know how to stop inflation after the Volcker era, this much they have said, and it is clear they are acting on that belief.

A lot of theories are going to be road-tested, and the experiment in monetary and Keynesian economics will be rigorous.

This will be interesting, indeed.

Facilis descensus Averno;
Noctes atque dies patet atri ianua Ditis;
Sed revocare gradum superasque evadere ad auras,
Hoc opus, hic labor est.

Smooth is the descent, the way down below;
Day and night the gates of Hell stand wide open;
But to retrace your steps, and return to clear skies:
This is the task, this is the real work.

Vergil, Aeneid

Bernanke Unleashes the Power of the Monetary Force

The Fed will lead us out of deflation, but how many years will we spend in the wilderness?

Federal Reserve Open Market Committee
Release Date: December 16, 2008
For immediate release

The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent. (That's it, we're effectively at ZERO - Jesse)

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.

Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity. (TASLF for homes and businesses. Will that be a two-page form like TARP? Can I fill it out online? - Jesse)

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. (Did Ben threaten them with martial law? Or just scare the hell out of them? - Jesse)

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.

Is the Fed Taking the First Steps to Selective Default and Devaluation?

We have been looking for an out-of-the-box move from the Fed, but this was not what we had expected.

The obvious game changing move would have been for the Treasury and the Fed to make an arrangement in which the Fed is able to purchase Treasury debt directly without subjecting it to an auction in the public market first. This is known as 'a money machine' and is prohibited by statute.

But as usual the Fed surprises us all with their lack of transparency. They are asking Congress about permission to issue their own debt directly, not tied to Treasuries.

This is known in central banking circles as 'cutting out the middleman.' Not only does the Treasury no longer issue the currency, but they also no longer have any control over how much debt backed currency the Fed can now issue directly.

If the Fed were able to issue its own debt, which is currently limited to Federal Reserve Notes backed by Treasuries under the Federal Reserve Act, it would provide Bernanke the ability to present a different class of debt to the investing public and foreign central banks.

The question is whether it would be backed with the same force as Treasuries, or is subordinated, or superior.

There will not be any lack of new Treasury debt issuance upon which to base new Fed balance sheet expansion. The notion that there might be a debt generation lag out of Washington in comparison with what the Fed issues as currency is almost frightening in its hyperinflationary implications.

This makes little sense unless the Fed wishes to be able to set different rates for their debt, and make it a different class, and whore out our currency, the Federal Reserve notes, without impacting the sovereign Treasury debt itself, leaving the door open for the issuance of a New Dollar.

What an image. The NY Fed as a GSE, the new and improved Fannie and Freddie. Zimbabwe Ben can simply print a new class of Federal Reserve Notes with no backing from Treasuries. BenBucks. Federal Reserve Thingies.

Perhaps we're missing something, but this looks like a step in anticipation of an eventual partial default or devaluation of US debt and the dollar.


Wall Street Journal
Fed Weighs Debt Sales of Its Own
By JON HILSENRATH and DAMIAN PALETTA
DECEMBER 10, 2008

Move Presents Challenges: 'Very Close Cousins to Existing Treasury Bills'

The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.

Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools.

The Federal Reserve drained $25 billion in temporary reserves from the banking system when it arranged overnight reverse repurchase agreements.

Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.

It isn't known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn't explicitly permit the Fed to issue notes beyond currency.

Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.

At the core of the deliberations is the Fed's balance sheet, which has grown from less than $900 billion to more than $2 trillion since August as it backstops new markets like commercial paper, money-market funds, mortgage-backed securities and ailing companies such as American International Group Inc.

The ballooning balance sheet is presenting complications for the Fed. In the early stages of the crisis, officials funded their programs by drawing down on holdings of Treasury bonds, using the proceeds to finance new programs. Officials don't want that stockpile to get too low. It now is about $476 billion, with some of that amount already tied up in other programs.

The Fed also has turned to the Treasury Department for cash. Treasury has issued debt, leaving the proceeds on deposit with the Fed for the central bank to use as it chose. But the Treasury said in November it was scaling back that effort. The Treasury is undertaking its own massive borrowing program and faces legal limits on how much it can borrow.

More recently, the Fed has funded programs by flooding the financial system with money it created itself -- known in central-banking circles as bank reserves -- and has used the money to make loans and purchase assets.

Some economists worry about the consequences of this approach. Fed officials could find it challenging to remove the cash from the system once markets stabilize and the economy improves. It's not a problem now, but if they're too slow to act later it can cause inflation.

Moreover, the flood of additional cash makes it harder for Fed officials to maintain interest rates at their desired level. The fed-funds rate, an overnight borrowing rate between banks, has fallen consistently below the Fed's 1% target. It is expected to reduce that target next week.

Louis Crandall, an economist with Wrightson ICAP LLC, a Wall Street money-market broker, says the Fed's interventions also have the potential to clog up the balance sheets of banks, its main intermediaries.

"Finding alternative funding vehicles that bypass the banking system would be a more effective way to support the U.S. credit system," he says.

Some private economists worry that Fed-issued bonds could create new problems. Marvin Goodfriend, an economist at Carnegie Mellon University's Tepper School of Business and a former senior staffer at the Federal Reserve Bank of Richmond, said that issuing debt could put the Fed at odds with the Treasury at a time when it is already issuing mountains of debt itself.

"It creates problems in coordinating the issuance of government debt," Mr. Goodfriend said. "These would be very close cousins to existing Treasury bills. They would be competing in the same market to federal debt."

With Treasury-bill rates now near zero, it seems unlikely that Fed debt would push Treasury rates much higher, but it could some day become an issue.

There are also questions about the Fed's authority.

"I had always worked under the assumption that the Federal Reserve couldn't issue debt," said Vincent Reinhart, a former senior Fed staffer who is now an economist at the American Enterprise Institute. He says it is an action better suited to the Treasury Department, which has clear congressional authority to borrow on behalf of the government.

US Treasuries and our Horribly Distorted International Currency Exchange Mechanism

At some point as the Fed seeks to create inflation it will cut the reserve deposit returns to banks until they are forced to lend.

Can the Fed create monetary inflation? That is the question and Bernanke believes he has the answer.

It will require the cooperation of foreign buyers of US credit seeking to underwrite their mercantilism and low domestic wage and consumption policies.

The key to recovery is the median real hourly wage, not the further expansion of credit and the perpetuation of an economic system based on an inefficient drag on economic growth by percentage-taking banks and rent-seeking elites who add little or no productive value.

We have a 'chicken and egg' standoff between aggregate workers wages and profits at the moment which only the government can move forward, but with care.

The seemingly radical but all too obvious answer is to begin to tax imports from nations who continue to refuse to float their currencies. This merely reverses the decisions that were made by Clinton and Bush to allow China to devalue and fix their currency and still obtain favored nation trading status without consequence.

It was always the answer. It will disadvantage the global financial sector through the dollar, but will begin to breathe life into economic reform around the world. The key is not taxes, but a market free of draconian industrial policies such as that which spawned the long deflation in Japan.

Countries which discourage domestic consumption and wages to build up the wealth of the State on the backs of the workers in the name of growth, and manipulate their currencies to promote trade policies must be discouraged from doing so, as they will.

This seems a radical solution because it is a change from the accepted economic dogma of the past thirty years, more ingrained as slogans than sound thinking. Smoot-Hawley, classic error. It will make things worse. Rubbish. The tariffs and trade barriers are already in place because of currency manipulation and artificial fixes. Why do some countries accumulate destabilizing and enormous deficits and credit balances? Because of the artificial thwarting of the markets. One only has to work the math.

But the alternative to a structural reform is almost certainly economic stagnation and increasing global conflict.

At some point even mighty China will find itself sitting on a pile of useless bonds with fire in the cities, unless it accepts change and stops hiding behind a Great Wall of Paper.

This is not to say that the fault lies with China or Japan. The primary cause of our distorted global economy is in the dollar reserve currency arrangement that is the mother of commodity wars and artificial imbalances.

The solution may be the adoption of a trade balanced basket of currencies, including some commodities not so easily manipulated by the central banks such as gold and silver and oil, as the basis for continuing world trade based on market economics.

Financial Times
Insight: Return-free risk
By James Grant
December 4 2008

US Treasuries are the investment asset of the year. The less they yield, the more their fans adore them. Then, again, these fearful days, yield seems to have nothing to do with investment calculation. Purported safety is all.

“Super-safe Treasuries”, the papers call these emissions of a government that, this year, will take in $2,500bn but spend $3,500bn. “Toxic assets” is how the same papers characterise orphaned mortgage-backed securities—or, for that matter, secured bank loans, convertible bonds, junk bonds or almost any other kind of debt obligation not bearing the US imprimatur.

“There are no bad bonds, only bad prices,” the traders used to say. They should say it again, only louder. In the spring of 1984, long-dated Treasuries went begging at yields of nearly 14 per cent in the context of an inflation rate of just 4 per cent. Those, too, were fearful times, the recollected horror being the great inflation of the 1970s. Inflation was ineradicable, the bondphobes said. Now a new generation of creditors espouses the opposite proposition. Deflation is baked in the cake, they say.

The truth is that no investment asset is inherently safe. Risk or safety is an attribute of price. At the right price, a lowly convertible bond is a safer proposition than an exalted Treasury. Watching the government securities market zoom, many mistake price action for price.

Yes, Treasuries might conceivably redeem the hopes of their besotted admirers. Maybe a deflationary chasm is about to swallow us all. Never before has the US been so leveraged. And—just possibly—never before were lending standards so reckless as the ones that brought joy to so many astonished mortgage applicants in 2005 and 2006.

In their magnum opus Security Analysis Benjamin Graham and David L. Dodd advise that “bonds should be bought on their ability to withstand depression”. They wrote that in 1934. So far is that rule from being honoured by today’s financiers that not a few bonds—and boxcars full of mortgages – could hardly withstand prosperity. Two urgent questions present themselves. One: does something far worse than recession loom? Two: does that certain something definitely spell much lower interest rates?

We can’t know, but we can at least observe. What I observe is a monumental push to reflate. The Federal Reserve is creating more credit in less time than it has ever done before – in the past three months the sum of its earning assets, known in the trade as Reserve Bank credit, has grown at the astounding annual rate of 2,922 per cent. Are the bond bulls quite sure that these exertions will raise no inflationary sweat?

Evidently, they are—at least, forward swap rates betray no such concern. The market’s best guess as to what the 10-year Treasury will yield in 10 years’ time is 2.78 per cent, never mind the famous (and now, as it seems, prophetic) remark of Fed Chairman Ben Bernanke that the Fed could drop dollars out of a helicopter in a deflationary pinch.

The non-Treasury departments of the credit markets have crashed. No surprise then that prices and values are deranged. Market makers have closed up shop for the year, while hedge funds cower in fear of redemptions. You’d suppose that professional investors – doughty seekers of value – would be combing through the debris for bargains. Alas, no. Most seem content to lend money to Henry Paulson (subsequently to Timothy Geithner) at 2 per cent or 3 per cent.

In corporate debt and mortgages, anomalies and non sequiturs abound. They are especially prevalent in convertible bonds. More so than even the average stressed-out fund manager, convertible arbitrageurs have been through the mill. It was they—and almost they alone—who owned convertibles. Now many of these folk must sell them.

Few buyers are presenting themselves, however, though extraordinary bargains keep popping up. Thus, at the end of October, a Medtronic convertible bond with a 1.5 per cent coupon with the debt maturing in April 2011 briefly traded at 80.75. This was a price to yield 10.6 per cent, an adjusted spread of 1,600 basis points over the Treasury curve (adjusted, that is, for the value of the options embedded in the convert, notably the option to exchange it for common stock at the stipulated rate). Contrary to what such a yield might imply, A1/AA minus rated Medtronic, the world’s top manufacturer of medical devices for the treatment of heart disease, spinal injuries and diabetes, is no early candidate for insolvency. Almost every day brings comparable examples of risks not borne by people who, in this time of crisis, have come to define risk as “anything not guaranteed by Uncle Sam”.

“Risk-free return” is the standard tag attached to the government’s solemn obligations. An investor I know, repulsed by prevailing government yields, has a timelier description – “return-free risk”.

James Grant, editor of Grant’s Interest Rate Observer, is an editor of the newly published sixth edition of “Security Analysis,” by Benjamin Graham and David L. Dodd.

The New Deal for the Banking System as the Financial Storm Intensifies

"Do you think he is so unskilful in his craft, as to ask you openly and plainly to join him in his warfare against the Truth? No; he offers you bait to tempt you. He promises you civil liberty; he promises you equality; he promises you trade and wealth; he promises you a reduction of taxes; he promises you reform... He prompts you what to say, and then listens to you, and praises you, and encourages you. He bids you mount aloft. He shows you how to become as gods. Then he laughs and jokes with you, and is familiar with you; he takes your hand, and gets his fingers between yours, and grasps them, and then you are his."
J.H. Newman, The Times of AntiChrist, 1889

We are seeing an enormous parody of Roosevelt's New Deal being rolled out in a hurried fashion for the bankers and the wealthy under the cloak of dire necessity prior to the likely change in political Administrations.

If we follow the political pattern of the 1930s, we will see a minority of Republicans and a sympathetic majority at the Supreme Court attempt to maintain the disbursal of liquidity largely to the corporations and banks, and to fight any progressive tax increases and social programs designed to push that liquidity directly to the public without passing through the tollgates of the financial system.

If this happens, we may see a powerful polarization in the country between a minority that will attempt to embrace state control to halt those programs and the encroachment on 'true American principles' and a suffering public, with a middle class pinned between them.

The corporatist appeal will be made to social conservatives, small businessmen, the banks and the corporations that spring up around them, and the lowest elements in the hatreds and prejudices and fears in the public, particularly the older middle class, to retrieve our national honor.

And if against all safeguards and probability this succeeds in gaining power, and burning the Constitution to preserve our freedom becomes a popular slogan, and a slyly articulate but otherwise inexperienced, almost mediocre, leader arises, and the corporate powers support this person in order to achieve their ends, then it will be time to leave, without looking back, before the storm breaks, and madness is unleashed, and a darkness falls over the land.

Bernanke May Seek New Ways to Ease Credit as Fed Rate Nears 1%
By Craig Torres

Oct. 23 (Bloomberg) -- Federal Reserve officials are likely to bring interest rates down so aggressively over the next few months that they will have to search for fresh tactics to continue easing credit.

The Fed's Open Market Committee will probably reduce the benchmark federal funds rate by half a point next week to 1 percent, the lowest since May 2004, according to futures trading. The official rate has never been lower since the Fed made it an explicit target in the late 1980s.

Further cuts below 1 percent could turn Fed Chairman Ben S. Bernanke's focus away from the main rate and toward more use of alternative tools. Those might include increasing its holdings of mortgage bonds to lower costs for homebuyers and purchasing securities directly from the Treasury in order to pump more cash into the economy, Fed watchers said.

``If there is need for more stimulus, the Fed will buy up government debt to keep borrowing costs low," said Adam Posen, deputy director at the Peterson Institute for International Economics and a co-author with Bernanke. That's tantamount to ``turning government debt, as it is issued, into money.'' (That is pure monetization and they can do it if they have the will and the need - Jesse)

Bernanke, 54, has already thrown the central bank's balance sheet into action in unprecedented ways. Working with the New York Fed, the Board of Governors has rolled out 11 new programs aimed at absorbing risk or making dollars available when banks don't want to loan. (A New Deal for the Banking System - Jesse)

Assets Doubled

The result: The central bank's assets, which include a loan to insurer American International Group Inc. and a pool of investments once held by Bear Stearns Cos., more than doubled to $1.772 trillion last week from a year-earlier total of $873 billion that comprised mostly Treasuries. The latest weekly figures are scheduled for release at 4:30 p.m. in Washington.

There's more to come. The Fed announced this week a backstop for money-market mutual funds to which it will commit another $540 billion. A commercial-paper program approved Oct. 7 could buy up to $1.8 trillion of securities.

``The net effect of these facilities has been a truly staggering pace of growth in the Fed's balance sheet,'' said Jan Hatzius, chief U.S. economist for Goldman Sachs Group Inc.

When the Bank of Japan fought deflation and a banking collapse earlier this decade, its balance sheet ballooned to more than 30 percent of gross domestic product as it pumped money into the economy, Hatzius said. He predicted ``further rapid growth'' in the Fed's, which is now equal to 12 percent of U.S. GDP. (The policy error is that they pumped the money into foolish projects and into an unreformed financial system, hopelessly compromised by the keiretsu corporatism of interlocking insider dealing. One does not start an engine that is broken by pouring more fuel into it. - Jesse)

`Helicopter Ben'

As a Fed governor, Bernanke did research on alternative policy tools between 2002 and 2004, when U.S. central bankers last cut the benchmark rate to 1 percent. Traders nicknamed him ``Helicopter Ben'' after a 2002 speech that referenced Milton Friedman's comments comparing such unorthodox methods to dropping money from a helicopter.

Vincent Reinhart, the Fed's director of monetary affairs at that time, said Bernanke's policy activism, which contrasts with his predecessor Alan Greenspan's almost exclusive use of the federal funds rate, derives from the chairman's research on policy errors in the Great Depression and during Japan's rolling recessions of the 1990s.

``He saw what we viewed as an obvious policy failure and it was in the ability of human reason'' to fix it, said Reinhart, now a scholar at the American Enterprise Institute.

`Quantitative Easing'

The Bank of Japan, struggling against deflation, slow growth and consumers' reluctance to spend, brought its policy rate close to zero before turning in 2001 to a so-called quantitative easing strategy of increasing money in accounts held for commercial banks. The policy lasted for five years, before the central bank began to draw down reserves and raised its benchmark rate to 0.5 percent, where it has been since February 2007.

The Fed has flooded the economy with so much cash that excess reserve balances at banks, or cash surpluses beyond what banks are required to hold against deposits, soared to $136 billion for the two-week period ending Oct. 8 compared with an average of $1.4 billion in the same month last year. (We showed this in a chart the other day. They are stuffing the banks with liquidity, and the banks are holding the reserves against writedowns and credit risk. At some point this will spill over and perhaps even break out, into what contrivances who knows. We may see a rise of 'superbanks' through acquisition. These will have to be taken apart in the coming years. - Jesse)

``The Federal Reserve has already entered a regime of quantitative easing,'' said Brian Sack, vice president at Macroeconomic Advisers LLC who also worked with Bernanke as an economist in the Monetary Affairs Division.

As their liquidity programs dump excess funds into the banking system, it's become more difficult for the Fed to keep the rate at which banks lend overnight to each other in line with policy makers' 1.5 percent target. (This is an absolutely key point to keep in mind - Jesse)

Below Fed Target

In an effort to put a floor under the overnight rate, the central bank started paying interest on the reserves banks deposit with it. That hasn't stopped the so-called effective federal funds rate from falling below the target every day since officials lowered their benchmark by half a point in an emergency move on Oct. 8.

In the two weeks since then, evidence of a deteriorating economy has mounted and will likely push Fed officials toward a further rate cut when they meet Oct. 28-29, economists said.

Industrial production in the U.S. fell in September by the most in almost 34 years, and retail sales dropped by the most in three years. Inflation pressures are easing as oil prices fall to a 16-month low, and nine months of job losses eliminates any pressure from wage increases.

Whether the target rate ends up below 1 percent depends on how fast consumers and businesses gain more access to low-cost credit. Economists at HSBC Holdings Inc. said the Fed would like to avoid cutting to zero. Still, if the economy doesn't improve, it ``could be at zero'' by the middle of next year, said HSBC economist Ian Morris.

``There is this understanding at the Fed that the worst thing you can do is save your ammunition,'' said Ethan Harris, economist at Barclays Capital Inc. ``You move fast -- that is the whole lesson of past crises in Japan and during the Great Depression.''

Professor Marvel Never Guesses. He Knows!

Is it likely that a fresh look at the economic data had Ben Bernanke and Don Kohn doing a sharp about face on the balance of risks to the economy? Given the speed with which their change in policy was communicated, catching a fellow Fed head flatfooted in spouting the party line the day before, it seems more probable that something on the order of one or more major players started to spew smoke from the cracks in their mark to moonbeams calculations, and Hank made that call to the Professor.

We obviously don't know, but suspect this revelation was connected with a subprime contagion affecting the derivatives markets. If derivatives are Weapons of Mass Destruction, then the Credit Default Swaps market is the H Bomb. Credit Default Swaps, if they start unwinding, can develop a chain reaction that will take out a fair chunk of the real economy, in addition to two or three big name corporations.

Subprime had the Fed a little concerned; CDS has them staring into the abyss and shitting their pants. Aren't you glad we have men so familiar with the mistakes the Fed made in 1929 to 1932 with regard to Fed Policy? We wish they had at least audited the courses covering the Fed's mistakes form 1921 to 1929. Sure, they are the experts; we're just concerned that they may be preparing to fight the last war.