Phorgy Phynance

Archive for the ‘Federal Reserve’ Category

Market Risk at the Federal Reserve – History books will not be kind

leave a comment »

During my days at Capital Group, we had an opportunity to bring Paul Harrison in to give a presentation at an internal research conference. This was prior to the crisis when people were still feeling good and were still confident that the Fed had conquered the business cycle. They even called it the Great Moderation.1

Paul was great. I truly enjoyed his presentation and he was very gracious with his time afterward putting up with my questions. I remember he was examining the term structure of credit spreads and the information that can be extracted from it. His presentation and subsequent question and answer session had a lasting impression on the way I look at fixed income markets.

However, one thing about it always seemed odd to me. Paul was the head of the Capital Markets Section at the Federal Reserve.  That wouldn’t be so odd in itself, but what I found odd about it was that they actually managed a risky fixed income portfolio. Why was the Federal Reserve managing a portfolio of corporate bonds? Talk about conflict of interest. Not to mention the potential for insider information.

Soon afterward, Paul left the Fed to work at a big investment bank and I left Capital. I hadn’t put much thought into it since then, but the “odd” feelings came rushing back when I read the following article from Zero Hedge:

Federal Reserve Loses $2.4 Billion In Taxpayer Money In Most Recent QE2 POMO Interval

Please go have a look.

Although quantitative easing is quite a different animal than the fixed income portfolio at the Capital Markets Section, the market risk is the same. The mark to market losses the Fed is now exposed to are astronomical. The sad thing is, I have very little confidence they even understand those risks. Bernanke is quite confident he can raise rates, but that is exactly the thing he should fear most. What is going to happen to yields in the US when they get their wishes and China floats the RMB (which I expect them to do within 4 years)?

It is difficult to inflate your way out of debt obligations when the Fed is the largest holder of US treasuries. When the RMB floats, China will take a hit on their USD holdings, but that will be hedged to a large extent by their improved purchasing power, which will only accelerate their evolution to a consumer economy. The US will once again increase manufacturing as promised but at the huge cost of quality of life as prices of all imports skyrocket.

Be careful what you wish for. It is sad for me to watch my country deteriorate like this at the hands of Bernanke and Geithner. History books will not be kind to either of them.

1: You dont hear that term very often anymore. I remember debating colleagues about the concept and told them when history books were written they’d look at the period of the Great Moderation as the most irresponsible period of monetary policy in history, but that is another story.

Written by Eric

December 11, 2010 at 11:05 am

Speculation: Bernanke’s days are numbered

with one comment

In this fun thread, on July 4, 2007, I wrote about one of Bernanke’s speeches:

This latest wind bag empty rant of his is almost laughable

The Financial Accelerator and the Credit Channel
June 15, 2007

He speaks of his model results as if they represent reality without question. It is notable that he only references papers that support his arguments without a nod to the opposing viewpoint. The more I read this guy’s stuff, the more upsetting it gets. I may have only been thinking about credit markets for the past two years, but I’ve been a researcher for a lot longer than that and I’ve developed a nose for BS and Bernanke’s articles reek of it.

Then, in response to doctorwes’ comment, I said (emphasis added in bold):

For example, he suggests that if many homeowners have little equity in their homes, and there is a decline in home prices, there might be a more negative impact on the economy than people would otherwise expect.

More than who expected? Sounds like a lame excuse to me. The proponents of the BIS view certainly saw it coming and several NBER papers are there (including Scwartz’) to prove it, which he conveniently chose to disregard. Sorry, you can’t take one side of a debate and when it turns out you’re wrong, claim to be ignorant of the other side.

In addition to my apocalyptic predictions, I also predict that Bernanke will be removed from his post in the not-so-distant future (say post Nov ’08 ).

We’ll see if he lasts until after the elections. I doubt it.

Written by Eric

January 22, 2008 at 7:14 am

Posted in Federal Reserve

Anna Schwartz, “The new group at the Fed is not equal to the problem that faces it”

leave a comment »

Wow. When I first began voicing my opinion about the Fed and monetary policy in a public phorum, it didn’t take long for me to be drawn to some papers by Anna Schwartz. On July 3, 2007, when I was asked what I would have done if I was in charge of monetary policy, I said:

If I were in charge from 2000-2007, I probably would have surrounded myself by smart people like Anna Schwartz, who wrote this gem (in 2002)

Asset Price Inflation and Monetary Policy


It is crucial that central banks and regulatory authorities be aware of effects of asset price inflation on the stability of the financial system. Lending activity based on asset collateral during the boom is hazardous to the health of lenders when the boom collapses. One way that authorities can curb the distortion of lenders’ portfolios during asset price booms is to have in place capital requirements that increase with the growth of credit extensions collateralized by assets whose prices have escalated. If financial institutions avoid this pitfall, their soundness will not be impaired when assets backing loans fall in value. Rather than trying to gauge the effects of asset prices on core inflation, central banks may be better advised to be alert to the weakening of financial balance sheets in the aftermath of a fall in value of asset collateral backing loans.

Now, she takes both Greenspan and Bernanke to task in this scorching article at the Telegraph:

Anna Schwartz blames Fed for sub-prime crisis

The high priestess of US monetarism – a revered figure at the Fed – says the central bank is itself the chief cause of the credit bubble, and now seems stunned as the consequences of its own actions engulf the financial system. “The new group at the Fed is not equal to the problem that faces it,” she says, daring to utter a thought that fellow critics mostly utter sotto voce.

“They need to speak frankly to the market and acknowledge how bad the problems are, and acknowledge their own failures in letting this happen. This is what is needed to restore confidence,” she told The Sunday Telegraph. “There never would have been a sub-prime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for,” she says.

That is a great article and although I should probably be a little more dignified that proclaiming “Bernanke sucks”, it is good to know that Anna Schwartz is also not a particularly big fan of those at the Fed right now.

Written by Eric

January 16, 2008 at 12:31 pm


leave a comment »

I lack the talent much less the venom to put together such a scathing piece as the one that Alan Abelson beautifully constructed over on Barron’s (via The Big Picture)

It’s publicly available for the time being so run and take a look while you still can:

Debasing Bernanke: BEN BLINKED

Wow! 🙂

Written by Eric

September 23, 2007 at 10:14 pm

Posted in Federal Reserve

Bye bye dollar

leave a comment »

Needless to say, after my comment on August 28

PS: I’ve been ignorantly harsh on both Greenspan and Bernanke, but I have to say that I am quite impressed with Bernanke’s recent performance maneuvering through the current credit crisis. I expect him to hold the target rate at 5.25% on September 18. If he does, I’ll gladly apologize for anything less-than-flattering I’ve ever said about him. If he lowers rates, I’ll lose respect and throw him back in the Greenspan “save my Wall Street buddies” bucket.

I wasn’t particularly excited about the surprise 50 bps cut in both target and discount rates for the general long-term prospects of the US economy, although on a selfish level it was certainly good for my career stability. As far as I’m concerned, it is open season for Bernanke bashing. Greenspan bashing has been accelerating as well. Besides, if things really get bad with the USD, we’ll just move to Hong Kong or something 🙂

One of the things that I learned from Al Wojnilower was that the US economy could certainly keep chugging along for as long as the USD was the world currency. As he liked to repeat often, having the USD as the dominant world currency is like having an “American Express card with no limit”. One of the things that keeps the USD as the world’s currency is its position in sovereign reserves as well as the fact that oil is priced in USD. As far as I can see, both of these factors are beginning a worrisome decline.

With sovereign reserves continuing to diversify away from USD and Saudi Arabia refusing to cut rates in lock step with the US marks a real turn in the outlook for the USD dollar, and consequently the ability of the US economy to continue chugging along.

Written by Eric

September 22, 2007 at 7:28 am

Merrill Lynch: The Credit Monitor

leave a comment »

Got this via the good guys over at Econocator:

Merrill Lynch – The Credit Monitor

“Easy money” is the root cause of current credit volatility. While mortgage finance, Hedge Funds, LBO’s, Yen-based financing, SIVs/Conduits and CDOs have all been cited as sources of structural leverage they are derivative of the 1% funds rate policy from the early part of this decade. As the Fed began the process of removing excess monetary liquidity, market participants simply manufactured it with financial leverage.

This process was seven years in the making. We doubt it will be unwound in two months time. We caution investors: beware of false recoveries.

The irony is not lost on us: last week’s apparent short-lived recovery in credit spreads was prompted by rising expectations of a 2007 Fed rate cut. Yet, it is the 1% “easy money” Fed Funds rate policy that is the origin of many of the current structural problems in the credit market. A rate cut seems like a curious solution to a problem that was incubated by liquidity. Moreover, the currency outcome could prove troubling. Should credit rally on such an action, it may serve as an opportunity to add new shorts/underweights.

Band wagon? Or people just waking up after a long period of delusions?

Written by Eric

August 18, 2007 at 1:30 pm