The Fed Has Gone Nuclear

Submitted by Rich Toscano on December 19, 2008 - 10:20am

On Tuesday, Fed Chairman Bernanke announced that the Fed was for the first time in history cutting its target funds rate to 0 percent (a range of 0 to .25 percent, to be exact, but it's close enough). Additionally, the Fed will shunt "large quantities" of money directly into the mortgage market. They will also consider directly buying long-term U.S. Treasury bonds, thus funding the government's activities and putting downward pressure on long-term rates. Finally, they are creating a new lending program to "facilitate the extension of credit to households and small businesses." I'm not sure what that means but I'm pretty certain that it entails the Fed handing out yet more money.

They certainly are spreading it around. One might wonder where all this money is going to come from. Chairman Bernanke left that part out of his statement, but the answer is that the money will largely be created out of thin air.

continue reading at voiceofsandiego.org

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Submitted by Blissful Ignoramus on December 19, 2008 - 10:45am.

And I'm thinking it might be time to refinance.

How low do folks think things will go for a 15 year fixed?

Submitted by peterb on December 19, 2008 - 10:56am.

All fiats look to be headed to ZIRP. The world is turning Japanese. Not a good sign. This is a huge gamble on Uncle Ben's part.

Just think how things will be if unemployment is higher in 3 months and we experience another drop in the stock market! Sentiment and trust will be gutted.

Gold and the miners theref should do quite well in this scenario. Honest money will start to be the only place anyone feels safe.
Props to Rich on this call from his "Case for Gold and Gold Stocks." article. Made me a pile o money from it in the last 3 weeks. Staying long for the duration.

Rates tend to sink in a recession. If you think this recession has a ways to go, you may want to wait on a refi. But then, qualifying later may be a lot tougher as well.

Submitted by Arraya on December 19, 2008 - 11:00am.

This is a huge gamble on Uncle Ben's part.

When one idea fails, 3 of the same ideas will surely solve the issue. They are gambling with other people's money, and that is always easy. It’s your money though, and the chances of winning are miniscule. They just don’t know what else to do....

Submitted by creative_cpa on December 19, 2008 - 11:53am.

If the Federal Reserve Bank buys Treasury debt, that is called "monetizing the debt". The last time that happened was when Jimmy Carter was president and we had massive stagflation. The prime rate hit 21.5% in December 1980.

Hang on to your hats, we are in for one wild ride!

Submitted by bsrsharma on December 19, 2008 - 9:55pm.

Jimmy Carter was president and we had massive stagflation.

Bernanke may be thinking that hyperinflation is the best cure for real estate crisis. If we get a sustained long term 10%-20% inflation per year, the real estate inventory can be gone in a year.

Submitted by massey on December 19, 2008 - 10:05pm.

Think tidal wave here. When a tidal wave is coming the surf recedes into the sea ( deflationary period..like now ). Immediately following that you have the destructive wave washing over land..which is what's going to happen once all this new money joins the money locked in the banker's vaults today.

From the start there was only really one way to solve this kind of debt crisis, inflate your way out of it.

Submitted by HereWeGo on December 20, 2008 - 12:23am.

creative_cpa wrote:
If the Federal Reserve Bank buys Treasury debt, that is called "monetizing the debt". The last time that happened was when Jimmy Carter was president and we had massive stagflation. The prime rate hit 21.5% in December 1980.

Hang on to your hats, we are in for one wild ride!

That's the true nuclear option IMO. It's nice to be able to borrow in your own currency, eh? And investors and CBs around the world seem happy to lend to us as well, at incredibly low rates.

Submitted by 4plexowner on December 20, 2008 - 8:21am.

Ron Paul on the Fed issuing its own debt:

"Can you see the huge problem here? They would have the power to burden the taxpayer with unlimited debt and they would be accountable to no one."

http://www.dailypaul.com/node/75616

http://www.reuters.com/article/ousiv/idU...

~

truly unprecedented actions being taken these days - if you aren't nervous you aren't paying attention

Submitted by barnaby33 on December 20, 2008 - 5:45pm.

My thought is that this is more of the same. The Fed still hasn't found a way to get all of this newly printed money out from behind bank walls. By destroying the long end of the curve are banks really going to be willing to lend more than now?

Hint, banks lend long, borrow short and live on the spread. How's that going to work if Uncle Ben aka Bend Over Ben, pushes down the long end of the yield curve to save all those ARM holders!
Josh

Submitted by Arraya on December 20, 2008 - 9:57pm.

Banks don't want to lend because they have to keep an eye on all the write downs they have coming, and there is a lot in the pipeline.

From Bloomberg:

“There is no demand coming from the interbank market at all,” said Patrick Jacq, a senior fixed-income strategist for Paris-based BNP Paribas SA, France’s largest bank. “Banks are borrowing straight from the Fed and hoarding that cash till they need some and then returning to the Fed. We don’t expect a return to normal conditions in the coming six months.”

Also they are potentially taking out almost HALF available credit lines for credit cards.

From MSNBC:

The credit card is the second key source of consumer liquidity, the first being jobs, the Oppenheimer analyst noted.

"In other words, we expect available consumer liquidity in the form or credit-card lines to decline by 45 percent."

Companies as well:

About 85 percent of domestic banks tightened lending standards on commercial and industrial loans to large and mid- size firms, the highest since the survey began in its current format in 1991, the Fed said in its latest quarterly Senior Loan Officer Survey conducted between Oct. 2 and Oct. 16.

That unemployment/default feedback loop could be a killer. Credit is going to evaporate from the economy and it should be interesting to see what it looks like in a year.

Submitted by patientrenter on December 20, 2008 - 10:42pm.

It doesn't matter right now if banks want to lend or not. The govt (through FHA, FNMA, etc) is handing out vast amounts of money for mortages at low rates, with low downpayments, to people with low incomes, for homes that are overpriced. Banks can join the fun, or not, it makes little difference

Submitted by Arraya on December 21, 2008 - 6:32am.

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Submitted by urbanrealtor on December 21, 2008 - 10:12am.

This is a good post from Rich (and everyone knows I don't always say that). I wish the discussion around it were more thoughtful.

I am interested in distinguishing liquidity increases from uncontrolled or irrational monetization. Zimbabwe creates lots of money out of thin air in huge quantities and thus makes its currency worthless. Weimar Germany did the same thing prior to the rise of the Nazi-led coalition.

There are other examples.

The difference here appears to be one that Bernanke has been describing for some time. He is not printing/lending/buying so much that he is going to drop the coin in our wallet dramatically. I won't soon need a 20 spot to buy a candy-bar. Further, this focused increase in money supply is moving in time to a major decrease in money supply (which is consonant with a massive, global de-leveraging).

Many economists have talked about using this strategy for a very long time. Basically a depression (however exactly you want to define that term) has, as a consistent feature, huge reductions in money supply as well as mass deflation. Putting money into circulation through various means is inflationary and increases money supply.

While there is always the danger of users of this money to lose faith in it, I am not sure there is precedent for such a loss of faith. I also don't see a visible cause for people to lose faith.

Increasing the global supply of dollars a few percent (and the global supply of money a smaller percent) does not turn us into Zimbabwe may be helpful for stability.

Submitted by Rich Toscano on December 21, 2008 - 12:17pm.

urbanrealtor wrote:
This is a good post from Rich (and everyone knows I don't always say that). I wish the discussion around it were more thoughtful.

I am interested in distinguishing liquidity increases from uncontrolled or irrational monetization. Zimbabwe creates lots of money out of thin air in huge quantities and thus makes its currency worthless. Weimar Germany did the same thing prior to the rise of the Nazi-led coalition.

There are other examples.

The difference here appears to be one that Bernanke has been describing for some time. He is not printing/lending/buying so much that he is going to drop the coin in our wallet dramatically. I won't soon need a 20 spot to buy a candy-bar. Further, this focused increase in money supply is moving in time to a major decrease in money supply (which is consonant with a massive, global de-leveraging).

Many economists have talked about using this strategy for a very long time. Basically a depression (however exactly you want to define that term) has, as a consistent feature, huge reductions in money supply as well as mass deflation. Putting money into circulation through various means is inflationary and increases money supply.

While there is always the danger of users of this money to lose faith in it, I am not sure there is precedent for such a loss of faith. I also don't see a visible cause for people to lose faith.

Increasing the global supply of dollars a few percent (and the global supply of money a smaller percent) does not turn us into Zimbabwe may be helpful for stability.

Couple quick counterpoints:

1. The Fed isn't talking about increasing the money supply by just "a few percent"

2. There is not a major decrease in the money supply underway. The money supply aggregates have for the most part experienced positive, or at worst flat, growth all year. A decline in asset prices is NOT the same as a decline in the supply of money. (The person selling the asset may have less money than they thought/hoped, but that is offset by the person buying the asset needing to bring less money to the table).

3. Weimar Germany didn't suddenly say, "hey, let's hyperinflate!" Initially, their very loose monetary policy stoked a boom and appeared on the surface to be very effective. The problems came to the fore when they had to keep increasing money supply faster and faster to keep the boom going, until all the "accrued debasement" finally caught up with the mark.

I am by no means saying that this is the same situation as Weimar or that we are necessarily going down that path. (There are big differences in the two situations). However, it's important to recognize that Germany's problems began with well meaning and initially successful attempts to use increases in the money supply to stimulate economic growth -- and that those attempts actually appeared to work for a while.

4. "I am interested in distinguishing liquidity increases from uncontrolled or irrational monetization." I'm not sure exactly what this means. They are printing money to:

A) buy junk mortgage securities whose worth is so questionable that nobody else will buy them
B) prop up housing at still-unaffordable levels
C) goose credit card lending to overindebted consumers
D) lend money to a fiscally undisciplined government that is already in intractable amounts of debt (though this lending is still only threatend as yet)

Exactly how low is your bar for "rational?"

Rich

PS - Great piece by Jim Grant in the WSJ: http://online.wsj.com/article/SB12297343...

Submitted by stansd on December 22, 2008 - 12:30pm.

Hi Rich/Others,

Couple thoughts/Questions-I'm strying to sort through this myself.

-Do the monetary aggregates you are referencing take into account the velocity of money, or just the money supply? Seems to me that velocity may be the (perceived?) issue given banks are sitting on their balance sheets.

For Rich or others-I rarely speculate in markets, but did short 30 year T Bonds last week at 2.56%. In my mind, my chief risks are that rates continue to drop, the interest I have to pay while they are short, and the management fee of the fund I used to short them-anything I'm missing? Seems the upside here vastly exceeds the potential downside.

-Also, I can't fathom why China/Japan/others who are needed to fund our rapidly increasing trade deficit would continue to buy notes at 2.56% from a government whose balance sheet leverage is rising like a baloon, who has shown its willingness to debase its currency, and when those richly priced foreign reserves could be used to spur consumption in their own ailing economies (Japan exports down 27%, China needs 8% or so GDP growth just to avoid an increase in unemployment). Also, how will the loss of highly priced petrodollars being recycled into T Bonds affect yields as those economies struggle with budgets that need $50/barrel oil just to break even-seems the capital needed to run the U.S. consumptive (is that a word) ponzi scheme will dry up shortly-that said (paraphrased), "market irrationality can persist longer than your liquidity)

Thoughts?

Stan

Submitted by Rich Toscano on December 22, 2008 - 12:40pm.

stansd wrote:

-Do the monetary aggregates you are referencing take into account the velocity of money, or just the money supply? Seems to me that velocity may be the (perceived?) issue given banks are sitting on their balance sheets.

Money supply. I was referencing them to specifically counter UR's claim that there was a "major decrease in the money supply".

BTW here are some graphs for those interested:

MZM

M2

Rich

Submitted by pencilneck on December 23, 2008 - 11:38am.

Reuters also likes the "Gone nuclear" phrase:

"It's easy to see why the central bank has gone nuclear, considering the poor record of fighting deflation. Highlights -- or, low points -- include the Great Depression of the 1930s and Japan's lost decade of the 1990s."

http://www.reuters.com/article/GCA-Econo...

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