Bernanke forecasts Low Interest Rates

Ben S. Bernanke, the Federal Reserve chairman, signaled on Wednesday that he did not plan to begin raising interest rates anytime soon, saying the economic recovery would remain halting for months to come. In presenting the Fed’s semiannual monetary report to Congress, Mr. Bernanke did not waver from the Jan. 27 statement of the central bank’s key policy making board, or from a Feb. 10 statement in which he explained to Congress the strategies for gradually reducing the vast sums that banks hold in reserves at the Fed.

When the Fed raised the emergency loan rate for banks, panic and forecasts flew out the Wall Street windows, founts of knowledge that entirely missed the financial crisis. What do they know now? About as much, I'd have to say.

Look at that chart in the background: Net worth of US households - $17.5 trillion of wealth destroyed from July 2007 to March 2009 on the downward trajectory. The perpendicular green arrow indicates when the stimulus bill was signed, February 17, 2009. The upward trajectory indicates $5 trillion recovered since the stimulus. That leaves a net of 12.5 trillion dollars of wealth lost. Surely it is not yet time to raise interest rates and put a brake on the economic recovery. Wonder why those sages who forecast for Wall Street firms can not figure that one out.

While Mr. Bernanke did not change his outlook on interest rates or the economy, he did announce two significant steps to improve transparency and accountability of the Fed, after a period in which the central bank has faced considerable criticism. Significantly, Mr. Bernanke said that the Fed would “support legislation that would require the release” of the names of borrowers that used the extraordinary lending programs the Fed created in 2008 to prop up the markets for commercial paper, money market funds and even consumer loans. The Fed lent to investment banks for the first time and helped arrange the sale of the investment bank Bear Stearns and the rescues of the American International Group and Citigroup.

Rift at Fed Over AIG Bailout

A Rift at the Fed Over the Bailout of A.I.G.
By LOUISE STORY and GRETCHEN MORGENSON


New documents submitted to Congressional investigators examining the 2008 rescue of the American International Group show that officials at the Federal Reserve were deeply divided over the structure of the bailout and its long-term implications. At the same time, regulators had to contend with major banks that were A.I.G.’s trading partners and were unwilling to accept a discount from the government when closing out the contracts the banks had struck with the insurance giant.


Ultimately, the government decided to make the banks whole on the contracts, a decision that the documents say was approved by Timothy F. Geithner, the Treasury secretary who, at the time, was president of the Federal Reserve Bank of New York. The Fed’s decision to pay A.I.G.’s trading partners in full on tens of billions of dollars in contracts has been controversial because many analysts say they believe the government could have negotiated a price for a fraction of that amount, reducing taxpayer funds used in the rescue. Similar contracts were being settled at heavy discounts in other deals where the government was not involved.

Not good negotiating, for the most important deals. Such incidents increases one's skepticism of government involvement in anything important.


Last Thursday, Thomas C. Baxter Jr., the New York Fed’s general counsel, told Congressional investigators of his frustration with the banks, according to committee staff notes obtained by The New York Times. “We asked for concessions, and they said no,” he said, according to the notes. “I wonder why we even bothered.” Mr. Baxter also said that Mr. Geithner verbally approved the decision to pay full price to the banks. A spokesman for the Treasury Department noted that Mr. Geithner’s decision to give the banks 100 cents on the dollar in the A.I.G. bailout was previously discussed in a report that the Treasury’s inspector general released last fall.

Why bother? Why not push the banks to accept?

According to a 13-page slide show prepared by the asset management firm BlackRock that was submitted to the committee, Merrill Lynch and a French bank, Société Générale, were “resistant to deep concessions” on their A.I.G. contracts. Goldman Sachs, another major trading partner, was willing to accept only “a small concession” on its contracts. The slide show is among more than 250,000 pages of documents provided to the House Committee on Oversight and Government Reform in preparation for a hearing next week on the Fed’s role in the A.I.G. bailout. The committee, which is led by Edolphus Towns, Democrat of New York, has been interviewing some of the people who will testify, including Mr. Baxter.

In October 2008, one month after the A.I.G. rescue was initiated, the New York Fed encountered heavy objections to its plans for structuring the bailout from its overseers at the Federal Reserve Board in Washington. The New York Fed had recommended creating two vehicles — known as Maiden Lane 2 and Maiden Lane 3 — to house securities taken in as part of the A.I.G. rescue. A similar vehicle had been created to hold the assets guaranteed by the government in the Bear Stearns collapse.


In an Oct. 15 e-mail message to Mr. Geithner, Sarah Dahlgren, the New York Fed official leading the A.I.G. effort, wrote, “Board staff again reiterated that they didn’t think that the Governors (unnamed) would go for ML2 or ML3.” Later in the same e-mail message, Ms. Dahlgren noted, “The Governors have cited the Bear Stearns deal as a one-off deal that was done on the understanding it wouldn’t be done again (so ML2 and ML3 aren’t well-received...)”


The e-mail message also summarized the board’s questions about the bailout. Atop the list: “What does any of this buy us?” Plenty, said the Treasury Department in a statement on Friday evening. “Those investments have turned out to be very sensible, and the fund at the center of the controversy is on track to return every dollar to taxpayers, and may well yield a profit,” said Andrew Williams, a Treasury spokesman.


The Fed was advised that the banks had valued the contracts in question at severely depressed levels. The contracts were tied to bundles of mortgage bonds known as collateralized debt obligations, or C.D.O.’s. A senior New York Fed official wrote in an Oct. 22 e-mail message to Mr. Geithner that there was a “discrepancy” between “what our advisers are saying these C.D.O.’s are worth and where the firms have them marked.”


Some of the banks seemed to recognize that the mortgage bundles might wind up being worth more than they were claiming at the time. According to BlackRock’s slide show, Goldman and Société Générale were willing to tear up some of the contracts with A.I.G. if they were allowed to keep the underlying C.D.O.’s, indicating that both banks may have thought they could increase in value. The Fed instead decided to take those C.D.O.’s onto its own books and pay the banks to extinguish the contracts.

In Fed Minutes, Worries About Low Rates’ Effects

WASHINGTON (Reuters) — Federal Reserve officials are increasingly confident that the American economic recovery is sustainable, but they do not see employment picking up soon, according to minutes from their November meeting released on Tuesday.

What a time to be unemployed, never a pleasant experience.

Policymakers also expressed concern about possible adverse repercussions from their vow to keep interest rates low for an extended period, including unwanted speculation in financial markets. “Members noted the possibility that some negative side effects might result from the maintenance of very low short-term interest rates,” the central bank reported in the minutes.

Gold is over $1,100 an ounce, driven by inflation fears of gold bugs.

Some investors and policymakers have argued that the Fed’s policy of rock-bottom borrowing costs may be driving investors to beef up their bets by using the falling dollar to fund their trades. President Barack Obama, during a recent visit to Asia, was lectured on the subject by top government officials in China.

The Federal Reserve Open Market Committee, the central bank’s policy-setting body, did not believe such speculative activity had taken place to date, contending that the dollar’s decline had thus far been “orderly.”

What else they gonna say?

“Any tendency for dollar depreciation to intensify or to put significant upward pressure on inflation would bear close watching,” the minutes said. The dollar dropped to a 15-month low against a basket of major currencies last week. For now, the minutes indicated policymakers are not widely concerned about inflation in the medium term. This was already evident from a string of recent speeches in which even the hawkish regional presidents of the Dallas and Philadelphia Feds have expressed dovish views on the prospects for a sustained rise in consumer prices.

Hawks being dovish.

The “central tendency” forecasts of policymakers were slightly more sanguine on the economy’s prospects but not dramatically so. Gross domestic product was expected to shrink substantially less this year than previously estimated. Similarly, the jobless rate, currently at a 26-year high of 10.2 percent, was now expected to come down more quickly than policymakers believed back in June. “Most participants now view the risks to their growth forecasts as being roughly balanced rather than tilted to the downside,” the minutes said.

There's American English, Elizabethan English, and policy-speak.

Nonetheless, there was a sense that any turnaround in the labor market would not happen quickly enough to stem the rising tide of joblessness. “The weakness in labor market conditions remained an important concern,” the minutes said. “The considerable decelerations in wages and unit labor costs this year were cited as factors putting downward pressure on inflation.”

Avoiding another bubble

Ben Bernanke and the Federal Reserve face a number of very difficult challenges in the years ahead. They include:

• Resisting pressure to monetize deficits, which would eventually cause high inflation.

• Implementing an exit strategy from the massive monetary easing of the past year.

• Maintaining the Fed's independence, which has been compromised by the direct and indirect bailout of financial institutions and congressional attempts to micromanage the central bank.

• Properly calculating asset prices and the risk of asset bubbles according to the Taylor rule, an important guideline central banks use to set interest rates.

• Supervising and regulating the financial system more effectively, particularly in the role of "systemic risk" regulator.

From 2002 to 2006, the Fed moved slowly because the recovery appeared anemic and because of significant deflationary pressures. This time around, the recession is more severe—unemployment is at 9.8% and is expected to peak above 10%, and we are experiencing actual deflation. Therefore, the incentive not to exit too soon will be greater and the risk of creating another bubble is greater. Indeed, the sharp increase in the stock market and commodities, and narrowing of credit spreads since March, are partly due to a wall of global liquidity chasing assets and already causing asset inflation.

Over time, once the fed-funds rate is normalized, incorporating asset prices into monetary policy making is also necessary to ensure financial stability. While it is correct that the fed-funds rates may not be the most effective instrument at controlling asset and credit bubbles, excessively cheap money is always a source of such bubbles. So faster normalization of the fed-funds rate will eventually be important.

The Fed also needs a greater regulatory backbone. The Fed had the power to regulate mortgage markets but failed to use this power out of a misplaced deference to laissez-faire attitudes and Wall Street. Regulating mortgage markets requires a careful balance: short-term regulatory forbearance to avoid a greater credit crunch, along with medium-term countercyclical supervisory actions in order to prevent the emergence of further asset and credit bubbles.

Establishing financial stability—in addition to price stability and growth—is the essential role of the central bank. Achieving this goal in a way that avoids moral-hazard distortions, as with the too-big-to-fail finance institutions, and prevents another bubble in the next years will surely be one of the greatest challenges ever faced by the Fed.

TARP Cop

Recession Job Losses Top 4 Million is today's headline. The government has poured trillions of dollars into stabilizing the financial system, trying to stave off an economic calamity. Part of that is attempting to steady banks by giving them capital. It is essential that credit markets work again. The Troubled Assets Relief Program, a bumbling piece of legislation that Bush and Paulson left the nation saddled with, is a 700 billion dollar rescue package. 700 billion is a lot of money, a lot of taxpayer money, and the government has a right, and an obligation, to make sure it is spent prudently and wisely. The first part of $350 billion disappeared into a banking black hole.

Neil Barofsky, the man overseeing the $700 billion bailout, is armed with broad authority, including the right to carry a handgun and the power to subpoena. As special inspector general for the Troubled Asset Relief Program, he is charged with tracking the bailout funds. In the process, Mr. Barofsky is ruffling feathers on Wall Street and in Washington, demanding access and information some aren't eager to provide.

The mentality that got us inot this mess has not changed much.

Lawyers at institutions that have received government aid are trying to figure out how much leeway they have to push back against Mr. Barofsky, say people familiar with the matter. Some government officials say they are concerned about Mr. Barofsky's aggressive approach.

Instead of being open and forthcoming, institutions that have received TARP funds are using lawyers to finesse it, to hide, to conceal.

Mr. Barofsky ... is a former prosecutor who has tackled white-collar crime and international drug traffickers. He keeps a wooden knife from Colombia as a reminder of just how violent crime can become. Now he can roam the halls of Wall Street almost unfettered. His powers, granted by Congress last fall, give him the right to investigate and audit "the purchase, management and sale of assets under TARP."

His mission is clear, unequivocal: investigate and audit TARP funds.

He takes his mission seriously and views his mandate broadly. In an interview, Mr. Barofsky says his office has "the right to investigate and audit any TARP dollar, anywhere it goes" and to go after any type of TARP-related fraud.

It is good, for a change, that the government is the party with the hard-charging, focused, aggressive lawyer.

The position carries greater reach and independence than the other two "special" inspector generals overseeing the Iraq and Afghanistan reconstructions. Those officials answer to the secretaries of state and defense, while Mr. Barofsky answers directly to Congress.

Good charter. Intention seems quite clear.

Some within the government worry Mr. Barofsky's approach is scaring away participation in the government's rescue programs, rendering them less effective. Government officials say they saw a spike in banks withdrawing TARP applications after Mr. Barofsky said he would require documentation on how they are using the funds. Some of that spike could be due to congressional rumblings about stricter oversight.

Want the money? Answer questions, and be (o, that word) transparent.

Some hedge funds are leery about the Fed's lending facility because of the heightened scrutiny that would result, a condition included at the behest of Mr. Barofsky.

Lack of accountability and clarity are exactly the reasons why we are in this mess.

Mr. Barofsky says his purpose is to make sure taxpayer money is spent the way Congress intended, and to go after anyone, inside or outside government, who misuses the funds. "Members of Congress told me repeatedly that they want me to be the person who goes after the people who want to steal," he says.

Amen.

Congress is moving to head off any challenges to his authority. Legislation passed by the Senate, soon to be considered by the House, would codify Mr. Barofsky's authority to peer into any firm benefiting from TARP dollars.

As if it were not already crystal clear.

Fed Chairman Backs Call for Higher Spending

The chairman of the Federal Reserve on Tuesday tacitly endorsed President Obama’s call for huge increases in spending and trillion-dollar deficits over the next couple of years, saying the economic crisis required aggressive action.

Spending, and not tax cuts, will solve the crisis. To believe otherwise is foolhardy and politically demagogic.

Though the chairman, Ben S. Bernanke, did not endorse any of Mr. Obama’s specific proposals, he echoed the president’s call for bold government action to address the economy’s immediate travails and pointedly refused to criticize his longer-term plans.

He can't be stepping into the middle of politics; how I wish other Fed chairmen had been equally prudent.

Mr. Bernanke, a Republican who was appointed by President George W. Bush, provided Mr. Obama and Democratic lawmakers with crucial backing for the political battles ahead. His comments were reminiscent of the support that his predecessor, Alan Greenspan, gave to Mr. Bush’s call for tax cuts in 2001. Many lawmakers in both parties said Mr. Greenspan’s comments had helped override Democratic objections to Mr. Bush’s tax cuts.

Putz. Another bad decision by Greenspan.

Mr. Bernanke, warning that the economy had yet to show hardly any sign of recovery, brushed aside objections by Republicans that Mr. Obama’s plans would lead to a dangerous growth of government.

Politics, and foolishness.

Republican lawmakers tried to draw the Fed chairman into their corner, to no avail. “There is in this budget a massive movement of the government to the left, in other words a massive expansion of the government,” warned Senator Judd Gregg of New Hampshire, the committee’s ranking Republican.

Expansion? Isn't that what Ronald Reagan and George Bush also did?

But Mr. Bernanke simply said that Congress and the White House needed to start thinking now about how to bring the federal budget back to normal.

Recovery first, then, when the signs are clear that the economy is back on track, sure, look to cut spending; but cut too early, and another recession will follow.

Lawmakers in both parties chastised the Fed and the Treasury for providing $30 billion more to the American International Group, the insurance conglomerate that had already received three rounds of government help totaling $152 billion.

As distasteful as it is, the company has to be saved. Once stable, it should be divided up, sold off, and let Hank Greenberg go jump in a lake.

Mr. Bernanke, in an unusually emotional response, criticized the insurance giant as making reckless bets that jeopardized the entire financial system. “If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one,” he said. Saying that A.I.G. had “exploited a huge gap” in the regulatory system, Mr. Bernanke said it became a “hedge fund, basically, that was attached to a large and stable insurance company” and made “huge numbers of irresponsible bets.”

Lack of regulation allowed AIG to become a monster.

How the Fed Reached Out to Lehman

Lehman's failure remains a gaggle of unanswered questions, unresolved issues and doubts.

In the early hours of Sept. 15, after the government refused to rescue the foundering Lehman Brothers, something odd happened. The Federal Reserve lent tens of billions of dollars to a subsidiary of the newly bankrupt bank. In other words, government officials who had refused to risk taxpayers’ money on Lehman before it collapsed did just that after it collapsed.

Why was Lehman not rescued? Why was Bear rescued?

Many people, at least on Wall Street, have come to view the decision to let Lehman die as one of the biggest blunders in this whole financial crisis. Christine Lagarde, France’s finance minister, called the decision “a genuine error.” Judge James Peck, who approved the sale of Lehman’s carcass to Barclays, the British bank, said it was a shame that Lehman had failed.

Excellent point.

The authorities are investigating whether Lehman executives misled investors about the firm’s financial condition before the firm failed. But the authorities might be asking similar questions about executives at other banks if, like Lehman, those institutions had been allowed to go under.

Why was the money lent? Twice?

The recently disclosed documents detailing the Fed’s loan to Lehman’s subsidiary cast some light on a failed effort to prevent Lehman’s implosion from cascading through the financial system. The loan, according to these documents, was a “carefully thought-out decision” to stabilize the market by propping up Lehman’s broker-dealer business, called LBI New York, so it could stay afloat long enough to “facilitate an orderly wind-down” of tens of thousands of trades with the other Wall Street firms. The unit was kept out of the Lehman bankruptcy.

Good reasoning, but the implosion did cascade; many people got scared, petrified, and things got ugly.

People involved in the process said that the Fed only lent the money as part of “an orderly wind-down,” which would have been different from lending money to an ongoing, or in this case, insolvent concern.

Key point.

Cost of bailout(s)

Another day, another bailout. So, what is the cost, thus far?

First, the Fed:

Since early August 2007, the Fed's balance sheet has grown from $851 billion to $2.245 trillion as it has created rescue programs such as the commercial-paper facility. In addition, it has drawn down its stockpile of safe Treasury securities from $791 billion to $476 billion to finance programs and lent out $185 billion of Treasury securities to Wall Street firms in exchange for riskier securities. In all, the central bank has already committed about $1.9 trillion to support financial markets ...

$2.245 trillion - $851 billion = $1.394 trillion
791 billion - $476 billion = $ 315 billion
$ 185 billion
$ 1.894 trillion

Though the Fed has written down $2 billion on loans to Bear Stearns, Fed officials consider its programs to be well-secured. It is also earning interest and fees.

Two billion is such a small number in this context.

Next, Treasury:

All together, that's $398 billion invested by the Treasury so far. The Treasury is also sure to tap another $350 billion available to the TARP through funds approved by Congress in October.

HUD:

The Department of Housing and Urban Development has pledged to commit $300 billion to help homeowners avoid foreclosure.

BROADER PLEDGES: Adding together rescue money already explicitly committed by the Treasury and Fed brings the dollars spent, loaned or invested to date to $2.3 trillion, a number that is sure to grow and doesn't count fiscal stimulus.

The numbers get much larger when one considers the size of some markets the government has pledged to support. The Treasury has a program to backstop $3 trillion worth of money-market mutual funds. (It hasn't had to tap any funds so far to honor that commitment and has reaped about $800 million in fees on it.)

The Federal Deposit Insurance Corp. is in line to guarantee as much as $700 billion worth of bank debt, according to FDIC estimates. It has also substantially expanded bank-deposit insurance. The Fed is standing behind $1.3 trillion in commercial paper. Various agencies are helping Citigroup to backstop $306 billion in investments.

And counting.

O, my, what a headache!

Secretary of the Treasury Paulson and Fed Chairman Bernanke testified today on Capitol Hill. The Chairman does not look very happy, does he? What is this guy saying? or maybe Do I really have to be here?


The second picture is on the front page of Friday's New York Times; this time the Secretary is feeling pain.