Economic Dreams - Economic Nightmares

US Fed Caught Between Rock and Hard Place

At Economist's View, Tim Duy tries to sort out Bernanke and Co.'s next moves. In short the Fed risks a dollar collapse on one horn of its dilemma and a systemic banking crisis on the other. Which path will they choose? Or is there some way to steer clear of a near-term-future in which the ever-vocal, times-past market cheerleader Alan Greenspan says we will see many banks failing (Financial Times, March 17). Here's Duy:

Fed Watch: Anything and Everything is On The Table, Tim Duy, March 17: … [P]olicy may soon be dangerously close to the having to choose between a collapse of the Dollar and a more generalized banking crisis. Another description of this tradeoff comes from Fed Chairman Ben Bernanke in a 1995 paper, The Macroeconomics of the Great Depression: A Comparative Approach:

A particularly destabilizing aspect of this process was the tendency of fears about the soundness of banks and expectations of exchange-rate devaluation to reinforce each other (Bernanke and James 1991; Temin 1993). An element that the two types of crises had in common was the so-called "hot money," short-term deposits held by foreigners in domestic banks. On one hand, expectations of devaluation induced outflows of the hot-money deposits (as well as flight by domestic depositors), which threatened to trigger general bank runs. On the other hand, a fall in confidence in a domestic banking system (arising, for example, from the failure of a major bank) often led to a flight of short-term capital from the country, draining international reserves and threatening convertibility. Other than abandoning the parity altogether, central banks could do little in the face of combined banking and exchange-rate crises, as the former seemed to demand easy money policies while the latter required monetary tightening.

To be sure, Bernanke is describing the Fed's tradeoff during the Great Depression, when it was constrained by gold standard. Still, the basic problem remains. Tight policy would accelerate and intensify the pain in the banking system, but loose policy could destabilize the Dollar, causing capital to flee the US and also undermining the banking system. And, to make matters worse, a collapse in the banking system due to tight money could then trigger a currency collapse.

I think it is safe to describe this as a no-win situation, which means an ugly choice has to be made. And, with this in mind, perhaps the Fed only offered 25bp on the discount rate in hopes they could avoid a greater than 25bp cut in the Fed Funds rates. At this point, that does not look like an acceptable domestic policy choice, and if they ultimate cut 50bp or more, they have accepted the risk of destabilizing the Dollar.

I have to imagine that global central banks are ready to intervene at the drop of a hat, and would not be surprised by some action when New York opens Monday. If there is an intervention, it will be interesting to see if the Fed participates. Could the Fed credibly buy the Dollar one day while cutting rates 75bp or more the next? And what are the odds of a successful intervention if the monetization option looks increasingly viable in the weeks ahead?

[N]othing but tough policy questions at this juncture. …

Bottom Line: An aggressive cut in the Fed Funds rate seems likely, with 100bp certainly on the table. Still, one has to ponder why this was not part of the Sunday policy package. Could it really be as simple as not being able to contact enough FOMC members to have a teleconference? Or was it hope that a bigger than 25bp Fed Funds rate cut might not actually be necessary? Or has the Fed come to believe that their policy actions might trigger a destabilizing fall in the Dollar? At this point, I anticipate a cut larger than 50bp, with even odds on 75 and 100. The greater the cut, the more the Fed is willing to risk a Dollar collapse.

Financial 'Meltdown Moment': Thomas Palley Suggests a Solution

Everyone paying attention to our current financial mess seems to be scratching their head, wondering just what might get us out. Paul Krugman threw up his hands earlier today. Thomas Palley to the rescue! Palley suggests simply that the Federal Reserve "open its term auction facility to all publicly traded financial intermediaries rather than just deposit taking institutions." Sounds reasonable to me, but I only watch from the sidelines.

I suspect that such a move would have some banks trembling in their boots, since they would have to play on a more level playing field than they are used to. I'm sure that some libertarians will scream, perchance for good reasons, that this is getting us one step closer to dreaded big-brother land. It will be interesting to see if Palley's suggestion garners favorable response, and from whom. To Palley:

Meltdown Moment: What Must be Done: … In today's crisis environment the problem in financial markets is not the level of interest rates, or even the size of the Fed's term auction facility. The problem is getting liquidity to those links in the financial chain that are most stressed. Reliance on the normal channels of distribution does not work when confidence has evaporated and markets have seized-up.

There is a very simple and fair solution to this problem. That solution is for the Federal Reserve to open its term auction facility to all publicly traded financial intermediaries rather than just deposit taking institutions. That means giving access to insurance companies, mortgage investment trusts, mutual funds, and hedge funds. These firms would be subject to the same borrowing terms as banks, and would have to post collateral of identical quality.

Such a change would level the playing field in financial markets and remove the unfair subsidy to banks. Most importantly, it would tackle the problem of credit market seizure that is afflicting all financial institutions. In a world where distinctions between financial intermediaries have become increasingly blurred, broadening access to the term auction facility is the logical and correct policy.

The Federal Reserve's current policy is failing because it is structured for the world of the past in which depository institutions dominated lending. Thus, current policy restricts access to emergency liquidity to deposit taking institutions, ignoring how lending has become detached from deposit taking. The challenge of the day is preventing a meltdown that destroys sound lenders and sound assets. That calls for widening access to temporary emergency liquidity. Afterward, there will be time to visit the question of regulatory reform and more permanent policy change.

Minsky Moment and Trillion Dollar Meltdown: What might Help?

George Magnus, UBS Senior Economic Advisor, widely credited for popularizing the "Minsky Moment" phrase a year ago, once-again invokes Hyman Minsky and suggests that we are likely facing a Trillion dollar financial meltdown when all eventually gets added up. And he says that "fixing the problem" goes way beyond simple Monetary Policy fixes. Legislative and regulatory fixes will need to accompany monetary policy fixes.

Magnus believes that Ben Bernanke sees the crisis in proper perspective and believes that the US Fed is doing what is necessary, although not sufficient to stem the worst outcomes from this crisis. Here is a link to three-part video (3 minutes per part, Feb 25) featuring Magnus as interviewed by Financial Times Gillian Tett. In part three, Magnus predicts a Credit Crisis Bailout (by the US Government and others) by October.

Meanwhile, US Treasury Secretary Henry Paulson is in full attack mode as to a Credit Bailout. And Allan Meltzer suggests (Feb 28) that, far from doing what appears proper and necessary, the Fed is repeating the mistakes of the 1970s.

Of the three, I think Magnus is more likely correct.

P.S. I'm wandering off for a few days skiing in the Utah mountains.

Bill Gross: Mr. Bernanke - we have a problem

Bill Gross's Feb 1 Investment Outlook is worth a look. Echoing Paul Krugman, Gross suggests that we now need some deep Keynesian stimulus, not the 'Stimulus Lite' fare being bandied about by the Bush Administration and the Congress. Implicitly, but without any real plan to make it happen, Gross also suggests we need to return to earlier fundamentals of honesty and thrift, abandoning the 'quick fix' mentality that has at once encouraged speculation and outright financial fraud and buried the American middle classes under mountains of debt. Soundbite: "[T]he U.S. economy and its somewhat coupled global companion will sleep walk for some time and a resumption of prosperity as we knew it will be dependent on reforms of monetary and fiscal policy resembling the 1930s more than our past decade." Here's more:

Bill Gross, Better Late than Never, Feb 1: … Paul Krugman, …, proposing revolutionary solutions for the Japanese recessionary malaise of the 1990s and writing a book in 1998 entitled The Return of Depression Economics … referred to the fact that the crucial task of future policy would be to bolster demand as was the case in the FDR-driven 1930s as opposed to encourage supply which has been the case since the Reagan revolution. Although Krugman doesn't comment, in my opinion, it's not that Reagan was wrong — he was in fact brilliantly correct and timely in his supply-side revolution.

Iverson aside: I can't go along with Gross here. I find the very idea that Reagan "was brilliantly correct" repulsive. I believe that Reagan helped to mislead the US, and helped jump-start a 30+ year-long "irrational exuberance" party that is now unwinding badly. Back to Gross:

That pendulum, however, appears to have swung too far in the direction of the private market. But Krugman (and yours truly) was a tad early in his forecast for reversal I think, because of the failure to recognize the potency and the inventiveness of modern finance.

Until recently, U.S. and therefore global demand has been driven by the ability to lower interest rates and extend credit to an increasing majority of Americans. Mortgages, auto finance, and credit cards were offered on increasingly liberal terms and continually lower yield and risk spreads because of Wall Street ingenuity and — importantly — the naïve endorsement of their black magic by rating services willing to sell AAAs for a fee. … Demand, as Krugman would likely retrospectively recognize, was bolstered and supported by innovative, securitized finance which in turn was nurtured by lax regulation and a belief that things could not go wrong — and if they did — that policy makers, both monetarily and fiscally oriented, would make things right. The repair, if needed, was labeled the "Keynesian compact" and it made for a deal with the American public: it would be OK to have free markets because policymakers know enough to prevent another Great Depression. Demand could always be stimulated with a combination of easy money/budget deficits. Prosperity in effect, was guaranteed.

Well "probably" guaranteed — but the historic growth rate of that prosperity may now be threatened. Because demand in the form of consumption has been artificially and fictitiously stimulated in recent years by financial engineering run amuck, there is a legitimate question as to whether its black hole imploding destructiveness can be totally countered with another dose of lower yields and deficit spending packages. The $150 billion "return to sender" deficit plan advanced by Bush and the Congress, for instance, amounts to just 1% of GDP and is labeled temporary. It will be of marginal benefit to long-term prosperity. To understand why, consider that the productivity of our economy ultimately depends on its ability to 1) innovate, and 2) save and invest, and that there is little of either in this stimulus package. Some have even suggested — and with my somewhat grudging concession — that this package will help the Chinese economy more than ours. Americans will use the rebates to buy Chinese imports offered at Wal-Mart and the $150 billion will then wind its way inevitably back to Asian coffers. The U.S. needs a Krugman "demand-based" fiscal package alright, but a $300-$500 billion permanent one, in addition to the proposed temporary package, because as mentioned in last month's Outlook [Pyramids Crumbling], as the system of modern day levered shadow finance slows to a crawl or even contracts at the edges, its ability to systemically fertilize economic growth must be called into question. But government writing checks for American consumers which then flow to foreign central banks is not the permanent solution; it only makes sense in the short-term as a life preserver. To provide a stable recovery path, government spending needs to fill the gap — not consumption. Public works programs, badly needed infrastructure repairs, as well as spending on research and development projects should form the heart of our path to recovery. Assistance for homeowners? That too — figure out a fiscal/regulatory way to stop the slide in housing prices and foreclosures but please — no traffic jams at the Wal-Mart checkout counter in 2009 and beyond.

Approaches to monetary policy must change as well. 1% short rates were so effective 5 years ago that they not only bolstered demand but created a housing bubble of Frankensteinian proportions. Those days, however were influenced by the creation and implementation of adjustable-rate mortgages (ARMs) that were priced at the short end of the yield curve. Millions of ARMs were issued at 2% and 3% teaser rates, many with terms of up to 5 years before their inexorable adjustment upwards. Surfeits of houses were bought at artificial prices because of these generous terms and billions in home equity loans were taken out — both driving demand and the economy forward. But adjustable-rate mortgages are a dying relic. Originators will no longer offer them except on onerous terms. No more teasers or pleasers of that ilk; there are regulators to deal with, and lawyers on the prowl with class action lawsuits in their briefcases.

And so the monetary attempt to halt housing's — and therefore the economy's — downward slide rests on the shoulders of the 30-year mortgage. If so, then Mr. Bernanke — we have a problem. First of all these 6-7% 30-year mortgages now require a significantly higher down payment than in prior years. 20% down? Say what? Where does a 30-year-old couple get that kind of money? Secondly, however, and just as important, what motivates a future homeowner to pay 6%+ interest for an asset that is going down in price? It was an easy decision to pay subprime yields of that and then some when housing prices were accelerating at double-digit annual percentages; the benefit was obvious. Now however, with prices in negative territory, the risk/reward is tilted towards the renter.

My point is that Chairman Bernanke must recognize the reduced benefits and obvious dangers of a déjà vu trek to 1% short rates. Those yields produced 5% 30-year mortgage rates to the homeowner for a 2-3 month period in 2003 and they could do so again, but bubble creating, inflation inducing damage to the U.S. dollar would be the likely result now. Best to stop far short of 1% and at the same time encourage reforms in FHA government assisted programs that would permit subsidized mortgage rates with minimal down payments.

An artificially low, 1% short-term interest rate was an elixir during the days of a burgeoning shadow banking system. It cannot be the solution now.

In combination, a well constructed, more than temporary fiscal/monetary stimulus plan is what is required to rejuvenate a U.S. economy reeling from a low punch delivered by a private market economy gone too far. Its "Rosemary's Baby" took the form of a shadow banking system based on leverage and the fateful conclusion that a finance-based economy alone can deliver prosperity. It cannot. As Keynes theorized and then Krugman affirmed, when private demand falters, it becomes the responsibility of government to fill the breach. Because it likely will not do so effectively until after a new Administration is elected in late 2008, the U.S. economy and its somewhat coupled global companion will sleep walk for some time and a resumption of prosperity as we knew it will be dependent on reforms of monetary and fiscal policy resembling the 1930s more than our past decade. Better late than never.

Catching up on Financial 'Interesting Times'

Let's begin with Paul Krugman's Dec 14 Authors@Google Series video on how we got into our current financial mess and some "mysteries" on how we might get out of it this side (or the other side) of a 'hard landing.' In this very good hour with Krugman, he covers the previous Long Term Capital Management induced mess, the Nasdaq "tech bubble", the housing bubble, the Fed, "financial innovation", and more. Good insights for we who don't spend 24/7 dealing with matters financial:

Krugman believes that the housing mess is with us for about the next six years, guessing, based on early '90s S. California housing bust, with an average 30% price drop (in "real" dollars) from "bubbleicious" peaks. In a blog post today, Unknown Housing Territory, Dec 19, Krugman gives us more:

… The bubbles in the most bubbleicious areas were bigger than anything we've ever seen — and there's every reason to think that the required fall in prices in those areas will be much bigger than anything we've seen since the Great Depression. …

In the video, Krugman admits being surprised by the enormous impacts of the housing and related credit crunch have on the "financial system". He highlights how the Fed has been 'behind the curve' on dealing with this latest crisis, naïvely believing that the same medicine that 'solved' the LTCM mess years ago would suffice here. Since that medicine didn't work this time, Krugman gives us glimpses of the newer approaches central bankers are trying to put into play.

One Highlight: Glassman's law, as a correlary to Stein's law (also from Bubble Denial, Dec 10 on Krugman's blog):

… [B]ack in 2005, when I started writing about the housing bubble — it didn't take much to see that something was way out of whack.

So how come the housing crisis has come as such a surprise to so many people?
Part of it was the usual bubble psychology. Economists like to cite Stein's Law: "If something cannot go on forever, it will stop." I think it needs to be paired with another law — let's call it Glassman's Law — along the lines of "If something unsustainable goes on for a while, there will be people claiming it can go on forever."

According to Krugman, everybody looks to the 1998 'fix' for the Long Term Capital Management debacle as a model for this episode. Problem is, that strategy doesn't seem to be working this time. The 'fix' as applied last August, seemed to work for awhile, but 'trouble' is now welling up again. So the Fed and other Central Bankers are now trying hard to funnel short- to medium-term liquidity into the system.

Krugman is hoping this latest, belated effort from central bankers will work, although he suggests there are no 'quick fixes' to this mess — adding that we still don't even know the size and extent of the mess. "Steve Cechetti is hopeful but has his doubts", says James Hamilton in his Monetary Policy Using the Asset Side of the Fed's Balance Sheet, Dec 16. Whatever you read from these extended hyperlinks, don't miss Cechetti's The Art of Crisis Management: Auctions and Swaps, Dec 16.

Noruiel Roubini is even less sure that even this latest easing will help , although he has been advising central bank "easing" for some time. See Roubini: First, Central Banks Are Getting Desperate in Dealing with the Liquidity Crunch …, Dec 18, and second, Why Monetary Policy Easing is Warranted Even in the Current Insolvency Crisis, Dec 15

Finally, Michael Shedlock (as an interesting member of the Libertarian Right) is apoplectic, not only at what he considers continuing mis-steps by the Fed, but also since Roubini, whom he admires as a forecaster, doesn't buy Shedlock's particular brand of 'free market fundamentalism': asking for the Fed to be abolished and for a return to the gold standard and private banking. See Shedlock's Missing the Boat on Monetary Easing, Dec 18.

Quite a bunch of interesting stuff out and about! Mostly I just sit back and read from the really good commentators I track on my sidebar (and my Google Reader). I don't pretend to be in the same league as they are on matters of finance and geopolitics. But I do like to try to sort out some of it, second hand. Ocasionally I even help others in their own sorting, and that makes this little hobby of mine worthwhile.

Happy Holidays to those who are celebrating such during this season.

British Humorists Bird and Fortune:The Banking Crisis

John Bird and John Forture are noted for their staged "interviews". This parody of the Banking Crisis made me laugh out loud. It's too bad that that the crisis is more the stuff of tragedy than comedy. Still, this little video ought not to be missed: You Tube — It's Credit and It's Crunchy

HT: BULL! NOT BULL — Favorite Videos

Note: I deleted an earlier, similar post where I inappropriately attributed "It's Credit and It's Crunchy" to humorist John Cleese. Apologies to Bird and Forture

More from Bird and Fortune: You Tube — The Subprime Crisis and Structured Investment Vehicles (SIVs)

Noland Debunks Greenspan's "No particular regrets" remarks

While I'm not yet ready to throw verbal rocks at Ben Bernanke, I certainly share Doug Noland's disdain for Alan Greenspan's behavior during the last decade and more. Here, with a few highlights, is Noland's latest view or where we stand and how we got here—cheerled by the US Fed:

No Regrets, Doug Noland, Credit Bubble Bulletin, Nov 23: November 23 – Bloomberg (Robin Wigglesworth and Craig Stirling): "Former Federal Reserve Chairman Alan Greenspan said he has 'no particular regrets' about his time at the central bank, adding that the deepening U.S. housing-market slump isn't result of his policies. 'Markets are becoming aware of the fact that the decline in house prices is not stopping,' Greenspan said… I have no particular regrets. The housing bubble is not a reflection of what we did, as it is a global phenomenon.'"

November 18 – Bloomberg (Anthony Massucci): "Former Federal Reserve Chairman Alan Greenspan said the dollar's decline hasn’t affected the global economy and is a 'market phenomenon.' 'So long as the dollar weakness does not create inflation, which is a major concern around the globe for everyone who watches the exchange rate, then I think it's a market phenomenon, which aside from those who travel the world, has no real fundamental economic consequences'…"

I don't know which of the two above quotes this week from Alan Greenspan I find more astounding. They are somehow equally despicable. The Greenspan Fed's fingerprints are all over the housing Bubble — at home and abroad. And they're everywhere when it comes to heightened global dollar and currency market tumult. Our much revered former Fed Chairman is making a fool of himself, a spectacle not all too supportive of confidence in our policymakers, Credit system, or currency.

Whether he will admit it or not, mortgage Credit inflation was central to the Federal Reserve's post-tech Bubble reflationary strategy. It really was a "Great Experiment" in inflationist monetary policy and, predictably, it failed miserably. The Fed and some notable Wall Street "strategists" feigned a system-wide "price level" that the Fed was obligated to adeptly manipulate to ensure that that evil “deflation” was not allowed to take root. What a crock. The risk was, then as it is now, U.S. Credit Collapse — and certainly not a somewhat deflating price level. Accommodating history’s most reckless Credit expansion over the past six years then ensured that the risk of collapse grew significantly greater while countermeasures turned increasingly unavailing.

I'll assume that the Fed simply lost control of mortgage Credit excesses. And as the risk of a devastating housing bust escalated, the Greenspan/Bernanke Fed became more ideologically intransigent in their opposition to pricking asset Bubbles. In this regard, Dr. Bernanke was Greenspan’s ideal surrogate. Unfortunately, we’re about to experience the consequences of the fundamentally flawed policy of ignoring Bubbles while they are inflating, choosing instead to wait for post-Bubble "mop up" duties. It was Greenspan himself decades ago that placed responsibility for the Great Depression on the Fed for repeatedly inserting "Coins In the Fusebox" during the Roaring Twenties. How differently would the world look today had the Fed not cut rates to 1% and left them at ultra-low levels for several years? How different would it be if the GSEs had kept their power dry, retaining financial resources to assist the mortgage market during this downturn instead of shooting all their bullets and more perpetuating the fateful Mortgage Finance Bubble? How differently would it be today if the dollar were fundamentally strong, instead of a currency carelessly debased to perpetuate an Economic Bubble?

As gatekeeper for the world's reserve Credit system and currency, to pass off our unfolding housing and financial messes as "global phenomena" would be laughable if it weren't so serious. "No particular regrets" Somewhere along the line the Federal Reserve lost sight of its fundamental mandate and responsibility — to protect the soundness and stability of our financial system and economy. Doubling our entire stock of mortgage debt in just over six years is certainly not consistent with price stability, financial stability, or economic stability — no matter what the reading on "core" CPI. And $800bn Current Account Deficits are an abomination and talk of a global "savings glut" shameful economics.

Moreover, it was our Credit system that led the world in the proliferation of securitizations, derivatives, leveraged speculation, Credit guarantees/insurance and highly tangled debt structures. And throughout his 18-year reign, Mr. Greenspan was the most vocal proponent of "Wall Street finance." He was the head cheerleader for securities-based risk intermediation, derivatives, dynamic hedging strategies, leveraged speculation and, generally, Credit Bubble Turned Global Financial Fiasco. If he were any kind of statesman, he would today at least be willing to admit where mistake were made.

U.S. mortgage excesses blighted the world. Credit systems around the globe adopted Wall Street securitization and derivatives practices, while incorporating uniform "risk management" strategies. Wall Street cut loose leveraged speculation to overrun financial systems around the world, while our Current Account Deficits were often "Recycled" back to high-yielding "structured products." And while not commonly recognized, U.S. mortgage Credit excesses and attendant Current Account Deficits concurrently debased the dollar while unleashing Credit systems globally. A complete lack of discipline — evolving into outright recklessness — at the "Core" nurtured rampant Credit and speculative excesses at the "Periphery". Bad "money" for the "reserve currency" equated to bad "money" proliferating throughout. And, let there be no doubt, monetary toxicity has progressed to the point where it has severely affected global Economic Structures. The situation will not be rectified by central bankers and an even greater bout of Credit inflation.

It is no coincidence that Greenspan made such ridiculous comments this week. As it has become increasingly apparent to the world that U.S. mortgage finance and the dollar are impending fiascos, our former Fed chairman is compelled to disavow responsibility. The housing Bubble is a "global phenomenon" and dollar weakness a "market phenomenon" with "no real fundamental economic consequences." It's stunning, and I can only contemplate how such nonsense sits with central bankers at the ECB, The People's Bank of China, The Reserve Bank of New Zealand, other European central banks, in the Middle East, and in Asia.

Outside of radically shifting financial, economic and geopolitical power away from the U.S. to the rest of the world, perhaps our policymakers' neglect of our currency hasn’t been of real consequence. Historians will look back at this period and have difficulty comprehending how a nation could have so indecorously squandered the benefit and privilege associated with reigning over the world’s reserve unit of exchange. Especially when it comes to energy resources, dollar devaluation has had momentous real consequences. Our vulnerabilities have been further exposed, while the standing of our competitors has been enhanced and our enemies empowered. Worse yet, the leading beneficiary of U.S. inflationism has been, not coincidently, the most unstable tinderbox region of the world. It is precisely these types of momentous inflation and economic consequences that manifest into financial and economic upheaval and calamitous global conflicts.

It was a short but eventful week. The Credit disaster unfolding at the GSEs came into clearer focus with the release of earnings from Freddie Mac. Agency debt and MBS spreads widened markedly. The mortgage implosion was at the brink of a major turn for the worst, with liquidity concerns spurring significantly wider Credit default swap prices for Rescap, GMAC, Countrywide, the Credit insurers, and financial institutions generally. The dominoes are lined up. Yet it is this type of acute stress that has always in the past extorted aggressive policymaker action. The Fed's traditional tool box, however, is woefully deficient to deal with impending Credit Collapse. I can only assume they're now diligently at work crafting new implements. [emphasis added]

Roubini's Nightmare

October Employment: Plus 166K or Minus 250K Jobs? Nouriel Roubini, Nov 02: … If you are interested in understanding where the economy is going you should [look not at the ambiguous Oct '07 "employment report", but ] rather look at the ongoing disaster in credit markets — with a severe and spreading credit crunch — that will get uglier in the next few months as financial institutions are forced to mark to market massive — still unrecorded — losses on trillions of mortgages and related MBS and CDO tranches. With the ABX index for BBB- now down to the 20s and even the AAA tranches now down from par to 79 there are hundreds of billions of losses that no financial institutions has even started to account for. When allegedly AAA tranches of CDO trade at 79 cents on the dollar you know you have a massive and severe financial nightmare ahead. So, instead of the NFP report look daily at what the ABX indices are telling you about what is happening the economy and the financial sector. [empahsis added]

One has to wonder whether this is really Roubini's nightmare or whether his real nightmare is that his bearish forecasts (which I've been following/echoing) won't come true and he will miss out on the rest of the upside from a "reflated" Bull Market.

For those are feeling a bit less Bearish than Roubini, here is a bit of confirming evidence (or soothing news) from Greg Mankiw:

The View from 1600 Pennsylvania Ave, Greg Mankiw, Nov 2: A friend in the White House emails me an economic update:

Today is Jobs Day. Here’s what you need to know about the October employment report:

• +166,000 net new jobs were added in October. This is almost twice what the markets expected.
• The unemployment rate is unchanged at 4.7%.
• The US economy has created 1.68 M net new jobs over the past year, and 8.3 M since the labor market turnaround in August 2003.
• We've had 50 months (4 years and 2 months) of continuous employment growth, a new record.
• Wages are up 1.2% over the past year, adjusting for inflation.

In other economic news, on Wednesday we got GDP data:

• GDP grew 3.9% in the 3rd quarter, well above market expectations of about 3%. This is the strongest quarterly GDP growth in 1½ years. Extra happy.
• We can see the effects of a strong labor market in the consumption numbers — people are working and their real incomes are climbing, so they're buying more stuff. Since consumption is about 70% of the economy, strong consumption growth is critical to continued GDP growth.
• Housing is still a drag — it knocked 1.1% off the third quarter growth number. This is bad but unsurprising. The silver lining is that there's no evidence the housing decline is spilling over into consumption.
• Business investment was solid. Investment in "equipment and software" grew at a 6% rate, the best in 1½ years.
• Exports continue to be strong, and they now make up 1 in 8 dollars of our GDP (12%). The rest of the world is growing, and they're buying our stuff.

This last point is a useful reminder — world economic growth is not a zero sum game. When other countries’ economies grow, they buy more US goods. That’s good for us. …

Later, Mankiw sprinkles a bit of gloom on the mix:

There are, however, some clouds going forward.

• It's probably going to take a while to work out of the housing downturn. We expect housing will continue to be a drag on GDP growth.
• Oil prices are nearing an all-time inflation-adjusted high (depending on how you measure inflation).
• The credit markets are still working through problems that first appeared in August.

Finally Mankiw ends, once again, on a happy note:

One of our favorite words when talking about the US economy is "flexible" — we have extremely flexible labor and capital markets. When bad things happen (e.g., a factory closing, wildfires, housing and credit market troubles), a flexible economy can adjust and recover quickly and with the smallest amount of pain. We're seeing the benefits of a flexible economy now.

When we look back some years hence, we will see whether the pessimist or the optimist prevailed. Or maybe even then the evidence will be so ambiguous that both will be declaring victory.

Debunking the 'Helicopter Ben' Meme

Via Econbrowser:

Money Creation and the Federal Reserve, James D. Hamilton, 09/23/07: … This is not to insist that concerns about higher inflation are unfounded. But, if one wanted to motivate such concerns from a monetarist perspective, one could not point to money that has been printed so far. Instead, the story would have to be that, in order to achieve the path for the fed funds rate that the Fed is now likely to set for the following year, the Fed will eventually need to add more reserves that do end up as more cash in circulation. In this scenario, markets have been reacting to an anticipation of future money creation and not to something that has already happened.

Now, I realize that this explanation may not be as entertaining as the whole Helicopter Ben meme. But on the other hand, it may be a whole lot more accurate.

Greenspan Still Doesn't Get It: Who does?

I was going to just lay out the guts of Doug Noland's latest, continued rant about the impending blow off of our giant "Credit Bubble". But then I wandered over to Jim Kunstler's place and found that his continued rant about our "Long Emergency" deals with Greenspan's reemergence as well. Kunstler's version is more fun, darkly, so we'll air it first (be sure to go to the source, 'cause I left out some of the funniest parts):

Shocked! Shocked! Jim Kunstler, Sept 17: Alan Greenspan's memoirs are being flogged across the airwaves, bandwidths and printing presses, and the cohort of those who comment on public affairs in these media are shocked by the Maestro's confessions -- first, that a housing bubble emerged out of his leadership in the banking sector, and second that the Iraq war is about oil. As usual, they're getting it all wrong -- about as wrong as Al himself got it. But that is the way of things in this age of cultural dissipation and gross cognitive dissonance.

Greenspan claims he had no idea that his cutting of interest rates to near zero would produce any irregularities in the US economy. Apparently he hadn't noticed that the Big Fund Boyz called him "Easy Al" for a reason. Or that when you introduce nearly free "money" (as in "available for lending") into a system of financial trade, the recognition of moral hazard tends to evaporate. As the nation's chief bank regulator, Greenspan also apparently failed to notice the upsurge in dodgy lending practices previously only seen among mafia loan sharks, drug dealers, or twelve-year-olds playing Monopoly.

But the really funny part of all this is that the media columnists are acting as though the American public got hoodwinked by Al. Which raises the question: just what the fuck was the public thinking when they bought half-million dollar houses on salaries under 60-K, taking out no-money-down, interest-optional balloon mortgages and other tricked-up contracts? The answer is: they walked into these arrangements with their eyes open because they thought they could get something for nothing. They thought the trend of steeply rising house prices would continue indefinitely and enable them to wiggle free of any hazard by flipping their houses to an endless supply of greater fools who would be there waiting to turn the very same trick. And the smoothies downstream in the mortgage and banking rackets were no less guided by avarice when they cooked up their formulas for bundling half-baked mortgages into tranches of tradeable securities. Easy Al may have failed to notice what was going on here, but then so did everybody else from The Wall Street Journal to the Securities and Exchange Commission.

This, of course, represents an insidious psychology. It could only happen in a culture that has come off the rails mentally, so to speak, as ours has in the sense that nobody has any sense of consequence, neither the leaders nor those who affect to follow the leaders. The leading religion in America is not evangelical Christianity, it is the worship of unearned riches, and its golden rule is the belief that is is possible to get something for nothing. Its holy shrines are Las Vegas and Wall Street. …

No, the American public, including the cheerleaders in the media, have only themselves to blame for the bitter harvest now underway in the asset and credit markets. And thus it would be salutary thing for Baby Jeezus, or the forces of nature, or whatever powers guide the universe, to now kick the shit out of them, so to speak, financially, because that is exactly what the American public is full of, from top to bottom….

Now, as to the shock of Al's revelation that the Iraq war is about oil -- the media and the public has got this all wrong, too. The logic here seems to be that because the Iraq war is about oil it is therefore unnecessary, optional, a mistake, an indulgence, something we should not dirty our hands in. In fact, the Iraq war is not about oil, per se, so much as it is about America's behavior here at home, about the choices we make for how we live on this continent. None of those who complain most loudly about our military presence in Iraq have advanced any proposals for reforming how we live here -- and hence for our enslavement to oil, much of the world's remaining supply of which happens to be in the neighborhood of Iraq. When these complainers start complaining about the ubiquitous acceptance of suburban sprawl and abject car-dependency -- and this includes the environmental boy scouts out there who want to get merit badges for buying hybrid cars -- then they will deserve to be taken seriously. Until then, the American people have got exactly the grinding war that they deserve. Let them whine about it all the way to the Nascar tracks, and let them console themselves with giant plastic bottles of Pepsi Cola and buckets of chicken raised on corn grown with oil byproducts.

On CBS's "60-Minutes" show last night, Greenspan, in his new role as a private sector economic consultant made predictions for the coming months in the US economy. He declared that the financial sector would get over the current credit squeeze as if it were a mild case of indigestion…. This gets back to the previous point about the Iraq war and oil in particular. Al doesn't get it. CBS's sycophant reporters don't get it. Nobody gets it. We are entering the zone of the long emergency in which the primary resource needed to run the industrial economies will become scarce, expensive, and profoundly destabilizing to markets and to normal life, such as it is known in this country. And the current problem in the markets is a reflection of the resource bankruptcy we are facing. Our problems are not about credit, they are about permanent insolvency. …

"Didn't Really Get It", Doug Noland, Sept. 14: I found it ironic that during the same week Alan Greenspan admitted he "Didn't Really Get It" when it came to the risks associated with subprime lending, Chairman Bernanke publicly reiterated and expanded his "global savings glut" thesis. …

Mr. Greenspan now admits that he didn’t really "Get It" until late 2005, while Dr. Bernanke's intellectual focus at the time was explaining how mounting U.S. Current Account Deficits were a phenomenon of global savings and investment dynamics. Both were more than intellectually content to sit back and marvel at U.S. economic "productivity" and the capacity of contemporary finance to Inflate Credit. Both also worked diligently to construct a framework rationalizing why the Fed needn't pierce Bubbles nor even go so far as administering a little "tough love". Both are curiously oblivious — at least publicly — to the notion of Pernicious Credit and Speculative Excess.

There is no reasonable excuse for our central bankers' failure to recognize and then move to check intensifying Mortgage Credit Bubble dynamics by 2004 — at the latest. It was (and remains) similarly inexcusable to disregard the U.S. Credit system's prominent role in financing rapidly escalating Current Account Deficits and resultant worsening global imbalances. …

The "global liquidity glut" has fomented myriad Bubbles — and the reality that seemingly all of the global ones remain very much in force empowers Chairman Bernanke to stick steadfastly to his "savings glut" theorizing. Yet "saving" doesn't fuel Bubbles — excessive borrowings do. …

Conventional thinking has it that the world economic backdrop, outside of U.S. subprime and housing woes, is vibrant and sound. This favorable backdrop, it is believed, explains global equities markets resiliency in the face of mounting U.S. and global Credit woes. [Alternatively,] the Global Credit Bubble and "Liquidity Glut" perspective takes a quite negative view of the current global backdrop. Bubbles proliferate.

Admittedly, most global Bubbles have been impervious to the Bursting U.S. Credit Bubble. China is a case in point. Yet there are important unappreciated dynamics to contemplate. First, domestic Credit Bubble Dynamics have become well entrenched around the world, especially with U.S. dollar impairment working to decisively limit the risk of currency runs in, say, China, Russia, Brazil, India, Asia and "developing" economies in general. The weak dollar and unrelenting U.S. liquidity outflows (C.A. Deficits and speculative flows) have nurtured quite atypical stability for a group of currencies that would otherwise suffer the acute vulnerability incident to overheated domestic Credit systems, asset markets, and economies.

[T]oday's backdrop would be altogether different had it not been for aggressive and concerted central bank intervention. Huge liquidity injections — and, as important, assurances from Chairman Bernanke to use "all of the tools at his disposal" — kept the U.S. and much of the global securities markets from seizing up. As it was, the extent of Acute Financial Fragility was perceived to require an immediate and bold marketplace onslaught that, ironically, worked to underpin most global Bubbles. Certainly, not much froth was allowed to come out of global equities. No froth has been removed from global inflationary pressures. Lower global yields are destabilizing and portend only greater Global Monetary Disorder.

It is the view of the Bernanke Fed (as it would have been of Greenspan) that a U.S. recession can and should be avoided. This is flawed and dangerous ideology. It is the market's view that the Fed will lower interest rates to whatever level necessary to sustain the U.S. expansion. This is wishful thinking. Recent history has spoiled both the Fed and the markets. Today, recession cannot be avoided, and the weak dollar and robust global inflationary backdrop will limit the Fed's flexibility.

As for our economy, there will be no escaping the harsh consequences associated with the bursting of a historic Mortgage Finance Bubble. Our Bubble Economy has been left severely imbalanced and acutely vulnerable, and it is simply impossible to avoid major disruptions associated with an abrupt curtailment of mortgage finance. California will be the poster child for this unfolding dynamic, although it will play out throughout the country. I'll reiterate my expectation that upper-end real estate — too frequently Bubbles financed by ARM, Alt-A, teaser rate, reset and interest-only mortgages — will prove greatly more problematic than subprime. Commercial real estate will be anything but immune. We have only begun to experience upheaval from the mortgage bust, dynamics that will follow a similar path to the burst technology Bubble — except the wreckage will be significantly more widespread and economic impact broad-based.

Unprecedented central bank interventions and, here at home, six-week Bank Credit growth to the tune of $220bn have sustained financial system liquidity. I question the sustainability of both. Especially with this week's apparent loosening of Credit conditions, there are great expectations for an impending revival in the securitization marketplace. The banks and Wall Street are praying. With an eye on California, I fear another ("jumbo") leg down in the ongoing mortgage crisis and an increasingly vulnerable economy. Another eye is planted on the hedge fund community, where I suspect we are only another market dislocation away from serious withdrawals and reinforcing liquidations.

One, if not the greatest, errors in central banking was committed back in 2002 — with Messrs. Greenspan and Bernanke at their respective strict and intellectual helms. They mistakenly reckoned THE bubble had popped. Together they set in motion an aggressive post-Bubble "mopping up" reflation, failing to appreciate that while the tech Bubble had burst THE Credit Bubble was poised for "blow-off" excess.

We are left today with an unbalanced Bubble Economy sustained only by ongoing and enormous Credit creation. Importantly, the Wall Street Risk Intermediation Machine is today gravely impaired, forcing the banking system to Balloon Bank Credit. This works effectively on a short-term basis, yet is an unfolding predicament. Credits to sustain a Bubble Economy are inherently highly risky (think CA mortgages or junk bonds) and it requires huge quantities of them. Bubble economies are replete with negative cash flow entities and others that become increasingly so as finance is curtailed and redirected. Today, the banking system is ill-prepared to play the role of lender of last resort for long. Moreover, the scope of required ongoing Credit inflation ensures dollar vulnerability.

An important aspect of my negative current view is the disconnect between unwavering marketplace confidence in the Fed's capacity to "reliquefy" and "reflate" and the reality of a limited arsenal and atypical lack of Federal Reserve control over unfolding developments. Importantly, Greenspan and Bernanke expended tremendous ammo in a historic reflation fight that, in the end, was a totally wasted cause. They misjudged and enfranchised the most profligate and wasteful Credit expansion in our history, while inciting a potent strain of inflation that now propagates largely outside of our control. They burned a major currency devaluation. A weaker dollar could have been a tool available to help soften today's much needed financial and economic rebalancing. Unfortunately, they used that policy card for a reflation that greatly exacerbated excesses and imbalances at home, while initiating global inflation dynamics much to the detriment of our citizens, economy and currency. We have today much greater financial fragilities, disastrous economic imbalances, and a feeble currency — whether the stock market chooses to discount it now or not.