From a small northwestern observatory…

Finance and economics generally focused on real estate

Posts Tagged ‘Federal Reserve

The FED — “Everything Old is New Again”

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Even though we’re both South Carolinians, I didn’t meet former FED Chair Ben Bernanke until 2004, when we were introduced at the American Economic Association’s annual FED luncheon in San Diego.  He was, at the time, a member of the FED Board of Governors, a seat he would soon resign to become the Chair of President W’s Council of Economic Advisors, and shortly thereafter the FED Chair, succeeding the long-serving Alan Greenspan.

So now, somewhat in contrast, we have  Jerome Powell nominated to be the new FED Chair.  Like Bernanke, Powell will come to the job having served as a FED Governor.  He also served in government, as Treasury Undersecretary, but spent most of his career in the private sector, most recently, intriguingly, at the Global Environment Fund, focused on specialty finance and opportunistic investments.  After several years of Yellen and Bernanke, we tend to forget that many prior FED chairs came with significant private sector experience.  Greenspan spent nearly his entire career on Wall Street, interrupted by a stint as President Ford’s Council of Economic Advisors Chair.  Paul Volker before him had two long stints at Chase Bank, interrupted by a brief period in the Kennedy Administration as an Undersecretary of the Treasury.   William Martin worked as a stockbroker at A.G. Edwards, Thomas McCabe was the CEO of Scott Paper, and William Miller was CEO of Textron.

Powell will be the 9th FED Chair since WW II, and most intriguingly, one without a degree in economics or finance.  Yellen, Bernanke, Greenspan, and Burns all had doctorates, so we tend to think that’s de rigueur.  Actually, it would appear that holding a Ph.D. in economics isn’t a prerequisite at all, and in fact of all of the FED Chairs in history, only those 4 held doctorates.  McCabe, the first FED Chair after WW II, held an BA in economics.  Martin, who succeeded him, studied Latin, originally considering a career as a Presbyterian minister.  (Originally appointed by Truman in 1951, Martin served as FED Chair under 5 presidents, leaving office in 1970.)  Miller, who served under Carter, was also a lawyer (and before that a Coast Guard officer) before joining Textron.  The great Marriner Eccles, who served as Chair for 14 years under Roosevelt and Truman, had an undergrad degree and came out of his family’s business in Utah.  (Intriguingly, this FED Chair who helped define Roosevelt’s New Deal was a registered republican.  Go figure…)

So, why the history lesson?  In part, to reflect on the fact that Powell may be one of the most mainstream appointments this White House has made.  While FED chairs tend to have an agenda, the job tends to be somewhat more reactive than proactive.  Consider the storm that Bernanke waded into, or the aftermath which Yellen has had to manage.  Powell’s job will be to stay the course, which has been quite good the past few years.  One tends to feel a bit sorry for him, recognizing that his will probably be an unenviably tough term of office.

(Footnote — Many will disagree with my comment about doctorates, and argue that Paul Volker had one.  He did not.  Volker held an MA in political economy from Harvard, and went on to do advanced graduate work in the subject at the London School but without the award of a degree, not that it appears to have held him back…)


December’s Livingston Survey

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The late columnist Joseph A Livingston started surveying economists about their forecasts back in 1946. It’s the oldest continuing survey of its kind, and is continued twice a year under the auspices of the Philadelphia Federal Reserve Bank. One of the neat things about this semi-annual report is that it compares the current central tendency of projections to the projections which were being made six months ago. In short, we can directly compare how economic forecasts are changing over time.

One of the biggest shifts is in the GDP growth rate for the 2nd half of 2015.  Six months ago, economists were projecting that we’d end the year with a modestly healthy 3.1% annual rate of growth.  Now, economists are forecasting we’ll end the year at about 2.1% — a fairly significant shift in sentiment.  Similar declines in GDP growth are projected for 2016.  Check my prior blog post about the 12th District report on the western economy, and particularly the impact a stronger dollar is having on the export market.

The good news — and it’s slight — is an improvement in the projections about unemployment.  Six months ago, economists were forecasting we’d end the year with an unemployment rate of 5.1%.  This has now been revised downward, ever so slightly, to 4.9%.  Also, inflation continues to be dead-on-arrival.  From the end of 2014 to the end of 2015, the consumer price index is projected to rise only 0.1%, in line with prior forecasts, and the producer price index is actually projected to fall by 3.2%.  Both indices are expected to swell in the coming year, but only slightly.  The current CPI forecast for the coming year is 1.8%, and PPI is 0.7%.  I’ll leave it up to the reader to pick a reason for this, but can you say “energy costs”?

Six months ago, interest rates were forecasted to rise.  Actual increases are somewhat lower than previously forecasted.  Six months ago, forecasters predicted we’d end the year with 3-month T-bill rates at 0.59%.  In reality, the November 23 auction was at 0.14%, although rates are trending up in December (0.28% as of Monday) in anticipation of Fed rate increases.  The current forecast is for 3-month rates to end the year around 0.23%, and for 1-year rates to end around 2.3% (down from the previously forecasted 2.5%).  Forecasters currently predict 3-month T-bills will hit 1.12% by the end of 2016, and 10-year notes will end next year around 2.75%.

Finally, forecasters are asked to predict the S&P 500 index for the end of the year as well as the end of next year.  Six months ago, the consensus forecast was an S&P level of 2158 for the end of the year, and this has now softened to 2090.  (It’s helpful to note that the S&P opened just under 2048 this morning.)  Forecasters currently project the S&P will hit about 2185 by the end of next year, which is an anemic growth of 4.5% over the coming 12 months.

If you’d like your own copy, which includes much more detail on these forecasts, you can download it for free here.

Tightened appraisal standards?

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Federal regulators have proposed new rules for “risky” mortgages, including tightened appraisal standards.  The proposed new rules are open for comment until October 15.

The Federal Reserve, the Consumer Financial Protection Bureau and other Federal regulators have proposed that all risky mortgages have appraisals performed by licensed or certified real estate appraisers.  Intriguingly, similar regulations were put in place two decades ago for all Federally insured mortgages by the Financial Institutions Reform, Recovery, and Enforcement Act (“FIRREA”).  This act essentially created the appraisal license laws that exist in the 50-states today, but over the years, the appraisal requirements have been diluted to the point where many loans are made without an appraisal.  These proposed regulations recognize the problems caused in the banking system by un-supported mortgage loans.

In an effort to prevent the use of fraudulent appraisals in illegal “flipping”, the regulations would also require a second appraisal if the seller had purchased the home at a lower price during the prior six months.

A mortgage would be deemed “higher risk” if the interest rate was significantly above the Average Prime Offer Rate, survey weekly survey from the Federal Financial Institutions Examination Council. As of last week, the AOPA stood at 3.64%for 30-year “conforming” loans, and under the proposed rules, a higher-risk loan would be one carrying a rate of 5.14% or higher.  For “jumbo loans” (generally those exceeding $417,000), the threshold would be 6.14%.

Written by johnkilpatrick

August 20, 2012 at 11:32 am

A truly dumb idea

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First, there is virtually NO chance that this idea will come to pass, thank goodness.

SOME pundits propose shutting down the Federal Reserve.  I’m serious.  Presidential candidate Ron Paul considers it a central tenet of his philosophy.  He would put us back on a gold standard, which would mean that the government could only issue paper dollars if they were backed by gold holdings (i.e. — Ft. Knox), and would stand ready to buy gold at a stated price.  One assumes that gold coins would also circulate, although at today’s rates, the smallest gold coin available today (1/10 oz) would be worth about $150.  Hardly the sort of thing you’d use in a vending machine.

From an economists perspective, it’s impossible to imagine a 21st century nation — particularly one with the most complex economy in the world — to exist without a central bank.  In the first decade of the 20th century, the U.S. suffered a tremendous depression, much of which was driven by bank liquidity problems (and thus bank failures).  To address this, the U.S. Government established not one central bank but in fact a network of regional central banks, all of which would coordinate their activities via a central Federal Reserve Board.  Members of the Federal Reserve Board are appointed by the President and confirmed by the Senate for 14-year terms, a period of time selected to make sure that no ONE political party or political philosophy would dominate.  The members of this board, along with a rotating subset of the Presidents of the regional banks, form what is called the Federal Open Market Committee (FOMC).

The FED really only has two tools at its disposal.  Taken together, these tools are called “monetary policy”.  It can set the “Fed Funds Rate” which is the rate at which member banks can borrow money for short periods of time.  Since member banks borrow (and pay back) constantly, this is an extraordinarily important base-line for interest rates.  A rise in this rate would stimulate a rise in overall rates throughout the economy.  Currently, this rate is about a half percent — nearly inconsequential.  Clearly, the FED wants to keep rates low to stimulate the economy.  A hint of inflation in the market would probably stimulate a rise in rates, to slow the economy down a bit and thus negatively impact inflation.  The FED can also buy and sell government bonds, and in fact can force member banks to buy and sell bonds.  Buying bonds from the banks puts money into the economy that these banks can lend.  Recently, the FED has been buying long-term bonds and selling short-term, to “twist” the yield curve.

The Government also influences the economy through “fiscal” policy, exerted through the Treasury Department.  Keynesians would hold that the government can stimulate the economy via deficit spending.  In the current economic crisis, the Fiscal and Monetary roles heavily intersected, particularly in the TARP funding under President Bush, and continued under President Obama, which used the full faith and credit of the Treasury to prop up our failing banking system.  The FED was an active participant in that process, and indeed (as shown in the movie), Fed Chair Bernake really sold this process to Congress.  As expensive as it was, and despite the political ramifications, it is beyond belief that any thinking person would have allowed our banking system to collapse.  A few banks dying was inevitable (e.g. — Lehman Brothers), but the entire system collapsing would have put the U.S. in an intractably difficult position, probably carrying the entire world’s economy with it.

As pointed out in a CNBC report by Mark Koba this morning (click here for a link), its noted that a gold standard would both put limits on growth as well as impose short-run volatility.  The American economy would, at least for short periods, be held hostage to the whims of gold traders. Further, production of gold in the world is probably insufficient to sustain reasonable levels of growth.

In addition, removing a relatively independent FED from the scene would leave the Treasury Secretary in an intractably politicized position.  The U.S. has had 75 Treasury Secretaries over the past 225 years, from Alexander Hamilton to Tim Geitner. (Also 6 “acting” secretaries who were never confirmed by the Senate.)  Many — if not most — have been contentiously fought over.  (The first Treasury Secretary, Hamilton, was shot in a duel. The second was run out of office after being accused of setting fire to the State Department building.)  Given the current contentiousness that permeates Capitol Hill, the notion of subjecting the American economy to the vagaries of Congress every 3 years sounds like something out of a third-world country, much less the most important economy in the world.

Fortunately, this proposal hasn’t a ghost of a chance.  Nonetheless, the inanity of it begs our attention.

Written by johnkilpatrick

February 8, 2012 at 11:34 am

Predicting recessions

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The onset of a recession is much like the onset of a bad cold, or perhaps the flu.  You THINK you know you have it, and then the next morning you wake up feeling like you’ve been hit by a truck.

What if we had a tool that could actually PREDICT a recession a year or so in the future?  Wouldn’t that be handy?  In fact, two researchers at the New York Federal Reserve Bank actually developed something a few years ago (early 2006, to be precise) that seems to have some promise.  They noted that the spread between 10-year Treasuries and 3-month Treasuries was a leading indicators of economic activity (which makes intuitive sense).  Using historical data, they craft a formula which calculates the probability of a recession occurring in the coming 12 months:

…where “spread” is the difference, in percentage points, between the 10-year yield and the 3-month yield and F is the standard normal distribution (mean of 0, standard deviation of 1).  Plotting their data over time, and comparing to the onset of a recession, they get Chart 2.  While no model is 100% predictive, this one clearly indicates that a recession is highly probable whenever the spread-indicated probability gets much above 30%.

Of course, the statistical math can get a bit hairy, but there is a handy rule-of-thumb.  As you can see from Chart 1, whenever the spread turns negative, a recession is fairly likely in the coming months.  Why?  Because a negative spread suggests two things:  first, that borrowers have little demand for long-term money, and second that investors are looking for a safe place to tuck money away that they don’t think they’ll need for a while, and aren’t afraid of inflation.  In short, the yield spread constitutes a fairly accurate survey of investor expectations about the economy.

Unfortunately, Estrella and Trubin end their research with July, 2006, which at the time was giving off a 27% recession signal for July, 2007.  A great test of their model would be to see if it would have predicted the onset of the December, 2007, through March, 2009, recession.   We used the same H.15 data from the Federal Reserve Board, and came up with the following:



Ironically, our analysis shows that the probability of a recession crossed the 30% barrier on July 31, 2006 — a month after the cut-off of their study, and 16 months before the official “onset” of the recession.


By the way, if you’re worried, the current probability is at 1.8%.  We’ll keep you posted.



Written by johnkilpatrick

November 23, 2011 at 10:13 am

Housing redux

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While I’m on the subject, the Royal Instition of Chartered Surveyors (RICS), of which I’m a Fellow, publishes a great . Last week’s edition had a piece on the U.S. housing market doldrums, with a particular emphasis on the dearth of mortgage purchases (the secondary market which is vital to the liquidity of the mortgage business).

As you might guess, this important segment of the market peaked in 2005/6, and with a brief attempt at pick-up in early 2008, has been on a downward slide ever since. The index currently stands more than 60% down from the peaks of just 5 years ago. The trend continues downward, and fell 3.5% in the third quarter of this year.

Mortgage Purchase Index

They note that residential investment as a percentage of GDP currently stands at 2.2%, down from pre-recession levels of 6.6%. What’s more, the excess supply overhang will take years to absorb, according to their analysis.

The health — or lack thereof — us currently a front-burner issue for the Federal Reserve, which is now looking at the mortgage bond market as a means of helping to stimulate this anemic sector. Both FRB member Daniel Turillo and Vice Chair Janet Yellen have made public pronouncements in that direction recently.

Written by johnkilpatrick

November 8, 2011 at 1:35 pm

Posted in Finance, Real Estate

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