Another Round of Insanity


Here we go again. Are we trying to outdo ourselves with Casino Capitalism and Crapshoot Politics?

The Federal Reserve, representing the banking system and in league with the Treasury, is trying to induce consumer demand by encouraging more borrowing against an over-leveraged housing market that they re-inflated with Quantitative Easing. It makes rational sense to borrow cheap money against assets, that is, until the insolvency of the system crashes again, leading to an even steeper deflationary de-leveraging that the Fed and the Treasury will be powerless to stop. Are we convinced the government will save us again from this folly? There’s another word for bailouts: it’s called “wealth destruction,” and someday the wealth runs out, even for the USA.

This is all a game of smoke and mirrors. An unnecessary game. From the WSJ:

Borrowers Tap Their Homes at a Hot Clip

Helocs Jumped 8% in the First Quarter

A rebound in house prices and near-record-low interest rates are prompting homeowners to borrow against their properties, marking the return of a practice that was all the rage before the financial crisis.

Home-equity lines of credit, or Helocs, and home-equity loans jumped 8% in the first quarter from a year earlier, industry newsletter Inside Mortgage Finance said Thursday. The $13 billion extended was the most for the start of a year since 2009. Inside Mortgage Finance noted the bulk of the home-equity originations were Helocs.

While that is still far below the peak of $113 billion during the third quarter of 2006, this year’s gains are the latest evidence that the tight credit conditions that have defined mortgage lending in recent years are starting to loosen. Some lenders are even reviving old loan products that haven’t been seen in years in an attempt to gain market share.

In 2013, lenders extended $59 billion of Helocs and home-equity loans. The last pre-boom year near that level was 2000, when lenders extended $53 billion, according to Inside Mortgage Finance.

“We’re seeing much more aggressive marketing campaigns [for Helocs] by banks in locations where home prices have risen,” said Amy Crews Cutts, chief economist at Equifax Inc., a firm that tracks consumer-lending trends. She said Heloc originations picked up in recent months as consumers began home-improvement projects. “We expect to see quite an uptick in Heloc activity” in the spring, she said.

Unlike home-equity loans, in which the borrower receives a lump sum, borrowers can draw on Helocs as needed. They can sometimes take a tax deduction on the interest from the credit line.

Homeowners are borrowing against their properties at a rising clip. In April, a home in Detroit sits for sale. Associated Press

Some individual banks have seen their Heloc originations rise much faster than the national average. Bank of America Corp., which has increased marketing for Helocs, said customers opened $1.98 billion in Helocs in the first quarter, up 77% from the first quarter of 2013. Matt Potere, who leads Bank of America’s home-equity business, said many customers are taking out Helocs to pay for home-improvement projects that were delayed during the housing bust.

“The driver is increased customer demand,” Mr. Potere said. “It’s an effect of higher consumer confidence and improving home values.”

Wells Fargo & Co. said data for the first quarter weren’t immediately available, but the company’s Heloc and home-equity loan originations were up 33% last year to $8.56 billion, and are running strong this year.

“That is the No. 1 product that customers want,” said Kelly Kockos, Wells Fargo senior vice president of home equity.

During the housing boom, Helocs were a source that many consumers tapped to remodel their homes, buy new cars and boats, travel and send their children to college. Lenders often let them borrow up to 100% of their home’s value, in the expectation that prices would continue to rise. However, when prices fell and borrowers weren’t able to repay, banks faced steep losses.

This time, lenders seem to be offering Helocs only to borrowers with good credit in locations where home values have risen, said Keith Gumbinger, vice president of mortgage-information site During the boom, homeowners could borrow up to 100% of their home’s value, said Mr. Gumbinger. Now it is most common to see a maximum of 80% and sometimes 85%, he said.

“Relative to where they were, lenders are still very conservative,” said Mr. Gumbinger. “Will the excesses of yesterday return? Only time will tell.”

As home prices declined during the housing crisis, lenders reined in Helocs by freezing the amount of credit available and restricting new credit. But now that home prices are appreciating and home equity is growing again, lenders are reversing course. According to the Federal Reserve, net household equity stood at about $10 trillion in the fourth quarter of last year, up 26% from the prior year.

“It’s really about the stabilization of the real-estate market and property values going up. It gives us more comfort as to the value of the homes—the equity is there and the client profiles look strong,” said Tom Wind, executive vice president of home lending at EverBank, based in Jacksonville, Fla. Starting in June, EverBank will offer Helocs for the first time since exiting the market in December 2007.

Some lenders are even bringing back “piggyback” loans, which serve as a second mortgage and cover part or all of the traditional 20% down payment when purchasing a house. Piggybacks nearly vanished during the mortgage crisis.

Banks have been emboldened to originate new Helocs in part because new regulatory requirements completed this year and last year make it less burdensome to do so. And in an era where interest rates are expected to rise in the future, some lenders say they prefer Helocs over some other home-equity products because interest rates on Helocs rise as interest rates rise, making the products potentially more profitable.

For consumers in need of cash, Helocs offer an alternative to “cash-out refinancings” in which a homeowner taps equity by taking out a new loan that is bigger than the existing mortgage.

Many homeowners have fixed-rate mortgages of between 3% and 4%, and many can’t get loans lower than that now.

Ian Feldberg planned to open a $200,000 Heloc this week with Belmont Savings Bank to help pay his son’s college tuition. The medical-device scientist purchased his home in Sudbury, Mass. for a little over $1 million in 2004, and estimates that its value dipped as low as $800,000 during the financial crisis. However, after applying for the line of credit, he found that its value had completely recovered.

“I’m very pleased about that. My options for tuition fees were either that or to cash in on my pension prematurely,” he said.

Navy Federal Credit Union, the largest credit union in the U.S. with more than $58 billion in assets, is moving aggressively, letting borrowers withdraw up to 95% of the value of their homes with Helocs, said Richard Morris, vice president of investor relations and equity lending. Navy Federal’s Heloc originations were $78.9 million during the first four months of this year, up 59% from the same period a year earlier.

US Dollar Value under Management by the Federal Reserve


Eye-opening graph.

Fed advocates will argue that dollar depreciation over this period has also led to more than twenty times growth in wages and incomes. But the uncertainty of currency values does not affect all sectors uniformly and arbitrarily creates winners and losers. So, the growth in incomes has come at the expense of savers and older Americans living on fixed income pensions. It has greatly favored those who have done little except borrow to buy financial assets and real estate. So the question is: do we want an economy of ‘four walls and a roof’ or one of productive factories? The first is a depreciating asset, the second an appreciating asset.

As James Rickards puts it in his book, Currency Wars: “The effect of creating undeserving winners and losers is to distort investment decision making, cause misallocation of capital, create asset bubbles, and increase income inequality. Inefficiency and unfairness are the real costs of failing to maintain price stability.”

More pointedly he writes:

The U.S. Federal Reserve System is the most powerful central bank in history and the dominant force in the U.S. economy today. The Fed is often described as possessing a dual mandate to provide price stability and to reduce unemployment. The Fed is also expected to act as a lender of last resort in a financial panic and is required to regulate banks, especially those deemed “too big to fail.” In addition, the Fed represents the United States at multilateral central-bank meeting venues such as the G20 and the Bank for International Settlements, and conducts transactions using the Treasury’s gold hoard. The Fed has been given new mandates under the Dodd-Frank reform legislation of 2010 as well. The “dual” mandate is more like a hydra-headed monster.

From its creation in 1913, the most important Fed mandate has been to maintain the purchasing power of the dollar; however, since 1913 the dollar has lost over 95 percent of its value. Put differently, it takes twenty dollars today to buy what one dollar would buy in 1913. Imagine an investment manager losing 95 percent of a client’s money to get a sense of how effectively the Fed has performed its primary task.

There is also an implication in the pro-Fed position that gradual inflation is necessary in order to grow the economy – an analogy to greasing the machine. But that is conjecture and disproven by robust growth during the latter half of the 19th century while we experienced mild deflation.  As I have argued in Common Cent$, economic growth is a function of technology and population growth through increased labor productivity. Manipulating price values through monetary policy does little to promote long-term stable growth and only aggravates unfair economic inequality. It seems it takes a long time for each generation to discover this truth.

Bonfire of the Humanities


bonfirebThis is how it starts…

This is sad, no matter how you see it. We start by burning the ideas (books) and end with burning those who adopt or even challenge those ideas. From the WSJ:

Bonfire of the Humanities

Christine Lagarde is the latest ritualistic burning of a college-commencement heretic.

It’s been a long time coming, but America’s colleges and universities have finally descended into lunacy.

Last month, Brandeis University banned Somali-born feminist Ayaan Hirsi Ali as its commencement speaker, purporting that “Ms. Hirsi Ali’s record of anti-Islam statements” violates Brandeis’s “core values.”

This week higher education’s ritualistic burning of college-commencement heretics spread to Smith College and Haverford College.


On Monday, Smith announced the withdrawal of Christine Lagarde, the French head of the International Monetary Fund. And what might the problem be with Madame Lagarde, considered one of the world’s most accomplished women? An online petition signed by some 480 offended Smithies said the IMF is associated with “imperialistic and patriarchal systems that oppress and abuse women worldwide.” With unmistakable French irony, Ms. Lagarde withdrew “to preserve the celebratory spirit” of Smith’s commencement.

On Tuesday, Haverford College’s graduating intellectuals forced commencement speaker Robert J. Birgeneau to withdraw. Get this: Mr. Birgeneau is the former chancellor of UC Berkeley, the big bang of political correctness. It gets better.

Berkeley’s Mr. Birgeneau is famous as an ardent defender of minority students, the LGBT community and undocumented illegal immigrants. What could possibly be wrong with this guy speaking at Haverford??? Haverfordians were upset that in 2011 the Berkeley police used “force” against Occupy protesters in Sproul Plaza. They said Mr. Birgeneau could speak at Haverford if he agreed to nine conditions, including his support for reparations for the victims of Berkeley’s violence.

In a letter, Mr. Birgeneau replied, “As a longtime civil rights activist and firm supporter of nonviolence, I do not respond to untruthful, violent verbal attacks.”

Smith president Kathleen McCartney felt obliged to assert that she is “committed to leading a college where differing views can be heard and debated with respect.” And Haverford’s president, Daniel Weiss, wrote to the students that their demands “read more like a jury issuing a verdict than as an invitation to a discussion or a request for shared learning.”

Mr. Birgeneau, Ms. McCartney, Mr. Weiss and indeed many others in American academe must wonder what is happening to their world this chilled spring.

Here’s the short explanation: You’re all conservatives now.

Years ago, when the academic left began to ostracize professors identified as “conservative,” university administrators stood aside or were complicit. The academic left adopted a notion espoused back then by a “New Left” German philosopher—who taught at Brandeis, not coincidentally—that many conservative ideas were immoral and deserved to be suppressed. And so they were.

This shunning and isolation of “conservative” teachers by their left-wing colleagues (with many liberals silent in acquiescence) weakened the foundational ideas of American universities—freedom of inquiry and the speech rights in the First Amendment.

No matter. University presidents, deans, department heads and boards of trustees watched or approved the erosion of their original intellectual framework. The ability of aggrieved professors and their students to concoct behavior, ideas and words that violated political correctness got so loopy that the phrase itself became satirical—though not so funny to profs denied tenure on suspicion of incorrectness. Offensive books were banned and history texts rewritten to conform.

No one could possibly count the compromises of intellectual honesty made on American campuses to reach this point. It is fantastic that the liberal former head of Berkeley should have to sign a Maoist self-criticism to be able to speak at Haverford. Meet America’s Red Guards.

Nazi bookburning

These students at Brandeis, Smith, Haverford and hundreds of other U.S. colleges didn’t discover illiberal intolerance on their own. It is fed to them three times a week by professors of mental conformity. After Brandeis banned Ms. Hirsi Ali, the Harvard Crimson’s editors wrote a rationalizing editorial, “A Rightful Revocation.” The legendary liberal Louis Brandeis (Harvard Law, First Amendment icon) must be spinning in his grave.

Years ago, today’s middle-aged liberals embraced in good faith ideas such as that the Western canon in literature or history should be expanded to include Africa, Asia, Native Americans and such. Fair enough. The activist academic left then grabbed the liberals’ good faith and wrecked it, allowing the nuttiest professors to dumb down courses and even whole disciplines into tendentious gibberish.

The slow disintegration of the humanities into what is virtually agitprop on many campuses is no secret. Professors of economics and the hard sciences roll their eyes in embarrassment at what has happened to once respectable liberal-arts departments at their institutions. Like some Gresham’s Law for Ph.D.s, the bad professors drove out many good, untenured professors, and that includes smart young liberals. Most conservatives were wiped out long ago.

One might conclude: Who cares? Parents are beginning to see that this is a $65,000-a-year scam that won’t get their kids a job in an economy that wants quantification skills. Parents and students increasingly will flee the politicized nut-houses for apolitical MOOCs—massive open online courses.

Still, it’s a tragedy. The loonies are becoming the public face of some once-revered repositories of the humanities. Sic transit whatever.

giordano_bruno(Giordano Bruno burned in Rome as a heretic.)

This is how it ends…

Back to the Races


Terrific. I guess it’s high time to roll the dice again on an overpriced home market. (That’s overpriced relative to median incomes and rent multiples.) People can’t afford homes because of a stagnant labor market, but that’s okay – let’s give everyone cheap loans and easy credit standards, since that worked so well last time. The real problem is that monetary policy has encouraged banks to build reserves and hold those reserves in asset markets instead of taking the risks of lending to home owners for overpriced housing assets. Relaxing lending standards doesn’t change this and only encourages the riskiest lending by marginal players in the mortgage lending business.

U.S. Backs Off Tight Mortgage Rules

In Reversal, Administration and Fannie, Freddie Regulator Push to Make More Credit Available to Boost Housing Recovery

By Nick Timiraos and Deborah Solomon

WASHINGTON—The Obama administration and federal regulators are reversing course on some of the biggest postcrisis efforts to tighten mortgage-lending standards amid concern they could snuff out the fledgling housing rebound and dent the economic recovery.

On Tuesday, Mel Watt, the newly installed overseer of Fannie Mae and Freddie Mac, said the mortgage giants should direct their focus toward making more credit available to homeowners, a U-turn from previous directives to pull back from the mortgage market.

In coming weeks, six agencies, including Mr. Watt’s, are expected to finalize new rules for mortgages that are packaged into securities by private investors. Those rules largely abandon earlier proposals requiring larger down payments on mortgages in certain types of mortgage-backed securities.

The steps mark a sharp shift from just a few years ago, when Washington, scarred by the 2008 crisis, pushed to restrict the flow of easy money that fueled the housing bubble and its subsequent bust. Critics of the move to loosen the reins now, including some economists and lenders, worry that regulators could be opening the way for another boom and bust.

For the past year, top policy makers at the White House and at the Federal Reserve have expressed worries that the housing sector, traditionally a key engine of an economic recovery, is struggling to shift into higher gear as mortgage-dependent borrowers remain on the sidelines.

Both Treasury Secretary Jacob Lew and Federal Reserve Chairwoman Janet Yellen last week noted the housing market as a factor holding back the economic recovery.

Mr. Watt, the former North Carolina congressman who took over as the director of the Federal Housing Finance Agency in January, used his first public speech on Tuesday to lay out the shift in course for Fannie and Freddie, and pegged executive compensation at the companies to meeting the new goals.

Fannie and Freddie, which remain under U.S. conservatorship, and federal agencies continue to backstop the vast majority of new mortgages being issued.

The FHFA has recently attempted to lure private investors back into the housing-finance market—and reduce the Fannie and Freddie footprint—by raising the cost of government-backed lending.

With few signs that private investors are returning on a large scale, Mr. Watt signaled a clear break with his predecessor, Edward DeMarco, who left the FHFA last month after nearly five years as its acting director.

“I don’t think it’s FHFA’s role to contract the footprint of Fannie and Freddie,” Mr. Watt said during a discussion at the Brookings Institution in Washington. Winding down the companies without clear proof that private investors are willing to step back in “would be irresponsible.”

His comments signal a move away from treating Fannie and Freddie as “institutions in intentional decline” towards “institutions that should be better prepared to form the core of our system for years to come,” said Jim Parrott, a former housing adviser in the Obama White House.

Mr. Watt’s remarks are significant, given legislation to overhaul the mortgage-finance giants and replace them with a new system that reduces the government’s role in housing appears headed for a dead end in the current session of Congress.

Mr. DeMarco in a separate speech at a banking conference in Charlotte, N.C., on Tuesday, urged restraint: “Do not confuse weakening underwriting standards and underpricing risk with helping people or promoting market efficiency.”

The new steps are the fruit of three years of strenuous pushback by those opposed to tighter lending standards.

In the wake of the 2010 Dodd-Frank law, regulators proposed a spate of new rules intended to eliminate questionable mortgage products and remove any incentive banks had to make loans unlikely to be repaid.

Among the biggest changes that were proposed: Borrowers would either have to put 20% down, or the bank would have to retain 5% of the loan’s risk once it was sliced, packaged and sold to investors.

The March 2011 proposal triggered a huge outcry from lawmakers, affordable-housing groups and the real-estate industry, all of whom said it would put the brakes on homeownership for millions of credit-worthy borrowers, particularly first-time buyers and minorities. [Note: Instead we’ve pushed the prices out of their reach and now want to enable them to borrow more debt! Is this insane?]

The potential for a high down payment also raised alarm bells at the Department of Housing and Urban Development, one of six writing the rule, according to government officials.

HUD officials agitated for a gentler approach, telling counterparts that a high down payment wasn’t the only way to prevent defaults, but would likely destroy any chance for a housing-market recovery.

At a meeting before the rule was proposed, a HUD official warned fellow regulators away from a 20% down payment, saying that “the impact is between uncertain and bad,” according to a person familiar with the discussions.

When the five other agencies were not swayed, HUD took another approach and refused to sign off on the proposal unless a 10% down payment was included as an alternative. Regulators agreed.

By August 2013, more than 10,000 comment letters had poured in to the agencies, and the response was almost universal: Regulators should avoid a high down-payment level.

The groundswell caught the attention of U.S. policy makers, who began to worry about the collective impact of so much new regulation.

Regulators announced a series of steps Tuesday that they said could help ease standards—abruptly raised by lenders during the financial panic—and make it easier for first-time and other entry-level buyers.

Mr. Watt said that he would direct Fannie and Freddie to provide more clarity to banks about what triggers “put-backs,” in which lenders have been forced to spend billions of dollars buying defective loans sold during the housing boom. To guard against future put-back demands, lenders say they have enacted standards that go beyond what Fannie, Freddie and other federal loan-insurance agencies require.

Mr. Watt said that he hoped that the changes would “substantially reduce” credit barriers, “and that lenders will start operating more inside the credit box that Fannie and Freddie” provide.

Shaun Donovan, the HUD secretary, announced on Tuesday similar changes designed to encourage lenders to reduce similar restrictions on loans insured by the Federal Housing Administration, which is part of his department.

Federal Reserve Gone Wild


From a report by First Trust Advisors, Brian Wesbury, Chief Economist:

The Fed has massively increased the size of its balance sheet, from roughly $850 billion in 2008 to its current $3.96 trillion. Quantitative Easing was accomplished by having the Fed buy bonds and pay for them by “creating” excess bank reserves – reserves above and beyond those that are required.

Now it looks like the Fed will finish tapering and then raise interest rates without shrinking its balance sheet. In this way, the Fed is behaving like any other government agency, not wanting to shrink again after growing during a crisis. But, in order to make this work, the Fed will eventually have to pay banks a high enough interest rate to incentivize them to keep excess reserves from turning into inflationary money growth.

However, not just banks hold reserves. Fannie Mae, Freddie Mac and some Federal Home Loan Banks hold reserves, too. But the “Financial Services Regulatory Relief Act of 2006,” only gave the Fed the legal right to pay interest on balances “maintained at a Federal Reserve Bank by or on behalf of a depository institution.” In other words…by law, the Fed can’t pay Fannie Mae or the others interest on reserves.

As a result, the money the Fed has injected into these institutions is a potential source of inflation if they lend their reserves to banks. So the Fed has dreamed up a new program of “reverse repos,” where it temporarily lends GSEs (and some money market funds) Treasury bonds with a promise to buy them back at a higher price in the future.

The price difference is an implied interest rate and by doing this the Fed is paying a higher rate today than these institutions can earn by buying 1, 3, or 6-month T-bills. The Fed is trying to mop up excess liquidity in the system so the money supply doesn’t inflate.

But this flouts the law written by Congress. In effect, by coloring outside the legal lines, the Fed is paying interest on reserves to “non-banks.” The Fed hopes this operation lets it have its cake (a large balance sheet) and eat it too (no rapid money growth).

In addition to undermining the rule of law, the practice is fraught with danger. If profitable lending opportunities accelerate, then, as the Fed tries to mop up excess reserves, it will be forced to raise interest rates higher and higher as an incentive for banks not to lend. Otherwise, if banks feel they can lend money to the private sector more profitably than they can lend to the Fed, they will not participate in the repo market.

This can cause the equivalent of an “arms race” in the financial system, where interest rates must be raised faster and further than the markets want in order to keep the lid on inflation and bank lending.

Rather than flout the law, the Fed should be looking for ways to unwind QE. It’s time has come and gone. The Fed is too big – much bigger than Congress (The Law of The Land) ever wanted.

We should see that the only choices available to the Fed are 1) to raise interest rates high enough to mop up excess reserves and risk economic stagnation, or 2) to lose their grip on inflation. Mostly likely we will get a combination of both, which we know as stagflation. A sharp correction is the only remedy, and the longer it is avoided, the larger and steeper it will eventually be.


Stressed Out


This passage is excerpted from a review of Timothy Geithner’s book, Stress Test. It’s said that it’s often better to be silent and thought a fool than to open your mouth (or write a book) and confirm it. These is one example of the “experts” and “elites” we empower to manage our lives. A questionable grant of the public trust.

One of the themes in “Stress Test” is Mr. Geithner’s difficulty in understanding the health of large financial firms. He admits that he didn’t see the mortgage crisis coming and didn’t grasp the severity of the problems after it appeared. He didn’t require that the banks he was overseeing raise more capital because his staff’s analysis couldn’t foresee a downturn as bad as the one that occurred.

None of this is particularly surprising in a man who, at the time he became president of the New York Fed, had never worked in finance or in any type of business—unless one counts a short stint in Henry Kissinger‘s consulting shop. At Dartmouth, Mr. Geithner “took just one economics class and found it especially dreary.” After three years at Kissinger Associates, he spent 13 years at the Treasury Department, becoming close to both Robert Rubin and Larry Summers, and then worked at the government-supported International Monetary Fund. Messrs. Rubin and Summers recommended him to run the New York Fed. “I felt intimidated by how much I had to learn,” he writes of taking up the job in 2003.

Mr. Geithner’s New York Fed was the primary regulator for Citigroup, C +0.53% where Mr. Rubin was a director. Although a former senior executive at the bank had warned Mr. Geithner that Citigroup was “out of control,” and the staff at the New York Fed “always considered [Citigroup] a laggard in risk management,” Mr. Geithner figured it wasn’t as risky as many of the non-banks that didn’t hold insured deposits. Looking back now, he concludes that “Bob Rubin’s presence at Citi surely tempered my skepticism, and he probably gave Citi an undeserved aura of competence in my mind.” Citigroup would require a series of taxpayer bailouts after it had been allowed to hide more than $1 trillion in risky assets outside its balance sheet. Mr. Geithner admits that “it wasn’t as well capitalized as we thought.”

Mr. Geithner was perhaps a natural choice to be Barack Obama‘s Treasury secretary, given how many Rubin and Summers associates were populating the administration. In his new job, he continued to promote his no-haircuts-for-creditors principle and even helped codify a plan for the largest firms to avoid bankruptcy if regulators believed their failure could be damaging to the financial system.

Mr. Geithner scoffs at what he calls the “moral hazard fundamentalists” and “Old Testament” types who worry that bailing out financial firms will encourage even riskier behavior. He says that the financial rescue programs enacted in the crisis years were a success because the alternative—which no one can ever know—would have been far worse. What we do know is that, six years later, the economy is suffering through a historically weak recovery and the emergency programs haven’t ended. The Federal Reserve is still providing easy credit for banks and for the U.S. government, which has racked up more than $8 trillion in additional debt since the end of 2007.

Did QE Work?


I repost this excerpt from because it reveals an emerging consensus on our economic policies for the past 6 years, particularly monetary policy that has mostly stimulated asset speculation and accommodated negligent fiscal policy rather than stimulate the real economy.

QE achieved some of its goals, missed others completely, and may have created a bubble. First, QE did remove toxic subprime mortgages from banks’ balance sheets, restoring trust and therefore banking operations. Second, it also helped to stabilize the U.S. economy, providing the funds and the confidence to pull out of the recession. Third, it kept interest rates low enough to revive the housing market. Fourth, it did stimulate economic growth, although probably not as much as the Fed would have liked.

However, it didn’t achieve the Fed’s goal of making more credit available. It gave the money to banks, which basically sat on the funds instead of lending it out. Banks used the funds to triple their stock prices through dividends and stock buy-backs. The large banks also consolidated their holdings, so that the largest .2% of banks control more than 70% of bank assets. Since banks didn’t lend out the money, inflation wasn’t created in consumer goods. As a result, the Fed’s measurement of inflation, the CPI, stayed within the Fed’s target. (Source: WSJ, Confessions of a Quantitative Easer, November 12, 2013)

However, QE did create asset inflation, first in gold and other commodities, and then in stocks, as investors were forced out of bonds.  An ounce of gold more than doubled, rising from $869.75 to $1,895 between 2008 and 2011. After that, investors shifted to stocks. The Dow rose  24% in 2013 as corporations followed the banks’ example and boosted stock prices with buybacks and dividends.

The Hidden Crisis: Stagflation

 StagflationMike O’Keefe, The Denver Post

Mismanaging economic policy always hurts the weakest members of society most. Remember the late 70s and the misery index?

From the WSJ:

How the Fed Fuels the Coming Inflation

As Milton Friedman said, ‘inflation is always and everywhere’ a result of excessive money growth.

The U.S. Department of Agriculture forecasts that food prices will rise as much as 3.5% this year, the biggest annual increase in three years. Over the past 12 months from March, the consumer-price index increased 1.5% before seasonal adjustment. These are warnings. Never in history has a country that financed big budget deficits with large amounts of central-bank money avoided inflation. Yet the U.S. has been printing money—and in a reckless fashion—for years.

The Obama administration has run huge budget deficits every year, which, together with the Bush administration, has amounted to $6.7 trillion from 2006 to 2013. The Federal Reserve financed almost $3 trillion of these deficits by purchasing Treasury bonds and notes. The Fed has also purchased massive amounts of mortgage-backed securities. Today, with more than $2.5 trillion of idle reserves on bank balance sheets, there is enormous fuel for greater inflation once lending and money growth rises.

To avoid the kind of damaging inflation the U.S. experienced in the 1970s and early ’80s, the Fed could raise interest rates, including the interest it pays banks on reserves, inducing banks to hold most of the $2.5 trillion of reserves idle. But interest rates high enough to discourage borrowing and lending would likely send the economy into another damaging recession.

Fed Chairwoman Janet Yellen recently admitted that the central bank doesn’t have a good model of inflation. It relies on the Phillips Curve, which charts what economist Alban William Phillips in the late 1950s saw as a tendency for inflation to rise when unemployment is low and to fall when unemployment is high. Two of the most successful Fed chairmen, Paul Volcker and Alan Greenspan, considered the Phillips Curve unreliable. The Fed’s forecasts of inflation ignore Milton Friedman’s dictum that “inflation is always and everywhere” a result of excessive money growth relative to the growth of real output. The Fed focuses far too much attention on distracting monthly and quarterly data, while ignoring the longer-term effects of money growth.

The country’s present dilemma originated in 2008, when the Fed properly and forcefully prevented a collapse of the payments system. But long before idle reserves reached $2.5 trillion, the Fed didn’t ask itself: What can we do by adding more reserves that banks cannot do by using their massive idle reserves? The fact that the reserves sat idle to earn one-quarter of a percent a year should have been a clear signal that banks didn’t see demand to borrow by prudent borrowers.

The Fed’s unprecedented quantitative easing since 2008 failed to lead to a robust recovery. The unemployment rate has gradually declined, but the main reason is that workers have withdrawn from the labor force. The stock market boomed, bringing support from traders, but the rise in asset prices of equities didn’t stimulate growth by inducing investment in new capital. Investment continues to be sluggish.

And some side effects of the Fed policies have had ugly consequences. One of the worst is that ultralow interest rates induced retired citizens to take substantially greater risk than the bank CDs that many of them relied on in the past. Decisions of this kind end in tears. Another is the loss that bondholders cannot avoid when interest rates rise, as they have started to do.

Accumulating data from the sluggish loan market and the weak responses of employment and investment should have alerted the Fed that the growth of reserves and the low interest rates haven’t been achieving much. Similarly, the Fed should have noticed in recent years that instead of a strong housing-market recovery, not many individuals were taking out first mortgages. Many of the sales were to real-estate speculators who financed their purchases without mortgages and are now renting the houses, planning to resell them later.

Most of all the Fed years ago should have recognized that the country’s economic problems weren’t arising from monetary factors. Instead of keeping interest rates low to finance deficits, the Fed should have explained that costly regulation, increased health-care costs, wasteful spending and repeated threats to raise tax rates were holding back the recovery.

Broadly speaking, the Obama administration has pursued a course the opposite of that taken by the Kennedy and Johnson administrations in the 1960s (and the Reagan administration in the 1980s). Kennedy-Johnson enacted across-the-board tax cuts: Promoting growth came first, redistribution later. By putting redistribution first and sacrificing growth, the Obama administration got neither.

Ironically, despite often repeated demands for increased redistribution to favor middle- and lower-income groups, the policies pursued by the Obama administration and supported by the Federal Reserve have accomplished the opposite. When the president campaigns in the midterm election, he will talk about the relative gains by the 1%. Voters should recognize that goosing the stock market through very low interest rates, not to mention the subsidies and handouts to cronies, have contributed to that result.

We are now left with the overhang. Inflation is in our future. Food prices are leading off, as they did in the mid-1960s before the “stagflation” of the 1970s. Other prices will follow.

The Dummies Guide to Piketty’s “Capital”


From The Economist:

Thomas Piketty’s “Capital”, summarized in four paragraphs

IT IS the economics book taking the world by storm. “Capital in the Twenty-First Century”, written by the French economist Thomas Piketty, was published in French last year and in English in March of this year. The English version quickly became an unlikely bestseller, and it has prompted a broad and energetic debate on the book’s subject: the outlook for global inequality. Some reckon it heralds or may itself cause a pronounced shift in the focus of economic policy, toward distributional questions. This newspaper has hailed Mr Piketty as “the modern Marx” (Karl, that is). But what’s it all about?

“Capital” is built on more than a decade of research by Mr Piketty and a handful of other economists, detailing historical changes in the concentration of income and wealth. This pile of data allows Mr Piketty to sketch out the evolution of inequality since the beginning of the industrial revolution. In the 18th and 19th centuries western European society was highly unequal. Private wealth dwarfed national income and was concentrated in the hands of the rich families who sat atop a relatively rigid class structure. This system persisted even as industrialization slowly contributed to rising wages for workers. Only the chaos of the first and second world wars and the Depression disrupted this pattern. High taxes, inflation, bankruptcies, and the growth of sprawling welfare states caused wealth to shrink dramatically, and ushered in a period in which both income and wealth were distributed in relatively egalitarian fashion. But the shocks of the early 20th century have faded and wealth is now reasserting itself. On many measures, Mr Piketty reckons, the importance of wealth in modern economies is approaching levels last seen before the first world war.

From this history, Mr Piketty derives a grand theory of capital and inequality. As a general rule wealth grows faster than economic output, he explains, a concept he captures in the expression r > g (where r is the rate of return to wealth and g is the economic growth rate). Other things being equal, faster economic growth will diminish the importance of wealth in a society, whereas slower growth will increase it (and demographic change that slows global growth will make capital more dominant). But there are no natural forces pushing against the steady concentration of wealth [Blogger’s note: So, economic corrections and depressions are not natural market processes?]. Only a burst of rapid growth (from technological progress or rising population) or government intervention can be counted on to keep economies from returning to the “patrimonial capitalism” that worried Karl Marx. Mr Piketty closes the book by recommending that governments step in now, by adopting a global tax on wealth, to prevent soaring inequality contributing to economic or political instability down the road. [Ah, and who would get to disburse that global tax revenue?]

The book has unsurprisingly attracted plenty of criticism. Some wonder whether Mr Piketty is right to think the future will look like the past. Theory argues that it should become ever harder to earn a good return on wealth the more there is of it. And today’s super-rich mostly come by their wealth through work, rather than via inheritance. Others argue that Mr Piketty’s policy recommendations are more ideologically than economically driven and could do more harm than good. But many of the skeptics nonetheless have kind words for the book’s contributions, in terms of data and analysis. Whether or not Mr Piketty succeeds in changing policy, he will have influenced the way thousands of readers and plenty of economists think about these issues.

Dig deeper:
“Capital” is a great piece of scholarship, but a poor guide to policy (May 2014)
Why did the French version of “Capital” not make the same splash? (April 2014)
Revisiting an old argument about the impact of capitalism (January 2014)

I can’t actually recommend this summary of the argument as I think it fails to address some of the weaknesses of Piketty’s logic (for example, r is embodied in g but Piketty’s all-encompassing definition of capital inhibits our understanding of how r is composed and what are the disparate distributional effects of r and g.). His data do provide valuable insights, but how to interpret these is fraught with potential error and ideological bias. I’d have to say that Mr. Piketty possesses the same ability to predict the future as Mr. Marx. (And that’s not Groucho.)

Added comment by The Economist:
[Piketty] prescribes a progressive global tax on capital (an annual levy that could start at 0.1% and hits a maximum of perhaps 10% on the greatest fortunes). He also suggests a punitive 80% tax rate on incomes above $500,000 or so.

Here “Capital” drifts to the left and loses credibility. Mr Piketty asserts rather than explains why tempering wealth concentration should be the priority (as opposed to, say, boosting growth). He barely acknowledges any trade-offs or costs to his redistributionist agenda. Most economists, common sense and a lot of French businesspeople would argue that higher taxes on income and wealth put off entrepreneurs and risk taking; he blithely dismisses that. And his to-do list is oddly blinkered in its focus on taxing the rich. He ignores ways to broaden the ownership of capital, from “baby bonds” to government top-ups of private saving accounts. Some capital taxes could sit nicely in a sensible 21st-century policy toolkit (inheritance taxes, in particular), but they are not the only, or even the main, way to ensure broad-based prosperity.

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