by Calculated Risk on 3/09/2010 01:10:00 AM

On the debate as to where to put the Consumer Financial Protection agency, Andrew Ross Sorkin brings us this quote in the NY Times:

[Edward L. Yingling, president of the American Bankers Association] says, “We don’t care where you put it,” adding that their position has always been “we’re totally against it.”

That sure makes it clear.

Sorkin discusses the debate in So Where’s Consumer Protection?, but this one is simple - if it is not independent, don't bother. Anything else is failure.

by Calculated Risk on 3/08/2010 11:03:00 PM

In the previous post I praised the Fed's short-term liquidity facilities. Another program that I supported was the Treasury's Stress Tests (conducted by the Fed). Here is what I wrote in early 2008:

One of the key elements of the Financial Stability Plan is to build "Financial Stability Trust" by conducting "A Comprehensive Stress Test for Major Banks" and providing investors and the public "Increased Balance Sheet Transparency and Disclosure".

Although lacking in details, this is a very good idea.

and

The real answer is to stress test the banks, and put them in three categories: 1) no additional capital needed, 2) some additional capital needed, and 3) preprivatization.

Although no banks were placed in the "preprivatize" category (I probably would have preprivatized a couple), these tests were an important step in providing metrics for the banks.

The following graphs compare the actual performance of the U.S. economy versus the two stress test scenarios - baseline and more severe - for GDP, house prices and unemployment.

Click on graph for larger image in new window.

The first graph shows real GDP (in red) and the two stress test scenarios (baseline and more severe). For this graph I lined up real Q4 GDP.

So far GDP is performing slightly better than the baseline scenario.

It is important to remember that GDP was revised down substantially for 2008 after the stress test scenarios were released.

The second graph is quarterly for the unemployment rate.

For most of the last year the unemployment rate has been higher than the more severe scenario. Now, in Q1 with the unemployment rate at 9.7%, the rate is slightly better than the more severe scenario.

And the third graph is for house prices using the Case-Shiller Composite 10 Index.

The heavy government support for house prices has kept prices well above the baseline scenario. This has obviously been very beneficial for the banks.

So far the economy is somewhat tracking the baseline scenario (slightly better for GDP, much better for house prices, and worse for unemployment). The key to the stress tests was to establish these metrics and have the banks raise adequate capital to survive the more severe scenario.

One of the problems with the stress tests was that the scenarios ended in 2010. And one of the policies has been to extend and hope (commonly called "extend and pretend") and this has pushed many problems out beyond the horizon of the stress tests.

Also I wouldn't judge the success of the stress tests by these graphs. Just establishing metrics was the key. The criteria for success be if any of the 19 banks get into trouble over the next couple of years and require additional support.

by Calculated Risk on 3/08/2010 07:14:00 PM

I think the Fed deserves praise for the successful completion of the short-term liquidity facilities. As NY Fed Executive VP Brian Sack noted today:

With the wind-down of these short-term liquidity facilities, it is a good time to look back and assess their performance. The bottom line here is simple: These programs were an unquestionable success. We have witnessed a remarkable improvement in the functioning of short-term credit markets and an impressive recovery in the stability of large financial firms. While a whole range of government actions contributed to this recovery, giving financial institutions greater confidence about their access to funding, and that of their counterparties, was most likely a crucial step toward achieving stability.

Moreover, the exit from these facilities has been quite smooth. At their peak, these facilities provided more than $1.5 trillion of credit to the economy. Today, the remaining balance across them is around $20 billion. It is impressive that the Fed was able to remove itself from such a large amount of credit extension without creating any significant problems for financial markets or institutions. That success largely reflects the effective design of those programs, as most were structured to provide credit under terms that would be less and less appealing as markets renormalized. This design worked incredibly well, as activity in most of the facilities gradually declined to near zero, allowing the Fed to simply turn them off with no market disruption.
emphasis added

I've praised Chairman Bernanke several times (and thereby indirectly the entire Fed staff) about the liquidity facilities, while lambasting him on other aspects of his performance (like regulatory oversight). Every now and then I think we should pause and recognize a job well done.

I agree with Sack's assessment. These short-term liquidity facilities were creative, well designed, and very effective. Nice work and thanks!

Make sure to read his entire speech. It is the best explanation of the exit strategy I've read.

by Calculated Risk on 3/08/2010 05:01:00 PM

From Brian Sack, Executive Vice President, Federal Reserve Bank of New York: Preparing for a Smooth (Eventual) Exit. Excerpts on MBS:

The Federal Reserve is approaching the scheduled end of its large-scale asset purchases. We have bought $169 billion of agency debt to date, nearly fulfilling our plan to purchase "about $175 billion." For MBS, we have only about $30 billion of purchases remaining to reach our $1.25 trillion target. In addition, we completed $300 billion of purchases of Treasury securities late last year. Looking across these programs, we have now purchased $1.69 trillion of assets, bringing us 98 percent of the way through our scheduled purchases.

My view is that the purchase programs have helped to hold down longer-term interest rates, thereby supporting economic activity. With the conclusion of the programs approaching, the Desk has been tapering the pace of its purchases of agency debt and MBS. However, even as the pace of our purchases has slowed, longer-term interest rates have remained low, and MBS spreads over Treasury yields have remained tight. This pattern suggests that the effects of the purchases have been primarily associated with the stock of the Fed's holdings rather than with the flow of its purchases. In that case, the market effects of the purchase program will only slowly unwind as the balance sheet shrinks gradually over time.
...
Chairman Bernanke noted that the Fed's holdings of agency debt and MBS are being allowed to roll off the balance sheet, without reinvestment, as those securities mature or are prepaid, and that the FOMC may choose to redeem some of its holdings of Treasury securities in the future, as well.

With this approach, the FOMC would be shrinking its balance sheet in a gradual and passive manner. That, in my view, is a crucial message for the markets. It should limit any reversal of the portfolio balance effects described earlier, effectively putting reductions in asset holdings in the background for now as a policy instrument. As long as this approach is maintained, it would leave the adjustment of short-term interest rates as the more active policy instrument—the one that would carry the bulk of the work in tightening financial conditions when appropriate.

This approach is cautious in several dimensions. First, a decision to shrink the balance sheet more aggressively could be disruptive to market functioning. Second, a more aggressive approach would risk an immediate and substantial rise in longer-term yields that, at this time, would be counterproductive for achieving the FOMC's objectives. Third, the effects of swings in the balance sheet on the economy are difficult to calibrate and subject to considerable uncertainty, given our limited history with this policy tool. And fourth, policymakers do not need to use this tool to tighten financial conditions. They can tighten financial conditions as much as needed by raising short-term interest rates, offsetting any lingering portfolio balance effects arising from the still-elevated portfolio.

Even under this cautious strategy of relying only on redemptions, the Federal Reserve could achieve a considerable decline in the size of its balance sheet over time. From now to the end of 2011, we project that more than $200 billion of the agency debt and MBS held by the Federal Reserve will mature or be prepaid, though the actual total will depend on the path of long-term interest rates and the prepayment behavior of mortgage holders. Thus, the Fed's asset holdings would shrink meaningfully if the FOMC maintains its current strategy of not reinvesting those proceeds. In addition, about $140 billion of Treasury securities mature between now and the end of 2011, giving the FOMC scope to reduce its asset holdings even further if it chooses to not replace some of those maturing securities.

While the passive strategy of relying on redemptions may be appropriate for now, it might not be sufficient over the longer-term. One problem is that relying only on redemptions would still leave some MBS holdings on our balance sheet for several decades. As indicated in the minutes from the January meeting, the FOMC intends to return to a Treasuries-only portfolio over time. This consideration could motivate the FOMC to sell its agency debt and mortgage-backed securities at some point, once the economic recovery has progressed sufficiently.
emphasis added

I recommend reading the entire speech, especially the section titled: Market Conditions: At Risk on Exit?

Sack believes there will be little increase in the spread between mortgage rates and the Ten Year Treasury yield when the MBS purchase program ends. Right now the Fed plans on letting the MBS roll off the balance sheet, so in Sack's view the impact on rates should be gradual.

by Calculated Risk on 3/08/2010 03:43:00 PM

If you thought Snowmageddon distorted the employment figures in February, just wait until March. (ht JH)

The BLS could report a March headline number of 200,000 net payroll jobs, and that could be viewed as a weak report.

The March report will be distorted by two factors: 1) any bounce back from the snow storms, and 2) the decennial Census hiring that picked up sharply in March.

Many analysts considered the February BLS report - showing a headline net loss of 36,000 jobs - as an improvement over January because of snow factors. The general view is the snowstorms subtracted 50,000 to 150,000 payroll jobs from the report. I think this is a huge unknown, but I think the actual impact was fairly low.

Also in February, the Census added 15,000 workers. Although this number is NSA (Not Seasonally Adjusted), there really is no seasonal factor for this hiring. If we estimate job losses at 50,000 ex-Census in February, this would imply a range of 0 to 100,000 jobs would have been added without snow factors - if the analysts are correct about the impact of the snow storm.

Also the Census will add something like 100,000 workers to the March report. Luckily the Census Bureau reports the Census hiring - May will be the really crazy month with 100s of thousands of workers added to follow-up on anyone who didn't mail back the Census (Mail it back!).

Add the numbers up: If the economy added no jobs in February (after snow effects) and no jobs in March, the March employment number would be 150,000 (50,000 bounce back from the snow, 0 for March, and 100,000 Census hiring).

If the economy added 50,000 jobs in February (after snow) - the consensus view - and adds another 50,000 in March, the March number will be around 250,000. And remember it takes 100,000 to 150,000 net jobs added per month to stay up with population growth. So a headline number of 250,000 - though an improvement - would still be a weak report because it just means 50,000 in March after distortions.

And if the economy added 100,000 jobs in February (very unlikely in my view), and another 100,000 in March - the bounce back would be 150,000 + 100,000 for March + 100,000 for the Census - and we would see a report of 350,000 jobs!

The Census distortions will last most of the year. The Census will add jobs through May, and then subtract jobs for the following 6+ months. Right now it is making the payroll report look better and will lower the unemployment rate slightly over the next few months (just 0.1% to 0.2%), and starting in June, Census hiring will make the payroll report look worse - but the net will be close to zero by the end of the year.

by Calculated Risk on 3/08/2010 01:15:00 PM

Jürgen Stark, Member of the Executive Board, European Central Bank, spoke at the NABE Economic Policy Conference that is being held in Arlington, Va. Stark's talk was titled: "Is the Global Economy Headed for a Lost Decade? A European Perspective".

From MarketWatch: 'Lost decade' possible for global economy, ECB's Stark says

"The failure to address long-overdue reform challenges promptly might result in a 'lost decade' for the global economy," Stark warned Monday ... "Only partial progress has been made so far, and the distortions that led to global imbalances are still present."
...
Despite some stability, "substantial fragilities remain and the outlook is fraught with risks," Stark said.

Stark apparently discussed the need for reform of financial oversight, flexible exchange rates (China), and more balanced trade.

Stark is also concerned about global stagflation.

And more from Reuters: ECB's Stark rebuffs European rescue fund idea

My view is another lost decade in the U.S. is unlikely, and I'm more concerned with deflationary pressures in the short term (next year or so) than stagflation.

Note: As I mentioned in the weekly schedule, Brian Sack, Executive Vice President, Federal Reserve Bank of New York will speak tonight (5 PM ET) on the Fed's Balance Sheet Policies. That is of more immediate interest!

by Calculated Risk on 3/08/2010 11:06:00 AM

I haven't looked at this in some time ...

UPDATE: According to the Census Bureau, in 2008 of the 25 years and over workers population (edit):

13.4% had less than a high school diploma.

31.2% were high school graduates, no college.

26.0% had some college or associate degree.

29.4% had a college degree or higher.

Click on graph for larger image in new window.

This graph shows the unemployment rate by four levels of education (all groups are 25 years and older).

Note that the unemployment rate increased sharply for all four categories in 2008 and into 2009.

Unfortunately this data only goes back to 1992 and only includes one previous recession (the stock / tech bust in 2001). Clearly education matters with regards to the unemployment rate - but education didn't seem to matter as far as the recovery rate in unemployment following the 2001 recession. All four groups recovered slowly.

The recovery rates following the great recession might be different than following the 2001 recession. I'd expect the unemployment rate to fall faster for workers with higher levels of education, since their skills are more transferable, than for workers with less education. I’d also expect the unemployment rate for workers with lower levels of education to stay elevated longer in this “recovery” because there is no building boom this time. Just a guess and it isn't happening so far ... currently the unemployment rate for the highest educated group is still increasing.

For more on the impact of education here is a graphic and some links from the BLS based on 2008 data: Education pays ...

by Calculated Risk on 3/08/2010 09:17:00 AM

From James Sterngold at Bloomberg: ‘On the Edge’ Banks Facing Writedowns After FDIC Loan Auctions (ht jb)

A Federal Deposit Insurance Corp. plan to auction more than $1 billion in assets seized from failed banks next month ... may trigger writedowns that weaken lenders nationwide.
...
The auctions may have wider repercussions. Of the $50.4 billion in loans seized from failed banks currently held by the FDIC, 63 percent involve participations by other lenders, according to data provided by agency spokesman Greg Hernandez.

“These banks can’t believe that the regulator they pay to protect them is going to sell these loans to someone who can flip them and cause them serious losses,” said Robert Reynolds, a lawyer at Reynolds Reynolds & Duncan LLC in Tuscaloosa, Alabama, ... “Our banks just cannot believe they’re being treated in a way that ultimately hurts the FDIC’s insurance fund, because some of them are right on the edge.”
...
“We have a number of banks teetering on the edge, and we don’t need this problem,” [John J. Collins, president of Community Bankers of Washington in Lakewood, Washington] said in an interview.

"This problem" is many small and regional banks are carrying loans above market value. The FDIC auction will establish market value (update: actually examiners can consider the distressed nature of the auction) - and the fear is this will lead to significant losses for many banks - and more bank failures.

by Calculated Risk on 3/07/2010 11:04:00 PM

A couple of articles tonight that fit together with my earlier post: Housing: A Tale of Boom and Bust and a Puzzle The puzzle is when the banks will start moving ahead with distressed sales (foreclosures and short sales).

First David Streitfeld at the NY Times writes about the Treasury's HAFA program: Short-Sale Program to Pay Homeowners to Sell at a Loss

Taking effect on April 5, the program could encourage hundreds of thousands of delinquent borrowers who have not been rescued by the loan modification program to shed their houses through a process known as a short sale, in which property is sold for less than the balance of the mortgage. Lenders will be compelled to accept that arrangement, forgiving the difference between the market price of the property and what they are owed.
...
Under the new program, the servicing bank, as with all modifications, will get $1,000. Another $1,000 can go toward a second loan, if there is one. And for the first time the government would give money to the distressed homeowners themselves. They will get $1,500 in “relocation assistance.”

Should the incentives prove successful, the short sales program could have multiple benefits. For the investment pools that own many home loans, there is the prospect of getting more money with a sale than with a foreclosure.

For the borrowers, there is the likelihood of suffering less damage to credit ratings. And as part of the transaction, they will get the lender’s assurance that they will not later be sued for an unpaid mortgage balance.
emphasis added

Short sales under HAFA are much better than foreclosures for many borrowers because HAFA requires lenders to agree not to pursue a deficiency judgment (one of the key stumbling blocks for eliminating 2nds). And this is also better for the 2nd lien holders too since they get something (note: the program also includes a deed-in-lieu of foreclosure option with similar payments and requirements).

Of course short sale fraud is also a huge concern. Streitfeld quotes economist Tom Lawler:

Short sales are “tailor-made for fraud,” said Mr. Lawler, a former executive at the mortgage finance company Fannie Mae.

And from James Hagerty at the WSJ: Home-Saving Loans Afoot

Rep. Frank said banks' reluctance to write down second mortgages is blocking efforts to reduce the first-lien mortgage balances of many borrowers who owe far more on their loans than the current values of their homes. ...

Many second liens have little value because of the plunge in home prices, Rep. Frank wrote, adding: "Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans."

As Hagerty notes, the banks are reluctant to write down the 2nd liens because they might still have value even after foreclosure. That is because 2nd liens are recourse, and the lenders could pursue the borrower for a deficiency judgment (or sell the loans to a collector). Frequently the most cost effective course of action for 2nd lien holders is to wait and do nothing. And that is frustrating for the 1st lien holder (commonly Fannie or Freddie).

Is $1,000 enough to get 2nd lien holders to sign off and give up the right to a deficiency judgment? I expect that the lenders will pick and choose ... but this should help.

Update: the WSJ has a copy of Barney Frank's letter to the four large banks.

by Calculated Risk on 3/07/2010 08:56:00 PM

The Financial Times reports: Big bank oversight to stay with Fed

Chris Dodd ... is set to propose this week that the 23 largest institutions stay under the Fed’s oversight ... At issue ... was the regulation of several hundred state chartered institutions that also want to remain under the Fed’s supervision.
...
“The Fed feels it is gaining some momentum,” said [an unidentified Senate aide].
excerpted with permission

The Fed has been lobbying hard, and according to the Financial Times, has the backing of Secretary Geithner and many of the bank lobbying associations.

The regional Fed presidents have been arguing for the Fed to retain supervision authority too. Dr. Altig at Macroblog quotes from Atlanta Fed President Dennis Lockhart's speech last week:

"... the Fed must play a central role in a defense structure designed to prevent or manage future crises. My key argument is the indivisibility of monetary authority, the lender-of-last-resort role, and a substantial direct role in bank supervision. Only the Fed can act as lender of last resort because only the monetary authority can print money in an emergency. To make sound decisions, the lender of last resort needs intimate hard and qualitative knowledge of individual financial institutions, their connectedness to counterparties, and the capacity of management.

"There is sentiment in Washington that would separate these tightly linked functions that are so critical in responding to a financial crisis. Removing the central bank from a supervision role designed to provide totally current, firsthand knowledge and information will weaken defenses against recurrence of financial instability. Flawed defenses could be calamitous in a future we cannot see."

It is probably true that supervision authority helps the Fed respond to a crisis, but what about preventing a crisis? The recent track record unfortunately speaks for itself.