Notes From Underground: The Significance of the WSJ OP-ED Piece … “Magnitude of the Mess We’re In”

A an op-ed piece in last weeks WSJ created a great deal of buzz in the financial media. Appearing a few days after the aggressive move by the FED, the opinion piece written by five eminent economists–George Schultz, Michael Boskin, John Cogan, Allan Meltzer and John B. Taylor–criticizes the Bernanke Fed’s QE policy from many different aspects. It is not the criticism that is significant but rather the stature of the economists that are calling the question of the FED’s continued one-dimensional response to the tepid growth following the deep recession of 2007-2008. The media would have the public believe that the only economists qualified to theorize on the problems at hand are those chosen by the FED and its research staff. The financial media bowed to the altar of Alan Greenspan– the Maestro, Oracle and whatever else–and thus the cult of personality was thrust upon the markets.

The op-ed piece shows that the world of economics is in disarray over how to confront the balance sheet recession. The idea that so many opposing views are beginning to emerge (see Richard Fisher’s scolding criticism of the FED in his Harvard Club speech) is going to cause grave concerns in the global financial markets. Brazil’s Finance Minister Guido Mantega was again speaking out against the FED’s QE program by resurrecting his previous arguments about the FED’s actions leading to a global currency war. The Fed’s beloved models do not take into account the global impact of its enigmatic monetary policy and because the world is far more dynamic then the models, many critical voices are starting to be heard. If the world begins to doubt the efficacy of the FED, then the world’s financial system is in for a great deal of turmoil going forward. The Draghi Plan for the EU is predicated on the same theoretical models as the FED’s, thus the criticism of the WSJ OP-ED piece can also be leveled at the ECB.

As I stated a few weeks ago and it was confirmed by Chairman Bernanke at the post-FOMC news conference that Bernanke is a hedgehog. For those who are not familiar with the essay by Isaiah Berlin, “The Hedgehog and the Fox,” Wikipedia defines the two types of animal metaphors thusly: “Hedgehogs who view the world through the lens of a single defining idea and Foxes who draw on a wide variety of experiences and for whom the world cannot be boiled down to a single idea.” This caricature of different ways to approach problem certainly to identify Mr. Bernanke. The pursuing of QE and liquidity providing is a laser type approach that up to now has failed to achieve the desired results. As some argue, the continued FED policy is preventing those policy makers with fiscal authority to adhere to their responsibility.

Dallas Fed President Fisher pulled no punches in his criticism of Congress, especially Senator Schumer. By enacting QE3, Bernanke relieved the pressure on Congress to deal with the “fiscal cliff.” Bernanke seemed to surrender to Schumer’s advice that the FED was the only “game in town.” As the criticism of the FED continues to mount, those on the sidelines are forced into HOPING that the Ivory Tower theoreticians are somewhat correct. What a terrible mess to be in, which explains why the GOLD and other hard assets continue to perform. The financial world is now left with an investment of trying to find the least vulnerable asset in an arena where the world’s central banks have gotten it so horribly wrong. If the FED’s policy is deemed to be a colossal mistake by the markets and investors begin to test the “theoretics” of the present policymakers, then the coming year will experience all types of market stresses. When the FED plays with the DOLLAR they are playing with the world’s reserve currency and that requires more than a single lens.

***The news on Spain seeking a formal ESM bailout continues to gain traction. In a piece in the London Telegraph by Louise Armistead, “Spain Will Need Extra Bailout,” the issue of the increase in non-performing loans is seen as a new variable in Spain’s growing list of problems. It has long been denied that NPLs were a banking problem and the Spanish authorities have previously reported a decrease in NPLs–hard to believe with an economy saddled with 25% unemployment rate. Spanish bankers have long argued that they had stored enough reserves in the “GOOD” years, thus could head off any increase in NPLs. In the Telegraph piece, “last week, the Bank of Spain said its bad debts at Spanish lenders had risen to record levels, with almost one in ten loans in arrears. It is the highest bad-loan ratio since central bank records began in 1962.”

The Spanish problems are increasing and the adverse feedback is beginning to be a severe drag on any type of growth for Spain. It is important to note that in Spain real estate loans are RECOURSE and unlike in many places in the U.S., merely mailing the keys to the house to the back does not absolve the borrower of liability–this is a problem for its furthers the impact of the adverse feedback loop. Where are the unemployed going to find the money to stay current on the mortgage?

***There was another Fed voice last week and I will challenge his thinking. San Francisco Fed President John Williams spoke on Thursday afternoon and told the audience that when Operation Twist ends on December 31, 2012, the FED could just increase its outright purchases of Treasuries. If the FOMC had not seen “substantial” and “sustained” improvements in the labor markets and the FED is leery of buying MBS, then it could just purchase longer term treasuries. In an article by Steven Beckner in MNI, President Williams is quoted as saying they had to be careful and not “impair ‘market function’ in the MBS market.” He doesn’t really say how the FED would impair the MBS market for if the goal is lower long-term rates. Well, what’s the problem?

Mr. Williams, I would argue that the FED’s actions have already impaired the markets and it can be seen in the fact that the SHADOW BANKING MARKET has dried up because of the lack of quality COLLATERAL for REPO. It is sitting on the FED’s balance sheet and preventing the needed assets to generate velocity in the financial system. If lenders can’t acquire the necessary collateral then the amount of lending taking place will be impacted. Maybe it is time to take the IOER negative so the markets can put some of the cash to work. The FED’s continued approach of more QE and then again more QE  is not the solution–too much uncertainty is continuing to plague the world’s financial system. Oh, the magnitude of the mess we are in!


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5 Responses to “Notes From Underground: The Significance of the WSJ OP-ED Piece … “Magnitude of the Mess We’re In””

  1. I'm Not Here Says:

    Everything is under (banksters’) control. Saudi’s helped crash the oil price. Gold and silver are under attack at this moment. Israel-Iran conflict is moved to the back burner until after the election results. In fact, everything will be put on hold for about another month. Central banks get to play with near 0% money

    Any stock market crash will be bought in earnest for price support at an acceptable level. Not sure what the taxpayers will do with all the new stock purchases via the Treasury via the Federal Reserve via the Plunge Protection Team but why worry? Taxpayers have very little say in the matter anyway.

    A vote for either candidate is a vote for the status quo.

    Euro can rise or fall as long as all the other currencies rise and fall in unison.

    When Mexico is the last great hope, you know the end is near.

    I’m still looking for those pre-xmas warehouse orders from July/August, haven’t seen them yet, must be pretty grim.

  2. asherz Says:

    If QEs were the answer, the Weimar republic would have prospered and there would have been no National Socialists coming to power resulting in 50 million dead. Othere examples abound..A recent trip to Zimbabwe witnessed a 100 BILLION dollar note for sale as a souvenir for $20. Economics 101 taught the lesson of pushing on a string. Velocity is not created by the printing press nor by moving to unsustainable debt levels.Our Princeton professor is taking the reserve currency and beating his drum to voo-doo economics.
    Look out below.

  3. Jacob Steelman Says:

    Let’s look at the consequences of Bernanke’s most recent QE3 to QEnth action. Immediately the commodity markets turned around. Iron ore at USD80 per tonne promptly reversed itself and went back above USD100.

    Bernanke was an appointee of the oil intersts and he has done a great job of making sure the price of oil has stayed much above the USD35 to which in sank at its depth in the GFC. The high prices of commodites keeps those borrowing to develop commodities including oil and gas from having calls on their loan covenants and thus keep the banks from having to take write downs as they would have had the economic correction been allowed to correct the malinvestments of years of Greenspan-Bernanke inflation.

    Bernanke is serving his masters and will continue to do so up until the time he is kicked out.

  4. kevinwaspi Says:

    Another good post, particularly on weaving together the folly of central bank policy with the impact on individual country problems yet to be seen by these experiments!
    I particularly enjoyed that you pointed out the NPL stats on the Spanish banks. Now let’s put those numbers in perspective. Looking at some Eurostat statistics and the IMF Global Financial Stability Report, I find that the total assets of the three largest banks in Spain add up to roughly 337% of the Spanish GDP. (Think about that for a minute.) In other words, with 9.9% of Spanish banks’ loans more than 90 days past due, nearly 30% of Spanish GDP is suspect! In comparison, the five largest banks of the U.S. have assets of roughly 60% of U.S. GDP, and all commercial bank assets to U.S. GDP are roughly 80% of U.S. GDP. The ECB will indeed have its hands full (I won’t say what they’ll be full of!) given the 25% and growing unemployment in Spain.

  5. yra Says:

    Professor -great post for adding much to fill in the gaps on the NPL in Spain–and the IMF is far an objective player in the game

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