“My logic is undeniable”
The Federal Reserve Board “Chair” is appearing before Congress on Tuesday to go through the usual charade of questions and answers regarding US monetary policy. Janet Yellen has politely let the Committee know that she is neither Chairman nor Chairwoman, this even though the statute clearly says that she is the “Chairman of the Board of Governors of the Federal Reserve.” Below follows some questions that members of Congress ought to ask Yellen, along with the answers she might make were Chair Yellen sufficiently honest and informed to respond directly. Special thanks to Rep. Mick Muvaney (R-SC), one of the few honest men in Washington.
1) The Debt Ceiling
Background: We in Congress have heard that the Fed has had meetings regarding a possible breach in the debt limit. Specifically, we think that people at the Fed may have been discussing, among other things, that the Fed would still accept Treasuries as collateral at the discount window, regardless of the status of the debt ceiling. There also may have been discussions with Treasury about a prioritization of payments. We haven’t confirmed this (despite asking for confirmation in writing).
Q: In the interest of trying to calm markets in advance of the impending debt ceiling discussion, could you please confirm whether such discussions have occurred and what the Fed is prepared to do in the event that the US debt ceiling is breached?
A: The Fed’s primary concern has always been maintaining the ability of the Treasury to operate in the debt markets. More that encouraging full employment or price stability, the Fed has always made the maintenance of orderly markets for Treasury debt among its top priorities. For example, preserving the number of domestic primary dealers was the rationale behind the merger of Bank of America and Countrywide, Bear, Stearns & Co. with JPMorgan and the acquisition of Washington Mutual with JPMorgan. In each case, these efforts failed, but preserving the stability and operational capabilities of the primary dealers has always been the Fed’s first, unspoken priority. As a result, should Congress fail to give the Treasury legal authority to borrow even more money, the Fed is prepared to bend the rules to the breaking point and beyond to maintain orderly markets and public confidence.
2) Remittances to Treasury
Background: As you know, the issue of Fed losses on its bond portfolio is something Rep Mulvaney and other members of Congress have been working on for several months. One possible line of questioning here would be to ask her how the Fed intends to deal with the interest payments that are being made on the $2.7 trillion in bank reserves on the books at the end of January.
Q: Madam Chair, just to follow up on the point about the debt ceiling, has the Fed had any discussion about either funding or forbearing with respect to the payments on the trillions of dollars-worth of Treasury debt and agency securities now held by the Federal Reserve System? Have you had any discussions with either the Treasury or the White House about providing Fed resources to prevent a default in the event that the debt ceiling is breached?
A: Of course we would never publicly admit to making such assurances to the Treasury, but in fact we have in place contingency plans to advance interest payments to member banks with reserves on deposit with the Fed in the event that the Treasury and/or the agencies cannot make scheduled interest payments on their debt. While such operations are probably not legal, the fact remains that the Fed places confidence above all other considerations and we will do whatever is necessary to keep the confidence game rolling.
3) The Volcker Rule
Background: Rep Mulvaney asked the following question of Fed Vice Chairman Daniel Tarullo. Mulvaney: “ What if the SEC says that a broker-dealer’s particular trade is OK under Volcker, but the Fed later says it isn’t, how would you deal with that conflict?” Tarullo: “If it’s a broker-dealer, and the SEC is OK with what practice the broker dealer (is) pursuing, then — then we (the Fed) don’t have — none of the rest of us (the OCC, the Fed, etc.) has the authority under the Volcker Rule and the statute to say, “no, that’s incorrect.”
Q: Are the broker dealer subsidiaries of a bank holding company covered by the Volcker Rule?
A: Probably not. The whole point of the Volcker Rule, at least as the Fed sees it, is to prevent the TBTF banks from holding the world hostage as was the case with the rescue of AIG. So long as the bank is not engaged in principal activities, the Fed is happy to look the other way as those activities are conducted by the broker dealer. The key issue is that the broker-dealer may not become a nominee of the bank and the bank may not extend any guarantees for the dealer’s activities. We must be able to flush the broker-dealer in a bankruptcy in the event that bank management screws up, but protect the insured depository. Whether or not the Fed has the guts and institutional courage to pursue such a course given the answer to Question 1 is another matter.
4. A Housing Recovery
Background: Madam Chair, it is pretty clear from the data published by CoreLogic and a number of analysts that the recovery of the housing market is over. More, between one quarter and one third of all home owners in states like FL, NV, OH, IL and CT are under water or have insufficient equity in their homes to sell. Loan applications are running about 50% below 2012 levels and further deterioration in home lending volumes ins predicted by most credible analysts. Finally, about 40% of all home purchases in December were for cash.
Q: Given the above, how can you and the other members of the Federal Open Market Committee pretend that quantitative easing or “QE” is actually helping the housing market? How would you compare the situation in states like Florida and Nevada today with the real estate debacle of the late 1920s and early 1930s?
A: Well, to be perfectly honest, QE is about preventing worldwide global deflation or at least slowing the deflation process. The impact of QE on the housing sector has largely been thwarted by the 2010 Dodd-Frank law and the implementation of the Basel III capital regime, so you are correct to ask the question. We on the FOMC really don’t have a good answer to the housing mess. The sad fact is that Americans do not have sufficient income or credit capacity to lift home price anywhere close to the levels seen prior to 2007. But in truth, if you were looking carefully at the housing data, US home prices started to slow or even decline in late 2004 and 2005. This is why depositories such as WaMu and Countrywide also started to shrink in terms of total assets and loan sales into the agency market, but we at the Fed could not tell the truth about this for fear of damaging confidence. Remember, our job at the Fed is not to deal with reality or hard data, but rather to pander to ignorant politicians in Washington and keep the American people comfortably numb as to the screwing they are taking in terms of inflation and falling living standards. Home prices, sad to say, usually reflect inflation and thus rise much faster than weak consumer income.
5. Unwinding QE? Really?
Background: Some members of Congress have questioned whether the Fed will face losses on its huge bond portfolio in the event that interest rates rise. Since rates have in fact risen significantly since the trough in Treasury yields in 2012, the supposition is that the Fed already faces large losses on its portfolio – at least in an economic sense. Now the Fed does not “mark to market” like a private bank, but if it did sell paper it would in theory take a loss and thus reduce its remittances to the Treasury. Two years ago, Rep Mulvaney pressed Chairman Ben Bernanke on that issue of bond sales and losses to the Fed. He said that the FOMC could still REPO the bonds to soak up excess liquidity. But since then, a number of market observers have opined that using the REPO market very well might not work on as large a scale as could be necessary to drain liquidity.
Q: Madam Chair Yellen, can you confirm whether the FOMC intends to sell any of the trillions of dollars-worth of Treasury paper and mortgage securities that have been acquired over the past several years?
A: Well of course we are not going to sell any paper. The 300% increase in System assets and the money supply has come at a time when the velocity of money has been falling rapidly, so selling securities and taking liquidity out of the markets would be national suicide. The whole point of this exercise is confidence, don’t forget, so selling debt and draining liquidity is a big “no no.” There is also the question of just who would buy the paper. The Wall Street dealer community is in no way ready to deploy sufficient capital to offload even 10% of the Fed’s holdings. The System position represents huge amount of duration that the private sector cannot possibly support, especially in the wake of the implementation of the Volcker Rule. So you can assume that the Fed is going to retain its portfolio and simply allow the assets to run off over time. Just imagine what would happen to the Dow, the NASDAQ and “confidence” if the Fed even thought about selling significant amounts of debt. Such silly talk.
6. What’s the Frequency Janet?
Background: For the past several decades, the Federal Reserve has been following a policy of low interest rates that goes against most classical economic warnings about the role of interest rates in a free market system. The nineteenth-century economist Walter Bagehot maintained that in order to prevent bank panics a central bank should provide liquidity to the market at a very high rate of interest. In a December 2013 interview in Zero Hedge, David Kotok of Cumberland Advisors noted that Antoine Martin of the Federal Reserve Bank of New York, in his important 2005 paper “Reconciling Bagehot with the Fed’s Response to September 11,” argued that Bagehot had in mind a commodity money regime in which the amount of reserves available was limited. Thus, keeping rates high was a way to draw liquidity, that is gold, back into the markets. Bagehot also understood that low interest rates fuel bad asset allocation decisions – what we call “moral hazard.” In the age of fiat money, however, economists have taken the opposite view, namely that an unlimited supply of reserves obviates the need to attract money back into the financial markets.
Q: Madam Chair Yellen, can you describe for the Committee just why you think that low interest rates are good for the US economy and how you believe that depriving savers and investors of positive returns on their assets is somehow beneficial to society?
A: Well, as a first principle you must realize that the model of political economy within the Fed and the FOMC today is no longer a classical liberal model as prevailed in the days of Bagehot. We are not even following what you might describe as a neo-Keynesian or Progressive model that we saw in the 1930s. No, today at the Fed we are following a purely socialist and authoritarian allocation model that ignores market forces and instead seeks to prevent asset deflation at all costs. Going back to my first response, the whole point of this exercise is to preserve the ability of the US Treasury to borrow new cash in the markets. If we have to annihilate savers and investors to achieve this objective, so be it, but the implicit if not explicit policy of the FOMC today is to subsidize debtors via a forced wealth transfer from savers. Some call this “financial repression,” but remember we at the Fed are all about saving the world from catastrophe today – even if our policy choices make the problems facing us tomorrow or next week even more horrific. If we were to really allow interest rates to rise, the market for Treasury debt would seize up and the financial markets would implode. We cannot allow that because Congress is incapable of dealing with the nation’s fiscal problems. We at the Fed are the platonic guardians of the global financial system. And our logic is undeniable….