Posts Tagged ‘Ben Bernanke’

QE3 A Boon to CMBS

Tuesday, November 13th, 2012

If history repeats itself, QE3 will be good for commercial mortgage-backed securities (CMBS). The Fed’s third round of quantitative easing – which is purchasing $40 billion of residential mortgage-backed securities (RMBS) each month from Fannie Mae and Freddie Mac – will free up money for the commercial real estate market and lure investors away from other vehicles in their hunt for maximum yield.  QE3 is expected to last at least until 2015.

“The primary difference between 2012 and 2010 is that commercial property prices in healthy markets are stronger than they were just two years ago.  At its peak, CMBS constituted 40 percent of all commercial real estate loans,” said John O’Callahan of CoStar.  O’Callahan notes that “Investment returns of 40 percent or more for riskier assets during QE1 were largely a result of a bounce-back from the lows caused by investor panic in late 2008 through early 2009.  The overall impact of QE becomes clearer upon examining QE2.  Prices of equities and high-yield bonds, including CMBS, gained a respectable 12 to 15 percent.”

Low interest rates mean that returns will narrow to as little as 150 basis points, forcing investors to look elsewhere for respectable yields.  Currently, B-piece CMBS investors are achieving 20 percent and higher yields.  By contrast, the Dow Jones Industrial Average’s yield has remained below three percent each of the last 20 years.

CMBS has “been a boon for us,” said Kenneth Cohen, head of CMBS at UBS Securities.  “You’ve seen a fairly good size increase in loan pipelines.  Our pipeline has increased probably 50 percent over the last six weeks.”  Borrowers also are cashing in on the favorable loan terms.  According to Fitch Ratings, loans in 2012 are averaging 95.7 percent of a stressed property’s estimated value; that’s up from 91.6 percent in 2011.

Despite the good news, industry experts don’t expect the resurgent CMBS market to resolve all financing woes.  For example, the encouraging loan terms are of minimal help to commercial real estate owners who are under water, nor will new issuance be adequate to refinance the $54 billion in CMBS loans coming due this year.  Additionally, some ratings firms warn that the credit quality of CMBS loans could increase risk for some investors.  In response, Moody’s Investor Services’ now requires that senior bonds have expensive credit protection.

Tepid 1st Quarter Growth Disappoints

Tuesday, May 15th, 2012

The American economy grew less than expected during the 1st quarter as the biggest gain in consumer spending in more than a year failed to overcome a diminished contribution from business inventories.  Gross domestic product rose at a 2.2 percent annual rate after a three percent increase in the 4th quarter of 2011, according to Department of Commerce Department statistics.  The median forecast called for a 2.5 percent increase.  Household purchases rose 2.9 percent, exceeding the most positive projection.  Home building grew at its fastest pace in almost two years.  The GDP data confirm the view of Federal Reserve officials who expect “moderate” growth as they repeated that borrowing costs are likely to stay low at least through late 2014.

In addition to the improvement in consumer purchases and home building, the economy benefited from a rise in auto production.  The GDP was negatively impacted by a drop in government spending and slower growth in business investment.  The United States is faring better than some other major economies.  The United Kingdom is in the throes of its first double-dip recession since the 1970s.  In Japan and Germany, GDP declined in the final three months of 2011, while China’s economy, the world’s second-largest, is also cooling.

“Consumers are remarkably stable and steady,” said Julia Coronado, chief economist for North America at BNP Paribas in New York.  “We’ll need to see final demand continue to improve.  We’re still in muddling-along territory.”

According to MarketWatch, the devil is in the details. “Growth of 2.2 percent is mediocre, but it’s worse than that once you peel away a few layers — about a fourth of the growth in gross domestic product was accounted for by a build-up in inventories, and half of it came from the building and selling of motor vehicles.  Strip away the inventory growth, and final sales in the economy increased 1.6 percent, the 4th quarter in the past five that was below two percent.  Although all the headlines report on the GDP numbers, the number to watch is final sales, because that gauges demand for our products, not merely how much we made.  Away from King Consumer, the rest of the economy is slowing.  Business investment spending dropped 2.1 percent, the first decline since 2009.  Let’s not get carried away too much by the gloom and doom.  The economy IS growing, even if it’s not as fast as we’d like.  The economy has grown by nearly seven percent since depths of the recession in 2009.”

As disappointing as the 2.2 percent is, the market will have to learn to live with lowered expectations.  From a market perspective, lukewarm growth could force Ben Bernanke’s hand to unfreeze lending, keep interest rates at their current lows, or re-use other monetary policy tools to keep money flowing.  Ironically, even with the Fed’s relaxed monetary policy, most of the extra cash in the economy remains on corporate balance sheets (Apple has billions on hand) or is going into the securities markets.

Official reaction was as expected. “Today’s advance estimate indicates that the economy posted its 11th straight quarter of positive growth, as real GDP (the total amount of goods and services produced in the country) grew at a 2.2 percent annual rate in the first quarter of this year.  While the continued expansion of the economy is encouraging, additional growth is needed to replace the jobs lost in the deep recession that began at the end of 2007,” said Alan Krueger, chairman of the White House’s Council of Economic Advisers.

Fed chairman Ben Bernanke called the slow pace of recovery “frustrating. Here we are almost three years from the beginning of the expansion, and the unemployment rate is still over eight percent.  It’s been a very long slog.  And that, I think, would be the single most concerning thing,” he said.

Retail Sales Are on the Rise

Monday, April 2nd, 2012

February retail sales climbed the fastest in five months. Even rising gas prices didn’t dampen demand for cars, clothing and other goods.  According to the Commerce Department, retail sales rose a seasonally adjusted 1.1 percent to $407.8 billion in February; January retail sales were revised upwards to show a 0.6 percent rise instead of the initially reported 0.4 percent.  If you don’t count cars, sales climbed 0.9 percent.  Economists queried by MarketWatch had anticipated a 1.2 percent gain for the headline index and a 0.7 percent advance for retail sales, not counting autos.

Consumers are “unfazed by higher gas prices,” said Jonathan Basile, an economist at Credit Suisse, who accurately forecast the increase in spending.  “This is a pleasant surprise on the overall picture for the economy.  For the Federal Reserve, it’s steady as she goes.  They will be encouraged, but there is still a long way to go.”

Gourmet-cookware chain Williams-Sonoma Inc., said demand improved at the start of the year following the holiday shopping season.  “Post holiday, we saw a progressively stronger retail environment,” said Laura Alber, the company’s chief executive officer, which reported record earnings for 2011.  Sales increased 1.6 percent at automobile dealers, reversing the previous month’s decline.  The results fell short of what the industry expected.  Cars in February sold at the fastest pace in four years, led by Chrysler and a surprise gain from General Motors. Light-vehicle sales accelerated 6.4 percent from January to a 15 million annual rate, the strongest since February 2008, according to Ward’s Automotive Group.

“There are a number of factors that are helping release this pent-up demand,” said Don Johnson, vice president of GM’s U.S. sales.  “They include stronger employment, good credit availability, and both of those are leading to improving consumer sentiment.”

Clothing store purchases rose 1.8 percent, the most since November 2010.  Furniture and general merchandise stores were the only categories to show a decrease in sales.  An improved employment and income picture are giving consumers the confidence to spend more. This is demonstrated by the fact that the Bloomberg Consumer Comfort Index rose to an almost four-year high in the week ended March 4.

Employers boosted payrolls more than forecast in February.

Dean Maki, chief U.S. economist at Barclays Capital Inc. and a former Fed researcher who specialized in consumer spending, projects Americans will boost purchases at a three percent yearly rate in the 2nd half of the year after a 2.5 percent gain in the first six months.

Federal Reserve policymakers are likely to retain their plan to keep interest rates low at least through late 2014.  Chairman Ben S. Bernanke said maintaining monetary stimulus is warranted even with employment gains and a lower jobless rate.  While there are “some positive developments in the labor market,” Bernanke said, “the pace of expansion has been uneven.” The rise in gas prices “is likely to push up inflation temporarily while reducing consumers’ purchasing power,” he said.

“We believe that the consumer is in better shape than recent downbeat commentary from Fed Chairman Bernanke,” said John Ryding and Conrad DeQuadros, analysts with RDQ Economics. Another Commerce Department report showed U.S. companies restocked at a faster rate in January, a sign that businesses expect stronger job growth to fuel more sales.  Business stockpiles rose 0.7 percent in January, while sales grew 0.4 percent.  For the remainder of 2012, JPMorgan Chase analysts forecast growth of 2.2 percent, an improvement from the 1.7 percent growth seen in 2011.

The rise in sales “signals that the improving economic fundamentals, particularly strong employment growth, are being translated into higher spending activity,” said Millan Mulraine, senior macro strategist at TD Securities. “This building momentum is especially encouraging for the recovery as it suggests that the self-reinforcing positive dynamics between jobs growth and spending activity could foster a more robust economic recovery in the coming months.”

Bernanke Defends Fed Policy on Job Growth, Inflation

Wednesday, February 22nd, 2012

Although the economy has improved in the past year, Federal Reserve Chairman Ben Bernanke told lawmakers that they still must cut the growing budget deficit.  “We still have a long way to go before the labor market can be said to be operating normally,” Bernanke said in testimony to the Senate Budget Committee.  “Particularly troubling is the unusually high level of long-term unemployment.”

According to Bernanke, the 8.3 percent unemployment rate understates the weakness of the labor market.  He reminded the committee that it is necessary to also consider other measures of the labor market, including underemployment.  Although the jobless rate has fallen five months in a row, it is still higher than the 5.2 to six percent that the Fed believes is consistent with maximum employment.  The percentage of the unemployed who have been jobless for 27 weeks or longer rose to 42.9 percent in January, compared with 42.5 percent in December, according to the Department of Labor.

“Over the past two and a half years, the U.S. economy has been gradually recovering from the recent deep recession,” Bernanke said.  “While conditions have certainly improved over this period, the pace of the recovery has been frustratingly slow, particularly from the perspective of the millions of workers who remain unemployed or underemployed.”

At the same time, Bernanke cautioned the Senators against holding back short-term economic growth by cutting the budget too much in the name of controlling the deficit.

The upbeat jobs data – the private sector added 243,000 jobs in January, sending the unemployment rate down to 8.3 percent – caused some Senators to ask about the Fed’s monetary policy as the economy shows more signs of life.  The Federal Open Markets Committee (FOMC) recently said that it expected to keep interest rates at historically low levels through late 2014.  Bernanke said the strategy is a reaction to concerns that low interest rates might set off inflation by noting that prices did not rise significantly during 2011.

Rather, Bernanke said that the Fed is consciously taking a “balanced approach” to spur economic growth with low inflation.  Previously, Bernanke told the House Budget Committee that the Fed would not sacrifice its two percent inflation goal to jump start employment.  ‘Over a period of time we want to move inflation always back toward 2 percent,” Bernanke told Representative Paul Ryan (R-WI), the committee’s chairman.  “We’re always trying to bring inflation back to the target.”

Bernanke offered a strong defense of the Fed’s inflation goal after Ryan suggested it should tolerate higher inflation to assure maximum employment.  “In looking at the two sides of the mandate, the rate of speed, the aggressiveness, may depend to some extent on the balance between the two objectives,” Bernanke said.  “We are always trying to return both objectives back to their mandate.”  Ryan, who has backed legislation to require the Fed focus exclusively on stable prices, said that he is “greatly concerned to hear the Fed recently announce that it would be willing to accept higher-than-desired inflation in order to focus on the other side of its dual mandate.”

Also during his testimony, Bernanke reiterated a promise to prevent Europe’s financial crisis from harming the American economy. “We are in frequent contact with European authorities, and we will continue to monitor the situation closely and take every available step to protect the U.S. financial system and the economy,” Bernanke told the Senate Budget Committee.

The Fed’s Secret Bank Loans Revealed

Wednesday, December 7th, 2011

In a stunning revelation, Bloomberg has obtained 29,000 pages of Federal Reserve documents detailing the largest bailout in American history.  According to an article that will appear in the January issue of Bloomberg Markets magazine, the “Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on December 5, 2008, their single neediest day.  Bankers didn’t mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy.  And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed’s below-market rates.”

The $7.77 trillion that the central bank made available stunned even Gary H. Stern, president of the Federal Reserve Bank of Minneapolis from 1985 to 2009.  According to Stern, he “wasn’t aware of the magnitude.”  It overshadows the Treasury Department’s better-known $700 billion Troubled Asset Relief Program (TARP) program.  When you add up guarantees and lending limits, it becomes clear that the Fed had committed $7.77 trillion as of March, 2009 to rescuing the financial system. That is more than half the value of the U.S. GDP that year.  “TARP at least had some strings attached,” said Representative Brad Miller (D-NC), a member of the House Financial Services Committee.  “With the Fed programs, there was nothing.”

According to Bloomberg’s editors, “Even as they were tapping the Fed for emergency loans at rates as low as 0.01 percent, the banks that were the biggest beneficiaries of the program were assuring investors that their firms were healthy.  Moreover, these banks used money they had received in the bailout to lobby Congress against reforms aimed at preventing the next collapse.  By keeping the details of its activities under wraps, the Fed deprived lawmakers of the essential information they needed to draft those rules. The Dodd-Frank Wall Street Reform and Consumer Protection Act, for example, was debated and passed by Congress in 2010 without a full understanding of how deeply the banks had depended on the Fed for survival.  Similarly, lawmakers approved the Treasury Department’s $700 billion Troubled Asset Relief Program to rescue the banks without knowing the details of the far larger bailout being run by the Fed.

“The central bank justified its approach by saying that disclosing the information would have signaled to the markets that the financial institutions that received help were in trouble.  That, in turn, would make needy institutions reluctant to use the Fed as a lender of last resort in the next crisis.  Fed officials argue, with some justification, that the program helped avert a much bigger economic cataclysm and that all the loans have now been repaid.”

Derek Thompson, a senior editor at The Atlantic, argues that the Fed’s secret bailout is a sign that it was doing its job.  According to Thompson, “First, you can be furious that the Federal Reserve ‘committed’ $7.7 trillion — a sum of money equal to half of the U.S. economy — to save the financial system.  I understand the shock, but we were at the precipice of catastrophe and that money wasn’t ‘spent’ so much as it was put at risk and subsequently recouped.  The economy has struggled in the three years since, but we avoided meltdown.  The trillions worked.

“Second, you can be furious that the banks made a profit off of their own mistakes — but $13 billion is a small price to pay for staving off Armageddon.  Third, you can be furious that the Federal Reserve went to court to keep this information out of the hands of journalists.  There, I’d agree.  It’s Congress’s job (not the Federal Reserve’s job) to pass laws that govern the banking sector, but Congress needs information to make good decisions about regulating banks and it’s disappointing that the Federal Reserve withheld details about its bailouts while the commission and the Dodd-Frank debate were ongoing.  Fourth, you can be furious that our central bank basically did the right thing when it had to, and its counterpart in Europe won’t — at the risk of a continental meltdown.”

Times’ Massimo Calabresi agrees. According to Calabresi, “But the Fed saved the world economy through all this lending without losing a penny in the process.  And after its initial heavy breathing, the article does give the Fed an opportunity to explain itself.  ‘Supporting financial-market stability in times of extreme stress is a core function of central banks,’ said William B. English, director of the Fed’s Division of Monetary Affairs.  “Our lending programs served to prevent a collapse of the financial system and to keep credit flowing to American families and businesses.’  In other words, lending money to banks in a crisis is the whole point of the Fed:  saving the world economy by flooding the system with money when it is about to freeze up is exactly what the central bank was created to do.”

The Fed has been lending money to banks since just after it was established in 1913. By the end of 2008, the Fed had created or expanded 11 lending facilities catering to financial firms that were unable to obtain short-term loans from their usual sources.  “Supporting financial-market stability in times of extreme market stress is a core function of central banks,” said William English, director of the Fed’s Division of Monetary Affairs.  “Our lending programs served to prevent a collapse of the financial system and to keep credit flowing to American families and businesses.”

 

Bernanke: No QE3

Wednesday, October 5th, 2011

Federal Reserve Chairman Ben Bernanke, in a long-awaited speech in Jackson Hole, WY, announced no new steps the Fed will take to prop up the shaky U.S. economy.  Rather, he expressed optimism that the economy will continue to recover, based on its inherent strength and from assistance provided by the central bank.  Bernanke restated the Fed’s determination to keep the federal funds rate “exceptionally low” for a minimum of two years.  He did not say what many had been hoping to hear: that the Fed would begin another round of quantitative easing – usually referred to as QE3.

 Bernanke said that he expected inflation to remain at or below two percent.  Additionally, he acknowledged that the recent downgrade of the nation’s AAA credit rating had undermined both “household and business confidence.”  He implied that there was only so much more the Fed can do to stimulate the economy, and that the time has come for Congress and the Obama administration to create “policies that support robust economic growth in the long term,” to reform the nation’s tax structure and to control spending.

“In addition to refining our forward guidance, the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus.  We discussed the relative merits and costs of such tools at our August meeting.  We will continue to consider those and other pertinent issues, including, of course, economic and financial developments, at our meeting in September,” Bernanke said.  He went on to clarify the Fed’s guidance about how long interest rates will remain exceptionally low.  “In what the committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years.”

As Bernanke delivered his remarks, the government cut its estimated 2nd quarter GDP growth to a paltry rate of one percent, a revision from the 1.3 percent previously reported.  The revision was expected and primarily due to weaker exports.  In more positive news, private spending and investment in April through June were slightly higher than initially estimated.  The GDP grew by an annual rate of just 0.4 percent in the 1st quarter.  The 2nd half of 2011 is expected to be somewhat stronger, but a major driver of the economy — consumer spending — remains weak amid slow hiring and sluggish income gains.

“This economic healing will take a while, and there may be setbacks along the way,” Bernanke said.  “Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery.  Although important problems certainly exist,  the growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years,” Bernanke said. “It may take some time, but we can reasonably expect to see a return to growth rates and employment levels consistent with those underlying fundamentals.”

“Economic performance is clearly subpar, and from that standpoint the case for some sort of further economic-policy assistance is just being made by the poor performance,” said Keith Hembre, chief economist and investment strategist in Minneapolis at Nuveen Asset Management.  Although Bernanke said the Fed has stimulus tools left, “the threshold to utilizing them is going to require fairly different conditions than what we have today,” such as lower inflation or a return of financial instability, Hembre said.

Bernanke also used the occasion to scold Congress for its tardiness in resolving the deficit debate. “The country would be well served by a better process for making fiscal decisions,” Bernanke said at the Federal Reserve Bank of Kansas City’s annual economic symposium.  “The negotiations that took place over the summer disrupted financial markets and probably the economy, as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses.”  Bernanke implied that a return to economic prosperity is at stake.  “I do not expect the long-run growth potential of the U.S. economy to be materially affected by the crisis and the recession if — and I stress if — our country takes the necessary steps to secure that outcome,” he said.  The budget process, according to Bernanke, would be more effective if negotiators set “clear and transparent budget goals” and established “the credibility of those goals.” 

Bernanke reassured investors that United States prospects for growth are sound over the long term and that the Fed has tools to aid the recovery if needed, even though he is not planning another stimulus at this time.  “What no action will do is give confidence to investors that things are not as bad as many people perceive, otherwise he would’ve acted,” Keith Springer, president of Springer Financial Advisors in Sacramento, CA, said.  “Investors will eventually see the positives.”

Housing Prices Still Weak, But Show Welcome Improvement

Tuesday, September 13th, 2011

Home prices revived somewhat during the 2nd quarter, but the housing market is still struggling.  Prices climbed an impressive 3.6 percent, compared during the three months ending March 31.  Despite the upbeat news, home prices are still down 5.9 percent compared with the 2nd quarter of 2010.  The rise in home prices came after three straight quarters of drops, the S&P/Case-Shiller national index — a recognized gauge of residential real-estate markets — reported.  The year-over-year decline was slightly more than the than the 4.7 percent drop that had been forecast by a consensus of experts at Briefing.com.  A separate monthly index of home prices in 20 major metro areas reported a month-over-month gain of 1.1 percent for June, and a 4.5 percent decline compared with last year.

The quarter-over-quarter price increase may be the last one for a while, said Stan Humphries, chief economist for the real estate website Zillow. He expects prices will weaken again.  “The August turmoil of credit rating downgrades, negative GDP revisions, stock oscillations and European debt woes are likely to leave a mark on both August home sales and home value appreciation,” according to Humphries.  “Monthly home value appreciation in June may mark the last hurrah before beginning to weaken in the back half of this year,” Humphries said.

Foreclosures still constituted a higher proportion of sales throughout the winter and spring as families took a break from home shopping; cash-rich investors dominate the market.  Nationally, home prices have returned to their 2003 levels.

Chicago, Minneapolis, Washington and Boston saw the largest monthly increases.  Cities hit hardest by the housing crisis, such as Las Vegas and Phoenix, reported small seasonal increases.  Housing has remained a drag on the economy and is one of the most important reasons why it is still struggling to recover two years after the recession officially ended.  Home sales in 2011 are likely to be at the lowest level in 14 years.  Home prices in many cities have reached their lowest points since the market bubble burst more than four years ago.  Home prices in Cleveland, Detroit, Las Vegas, Phoenix and Tampa are at 2000 levels.  “These shifts suggest that we are back to regional housing markets, rather than a national housing market where everything rose and fell together,” said David M. Blitzer, chairman of the S&P’s index committee.  “This month’s report showed mixed signals for recovery in home prices. No cities made new lows in June 2011, and the majority of cities are seeing improved annual rates,” Blitzer said.  “Looking across the cities, eight bottomed in 2009 and have remained above their lows.  These include all the California cities plus Dallas, Denver and Washington D.C., all relatively strong markets.”

“There’s no theoretical floor for prices. If the economy worsens, housing will get into a vicious cycle of falling prices and foreclosures,” said Mark Zandi, chief economist at Moody’s Analytics. “When prices fall, confidence wanes.”

Foreclosures and short sales — when a lender sells for less than what is owed on a mortgage – accounted for approximately 30 percent of all home sales in July, an increase from about 10 percent reported in normal years.  Nearly 1.7 million potential foreclosures are being delayed, according to real estate firm CoreLogic, either by backlogged courts or lenders waiting for the conclusion of state and federal investigations into questionable foreclosure practices.

“Prices aren’t going to rebound back rapidly,” said Paul Dales, a senior U.S. economist at Capital Economics Ltd. in Toronto.  “Most people think that when the downturn ends the recovery will be pretty good, but that’s not going to be the case at all.”

 “Consumer confidence is still weak, and the housing sector remains in a fragile state,” According to Robert Toll, chairman of Toll Brothers, Inc. the nation’s largest luxury homebuilder.  “The nation’s economy continues to suffer from the lack of jobs in housing construction and the related manufacturing and service sectors that a decent new-home market would typically generate.” 

Federal Reserve Chairman Ben Bernanke said “an overhang of distressed and foreclosed properties, tight credit conditions for builders and potential homebuyers, and ongoing concerns by both potential borrowers and lenders about continued house price declines” are hurting the housing market.

Lawrence Yun, chief economist at the National Association of Realtors, described the activity as “underperforming.  The market can easily move into a healthy expansion if mortgage underwriting standards return to normalcy,” he said.  “We also need to be mindful that not all sales contracts are leading to closed existing-home sales.  Other market frictions need to be addressed, such as assuring that proper comparables are used in appraisal valuations, and streamlining the short sales process.”

Despite a Sluggish Economy, American Household Wealth Is On the Rise

Monday, July 11th, 2011

American households’ net worth moved up a bit as the year began, with rising stock prices, increased savings and debt reductions outpacing an ongoing decline in real-estate prices.  According to the Federal Reserve, average household wealth in stocks, bonds, homes and other assets — minus mortgages and other debts — rose 1.2 percent to $58.1 trillion during the 1st quarter.  The increase is likely to boost the economy, because as peoples’ net worth increases, they tend to become more confident about their financial future and more willing to spend.  Noting the recent decline in stock prices, “in general, financial wealth has been increasing, which would tend to increase consumer spending,” said Goldman Sachs economist Andrew Tilton.

Even though Americans’ net worth rose to its highest level since the middle of 2008, it remained significantly below the peak of $65.8 trillion in June 2007.  Additionally, the upsurge has been driven primarily by stock prices, which benefit people who have invested their money.  The significantly larger percentage of Americans who have the majority of their wealth in their homes is still feeling the continuing real-estate slump.

Paul Ashworth, who owns Ashworth Drugs, a pharmacy in Cary, NC, says his retirement portfolio has recovered somewhat in recent years, but still is more than 20 percent less than its level when the recession began.  The Ashworth family has curtailed dining out and scrapped its subscriptions to the ballet and symphony.  “The bounce hasn’t really made me feel better at all,” Ashworth said.  “I still have a job, but I don’t feel as secure.  We don’t feel as good about getting out and spending as we used to.”

The Fed’s quarterly overview of American household, business, bank and government finances showed that companies are accumulating profits rather than spending them.  Cash holdings and other liquid assets rose 2.6 percent to $1.91 trillion.  At 6.8 percent of total assets, the level of cash reached its highest level in nearly 50 years.  Debt levels in budget-crunched state and local governments showed slight declines, but that was outpaced by an increase in federal debt.  Government debt rose two percent to $12.1 trillion during the 1st quarter.

Meanwhile, the value of real-estate assets continued their decline, falling 1.9 percent to $18.1 trillion.  The ongoing decline in housing is hurting consumer spending.  During the housing boom of the last 10 years, many homeowners extracted wealth from their houses through mortgage refinancing and home-equity loans, which spurred spending.  Now, with many homeowners owing more on their mortgages than their properties are worth, that is no longer occurring.  Instead, many consumers are skeptical about the recovery’s strength and are still not spending on home improvements.

Writing on the Reason.com blog, Tim Cavanaugh says that “You know what you almost never hear about anymore?  How the American consumer will lead the way to an economic recovery.  Just a year ago learned pundits were holding out hope for another consumer-led recovery.  The New York Times was still clinging to the consumerist wreckage as recently as May.  In December, the remarkably durable idea that U.S. consumers will restore prosperity was still generating such brilliantly tautological news as ‘Consumers give boost to holiday sales.’  But the mirage of the consumer-led recovery has been fading for years.  Retail sales rose 0.6 percent in the month of December, an increase that fell well below expectations of 0.8-0.9 percent, and a letdown after a Festivus season filled with tales of confident, resurgent shoppers.”

The 1st quarter of 2011 is not the only time during the Great Recession when household wealth grew. John Ryding, chief economist at RDQ Economics, notes that household net worth grew by $5 trillion between the 1st and 3rd quarters of 2009, after declining sharply earlier in the recession.  Additional spending generated by the rebound helped keep the savings rate from climbing to seven or eight percent.  Household savings encourage long-term economic vitality, but a rapid upward adjustment makes consumer-spending growth more difficult to achieve in the near term — a phenomenon known as the “paradox of thrift.”  If the savings rate remains relatively static or rises slowly, it would remove one of the headwinds to consumer-spending growth in the near future.  That would be a bullish sign for the economy, because consumer spending accounts for roughly 70 percent of GDP.

Is QE3 On the Horizon?

Tuesday, June 21st, 2011

Now that QE2 (quantitative easing 2) is winding down – and with the economy sputtering – will Federal Reserve chairman Ben Bernanke call for a new round of stimulus in the form of QE3? The answer likely is “no”, although it’s doubtful that the Fed will tighten monetary policy until the economy is stronger.  The central bank’s strategy has been to buy Treasury bonds to increase the money supply and foster growth.  The second round of such purchases, worth $600 billion, ends June 30.

Writing in the Washington Post, Neil Irwin says that “The lousy unemployment report comes on the heels of other disappointing economic data, but Fed officials view the current situation as different from the conditions that led to last year’s bond buying.  The recent round of data is neither alarming enough nor definitive enough to make them reconsider the unconventional monetary policy.  For one, much of the economic slowdown in the first half of the year was likely driven by temporary factors.  The Japanese earthquake and tsunami appear to have disrupted the supply chain at U.S. factories more than initial forecasts, contributing to the drop in manufacturing activity and May’s sluggish employment report.  And although oil prices spiked earlier in the year, they have ebbed downward since late April.”

Mohamed A. El-Erian, CEO and Co-CIO of Pimco, agrees, noting that “Notwithstanding the historical parallel, I suspect that it is very unlikely that there will be a QE3.  This view is based on an assessment of economic, political and international factors.  As Chairman Bernanke noted in his August Jackson Hole speech, and reiterated in his first press conference, policy measures should be judged in terms of the expected balance of benefits, costs and risks.  I suspect that there is now broad agreement that, in the case of QE3, this balance has shifted: lowering the potential gains and increasing the probability of collateral damage and adverse unintended consequences.  It is also clear that, in its attempt to deliver ‘good’ asset price inflation (e.g., higher equity prices), the Fed also got ‘bad’ inflation.  The latter, which essentially took the form of higher commodity prices, is stagflationary in that it imposes an inflationary tax on both production and consumption — thus countering the objective of QE2.”

There’s also the point that QE2 has had mixed results.  According to Bernanke, “Yields on 5- to 10-year nominal Treasury securities initially declined markedly as markets priced in prospective Fed purchases; these yields subsequently rose, however, as investors became more optimistic about economic growth and as traders scaled back their expectations of future securities purchases.  Equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation…has risen to historically more normal levels.”

Philadelphia Fed President Charles Plosser warns that QE2 provides excessive stimulus: The central bank has “a trillion-plus excess reserves,” he noted, which could be “the fuel for inflation.”  Anticipated inflation could explain the sudden increase in long-term yields that began last November.  But the rate for 10-year Treasury Inflation Protected Securities (TIPS), rose at the same time, which contradicts that interpretation.  At the same time, the five-year TIP rate didn’t rise.  Had that rate increased, there would have been a sign of a stronger economy in the next five years.


UBS thinks that QE2 failed and is strongly opposed to another round of stimulus.  Maury N. Harris, UBS’ Managing Director and Chief Economist for the Americas, says that “The evidence that QE2 boosted economic activity is lacking.  Yields moved higher and equity markets did as well, although the latter was justified by rising corporate earnings.  They importantly reflected better volumes, which probably cannot be traced to any believable instantaneous response to policy that works with a lag.  Despite the recent weakness in the data, we continue to view the recent slowing as insufficient to prompt further QE from the Federal Reserve.  Relative to conditions in August 2010, when QE2 was floated by Chairman Bernanke, labor market conditions are better.  Additionally, the threat of disinflation last fall has given way to a somewhat more disturbing build-up in inflation pressures as core inflation continues to accelerate.”

Bernanke Talks Tough on Bank Regulation

Wednesday, May 18th, 2011

The Federal Reserve is identifying risks in the financial system that could someday erupt into a new financial crisis, but regulators must be careful not to unintentionally hamper lending as they set up new oversight, according to Chairman Ben Bernanke.   “We want the system to be as strong and resilient as possible,” and more intense oversight and changes such as requiring banks to hold more capital will help, said Bernanke at the Federal Reserve Bank of Chicago’s Bank Structure & Competition conference.  “If we can’t arrest risks, we want to make sure the financial system is defending itself,” he said.  The Dodd Frank Act establishes governmental structures to analyze risk aimed at preventing another financial failure as harsh as the one that almost brought down the world’s economy in the fall of 2008.

Through the Financial Stability Oversight Council and within the Fed, regulators are still analyzing what can cause “systemic risk,” – identified as risk that can cause widespread financial failure, Bernanke said.  Similar actions are underway in other nations; Bernanke said that regulators worldwide are communicating with each other while implementing their own systems.  If the new structures had been in place previously, Bernanke said, the 2008 financial crisis likely would not have happened. The old system of regulation spread authority across too many entities, was poorly coordinated, and problems “fell through the cracks.”  As the Federal Reserve develops a structure for analyzing risk, Bernanke said the focus must go beyond “fighting the last war.”  Future financial threats may differ from those of the past, which is why the banking industry currently is facing new oversight.  When some banks announced plans to pay shareholders dividends, regulators applied “stress tests” to their finances to determine if the institutions would be sound even if the economy weakened.  According to Bernanke, the government’s new stress testing system has provided accurate assessments of bank finances.

Even so, the regulations – the first new ones in 70 years — will be written to encourage bank compliance.  “No one’s interests are served by the imposition of ineffective or burdensome rules that lead to excessive increases in costs or unnecessary restrictions in the supply of credit,” Bernanke said.  “Regulators must aim to avoid stifling reasonable risk-taking and innovation in financial markets, as these factors play an important role in fostering broader productivity gains, economic growth, and job creation.”

Bernanke and Fed officials are trying to balance the need to diminish the risk of another financial crisis with the aim of stimulating the economy after the worst recession since the Great Depression. The Dodd-Frank Act gives the Fed the job of overseeing the biggest financial companies.  “While a great deal has been accomplished since the act was passed less than a year ago, much work remains to better understand sources of systemic risk, to develop improved monitoring tools, and to evaluate and implement policy instruments to reduce macro-prudential risks,” Bernanke said.

Lawmakers who solidly opposed the financial overhaul legislation, say Dodd-Frank goes too far and might make it more difficult for American banks to compete globally.  Some are working to cut funding for agencies established by the law and limit the scope of new rules.  According to the General Accounting Office, the law will cost nearly $1 billion to implement in 2011.

Additionally, Bernanke cited the sovereign-debt concerns in Europe as an example where the analysis led to the May 2010 decision by the Federal Open Market Committee to authorize “dollar liquidity swap lines with other central banks in a pre-emptive move to avert a further deterioration in liquidity conditions.”

To listen to our podcast on financial reform with Anthony Downs of The Brookings Institution, click here.