Thursday, March 26, 2015

Fed has no effect on the economy

The Fed follows the market, and often has no effect on the market. And nobody else than Christopher A. Sims, Nobel Prize in Econ 2011 winner says this (explicitly), in his work, which you can get a sample of online. Sims found a lag between Fed action and an economy’s response, with two key points: often the action and response were uncorrelated (had no effect), and the Fed *reacted* to the market in setting rates. BTW Sims is NOT a ‘real business cycle’ advocate, so you cannot say he is blinded by this framework. Source: – Leeper, Sims, and Zha (1996). “2 Another robust conclusion, common across these models, is that a large fraction of the variation in monetary policy instruments is attributable to systematic ***reaction*** by policy authorities to the state of the economy. This is of course what we would expect of good monetary policy, but it is also the reason why using the historical behavior of aggregate time series to uncover the effects of monetary policy is difficult. The size of effects attributed to shifts in monetary policy varies across specifications of economic behavior. We show, though, that most of the specifications imply that ***only a modest*** portion (or in some cases, ***essentially none***) of the variance of output or prices in the US since 1960 is attributable to shifts in monetary policy. Furthermore, we point out substantive problems in the models that imply large real effects, and argue that correcting these problems lowers the implied size of the real effects.”

Tuesday, August 4, 2009

The US government, via the Federal Reserve and US Treasury, caused the financial meltdown in September 2008.

Major premise: The US government, via the Federal Reserve and US Treasury, caused the financial meltdown in September 2008. (Cause-in-fact, not proximate cause).
Minor premise: There was no need for a bailout by the US government. The US stock market crashed and the panic continued after the bailout was reinstated. When the first bailout was rejected, the market actually rallied.

Argument in favor of thesis:
Major premise arguments--
The Ted Spread is a good proxy for panic in the credit market.
The Ted Spread spiked only after September 11, 2008, which was after the US government took over Fannie Mae and Freddie Mac. Reference I(1) below, note the spike upwards.

The stock market did not crash until September 30, which was after Paulson/Bernanke proposed the first bailout, which was formally announced on September 18. However, it is speculated (but not proven) that the plans for the bailout must have been discussed by Treasury and the Federal Reserve at least a few days before September 18. If in fact the plans were formulated on or before September 11, then it can be argued that the credit markets froze up because credit holders thought they would benefit from the bailout rather than trading their toxic debt. This cannot be proven at this time however [but see this thread below on Volcker's proposal in the Wall Street Journal, a few days before the Fed and Treasury bailout plea to Congress]

Minor premise arguments--
The Ted Spread historically has spiked just as dramatically as it did in September 2008, see for example the Ted spread in the late 1970s, in particular 1978 (Reference I(2) below). Yet the economy did not collapse, as per Paulson’s statement on September 18 in support of the first bailout (“"If we don't do this, we may not have an economy on Monday." Reference II below). Similarly, the equivalent of the Ted Spread in Japan has spiked upwards as dramatically as in the US during the 1990s, but it did not cause the end of the Japanese economy (reference: guest on Bloomberg, link unavailable).
Even with the first bailout voted down by the US Congress, on September 29, the market did not crash, in fact the next day it rallied. It crashed beginning after October 1, when the Senate formulated their own bailout plan on October 1, when the U.S. Senate passed HR1424, their version of the $700 billion bailout bill. Thus the bailout being rejected was either neutral or even positive for stabilizing the credit panic.

BTW, we are discussing in this thread the "cause-in-fact" of the Crash, not the "proximate cause". That is, what caused the bubble to pop, not what caused the bubble to inflate in the first place. This is important since a balloon that is overinflated can be gradually allowed to deflate without harm to the balloon, rather than, as was done by the US government, popping the balloon and causing a panic.


I) (1) Ted Spread:
(2) Long term TED spread:

II) Timetable of Financial Crisis for September 2008:
September 2008
Main article: Global financial crisis in September 2008
September 7: Federal takeover of Fannie Mae and Freddie Mac, which at that point owned or guaranteed about half of the U.S.'s $12 trillion mortgage market, effectively nationalizing them. This causes panic because almost every home mortgage lender and Wall Street bank relied on them to facilitate the mortgage market and investors worldwide owned $5.2 trillion of debt securities backed by them.[137][138]
September 14: Merrill Lynch is sold to Bank of America amidst fears of a liquidity crisis and Lehman Brothers collapse[139]
September 15: Lehman Brothers files for bankruptcy protection[140]
September 16: Moody's and Standard and Poor's downgrade ratings on AIG's credit on concerns over continuing losses to mortgage-backed securities, sending the company into fears of insolvency.[141][142]
September 17: The US Federal Reserve lends $85 billion to American International Group (AIG) to avoid bankruptcy.
September 18: Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke meet with key legislators to propose a $700 billion emergency bailout through the purchase of toxic assets. Bernanke tells them: "If we don't do this, we may not have an economy on Monday."[143]
September 19: Paulson financial rescue plan is unveiled after a volatile week in stock and debt markets.
September 23: The FBI discloses that it had been investigating the possibility of fraud by mortgage financing companies Fannie Mae and Freddie Mac, Lehman Brothers, and insurer American International Group, bringing to 26 the number of corporate lenders under investigation.[144]
September 25: Washington Mutual is seized by the Federal Deposit Insurance Corporation, and its banking assets are sold to JP MorganChase for $1.9 billion.
September 29: Emergency Economic Stabilization Act is defeated 228-205 in the United States House of Representatives; Federal Deposit Insurance Corporation announces that Citigroup Inc. would acquire banking operations of Wachovia.[145]
September 30: US Treasury changes tax law to allow a bank acquiring another to write off all of the acquired bank's losses for tax purposes [146]
III) Stock market DJIA: