Banking Law Prof Blog

LIBOR - Is It Reliable & What Does It Say About the Current Financial Crisis?

A disturbing article in the WSJ last week suggested that the London inter-bank offered rate (Libor) may be less than fully reliable because some troubled banks may not be reporting the high interest rates they must pay to secure loans from other banks.  Libor is calculated daily on the basis of information reported from banks worldwide.  Troubled banks might have been reporting that they are paying a lower interest rate than they actually are because they don't want to 'fess up that their financial condition is so bad that they must pay an extremely high rate to borrow funds from other banks.

Libor is the base rate for calculating the interest on all sorts of loans, so if Libor is reported to be artificially low, then borrowers whose loans bear interest at Libor plus a specified percentage rate will be paying an artificially low rate.  That would be good for borrowers in the short run, but if there's a readjustment of Libor those borrowers could get hit with a sudden increase and the economy would suffer commensurately.  In addition, if Libor is artificially low, it misrepresents the severity of the financial crisis because it hides the fact that, in actuality, more banks are having to pay a substantial risk premium because of their troubled condition than we can see reflected in Libor.

Link to April 16, 2008, Wall Street Journal Page 1 Article, "Bankers Cast Doubt on Key Rate Amid Crisis" by Carrick Mollenkamp:  http://online.wsj.com/article/SB120831164167818299.html?mod=todays_us_page_one

In response to concerns about Libor, the British Bankers' Association (BBA) which oversees Libor "fast-tracked" an investigation into Libor accuracy. 

(ag) April 22, 2008, in Economy

Hedge Funds Driving Up the Price of Gasoline & Other Commodities

My Corporate Governance class at the Texas Tech University School of Law was discussing Institutional Investors, including hedge funds, as a potential monitor for the boards of directors of publicly traded companies.  In the course of the discussion, we also talked about a big negative impact hedge funds and pensions funds are having on the current price of gasoline, corn, and other basic commodities.

Thanks to Tadd Tobkin for this controversial article which raises the argument that even Calpers, which most people think of as one of the most socially concerned institutional investors, must assume some blame for the fact that food prices in third world countries have risen to the point that people are starving -- a result of institutional investors "pushing a wall of money  into the $200bn  commodity index funds."

(ag) April 16, 2008, in Economy

Fish Don't Know They Are Wet

Federal Reserve Governor Kevin Warsh delivered a speech entitled "Financial Market Turmoil and the Federal Reserve:  The Plot Thickens" to the New York University School of Law Global Economic Policy Forum today.

Warsh identifies excessive liquidity as the root cause of our current financial problems. He says,

"Some believe the story of the current market turmoil began in August, and will end when the housing market stabilizes. But, in my view, the narrative actually began in a seemingly more benign time with underpinnings more fundamental than the value of the housing stock. Financial institutions and other market participants grew increasingly dependent on the extraordinary liquidity around them. When liquidity faltered, the weaknesses of the existing architecture abruptly revealed itself."

"A metaphor, perhaps, is instructive: Fish don't know they are wet. And they don't learn unless their memories are long or the water is gone."

My take:  With all due respect, excessive liquidity is only one factor in a deepening disaster.  Warsh concludes this speech with a call to make liquidity a key consideration in the proposed reorganization of the financial regulatory structure.  I'm just not sure what that means, but here's what he says: 

"A new financial architecture, born of the forces of creative destruction, is early in the process of construction with the aid of the Federal Reserve and other public authorities. But for the new paradigmatic architecture to be enduring, market-supplied liquidity must come to predominate."

My take again:  ?????

(ag) April 14, 2008, in Economy

IRS Stats

Today's WSJ carries an article worth noting on Page B3:  "IRS Corporate Tax Audits Fall," by Jesse Drucker.  Surprisingly, the rate at which the IRS audits large corporations hit a 20-year low in 2007.  The audit rate for small businesses, however, is sharply increasing. 

(ag) April 14, 2008, in Economy

Economic News - Bad to Worse

Thanks to Sally Thompson for this intriguing look at the question, "Are Bernanke's Hands Tied? -- Eight Reasons Why the U.S. May Be in Worse Trouble Than You Think."

Link:  http://www.currencytrading.net/2008/are-bernankes-hands-tied-8-reasons-the-us-may-be-in-worse-trouble-than-you-think/

(ag) April 14, 2008, in Economy

Excessive Executive Compensation

All the scoop on current issues in Executive Compensation: 

http://www.nytimes.com/2008/04/06/business/06comp.html?_r=1&scp=2&sq=executive+compensation&st=nyt&oref=slogin

(ag) April 9, 2008, in Economy

Housing Bubble? What Bubble?

Alan Greenspan denies all.  He claims that "the U.S. bubble was close to median world experience and the evidence that monetary policy added to the bubble is statistically very fragile."  He makes this disclaimer with a straight face, although under his leadership, the Federal Reserve reduced interest rates from 6.5% in late 2000 to 1% in June 2003 -- and kept rates at 1% through May 2004.  At 1%, it's almost like giving money away instead of lending it.

Link:  http://www.cnbc.com/id/23948760

(ag) March 7, 2008, in Economy

Credit Default Swaps -- and other issues relating to the Subprime Mortgage Collapse Explained

Yesterday, NPR interviewed Law Professor Michael Greenberger, who provided an explanation of the complex derivatives, such as credit default swaps, which are not transparent and, as a result, create a "shadow" economic impact which we still can't fully evaluate.

Link:  http://www.npr.org/templates/story/story.php?storyId=89338743

(ag) April 4, 2008, in Economy

The "R" Word

Federal Reserve Chairman Ben Bernanke finally said it.  He is quoted in today's WSJ as testifying before Congress' Joint Economic Committee on Wednesday that, "A recession is possible."

Of course, a rose by any other name would smell . . . and many have been thinking the same thing even before Chairman Bernanke named our fear.

Links to other news reports:  http://www.bloomberg.com/apps/news?pid=20601087&sid=aKXpOkaCuAy4&refer=home

http://www.msnbc.msn.com/id/23917696/

http://news.yahoo.com/s/ap/20080402/ap_on_bi_ge/bernanke_congress

(ag) April 3, 2008, in Economy

Alphonso Jackson - Fraud Fallout at a Bad Time

Just when plates are full-to-overflowing with housing-related issues, the Secretary of Housing and Urban Development Alphonso Jackson announced his resignation yesterday so that he can "attend more diligently to personal and family matters."  His euphemistic resignation statement, naturally, makes no reference to the pending criminal investigation relating to his role in awarding HUD contracts.

Link to article:  http://www.chicagotribune.com/news/nationworld/chi-hud-official-quitsapr01,1,7990065.story

HUD Announcement:  http://www.hud.gov/news/release.cfm?content=pr08-046.cfm&CFID=5265834&CFTOKEN=17118067

(ag) April 1, 2008, in Economy

Fed's New Approach - Shades of FSLIC in the 1980's?

Mergers of underwater thrifts with slightly stronger ones postponed the S&L crisis of the 1980s --- but only for a time; meanwhile, ultimate losses had increased.  Could this be deja vu? Last week, the Fed & Treasury encouraged or arranged for JPMorgan Chase to offer to acquire Bean Steans, the investment firm going down for the third time as a result of the subprime mortgage crisis.

What about good old "moral hazard"?  It's an economic axiom that people take more risk with other people's money than with their own.  Is assisting this deal by guaranteeing $30 billion of Bear Stearns' troubled subprime mortgages rewarding not only Bear Stearns & its shareholders for bad decisionmaking but also JPMorgan Chase, which almost certainly had significant exposure resulting from credit default swaps?

Of course, if you approve of this bailout, you believe that it saves the financial markets from worse problems.  But have we seen the last of struggling giants in need of government assistance?  I think not.  So where does it stop?  Is this type of deal only masking and delaying problems?  And what about the homeowners facing foreclosure?  Should we bail out the big boys and leave mom & dad in the lurch?  But wait, even on the individual mortgage level, how do we separate the real victims from speculators?

This subprime mortgage situation has so many levels of risk-shifting.  It looks like a nation-wide shell game.  Not even the experts have unraveled all the financial machinations that spun out of subprime mortgages, so we still don't know where the actual losses will reside.  And it's impossible to tell when enough government assistance is enough -- and when it simply makes a bad situation worse.

Interesting links:

"In the Fed's Crosshairs:  Exotic Game"  http://www.nytimes.com/2008/03/23/business/23gret.html

" When feds save greedy firms, economy and morality collide" azcentral.com http://www.azcentral.com/news/articles/0323biz-moralhazard0323.html

New development:  Bear Stearns shareholders complain that $2 per share is too low.  JPMorgan Chase may increase its bid to $10, but the regulators reportedly don't like that.

Link:  http://news.yahoo.com/s/ap/20080324/ap_on_bi_ge/jpmorgan_bear_stearns

(ag) March 24, 2008, in Economy, FRB 

The Fed Tries New Tricks

You really have to give Federal Reserve Chairman Ben Bernanke an A+ for effort.  As the financial markets continue to struggle, the Federal Reserve is inventing new tools to inject liquidity into the market and calm investor fears. 

Today, the Fed announced a new Term Securities Lending Facility (TSLF), pursuant to which the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program).  The Fed is working to design an auction process for making these securities available.  Auctions will be held on a weekly basis, beginning on March 27, 2008.

The Federal Reserve is working very cooperatively with central banks in the other G-10 countries to head off more serious global economic problems.

Link to FRB Press Release:  http://www.federalreserve.gov/newsevents/press/monetary/20080311a.htm

And how are these measures being received?  Very favorably!  The Dow Jones Industrials posted their largest one day gain in five years.

Link to news story:  http://biz.yahoo.com/ap/080311/wall_street.html

The only problem is:  Banks are still not lending.  (Hey, once burned twice shy!)

Link to news story:  http://finance.yahoo.com/banking-budgeting/article/104605/Fed-Pumps-More-Money-Into-Financial-Markets

(ag) Tues., Mar. 11, 2008, in Economy

The R Word?

If it declines, it headlines!  (My economy-related version of "If it bleeds, it leads.")

Goldman Sachs suggested on Wednesday that the U.S. could be headed down Recession Road:

Link:  http://www.kansascity.com/business/story/437955.html

Now, AP is singing that same tune.  The stock market finished down today & fears about the continuing fallout from the subprime mortgage meltdown are blamed.

LInk:  http://biz.yahoo.com/ap/080111/wall_street.html

(ag) Jan. 11, 2009, in Economy

Balancing Inflation Concerns Against Financial Markets Volatility

Dallas Federal Reserve President Richard Fisher, who rotates onto the Federal Open Market Committee in January 2008, expressed concerns about whether the Federal Reserve Board's current and future interest rate decisions could lead to higher inflation.  Although he recognizes the serious concerns raised by turmoil in the financial markets, he sees the national economy as basically strong. 

The Dallas Morning News posted a story today, analyzing Fisher's remarks delivered in Amarillo, Texas, and comparing Fisher's viewpoint with that expressed by Federal Reserve Vice Chairman Donald Kohn, also delivered today, which suggests that we may see another interest rate reduction in response to conditions in the financial markets.

Link to Kohn speech:  http://www.federalreserve.gov/newsevents/speech/kohn20071128a.htm

Link to Dallas Morning News article:  http://www.dallasnews.com/sharedcontent/dws/dn/latestnews/stories/112907dnbusdallasfedinflation.ab5e0d.html

(ag) Nov. 28, 2007, in Economy

G7 Finance Ministers Meet in DC

Today was an auspicious time for a meeting of the G7 Finance Ministers and Central Bankers. This is a "pre-meeting meeting" in advance of the IMF and World Bank meeting in Washington, D.C., this weekend. Countries included in the Group of Seven are: Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

The joint statement issued by the G7 Finance Ministers was optimistic in the extreme:

"The global economy is in its fifth year of robust growth. Recent financial market turbulence, high oil prices, and weakness in the housing sector will likely moderate this growth. Nevertheless, our overall economic fundamentals continue to be strong and emerging markets are providing critical impetus to the strength of the world economy."

Link to Joint Statement: http://www.treas.gov/press/releases/hp625.htm

(ag) Oct. 19, 2007, in Economy

Does History Repeat Itself?

The short answer is, "No, not exactly."  Still, today's stock market plunge recalled Black Monday of 1987 -- exactly 20 years ago today -- the largest one-day percentage decline in the history of the stock market.

Today (Friday), the DJIA fell 366 points, the worst percentage drop for the Dow and the S&P 500 since August 9th.  After the August stock market drop, the European Central Bank injected liquidity into the banking system to help calm the financial markets.

All the calming has not resolved market volatility stemming from the housing market decline and the subprime mortgage market meltdown.  It's still a bumpy ride.

(ag) Oct. 19, 2007, in Economy

Ben Bernanke Explains the Fed's Response to Financial Markets Problems

In a speech this week to the Economic Club of New York, Federal Reserve Board Chairman Ben Bernanke explained the reasoning behind the FRB decisions to provide increased bank liquidity through open market operations and the discount window and the FOMC federal funds rate cut.  He also gave his assessment about how those actions have worked in achieving their intended purpose.

Chairman Bernanke discussed the widespread investor concern about all mortgage-related products -- not just those tied in some way to subprime loans.  He also talked about bank liquidity concerns that created a "credit crunch" for all borrowers.  He took a look back in history to explain the Fed's efforts to reassure banks and the market that our central bank would supply needed liquidity to financial institutions.  He emphasized, however, as he has done throughout the subprime meltdown, that the Fed is not in the business of bailing out lenders or investors who made bad decisions.

In Chairman Bernanke's estimation, the Fed's provision of liquidity has been helpful and since mid-August the financial markets have stabilized to a degree.  The housing market continues to weaken.  And potential inflation triggers such as rising oil prices remain. 

In a true "glass half full" conclusion, Chairman Bernanke said, "Market participants are learning and adjusting--for example, by insisting on better mortgage underwriting and by performing better due diligence on structured credit products. Rather than becoming more crisis-prone, the financial system is likely to emerge from this episode healthier and more stable than before."

Link:  http://www.federalreserve.gov/newsevents/speech/bernanke20071015a.htm

(ag) Oct. 18, 2007, in Economy

Nobel Prize for Work on Information and the Market

This year's Nobel Prize in Economics was awarded to three American scholars for their work using game theory to explain how incentives and private information affect the functioning of markets.

Link:  http://www.cnn.com/2007/WORLD/europe/10/15/nobel.economics.ap/index.html

(ag) Oct. 15, 2007, in Economy

Federal Reserve Board Governor Kohn Talks About the State of the Economy

Federal Reserve Governor Donald Kohn outlined his view of the U.S. economy and explained the reasons behind the FOMC's recent interest rate cut.   After declining to lower the federal funds target rate during the summer and then delivering a larger than expected reduction in September, several Federal Reserve Governors have offered detained explanations.  The take is basically this:  Disruption in the financial markets caused by subprime mortgage problems finally reached the tipping point -- where concerns about recession outweighed concerns about recession.

Link:  http://www.federalreserve.gov/newsevents/speech/kohn20071004a.htm

(ag) Oct. 9, 2007, in Economy

Economics and Sports - Enjoy!

The Federal Reserve has managed to combine economics and sports trivia.  Check out their interactive game, Peanuts and Crackerjacks: 

Link:  http://www.bos.frb.org/peanuts/indexnosound.htm

(ag) Oct. 8, 2007, in Economy

Happy Anniversary Dow Jones Indexes - Oct. 5

October 5, 2007, marks the 10th anniversary of trading in options on the Dow Jones Industrial Average at the Chicago Board Options Exchange (CBOE).

Link to story:  http://money.cnn.com/news/newsfeeds/articles/primenewswire/127963.htm

(ag) Oct. 3, 2007, in Economy

Our Resilient Stock Market

Dsepite all the recent gloom and doom, the Dow Jones Industrial Average closed yesterday at an all-time high of 14,087.  Overnight, global markets responded favorably.

(ag) Oct. 2, 2007, in Economy

So, Are We In Crisis?

Federal Reserve Governor Randall Kroszner addressed the Federal Reserve Bank of San Francisco's Conference on the Asian Financial Crisis of ten years ago.  But, his remarks began with "reinforcing" remarks made last week by Chairman Bernanke on the recent turbulence in financial markets".  The folks at the Fed acknowledge a "fairly sharp downturn in housing markets" and "growing investor concerns about mortgage credit performance, particularly with subprime mortgages", as well as the possibility that "If current conditions persist in mortgage markets, the demand for homes could weaken further, with possible implications for the broader economy".  Here's the bright side:  "Fortunately, this recent period of turbulence in financial markets has occurred at a time when U.S. commercial banks are strongly capitalized, reflecting years of robust profits".

The meat of Governor Kroszer's talk related to his recent study of banking crises.  He sought to provide a framework for analyzing the impact of banking crises on real economic activity, based on analysis of crises originating in various countries during the past 25 years. Kroszner offered three insights for policymakers:  

1.  the importance of a healthy banking system,

2.  the impact of sound macroeconomic policy, and

3.  the benefit of high levels of transparency and disclosure. 

He ended with the caveat that no two crises are alike and yesterday's solutions may not cure today's problems. 

(ag) Sept. 11, 2007, in Economy

Former Federal Reserve Governor Dies

Former Federal Reserve Governor Edward M. Gramlich died last week of leukemia.  His papers and speeches on subprime lending and predatory lending were among the first to recognize this growing problem. 

(ag) Sept. 10, 2007, in Economy

Ben Bernanke and Housing Market/Financial Market Turmoil

Here's Federal Reserve Chairman Ben Bernanke, pictured at his swearing-in in the company of former Federal Reserve Chairman Alan Greenspan.  As I've discussed in previous posts, Chairman Bernanke is clearly following his own economic thought about when it is appropriate for the FOMC to cut the target federal funds rate in response to financial market turmoil and when it is not -- even if Alan Greenspan would have done something different. 

Chairman Bernanke gave a speech to the Federal Reserve Bank of Kansas City's Economic Symposium, in Jackson Hole, Wyoming, on August 31, 2007.  His remarks are entitled:  "Housing, Housing Finance and Monetary Policy". 

He provides an excellent history of the U.S. housing market and its interrelation with monetary policy.  Although he feels strongly that the Fed should not bail out investors who made bad decisions, he also recognizes the broad economic impact of the housing and financial market turmoil.  So, will the FOMC cut rates this month?  . . . It's a continuing saga.

Link to Speech:  http://www.federalreserve.gov/boarddocs/speeches/2007/20070831/default.htm

(ag) Sept. 4, in Economy

Bernanke and the Market

In reaction to release of the FOMC minutes (referenced in my last post), the stock market took another sharp downturn, from which it rebounded somewhat.  The FOMC minutes highlighted discussion about the risk of inflation being greater than the risk to economic growth.  There was no indication that the FOMC gave any serious consideration to cutting the target federal funds rate in response to the subprime mortgage problems that are spilling over to dampen economic growth in this country. 

Apparently, investor expectation is that the Federal Reserve, through the FOMC, will use its control over the target federal funds rate (and consequently the rates all borrowers pay) to address issues in the stock market (volatility and share-price drops) and in financial markets (liquidity).  When that expectation meets a different reality -- that the Federal Reserve, under Ben Bernanke's Chairmanship, is reluctant to use its federal funds rate authority in this way -- disappointment over no rate cut and no talk of future rate cuts translates into stock sell-offs and depressed stock prices.

On the other hand, Ben Bernanke has repeatedly announced the banks experiencing a liquidity problem can borrow at the Federal Reserve's discount window.  Thus, under Bernanke's leadership, the Fed sees the federal funds rate as the proper tool to combat potential inflation rather than an immediate knee-jerk response to a sudden, serious drop in the stock market.  Bernanke sees the Fed's role as "lender of last resort" through the discount window as the proper way to address liquidity issues.

Contrast this approach with former Federal Reserve Board Chairman Alan Greenspan's actions.  After  Black Monday in 1987, the Fed moved immediately to cut the discount rate.  So, investors expected the Fed to do the same this time around.

Ben Bernanke just doesn't see that as appropriate right now.  He wants to provide enough liquidity through banks so that good borrowers can have access to loans, but he wants those subprime lenders and investors who made bad decisions to feel the pain.  He does not want to bail them out with low interest rates.

We will see how his strategy plays out.

(ag) Aug. 30, 2007, in Economy

Financial Markets in Turmoil

The Dow Jones Industrial Average is back up over 13,000 - down from its all-time high (over 14,000) only a month ago.  Stocks were up a bit today.  Friday, the Federal Reserve issued two announcements designed to calm the markets: 
1.  The Federal Reserve Board cut its primary credit rate at the discount window to 5-3/4 percent, a reduction of 50 basis points.  This narrows the difference between the primary credit rate and the FOMC's target federal funds rate to 50 basis points. This reduction is labeled as "temporary" and the FRB says it will remain in place until market liquidity has improved.   This step was requested by the Federal Reserve Banks of New York and San Francisco.  The Fed continues to remind financial institutions that the "discount window" is available in the event of liquidity needs.

Link:  http://www.federalreserve.gov/boarddocs/press/monetary/2007/200708172/default.htm

2.  The FOMC issued a very short statement designed to reassure everyone that they are on top of the situation, saying, "Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward.. . .[D]ownside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets."

Link:  http://www.federalreserve.gov/boarddocs/press/monetary/2007/20070817/default.htm

Well, they're not lowering the target federal funds rate right now.  And some parts of the FOMC statement can only be described as a profound grasp of the obvious.  The Federal Reserve has provided the financial markets with a total of almost $120 billion of liquidity over the past few weeks. The FOMC meets again on Sept. 18.

(ag) Aug. 20, 2007, in Economy

The Fed Steps Up - More Liquidity to Ease Market Concerns

The Federal Reserve posted announcement today of its decision to make liquidity available "as necessary" to keep actual federal funds rates close to the FOMC's target of 5 1/4%.  The Federal Reserve injects liquidity into the economy through its open market operations - buying more U.S. treasury securities, so investors hold more cash and fewer treasuries.

The Fed is not dropping the target interest rates on federal funds (what banks charge each other to borrow reserves held at the Federal Reserve Banks).  This target rate is set by the Federal Open Market Committee (FOMC), which just confirmed on Aug. 7, 2007 that it will maintain a rate of 5 1/4%.   This means that the FOMC still believes that a target interest rate of 5/14% is necessary to balance two objectives:  reasonable economic growth and low, stable inflation.

A second part of the Fed's announcement today says that:  "In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets. As always, the discount window is available as a source of funding."

This means that if a bank experiences a flood of cash withdrawals from the banking system because investors are scrambling to cover other losses due to bad subprime mortgage related investments or losses due to stock market declines, the Federal Reserve will let that bank borrow cash directly from the Fed itself.  This is the "discount window".  The "discount window" allows the Federal Reserve to act as "the lender of last resort" - the place banks can borrow funds when they can't get them anywhere else, at least within the time frame or at the rates they need.  The traditional use of the "discount window" is to prevent "runs" on a bank from rendering it insolvent.  Letting depositors know that they can get their money calms things down.  In a situation like we have now, letting borrowers know that banks will have money to lend will, it is to be hoped, calm turbulent financial markets and bring things back to business as usual.

The road not taken by the Fed, lowering target interest rates, could also create liquidity by allowing businesses to borrow at lower rates, so they could afford to borrow and pay less interest -- with the objective of growing their businesses using these borrowed funds.  But making more money available generally because of lower interest rates can drive up prices in the economy  -- because more businesses and consumers can afford to pay higher prices to satisfy their demand for goods and services.  Rising prices are what inflation's all about. 

So, the Fed seeks to balance the need for enough lendable funds at a given interest rate to keep businesses growing and not so much liquidity in the system that inflation results.

The current situation illustrates the interplay of three tools the Federal Reserve Board can use as it implements monetary policy:  setting the target federal funds interest rate; injecting or removing liquidity from the financial system by buying or selling U.S. Treasuries; and allowing banks to borrow at the "discount window".

Link to FRB announcement:  http://www.federalreserve.gov/boarddocs/press/monetary/2007/20070810/default.htm

(ag) Aug. 10, 2007

Stock Market Volatility, Subprime Loans, Credit Crunch Fears, and Our Global Economy

Here's my take on the current economic situation:

The U.S. stock market has reacted badly over the past few days to the global spillover from the U.S. subprime lending debacle.  Today a major French bank suspended withdrawals from three of its hedge funds that were invested in U.S. subprime mortgage-backed securities because the bank could not properly value these subprime mortgage related "assets".  This announcement fed global concerns about "liquidity in the system" - whether borrowers can borrow money in the future. 

As banks, hedge funds, and institutional investors lose money on subprime loans in the U.S. market (which once looked like such a great deal with their high interest rates - and that should have been a clear signal that they also carried a high risk of default), these traditional sources of credit to businesses may have less money to lend even to good borrowers.  In addition, lenders are tightening credit standards, making not-so-good-borrowers very concerned about their ability to borrow in the future.  Perception is sometimes what matters in the financial markets (at least until reality crashes in), so nervous corporate borrowers translate to nervous investors in corporate stocks, which translates to volatility in the stock market with people wanting to get out while the getting's good.

The European Central Bank stepped right in today, with an infusion of liquidity into their banking system, to calm fears and restore normalcy.  The Federal Reserve's FOMC, however, this week told us that they would not lower interest rates in the U.S.  The FOMC still says inflation is a bigger concern than economic recession.  However, if companies cannot borrow enough to keep their businesses and the economy growing, either because interest rates are too high to encourage borrowing or because lenders lose so much money in the subprime market that they don't have enough funds to lend, it becomes increasingly difficult to maintain a healthy economy.  Sustained losses in the stock market will also head us toward a recession.

President Bush assures us we have nothing to worry about.  I'm just not sure words alone are enough to restore stock market stability.

Stay tuned. . .

Here's a link to one report out of the many today:  http://money.cnn.com/news/newsfeeds/articles/newstex/AFX-0013-18792522.htm

(ag) Aug. 9, 2007, in Economy

Subprime Concerns & The Stock Market

Today's Wall Street Journal -- and other news sources -- are trying to sort out the Dow Jones Industrial Average's sharp decline on Thursday.  See Gregory Zuckerman's article "Dow Falls 311.50 As Trades Fly" for the conclusion that "[t]he markets' problems are a sign that the angst about risky subprime home loans, which has shaken Wall Street recently is bleeding into other areas, amid fears that financkal players could face bigger losses than anticipated, and that higher borrowing costs could affect the overall economy."

Trading volume on the NYSE set a record with 5.87 Billion shares traded on Thursday, surpassing the previous record of 4.16 Billion set earlier this week.  The Dow dropped 2.3%, leaving the index at 13473.57, just a few days after it set a record high of 14,000.

Zuckerman's article also notes that "even gold prices, seen as a haven in turbulent times, dropped as speculative investors sold to raise cash."  Treasury bond prices rose and the dollar weakened.  Bid-ask spreads generally are widening as brokers try to protect themselves.  Banks are requiring hedge funds to provide more collateral to support their borrowings.

Some brighter notes:  The U.S. economy is growing -- although slowly; The world economy is expanding briskly; and Corporate defaults are low.

(ag) July 27, 2007, in Economy

Our National Economy - Views from the 12 Federal Reserve Districts

Here's a great analysis of the current state of the U.S. economy, assembled from regional perspectives.  Sectors of the economy receiving comment include: 

1.  Consumer Spending and Tourism

2.  Business Spending and Hiring

3.  Construction and Real Estate

4.  Manufacturing

5.  Banking and Finance

6.  Prices and Labor Costs

7.  Energy and Natural Resources

8.  Agriculture

Link:  http://www.federalreserve.gov/fomc/beigebook/2007/20070725/default.htm

(ag) July 25, 2007, in Economy

Presenting the State of the U.S. Economy for Short Attention Span Theater

Here's a great discovery:  Each month the San Francisco Federal Reserve Bank posts one page highlights summarizing that state of the U.S. Economy. Don't take my headline as disparagement; I plan to check this out each month myself. 

Link to June's FedViews:  http://www.frbsf.org/publications/economics/fedviews/index.html

(ag) July 3, 2007, in Economy

Thinking About the Yield Curve

We all learned in Economics 101 that the normal yield curve for term interest rates is upward sloping, reflecting lower interest rates for shorter maturities of investments that increase to higher interest rates for longer maturities.  Over the past year, we've heard considerable discussion about the "flat or inverted yield curve", reflecting short term interest rates that are higher than long term interest rates. This abnormal yield curve has historically predicted recession.  Now it appears that the yield curve may be returning to its normal slope.  Home buyers can see the result in rising rates for 30 year mortgages.

Check out an interesting article in the June 20, 2007, issue of the Wall Street Journal at Page D1:  Jane J. Kim & Ruth Simon, "Long-Term Rate Rise Prompts Strategy Shift".

Another source: Caroline Baum, "Yield Curve Rights Itself without Fed's Help" (June 21, 2007), Bloomberg.com   

http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_baum&sid=a0HDOcF2xmPE

(ag) June 22, 2007, in Economy

Greenspan Goes Back to Work

According to today's Wall Street Journal, Former Federal Reserve Chairman Alan Greenspan has his first client since departing the hallowed halls of the Fed more than a year ago.  He will consult with Allianz AG's Pacific Investment Management Co. (Pimco).

Greg Ip's article on page C1, entitled "Greenspan Joins Fellow Legend", reports that "[a]mong the predictions Mr. Greenspan has made for his new client:  World interest rates are headed higher in the next few years."  I could have told you that!

(ag) May 16, 2007, in Economy

Dallas Federal Reserve President Richard Fisher Speaks About the U.S. Economy: "In the service arena we are hotter than Scarlett Johansson."

My favorite economist, Dallas Fed President Richard Fisher, has another noteworthy speech on the Dallas Fed website: "The Dog That Does Not Bark but Packs a Big Bite: Services in the U.S. Economy" - Remarks before the U.S.–China Business Council, the Coalition of Service Industries and the American Council of Life Insurers.

Link to Speech:  http://dallasfed.org/news/speeches/fisher/2007/fs070514.cfm

(ag) May 15, 2007, in Economy

T. Boone Pickens Talks About Oil Prices

Legendary Dallas oilman T. Boone Pickens spoke to the 11th Annual Metroplex Growth Capital Conference on May 3, 2007.   According to a May 14, 2007, article in the Fort Worth Business Press, entitled "Conference Speakers Point to $70-$80 Oil by End of Year" and written by John Armistead, here's what Pickens had to say:

"I think we'll see $80 oil by the end of this year.  Oil supplies, I believe, have peaked and reserves are declining.  Demand will continue to grow, and oil is not being replaced.  The U.S. uses 25 percent of the world's oil but has only 5 percent of the world's population.  You do the math and try to figure out what is going to happen.  We have to make innovative changes."

If this guy thinks our economy and the world economy face trouble on account of oil prices, then we are facing trouble.  When are we going to see something other than the "ostrich approach" to this issue?

(ag) May 14, 2007, in Economy.

Consumer Debt Levels -- Not Just a U.S. Problem

On the front-page of the Wall Street Journal for May 10:  "Borrowing Binge Fuels U.K. Economic Worries" by Joellen Perry.  Some astounding facts include a comparison of household consumer debt as a percentage of disposable income.  For 2005 in the U.S., it's a staggering 135%.  But in the U.K. for 2005, it's 159%.  Just as in the U.S., there will be serious repercussions if the economy slows.  Fortunately, the British economy, fifth largest in the world, is in its fifteenth year of uninterrupted growth and is expected to grow 2.9% this year.  Nevertheless, banks there are facing significant losses due to consumer delinquencies.  Housing prices have skyrocketed, which is one key factor in household debt levels.  Home repossessions in 2006 jumped 65%.  Consumer bankruptcies (called Individual Voluntary Arrangements or IVAs) are also up substantially.

This article presents a factor I had not previously considered in assessing the world economy.  Check it out. 

(ag) May 11, 2007, in Economy

Fed Keeps Interest Rates at 5 1/4%

No surprise!  The Federal Open Market Committee (FOMC) voted unanimously today to hold the target federal funds rate at 5 1/4%.  The statement was short and bland.

Link:  http://www.federalreserve.gov/boarddocs/press/monetary/2007/20070509/default.htm

(ag) May 9, 2007, in Economy

"Devil Take the Hindmost"

Speaking of bubbles, I recommend that you add this book to your reading list:  Chancellor, DEVIL TAKE THE HINDMOST (2000).  It is both informative and readable.

Here's a list of the chapter titles, so you can get a flavor for the contents:

1. 'This Bubble World': The Origins of Financial Speculation

2. Stockjobbing in Change Alley: The Projecting Age of the 1690s

3. The Never-to-be-Forgot or Forgiven South-Sea Scheme

4. Fools' Gold: The Emerging markets of the 1820s

5. 'A Ready Communication': The Railway mania of 1845

6. 'Befooled, Bewitched and Bedeviled': Speculation in the Gilded Age

7. The End of a New Era: The Crash of 1929 and Its Aftermath

8. Cowboy Capitalism: From Bretton Woods to Michael
Milken

9. Kamikaze capitalism: The Japanese Bubble Economy of the 1980s

Epilogue: The Case of the Rogue Economists

(ag) May 9, 2007, in Economy

Bubble, Bubble, Toil and Trouble?

Okay, Shakespeare's three witches didn't say that, but they might have if they had been following the stock market rise.  In yesterday's Wall Street Journal, Peter McKay reviews the recent trend in "The Dow Climbs Past 13300, Powered by Aluminum Bid".

McKay notes that May 7, 2007, represented the fifth consecutive record close for the Dow Jones Industrial Average.  With rises in 24 of the last 27 trading days, McKay calls this the "most consistent rally since 1927.  The last streak of five consecutive closing records was in April 1999". 

Not to be a naysayer, but we all know that what goes up must come down -- eventually.   

(ag) May 9, 2007, in Economy

 

Richard Fisher Discusses Four Conundra

Check out Dallas Federal Reserve Bank President Richard Fisher's remarks to the 2007 Annual Conference of The Investment Adviser. 

His speech is entitled "Comments on Current Conundra".  The four conundra he discusses are:

1.  the impact of globalization;

2.  the problems of accuracy and timeliness of data used to gauge economic performance;

3.  how this country "will deal with the problems of fiscal recklessness that have led us into a cul-de-sac of long-term liabilities of almost unfathomable dimension"; and

4.  the flat or inverted yield curve.

By far the most dangerous of the conundra is Number Three:  Whopping unfunded liabilities that will erode our children's future.  Fisher, as usual, articulates a thoughtful viewpoint.

Link:  http://dallasfed.org/news/speeches/fisher/2007/fs070426.cfm

(ag) May 1, 2007, in Economy

Emerging Countries - Does Foreign Direct Investment Help or Hurt?

Dallas Federal Reserve economist Anil Kuman has some intriguing things to say about foreign direct investment (FDI) in emerging economies.  His article, "Does Foreign Direct Investment Help Emerging Economies?", appears in the Dallas Federal Reserve Bank's January 2007 Economic Letter.

Link:  http://dallasfed.org/research/eclett/2007/el0701.html

(ag) March 24, 2007, in Economy

Bernanke's Top Three Issues

Federal Reserve Chairman Ben Bernanke delivered remarks (via satellite) to the Independent Community Bankers of America's Annual Convention.  His topic was "GSE Portfolios, Systemic Risk and Affordable Housing".

Chairman Bernanke's discussion of the policy questions surrounding Freddie Mac (FHLMC - Federal Home Loan Mortgage Corporation) and Fannie Mae (FNMA - Federal National Mortgage Association), both Government Sponsored Entities (GSEs), is well worth reading.  He spells out these GSEs two lines of business: 

1.  Purchasing mortgages from the original lenders, pooling and packaging the mortgages into Mortgage Backed Securities, adding their guarantees to these securities, and selling the MBSs.  This activity allows the originating lenders to divest themselves of default risk and loan servicing costs.  It also generates cash for the originating lenders, which can be used to originate more loans.  Bernanke calls this "increasing the liquidity of the residential mortgage lending market" and increasing the availability of housing loans to low and moderate income borrowers seeking to realize the American dream of home ownership. 

2.  Enhancing profit for the GSEs themselves by buying MBSs and other investments for their own portfolios.  Because of a general (and currently not legally grounded) perception that Congress would not allow a GSE to fail, Freddie and Fannie are able to borrow at rates more favorable than U.S. Treasury rates.  This access to cheap, unlimited credit to buy assets for their own portfolios is almost a license to print money -- and may not