The Federal Reserve will end its quantitative easing – or credit easing as Bernanke refers to it – in the first quarter of this year. They have already completed their Treasury purchases and will complete their agency bond and MBS purchases by the end of March. That’s the exit plan. I am of the opinion that most of what has transpired in the economy over the last year or so is a result of the Fed’s efforts and has very little to do with the stimulus bill or other efforts of the politicians. In fact, I believe that President Obama’s aggressive legislative agenda has more likely retarded the recovery due to the uncertainty it adds but of course that is just a matter of opinion. Despite what some economists will tell you in defense of government spending – and what I’ll say in opposition – there really is no way to know how things would have turned out if the stimulus spending hadn’t happened. We will be finding out fairly soon though how things will be in the absence of quantitative easing – money printing to put it in simple terms – by the Fed.
The Fed’s actions last year supported the mortgage market and kept mortgage rates down while also, at least indirectly, financing the federal budget deficit. Banks from whom the Fed bought mortgage-backed securities used the proceeds to buy Treasury notes instead and the government was able to finance its record deficit at low rates. That serendipitous arrangement comes to an end soon, which probably explains why the limits on Treasury investment in Fannie Mae and Freddie Mac were just raised to infinity. If the Fed doesn’t buy their paper, Treasury will provide the financing to continue subsidizing the mortgage market. All in an effort to keep interest rates – and specifically mortgage rates – lower than the market would like them to be.
One consequence of the Fed’s actions last year was an increase in their profits that are turned over to the Treasury. The interest from all those MBS, Agencies and Treasuries totaled some $50 billion last year of which $46 billion was turned over to the Treasury. Thinking about how the money flows through the system will give you a headache and also inform you as to how rickety is the Fed scaffolding holding up the economy. The Treasury invested $112 billion in Fannie Mae and Freddie Mac and the Federal Reserve bought $200 billion of agency debt. By the end of March, the Fed will have bought $1.25 trillion in agency MBS to support the value of mortgages on Fannie and Freddie’s balance sheet. And now the Fed has returned $46 billion to the Treasury from interest it received from, among others, Fannie Mae and Freddie Mac. If you are wondering why the stock market is up, the recession according to GDP has ended and yet we still aren’t adding any new jobs, this should give you a big clue. This Madoff like scheme was required just to keep the mortgage market from flying apart at the seams and while it was successful, it didn’t do anything for the real economy beyond propping up the market for existing homes.
Meanwhile, Washington wastes time on irrelevancies such as the latest incarnation of the Pecora commission and other populist theatrical measures while the real drama of running a business in this uncertain environment plays to an empty room. The Financial Crisis Inquiry Commission is headed by Phil Angelides who served for eight years as Treasurer of now nearly bankrupt California and somehow failed to get elected governor on a platform of higher taxes and more government in a state failing because of high taxes and too much government. It is that kind of deep thinking that I have come to expect from our political class. The other members of the commission inspire similar levels of confidence and I expect them to live up to the example of the 9/11 commission by starting with low expectations and accomplishing even less.
The guests of the star chamber last week were the CEOs of Goldman Sachs, Bank of America, JP Morgan and Morgan Stanley. Goldman CEO Lloyd “God’s Work” Blankfein took the brunt of the abuse as he attempted to explain that shorting sub prime in one part of the firm while selling it to customers in another part is really just inventory management and if Wal Mart could sell more than they actually had, they would be short LCD TVs for sure. Or maybe it was risk management; I’m not sure since I didn’t waste much time watching this farce. Congress formed this commission to find scapegoats and I’m sure they’ll find plenty. Like most everything else that emanates from DC, it is theater and not a serious attempt to find real solutions.
The end of quantitative easing by the Fed may be a wake up call for the politicians that it is time to act seriously on the economy. Or it might come sooner; President Obama rushed to Massachusetts this weekend to campaign for Martha Coakley, the Democratic candidate for the Ted Kennedy Memorial Senate seat who has managed to find a way to fall behind in a state where Republicans are outnumbered like Custer at Little Big Horn. While some are saying Coakley is just a bad candidate – and there is a lot of truth to that – I find it hard to believe that the President’s approach to the economy isn’t playing a part as well. The public voted for change and hope but Congress is still a wholly owned subsidiary of the financial industry and unless you belong to a union you don’t have much hope. And the public isn’t fooled by the symbolism of President Obama’s just announced tax on large banks; no one in their right mind believes the tax will reduce Jamie Dimon’s paycheck by one cent. It is the customers of the banks that will pay the tax.
The problems that face the US economy are serious and they deserve a serious response, not populist pabulum designed to sate the public’s infantile hunger for revenge. A serious response would address our debt issues and our lack of productive investment. A serious response would provide incentives for market directed investments not the latest fad dreamed up by politicians and activists. A serious response would address entitlement reform honestly. A serious response would address the development of traditional domestic energy sources in addition to alternatives. A serious response would find more than token waste in the federal budget. And most importantly, the public would take a serious response seriously.
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Weekly Economic and Market Review
The economic data continues to be generally positive with weakness still apparent mostly in the consumer. The trade deficit rose which I take as good news since the only time it has been close to balance in the last 30 years has been during recession. The Beige Book confirmed what the economic statistics have been telling us – the economy is improving but slowly. Retail sales were down from November but up from last year (mostly due to higher gas prices). The consumer continues to be the sore spot in the recovery. Jobless claims are stuck in the mid 400s which is better than it was but far from good. The inventory correction may be over as the inventory/sales ratio is almost down to where it was before the recession. Inventory rebuilding will be important to first quarter growth. Consumer prices rose modestly, but the year over year numbers are now rising pretty smartly – as I’ve been warning about for months now. The year over year rate is up to 2.7% and seems likely to rise more in the first quarter. Finally, the Empire State Manufacturing survey and the Industrial Production report were both very positive. Production will have to rise now that inventories have been worked off; the question is how long it will last.
The stock market was down slightly last week as earnings season got underway. Alcoa, Intel and JP Morgan all reported better than expected and saw their stocks fall anyway. That may mean that the market has caught up to the earnings expectations or it may not mean anything. There were reasons to question all three earnings reports that were specific to the companies reporting. We’ll see how this week goes as the earnings parade kicks into high gear. Markets this week will also be reacting to political news. If Coakley loses in MA Tuesday, there might be a general market reaction to the upside although I won’t go as far as Cramer and call for a big rally. There could be some fireworks in the healthcare related stocks, but I would look for a negative reaction. Say what you will about the proposed reform but don’t think the health companies didn’t lobby their way into a favorable position. Losing tens of millions of potential customers likely won’t be well received by investors.
Most commodities were down on the week as the dollar staged a pretty good rally on Friday. REITs were little changed on the week.
Watch Chile stocks this week which have been rallying on the expected win by Pinera. Buy the rumor sell the news.
Oil prices eased last week but the trend is still up:
The trend for oil and most commodities will be influenced by the course of the dollar. Friday’s reversal to the upside was very positive for the greenback:
In what has to rank as the most unlikely rally, Japanese stocks broke out last week. I have no idea what to make of this yet.
Watch for a reversal in the HMO stocks if Brown wins in MA Tuesday: