There Is No Bubble and Even if There Is It’s Not a Problem, by Economist’s View Blog

The big story today seems to be the Fed’s comments about the housing bubble in transcripts from their meetings in 2006. The transcripts show what we already knew, that the Fed was never fully convinced there was a housing bubble, and asserted that even if there was the dmage could be contained — they could easily clean up after it pops without the economy suffering too much damage:

Greenspan image tarnished by newly released documents, by Zachary A. Goldfarb, Washington Post: The leaders of the Federal Reserve went around the room saluting Alan Greenspan during his last major meeting as chairman of the central bank Jan. 31, 2006. …

Some six years later, Greenspan’s record — sterling when he left the central bank after 18 years — looks much more mixed. Many economists and analysts say a range of Fed policies contributed to the financial crisis and resulting recession. These included keeping interest rates low for an extended period, failing to take action to stem the bubble in housing prices and inadequate oversight of financial firms.

The Thursday release of transcripts of Fed meetings in 2006 shows that top leaders of the Fed — several of whom continue to hold key positions today — had a limited awareness of the gravity of the threat that the weakness in the housing market posed to the rest of the economy. And they had what turned out to be an excessive optimism about how well things would turn out. …

A Fed economist reported in a 2006 meeting that “we have not seen — and don’t expect — a broad deterioration in mortgage credit quality.” That turned out to be incorrect.


Goldman: The Fed Needs To Print $4 Trillion In New Money,

With just over a week left to the QE2 announcement, discussion over the amount, implications and effectiveness of QE2 are almost as prevalent (and moot) as those over the imminent collapse of the MBS system. Although whereas the latter is exclusively the provenance of legal interpretation of various contractual terms, and as such most who opine either way will soon be proven wrong to quite wrong, as in America contracts no longer are enforced (did nobody learn anything from the GM/Chrysler fiasco for pete’s sake), when it comes to printing money the ultimate outcome will certainly have an impact. And the more the printing, the better. One of the amusing debates on the topic has been how much debt will the Fed print. Those who continue to refuse to acknowledge that the economy is in a near-comatose state, of course, hold on to the hope that the amount will be negligible: something like $500 billion (there was a time when half a trillion was a lot of money). A month ago we stated that the full amount will be much larger, and that the Fed will be a marginal buyer of up to $3 trillion. Turns out, even we were optimistic. A brand new analysis by Jan Hatzius, which performs a top down look at how much monetary stimulus is needed to fill the estimated 300 bps hole between the -7% Taylor Implied Funds Rate (of which, Hatzius believes, various other Federal interventions have already filled roughly 400 bps of differential) and the existing 0.2% FF rate. Using some back of the envelope math, the Goldman strategist concludes that every $1 trillion in new LSAP (large scale asset purchases) is the equivalent of a 75 bps rate cut (much less than comparable estimates by Dudley, 100-150bps, and Rudebusch, 130bps). In other words: the Fed will need to print $4 trillion in new money to close the Taylor gap. And here we were thinking the economy is in shambles. Incidentally, $4 trillion in crisp new dollar bills (stored in bank excess reserve vaults) will create just a tad of buying interest in commodities such as gold and oil…

Here is the math.

First, Goldman calculates that the gap to close to a Taylor implied funds rate is 7%.


Our starting point is Chairman Bernanke?s speech on October 15, which defined the dual mandate as an inflation rate of ?two percent or a bit below? and unemployment equal to the committee?s estimate of the long-term sustainable rate. The Fed?’s job is then to provide just enough stimulus or restraint to put the forecast for inflation and unemployment on a ?glide path? to the dual mandate over some reasonable period of time. Indeed, Fed officials have implicitly pursued just such a policy since at least the late 1980s.

To quantify the Fed?s approach, we have estimated a forward-looking Taylor-style rule that relates the target federal funds rate to the FOMC?s forecasts for core PCE inflation and the unemployment gap (difference between actual and structural unemployment). At present, this rule points to a desired federal funds rate of -6.8%, as shown in Exhibit 1.3 Since the actual federal funds rate is +0.2%, our rule implies on its face that the existence of the zero lower bound on nominal interest rates  has kept the federal funds rate 700 basis points (bp) ?too high.?

It is important to be clear about the meaning of this ?policy gap.? It does not mean?as is sometimes alleged?that policy is tight in an absolute sense, much less that it will necessarily push the economy back into recession. In fact, policy as measured by  the real federal funds rate of -1% is very easy. However, our policy rule implies that under current circumstances?with the Fed missing to the downside on both the inflation and employment part of the dual mandate (and by a large margin in the  latter case) ?a very easy policy is not good enough. Instead, policy should be massively easy to facilitate growth and job creation, fill in the output gap, and ultimately raise inflation to a mandate-consistent level.

Next, Goldman calculates how much existing monetary, and fiscal policy levers have narrowed the Taylor gap by:




The 700bp policy gap clearly overstates the extent of the policy miss because it ignores (1) the expansionary stance of fiscal policy, (2) the LSAPs that have already occurred and (3) the FOMC?s ?extended period? commitment to a low funds rate. We attempt to incorporate the implications of these for the policy gap in two steps.

First, we obtain an estimate of how much the existing unconventional Fed policies have eased financial conditions. In previous work we showed that the first round of easing pushed down short- and long-term interest rates, boosted equity prices and led to depreciation of the dollar. Although our estimates are subject to a considerable margin of error, they suggest that ?QE1? has boosted financial conditions?as measured by our GSFCI ?by around 80bp per $1 trillion (trn) of purchases. Moreover, our estimates suggest that the ?extended period? language has provided an additional 30bp boost to financial conditions. A number of studies undertaken at the Fed similarly point to sizable effects on financial conditions. A New York Fed study, for example, finds that QE1 has pushed down long-term yields by 38-82bp. A paper by the St. Louis Fed also finds a sizable boost to financial conditions more generally, including equity prices and the exchange rate.

Second, we translate this boost to financial conditions?as well as the expansionary fiscal stance?into funds rate units. To do so, we attempt to quantify the relative impact of changes in the federal funds rate, fiscal policy and the GSFCI on real GDP. As such estimates are subject to considerable uncertainty we take the average effect across a number of existing studies (see Exhibit 2). With regard to monetary policy, the studies we consider suggest that a 100bp easing in the funds rate, on  average, boosts the level of real GDP by 1.6% after two years. A fiscal expansion worth 1% of GDP, on average, raises the level of GDP by 1.1% two years later. Using existing studies to gauge the effects of an easing in our GSFCI on output is more difficult as other researchers construct their financial conditions indices in different ways. Taking the average across studies that report effects for the components of their indices?thus allowing us to re-weight the effects for our GSFCI? and our own estimate suggests that a 100bp easing in financial conditions increases the level of GDP by around 1.5% after two years.

What does this mean for the real impact on the implied fund rate from every incremental dollar of purchases?




Combining these two steps suggests that $1trn of asset purchases is equivalent to a 75bp cut in the funds rate (calculated as the effect of LSAPs on financial conditions (80bp), multiplied by the effect of financial conditions on GDP (1.5%), divided by the effect of the funds rate on GDP (1.6%)). This estimate reinforces the view that QE1 helped to substitute for conventional policy. Our estimate, however, is less optimistic than the 100-150bp range cited by New York Fed President Dudley, or the 130bp implied by Glenn Rudebusch of the San Francisco Fed.

In terms of the other policy levers, our analysis implies that the ?extended period? language is worth around 30bp cut in the funds rate and a fiscal stimulus of 1% of GDP is equivalent to around 70bp of fed funds rate easing.

So how much more work should the FOMC do? Exhibit 3 shows that consideration of policy levers other than the funds rate cuts the estimated policy gap by more than half, from 700bp to 300bp. Of this 400bp reduction, the easy stance of fiscal policy is worth 240bp; QE1 is worth 130bp; and the existing commitment language is worth another 30bp.

And the kicker, which shows just how naive we were:

We can then express the remaining policy gap in terms of the required additional LSAPs. Using our estimate that $1trn in LSAPs is worth an estimated 75bp cut in the federal funds rate and assuming that all other policy levers stay where they are at present, Fed officials would need to buy an additional $4trn to close the remaining policy gap of 300bp.

Now, for the amusing part: what does $4 trillion in purchases means for inflation. Or, a better question, when will $4 trillion be priced in…

In reality, the FOMC is unlikely to authorize additional LSAPs of as much as $4trn, unless the economy performs much worse than we are forecasting. The committee perceives LSAPs as considerably more costly than an equivalent amount of conventional monetary stimulus, and is therefore not likely to use the two interchangeably. Many Fed officials believe that there are significant ?tail risks? associated with LSAPs and the associated increase in the Fed?s aggregate balance sheet. These  risks include the possibility of substantial mark-to-market losses on the Fed?s investment, which might prove embarrassing in the Fed?s dealings with Congress and could, in theory, undermine its independence. They also include the possibility that the  associated sharp increase in the monetary base will lead households and firms to expect much higher inflation at some point in the future.

Unfortunately, it is extremely difficult to put a number on the perceived or actual cost of an extra $1trn in LSAPs in terms of these tail risks. However, we have some information on how the FOMC has behaved to date that might reveal Fed? officials? perception of these costs.

Oddly, nobody ever talks about the impact of “unconvential” printing of trillions on commodities such as oil and gold. They will soon.

Our analysis is therefore consistent with additional asset purchases of around $2trn if the FOMC?s forecasts converge to our own. It is unlikely, however, that the FOMC will announce asset purchases of this size in the very near term. Rather, our analysis suggests that the timing of the announcements should depend on whether, and how quickly, the FOMC?s forecasts converge to ours.

Hatzius pretty much says it all- suddenly the market will be “forced” to price in up to 4 times as much in additional monetary loosening from the “convention wisdom accepted” $1 trillion. We have just one thing do add. If Goldman has underestimated the impact of existing fiscal and monetary intervention, and instead of closing 4% of the Taylor gap, the actual impact has been far less negligible (and if Ferguson is right in assuming that all this excess money has in fact gone to chasing emerging market and commodity bubbles), it means that, assuming 75bps of impact per trillion, the Fed will not stop until it prints nearly ten trillion in incremental money beginning on November 3. That’s almost more than M1 and M2 combined.

Is the case for $10,000 gold becoming clearer?

Bernanke Asset Purchases Risk Unleashing 1970s Inflation Genie, by Craig Torres,

Official portrait of Federal Reserve Chairman ...

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For the second time since he became chairman in 2006, Ben S. Bernanke is leading the Federal Reserve into uncharted monetary territory.

Bernanke next week is likely to preside over a decision to launch another round of large-scale asset purchases after deploying $1.7 trillion to pull the economy out of the financial crisis, comments from policy makers over the past week indicate. This time, with interest rates already near zero, the Fed will be aiming to increase the rate of inflation and reduce the cost of borrowing in real terms. The goal is to unlock consumer spending and jump-start an economy that’s growing too slowly to push unemployment lower.

Estimates for the ultimate size of the asset-purchase program range from $1 trillion at Bank of America-Merrill Lynch Global Research to $2 trillion at Goldman Sachs Group Inc., with economists at both firms agreeing the Fed will likely start by announcing $500 billion after the Nov. 2-3 meeting. The danger is that once the Fed kindles price increases, inflation will be difficult to control.

“By reducing real interest rates and trying to break the psychology of ‘Why spend today when I can buy goods cheaper tomorrow,’ they are hoping to drive growth that would be more commensurate with a pickup in employment,” said Dan Greenhaus, chief economic strategist at Miller Tabak & Co. in New York. “The risk is a late 1970s type of scenario where the inflation genie gets out of the bottle.”

The U.S. Treasury Department yesterday sold $10 billion of five-year Treasury Inflation Protected Securities at a negative yield for the first time at a U.S. debt auction as investors bet the Fed will be successful in sparking inflation. The securities drew a yield of negative 0.55 percent.

‘Unacceptable’ Inflation

William Dudley, president of the New York Fed and vice chairman of the Federal Open Market Committee, yesterday repeated that current levels of inflation and a 9.6 percent unemployment rate are “unacceptable” and said the Fed needs to take action, even though expanding the balance sheet isn’t a “perfect tool.”

“To the extent that we can do things to improve the economic environment, we certainly owe it to the millions of people who are unemployed to do so,” Dudley said in response to audience questions after a speech in Ithaca, New York. Policy makers haven’t yet decided whether to buy additional assets, he said.

A second jolt of monetary stimulus would expand the Fed’s $2.3 trillion balance sheet to a record and likely work through the exchange rate as well as interest rates, said former Fed governor Lyle Gramley. A weaker dollar would boost U.S. exports and push prices higher as the cost of imported goods rises.

Competitive Exports

“It is a channel that works not only from the standpoint of encouraging more growth and making exports more competitive, but if you’re worried about inflation getting too low, this tends to put a little upward pressure” on it, said Gramley, a senior adviser at Potomac Research Group in Washington.

An index of the dollar versus six major currencies is down 5.2 percent since Sept. 20, the day before Fed officials concluded their last meeting by saying inflation measures were “somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.” The Standard and Poor’s 500 Index is up 3.8 percent since then.

A 10 percent decline in the dollar in the first six months of next year would push the economy above estimates of trend growth, moving indicators on inflation and employment more rapidly toward the Fed’s policy goals, according to a simulation run by Macroeconomic Advisers LLC on their model of the U.S. economy.

Effect on GDP

Gross domestic product would rise 1.1 percentage points more than the St. Louis-based firm’s baseline forecast for next year, to 4.8 percent. In 2012, growth of 5.7 percent would exceed the baseline forecast by 1.3 percentage points.

Unemployment would fall to 7 percent by the end of 2012, 1.4 points lower than the firm’s baseline forecast. The consumer price index, minus food and energy, would rise 0.4 percent and 0.7 percent more each year.

A continuing rally in stocks could also provide an added lift to growth, the firm’s simulation showed.

The firm, co-founded by former Fed governor Laurence Meyer, predicts the Wilshire 5000 stock index will jump 14 percent next year and 16 percent in 2012. The index tracks the impact of rising asset prices on household net worth. An additional 10 percent gain in the stock index in the first half of 2011 boosts growth by 0.1 percentage point and 0.3 percentage point more than the firm’s baseline forecast.

‘Transmission Mechanism’

“The transmission mechanisms are risk assets and a lower dollar,” said Steven Einhorn, who helps manage $5 billion at hedge fund Omega Advisors Inc. in New York. “Exports will respond over the next six to 12 months, and a further lift in risk assets will have benefits in more consumer spending as it lifts households’ net worth.”

A weaker dollar won’t be welcomed by U.S. trading partners concerned about the danger of competitive devaluations as nations seek to boost exports and growth.

Bernanke received “criticism” at a meeting of Group of 20 central bankers and finance ministers in South Korea last weekend, said German Economy Minister Rainer Bruederle.

“It’s the wrong way to try to prevent or solve problems by adding more liquidity,” Bruederle told reporters. “Excessive, permanent money creation in my opinion is an indirect manipulation of an exchange rate.”

$500 Billion

Economists Jan Hatzius at Goldman Sachs and Ethan Harris at Bank of America predict the Fed will spread an initial $500 billion in asset purchases over six months. That is the figure mentioned in the Oct. 1 speech by Dudley, who said $500 billion in purchases could have the same effect as cutting the benchmark federal funds rate by as much as a 0.75 percentage point.

The FOMC’s meeting next week could be contentious, with regional bank presidents such as Charles Plosser of Philadelphia and Richard Fisher of Dallas expressing concern in public remarks about a second round of asset purchases. Neither is a voting member of the FOMC this year.

Plosser told reporters Oct. 20 that high unemployment may not be “amenable to monetary-policy solutions” and added that he was “less inclined to want to follow a policy that is highly concentrated on raising inflation and raising inflation expectations.”

Fisher said central bank officials must be mindful of the effect their actions are having on the dollar.

Dollar Impact

“We need to be aware of the impact whatever we do has on other variables, and one of the variables is the dollar, the value of the dollar against other currencies,” Fisher said in an Oct. 22 interview in New York.

The prospect of an easier policy for a long period could prompt foreign investors to use Fed purchases as an opportunity to unload longer-term Treasuries, said Vincent Reinhart, former director of the Fed Board’s Division of Monetary Affairs.

“This might put more pressure on the exchange value of the dollar than the Fed is willing to tolerate,” said Reinhart, a resident scholar at the American Enterprise Institute in Washington.

Some commodity prices have already started to move up in anticipation of further Fed stimulus. Gold futures traded on the Comex in New York have risen 22 percent this year to $1,338.90 an ounce, while silver is up 40 percent.

“The Fed would like to talk up as many asset classes as it can,” said Scott Minerd, the Santa Monica-based chief investment officer at Guggenheim Partners LLC, who helps oversee $76 billion.

Asset Bubbles

“The history of the Fed, over the last 20 years, is one of bubble to bubble: one bubble deflates to create another bubble,” Minerd said. “We are certainly heading into the mother of all bubbles with commodities and gold.”

Another danger for the Fed is that its policy fails to have the intended effect, damaging the central bank’s credibility, Reinhart said.

“What happens if they bulk up the portfolio by another $500 billion in the next six months and there is no material change in markets or the outlook,” he said. “Presumably, the Fed will double-down and buy some more, but at some point, people will ask, ‘Is that all there is?’”

U.S. central bankers cut the benchmark lending rate to zero in December 2008. Seeking more stimulus, they launched a $1.7 trillion program to buy mortgage-backed securities, housing agency debt and U.S. Treasuries. The purchases ended in March.

Jackson Hole

Bernanke told central bankers in Jackson Hole, Wyoming, in August that those purchases “pushed investors into holding other assets with similar characteristics,” lowering interest rates on a broad range of debt.

While a second round of Treasury purchases would also lower nominal rates, the FOMC has been explicit about the need to lower real interest rates through higher inflation, minutes of its Sept. 21 meeting show.

The personal consumption expenditures price index, minus food and energy, rose at a 1.4 percent annual rate in August. That’s below the Fed’s long-run preference range of 1.7 percent to 2 percent. The year-over-year increase in consumer prices jumped as high as 14.8 percent in 1980 during the administration of Jimmy Carter.

Even moderate rates of inflation can shift wealth through the economy. Companies can make more money because their prices rise faster than wages. Households can also benefit as incomes eventually rise while costs on fixed-rate debt stay the same.

Chipotle Mexican Grill Inc. chief financial officer John Hartung told Bloomberg Television Oct. 22 that he expects inflation to be in the low-single to mid-single digits next year. “We would welcome modest inflation along with the continued pickup in consumer demand,” Hartung said.

To contact the reporters on this story: Craig Torres in Washingtont ; or Scott Lanman in Washington at

To contact the editor responsible for this story: Christopher Wellisz at

Refinancing, Not Foreclosures, is the Issue; Richard Alford on Bill Dudley and QEII, The Institutional Risk Analyst Blog

One good rule thumb in trying an understand what’s happening with the [global] economy is listen to what Mr. Geithner says, and know that’s not possibly right. So, last week when Mr. Geithner states there’s no currency wars, that pretty much means it’s raging full scale, and the Fed’s dropping the biggest bombs.


Joe Costello

One of the deepest, most sincere human illusions is the faith that there is (or can be) “real money” as opposed to “unreliable” money that does not hold a certain value and purchasing power. I discovered long ago from reading the history of money that this kind of certitude has never been the case except for very brief periods. Money is man-made and therefore subject to all the myriad fluctuations and follies in human arrangements. Obviously, this upsets people, especially goldbugs. They need to get over it though I doubt they ever will. I suspect Chris (maybe Joe) would like to get back to the Gold Standard, though he is too practical to say so directly. That regressive choice would be our true road to serfdom. If gold is the only “real” money, then working people should be paid for their labors in real gold, not paper certificates. 

William Greider
“The Last Word on Funny Money”


In this issue of The Institutional Risk Analyst, we return to a subject which we have awaited for nearly three decades and which many of the inhabitants of Wall Street have only recently discovered, namely the imperfection of collateral liens on mortgages underlying asset backed securities or ABS. The failure on the part of the largest banks to perfect the liens on the home, office building or other real property that underlies a securitization is turning out to be not merely a legal headache — and it is — but also the operational catalyst for the next crisis in financials. But the foreclosure mess is not — repeat not — the crux of the biscuit, to paraphrase the late great composer Frank Zappa.


We also feature a comment by our contributor Dick Alford on the recent speech by NY Fed President William Dudley regarding the resumption of quantitative easing or “QE.” Suffice to say that Dudley has adopted the happy face messaging seen in use by Fed Chairman Ben Bernanke and other members of the compliant Federal Open Market Committee in Washington. Yet as we shall be telling an audience later today at American Enterprise Institute, the best part of the financial crisis lies ahead.  Click here to download the slide deck, “Pictures of Deflation.”


We noted in previous comments that the Fed’s zero interest rate policy or “ZIRP,” in conjunction with QE, is draining something on the order of $1 trillion annually in income from individual and corporate savers to subsidize the banking sector. The key thing to understand about the continuing crisis in the mortgage sector is that the process of foreclosing on homes is reducing assets of commercial banks by an amount that is far larger than the $1 trillion in total tangible capital of the U.S. banking industry.  Read that last sentence again.


While the Fed has been attempting to refloat these same banks — and their bond holders — on a sea of cheap money, the central bank is ignoring the larger, structural problems in the real estate sector. Forget mere valuations losses on ABS and derivatives on same. The real surprise heading for Washington and Wall Street is when everyone realizes that the big risk facing the U.S. economy is not from the foreclosure crisis, but from the actions of the “Big Five” financial monopolies — Fannie MaeFreddie MacBank of America (BAC) (Q2 2010 Stress Rating “C”), Wells Fargo (WFC) (Q2 2010 Stress Rating “B”) and JP MorganChase (JPM) (Q2 2010 Stress Rating “C”) to prevent tens of millions of American homeowners from refinancing their performing mortgages.


But first, let’s take a stroll down memory lane.


A few years back, a young analyst from the FRBNY named Chris Whalen went to work at the London branch of Bear, Stearns & Co. During the morning we sold German bunds and the other debt issued by what are now the EU member nations.  In the afternoon we sold mortgage-backed securities. Terms like CMO and convexity were soon heard on the trading floor as we vigorously stuffed large quantities of these very early private label RMBS into every open orifice on the European continent, including a number of large Japanese banks and insurance companies. Thus was coined the term “yield to commission.”


During this period, we stayed in touch with our colleagues at the Fed, particularly a courageous attorney named Walker Todd , who was then working at the FRBNY. We described in previous comments how members of the Fed’s Washington staff persecuted Todd and other Reserve Bank officials for having the temerity to object to some of the more ridiculous policy positions pursued during the tenure of Fed Chairmen Paul Volcker and Alan Greenspan (See “IndyMac, FDICIA and the Mirrors of Wall Street’, January 6, 2009”). There is an entire chapter devoted to the good works of Chairman Volcker and his protege, Gerald Corrigan, in the upcoming book, Inflated: How Money and Debt Built the American Dream.”  And we answer the question: Is Paul Volcker the father of “Too Big To Fail?”  Click here to see the new target page for inflated.


The Fed’s Washington staff was particularly infuriated by Todd’s writings regarding the amendments to the Federal Reserve Act contained in the FDICIA legislation in 1991. The amendment pushed by then-Fed staff director Donald Kohn was adopted without vote during a late-night Senate conference committee session chaired by none other than Christopher Dodd (D-CT). In a very real sense, Dodd, Kohn and armies of Wall Street attorneys from the large banks who drafted the amendment are the authors of the great bank bailout of 2008.


One of the topics we discussed at length with Todd in the mid-1980s was the way in which Wall Street firms underwriting of residential mortgage backed securities or “RMBS” failed to perfect the collateral lien of the securities against the home or other real estate. This was a serious legal problem, especially if you believe in property rights and due process of law. Yet because the value of the real estate that served as collateral was rising pretty much continuously during the past several decades (Hello — What’s wrong with this picture?), the issue of imperfect collateral liens in ABS received little attention from the Fed or other regulators. See our comment: “No True Sale: Interview with Joseph Mason’, March 3, 2008”


Now let’s walk through the process of creating an RMBS to illustrate the problem facing many home owners, lenders and investors. We’ll use the actual example of IRA cofounder Christopher Whalen. Back in 1998, Chris and his wife bought a home in Westchester County NY. The primary mortgage was originated by and independent broker and placred with Roslyn Savings Bank, which retained the paper for its own portfolio. In 2001, Chris refinanced with the Bank of New York Mellon (BK) (Q2 2010 Sress Rating: “A”), which immediately sold the “Alt-A” loan to the firm formerly known as Lehman Brothers. But that was only the start of this mortgage’s journey.


The loan was then resold by Lehman Brothers to a special purpose vehicle (SPV) and then sold again to a Delaware trust created to securitize the mortgage into an ABS. Lehman controlled the trust, but the vehicle was administered as though it were in fact separate. Servicing was provided by Aurora Loan Servicing, a wholly owned subsidiary of Lehman, which is now being liquidated. When the time came to sell bonds to investors, the trustee for the Delaware vehicle issuing the securities repeated the process performed thousands of times before and merely took the documentation describing the mortgages into a file folder and went on to the next deal.


Here’s the problem. If you go down to the Courthouse in White Plains, New York, and pull up the title record for the property purchased a decade ago by the Whalens, the only indication of any encumbrance over the collateral that is supposed to back up the securitization sold to investors by Lehman Brothers is the original assignment to Roslyn Savings and later to the Bank of New York. There is no change in recordation of the collateral lien on the property to Lehman Brothers much less the SPV or the Delaware trust that acted as the securitization vehicle in the ABS.


In the event of a default, it could be argued that Lehman Brothers never owned the loan and thus never had the power to assign ownership to the SPV or the Delaware trust. Indeed, in plain legal terms, Bank of New York (and now JPMorgan, the successor to the Bank of New York retail business), is the only party with legal standing to enforce the lien on the property. But as far as Bank of New York is concerned, the loan was sold to Lehman Brothers more than a decade ago.


Now you are probably wondering why the good people at Lehman Brothers never bothered to send a paralegal to the New York State Courthouse in White Plains to record a change in the collateral lien — at least regarding the sale to Lehman Brothers. The cost of perfecting the lien on the hundreds or even thousands of loans in a typical ABS costs money, but in aggregate would have added less than half a point to the cost of the deal. But the investment bankers at Lehman Brothers took that half point as profit instead of doing their jobs. No doubt claims for fraud, RICO and other misdemeanors are possible against Lehman and other RMBS underwriters, as with the civil RICO lawsuit againstCitigroup (C) (Q2 2010 Stress Rating “C”) and Ally Financial (Q2 2010 Stress Rating “A+”).


You can argue that the banks were greedy and stupid for failing to perform their legally required duties as securities dealers and fiduciaries. You can also argue rightly that many banks are doing stupid things in foreclosures as they are being overwhelmed by mortgage defaults. But these very real concerns miss the larger issue. The bigger point that members of the media and the other happy campers who are following the foreclosure mess need to understand is that a poorly managed documentation trail does not change the fact that the loans are bad.  Focusing on the foreclosure mess at the expense of paying attention to the larger, secular threat from the deflation of the mortgage sector could be a fatal choice for American consumers, banks and the nation as a whole.


House Speaker Nancy “Red” Pelosi (D-CA) and all of the other politicians clamouring for inquiries of bad home foreclosures are simply playing to their ill-informed audience. Neither Pelosi, most members of Congress nor the vast majority of Americans understand that the real crime by the Big Five banks is not the failure to perfect the loan documents on a mortgage a decade ago, but the active steps being taken today to prevent millions of American households from exercising their contractual right to refinance their mortgages when interest rates fall.


The focus by Washington on the very real mortgage foreclosure mishaps committed by many lenders is the functional equivalent of putting Al Capone away for tax evasion. The real, continuing act of racketeering and criminality being committed by the Big Five banks is the cartel behavior which prevents home refinancing for performing borrowers and also renders Fed monetary policy largely ineffective. Instead of suing American Express (AXP), the Department of Justice should be suing the Big Five for anti-trust violations, price fixing and criminal RICO. Until the blockade erected by Fannie Mae and Freddie Mac to prevent refinancing of performing mortgages is removed, Fed monetary policy will be stymied and no amount of QE will be effective in stabilizing much less re-inflating the U.S. economy.


Why Does Bill Dudley Want More QE?
By Richard Alford

New York Federal Reserve Bank President William Dudley gave a very well received speech last week. It is easy to see why Wall Street applauded the speech. It promised further steps by the Fed to support asset prices. It is less clear why anyone outside Wall Street would applaud the speech, as it contained arguments that were disingenuous, logically inconsistent and possibly dangerous.


Dudley addressed a number of questions, including: “How much would the Fed have to purchase to have a given impact on the level of long-term interest rates and economic activity? Dudley asserts that recent experience suggests: “that $500 billion of purchases would provide about as much stimulus as a reduction in the federal funds rate of between half a point and three quarters of a point.” This was the take-away money passage and was quoted frequently in the press.


However, the full answer is neither as precise nor as certain. A little later in that discussion Dudley went on to say: “Suppose the Fed was indeed successful in reducing long-term interest rates further-what then? Some claim that lower rates would have no effect on economic activity-that the Fed would be ‘pushing on a string.’ This is too dark a view. Although the responsiveness of demand to reductions in interest rates is probably lower in a world in which balance sheet constraints are important, the responsiveness is not zero. I believe that it remains significant.”


Dudley asked: “How much would the Fed have to purchase to have a given impact on the level of long-term interest rates and economic activity? And asserting without qualification that QE is stimulative (and stimulative is generally understood to imply increase economic activity) in the first statement, Dudley backtracks in the second statement even as he dismisses the opposing view with an unsupported assertion: “This is too dark a view.”


After presenting a precise quantitative link between QE and long-term rates, the best Dudley can offer in regard to the link between changes in long-term rates and economic activity is: “I believe that it is significant”. In fairness to Dudley, it is the best any supporter of QE can do. Given the failure of QE to stimulate the Japanese economy, there is no evidence that QE will stimulate economic activity in the US today.


We need to recognize that assertions regarding the effectiveness QE are just part of a belief system unsupported by data — the definition of most modern religions.  This is troubling enough, but Dudley goes on to sketch the mechanism by which he believes that QE would support economic activity:


“Even in today’s challenging circumstances; lower long-term rates would support the economy through a number of channels. Lower long-term rates would support the value of assets, including houses and equities and household net worth. Lower long-term rates would make housing more affordable and support consumption by enabling households to refinance their mortgages at lower rates. This would increase the amount of income left over for other spending.”


In short, Dudley supports QE partly because he believes that it would lead to a policy-based, higher asset-price, easier credit, consumption-driven boom much like but more widely based than either the NASDAQ technology stock or more recent real estate bubbles. This ought to be very troubling as it suggests that the Fed has not learned from past mistakes.  The Fed believed that the financial markets without serious oversight were efficient and robust enough to weather a prolonged period of a near zero real and then unusually low Fed funds rates, as well as a tidal wave of financial innovation. The Fed’s fundamentalist faith in efficient markets was misplaced, as shown when risks they had dismissed were realized. Currently, the markets is pricing-in the Fed ushering in QE2 with “shock and awe” after the next FOMC meeting. It appears that the Fed will expose the economy to risks it has cavalierly dismissed as “too dark” in pursuit of returns that it “believes” exist. The public deserves better. It deserves a good faith analysis and honest presentation of both the upside and downside risks attached to QE.


Early in the speech, Dudley applauded the rise in the personal savings rate and deleveraging as necessary steps to restore sustainable growth. However, late in the speech he argues that QE will work because it will depress savings and encourage the re-leveraging of the economy. But how can we re-leverage the economy when, as discussed above, banks are shrinking because neither the Treasury or the Fed have the courage to immediately restructure these institutions?  Logical consistency ought to be a necessary component of policy and explanations of policy, but apparently not at the Fed.


Dudley remains mute on a number of ancillary issues. For example, he does not mention the transference of more than three-quarters of a trillion dollars annually from savers to the banks due to low rates even though this decreases the amount of income available for consumption spending. He also remains mute on the blurring of the distinction between the Fed and Treasury. From the Fed financing the public ownership of AIG to the apparent willingness to commit to monetizing (though QE) of the fiscal deficit, the Fed has moved in the direction of allowing both the Executive and Legislative branches of government to avoid their responsibilities.


It is October in an election year. One expects speeches such as this from candidates running for public office, but not from Fed officials.


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