Noise And Fed’s Take on Inflation by Frederick Sheehan, AU Contrarian
Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009), which was translated and republished in Chinese (2014). He is researching a book about Ben Bernanke.
On June 18, 2014, and July 2, 2014, Federal Reserve Chairman Janet Yellen announced her bureaucracy will let inflation do its own thing. She is steadfast in her determination to meet the Fed’s dual mandates under the Bernanke-Yellen dispensation, that is, she will not interfere with either the central bank-induced asset or price inflations.
A discussion of asset inflation will follow, with a quick note first about the June 18 press conference. Yellen stated: “Let me just say inflation continues to run well below our objective.” This was not true. The Fed’s measurement for inflation (Personal Consumption Expenditure) was 1.6% in May (1.8% in June, announced after this press conference.) By every other measure, inflation is above 2.0%. The all-items, PCE price index, published by the Dallas Fed, rose at a 2.8% annual pace in May.
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But enough for the numbers. Yellen also said on June 18: “[T]he Committee remains mindful that inflation running persistently below its objective could pose risk to economic performance.” This is central-banker talk for inflating at any rate. When the Fed chief was queried about current inflation measures in the danger zone, she said that is “noise.” To another press-conference question about inflation, she dismissed these signs as “noisy.”
The Rt. Rev. Ronald Knox compared a politician to a baby. Both are “a loud noise at one end with no sense of responsibility at the other”
It is true that, having achieved this advanced stage of mayhem among economic, financial, and price relationships, Yellen cannot manage a modest adjustment. The shift of costs and prices to a semblance of balance will be chaotic.
July 2, 2014, will be recorded as the date Janet Yellen announced she would not stand in the way of asset bubbles. This was baked in the cake. She had made this clear for the longest time, but the headlines finally caught up to her long-held stand.
Chair Yellen spoke on July 2 at an IMF function in Washington, DC. She declared: “Because a resilient financial system can withstand unexpected developments, identifications of bubbles is less critical.” On March 23, 2010, Yellen identified asset prices as the cause of the recession. (“It was housing, of course, that led the economy down.”) In the summer of 2014, she is still saying it will be years before the American economy recovers from the housing collapse. Go figure.
Bloomberg’s headline captured the essence: “Yellen Says Rate Policy Shouldn’t Change over Stability Concerns.” The Wall Street Journal announced on July 3, 2014: “Yellen Affirms Low-Rate Tack.” The story opened: “Janet Yellen pushed back strongly against the notion the central bank should consider raising interest rates to avoid fueling future financial crises, in her most detailed and forceful comments on financial stability since taking the Federal Reserve’s helm in February.” The New York Times spread the same message on July 3: “Janet Yellen Signals She Won’t Raise Rates to Fight Bubbles”
It was 15 years ago, on June 17, 1999, when Federal Reserve Chairman Alan Greenspan told a dumbstruck Congress the Fed was not in the asset-inflation business. Chairman Lily Liver announced: “But bubbles generally are perceptible only after the fact. To spot a bubble in advance requires a judgment that hundreds of thousands of informed investors have it all wrong. Betting against markets is usually precarious at best.”
Greenspan’s announcement was the forerunner to the bubble-blowing central banks that have followed. Everybody who wanted to know was well aware Greenspan had inflated the NASDAQ bubble. A stream of protest followed, but, as Mario Draghi and Janet Yellen have surely noted, they will suffer no establishment criticism for the crashes to come. Our encrusted institutions have paid and continue to revere “Doctor Greenspan.”
The New York Times editorial page was in a tizzy the day after Greenspan’s abdication of responsibility: “The new Greenspan is brimming with self-assurance. Let us hope the market does not test his new confidence.” The author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession continued: “If only the New York Times had brimmed with enough self-confidence to state that the Federal Reserve chairman was abandoning the Federal Reserve’s responsibility.Maybe the Times was too stunned for such a response. In one gulp,it learned that the Fed did not, and could not, see the hot-air balloonit had so generously expanded – mostly with Greenspan’s hot air. Theeditors had long trusted the chairman. When Greenspan had issued hisstock market warning in February 1997, the Times stood by Greenspanin an editorial with the title: “Wise Warnings to Giddy Investors.”…. In the editors’ words: “To ward off the bad outcome, Mr. Greenspan gently reminded investors that stock prices fall as well as rise. . . . He also reminded them that the Fed will not shrink from raising interest rates – which will draw money out of stocks.” The 1997 Times editorial went on to remind readers that those on Wall Street who “contend that the American economy is heading toward unprecedented prosperity” lack perspective: “like any story that says the future will be unlike the past, the predictions are probably wrong.”…. Between May 29 and June 29, 1999 (the month leading up to the June 29-30, 1999, FOMC meeting), the New York Times discussed the stock market bubble in 10 separate articles. (A headline on May 30: “Pop! Goes the Bubble.”) The word bubble was used only once at the June 29-30 [FOMC] conclave. The stock market was mentioned 21 times at this meeting.”
Here we are again, but the argument that followed Greenspan’s disclosure will probably be absent. In August 1999, the Authorities even deemed it necessary to drag an unknown economics professor to its annual Jackson Hole love-in where he obligingly delivered a fourth-rate but fawning speech that dismissed central banks from asset bubble responsibility. That fourth-rate professor was Ben Bernanke.
To close out the earlier episode, there had been considerable angst at FOMC meetings in 1997 and 1998 about the stock market bubble. After the February 1997 warning (not as well known, but more direct, than his December 1996 “Irrational Exuberance” speech), he never uttered a word of caution about stocks again. Behind closed doors, several members of the FOMC continued to warn about NASDAQ indulgence. Jerry Jordan, the Cleveland Fed President, was a persistent critic. He kept discussing books he recently read about the 1920s and the need to evaluate asset as well as price bubbles. Greenspan put a stop to that at the December 1998 FOMC meeting, ordering the Committee to not mention asset bubbles again. It didn’t.
Yellen’s disavowal was every bit as disgraceful as Greenspan’s. On July 2, Yellen admitted to “pockets of increased risk taking” However, she also stated: “I do not presently see a need for monetary policy to deviate… to address financial stability concerns…”
To this point, one might think she was still on top of “financial stability concerns” since the Fed saw “pockets” of problems. She explained an “increased focus on financial stability risks is appropriate,” but the potential costs of diminishing economic performance “is likely to be too great” to give such risks “a role in monetary decisions, at least most of the time.” In other words, to raise short-term interest rates by 0.5% would so destabilize the economy, Yellen has decided to sit back, let the asset bubbles burst, then blame the bankers, speculators, and home-buyers who should have known better.
After the deluge, Yellen will be called before some committee, and state, as she did in her confirmation hearing as Federal Reserve governor in 2010: “We failed completely to understand the complexity of what the impact of the decline – the national decline – in housing prices would be in the financial system. We saw a number of different things and we failed to connect the dots. We failed to understand just how seriously the mortgage standards, the underwriting standards, had declined, what had happened with the complexity of securitization and the risks that were building in the financial system around that.”
Right out of the box, she should have been stopped by a committee member. “Why did you need to understand “complexity”? This is the camouflage of economists who huddle in damp caves worshipping moldy mathematical equations within a degenerating field freed from matter. This is the language of anti-matter.”
Janet Yellen was a Federal Reserve governor from 1994 to 1997. She was president of the San Francisco Federal Reserve district from June 14, 2004 until 2010. She was then appointed to the Federal Reserve Board of Governors in Washington and succeeded Ben Bernanke as chairman on February 1, 2014.
On May 1, 2014, Janet Yellen described her time at the San Francisco Fed to a conference of community banks: “As you may know, before I rejoined the Federal Reserve Board as Vice Chair in 2010, I had the privilege of serving for six years as president and chief executive of the Federal Reserve Bank of San Francisco. The 12th district is the largest of the Fed’s districts, covering nine western states, and it is home to a significant number of community banks, the majority of which are supervised by the San Francisco Fed directly or indirectly through bank holding companies. Community bankers helped me, when I served as president, to take the pulse of the local economy and also to understand how regulatory and policy decisions in Washington affect financial institutions of different sizes and types, sometimes in very different ways. During the financial crisis, I saw firsthand the challenges that community banks faced in a crisis they did little to cause, and I have felt strongly ever since that the Fed must do what it can to ensure that the actions taken following the crisis do not place undue burdens on your institutions.”
No mention of the elephant in the room she ignored, but, in the media discussion after she had been nominated for the chairmanship, Yellen was made out to be the Fed personage who was right on top of the housing bubble. In addition to the glowing tributes in the Times and Journal, were the Hallelujah bouquets tossed by worthies. On September 29, 2013, Alan Blinder, a professor at Princeton, which says it all, wrote in the Wall Street Journal: “She warned as early as 2005, that the titanic real-estate market was headed to an iceberg.” This is a dubious claim, which we may pursue another time. But – let’s assume she did foresee the iceberg – other than to other academic economists, that makes her subsequent catatonic response all the more reason to know she was unfit for the chairmanship, since, even accepting Blinder’s construction, she held the catbird’s view from San Francisco and did nothing.
The “complexity” she refers to was simple to understand. The San Francisco Fed is responsible for banking in the western states, California, Arizona, and Nevada among them. Between July 2002 and July 2005, the number of houses built in Phoenix doubled. The number of new houses increased in Las Vegas by 53% between August 2004 and July 2005.
The median price for an existing, single-family house in California rose from $237,060 in 2000 to $542,720 in 2005. Over 20% of those who bought houses between 2003 and 2005 devoted over one half of their earnings to mortgage payments. One of the more recent innovations was the “interest-only” mortgage. The buyer might be able to delay principal payments for the first 10 years. These were dangerous instruments. There was general agreement to that assessment in 2002, when only 2% of California mortgages were interest only. Under Janet Yellen’s supervision, they could not be sold fast enough. By early 2004, the proportion exceeded 47%. By the second half of 2004, that rose to 67% of all California residential mortgages.
At the time of Yellen’s “warning,” house prices were out of reach, so the terms were relaxed. The “2 and 28” mortgage – a two-year “teaser” rate that adjusted (“reset”) for the next 28 years – was booming. From $220 billion in two-year ARMS in 2003, the volume rose to $440 billion in 2005. Consumer credit (excluding mortgage payments) had risen from $1.3 trillion in 1998 to $2.36 trillion by 2006: an average of $21,000 per household. More Americans were living on home-equity withdrawal. They were liquefying their equity and monetizing the proceeds. American wages rose a total of $27.5 billion in 2005. Homeowners withdrew $800 billion of equity from their houses – equal to a 13% pay raise. This is the income that allowed Americans to buy (in a way) higher priced houses and empty the shelves at Home Depot.
The most spectacular mortgage factories were in the heart of San Francisco President Janet Yellen’s district. We can look at a single town. Irvine, California had been an engine for American “growth,” to which Yellen pays homage – no matter the source. New Century of Irvine, the second largest subprime lender in 2005 ($35 billion) closed its doors in March 2007. Option One of Irvine, the fourth largest ($29 billion), also failed. Irvine was home to Ameriquest, the ninth largest sub-prime lender in 2005 ($19 billion in volume). Ameriquest paid a $325 million fine for unsavory practices. It no longer exists. By the time it went to court, its founder, Ronald Arnall, also founder of Long Beach Savings and Loan in 1980 (another story some may remember), had taken his post as U.S. ambassador to the Netherlands. Arnall was a large fundraiser for Bush the Younger. Arnall had spun off another portion of Long Beach Savings and Loan to Washington Mutual. This became Washington Mutual’s subprime lending arm. New Century,