Econbrowser‘s James Hamilton noted the Fed 50bp rate cut and pondered how long it will take for the easing to reach Main Street:
My bottom line: the Fed’s moves this month have to help relative to where we would have been without them, but it will take some time to see by how much. If indeed a recession began in December (and I repeat that no one knows for sure whether or not it did), things are going to get worse before they get better.
I’m not sure about Prof. Hamilton’s use of the Fed Funds Rate as the independent variable in the regression – it is more usual to use the yield on the 10-year Treasury note, as has been done (casually) by the Federal Reserve Bank of San Francisco … :
Figure 1 shows monthly data for the 10-year Treasury note rate from the beginning of 1995 through June of this year. The figure also shows the average subprime mortgage rate of lenders in the MIC sample (approximately 30 subprime lenders), beginning in January 1998. For comparison, the average mortgage rate for “prime” mortgages also is shown, for the whole period.
it appears that the prime mortgage rate tends to go up and down, by roughly proportional amounts, with the Treasury rate, but the subprime mortgage rate, although positively correlated with the Treasury rate over the period as a whole, does not follow it as closely. Statistics confirm this; the correlation coefficient between the prime mortgage rate and the 10-year Treasury note rate over the 1998-2001 period is 0.9, whereas the correlation coefficient for the subprime mortgage rate is only 0.4. (Two sets of numbers that are perfectly correlated have a correlation coefficient of 1.)
… and in the pricing of RMBS:
There are good reasons to choose the 10-year yield and the spread between this yield and the 3-month T-bill rate for capturing the salient features of MBSs. The MBSs analyzed in this paper have 30 years to maturity; however, due to potential prepayments and scheduled principal payments, their expected lives are much shorter. Thus, the 10-year yield should approximate the level of interest rates which is appropriate for discounting the MBS’s cash flows. Further, the 10-year yield has a correlation of 0.98 with the mortgage rate (see Table 1B and Figure 3). Since the spread between the mortgage rate and the MBS’s coupon determines the refinancing incentive, the 10-year yield should prove useful when valuing the option component.
The Fed Funds Rate may be expected to have influence, to be sure (of course it does! If it didn’t, it wouldn’t be so important, right?) but if this influence is exerted via the 10-year rate, then transmission to the real economy can be hung up by all the things that hang up the 3-month-to-10-year slope … which can vary a lot!
We find the surprising result that no model clearly outperforms the univariate autoregressive model. This is one of the simplest possible models: it basically forecasts in every period that the GDP growth will simply follow its historical average rate back to the mean. This may be sobering for not only the Fed but for the macroeconomics profession as a whole: knowledge of interest rates, labour market conditions, capacity utilisation, inflation, or any of about 50 additional variables does not systematically improve our ability to foretell where real activity is headed.
In other words … forecasting, schmorecasting. It’s a chaotic world. Meanwhile, Paul Krugman of the NYT asks:
So: is it even possible for the Fed to cut interest rates enough to create a renewed housing boom? (The Fed can cut the overnight rate all the way to zero, but even large changes in the overnight rate can have only modest effects on mortgage interest rates, if the market perceives those changes as temporary.) If it can’t, how much can the Fed really do to help the economy?
Transmission is a hot topic. Menzie Chinn of Econbrowser reviewed the various channels whereby monetary policy influences GDP and concludes:
What is the (policy) upshot of this discussion? In answer to the question of which sector can fulfill the role previously filled by housing, I would say the only candidate is net exports. The decline in the Fed Funds rate has led to a depreciation of the dollar. In the future, net exports will be higher than they otherwise would be. However, the behavior of net exports, unlike other components of aggregate demand, depends substantially on what happens in other economies. If policy rates decline in the UK, the euro area, and elsewhere, additional declines of the dollar might not occur. (And as I’ve pointed out before, if rest-of-world GDP growth declines (as seems likely ), then net exports might decline even with a weakened dollar).
I think the main point is that the decreases in interest rates, working through the traditional channels, will have a positive impact on components of aggregate demand. With respect to the credit view channels, the impact on lending is going to be quite muted, I think, given the supply of credit is likely to be limited. In fact, I suspect monetary policy will only be mitigating the negative effects of slowing growth and a reduction of perceived asset values working their way through the system.
While the collapse of the US housing market actually had an effect on the real economy, we are now getting news that the collapse of US housing investments is having an effect on real companies:
Bristol-Myers Squibb Co. narrowed its loss in the fourth quarter as surging sales of its anti- clotting pill Plavix partially offset charges for costs that include investments backed by subprime securities.
The net loss was $89 million, or 5 cents a share. The company wrote off $275 million in investments in the quarter, which could rise to as much as $417 million, said Rebecca Goldsmith, a spokeswoman for the New York-based drugmaker, in a telephone interview today.
Speaking of the real economy (remember that?) today brought another example of the Great Credit Bubble Popping of 2007-??:
New York real estate developer Harry Macklowe will sell the General Motors Building on Fifth Avenue in Manhattan next month to help pay debts he owes to Deutsche Bank AG, said two people with knowledge of the plans.
Macklowe, 70, bought seven Manhattan skyscrapers from billionaire Sam Zell’s Equity Office Properties Trust for $7.2 billion a year ago, spending $50 million of his own money and borrowing the rest. The developer reached an agreement to turn the properties over to lenders because he was unable to refinance as real estate values declined over the past year, the Wall Street Journal reported today.
Holy smokes! I know that there are a lot of seminars on How to Buy Real Estate With No Money Down, but I hadn’t quite realized leverage of 144:1 was possible for big deals!
While Naked Capitalism republishes an essay that takes a much harsher view of the medicine required:
It is easy to lose sight of the overall picture. Main Street consumers have overspent and over-borrowed and are unable to meet their obligations. The fact that households may have so behaved because they were enticed by “teaser loans” does not change the facts; it only assigns blame. Consumption has been above sustainable levels and needs to adjust down, whatever view one has about the responsibility of adults over their financial decisions.
The adjustment of private consumption to sustainable levels is necessary, but is likely to have a negative influence in the short run on the growth of aggregate demand, of which it represents more than 70 per cent. It is hard for this adjustment to take place without bringing down the rate of growth of gross domestic product, possibly to negative numbers.
The US should face its need for adjustment with courage and reason, not fear. It should stop behaving as the whiner of first resort, ready to waste all its dry powder on a short-sighted attempt to prevent a 2008 recession. Many poorer countries with weaker markets and institutions have survived and benefited from an adjustment that involves a year of negative growth. Faster bank recapitalisation, fiscal investment stimulus and international co-ordination should be first on the policy agenda.
“The Fed as well as the government are responding to recession fears,” said Mike Pond, head of Treasury and inflation-linked strategy at Barclays. “At the same time they are sparking inflation concerns from a longer term perspective.” He thinks those concerns are justified. “We see pressures not just from the domestic economy but from import prices as well as global pressures on food and energy prices. And from a longer term perspective, a Fed who was focused more on risks to growth than higher inflation should put upward pressure on inflation risk premiums.”
It should be noted, however, that these data were used using the breakeven rate. Assiduous readers will remember that the Cleveland Fed attempts to adjust the breakeven rate for other factors affecting TIPS pricing. Their data is updated only once per month, on the first … we will see shortly if there is some independent confirmation!
Meanwhile, the monoline question is getting more interesting, with MBIA first reporting a big loss:
The bond insurer announced $2.3 billion of losses for the fourth quarter which included $3.4 billion of writedowns ($3.5 billion according to the Wall Street Journal). Premiums also fell, indicating new business is falling off, not surprising given the doubts about the AAA rating. The press release also stated that Warburg Pincus nevertheless closed on its $500 million investment in the firm.
… and then drawing a line in the sand, daring the ratings agencies and speculators to cross:
MBIA Inc. Chief Executive Officer Gary Dunton said the world’s largest bond insurer has more than enough capital to keep its AAA credit rating and dismissed speculation the company may go bankrupt.
Dunton, speaking on a conference call after Armonk, New York-based MBIA reported a $2.3 billion fourth-quarter loss, blamed “fear mongering” and “distortion” for driving the company’s stock down more than 80 percent in the past year.
Not a bad day on the market! The new issues TD.PR.Q and BNS.PR.O settled, trading lots in a tight range slightly above par … however, trading in the ratchet / fix-float / floater section was again terribly sloppy. Volume was reasonable … but still on the light side of normal.
And, best of all, it’s month-end! The Claymore ETF, symbol CPD, finished with a NAV of 17.95, unchanged on the month, after hitting a low of $17.76 just after the announcement of the new issues. A price of 17.75 would have been near as dammit to a new trough. I am very pleased with the performance of Malachite Aggressive Preferred Fund for the month … my monthly NAV computation chore still awaits, but will show substantial outperformance vs. the indices.
|Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30|
|Index||Mean Current Yield (at bid)||Mean YTW||Mean Average Trading Value||Mean Mod Dur (YTW)||Issues||Day’s Perf.||Index Value|
|Major Price Changes|
|BCE.PR.B||Ratchet||-4.1263%||Hasn’t anybody shot this market maker yet? Closed at 22.77-24.24, 2×6. Maybe the guy just couldn’t keep up with the fast market – 800 shares traded at 23.01.|
|BNA.PR.B||SplitShare||-2.2263%||Asset coverage of 3.6+:1 as of December 31, according to the company. Now with a pre-tax bid-YTW of 7.76% based on a bid of 21.08 and a hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (5.89% to 2010-9-30) and BNA.PR.C (7.78% to 2019-1-10).|
|POW.PR.B||PerpetualDiscount||-1.5365%||Now with a pre-tax bid-YTW of 5.68% based on a bid of 23.71 and a limitMaturity.|
|BSD.PR.A||InterestBearing||-1.1435%||Asset coverage of just under 1.6:1 as of January 25 according to the company. Now with a pre-tax bid-YTW of 7.08% (mostly as interest) based on a bid of 9.51 and a hardMaturity 2015-3-31 at 10.00.|
|BAM.PR.I||OpRet||-1.1067%||Now with a pre-tax bid-YTW of 5.61% based on a bid of 25.02 and a softMaturity 2013-12-30 at 25.00.|
|BNA.PR.C||SplitShare||+1.0638%||See BNA.PR.B, above.|
|IAG.PR.A||PerpetualDiscount||+1.0890%||Now with a pre-tax bid-YTW of 5.45% based on a bid of 21.35 and a limitMaturity.|
|BCE.PR.R||FixFloat||+1.2603%||Now with a pre-tax bid-YTW of 5.57% based on a bid of 23.30 and a limitMaturity.|
|PWF.PR.L||PerpetualDiscount||+2.0000%||Now with a pre-tax bid-YTW of 5.46% based on a bid of 23.46 and a limitMaturity.|
|BNS.PR.O||PerpetualPremium||550,670||New issue settled today. Now with a pre-tax bid-YTW of 5.62% based on a bid of 25.02 and a limitMaturity.|
|TD.PR.Q||PerpetualDiscount||433,512||New issue settled today. Now with a pre-tax bid-YTW of 5.58% based on a bid of 25.11 and a call 2017-3-2 at 25.00.|
|BCE.PR.G||FixFloat||96,300||RBC crossed 93,900 at 23.75 … closed at 23.70-85, 20×21.|
|CM.PR.I||PerpetualDiscount||39,874||Now with a pre-tax bid-YTW of 5.76% based on a bid of 20.55 and a limitMaturity.|
|CM.PR.A||OpRet||38,000||Nesbitt crossed 30,000 at 25.86. Now with a pre-tax bid-YTW of 0.93% based on a bid of 25.85 and a call 2008-3-1 at 25.75|
There were eightteen other index-included $25.00-equivalent issues trading over 10,000 shares today.