Conference Call of the Federal Open Market Committee on January 21, 2008
This is the second inter-meeting meeting in the month, called apparently on short notice:
BERNANKE. Good afternoon, everybody. Thank you for taking time on your holiday. The purpose of this meeting is to update the Committee on financial developments over the weekend and to consider whether we want to take a policy action today.
The holiday is Martin Luther King, Jr. Just twelve days earlier, in the previous inter-meeting meeting, it was determined not to take any policy action.
Bernanke turns the floor over to Dudley, to give an update of the markets; as in the previous meeting, after a brief comment on various credit markets (including the known-to-be-manipulated LIBOR), he turns to equity markets:
…the macro outlook and broader financial market conditions have continued to deteriorate quite sharply. The S&P 500 index, for example, fell 5.4 percent last week; it is down almost 10 percent so far this year. Today it fell another 60 points, or 4.5 percent, so that means that the cumulative decline in the S&P 500, if it opens near where the futures markets closed today, will be nearly 15 percent since the start of the year. Global stock markets were also down very sharply today—Monday. Depending on where you look, the range of decline was anywhere from 3 percent to 7½ percent, pretty much across the board.
Losses at Merrill Lynch and Citigroup are noted, indicative of further write-downs in subprime, credit card, and other loans.
A newish wrinkle here in terms of bank markdowns reflects the deterioration of some of the monoline guarantors. Merrill Lynch, for example, announced a multibillion dollar charge for its exposure to ACA, which is the most impaired of the monoline guarantors.
What is a “monoline guarantor”?
An insurance company that provides guarantees to issuers, often in the form of credit wraps, that enhance the credit of the issuer. These insurance companies first began providing wraps for municipal bond issues, but now provide credit enhancement for other types of bonds, such as mortgage backed securities and collateralized debt obligations.
The rapidity of deterioration is noted, for example:
The problem with the monoline guarantors is that raising capital has become much more difficult. Ten days ago, for example, MBIA issued 14 percent surplus notes, which are now trading at about 70 cents on the dollar.
Further downgrades of these monoline guarantors are likely, and will affect money-market funds, municipal bond funds, and other financial institutions – this last risk is interesting, as Dudley explains:
The monoline insurers don’t have to mark to market the consequences of the deterioration in, say, the structured-finance product they insured. All they have to do is pay out, as it is incurred, the interest that the structured-finance product can’t pay out. So their losses are going to be realized only very gradually over a long period of time. There is no sort of foreshortening of all that into the present. In contrast, if a monoline guarantor gets downgraded and so the financial institution no longer has the support of that monoline guarantee, they have to write down instantaneously the value of the assets that were wrapped by that guarantee. So it’s quite a big difference in terms of the market impact as you transfer that risk from the monoline guarantors to the financial institutions that bought that insurance.
The markets are pricing in further rate cuts:
At this point, monetary policy expectations have priced in a lot of easing over the near term. As of Friday’s close, there were about 67 basis points priced in through the January meeting at the end of the month and about 110 basis points priced in through the March meeting (if you look at the April federal funds futures contract).
Bernanke then offered his thoughts. He was reluctant to call this meeting – after all, less than two weeks earlier the decision was made not to take an inter-meeting policy action:
However, I think there are times when events are just moving too fast for us to wait for the regular meeting. I know it is only a week away, but seven trading days is a long time in financial markets.
It will be seven trading days until the regularly scheduled meeting. Bernanke treats these seven days as if they encompassed the events described in Genesis 1.
As Bill described, over the holiday, global stock markets have been falling very sharply, both in Asia and in Europe. As he mentioned, even though the U.S. markets are closed, the S&P 500 was off about 60 points today, close to 5 percent. That makes the cumulative decline in the S&P 500 since our last FOMC meeting 16½ percent.
Don’t worry; even though the chairman is obviously focused on stock markets, he isn’t really focused on stock markets. Really.
Obviously, it is not our job to target stock values or to protect stock investors, but I think that this is a symptom of both sharply mounting concerns about the economy and increasing problems in credit markets.
See, he said so himself.
The problems are expanding well beyond sub-prime, the contained little nuisance from just a few short months ago:
I think there is a general sense—I certainly feel in talking to market participants—that it is not just subprime anymore and that there are real concerns about other kinds of consumer credit—credit cards, autos, and home equity loans—and that there is fear of housing prices falling enough that contagion will infect prime mortgage loans.
Imagine how exciting it must be to be sitting in the driver’s seat of during the trip through the end of the world. Is it possible that Bernanke somewhat enjoys this?
Bernanke wants to take action; meaningful, inter-meeting action:
I think we have to take a meaningful action—something that will have an important effect. Therefore, I am proposing a cut of 75 basis points. I recognize that this is a very large change.
Has the Fed decided, unlike the meeting a few days earlier, that the economy is in recession? The recession that actually began three weeks before this meeting?
…on Friday I had a briefing from Dave Stockton [Fed economist] and his team about their Greenbook forecast for next week’s meeting. They have not made an explicit recession call, but they do forecast very weak growth going forward.
No recession call, but somehow the economy needs a “meaningful” boost.
Additionally, Bernanke believes the Fed is behind in cutting rates, by 100 basis points. He discusses the potentially significant recession on the horizon:
…a paper by Carmen Reinhart and Ken Rogoff has been circulated in the past couple of days, which compares some indicators of our economy with other major financial crises and finds that we rank at the moment among the five largest financial crises in any industrial country since World War II. Given what their indicators show, they conclude that, if we have only a mild recession in the United States, it would be a very fortunate outcome.
Price inflation will be watched, but it is of little concern. The potential magnitude of the upcoming events is the concern. Bernanke doesn’t want to discuss it any longer; it is time to act:
We can no longer temporize. We have to address this crisis. We have to try to get it under control. If we can’t do that, then we are just going to lose control of the whole situation.
Bernanke goes around the (virtual) room. Evans is supportive of the proposed 75 basis point reduction, indicating he was ready for action at the last inter-meeting meeting. Stern supports the proposal as well, with an interesting comment:
What has really caught my attention is the breadth of the weakness of the incoming data and the extent of the financial problems, some of which Bill Dudley covered.
In the previous meeting, he did not make a strong case for a reduction. Yet, in 12 days he is captured by the breadth of the weakness.
Yellen is also supportive:
I strongly support your proposal for a 75 basis point funds rate cut today, and I like the proposed wording of the statement. The outlook has deteriorated, not only since December but since our conference call. The downside risks have clearly increased. I think the risk of a severe recession and credit crisis is unacceptably high, and it is being clearly priced now into not only domestic but also global markets.
Rosengren is supportive as well.
Poole puts a fly in the punch bowl:
I accept all the discussion about the risks of recession and the risks of the financial markets. All those are relevant to what we do next week. But the key issue for me is what we get by acting now rather than nine days from now.
His concern seems to be one of timing and therefore message. He believes a move at this inter-meeting meeting will be seen as reacting to stock market declines, and otherwise a sop to the stock market, nothing more. He asks for further discussion regarding the pros and cons of moving now as opposed to in a few days.
Geithner is all in. He pooh-poohs Poole’s concerns, labeling these as “irresponsible”:
If we were to wait until the meeting, we would be taking just too much risk. I think it would be irresponsible to take the risk that we would see a substantial further deterioration in confidence and in market prices, which would do substantially more damage to market functioning than we have witnessed so far.
Hoenig offers several interesting comments:
I am troubled by this, I will admit. I understand the arguments, and it is difficult to argue against dodging a crisis. It is a very daunting thought to think about a crisis that you might have avoided had you just taken certain actions.
He is suggesting that the Fed blew it before, leading to this current situation.
I would echo Bill Poole a bit in terms of understanding what we will get out of this and how we will deal with backing away from this in the future because part of the reason we have the problem today, of course, is the last crisis.
The problem lays in the Fed’s reaction to the last crisis.
The desire is to intervene, to get the market rates down, and to bring confidence; but then our ability to pull out of that is compromised because we can’t be sure in an uncertain world of how strongly the economy might be coming out of something. Therefore, we often delay and create the next issue that we have to deal with—as we are today.
He admits the Fed flies blind.
I know we are being driven heavily by these markets.
Lacker also supports the 75 basis point cut, but would also wait until the regular meeting. Lockhart supports the reduction now.
Fisher prefers to wait. He offers an interesting comment about process:
Unlike President Rosengren, although I am only about 30 percent of my way through my CEO calls in preparing for the meeting, I don’t hear a widespread expectation of recession. I do hear a concern about slowing down, and we have seen that in all of the indexes that I like to talk about in the meetings from the credit card payables, delinquencies in payments, the Baltic index, et cetera, et cetera. But the words “severe recession” I have yet to hear from the lips of anybody but those in the housing business, and for them, it gets more severe with each passing moment.
Even talking to major business leaders does not offer enough information to centrally plan the market for money and credit.
Pianalto would move now, as proposed:
My conversations with the bankers in my District indicate that the earnings reports that are coming out will demonstrate that problems have spread beyond just the mortgage sector. They are also seeing deterioration in credit card and other consumer debt.
Plosser joins the crowd that is concerned that such a move now will be seen as nothing more than a reaction to stock markets. He is supportive of the reduction at the regularly scheduled meeting. Rapid rate cuts at the interim meeting will do little for the areas of most fragility:
It is not clear to me that the fragility that exists in the market in fact will be solved by rapid cuts in the funds rate. I share President Lacker’s concern that it is not clear that lowering the funds rate is a solution to the problem of the monoline insurance companies or others.
He further notes the poor track record of the Fed at withdrawing such measures:
I share Governor Mishkin’s view that if, in fact, we are to get aggressive, we also have to be willing to take it back when times change. I understand that view, and I can live with it, except the history of this institution is that we haven’t been very aggressive in doing that or demonstrating our ability to do that.
In terms of the problems in the financial markets, the monoline insurers and others, that is a problem of the capital of those firms. Cutting the funds rate does nothing to build up capital for those firms.
Kohn supports Bernanke’s proposal. He takes exception to the comments regarding the Fed’s inability to withdraw such measures in a timely manner:
In terms of taking it back, the point that President Hoenig made, I think the history of what we have done is pretty complicated and more complex maybe than that we are always too late taking it back. If we were always too late, we would have seen an upward trend in inflation. But we haven’t. We have seen a downward trend in inflation for the past 25 years. So it seems to me that the proof of the pudding is in the inflation eating…
His evidence is solely regarding price inflation. Not one mention of the booms and busts – no dotcom bubble, no housing bubble, none of it. This is consistent with my view that as long as common measures of consumer price inflation remain benign, the easing will continue – regardless of the economy or any other factors.
Warsh sees the end of the world if the Fed doesn’t do something today; Armageddon:
My judgment would be, if we chose not to act today, that we would in all likelihood not make it until next week…. just because we don’t have a panacea, just because monetary policy can’t solve the monoline problem and can’t solve some of the other problems, doesn’t mean that we shouldn’t be doing our part. It strikes me that by taking action today we are doing our part.
Kroszner is also supportive of an immediate move, advising only some word-smithing to the statement regarding the Fed’s keen eye on inflation.
Hoening comments that a strong move today is likely only going to result in making a strong move at the official meeting. Perhaps doing 50 basis points now and 50 basis points next week is a better answer.
Bernanke reiterates a point from the previous meeting – he knows how to take away the punch bowl when necessary, learning the lessons from past mistakes:
I think we have learned from that. I think we will be very sensitive to that.
Six years and counting – no demonstration of a lesson learned yet.
Bernanke wants to plough ahead. Hoening makes another very interesting observation:
I think if we make this statement as strong as we can about the need to watch inflation, and if we understand among ourselves that, as we take this action today and the follow-up actions that I am certain we are going to take, we will watch these inflation numbers, including broad asset values…
Ultimately he capitulates:
I do not wish to be dissenting on this, as troubled as I am about it. I do understand the psychology of it. For those reasons, I am willing to go along with this.
After this, the vote is taken. Only Poole votes “no,” adding:
And you could add this sentence of explanation, “President Poole does not believe that current market conditions justify policy action before the regularly scheduled meeting next week.”
This ends the second inter-meeting meeting in January.