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.
Bingo.
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.
Poole adds:
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.
Ah yes, the USA is the grand laboratory with which I can conduct my economic experiments... *laughs maniacally*
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