Something Useful Which the Fed Could Do
Buy Greek bonds.
I am very suspicious of proposals that the Fed do more to save the economy which do not specify what. They seem to be based on the idea that expanding Fed liabilities would be useful no matter what assets the Fed buys. I am convinced that Fed purchases are useful if and only if the Fed purchases assets which private investors fear. I think the QEII experiment supports this view.
Investors fear Greek government bonds. The Fed certainly has the legal authority to buy foreign treasury securities. It can save Greece any day it pleases. This would be good for the USA, because it reduces the risk of another world financial crisis.
There is no chance that the Fed will do this. I don’t know why ?
I think that would be an awful idea. First, the Fed’s priority at this time should be the American economy. Another Mexico bailout (which is what you are proposing) makes sense when the US economy is moving. But when the US is tanking, the US should be the Fed’s priority. There is already an entity that is equipped to do what you suggest (buying Greek bonds to bail out Greece directly and German banks indirectly) and that’s the ECB. If Germany wanted it to happen, it could happen this afternoon.
But the second, bigger problem, is that I think it would be yet another step of addressing the wrong problem. Here in the US, the problem is weak aggregate demand. As I pointed out in early 2008, bailing out banks wasn’t going to touch that, and it wasn’t even going to get banks to loan out more money (that latter being the pitch under which the whole stupid program was sold here).
The “unorthodox” tools the Fed has used have all been geared toward the same goal: give the banks money to cover up for the bad moves they made in the past. If they want to be really unorthodox, they need to do something else. Here’s my off the cuff proposal.
Send every American citizen, every American national, and every resident alien a giftcard for for some amount of money, say $1,000. (Do not, repeat, do not deposit the money directly in their bank accounts!!!!) Make sure the card expires in three months. That money will get spent. It will start generating demand.
Now, I know what you’re thinking: inflation. But no, it won’t generate inflation. When aggregate demand is so low, putting more money into the system is not going to cause a huge runup in prices overall. Besides, the Fed has already done it, except that the banks were the recipients of the largesse. When the Fed replaced what a bank claimed was $X of toxic assets with what actually is $X of treasuries, the Fed was handing the bank $X. And along the way, it was creating $X.
I’m more sympathetic than Mike–if you can buy at negative real rates, Greek bonds won’t cost that much–but you picked the wrong target.
Greece–unlike Portugal, Ireland, Italy, and Spain–was dysfunctional before the current economic upheaval. It’s central problems–tax evasion and spending at levels that pretend tax evasion doesn’t exist–won’t be solved by more investment. (If anyone believed it would, they wouldn’t be in this situation.)
Portugal or Italy would, arguably, be a good investment. (Ireland and Spain were both victims of property bubbles and, in the former case, a government stupid enough to promise to make all the German banks that made ridiculous loans to insolvent Irish banks whole.) And announcing either one publicly would effectively draw a “this far and no further” line in the sand on the collapse of the EMU. (This assumes the US believes the EMU is a good idea. Tim Geithner does and, as Brad DeLong notes, Tim wins everything. [I leave out whether the win is a good or a bad thing.]) On those grounds, I prefer Portugal;more likely to recover sooner.
The argument against Mike’s argument is precisely the argument Clinton made at the time of the Mexican bailout, when the overnight poll had 91% of Americans opposed to it. If we don’t do this, the consequences 18 months from now are worse for the US, and no one then will remember that they opposed doing this now.
I don’t believe that applies to Greece, which needs its own currency and to keep its assets; right now, they look like BofA-East, having a fire sale on their growth areas (China, ML) to slow their descent into the abyss. But Portugal or Italy–and the EMU itself–can be saved, even though some French banks are going to take a pasting. We can do that, it would be good for us to do that, and we should do that.
You’ve got the right idea; you’re just aiming at the wrong target.
I agree that Greece is the wongest target. And I agree that if the Euro area can be righted, so much the better not just for them but for us too.
But respectfully, I think you and Robert are missing the point. So far the solution to the fact that the boat is sinking has been to give the folks in the first class, some of them incidentally being the folks who designed the boat or sold the shipbuilder subpar material, a refund on the cost of their ticket, and to harangue the folks in steerage for not spending enough at the shops on the Lido deck. Now you’re suggesting that the ship’s captain should also pay for refunds for the first class voyagers on other sinking ships. A better option would be to concentrate on keeping the boat afloat while making a run for the shore.
And incidentally… there is no “thus far and no further” in Europe without Germany being onboard. After so many other bank bailouts, naked bailout of German banks while even more of nothing is done for the American taxpayer is not going to play. Like I said upthread, this isn’t a situation of bailing out Mexico. This isn’t a liquidity crisis, and the US (nevermind Greece and Spain) is in worse shape than Mexico was than when Clinton bailed them out.
Heck, insane as Ron Paul’s views of the Fed are, I’m about ready to buy a pitchfork and join him as the lesser of the remaining evils.
Wouldn’t it also be good for the Fed to buy state and municipal bonds?
It would certainly increase the abilityh of the state and local governments to spend money. I think that’s a good thing. Not sure many liberatrian blogs would agree.
I am discussing what the Fed can do. The Fed can’t give money away. Your proposal is not possible given the law. Also the Constitution. That is something Congress could do but it won’t. The Fed can loan to depository institutions, it can loan to other entities during a financial crisis (as in not now) and it can buy assets issued by Treasuries. It can’t send money to people.
The idea that this would be good for the USA is based on the widespread fear that a European crisis will cause a second recession. I was not advocating doing it for the sake of the Greeks.
The argument that the Fed can’t loan to risky borrowers, because the US economy is in bad shape seems backwards to me. When the economy is healthy, an expansion of the money supply causes inflation. The advantage of being in a liquidity trap is that the Fed can issue liabilities without creating any problems (might even help a bit).
Yes of course the ECB could do it, but the ECB won’t. That somone else *should* do something is not an argument against doing it, unless one thinks that they will do it if we don’t. Believe me political Europe is pretty paralyzed (it’s hard to decide by consensus). I don’t think it is wise to bet the US economy on Europeans getting their act together.
On bank bailouts, the decision to not bail out Lehman didn’t work out so well. I see Ken Houghton being more sympathetic than you below, but I think the Fed made a huge amount of money bailing out the financial system. It didn’t prevent the recession (I think it did prevent a replay of the Great Depression) but it was worth the price, which, I think, the Fed estimates about right at around negative $100 billion so far. Sensible people (including Ken) think the Fed and I are off by a few hundred billion, and I don’t want to redebate it here.
I was thinking Italy, but that looked like self interst, so I replaced it with Greece. On Greece I think the current government is responsible (unlike father like son) and teh mess was made by the new Democrats (and daddy Papandreu .. ok and Simitis a little). Also if they collapse the panic will spread. Lehman blew it too, but letting them fail doesn’t look so smart.
Still upon reading your comment, I concede, you are right and I am wrong. Greece will default (the sooner the better since it is inevitable). The line has to be held somewhere else. The problem is that total Italian debt is huge (Greece is nice and small). Uh so hold the line somewhere West of here.
Mike our disagreement (as I argued above) is over what the Fed can do not over what should be done. I think that Congress shouls send cash to regular Americans (plus soak the rich who aren’t liquidity constrained so that would be slightly less demand now when we need it and also less later when it will crowd out investment and net exports).
If I thought the Fed could send cash to US residents, I would agree that it should. I don’t even care whether it would be legal (I think not) or constitutional (certainly not) so long as it managed to get the cash out. Our disagreement is about the law in practice (as in what one can get away with doing not what is legal) not about optimal policy.
It would be good Min. The magnitude of the effect depends on the interest rates states and municipalities have to pay. If the interest rate is low for some state, then the Fed won’t help it much*. The Fed can help states and municipalities which have to pay very high interest rates, because investors are afraid of default. If the Fed bears the risk, private investors will demand a lower expected return**.
Generally my view is Fed purchases of assets which investors don’t fear are almost pointless and that the Fed has to purchase assets which investors fear. Greak Treasuries sure fit that bill.
*interest rates can’t be driven below zero of course but beyond that it is very hard to drive medium term interest rates below 2% as the Fed demonstrated by QEII — demand is very interest elastic so a huge change in the amount private investors have to hold causes a small change in interest rates.
**Note the expected return is net of expected losses due to default, it is high for risky assets. The risk premium demanded is greater the more of the asset the investor holds.
Oh one last thing (as usual most comments on my post are mine). I propose buying Greek bonds on the secondary market. This isn’t exactly giving anyone anything. It is buying an asset for the going price. OK so this will drive up the price (which is the point).
The logic is that Greek bonds are paying huge returns (and will unless Greece defaults). So they are risky but the risk is compensated. The European Greek rescue involves loaning the Greek Treasury money at rates much lower than those demanded by the private sector.
That isn’t my proposal. If the Fed bought just a bit of Greek debt, and markets were efficient (and pigs flew) then the Fed would get a very high expected return (net of losses due to default). It would bear risk. This is fine. That would mean high Fed liabilities if Greece collapsed. That would be an automatic stabilizer for the USA.
The point of the exercise, however, is to buy a lot of Greek debt which would drive down the yield on Greek debt which would hasten the date when Greece can go back to financial markets (assuming it doesn’t default which requires Europe to get its act together).
The proposal is really the same old same old buy risky assets — there is no point in buying safe assets, the expected cost of buying risky assets is a profit, the risk is better born (really hidden from consumers) by the Fed than born by consumers.
Here I am again. Look I would rather the Fed bid at the Greek bond auction rather than buying them on the secondary market (so the price it drives up would go to the Greek Treasury not investors) but IIRC there aren’t going to be any Greek bond auctions anytime soon as the price Greece could get is too low. So pushing up the price of assets owned by investors is the only option.
“I am discussing what the Fed can do. The Fed can’t give money away. Your proposal is not possible given the law. Also the Constitution.”
Say Joe Schmoe bought a Beanie Baby at the height of the market for $100, but the value of that Beanie Baby on the open market is rapidly approaching zero. Joe Schmoe bought the Beanie Baby for investment purposes, but he kind of likes it too… so in his mind it should be worth $110.
Now, the Fed comes along and offers to replace that Beanie Baby with Treasuries valued at what Joe Schmoe claims the Beanie Baby is worth (i.e., $110). That’s a naked giveaway of money. And its a naked giveaway of money when we’re talking not Joe Schmoe, Beanie Babies, and $110, but rather Big Bank, CDOs, an d $110 million. And to the best of my knowledge, it is not legal for the Fed to shower such largess on Joe Schmoe or on Big Bank. But the Fed found a way to do it for Big Bank. So I’m pretty sure it could find a way to do it for Joe Schmoe if it put its mind to it. It won’t, mind you, but the legality is not an issue.
I’m similarly unsympathetic to the “making a profit on the trade” as an ex post justification. My guess is that if the Fed started buying up Beanie Babies, we’d have a market for them soon that would eclipse the previous Beanie Baby bubble. And if the Fed sold its own collection after it got things moving, it would make money too. As I recall, that’s more or less the scheme the Hunt brothers were working on in the silver market… and it worked until they ran out of money. The Fed wouldn’t run out of money.
Finally, I’m very very unsympathetic to the idea that bonds of organization X going to zero is a tragedy. It might be a tragedy for parties with the wrong position in the financial sector, and it might even lead to a freezing up of trades in the financial sector. But the financial sector is part of the supporting cast, not what makes the economy run. How has Main Street been affected any different by the fact that Wall Street was bailed out?
Besides that, Wall Street isn’t based on what happened in the past. Money keeps flowing in from 401-ks. It has to go somewhere. If BofA and Citi and Goldman and Morgan Stanley all went bankrupt, it would still go somewhere. Hell, there were a group of guys who lost a lot of money at Salomon. Then they lost more at LTCM. Then they created a new fund that imploded. Now they’re raising money for round 4. You’d think only a moron would invest with them at this point. But there seems to be plenty of stupid money waiting to do it again.
On a country level… Argentina seems be better off having repudiated its debt. The debt holders got screwed. But that’s capitalism, right?
It seems to me that the term ‘excess liquidity’ is not being used enough in this discussion, nor in general across the board.
It is the relationship between the volume of investment capital and incomes, that stretches from the onset of the ‘lost decade’, to the current mess that hints at what is stalling human progress. Of course Bernanke & Co. pretend not to understand what causes bubbles… but that is because they prefer not to disclose that their actual objective is to aid US investors in the controling of as much global market share as possible. In other words, ‘they’ know that a bottom-up stimulus would solve the demand problem, but that is not a priority. Americans are of course 4% of the global population but they own 56% of global market share… and ZIRP, QE, and TARP were aimed at that global economic ‘war’ (ARRA is a little more complicated).
Of course TARP also caused trillions to reappear in the global equity markets and it is not as simple as just pouring capital into the hands of US investors… but, there is always this ‘larger’ consideration of dominating the global investment ‘rush’. The powers that be, are constained though by the relationship in the US economy between incomes/wages and the volume of liquidity, and the fact that too much capital in a single economy has now stymied one investment-based economy after another is seemingly fairly obvious… yet ignored.
What needs to happen, is a bottom-up stimulus on a global scale. Wages must rise from the very bottom of the global labor markets. There is simply too much downward pressure on wages and this pressure is constraining investment in the very nations that have become dependent on investment. There is in fact a natural balancing effect in Capitalism which puts limits on labor exploitation… if only more of us could learn to appreciate the beauty of that dynamic.