What is the Question? Responding to Paul Krugman
by Mike Kimel
What is the Question? Responding to Paul Krugman
Paul Krugman has been kind enough to respond to my post which in turn was commenting on an earlier post he had written.
As I noted in my previous post, I’m very leery about writing this, given Prof. Krugman is usually a very perceptive individual and I’ve noticed that Prof. Krugman is usually right when he is in a disagreement with someone. My trepidation is increased quite a bit by the fact that we’re treading on ground that is so much closer to his area of expertise than the two topics I normally write about. That said, I still believe he is wrong, and I will try to make my point a bit more explicit.
Prof. Krugman’s response comes in four paragraphs. The first is merely an introduction. In the second paragraph, Prof. Krugman states:
Ordinary monetary policy involves cutting short-term rates to fight a slump; it’s not what we’re talking about here, since it’s hard up against the zero lower bound.
But the large-scale conventional expansion the Fed engaged in by getting to the zero bound has, of course, widened the spread between short and long term rates , since markets expect short rates to rise above zero eventually. So looking at the raw data on the short-long spread tells you nothing.
Now note this from Krugman’s earlier piece (bolding also mine):
Furthermore, Fed efforts to do this probably tend on average to hurt, not help, bankers. Banks are largely in the business of borrowing short and lending long; anything that compresses the spread between short rates and long rates is likely to be bad for their profits.
And the things the Fed is trying to do are in fact largely about compressing that spread , either by persuading investors that it will keep short rates at zero for a longer time or by going out and buying long-term assets. These are actions you would expect to make bankers angry, not happy — and that’s what has actually happened.
Notice… in Prof Krugman’s second post, the spread widened. In his first, post, the one to which I objected (and in response to which I showed a graph of the spread), the spread compressed. As I understand it, on that issue to which I objected, we are now on the same page – we both agree the spread widened. But then what Krugman wrote in his first post about banks being made worse off is not correct, all else being equal.
What I don’t understand in Prof. Krugman’s second post is the last sentence of the paragraph shown above – why does looking at the short long spread tell us nothing? I could be wrong, but I am assuming Prof. Krugman is stating that it wasn’t the Fed’s intent to widen the spread. the widening of the spread was not the intent of the Fed. That may well be correct – Prof. Krugman knows the key players personally and I do not, so he enjoys both greater access to and greater insights into the behavior of the people involved.
In his next paragraph, Prof. Krugman writes:
QE is an attempt to get traction despite those zero short-term rates by buying long-term debt, hopefully narrowing the spread and thereby boosting the economy. I don’t think it’s had a large effect, but that’s the goal.
Again, I don’t dispute what Krugman believes the Fed was trying to do with QE. I also don’t dispute his opinion that it didn’t have much of an effect. Personally, I suspect the positive effect on the economy of QE was very close to zero and I wrote about my expectation that the effect would be very close to zero at the time.
As I recall, Prof. Krugman was also stating the same thing in real time, albeit more rigorously. In fact, I would say Prof. Krugman made the point better than anyone of whom I was aware. He also was, to my knowledge, the first person with a big platform to make the point that the “bond vigilantes” were wrong as QE would not result in inflation. All of which is to say, not only am I in agreement with him on this issue, I have been one of the small voices supporting him on the issue since 2008.
So let us move on to my other objection to Prof. Krugman’s post (the first being the non-existent compression of short and long term interest rates, and how that was negatively impacting banks). My problem, and the one that I share with many others, is with this statement from Prof. Krugman’s earlier post:
The naive (or deliberately misleading) version of Fed policy is the claim that Ben Bernanke is “giving money” to the banks. What it actually does, of course, is buy stuff, usually short-term government debt but nowadays sometimes other stuff. It’s not a gift.
To claim that it’s effectively a gift you have to claim that the prices the Fed is paying are artificially high, or equivalently that interest rates are being pushed artificially low. And you do in fact see assertions to that effect all the time. But if you think about it for even a minute, that claim is truly bizarre.
Now let me be 100% clear. I do claim it’s a gift. And did so without mentioning interest rates at all (except in the context of checking whether interest rates compressed or not). Regular readers know I virtually never mention interest rates as I don’t think they are particularly important when it comes to the outcomes of monetary policy. (What is important? Well, it is called
My claim that the Fed gave a gift to a certain very specific subset of banks and similar entities is based on the following:
1. the housing market was tanking, driving down home prices and driving up foreclosures
2. the expectation was that the situation in the housing market was becoming worse and foreclosures were going up with no end in sight
3. the perceptions described 1. and 2. was that derivatives based on mortgages would continue losing value and nobody knew where the process would end
4. as a result of 1., 2., and 3., nobody wanted derivatives based on mortgages… those who had such derivatives on their books wanted them gone, and nobody else would buy them at any price
Whether the perception of the risk associated with holding those assets was correct or not, it was what everyone believed. The Fed stepped in and paid a price that only made sense in a world where there were no such perceptions of risk. And it wasn’t willing to help everyone that had been blindsided by these perceptions of risk, but rather just one group that had made some very poor decisions.
Put another way – the Fed was willing to relieve some (but not all entities) of assets they didn’t want at a price much higher than those entities could have received from anyone else. That is a gift.
Prof Krugman closes his new piece with this:
And as for the other thing: Kimel apparently thinks the Fed is buying privately issued MBS, aka toxic waste; actually it’s only buying agency debt, which already has an implicit federal guarantee and is functionally not much different from long-term Treasuries.
This is sort of correct, but not in a helpful way. First, a quibble – leaving aside principal reinvestment the Fed no longer is buying agency debt. Now, some substance – yes, the agency debt had an implicit federal guarantee. But… let us be very precise about our definition.
Agency debt means debt issued by a US gov’t sponsored agency. A US government sponsored agency is an agency created by the Federal government to engage in particular commercial activities. Fannie Mae, for example, was created by the Federal government to securitize mortgages and thus help increase the size and scope of the secondary mortgage market, which in turn would make mortgages easier for most people to get.
But Fannie Mae became a publicly traded corporation in 1968. It was no longer owned by the Federal government, and it started acting in the best interest of its shareholders. The Federal government no longer backed the debt Fannie Mae issued, but it was in Fannie Mae’s interest to imply that its debt and its operations were, in fact, guaranteed by the Federal government as that allowed it to borrow for less. If that sounds like the same reason why some charlatan goes around pretending be an heir to the Rockefeller fortune, well, it is, and it puts precisely the same obligation on the Rockefeller family as Fannie Mae put on the Federal government.
So, Fannie Mae’s “implicit guarantee” only began to have any real world value at the point where the Federal government took the company over and that really did happen before the Fed started picking up MBS. But if the Treasury was willing to guarantee MBS debt, why had the market for the debt dried up?
The answer has to do with the size of the Treasury’s guarantee. Remember, the size of the MBS problem was, at the time un-knowable, Hank Paulson’s bazooka had $700 billion in it, was rapidly being seen as inadequate to the task, and there was a big fight over increasing the debt ceiling going on. There was no certainty over whether Congress was going to pony up money to keep the Federal government going, much less pay off some recently acquired private obligations run up by a group of companies suddenly being given the gimlet eye.
Even if you forget about the existence of that uncertainty, the mere fact that the Fed had to step in should remind you that uncertainty was there and was big. If the markets believed the Federal government was providing a full and credible guarantee, the markets for the MBSs would have unfrozen. There has been a lot of money sloshing around earning zero in the last few years – why wouldn’t investors on the sidelines take a positive return guaranteed by the Federal government… unless they didn’t believe the guarantee.
All of which is to say, the gift came not just from the Fed. The Federal government, in the form of the Treasury department, took the first crack, but what was sitting in that particular corner of the financial kitty litter box was too big for the Treasury’s scoop alone. That just goes to show how big of a gift public entities gave to a small group of miscreants.
In closing, I’d like to address a final point… something from Paul Krugman’s post that I originally responded to, namely (and I’m paraphrasing) how are these policies are supposed to hurt the rest of us?
The answer is simple… moral hazard. Most of us were pretty sure that when push came to shove, certain entities would be saved from their folly. Now, any doubts are gone. We know with absolute certainty that it’s true. We have seen the lengths to which our government has gone to save these favored few. Those entities, going forward, have the magic guarantee. So not only has competing against them gotten more costly, it has gotten more costly simply not to be them. Because those entities know they can take bigger risks with no penalty, so they will.
There were other, better ways to proceed. None of them are perfect, but I’ll mention three better options that I wrote about back in 2008.
One would be for the Treasury and the Fed to guarantee that during the crisis, a) any financial entities that couldn’t meet their obligations would be taken over the moment they failed to make a payment and b) the moment a financial entity was taken over by the Treasury + Fed, those two would guarantee that entity’s debts. There would still be moral hazard but it wouldn’t be nearly as bad. We wouldn’t be treated to quite the same spectacle of companies on taxpayer life-support giving themselves huge bonuses while mocking the hoi polloi with drivel about the importance of their place in society. More importantly, we the people would be getting a lot more bang for our collective buck.
Another option would be to allow the public to bank with the Federal Reserve. Things have changed in the past 100 years, after all. Financial intermediaries aren’t all that necessary these days, except to the intermediaries themselves. Besides, the Fed can misread someone’s FICO scores just as easily as Bank of America can, and Ben B is paid orders of magnitude less than his counterpart at B of A. If people could bank directly with the Fed, there wouldn’t be a need to save a bunch of entities whose bad decisions periodically “require” some sort of bail-out.
A third option (one I noted at the time was ludicrous, but was less ludicrous than what would eventually transpire) would be for the Fed & Treasury to have simply recognized at the time that a process that relied on banks loaning money to the public to get the economy hopping had no hope of working because there wasn’t a mechanism to get banks to loan money to the public. The Fed could simply have handed each American a menu and said: “pick $X worth of stuff from this menu.”
This gets back to my statement that from where I’m standing, interest rates aren’t something on which monetary policy should focus. Money, and where that money goes, should be the focus. To quote a comment left by a reader called Mark at Professor Krugman’s blog the other day:
If the Fed printed one trillion in cash and gave each American $3000, I have a pretty good understand what the result would be. But purchasing one trillion in long term treasuries seems to just make an already large pile of unused, uncirculated money even larger. I’m not sure how this qualifies as quantitative easing any more than Bill Gates walking into soup kitchen qualifies as quantitative easing.
I’ve already discussed your mischarcterization of agency MBS as toxic assets in the prior discussion (BTW: agency MBSs are NOT DERIVATIVES either) but here i want to address the following
—
“One would be for the Treasury and the Fed to guarantee that during the crisis, a) any financial entities that couldn’t meet their obligations would be taken over the moment they failed to make a payment and b) the moment a financial entity was taken over by the Treasury + Fed, those two would guarantee that entity’s debts.”
—–
That would have been a huge subsidy of bond investors – what Ireland did. And would have been both a blatant misuse of taxpayer money to subsidize foolish investors and a crippling debt burden on the USA. Thanks God they were not so stupid as the ECB or as craven as the Irish government.
of course they did not have the authority to do that anyways. Essentially you want Treasury and Fed to use retroactively the resolution authority that is in Dodd-Frank 2 years before it passed (thanks to strenuous lobbying by the Obama administration and over unanimous GOP opposition plus strenuous lobbying by banks). They didn’t have that authority.
You need to distinguish two different Fed actions:
1. Normal policy actions tend to push down short rates and effectively widen the short-long spread.
2. QE policy actions and promises to hold short rates low for a long time tend to push down long rates and effectively compress the short-long spread.
Prof. K is thus correct both times.
I’ve already discussed your mischarcterization of agency MBS as toxic assets in the prior discussion (BTW: agency MBSs are NOT DERIVATIVES either) but here i want to address the following
—
“One would be for the Treasury and the Fed to guarantee that during the crisis, a) any financial entities that couldn’t meet their obligations would be taken over the moment they failed to make a payment and b) the moment a financial entity was taken over by the Treasury + Fed, those two would guarantee that entity’s debts.”
—–
That would have been a huge subsidy of bond investors – what Ireland did. And would have been both a blatant misuse of taxpayer money to subsidize foolish investors and a crippling debt burden on the USA. Thanks God they were not so stupid as the ECB or as craven as the Irish government.
of course they did not have the authority to do that anyways. Essentially you want Treasury and Fed to use retroactively the resolution authority that is in Dodd-Frank 2 years before it passed (thanks to strenuous lobbying by the Obama administration and over unanimous GOP opposition plus strenuous lobbying by banks). They didn’t have that authority.
rootless_e,
That’s not what I meant. If you had committed to make a payment stream (such as the interest payments on a bond), and you failed to make that payment stream, the government steps in, seizes the assets you do have, and then takes over your obligations. As noted in the post, it had its problems. I hadn’t anticipated a situation where a bank might owe more than a country’s GDP when I first suggested that.
As to authority… as you note, in the current mess a lot was an excuse to break a lot of rules.
The distiction between goals and reality needs to be kept in mind. Real what Krugman wrote in both posts with that distincton in mind, and you’ll see that, for instance, he wrote the first time that the goal of Fed asset purchases is flatten the curve (narrow spreads). The reality is that the curve is steeper, but that’s why the Fed engaged in asset purchases. If the Fed had not engaged in asset purchases, it’s vey likely that the curve would have been steeper, still.
You point out that the spread between the funds rate and mortgage rates is wide. True, but mortgage rates are at historic lows. Depending on which of those you look at, you can come to very different conclusions about the impact of Fed policy actions. However, if you think about a fairly straightforward counterfactual – mortgage rates could have been higher than they are now if the Fed hadn’t bought MBS – the picture makes more sense. Cutting the funds rate to near zero widens spreads measured off the funds rate, even though yields on other assets are low. The asset purchase program recognizes that yields can be driven lower still.
Banks, of course, face a narrower spread when if the Fed manages to lower long rates through asset purchases, even if the absolute yield spread remains wide.
I kinda think you know all this. I kinda think you are focused on winning a debate, even at the cost of misunderstanding what it is the other side of the debate is saying.
The distiction between goals and reality needs to be kept in mind. Read what Krugman wrote in both posts with that distincton in mind, and you’ll see that, for instance, he wrote the first time that the goal of Fed asset purchases is flatten the curve (narrow spreads). The reality is that the curve is steeper, but that’s why the Fed engaged in asset purchases. If the Fed had not engaged in asset purchases, it’s vey likely that the curve would have been steeper, still.
You point out that the spread between the funds rate and mortgage rates is wide. True, but mortgage rates are at historic lows. Depending on which of those you look at, you can come to very different conclusions about the impact of Fed policy actions. However, if you think about a fairly straightforward counterfactual – mortgage rates could have been higher than they are now if the Fed hadn’t bought MBS – the picture makes more sense. Cutting the funds rate to near zero widens spreads measured off the funds rate, even though yields on other assets are low. The asset purchase program recognizes that yields can be driven lower still.
Banks, of course, face a narrower spread when if the Fed manages to lower long rates through asset purchases, even if the absolute yield spread remains wide.
I kinda think you know all this. I kinda think you are focused on winning a debate, even at the cost of misunderstanding what it is the other side of the debate is saying.
Marty Joyce,
With respect, Prof. Krugman’s point in his first post (read the second blurb I quoted): the Fed is trying to A) compress the spread, B) smaller spreads hurts bankers C) pissing them off bankers, which in turn D) is a sign that the Fed is not giving the banks any sort of a gift.
Essentially, Prof. Krguman said: A –> B –> C –> D. Evidence for D traces back to A. So it is entirely legitimate to point out that if A is not happening, support for D being true is lost. And that is all I did in my earlier post – I noted that instead of A, we were seeing “not A.” In his more recent post, Prof. Krugman also stated that instead of A, we were seeing not A. But his whole argument for D was based on the prior steps.
It doesn’t matter why not A, what matters is that one can no longer claim that B) bankers are seeing their profits hurt, are C) getting irritated at the Fed because of it, and D) this is a sign that the Fed is hurting bankers, not provding them with a gift.
Mike,
First – congrats by making the big time with a discussion with Krugman.
Second – I beleive the banks in Iceland, collectively, actually did owe more than the country’s GDP. (I may be conufsed with Ireland but I’m pretty sure it was Iceland.)
Have fun!
Islam will change
Mike Kimel – you missed rootless_e’s point, it seems.
In your answer, you simply restated your premise that rootless_e is questioning. You do throw shareholders to the wolves, appropriately so, but why do you defend private creditors to private financial insitutions? That is rootless_e’s question in his 1:32pm comment.
Let me ask again.
Why in the world should the government make whole unsecured creditors to a private financial institution?
You are working your way up the capital structure of a private financial entity, and deciding that below a certain line are free-market losses (common equity, preferred equity?), above that line is government guaranteed (certainly FDIC-insured depostis, you include BHC debt, but presumably not accounts payable / unsecured working capital lines).
Where in the capital structure are you drawing that ‘government guarantee’ line, and why?
From my perspective, the only plausible answer for where you did draw that line is that you think there was no other solution that wouldn’t have destroyed the world, and thus BHC creditors had to be saved. If so, say that, and defend that clear position.
MJ,
A follow-up if I may… as I said, to me it seems odd to be looking at interest rates in this story, but look carefully at your own point number 2. You are saying that by pushing down short term rates, QE pushes down long term rates by even more. After all, you don’t have compression unless the long rates (an indirect effect of QE) get pushed down by more than the short term rates (a direct effect). I’m not saying it can’t happen but in general, regardless of the policy, once removed effects don’t outweigh the direct effects. And in this case, as I noted in my earlier post, the data doesn’t support that finding at all. Things may change, of course.
Steve Hamlin,
Ah, I see your point. (rootless_e – my apology!)
First, you are correct, this approach is not optimal and it has its problems. As I noted upthread, I hadn’t anticipated a situation in which a bank might owe the country’s GDP.
The post in which I wrote this particular suggestion was in response to the notion that the markets had frozen up because nobody knew whether their potential counterparty would be the next domino to fall. I noted that if that was the problem, the simple solution was to take away the uncertainty. You can keep buying those packages of mortgages with no worries, because if the guy you bought it stopped paying, the gov’t would step in, seize his assets, ad pay you.
It was obviously not an approach intended for the long haul. That said, its my leaast favorite among the three I mention in the post. I prefer the second one, but could have lived with the third one.
Your first alternative is worse from the point of view of not rewarding irresponsible financial actors at public expense. Your second two involve not bending the rules but wholesale invention of new powers for which there was no support in the government or the public. That is, they were not actual alternatives. One might as well suggest the “alternative” that the Fed announce that finance capitalism doesn’t work, round up and shoot the CEOs down Wall Street, and turn over the economy to Workers Soviets. Whatever positive aspects one can find in such an “alternative”, it is not within the real of possibility. If you want radical changes in the economy, the people to convince are the broad public, not the board of directors of the FRB.
kharris,
Let me be perfectly blunt. Take this statement of yours: ” However, if you think about a fairly straightforward counterfactual – mortgage rates could have been higher than they are now if the Fed hadn’t bought MBS – the picture makes more sense “
Yes, and there are a bunch of counterfactuals that could show anything. And Prof. Krugman and you are, in my opinion, too focused on something that is too small. Here is the big picture. There are a handful of vampires that were mortally wounded. Instead of taking the opportunity to drive a stake through their heart, the Fed has lovingly nursed them back to health and affixed them back onto your neck and mine. I don’t care about the spreads widening or shrinking. I really don’t. I think its trivia. The only reason I even commented was because Prof. Krugman was telling me that the compression in the rates was evidence that the Fed was affixing that vampire to my neck (and yours) over the protests of that vampire, and thus, I should be happy about it. Sorry, no.
buffy,
Yes, it was Iceland. As to the attention, I suspect its a one time thing. I wish people would pay more attention to what I wrote about on what the data says about taxes as that’s the area I blog on the most.
Except QE doesn’t push short rates down, they are already down due to conventional policy. All it can do it push long rates down. But that is why your chart of the lack of compression is relevant. The Fed is doing its best not to compress rates and hurt the banks. Conventional policy is a gift to the banks but it is always a gift to the banks other than the short intervals when the Fed is slowing the economy. It is how they make their money. Borrow short, lend long, and rely on the Fed to bail you out if you get into trouble. Now the banks think this is hard work for which they are getting paid, but one can consider it a gift since only a bank can borrow from them.
rootless_e,
Sorry. I was under the impression that both the Fed and the Federal gov’t discovered a number of powers they apparently held during the crisis. Had they chosen a different path, they would have discovered a different set of new powers.
“This is sort of correct, but not in a helpful way. First, a quibble – leaving aside principal reinvestment the Fed no longer is buying agency debt. Now, some substance – yes, the agency debt had an implicit federal guarantee. But… let us be very precise about our definition.”
I usually agree with Krugman but his comment on agency debt just made my head spin like a top. Regardless of the “implicit guarantee” has he forgotten what it was like in late 2008? Everybody sure was acting as though the MBS were a radiactive pile of sludge. The banks sure didn’t want it and the eventual solution was to bury it in a concrete vessel deep within the bowels of the Fed balance sheet. If that isn’t a financial bailout then what is it?
In any case I’m glad you stood your ground.
Mark A,
I usually agree with Prof. Krugman too. I keep thinking I must be missing something. First, while I think he’s wrong interest rates, interest rates seem to me to be a sideshow. I just don’t see why he’s so worried about interest rates. Yes, I understand the corner solution problem, and how its the reason Prof. K likes to give for why we’re essentially pushing on a string. But really, this is distracting him from stuff that is important.
Second, I think this may have something to do with his conclusion that somehow the banks are getting screwed over, which clearly isn’t right.
Your comment (from “Everybody” to “it?”) states my entire post much more succinctly.
I read Krugmans post differently than you did (but I do not know anything about financial or macro economics so I might be way off)
First off – note that he now talks about “These days”, and not “the lending a lot of money to banks under the TALF and all that” (Krugman have many times, at least implied, that the banks were saved).
Secondly, the way that QE might hurt banks is through higher inflation than expected. Krugman do not seem to think that QE will be able to generate much inflation, but he seems to think that it is worth a shot.
In a perfect market with representative actors (yes – that’s ridiculous – but I do not know in what direction an introduction of imperfections would take the results) I do not think the banks are better or worse off with QE and low spread compared to no QE and high spread (they just represent two equally good return/risk pairs).
In reality, banks do not seem to be lending that much more (or, somewhat equivalently, doing it to a that much lower interest rate) because of QE. If you see the kind of assets the FED buy as close substitutes to money/reserves, you would not expect them to (see Delong).
The spread will naturally rise as you move towards ZLB. When the interest rates are, say, 2 % the actual future interest rates might be above or below the present interest rate. At the ZLB, the future interest rate can only be above or similar to the present interest rate.
But as I said, I might be way off.
Oh.
geijer,
I can’t speak for Prof Krugman. I am pretty sure he does not believe inflation is likely – he’s had many posts on bond vigilantes pointing out just that.
I think you are right that banks don’t seem to be loaning all that much. I didn’t expect that to happen, as I started writing back in 2008. I’m not sure what the solution is, given the path on which we’ve embarked.
I suspect that you are simply being coy, and that you don’t actually fail to understand the very basic point that Krugman and several commenters here are making, but just in case…
The compression of the spread as a result of QE — the proposition you have labeled “A” — has in fact occurred. Krugman *did* say as much and he has *not* said otherwise in any of the posts that you cite.
However, the spread between short and long rates is not significantly smaller than has historically been the case because — and this is the point that you stubbornly refuse to acknowledge — standard, non-QE, Fed actions drove down short term rates in the first place. Thus, even after QE drove down long term rates, the spread remained roughly the same as it has historically been. That’s why Krugman says, entirely correctly, that looking at historical data on the spread is meaningless: the fact that the spread is X says nothing about whether a particular action has raised or lowered long term rates (and thus increased the spread). In order to draw meaningful conclusions, you also need to take account of other actions (in this case standard Fed policy actions, not QE) that have affected the other component of the spread — short term rates.
You also conflate Treasury actions with Fed actions. Once Treasury had taken over Fannie and Freddie, their obligations truly were public. The Fed’s subsequent purchases of Fannie/Freddie assets is not what thrust those obligations on the public. Thus, nothing about the rottenness of the bailouts supports your assertions about the Fed’s supposed giveaways to banks.
Your original contention, to which Krugman’s last post was a response, that the Fed (not Treasury, or the federal government generally), by engaging in QE, is giving money to banks, is simply unsupported by anything you have said so far.
“When ?” Is the question. I’m real sure I shouldn’t comment on this debate (except congratulations Mike you’ve made the very big time). But I will. I think Mike and Krugman are writing about things the Fed did in differenr years. In particular, when Krugman writes QE he clearly means QE 2 and operation twist. I can defend him by getting picky about what the definition of “is” is. I think he claimed that the Fed isn’t now giving money to banks or considering giving money to banks. Rather it’s possible future efforts would take money from banks by flattening the yield curve.
Loans to banks during the we’re all gonna die phase were at interest rates far below the market rate (that’s what it means to be a lender of last reasort). As Mike notes, the Fed paid way more for agency issued RMBS than the market price. Finally aside from QE n, driving down the federal funds rate steepened the yield curve ( as noted by Krugman).
Krugman’s valid point on the loans and RMBS purchases are that what’s done os done. The current debate is about things the Fed might do which are bad for banks. The rescue (including QE 1) was good for banks also because it was on very generous terms (they lent freely but not t a penalty rate). But that was long ago.
One final little thing — the Fannie Freddie bailout preceded TARP and did not ount towards the 700 B limit.
No this is the final thing RMBS aren’t really treasury guaranteed. If the mortgager doesn’t pay, fannie and the feds in general aren’t liable. That’s why the RMBS have higher yields than treasuries.
Bubba,
In today’s post, I copied pretty much the entire second post Prof. Krugman wrote. I bolded the following in the first quote.
But the large-scale conventional expansion the Fed engaged in by getting to the zero bound has, of course, widened the spread between short and long term rates
Now, you stated this:
“The compression of the spread as a result of QE — the proposition you have labeled “A” — has in fact occurred. Krugman *did* say as much and he has *not* said otherwise in any of the posts that you cite. “
I’m not being coy – Prof Krugman is specifically stating that the spread widened. Now, you are insistent, so I’ll go further. The only way I can make sense out of this is if you are claiming that there was a widening of the spread as we got to the “zero bound” and then a narrowing as QEx was launched.
But that’s not entirely right. The spread peaked in the first week of November 2008. The ff was, at the time, at .24. It did have a slight uptick, but I don’t think its gone over .24 since Dec 10 2008 and has been below that since. So… getting to zero bound, we see first a widening, then a much smaller compression. (to me it just looks like a series overshot, but we can ignore my cursory glance).
Now, QE1 started in late Nov of 2008 and ran through March of 2009…. I guess it is possible that the market started to move interest rates several weeks before the Fed launched QE1, but if I recall correctly, the announcement itself came on November 25 2008. The announcement would have had to have been leaked 3 weeks before it happened to have that effect. I just don’t see it.
Similarly, zooming in on the end of March when QE1 ended, I don’t see any sign of anything happening in the series. (I’m happy to send you my spreadsheet – you can mess with the graph yourself.)
QE2 ran from June 3 of 2009 to the end of June 2010. Again, if there’s any non-random change in the series at the beginning or the end of that series, it isn’t immediately evident to me as I play with the graph.
People keep insisting so I keep checking, but I’m sorry… but if the spread is reacting to the zero bound, QE1, or QE2, I don’t see it.
a variation on the theme: The Urge To Tighten – Krugman vs Sheila Bair
bair has also recently satirized the bank giveaways: Fix income inequality with $10 million loans for everyone! “Under my plan, each American household could borrow $10 million from the Fed at zero interest”
krugman has an agenda here, mike…you cant reason with an agenda…
“There are a handful of vampires that were mortally wounded. Instead of taking the opportunity to drive a stake through their heart, the Fed has lovingly nursed them back to health and affixed them back onto your neck and mine.”
You don’t like credit markets. That’s OK.
You can get your mortgage/credit card/student loan/auto loan/equipment lease/whatever at the rates prevailing outside the US, i.e., about 1.5 to 2 times your usual rate, but please don’t then go complaining about how everything costs so much more these days.
You still think that FF is the rate at which banks borrow? It’s not. Please stop that.
Plot 15-year mortgage rates vs. 10-year treasuries or something. No, wait! Let me do it:
http://research.stlouisfed.org/fred2/graph/?g=6EX
vs.
http://en.wikipedia.org/wiki/Quantitative_easing
Or even 30-year mortgages vs. 30-year treasuries (short series since they were discontinued until the late 00s):
http://research.stlouisfed.org/fred2/graph/?graph_id=73458
See the QE? See it work?
But why do you ignore the word “conventional” in the bolded passage? The whole point is that there is a distinction between conventional Fed operations and QE. Krugman’s comment, which is expressly about conventional expansion, somehow shows that he agrees that QE — i.e., unconventional expansion — widened the spread???
As for whether QE had such an overwhelming effect that long term bond rates moved in perfect concert with QE’s occurence, I don’t know anyone who has claimed that. Long rates could have been falling at a particular moment in late 2008 for any number of reasons. All people like Krugman are saying is that the effect of QE, whatever it is (and it’s probably not much), is not to raise long term rates, and thus is also not to widen the rate spread. Conventional Fed operations tend to lower short rates. QE tends, if anything, to lower long rates. Other events also affect rates (e.g., expections of long term recession will tend to lower long rates), and thus the spread between short and long rates. The facts you cite are consistent with, and certainly don’t contradict, this story.
Cameron,
I didn’t say I don’t like financial markets. I just don’t like the bsd actors in them.
I’ve stated the financial model I’d like to see before:
a. The public can bank at the Fed as if it were any other bank
b. Private banks are free to compete with each other and the Fed for deposits
c. No bail-outs of banks or other financial institutions – you go bankrupt, your assets gets seized by the Fed.
Cameron,
Later today I will try to send Dan a post based on a graph that shows:
a, The 30 year mortgage less the FF spread
b, The FF
c. Both QE periods
I have the graph that shows all of those series completed, I just have to write it up. (Bear in mind, I also have to earn a living so I’m moving as fast as I can.)
Prof. Krugman hasn’t objected to the FF or the 30 year mortgage. So the graph I already produced is for him. But I’m willing to add to the post, and put up a second graph.
I’d be happy to look other series instead of the FF as well – tell me what. But please, if we’re trying to show that Prof. Krugman was right about what happened between the difference between the short term rates at which the banks borrow and the long term rates at which they lend, please please please pick a short term rate that is a short term rate, and one at which the banks can borrow.
I mean, come on, 15 year mortgage rates v. 10 year treasuries says what in the context of Prof Krugman’s story? Banks are borrowing at the 10 year treasury rate now, and that’s their short term rate?
(Regular readers know I do these requests – I am not embarassed to be proven wrong iof the data shows that to be the case. But like I said, my time is limited. Pick a series that fits the story and I’ll graph it. I’m willing to follow you down the yellow brick road… once. Don’t keep coming back with alternative series if the story doesn’t work.)
Thanks Robert.
Also, I’ll have to think about how to put some of what you mention in terms of timing on a graph.
Also, this is key: “No this is the final thing RMBS aren’t really treasury guaranteed. If the mortgager doesn’t pay, fannie and the feds in general aren’t liable.”
I kind of thought this was true, but didn’t know. Any idea where this is described officially?
rjs,
I’m not convinced that Prof. Krugman has an agenda. As I noted upthread, I’m going to start putting this stuff on graphs. When everyone says you’re wrong (and right now, Prof Krugman has the armies behind him) you have check everything several ways.
Robert,
I think your point that lending during QE 1 was done without a penalty rate, seems to validate Mike’s overall point. This “may have been long ago, and what’s done is done”, except that this policy choice may do more harm than good in the long run. Time will tell.
bubba,
OK. I will write a post with a grpah which hopefully will go up later today. The graph shows the two QE periods, the conventional periods, the spread, and the FF separately.
rjs,
I think it is unfair to state that Prof. Krugman has a pro-bank agenda based on the information posted. I think the problem is a bit different, and two fold:
a. Prof. Krugman knows the people involved. Its tough to be critical of people you know and like, particularly if they’re doing the best they can in a tough spot. We may not think Bernanke is doing the right thing, but he is in a tough spot, he’s probably a nice guy, and he’s trying.
b. Prof. Krugman has too much of a focus on interest rates, and naturally, that is something that the financial sector pays more attention to than any one else. Almost by default, in such a scenario, you end up with at least some sympathy toward the position of the folks who are the ones who care more for what you care about.
mike, i didnt mean, & i dont think, that PK has a “pro-bank” agenda…his pro-Fed, pro-conventional macro agenda is what i was referring to…
krugman can no longer think outside of his box…he has become conservative, & he’s carrying water for the status quo…