Thursday, January 31, 2008

Why? What? When?

The Fed cut rates by another 50 bp (0.50%) yesterday for an unprecedented total 125 bp in just 8 days. This brings the target rate to 3.00%, already one of the lowest levels since Bretton Woods and the inception of the Dollar Hegemony era. And there is more to come: immediately after the FOMC announcement a major Wall Street firm predicted (begged?) that the next cut will be a full 100 bp to 2.00%.

Data: St. Louis Fed

By comparison, Fed funds were already at a low 3.00% on Sept. 1, 2001 towards the end of the previous recession, and Mr. Greenspan only took them lower because of the tragic events that transpired on 9/11. We may fault the Maestro for thus starting the largest real estate bubble in US history, but I am certain that every one of us would have reacted to the emergency in the same way and slashed rates, at the time.

Are we faced with an emergency today? Clearly, the unprecedented actions by the Fed and the administration show they are worried - panicked, even - that the developing economic slowdown portends much worse than a garden-variety recession. Their "sweat" is clearly showing, in sharp contrast to sensible advice ("Never let them see you sweat") and Shakespearean observation ("The lady doth protest too much, methinks").

I will try to briefly answer the three questions from the post title.

Why are they worried? Because the global economy has become so highly financialized that everyone looks to "markets" for their decisions - even their emotional well-being. Mainstream media run live tickers on their stations and sites, and economic news that were once relegated to the back sections are now at the front page. This is a very dangerous dynamic, nestled as it is within a highly complex system.

What are they worried about? That negative market action will be instantly transmitted via the above dynamic to the "real" economy, resulting in a seizure: slashed consumer spending and mass layoffs. And this holds for the entire world, not just the US, because global markets have become highly correlated.

How fast could this happen? We already saw last week how quickly global markets can accelerate to the downside. In the era of "just-in-time" everything, the domino effects to the "real" global economy can't be cushioned by inventory builds or delayed production and delivery schedules. Every businessman is now trigger-happy - look at the chart below.

Chart: FRB

Perhaps the Fed's rapid-fire cuts will prevent the slowdown from turning into what Mr. Bernanke and the administration fear most. But their fear has me spooked, I'll tell you... To paraphrase FDR: The only thing I have to fear, is their fear itself.


P.S. The Monster Employment Index for January was just released, showing a sharp drop from previous months and also falling to the lowest level since February 2006. The index tracks online employment advertising.


  1. I must agree, seeing the Chieftains panick doesn't install confidence in the Indians.
    Of course they have access to more info than we have. Whatever they're looking at, they don't like it one bit.

  2. They're doing what they believe they have to do in order to prop up asset values. Including equities. This was, I would think, made more than clear by last week's 'emergency' 75bp cut (as if it could not have waited one week). I don't know if I would call it panic or not; it all seems rather pro forma to me.

  3. As I see it, the problem is that ordinary Americans -- who would drive any recovery -- cannot afford to borrow more at any interest rate, not even zero.

    Debt is not prosperity.

    Notice how the markets reacted yesterday even after the announcement of the rate cut. It went up at first, but then still closed down for the day.

    Speaking of dominoes:

    Heaven, heaven help me. I'm one of the dominoes.

  4. A couple of years ago, I set out to learn what I didn't know about our monetary policy, debt, finance, etc. (I never studied it in school.) I got panicky over what I learned. I fear a total meltdown of the dollar. I never thought it would happen terribly quickly and I never could figure out what the trigger would be -- but then lenders stopped lending to subprime borrowers because subprime borrowers were defaulting and I think that was the start of the tumble.

    Just from what I understand, we've built a monetary house of cards and you only have to pull out one to make the rest of them fall.

    Anyway, the Fed cuts do look like panic to me. I wonder why they did it so quickly? What are they seeing that we aren't? I don't think this is totally related to the stock markets and this cut isn't going to prop up overvalued assets. How do Fed cuts affect derivatives?

  5. The credit crunch basically stopped the cash out refinance activities of the past few years and thereby has greatly reduced demand. This is what has got them spooked as well as a growing bank crisis that no one can see the end of. I'm concerned as well and I don't think that we will avoid a severe downturn no matter what the rate cut is because the credit system is impaired enough that the banks aren't going to lend, they are going to use the temporarily increased yield to replace their missing reserves. They used the reserves to cover the first big round of losses but there are more losses to come. Not a very good situation for the general economy or individuals. Being spooked by these panicky attempts to stimulate the economy is the rational reaction.

  6. Every organization with a large stake in this is lying, the rating agencies, SEC, Freddie, Fannie, the banks. They're all whistling past the graveyard. It's a gamble. It may work, it may not. If it doesn't, it'll be for the worst. Bad and long.

  7. I can't find the rationale.
    Why raise the rate to 5.25% and then slash it to 3% in this short timeframe? Was it the surgeon cut in the suppurating bubble?
    The feeling is that something is missing in the picture and this same feeling is disturbing.
    And yes, banks and finance in general are casinos. Absit iniuria verbis for casinos.

  8. I want to add that I think H has made a good point/is right about the prevalence of news and information about the market(s): it is very important for people to see that the Fed is acting in order to maintain sentiment. However the problem is now deflating (grossly inflated) asset prices (also a lack of trust between counterparties), and let's just say it is not at all obvious that rate cuts can do much about that. So the Fed risks using up all its ammunition in a futile effort, which will probably seriously damage its credibility.

  9. Why raise the rate to 5.25% and then slash it to 3% in this short timeframe?

    Because they don't know what else to do; twiddling with rates/'liquidity' is what the Fed does, so that's what they're doing.

    You're not the only one who doesn't get the rationale. The best I can come up with is that it might boost demand for housing a bit, and save a (relatively) few people whose loans will soon reset from going into default. But if asset/house prices will still decline, probably significantly, as I think they will, how effective will that be?

  10. Hellasious,

    The Monster chart is GREAT! Love It!

  11. H.

    If this is global, then why aren't the Bank of England and ECB slashing rates as well?

  12. If this is global, then why aren't the Bank of England and ECB slashing rates as well?...

    Because their mandate is completely different from the Fed's and because by tradition (at least BuBa) they are much more inflatio-phobic vs. the Fed's deflation phobia.

  13. What I fear is a massive bailout to all the bad actors in this charade--the insurers, the mortgage firms, the banks. The craven leadership of this country will attempt to shift the bill to the average American.

    I'm really ambivalent about this point, we deserve the government we get. After the colossal mistake of invading a non-threatening state Americans elect this fool again? Maybe at some point Americans will start paying attention again, because the next maladministration may be more efficient in their malfeasance. We have almost seen the wet dream of Grover Norquist come true--the complete destruction of the federal budget system.

    The only "decoupling" I've seen is the American wage earner from the profits of the large corporations. We truly are our own worst enemy.

  14. The Fed is simply doing what comes natural to them... Cutting the FF rate.

    Our elected officials are doing what comes natural to them..... Faith based Stimulus Package.

    The bankers and out brethren on Wall St. are doing what comes natural to them.... Stealing and robbing John Q. Public Blind.

    John Q. Public is doing what comes natural to him.... Swallowing all the Bull Shit.

    I pity those fools.

    Take care of yourselves, no one else will.

    Best regards,


  15. Don't some of the more problematic mortgage resets look to LIBOR?

    Also, what are the paths to the Euro more fully displacing the USD as the global reserve currency and how does this affect the ECB; how might the ECB act to futher encourage such a shift?

    I don't see much on the blogs lately about BoE or ECB moves.

  16. "Faith based Stimulus Package" ... too funny!

  17. Does anyone know the easiest way to get into shorting the market via options? I read somewhere that soon picking stocks to short will be as easy as opening the newspaper to the stock section and thowing a dart.

    Please don't tell me how hard/risky this is as I am not a gambler but WTF else can one do at this point? If I lose my capital FINE but I don't want them coming after my other assets if I pick the wrong stock to short.

  18. ... and we all need absolution as we have indeed sinned

  19. @ "The only 'decoupling' I've seen is the American wage earner from the profits of the large corporations." Nicely put! The comments are on a roll today.
    At least I can still laugh at the absurdity of it all.

  20. hellasious: Today's post is a major disappointment. It's full of postulation that have little basis in reality and mimic content authored by precious metals hawks.

    1. There is no going back to some simpler financial time. It reminds me of the ridiculous Reganism of imagining some previous era as somehow simpler and better.

    2. It's sad to see so much ability and insight just wasted on undisciplined rambling about the Fed while advocating the usual precious metal pablum.

    The Right-Thinking-Fellows Club will go on without me and your fans will bid me a fond farewell.

    You are just another idi0t wasting a precious gift.

  21. The comments about 'decoupling' and 'stimulus packages' are on a roll today.
    At least I can still LOL at the absurdity of it all.

  22. finisterre... I have only one word for you: "Sugarscape"

    Anon, is this what you are looking for: Inverse ETF's

  23. advocating the usual precious metal pablum

    Are we reading the same blog? I saw no reference, stated or unstated, about gold and its buddies.

  24. To Anon. who needs a better choice of epithets and - apparently - a little more care when reading:

    I don't like being called an idiot, even if a "gifted" one, but where did you see the precious metals pablum?

    Just curious...

  25. Anonobeast:

    "There is no going back to some simpler financial time."

    Why not? Seems the sophistication is a bit much for all of the luminaries in the system. Or maybe it makes it easier to hoodwink the rubes.

    That why we have W and his minions running things, we all know the sophistication and competence he brings to the table.

  26. okielawyer,

    That's what we call a Fed cat bounce.

  27. Hell, would you share your thoughts on precious metals?

  28. thai mcg,

    Thank you, but not really. I had know about those already and I understand the short one to be 1:1 and the ultra-short one to be 2:1 as far as returns.

    I need LEVERAGE ;) I want to do an experiment and see if I can turn 5k into something much larger in a short period of time.

    Do I need to open a brokerage account or is it better to go through something like E-Trade? I really don't want to have to call anyone to buy the puts nor do I want to fill out reams of paperwork listing all my assets.

  29. Have to disagree Hellasious....The reason the ECB is not allowed to slash rates like the Federal Reserve, is because that would raise the value of the USD on the DX. Remember, the Euro makes up 58% of that index. Also, these CB's are coordinated through Basel and so the Fed cuts away and the ECB stays away. That's the plan. Keep the USD weak, EUR strong...Because..If the USD and JPY strengthen materially, the result will be a complete unwinding of the pyramid scheme from 2003. I am looking forward to this outcome as the grand wizards in Basel get scathed.

  30. Hell wrote,

    "We may fault the Maestro for thus starting the largest real estate bubble in US history, but I am certain that every one of us would have reacted to the emergency in the same way and slashed rates, at the time."

    There are a number of responses to that assertion, one is, that perhaps you or I would not have allowed the stock market bubble to get so out of hand such that mad money pumping would have become necessary.

    Two, as you know, there were many things Greenspan could have spoken out about regarding the then new creative finance that served as a great engine of the real estate bubble. Then there were simply all the myriad half truths and distortions of t truth that Greenscam lent his most influential voice to.

  31. to edwardo, about Greenspan:

    Undoubtedly, and I agree with you.

    I was referring to the immediate response after the 9/11 events. We were already in a recession and then this tragedy happened - he had to cut.

    The big mistake came after, when he left rates too low, for too long and then raised them in baby 25 bp steps.

    But, as usual, hindsight gives us the benefit of 20/20 vision now...



  32. "I need LEVERAGE ;) I want to do an experiment and see if I can turn 5k into something much larger in a short period of time."

    If you need leverage, go to IB or TOS and open a futures account. However, I can bet that you will lose your 5K in a very short amount of time. Leverage needs precision - not just a vague feeling that the markets are going to drop.

  33. In a hyperinflation, all stocks are "the wrong stock to short".