The right amount of quantititative easing.

Krugman has a post up expressing approval of the Fed's announced intent to buy 1 trillion in long-term bonds. I'm all for quantitative easing (I wonder what Orwellian instinct causes them to avoid the proper phrase "printing money") but not on this scale. M1 is only about 1.6 billion (and was less that 1.4 last summer) so this is about a 60% increase in the money supply, coming on the heels of some significant printing in Q3-Q4 2008. Crudely, you'd expect about 60% inflation from this and that's far too much. As Krugman points out, the prices of these bonds will drop as the economy recovers and interest rates decrease. So even if the Fed pulls back as hard as it can in a year or so we're still left with about a 15% increase and I very much doubt the Fed will pull back even that hard as IMO that would throw us into a depression.

I think a better guide would be to print enough money, excuse me, "quantitatively ease" enough, to keep the leading indicators moderately positive. That should be enough to get us out of recession without risking the worst inflationary shock since the Constitution was written.

Are you ready to be Geithnerized?

Geithnerize, vb: To make somebody grossly overpay for something, and still end up not owning it.

The core problem for the banking sector is that the banks have lost far, far more money than they could have and remained solvent. As Yves Smith pithily puts it:

Let's start with the basics. The US banking system is insolvent. Got that? Insolvent. That does not mean every bank in the US is toast, in fact quite a few are probably just fine, and another large group is no doubt hurting and undercapitalized, but ... a significant portion of the very biggest banks are insolvent.

The fair solution is that the insolvent current banks have to be shut down, their owners wiped out, their managers fired, and new banks started with new owners, new managers, and new capital. Fair, efficient, and straightfoward - but it will ruin many of those responsible for the disaster, especially current bank management. Their solution? Make the taxpayer pay to keep them rich - via Geithnerization!

We've already had a lot of Geithnerization already - the TARP, which overpaid by at least 87 billion for equity that doesn't carry voting rights; the Citibank bailout, where the US government gave Citibank guarantees so grotesquely underpriced they won't even let us find out what they guaranteed; and the similar BOA bailout. And the public is getting wise to the Geithnerization process.

So the new Geithner plan cleverly dresses up another (and huge!) round of Geithnerization with some platitudinous frills (but little substance) to disguise the ravenous monstrosity at the core of the plan. Lurking at the core:

a) TARP style useless equity in the "Capital Assistance Program". Undercapitalized banks get money from the treasury in return for preferred shares - inevitably underpriced, since the bank are undercapitalized. The preferred shares aren't voting, so no control over the bank for the taxpayer who's going to pay so much for it. Just like with Citi, we get to pay more than the banks are worth, and somebody else still owns it.

b) A "public-private investment fund" which will take equity mostly (read all) from the private sector to take loans from the public sector to buy assets that can't be valued accurately. Result: if the assets go up, the private investors take all the gains; if they go down private investors lose a little and the public loses a lot on the bad loan. Geithnerization for uncertain assets!

The plan has some nice-sounding frills calling for bank audits (but with no specifics), posting some information to the Web (but again, no details), and some expanded programs for mortgage modification. Of real merit is a plan to expand the Term Asset-Backed Securities Loan Facility (TALF) to 1 trillion. This really helps, because as I've said, the fundamental solution is to have new bank with new money take over lending. With the TALF the Federal Reserve will be doing it. Of course the point is that since Geithnerizing the public won't actually help the credit market, they needed to put in a program that would. We don't have to rip off the public to expand the TALF.

But no detail can disguise the 1 trillion plus plan to make the taxpayer pay for investors to own and get rich on assorted shady assets. But what do you expect when you appoint a Treasury secretary whose primary goal is saving the banks from nationalization?

Are you ready to be Geithnerized now?

A better CPI

From Mish Shedlock, here's a graph of the CPI with owner equivalent rent replaced by the Case-Shiller Index aka the CS-CPI. It would have led to much better Fed action in the current cycle. The Fed would have pulled back credit in 2003, tempering the bubble, and would be broadly inflating now, tempering the depression. Wouldn't it be nice to have a Fed that used good metrics?

Reforming the Federal Reserve

The policy responses to the current crisis have exposed some bad governance problems with the Federal Reserve. Like most central banks, the Fed is fairly independent, and needs to be as otherwise there are massive incentives for electorally directed manipulation of the money supply. However, in the current crisis the Fed has used its independence to provide massive benefits to private interest, most notably with with Citibank bailout, ultimately from the pocketbook of the taxpayer.

Clearly it's totally unacceptable for any institution to effectively give hundred of billions of taxpayer money with no effective control. We'll pay for years covering the past year of thinly disguised giveaways. However, we don't want to put the Federal Reserve under the direct control of the President due to the need for independence.

To solve this dilemma, I have a simple proposal: the Federal Reserve will only be allowed to own debt explicitly guaranteed by the federal government. It will not be authorized to make any guarantees of any other assets, or to participate in any derivatives. It may make loans only when suitably collateralized by government-guaranteed debt. If the Fed needs to operate a discount window, it must first get guarantees from the political system, so it will no longer be able to effectively give away money without taxpayer control.

The Federal Reserve will still be able to control the money supply but it will only be able to use use its implicit call on taxpayer money to benefit government-guaranteed entities, which is restrictive enough. I think this proposal provides leeway for the Federal Reserve to perform its monetary function with adequate interference while ensure that benefits from government granted authority are controlled by Congress and the Executive branch.

Bank of the Fed Expands; Is Nationalization Imminent?

Yesterday the Fed announced, not one, but two major lending programs: 200 billion for consumer credit and 600 billion for mortgages. This is the Fed moving further into the "Bank of the Fed" approach I advocated during discussion of the TARP bailout. The Fed is effectively taking "deposits" in the form of Treasury bill purchases and using the money to make loans to private entities. The loans are currently being made indirectly, by supports to private bank lending, because the Fed lacks the infrastructure to evaluate individual loans.

This has engendered a lot of concern about wasting money and crowding out private lending/borrowing; of which some concerns have made it to the mainstream media. These concerns are legitimate; during the TARP controversy I was particularly concerned with the Fed crowding out essential lending to make wasteful loans. However, I think at the moment there's just no choice. For whatever reason, banks are unable to convert virtually free money from the Fed into consumer and commercial credit except at exorbitant rates. We need credit for our society to function and apparently nobody but the Fed can do it.

Lending by the Fed, though, may very well drive what's left of the banking system out of business. The Fed has access to unbelievably cheap money; at this writing it can borrow for 3 months at a rate 0.04% (free, essentially) and for 30 years at the astonishing rate of 3.52%. There's no way private banks can compete with that. If the Fed loans to some people but not others it is effectively providing an enormous subsidy to the favored and will create monster distortions in the economy. In addition, the Fed will face severe political pressure, as we've seen with the attempt to give away the farm to the banks while the auto industry gets crumbs. So I think the Fed will have to be relatively even-handed in its lending, and this is going to leave the Fed dominating most lending much as Fannie and Freddie now dominate mortgage lending.

So in the very near future we will likely have a de facto nationalized banking system, with governmental standards determining who does and who does not receive loans. Good or bad, it's now basically inevitable since the private banking system used the freedom provided by deregulation to go out and commit suicide. It is truly ironic that the mad drive to deregulate of the past 25 years will lead to socialism on a scale not even considered seriously in America before. But, that's the situation, and we now have to start thinking about how the government will run the bank.

Bank of the Fed Starts Operations

Amidst all the bad news, there is some good news. The Bank of the Fed is open for business and it's helping a lot. The Fed tripled its working capital duration window on Monday and commercial paper volume in those durations (>20 days) is now running only moderately below the year's averages and about twice the rate of the last two weeks in September. The market has shifted hard to asset-backed paper, which I assume reflects a Fed collateral requirement. In the longer durations asset-backed paper is at volumes far above typical averages while all other CP markets are virtually shut down.

http://www.federalreserve.gov/
re...volumestats.htm

The A2/P2 spread is down, to "only" 2.93. Still twice that of the 74-75 recession, but probably an overestimate since the market is obviously restricted in its ability to handle that kind of paper. So perhaps the market is only predicting the worst recession since 1937 now rather than a depression.

http://www.federalreserve.gov/re...ov/releases/cp/