Tag Archive for Federal Reserve

Is inflation nuked, or just sleeping?

2010, the year than began with a whimper and may leave with a bang.

First up, Iceland’s parliament, known as the Althing, has announced that it will make good on deposit guarantees…. quotes from their ministry of finance below:

“Yesterday evening the Icelandic parliament Althingi approved a legislation authorising a state guarantee for loans by the UK and the Netherlands to the Depositors’ and Investors’ Guarantee Fund to cover payment of mandatory minimum deposit guarantees to holders of savings accounts in branches of Landsbanki Islands hf. in those countries.

Adoption of this legislation marks the end of a difficult and protracted international dispute with an agreement providing for the equitable sharing of the burden of the lost savings deposits between the states concerned. The dispute has impeded Iceland’s relations with other nations and the issue has been the subject of heated and widespread controversy among the general public. The adoption of the Act was a difficult step for the Althingi. Resolving the dispute in this manner is regarded as a prerequisite for continuing reconstruction efforts which have been underway since the economic shocks suffered by Iceland in the autumn of 2008 and which have already made very significant progress”.
(Ministry of Finance, December 31, 2009)

We’ll take that as a good sign that the reconstruction of the post-crash economy is proceeding apace. Note, however, that a condition of relative stability is not the same thing as a full return to normality.

Goldman Sachs‘ chief economist Jan Hatzius sounded somewhere between restrained and downbeat for the prospects of 2010 in the brief interview he granted the WSJ. See the interview here.

Our own chart study of inflationary expectations based on the data from the University of Michigan and published on the Federal Reserve’s FRED database shows a weak concern for inflationary processes taking hold anytime soon. Mind you, this isn’t a chart of actual inflation, but rather the prediction of inflation in the future.

Note also that the phase after the dot com meltdown until the credit crisis showed an accelerating belief that inflation would assert itself in the future. It is the expectation of future inflation that drives people to accumulate debt (as inflation reduces the cost of repaying debt, assuming you got a fixed rate loan), accumulate real estate and physical assets, and generates a general surge in “animal spirits”. For now, the inflation mind set appears to have fallen well below the trend of the past 25 years.

Inflationary expectations

Inflationary expectations

Anything else we might care to notice ? The map below – first published on Wikipedia and composed by Mike Sefras – shows an interesting situation with regard to US unemployment. There are regions with much worse than average unemployment – some which appear to be bordering on the true desperation conditions of a real depression mirroring the 1930s (black zones on map), other regions that appear to be in fairly good shape (light blue), and an equal amount of in-between zones.

The take home lesson is that the generalized state of misery that brings about massive collective action is absent in the US. There’s enough true catastrophe to get a certain amount of legislative change done, but not nearly enough for a grand social overhaul. This no doubt explains the long and contentious debates in the media and the political mechanisms where radical change and social stasis are in a tug of war for meme dominance.

US unemployment map

US unemployment map

House approves biggest overhaul of financial regulation

On Friday the House of Representatives passed the Wall Street Reform and Consumer Protection Act, a landmark legislation proposing sweeping changes to regulation of the financial system.

In a victory for the Obama administration, the 1,300-plus-page bill passed by a 223-202 margin (with all Republicans and 27 Democrats against). The Senate is working on its own measures to be debated early next year. Eventually, a final, compromise version will have to be negotiated between the two chambers.

The sprawling legislation will, in effect, regulate the financial services industry as well as most aspects of personal consumer banking. It covers everything from too-big-to-fail firms, banking regulation, hedge fund regulation, derivatives trading, executive compensation, to the simplest consumer financial products.

Republicans criticized the (Democratic) legislation, saying it could cause job losses, restrict the availability of credit and enable future bailouts of failing companies.

Let’s have a look at the main points of the reform bill.

Consumer protection

A central element of the bill is the creation of the Consumer Financial Protection Agency (CFPA), a new federal agency with far reaching powers to control all types of financial products offered to consumers (including a variety of loans, mortgages, credit cards, etc).

The bill also incorporates the mortgage reform and anti-predatory lending bill the House passed earlier this year. It prohibits lending to those consumers who shouldn’t be taking such financial risks and orders lenders to ensure that borrowers can repay the loans they are sold.

In a rare win for the banking industry, the House rejected an amendment that would have allowed bankruptcy judges to reduce mortgages of distressed borrowers. (A measure that, if adopted, would most likely have limited the willingness to lend.)

Financial Services Oversight Council

The inter-agency council, chaired by Treasury secretary, will identify and impose additional regulation on companies that are deemed ‘too big to fail’ and whose collapse would put the financial system at risk.

Dissolution of troubled companies

The bill aims to create a $200 billion ‘systemic dissolution fund’ (financed by fees to be levied on financial institutions) to cover the costs of dissolving firms that pose a threat to the economy. The government will have new powers to break up or dismantle large, failing financial institutions, in order to prevent a contagion to the rest of the system.

Fed audits

The bill will limit the power of the Federal Reserve, removing its consumer protection authority and limiting its ‘lender of last resort’ power.

It also includes a provision for Fed audits, subjecting its monetary policy and lending to financial firms to audits by congressional watchdogs. (The Fed argued this threatens its political independence, implies monetary policy will no longer be independent and decisions could be influenced by politics – all of which could unsettle the markets. Inflation and long term interest rates could also rise if investors believed the Fed to be under political pressure to keep growth going.)

Regulation of OTC derivatives

The legislation imposes, for the first time, regulation on the over-the-counter (OTC) derivatives market. It establishes a central clearing requirement for participants in the OTC derivatives market, aiming to increase transparency. Commercial end users, who use derivatives to hedge their price risk, will be exempt from the clearing requirement.

Regulators will also have powers to set capital and margin requirements, as well as position limits on financial and commodity-based derivatives.

Executive compensation

The bill takes on Wall Street compensation, giving shareholders a nonbinding vote on executive pay. It also requires financial firms to disclose any compensation structures that include incentive-based elements, and empowers regulators to ban inappropriate compensation practices.

Investor protection

SEC’s powers will be strengthened to allow for improved investor protection and regulation of the securities markets. A new study of the securities industry will identify necessary reforms, in response to the failure to detect the Madoff and Stanford Financial frauds.

Hedge funds & private equity regulation

Hedge funds, private equity firms and offshore funds will have to register with the SEC and will be subject to systemic risk regulation.

Federal Insurance Office

The Federal Insurance Office (FIO) will be set up to monitor, for the first time, the insurance industry, including identifying possible gaps in the regulation of insurers that could contribute to a systemic crisis.

Reform of credit rating agencies

The bill addresses the role rating agencies played in the economic crisis, aims to reduce conflicts of interest and impose a liability standard on the agencies.


Everyone agrees that some changes are necessary. But we have had plenty of government regulation, and it has failed in the past. Can new government agencies and more bureaucrats employed to oversee and regulate the industry stabilize the markets and avoid future crisis?

I fail to see how this (or any) regulation can really ‘prevent such crisis from ever happening again’ (as Obama stated). Unless the government bureaucracy manages to stifle competition and kill innovation in the financial markets, there will always be new products, risks and indeed, crisis.

After all, while the 2008 meltdown brought the world to the brink, it wasn’t the first time (remember how the Russian financial crisis and LTCM implosion led to near Armageddon in 1998?). And I suspect it won’t be the last.