"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Monday, August 30, 2010

Really good links - QE - Kocherlakota - Mother of all bank runs - Flight to safety - Basel - Bond bubble

Alan Blinder - QE - "If the FOMC is serious about re-entry into quantitative easing, it should buy private assets, not Treasurys. Which assets? The reflexive answer is: more MBS. But with mortgage rates already so low, how much further can they fall? And would slightly lower rates revive the lifeless housing market?
        To give quantitative easing more punch, the Fed may have to devise imaginative ways to purchase diversified bundles of assets like corporate bonds, syndicated loans, small business loans and credit-card receivables. Serious technical difficulties beset any efforts to do so without favoring some private interests over others. And the political difficulties may be even more severe. So the Fed will go there only with great reluctance."

Adam P - Kocherlakota - "the very worst part of what Kocherlakota said is that he was advocating for a policy and that policy was to tighten monetary policy *TODAY*.
        If the Fed stands ready to raise rates before inflation has increased (based on other indications of a normalization) then that is a change in the reaction function that constitutes a tightening. (Look at it this way, in Sumner's phrasing it is a statement that the Fed stands ready to reduce the money supply even earler than we though, the monetary injection has gotten *less permanent*)."

Brad DeLong - Mother of all bank runs - "However, at some future time the dollar will cease to be the linchpin of the world financial system, in which case the Federal Reserve's financing its balance sheet via overnight borrowing will leave it vulnerable to the mother of all bank runs. It would be very good to fix this now: to give the Federal Reserve now the option to borrow not in what are essentially demand but rather in time deposits--to grant the Federal Reserve the power to issue its own bonds. This diminishes the chance of a great financial crisis in 2050 or so, with no downside that I can see"

David Pearson - Flight to safety? - "To further confuse the picture, the "flight to safety" or "safe haven" explanations for zero 5yr real yields simply do not fit with other asset prices. Investment grade corporate bond spreads, for instance, are at very tight levels -- indicative of little credit fear. High yield bonds are also enjoying a boom. So the bond market is sending mixed signals: corporate default risk is very low, but required real returns on a risk-less asset are zero. Further, record-high gold prices are indicative of some level of long term inflationary fear, and while TIPS inflation has declined, it is still positive. How could these prices all be reconciled?"

Craig Pirrong - Basel - "Risk-based capital requirements are like a regime of price controls, in this instance, risk price controls. If some risks are mispriced, and particular, priced too low, all affected institutions face the same incentives to take on those particular risks. The more institutions that fall under the capital regime, the more institutions that will take on these underpriced risks. That’s why I am very leery of global capital regimes, a la Basel. If they screw up the prices–and screw them up they will, with metaphysical certainty–the effect of the perverse incentives will be global."

Nick Rowe - Bond bubble - "I approach the question of "fundamental value" as a macroeconomist, not a microeconomist -- from a general equilibrium, not partial equilibrium perspective. If we define the "fundamental" value of an asset as the price that asset would have if all markets, not just the market for that asset, were in long-run equilibrium (and with inflation at target), then bond prices are above their fundamental values. And if we define "bubble" as a price above that fundamental value, then bond prices are a bubble."

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