Tag Archives: QE

Housing Bubble Redux

The root cause of the financial crisis was the housing bubble, going back to Clinton’s repeal of Glass Steagall and looting at FNMA, but – what was the trigger? Understanding the chain of events helps us to evaluate the policy response, and also suggests what to look for the next time.

The nadir, as everyone knows, was the S&P 500 touching 666 in March 2009, before its rescue by Chairman Bernanke. Lehman Brothers had failed in September 2008, precipitating the crash in October, but the market had peaked a full year earlier.

Crash Chart

The NBER identified December 2007 as the recession’s start, and it’s not surprising that the market peaked a few months ahead. It is generally a leading indicator for the economy. Mortgage lending, with its new ecosystem of boiler rooms and dodgy paper, had been shaking out all year. This is variously attributed to a dip in housing prices, declining demand for mortgage backed securities, and rising mortgage interest rates.

… the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not – FCIC

So, among the proximate causes, which was the trigger? Did the Fed pop the bubble by raising rates? Probably not. Fed funds had ramped steadily throughout the bubble, but had been flat at 5.25% since July 2006. That’s an indication the Fed was trying not to spoil the party.

Housing Bubble

Mortgage rates peaked in July 2006 and so, roughly, did the Case-Shiller home price index. The chart shows rates following the price trend up, and then following it back down.

It’s reasonable to suppose that the recession started and then people couldn’t make their mortgage payments, but the timing doesn’t support that. The recession was not a cause of the bust, nor was it obviously an effect. Delinquent mortgage payments, especially for Miami condos, had been on the rise throughout 2006. This chart is from the Financial Crisis Inquiry Commission.


These were flippers running out of people to flip to, like punters at the end of a chain letter, plus some poor fools actually occupying the homes and trying to make the payments. The trough of the rate trend was around 2003. If you had signed an ARM then, your interest rate had just about doubled by 2006.

  • Delinquencies start to rise in 2006.
  • Home prices peak, June 2006.
  • Mortgage rates peak, July 2006.
  • Mortgage bonds downgraded, July 2007.
  • Stock market peaks, October 2007.
  • Recession starts, December 2007.
  • Stock market crashes, October 2008.

Right up until the crash, this reads like a normal business cycle recession. David Stockman argues that main street banks were never in danger from the housing market, because they had been run out of it by big investment banks. On this reasoning, policies like TARP, ARRA, and QE were a response to Wall Street, not the recession.

If you had been alert, you could have predicted when the housing bubble would burst simply by looking at the timing of the 5-year ARMs. Stanley Druckenmiller knew that risk premiums were too low in 2004, but it took him another a year to identify the housing bubble.

When you have zero money for so long, the marginal benefits you get through consumption greatly diminish, but there’s one thing that doesn’t diminish, which is unintended consequences.

We are in a similar phase now. Everyone knows that six years of ZIRP have planted a bomb somewhere in the economy, but no one knows for sure where it is.


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The Third Arrow

Shinzo AbeThe second of Prime Minister Abe’s “arrows” was a monetary stimulus that demolished the yen. This earned him, and BOJ Governor Kuroda, some scorn from the sound money people. A more optimistic read is here, from Professor Koichi Hamada. Both sides agree that Japan’s ultimate salvation will be the third arrow, structural reform.

The first task should be to eliminate or, at least, reduce the thicket of government regulations that is stifling economic dynamism – Koichi Hamada

This parallels the debate we have had in the West. The plan was to use fiscal and monetary stimulus to buy time and ease the pain of structural reform. Here in America, with the privilege of issuing the world’s reserve currency, we seem to have dodged the bullet. Quantitative easing alone was sufficient to paper over our structural problems until growth resumed.

Europe will not be so lucky. There, reform is a must. Mario Draghi has been dragging his feet on quantitative easing, citing the moral hazard specifically. Politicians will not tackle reform when times are good, and they expect to be bailed out when times are bad.

We refer here to Japan’s structural trap, instead of the more fashionable “secular stagnation,” because it’s more precise and also because of Robert Dugger’s seminal paper on the topic. The other term, due to Larry Summers, admits no policy action – as if stagnation were inevitable. Specifically, reforms that have been proposed for Japan include:

  • Reduce government regulation
  • Open protected industries (farming) to free trade
  • Reduce the corporate tax rate
  • Overhaul labor protections
  • Encourage more women to work
  • Reform the electricity market

This may read like Ayn Rand’s wish list, but it really is Abe’s third arrow. See interview here, for example. Jeremiah has no doubt it will succeed – if it ever flies. The pundits will then forgive Abe’s preparatory measures. He would become the first politician ever to escape a structural trap (the second, if you count Gerhard Schröder). No one will care how many arrows he used.

See also: Governor Kuroda – Genius or Madman?

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QE Apologia

Now that the Fed has ended QE3, people are starting to evaluate the results. The economist has a roundup of academic studies. Positive findings about QE are generally the “could have been worse” variety. The various studies claim:

  • QE generated some inflation, but not enough
  • It did not generate hyperinflation
  • It did not contribute (much) to inequality
  • The “reach for yield” was justified

The quotation below pretty much sums up Jeremiah’s opinion. We cited hyperinflation as a risk, early on, but the real concern is trillions of new dollars sloshing around equity markets and not creating jobs. Applying the coefficient from a British study, the Fed’s $4 trillion intervention should have generated a roughly 6% gain in output. It didn’t.

QE’s detractors point out that central banks have expanded their balance-sheets by trillions of dollars, yet are still nurturing lackluster recoveries.

The results on inequality and low yields are equivocal at best. People holding financial assets have enjoyed 150% gains, thanks to QE (see chart). But, say the apologists, low yields have also helped people pay their debts. The reach for yield, which has pension funds investing in junk bonds, is justified if it prevents a “catastrophic” breakup of the Euro.


Overall, the collection of studies provides weak justification for such an extreme policy. The Fed has expanded its balance sheet fivefold, and the academics need a microscope to find the upside – plus, a raft of counterfactuals about how terrible sound money would have been.

We find The Economist’s title, “Early Retirement,” especially cynical. In the real world, our kids can’t find jobs, and the grandparents cannot retire. They will work until they die, because QE destroyed their savings.

See also: Of Flat Lines and Derp

Update: Here is a nice, impartial summary of the arguments for and against QE, with the current status. It is too basic for Jeremiah readers, but something to share with the kids. One editorial point – the author says “three problems,” and then lists four. The fifth would be that people with saving accounts are now enemies of the public good. German “strafzins” is best translated as penalty rate.

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Of Flat Lines and Derp

Paul Krugman is here again with his favorite straw man argument. Krugman is smart and everyone else is stupid because QE has not resulted in hyperinflation. He doesn’t say “stupid,” though. He says “derp,” which means “I have statistics which seem to support my prejudices and you don’t.”

InflationApparently, hyperinflation is the only negative outcome recognized by the good doctor. He presents a lovely FRED chart proving his point. CPI has been flattish for six years, while money supply has grown. Can you think of any negative outcomes, other than inflation? Here is one hint, from FT, and another from Jeremiah. The quote below is from an ECB study.

An increase in the monetary base tends to … benefit primarily those on higher incomes, who hold a larger amount of overall savings in equities, and thus benefit from greater capital income.

Krugman’s chart shows only that his prescribed policy has avoided one particular negative outcome. It does not prove that the policy has actually worked, nor does it address the many other negative outcomes. Krugman’s acolytes are nonetheless hailing this one chart as the decisive defense of QE.

So, has the policy achieved its stated goal of increasing employment? Let’s look at another FRED chart. It looks a lot like the CPI chart, doesn’t it? Based only on these two variables, you would conclude that QE has had no effect at all.

EmploymentAt this point, we are obliged to point out that both these charts are bunk because the fivefold increase in money supply is obscuring smaller changes in the dependent variables. Accordingly, we drop it and display only employment and inflation. We already know what the history of QE has been over the period, and now we can see that inflation has indeed risen while employment has remained flat.


Finally, we observe that Krugman, a college professor and an economist of some note, is here coining a childish new term of abuse for his opponents – while engaging in exactly the sort of factless advocacy he presumes to criticize.

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Goodbye, Ben Shalom

ben-bernankeRegular readers know that Jeremiah was for QE before he was against it.  This is actually the consensus view of professional economists – Raghuram Rajan, for instance, since we were just talking about him.  Chairman Bernanke will be remembered for QE #1, which averted a certain disaster.  Subsequent rounds of QE were more risky and less effective.  Before stepping down, Bernanke also began the process of tapering off QE.

It now seems obvious that central banks should have done what they did … restored liquidity to a world financial system that would otherwise have been insolvent

The strong dollar people hated QE from the beginning.  Their fears were confirmed by inflated returns in the stock market.  At the other end of the spectrum, Paul Krugman is still beating the drum for more.  You can’t please everyone.  Bernanke also had a hand in shoring up the euro.

It is often the mundane achievements that turn out to be the most durable.  Chairman Bernanke took huge steps in making the Fed more transparent, with regular statements, published minutes, and quantitative targets.

But no amount of transparency can offset the cultism which now surrounds the Fed.  On Monday, the stock market was idle, as the world waited for the new Chairman’s testimony.  Bernanke retires with a good record, on balance, but there is work to be done.

Chairman Yellen must disabuse Congress, and the world, of their superstitions about the Fed.  Monetary easing is a poor remedy for unemployment, not to mention inequality.  Jeremiah would like to see the new Chairman remind Congress of its own responsibilities, and maybe even question the “dual mandate.”

Update:  Well, that was just embarrassing.  Congress begged the new Chairman for help with unemployment, inflation, mortgage lending, inequality, and the weather.  The price of gold went straight up.

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Inflation at Tiffany’s

AudreyHepburnTiffany’s is having a good year.  Bloomberg attributes the upscale jeweler’s success to a rising stock market and house prices.  If you’re a Fed watcher,  you know that the “wealth effect” is official policy.

Tiffany’s is also raising prices.  That’s the inflation the Fed has been looking for.  It is starting with the rich, logically enough.  This really is trickle-down economics.  Unlike the supply side boom we saw in the 1980s, the Fed’s beneficiaries are not creating any new wealth.  They just happen to be nearer the monetary spigot.

There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.

Now we have populists of all kinds – including the pope – calling for change and denouncing capitalism.  The tragic symptoms are obvious, but is capitalism really the cause?

Lenin (and Keynes) knew that the quickest way to destroy capitalism was to debauch the currency.  It automatically makes the rich richer, and it screws everyone else “in a manner which not one man in a million is able to diagnose.”  Not even the pope.

Update:  We wanted to tweak the pope over his misinformed attack on capitalism, but Matt Welch has done a better job.  Writing in Reason, Welch notes that the political left, which normally dislikes the church because of its stance on abortion, gay rights, and evolution, suddenly loves the pope when he comes out against capitalism.

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Government Is Not the Solution

Last week, we reported on the epiphany of Larry Summers.  In his speech to the IMF, Mr. Summers reluctantly admits our economy has structural problems that stimulus can’t fix.  This was a watershed moment in economic policy.  If you didn’t know from the content, you would certainly know it from the reaction.

Understandably, people want to pillory Summers because much of this failed policy was his idea.  You have to give the guy credit, though, for recognizing a mistake and admitting it publicly.  Less flexible thinkers have been caught off guard.  Paul Krugman is here, rearranging his position so that he continues – retroactively – to have been right all along.

Apparently our structural problems, demographic challenge, and persistent trade deficit are news to Dr. Krugman.  He is still not changing his policy, though.  It just means we’ll need fiscal and monetary stimulus for much longer than expected.

Jeffrey Sachs was more satisfying.  He repeats his call for a new framework to stimulate private investment in new industries – not “the old standard-bearers of housing, cars, and consumer goods.”  This sounds a lot like the restructuring Robert Dugger recommended for Japan.  Coincidentally, the Economist has an update on that.  Japan’s economy is stifled by red tape and bureaucracy.  We are truly following their footsteps, just as Dugger predicted.

There is an investment shortfall because the financial, regulatory, and policy barriers to high-return investments have not been addressed.

Sachs has the most practical solution we have heard, although we are a little wary of public-private investment schemes.  Jeremiah would like to try private-private solutions first.  Japan’s MITI worked well until it didn’t, and central planning in America – except for DARPA ­–has a pretty poor record.

Summers may have been the first to say it out loud, but we find this (emphasis added) in the FOMC minutes from October:

Participants also considered scenarios under which it might, at some stage, be appropriate to begin to wind down the program before an unambiguous improvement in the outlook …

So, the establishment is preparing for an early end to the stimulus – no digging ditches and filling them up, no alien invasion.  We will have to knock down those policy barriers or, as the entrepreneurs say, “get government off my back.”

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