From: vince farrell
Sent: Sunday, February 24, 2008 8:27 PM
The Federal Reserve was established in 1913 after a series of bank failures brought the economy to its knees. It was given the dual charter of promoting growth and maintaining price stability. The European Central Bank (ECB), a much later creation, is focused on price stability alone, and, thus, its maniacal preoccupation with inflation. The Fed is actually 12 banks across the U.S. and its importance to the economy comes from its ability to make money available, or not available.
The Fed Funds rate is the interest rate the Fed can control. It is the rate that banks borrow from one another on an overnight basis. Such loans are needed since a banks daily operations requires a certain amount of liquidity on hand to stay within federal guidelines. The Fed Funds rate is now 3%, down from 5.25% a short while ago. Not so many years ago the Fed didn't announce its target and we were left to figure it out by watching the Fed in its "open market operations."
When the Fed wants to lower the Fed Funds rate it goes into the market and buys govenment bonds from banks that hold them. The Fed "makes an offer they can't refuse" in that the price they are willing to pay is a touch better than otherwise existed before they entered the market. The Fed creates money by writing a check for the purchase of the bonds and the bank that was the seller is now left with cash to invest. As the Fed keeps buying, cash builds up and because there is more cash to be let out, interest rates come down. When the Fed wants to raise rates it does the opposite. It sells bonds at an attractive enough price to attract demand and takes the cash tendered in payment for the bonds out of circulation, thereby making fewer dollars available for loans and raising rates.
As mentioned, the Fed has been lowering rates by buying bonds and pumping cash into the economy. The supply of money has been growing. One measure of money is a thing called M2. It measures cash and money in demand accounts, like checking accounts. M2 has grown by $140 billion in the last four weeks, which is a lot. The growth rate for M2 is up to 11%. MZM, which is "money with zero maturity", or cash (why not just call it cash?) is growing at a 20% clip.
One fly in the ointment is the Fed cannot force banks to lower rates in line with the decline they have architected in the Fed Funds rate. Banks are quick to pass along higher rates, but notoriously slow to lower rates as rapidly. Since the Fed started this round of cuts, some rates have actually increased as banks are taking advantage of the lower cost of funding to loan out at more favorable terms and attempt to repair the damage created by all the writeoffs. There is nothing the Fed can do about that. Also, if lowering rates doesn't stimulate demand by potential borrowers, the Fed is said to be "pushing on a string."
Generally, the process works. The Fed tends to move gradually and tries to gauge the reaction to each step in the process. Right now the emphasis is on stimulating loan demand, but the second mandate, price stability (inflation) is never far from the Fed Governors minds, thus the generally cautious approach.
So sorry to have done this to you on a Monday morning. As a reward for having read all of this eye-glazing stuff, let me tell you a true story. I am not clever enough to make this up. I was at the gym, and a pal named Biff came up. The conversation:
Biff (to Farrell): Do you write a lot ?
Farrell: Well, I write some.
Biff: Well, do you have to use a lot of verbs? I have to write an article and I don't know a lot of verbs.
Farrell: (increduously) Verbs come in real handy some times, Biff.
Voice from the back of the locker room: Biff, just put "ing" on any word and it's a verb.
Biff: I can do that. (and off he went as happy as a man could be)
And I pay money to belong to this gym.
From: vince farrell
Sent: Monday, February 25, 2008 7:14 AM
From: vince farrell
Sent: Monday, February 25, 2008 7:14 AM
Fannie and Freddie report earnings this week and, hopefully, we will get a better fix on the sub prime crisis.Both are expected to report big losses and Merrill downgraded both to a "sell" on Friday.These companies acquire mortgages and keep some, sell some, and guarantee the payments on those they package and sell as Collateralized Whatever's. I doubt we will see any relief but let's pull the results apart when we get them.
American International Group also reports this week and the company already said there would be a 5.2 billion dollar accounting write-off. Investors will be watching to see if that's all.
Gentle Ben testifies Wednesday before the House Financial Services Committee. The January Producer Price Index is reported Tuesday and a gain of .4% for the headline number is expected ,and +.2% for the core (ex food and energy.) On Thursday, the Q4 GDP will be revised and look for the original gain of +.6% to be raised a little due to the better export number that was reported with the trade deficit a short while ago.
The point to this list is that there is very little hope for meaningful good news this week, BUT, if stocks decide to do well without good news, then that is the good news.
Another way of looking at things was detailed in a very interesting article in Sundays NY Times business section. The author, Mark Hulbert, quoted a study by Owen Lamont of the International Center for Finance. Lamont has constructed a gauge that measures the percent of all publicly traded shares that began their life in the last 36 months.The proportion increases as new issues come to market, a sign of enthusiasm. The all-time high was 15% in 1929, at the beginning of the Great Depression. The second highest was 11% in March, 2000, just as the Internet bubble burst.
The ratio is now 5.1%, in line with the long term average. When the market was at its recent high in October of last year the percentage was 5.6%. This level has generally allowed above average returns in the subsequent years. Hopefully, that is correct, but at least by this measure the market is far from exuberantly valued.
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