The Fed Thinks of Ways to Claw Back Some of the Stimulus Money: This Will be A Disaster as Congress Will Continue to Spend and Spend.

Abstract: The Federal Reserve acts nervously as if it is suddenly time to pull back some stimulus money before inflation starts up and are considering ways to do so. It apparently has no firm plan and it if did have one this plan would interfere with the massive social spending we get from Congress. We are hopelessly mired in debt to the point where every worker who makes more than $31,000 owes $192,000 in national debt and $7,600 in yearly interest payments on that that debt and we merely print money to pay for that thus monetizing the debt. Our socialist government is determined to ‘spend us’ out of this recession.[1] Such massive deficit spending threatens our currency and ability to handle debt and can only go so far until the money must be clawed back or ‘unwound’ by the Fed. They have no reasonable plan to do so according to a recent article. Even if they had a plan Congress would ignore it as they are determined to spend some 9 trillion dollars more in Obama’s first term. Thus, control of funds, interest rates and capital are confounded with the net effect that our currency will inflate and possible fail. That would bring chaos and probably a civil war.

One of the chief difficulties we encounter in our governmental system occurs where there is a distinct separation of power among government groups as the parts may reflexively interact in different ways with different agendas and achieve something other than the desired collective expected result.  We face the very nasty problem of our currency inflating if and when we get around this deflationary spiral[2] we were in and the debt that lingers on our books.  We don’t know how much the Fed spent and where it went [Bernanke will NOT tell us] so we can only guess and estimate indirectly what they are doing. So, now the Fed wants to sell bonds or other to ‘unwind’ the stimulus monies that supposedly saved us from depression. The Executive Branch wants to spend more. Our economy might collapse from all this.[3]

Here is the situation as I see it and will offer an example of a single house as a demonstrative piece so we can at least think about this mess in a rational way using simple numbers: We can start with a house that was worth $100,000 in 2007 with a $90,000 mortgage that is now worth $65,000.  Clearly, the home was an investment in the usual terms and this generated $10,000 in equity credit to buy TVs, cars and other items as the interest payments could be deducted from income taxes.  Credit is money. Loans made with, say, $5,000 from this asset were performing as the lender was getting monthly payments over some term from 4-8 years. Fine. We can assume that the bank offered the mortgage and that this bank had only one customer.

The bank is now in to this deal at $94,000 less some interest payments over a few years [=90,000-1,000+5,000]. It should be clear at this point that $35,000 in wealth was just lost because there is no way to sell the asset at the original price. The bank is just fine if the homeowner does not default or skip a few mortgage payments. Should the homeowner lose his or her job then the mortgage goes into default and the bank is holding an asset that is worth $65,000 less about $3,000 in foreclosure fees and other expenses, so the bank can expect to get only $62,000 from a distressed sale and take a loss of 94-62 or $32,000 a 34% loss.

The bank’s balance sheet is now very negative and they have a toxic asset they cannot sell. According to mandated federal accounting principles, some of which changed recently[4], the bank’s balance sheet is unquestionably negative and the customary 6% reserves cannot cover this episode.  So, the government steps in and wires the bank $35,000 to put in their capital reserve account so make the balance algebraically positive thus avoiding a bank failure.  Where does this money come from? Some of it comes from TARP [read the taxpayer] and the rest is just ‘printed’ electronically by the Fed or Treasury [again, read the taxpayer]. Luckily for the inflation process this money just rests in the teir-1 capital accounts of the banks and goes nowhere.

Sooner or later the economy might rebound and the house, now owned by the bank, would rise to its original $100,000 price in open markets and then the funds from the Fed would need to be withdrawn.  Operating simultaneously is an amount of ‘stimulus’ money that is being borrowed or printed by Congress to attempt to infuse the economy with new jobs and growth  and essentially replace the lost $32,000 on the house and restore the lost job of the homeowner. Thus, the money supply is increased vastly and when the velocity of the money rises [from commerce, loans to banks and movement from bank to bank] the multiplier is 10 and a mere $1,000 can become $10,000 in 18 months of normal economic activity.  In our bank example the velocity is essentially zero so the multiplier[5] is 1.0. If times returned to normal a loan from this bank would increase the money supply by 10 and that must be stopped by the Fed. A trillion dollars can thus become 10 trillion and our money supply is only a bit above 8 trillion. Our money supply would surge to 18 trillion from its current 8 trillion with massive inflation.

Attempts to provide stimuli lead to disasters like the previous ‘jobs’ program that spent $92,000 per job![6] And, then, we spent $24,000 per car on the Clunker Follies and a mere $43,000 per house on the housing scam. [7] And, none of these had a lasting effect. All of the money to do this was either borrowed or printed up quickie fashion by our government. Attempts to give homeowners a break and relive them of some of their mortgage debt by forcing the banks to change principal or interest rates or both now shows us that the previous refinancing recidivism rates hit 70%[8] but is not apparently considered as evidence of a failed program. This means they will keep on printing money and trying to stuff wealth back in the hands of the ‘poor’ for social and political reasons.  This is a clear demonstration of failed government thinking and action  that can sink our economy in debt. They either don’t know what they are doing or are deliberately wrecking our economy or a combination of both.

This over-simplified example highlights the government’s response to a market bubble. The thinking here is if home equity is lost then the government should just borrow or print up money to restore the wealth in the house somewhere its original value. This would restore equity and thus credit and raise the GDP from consumer spending. Thus the government believes that we should have a zero sum wealth machine that compensates people for occasional market crashes at least in home ownership. The presumed source of repayment for this debt is eventually to tax the rich, but, unfortunately, this group starts at $31,000 and upward so many people who think the ‘rich’ are those who make millions are going to bet a nasty surprise.

On this simple unit scale example [this one homeowner plus a spouse that works] we then must note that the National Debt is now 12 trillion dollars and rising soon to 14 so the pair is in debt a sum of 2 x $192,000 or $384, 000 because there are only 65 million workers who pay most of the federal income tax [those with incomes of $31,000 and up] and a trillion dollars in debt is thus $16,000 [1 trillion divided by about 65 million] per taxpayer per trillion dollars and 16 x 12 is $192, 000.  On top of this is state and consumer debt that makes the numbers higher but this must be ignored to simplify the situation for illustrative purposes.  So, what do they intend to do?

“Dec. 31 (Bloomberg) -- Federal Reserve officials are considering a proposal to schedule limited sales of bonds from the central bank’s $2.2 trillion balance sheet as part of a range of tools for withdrawing record monetary stimulus.”[9]-- Fed Discusses Limited Bond Sales to Withdraw Stimulus (Update1) By Craig Torres

In the new book This Time is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth Rogoff there are comments about off-balance sheet spending but no numbers at least in the preface of this book I am just starting to read. The Social Security system was put off-budget so FDR could tax the public and it wouldn’t appear in the budget and be a threat to politicians of the New Deal and he could actually borrow money from this system and use it for political reasons. This is a Ponzi scheme, of course, and the politicians got away with it because of their promises to a later generation. Presumably we know how much money is collected form FICA and FICM and such and that the SS system is going broke and will hit the zero balance point [where the outflow is equal to the tax revenues] in only 5 years then taxes will have to be raised. We have no idea how the Fed got a $2.2 trillion balance sheet or how much they spent since September 2008. One article by CNBC[10] thought our Fed spent 7.36 trillion dollars as of Nov. 17, 2008 and scattered it around the world. We cannot find out where this money went.  The fed balance sheet does not show this.[11] Our money supply, M2, is only about 8.4 trillion now. [12] We spent 600 bln on some GSE MBS NO NAME Program, whatever that is.

“Chairman Ben S. Bernanke is trying to wind down emergency stimulus programs that helped avert a second Great Depression, while alleviating concerns that inflation will accelerate as the economy picks up. U.S. Treasury securities posted their worst performance since the 1970s after the Obama administration borrowed record sums to help drive the rebound from recession.”-- Fed Discusses Limited Bond Sales [Emphasis is mine in all quotes.]

““Here is the worry: What if they try to tighten and they lose control of the federal funds rate?” said Mark Spindel, chief investment officer of Potomac River Capital LLC in Washington, which specializes in inflation-linked bonds. “The challenge they have is to articulate how they are going to tighten and make sure all these tools work together.””-- Fed Discusses Limited Bond Sales

The Fed has to compete with Freddie Mac and other groups and the 10-year T bonds are just under 4% now and will probably rise. [The 10-year bond usually sets the price of capital.] They have been buying up mortgage backed securities lately and trying to keep interest rates as low as possible to encourage house buying and thus increasing the market value of the average house. A miscue then puts business capital at a higher cost and this would prevent hiring new employees.  Small businesses, which make up nearly 70% of all new jobs, cannot make up a coherent 1, 2 or 5 year business plan because of the new healthcare taxes and a myriad of other unknown costs. Higher interest rates would just add more to the middle lines of the business balance sheet and discourage hiring. The phony PPIP [Public-Private Investment Program conjured by Secretary of Treasury Tim Geithner, who offers us lies[13] about the strength of the dollar[14]and cheated on his taxes] fizzled out because there was no way to price toxic assets.[15] Any error here would either stuff excessive taxpayer-funded capital into the banks or sink the banks or do nothing. This idea was a joke but the toxic assets still hang around like anxious buzzards waiting to erase some more capital when they can. This is a result of Congressional ‘affordable housing’ programs for ‘the poor’ and cost us probably 10-15 trillion already. This  ‘affordable housing’ was some obvious social mandate and Congress passed the CRA [Community Reinvestment Act][16][17] that resulted in AAA rated 2007 subprime mortgage bundles descending only 28 cents on the dollar.[18] Lower rated bundles are less than 5 cents on the dollar. Good bye.

There are some major problems with this kind of socialist thinking:

[1] The general ideal that the administration can fix prices and ‘spread around’ the wealth is a joke that has never been proven except in little places like Sweden or Norway who have strong revenues from the dirty gun business [Sweden] or North Sea Oil [Norway] or the dirty money business as in Switzerland. Places like Russia with vast natural resources have bungled the job for centuries. Governments have never efficiently run businesses except in the case of Fascist governments during a depression. They don’t have the skills to micromanage business so they must watch and closely control business leaders using fascism[19] as they do in China and Japan. Governments, as such, surrender an enormous amount of supremacy to others in cases like these and risk losing control of major blocks of power.

[2] The general idea that you can spend and spend and encourage debt to close to countries GDP as we are doing [14 trillion GDP and 12 trillion debt] sounds alarms all around the world especially in the IMF and with credit agencies. California[20][21][22] will show us the folly of excessive spending as they will certainly default unless Washington throws them some money from the pile of printed dollars and then other states like NY, NJ, MD, MI and others will beg for alms.

“The Fed is developing tools that can help take reserves off the market. This week, the Fed proposed selling term deposits to banks, which would remove reserves from the day-to-day trading market, locking them up for as long as six months.

The New York Fed began this month testing reverse repurchase agreements as another way to pull cash out of banks. In a reverse repo, the Fed contracts to sell and repurchase securities over a set period, draining cash from the banking system.”-- Fed Discusses Limited Bond Sales

[3] The first thing wrong with these measures to claw back stimulus money is that the Executive Branch wants to spend more so where does the money come from? The government thinks they can ‘rescue’ the automobile industry by seizing the assets, cropping the investment of bond holders and then designing new green cars and things will become normal. They also think they can ‘create’ new jobs by taxing energy [adding to business middle lines thus reducing profits] and financing windmills and other projects. The faulty thinking here is that they are endorsing energy sources that have much higher costs than existing energies so the markets are backward.

“Fed officials are considering the sequence for using their various tools for withdrawing monetary stimulus. They may start by raising the interest on reserves rate and draining reserves, followed by asset sales, Meyer said in a Dec. 15 research note.”-- Fed Discusses Limited Bond Sales

Or, if you think about these alternatives you can conclude that they don’t know what to do. But, be sure that cutting taxes for small businesses to encourage hiring is the very last thing they might try. Look out for roaring inflation.

There is where we are with the left: hopeless.

rycK

Comments: ryckki@gmail.com

[12] M2 is now exactly 8.392 trillion  http://www.federalreserve.gov/releases/h6/Current/