Shadow Open Market Committee meets today - position papers available

The second semiannual meeting of the revamped Shadow Open Market Committee (SOMC) will be meeting later today, Wednesday afternoon, September 30, 2009 at the Cato Institute in Washington, D.C. The focus for this meeting will be "Exit Policies for Sound Central Banking." Position papers are now available. In other words, how and when should the Federal Reserve unwind all of the current monetary stimulus that it has pumped into the financial system. The symposium will run from 12:30 p.m. to 5:15 p.m. with a reception to follow. Registration and check in is at noon. Advance registration is advised since space is limited, but you can watch the event live from the symposium page.

Position papers are now available.

The quick summary of the symposium is:

The SOMC would like to invite you to a September 30, 2009, symposium on appropriate exit policies for the Federal Reserve, European Central Bank' and other leading central banks. This meeting will begin with a panel discussion on pressing issues facing global monetary policies, featuring Donald Kohn, vice chairman of the Federal Reserve and Athanasios Orphanides, Member of the Governing Council of the European Central Bank. A guest lecture will be presented by former SOMC member William Poole. Position papers will be presented by SOMC members Charles Calomiris, Michael Bordo, Bennett McCallum, Marvin Goodfriend, Gregory Hess, Mickey Levy and Anna Schwartz. The audience will be encouraged to participate in the discussions.

The papers to be presented by the committee members are:

Michael Bordo, The Fed's Monetary Policy during the 1930s: A Critical Evaluation

Charles Calomiris, Reassessing the Role of the Fed: Grappling with the Dual Mandate and More?

Marvin Goodfriend and Bennett McCallum, Exiting Credit Policy to Preserve Sound Monetary Policy

Gregory Hess, Fannie and Freddie: The Houseguests that Just Won't Leave

Mickey Levy, Macroeconomic Policies and the Economy

Anna Schwartz, Restoring Monetary Sensibility

Some of those position papers are already available online, either through the linked titles above or on the SOMC web page at Claremount McKenna College.

Bill Poole's lecture is entitled "Exit Policies from the Financial Crisis -- To What?". Currently a senior fellow at Cato, Bill was president of the Federal Reserve Bank of St. Louis. Before that as a Professor of Economics at Brown University he had been a member of the original Shadow Open Market Committee.

"The Shadow" is a small group of economists who meet periodically to present papers on and discuss various aspects of the economy and monetary policy that are relevant to the Federal Reserve in general and the Federal Open Market Committee in particular.

The goal of the SOMC, as stated on their old web site, was that:

The Committee's deliberations are intended to improve policy discussions among policy makers, journalists and the general public with the hope that wiser policy decisions will result.

The web site has not been updated since May 2006, so the SOMC "charter" may have changed, but I suspect not.

As the old web site says, "The SOMC is an independent organization whose members are drawn from academic institutions and private organizations." The SOMC is mostly academic, and certainly nobody currently in the government, although members of the SOMC have gone on to join the Federal Reserve and former Federal Reserve officials and employees have joined the SOMC after leaving government employment.

Previous members continuing on the "new" SOMC are Professor Gregory Hess of Claremont McKenna College, Mickey Levy of Bank of America, Professor Bennett McCallum of Carnegie Mellon University, and Anna Schwartz of NBER.

The new SOMC members are Professor Michael Bordo of Rutgers University, Professor Charles Calomiris of Columbia University, and Professor Marvin Goodfriend of Carnegie Mellon University.

There is a new web page for the committee at Claremont McKenna College, but it has not yet been updated for the upcoming meeting. The papers from the April meeting are still there for download.

I have been attending the SOMC as an observer since... longer than I can remember... since about 2000.

The first SOMC meeting was back in September 1973. The SOMC was founded by Prof. Karl Brunner of the University of Rochester and Prof. Allan Meltzer of Carnegie-Mellon University.

For those of us into economics, finance, monetary policy, and fiscal policy, it will be an exciting afternoon.

It is always interesting to listen to the form of questions asked by "the media."

See the Cato web site for details on attending.

-- Jack Krupansky

ECRI Weekly Leading Index rises sharply and indicates an imminent economic recovery

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose sharply by +1.33% vs. +0.10% last week, and its annualized growth rate rose sharply from +22.9 to +24.3 and has surged to "a 60-week high", and its distinct upturn strongly suggests that recovery is on the way.

This was the fourteenth consecutive positive reading for the WLI growth rate.

The WLI has risen for 25 of the past 28 weeks.

The WLI has now recovered to its level at the end of July 2008. That is a major recovery, but also highlights that the economy has a long way to go to get back to "normal", whatever the "new normal" really is, especially given all of the economic distortions of the years that led up to the financial crisis.

According to ECRI, the recovery is "unstoppable"  and there are "no relevant roadblocks" to a sustainable recovery, and that "With WLI growth climbing to a fresh record high, the economic recovery is far from fragile."

My personal outlook is that: The recession of the U.S. economy that started in December 2007 and sharply accelerated in August 2008 finally looks as if recovery will be firmly underway within the next few months.

Although a double-dip recession or "W" recovery cannot be completely discounted, it is becoming quite clear that the overall U.S. economy is on the verge of positive growth of spending and output, even if unemployment is still problematic.

I did watch a recent video in which ECRI insisted that a double-dip was definitely not in the cards based on the strength of the bounce in the leading indicators.

Although quite a few, but not all, of the current economic reports continue to show significant weakness, there is also a vast amount of potential stimulus (especially from the Federal Reserve) in the pipeline that could kick-start the economy within the next couple of months. Please keep in mind that we could continue to see further employment losses or gains in unemployment even as recovery is underway.

-- Jack Krupansky

Richard Posner: How I Became a Keynesian

This is primarily a mental note to myself to eventually read the article by Richard Posner in The New Republic entitled "How I Became a Keynesian - Second Thoughts in the Middle of a Crisis". I started reading it and it has some great insight, for example:

The General Theory is full of interesting psychological observations--the word "psychological" is ubiquitous--as when Keynes notes that "during a boom the popular estimation of [risk] is apt to become unusually and imprudently low," while during a bust the "animal spirits" of entrepreneurs droop. He uses such insights without trying to fit them into a model of rational decision-making.

This seems to be a good summary from the first page of the article:

We have learned since September that the present generation of economists has not figured out how the economy works. The vast majority of them were blindsided by the housing bubble and the ensuing banking crisis; and misjudged the gravity of the economic downturn that resulted; and were perplexed by the inability of orthodox monetary policy administered by the Federal Reserve to prevent such a steep downturn; and could not agree on what, if anything, the government should do to halt it and put the economy on the road to recovery. By now a majority of economists are in general agreement with the Obama administration's exceedingly Keynesian strategy for digging the economy out of its deep hole. Some say the government is not doing enough and is too cozy with the bankers, and others say that it is doing too much, heedless of long-term consequences. There is no professional consensus on the details of what should be done to arrest the downturn, speed recovery, and prevent (so far as possible) a recurrence. Not having believed that what has happened could happen, the profession had not thought carefully about what should be done if it did happen.

Baffled by the profession's disarray, I decided I had better read The General Theory. Having done so, I have concluded that, despite its antiquity, it is the best guide we have to the crisis. And I am not alone in this judgment. Robert Skidelsky, the author of a superb three-volume biography of Keynes, is coming out with a book titled Keynes: The Return of the Master, in which he explains how Keynes differed from his predecessors, the "classical economists," and his successors, the "new classical economists" and the "new Keynesians"--and points out that the new Keynesians jettisoned the most important parts of Keynes's theory because they do not lend themselves to the mathematization beloved of modern economists. Skidelsky's summary of what is distinctive in Keynes's theory is excellent.

-- Jack Krupansky

The Continued Risk of Troubled Assets

This is primarily a mental note to myself to eventually read the August 11, 2009 Congressional Oversight Panel report on The Continued Risk of Troubled Assets. Despite all of the hype, fearmongering, and general dis/mis-information floating around about the financial crisis, this report has a lot of hard, factual background.

Personally, as frightening as "troubled assets" sound, my view is that the goal is to get the economy going again and then a vast swath of these "troubled" assets will lose a lot of their risk. Sure, a double-dip into a deeper recession would spell a lot of trouble for the troubled assets, but as someone once famously said... It's the economy stupid! The Federal reserve has two big jobs right now: 1) provide financial "support" for the banks so that they can limp along despite the burden of "troubled assets", and 2) provide money to boost the general economy so that the troubled assets are actually productive assets for the banks.

The real solution is not to dump the "troubled assets", but to modify the terms of so many of the underlying mortages so that the risk is actually reduced and the assets are no longer "troubled".

In summary, my view is that the main focus should be on getting the economy on track since the risk to any mortgage-based asset is that so matter how solid a mortgage looks, its risk shoots through the roof when the homeowner loses their job for an extended period of time.

For the longer term, we need to come to grips with the fact that the banks were unable to recognize and adjust for the fact that the were holding assets that were over-valued due to to an asset bubble. Dealing with asset bubbles is an unsolved problem.

In any case, I wish I could find the time to study that report.

-- Jack Krupansky

Monthly GDP for July ROSE by +0.3% (+4.3% annualized), Q3 tracking for a +3.3% annualized gain

Monthly real GDP, one of the five primary economic indicators that the NBER Business Cycle Dating Committee (NBER BCDC) uses to judge recession start and end dates, rose moderately in July by +0.3% or +4.3% annualized, after a -0.1% decline in June, and real Q3 GDP is forecast to rise by +3.3% annualized, according to Macroeconomic Advisers (MA). The government does not publish GDP data at a monthly level, but the NBER Business Cycle Dating Committee says that they refer to sources such as Macroeconomic Advisers (MA) and their MGDP data series. As Macroeconomic Advisers summarized GDP for July:

Monthly GDP rose 0.3% in July and was in line with the nearly flat trend exhibited since January.  The July increase was roughly accounted for by nonfarm inventories, whose drawdown in July was much smaller than in June.  Within final sales, an increase in domestic demand was just offset by a decline in net exports.  The level of monthly GDP in July was 0.9% above the second-quarter average at an annual rate.  We expect monthly GDP to continue to trend higher, marking June as the last recession month.  Average monthly increases of 0.6% per month in August and September would support our latest tracking forecast of a 3.3% annualized increase of GDP in the third quarter.

This report effectively "calls" the end of the recession as June: "We expect monthly GDP to continue to trend higher, marking June as the last recession month."

This one report does not necessarily herald the return of happy days for everyone, but at least it is not indicating a worsening of the trend.

Annualized real GDP in July was at roughly the same level as in February 2006, which is 4.42% below the peak GDP in June 2008 and 3.77% below GDP at the start of the recession in December 2007.

If the NBER BCDC is the definitive expert on marking of recessions, MA is the definitive expert on calculating real GDP at the monthly level with their MGDP data series.

-- Jack Krupansky

ECRI Weekly Leading Index rises modestly and indicates an imminent economic recovery

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose modestly by +0.16% vs. +0.48% last week, and its annualized growth rate rose modestly from +22.5 to +22.9 and has surged to "a fresh record high", and its distinct upturn strongly suggests that recovery is on the way.

This was the thirteenth consecutive positive reading for the WLI growth rate.

The WLI has risen for 24 of the past 27 weeks.

The WLI has now recovered to its level in mid-September 2008. That is a major recovery, but also highlights that the economy has a long way to go to get back to "normal", whatever the "new normal" really is, especially given all of the economic distortions of the years that led up to the financial crisis.

According to ECRI, "We have never wavered on our call precisely because at this stage of the cycle there are no relevant roadblocks", referring to concerns over rising unemployment, the lack of job growth, debt levels of consumers, and worry about a possible double dip in the economy. They also said that "Variations of these fears have existed at this stage of the last 20 business cycle recoveries spanning over a century."

Last week ECRI said that "We expect non-manufacturing employment -- which is where 91 percent of us work -- to be positive by year end", and "We are talking about recovery that includes jobs growth in the non-manufacturing sector, and we are talking about a recovery that includes increases in consumer spending. So, in spite of the fact that many people look at this recession as being unprecedented and unlike any other, what we're seeing in our indexes is that there are a lot of similarities to previous recessions and recoveries."

My personal outlook is that: The recession of the U.S. economy that started in December 2007 and sharply accelerated in August 2008 finally looks as if recovery will be firmly underway within the next few months.

Although a double-dip recession or "W" recovery cannot be completely discounted, it is becoming quite clear that the overall U.S. economy is on the verge of positive growth of spending and output, even if unemployment is still problematic.

I did watch a recent video in which ECRI insisted that a double-dip was definitely not in the cards based on the strength of the bounce in the leading indicators.

Although quite a few, but not all, of the current economic reports continue to show significant weakness, there is also a vast amount of potential stimulus (especially from the Federal Reserve) in the pipeline that could kick-start the economy within the next couple of months. Please keep in mind that we could continue to see further employment losses or gains in unemployment even as recovery is underway.

-- Jack Krupansky

Money market fund guarantee program ends today

Back at the peak of the financial crisis people were even starting to panic about supposedly ultra-safe money market mutual funds after one of them actually did the unthinkable and "broke the buck". In a successful effort to head off the panic, the U.S. Treasury instituted "a temporary guaranty program for the U.S. money market mutual fund industry" on September 19, 2008 which covered all balances at U.S. money market funds as of that date: "the U.S. Treasury will guarantee to investors that they will receive $1 for each money market fund share held as of close of business on September 19, 2008." That initial guarantee was scheduled to last through April 30, 2009, but was eventually extended "through September 18, 2009." That is today. So, after midnight tonight that guarantee program will no longer be in effect for your money market mutual funds.

Please note that this guarantee program is for money market mutual funds, not money market accounts or other savings account at banks which are FDIC-insured.

The good news is that despite many lingering problems and economic weakness, the overall financial system is in much better shape than a year ago. Also, the Federal Reserve has a temporary support program for commercial paper, which is a key component of most money market funds. And, just about everybody is much more carefully monitoring the quality and risk of assets purchased by money market funds. In fact, the incredibly small yields on money market funds are driven in large part by the refusal of virtually all money market funds to hold anything but very low risk assets, such as those covered by the Federal Reserve commercial paper program or of similar quality.

The bottom line is that money market funds are much safer than a year ago, even without a guarantee program. Besides, if we ever get another crisis comparable to (or worse than) that of a year ago, I am sure that the U.S. government would once again step in with a comparable temporary guarantee program.

I keep most of my idle cash in FDIC-insured bank savings accounts due to their much higher yield, but I do not lose any sleep about my remaining cash that is in Fidelity money market funds, either with the guarantee or with the prospect that the Treasury guarantee is "here today and gone tomorrow", literally.

-- Jack Krupansky

FDIC launches a foreclosure prevention initiative

The U.S. government has tried to implement a number of different initiatives to help consumers with their mortgages in the current financial and economic crisis. These initiatives have helped, but not as much as would have been hoped. Now, today, the FDIC is launching a new foreclosure prevention initiative. How much this latest initiative helps will remain to be seen. There are probably other initiatives in the pipeline, but given the glacial pace of government bureaucracies, it could be awhile before the full force of all of these initiatives is felt by the average consumer having mortgage problems.

The new announcement says:

The FDIC is launching an initiative to help consumers and the banking industry avoid unnecessary foreclosures and stop foreclosure "rescue" scams that promise false hope to consumers at risk of losing their homes. This initiative includes outreach, referral services, and an information tool kit. Raising consumers' awareness of foreclosure "rescue" scams will give borrowers more confidence in knowing they are working with legitimate counselors and servicers to obtain a loan modification that could help them avoid foreclosure.

The main elements of this latest initiative are:

• Outreach events for bankers and consumers.
• A telephone and Internet referral service via the FDIC's Call Center at 1-877-275-3342 or www.FDIC.gov, which directs consumers to legitimate counselors, mortgage servicers, and state and federal law enforcement agencies.
• An information tool kit that is available at http://www.fdic.gov/foreclosureprevention.

That may not sound like much, but it is just one piece of the overall big picture.

-- Jack Krupansky

ECRI Weekly Leading Index rises moderately and indicates an imminent economic recovery

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose moderately by +0.64% vs. +0.23% last week, and its annualized growth rate rose moderately from +20.8 to +21.3 and has surged to "an all-time high that points to a more vigorous recovery than consensus has shown", and its distinct upturn strongly suggests that recovery is on the way.

This was the twelfth consecutive positive reading for the WLI growth rate.

The WLI has risen for 23 of the past 26 weeks.

The WLI has now recovered to its level in mid-September 2008. That is a major recovery, but also highlights that the economy has a long far to go to get back to "normal."

According to ECRI, "The rise in WLI growth to a record high reinforces our earlier forecast that at least the early stage of the current economic recovery will be more vigorous than the last two."

ECRI also said that "We expect non-manufacturing employment -- which is where 91 percent of us work -- to be positive by year end."

And ECRI said that "We are talking about recovery that includes jobs growth in the non-manufacturing sector, and we are talking about a recovery that includes increases in consumer spending. So, in spite of the fact that many people look at this recession as being unprecedented and unlike any other, what we're seeing in our indexes is that there are a lot of similarities to previous recessions and recoveries."

My personal outlook is that: The recession of the U.S. economy that started in December 2007 and sharply accelerated in August 2008 finally looks as if recovery will be firmly underway within the next few months.

Although a double-dip recession or "W" recovery cannot be discounted, it is becoming quite clear that the overall U.S. economy is on the verge of positive growth of spending and output, even if unemployment is still problematic.

I did watch a recent video in which ECRI insisted that a double-dip was definitely not in the cards based on the strength of the bounce in the leading indicators.

Although quite a few, but not all, of the current economic reports continue to show significant weakness, there is also a vast amount of potential stimulus (especially from the Federal Reserve) in the pipeline that could kick-start the economy within the next couple of months. Please keep in mind that we could continue to see further employment losses or gains in unemployment even as recovery is underway.

-- Jack Krupansky

Greenspan is right, there will be more financial crises in our future

A Reuters article entitled "Another financial crisis inevitable: Greenspan" reports on a speech by former Federal Reserve Chairman Alan Greenspan on the inevitable prospects for future financial crises. Greenspan is of course correct when he says that "crisis will happen again" and that the cause will be "the unquenchable capability of human beings when confronted with long periods of prosperity to presume that that will continue." In other words whenever "investors" once again start treating risk as irrelevant, the foundations of our financial system will once again begin to crumble. He correctly fingers the prime culprit as speculation as he says that "human beings begin to take speculative excesses with the consequences that have dotted the history of the globe basically since the beginning of the 18th and 19th century." Why can't we cure this speculative urge? Human nature. Greenspan says "It's human nature: unless somebody can find a way to change human nature we will have another crisis."

Sure, we can change the rules and regulate the dickens out of our financial system, but human nature and the attendent desire to speculate will always lead people to figure out how to game the system in ways that no human rules could have necessarily predicted.

Sure, we can "fix" the banking system, but the next big crisis will probably be somewhere else, somewhere where we didn't expect it. As Greenspan says, "crisis will happen again but it will be different."

A second problem of human nature as I see it is simply "monkey see, monkey do." If only one firm utilized some exotic financial practice the impact on the overall system could be easily contained, but once one firm is wildly successful at cheating fate, all of the other firms go into copycat mode and then a non-threat rapidly becomes a systemic issue.

What he did not say explicitly is that the best way to deal with these unpredictable and unknowable crises is the infamous "Greenspan Doctrine" where rather than figure out how to avoid the crisis in advance we simply focus on having the flexibility and resources to clean up the mess after it happens.

What about all of the experts who predicted this crisis? As the old joke goes, Economists have predicted nine of the past five recessions. In other words, there are always a subset of economists and analysts who are predicting impending doom, but most of the time they are flat out wrong. Trying to isolate and determine which tiny subset of doomsayers are correct this or next time is quite the fool's errand.

I say stick with the Greenspan Doctrine, but at least make some attempt to highlight asset prices that are way out of whack. Of course, even Greenspan tried to do that once with his infamous "irrational exuberance" comment which fell on quite deaf ears. Still, the concept deserves another crack. People really do need to be aware when risk is rising even if perception of risk is falling. A strictly quantitative measure is appropriate even if the rhetoric of risk does not ring clear in our minds.

Now, whether the next big crisis is in 10, 20, 25, 50, or even 75 years is of course complete speculation. Sure, we will have plenty of mini-crises along the way as people continue to thrill to stressing the limits of our system, but hopefully we will continue to have enough flexibility and resources in the government's financial arsenal to counteract the whims of human nature.

-- Jack Krupansky

More thoughts to add to the Krugman discussion

I had a few more thoughts related to Paul Krugman's article in The New York Times (Magazine, it turns out) entitled "How Did Economists Get It So Wrong?" and my own response.

First, in addition to the fields of study I listed, namely, economics, finance, banking, the Federal Reserve and money, non-bank financial system, and overall financial system, I would add a few more:

• Accounting
• Management science and how businesses are structured, controlled, and operated
• Risk management
• Insurance
• Derivatives
• Commodities as an asset class rather than just a real resource
• Real estate

The special role of hedge funds needs to be "covered", but does not fit into any neat category. The issue is simply size and when the dollar value of hedge funds suddenly becomes the tail that can wag the dog. See also predatory capital below.

The special role of leveraging needs to be "covered" as a systemic risk, but does not fit into a particular field of study or specific models of the overall financial system.

I am not sure how to categorize what I would call predatory capital which is a very destructive force in our financial system. Typically in comes in the form of hedge funds, but can also come from in-house proprietary trading desks at large financial institutions. It includes:

• Large-scale short-selling of stock to attack, damage, and even destroy companies without offering any productive value to society.
• Large-scale derivative bets that have the potential of severely damaging or even destroying the collective counter-parties.
• Large-scale leveraged buyouts which damage the financial health of the target companies, such as causing them to take on enormous debt loads.

The mis-marketing of auction-rate securities (ARS) as the equivalent of money market mutual funds is just one example of information mismanagement, which can cripple all or part of the financial system. Brokers in the field were misled to believe that ARS were as good as money market funds when that simply was not the case. Brokerage customers were then in turn misled, but it was the internal mismanagement of information that initiated the problem. Sure, the fine print, or at least some of it, was there, but brokers were misled to believe that it could safely be ignored. Traditional money market funds also have this problem, but the failures last year were limited and the U.S. Treasury introduced a temporary guaranty program, but that expires this month. All of us money market fund investors sincerely believe that the fund managers will make good no matter what, but the simple fact is that there is no FDIC-like program in place for money market funds. This constitutes information mismanagement and will likely become a problem someday. Fund managers are basically perpetrating a fraud and government regulators are permitting it. ARS was relatively small, but money market funds are a very large portion of money, capital, and credit.

-- Jack Krupansky

More thoughts on Krugman and "economists"

Although Paul Krugman's article in The New York Times (Magazine, it turns out) entitled "How Did Economists Get It So Wrong?" seems to fall short of its intended mark, it does succeed quite well at opening up a giant can of worms and encourage people to take a look at what is in "there." The first big question is where "there" really is. Nominally, the article is about economists, which is true enough, but his discourse quickly takes a lot of detours.

I am still gathering my own thoughts, but one thing that appears to be crystal clear: the current financial crisis was a failure of the financial system and its regulation and not economics per se.

There are distinct and separate fields of study:

• Economics
• Finance
• Banking
• The Federal Reserve and money
• Non-bank financial system
• Overall financial system

In fact, as far as I know, there are not even formal fields of study for the latter two critical elements of our economy.

So, a key isue is that there is very little overlap or interaction between the study of economics, finance, and banking.

• The overall economy assumes a stable banking and investment banking system.
• Financial evaluation of assets assumes a relatively stable economy and banking system.
• Banking is supposed to assume that the economy wobbles between boom and bust and asset pricing wobbles between overvalued and undervalued.

There is indeed a common thread that connects all of the fields of our economy and financial system: money. Technically there are multiple threads, with the three most important being:

• Money
• Capital
• Credit

The simple fact is that most subfields of economics assume that money, capital, and credit are stable and ample.

Economists are not complete idiots. They do know that without stable and ample money, capital, and credit the whole economy and financial system grinds to a halt.

That is what happened. There was no way for a pure economist to know in 2007 or 2006 or 2005 that in September of 2008 our entire system of money, capital, and credit would essentially grind to a halt.

But if you had bothered to ask any card-carrying economist back in 2005 or 2006 or 2007 what would happen to the economy if the supply of money, capital, and credit were to completely dry up, every economist, no matter what his stripe would have been able to quickly tell you that of course the whole economy would grind to a halt.

Now if you had asked economists whether they believed that there was a significant risk that the supply of money, capital, and credit might completely dry up in, say, 2008, they would have easily and quickly told you two things: 1) they wouldn't know since finance and banking are not areas of expertise for economists, and 2) it would be highly unlikely since the Federal Reserve would never let that happen.

Sure, there are gold bugs and so-called Austrian economists who would tell you that our system is doomed to repeated crises, but these people have so set up themselves to be isolated from the mainstream that they have essentially no credibility in the mainstream. As the saying goes, even a stopped watch is right twice a day.

Now to be fair, most economists know a little (or more) about finance and banking and financial analysts know a fair amount about economics and banking and bankers know a bit about economics and asset prices, but the general rule is still that each is an expert in there own field and not usually completely on top of the gory details of the other fields. And nobody appears to be an effective expert on the interlinked system of money, capital, and credit.

Now, it it does happen that there was plenty of scuttlebut circulating in 2006 about shady practices in banking and finance, specially with mortage rules, securitization, and leveraging, but the truth is that none of that would fit into any of the formal models used by economists, other than if they were to question a key assumption: are there forces at play that might undermine complete confidence in money, capital, and credit. If people had focused on factors that can impact money, capital, and credit, then maybe the crisis could have been averted.

Or, maybe if the Federal Reserve had a lot more power and a lot more ready capital, the Fed could have more instantly been able to step in and cover supply disruptions in money, capital, and credit, rather than the slow, gradual, piecemeal approach they were forced to use which did in fact work but with such dramatic lags that disruptions in the financial system were quickly able to infect the overall economy in a very dramatic manner.

As the system stands, the Federal Reserve is nominally in charge of regulating money and the private sector nominally provides and self-regulates capital and credit. I am not in favor of changing that per se in normal times, but I am in favor of some sort of trigger that gives the president and the Federal Reserve authority to step in on a systemic disruption of capital and credit on a moment's notice until the private sector is once again able to regain confidence in its ability to supply capital and credit.

As the fields of economics and finance stand today, they have virtually nothing to offer on this matter of assuring stability of the supply of capital and credit.

I'll stop there for now. This topic deserves a lot more thought.

-- Jack Krupansky

What is Paul Krugman really getting at and what do economists really need to do?

I read the entirety of Paul Krugman's article in The New York Times entitled "How Did Economists Get It So Wrong?" and initially found it quite captivating and enthralling, but ultimately I found my self very disappointed. Sure, in some sense he did ultimately answer the title question by detailing for us how all of these various economic models and "schools" are simply flawed. Fine, but we already knew that from past experience, right? And telling us that economists have been "Mistaking Beauty for Truth" is not terribly helpful. He tell us about why be believes that behavioral finance and behavioral economics may be able to help us out, but I did not find his case overwhelming convincing. He does invite us to re-embrace Keynes, which is modestly helpful, but still far less than completely satisfying. In short, he simply does not deliver the goods. Instead, he gives us a partial answer and a partial prescription that both leave us thinking that something is missing.

The best part that I can find is where he says:

Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system. If the profession is to redeem itself, it will have to reconcile itself to a less alluring vision -- that of a market economy that has many virtues but that is also shot through with flaws and frictions. The good news is that we don't have to start from scratch. Even during the heyday of perfect-market economics, there was a lot of work done on the ways in which the real economy deviated from the theoretical ideal. What's probably going to happen now -- in fact, it's already happening -- is that flaws-and-frictions economics will move from the periphery of economic analysis to its center.

That is good stuff and all well and good, but trying to model "flaws and frictions" with some significant degree of accuracy for a massive economy such as ours is probably yet another fool's errand.

I am still struggling to collect my own thoughts on what went wrong, but my hunch is that there is still plenty of essential data that is not yet public. Maybe five years from now we will have enough of the key and essential facts available to actually pinpoint the small number of avoidable mistakes that brought the crisis upon us and that realistically could have been avoided.

I see that there are two critical but rather distinct questions before us:

1. How do we assure both a healthy and vibrant economy and that we do not have a replay of this crisis over the next 75 years?
2. How do we anticipate and avoid other forms of financial crisis that are wholly different from this and all previous financial crises that might occur 75 to 100 years from now?

If you go back to 1930 and ask people whether the U.S. will be able to "fix the system" so as not to have another depression for at least 75 years, who would have believed it would be possible, but yet we actually did it.

On the other hand, what could "the authorities" really have done back in 1930 to have avoided this latest crisis? I think that is the question we want answered and in a way that will enable us to avoid a major crisis 75 years from now. I did not find Paul Krugman's piece at all enlightening in that sense.

I do have some of my own ideas, but I am still struggling with them.

I do think we need to rethink our definitions for money, capital, credit, banks, non-bank financial institutions, etc. in a way that accounts for the roles of massive hedge funds, foreign capital, and offshore entities, not to mention non-banking financial activity within banks (e.g., Citigroup and its gigantic securitization SIV.)

We need to refine our conception of the Federal Reserve to give it even more power, but in a more focused manner that keeps the Fed focused on its primary mission. The Fed could have interceded and moderated the crisis more effectively, but as the institution is currently formulated they were unable to "see" the true nature of the problem in real-time.

The key missing ingredient is an overall regulatory framework that is agile and able to both allow innovation and to simultaneously recognize when regulation needs to be applied to innovation.

The alternative is what we just experienced. It is called the Greenspan Doctrine. Rather than try to avoid all crises, the regulatory framework is designed to flexibly and rapidly clean up the mess after the fact. To be clear, that is where we are today. That is the default. We are in fact in the process of proving that this doctrine does still work. Yes, it is working, but the costs and level of pain are quite extreme and widely considered unacceptable.

The risk with replacing the Greenspan Doctrine is that we either end up stifling the economy and innovation or actually inducing mini-crises as we distort the economy and financial system at times when we perceive that a crisis might be developing when in fact there is no true crisis developing. In other words, when the cure is worse than the disease.

In any case, Paul Krugman, et al, have a lot more work to do to answer his headline question with a greater degree of utility.

-- Jack Krupansky

Employment is still a wilted green shoot

The monthly Employment Situation report for August did not have much in the way of good news other than that it continued the "less bad" trend of recent months. Unemployment continues to trend up. Employment continues to trend down, but at a slower rate of decline. None of this is "good" per se, but is par for the course at such an early stage of a recovery. The expectation is that it will take another four to ten months for employment to stabilize and start rising again and for unemployment to begin trending down again. All of that is as expected and perfectly within the realm of reason for the early stages of a complex economic recovery.

So, for now call this a wilted green shoot.

My personal expectation is that we will start to see growth in employment somewhere in the November to March timeframe. Unfortunately, unemployment may not begin a sustained decline until later in the spring.

-- Jack Krupansky

ECRI Weekly Leading Index rises modestly and still indicates an imminent economic recovery

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose modestly by +0.29% vs. -0.48% last week, and its annualized growth rate rose sharply from +19.6 to +20.8 and has "surged to a 38-year high that suggests the recovery is on track", and its distinct upturn strongly suggests that recovery is on the way.

This was the eleventh consecutive positive reading for the WLI growth rate.

The WLI has risen for 22 of the past 25 weeks.

The WLI has now recovered to its level in mid-September 2008. That is a major recovery, but also highlights that the economy has a long far to go to get back to "normal."

According to ECRI, "With WLI growth rising to a new 38-year high, U.S. economic growth is poised for a stronger snap-back than most expect."

My personal outlook is that: The recession of the U.S. economy that started in December 2007 and sharply accelerated in August 2008 finally looks as if recovery will be firmly underway within the next few months.

Although a double-dip recession or "W" recovery cannot be discounted, it is becoming quite clear that the overall U.S. economy is on the verge of positive growth of spending and output, even if unemployment is still problematic.

I did watch a recent video in which ECRI insisted that a double-dip was definitely not in the cards based on the strength of the bounce in the leading indicators.

Although quite a few, but not all, of the current economic reports continue to show significant weakness, there is also a vast amount of potential stimulus (especially from the Federal Reserve) in the pipeline that could kick-start the economy within the next couple of months. Please keep in mind that we could continue to see further employment losses or gains in unemployment even as recovery is underway.

-- Jack Krupansky

ISM Non-Manufacturing (services) report shows modest improvement

The ISM Non-Manufacturing (services) Report On Business for August showed a modest improvement since July. The NMI/PMI index was at 48.4 which is still modestly below the 50.0 breakeven level, but modestly above the 46.4 level in July. So, the services sector was still contracting, but only modestly. The good news is that the Business Activity/Production index rose moerately and is finally above the breakeven level. New Orders continue to contract, only only very slightly (49.9 versus the 50.0 breakeven level.) The Backlog of Orders continued to contract and at a faster level, but New Export orders rose sharply and are now moderately above breakeven.

Clearly we are not yet completely out of the woods, but this report was a green shoot.

-- Jack Krupansky

Unemployment insurance claims remain a stagnant wilted green shoot

Despite all the chattering that the recession may be over, the jobs front is still a source of despair. The rate of job loss has declined recently, but is still not anywhere near healthy. Unemployment insurance claims were mixed last week. Initial claims did fall modestly, but the 4-week moving average rose by the same amount. Continuing claims rose moderately, but the 4-week moving average declined modestly. A classic mixed bag. Call it a wilted green shoot.

The 4-week moving average of initial claims rose modestly to 571,250, which is well above the 300,000 level we would expect to see in a healthy economy.

The 4-week moving average of continuing claims is down to 6,216,000, but that is well above the 2.5 million level we might see in a healthy economy. It is unknown how many continuing claims exhausted their benefits and are no longer counted, but "count" as a decline in continuing claims.

In short, the unemployment picture has stagnated. This is to be expected at this early stage in a recovery, where businesses are still struggling to cut costs and the bulk of the impact of government stimulus is still off in the future.

-- Jack Krupansky

PIMCO's September 2009 Investment Outlook, "On the 'Course' to a New Normal"

I just finished reading PIMCO's September 2009 Investment Outlook, "On the 'Course' to a New Normal" by Bill Gross. The focus of the latest newsletter remains on PIMCO's model of "a New Normal global economy" driven by "DDR" -- deleveraging, deglobalization, and reregulation -- over the next 10 or maybe even 20 years.

I agree that they have sniffed out the right facts in the near term, but I do not concur that they have necessarily projected the relevant facts accurately far out into the future. Maybe DDR will be the focus in the very short term, but my hunch is that a couple of years from now we will be preoccupied with new issues that we do not even recognize today. And some of the things we agonize about today will evolve into complete non-problems within a few years.

There will be plenty of technological advances over the next five to ten years, few of which are recognized in PIMCO's "model" of the future. I do not know exactly which energy or green technlogies will be more successful over the next ten years, but PIMCO is certainly not inspiring any confidence in their own ability to forecast technology adoption and evolution over a long time horizon.

Sure, economic growth in the U.S. is very likely to be extremely uneven in the next few years, but that is par for the course. I do not see any particularly good reason to believe that average economic activity will be as low as PIMCO forecasts. They see high current unemployment as a drag, but I see it as an available resource.

-- Jack Krupansky

Allan Meltzer: What Happened to the 'Depression'?

Allan Meltzer,  professor of economics at Carnegie Mellon University, had a good opinion piece in The Wall Street Journal yesterday entitled "What Happened to the 'Depression'? - Despite the rhetoric from Washington, we were never close to 25% unemployment" in which he debunks the comparisons of the current recession to The Great Depression. He asks "So why do many opinion makers insist on inaccurate and frightening analogies that overstate the severity of present conditions?" and then proceeds to point out the many political benefits of such a comparison, with similar benefits for many economists and the media.

Prof. Meltzer also takes the time to point out a fact that I knew but never shows up in the media: The Great Depression consisted of two recessions, from 1929 to 1932 and from 1937 to 1938.

The most significant point that I think Prof. Meltzer makes is that it was a huge mistake for the Federal Reserve to stand by and let Lehman Brother fail. As he says, "Allowing Lehman to fail without warning is one of the worst blunders in Federal Reserve history." By the way, Prof. Meltzer has written the definitive history of the Federal Reserve. Prof. Meltzer tells us that "After 30 years of bailing out almost all large financial firms, the Fed made the horrendous mistake of changing its policy in the midst of a recession. That set off a scramble for liquidity and heightened the public's distrust in the market." And, as they say, the rest is history.

The good professor closes with his own prescription:

A sensible administration would revise its policy. It should start by scrapping what remains of the stimulus. As the world economy recovers, the United States should choose to expand its exports so that it can service its large and growing foreign debts. That means reducing corporate tax rates to increase investment. Instead of implementing policies that increase regulation and raise business costs, we need to increase productivity. And the Fed should soon begin to reduce the massive volume of outstanding bank reserves, which is the raw material for future money growth.

Prof. Meltzer certainly knows his stuff, but there are always more ways than one to skin a cat. The administration's approach may be rather sub-optimal and in a state of flux and Prof. Meltzer's prescription may be distinctly superior, at least in the abstract, but that is not to say that the administration's approach is strictly doomed to either fail or necessarily even to dramatically underperform compared to Prof. Meltzer's approach.

-- Jack Krupansky

Made my Kiva micro-loan for the month of September

I made a new micro-loan through Kiva for the month of September. My intention is to make a new micro-loan every month, if possible, from repayments for past micro-loans. Repayments in August were more than enough to fund this latest micro-loan (and one for October, November, and December as well.) All of these micro-loans are for micro-entrepreneurs in business in developing countries.

This one was for a group of five (one man, four women) in Kabul, Afghanistan for their individual business needs, including: purchasing beading materials, fruit cart business, general store, bakery business, and selling of books, pens, and other things. It is an 11-month micro-loan for a total of $1,075, of which I lent $25. The micro-loan was already disbursed to the micro-entrepreneur on July 27, 2009 by the local partner. Kiva is raising funds to essentially buy that loan from the local partner.

I now have only one micro-loan that is delinquent. It is actually just due to the field partner experiencing difficulty with transferring the money back to Kiva due to some new local government requirement. The other loan which was tagged as being delinquent has now been fully repaid.

I have made a total of 21 micro-loans to date, since December 2009.

Here is my Kiva public lender page: http://www.kiva.org/lender/JackKrupansky

Note: This is all real and good, but these micro-loans do not net any interest to us micro-lenders. Kiva's fine print:

Lending to the working poor through Kiva involves risk of principal loss.
Kiva does not guarantee repayment nor do we offer a financial return on your loan.

Still, at least we know our money is really helping somebody better their lives in a visible way rather than put the money in a bank account or money market fund where who knows what it helps to pay for or what good it does and for only a few pennies of profit in our pockets.

-- Jack Krupansky

ISM Manufacturing report shows strengthening of the economy and finally growth in the Manufacturing sector

The ISM Manufacturing Report On Business for August showed a modest expansion of the U.S. manufacturing sector for the first time since January 2008, and a continued strengthening of the overall U.S. economy. The ISM Manufacturing report has shown growth in the overall U.S. economy for four consecutive months now. The overall manufacturing index came in at 52.9, modestly above the 50.0 breakeven level. New Orders were positive for a second consecutive month. Production was positive for a third consecutive month. Backlog of Orders is now growing rather than contracting. Exports grew for a second consecutive month. The only real negative was that (manufacturing) employment continues to contract, although at a slower pace.

This report does not definitively tell us that we are completely out of the woods, but it is a patch of very green shoots.

The real bottom line here is that this report indicates that the overall economy is growing again:

The past relationship between the PMI and the overall economy indicates that the average PMI for January through August (42.2 percent) corresponds to a 0.3 percent increase in real gross domestic product (GDP). However, if the PMI for August (52.9 percent) is annualized, it corresponds to a 3.7 percent increase in real GDP annually.

There is always the risk of a double-dip recession, but for now we are on track for at least some economic growth.

There is some legitimate concern that this "spike" in the ISM Manufacturing index may be due in large part to the infamous "cash for clunkers" program. That may be partially true, but my hunch is that this program may also simply have been the straw to break the camel's back of the slowdown of manufacturing. Now, instead of wondering when the slowdown will stop, people will be producing again and simply wondering when or if the improvement may stop.

For now, the future is indeed looking a little bit brighter.

-- Jack Krupansky