Why the Fed's Zero Interest Rate Policy Isn't Working

Published: Friday, 30 Sep 2011 | 2:13 AM ET

Slightly more than a decade ago, I spent many hours at the Bank of Japan talking with officials about the paradoxes of ultra low rates. At the time, BoJ officials faced intense pressure from politicians and markets to boost growth; so they were duly implementing quantitative easing or their zero interest rate policy.

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However, the more they experimented with Zirp, the more skeptical they seemed about whether it really worked. The essential problem, they moaned, was that Japan’s financial system was so broken that it had become bifurcated: some companies desperately needed cash, but could not borrow because the banks were too risk-averse to assume credit risk, with or without Zirp.

However, healthy companies that did not need loans were finding it laughably easy to raise money. The result was a classic liquidity trap. And, as such, it left men such as Masaru Hayami, then serving as BoJ governor, privately joking that he really ought to raise rates – not cut them – since that, at least, would make long-suffering savers happy.

These days, the shadow of Japan is hanging over America’s Federal Reserve (and not just because when Ben Bernanke was an academic, he used to write extensively on Zirp, and question whether Hayami was trying hard enough). Last week, the Fed announced the latest variant in its home-spun version of Zirp: the so-called ‘Twist’ operation, a move that sees it purchasing long-term bonds and mortgage securities, in place of short-term term debt and government bonds.

This aims to lower long-term borrowing costs, and thus supply more credit to the business sector and mortgage world.

But, the Fed’s problem – like Japan a decade ago – is as the International Monetary Fund puts it in its latest financial stability report, the economy is “bifurcated”. Many large American companies, particularly those with global operations, are highly profitable and liquid. Unsurprisingly, for them “bank lending conditions and capital market financing remain easy”, the IMF notes.

But many small and medium-sized companies – or the entities that typically create jobs inside America, not overseas – find it hard to raise funds. A survey conducted by the International Franchise Association in Washington, for example, notes that whereas in March half of its members expected credit conditions to improve soon, now less than a quarter expect any easing; even as Treasury yields fall.

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There is bifurcation in the mortgage market too. On Thursday Freddie Mac announced that the average rate on a conventional fixed-rate 30-year mortgage had tumbled to an all-time low of 4.01 percent (and in western US regions, just 3.95 percent), following ‘Operation Twist’. Wall Street bankers are buzzing with tales of savvy financiers refinancing home loans at rock-bottom rates. But, as a report from the Institute of International Finance says, “in order to take advantage of lower mortgage rates, borrowers have to refinance their mortgages, which can be difficult to impossible, if the value of home equity has been eroded”. Twist, in other words, does nothing for households with negative equity (estimated to be about a quarter of the total); nor those in distress (another quarter.) Worse still, Fannie and Freddie are not allowed to refinance their loans. Little wonder that mortgage approvals are falling fastest in communities with high levels of negative equity and repossessions – precisely the area that the Fed wants to help.

Is there any solution? At the IMF meetings last weekend, proposals fell into three strands. Some voices, particularly in Europe, want regulators to “urge” the banks to lend, via targets or political pressure. Witness, for example, the calls made this week by the Financial Policy Committee in the UK (which also faces a bifurcation problem.) However, bank lobbyists retort that a better solution would be to water down efforts to tighten capital standards; according to the IIF, what is hurting credit provision is excessive regulation and uncertainty.

Meanwhile, some economists are now pressing the Fed and other central banks to get more directly involved in lending themselves. Alan Blinder, the former vice-chairman of the Fed, for example, likes the idea of the Fed purchasing more mortgage bonds, or even corporate loans; another proposal floating around is to securitize loans to small American businesses, which could then be purchased by the Fed, via another version of Twist.

Such ideas may help at the margins; purchasing securitized bundles of SME loans, for example, seems sensible. But none is a silver bullet, least of all when eurozone woes are making US banks even more risk averse. If Hayami were still alive today, it would be interesting to know what advice he would give; and even more interesting to know how Bernanke might respond.

From CNBC.COM

What Europe’s Leaders Mean When Their Mouths Move

The error most Americans make when trying to understand the European debt crisis is this: They fail to realize that the euro isn’t just a doomed currency, but a language unto itself.

Too often the great mishaps of our era can be ascribed to a failure to communicate -- from the lip-synching scandal that engulfed the German pop/dance act Milli Vanilli, to the time when Greece’s government started leaving all those extra zeros off the liabilities side of its balance sheet a decade ago. If only these deceptions had drawn proper scrutiny at the outset, much needless pain and suffering could have been avoided.

And yet, the more things change, as they say. It’s bad enough for average Americans that most European leaders speak English with heavy accents. What’s worse, even when we can make out the words they utter, it’s almost always impossible to figure out what these officials are really saying. That’s because they’re speaking in Euro-ese.

Fortunately, there is an answer to their endless riddles: a Euro-to-English dictionary, excerpts of which I have included below. (Click here to read about its close linguistic cousin: the Goldman Sachs dictionary.) To truly see the meaning of the seismic events rapidly reshaping Europe, you must know what the following 10 Euro terms of art mean in plain American English:

1. Finance ministry: A house of worship where government leaders go to pray for bailouts, economic miracles, panaceas and other forms of divine intervention.

How to use in a sentence: Officials at the Greek Finance Ministry said they remain hopeful the country will receive its next batch of rescue loans in time to avoid a cataclysmic default.

2. Coordinated: Chaotic, unfocused, brain-dead, paralyzed to the point of nonexistence; even in its best moments resembling a hopeless klutz.

Example: Finance ministers from the Group of 20 nations last week said they were “committed to a strong and coordinated international response to address the renewed challenges facing the global economy.”

3. Firewall: A partition made of fireproof material to prevent the spread of flames from one place to another. Of no use in containing a financial crisis, except as vague public- relations catnip for readers of news articles who can’t tell the difference between napalm and a 10-year bond.

Usage: U.S. Treasury Secretary Timothy Geithner, who is fluent in both Euro and Mandarin, last weekend urged euro-area nations “to create a firewall against further contagion.”

4. Contagion: A financially transmitted psychiatric condition, marked by intense fear of losing everything. Only known treatments in use at the moment are firewalls, rather than anything that actually works.

5. Peripheral country: A core, indispensable member of the European Union. Related word: Sovereign, meaning German or subservient to Germany.

Example: “Although some peripheral countries in Europe continue to experience acute pressure on their sovereign debts, the risk of a broader contagion throughout the area did not materialize,” Italy’s finance minister, Giulio Tremonti, said April 16, four months before Europe’s central bank rescued Italy via large, open-market purchases of Italian government bonds.

6. Stability mechanism: A wooden paddle ball, mainly used for contests between office workers to see how many times they can bounce the little rubber ball off the paddle without missing; also advertised as a cure-all device for comatose economies.

Usage: The European Stability Mechanism, due to take effect in 2013 as a permanent successor to the region’s current bailout fund, will have a “lasting, stabilizing, confidence-creating function,” German Finance Minister Wolfgang Schaeuble told reporters on Sept. 24.

7. TORRP: The much-awaited European version of TARP. Abbreviation derived from the second letter of each of the following countries’ names: Italy, Portugal, Ireland, Greece and Spain.

Rumored to stand for Troubled Obligation Relief Relief Program, providing relief from the relief. In fact, it stands for nothing in particular, like other government institutions. Unlike the U.S. Troubled Asset Relief Program, any TORRP money distributed to European banks is guaranteed never to be repaid.

8. Controlled default: The act of telling another country’s government that it’s OK to stiff most creditors, and then watching with morbid fascination to see if the global banking system falls apart. Originally an aviation term used to describe the final landing of the Hindenburg, which crashed all by itself without taking any other zeppelins with it.

9. Recapitalize: To transfer money from a country’s middle- class taxpayers to an insolvent bank -- in essence, a bribe to bondholders and senior management -- as a way of ensuring that the wealthy don’t rise up and oust the government.

Related term: Austerity. As in, an economic-stimulus program that involves doing exactly the same thing, except the money comes from the citizens of a different country, such as Greece, who are left to subsist on a diet of untreated water and surplus rice.

Usage: “More banks may need to be recapitalized,” European Union Competition Commissioner Joaquin Almunia said Sept. 20 at a press conference in Brussels. “That’s why it’s so important to solve the sovereign-debt crisis without a delay.”

10. Covered-bond purchase program: Forget it, way too complicated to explain here.

Just remember this. The EU and its member nations’ finance ministries are proceeding with their coordinated efforts to erect firewalls, and will never permit contagion to spread beyond the euro area’s peripheral countries. Remain calm. All is well. Everything is under control.

In addition to their plans to recapitalize Europe’s banks and revitalize the region’s economies, through TORRP and the European Stability Mechanism, there’s always the fallback option of a prepackaged, orderly, controlled default by Greece, even if Europe’s leaders aren’t ready to say so publicly yet. What’s important to keep in mind is that we’re all in this together, regardless of whether you can understand a word any of these people are saying. 

From Bloomberg.com

5 Reasons for Current Euro Strength (And Why It Is Temporary) 

Euro/dollar is significantly higher, after a convincing and healthy move. There are 5 reasons for this rise, that may not hold for too long. These levels are the highest level since Ben Bernanke announced Operation Twist, a move that sent the euro as well as most currencies, commodities and stocks plunging. Will this hold? 5 Reasons:

1. Pumped up EFSF: The obvious reason is the hope that European leaders will agree to beef up the bailout fund, known as EFSF. This can be done via leveraging the current allocation and setting its size to between €2 to €3 trillion. Another idea is using the European Investment Bank (EIB) for this purpose. These talks are still vague and they are frequently denied by many leaders across the continent. They also cause discomfort in the German parliament which is set to approve the previous July 21 agreement to beef up the EFSF powers on Thursday. Nevertheless, hope is strong this week. 

2. Finland giving up: The northern country that demanded collateral in return for providing its share in the next tranche of aid is backing on this demand. They acknowledge that this is unlikely now and warn that their support for future moves should be doubted. The future is in the future, and in the present, they remove a big stone from the path to the next tranche of aid. 

3. US Weakness: Things on the other side of the Atlantic aren’t rosy. The latest reminder is the US Consumer Confidence that remained weak at 45.4 points, below expectations. The list of weak US figures is very long. 

4. Short covering: CFTC data has shown that positions were quite extreme in favor of the dollar and against the euro. While a small bias goes hand in hand with the direction of currencies, extreme positions tend to get covered violently. This might be happening now.

5. End of month / quarter adjustments: This is why the nature is temporary. Stocks were heavily hit in September and also in August. The dollar strengthened during this period. On the other hand, “safe” bonds from the US, UK, Germany and others gained. Some big funds are committed to certain portions of each asset class in their portfolio. The recent moves might be related to such movements, and can evaporate next week. The situation in Europe remains problematic. An immediate rescue option already exists and is being used: bond buying by the ECB. If this rises, it will become QE (€ printing), and that will weaken the euro. If Greece defaults and stay within the euro-zone (this may be in the works for the first week of November), it will also weaken the euro.

From forexcrunch.com

Waiting for a reversal of EURJPY

Yesterday, EURJPY had an reversal in London session. The price touched 101.9 before going up with some positive fundalmental news from Eurozone. EURJPY has broken all fibonacci retracement level with the peak (103.75) and bottom (101.9). We hope to see a bright period today. But We can see on the chart, EURJPY 's moving in the downward channel. Although, the Price bounced on the convergence level with Fibonacci level 50% and Pivotpoint to set up a higher low, however we still waiting a breakout the level around 103.5 so that EURJPY can escape from the downward channel in 30 minutes chart.

With the effort of eurozone and G20 to solve the financial crisis, we can believe the downward of EUR can be stopped.

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