Why You Read EPJ

CNBC reports today:

The Fed Has a $110 Billion Problem with New Benjamins..A significant production problem with new high-tech $100 bills has caused government printers to shut down production of the new notes...An official familiar with the situation told CNBC that 1.1 billion of the new bills have been printed, but they are unusable because of a creasing problem

EPJ two months ago:

Burying the news on a Friday afternoon, the Federal Reserve Board announced a delay in the issue date of the redesigned $100 note, which was originally scheduled for 2-10-11.

The Bureau of Engraving and Printing, a division of the Treasury, manufactures Federal Reserve notes and has identified a problem with sporadic creasing of the paper during printing of the new $100 note, which was not apparent during extensive pre-production testing, the Fed said. As a consequence, the Federal Reserve will not have sufficient inventories to begin distributing the new $100 notes as planned.

 
Always, always read the late Friday news releases and holiday releases. That's where they always hide the good stuff.

EPJ 5 Months Ahead of California Papers

Derek J.  Simmons emails:

Back in May you blogged info you’d found about 32 states borrowing money from the Feds to keep their UI funds afloat.  Local press in California just yesterday—conveniently AFTER the election—discovered what you had found 5+ months earlier [See LA Times andSan Francisco Chronicle]. I just found your site and you through “digging” with Google. Thank you for that information.

Yes, I Can Read Rupert Murdoch's Mind

Business Insider reports:

Murdoch's Latest Plan To Kill The Internet: Launch New National Newspaper For iPads And Cellphones

News Corp. Chief Executive Rupert Murdoch is embarking on an ambitious plan for a new national digital newspaper to be distributed exclusively as paid content for tablet computers such as Apple Inc.'s iPad and mobile phones

EPJ August 3rd (with a little help from The Austrailian)

What Rupert Murdoch Is Really Up To

He's teaming with Steve Jobs.

He doesn't care how many subscribers he gets via his internet paywalls. He is going to eventually shut down his internet product. His model is about selling his content via iPads, where it can't be copied or linked to, or searched.

Alert (Sort Of ): Fed May Stop Targeting Fed Funds

File this baby under "Why you read EPJ."

Bob Murphy sends me a link to a Scott Sumner piece on news that the Federal Reserve may stop targeting the Federal Funds rate.

Sumner quotes a January 26 Bloomberg story:

Federal Reserve policy makers are considering adopting a new benchmark interest rate to replace the one they’ve used for the last two decades.

The central bank has been unable to control the federal funds rate since the September 2008 bankruptcy of Lehman Brothers Holdings Inc., when it began flooding financial markets with $1 trillion to prevent the economy from collapsing. Officials, who start a two-day meeting today, have said they may replace or supplement the fed funds rate with interest paid on excess bank reserves.

“One option you might want to consider is that our policy rate is the interest rate on excess reserves and we let the fed funds rate trade with some spread to that,” Richmond Fed President Jeffrey Lackertold reporters on Jan. 8 in Linthicum, Maryland

Sumner calls this a "momentous change."

So is this a "momentous change"? Is Richmond Fed President Lacker on to something here? Er, yup. But it is only recognizing reality. I acknowledged the importance of the interest rate on excess reserves versus the Fed funds rate in 2008. Back then the Fed was doing something a bit different with the rate on excess reserves versus the Fed funds rate, but it was clear that the rate on excess reserves would become the key rate. On October 7, 2008, I wrote:

Fed Funds Rate Cuts Have Become Irrelevant

A new litmus test has developed to determine how well economists understand the machinations of Federal Reserve operations.

Any analyst now calling for cuts in the Fed Funds rate, or forecasting further cuts in the rate, will fail the test.

Yesterday, the Fed announced that it will begin to pay interest on depository institutions' required and excess reserve balances...

Paying interest on required and excess reserve balances changes the entire role of the Fed Funds rate with regard to Fed monetary policy, as long as real rates are below the rate paid by the Fed on excess reserves...

The Fed may cut the funds rate in the future for cosmetic reasons to calm the markets, but it is not necessary for the Fed to do so, given that it is now paying interest on reserves at above market rates.

Thus, any analyst calling for a Fed rate cut doesn't understand how the Fed works and the impact the new rule changes will have.

Sumner calls the Bloomberg story a "trial balloon." I think it is simply recognizing the major significance that the excess reserve rate already has on monetary policy. The rate on excess reserves now controls monetary policy to a greater extent than the Fed Funds rate. But all this is dependent on the interrelationship between the Fed Funds rate, the excess rate and the real rate (The real rate being the rate that would exist without Fed interference in the interest rate market.)

The Fed could put the Fed funds rate back into play by setting the rate on excess reserves below the real rate. That they are not clearly indicates that they have already moved to the excess reserve rate as the dominant monetary policy weapon.

Making a formal notice of the Fed targeting reserve interest rates would serve only to confirm the reality of the situation dating back to October, 2008.

Why You Read EPJ, Chapter 9,812

WSJ is finally reporting on the fact that the Federal Reserves hopes to control money growth by controlling the interest rate on excess reserves:

Central bankers in recent speeches have flagged a new and relatively obscure tool they believe will help them control inflation when they start winding down their unprecedented provision of liquidity to banks.

The tool is the Federal Reserve’s ability to pay interest on bank reserves held at the institution. The central bank can now compensate banks at a rate closely in line with its overnight fed funds rate target.

In theory, that makes keeping required and other reserves at the Fed an attractive option for banks. Central bankers say that power, gained last fall, allows them to get better control over the funds rate target. It also allows them to manage bank reserves more tightly, and they think it has already given them important control over prices pressures.

That’s important given the huge level of reserves banks now have after two years of extraordinary Fed liquidity provisions.

So-called excess reserves, closely watched by many inflation hawks, now stand at just under $800 billion, compared with almost negligible levels just ahead of the start of the recession. That’s in a world where the Fed’s balance sheet will likely go over $2 trillion by year end, up from around $800 billion at the start of the crisis.

If that liquidity were to flow into markets it could cause a huge inflation surge completely unwanted by policy makers. That’s why as the Fed starts to mull its eventual exit from 0% interest rates and heavy duty emergency lending, central bankers have been touting their interest paying powers as a primary tool in their bid to normalize policy.

“It’s incredibly important that they have this tool,” said Michael Feroli, an economist with J.P. Morgan Chase. It gives policy makers the breathing room to sell off their considerable store of assets at more leisurely pace, he explained.

An exit from current Fed policy lies some time away. Even so, economists believe when the Fed begins to raise rates and keeps reserves under control, it can then move more slowly to unload the considerable range of securities it has bought during the crisis. This should bring a relatively orderly unwind of all the Fed’s emergency actions....

I first suspected this months ago, in June to be specific, and I laid the whole thing out in August.

Ice-Nine or Why You Read EPJ?

Bloomberg writers Bob Ivry, Mark Pittman and Christine Harper are getting major props for their Ice-Nine story . Andrew Leonard at Salon highlights the story. Credit Writedowns says of the piece:

Bloomberg News is writing a very worthy series of retrospective articles on the financial panic of September 2008. I profiled the first one on Monday. The next in the series came out yesterday and it makes for riveting and enlightening reading.

Bloomberg News reporters Bob Ivry, Mark Pittman and Christine Harper talked to a large number of market participants to get a sense of what happened in the financial system to bring the global economy to its knees, not just at Lehman but throughout the system. Their analysis hits on the money markets as a catalyst for the market meltdown.

Mohammed El-Erian has the money quote with a nice reference to Kurt Vonnegut and Cat’s Cradle by the Bloomberg team.

The ice-nine wasn’t noticed by most market participants at first, said Mohamed El-Erian, chief executive officer of Newport Beach, California-based Pacific Investment Management Co., the world’s largest fixed-income fund manager.

“Monday and Tuesday, people didn’t quite see what was happening,” El-Erian said in a July interview. “You had to be on the desk in the payments and settlements system, cash and collateral, to start seeing cascading market failures and a complete erosion of trust.”

So what's my take on all this?

Ah, well, ice-nine is a fictitious material in Kurt Vonnegut's novel "Cat's Cradle" that freezes the entire world's oceans. The metaphor the writers are referring to is the freezing up of the commercial paper markets last year. In my view, the metaphor should be extended to the brains of most journalists and economists who were on brain freeze back then and continue to be so now, about most everything that goes on in the world of economics. (Witness their current coverage of ObamaCare. How often have you heard it mentioned about how it will destroy incentives for new innovations in medical treatment?)

Kudos to to Ivry, Pittman and Harper for digging this important story out, but I had them beat on this story by months. How many months? For a good chunk, I had it nailed, last year, in real time.

The reporters point to panic that circled around the mid-September period when the money market fund, Reserve Primary Fund, broke a buck:

Treasury Secretary Henry M. Paulson Jr. left his suite at Manhattan’s Waldorf-Astoria Hotel last Sept. 15 after a sleepless night, feeling he’d done all he could to minimize the damage from that morning’s collapse of Lehman Brothers Holdings Inc., aides said....Nobody accounted for Bruce R. Bent. The 72-year-old graduate of St. John’s University in Queens, New York, created the first money market fund in 1971, the Reserve Primary Fund. He touted it as an investment so safe it would lull clients to sleep -- so safe that, even with $785 million in loans to tottering Lehman, Bent and his wife had jetted to Rome that Sunday evening to celebrate their 50th wedding anniversary....On Sept. 15, while his flagship fund was sinking under the surge of redemption requests, Bent was speed-dialing from Rome.

That the money market breakdown was a key to Treasury and Fed panic was a story I had back in February. In a post, The Government Panic of September 2008 I wrote:

I now believe that the United States government went into full panic mode in September, 2008 and continues in panic mode to this day. This has serious implications for the future direction of the economy. Those in government who truly understand the current situation must have serious doubts as to whether the United States financial structure will survive in any form close to what it is today....
there were serious runs on money market funds back in September 2008, and...the government, early on, took an active hand in trying to kill this news...

They also write this:

The ice-nine wasn’t noticed by most market participants at first, said Mohamed El-Erian, chief executive officer of Newport Beach, California-based Pacific Investment Management Co., the world’s largest fixed-income fund manager.

“Monday and Tuesday, people didn’t quite see what was happening,” El-Erian said in a July interview. “You had to be on the desk in the payments and settlements system, cash and collateral, to start seeing cascading market failures and a complete erosion of trust.”

Get that? Head PIMCO trader Mohamed El-Erian saying people didn't quite see what was happening on Monday and Tuesday, back in September '08. You had to be on the payments and settlements desk. Ah, no you didn't. The headline on my post on the Tuesday El-Erian is referring to was:

Holy Sh*t: Money Market Breaks Buck; Freezes Resumptions

To me this was big news. Given the spooked financial markets, all we needed was to spook money market holders. Spooked money market holders meant redemptions which would lead to escalating liquidations of commercial paper, which would spook commercial paper markets. The next day I spotted the escalating panic right away. I wrote in a post, What Happens If There Is A Run On Money Markets? Is There A "Money Market Mutual Fund Holiday" Ahead? :

News that the Reserve Primary Fund, the oldest mutual fund in the country with $64 billion under management, has broken the buck and frozen redemptions for 7 days, is not good.

Edges of panic are beginning to appear throughout the system. There is a flight to absolute safety. 3-month T-Bills are trading to yield 0.558% ( yield not seen since 1954!). Gold, as I write, is up over $88.50.

Real time, baby. Not a year later.

But, hey, at least the story is getting out and getting some needed attention. Nice work by Ivry, Pittman and Harper. They still don't have the real big story of the squashing of the news by the government back then, but, hey, maybe next year. At least, they are working on the story, not like most ice-nined reporters.

Why You Read EPJ

We're way ahead of the pack, again.

Floyd Norris at NYT writes today:

A few weeks ago, John Thain took a lot of heat for having asked for a $10 million bonus for his work running Merrill Lynch, whose stock price plunged during his tenure before he sold it to Bank of America. He backed down and did not get the money.

Now we hear that B of A is in line to get a big infusion of money from the government, along with a guarantee of values of dubious assets. Much of the problem is said to come from dicey Merrill assets.

If it really is Merrill assets that are cratering now, Mr. Thain earned that bonus, and more, in getting the company sold before the problems became this bad.

Four months ago, back in September of '08, we wrote:

Thain probably deserves his exit pay more than anyone else during the current financial crisis. Merrill is supposed to be the next Lehman and somehow Thain is able to sell Merrill for $29 per share? Not only does Thain deserve the $25 million, Merrill shareholders should chip in to make a bronze statute of Thain and plant it in front of the NYSE.

The Fed Funds Rate and Why You Read EPJ

One month ago, we posted a note that headlined: Fed Funds Rate Cuts Have Become Irrelevant

In that post we wrote:

A new litmus test has developed to determine how well economists understand the machinations of Federal Reserve operations.

Any analyst now calling for cuts in the Fed Funds rate, or forecasting further cuts in the rate, will fail the test.

Yesterday, the Fed announced that it will begin to pay interest on depository institutions' required and excess reserve balances...

Paying interest on required and excess reserve balances changes the entire role of the Fed Funds rate with regard to Fed monetary policy, as long as real rates are below the rate paid by the Fed on excess reserves...

The Fed generally stays at its target. So under the old rules, if the Fed wanted to add reserves, it would more than likely cut the target Fed Funds rate below 2%, to keep the target in line with its actual operations. Now, however, with the Fed paying interest on its reserves at a rate near the target Fed Funds rate, the Fed can add any amount of reserves it wants and the Fed Funds rate won't go down, because the Fed is, in effect, simultaneously providing a floor to the Fed Funds rate at the near target rate, or at least the target rate for the excess reserves, since a bank will not withdraw reserves when the Fed will pay it for the reserves.

I have seen ZERO reporting on this extremely important fact, until today.

James Hamilton at Econbrowser covers much of the same territory and also expands on it, by examining (with apparently the help of Wrightson ICAP ) the role of an interesting arbitrage of GSE balances at the Fed that other Fed depository institutions can conduct. His ultimate conclusion:

...the target itself has become largely irrelevant as an instrument of monetary policy, and discussions of "will the Fed cut further" and the "zero interest rate lower bound" are off the mark.

Congratulations, to James for figuring out what we did a month ago. It's still a feather in his cap, (You have to be really good to stick with us in real time). Most Fed watchers still don't get what is going on, with the Fed Funds rate.