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2009 Fed Challenge
Venisha Powell
Justin Durso
Aaron Naisbitt
Ray Tannheimer
Robert Searle
1
Introduction
State of the Economy
Fed Response and Exit Strategy
Long Term Stability
Regulatory Reform and Beyond
Final Recommendations
2
% Change in GDP
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
-8.0
3
Real GDP
4
Real GDP
2.8%
rd
(3
Q)
Personal Consumption
2.9%
Government Spending
8.3%
Business Investment
Exports
Imports
4.1%
17%
20.8%
GDP = C+I+G+(X-M)
5
UM Consumer Sentiment
6
FOMC GDP Forecast
2004
2005
2006
2007
2008
3.1 2.7 2.4 2.5 -1.9
Actual
2009
2010
2011
2012
Longer
Run
-
-
-
-
-
5
3
Upper End of Range
-
-
-
-
-
0
4
4.6
Lower End of Range
-
-
-
-
-
-0.5
2
2.5 2.8 2.4
http://www.federalreserve.gov/monetarypolicy/fomcminutes20091104epa.htm#figure1
7
Unemployment
12
Nov 2009: 10.0%
10
8
6
Jan 2008: 4.9%
Nov 2009
15.4 Million
Unemployed
4
2
0
Jan 2007
Jul 2007
Jan 2008
Jul 2008
Jan 2009
Jul 2009
8
Establishment Data
Nonfarm payrolls
Year
Jan Feb Mar Apr May Jun
36
184
35
156
54
Jul Aug Sep Oct Nov Dec
-65
-28
100
165
Annual
2007
180
2008
-72 -144 -122 -160 -137 -161 -128 -175 -321 -380 -597 -681 (3,078,000)
2009 -741 -681 -652 -519 -303 -463 -304 -154 -139 -111
215 120 1,152,000
-11
(4,078,000)
2008 – 2009 Job Losses: 7,156,000
9
Unemployment Claims
November jobs numbers better than expected
A positive sign that the economy is turning around
10
Unemployment Time Frame
Long-term unemployment is already
much worse than in the 1980s
November 5.9 million
38 % unemployed six months +
(highest on record)
20% unemployed 1 year or more
(Financial Times www.ft.com)
11
FOMC Unemployment Forecast
2004
Actual
Upper End of Range
Lower End of Range
2005
2006
2007
2008
2009
2010
2011
2012
Longer
Run
5.4 4.9 4.4 4.8 6.9 - 10.3 10.2 8.7 7.6 6.3
- 9.8 8.6 7.2 6.1 4.8
http://www.federalreserve.gov/monetarypolicy/fomcminutes20091104epa.htm#figure1
12
Underemployment & Job Elimination
U6 October 17.2%
Down from 17.5% in October
Increase in underemployment
9.2 Million working part time
Increase in discouraged workers
Discouraged workers 861,000
Jobs
Being
Eliminated
13
CPI
14
CPI - Inflation
The inflation rate after a recession is often well
below the rate prior to the recession
Inflation and Monetary Policy in Extraordinary Times
by Eric S. Rosengren, President & Chief Executive Officer
The Greater Boston Chamber of Commerce: Financial Services Forum
Boston, MA October 2, 2009
15
FOMC Inflation Forecast
2004
2005
2006
2007
2008
3.3 1.9 3.6 1.7
2009
2010
2011
2012
Longer
Run
-
-
-
-
-
2
Actual
3
Upper End of Range
-
-
-
-
-
1.7
Lower End of Range
-
-
-
-
-
1
2.4 2.3
2
1.1 0.6 0.2 1.5
http://www.federalreserve.gov/monetarypolicy/fomcminutes20091104epa.htm#figure1
16
Housing
17
Housing
Home price increases
greatly outpacing GDP
18
Housing
19
Small Business
Cash Flow
Issues
Alternative
lender cannot
obtain credit
from traditional
banks
Small Business
cannot obtain
credit from
traditional
banks
Cash Flow
Alternative
lender develops
cash flow issues
Alternative
lender has
difficulty
collecting
collateralized
A/R
Seeks
alternative
funding from
small business
lender
With cash flow Issues and liquidity problems, small businesses have no
choice but to reduce costs, and reduce capacity utilization.
Unemployment rises, and consumption decreases further
20
Inflation and Business
The forecasters that are predicting
relatively low inflation over the next
several years – and I generally share this
view – highlight the importance of excess
capacity in the economy
Inflation and Monetary Policy in Extraordinary Times
by Eric S. Rosengren, President & Chief Executive Officer
The Greater Boston Chamber of Commerce: Financial Services
Forum
Boston, MA October 2, 2009
21
Deflation for Business
Deflating prices
• Lead to lower revenues
• Hurt profit margins
Businesses trying to keep profit margins
steady will look to reduce costs
- thus unemployment will tend to rise
22
Small Businesses
•Employ more than half of private sector
workers
•Generate half of new net jobs annually over
past decade
•Account for more than 1/2 of nonfarm GDP
•Small firms cannot offer innovative new
products or services without credit
http://www.federalreserve.gov/newsevents/testimony/mishkin20080416a.htm
23
Fixed Investment
24
PPI
25
Corporate Profits
26
Total Inventories
27
Durable Goods Orders
28
ISM MPI
29
Budget Deficits
30
National Debt as % of GDP
31
Structural Deficits
32
Glass-Steagall
Banking Act of 1933 is also known as the
Glass-Steagall Act
• Established the FDIC as a temporary agency
• Separated commercial banking from
investment banking - establishing them as
separate lines of commerce.
Regulation Q
• Limit on Interest Rates Banks could pay
(Including rate of 0 on checking accounts)
33
Gramm-Leach-Bliley
•Widened the range of activities banks can
conduct
•Repealed restrictions separating commercial
banking from securities
•Separated commercial banking from the
insurance
GLB Permits single holding companies to offer
banking, securities, and insurance as they had before
the Great Depression
34
Mergers and Acquisitions
Citigroup merges with Travelers,
Primerica and Smith Barney
Financial Services –
•Banking
•Securities
•Insurance services
35
Mergers and Acquisitions
36
2009 Bank Failures
124 Bank Failures in 2009 as of 11/30*
Another possible 117 banks have liquidity problems
according to the Wall Street Journal
Liquidity Problems are Confidence Based
Banks don’t trust the accounting for assets on balance
sheets
Asset reporting regulations that make the
bank balance sheets transparent will be key
to restoring confidence in banking system
http://www.fdic.gov/bank/individual/failed/banklist.html
37
Excess Reserves
38
Monetary Base
39
Money Multiplier
40
TED Spread
http://www.bloomberg.com
A Eurodollar is an American dollar on deposit in any bank outside the
United States, and is therefore not subject to regulation by the U.S.
Federal Reserve.
41
Global & Domestic Credit
Internationally, credit markets have been
stabilized as central banks have alleviated
Systemic Risk fears
Domestically large businesses use banks for
30% of their financing, while banks provide
90% of all small business financing needs
27 million small businesses nationally employ
½ the nation’s private sector workforce, and
have roughly $1 trillion in debt outstanding
42
Fed’s Response to the Crisis
• Use of Traditional Tools
• Currency Swaps
• Balance Sheet Expansion (Credit Easing)
• Support for Institutions Posing Systemic
Risk
• Exit Strategy
43
Use of Traditional Tools
•Target Fed Funds Rate Reduced to 0-.25%
•Discount Rate Reduced to .5%
•Limits to traditional tools
Fed Funds rate at floor
Stigma attached Discount Window use
44
Currency Swaps
http://www.economagic.com
45
Balance Sheet Expansion
Credit vs. Quantitative Easing
• Credit Easing: asset focus
Loans and purchases are made to
effect change in specific markets
• Quantitative Easing: liability focus
Volume of bank reserves are target
of policy
46
Fed Balance Sheet Expansion
(Source: CalculatedRisk from Atlanta Fed data)
47
Categories of Credit Easing
• Short-term lending for financial
institutions
TAF, PDCF, MMIF, AMLF
• Targeted lending
TALF, & CPFF
• Purchase longer-term marketable
securities
Treasury and GSE-related securities
48
Short Term Lending for Financial
Institutions
• Term Auction Facility
Provides short-term liquidity without stigma of
discount window
• Primary Dealer Credit Facility
Supports Fed’s ability to buy and sell securities
• Money Market Investor Funding Facility
Stunted run on money market by providing investors
with liquidity
• Asset-Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility
49
50
Targeted Lending
• Term Asset-Backed Securities Loan Facility
Aimed at restarting flow of credit in auto, student,
credit card, and small business lending markets.
Expanded to include commercial mortgage market
• Commercial Paper Funding Facility
Aimed at backing stable commercial paper issuers
51
TALF
Initiated
52
CPFF Success & Wind-Down
53
Purchase of Long-Term
Securities
• Treasury Securities
• Government-Sponsored Enterprise Debt
• Government-Sponsored Enterprise
Mortgage Backed Securities
54
Support for Specific Institutions
• Lehman Brothers’ collapse caused
significant systemic faltering
• Institutions posing systemic risk
Bear Stearns
AIG
• Fed’s decision to act
Threats to global financial system
special programs
55
Exit Strategy
• Transition from easing to tightening
• Paying Interest on reserves
• Reducing the balance sheet
1.
2.
3.
4.
Recovery and Runoffs
Reverse Repurchase Agreements
Term Deposits at Fed
Sale of Long Term Securities
56
Monetary Policy & Asset Prices
Debate over Fed’s role in preventing
asset bubbles is being reconsidered
Low Interest rates have fueled
“excessive speculation and risktaking”
57
USD Index
58
Gold vs. USD Index
Source: WSJ
59
Surging Commodity Prices
60
Crude Oil
Source: WSJ
61
MSCI World Equities Index
62
Mortgage Backed Securities
U.S. Residential Mortgage-Backed Securities Issuance
1995 through 2007
1995 - 2007
3
Trillion Dollars (U.S.)
Agency
Prime Jumbo
Alt A
Subprime
Other
2
1
0
1995
1996
1997 1998 1999 2000
2001
2002
2003 2004
2005
2006 2007
Year
Financial institutions issue huge amounts of MBS
Source: Inside Mortgage Finance
Investors
buy and sell assets at 10 – 12 underlying value
Source: Gerald P. Dwyer, Jr., 2008 and 2009
63
Excessive Leverage 2003 - 2007
64
“Leaning against the wind”
Raising interestrates to dampen
potential excesses
Evidence from 1999 and
2004 suggests asset bubbles
may not respond to policy
tightening
“Monetary Policy, for
which we in the
Federal Reserve are
responsible, is a
blunt instrument
with economy-wide
effects”
-Gary Stern,
President
FRB of
Minneapolis
65
Alternative Approach: Regulation
Targeted effort to mitigate
excessive speculation and risk
• Micro-prudential
• Macro-prudential
“The best approach here if at all possible is to use supervisory and
regulatory methods to restrain undue risk-taking and to make sure
the system is resilient in case an asset price bubble bursts in the
future.”
-Ben Bernanke, Federal Reserve Chairman
66
Micro-Prudential Regulation
Enhance Regulatory Capital Standards
• Higher Capital Requirements
• Contingent Capital Instrument
Regulate OTC Derivatives Markets
• Centralized clearing
• Standardized reporting
• Supervision of derivatives dealers
Consumer Financial Protection Agency
• Reduce predatory lending and
deceptive practices
Regulation of Hedge Fund Industry
• Register with SEC
International Coordination
• Accounting standards
67
Macro-Prudential Regulation
Resolution Authority for “Too Big To Fail”
Reduce moral hazard
Eliminate taxpayer liability
Increase incentives for sound management
Systemic Risk
Identify regulatory gaps, perverse
incentives, sources of market instability
68
Financial Stability and Oversight Commission
Chair
Appointed by President
FEDERAL
RESERVE
Financial Services
Advisory
Council
TREASURY
SEC
FDIC
CFTC
CFPA
Legend
SEC
Securities Exchange Commission
FDIC
Federal Deposit Insurance Commission
CFTC
Commodity Futures Trading Commission
CFPA
Consumer Financial Protection Agency
69
Policy Recommendations
Maintain Target Fed Funds Rate 0.0 - 0.25%
Economic conditions likely to “warrant
exceptionally low levels for an extended period”
Continue Asset Purchases
Improve regulation and supervision of the
financial services system
Systemic Risk Regulation
Financial Stability and Oversight Commission
70
Questions
71