Federal Reserve and Monetary Policy: If I had the money I would $hort the dollar.

I’ll use the following papers as references: Governor Frederic S. Mishkin
At the Business Cycles, International Transmission and Macroeconomic Policies Conference, HEC Montreal, Montreal, Canada
October 20, 2007
Headline versus Core Inflation in the Conduct of Monetary Policy (a Taylor rule is given in foot note #2)
and
Discretion versus policy rules in practice John B. Taylor.

I’ll remind readers about Greenspan’s interest rates conundrum. The problem, my opinion, is in the output gap. The output gap is a measure between real GDP and trend real GDP. However, the US of A’s large trade deficit makes the output gap highly uncertain because economic conditions on “Main Street” are inhomogeneous. The Method of Moving Frames: See Wikipedia (for resource links) indicates that a component that is transformed has many elements.

Example: a producer uses a electronic component from another market. That component has a value added chain (topological lift) associated with it. Yes, using a component from the other market lowers the price and releases the resources used in the producers market however, those resources (mainly people) have to be addressed by an economic policy. Bush’s current economic policy (Oct 2007) is to let the market handle it. The market created a two tier labor (people) system. See my Neoclassical blog for details of group transformation and group convolution.

In other words, The FOMC should be using their discretion not policy rules.

There is another credit crunch coming. Sec of Treasury Paulson has made sure of this event. He said that there is a mortgage meltdown. I think it is going to come from the credit derivatives market. See OCC’s Quarterly Report on Bank Derivatives.

It’s the total risk-based capital that gives me the chills.
Total Risk-Based Capital: The sum of tier 1 plus tier 2 capital. Tier 1 capital consists of common shareholders’ equity, perpetual preferred shareholders’ equity with noncumulative dividends, retained earnings, and minority interests in the equity accounts of consolidated subsidiaries. Tier 2 capital consists of subordinated debt, intermediate-term preferred stock, cumulative and long-term preferred stock, and a portion of a bank’s allowance for loan and lease losses.

I bet that subordinated debt has to be reprised.

It’s going to be a struggle between those who want to $hort the dollar and those who want to support the dollar in order to protect their dollar denominated a$$et$. There is no support for the dollar from the Bushies. If one assumes free market principles are executing their own strategies, with no collusion, then the time average price movements will indicate which side has the most money, leverage and guts. The general trend is dollar weakness.

Of course, the 1,000lbs Gorilla (China) can change all that. A possible scenario is China buying a financial institution (example; Bear Stern) from which it could support the dollar without having the Federal Reserve looking over its shoulder. The Security and Exchange Commission is much easier to deal with. Considering the fact China will be doing Bush’s job, the SEC will be very willing to bury all complaints in its procedural process.

I was listening to CNBC’s Closing Bell’s debate about Sovereign Funds. A Bear Stern’s senior manager’s opinion about a sub-prime meltdown and the whether China defends their currency was proven wrong. He indicated that the sub-prime will get worst if China defends their currency. National Sovereign Funds have become a issue due to their size and the fact that the Bush administration is inept, US Congress are a bunch of spineless, gutless YELLOW BELLIES, the (Anti)US Chamber of Commerce is still in its Nazification of America project [They labeled trail lawyers as a bad influence on American business and denounced Edwards. The problem for American businesses is the sub-prime meltdown and the credit crunch. I‘ll change my mind if the Chamber follow their “MO“. I want them to blame the financial sector and denounce Romney as a bad influence on American business and does not deserve to be President of the US of A. I don't think they will. So I guess all Demsocrats are traitors.] and Wall Street and Beltway insiders are hypocrites. If Uncle Sam had a surplus, Wall Street will what a big tax cut. If Uncle Sam makes an investment in a company, rivals will call that a government subsidy. If Uncle Sam makes an investment in a sector say, for example, spending a few billion more for children’s healthcare, Beltway insiders will call that Socialize Medicine. National Sovereign Funds have become a systemic financial risk in a free market economy.

One little fact is overlooked by those who think NSFs are just investments: their governments also control their respected monetary policy. We know Bernanke went to China. What we do not know is how much of an influence China’s central bank (and other NSF central banks) plays in the Federal Reserve’s decision making process.

From BankRate.com (updated 9/26/07)
What it means: FNMA is the Federal National Mortgage Association, commonly known as Fannie Mae. Fannie Mae is a corporation created by Congress to support the secondary mortgage market. It purchases Federal Home Administration, Veterans Affairs and conventional mortgages from primary lenders and sells them to investors. The index measures mortgage commitments (Mtg Com) for delivery (del) within 30 to 60 days; that is the required net yield on mortgage loans that lenders sell to FNMA, which in turn sells them to investors.
How it's used: It's an index that is used primarily by lenders that sell their loans to Fannie Mae. The lenders use it to price their loans. It has little direct impact on ordinary investors.

What it means: LIBOR stands for London Interbank Offered Rate. It's the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London. It is a standard financial index used in U.S. capital markets and can be found in the Wall Street Journal. In general, its changes have been smaller than changes in the prime rate.
How it's used: It's an index that is used to set the cost of various variable-rate loans. Lenders use such an index, which varies, to adjust interest rates as economic conditions change. They then add a certain number of percentage points called a margin, which doesn't vary, to the index to establish the interest rate you must pay. When this index goes up, interest rates on any loans tied to it also go up. Although it is increasingly used for consumer loans, it has traditionally been a reference figure for corporate financial transactions.

What it means: One year MTA. This index is an average of the monthly one-year Treasury adjusted to constant maturity for the past 12 months. Yields on Treasury securities at constant maturity are determined by the U.S. Treasury from the daily yield curve. That is based on the closing market-bid yields on actively traded Treasury securities in the over-the-counter market.
How it's used: It's an index that is used to set the cost of variable-rate loans, particularly adjustable-rate mortgages (ARMs). Lenders use such an index, which varies, to adjust interest rates as economic conditions change. They then add a certain number of percentage points called a margin, which doesn't vary, to the index to establish the interest rate you must pay. When this index goes up, interest rates on any loans tied to it also go up. Since this index is an annual average of the monthly one-year CMT yield, it is less volatile than other indexes that are not smoothed out over such an extended period of time, such as the monthly one-year CMT.

What it means: One Year CMT. An index published by the Federal Reserve Board based on the monthly average yield of a range of Treasury securities, all adjusted to the equivalent of a one-year maturity. Yields on Treasury securities at constant maturity are determined by the U.S. Treasury from the daily yield curve. That is based on the closing market-bid yields on actively traded Treasury securities in the over-the-counter market.
How it's used: It's an index that is used to set the cost of variable-rate loans, particularly adjustable-rate mortgages (ARMs). Lenders use such an index, which varies, to adjust interest rates as economic conditions change. They then add a certain number of percentage points called a margin, which doesn't vary, to the index to establish the interest rate you must pay. When this index goes up, interest rates on any loans tied to it also go up. Since this index is a monthly average of the one-year CMT yield, it is less volatile than daily interest rate movements but more volatile than other indexes such as the 11th District Cost of Funds.

Some Wall Streeters indicated the sub-prime rate was tied to LIBOR rather than US Treasuries. I made this table to see if some of Wall Street’s pundits opinion about the spread between Libor and US Treasuries will narrow if the Fed lowered Fed Fund target. If one looks at this historic graph (http://www.moneycafe.com/library/libor.htm) then I do not see how a slight drop in LIBOR can help the sub-prime market.

Rate Type	Year Ago	Last Month (Aug 07)	Sept 07	Diff (FNMA - LIBOR) Year Ago	Last Month	Sept
FNMA	6.19	6.31	6.3
LIBOR 1 yr	5.31	5.2	4.9	.88	1.11	1.4
				Diff (LIBOR-MTA or CMT) Year Ago
1 yr MTA	4.664	4.983	4.933	.646	.217	-0.033
1 yr CMT (monthly)	5.08	4.983	4.933	.23	.27	-0.033

If LIBOR needs to be around 1.5% to be a help in the sub-prime mess, then why did the Fed only cut 50 bases points? We know England’s 5th largest bank had a run. England’s central bank did its job but, why did the Fed cut Fed Fund target rate? Was it because a lot of NSFs uses LIBOR? If the Fed’s rate cut means higher food and energy cost, one can bet that US citizens will be screaming for the head of Bernanke (and the rest of the FOMC) on a silver platter.

Another question: “Will any rate cut help the housing market”? The answer is no. Two of the largest secondary mortgage companies (Fannie and Freddie) committed fraud. This fraud went on for years (98? (according to OFHEO's civil law suit) - 2005). Foreign investors buy those GSE’s bonds.

From Flow Matrix; 2006 1998

98 $301 billion

2007 $1,190.9 trillion

There are two problems with these GSE’s

• They are too big. They can shut down the housing market.
  
• There is a known connection between the GSE’s bond rate and US Treasuries.

Let’s take a look at the user cost of capital. From Housing and the Monetary Transmission Mechanism (all terms are defined in the paper)

Fraud invalidates the after tax real interest rates. This went on for years. The problem comes in the form of appreciation/depreciation of house prices. One house sold can affect the asset price. The user cost of capital is a time series equation. The user cost at t + 1 is effected by the interest rate a time t (along with house appreciation/depreciation). Years of fraudulent behavior suppresses the after tax real interest rates which in turn feeds the ever increasing price/decrease of the housing market.

Years of NSFs investment in both the GSEs and US Treasuries also supress after tax real interest rates.