Mixed Signals on the Bugdet

The White House's FY2010 budget is now online. the new proposal sends a couple of mixed signals. As Obama promised, the budget seeks to reduce the deficit. Under this plan the deficit would go from 12.3 percent of GDP today to 3.5 percent in 2012 at the end of Obama's first term. That's a big decline in deficits does not surely mean any reduction in the debt.

Financial Stabilization Reserves

The budget could be altered significantly by the existence of one line item: additional financial stabilization efforts. The current budget places $250 billion in for 2009 and provides no estimates for following years. According to the proposal, "Additional action is likely to be necessary to stabilize the financial system and thereby facilitate economic growth."

The $250 billion is meant to facilitate $750 billion in additional asset buys (assuming that the government is able to recover 66 percent of any purchase price--the average recovery rate for purchases so far). In a previous post, I noted that recovery rates vary considerably by asset type, with the auto loans resulting in little expected return. If the government goes after the most toxic assets recovery rates are likely to decline.

Upbeat Unemployment projections

The budget's projections for unemployment signal faster recovery than either the CBO or market participants project. Below are the projections for unemployment along with those from the CBO and according to the blue chip stocks. We can see that the budge unemployment projections peaks at least .5 percent lower than the other two measures and begins to decline in 2010 rather than 2011. These near term differences could impact how much money needs to go toward further stabilization, and the budget uses the projection lest likely to call for more spending.

Source: An Era of New Responsibility, Office of Management and Budget, 2-26-09

Big Purchases by the Federal Reserve

In his semi-annual report to Congress today, Federal Reserve chairman Ben Bernanke said:

To support housing markets and economic activity more broadly, and to improve mortgage market functioning, the Federal Reserve has begun to purchase large amounts of agency debt and agency mortgage-backed securities.

He's very serious since the Federal Reserve started tracking mortgage-backed securities (MBS) in its assets in January, it's made big purchases.

Factors Affecting Federal Reserve Balances H.4.1

Yes, that's purchase of more than $55 billion during the week of February 12th. This kind of aggressive action fits the model begun by the interest rate slashing and other credit lines and purchase programs created by the Fed within the past year.

New Federal Reserve website

This morning the Federal Reserve launched a new section at the Board of Governors website. The new section on Credit and Liquidity Programs and the Balance Sheet gives a good overview of the actions the Fed has taken to deal with the crisis. Most importantly, it's pretty readable for a general audience. Of note is the inclusion of charts of the Fed's balance sheet. The sheet has more than double this year from about $920 billion in January of 2008 to over $2 trillion the same time this year.

The Fed provides the figure below.

The Fed chart which goes back to 2007 does a good job of showing the spike in assets. Yet if we go back farther, say to 1996 we see that the growth seen this year is phenomenal.

(Source: Federal Reseve Statistical Release H.4.1 Factors Affecting Reserve Balances, Board of Governors of the Federal Reserve, weekly)

Sorry the data is only a few points since the Fed provides this series only as text--I have yet to read it all into a file. Yet we can still see the slow growth over that period. It took over a decade for the Fed's assets to double. Due to the Fed's litany of new lending programs including TALF, swap lines, and commercial paper, the current doubling took less than a year.

Prepare for what you Believe

In a joint agency statement, Federal financial experts stressed that banks are well capitalized. For now. Yet the new plan prefers for "a more challenging economic environment." You don't plan for that unless there's a chance it's coming.

The announcement, preceding the launch of the Capital Assistance Program (CAP) on Wednesday, says that things could get worse. CAP will allow firms to take on mandatory convertible prefer ed shares form the government. The plan prefers that firms seek private capital but provides government money as a backstop.

Today's announcement seems caught between announcing a new government capital injection and trying to shore up confidence. Unlike TARP, the money is not be rushed out the door and may be vetted more clearly. According to the statement,

Currently, the major U.S. banking institutions have capital in excess of the amounts required to be considered well capitalized. This program is designed to ensure that these major banking institutions have sufficient capital to perform their critical role in our financial system on an ongoing basis and can support economic recovery, even under an economic environment that is more challenging than is currently anticipated. The customers and the providers of capital and funding can be assured that as a result of this program participating banks will be able to move forward to provide the credit necessary for the stabilization and recovery of the U.S. economy. Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands.

Two things to note, one the government is preparing for a situation worse than current estimates. Estimates have changed very quickly for major industries lately (GM's latest sales projections come to mind). Second, the statement skews against bank nationalization but doesn't rule it out.

Michiaganders Support Auto Bailout

IMBY (In My Back Yard), please.

In a new poll out today, Rasmussen Reports finds that 52 percent of Michigan voters approve of additional taxpayer-backed loans to GM and Chrysler. 36 percent of Michigan voters disapprove and 12 percent are undecided.

The figures markedly contrast the 64 percent national disapproval for more loans.

While the wedge already seems large, the timing may make it worse. The national poll was conducted on February 16-17. The auto companies released their new plans and projections on the 17th, meaning that some in the national poll had yet to see the size of the packages being requested. The Michigan-wide report was conducted February 18th, after the companies requests had been released and prominent papers like The Detroit Free Press outlined the proposals.

In the national poll, some people were responding to the very idea of more money for Detroit. In the Michigan poll some were likely responding to their more immediate reaction the the outlined plans.

Fed: 2009 will worsen with improvements in 2010

Today's release of the minutes from the Federal Open Market Committee's January meeting provides new insight into the thinking of the Federal Reserve. Beyond the rather dry voting record the FOMC has begun releasing a Summary of Economic Projections (SEP). The SEP addition provides forecasts of the economy and tracks changes in the outlook of FOMC members. The figure below provides the January outlook for GDP growth and unemployment in the coming years.

GDP growth began to slump and unemployment began to rise in 2007 and saw rapid change in 2008. The FOMC predicts that 2009 will be worse by both measures but that growth will increase in 2010. The Fed is careful to state that while its new data should inform policy that "
Considerable uncertainty attends these projections, however."

In fact, predicted ranges widen as the figures head out toward 2011.

The new release is part of an effort, stressed in a speech today by Chairman Bernanke, to improve transparency at the Federal Reserve. Commented Bernanke,

But, as I have discussed today, we will do more on this front, both expanding the information we provide and improving how we communicate that information. Increased transparency is the best way to demonstrate that the Federal Reserve's nontraditional policies are well conceived, well managed, and produce substantial public benefit.

This plan is to include a new website to the slew of websites already being added to the government rolls, recovery.gov, financialstability.gov, among others.

The FSP was unclear even to its planners

The Washington Post reports today that the administration's financial rescue plan, the Financial Stability Plan, underwent large changes in the 11th hour before Secretary Geithner's speech last week.

While NYT columnist Paul Krugman is at least encouraged that Geithner was able to take the lead in changes, I'm more concerned about the continued vacuum left by Treasury's vague plan. The WaPo story includes a series of rhetorical questions, all of them reporters would surely enjoy answering. The lists inclusion leads me to believe not that The Post is slacking but that Treasury simply has no clear answers.

From The Post:

But there were multiple complications: How much government financing would be needed? What other incentives would be needed to get private firms on board? Where would the government get the money? What assets would the fund buy? Would the government have a say in which banks they're bought from? Might there be more than one fund?

If only Treasury had some place where it had told people to go for information. Oh wait, it's still just a test page.

FOMC: Adding employment or folly?

The Federal Open Market Committee (FOMC), the Federal Reserve group that sets interest rates added to it work hours today.

The FOMC has eight remaining meetings this year. Four were one-day meetings and the other four were two-day affairs. Today the FOMC announced that all eight will be two-day meetings. The extension will allow members additional discussion time. From a pure policy standpoint, this extra discussion may yield little, as short-term interest rates are already zero and the FOMC has made clear it will not raise them soon.

Yet the FOMC is greatly changed since last year. Tim Geithner left his post at the FRBNY to go to Treasury. He has been replaced by new FRBNY President William Dudley.
Also at the start of each year Presidents of the regional Fed banks filter in and out of the FOMC. This year Chicago, Richmond, Atlanta, and San Francisco all serve. If the extended meetings increase the appearance of hard-working and unified Fed, they may be worthwhile.

Auto Financing Rates on the Rise

Source: Federal Reserve Statistical Release G.19 Consumer Credit, Release February 6, 2009

As the automotive industry watches sales plummet, the interest rates on auto loans has increased.

New data released today by the Federal Reserve shows that the interest rate for new car loans has at auto finance companies has increased to 8.42 percent in December of 2008 from 6.41 percent in October. These rates have been on the rise since July, the December figure is the highest since 1997. This likely explains some of the fall off. In a future post, I hope to compare these rates to other consumer credit rates.

We're Discouraged

By now everyone has seen the dismal jobs numbers from January of this year. The Department of Labor release from this morning is bad. Unemployment rose .4 percent up to 7.6 percent. It's highest level since 1992, according to Bloomberg. That's a loss of almost 600,000 jobs. Of course, beyond the headline numbers there is more bad news. One understated figure is the number of people who want jobs but have stopped looking for them. This number has grown steadily in recent months, increasing by 889,000 people year-over-year.

While people leave the labor force for a variety of reasons, the Department of Labor's Bureau of Labor Statistics (BLS) asks people if they were discouraged.

According to BLS, discouraged include people perceive that:

A)no work available,

B) they could not find work,

C) They lack schooling or training,

D) employers think they are too young or old

E) they other types of discrimination.

This subcategory of the people who want but are not seeking work has also grown. I've charted the percentage of people who want but are not seeking work, who say they are discouraged.

The figure now stands at 12.51 percent, a 33 percent increase year-over-year since last January. These people may be difficult to woo back into the labor force. While they may not impact unemployment figures they may not contribute much to the economy.

Will the stimulus make life more expensive

In my last post, I commented on the timing of the stimulus. In a letter yesterday to Committee on Budget ranking member, Senator Judd Gregg (R-NH), the CBO applied a bit of basic macro theory to the stimulus package. The letter, which examines the Senate's version of the bill, predicts a stimulus in the short-run but a small decline in long-run GDP due to increased debt.

In the longer run, the legislation would result in a slight decrease in gross domestic product(GDP) compared with CBO’s baseline economic forecast.

More importantly, the CBO underscores that stimulus cannot provide long-run growth if it only increases demand without increasing our productive capacity. According to the letter,

Even if the fiscal stimulus persisted, however, the short-run effects on output that operate by increasing demand for goods and services would eventually fade away. In the long run, the economy produces close to its potential output on average, and that potential level is determined by the stock of productive capital, the supply of labor, and productivity. Short-run stimulative policies can affect long-run output by influencing those three factors, although such effects would generally be smaller than the short-run impact of those policies on demand.

This statement provides the integrated short-run (Keynesian), long-run (classical) framework that causes aggregate supply to have very different properties over time. Without increases in agrregate supply, the stimulus could lead to inflation if an increase in demand must adopt to lower long-run supply. It may of course be that we are operating below the long run supply (the exact arguement that stimulus supporters will use high unemployment numbers to make). If so then the timing of the stimulus again becomes important.

Even strong Keynesian's like Steve Fazzari have noted that what we spend our money on matters. Increases in education or training may increase long-run aggregate supply spending on infrastructure may not if we are just using old techniques to repair roads, etc.

It should also be noted that the CBO report provides a wide range of possible impacts from the stimulus. For instance it indicates that the plan could provide anywhere from 1.4 percent over baseline increase in GDP to 4.1 percent in 2009. Sadly, the estimates are non-stochastic (or at least not presented as such) so their likelyhood is more difficult to determine.