US adopts zero interest rate policy

[J]

Bloomberg link

Fed Cuts Rate to as Low as Zero, Will Use All Tools (Update2)

By Scott Lanman and Craig Torres

Dec. 16 (Bloomberg) -- The Federal Reserve cut the main U.S. interest rate to as low as zero and said it will buy debt as the next step in combating the longest recession in a quarter-century and reviving credit.

The Fed “will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability,” the Federal Open Market Committee said today in a statement in Washington. “Weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”

Treasury notes rallied in anticipation the Fed will buy the securities to force borrowing costs for consumers and companies lower. Nine rate cuts in the prior 14 months and $1.4 trillion in emergency lending failed to reverse the economic downturn. Today, the Fed said it will target a federal funds rate of between zero and 0.25 percent.

“The focus of the committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level,” the FOMC said.

The dollar tumbled against the euro and yen. Stocks climbed, pushing the Dow Jones Industrial Average up 216 points, or 2.6 percent, to 8797.12 at 2:53 p.m.

Printing Money

“The Fed is sending a message that it will print money to an unlimited extent until it starts to see the economy expanding,” William Poole, former president of the St. Louis Fed and now a senior fellow at the Cato Institute in Washington, said in an interview with Bloomberg Television. Poole is also a contributor to Bloomberg News.

The statement noted that the Fed has already announced it will purchase the debt issued or backed by government-chartered housing finance companies, and said the Fed is ready to expand the program. The central bank said it continues to weigh the potential benefits of buying longer-term Treasury securities.

The deepening economic slump pushed unemployment to 6.7 percent last month, the highest level since 1993, while builders broke ground on the fewest new homes since record-keeping began in 1947. Deflation is also emerging as a risk: consumer prices fell the most on record in November, the Labor Department said earlier today.

No Dissent

Today’s vote was unanimous. In a related move, the Fed lowered the rate on direct loans to banks and securities dealers to 0.5 percent. It set the payment on the reserves that commercial banks hold at the Fed at 0.25 percent, down from 1 percent.

Fed policy makers twice pared the federal funds rate, or overnight lending rate, to 1 percent since adopting it as the main tool of monetary policy in the late 1980s. The 1 percent rate held from June 2003 to June 2004, and again from the end of October to today.

The Bank of Japan has been the only major central bank in modern times to mix a policy of steep rate reductions with quantitative easing, or the strategy of injecting more reserves into the banking system than needed to keep the target rate at zero.

Japan’s central bank kept its main rate at zero from 2001 to 2006 while flooding the banking system with extra cash to encourage lending, spur growth and overcome deflation. The abundant funds failed to prompt lending by commercial banks, which expanded their reserves at the central bank almost nine times by early 2004.

Emergency Loans

Bernanke, acting with New York Fed President Timothy Geithner, has set up emergency loan programs aimed at averting a collapse of the nation’s credit markets. Geithner is President- elect Barack Obama’s pick for Treasury secretary and didn’t attend today’s meeting.

The Fed has enlarged bank reserves, supported issuance of commercial paper and provided liquidity to government bond dealers. It is also swapping dollars with the European Central Bank and its other counterparts to supply banks in other countries.

The moves have swelled the Fed’s balance sheet to $2.26 trillion from $868 billion in July 2007. That’s in addition to the $700 billion Troubled Asset Relief Program, which the U.S. Treasury has used since October to channel about $335 billion of capital injections into banks and other financial companies.

Still, the economy has crumbled, with employers cutting 533,000 jobs from payrolls in November for a total loss this year of 1.9 million, which more than erases the 2007 gain of 1.1 million.

Credit remains scarce in many markets and major financial institutions worldwide continue to report losses and writedowns totaling $994 billion.

Shrinking Economy

Macroeconomic Advisers LLC, a St. Louis-based consultant, says the economy is probably shrinking at a 6.5 percent annual pace this quarter, which would be the biggest drop since 1980.

The firm forecasts a 4.2 percent annual contraction rate in the first quarter, returning to no growth in the second quarter and a 2.3 percent expansion rate in the second half of 2009.

Early this month, as a panel of leading U.S. economists declared the recession began in December 2007, Bernanke signaled he was ready to dig deeper into the central bank’s toolkit. He said he may use less conventional policies, such as buying Treasury securities, because his room to lower the main U.S. rate from the current 1 percent level was “obviously limited.”

Fading Relevance

The federal funds target rate has weakened as a monetary policy tool because the Fed’s flood of funds has caused the average daily rate to trade below the policy goal every day since Oct. 10.

The gap between the target and the effective rate, or average daily market rate, has averaged about a half point since Sept. 12. The gap averaged just above zero from the start of this year through Sept. 2.

The central bank is trying to lower mortgage rates by purchasing up to $100 billion of debt issued by housing-finance providers Fannie Mae and Freddie Mac and $500 billion of mortgage-backed securities guaranteed by the companies.

The Fed’s counterparts around the world have staged their own interest-rate cuts. The ECB has lowered its main rate to 2.5 percent this month from 4.25 percent in July, while the Bank of England reduced its rate to 2 percent this month from 5.75 percent in July.

ECB President Jean-Claude Trichet said yesterday there’s a limit to how far the bank can cut interest rates and signaled policy makers may pause in January. “Do we have a feeling there is a limit to the decrease in rates? At this stage certainly yes,” Trichet told journalists in Frankfurt.

While the Fed can’t push interest rates below zero, “the second arrow in the Federal Reserve’s quiver -- the provision of liquidity -- remains effective,” Bernanke said in a Dec. 1 speech.

But remember, the US is different and special so it won't end up with a lost decade or two like Japan. The predictions for a 2nd half turnaround in 2009 are equally hilarious, we were supposed to have one in the 2nd half of this year according to the "experts", yet here we are. Also, printing unlimited money is going to grow the economy? I really want to know what kind of drugs these people are using.

[Admiral Valdemar]

Firing up the presses is a bad omen. It's only a matter of time now. The dollar will soon become worthless, the paper sold by the Treasury will be left to catch dust and without such foreign buyers servicing the US's debt, the imports will dry up. No one sends stuff to people who give nothing in return.

[Illuminatus Primus]

Well, what should have Japan done rather than what it did? Just toughed it out and let things hurt, but get over with?

[Darth Wong]

Yes, I'd be quite curious myself to hear the genius solutions that J and Admiral Valdemar have for our current predicament. The fact is that they haven't got one, so they just jeer and heckle at any efforts anyone makes to ensure stability.

I also find the calls to "let the chips fall where they may" particularly heinous. They echo the disgusting callousness of far-right conservatives in their attitude that an unlimited amount of volatility in the human labour market is OK as long as the system eventually comes out of it stronger. Never mind that real living human beings will be swept up and ripped apart in the upheavals they recommend as a superior outcome. It would actually be better to have a "lost decade" than to quickly "get it over with" in terms of human suffering, but I suppose that if you view the economy as nothing more than a fancy computer simulation with numbers and no real people involved, then they're right

[Phantasee]

I'm not as well-versed in economic theories as you guys are, and to be honest, I haven't been around long enough to personally witness a lot of different situations that people refer to (Japan's lost decade, for one).

But tell me this: this act, while it may be bad for the long term growth, which is so important to the capitalist system, will it be "good" in some way for regular people? People, not labour resources. I'm assuming a "lost decade" means little or no growth for a long period of time? So standards of living might go down, or stay the same (?), for the average person, but it's not as bad as the upheavals DW refers to?

So in the end, the only people fucked by this are the capital controllers, the banks and large corporations and such. Sounds like fair play to me.

[Darth Wong]

By "upheavals", I'm referring to the people who say we should just let <insert industry name here> collapse because that way, the economy will come out stronger ten years from now than it would otherwise.

The ironic thing is that many of them have opposed the "economic growth at all costs" doctrine before, when it came from the mouths of conservatives.

[Admiral Valdemar]

Yes, I'd be quite curious myself to hear the genius solutions that J and Admiral Valdemar have for our current predicament. The fact is that they haven't got one, so they just jeer and heckle at any efforts anyone makes to ensure stability.

I also find the calls to "let the chips fall where they may" particularly heinous. They echo the disgusting callousness of far-right conservatives in their attitude that an unlimited amount of volatility in the human labour market is OK as long as the system eventually comes out of it stronger. Never mind that real living human beings will be swept up and ripped apart in the upheavals they recommend as a superior outcome. It would actually be better to have a "lost decade" than to quickly "get it over with" in terms of human suffering, but I suppose that if you view the economy as nothing more than a fancy computer simulation with numbers and no real people involved, then they're right

This assumes there is another way to deal with this situation. There isn't. You pay the piper in the end, the idea is to not get into the problem in the first place. I don't see how pointing out stupid decisions that have screwed so many people over is such a bad thing when there are no actual alternatives.

Stability, by the way, is the last thing this "solution" will produce.

[Stark]

Is 'didn't work' defined as 'didn't immeditately turn it around'? I mean if you look at previous economic shindigs, you can find people who declare any action made it worse/would have fixed it, depending on their political leanings.

[Admiral Valdemar]

Is 'didn't work' defined as 'didn't immeditately turn it around'? I mean if you look at previous economic shindigs, you can find people who declare any action made it worse/would have fixed it, depending on their political leanings.

The system has been in trouble for many years now (some would say since the '90s, others to as far back as the removal of the gold standard in the '70s), and it could be argued that our economic model is itself destined to implode in these ever more powerful Kondratiev cycles. So long as the powerful looked after their own and people were allowed access to easy credit, this was going to be the inevitable result.

Now, I could have told you how to sort this out a decade ago, before we really took off with such debt inflation, but today it's really not going to end in anything other than default or hyperinflation and then probably default. People have been living beyond their means, and, frankly, no one would ever elect me president if I put forward proposals for making a more stable society, because it gimps people something awful compared to the boom times they've recently had.

[J]

I actually have posted solutions to various parts of the problem in previous posts, but I guess I can put it all together.

With regards to mortgages. What's needed here is a full principal reduction to adjust the monthly payments to affordable levels, accompanied with full income documentation. This will apply only to a single primary residence, speculators and all others who were seeking to profit off a home and got burned will take their losses. Getting back to the mortgage rework, we confirm what the borrower is earning and the principal on the home is taken down to 3 times the family income, as has been the standard for a prime mortgage since the Great Depression. This instantly corrects housing prices to sustainable historical norms and drastically reduces the number of defaults & foreclosures. All future mortgages will be full documentation, fixed rate, and no more than a 35% debt to income ratio. Note that the recovery value on a foreclosure is currently only 20-30% of the original loan amount, and falling, if the home can actually be sold and in most cases they can't. My planned rework would give a 40-75% recovery on the original loan depending on the area.

Next, the government can take $500 billion to a trillion and use it to start up around a dozen new banks. This can be paid for by recinding the TARP and a couple other liquidity programs which are currently propping up the zombie banks. If Bank of America or JPM goes down the FDIC can take care of it (oh yeah, fully fund the FDIC), and customer & business accounts can be moved over to the new federally chartered banks. After the immediate crisis is over these government banks can then be IPO'd since Americans have a pathological hatred of anything that's government run.

At the same time full balance sheet transparency needs to be restored, no more hidden assets, no more lying about the value of assets, no more fudging of numbers while the SEC turns a blind eye. All assets are now "mark to market", if there are no buyers nor market for a given asset, it's worth zero and so noted on the balance sheet until there is a buyer. Part of the reason why there's no lending going on between financials is they all know that others are dirty, since they themselves are lying on their balance sheets. The lending won't restart until trust is restored, and that's done with transparency so all parties know where others stand.

Glass-Steagall will have to reinstated, that way when investment banks do stupid things and go under they don't take the commercial part with them. We got to where we are in part due to investment banks taking absurd risks since they could raid their commercial operations to cover their losses. And when the commercial part no longer has the money to cover the losses, kaboom, ordinary Americans lose their savings. Reinstate Glass-Steagall and investment banks can gamble to their hearts' content while commercial banks provide a safe stable haven for businesses and ordinary people.

Leverage limits will also have to come back, every financial which has blown up in the current crisis was running a leverage ratio of over 50:1, that is for every dollar they actually possessed they were loaning, gambling, or otherwise "investing" $50. A little 2% hiccup in their investments and they're completely wiped out. Leverage has to come down to 10:1, max.

Then we have the whole derivatives and structured finance mess, the big problem now is they're all done "over the counter" and there's no standards nor supervision. There's a lot of fishy business going on and if something blows up it's nearly impossible to contain. A central clearing house needs to be established to regulate this market and ensure margin requirements are met and all counterparties are sound and have the ability to pay up if needed. For instance, we can't have a company with $1 million in assets insuring $10 billion worth of debt, if that debt goes bad there's no way the company can pay up.


I don't pretend that this plan is either painless or fair, it isn't. But it will get us out of this mess with the least amount of suffering and will do so in a comparatively short time compared to the alternatives. There will still be plenty of pain for everyone, but at this late stage it's unavoidable. We let the cancer spread, a few years ago we could've cut it out and been on our way the next day, now nothing short of chemotherapy will cure it.

[Straha]

The Fed needs to start printing money now because, if it doesn't, the U.S. is in for a massive deflationary shit storm, which would make a shitty situation far worse. I could try to explain it here but there's a much better explanation over here:

*ttp://ww w.scrivener.net/2008/12/mvpq-in-pictures.html

Also, it's funny to hear comparison to Japanese policy here because Japan is often criticized for not lowering their interest rates fast enough. When they finally did lower their rates far enough it was too little, too late and compounded with earlier policy missteps to make the whole situation worse, not better.

[J]

The Fed needs to start printing money now because, if it doesn't, the U.S. is in for a massive deflationary shit storm, which would make a shitty situation far worse. I could try to explain it here but there's a much better explanation over here:

*ttp://ww w.scrivener.net/2008/12/mvpq-in-pictures.html

Also, it's funny to hear comparison to Japanese policy here because Japan is often criticized for not lowering their interest rates fast enough. When they finally did lower their rates far enough it was too little, too late and compounded with earlier policy missteps to make the whole situation worse, not better.

The Fed's been printing since August, note the monetary base column. Since then we've had a good chunk of the financial system implode taking the economy along with it. So I guess the Fed isn't printing fast enough and should take a few lessons from Zimbabwe?

[Uraniun235]

Well, what should have Japan done rather than what it did? Just toughed it out and let things hurt, but get over with?

I'm curious to know, if Japan had just 'toughed it out', would it actually have been in a better position by now? What assumptions are used to make that judgment? And what would it mean for economic/financial theory if Japan had just 'toughed it out' and found itself in a worse position by now?

(please note this is not intended as an adversarial post)

[Ryan Thunder]

The Fed needs to start printing money now because, if it doesn't, the U.S. is in for a massive deflationary shit storm, which would make a shitty situation far worse.

I'm afraid I don't get it. At the simplest level (imagine that I'm a complete moron ), why would deflation make things worse?

[Admiral Valdemar]

I'm curious to know, if Japan had just 'toughed it out', would it actually have been in a better position by now? What assumptions are used to make that judgment? And what would it mean for economic/financial theory if Japan had just 'toughed it out' and found itself in a worse position by now?

(please note this is not intended as an adversarial post)

That is an interesting question and one I believe relevant to the US' situation now, even if the situations aren't exactly alike. Some have argued that the US should have gone and made all Level 3 assets marked to market and transparent last year, as soon as this problem started cropping up in the summer. At least maybe then the markets would have had a sudden upheaval and some pain, if with the possibility of rebuilding from that collapse far quicker and with a clean slate in a less hostile period. Now, if you try that, the already frozen credit markets will be just as stuck, only instead you'd have wasted trillions in trying to prop up organisations that are still trying to bluff to the world that they have more assets than they're worth. No one is going to buy that now, and protectionism seems to be the order of the day.

The US going ZIRP, or the next best thing, means any incentive to save disappears at the time most crucial for suring up the savings funds. The very idea that we can spend our way out of debt is ludicrous, yet here we are, mortgaging our childrens' futures to try and solve a clusterfuck of our own doing.

Taxes to the rich should have been raised, a more stringent look at credit card and mortgage loans would also have helped and more importantly, Glass-Steagall never should have been rescinded. The markets, if they hadn't been inventing new ways of cooking the books, would have had to play the old fashioned way. We'd be a poorer society compared to what we've known, but we sure as hell wouldn't be staring into an abyss. I'd much rather have a sustainable lifestyle that is stable, albeit, with less excess, than one where you can live beyond your means and live it up large before the inevitable day comes when you have to, shock horror, pay back what you owe. The vast majority of people in the shit today got there by their own greed as much as the City's or Wall Street's.

As a saver who has only ever been sensible with money, the yahoos with over leveraged bank accounts seeking help from the government can suck my dick. That goes double for the "baby boomers" who have gladly set up this house of cards and allowed it to get in such a state that we face economic ruin.

[Starglider]

The Fed needs to start printing money now because, if it doesn't, the U.S. is in for a massive deflationary shit storm, which would make a shitty situation far worse.

I'm afraid I don't get it. At the simplest level (imagine that I'm a complete moron ), why would deflation make things worse?

Because it increases the real value of all debts, meaning more defaults, more credit destruction, more deflation etc. Meanwhile people holding cash aren't inclined to spend it, because it's appreciating in real value even if the interest rate is zero. It's a vicious spiral.

[Guardsman Bass]

Well, what should have Japan done rather than what it did? Just toughed it out and let things hurt, but get over with?

I'm curious to know, if Japan had just 'toughed it out', would it actually have been in a better position by now? What assumptions are used to make that judgment? And what would it mean for economic/financial theory if Japan had just 'toughed it out' and found itself in a worse position by now?

(please note this is not intended as an adversarial post)

They wouldn't have quite so much national debt.

[Admiral Valdemar]

And that is why the Fed, and other central banks, are trying their damndest to halt deflation. We've gone from high inflationary pressure to deflation in months, and since many people and corporate entities along with governments hold debt (it's what makes the world go round), the last thing you need is for the ability to keep on top of such debts slipping away. The Fed would much rather risk hyperinflation Weimar style than deflation, though neither are healthy.

The inflation figures have come down and stabilised now in the UK, and no doubt the US and elsewhere too. This could change in the near future still, because energy price volatility is the most assured thing now. Prices need not keep going up, or fall drastically only. They can do both, and that will lead to all costs being volatile. The cheap oil and gas prices today may inevitably trigger far higher inflation in the near term, since the investment needed to maintain the most vital infrastructure on Earth will be sorely lacking, which means costs have to rise to accommodate any supply issues. This doesn't make fiscal planning any easier.

[Ryan Thunder]

The Fed needs to start printing money now because, if it doesn't, the U.S. is in for a massive deflationary shit storm, which would make a shitty situation far worse.

I'm afraid I don't get it. At the simplest level (imagine that I'm a complete moron ), why would deflation make things worse?

Because it increases the real value of all debts, meaning more defaults, more credit destruction, more deflation etc. Meanwhile people holding cash aren't inclined to spend it, because it's appreciating in real value even if the interest rate is zero. It's a vicious spiral.

Oh, I see. I would have expected people to spend more since they have more, myself.

Of course, this whole inflation/deflation issue comes about because some douche thought it would be a great idea to treat money like a commodity that can be bought and sold at any value.

[Starglider]

Oh, I see. I would have expected people to spend more since they have more, myself.

The very fact that someone has cash reserves in the first place means they aren't likely to be a spendthrift. Short-term savings have also been depressed by the sheer amount of low-interest easy credit available. However if prices start falling visibly month-on-month, and store credit is unavailable or (even more) extortionate, we should finally see some shift back to saving up for things you want instead of just taking credit. Unfortunately a major social transition from buy-now-pay-later to save-up-then-pay-cash, while good in the long run, would depress sales for years.

Of course, this whole inflation/deflation issue comes about because some douche thought it would be a great idea to treat money like a commodity that can be bought and sold at any value.

Uh, what? Money is the ultimate commodity, that's pretty much the definition of money; a universally exchangeable store of value.

[Count Chocula]

Starglider, one minor quibble: the "money" we use today is more properly described as currency. In and of itself, an Andy Jackson ($20 bill) has no intrinsic value, and is not a store of value per se, but a yardstick to use for market transactions. That yardstick, unlike items with intrinsic value or use, such as oil, changes in length depending on its perceived rate of exchange for goods. Many items have been used as money over the millennia, but that's a different thread.

I suppose this will help banks, who borrow short and lend long, but that assumes the banks will extend credit to people looking for money. IMO, the reluctance of banks to lend is a contributing factor of the Big 3 automakers' and home construction business' decline, never mind that too many cars were built and too many homes were built on spec. The elephant in the closet that nobody seems to be talking about is the likelihood that Americans simply can not afford to take on new debt, regardless of how much banks can theoretically issue.

[Coyote]

But, if the dollar sinks in value, won't that make US exports more attractive (and mean jobs to build exports) and also force oil prices to stay (comparatively) low? It would be "shock therapy", so to speak, by turning the US into a Japan-style export economy-- workers would get either low wages or wildly inflated ones, and with zero interest there'd be no reason to sock money away in savings-- but it would keep US industry on life support for awhile, wouldn't it?

[J]

I suppose this will help banks, who borrow short and lend long, but that assumes the banks will extend credit to people looking for money. IMO, the reluctance of banks to lend is a contributing factor of the Big 3 automakers' and home construction business' decline, never mind that too many cars were built and too many homes were built on spec.

Well, until the Fed's and Treasury's actions throw the entire yield curve out of joint and then the banks are well and truly toast. Portions of the yield curve have momentarily gone inverted during the past few months, if a large portion flattens or goes inverted then the regular business model is out the window and even sound banks will be squeezed hard or driven out of business entirely.

The elephant in the closet that nobody seems to be talking about is the likelihood that Americans simply can not afford to take on new debt, regardless of how much banks can theoretically issue.

I've mentioned this point in previous posts, Americans have been sucked dry with HELOCs, option ARM mortgages, no-fee credit card balance transfers, carry-over car loans and 1001 kinds of exotic (& toxic) loan products. The people are choking on debt and there's no way to jam even more debt down their throats, trying to do so is like pushing on a string.

But, if the dollar sinks in value, won't that make US exports more attractive (and mean jobs to build exports) and also force oil prices to stay (comparatively) low? It would be "shock therapy", so to speak, by turning the US into a Japan-style export economy-- workers would get either low wages or wildly inflated ones, and with zero interest there'd be no reason to sock money away in savings-- but it would keep US industry on life support for awhile, wouldn't it?

Sounds great, except for one small problem: who's going to buy those US exports?

[Starglider]

In and of itself, an Andy Jackson ($20 bill) has no intrinsic value, and is not a store of value per se, but a yardstick to use for market transactions.

Wrong. The very fact people have savings accounts (or just cash stuffed into a safe) makes money a store of value. It doesn't matter that the value only exists as long as there is a society out there who also values money; frankly gold is nearly as bad, most of the value of that is due to the shared perception that it is rather than any intrinsic usefulness. The gold standard people can bleat all they want but that won't change the reality that fiat currency does act as store of value in practice (how good of a one is another debate).

[Col. Crackpot]

Here is a tidbit of sanity from my little window on the world

Over the past several weeks, despite significant dips in LIBOR and the FED rate, fixed equities I'm dealing with are remaining in the high seven's and low eight percent range, while traditional first position mortgages (Purchase or NO cash-out straight refi's) have dropped under five percent. Granted, HELOCS are are in the three's and fours, but the underwriting guidelines for those have become downright draconian. What does that tell us? Banks (at least mine, and the last remaining investors that will accept a brokered deal) don't want anyone using their house as a ATM machine anymore and are working this into their pricing.