William J. Polley

More regular posting in a few days.  I have been preoccupied with way too many other things, but they will settle down soon.  My New Year's resolution is to do some work on the blog.  Importantly, I need to investigate what sort of blogging tools there are out there to make my life easier.  Suggestions are welcome!

It has not been the easiest year from the standpoint of the macroeconomy.  It has been an interesting year to be an economist however.  Here's hoping that 2009 will be slightly more normal.

A very happy New Year to you and yours... I promise plenty of interesting posts in the new year.

Reuters is reporting that President-elect Obama will nominate Georgetown law professor Daniel Tarullo for one of the two open seats on the Federal Reserve Board of Governors.  Story here.  Tarullo's bio here.

From the looks of his qualifications, Tarullo will add some expertise to the Board in the area of financial regulation.  Having a legal scholar on the Board will be quite beneficial for the Fed as it copes with changing regulations, both those that they write and those that affect the environment in which they operate.

Oh, come on, you knew he would get it, right?  (Time magazine)

Actually, since 1964 every president except Nixon and George H.W. Bush received the honor in the year they were first elected.  (See full list)

That's right.  Johnson, Carter, Reagan, Clinton, and George W. Bush all were Person of the Year in the year of they were first elected.

So this should not come as that much of a surprise.

... to have a zero funds rate.  Well, almost zero.  When I got up this morning to give my final exams, I thought how the FOMC will almost certainly go down to 25 b.p.  They'll want to go all the way to zero, but something in them just doesn't want to say "zero".  They need a way to go to zero without really saying that they're going to zero.

And so they did.  (FOMC Statement)

The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent. 

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined.  Financial markets remain quite strained and credit conditions tight.  Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably.  In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.  In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. 

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.  As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.  The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.  Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.  The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

It had to be done.  If we were to go another 6 weeks speculating about whether and when we would actually have quantitative easing, I'm not sure the market could cope with the uncertainty.  To go down to 25 b.p. is effectively an admission that they need to go to zero, so you might as well just do it.

Now the game has changed.  Say what you will about the fact that the normal monetary policy channels haven't been working for some time.  That is history now.  Tomorrow when they get up and go to work, they will have to come to terms with the fact that they have committed to operating in a whole new environment.  December 16, 2008 will be right up there with October 6, 1979 in the short list of monetary turning points--but the turn is in the opposite direction.

Tomorrow their real work begins--revealing to the world what it means to "employ all available tools".  That phrase is going to be ringing in my head all night.

Nonfarm payroll employment down 533,000 in November.  (Full text)

No nice way to spin that news.  The things I'm reading lead me to expect December to be nearly as bad.

I'm giving a seminar in a bit, so I don't have time for more now.  Hopefully more time this weekend.

UPDATE:  David Henderson at EconLog points out that the 533,000 is a smaller percentage of the labor force than it was in the 1970s.  True.  That's one of the aspects of the problem I intend to think about this weekend.  Also, see the comments to his post for more discussion.  I think it is safe to say that in percentage terms the job losses from this recession are going to exceed the last two recessions, and rival those of the '70s and '80s.  More later.

Perhaps the better question is:  "Should the government back mortgages at 4.5%?"

Before you answer, look at the yield curve.

Then read this from the Wall Street Journal:  (Hat tip to Calculated Risk)

WASHINGTON -- The Treasury Department is considering a plan to revitalize the U.S. home market that would push down interest rates for loans to purchase a home, according to people familiar with the matter.

The plan, which is in the development stage, would temporarily use the clout of mortgage giants Fannie Mae and Freddie Mac to encourage banks to lend at rates as low as 4.5%, more than a full point lower than prevailing rates for standard 30-year fixed-rate mortgages.

Government officials are under pressure to address falling home prices and mounting foreclosures, which underpin the financial crisis. The Treasury has struggled for months to come up with a plan that would ease the strains on borrowers without appearing to bail out homeowners and lenders.

"...without appearing to bail out homeowners and lenders."  One out of two ain't bad.  Continuing...

Treasury views this plan as potentially halting the slide in home prices by enabling borrowers to afford bigger loans, thus increasing demand and pushing up home values. The lower interest rates would be available only to borrowers who are buying a home, not those refinancing a mortgage.

Aww, shucks.  Well, maybe they'll offer it for refis next week.

One problem I see is that this looks like it will have a lot of moving parts.  That is, it relies on "encouraging banks to lend" and then backing the mortgages using "the clout of...Fannie Mae and Freddie Mac."

Show of hands everyone who thinks that'll work?  I thought so.  No, this has all the earmarks of being a pretty lousy idea.

But wait, remember what I said about the yield curve?  What if the government issued a special series of 30 year mortgage bonds and then (*gulp*)... well, you complete the sentence because I can't bring myself to do it (hint: it includes the word "nationalize").

Made you think, didn't it?  And that's what is so unique (and more than a little worrying) about this whole situation.  This could potentially be a moneymaker for the Treasury (at least this week--one must strike while the iron is hot), but long term it's a bad idea.  Because once you do it, it won't go away.  My message to the outgoing and the incoming administrations is to think very, very carefully before jumping on something like this.

I remember distinctly an interview I gave almost exactly a year ago (almost to the day) in which I cautioned that the wrong solution could just end up prolonging the inevitable (with regard to the subprime mess, foreclosures, etc.).  That was a year ago.  I'm saying it again here today.  Will I be saying it again a year from now?

The last paragraph is, to me at least, the most troubling thing I have written to date on the crisis.

Clearly the markets have unwound considerably in the last year, and they have a good distance to go.  I'm all for the Fed and the Treasury protecting the integrity of the payments system, but that side of things appears to be somewhat more stable now.  Perhaps its time to let things sort themselves out a bit before putting in a false bottom.