Making Policy by Anecdote
The government shutdown means that the Federal Reserve Open Market Committe doesn’t have access to their usual inflation/economic data. Today, the FOMC lowered the Federal Funds Rate by 25 basis points. The following are excerpts from the press conference.
Howard Schneider of Reuters: I just wanted you to elaborate a little bit on what you said a moment ago about a continued shutdown making it more difficult to make a move in December and that may make you more cautious. To the degree that you are relying on private data that isn’t the gold standard, or that you’re relying on your own surveys of the beige book, do you worry at some point you’re going to have to start making policy by anecdote?
Powell: This is a temporary state of affairs. We’re going to do our jobs.
Powell rambled on answering the question after that. The last question was asked by Jennifer Schonberger of Yahoo Finance.
Schonberger: Both regional and large banks have taken losses on loans- given delinquencies on subprime auto loans- JP Morgan CEO Jaime Daimon warned, “When you see one cockroach, there may be more likely.” I’m curious how the Fed is looking at these loan losses and if it poses risk to the financial system or the outlook for the economy. Is it a warning sign?
Powell: We watch these credit conditions very carefully. You’re right. You’ve seen rising defaults in subprime credits for sometime now. Now you’ve seen a number of subprime credit- automobile credit- institutions having significant losses and some of those losses are now showing up on the books of banks. You know, we’re looking at it carefully. We’re paying attention. I don’t see at this point a broader credit issue. It doesn’t seem to be something that has very broad application across financial institutions. We’re going to be monitoring this quite carefully and making sure that is the case.
Schonberger: And then separately, many, you yourself, have said that we’re in a bifurcated economy right now with high net worth individuals continuing to spend with lower income pulling back. How much of consumer spending continuing hinges on the stock market remaining strong? In some odd way does the market help keep the economy buoyant?
Powell: [After blabbering] It would affect spending if the stock market went down, but it wouldn’t drop sharply unless there were quite a sharp drop in the stock market. [More blabbering]
The subprime auto loans that they are referencing are for Tricolor and First Brands. Tricolor sold cars and made car loans to illegal immigrants. First Brands sold autoparts to Tricolor. Many of Tricolors borrowers are being deported or simply not making payments.[1]
Interestingly, interest rates for 10-year and longer term treasuries have increased in response to the Fed decreasing the funds rate for the 5th time. At some point, it breaks.[2]
Additionally, the Reverse Repo Market has effectively been drained, finally. That means that banks are looking for overnight Repo loans from the Fed because they are short of cash, instead of making overnight Reverse Repo loans to the Fed in the repo market as they had been doing since 2021.[3]
To explain, a Repo loan is when the Fed loans money to big banks overnight in exchange for government bonds as collateral. A Reverse Repo loan is when a big bank loans money to the Fed in exchange for bonds as collateral.* The above chart effectively shows the supply of the big banks’ easy money created in response to the Covid lockdowns declining. For whatever reason (bad loans) they are short of cash. It shows a credit crunch.
The more things change, the more they stay the same. Just like in the credit crisis of 1772, our economy relies on cheap credit.[4]
To quote Henry Hamilton, The Failure of the Ayr Bank, The Economic History Review 1956: Vol 8 Issue 3, Page 414,
“Some projects, such as agricultural improvements or the building of a lint mill, had a short gestation period, others, like afforestation or the Forth and Clyde Canal, could only become profitable years after the initial investment had been made. All required a steady flow of finance while operations proceeded. It was to meet this need that the Ayr Bank was founded.
[…]
The climax of the long rise in activity came in 1771. In the following year all the indices of production turned down. There had been a good deal of speculative activity in 1770-1 and this contained within itself the seeds of collapse. Overtrading and the too liberal, if not extravagant, creation of credit by the Ayr Bank undermined confidence in London and in Edinburgh. When this happened the boom was bound to burst. The failure of the Ayr Bank followed inevitably and this completed the destruction of high hopes and optimistic expectations.”
*End Note: The Fed does not need to engage in reverse repos to get a loan because the Fed can print money whenever they want; so, they were only doing reverse repos to keep big banks from investing more of the newly printed money in the rest of the economy and thus inflating prices further. Despite that, those banks still need more money (cheap loans).
[2]https://www.hamiltonmobley.com/blog/the-golden-age
