Federal Reserve ChallengeDecember 10 2008

Damian Gray

Ben Blieden

Scot Weisman

Adam Nichols

Robert Searle

Monetary Policy Recommendations

Maintain Fed Funds Rate at 1%

Lower Cost of Capital

Purchase Long term Debt

Create Innovative Lending Facilities

2004

Q3

2004

Q4

2005

Q1

2005

Q2

2005

Q3

2005

Q4

2006

Q1

2006

Q2

2006

Q3

2006

Q4

2007

Q1

2007

Q2

2007

Q3

2007

Q4

2008

Q1

2008

Q2

2008

Q3

-1

0

1

2

3

4

5

6Percentage Change GDP

Source: BEA

3rd Quarter GDP -.5%

• Personal consumption 3.7%• Government consumption 5.4%• Business Investment .4%• Exports 3.4%• Imports 3.2%

Source: BEA

GDP = C+I+G+(X-M)

GDP forecasts

• Goldman Sachs predicts 4th quarter GDP will go down 5%

• Personal consumption will continue to decrease in 2009

• Barack Obama’s plans will boost government consumption in 2009

Source: CNN

Loss of Jobs

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-0

7

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-0

8

-600

-500

-400

-300

-200

-100

0

100

200

300

Nov. 8: 533,000

Total Year to Date:Nearly 2 Million

Source: BLS

Unemployment Rising

0

1

2

3

4

5

6

7

8

January 2008: 4.9%

November 2008: 6.7%

Source: BLS

Other employment problems

• Unemployment – lagging indicator• Increase in underemployment

– The number of workers who are working part time for economic reasons has increased by 2.8 million in the past year

• Increase in discouraged workers– In the past year discouraged workers have gone up

from 259,000 to 608,000

Source: BLS

Unemployment Forecasts

• Unemployment will continue to rise throughout 2009 and by December it may reach 9-10%

• Obama is planning to create millions of jobs through extensive government spending

Source: CNN Money

Inflation vs. Core Inflation

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-0

7

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

-1.5

-1

-0.5

0

0.5

1

1.5

InflationCore Inflation Source: BLS

Deflation and Collateral

Deflation can lead to significant declines in the value of collateral owned by households and firms, making it more difficult to borrow

Falling collateral values on outstanding loans, reduces manufacturing and lowers consumption

Inflation Targeting

Making the Fed's inflation goals more explicit could reduce uncertainty and assist business and financial market planning

Housing Bubble• Irresponsible Lending/Borrowing

– Fannie and Freddie mortgages rose 600% during the 90s surpassing $5T

– Housing prices jumped 80% in 8 years

• Lack of regulation & oversight• Credit regulators not understanding how to rate

collateralized debt obligations (CDOs) and commercial mortgage-backed securities (MBSS)

Source: CNBC

Inflated home Prices

Rise in Mortgage Rates

Janu

ary

2004

Mar

ch 2

004

May

200

4

July

2004

Septe

mbe

r ...

Novem

ber .

..

Janu

ary

2005

Mar

ch 2

005

May

200

5

July

2005

Septe

mbe

r ...

Novem

ber .

..

Janu

ary

2006

Mar

ch 2

006

May

200

6

July

2006

Septe

mbe

r ...

Novem

ber .

..

Janu

ary

2007

Mar

ch 2

007

May

200

7

July

2007

Septe

mbe

r ...

Novem

ber .

..

Janu

ary

2008

Mar

ch 2

008

May

200

8

July

2008

Septe

mbe

r ...

Novem

ber .

..0

1

2

3

4

5

6

7

8

30 Year Fixed 1 Year ARM

Source: Bloomberg

Rising Energy Costs(CPI) Energy

Fall in Home prices andNon-Farm Payrolls

Rise in Foreclosures

Failures

• Bear Stearns -> JPMorgan Chase• Lehman Brothers ($1.35B) -> Barclays• Wachovia ($15.1B) -> Wells Fargo• Washington Mutual -> JPMorgan Chase• Countrywide -> Bank of America• Merrill Lynch -> Bank of America

Multiplier Effect

The decrease in the velocity of money has a multiplier effect because money being introduced by the Fed is not being multiplied

Instead creating a contraction - The slowing velocity leads to a negative multiplier effect

Money Supply Increasing

M1 Multiplier Decreasing

-5

-4

-3

-2

-1

0

1

2

3

4

5Personal Consumption (Percent Change)

-3.7%

1.2%

Source: BLS

Consumer Confidence Falls

Jan-05Jan-91Jan-77Jan-63Jan-49Jan-35Jan-21Jan-07Jan-93Jan-79Jan-65Jan-510

20

40

60

80

100

120

Source: Conference Board Consumer Resource Center

Why Consumer Confidence is Falling

• Tight credit conditions• Job losses• Falling incomes• Uncertainty of the future

Consumer Saving

Falloff in Retail Sales

Jan-05Jan-03Jan-01Jan-99Jan-97Jan-95Jan-93Jan-91Jan-89Jan-87Jan-85290000

300000

310000

320000

330000

340000

350000

Retail Sales (excluding food) per month

Mil

lio

ns

of

Do

llar

s

Source: www.economicindicators.gov

Troubled Asset Relief Program

• Treasury’s Capital Purchase Program

– Recapitalize bank balance sheets

National Debt

• Greater Than $11trillion, October 1st, 2008

• Over 73% of GDP

• Largest ever during WWII at 122%

Source: IOUSA

Debt as a % of GDP

Who Owns the Debt ?

• Government Accounts (Trust Funds)– Largest is Social Security – Medicare, Medicaid problems as population ages

• Publicly-held: $6.302 trillion– $2.74 trillion foreign-owned– Japan $585.9 billion & China $541 billion

• Congress has approved 6 increases of the debt limit since 2002, totaling $4.915 trillion– Most recently Oct. 3, 2008 - $700 billion

Concord Coalition

Budget FY 2008• $2.5 trillion in revenue• $2.9 trillion in spending

Personal Income Tax41%

Payroll FICA31%

Corporate Income Tax12%

Other2%

Deficit14%

Source: IOUSA

$400 billion deficit in the FY 2008 budget

Cost to Economy of Big Three Auto Makers Failure

239,341 Direct job losses973,969 Supplier job losses 1,738,034 Related industry jobs $150.7 billion Personal income$14.3 billion Increased transfer payments

(unemployment)$21.1 billion Social Security payroll taxes $24.7 billion Personal income taxes

Source: CNN Money

Annual Auto Industry Jobs Loss

Source: BLS

Unfunded Promises

Liabilities11

21%

Social Security7

13%

Medicare (A,B)26

49%

Medicare (D)8

15%

Misc1

2%

$53 trillion in promises

Chart shownin trillions Source: IOUSA

Negative Effects

• With Rising Unemployment– Tax Revenue drops– Increasing the deficit– Decreasing our solvency

• Unfunded promises rising on top of debt

• Example set for over leveraging consumers

0

500000

1000000

1500000

2000000

2500000

3000000

19

43-0

1

19

45-1

0

19

48-0

7

19

51-0

4

19

54-0

1

19

56-1

0

19

59-0

7

19

62-0

4

19

65-0

1

19

67-1

0

19

70-0

7

19

73-0

4

19

76-0

1

19

78-1

0

19

81-0

7

19

84-0

4

19

87-0

1

19

89-1

0

19

92-0

7

19

95-0

4

19

98-0

1

20

00-1

0

20

03-0

7

20

06-0

4

Do

llars

($

)

Year

Consumer Debt

Seasonally Adjusted

Rising American Consumer Debt

Source: BLS

1977 Amendment to the Federal Reserve Act

1.to promote "maximum" sustainable output and employment

2.to promote "stable" prices

Monetary Policy Focus

Encourage business investment and consumer spending by:

–lowering the cost of capital–increasing the availability of credit

Declining Commercial and Industrial Loans

Falling Gross Private Domestic Investment

Effective Rate vs. Target Rate

Quantitative Easing

• Current lending facilities– Term Auction Facility (TAF)– Term Securities Lending Facility (TSLF)– Primary Dealer Credit Facility (PDCF)– Commercial Paper Funding Facility (CPFF)– Term Asset-Backed Securities Lending Facility

(TALF)– Interest on Reserve Balances

Expanding Reserve Bank Credit

Interest on Reserves

• Nov 5th action to set remuneration rate equal to target enables better control of effective rate

• Encourages banks to hold reserve deposits at Fed - further expansion of consumer and business credit facilities

The Rising Effective Fed Funds Rate Since November

Growth of Reserve Balances at Federal Reserve Banks

Term Asset-Backed Securities Facility (TALF)

• For growth to occur there must be consumer spending and business investment

• TALF aids credit markets for consumers and small businesses by incentivizing lending for banks

FRBNY

Consumer and Small Business

Bank

Non-Recourse Loan

Loan$$$

Asset-Backed Security

ABS Collateral

Small Business

• Employs more than half of private sector workers

• Generate half of new net jobs annually over past decade

• Account for more than1/2 of nonfarm GDP

• Small firms cannot offer innovative new products or services without competitive credit.

http://www.federalreserve.gov/newsevents/testimony/mishkin20080416a.htm

Long Term Debt

• Purchase long term Treasury and agency (Fannie, Freddie, etc.) debt to influence yields

Purchases on the open market:

• Drive down yields • Influence other long term interest

rates across the financial markets

30 Year Bond Yields Falling

10 Year Treasury Notes Falling

National 20 & 30 yr Fixed Mortgage Rates Falling (bankrate.com)

Fiscal Recommendations

• Complement Fiscal PolicyNew lending facilities

• Infrastructure Development• Green Technology

Increase Consumer Confidence• Create Jobs through incentives (green)• Housing opportunities and retention• Fed & Treasury work to make FDIC Insurance

permanent

Obama’s Short Term Emergency Plan

• A thousand dollar ($1,000) emergency energy rebate

• Fifty billion dollars to jumpstart the economy and save 1 million Americans from losing their jobs

• $ 25 Billion Stake Growth Fund

• $ 25 Billion Jobs and Growth Fund

Source: Barackobama.com

Obama’s Plan for Business• Create 5 million new jobs through Green, Clean Energy,

and Alternative Fuel Initiatives

– $150 billion over 10 years• Biofuels and fuel infrastructure• Commercial scale renewable energy

• Double Funding for Manufacturing Extension Partnerships

• Boost Renewable Energy Sector– 25% of American electricity from renewable resources by 2025

Source: www.barackobama.com

Infrastructure Investment

• Create National Infrastructure Reinvestment Bank

• Transportation Infrastructure Projects across USA

• Create up to 2,000,000 jobs

• Stimulate new business activity

Source: www.barackobama.com

INFRASTRUCTURE Complement Fiscal Policy Initiatives

• Create New Lending Facilities SPECIFICALLY for Infrastructure Improvements

• Low Cost Financing will promote Business Opportunity and Expansion

• Jobs Created

GDP = C+I+G+(X-M):

G will lead to I, which will also promote C

Historical Perspective – Lessons Learned

Prosperity of the 1990’s was due to:• Advance of the Internet – new opportunities• Moore’s Law – every 18 months technology was

predictably smaller, faster, cheaper to produce• New companies with new products • Ability to use, process INFORMATION

• New Technologies• New Companies• New Jobs• Higher Wages• Better , Cheaper Technology and Efficiency keeps Inflation in check

Dependence on Oil –The Cost Push Problem

Cost Push Inflation – where resource or input prices cause finished goods prices to rise, would still be a problem (like OIL prices)

Recommendation

The Fed funds alternative technologies through new lending facilities to reduce our dependence on foreign oil

Get Back to Innovating• Get back to Innovating, Producing new

Alternative Energy Products• Reduce our dependence on foreign oil• Lowering Imports, Export New Innovations• New Green Technologies will spur new

Opportunities

Creating New Lending Facilities SPECIFICALLY for New Technologies:

New Products, New Companies, New Jobs

GDP = C+I+G+(X-M):

I will lead to C, and will also help promote (X-M)

M3 Growth in 90’s

Private Asset Exchange Lending Program

• Provides needed liquidity to larger businesses, both financial and non-financial

• Provides profitable situation for Treasury and taxpayers that can assist in new fiscal policy expenditures

TreasuryFederal Reserve

Business

CommercialBanks

Private Asset Exchange Lending Program

Treasurie

s

$$$$$

Loan $$$Private Assets

Treasuries

PrivateAssets

Maintain Target Rate at 1%

• Concentrating on Long Term Rates strategy, with Fed Communication:

**Remarks by Governor Ben S. Bernanke At the Annual Washington Policy Conference of the National Association of Business Economists, Washington, D.C. March 25, 2003

As with fiscal policy, public beliefs about how monetary policy will perform in the long run affect the effectiveness of monetary policy in the short run. **

Avoid Liquidity Trap

• Avoid nominal rate dropping to 0%• Reserve this option for Q1 2009 in case

the economy does not respond to Fiscal initiatives

Money Market Squeeze

Lowering FFR below 1% will squeeze Money Markets:

• Money Market Expense Ratios make it difficult to manage money funds for banks

• Losses in U.S. money market mutual funds will cause investors to stay away from short-term markets

Fed Recommendations

• Maintain Fed Funds rate at 1% at this time• Continue “Quantitative Easing”• Continue paying Interest on Reserves• Maintain lending facilities• Purchase long-term debt• Create new “Private Asset Exchange Lending”

program

Effects on GDP

These Recommendations should:• Increase Confidence between Banks (encouraging

lending)• Loosen tight consumer credit (encouraging

consumption)• Support Manufacturing (increasing employment) • Promote innovation (get us off oil, increase investment)• Increase Consumer Confidence (promoting spending)• Reverse the GDP downward Trend (C+I+G+(X-M))

Questions