The Federal Reserve: Everything You Wanted to Know But Were Afraid to Ask. CFA Societies 2014 Texas Investor Summit

Transcription

1 The Federal Reserve: Everything You Wanted to Know But Were Afraid to Ask CFA Societies 2014 Texas Investor Summit Southern Methodist University February 14, 2014

2 The Federal Reserve: Everything You Wanted to Know But Were Afraid to Ask CFA Societies 2014 Texas Investor Summit Southern Methodist University February 14, 2014 Harvey Rosenblum Professor of Financial Practice SMU Cox School of Business

3 Road Map The Economy Last seven years Ugh! Next seven years The Federal Reserve Evolving missions and roles Changed forever by Great Recession Challenges in 2014 and beyond Monetary policy Regulatory policy New management team

4 Overview of 2014 Economy Weakest economic recovery in generations Avoided another Great Depression Five years of healing, but not healed Poised for return to semblance of normality Finally benefitting from some tailwinds

5 Index, GDP per capita 100 = Peak How Bad Was It? Peak Current Cycle 2005 Q Q Average of Prior Cycles 11.2% below average of prior cycles in 2013 Q3 t 8 t 6 t 4 t 2 Peak=t t + 2 t + 4 t + 6 t + 8 t + 10 t + 12 t + 14 t + 16 t + 18 t + 20 t Q Q Q Q Q Q Q Q4 NOTE: The grey area indicates the range of the major recessions since 1960, excluding the short 1980 recession. SOURCE: Concept from Atkinson, Tyler, David Luttrell, and Harvey Rosenblum, How Bad Was It? The Costs and Consequences of the Financial Crisis, Federal Reserve Bank of Dallas, Staff Papers, July 2013.

6 Crisis Dramatically Lowers Income Expectations Median, Apr 03-Apr 08: 9.8 Net percent of respondents who expect their income to increase Median, May 08-Aug 13: -3.0 SOURCE: Atkinson, Tyler, David Luttrell, and Harvey Rosenblum, How Bad Was It? The Costs and Consequences of the Financial Crisis, Federal Reserve Bank of Dallas, Staff Papers, July 2013.

7 GDP Growth % change, SAAR Long-run average: Forecast Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q SOURCE: Bureau of Economic Analysis.

8 Employment by Federal Reserve District Index, Dec. 07 = Dallas Minneapolis New York Kansas City Richmond Boston Philadelphia Chicago St. Louis Atlanta San Francisco Cleveland Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 SOURCE: Federal Reserve Bank of Dallas.

9 Shifting Winds in 2014: What s Different, What s the Same vs ? Different (Pluses) Banking Stock market Housing/real estate Autos Energy Governments Europe Reduced uncertainties Same (Drags) Regulatory and tax drags Changing Monetary policy tending toward milder stimulus

10 Banking Recovery Suggests Economic Recovery Not Far Behind Percent 1.6 Return on Average Assets (US Banks) Q SOURCES: Federal Financial Institutions Examination Council; Federal Reserve Bank of St. Louis.

11 Stock Price Rebound: FOMC s QE at Work Index (monthly averages) 2,000 1,800 S&P 500 Stock Price Index Dec. 1,808 1,600 1,400 1,200 1, SOURCES: S&P Dow Jones Indices LLC; Federal Reserve Bank of St. Louis.

12 Household Deleveraging Ending $, Trillions Q Total Debt SOURCE: Federal Reserve Bank of New York/Equifax.

13 Shifting Winds Tailwinds Autos stabilizing at 16 million units Energy from foreign dependency toward selfsufficiency, like a tax refund Governments shrinking deficits as tax revenue improves and drives improved ability to spend Europe much improved outlook Government policy uncertainty reduction of partisan abyss, until elections resume Headwinds Regulatory/taxes Dodd-Frank symbolic Some emerging market economies

14 Economic Dashboard, Nov Unemployment rate Junk-bond spread Year-over-year Real GDP growth Percent of jobs recovered Engine stall Headline PCE Warning Unemp. jump Yield curve 5 Oil shock SOURCE: Federal Reserve Bank of Dallas.

15 Monetary Policy The Wild Card in 2014 From $85 bil./month to $75 bil./month to $65 billion/month to? From record ultra-easy policy (unprecedented ease) to? Knowing the impact of unprecedented events is impossible

16 Why is the Fed Difficult to Understand? Quasi-public: Independent within the government Central, governmental agency (BoG) with distributed power across the nation to 12 regional Federal Reserve Banks (FRBs) A not-for-profit with profits of more than $200B over the last 3 years (returned to the U.S. Treasury) Quasi-private: Fed is in the money production business But not a monopoly: 90% of money production is outsourced to private sector (for-profit banks)

17 21 st Century Goals and Legal Mandates of the Federal Reserve Macroeconomic stability Price stability Maximum employment Healthy, steady economic growth Banking and financial stability Goals sometimes conflict Goals must often be prioritized Goals often create moral hazard

18 Fed Policy and Moral Hazard

19 Mission Impossible? If the Fed only did XYZ BUT there are no silver bullets and no training manual Would YOU want the job of a central banker?

20 Three Funerals and a Wedding Funerals 1. The Great Moderation 2. The banking system as we have known it 3. The Fed funds rate as the primary monetary policy tool Wedding Increased government involvement and intrusion in the private sector economy (a tipping point for capitalism?) Source: James Bullard, Regional Economic Summit, Evansville, Indiana, Nov. 20, 2008

21 Monetary Policy and the Economy Fall of 08: the game changed as a host of unconventional policy tools were implemented: Term Asset-Backed Securities Loan & Term Deposit Facilities Term Auction Facility Commercial Paper Funding Facility Term Securities Lending Facility Primary Dealer Credit Facility ABCP MMMF Liquidity Facility Money Market Investor Funding Facility Interest on Required and Excess Reserves Large-scale Asset Purchases When Facilities were no longer needed, the expired how many government agencies sunset programs without a loss to taxpayers?

22 The Banking Bust Total $$ of 165 failed institutions: TOTAL Assets of (essentially 2) Assisted Banks: (failure with a different label) Bank assets directly supported Commercial Bank assets of 7 other firms forced to take TARP funds: Total Banking Assets supported: $542 billion $3.22 TRILLION $3.8 TRILLION $4.0 TRILLION $7.8 TRILLION 2/3 of the commercial banking industry!

23 Choosing the Road to Prosperity: Why We Must End Too Big to Fail Now Dallas Fed 2011 Annual Report Complete Annual Report issue and presentation may be found at:

24 Summary of Dallas Fed 2011 AR

25 Dodd-Frank Act ( DFA ) Entrenches, rather than ends, Too Big To Fail Unworkable and unenforceable due to length, conflicts, and complexity Increased government intrusion and weaker market incentives Next financial crisis will be bigger and be upon us sooner with DFA Last crisis cost $15-30 Trillion (1-2 years of output) DFA reinforces perverse incentives As a nation, we cannot afford to repeat these same avoidable mistakes DFA reinforces perception of future bailouts Designates large, complex financial companies as Systemically Important Financial Institutions (SIFI) Provides taxpayer funds for Debtor In Possession financing of bankrupt holding companies and subsidiaries

26 Monetary Policy Going Forward QE had enormous impact on stock market and other asset markets, the primary tailwind impacted by policy Slowly offset some of the economy s headwinds Negatively impacted senior citizens dependent on interest income, sapping confidence and spending in this sector QE tapering reverses the FOMC s undermining of confidence in the economy Words, and especially body language, often speak louder than policy actions

27 Concluding Remarks Tailwinds take over and drive an improving economic outlook Financial crisis behind us for a few more years, but underlying sources of last crisis remain in place Risk to 2014 outlook: Economy could be much stronger than I have indicated Fed s new management team must manage new regulatory role and potential emerging market crisis

28 THANK YOU QUESTIONS?

29 Fruits of the Taylor Rule Percentage of time spent in recession % of time in recession, Pre-Fed v. Post Source: National Bureau of Economic Research