New Study Shows Money Has Tightened Despite Fed’s Efforts
The Federal Reserve has pushed small-term interest rates to near zero, flooded the financial system with loans and committed to buy more than $1.7 trillion of mortgage and Reserves securities to restart a financial system devastated by the debt crisis. After all that, but, financial conditions tightened a bit at the end of 2009, according to a new study produced by a collection of Wall Street and literary researchers.
The reason is that even with exceptionally low interest rates, capital markets aren?t humming and bank lending is weak. One example: Issuance of asset backed securities — which are securities backed by auto loans or credit card debt — was a scant $28.7 billion in the fourth quarter, down from $51.1 billion in the third quarter and $50.1 billion in the second. Levels of money-making paper — the small-term credit many companies used to fund themselves before the financial crisis — were also soft, with outstanding paper at $1.1 trillion at the end of January, compared to $1.3 trillion in September.
In an unusual collaboration, the chief economists from Goldman Sachs and Deutsche Bank teamed up with economists at Princeton University, Columbia University and New York University to produce an index measuring financial conditions. It is an vital exercise because financial conditions help to drive economic progression, inflation and asset prices. When money is loose and simple, the economy tends to grow quicker in the small-run, though inflation and asset price booms can build. Tight money, on the other hand, is like a lack of oxygen which can strangle progression.
There are already more than a half dozen financial-conditions measures floating around Wall Street, academia and the Fed. Many of them focus on the price of money in the financial system — interest rates — and not the quantity of money. Economists Jan Hatzius (Goldman), Peter Hooper (Deutsche Banks), Frederic Mishkin (Columbia), Kermit Schoenholtz (NYU) and Mark Watson (Princeton) produced a new index the includes many uncommon measures of the amount of money in the financial system, including issuance of asset backed securities and money-making paper and the small-term securities used by investment banks to fund themselves. They included 44 indicators in all. They are presenting the paper today at a gathering on monetary plot in New York which will include several senior Fed officials.
What they found is that after improving markedly in the first half of 2009 — thanks in large part to the Fed?s money pumping exercises — financial conditions tightened again in the second half of the year, unusually so for the ahead of schedule stages of a recovery. ?The fact that financial conditions are still impaired, at smallest amount in some parts of the system, is consistent with the thought that the recovery is going to be a slow one,? Mr. Hatzius said. ?It is consistent with a honestly slow, U-shaped recovery.? It also suggests inflation and bubbles shouldn’t be a huge worry in the U.S. — money is cheap but not easily accessible as it was during the boom.
One of the most vital drivers of the economists? financial conditions index was the asset-backed securities markets, where money-making real estate loans, car loans and many other kinds of bank loans were financed during the credit boom. Loans in this market are packaged into securities and sold to investors around the world. In 2006, issuance of asset backed securities — not include residential mortgage backed securities — topped $700 billion, according to the Securities Industry and Financial Markets Association. It was $168 billion last year.
The Federal Reserve has expended huge amounts of energy trying to restart this market, with the creation of a program called the Term Asset-backed Securities Loan Facility, or TALF, which provides cheap, nonrecourse funding to investors who buy these securities. Issuance of the securities perked up after the program was launched last March, but the market remains highly impaired. One problem: Many investors have become less trustful of credit ratings attached to the securities after the bust. Many individuals and firms also wait loath to take on more debt.
A similar pattern is showing up in the ?repo? loan market, where many securities brokerages and banks funded themselves before the financial crisis hit. In this market, a financial firm uses its securities holdings as collateral for small-term loans, which help it to fund its activities. Panics in this market in 2008 helped to drive firms like Bear Stearns and Lehman Brothers to the brink. The market picked up a bit last year, but at $1.338 trillion in the third quarter, was still less than three-fifths its size in 2007. That also held down the economists? index. Broader measures of money progression are also soft. M2, a measure of deposits in the banking system and money market assets, contracted at a 0.9% once a year rate in the three months through January, according to Fed data.
?It is still the aftermath of the bubble,? says Mr. Hatzius. ?The deleveraging still continues.?