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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
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
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
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
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
How Bad Was It?
90
95
100
105
110
115
120
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 + 22
Index, GDP per capita 100 = Peak
2005 Q4 2007 Q4 2006 Q4 2008 Q4 2009 Q4 2010 Q4 2011 Q4 2012 Q4
Peak Current Cycle
2005 Q4–2013 Q3
Average of Prior Cycles
11.2% below average of prior cycles in
2013 Q3
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 2007-09 Financial Crisis,” Federal Reserve Bank of Dallas, Staff Papers, July 2013.
Crisis Dramatically Lowers Income Expectations
Net percent of respondents who
expect their income to increase
Median, Apr ‘03-Apr ‘08:
9.8
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 2007-09 Financial Crisis,” Federal Reserve Bank of Dallas, Staff Papers, July 2013.
GDP Growth
3.0
-10
-8
-6
-4
-2
0
2
4
6
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
% change, SAAR
2007 2008 2009 2010 2011 2012 2013
Long-run average: 2.8
Forecast 2014
SOURCE: Bureau of Economic Analysis.
Employment by Federal Reserve District
90
92
94
96
98
100
102
104
106
108
Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
Index, Dec. ‘07 =100
Dallas
Minneapolis
New York
Chicago
Kansas City Richmond Boston Philadelphia
St. Louis Atlanta San Francisco Cleveland
SOURCE: Federal Reserve Bank of Dallas.
Shifting Winds in 2014: What’s Different, What’s the Same vs. 2008–11?
Different (Pluses) Same (Drags) Changing
Banking Stock market Housing/real estate Autos Energy Governments Europe Reduced
uncertainties
Regulatory and tax drags
Monetary policy tending toward milder stimulus
Banking Recovery Suggests Economic Recovery Not Far Behind
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
2003 2005 2007 2009 2011 2013
Return on Average Assets (US Banks) Percent
SOURCES: Federal Financial Institutions Examination Council; Federal Reserve Bank of St. Louis.
Q3 1.05
Stock Price Rebound: FOMC’s QE at Work
600
800
1,000
1,200
1,400
1,600
1,800
2,000
2003 2005 2007 2009 2011 2013
S&P 500 Stock Price Index Index (monthly averages)
SOURCES: S&P Dow Jones Indices LLC; Federal Reserve Bank of St. Louis.
Dec. 1,808
Household Deleveraging Ending
0
2
4
6
8
10
12
14
2003 2005 2007 2009 2011 2013
Total Debt
SOURCE: Federal Reserve Bank of New York/Equifax.
$, Trillions Q3 11.3 7.9
Shifting Winds
Autos – stabilizing at 16 million units Energy – from foreign dependency toward self-
sufficiency, 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
Regulatory/taxes – Dodd-Frank symbolic Some emerging market economies
Tailwinds
Headwinds
Economic Dashboard, Nov. 2013
8 2 . 8
-1
-0.5
0
0.5
11.5 2 2.5
3
3.5
4
4.5
5
0.92
HeadlinePCE
-2.5
-2
-1.5
-1
-0.5
0
0.51
1.5 22.5
3
3.5
4
4.5
5
5.5
6
1.65Year-over-year
Real GDP growth
4
4.5
5
5.5
66.5 7 7.5
8
8.5
9
9.5
10
7.3
Unemployment rate
Percent of jobs recovered
33.5
4
4.5
55.5
6 6.5 77.5
8
8.5
9
9.510
4.28
Junk-bond spread
Warning
Unemp.jump
Yieldcurve
Oilshock
Enginestall
SOURCE: Federal Reserve Bank of Dallas.
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
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)
21st 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
Fed Policy and Moral Hazard
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?
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
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?
The Banking Bust 2008-2009 Total $$ of 165 failed institutions: $542 billion
TOTAL Assets of (essentially 2) Assisted Banks: (failure with a different label)
$3.22 TRILLION
Bank assets directly supported ‘08-’09 $3.8 TRILLION + Commercial Bank assets of 7 other
firms forced to take TARP funds: $4.0 TRILLION
Total Banking Assets supported: $7.8 TRILLION
2/3 of the commercial banking industry!
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: http://www.dallasfed.org/fed/annual/index.cfm
Summary of Dallas Fed 2011 AR
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
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
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
THANK YOU
QUESTIONS?
05
101520253035404550
1857–1914 1915–1938 1939–1960 1961–1982 1983–2007 2008–2011
Source: National Bureau of Economic Research
Percentage of time spent in recession 48
21
0
20
40
60
1857-1914 1915-2011
% of time in recession, Pre-Fed v. Post
Fruits of the Taylor Rule
