Tuesday, September 9, 2014

09/28/2006 Volcker, Corrigan, McDonough and Geithner *

For the week, the Dow gained 1.5% and the S&P500 1.6%. Economically sensitive issues were strong. The Transports jumped 2.9%, and the Morgan Stanley Cyclical index gained 2.2%. The Utilities increased 1.3%, and the Morgan Stanley Consumer index added 0.9% (up 10.5% y-t-d). The small cap Russell 2000 gained 1%, and the S&P400 Mid-Cap index rose 1.6%. The NASDAQ100 jumped 2.0% and the Morgan Stanley High Tech index 2.3%. The Semiconductors increased 1.2%. The Street.com Internet Index gained 2.9% and the NASDAQ Telecommunications index 1.1% (up 12.5% y-t-d). The Biotechs surged 2.7%. The Broker/Dealers rose 1.6%, increasing y-t-d gains to 16.5%. The banks added 0.8%, raising 2006 gains to 9.1%. With bullion up $9.30, the HUI Gold index gained 2% (Q3 down 10.9%). 

Notable third-quarter gains included the Morgan Stanley Consumer index (6.9%), the Morgan Stanley High Tech index (7.6%), the NASDAQ Telecommunications index (7.0%), the Broker/Dealers (7.0%), the Morgan Stanley Retail index (7.4%), NYSE Healthcare (7.0%) and the NASDAQ Other Financial index (10.6%). The Dow Transports dropped 9.7% during Q3 and the AMEX Oil Index (XOI) declined 6.0%. The S&P 500 Homebuilding Index rose 3.3% during the quarter, reducing y-t-d losses to 28.2%.

For the week, two-year Treasury yields added 2 bps to 4.69%. Five-year yields rose 4 bps to 4.58%, and bellwether 10-year yields increased 4 bps to 4.63%. Long-bond yields gained 3 bps to 4.76%. The 2yr/10yr spread ended the week inverted 6 bps. The implied yield on 3-month December ’07 Eurodollars rose 4 bps to 4.79%. Benchmark Fannie Mae MBS yields jumped 7 bps to 5.86%, with MBS notably lagging Treasuries this week. The spread on Fannie’s 4 5/8% 2014 note was little changed at 32, and the spread on Freddie’s 5% 2014 note little changed at 30. The 10-year dollar swap spread increased 0.3 to 53.8. Corporate bonds generally traded in line with Treasuries, although junk spreads widened a few bps this week. 

During the quarter, 2-year Treasury yields dropped 47 bps, five-year yields 51 bps and 10-year yields 45 bps. Long-bond yields sank 51 bps. December Eurodollar yields dropped 26 bps during Q3. Junk bond spreads widened 38 bps during the quarter.   

September 28 – Reuters: “Global issuance of investment grade debt surged 13 percent year-to-date compared with the same period last year, led by growth in U.S. bond sales, according to preliminary data from Dealogic… More than $1.36 trillion of investment grade debt has been sold worldwide year-to-date, compared with $1.20 trillion in the first three quarters of 2005… Sales of high-grade debt in the United States rose 22 percent to $477.08 billion… Investment grade bond sales in Europe, the Middle East and Africa [EMEA] rose to $688.65 billion, up 16 percent… Asia sales of investment grade corporate debt, excluding Japan, rose 11 percent to $93.72 billion…, while issuance in Japan plunged 33 percent to $57.31 billion… Sales of high-yield corporate debt jumped 29 percent in EMEA to $37.55 billion… In the United States, high yield bond sales rose 16 percent to $75 billion… New sales of asset-backed and mortgage-backed securities…dropped globally over last year’s volumes. This was led by an 11 percent decline in the United States to $1.41 trillion… Volumes in EMEA, by contrast, grew 32 percent to $322.78 billion from $243.79 billion in 2005, Dealogic said.”

September 29 – Financial Times (David Oakley): “Leveraged finance borrowing accounted for almost a quarter of all global corporate fundraising in the first nine months of the year, according to…Dealogic, largely as a result of increased merger and acquisition activity. Total leveraged finance volumes hit $1,040bn at the end of the third quarter, a 14 per cent increase compared with the same period in 2005. High yield corporate bond volume accounted for 15 per cent of the total at $160.5bn, little changed from last year, with leveraged loan issuance representing the majority of the growth in volumes. Leveraged loan volume has increased by 16 per cent to $883.4bn, from $761.4bn in the first nine months of 2005…The US market drove the bulk of the growth in leveraged finance volumes, with a 19 per cent increase in the Americas, compared with just a 9 per cent increase in Europe, the Middle East and Africa.”

Investment grade issuers this week included Citigroup $1.0 billion, Hartford Financial $1.0 billion, Masco $1.0 billion, Cardinal Health $850 million, Commonwealth Edison $415 million, PNC Funding $450 million, Federal Realty Trust $375 million, and Zions Bancorp $145 million. 

Junk bond funds saw outflows of $96 million during the week (from AMG). Junk issuers included Georgia Gulf $700 million, Dominion Resources $500 million, Service Corp of America $500 million, FTI Consulting $215 million and Ace Cash Express $175 million.

September 27 – Bloomberg (Patricia Kuo): “A record $20 billion of leveraged buyouts in Australia is increasing borrowing costs for the nation’s biggest companies to a nine-month high.”

International dollar debt issuers included Kaupthing Bank $3.0 billion, Nationwide Building Society $1.75 billion, Diageo $1.5 billion, Swedish Export Credit $1.0 billion, ANZ National $750 million, Export-Import Bank of Korea $800 million, Petrobras $500 million and Itabo Finance $125 million.

Japanese 10-year “JGB” yields rose 4.5 bps this week to 1.665%. The Nikkei 225 index surged 3.2% to get (barely) back in the black for the year (0.1%). German 10-year bund yields added 1.5 bps to 3.705%. Emerging markets ended a strong quarter on a firm note. Brazil’s benchmark dollar bond yields dropped 16 bps to 6.37%, capping off a quarter that saw yields sink 75 bps.  The Bovespa equity index surged 4.5% this week (up 8.9% y-t-d). The Mexican Bolsa gained 2.6% this week to trade to a new record high, increasing Q3 gains to a notable 14.6% (up 23.2% y-t-d). Mexico’s 10-year $ yields rose 2 bps to 5.76%, yet were down 74 bps during the quarter. The Russian RTS equities index gained 3.0%, increasing Q3 gains to 3.7% (up 37.7% y-t-d). India’s Sensex equities index rose 1.8%, with a 3-month gain of 17.4% (y-t-d up 32.5%).  During the quarter, the major equity indices in Peru surged 27%, Colombia 21%, and Costa Rica 21%. 

European equities enjoyed a very strong third quarter. Although UK’s FTSE 100 increased only 2.2%, France’s CAC40 rose 5.7%, Germany’s DAX 5.7%, Spain’s IBEX 12%, the Dutch Amsterdam Exchange 9.9%, Sweden’s OMX 8.7%, Denmark’s OMX 8.7%, Switzerland’s Swiss Market index 10.1% and Belgium’s BEL20 9.9%. Major equities indices in Portugal gained 8.7%, Ireland 9.4%, Iceland 14.8%, Luxembourg 10.0%, Finland 2.8%, Austria 3.3%, Greece 6.4%, Poland 8.4%, Czech Republic 4.1%, Hungary 1.6%, Romania 12.7%, Croatia 16.6%, Estonia 11.2%, Lithuania 12.8%, Bulgaria 8.8%, Turkey 4.2%, South Africa 4.9%, Egypt 32.6%, Kuwait 1.8% and Israel 7.3%.   

In Asia, the Nikkei rose 4.0%, Hong Kong’s Hang Seng 7.8%, Taiwan’s TAIEX 2.7%, and China’s Shanghai Composite 4.8%. Major indices in South Korea jumped 5.5%, Australia 1.6%, New Zealand 0.1%, Thailand 1.2%, Indonesia 17.1%, India 17.4%, Singapore 5.5%, Malaysia 5.8%, and Philippines 17.4%.   

This week, Freddie Mac posted 30-year fixed mortgage rates sank 9 bps to 6.31%, down 49 bps in 10 weeks but up 40 bps from one year ago. Fifteen-year fixed mortgage rates fell 8 bps to 5.98% (low since week of March 23), although were up 50 bps from a year earlier. One-year adjustable rates declined 7 bps to a 27-week low 5.47% (up 79 bps y-o-y). Surprisingly, the Mortgage Bankers Association Purchase Applications Index fell 5.5% this week. Purchase Applications were down 22% from one year ago, with dollar volume 22% lower. Refi applications declined 4.1%. The average new Purchase mortgage rose to $224,800, while the average ARM increased to $363,000.

Bank Credit declined $10.0 billion last week to $8.003 TN.  Year-to-date, Bank Credit has expanded $496 billion, or 9.0% annualized. Bank Credit inflated $611 billion, or 8.3%, over 52 weeks. For the week, Securities Credit sank $35 billion ($55bn 2-wk decline). Loans & Leases surged $25 billion during the week and were up $370 billion y-t-d (9.3% annualized). Commercial & Industrial (C&I) Loans have expanded at a 15.8% rate y-t-d and 14.3% over the past year. For the week, C&I loans jumped $8.2 billion, and Real Estate loans surged $16.4 billion. Real Estate loans have expanded at a 10.2% rate y-t-d and were up 10.8% during the past 52 weeks. For the week, Consumer loans declined $5.1 billion, while Securities loans added $0.4 billion. Other loans were up $5.1 billion. On the liability side, (previous M3 component) Large Time Deposits dropped $22.5 billion.    

M2 (narrow) “money” supply rose $22.1 billion to $6.890 TN (week of September 18th). Year-to-date, narrow “money” has expanded $204 billion, or 4.2% annualized. Over 52 weeks, M2 has inflated $292 billion, or 4.4%. For the week, Currency dipped $0.5 billion, and Demand & Checkable Deposits declined $3.8 billion. Savings Deposits jumped $21.5 billion, while Small Denominated Deposits gained $3.6 billion. Retail Money Fund assets added $1.3 billion.   

Total Money Market Fund Assets, as reported by the Investment Company Institute, declined $7.7 billion last week to $2.218 Trillion. Money Fund Assets have increased $161 billion y-t-d, or 10.4% annualized, with a one-year gain of $274 billion (14.1%). 

Total Commercial Paper jumped $20.1 billion last week (8-wk gain of $112.6bn!) to a record $1.902 Trillion. Total CP is up $261 billion y-t-d, or 21.2% annualized, while having expanded $304 billion over the past 52 weeks (19.1%). 

Asset-backed Securities (ABS) issuance declined this week to $14 billion. Year-to-date total ABS issuance of $545 billion (tallied by JPMorgan) is running about 5% below 2005’s record pace, with 2006 Home Equity Loan ABS sales of $373 billion 1% below last year. Also reported by JPMorgan, y-t-d Global CDO Issuance of $317 billion is running 70% ahead of 2005.

Fed Foreign Holdings of Treasury, Agency Debt declined $12.0 billion to $1.661 Trillion for the week ended September 27th. “Custody” holdings were up $142 billion y-t-d, or 12.5% annualized, and $197 billion (13.5%) over the past 52 weeks. Federal Reserve Credit fell $3.7 billion to $825.2 billion. Fed Credit is down $1.2 billion (0.2%) y-t-d, while expanding 3.1% ($24.7bn) over the past year. 

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $549 billion y-t-d (18.1% annualized) and $625 billion (15.8%) in the past year to a record $4.595 Trillion. 

Currency Watch:

September 25 – Financial Times (Richard McGregor): “It operates out of a nondescript office tower in Finance Street and, shortened to its English acronym “SAFE”, sounds like one of those fictitious shadowy organisations from a Sixties spoof spy show. But the Beijing-based State Administration of Foreign Exchange has a serious, real-world job – to manage China’s towering stack of foreign currency holdings. Once, this would not have mattered much outside China’s borders, but the country’s swelling trade surpluses and large capital inflows have given Safe an investment pot to rival global fund management giants. Within the next few weeks, China’s reserves are due to top $1,000bn – a record for any country, let alone a developing nation like China. But it is not a moment everyone in China will be celebrating, especially the officials at Safe and their masters at the People’s Bank of China, the central bank. “One trillion is a big amount, but it is also a hot potato,” says Ha Jiming, chief economist at China International Capital Corp, the country’s largest investment bank. “If it is not well managed, any erosion of value will be a source of shame for whoever is responsible for it.”

The dollar index gained 1% this week to 85.68, with the dollar index posting a 1.36% third-quarter rise.  On the upside, the Brazilian real increased 1.8%, the Iceland krona 0.8%, the Chilean peso 0.8%, the Colombian peso 0.7%, and the Mexican peso 0.5%. On the downside, the South African rand declined 1.7%, the British pound 1.5%, the Japanese yen 1.4% and the New Zealand dollar 1.3%. For the quarter, the Iceland krona gained 8.4%, the New Zealand dollar 7.4%, the Colombian peso 7.3%, Philippines peso 5.7%, and Turkish lira 4.9%. On the downside for the quarter, the South African rand fell 7.8%, the Norwegian krone 4.8%, the Japanese yen 3.2%, and Nicaragua cordoba 2.8%.

Commodities Watch:

September 28 – Bloomberg (Jeff Wilson): “Wheat prices in Chicago rose to a nine-year high on speculation that drought will cut production by as much as half in Australia, the third-largest exporter of the grain behind the U.S. and Canada.”

This week, Gold gained 1.6% to $599 and Silver 2.0% to $11.54. Copper added 0.5%, increasing y-t-d gains to 79%. November crude rose $2.32 to end the week at $62.87. November Unleaded Gasoline rallied 5%, while November Natural Gas lost another 3.7%. For the week, the CRB index gained 1.6% (down 7.9% y-t-d), and The Goldman Sachs Commodities Index (GSCI) rose 2.4% (down 0.9% y-t-d). For the quarter, the CRB index dropped 11.8%, crude 15%, unleaded gasoline 30%, natural gas 7%, and gold 2.7%. Silver gained 4.7% and copper rose 6.1%.

Japan Watch:

September 29 – Bloomberg (Jason Clenfield): “Japan’s jobless rate held near an eight-year low for a second month, signaling wages may rise and drive a recovery in consumer spending. The unemployment rate was 4.1 percent in August…”

September 29 – Bloomberg (Mayumi Otsuma and Lily Nonomiya): “Japan’s industrial output rose to a record last month and inflation accelerated, giving the central bank room to raise interest rates by the end of the fiscal year in March.”

China Watch:

September 29 – Bloomberg (Jianguo Jiang): “China’s economic growth will accelerate to 10.5 percent this year and inflation will slow to 1.5 percent, the central bank's research bureau forecast…”

September 29 – The Wall Street Journal (Gautam Naik): “An unprecedented surge in research and development spending is helping China catch up with the two longstanding leaders in the field, the U.S. and Japan, a new study found. R&D spending in China has been growing at an annual rate of about 17%, and is far higher than the 4% to 5% annual growth rates reported for the U.S., Japan and the European Union over the past dozen years. China’s massive investments in education are also bearing fruit. In 2002, its industrial-research work force was 42% the size of the equivalent U.S. work force, up from 16% in 1991.”

September 29 – Bloomberg (Matthew Brooker): “China plans to send officials to 11 provinces and major cities to enforce policies aimed at cooling the real estate market, seeking to quell local resistance that has blunted the impact of central government directives.”

September 25 – Bloomberg (Nipa Piboontanasawat): “Hong Kong’s export growth slowed for the first time in three months in August as U.S. demand for goods shipped through the city’s ports cooled. Overseas sales rose 9.9 percent from a year earlier…”

Asia Boom Watch:

September 29 – Bloomberg (Cherian Thomas): “India’s economy expanded 8.9 percent last quarter, beating economists’ forecasts and adding pressure on the central bank to raise its benchmark interest rate for a fourth time this year to curb inflation.”

September 29 – Bloomberg (Anoop Agrawal): “India’s current account deficit widened to $6.1 billion in the three months ended June 30, from $3.56 billion a year ago…”

September 28 – XFN: “South Korea’s industrial output rose 10.6% year-on-year in August, supported by robust sales of semiconductor chips, display panels, ships and cars, the National Statistical Office said.”

Unbalanced Global Economy Watch:

September 29 – MarketNewsInternational: “Mortgage approvals in August held steady close to their July high while broad money growth accelerated to a 16-year high, data published by the Bank of England Friday showed… M4 money growth came in at 0.8% on the month in August and up 13.7% on the year. The yearly growth rate was last higher in November 1990.”

September 28 – Bloomberg (Simone Meier): “France’s economy expanded at a faster-than-expected pace in the second quarter as consumers and companies stepped up spending. Gross domestic product rose 1.2 percent from the first quarter, when it gained 0.4 percent…”

September 28 – Bloomberg (Evalinde Eelens): “The Dutch economy expanded more than estimated in the second quarter as exports and investments rose… Gross domestic product rose 1.2 percent from the first quarter… That is the highest growth rate since the first quarter of 2004…”

September 28 – Bloomberg (Bunny Nooryani): “Norway’s jobless rate unexpectedly fell to a five-year low in September… The unemployment rate decreased to 2.4 percent from 2.7 percent in August…”

September 27 – Bloomberg (Daniel Frykholm): “Swedish consumer debt grew an annual 12.7 percent in August, about the same pace as the previous month, as falling unemployment and rising housing prices spurred borrowing.”

September 28 – Bloomberg (Jonas Bergman): “Swedish retail sales grew 8 percent in August from a year earlier, little changed from July, as declining unemployment and rising incomes stoke spending.”

September 28 – Bloomberg (Jonas Bergman): “Denmark’s jobless rate held at a 32-year low in August as employers hired more workers to keep pace with rising demand. The jobless rate was unchanged at 4.4 percent…”

September 29 – Financial Times (Kerin Hope): “Greece suddenly found itself 25 per cent richer yesterday after a surprise upward revision of its gross domestic product, the fruit of a change to national accounts designed to capture better a fast-growing service sector - including parts of the black economy such as prostitution and money laundering.”

September 29 – Bloomberg (Nasreen Seria): “South African credit growth unexpectedly accelerated to an annual 25 percent in August, indicating higher interest rates have failed to curb consumer spending and reinforcing the case for more increases.”

September 28 – Bloomberg (Nasreen Seria): “The cost of goods leaving South African factories and mines rose an annual 9.2 percent in August, the fastest pace since December 2002…”

September 28 – Bloomberg (Tracy Withers): “New Zealand consumer borrowing for housing and consumption rose 13.6 percent in August from a year earlier, the slowest annual pace since August 2003, according to…the Reserve Bank.”

Latin American Boom Watch:

September 25 – Bloomberg (Thomas Black): “Mexico’s August trade deficit more than doubled from the previous month as rising wages and falling interest rates sparked a 32 percent jump in consumer imports. August’s trade shortfall widened to $783 million… Exports rose 17.1 percent to a record monthly high of $22.8 billion and imports climbed 17.3 billion to $23.6 billion, also a record high.”

September 26 – Bloomberg (Eliana Raszewski): “Argentina’s government raised its 2006 economic expansion forecast to 6 percent from 4 percent in the budget proposal for next year, presented to congress today.”

September 27 – Bloomberg (Matthew Walter): “Chilean retail sales growth rebounded in August, expanding 6.2 percent from the same month a year ago.”

September 28 – Bloomberg (Alex Kennedy): “Venezuelan imports rose for a sixth month in July as record oil income fueled an economic expansion that boosted consumer demand for foreign-made goods.”

September 25 – Dow Jones (Robert Kozak): “Strong mineral sales helped lift Peru’s exports to $1.88 billion in August, 27% higher than in the same month a year earlier, government agency Prompex said…”

Central Banker Watch:

September 26 – Bloomberg (Christine Harper): “The U.S. Federal Reserve may have to extend its supervisory authority to securities firms and hedge funds to keep up with the growing role they’re playing in the financial system, said Timothy Geithner, president of the Federal Reserve Bank of New York. ‘We have capital-base supervision over a diminished and smaller share of the system as a whole,’ Geithner said… ‘We may come to a point in the future that we may have to revisit both the scope and the design of that framework.’”

Bubble Economy Watch:

August Personal Income rose 0.3% from July and has now expanded at a 7.5% rate y-t-d. Personal Spending was up a slower-than-expected 0.1% during August, the weakest performance since November.  The Chicago Purchasing Managers Index jumped 5 points during September to 62.1, a 14-month high. August Durable Goods Orders were reported at a weaker-than-expected down 0.5%, with New Orders up 3.6% y-o-y and New Orders Ex-Transports up 5.2%.

September 27 – Dow Jones (Benton Ives-Halperin): “U.S. manufacturers are now paying almost a third more for structural costs, such as corporate taxes and natural gas prices, than America’s major trading partners, a significant increase in the cost disadvantage for U.S. firms over the last three years, according to a study… External costs now add 31.7% to U.S. manufacturers’ production costs compared to the U.S.'s major trade partners, an increase from 22.4% in 2003. ‘The sharp rise in these non-wage costs represents a significant and long-term problem for our nation's manufacturers and America’s economy,’ said John Engler, president of the National Association of Manufacturers…”

September 27 – The Wall Street Journal (Vanessa Fuhrmans): “The health-care premiums of employers and their workers have climbed twice as fast as wages and inflation in 2006 -- to nearly double their cost in 2000 -- and they look to rise at a similar clip next year, two nationwide surveys show. That said, the pace of increase is about half what it was just a few years ago. The average family premium rose 7.7% in 2006.”

September 26 – PRNewswire: “Compensation for newly hired employees may be on the increase, according to the October report of the Leading Indicator of National Employment…which finds that new-hire compensation jumped in September.  In addition, over half of manufacturers and service-sector employers plan to expand hiring in October, indicating that the job market continues to remain strong…”

September 28 – EconoPlay.com (Gary Rosenberger): “New vehicle sales slid in September as domestic manufacturers took back a blockbuster zero-percent incentive and replaced it with others that got zero attention… Toyota continued to plow ahead of the competition and there are expectations of substantial increases even as other Japanese and European imports slowed a bit, possibly due to inventory shortfalls. Most dealers were about even with last year, a poor showing in light of the employee-discount hangover and the Hurricane Katrina fuel price run-up that put a major and lasting dent on the car market at the time.”

September 28 – PRNewswire: “Americans are expected to continue to open their wallets this holiday season, according to Deloitte & Touche USA LLP, despite some uncertainty about the economy. As a result, Deloitte’s Consumer Business practice expects that holiday sales, excluding autos and gasoline, will increase 7 percent during the November-to-January period, less than last year’s exceptional 7.8 percent increase, but still above the past decade’s average growth rate.”

Real Estate Bubble Watch:

September 27 – Financial Times (Saskia Scholtes and Michael Mackenzie): “Growing numbers of hedge funds have placed bets on a slump in the US housing sector in recent weeks, weakening a key index tied to the performance of subprime mortgages, according to dealers. ‘We’ve seen macro hedge funds become increasingly negative on the US housing market. It seems to be the one trade that they can all agree on,’ said Jack McCleary, head of US asset-backed securities trading at UBS.  As a result, the ABX index – which represents a basket of credit default swaps on subprime mortgages and home equity loans – has declined significantly. The lowest-rated tranche of the index has been most affected, widening by around 50 basis points over the last two weeks.
CDS on asset-backed securities such as home equity loans provide a type of insurance against the default of a specific security. The buyer of insurance pays a quarterly premium in exchange for guaranteed payments if the underlying security experiences losses.”

August Existing Home Sales were reported at a somewhat better-than-expected annual rate of 6.30 million. For perspective, this is down from last year’s record 7.072 million sales, 2004’s 6.784 million, and 2003’s 6.183 million, yet remains significantly (58%) above the 3.993 million nineties annual average. August New Homes Sales were also marginally above consensus expectations at 1.050 million annualized. This compares to 2005’s record 1.282 million New Home Sales, 2004’s 1.282 million, and 2003’s 1.086, but is at the same time much larger than the nineties average 698,300.   August Existing Home Sales were down 12.6% from near record year ago sales, with y-t-d sales running 6.5% below last year’s record pace. August New Home Sales were down 17.4% from August 2005, with y-t-d sales running 15.2% below 2005’s record pace.

Now let’s take a look at Prices. Despite the steep drop in transactions, Average (mean) August New Home Prices were up 3.2% from a year earlier at $304,400 (down from July’s record $314,200). August Average Existing Home Prices were down 1.2% from a year earlier to $272,800 (18 month rise of 9.5%). August Calculated Transaction Value (CTV) was down 13.7% from a year ago, although y-t-d CTV is running only 3.6% below last year’s pace.

While Sales Transaction volumes sank 30.1% from one year ago, California Median Home Prices jumped almost $10,000 during August to a record $576,360. Median Prices were up only 1.6% from the August 2005 price spike, while maintaining a 22% rise ($105,440) during the past 18 months. Golden State Condo Sales were down 31.6% from August 2005, with Prices about unchanged at $433,720 (up 13%, or $48,320 over 18 months). And while inflated prices have held up remarkably well so far, there are darkening storm clouds on the horizon. “C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in August 2006 was 6.8 months, compared with 2.6 months for the same period a year ago… The share of homes on the market for 90 days or longer has nearly quadrupled from 6% in August 2004 to 22% last month.”

Financial Sphere Bubble Watch:

September 29 – Financial Times (Lina Saigol ): “A resurgence of hostile takeover bids around the globe has helped push the volume of mergers and acquisitions to a record $2,672bn in the first nine months of the year. There have been 132 unsolicited bids so far this year, more than double the number in the same period last year and the highest since 1999, said Dealogic… The rise has been fuelled by audacious chief executives seeking growth, record liquidity and increased shareholder activism. ‘Companies are prepared to materially raise their offers when they have been initially rejected, sometimes finding another15-40 per cent of value in their pockets,’ said Gavin MacDonald, European head of M&A at Morgan Stanley… Europe-targeted M&A exceeded $1,000bn for the first time, reaching $1,080bn - an increase of 40 per cent over the same period last year. US-targeted deals rose by 12 per cent to $943.8bn, while Asia Pacific, excluding Japan, rose by 26 per cent to $244.0bn.”

September 29 – Financial Times (James Politi): “The tide of large private equity deals continued in the third quarter, with buy-out groups sealing more than $180bn worth of transactions and shattering the 16-year-old record for the world’s biggest leveraged buy-out… Expectations have been growing on Wall Street that the boom period for private equity could come to an end amid rising interest rates and higher asset valuations. But the latest figures from Dealogic suggest that buy-out executives continue to be bullish about their ability to generate high returns from acquiring companies with large amounts of debt, and selling or floating them a few years from now.”

September 29 – Financial Times (Joanna Chung): “The volume of initial public offerings fell sharply during the third quarter - but 2006 remains on track to break a five-year high for new shares issues. Money raised by IPOs in the latest quarter was just $36.1bn compared with $66.8bn in the second quarter, according to Dealogic…But the size of the global market for IPOs is still set to exceed that of last year - and become second only to 2000… They also helped overall equity capital markets activity for the first nine months to rise 22 per cent to $491.1bn compared to the same period in 2005, the highest nine months on record…The US market was among the most sluggish during the third quarter, raising just $5.8bn compared with $18.4bn in the second quarter… But total global IPO volume for the first nine-months of the year rose 38 per cent to $140.6bn over the same period last year…”

September 28 - Dow Jones (Campion Walsh): “Credit derivatives grew 20% to a notional value of $6.6 trillion during the second quarter, a pace that has drawn attention from bank regulators… Overall, the notional amount of various types of derivatives in commercial bank portfolios rose 8% to a record $119 trillion during the second quarter, and the amount was 24% higher than a year earlier, the OCC said… While interest-rate contracts continue to make up the vast majority of these derivatives at 83% of the total, credit derivatives, comprising just 6%, are the fastest-growing component.  ‘Credit derivatives have grown 60% since the second quarter of 2005, and the continued strong growth in credit derivatives is an area receiving close attention from the OCC,’ said Kathryn Dick, the agency’s deputy comptroller for credit and market risk.” 

September 25 - Dow Jones (Campion Walsh): “Syndicated credit quality has declined slightly since last year, while total syndicated credit outstanding grew 15% on-year to the highest point in five years, according to a U.S. regulators’ survey... 
About 5.1% of a total $1.87 trillion in syndicated U.S. credit was considered ‘at risk’ as of the second quarter of 2006, up from 4.8% of a total $1.63 trillion a year earlier… The nearly $250 billion, or 15%, expansion in syndicated credit was the biggest annual gain in eight years, reflecting increased financing for mergers and acquisitions…”

September 26 – Dow Jones (Thomas Kostigen): “The derivatives market has soared, reaching nearly $300 trillion in value. Considering that the total value of the stock and bond markets combined amounts to only $65 trillion, it’s worth wondering how so much extra value can be squeezed out of instruments that are essentially fake. Derivatives are priced according to their ‘notional value’ not their ‘actual value’ because their value is based on the performance of an underlying financial asset, index or other investment… You would think regulators would be concerned about what’s effectively a hedge of the capital market as a whole. But they aren’t. Indeed, new rules loosen the strictures for pension funds and large institutions to invest in the derivatives market.   Any misstep or stumble in the capital market could be a recipe for disaster -far more than what we have seen in the past… The notional value of derivatives almost tripled in the first half of the decade, growing from $98 trillion in 2000 to $270 trillion in 2005, according to Wall Street research firm TowerGroup.”

Energy Boom and Crude Liquidity Watch:

September 26 – Bloomberg (Matthew Brown): “The United Arab Emirates economy, the second largest in the Arab world, is expected to grow this year by almost a quarter after oil prices rose to a record in July, the Gulf News reported…”

Climate Watch:

September 29 – Bloomberg (Madelene Pearson): “Drought in Australia is worse than expected and will damp growth in the Asia-Pacific region’s fifth-largest economy, said Treasurer Peter Costello. Australia, which had its driest August since records began in 1900, may witness above-average temperatures and below-average rains in parts of the country in the next three months as El Nino conditions develop, the weather bureau said…”

Speculator Watch:

September 25 – Bloomberg (Matthew Keenan and Brian K. Sullivan): “Yale University’s $18 billion endowment outperformed Harvard’s in fiscal 2006, posting a 22.9 percent investment return on gains from hedge funds and stocks outside the U.S.”

September 27 – Bloomberg (Ann Saphir and Elizabeth Stanton): “An increase since mid-2004 in trades that distort prices in the $4.1 trillion market for U.S. government debt has drawn the attention of regulators, and federal enforcement agencies continue to investigate the trades, a Treasury official said. ‘Simply put, we have observed instances in which firms appeared to gain a significant degree of control over highly sought after Treasury issues and seemed to use that market power to their advantage,’ Deputy Assistant Secretary for Finance James Clouse said today in the text of a speech at the Bond Market Association in New York. ‘In the process, prices in the cash, repo and futures markets appear to have been distorted to varying degrees…’ The financial incentives to manipulate or ‘squeeze’ an issue have risen markedly since mid-2004,' Clouse said.”

 Volcker, Corrigan, McDonough & Geithner:

The Women’s Economic Round Table sponsored a panel discussion Tuesday in New York that featured New York Federal Reserve Bank President Timothy Geithner, former NY Fed President and FOMC Chairman Paul Volcker, former NY Fed chief and FOMC vice-chairman Gerald Corrigan, and former NY Fed President William McDonough. The discussion of monetary policymaking amongst some of our most seasoned central bankers ran the gamut from inflation, to asset bubbles, to communications, to LTCM and supervision. I have extracted quotes from what I found to be (transcribing from a recording) an interesting and, at times, enlightening 90 minute discussion.

Timothy Geithner: “I should start by saying it’s a remarkable accomplishment to bring these three (Messrs. Volcker, Corrigan and McDonough) together... So we’ve each been fortunate to be part of a really great central bank, a great institution. And I think I’ve heard each of these men say that they were proud to be part of the most important part of the most important central bank in the world. Beyond their individual contributions to the New York Fed, of course, these three men, along with Tony Solomon and with Alan Greenspan, really helped define the modern doctrine of U.S. central banking. This is a doctrine that’s brought great benefits and practice to the U.S. economy over the last two decades. And it’s been hugely influential around the world. And it remains in place today. And I want to just say a few words in tribute to them about the key tenets of this doctrine, about the elements that distinguish their reign, their reign in the Fed.

They recognize, of course, that central bank credibility is vital; it’s hard to earn, costly to lose. Credibility depends critically on the confidence we engender that we will keep inflation low. But credibility is more complicated than that. It depends on the confidence we engender in our capacity to understand the forces operating on our economy. It depends on how, not just whether, we achieve price stability.

These men recognized, of course, that the Fed has important responsibilities beyond the conduct of monetary policy - that the Fed was given, at its inception, a very important role in the financial system in defining the appropriate balance between innovation and resilience, between efficiency and stability, and our capacity to contain risk. Systemic risk today depends a lot on how wisely we are in executing our supervisory responsibilities and how robust we make the infrastructure that underpins financial markets and how close we are to markets in understanding innovation at the frontier and then our willingness to act with speed and force when financial distress might threaten the overall performance of the economy.

They recognized also that while monetary policy is critical to how well the U.S. economy performs, the overall level of economic performance - the quality of growth in the United States - depends on policies outside the province of the Federal Reserve. It depends on the environment government creates for risk-taking and innovation, on the quality of education, on how open we are to the rest of the world, and on the broad stance of fiscal policy. They each spent capital in trying to make the case for better policies in these areas, and their personal credibility made them influential voices even if their governments they served with did not always defer to their judgment.

They recognize that U.S. policies have a huge impact on the rest of the world and that the fortunes of the world matter more and more to the fortunes of the United States. They made huge personal investments in building a strong network of relationships with financial officials and market participants around the world. And their tenures in office, of course, were defined in important ways by what they did to help resolve financial crises outside as well as inside the United States…”

Question (Terri Thompson): “I would like to ask this question of all three previous Presidents. Central bankers are often characterized as overprotective - the overprotective mothers of the global economy - because they worry so much. So my question for you is, what are the two or three things that worry you most today?”

William McDonough: “The thing that worries me most, in fact, the only thing that worries me a great deal - are what are popularly called the global imbalances. The United States of America last year needed to import $800 billion of other people’s savings; six and a half percent of gross domestic product. Unlike the days of yore when it was rich countries that were exporting savings to poor countries, it is now emerging market countries - China, Brazil - which are not investing enough in their own societies and sending money to the United States. It seems to be a good deal. We are the importer of last resort. They want to export things. We have very well developed financial markets - very creative financial services companies. And, so we are the place to invest of last resort.

In my view, this is not in the interest of the United States. We are a country that has a very serious problem with our aging population, of which I’m part. The Social Security system and the Medicare system on an actuarial basis are both in deep bankruptcy. Therefore, it is not appropriate for us as a society to be living higher than we should on other people’s savings from poor countries. China has 400 million people living below the poverty line; 800 million people living in poor rural areas. It makes no sense that they have a trillion dollars in reserves and that we, the people of the United States, are living better as a result of it. We have to do a better job. They have to do a better job in managing their economies. This is a situation which, left to its own devices, is one that will hit a brick wall. The only question is when.”

Gerald Corrigan: “The first point I would make is related somewhat to the one Bill just made – its kind of the other side of it. That is that the United States savings rate is virtually zero. The household saving rate is negative. And for the reasons that Bill mentioned and a whole bunch of other reasons as well, this is a potentially very dangerous situation, not only in terms of economic and financial terms, but it brings with it, I think, some potentially very serious problems down the road in terms of the well being of our own citizens. You know, as I said, that’s very closely related to Bill’s point about imbalances. 

The second thing that I would mention is I think there is what I will describe as a small risk that the old inflation genie could sneak out of a bottle on us again. I emphasize that I think that is a very small risk, but if there’s one thing I think I’ve learned in the 40 years it is now in the financial fights that is once the genie is out of the bottle, it’s very, very difficult and expensive to put it back in the bottle. 

I would just add to both of those points, whether it’s inflation or imbalances or savings, the other thing you have to be very cognizant of is that these kinds of problems clearly have potential to generate potential elements of financial instability. And the fact of the matter is that no matter how smart we think we are, we are virtually incapable - individually and collectively - of being able to anticipate the specific timing and triggers associated with financial shocks. So if you put that variable into the equation, it seems to me that it just reinforces in spades how important it is to get the fundamentals right.”

Paul Volcker: “Well, what I immediately thought, Terri, when you asked the question, I should resist the temptation to say what worries me the most is that I’m not in Washington. That’s not quite true because I take great confidence in the people in the Federal Reserve and elsewhere, particularly Tim Geithner. But both of my associates here have already touched upon the issues that I would put front and center economically.

I do worry about a lot of things in the economy these days, because I do think an awful lot is going wrong in the world generally that are even more important than monetary policy. But I don’t think I’ll get into those too deeply and just underscore what my two friends just said. I am a little bit more worried about inflation than Mr. Corrigan – although he expressed a worry. Not that it’s high, not that it’s going to go running away, but it’s kind of creeping up.

And I am impressed by the degree of pressure - if that’s the right word - psychological pressure, political pressure there is not to do anything about it. A lot of people out there on Wall Street and on Main Street are operating on the assumption that nothing very startling will happen in terms of restraint. And that’s reflected in attitudes pretty broadly. But once people are convinced that that’s the case, it can creep up on you. And the more it creeps up on you, the more difficult it becomes to do something about it.”

Question (Heidi Miller): “…I think about Long-Term Capital [Management], certainly in light of what happened last week with Amaranth. And I wonder if, in retrospect, Mr. Corrigan, you think that intervening in long-term capital was a wise decision and if so, do you think it made any difference long-term in the evolution of the hedge fund market?”

Gerald Corrigan: “First of all, I would take exception with the term ‘intervention’ or ‘intervening.’”

William McDonough: “Bravo.”

Gerald Corrigan: “If every time I called a meeting, to bring together at 33 Liberty Street (NY Fed offices) a bunch of chief executive officers of financial institutions, that had been defined as intervention, I would’ve made Attila the Hun look like a pacifist.”

Gerald Corrigan: “I really think that - in all due respect Heidi - it is not the way I think at all. I think what the Fed did and Bill, Peter Fisher, and Dino Post, who is here, and Alan & Company in Washington, all were supportive of that. What they did was provide, essentially, a setting within which a broad cross section of leaders from the private sector were able to sit down in the presence of each other, with no black smoke or white smoke going out the chimney at Liberty Street, and sort out what they collectively thought was in their best interest and in the best public interest to stabilize what potentially could have been a very, very, very nasty situation. And I think that’s all for the credit of the Federal Reserve and I think it’s also to the credit of the tradition of Liberty Street, if I can put it that way.

Now, as to the second part of your question, did what you call ‘intervention’ bring with it some kind of a moral hazard problem? I think that was the spirit of your question. And, again, I can just say that that risk is always there, but it seems to me that in that particular case on the private sector some $3.5 billion worth of checks that afternoon, that’s a pretty powerful antidote to moral hazard. So, the answer to your second question, in my judgment, would be no. I think that that was one of many examples where, in my judgment, the Fed unambiguously did the right thing in the interest of the well-being of the system.”

William McDonough: “Can I add a footnote to that. I think it’s very important that one realize what all of the Presidents of the Fed have done, when you had that kind of a meeting. I’ll just give you my own introductory spiel, which was, ‘I’m the public servant. The psychic income of serving the nation as a patriot is mine. You all are responsible for your shareholders. And you have to decide whether what may well be in the public interest is in the interest of your shareholders. Because I want to make it very clear that whatever you do has to be for that reason. The Federal Reserve owes you nothing; the government of the United States owes you nothing; and I owe you nothing. There’s nothing but a private sector solution for a private sector problem.’ That’s it. And that is a spiel that I gave every time I had the kind of meeting to which Gerry refers, and it’s one that I think is absolutely essential. Private sector people are paid by their shareholders to represent their shareholders. They’re not paid to be patriots. It’s nice if they’re patriots, but what they should be doing in making the kind of decision to recapitalize Long-Term Capital Management, was because they thought their shareholders were better off to recapitalize it than to let it fail and have a real question about what damage it would do to them.”

Gerald Corrigan: “I agree with that too, but I also believe the major financial institutions also have the responsibility for the well-being of the system. It’s not just the shareholders.”

Paul Volcker: “Well, in the interest of truth in speaking, I recall that I expressed certain reservations about that particular operation at the time. And I hold steadfast to my reservations about that particular operation, at that particular time, for a variety of reasons, which I could exculpate at length, but maybe I will refrain from doing so. Let me say, quite simply, that this was not an institution that was considered to be in the normal ambit of Federal Reserve supervision and oversight at the time. It is not an institution that by law had access to Federal Reserve facilities. Now, technically, the Federal Reserve provided no money in this case - is quite clear. But it did provide a convenient meeting room, which implied a certain degree of moral suasion, I think, in the process. Whether this was justified for this particular institution, at this particular time, I must take a little exception to something Gerry said - that this was a broad section of [financial] leaders. I think this was 13 investment banks who were heavily…”

William McDonough: “Seventeen institutions, most of them were commercial banks.”

Paul Volcker: “Oh, Merrill Lynch - the big ones, just take the big ones here; Merrill Lynch, Goldman Sachs, Salomon, on and on and on.”

William McDonough: “Salomon… at that time was part of Citigroup.”

Paul Volcker: “Were the major - the major drivers of this rescue, as I recall it. The one commercial bank that I was involved with didn’t like the idea and went ahead with great reluctance.”

Gerald Corrigan: “Bankers Trust?”

Paul Volcker: “I agree with that. Even when it was a commercial banking operation it didn’t like it. But, you know, there are things I don’t know about it - whether there were other solutions on the table. I thought it perfectly possible these people would get rescued and they’d go out and make another mutual fund or investment fund, in which they did.”

Question (John Authers): “At what point is it appropriate for the New York Fed to come in and clean up the industry’s act for it [Credit derivatives] and what are the main steps that need to be taken to clean up the credit derivatives [market]?”

Gerald Corrigan: “Let me try to briefly put this issue in a little bit of context. And I’m sure some people in this room know that it was an industry group that I was chairman of that in a very real way put the spotlight on this whole collection of issues related to the integrity of the infrastructure supporting the operation of the OTC derivatives market in credit derivatives in particular. And I’m not going to go into the details except to say that when we were putting that industry report together in May of 2005, I have to confess that I myself, was taken aback if not shocked when I discovered - I still kick myself that I didn’t discover this problem earlier - but when I discovered the severity of the problems with the, again, potential implication that in the face of those problems, if for other reasons, we had some major financial disturbance, the condition of the infrastructure supporting those markets would have, without a doubt, in my judgment, made an extremely difficult situation all the more difficult…”

Question (Terri Thompson): “I’d like to discuss a little bit about communications. Walter Bagehot for whom the (Columbia University’s) Knight-Bagehot program was named, was a real proponent of clear, precise, concise writing for journalists… How important is effective communications to the Fed? How has communications changed over the years and requirements changed over the years and do you believe that the markets and the media misread remarks made by the Fed Chairman and bank president and if so, why?”

Gerald Corrigan: “I’m going to give this one to the master (Paul Volcker), but I have to say just one quick thought… To me, the suggestion or train of thought - the idea - that Central Banks can and should telegraph in advance every single time it’s going to change the Federal Funds rate or whatever the operational policy target might be - it just seems to me to be very short-sighted at the extreme – I will use the extreme deliberately. One could make a case that what you’re doing if you adopt that position as kind of the rule of the day or the month or the year, is you’re basically turning over the responsibility for monetary policy to the financial markets. That just doesn’t seem to me to be very good idea.”

Paul Volcker: “Well, in this area of communication, I always thought the high point of my career was once when I was testifying before the Congress in the Humphrey Hawkins [framework] and the headline in the Wall Street Journal was ‘Federal Reserve Tightens.’ The headline in New York Times was ‘Federal Reserve Eases.’ And all I was trying to do was explain the complexity of the real world. And people read into what you say, what they think. In that particular case, I’m sure there were some monetarists who thought - I don’t remember which side they were on - they thought we were tightening or easing and some interest rate people who thought the opposite.

So, it was what they read into the testimony, not what was said. But, I do think that actions speak louder than words, and the words should as little as possible confuse things. It’s almost gotten to the point where I don’t know that we need all this apparatus of open market operations anymore. The chairman can go out and say, ‘We raised the Federal Funds rate by a quarter percent today.’ The market says, ‘Yes, sir,’ and up it goes or down it goes, and the rest of you can go to sleep. I think that’s going a little too far in making the objectives clear, because the market ought to make up its own mind once in a while. And eventually they will, but I - how much they need to be spoon- fed, so to speak. But, I don’t know, I’m in the old school, so.”

Question (Heidi Miller): “I was really struck: a number of you - the guardians of the economy or economic policy - you talked about monitoring markets in a way that would be good for market practices or the broader economy. And yet, somebody also used the term ‘normal ambit of supervision’ and it strikes me in a world where non-bank financial institutions are increasingly involved in creating derivative instruments and trading those instruments - where capital moves and indeed, some great creativity takes place in London as much as it does in New York - that the role of the supervisor has been, in fact, diluted a little bit. And, so, I was wondering if you could address the issue of whether the Fed’s supervision is sufficient in a world where other entrants are evolving and creating change in the economy?”

Timothy Geithner: “An interesting, complicated question. I think we have ample authority today to satisfy the objectives we’ve been given for supervision/regulation. I do think, though, that there’s been enough change in the financial system over the last two decades or so, that we have to be prepared occasionally to reassess whether we’ve got the broad balance right. Whether this overall framework we have of supervision regulation - where we have capital base supervision over a diminished and smaller share of the system as a whole - works in delivering the balance between efficiency and stability that’s so important. That’s a judgment that we’ve just got to be prepared to look at over time. I don’t think you can look at the balance today and say it’s clearly wrong, it’s clearly inadequate. But we may come to the point in the future that we’re going to have to revisit both the scope and the design of that basic framework.”

Paul Volcker: “I think this a big, big issue in terms of the changes in the market which get back a little bit to the intervention with Long-Term Capital Management. I have always been a great defender of the proposition that the Federal Reserve should be the leading regulator and supervisor of banks. There are other agencies involved, but when push comes to shove - because of lender of last resort position. In other words, the Federal Reserve has a special responsibility. And once you controlled the banking system, that was enough, and the rest of the market ought to go on its own.

Well, that was fine when commercial banks were 60% or 70% of the financial system and we’re a long, long ways from that and in fact, what we still call the big commercial banks, aren’t commercial banks anymore. That’s kind of a subsidiary operation and they all want to become investment managers and investment banks and insurance companies and all sorts of things. Which really raises the question of whether what we have in law is the traditional supervisory distribution of authority, is really relevant. Now, we make-do for the reasons that Tim suggested: by the momentum of history and authority and moral suasion and all the rest and demonstrated again with Long-Term Capital Management.

But as one who has violently defended the role of the Federal Reserve - the rather unique role of the Federal Reserve in this area - I think it’s time that that gets reviewed. And if that is, in fact the case, maybe the law does have to be changed to reflect that a little more clearly, with all the complications that that will involve. Where do you go? What seems to be fashionable these days - go with the British initiative and say all the regulation ought to be stuck in some other agency, somewhat removed from the Central Bank? I guess eventually, we’re going to have to face up with it sooner or later.”

William McDonough: “I think that the likelihood is that probably in the fairly distant future, the Congress of the United States and the President of the day will have to decide that the present system of the Federal Reserve supervising directly, only banks, and the securities firms are sort of regulated by the SEC and the hedge funds are more or less not regulated by anybody - that that is a situation which can work, but it invariably demands now that the Federal Reserve interest itself in institutions other then the banks more then it had to in the past.

That’s why Paul Volcker and I have a little difference of opinion in LTCM. It’s that issue alone. But whether you had something less dramatic - the lead up to 12/31/99 - would the computers work or not work. Well, frankly it didn’t make a whole lot of difference whether it was a bank’s computers that didn’t work or Goldman Sachs’ computers that didn’t work. It still would have been a problem and the Federal Reserve would have had to be in the middle of it, if only supplying liquidity through the banking system to the market in general.

It’s a situation like many things in America that works almost despite the design, which is very much inherited from the past. And one would hope that we won’t wait until a crisis that is truly a mess for the Congress and the President to look at the structural issues and decide to put in place a supervisory system that is more appropriate for the day. I would be very much opposed to a supervisory system of the kind that the United Kingdom has in which, by and large, the Bank of England just isn’t involved. I can’t imagine a regulatory system in the United States in which it would not be better if the Federal Reserve had a very powerful and important position.”

Question (John Authers): “I’d like quickly to ask one other question on monetary policy. How important - traditionally when you think of monetary policies as being led by inflation, the control of inflation - how important are assets prices and asset prices beyond the inflation statistics in monetary policy and how should – how important should they be? You know, under Chairman Greenspan people had the impression at one point that he was trying to talk down the markets and at other points that he was injecting liquidity to help the stock market. And now we’ve got great fears in the housing markets and whether or not that will have knock-on effects on the economy. So, I guess, that’s the question I’d be interested in asking everybody, to what extent do asset price bubbles and asset prices beyond those in the inflation statistics matter to the formation of monetary policy?”

Paul Volcker: “Well, the question is the importance of asset bubbles, I take it, and what the Federal Reserve should do. I would approach an answer to that question by a parable, not exactly a parable, but – there’s a lot discussion about what went wrong in Japan in the last 15 years. And somehow with the consumer price index declining by 1% a year or being stable for five years and then declining by 1% a year for the next five years - and the common lore is named ‘deflation.’ I don’t know how that’s deflation, exactly. We live in a peculiar world where 3% inflation is stability, but a half a percent decline in the price index is deflation. So, I’m not quite up with modern nomenclatures here.

But what I do sense is the trouble in Japan was not by all odds primarily that the price index was declining by half a percent a year, but the fact that both the real estate market and the stock market declined by 75% from the peak of the late 1980s and particularly within the context of the Japanese financial system, which was very heavily dependent upon real estate prices. And, in fact, [with] the banks heavily dependent upon stock prices as well, [this] created a great drag on economic activity for a while. So, if you accept that proposition as a reasonable interpretation of reality, you would say the problem was in retrospect, the bubble. And why was that permitted to proceed as long as it did and as far as it did without an earlier reaction in monetary policy.

In fact, there was a reaction eventually that came too late and exacerbated the decline. A lot involves, you know, whether in prospect or retrospect, a very difficult judgment. And nobody wants to intervene in every wiggle or every potential excess in the markets, for sure. And how do you reconcile that desire to stay out of these markets with the recognition that when apparent risk of a bubble and a reaction becomes great enough so that it’s worth taking a little risk through, I would say general measures, to deal with it.”

Gerald Corrigan: “I’ll answer it with my own questions and answers, rather than your questions and my answers. The first question I would say is…should central banks, in any way, target asset price bubbles - whether it’s in housing or stock prices or whatever. And the answer to that question, to me, is no. I have no reservations, but there’s another question, though. The other question is, are there circumstances in which emerging conditions in the form of asset price bubbles, might well warrant a tilt in monetary policy? In other words, to err on the side of maybe being a little bit more firm rather than a little bit more easy. My answer to that question is yes. There are circumstances in which I think that would be quite appropriate, but circumstances are not a cookbook or a rule book.”

William McDonough: “Let me add, very much in agreement with Gerry. I think that the policy instruments available to the Federal Reserve do not lend themselves to aiming right at an asset bubble. If you take the period between a certain remark about ‘irrational exuberance’ and the market correcting, there was about three and a half years. During that time, certainly it looked as if stock prices were rather heady, but it also looked as if in order to actually attack the asset prices, the cost would be to tank the real economy. You can do some leaning - I agree very much with Gerry in that regard - you can have monetary policy be a little firmer than it might otherwise be or a little more accommodative than it otherwise might be, but I don’t think there’s anyway in the world in which it would be justified for the Central Bank to say, well, the equity market’s higher then we’d like it to be, the stock market is - the housing market is higher then we’d like it to be - so let’s really put in a very firm monetary policy and slow down the economy, create a lot of unemployment. That simply is not what the laws of the United States say that the Federal Reserve should be doing. Leaning against it, as Gerry suggests, I think is very appropriate, but a direct attack on asset prices - I just don’t think we have the tools and the use of the tools would be very detrimental to the well-being of our people.”

Question (John Brademas): “My question is, what have you to say about the impact on the future of the American economy of the rising deficits in the government of the United States? And what, if anything, can the Federal Reserve do about them?”

Gerald Corrigan: “First of all, you’re asking what the Federal Reserve should be doing about this? The answer basically is nothing. People in the Federal Reserve can go out and give speeches and all that, but this is not a Federal Reserve problem. And I think the future of the Federal Reserve, which is Mr. Geithner and his associates and Mr. Bernanke and his associates, that the most important thing that the Federal Reserve has got to do is keep a steady hand on the helm and not let monetary policy perpetuate this problem.

But on the larger question - and you know this perhaps better than anybody in this room - what we need to get even the beginnings of a solution to this problem is a return of a genuine spirit of bipartisanship within the political mechanism in Washington, both in the Congress and the executive branch. And I don’t know where you are on that, but as I look at things, at least right now, I must say I do not see a wave of bipartisanship standing around the corner or waiting to join the party.”