MuniLand

Why the Federal Reserve should buy national infrastructure bonds

The Federal Reserve is in the middle of a third round of bond buying that is commonly called quantitative easing (or QE3). The goal is to suppress interest rates, and it was the main monetary policy tool that the Fed began using in December 2008 to support the financial system during the credit crisis. The financial system has returned to racking up record-breaking profits, and the Fed has shifted the purpose of QE to propping up the housing system and the general economy.

By some measures though, the housing market may be showing bubble-like properties again from the broad efforts of the Fed. Rather than potentially fueling a new bubble, the Fed should turn to buying infrastructure bonds to rebuild America’s energy grid, bridges, roads, rail systems and ports. This would be a direct investment in the public sector of the nation, rather than the personal assets of households. If the Fed invested in America’s hard assets, it would create jobs and put in place the necessary framework to truly spur economic expansion.

The efforts of the Fed to prop up the housing market may be entering bubble territory in select markets (see Phoenix) as housing values rise more quickly than household incomes. From the blog Dr. Housing Bubble (emphasis mine):

The Case Shiller data is showing a steady increase in home prices across the United States. The headline figures are clear but rarely make the connection that much of this gain is coming on the back of unprecedented Federal Reserve intervention.  Data is clear that household income is not making any significant gains.  These gains are coming largely from added leverage produced by lower mortgage rates.

The Fed’s aggressive efforts to prop up the housing market through their purchases of mortgage-back securities (they own $933 billion) has lifted existing home sales back to their bubble-high of 2007 and helped lift housing prices. It has also given credit-worthy borrowers a chance to refinance their mortgages to lower rates and free up cash for other purchases. Although the Fed will only buy mortgage-back securities (MBS) that are guaranteed by agencies of the federal government (Fannie Mae and Freddie Mac) its intervention has trickled throughout the entire housing market.

We shouldn’t dread the debt limit

“Have a drink out there, folks, and just know that your kids and grandkids will be out there picking grit with the chickens,” says former U.S. Senator Alan Simpson in the video above. Simpson’s quip is the best summary I’ve ever heard of the public’s lack of understanding of the severity of the nation’s fiscal crisis. The federal government is currently borrowing 42 cents of every dollar that it spends. Thanks to the Federal Reserve’s quantitative easing and the strong global demand for U.S. Treasury debt, the nation has been able to borrow heavily at low interest rates to cover its budget shortfalls.

But the debt is piling up so high that the country might face a borrowing shock if there were a black swan event or if bond vigilantes forced higher interest rates. It’s not a question of whether rates will rise – they certainly will. What we don’t know is when it will happen. The same politicians who created this fiscal quagmire have now tasked themselves with fixing it. Despite numerous proposals on how to get our debt under control, the political dynamics of the issue make it likely that nothing will be resolved in Congress until after November’s election. The Washington Post reports:

But once the election is over … the issue of the debt will quickly rise to the top of the agenda – and not just because of the debt limit. In January, policymakers also will be facing the first round of harsh, across-the-board spending cuts adopted last summer, as well as the expiration of a host of tax cuts that benefit every American household. Unless Congress agrees on an alternative deficit-reduction strategy, the policies threaten to deliver a fiscal shock that could throw the nation back into recession.

Troubles in Volcker land?

My post last week about ditching the Volcker Rule and returning to some form of Glass-Steagall got a lot of positive responses. Back then I wrote that the Volcker Rule, which requires regulators to cleave risky trading for a bank’s house account from deposits insured by the FDIC, is immensely complex and that it will never be properly defined or enforced. Several regulators in the past week have agonized publicly over the need to get the rule “right.”

First among them was Fed Chairman Ben Bernanke. In the three minutes of C-Span video above, Bernanke says: “We are going to try and do our best to clarify the distinction between proprietary trading and market making.” It’s clear that even to our top banking regulator, defining Volcker properly is nearly impossible.

SEC Chairman Mary Schapiro had this to say on Volcker, via The Hill:

When asked by Rep. Mario Diaz-Balart (R-Fla.) if regulators would be better off scrapping the proposal and starting over, Schapiro was noncommital.

Forget Volcker — bring back Glass-Steagall

Imagine you are a financial regulator whose agency is underfunded, understaffed and under-trained and that firms under your jurisdiction are likely to pick off your best employees by offering them triple the salary you pay them.

Furthermore, imagine that Congress has written an 800-page law that instructs you to write and enforce new regulations on banks and securities firms to ensure financial stability for the system. The most complex part of this new law, the Volcker Rule, would require you to cooperate with three other agencies to jointly issue a 530-page Proposed Rule that asks 1,300 questions.

Now imagine that in the course of honing this rule, 17,000 comment letters will flow into your agency, the majority of which promote the status quo.

The ability to think and generate new ideas

The research department of the Federal Reserve Bank of New York released an interesting paper this week entitled “How Colleges and Universities Can Help Their Local Economies” (the video above is a good summary). The work centers on two ideas: 1) graduates can join the region’s educated workforce and contribute to economic growth; and 2) “human capital” is expanded when institutions team up with local business, or attract new businesses, to commercialize technology developed at the school.

I think these are good observations and help justify public support of higher education, but the analysis overlooks some big ways for institutions to drive economic growth more broadly. For example, Stanford University’s Engineering School is offering some of its most popular classes free of charge to students and educators around the world.

Here’s the best thinking from the New York Fed paper (page 2):

Higher levels of human capital in a region can contribute to higher levels of economic activity for several reasons. Human capital increases individual-level productivity and the generation of ideas. By extension, a region having more people with higher levels of human capital should have greater economic activity overall.

Muniland: the big picture (part 1)

A lot of municipal bond reporting zooms in on particular issuers or sectors and assumes that the reader understands the broader market. But the municipal bond market is foreign to most people, and I thought that it might be useful to sketch out the bigger picture. Here are some quick bullet points:

1. As of the third quarter of 2011 the size of the municipal bond market was $3.733 trillion. To put that into perspective, as of Jan. 25 there was $15.236 trillion of U.S. Treasury debt outstanding.

Source: Federal Reserve Flow of Funds (page 92)

2. Municipal bonds issued by state and local governments predominate, but there are also large amounts issued by nonprofits (think hospitals) and industrial revenue bonds (think sewer and water systems).

When home prices and property taxes diverge

The latest S&P/Case-Shiller Home Price Index, released yesterday, wasn’t pretty. Housing values continued to fall, their 5th consecutive year-on-year decline. (You can download the data here). The Federal Reserve Bank of Cleveland had this to say about the release:

According to today’s [Case-Shiller] report, the fourth quarter started with broad-based declines in home prices… On an annual basis, the 10-city composite is down 3 percent and the 20-city composite is down 3.4 percent, and eighteen of the 20 MSAs are also in negative territory.

Basically, there’s blood on the streets everywhere.

The Federal Reserve Board reports in its Flow of Funds data (line 4) that the value of household real-estate assets has declined from $22.7 trillion in 2006 to $16.1 trillion in the third quarter of 2011. That’s a loss of 30 percents. Have revenues from property taxes, which are supposed to reflect the property valuations, mirrored the same decline?

Found: $840 billion in municipal bonds

The Federal Reserve has quietly admitted they had undercounted about $840 billion of municipal bonds. Bloomberg reports on this new pile of assets:

The U.S. municipal-bond market is 28 percent larger than reported in June, according to a quarterly Federal Reserve release, which used new data showing individuals own more state and local-government debt.

[...]

“The estimate of household holdings of municipal securities and loans is revised up by about $840 billion, on average, from 2004 forward,” according to the Fed’s Flow of Funds Accounts report for the third quarter.

The Fed’s data snafus

Most everyone knows that the Federal Reserve Board is responsible for making monetary policy, handling prudential oversight of many of the nation’s banks and keeping the clearing and payment system flowing. But the Fed has another fundamental function that often goes unnoticed: collecting financial and economic data.

Good policymaking flows from having fresh and accurate data. From my little experience with the Fed they are not doing very well at this task.

Reuters is reporting that Fed Governor Elizabeth Duke believes that household debt has declined since the financial crisis of 2008 and that this reduction in household balance sheets will position families to participate in the recovery when conditions tick up. From Reuters:

Vermont rebuilds while Congress fights

The state of Vermont is struggling to gather funds to repair the flood damage from Hurricane Irene, the state’s worst natural disaster since the floods of 1927. Generally the state would rely on support from the federal government to replace and repair this infrastructure, but the U.S. Congress is locked in a fight over funding the Federal Emergency Management Agency as part of a larger fiscal battle that could shut down the federal government. From CBS News:

Congress is headed for a showdown over disaster relief funding that could bring the government to the brink of a government shutdown again.

House Speaker John Boehner has scheduled a vote tomorrow on a bill that would keep the government operating through Nov. 18. If the Senate and the House do not approve the stopgap measure, known as a continuing resolution, before the fiscal year ends Sept 30, the government would be forced to shutdown.

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