Back on March 4, I posted the top two charts.

 The use of all types of collateral in the inter-dealer GCF repo market has fallen dramatically. The average daily value of Treasury GCF repos in February was down 32.25% from a year ago. Repos financed with Fannie and Freddie’s debt were down 60.86%. Agency MBS GCF down 53.32%.


In part, this appears to be driven by quantitative easing. If you look at the chart, you’ll see a lot of correlation with QE events and the peaks in the Treasury and MBS GCF repos. For example, the last peak (on the right of the chart) came in September 2013, the taper head fake. 

Why would QE drive down GCF repos? I think the explanation is that QE and and GCF repo do something very similar: exchange Treasuries and MBS for cash deposits. If you’ve got a lot of cash from QE, you don’t need to borrow it on the GCF repo market. The fall in rates in the GCF market supports this, I guess.

One question: if there’s a lot of substitution of QE for GCF repo, does this mean QE is less effective? Seems to me that the “Q” part of QE has to do with quantity. If market participants are decreasing their access to cash on the GCF market because they’re getting it through QE, there’s not much net QE going on at all.

An alternative explanation (or perhaps complementary): MBS issuance is way down as well. Bond trading is down as well (as you can see in the bars on the chart; notice, however, that the trading and repo markets are on a different scale). So the decline in GCF funding could be driven by “demand” as well. With fewer issues and trades, the need for financing should decline.

The stacked version of the GCF chart really shows the contraction nicely.

A few days, on March 7 later I posted this and the third chart: 

Those of you following the great GCF Repo mystery will want to see this chart.


Looks like a big part of the absence of GCF can be explained by the Fed’s new reverse repo facility.

Feeling Froggy with Robin Williams

I never met Robin Williams but my daughter Rose did.

I think Mork & Mindy changed my life. I’m not sure I can explain how but my wife probably can. She often feels like she lives with a clueless alien and I usually agree. Mork, Robin Williams, taught me that was okay. Maybe even normal in a really not-normal way.

Rose was standing on a corner in Brooklyn. She was 3 1/2 years old. It was a rainy day so she was wearing her froggy rain boots.

"Are your boots made out of frogs?" asked a stranger.

"Yes. In a sense," Rose replied.

"I hope that sense isn’t smell. Because dead frogs smell like formaldehyde," the stranger said.

"How rude!" Rose told him. She wondered if her boots smelled and what formal-ideahide might be.

"Too true," he said.

The light changed. Robin Williams stood still. As Rose crossed the street, she heard a sound from behind her.

"Ribbit. Ribbit. Ribbit."

RIP Robin Williams. Thanks for all the laughs.

Godel’s Loophole: A Mystery Resolved

One of the great unsolved problems of American constitutional law goes by the name of “Godel’s Loophole.”  

I’ve solved the problem. But before I get to the solution, let’s go through the problem.

Kurt Godel, the famous Austrian mathematician and philosopher who emigrated to America, once claimed to have found a logical contradiction in the U.S. Constitution. Because of this fatal flaw, the U.S. was vulnerable to being transformed into a dictatorship, according to Godel.

The story of the loophole comes to us from Princeton University mathematician Oskar Morgenstern. He says that Godel claimed to have discovered the constitutional weakness while studying for his U.S. citizenship examination. 

Morgenstern and Albert Einstein both tried to dissuade Godel from spending too much time thinking about this point. Apparently they had a lot of conversations about this because Godel was obsessed with the point. You probably would be too if you had lived to see Austria transform from a Republic to a fascist state.

 Morgenstern and Einstein warned Godel that he really shouldn’t press this point during the citizenship interview. What happened next will blow your mind, as the internet likes to say.

When we came to Trenton, we were ushered into a big room, and while normally the witnesses are questioned separately from the candidate, because of Einstein’s appearance, an exception was made and all three of us were invited to sit down together, Gödel, in the center. The examiner first asked Einstein and then me whether we thought Gödel would make a good citizen. We assured him that this would certainly be the case, that he was a distinguished man, etc.

And then he turned to Gödel and said, Now, Mr. Gödel, where do you come from?
Gödel: Where I come from? Austria.
The examiner: What kind of government did you have in Austria?
Gödel: It was a republic, but the constitution was such that it finally was changed into a dictatorship.
The examiner: Oh! This is very bad. This could not happen in this country.
Gödel: Oh, yes, I can prove it.

So of all the possible questions, just that critical one was asked by the examiner. Einstein and I were horrified during this exchange; the examiner was intelligent enough to quickly quieten Gödel and broke off the examination at this point, greatly to our relief.”

So what was Godel’s loophole? The answer doesn’t seem to have been recorded in any surviving document. Speculation is rampant on the internet. Most of it, of course, is deeply unsatisfactory.

Fortunately, I’ve discovered a loophole and I think it’s what Godel had in mind. It meets the most important criteria: it is based on ‘inner contradictions’; it could lead to the end of the Republican form of government; it is not obvious or widely known.

The problem arises because of a flaw in Article II of the constitution. Section 1 of this article assigns the executive power to the president, sets the term for elected presidents and vice-presidents at 4 years, and establishes the electoral college procedures for presidential elections.

It also limits the presidency to natural born citizens, sets the minimum age, provides for the compensation of the president, and includes the oath of office of the president.

The problem arises from the 6th clause, which describes the succession to the presidency in certain cases. 

In Case of the Removal of the President from Office, or of his Death, Resignation, or Inability to discharge the Powers and Duties of the said Office, the Same shall devolve on the Vice President, and the Congress may by Law provide for the Case of Removal, Death, Resignation or Inability, both of the President and Vice President, declaring what Officer shall then act as President, and such Officer shall act accordingly, until the Disability be removed, or a President shall be elected.

This leaves open the question of who shall be president when the vice president and the president are both removed, dead, or incapacitated. Congress gets to decide who shall act as President.

There is, however, no mention of a term of office for this type of president. The four year term mentioned in the first clause of Article II clearly refers to elected presidents and vice presidents. Neither is there an indication of when the next election must be held. And so long as there is no election, the Congressionally selected officer remains president. 

That is, Congress could remove an elected president and vice-president and set up a new, unelected president who could hold the office indefinitely. 

This section of the constitution was amended in 1967 but that amendment doesn’t resolve this problem. Godel’s Loophole is still there.

Venn Diagram of Venn Diagrams.
In honor John Venn’s 180th birthday.
(Note: I didn’t create this and don’t know the source. If you made it, let me know and I’ll gladly give you credit.)

Venn Diagram of Venn Diagrams.

In honor John Venn’s 180th birthday.

(Note: I didn’t create this and don’t know the source. If you made it, let me know and I’ll gladly give you credit.)

We need to talk about money and nominal growth

Scott Sumner’s recent post on the alleged irrelevance of monetary policy channels seems aimed to alienate anyone who has taken the time to notice what’s been going on with the economy, banking and monetary policy for the last few years.

Sumner says there’s “no need to talk about ‘channels’” because concerns over propensities to spend, borrow, or lend can be shown to be false by three statements about the world. What are the statements?

1. Counterparties don’t matter.  The Fed buys assets from counterparty X, who almost always immediately cashes the check and the new base money disperses through the economy almost precisely as it would if the Fed had bought assets from counterparty Y, or counterparty Z.

That’s just not right. When the Fed buys a bond, it buys it from a primary dealer. The primary dealer, in turn, either had it in inventory or, more likely, bought it from one of its customers.

Customers buy and sell bonds continuously, whether or not the Fed is buying. The banks have multiple teams of guys whose job it is to facilitate customers doing this. The selling and buying is based on price and other considerations (like portfolio rebalancing or consumption plans). The folks selling bonds do whatever they were going to do with the proceeds—reinvest, pay for their kids college, buy a swimming pool—regards of whether it was the Fed buying or not.

The customer didn’t get a check to cash when he sold his bond. Instead, the balance in his deposit account with the dealer showed an increased. That’s a minor quibble but it is important since I think the concept of “cashes the check” leads to confusion.

This deposit growth doesn’t disperse anywhere. It sits as a deposit until the customer does something else with it, in which case it just becomes a deposit in another account. How would it disperse? Remember, Scott is arguing that “propensity to spend” doesn’t matter. But it is only through spending that the deposit disperses.

2.  The propensity to spend doesn’t matter for the same reason.  Once counterparties get rid of the new base money, the impact on NGDP depends on the public’s propensity to hoard money, and any change in the incentive to hoard. In the long run money is neutral and NGDP changes in proportion to the change in M, depends on the ‘M’ regardless of whether the person receiving the money has a marginal propensity to consume of 90% or 10%.  Either way they’ll almost always “get rid of” the new money, either by spending it or saving it.  Saving is not hoarding, it’s spending on financial assets.

That last sentence is correct.  When the Fed buys a Treasury or a government-backed mortgage-bond from someone who was using it as a savings/investment vehicle, the former bond holder is left with a deposit in a savings account and that deposit is a financial asset.

Why is the counterparty going to “get rid of the new base money?” She is going to do whatever she was going to do with the proceeds of the bond sale. Perhaps spend it on consumer goods, perhaps purchase a different financial assets.

She traded her bond for “base money,” which is to say an increase in his deposit account. I suppose you can say that she’s “spending it on financial assets” since she has “purchased” a deposit at a bank.

But how is this getting rid of anything? It’s just accepting what was on offer in exchange for the bond.

3. The lending channel doesn’t matter.  In the long run all nominal prices rise in proportion to the change in M.In the short run sticky wages and prices cause the new money to have non-neutral effects.  Those non-neutral effects reflect wage and price stickiness, not “channels” of spending.

Why would nominal prices rise because savings are now held in dollar denominated bank deposits instead of dollar denominated government bonds?  What’s changed that could cause a change in NGDP?

Sumner’s obviously a smart and thoughtful guy. But he’s never explained to my satisfaction why we should expect great macro-economic effects from this “new money.” Treasuries are future claims on money, acquired in exchange for current money. So what has happened when “base money” is expanded through QE, is that the central bank has transformed future claims into present claims.

What has changed isn’t really a change in quantity. What’s changed is the yield, maturity and liquidity characteristics of the public’s holding of financial assets. Perhaps those differences are enough to trigger a nominal rise in prices but I suspect that’s getting things backward. It’s not the change of the mix of financial assets (fewer bonds, more deposits) in portfolios that activates behavior likely to push up prices or nominal growth; it’s the change in behavior and plans that leads to changes in portfolios.

“ If I had the choice I would never be in default servicing again. I’d tell anyone who took out a mortgage, if you’re 60 days late, we’re selling the mortgage and we don’t want to do any business with you again. ”

Jamie Dimon, J.P. Morgan Chase Investor Day 2014

The Weird and Costly Stigma of the Discount Window

In my piece for Heard on the Street today, I criticize banks for willingly overpaying for things just to keep up appearances.

Before the crisis, banks often overpaid to buy back shares. During the crisis, they overpaid to borrow money from the Fed’s Term Auction Facility. And now the danger is that they’ll overpay when making buybacks again.

The column is focused on buybacks but I think it’s worth reflecting for a moment just how weird it is that banks insisted on overpaying to borrow money from the Fed even as their balance sheets were under immense pressure. 

The discovery of overpayment comes from the paper linked to in this blogpost at Liberty Street Economics. Fed economists found that in the depths of the financial crisis banks willingly overpaid for loans from the Fed, bidding for loans from the Fed’s Term Auction Facility at a substantial premium over what it would have cost them to borrow from the Fed’s discount window.  .

“In summary, our results show that banks could have lowered their interest expenses substantially during the financial crisis of 2007 and 2008 by borrowing from the DW instead of from the TAF or from the financial markets,” the Fed’s Olivier Armantier explains.

Why on earth would banks willingly pay the higher rate?

My non-serious response is that the banks borrowed at higher rates than necessary in order to set an example for their customers.

"Stop choosing the cheapest loan! Be like us wealthy bankers and choose the more expensive loan! It’s, uhm, prestigious!" 

The Fed’s economists say the “stigma” attached to borrowing from the discount window is to blame. But there is something a bit mysterious about this stigma. Discount window borrowing is confidential and it has been more than a decade since the Fed changed the rules so that even perfectly healthy banks can come to the window. There’s no logical or structural reason anyone should associate borrowing from the discount window with financial weakness. 

If anything’s going to be stigmatized by bankers,shouldn’t it be the choice to borrow more expensively?

-->