“Well, when I posted Part 4 I did not intend to post a Part 5. However, after reading and listening to Janet Yellen’s speech to the Michel Camdessus Central Banking Lecture at the meeting of the International Monetary Fund in Washington, D.C. yesterday it prompted me to post this rant.
Janet Yellen yesterday confirmed what the Redneck has ranted about over the last 6 months and believed for the past 40 years. Will the Federal Open Market Committee (FOMC) get it right? I don’t know, but if Chairman Yellen and her colleagues at Federal Reserve Board and FOMC follow the approach laid out in her speech I believe we have a chance to avoid another major financial collapse. As I ranted in Part 4, we cannot afford another collapse of our US financial system.
Unfortunately, our financial system and economy has developed into being a major partner in the economies around the World. The World economies and politics are real fragile, my friends. I made a recent trip to Bermuda. Virtually nothing “Made in China” is in the stores on Bermuda. The tags read Made in Italy, or England, or India, or France, and so on. A major dip in economic activity within the European Union or China would have a similar impact on our financial system and economy. A significant political event like a war in the Middle East between Israel and Iran, Islamic extremist succeeding in controlling major oil fields, a collapse of the internet, or Russia cutting off oil and gas supplies to Europe would bring down our financial markets and financial system.
The significant take away from Chariman Yellen’s speech for me is the major change by the FOMC recognizing the risk of simply raising interest rates because of improved employment in the US and promoting financial stability through a macroprudential approach. Her comments were: “If macroprudential tools are to play the primary role in the pursuit of financial stability, questions remain on which macroprudential tools are likely to be most effective, what the limits of such tools may be, and when, because of such limits, it may be appropriate to adjust monetary policy to “get in the cracks” that persist in the macroprudential framework.11
In weighing these questions, I find it helpful to distinguish between tools that primarily build through-the-cycle resilience against adverse financial developments and those primarily intended to lean against financial excesses.” She references the following in her speech.
11. These questions have been explored in, for example, International Monetary Fund (2013), The Interaction of Monetary and Macroprudential Policies (PDF) 
(Washington: IMF, January 29).
12. The IMF recently discussed tools to build resilience and lean against excesses (and provided a broad overview of macroprudential tools and their interaction with other policies, including monetary policy); see International Monetary Fund (2013), Key Aspects of Macroprudential Policy (PDF) (Washington: IMF, June 10).
Another takeaway from her speech referenced achieving a “nominal rate of interest” that would hold the market rate of interest around three percent (3%). 10 year US Treasury Bonds current market yield is around 2.62%. Any interest rate spike would have a major influence on mortgage rates and the housing market, commercial real estate development, and the carrying cost of the US National Debt. Some of the bobble heads on CNBC, Fox Business, and Bloomberg today are saying the “nominal rate” could rise to no more than two percent (2%) without causing the market yield rate to rise above four percent (4%). The “nominal rate” today is somewhere between zero percent (0%) and one quarter of one percent (0.25%)
I have cautioned in previous rants any increase in the “nominal rate” would have dramatic impacts on our financial system. One of the major “cracks” in the macroprudential tools to be examined should be the mark-to-market accounting method mandated by the Federal Securities and Exchange Commission and the Financial Accounting Standard Board for financial institutions and other companies whose assets include long-term marketable securities and negotiable securities.
Remember, when Greenspan took the nominal rate from 4% in the 1990’s to 8.5% that was a 200% increase resulting in close to a 50% devaluation of long-term marketable securities. We had the financial crisis of 2001-2002. When Bernacke took the rate starting in 2006 from 1% to 4.5%, a 450% increase resulting in a major devaluation of long-term securities. We had the major collapse of 2008. The BIG question now remains, “what will happen to our financial system when the nominal rate goes from 0.25% to 2.0%. That is an 800% increase!!!
Maybe the Redneck has missed the boat, but raising the nominal rate has to be done slowly over several years and the “cracks” in the macroprudential tools must be filled. Serious study and consideration must be given to eliminating or changing the mark-to-market accounting method for financial institutions and companies with long-term negotiable securities. This has now prompted me to rant further about current accounting standards and methods used by US companies to report their financial statements. Check back in a few days.
The Redneck Economist, July 3, 2014