Capital Markets Update

By Louis S. Barnes Friday, October 14, 2011
New, non-recession data here, more elegant pretending in Europe, now can-kicking at two-week intervals, and fear has left markets. For now.
September retail sales rose 1.1% over August, and the small business NFIB survey also found conditions in September slightly improved. In direct result, 10-year T-notes are trading up from 1.70% just two weeks ago to 2.25% -- last so high two months ago. Mortgage rates have risen accordingly, pressing 4.375%.
Some self-correction is in play, as mortgage refi demand is now shut off altogether, but the Treasury is a continuous seller of paper, the Fed's Operation Twist unable to offset. This last week the Treasury auctioned $66 billion long-term notes and bonds and everyone who bought is today under water. Until and unless markets get more negative news there is zero chance of rate improvement.
Pauses in news flow, and hence in markets are routine. This one…not routine.
Europe, as everyone now knows is the most immediate and powerful market-mover. Our rates would be much higher if there were any market belief that Europe will find a real solution. At its self-imposed deadline in two weeks, perhaps another band-aid, but the Euro-chatter sounds like any other failing deal. The wacky hope that China and other emergings will fund a Euro-bailout, or that banks will self-recapitalize in some miracle of loaves and fishes… all silly. Either Germany throws in, big, or not.
The Fed is paralyzed by internal politics. The dissenters, Fisher in Dallas, Plosser in Philly, and Kocherlakota in Minneapolis, are mistaken and rigid in their demand that the Fed leave the field. They could be overcome by the others, who are aware of peril, but they have lost the foundation for their case.
The Fed's staff is the power center. The staff forecast historically is more accurate than any other, public or private, but the staff is lost. Its forecasts going back two years have been more wrong than right, repeatedly betting on accelerating recovery only to have the economy slide back. At the Fed's September meeting, the staff revised down its near-term forecast for the fifth straight time, and that may be a mistake.
Everybody knows that the Administration and Congress are frozen, and may stay so for another 18 months. Events may warm them to action, but left to themselves they'll do nothing. A great deal of commentary from all political directions says that this state of locked and hostile partisanship is new.
It is not new. It is certainly as old as this country, and as old as democracy. In financial crises, the S&L disaster is the most recent example. Everyone connected to the thing knew by 1980 that a $3 trillion industry (in today's dollars) was toast. Paul Volcker, modern folk hero, pushed the S&Ls of the back of the sled without a shred of planning; Jimmy Carter in his last year did nothing; Ron Reagan at first ignored the matter, then his "grow-out" policies that quadrupled the damage, and the '86 tax reform accidentally doubled the losses again. Bush '41 finally raised the money to pay off the depositors, and the RTC by 1993 disposed the assets -- 14 years total!!
And the S&Ls were a small problem compared to this one.
A prior problem as big as this: the run-up in inflation from 1965 to 1981, punctuated by two oil crises, oil from $3/bbl to $38/bbl at the peak, and by two nasty recessions, unemployment as high or higher than this.
From 1929 to 1933, essentially every step taken by government either did nothing, or made the Depression worse.
Today, we are six years into blown housing bubble, twenty years into international-competitiveness absent-mindedness, and at the end of 45 years of borrowing to cover promises to ourselves that we cannot afford.
Today's trouble is real, but we are no different. Our institutions are intact. We are right on plan: we won't do anything until we get a better consensus on what went wrong, what is wrong now, and what to do. Just like always.
Patience. Although for the moment it is a real pain in the ass.