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President’s Speech

Presentation to the Burnham-Moores Center for Real Estate
School of Business Administration, University of San Diego
San Diego, CA
By Janet L. Yellen, President and CEO, Federal Reserve Bank of
San Francisco
For Delivery on February 22, 2010, 8 AM Pacific time, 11:00 AM Eastern
Download PDF Version (79KB)

The Outlook for the Economy and Monetary Policy1

Thank you, William. It’s very nice to see a familiar face and to receive such a gracious introduction. And it’s a pleasure to be here with you in beautiful San Diego. This morning, I will try to cover a lot of ground. I’ll survey the economic landscape, and give you my reading of the outlook for the national economy. I’ll also discuss the situation in San Diego and finish with some comments about monetary policy. In particular, I want to go over a matter that’s on the minds of many people right now: the Federal Reserve’s strategy for winding down the extraordinary measures taken during the financial and economic crisis of the past few years. My comments reflect my own views, and not necessarily those of my Federal Reserve colleagues.

Given the dismal economic news we faced for so long, it’s a great relief for me to report that the tide appears to have turned. We are seeing convincing evidence that an economic recovery is well under way. Still, as I’ll explain in greater detail in a few minutes, the fact that the economy is growing again doesn’t mean we’re where we ought to be. Far from it. In particular, the unemployment rate is unacceptably high, creating real hardship for millions of Americans. But, at least we’re heading in the right direction.

Let me start with the good news. Real gross domestic product, or GDP, the broadest measure of a country’s total output, has turned around impressively. It rose at a robust 5.7 percent annual rate in the fourth quarter of 2009. That’s a very welcome change from the huge declines we saw during the recession. In fact, it’s the best gain in GDP we’ve seen in six years. If we were able to sustain growth like this, we would experience a vibrant V-shaped upswing like those that occurred following past severe recessions.

Unfortunately, I’m not at all convinced that a V-shaped recovery is in the cards. That fourth-quarter leap in GDP overstates the underlying momentum of the economy. Much of it was due to a slowdown in the pace at which businesses were drawing down inventory stocks compared with earlier in the year. Less than half of the fourth-quarter growth reflected higher sales to customers. Those sales did grow, but at a lackluster 2.2 percent. It appears that businesses are getting their inventories closer in line with sales, which is a good thing. But such inventory adjustments can be a potent source of growth only for a few quarters. I’d feel much more confident about the prospect for a sustained robust recovery if I saw evidence of more vigorous growth in actual sales.

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Some items I found worth perusing –

• China New Village Makes Chanos See Dubai 1,000 Times (Bloomberg)
• Debt Deals Haunt Europe (WSJ)
• The Deflationist: How Paul Krugman found politics (The New Yorker)
• Former SEC Chair Arthur Levitt on Risk and Discipline in the Financial Markets (WSJ OpEd)
• AIG Death Spiral Ends as Bailout Support Brings Stable Revenue (Bloomberg)
• Credit card relief is here, but watch out for new traps (CNN/Money)
• RollingStone.com Accidentally Lets Its Domain Expire (DJMT)
• Fear the blobfish (LATimes)
• Roger Ebert: The Essential Man (Esquire)

What are you reading?

Curious Displays from Julia Tsao on Vimeo.

hat tip boingboing

There are all manner of garbage ads showing up on the site — reverse mortgages and other dreck.

I need to tweak the ad server settings — I am in the midst of moving to Google Ad Manager, and there is a bit of learning curve. Please bear with me.

Ignore the junk, and they should be gone soon enough.

My pal, and Lola Jane Farrell’s honorary uncle, Doug Kass, once quipped that if you could remember the 1960′s it was because you didn’t have enough fun. I remember the music well enough. I still listen to it. Maybe the best music ever. If you remember the 1970′s in New York City you wish you could go back to the ’60′s. The City was dirty, seemingly lawless with the “squeegee guys” attacking your car if you stopped at a light, and had a general feeling on being unsafe.

The City’s finances were absolutely unsafe. Profligate spending had brought New York to the brink of bankruptcy. Officials didn’t act like it, figuring they could always kick the can down the road. They conjured up wonderful financing gimmicks like RAN’s — Revenue Anticipation Notes — to get the cash needed today by hocking alleged revenues that would appear later (and sometimes didn’t). TAN’s were Tax Anticipation Notes and raised money from investors to be paid when taxes got collected later. Forget that those taxes were going to be needed later to pay the City’s bills. Abe Beame was the Mayor when the bill came due. He was a true New Yorker. His parents fled Poland and he was actually born in London. He went to City College and became an accountant. He taught public school and served in City government for decades as budget director and Comptroller. When he ran for mayor his slogan was “He knows the buck.” But neglectful leadership for many years came to a head and the City was on the brink.

An acknowledged budget deficit of $600 million proved to be $2.2 billion. The City had accumulated $14 billion in debt (a mountain in 1975), and $6 billion of it was short-term and needed to be rolled over regularly. In February of 1975, a scheduled offering of the above-mentioned TAN’s was cancelled when the underwriter bailed. Beame attacked back with 8,000 layoffs that proved to be less than 500. Employee reductions included retirees who had left months before. A “hiring freeze” resulted in 13,000 more jobs. Pleading with the Feds brought the famous headline, “President Ford to City: Drop Dead.”

New York State responded with the creation of the Municipal Assistance Corp, and Big Mac came into being. Big Mac converted some city taxes to state revenues and were used as the guarantee for Big Mac bonds. Felix Rohatyn, another immigrant whose family fled the Nazis, headed up Big Mac. He was the chief rainmaker at Lazard and one of the foremost bankers of the day. He had gone to Middlebury — which I mention because my son Chris did as well. After working to rescue NYC he became Ambassador to France and now still hangs his hat at Lazard.

It was necessary to pay 11% interest on the early Mac issues when high-grade municipal paper was yielding around 7%. But since such luminaries as President Giscard of France and Chancellor Helmut Schmidt of Germany were expressing international concern about a NYC failure, it was considered necessary to do whatever it took. Punitive payroll cuts followed and, cleverly, the City’s pension funds were required to buy Big Mac bonds and eventually 40% of the pension was so invested. Talk about getting your attention!

Having spent the past two weeks in Europe (half business and half vacation) it occurs to me an NY-style approach to the Greek issue should be employed. President Ford told NYC to drop dead but at the end of the day, after severe cost cutting and what-not, both the Feds and the State government got involved in righting the ship. The Greek government used a modern day TAN/RAN end-run with a Goldman-concocted currency swap that I sure don’t understand (and if you don’t understand it could be because they don’t want you to) to push debt down the road and make it appear their finances were ok. So truing up accounts brought the deficit as a percent of GDP from a low-single-digit number to a healthy teenage number, and I still don’t trust it.

On February 15th, finance ministers from the 16 Euro countries told Greece to cut its budget deficit to 8.7% of GDP this year. Too bad they didn’t listen to 155 German economists who submitted a paper in 1999 that said “some” (read Greece) were using “creative accounting” that would “undermine confidence in the euro.” Chancellor Merkel of Germany, the richest of the euro countries, has said Germany won’t give a single euro to Athens until Greece cuts its deficit. Over 50% of Greece’s budget is used for salaries and pensions. The average retirement age is 58, and tax evasion is a national sport. Over 30% of the VAT tax goes uncollected and if you believed the tax returns, 95% of those that file make less than 30,000 Euros. The system is rife with corruption and tax collection is a negotiation at best. Chancellor Merkel: tell Greece to drop dead and go hire Felix Rohatyn. Mayor Beame died at age 94 but Felix has an institutional memory of how to fix these things. Civil servants need to take a pay cut, the average retirement age has to go up, and taxes have to be collected. Otherwise Greece will be the first to seek a bailout and Portugal, Spain, and Italy will line up behind them. Let the International Monetary Fund (IMF) be the European version of Big Mac. But don’t go long the euro against the dollar!

Much more to come this week as I get back into a groove. But the health care summit on Thursday could be interesting. President Obama has a chance to regain some momentum by making the Republicans look to be obstructionist. But it’s a slippery slope. The President feels the “message” has not been communicated properly. But it may be the “substance” is being rejected and that people don’t want to change their health care. Live TV could make this illuminating.

I don’t think here has ever been a bull market that hasn’t had a 10% correction in the first 12-14 months. This market started last March so we are not yet to the one-year anniversary. But I still like the bet we have a correction going on.

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Vincent Farrell | 212-380-4909 | vfarrell@soleilgroup.com

Looking a numerous earnings charts, we can come to several conclusions:

First, the charts imply that the worst of the crisis and recession driven earnings collapse is over.  Second, it appears that earnings are normalizing, i.e., returning to their prior range. Third, that stocks can no longer be described as cheap. Lastly, whether stocks are art fair value or are expensive will be determined by how much equity prices gain relative to ongoing improvements in earnings.

click for larger graphs, below

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How Cheap are Stocks ? (1871-2011)

The Chart Store

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Inflation Adjusted S&P Earnings Show Normalization

via Chart of the Day

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Average Trailing P/E Ratio (1871-2011)

The Chart Store

Ahead of Bernanke’s testimony in front of Congress this week, we’ve seen some modest splintering in the opinions of its members in terms of when to unwind their massive accommodation. In one corner is Hoenig who dissented at the last meeting in keeping the ‘exceptionally low’ for an ‘extended period’ language. In the opposite corner is Yellen who in a speech given today said “the economy still needs the support of extraordinarily low rates.” She sees “convincing evidence that an economic recovery is well under way” but highlights many risks to it, which we all know. She believes in the asymmetric policy of slashing rates once the economy turns south but keeping them low well after the recovery begins. Hoenig seems to think that emergency rates aren’t appropriate when the emergency is over. Either way, what the Fed does with their huge holdings of MBS/agency paper will lead the discussion over what comes next.

click for video

by Visual Economics