I followed a rather circuitous, unorthodox route to the little corner of Wall Street I occupy, so I don’t really know what goes on in all those big, glass-walled buildings that turns eager, bright-eyed young graduates of the finest schools into cynical, herd-following, careerists. But I imagine that early in orientation an avuncular veteran of the wars is trotted out to impart the wisdom of his years. Buy low, sell high. Bond yields up, bond prices down. Don’t fight the Fed.
The wisdom of that last saw is called into question when the events of this decade are scrutinized. Oh sure, the markets manage their reflexive, 3% jumps on the days when the Fed cuts, particularly when it goes 50 or 75 bps 40 minutes before the markets open after a long weekend, as has been its wont in the recent past. But viewed from a slightly longer term perspective, the Fed’s interest-rate setting power—note the distinction between that specific power and the myriad special “facilities” it has established over the last 8 or so months, where the Fed most certainly has had an impact—has become less and less effective over time.
Roughly since the bursting of the tech bubble, the credit markets have frustrated Fed policy at every turn, moving in opposition to the Fed funds. Stephanie Pomboy of MacroMavens refers to this as the broken lever. Below are two charts illustrating the Fed’s impotence, courtesy of MacroMavens.
One could argue that the ineffectiveness of Fed interest policy today is simply a function of the old concept of pushing on a string, that the monetary transmission mechanism breaks down during a debt deflation/liquidity trap. You’ll get no argument from me; that’s definitely a big piece of the puzzle. But I think there’s another factor at work here as well.
In it, Noland goes so far as to speculate that Greenspan’s infamous endorsement of adjustable rate mortgages, spectacularly ill-timed to coincide with interest rate lows, was a desperate attempt to transfer the enormous interest rate risk sitting on the GSEs’ balance sheets to the individual homeowner. Talk about your unintended consequences! And talk about your irony, with the poor homeowner, or no longer homeowner, but still taxpayer, again on the hook, more directly this time, for Fannie and Freddie’s ill-conceived and overleveraged balance sheet risk.