6.5% unemployment in October — worst since early Clintontime.  Worse still were the revisions of the August and September numbers.  And as Karl Denninger noticed, the number of unemployed plus the number of people working part-time who’d like to work full-time now tops 11%.  (And who knows what the real figure would turn out to be once John Williams applies Carter-era standards to the numbers.)

As I write, the president-elect is meeting with his “Transition Economic Advisory Board,” his temporary brain trust as it…

The Dow logged its second best one-day point gain, 889 points, in its even more storied history yesterday:

Percentage wise, at 10.8%, the rally ranks sixth. The S&P and Nasdaq trundled alongside the old lady like puppies.

After finding a new “credit crisis” low on Monday, traders on Wall Street snapped back…

The essence of the Fed's balance sheet used to be quite simple. The Fed's primary operations would consist of either buying outstanding Treasury securities or issuing loans to banks through its discount window. It paid for these transactions by creating credits in accounts that banks hold with the Federal Reserve, known as reserve deposits. Banks can turn those reserves into green cash any time they desire, so the process is sometimes loosely summarized as saying that the Fed pays for the Treasury bills it buys or loans it extends by "printing money". Before the excitement began, the Fed's assets consisted primarily of the Treasury securities it had acquired over time (about $800 billion as of August 2007) plus its discount loans (an insignificant number at that time). Its liabilities consisted primarily of cash held by the public (about $800 billion a year ago) plus the reserve deposits held by banks (which again used to be a very small number).

Bernanke's overriding goal since then has been to extend a huge volume of short-term loans to financial institutions. If he'd done that in the usual way, just creating new reserve deposits with each new loan, the supply of cash would have ballooned, bringing worries of inflation. The Fed didn't want to do that, and in fact there was no shortage of funds available for overnight interbank lending. The fed funds rate, an average overnight lending rate between banks, is already quite low, and further reductions seem unlikely to accomplish much. But longer term interbank lending rates remain quite high relative to the overnight rate.

Bernanke's first approach to this challenge was to "sterilize" the new loans from the Fed, basically selling off the Fed's Treasury holdings at the same time that it extended the new loans. When a counterparty buys the Treasury security from the Fed, the Fed debits the bank's account with the Fed, and these debits net out the credits that would be created as a consequence of the Fed's new loans. Reserves go up with the loans, down with the sale of Treasuries, so the net result is an increase in loans from the Fed but no change in reserve deposits. These new Federal Reserve assets came in many colors and flavors, including the Term Auction Facility, the Primary Dealer Credit Facility, currency swaps (which I presume is the biggest single item in the burgeoning "other F.R. assets" category), and the seriously non-acronymizable Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility.

But $800 billion-- the total stock of Treasuries that Bernanke originally had available for this purpose when he started down this path over a year ago-- only goes so far these days, particularly when you remember that a quarter trillion of those securities are now being used in the Term Securities Lending Facility, which the Fed records as an off-balance-sheet transaction. To enable it to extend more than $800 billion in loans without "printing more money," the Fed asked the Treasury to implement a Supplementary Financing Program in which the Treasury would sell securities directly to the public but simply keep the funds in an account with the Fed. The payments by the public for these securities then initiate a flow of reserves out of private banks, the same as if the Fed itself had sold Treasuries to the public out of its own holdings, so the SFP enables the Fed to sterilize a greater volume of loans than it could if it had to rely solely on its original holdings of Treasury securities. The Treasury supplementary account as of last week has provided the Fed with an additional $559 billion to play with. It appears from the latest balance sheet that the Fed has now asked the Treasury to do the same sort of thing with the Treasury's "general account" with the Fed. Historically, that account was just used to facilitate daily Treasury transactions, and was usually held to about $5 billion. Last week, it's up to $56 billion.

It's clear that the Fed is now also using yet another tool to balloon its balance sheet, namely, deliberately encouraging banks to sit on their excess reserve deposits. When these started to shoot up at the end of September, I initially attributed this to frictions in the interbank lending market. But with the announcement on October 6 that the Fed would begin to pay interest on those deposits, and the further announcement on October 22 that the Fed is now raising that interest rate to within 35 basis points of the target for the fed funds rate itself, it is clear that the Fed has now settled on a deliberate policy of encouraging banks to just sit on the reserves it creates, giving it another device with which to expand its balance sheet without increasing the quantity of cash held by the public. That's provided another quarter trillion for the alphabet soup of new facilities.

I had a call from a reporter this week asking me to explain why the Fed raised the interest rate paid on reserves. I think she was expecting a 30-second sound bite, but instead we went back and forth for about 15 minutes and I'm not sure even then that I succeeded in getting the basic idea across. At that point she asked me, "Do you see it as an encouraging development that the Fed has taken this step to address the credit crunch?" My immediate answer was no. It's not an encouraging development because it means that the heroic efforts that the Fed has taken previously weren't enough. The Fed's first $100 billion didn't do it. The Fed's first $1 trillion didn't do it. Having the Treasury take over the $5 trillion in debts and guarantees of Fannie and Freddie didn't do it. The Treasury's $3/4 trillion rescue/bailout package didn't do it. And another quarter trillion will?

If the spread between overnight and 3-month interbank lending rates indeed results from pure illiquidity of the latter market, it seems to me it shouldn't have required too much grease to get that market lubricated. But if, as argued by John Taylor and John Williams, the spread instead represents compensation for counterparty risk, it doesn't matter how much term lending the Fed does. Its actions would only move that spread to the extent they reduce the counterparty risk itself. The primary consequence of the actions would not be to change the spreads but instead would just shift the risk onto the Federal Reserve's balance sheet.

There was another juicy morsel in the latest H.4.1. The latest report acknowledges that the Fed has taken some losses on some of these unconventional assets. The Fed last week wrote off $2.7 billion in losses on the loans to "Maiden Lane LLC," an entity created through the Bear Stearns package. The assets of Maiden Lane consisted of claims on certain troubled securities, and the liabilities consisted of a loan from the Federal Reserve. The Fed now admits that Maiden Lane won't be repaying all of the loan, so it had to reduce its claimed assets by $2.7 billion. This also required a corresponding imputed $2.7 B reduction in the "other" category on the liabilities side of the Fed's balance sheet, presumably in large part coming from debits to the "surplus" and "other capital accounts" entries in the Statement of Condition of the Federal Reserve Bank of New York, though I haven't traced through the details of exactly how that was implemented.

Regardless of the accounting, here's how those losses will show up in practice. When the Treasury auctioned the T-bills for the increase in its supplementary and general accounts with the Fed, and when the Fed sold off its existing holdings of Treasuries, the Treasury started making interest payments to the public. The Fed is also receiving interest on the loans it made, and returns that interest to the Treasury. As long as the loans are performing, it is a wash to the Treasury. But if some of the Fed's loans go bad, it means the Treasury is on the hook for the extra interest costs with no offsetting receipts. In other words, any losses by the Federal Reserve are equivalent to a fiscal expenditure financed by Treasury borrowing.

The notes to the H.4.1. seem to imply that the Fed's intention is to update its assessment of the "fair value" of its Maiden Lane holdings as of the end of each quarter, which would mean no new markdowns until January.

But that doesn't mean that the remaining $1,839 B in Fed assets will all continue to bring in their hoped-for receipts for the Treasury between now and then.

Technorati Tags: macroeconomics, economics, Federal Reserve, interest rates, term auction facility, TSLF, TAF, term securities lending facility, credit crunch

You can follow the link to Shadowstats' response to Greenlees and McClelland and judge for yourself, but my impression is that the response is more philosophical than quantitative. In a separate phone conversation, Williams further clarified the Shadowstats methodology. Here's what John said to me:

I'm not going back and recalculating the CPI. All I'm doing is going back to the government's estimates of what the effect would be and using that as an ad factor to the reported statistics.

I had formed the mistaken impression that Williams was indeed trying to go back and recalculate measures such as the CPI based on a retrospective application of the historical BLS methodology. I found the specific quantitative results provided by Greenlees and McClelland to be convincing demonstrations that this could not be the case. I take further comfort in the understanding that Williams agrees that his numbers indeed do not represent the outcome of such a procedure.

Technorati Tags: CPI, inflation, Shadowstats, macroeconomics, economics

Have you ever wondered why the CPI, GDP and employment numbers run counter to your personal and business experiences? The problem lies in biased and often-manipulated government reporting.

Here's John Williams' exhibit 1 in the case against the government:

The other extreme view holds that incompetence is the problem. (This blogger does not use the word, but the adjective seems implicit in the discussion).

Personally, I think that many of these shortcomings in the data series reported by the government are a function of how well funded the agencies are, the priority accorded good data collection by the highest levels of the government (clearly, if no premium is placed upon the usefulness of information, then there will be little inclination to push for innovation in data collection), and the requisites of timeliness.

(Parenthetically, I won't deny that sometimes, the level of management seems FEMA-esque, as in the recent attempt to digitize the next Census. But I am hopeful the next administration will put in better management.)

On the first point, I've already noted how funding has been declining for the various statistical agencies. [1].

How does this debate reflect upon the current debate over the economy's state? At the time of the last recession, note that GDP was recording positive growth. It was only after some revisions did it become apparent that GDP growth had slipped into the negative region. And even later, subsequent estimates indicated that the growth rate had not gone negative for two consecutive quarters. I reprise the below graph to illustrate this point.

To highlight the challenges faced in terms of generating timely estimates of GDP, consider the nature of the data used to calculate GDP. Figure 1, drawn from Chart 1 of Arnold Katz's "An Overview of BEA's Source Data and Estimating Methods for Quarterly GDP" (BEA, November 2006) [pdf] shows the type of data used to generate the advance and preliminary GDP releases. Note the large amounts of “trend-based” data used particularly in the advance release. Fully 55% is “trend based” and “trend based and monthly data” in the advance, dropping to 24.2% in the preliminary.

The final vintage exhibits substantially little change -- in terms of the types of data -- relative to the preliminary vintage. What one does see is that in the annual revision, usually released in July of each year, a lot of additional information is incorporated. So the time profile of GDP could change yet again as more information is released.

As noted in this document:

The source data that BEA uses are collected from a variety of sources and, with few exceptions, for purposes other than the preparation of BEA's estimates. Data collected by Federal Government agencies provide the backbone of the estimates; these data are supplemented by data from trade associations, businesses, international organizations, and other sources. The Government data are from a number of agencies, mainly the Commerce Department's Bureau of the Census, the Labor Department's Bureau of Labor Statistics, the Internal Revenue Service and other agencies of the Treasury Department, the Office of Management and Budget, and the Agriculture Department. Some of the Government-collected data, referred to as "administrative" data, are byproducts of government functions such as education programs, tax collection, defense, and regulation. Nonadministrative data, sometimes referred to as "general purpose" or "statistical" data, include the periodic economic and population censuses and a wide range of sample surveys, such as those that collect data on manufacturing, farm activity, and prices. Of the relatively few data items that BEA collects, most refer to international transactions. These include international trade in services and direct investment (both by foreign residents in the United States and by U.S. residents in foreign countries).

The source data available to BEA are not always ideal from the point of view of preparing the national economic accounts. BEA must develop estimating methods to transform the data. The estimating methods adjust the best available data to the concepts needed for the accounts, fill gaps in coverage of the source data, and make adjustments to the source data to obtain the needed time of recording and valuation.

I think this places into context some of the trade-offs that have to be made when trying to generate estimates of GDP (and its components) fairly quickly after the end of the relevant time period. Inspection of, for instance, the consumption block, highlights how much of the data are trend-like in the first couple of announcements:

In any case, I think these are points that need to be kept in mind as one takes the most recent GDP numbers, and makes flat out statements that we are -- or are not -- in a recession. (Egregious example here.)

Now what about the conspiracy view, that says the government is systematically fudging the numbers to minimize inflation. I think there are two questions to be addressed. The first is whether the older approach is "better" than the newer approach, which incorporates hedonics and allows for changes in basket weights. The second is whether the changes in methodology over time invalidates intertemporal comparisons of inflation rates. I think the case for an affirmative is somewhat stronger in the second than the first, although even in the second case, there are "fixes" to the problem.

As mentioned before, on the SGS website, and you'll see assertions about how the government has manipulated the CPI over time, so that if one calculated inflation using CPIs calculated as they were pre-Boskin Commission, then one would obtain higher inflation rates. I don't doubt this specific assertion, although without having all the spreadsheets, I can't verify it (the issue of whether this is all intentional, well, WMD/Iraq does give one pause for thought, but I still am skeptical). But the fact that there might be different biases at different times in the data series doesn't mean that ignoring quality changes in the past was a good thing. On the other hand, it's hard to adjust to take out the quality changes in the past. But if one were concerned about this specific issue, one could use the experimental research CPI series calculated by BLS.

On the first issue, however, it does seem to me that one does want to adjust for quality changes.

Now what is true is that the RS series does not hold fixed the weights -- so the weights change in this series in 1987 and 1998. But the question that needs to be asked is whether one should hold weights fixed at, say, their 1982-84 levels, when trying to assess the inflation rate in 2007. I think the answer is no, and the reason goes to substitution effects. As relative prices change, consumers substitute away from the relatively expensive items. Holding fixed the weights overstates inflation. Of course, using the new expenditure shares as weights understates inflation. There is no really correct measure (unless one knows some very specific things about the consumer utility function), just as one can't say that Paasche is "better" than Laspeyres.

So, if it's not conspiracy, and it's not incompetence, but it's resource constraints, then what's to be done? First, and easiest, we all have to be more careful consumers of data. In particular, one needs to understand the preliminary nature of the data. Second, more difficult, one needs to fund the collection and analysis of data more fully. Because there is no natural interest group constituency for data collection, I doubt this will occur easily. It certainly will not occur if those at the very top value dogma over data.

Parting shot: Looking at the latest data, note that while GDP growth (q/q, log terms) in 2008Q1 is greater than zero, it is perilously close to 0. And it is less than the corresponding value for 2001Q1 reported in May 2001, which eventually turned out to be negative. That's not conspiracy -- that's an outcome of constraints -- some unavoidable, some a function of funding choices.