
A decade after the crisis, The Fed plans to shrink its bond holdings - jpelecanos
https://www.wsj.com/articles/the-fed-a-decade-after-the-crisis-is-about-to-embark-on-the-great-unwinding-1505746843
======
joe_the_user
Color me completely skeptical - not that it won't happen (though it might not)
but that it will mean what the WSJ seems to say.

One of the things about the "winding" which started all this was that it
involved bailing out institutions considered too-back-to-fail.

And that bailing out altogether meant that such institutions had the "full
faith and credit of the US government", just like what's printed on dollar
bills and these institutions could effectively print money more or less like
the Fed.

So the Fed itself has said it will start selling it's particular portfolio,
with the proviso that it will stop if anything seems to be going wrong. Which
is to say that this is "privatizing the bubble" since the too-big-to-fail
institutions can effectively "print" any money that leaves via the Fed's
action. Obviously, there are micro ways that this will play out, this will
change the color and emphasis of the "Greenspan Put" or it's many latter-day
equivalents but those are small adjustments, not fundamental shifts - ie,
we're still in bubble-nomics, well, unless the Fed really fumbles this.

~~~
linkregister
I've seen this used as a pro-bailout talking point: "the government made a
large profit off of the institutions it bailed out." I haven't had the time to
evaluate it. Is it credible? If so, would it change your view? Or are the
valuations non-GAAP or otherwise not transferrable at the same value?

~~~
wahern
The Federal Reserve != the U.S. Treasury

The U.S. Treasury turned a profit on TARP. TARP debits and credits work just
like any other government expenditure.

A lot of pundits lump TARP with the Federal Reserve's quantitative easing (QE)
program. QE was a program where the Federal Reserve itself purchased assets
(mortgage securities, bonds, etc). The assets to purchase these were much more
akin to printing money, I suppose. And this program was much larger than TARP
in dollar value. This asset purchase program has turned a profit for the
government because dividends, resales, etc, have exceeded the outlays. The
Federal Reserve must, by statute, transfer such profits to the Treasury.

I say "I suppose" because _anybody_ can print money. For example, I can give
you an IOU in exchange for gold bars. You can then put that IOU on your books
as an asset, which in turn allows you to borrow against it, perhaps getting
even more gold bars of your own if you can convince others the IOU was worth
more than you paid. We got into this mess because the investment banks were,
conceptually, printing money by assembling mortgages into securities and then
reselling or borrowing against the securities for a price (in retrospect) far
greater than the long-term return of the underlying assets. Derivatives
markets then multiplied the differential many fold. In all these cases nobody
actually prints currency notes; nonetheless, the total dollar value of assets
on the books has increased.

I don't think it's very useful to equivocate all these financial machinations.
Papering over them is precisely how we got into this mess.[1] And while I
guess it's fair to say that the Federal Reserve can print money, the
implications of that are neither clear nor inevitable. The Federal Reserve has
a legal mandate to keep inflation rates low. Often people are trying to allude
to the specter of hyperinflation. But it's worth remembering that the
hyperinflation in Weimar Germany was very much _intentional_. The Germans
pursued hyperinflation to spite the WWI allies, as it allowed them for a time
to minimize the effect of war reparations on their domestic economy (if they
printed money fast enough, they could purchase foreign currency before the
official exchange rates reacted[2]). Eventually it became something that they
were, politically, unable to roll back. Hyperinflation in Zimbabwe was a self-
fulfilling prophecy, and a symptom of a failed state, similar to the tail end
of the Weimar Republic.

Note that in both cases these events were fundamentally driven by politics. If
the Federal Reserve ever got itself into a situation where it couldn't stop
pumping assets into the system, it's almost certain that it would have been
preceded by Congress first changing the laws. Currently the Federal Reserve is
substantially (though not completely) independent from political forces. In
any event, if the Federal Reserve ended up in that sort of situation it would
undoubtedly be symptomatic of much larger problems in the country.

[1] Thinking they're unnecessary and could be done away with is naive. The
book-value of assets will always involve guess work because it requires people
to quantify the likelihood of future events based on imperfect information
about the present. And there will always be mechanisms that compound errors in
this guess work. The way you control systemic risk is through diversity and
uncoupling.

[2] Ironically, the gold standard made this arbitrage both feasible--it took
longer for individual exchange rates to react--and was a central cause--the
gold standard caused severe deflation across Europe. Deflation sucks for
debtors, and war reparations made Weimar Germany the biggest debtor of them
all.

Why severe deflation across Europe? It coincided with the apex of the
industrial revolution in the U.S. The U.S. was pumping out radios and
refrigerators like crazy, and Europeans were buying them up like hot cakes.
Because everybody was on the gold standard, and because every central banker
refused to readjust their exchange rate with gold, increasing amounts of gold
in all the central banks in Europe were credited to the U.S. account balance.
That meant less gold per unit of national currency, which meant deflation. The
way inflation in the U.S. occurred is that Europeans began purchasing U.S.
securities, because each unit of domestic currency purchased increasing amount
of American dollars. Likewise, repatriated profits were dumped into the stock
market. This is how the gold standard directly precipitated the stock market
crash of 1929.

Something similar is happening between China and the U.S., except that the
U.S. dollar is a floating currency and China is attempting to avoid domestic
inflation by preventing the repatriation of assets (that is, China effectively
forces producers to invest their profits in U.S. securities). The end result
is that deflation is blunted in the U.S., but it's a huge reason why despite
QE we haven't seen much inflation.

~~~
uiri
One thing I don't understand about how debt is supposed to "print" money is
that each asset dollar is cancelled out by a liability dollar (the debt in
question). So if you borrow $(X+k) against an asset worth $X, then you're
underwater by $k.

Nonetheless, thank you for the interesting and informative post.

~~~
wahern
If I borrow $5 then I'm immediately in the red. But presumably I'm borrowing
that $5 so I can turn a profit of $6 tomorrow. I then pay my $5 off and borrow
$6 more. Now I'm $1 richer but still in the red. Rinse & repeat. When the day
comes that you can't repeat and you need to unwind, if the resale value of
your assets is less than your liabilities, then you go bankrupt. This is
literally how the 2008 crisis unfolded, except in a domino fashion. Not
because the entire system as a whole couldn't have absorbed the losses (again,
both TARP and the Federal Reserve ultimately made a profit, even early on),
but because 1) the web of the financing directly or indirectly exposed to
mortgage-backed securities reached so far, and 2) unwinding is never
instantaneous (it cascades), short-term lending seized up. For various
technical reason most large businesses (especially but not exclusively
investment banks) rely on short-term lending for liquidity. When the system
seized everybody had to begin to unwind at precisely the moment when the
immediate resale value of their assets (especially mortgages, and light of the
disruption of lending normally used to purchase such assets) was exceptionally
low--lower then the (in retrospect) long-term return.

On some level it's all as simple as we intuitively think it is. I think the
difficulty is coming to the realization that it's turtles all the way down--
there's no magical, true price where book-value perfectly reflects all "real"
assets. This dynamic complexity is most apparent when you dig into currency
exchange rates, where you very often get very counter-intuitive results when
you [literally and figuratively] follow the money. I'm by no means an expert,
either in finance, accounting, or math. But I did study international
economics in undergraduate, which has helped me to internalize the notion that
there's no "true" price to anything except for what others are willing to
exchange at any one moment, given all their imperfect information and
incentives. And in graduate school I took an economics course with a professor
who wrote one of the first studies (commissioned by Toyota) that empirically
showed how exchange rates fluctuated in response to current account surpluses
and deficits, in turn effecting demand & supply--a phenomenon everybody now
takes for granted but which was not widely appreciated at the time even though
it's obvious in retrospect. He really only mentioned it in passing one day,
but the concept really stuck in my head and has helped me to conceptualize
(albeit very imperfectly and at a high level) that valuation is an ongoing
process; quantifying it at a fixed point in time is less meaningful than we
intuitively believe.

But don't take my word for any of this. One of the most enlightening books
I've ever read is "Lords of Finance: The Bankers Who Broke the World", which
won the 2010 Pulitzer Prize. I read it in 2010, shortly before I read The Big
Short, because of the accolades and because I wanted some context to the
economic crisis. It's partly a scholarly work which makes it little dry, but
its still very accessible. Basically, everything I said above about the role
of the gold standard in the interwar period (WWI to WWII) comes directly from
that book. Reading the Big Short explains how the mortgage-backed securities
market works. It helps to have some grounding in economics to really maximize
your dividends from reading those books.

~~~
danmaz74
Thanks from me too, very interesting. I'm also no professional expert, but it
looks to me like this can be non-intuitive because borrowing "creates money"
only when said borrowing is linked to an asset bubble.

Case in point: if my house appreciates on the market by $100K, I am $100K
"richer"; this by itself doesn't increase the circulating money. But if I'm
able to borrow $100K by mortgaging the increased value of my house, now I have
$100K more to spend. The lender has $100K less in their bank account, but they
now have a mortgage-backed security which is worth $100K and that, if there is
a liquid market for such securities, can be almost as good as actual dollars
for trading. The circulating money has increased.

It gets even worse. If the lender and/or the borrower use even just a part of
those $100K to speculate in the housing market, the bubble will accelerate...
until, at some point, enough people actually want to use their new riches to
buy products that aren't part of the asset bubble, and producers of those
products don't accept those inflated securities as payment. Then, the bubble
bursts.

And, by the way, this whole mechanism has nothing to do with bad central banks
or fiat money. It's perfectly consistent with a perfect free market AFAIK, and
the only (not easy at all) way to prevent it is regulation.

~~~
AnimalMuppet
Well, the central bank is supposed to watch out for this kind of stuff, and
adjust to prevent it. The problem is that several other actors also have
levers they can adjust, and they act after the central bank does. This means
that the central bank has a very imprecise kind of control.

------
module0000
Not the usual story you see on HN... but it's still interesting - if the
trading of US debt is the kind of thing that gets you going.

That said, it _does_ get me going. What this story is telling you is:

1) Futures on US treasury bonds are going to fall, as the DOT unloads _42
million_ of them. This is a lot, and it will affect the value of your
investments/401k in a non-trivial way.

2) Equities(and futures based on them, e.g. ES/NQ/DJIA) are going to rise,
simply due to their inverse relationship with treasury bonds.

3) Commodities(such as oil, gasoline, natural gas) will increase in price.

4) Foreign interests will have a "fire sale" of US debt available to them for
purchase. Whether or not they will buy it is anyone's guess. I'd say "if you
know, you should tell us!", but we all know that won't happen.

What does this mean for the average investor? Short on bonds, long on
equities. Your 401k or other managed investment portfolio is likely taking
this approach on your behalf anyway(if they aren't, fire them and find one
that does).

Edit: If you want to know what these particular financial instruments are and
how they work(bonds and how they are traded), see here:
[https://www.cmegroup.com/education/files/understanding-
treas...](https://www.cmegroup.com/education/files/understanding-treasury-
futures.pdf)

~~~
drunkpotato
Is it possible that bonds and equities both lose value?

~~~
hkmurakami
Yes, esp since over the last decade we saw a bull market in both bonds and
equities, where the equity market was arguably driven by loose monetary
policy.

If the equity markets were buoyed significantly by policy, then unwinding this
would have the inverse effect.

------
sitharus
Same article without the paywall: [http://www.msn.com/en-us/money/markets/the-
fed-a-decade-afte...](http://www.msn.com/en-us/money/markets/the-fed-a-decade-
after-the-crisis-is-about-to-embark-on-the-great-unwinding/ar-AAs8lnh)

------
paulpauper
Since 2008, given all the failed past predictions about the fed being unable
to wind-down its balance sheet, failed predictions of TARP being a failure,
failed predictions that rising interest rates would hurt the US economy, and
failed predictions about how the fed ending QE would hurt the economy, I have
every reason to believe, even without knowing all the details of this story or
having any claim to clairvoyance, that this too is nothing to worry about and
will pass like all the other doom and gloom premonitions. Against all odds,
policy makers keep pulling through, defying predictions of doom. It doesn't
always make sense, but sometimes you have to suspend skepticism and put your
faith in IQ and policy. The EMH also stipulates that this is wind-down is
already priced into the bond and stock markets, so betting against the bond
market in anticipation of these bonds flooding the market, is far from a sure-
fire strategy.

------
aaronhoffman
Good podcast on this topic: [https://itunes.apple.com/us/podcast/the-lara-
murphy-show/id1...](https://itunes.apple.com/us/podcast/the-lara-murphy-
show/id1084202846?mt=2&i=1000391675152)

~~~
pmorici
Non-iTunes version

[https://lara-murphy.com/podcast/episode-42-feds-plan-
unload-...](https://lara-murphy.com/podcast/episode-42-feds-plan-unload-feds-
bonds/)

------
ChuckMcM
A blendle link for those with Blendle : [https://blendle.com/i/the-wall-
street-journal/the-fed-braces...](https://blendle.com/i/the-wall-street-
journal/the-fed-bracesfor-the-great-unwinding/bnl-
wallstreetjournal840-20170919-1_4?sharer=eyJ2ZXJzaW9uIjoiMSIsInVpZCI6ImNodWNrbWNtYW5pcyIsIml0ZW1faWQiOiJibmwtd2FsbHN0cmVldGpvdXJuYWw4NDAtMjAxNzA5MTktMV80In0%3D)

Pretty much no matter what it is going to be something economists are going to
debate for the next 100 years :-)

------
CaliforniaKarl
It seems to me that it's unusual to see something be cleaned up, without that
something also being totally destroyed. I hope this goes well!

~~~
jarjar12
Eh. You have wrong it.

Market keeps going up because we continue to have global growth. Over 66% of
countries are showing positive GDP and growth. US growth is also fairly high.
Historically GDP averages around 1.8%. The talk of 3% is just politics.

In addition, technology has created a lot of efficiency providing healthy
profits for businesses.

In addition, there is a high feedback loop of spending by all major
businesses. Example: apple produces phones that require a lot of software and
hardware to work which means a lot of other companies involved which also
creates competition among multiple phone companies to also produce something
similar and so on.

Yes we are at a fair valuations and I sincerely hope for a 10-20% correction.
But we are in a 20 year bull run with minor bears in between.

About money printing. Yes I agree some day one of the central banks will be
trouble but other will bail it out.

Also cheap money is good. It helps mid to lower income families come up. Micro
loans are good example of it. Why can't lower income generating families have
access to cheaper money ? Why do they have to pay 8-10% interest?

Imagine if you were from a low to mid income family, wanting to go to school
won't you want cheaper loans. And if people abuse that privilege then they
will pay for it. If you are just getting out of school and need some house
loan etc. won't be bette to have easy access to money? Or do you want 8-10%
interest ?

Yes I agree a lot of money has been printed but it has created healthy money
vilocity that has gone appropriately to create value for everyone.

World was much worse 15 years ago just go back and look.

~~~
ThrustVectoring
>If you are just getting out of school and need some house loan etc. won't be
bette to have easy access to money? Or do you want 8-10% interest?

Not if everyone has access to easy money, no.

House prices are roughly set by prevailing rents. Take the cost of renting and
the cost of ownership and set them to roughly equal. Now, drop interest rates
on mortgages a couple percent, what happens to house prices? Monthly payments
of mortgages go down, renters and potential landlords see it and try to win
bids for houses, driving housing prices back up again.

Much the same thing is, IMO, going on with college prices: since they're
largely financed, easier credit leads to higher bids. I'd much rather have
college affordable period on a part-time entry-level salary than have interest
rate times tuition be affordable on a white-collar salary.

Basically, lower interest rates doesn't particularly help future borrowers.
Falling interest rates helps folks who hold assets and can sell them or
refinance the debt servicing them.

------
tmaly
I do not believe they will do this. The US has 20 trillion in debt right now.
If you notch the interest rate up just a little bit, you will create chaos in
the financial markets.

