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Financial Market Turmoil and Recession: What’s Next? James Bullard President and CEO May 12, 2009 Indiana University Any opinions expressed here are my own and do not necessarily reflect those of the Federal Open Market Committee members. Measuring Uncertainty: Real GDP Growth Percent 7 5 Real GDP Growth Top 10 Blue Chip Forecasts (As of 5/10) Bottom 10 Blue Chip Forecasts (As of 5/10) 3 1 -1 2008 2009 2010 -3 -5 -7 Source: Bureau of Economic Analysis and Blue Chip Economic Indicators. Growth Rate in Real GDP, SAAR, Percent 2008:Q4, 2009:Q1 Canada -3.4, -6.0 U.S. -6.3, -6.1 Russia -1.5, -22.2 U.K. -6.1, -7.3 EU -6.3, -7.9 China 1.3, 6.4 India 0.4, 6.0 Japan -12.1, -19.3 Latin America -8.3, -5.9 South Africa -1.8, -2.7 Australia -2.1, 0.4 Source: Barclays Capital Global Economic Weekly. Tracking the Global Recession: United States Source: Federal Reserve Bank of St. Louis, http://research.stlouisfed.org/recession/. Measures of Financial Market Stress Debt Pricing: Bond Spreads to 10-Yr Treasury (Monthly data. Last Observation: April 2009) BBB AA AAA Source: Federal Reserve. Cost of Credit Protection (Weekly Data. Last Observation: May 5, 2009) Basis Points Basis Points 1000 2500 900 JPM 800 GS 2000 700 600 C 500 BAC 400 WFC 1500 1000 300 200 MS (Right Scale) 500 100 0 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Source: Bloomberg. Stock Market Indexes (Weekly Data. Last Observation: May 8, 2009) Index Jan. 2007 =100 120 Dow Jones U.S. Total Stock Market Index 100 80 60 S&P Financial Stock Market Index 40 20 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Source: Standard and Poor’s and Wall Street Journal. Housing Markets Mortgage Market Mortgage Rates: Fannie Mae Commitment Rates 30-Yr Fixed. MBA Mortgage Applications Index. 3/16/1990 = 100 (11/2/02007 – 5/5/2009) (1/5/2007 – 5/5/2009) Percent 6.5 Index 1400 1200 6.0 1000 5.5 5.0 800 600 400 4.5 4.0 Nov-07 Jan-08 Mar-08May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 200 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Sources: Federal Reserve, Bloomberg. New and Existing Home Sales (Monthly Data. Last Observation: March, 2009) Thousands Thousands 9000 1500 Existing Homes 7000 1250 1000 5000 750 500 3000 New Homes (Right Scale) 250 1000 1999 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Regulatory Reform The Clamor For Regulatory Reform Historically, important crises have resulted in regulatory reform. The Panic of 1907 led to the founding of the Federal Reserve. The Depression led to the enactment of Glass-Steagall in 1933, creating the FDIC, and separating commercial from investment banking. The Thrift Crisis in the late 1980s led to the enactment of FDICIA and “prompt corrective action.” The collapse of Enron and Worldcom led to the enactment of Sarbanes-Oaxley. Portions of the Regulatory System Work Well Bank regulation outside the largest financial institutions has worked well during the crisis. We do not see the small bank panic that characterized the Depression, even though this is a big crisis. The system of deposit insurance, prudential regulation, and a credible resolution regime solves that problem. Less Successful Regulation The key problem areas in this crisis have been with large banks and large non-bank financial firms. These are often global enterprises. As a result, it has been difficult to discern how these firms were coping with the crisis. In addition, the resolution regime is unclear. These firms are often considered “too big to fail” because of the market disruption that might be caused. The correct phrase is “too big to fail ... quickly.” The Fed’s Role in Regulation The Fed is the nation’s lender of last resort. If the Fed may be lending to institutions, it will need to have a role in regulating those institutions. The Fed also runs the monetary policy of the nation. To perform this function effectively, the Fed needs to know the condition of the financial system. The Fed and Systemic Risk Three important systemic calls by the Fed: William Poole on GSEs.* Gary Stern on “Too Big to Fail.”** Ned Gramlich on subprime.*** * William Poole, “Financial Stability,” 2002; “Housing in the Macroeconomy,” 2003; and “Reputation and the Non-Prime Mortgage Market,” 2007. ** Gary H. Stern, Ron J. Feldman, Too Big To Fail: The Hazards of Bank Bailouts, Brookings Institution Press, 2004. *** Edward M. Gramlich, Subprime Mortgages: America’s Latest Boom and Bust, Urban Institute Press, 2007. Inflation Risks May-09 Apr-09 Feb-09 Mar-09 Jan-09 4 Dec-08 Nov-08 Oct-08 Sep-08 Aug-08 2 Jul-08 3 Jun-08 May-08 Apr-08 Mar-08 1 Feb-08 Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Aug-07 Jul-07 World Policy Rates (Daily data as of May 8, 2009) Rate (%) 6 5 U.K. Euro Area Canada U.S. Japan 0 Implied 5-Year Spot Inflation Rates (Weekly data. Last Observation: May 8, 2009) 3 2 1 0 -1 -2 -3 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Source: Federal Reserve. $2000 $1500 Lehman Fails $2500 Year End 2007 Billions Bear bought by JP Federal Reserve Credit: Component Size and Cumulative Total (Weekly, 10/3/2007 to 5/6/2009) TALF: $6, $2062 Agency Debt and Agency MBS: $437,$2056 Institutional Support: $108, $1618 Short-term Liquidity Facilities: $602, $1511 $1000 FX Swaps: $249, $909 $500 Treasuries and Traditional Lending$660,$660 $0 Source: Federal Reserve. Federal Reserve Credit (Weekly Data. Last Observation: May 6, 2009, and Projected Values.) Billions of Dollars 3,000 2,500 2,000 Short-Term Lending to Financial Firms and Markets Rescue Operations Operations Focused on LongerTerm Credit Conditions Treasury Portfolio 1,500 1,000 500 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Sources: Federal Reserve. Federal Reserve Bank of St. Louis stlouisfed.org Federal Reserve Economic Data (FRED) research.stlouisfed.org/fred2/ James Bullard research.stlouisfed.org/econ/bullard/
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