Fed Advisory Council Drops A Bombshell

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
June 4, 2013

IN THIS ISSUE:

1. Federal Advisory Council – Bankers Warn Fed About QE

2. US Economy: Consumer Confidence Jumps, But…

3. The IRS Scandal – What You Need to Know

Overview

Last Friday afternoon, the Fed released the minutes from a May 17 meeting of the Federal Advisory Council (FAC) – that you probably never heard of before today. The Council is a group of 12 influential bankers from across the country who meet periodically and give the Fed Board of Governors input regarding the economy, monetary policy, etc. To my knowledge, no one in the mainstream media has reported on what you will read here today.

For reasons I’ll explain below, these FAC minutes had never been released to the public before last Friday. So not only did the release of the May 17 FAC meeting minutes come as a surprise last Friday afternoon, the content of those minutes clearly indicate that the bankers on the Council are becoming increasingly uncomfortable with the Fed’s unprecedented “quantitative easing” policy. US stocks sold-off sharply on Friday after the release of those minutes.

Following that discussion, I will review the latest economic reports over the last couple of weeks and let you know what we’re looking for in reports during the balance of this week.

Finally, I’ll give you my take on the escalating IRS scandal that is now being investigated in Congress. I will suggest to you that the roots of this scandal go all the way back to the landmark Citizens United vs Federal Election Commission decision made by the Supreme Court in January 2010. For whatever reasons, the media hasn’t seemed to make that connection.

Federal Advisory Council – Bankers Warn Fed About QE

Most people have never heard of the Federal Advisory Council (FAC), which is composed of 12 representatives of the banking industry. The FAC consults with and advises the Fed Board of Governors on all matters within the Board’s jurisdiction. The FAC ordinarily meets with the Board of Governors four times a year as required by the Federal Reserve Act, and the meetings are always held in Washington, D.C.

Meetings are typically held on the first or second Friday of February, May, September, and December. The last FAC meeting was held on Friday, May 17. The minutes from these FAC meetings are normally not made public. However, for the first time the Fed chose to release the minutes from the May 17 FAC meeting shortly after lunch last Friday.

There’s an interesting side-story here. According to several reports, Bloomberg formally requested that the Fed release the minutes of these periodic FAC meetings, and the Fed apparently did not agree. Bloomberg then gained access to the information via the Freedom of Information Act. This forced the Fed’s hand, and last Friday it released the minutes of not only the May 17 meeting, but of all FAC meetings going back to 2011.

To say that the markets were not prepared for the release of these minutes is an understatement. Why? Because the minutes revealed that many of the bankers on the FAC are more than a little concerned about the Fed’s unprecedented “quantitative easing.” What follows is a smattering of concerns raised by members of the Council.

Most of the early discussions in the FAC minutes were benign and focused on the economy and how most sectors are improving modestly. In Item 8: Monetary Policy, it says that QE is likely to continue for another "one to three years." That should have been viewed as good news (if you can call it that), since the markets have been worried of late that QE might be ended or “tapered” by the end of this year.

However, on page 15, the discussion turns to the question of whether the record QE asset purchases by the Fed have really been effective in stimulating the economy and there is certainly disagreement among the bankers on the Council. The minutes read:

“However, the effectiveness of the [Fed QE] policies in producing healthy economic and employment growth is not clear. Uncertainty about fiscal and monetary policy is deterring business investment that would spur growth, and despite policy accommodation, economic growth has remained sluggish and uneven.”

The minutes go on to discuss the "potential risks" associated with QE. In particular, the bankers warned about how reduced mortgage and Treasury yields are:

"…disruptive to management of fixed-income portfolios, retirement funds, consumer savings, and retirement planning. They may encourage unsophisticated investors to take on undue risk to achieve better returns."

I do not believe the Fed has acknowledged this in any of its other reports, minutes, etc. The FAC minutes go on to say:

"…current policy has created systemic financial risks and potential structural problems for banks. Net interest margins are very compressed, making favorable earnings trends difficult and encouraging banks to take on more risk.”

To my knowledge, the Fed has never admitted this in print either. The bankers go on:

“The Fed’s aggressive purchases of 15-year and 30-year MBS [mortgage-backed securities] have depressed yields for the ‘bread and butter’ investment in most bank portfolios; banks seeking additional yield have had to turn to investment options with longer durations, lower liquidity, and/or higher credit risk.”

The bankers also voiced yet another real risk they see as a result of QE:

“Finally, the regressive nature of the artificially compressed savings yields creates pent-up demand within bank deposit portfolios; these deposits may be at risk once yields begin to rise and competitive pressures increase.”

And lastly, the bankers expressed serious concerns should the Fed decide to end QE:

"Uncertainty exists about how markets will reestablish normal valuations when the Fed withdraws from the market. It will likely be difficult to unwind [QE] policy accommodation, and the end of monetary easing may be painful for consumers and businesses. Given the Fed’s balance sheet increase of approximately $2.5 trillion since 2008, the Fed may now be perceived as integral to the housing finance system."

Put differently, the bankers are warning that if the Fed ends or “tapers” its huge purchases of MBS, and to a lesser extent long-dated Treasuries, it would likely lead to an economic slowdown and would be potentially very damaging to the housing market.

After reading these minutes, I certainly can see how the news spooked the markets on Friday – even though most people had never heard of the Federal Advisory Council before then. In any event, stocks sold off hard on Friday afternoon after the FAC minutes came out, as you can see in the chart below.

Dow Jones Industrial Average

Before leaving this topic, I should point out that the minutes from the May 17 FAC meeting are a radical departure from the minutes of the previous FAC meeting on February 8 when the bankers had glowing things to say about QE for the most part. In fact, none of the excerpts I quoted above from the May 17 meeting were included in the February 8 minutes.

The point is that the bankers on the council have undergone a significant transformation in their thinking on QE from just a few months ago. They are now much more concerned about the risks associated with QE rather than the benefits, which they now conclude are “not clear.”

If you wish to review the May 17 Federal Advisory Council minutes, CLICK HERE.

If you wish to review the February 8 Federal Advisory Council minutes, CLICK HERE.

US Economy: Consumer Confidence Jumps… But

The best news last week came on Tuesday when the Conference Board reported that its Consumer Confidence Index jumped significantly more than expected in May. The index climbed to a five-year high of 76.2 in May from an upwardly revised 69.0 in April. The increase easily beat the consensus of 72.3. Consumers were more optimistic about the health of the economy over the next six months.

On Friday, the Reuters/Univ. of Michigan’s Consumer Sentiment Index brought more good news. The index increased to 84.5 in May, the strongest since July 2007, from 76.4 a month earlier. The consensus suggested a rise to only 83.7. But it remains to be seen if the latest rise in consumer confidence will translate into higher personal spending. Consumer spending fell 0.2% in April. We won’t see May spending numbers until the end of this month.

Last Thursday the Commerce Department released its second estimate of 1Q GDP showing the economy downshifted slightly to 2.4% (annual rate) compared with 2.5% in its advance estimate in late April. This was below the pre-report consensus which suggested the number would rise closer to 3%.

On the housing front, new and existing home sales in April rose more than in the previous month. US home prices rose 10.9% in the 12 months ending in March for their largest annual gain in seven years, according to the latest Standard & Poor's Case-Shiller Index released last Tuesday. The bad news was that housing starts fell sharply in April.

The Chicago Purchasing Managers Index was released on Friday, and it was much stronger than expected at 58.7 for May, up sharply from 49.0 in April. Any reading above 50.0 indicates that manufacturing in this region is expanding.

The ISM manufacturing index was released yesterday and it was disappointing. The Institute for Supply Management reported that its manufacturing index fell in May to 49.0, down from 50.7 in April, and well below the consensus of 50.9. Any reading below 50.0 indicates that manufacturing nationwide has contracted mildly recently.

On Friday, we get the official unemployment rate for May. Currently, the consensus is that it will remain unchanged at 7.5%.

The IRS Scandal – What You Need to Know

With wall-to-wall coverage in the media, I have been hesitant to comment on the escalating IRS scandal. The main question, of course, is whether or not the president and/or top officials in his administration knew about the scandal prior to late April when President Obama said, “I read about it in the news, just like you.”

To fully understand this scandal, I believe we have to go all the way back to late January 2010 when the Supreme Court ruled – in Citizens United vs Federal Election Commission – that corporations and unions could contribute virtually unlimited funds to support political candidates of their choice. I have not seen anyone in the mainstream media suggest that this Supreme Court decision was the genesis of the IRS scandal, but I believe it was.

You may recall that President Obama was absolutely livid over this landmark decision. This was the first time I had ever seen Obama “lose it” on camera – he was noticeably angry! He stated:

“This ruling opens the floodgates for an unlimited amount of special interest money into our democracy. It gives the special interest lobbyists new leverage to spend millions on advertising to persuade elected officials to vote their way – or to punish those who don’t.

I can’t think of anything more devastating to the public interest. The last thing we need to do is hand more influence to the lobbyists in Washington or more power to the special interests to tip the outcome of elections.

…We don’t need to give any more voice to the powerful interests that already drown out the voices of everyday Americans. And we don’t intend to. It will be a priority for us until we repair the damage that has been done.”

You may recall that the High Court issued its January 2010 ruling just as crucial mid-term election campaigns were getting under way. Obama and the Democratic Party were feeling pressure from a string of losses in New Jersey, Virginia and in Massachusetts, where Republican Scott Brown came from behind to win a Senate seat Democrats had held for decades.

But why were the Democrats feeling so desperate? After all, the Citizens United decision opened the ‘floodgates’ for BOTH political parties. I believe that it was because they feared that ultra-rich Republican groups would contribute significantly more money than Democrat supporters.

Furthermore, much of the big money flooding the political arena post-Citizens United was increasingly coming not from so-called “Super PACs, but from nonprofit organizations that described themselves as “social welfare advocacy groups.” IRS applications for such nonprofit status exploded.

Democrats felt they had to do something. Obama vowed as much in the last sentence of the quotes highlighted above.

Initially, the IRS came under pressure to take steps to enforce rules that bar nonprofit social welfare groups from making politics their primary purpose. When this proved to be difficult to do, there was even talk of a constitutional amendment to overturn the Citizens United decision. That effort didn’t materialize.

At some point, “someone” pressured the IRS to postpone applications for nonprofit status, especially those with the words “Tea Party” or “Patriots” in their name. Some of these applicants have been waiting three years and still don’t have their nonprofit status. Some of these groups testified before Congress today – finally.

The problem is, we don’t yet know who that “someone” was. Many believe that it was a person high up in the Obama administration, or perhaps more likely, someone high up in the Obama campaign hierarchy. It is unclear if we will ever know who pressured the IRS.

Wall Street Journal columnist Kimberley Strassel has a different theory. She believes that President Obama purposely telegraphed the message to the IRS himself in public speeches wherein he roundly criticized nonprofit groups that were donating large sums to his enemies. Ms. Strassel wrote the following in the WSJ on May 19:

“The media and Congress are sleuthing for some hint that Mr. Obama picked up the phone and sicced the tax dogs on his enemies. But that's not how things work in post-Watergate Washington. Mr. Obama didn't need to pick up the phone. All he needed to do was exactly what he did do, in full view, for three years: Publicly suggest that conservative political groups were engaged in nefarious deeds; publicly call out by name political opponents whom he'd like to see harassed; and publicly have his party pressure the IRS to take action.”

To read the full article, entitled “The IRS Scandal Started at the Top,” CLICK HERE. You really should read it regardless of your political views.

In closing, it remains to be seen if the congressional investigations will ever find out who pressured the IRS to postpone applications for nonprofit status. What we do know is that it has been going on for a very long time, dating back at least to March/April 2010. Someone should be punished.

Unfortunately, it may have also had a significant effect on the 2012 presidential election as many conservative voices were afraid to speak out. What a remarkable coincidence!

What I hope to do today is point out that the roots of this scandal go all the way back to the Citizens United decision in 2010. The media hasn’t seemed to be able to make that connection. No surprise there!

All the best,

Gary D. Halbert

SPECIAL ARTICLES

Federal Advisory Council – information, members, minutes

Consumer confidence jumps to 6-year high

Timeline of the IRS Scandal (from POLITICO, no less)