Black communities need more help from the Federal Reserve Board

An estimated $7 billion in corporate pledges have been made to facilitate efforts that support racial justice, and help activities that seek immediate solutions to the crisis affecting Black people.

We are very familiar with these types of promises, having launched the first website focusing on financial support for minority communities in 1995 and a new website to monitor such corporate pledges.

Yet it appears that only $188 million of that $7 billion is money someone can reasonably expect to get their hands on. Further, in certain sections of the Black community, there is concern about the effectiveness of the traditional organizations identified as recipients of the pledges. And there appears to be less concern with newer, trending organizations.

Our recent survey of customers banking at black-owned banks suggests most consumers who do not use Black banks are concerned about their financial stability, and have not been able to leverage financial resources from these institutions.

Programs that rely on secondary institutions to provide capital to already underutilized Black-owned banks add another stumbling block to the effort to get capital where it is needed.

Certainly, more money will help. But there may be more effective methods such as creating a digital wallet and currency to get money directly to affected communities without the need for money-sapping intermediaries; or creating a large credit program at the Federal Reserve. The latter approach holds the most promise.

Recall that the Federal Reserve Board created a secondary market corporate credit facility to purchase a more diversified portfolio of corporate bonds that include supporting large employers. Regrettably, very few Black-owned firms are eligible for this program, having been locked out of the corporate-debt market largely due to discrimination, both involuntary and self-imposed.

The Fed also created the Main Street Lending Program meant to encourage cash flows to small and midsize businesses by purchasing up to $600 billion in loans. But already, the number of black-owned small businesses plummeted by 41% between February and April when the coronavirus pandemic started in the U.S., according to a working paper published by the National Bureau of Economic Research.

The financial loss to the Black-owned businesses is estimated at $23 billion due to the pandemic. Therefore, the Fed should allocate $23 billion of the $600 billion in its Main Street program to Black-owned firms, using a wide array of financial instruments and techniques.

Lastly, Black people need a truly collaborative and cooperative effort — in and by the Black community — a community often trained to be petty and cutthroat to each other given the paucity of resources at its disposal. After Creative Investment Research, in the public spirit, disseminated an estimate of corporate pledges to the Black Lives Matter cause (at $1.6 billion), several foundations made donations totaling $1.7 billion.

Now is the time to let go of bad habits for the survival of the Black community. In so doing, we can also show the world the way out of the crisis.

First published at: The American Banker Newspaper: Black communities need more help from Fed https://www.americanbanker.com/opinion/black-communities-need-more-help-from-fed 

Nationalize the Banks

According to the Financial Times, megabank Wells Fargo & Co “has asked the U.S. Federal Reserve to remove an asset cap introduced during its accounts scandal in order to allow it to support businesses and customers hit by the coronavirus economic fallout..”

The growth cap was imposed after the bank “acknowledged that it improperly foreclosed on 545 distressed homeowners after they asked for help with their mortgages, created 3.5 million fake accounts, charged 570,000 customers for auto insurance they did not need, and illegally repossessed vehicles from hundreds of service members.” Former bank employees state that Wells "targeted black churches” and neighborhoods by offering escalating-interest mortgages, which some loan officers called “ghetto loans.”

This week, the bank demanded that call center workers come to the office despite coronavirus, but agreed to pay "all of its domestic full-time employees who make less than $100,000 a year.. a pre-tax payment of $600 and part-time employees.. a $300 bonus."

Wells suggested the Fed remove the $1.95 trillion asset cap, “which has curbed its growth and profitability since it was imposed in 2018..” In 2019, Wells Fargo reported net income of $19.5 billion.

This request must be viewed in the context of the current COVID crisis and banking industry profits. JPMorgan Chase, the country’s largest bank, reported record profits of $36.4 billion in 2019, the highest annual earnings any U.S. bank has ever reported. Citigroup announced its best results since the 2008 financial crisis, reporting $19.4 billion in profits for 2019.

Wells Fargo’s request exposes the greed and lack of public concern that is the cause of the bad banking behavior we have seen in recent years. These are simply greedy, unpatriotic institutions whose behavior now, in the midst of this crisis, borders on the psychopathic. (A Former Wells Fargo CEO wants people to go back to work and 'see what happens.' He said 'Some may even die, I don't know.' This lack of empathy is the textbook definition of a psychopath.)

The country is in the beginning stage of the most serious social and economic crisis it has ever faced. To ensure the country does not fall into depression, the federal government will need to make deposits directly into roughly 300 million banking accounts. It will have to send direct payments via new fintech platforms, like Venmo and PayPal, to reach the broadest number of citizens. Credit unions and check cashing firms will also have to be included, quickly, while avoiding double counting, and making sure that only eligible US citizens receive money.

Mortgage and loan terms will also have to be revised. We know financial institutions can do this, since it’s what they did in the years leading up to the financial crisis, when loan terms were revised in favor of the banks, in many cases without letting borrowers know. (In 2001, we helped create one of the first wide scale home mortgage loan modification projects in the United States. The project helped families victimized by predatory lending practices. See: https://www.creativeinvest.com/PropertyFlipping.pdf ) Now, the task is to reset loan terms in favor of borrowers. It is uncertain that banks can do this in a fair, unbiased manner. This is why nationalization is needed.

While privately-owned banks place “short-term profits for their shareholders as their highest priority” they are required to “maintain stability and public confidence in the nation's financial system.” Megabanks must be part of the solution, but, if a bank is primarily worried about profitability before the public interest in THIS environment, they will only make things worse.

The solution is to have the government, via the Fed, in the public interest, take over the banks.

Semiannual Monetary Policy Report Hearing

Last week, Chairman of the Federal Reserve, Jerome H. Powell appeared before the House of Representatives Committee on Financial Services to present the Semiannual Monetary Policy Report. Chairman Powell opened his remarks by stating that “the economy performed reasonably well over the first half of 2019 and the current expansion is now in its 11^th year.” Inflation has run below the FOMC 2% objective, trade tensions and concerns about global growth have weighed on economic activity."

The Current Economic Situation

Labor Market: job gains remain healthy, with the unemployment rate falling to 3.7% in June. Employers are increasingly willing to hire and train workers with fewer skills.  Unemployment for African Americans and Hispanics remain well above the rates of whites and Asians. Urban employment rates are higher than those in rural communities. Labour force participation by those in their prime working years is lower in the US than in comparable nations.

GDP: GDP increased to last year’s pace at a rate of 3.1% in the first quarter of 2019, largely due to net exports and inventories. Growth in consumer spending was weak, but recovered and is now at a solid pace. Growth in business investment has slowed, possibly reflecting trade tensions and slower global economic growth. Housing investment and manufacturing output declined in the first and second quarter.

Inflation: Inflation has run below the FOMC 2% objective. Overall consumer price inflation declined to 1.5% in May. PCE inflation (excludes food and energy prices) decreased to 1.6% in May

Outlook

Powell stated that the Federal Reserve’s outlook “is for economic growth to remain solid, labour markets to stay strong, and inflation to move back up over time to the Committee’s 2 per cent objective.”

Uncertainties in recent months, relate to slowing economic momentum in foreign economies, unresolved government policy issues (trade development, federal debt ceiling, and Brexit), and the risk that weak inflation poses, will be monitored and may affect the Federal Reserve’s outlook.

As mentioned above, labour force participation by those in their prime working years and the rural-urban labour market disparity are concerns. Powell noted that the lack of upward mobility for lower-income families as an issue. He stated that finding ways to boost productivity growth should be a national priority, since this leads to rising wages and, ultimately, a higher living standard.

Monetary Policy

The Federal Open Market Committee (FOMC) target range for the federal funds rate was 2.25-2.5 per cent during the first half of the year. Powell remarked that the Committee has decided to enact a strategy of patience to determine future adjustments.

At May’s meeting, progress made in trade negotiations with China were encouraging factors leading to the Committee not adjusting their policy rate. In the time since, trade tensions have reemerged, creating uncertainty. Slowing global economic growth indicators raise added concerns that trade weakness will continue to affect the US economy and possibly help spark further declines in business confidence.

Powel reiterated the Committee's June meeting statement: increased uncertainties concerning the economic outlook.

Framework

The Federal Reserve began purchasing securities in 2007 when the financial crisis began.  Since then, total system assets increased from $870 billion in August 2007 to $4.5 trillion by January 2015.  In October 2017 the FOMC balance sheet normalization program began and has since lead to a decrease in total assets to $3.8 trillion in July 2019. 

Beginning in May 2019, the Committee’s intentions were to reduce holdings of Treasury securities by reducing the cap on monthly redemptions from $30 billion to $15 billion, ending in September 2019. Beginning in October 2019, up to $20 billion per month in Mortgage Backed Security principal payments will be reinvested in Treasury securities. Limited MBS sales might also be an option in the long run to reduce holdings.

Conclusion

After Powell’s hearing, Chicago Federal Reserve Bank President, Charles Evans indicated that the Fed should cut rates by half a per cent before the end of the year in an effort to increase stubbornly low inflation rates. 

Both Republican and Democratic committee members seemed pleased with the Chairman’s monetary policies.  He received praise from both sides on keeping the agency independent amid pressure from the White House.

Research provided by Tisa Forrest, Johns Hopkins University, Impact Investing Analyst

Probability of Fed Rate Hike is 90.53%

Our model of Federal Reserve policy estimates the probability that the Federal Reserve will increase interest rates. Our July 3rd Summary shows that the probability of the US Federal Reserve increasing the federal funds rate is 90.53%.

While our model needs to be adjusted, as noted below, we remain confident in these results.

The first forecast adjustment element are the previous hikes. Recall that in March, 2018, our model predicted a rate increase with a 92.3% probability. The rate increase following the June 12 – 13 FOMC meeting decreases the probability of subsequent rate increases, if only slightly (90.53% vs 92.30%). One precedent for the Fed raising rates in this manner came in 1994, during the Clinton Administration, when the Fed raised rates from February to May at a 25 basis point pace. Interest rates increased from 3.25% to 4.25% in 4 months (FED, 2018).

Each successive rate increase adds less to policy impact. Given that the Fed has  raised interest rates two times so far in 2018, the fact that the probability has fallen is consistent with our thinking.

The second forecast adjustment concerns inflation. Both Core PCE and CPI continued increasing in June and are now thought to represent a trend. Core PCE references living expenditures excluding food and energy. Yes, the impact on inflation of a trade war must be considered, also. The current Administration has initiated several tariff increases against China, Canada, Europe, NAFTA partners and others. A trade war makes it harder for the Federal Reserve to increase rates, since tariffs increase expectations concerning inflation by increasing prices for the purchased goods that are subject to a tariff. The Fed will want to be cautious about stoking runaway inflationary expectations. Indeed, the impact of the previous interest rate hikes and the looming trade war caused the Dow Jones Industrial Index to fall from 25320.73 on June 12th to 24174.82 on July 3rd. Uncertainty concerning trade will definitely have unpleasant impacts on industrial production, even with minor buffer policies, like allowing ZTE is resuming activities temporarily (Jenny Leonard, 2018).

In summary, the Fed will consider the impact on inflation of a trade war and might continue increasing interest rates but at a slower pace if the situation worsens.

Consumers are the third forecast adjustment factor. Our model uses two major indicators of consumer expectations: Consumer Sentiment, which indicates the confidence consumers have in the economy, and inflation expectations -consumer expectations concerning changes in the prices of goods. The Fed may wish to stop increasing rates in order to give consumer confidence time to adjust.

Given these factors, our adjusted probability of a Fed rate hike is lower than the unadjusted 90.53% probability. The next Fed Interest Rate Decision will be made public on Aug 01, 2018 02:00PM ET.

Research by Ryan Brand, Rongbin Ye, Impact Investing Analysts. EDITED BY WILLIAM MICHAEL CUNNINGHAM

References

Bloomberg Database. (2018). Dow Jones Industrial index & Yield Curve & Interest rate expectation. Retrieved from Bloomberg Terminal.  

Federal Reserve Database. (2018). FED Economic Data. Retrieved on July 3rd from: https://fred.stlouisfed.org

Trump's Tariffs on China will Mainly Hurt the Fed by Hongcheng Chen, Creative Investment Research

The Federal Reserve’s Federal Open Market Committee (FOMC) meeting statement on March 21, indicated that the Committee voted for a quarter-point increase in federal fund rate. (See: http://twisri.blogspot.com/2018/03/probability-of-fed-rate-hike-in-march.html)

The Fed seemed to signal, by this rate hike, that a more robust economic outlook, strengthened, at least in part, due to fiscal policy (tax bill), provides a solid base on which to tighten (increase interest rates) monetary policy more aggressively in the future. The FOMC also sought to cling to a strategy in 2018, according to the statement, that “supports strong labor market conditions and a sustained return to 2% inflation.”

Top FOMC considerations: Inflation targets and the labor market

This cautious stance diverged from market expectation in a surprising way: the market seemed to expect more. The accommodative monetary policy and moderate rate hikes reflected in the FOMC statement caused investors to retreat from their expectations concerning fed rate hike increases. The US dollar Index(DXY) weakened by 0.51%, and both the crude oil future index (CLK18.NYM) and gold future index (GC) increased by 2.28% and 0.43% respectively on the day the FOMC statement was released.

The market may have anticipated an even more aggressive Fed rate hike path, given Fed Chairman Powell’s optimistic view on the economy noted at the semi-annual monetary policy hearing of Tuesday, February 27, 2018. However, any policy uncertainty should be removed now because target inflation rate and employment level are clearly now the top considerations when the Fed acts to implement rate hikes.

For the balance of 2018, I think the Fed will stick to its gradual pace of rate hikes with a 2% inflation target in mind while attempting to maximize employment. The emergence of the employment variable now becomes a hidden priority behind the obscure economic terminologies in the FOMC statement.

Trump’s tariff plan will drag the Fed down

Unforeseeable instability always affects the way in which the Fed reaches its goal and the Trump administration never fails to add instability.

On March 22, President Trump signed a presidential memorandum that imposes tariffs on $60 billion in Chinese imports. Trump has been bothered by the $375 billion goods China/US trade deficit. China and made every effort to change the allegedly “unfair terms of trade”.

As tough and patriotic as Trump thinks he is, hitting China with tariffs can be a tremendous impediment to the Fed, limiting their ability to reach their goal of maintaining an inflation target and maximizing the employment level.

•  Increased prices will push inflation higher and cause job losses.

The tariff imposed on goods like aluminum and steel will be passed on to manufacturers and then to consumers. The sharply increased price of steel and aluminum and the products derived from these materials may contribute to rising inflation, causing the Fed to overshoot it’s 2% long-term inflation goal.

As a result, the Fed may have to increase the federal fund rate in order to adjust to the resulting spike in inflation, should we see one. Undoubtedly, such forced tight monetary policy will further damage the labor market and reduce the prospects for continued economic growth.

While a tariff on imported steel and aluminum can help domestic manufacturers win back  market share and thus will create more jobs in that specific set of industries, the increased cost of production may cancel out this effect and may eventually lead to job losses.

What’s particularly galling about this is that history has already taught us this particular lesson. On March 5, 2002, President Bush imposed tariffs of 8%-30% on imported steel to protect domestic steel manufacturers. A trade group, the US Consuming Industries Trade Action Coalition asserted that the temporary tariffs would give rise to more job losses in the steel-using industries than they would save^[1]. This assertion was confirmed by research conducted by Francois and Baughman^[2], who showed that 200,000 Americans lost their jobs due to higher steel prices in 2002.

Unexpectedly high inflation and job losses are definitely not the goals that the Fed is pursuing.

•  China’s retaliation will adversely affect US employment and economic growth.

China showed no fear relative to Trump’s intended tariff hit: “China has no intention of having  a trade war with any country,” Chinese ambassador Tiankai Cui responded in a CGTV interview. “But if anybody is trying to be provocative, we will fight until the end.”

On March 23, China’s Ministry of Commerce announced a plan to counterattack Trump’s stiff trade tariffs with a list of targeted US products. The listing includes fruit, wine, pork, ginseng, and stainless steel pipe.

The US would not benefit from a trade war. According to the US Department of Agriculture, China is one of US largest export markets in the world and US exports of agricultural and related products totaled $26 billion. US soybean exports to China alone increased 13 times between 2001 to 2016^[3].

Since China’s retaliation list is comprised mostly of agricultural products, US based agriculture-related industries will suffer huge monetary losses, leading to job losses. Consequently, any jobs saved in the steel and aluminum industries will be counterbalanced by job losses in agriculture-related industries.

Demand elasticity is the percentage change in product (or service) demand relative to the percentage change in product price. The higher demand elasticity is, the more sensitive demand is relative to product price. For example, if demand elasticity for product A is -0.1 and that of product B is -0.05, then a 1% increase in price of A will cause 0.1% decline in demand for A, while a 1% increase in price of B will cause only a 0.05% decline in the demand for B. In this case, B is less sensitive to price changes.

What’s more, the demand elasticity range for steel in US is -0.3 to -0.2^[4], lower than that for products such as fruit in China (a US agricultural export), where the demand elasticity range is -1.042 to -0.693^[5] . A 1% increase in price of steel due to the tariff will lead to decrease of only 0.2% to 0.3% in steel demand, while the same 1% surge in price of fruit caused by tariff will lead to decline in the demand for fruit of 0.693% to 1.042%. Obviously, US exports of fruits to China will be affected more seriously than Chinese imports of steel. 

Exports of US agricultural products will decrease more than the imports of Chinese steel will be curbed. US GDP will be more negatively affected due to the decline in net exports.

To get a better feel for this, let’s take a look at the Gross Domestic Product (GDP) formula and do the math.

Recall that GDP = C + I + G + (X - M)

Again, job losses and sluggish economic growth are exactly the opposite of what the Fed is working to achieve.

War is war. No one wins when their economies are so tightly tied with each other. While the chance of a full scale trade war remains small, the Fed’s job will be anything but easy should one occur.

Inflation, job losses and stagnant economic growth.

Is the Fed ready?

1. Read, R. (2005). The political economy of trade protection: the determinants and welfare impact of the 2002 US emergency steel safeguard measures. The World Economy, 28(8), 1119-1137.

2. Francois, J., & Baughman, L. M. (2003). The unintended consequences of US steel import tariffs: A quantification of the impact during 2002. Study prepared for the CITAC Foundation, Trade Partnership Worldwide, Washington, DC.

3. Despite Continued Challenges, China Offers Huge Potential for U.S. Farm Exports. (n.d.). Retrieved March 24, 2018, from https://www.usda.gov/media/blog/2018/01/31/despite-continued-challenges-china-offers-huge-potential-us-farm-exports

4. Barnett, D. F. (2011). Up from the ashes: The rise of the steel minimill in the United States. Brookings Institution Press.

5. Han, T., & Wahl, T. I. (1998). China's rural household demand for fruit and vegetables. Journal of Agricultural and Applied Economics, 30(1), 141-150.