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To: pater tenebrarum who wrote (92438)	4/10/2001 6:06:07 PM
From: NOW	Read Replies (2) \| Respond to of 436258

Good read from Belkin: Has The Fed Abdicated Its Authority? A recent surge in the money supply brings us up to Y2K crisis levels. Yet the money supply appears to be getting goosed, not by the Fed, but by Fannie Mae - as if there is a tacit agreement to use the quasi-governmental agency as a Keynesian pump-priming mechanism. Have Greenspan & Co. ceded control? -------------------------------------------------------------------------------- Michael Belkin NEW YORK - It's important to watch Fed policy and U.S. monetary aggregates closely, because of their powerful influence on financial markets. Recently, M2 and M3 growth has skyrocketed... (M2 +11.3%, M3 +13.2% 3 month annualized growth rates as of February 25). This monetary surge is equivalent to those that accompanied the Fed's Y2K credit expansion over a year ago, or the late-1998 LTCM bailout. Those were bullish events for the U.S. equity market... that is, until the monetary binge ended. Those previous two episodes coincided with an expansion of Federal Reserve Credit. For those not familiar with the mechanics of Fed policy - it is simply supply and demand. The Fed expands its balance sheet by buying or repoing Treasury Securities - Fed credit flows out into the monetary system into productive activities such as new investment in plants and equipment - or into speculative purposes such as inflated bids for 3G telecom licenses or margin debt to purchase Internet stocks. An increase in Fed credit is supposed to be associated with a lower fed funds interest rate and higher money supply growth. A decrease in Fed credit is supposed to be associated with a higher fed funds interest rate and lower money supply growth. That's the theory. This year, reality has contradicted theory. The Fed has cut the fed funds rate 100 basis points - but Fed Credit has declined 2%. Is this voodoo monetary policy? The bulge in the money supply is not coming from Federal Reserve operations (unless the Fed has something like off-balance sheet loans to the Janus Fund to meet redemptions). Also, the money supply bulge cannot be fully attributed to the banking sector - commercial bank credit is up just $28.4 billion (0.5%). The double-digit annualized percentage gains in U.S. money supply must have another source. That source appears to be Fannie Mae - the U.S. housing lender. We are indebted to Doug Noland of David Tice & Associates for inspiration on this topic, clients should read his credit bubble bulletin for another perspective... While we respect his analysis, we have a slightly different conclusion. Doug Noland thinks the Fannie Mae credit expansion is Apocalypse Now - we think it is probably bullish now (for equities, not bonds) and Apocalypse Later. Credit expansions are usually bullish for equities. For readers not familiar with Fannie Mae, it is a Government Sponsored Enterprise (GSE), which purchases mortgages from home lenders and then holds them on its balance sheet - or packages them into mortgage backed securities, which are sold to investors. Fannie Mae funds its mortgage securities by issuing debt, which is purchased by money market funds and investors. Fannie Mae's profit is the margin between what it pays on borrowings and what it earns on mortgages. As a GSE, Fannie Mae's borrowing costs are lower than are non-GSE's. The Doug Noland theory is that mortgage purchases by Fannie Mae are credit-creating operations in the same manner as Fed Open Market operations. That is a crucial distinction. If Fannie is simply recycling credit within the system, then its operations are inconsequential with regard to credit expansion and financial markets. But if Fannie Mae is creating new credit when it issues paper to money market funds and purchases mortgages, then there must be some sort of multiplier effect on the credit created, as there is with high-powered Fed credit. Fannie's web site suggests a multiplier effect, at least for the housing market: 'First, we pay cash for mortgages that we buy from lenders and hold those mortgages in our portfolio. The lenders, in turn can use that money to make more mortgages for more home buyers.' After credit spreads widened in the wake of the 1998 LTCM/Russia crisis, Fannie Mae dramatically stepped up its purchases of mortgages and thereby helped heal the strain in fixed income market credit spreads. After that Fannie Mae balance sheet expansion, the equity market rallied strongly and the Treasury bond market collapsed (as investors moved away from safer and into riskier assets). Credit spreads widened again in 2000, to levels approaching (or exceeding in the case of junk bonds) the widened credit spreads of 1998. Late last year, Fannie Mae once again started expanding its balance sheet aggressively - buying mortgages and issuing debt to money market mutual funds. Credit spreads have since declined. Institutional money market fund assets have surged by $60 billion this year, accounting for a large portion of that money supply bulge. It would appear that Noland is right on with his Fannie Mae analysis this year. The money supply is not being goosed by the Fed, but by Fannie Mae - as if there is a tacit official agreement to use GSE's as a Keynesian pump-priming mechanism. Has the Fed abdicated monetary authority to Fannie Mae? What are the implications for financial markets of this money supply pump-priming? While it is not 1998 all over again, as long as Fannie Mae keeps pumping up the money supply, speculative juices are likely to flow. Further Fed interest rate cuts are also looming. While the U.S. equity market has probably entered a long-term bear market, the odds favor a knee-jerk bear market rally in the depressed Nasdaq index - before a deeper decline later this year. Bonds should top out (as they did after the late-1998 credit expansion) on jitters over excessive money pumping. Wall Street's Inside Outsider Michael Belkin is the president of Belkin Limited, an economic and financial market forecasting firm in New York. Six years with Salomon Brothers gave Mr. Belkin a decidedly skeptical viewpoint toward mainstream Wall Street analysis, finding it less than rigorous. His firm currently serves as investment advisor and commodity trading advisor to extremely high net worth individuals and corporations. Belkin is a frequent contributor to Strategic Investment and The Daily Reckoning.