Fed President Contradicts Yellen’s “No Crisis In Our Lifetime” Claims

There’s not much more to say here… Yellen’s “in our lifetimes” comment is all over the news. Whether or not she means her lifetime isn’t clear. She turns 71 in less than a month.

In his town hall meeting this week, Kashkari was difficult to pin down on his thoughts about another crisis in the near-term. But he wasn’t overly optimistic either.

“There’s nothing on the horizon that tells us another ‘08 crisis is imminent,” Kashkari said. “But again, these things always surprise you by their nature.”

This is somewhat of a departure from what Kashkari said in the past. Less than a year ago in November 2016, he stated there was a 67% chance of another major meltdown.

According to her most recent comments, Yellen seems to believe the banking system is no longer a legitimate threat to the economy.

“I think the public can see the capital positions of the major banks are very much stronger this year,” Yellen said this week. “All of the firms passed the quantitative parts of the stress tests.”

Yellen is referring to the annual “stress tests” on big banks mandated after 2008. But the quantitative parts of the test she’s applauding aren’t a clear indicator of stability — big banks can manipulate their investments and operations to pass them.

The qualitative portions of the test aren’t so easy. But the Fed is dropping those qualitative testing requirements for 21 of the 34 banks in question; and it may drop them for the others soon.

Yellen is equally lax on size regulations of big banks, i.e. the “too big to fail” conundrum. When questioned on the issue directly at an FOMC Press Conference from last March, she gave a cryptic answer with the conclusion, “I’m not aware of anything concrete to react to.”

While Yellen is dismissing the banking system as finished business, Kashkari says the problems behind our last crisis are still alive and well.

“I go up to Capitol Hill quite often… every member of Congress that I meet with, I say Dodd-Frank has done some good… it has not gone far enough on the biggest banks,” Kashkari said at his recent town hall. “The biggest banks are still too big to fail, and you need to know that. And we need to do something about that.”

Leading the rate hike crusade, Yellen is adamant about the economy being ready for the Fed’s ambitious plans to raise rates. So far, after each hike Yellen has pointed back to the same indicators for justification — things like unemployment, inflation, and market performance. But the most she can say about those indicators is that they’re okay. By no stretch of the imagination would anyone call them great, or even good.

But the mystery of Yellen’s fixation on today’s mediocre economic indicators isn’t hard to solve. Her fear of the Fed “running out of bullets” when the next crisis arrives is the real motivator. The Fed can’t slash rates later if it doesn’t start raising them from zero now.

After voting against the past two rate hikes, Kashkari is sounding the alarm bells on the Fed’s push to continue raising rates. In his Medium post from earlier this month, he explains his rationale for dissenting on the past two hikes, and warns that the Fed may be misreading the economy, and setting us up to repeat mistakes from the past, but in reverse:

“For me, deciding whether to raise rates or hold steady came down to a tension between faith and data.

“On one hand, intuitively, I am inclined to believe in the logic of the Phillips curve: A tight labor market should lead to competition for workers, which should lead to higher wages. Eventually, firms will have to pass some of those costs onto their customers, which should lead to higher inflation. That makes intuitive sense. That’s the faith part.

“On the other hand, unfortunately, the data aren’t supporting this story, with the FOMC coming up short on its inflation target for many years in a row, and now with core inflation actually falling even as the labor market is tightening. If we base our outlook for inflation on these actual data, we shouldn’t have raised rates this week. Instead, we should have waited to see if the recent drop in inflation is transitory to ensure that we are fulfilling our inflation mandate.

….

“The outcome that the current FOMC is so focused on avoiding, high inflation of the 1970s, may actually be leading us to repeat some of the same mistakes the FOMC made in the 1970s: a faith-based belief in the Phillips curve and an underappreciation of the role of expectations,” he wrote.

“In the 1970s, that faith led the Fed to keep rates too low, leading to very high inflation. Today, that same faith may be leading the Committee to repeatedly (and erroneously) forecast increasing inflation, resulting in us raising rates too quickly and continuing to undershoot our inflation target.”