Shakespeare’s Macbeth, Act V, Scene V: “To-morrow and to-morrow creeps in this petty pace from day to day, to the last syllable of recorded time; and all our yesterdays have lighted fools the way to dusty death. Out, out brief candle! Life is but a brief shadow, a poor player that struts and frets his hour upon the stage, and then is heard no more. It is a tale told by an idiot, full of sound and fury, signifying nothing.”

So Insurance Industry…what/who is “creeping in” its “petty pace from day to day”? Why, it is the Federal Reserve and rather than signifying nothing, it is signifying a big something. Right now that “it” (i.e., group capital requirements, enhanced prudential procedures, recovery and resolution plans, new reporting requirements and perhaps even some accounting changes, etc.) may be directed only at designated SIFIs, but it is likely to continue its creeps from day to day. Now hear this!

And talk about “outrageous fortune” (Hamlet, Act III, Scene I), the Federal Reserve Bank of Kansas City took its turn hosting its annual get-together of international banking and financial ministers from Thursday evening, August 25^th, through early afternoon on Saturday, August 27, in of all places Jackson Hole, Wyoming! Yes, Jackson Hole, Wyoming, the financial capital of the world and of course, the easiest place to get to. Especially if you’re perhaps Jean-Pierre Danthine, President of the Board of Directors of the Paris School of Economics or maybe Norman Chan, Chief Executive of the Hong Kong Monetary Authority. Jan Toth, Deputy Governor of the National Bank of Slovakia and Jose Dario Uribe Escobar, Governor of the Central Bank of Colombia, amongst others, must also have had a nice trek. One hundred twenty-six people are on the roster of attendees! How much do you think this junket cost and who do you think actually paid for it? And what benefit do you think you received for that cost because you (and I) certainly ultimately paid for it?

The title of this event was “Designing Resilient Monetary Policy Frameworks for the Future.” The title is ironic considering the question as to whether there is an economic future if policies are developed by these attendees—considering their track record (mine at Saratoga is also not so good either). Of course there was a “reception” and dinner on Thursday night but the big doings started on Friday morning at 8AM with an opening speech by Janet Yellen followed by an 85-minute presentation and discussion on “Adapting to Changes in the Financial Market Landscape.” There was a 35-minute discussion on “Negative Nominal Interest Rates” and then a 65-minute timeframe allotted to “Evaluating Alternative Monetary Frameworks.” This rough morning workout was then followed by lunch (with a speech by a Princeton professor). The afternoon schedule was easy: “Adjournment”!

The next morning, the attendees watched a panel discussion on “Central Bank Balance Sheets and Financial Stability” for a full 35 minutes followed 25 minutes of “General Discussion” in turn, followed by “The Structure of Central Bank Balance Sheets” and then they had an “Overview Panel.” The show was over by 2PM.

In summary then, 125 heavyweights plus assistants, technical people and meeting professionals, travelled God knows how long to a resort to hear seven presentations for relatively brief periods. Can’t you see the value for that? Are you happy?

In contrast, on August 25^th and 26^th the Wall Street Journal published a few interesting articles about the Federal Reserve Board and other central bankers. The first (appearing on Page A2 and authored by Greg Ip) is titled: “Central Bankers’ Challenge: Staying Relevant.” The first sentence reads: “When central bankers gather this week in Jackson Hole, Wyo., they will be consumed not with some pressing crisis in the global economy but by an existential threat to their relevance.” The thrust of the article is the fact that low interest rates (they are actually more than “low,” they essentially don’t exist anymore) should cause an increase in economic growth and some inflation, but that has not occurred, so either the Ip-denoted so-called “natural interest rate” has fallen by more than the US Federal policymakers guessed (i.e., from 4.5% in 2007 to 3%, to perhaps 1.5-2%, so that the tools remaining for the FRB to use in case of a further downturn are much more limited) or something else—missed by all—has occurred. [As a note, which perhaps I should direct to Mr. Ip, the wording and numbers presented at the end of his second paragraph are somewhat unclear since he first refers to a combination of the “U.S., Canada, Britain and the Eurozone” but then switches to “the U.S. natural rate “Fed policy makers think….”]

Mr. Ip also notes the tie between interest rates, economic growth, inflation, savings rates and investment sets forth the goals of central bankers to keep a balance between savings and investment “and thus keep economies fully employed and inflation stable.”

Mr. Ip includes an interesting quote from Mr. Daniel Tarullo (a member of the Fed’s Board of Governors) as follows: “Does a low interest rate…environment that lasts a long time create conditions that might pose risks to financial stability?…I think the answer is probably yes,…” So Danny Boy actually “thinks”! Interesting…and I guess “the pipes are calling” too because it seems to me that eight years straight is a long time. Do you think that insurers pricing products in the 1990s considered that there would be a low interest climate in the first decade of this century followed by another decade or so of the same condition? What interest rate are workers’ compensation reserves currently being discounted at?

Mr. Ip includes a reference to Larry Summers’ cited advocacy of the use of “helicopter” money for infrastructure purposes but I will leave that alone since the Cleveland Fed President, Loretta Mesta, was cited in an Australian published report as having advocated for the use of “helicopter” money but she has since stated clearly that is not the case (“Cleveland Fed President Loretta Mester did not advocate the use of helicopter money and does not advocate it.”). Case closed.

What does all this talk of interest rates mean to us? Well if you are a “saver” you are not getting very much for your savings at the bank. If you buy high grade bonds, you are not getting very much either. If you buy below investment-grade bonds, credit spreads have narrowed so you are getting a return commensurate with the risk. You won’t be able to find a fixed annuity that allows for a decent rate of return. If you are approaching retirement or already there, you are not able to de-risk from the equity markets and obtain the rates of returns on your savings as you planned. If you are an insurer who priced products using longstanding assumptions about interest rates, how are you going to obtain the cash in-flows to ultimately take care of the cash outflows? Yet, the elitists that run our economy and think that they should, take junkets to places like Jackson Hole, Wyoming (a beautiful slice of nature, by the way) and do so as if it’s the ordinary course of business. Have any of them ever run a business?

The second Wall Street Journal article also ran on August 25^th appearing on page A11. It’s entitled: “The Federal Reserve Needs New Thinking” and is written by one of their own, former Fed Board member, Kevin Warsh. Mr. Warsh is an interesting subject inasmuch as he was 36 when appointed to the Fed (by President Bush in 2006) and he resigned from the Board in 2011, notwithstanding that his term extended to 2018. Also, he actually worked in the securities industry prior to his appointment.

The first sentence of the article is: “The conduct of monetary policy in recent years has been deeply flawed.” [Emphasis added] He continues by noting that the Jackson Hole meeting is designed for “policy makers to consider monetary reform.”

His analysis of the current state of affairs is quite succinct: “U.S. economic growth lags prior recoveries, falling short of forecasts and deteriorating in the most recent quarters.” However, he refers to the Jackson Hole meeting as “timely and consequential.” Noting the above description of the meeting, do you think that really is the case? Was the meeting “consequential”? Where would we all be if they hadn’t met?

Mr. Warsh continues: “Policymakers around the world neither predicted nor can adequately explain the reasons for current inflation readings below their targets.” Therefore, he finds it “puzzling that so many academics are pushing to raise the current 2% inflation target to a higher target of 3% or 4%.” Could the answer be that the policymakers don’t really know what they are doing and so should stop “doing”? Mr. Warsh argues for a “broader reform agenda.” Is that what we want the Fed to do? By the same people who have conducted a “deeply flawed monetary policy”?

But, there is redemption, as Mr. Warsh notes: “Two major obstacles must be overcome: group-think within the academic economics guild, and the reluctance of central bankers to cede their new power.” There are some other major obstacles as denoted below, but the fundamental question is why they have so much power in the first place. Why is it thought that 125 guys and gals (plus perhaps several dozen more non-attendees) have the knowledge, skill and insight to run a global economic structure that has thousands (and probably millions or billions) of moving parts? Do we want anyone to “run” the economy?

Mr. Warsh goes on: “Real reform should reverse the trend that makes the Fed a general purpose agency of the government. Many guild members believe that central bankers—non-partisan, high-minded experts—are particularly well-suited to expand their policy remit. They fail to recognize that central bank power is permissible in a democracy only when its scope is limited, its track record strong, and its accountability assured.” (Maybe the problem is they are “high”!) So why is it that they are not held accountable for the decisions they make that result in flawed results such that when taken to natural conclusions actually kill people (you lose your job, you lose your income, you lose your insurance, etc.)? And now of course, we need these same people to engage in a “reform agenda”! Excuse me!

Actually, Mr. Warsh lays it out clearly:

new dogmas pushed into the mainstream of monetary policy;
data dependence causing erratic policy lurches;
noisy data;
obsession with asset prices and their maintenance at higher levels;
“ambiguity in the name of clarity”;
markets as beasts to be tamed;
markets to be manipulated.

He also notes: “From the beginning of 2008 to the present, more than half of the increase in the value of the S&P 500 occurred on the day of the Federal Open Market Committee decisions.” I note that the market hit this century’s low as a result of the downturn on March 9, 2009 (676) but was at 1565 on October 9, 2007 and has since regained all that was lost and then some. But the S&P at 2187 (as I write this) is only 140% of where it was in the Fall of 2007. So after nine years, the S&P has increased by a compounded rate of just under four percent. If we took a long-term average rate of return of say six percent, where would we be? Instead of a 40% gain, we have an almost 69% gain and the S&P would be at 2644 not 2187! Maybe we should not look at where we are but rather where we should and could be.

Finally Mr. Warsh notes that “(t)he Fed is suffering from a marked downturn is public support.” He rightly notes that post Dodd-Frank, the Fed “micromanages big banks and effectively caps their rate of return.” The key word there is “micromanages.” Not mentioned is that this is now seeping into the insurance industry with the Fed overseeing “systemically important” (whatever that means) insurance groups. The problem is the Fed doesn’t know how to manage a commercially operational bank and especially, an insurance company. In the real world, business decisions have to be made expeditiously because the mantra of a commercial business is, or at least ought to be: “make money!” Businesses don’t exist to have exacting procedures and processes in place; they exist to do business.

It should be noteworthy, but often isn’t, that most of today’s major insurers have been around for many decades and indeed several for way more than a century. And, they have grown and succeeded in their business endeavors. I am not proposing that managing risk within a business is unimportant but it doesn’t supersede the actual conduct of business. Companies have been operated without formal risk committees, risk coordinators, Chief Risk Officers, etc., and succeeded. Corporate governance/risk management is not an end unto itself and in fact should only be employed based on positive cost/benefit basis. If a company has a perfect risk management structure but does no business, how good a deal is that?

As just one example, let’s look at the Fed’s proposed rule (NPR) issued in June 2016 as “Enhanced Prudential Standards.” It indicates that a risk committee must be an independent committee of the board, chaired by a director who is not, and has not been, an officer or employee of the company for the previous three years. But does the committee or its chair have to have any definitive experience within the insurance industry so that they fully understand the risks that pertain to the insurance business? Should that experience be specific to the business of the entity the risk committee is assessing (e.g., life, property/casualty, health, etc.)? Suppose the chair was an employee more than three years ago and has outstanding stock options and/or is receiving a pension from the company? The NPR requires that at least one member of the risk committee must have experience identifying, assessing and managing risk exposures for large, complex financial firms. So banking is like insurance and that experience counts? If there is a five-member committee, only one must have that ability?

This is sophomoric thinking and almost beyond belief (unless you have experienced it first-hand). Most of the NPR is of that ilk (as is the one on capital standards) so I won’t go into a chapter and verse critique; however, what is critically missing from anything the Fed has done (e.g., resolution and recovery plan development requirements) is to clearly identify the cost/benefit basis for any of their proposals. It is noteworthy that the Fed issued an NPR in 2012 that generated hundreds of comments of which we are assured the Fed took due note in the 2016 version. How much did all the effort that went into the 2012 NPR, the comments and review thereof and the development of the 2016 NPR cost? What quantifiable benefit to policyholders, shareholders and taxpayers (that’s you and me folks, and most likely in all three constituencies) has been obtained or is to be obtained? In essence, it’s a textbook-type approach that suggests: “Just do it because it sounds good”! We’re living in an era of advanced absurdity. We need reform alright.

The third Wall Street Journal quite extensive article appeared on pages A1 and A6 on August 26^th written by Jon Hilsenrath. This one is entitled “Years of Fed Missteps Fueled Disillusion With the Economy…” and starts out: “In the past decade Federal Reserve officials have been flummoxed by a housing bubble that cratered the financial system, a long stretch of slow growth they failed to foresee and inflation persistently undershooting their goal.” Sounds like a good track record! Do we want to bet on these guys again? Ya’ think?!

The President of the Boston Fed, Eric Rosengren, chimes in: “There are a lot of things that we thought we knew that haven’t turned out quite as we expected.” “Quite” as expected? And, surprise, surprise: “The financial markets are not as stable as we previously assumed.” Hey “Ricky, don’t lose this number”!

Did you know that the 1990s were a period in economics known as the “Great Moderation”? Policymakers could do no wrong, until the tech bubble burst just after the 1990s! But alas, now “the central bank confronts hardened public skepticism and growing self-doubt about its own understanding of how the U.S. economy works.”

Mr. Hilsenrath states: “The Fed’s own uncertainty about the economy’s underpinnings is more than a decade in the making and traces to three key developments that have thrown officials for a loop.” These are:

Complexity of the financial system has led to bubbles;
A long-term slowing of worker productivity;
Lack of inflation response to employment.

The article contains a discussion on each of the above. One of the bubbles, real estate, well that was all the fault of “Ferbus.” Ferbus, that’s a Fed model, “failed to show how a fall in home prices would ripple through the financial sector, freezing credit that was the lifeblood of the economy.” Are you crying?

As to number two, again the Fed’s model (poor thing doesn’t have a name) just didn’t recognize that between 1994 and 2003, productivity rose at an average annual rate of 2.8% but as risen only at a rate of 1.4% since then and only at a rate of .4% since 2011. Look yourself in the mirror.

Inflation is supposed to rise when unemployment falls; but as unemployment has supposedly decreased there’s been scant inflation. How come? Well perhaps unemployment hasn’t fallen. Maybe the figures we get each month are phony. After all, there’s the lack of auditability of the results of the Census Bureau’s labor statistics (lost computers), the seasonal adjustments, the birth-death model, etc. [Note: New York Post columnist John Crudele has written extensively on this and you can Google his articles.] Could it be that the Fed has used and still uses bad data?

Finally there is Larry Summers’ tag line: “We should be extremely worried. We are essentially on a fairly dangerous battlefield with very little ammunition.”

Anybody got a shovel?

“Fed” Up: Sound and Fury…Signifying…What?

Martin Carus