Guzzo the Contrarian

The Wall Street Journal and the WSJ Real Time Economics blog reported today that Federal Reserve governor Frederic Mishkin has tendered his resignation and plans to leave the Fed in August.

Now, most average individual investors would say “Who the heck is Frederic Mishkin?”. But, I’m a little different. I know about Frederic Mishkin only because he was indirectly responsible for my 100% move to cash in my retirement portfolio a couple of years ago. So, news of his resignation piques my interest.

Fed Governor Mishkin co-authored the research paper: The Yield Curve as a Predictor of U.S. Recessions (pdf), which I often refer to as the “inverted yield curve theory”. According to the abstract of this paper:

“The yield curve—specifically, the spread between the interest rates on the ten-year Treasury note and the three-month Treasury bill—is a valuable forecasting tool. It is simple to use and significantly outperforms other financial and macroeconomic indicators in predicting recessions two to six quarters ahead.”

Also, according to data presented in this research paper, whenever the yield curve inverts, there is a great degree of probability (depending upon value of the spread) of a recession occuring within 2-6 quarters. What’s powerful about this information is that an inverted yield curve has preceded every recession since the 1960’s.

So, after the yield curve first inverted in July, 2006, I moved my retirement portfolio into cash. The yield curve remained inverted for approximately eleven months, reached approximately a peak probability of 50%, and didn’t revert until June, 2007, and after Fed intervention.

Around October 2007, the economy (and stock market) started it’s descent. If NBER determines later this year that a recession started prior to January 2008, then this theory would continue on it’s excellent forecasting track record.

To get back to my original point..

What’s interesting about Dr. Mishkin’s tenure is that he was appointed to the vacancy left by departing Fed governor Roger Ferguson in 2006, just about the time the yield curve inverted. Now he’s resigning just after the Fed’s intervention to prevent a meltdown in the economy, and possibly just before the “official” definition of a recession is reported by NBER. This all smells very fishy.

According to the WSJ:

Before joining the Fed, Mr. Mishkin had a prominent reputation for his work on finance, monetary economics and central banking. He has published numerous books including several text books and has had several consulting assignments with foreign groups and central banks. The loss of that outside income and the cost of maintaining separate homes in Washington and the New York City area may play a part in his expected decision to return to Columbia, acquaintances say.

The government always has to put a positive spin on these things. One wonders if this is the full reason for Dr. Mishkin’s resignation. The economy is shaky at this time and the last thing the Fed needs is instability within the board. His resignation will also create an unprecedented 3-member vacancy on an only 7-member board. So why leave right now?

Could their be unsolvable conflicts between him and other board members? According to an April, 2006 WSJ article concerning Dr. Mishkin’s appointment:

If appointed, Mr. Mishkin would beef up the Fed’s monetary-policy expertise after a series of appointments by the Bush administration tilted the composition of the seven-member board toward financial-industry experts.

It’s hard to believe that economics (pun intended) would play a significant role in his decision. A person in his position has usually attained financial stability, and money usually wouldn’t be the most important determinant in decision-making.

Who knows? Maybe its possible that Dr. Mishkin feels he has done his job and is no longer needed. On the other hand, maybe something’s about to happen that he just cannot agree with or support.