October 24, 2014

AIG Redux – How the Fed Usurped Congress

The AIG bailout is in the news again. At the time of the bailout, I argued that while it was necessary, the Fed should not have played the role in the bailout that it did. Some of the testimony at the current trial suggests that a reassessment of the reasons for those positions is in order. However, nothing revealed at the trial to date has changed my mind about three crucial points:
• The AIG family of companies was experiencing a liquidity crisis and a number of its subsidiaries were insolvent.
• A default by any of the subsidiaries would have had systemic repercussions.
• The bailout as structured was profoundly anti-democratic. The Fed took actions that, at a minimum badly bent both the law and its legal mandate and should be reserved for the Judicial, Legislative and Executive branches of government.
These points are fleshed out below and an alternative course of action that would have avoided some of the bailout’s shortcomings is offered.
AIG was in financial difficulty and not simply because of the CDS positions at the AIG Financial Products subsidiary, but also because of losses at insurance subsidiaries. Numerous insurance subsidiaries of AIG had borrowed money using assets as collateral. They then used the borrowed money to buy MBS. In short, they had leveraged up and purchased real estate-based assets in order to enhance their returns. However, the prices for MBSs started to decline in earnest with the problems at Bear Sterns, and losses ensued. As part of the bailout, the Fed ultimately had to loan AIG approximately $185 billion against collateral (MBSs). The face value of the collateral was well in excess of the $185 billion. This occurred when there was virtually no market for those securities and AIG’s market capitalization was less than $20 billion. Some of the insurance subsidiaries also received necessary direct capital infusions as part of the bailout.

Losses at AIG subsidiaries had implications not only for policyholders, but for other counterparties, including numerous pension and employer-sponsored savings plans that had invested in AIG-sponsored GICs (guaranteed investment contracts), as well as investment banks and other financial institutions.

The financial problems were compounded by contractual arrangements. As standard practice, many financial contracts contained cross default clauses. Cross default clauses imply that if a firm defaulted with one counterparty, all the firm’s other counterparties had the right to act as if the firm had defaulted on them. In short, if one AIG subsidiary defaulted with a counterparty, the other counterparties would have acted to seize collateral, suspend payments, and initiate legal actions before other counterparties had. Further complicating matters, numerous AIG subsidiaries had guaranteed each other. Consequently, insolvency or illiquidity at one subsidiary implied problems for the other subsidiaries that had guaranteed its liabilities. When a single default could have generated cascading market wide uncertainty, there would have likely been numerous defaults. This would have been in addition to the shock of the failure of a large financial institution that had been rated AAA just days before.

At the trial, it has been asserted that there were viable private bids for AIG. While it is possible that numerous parties had an interest in AIG or parts thereof, given the disagreement about the size of the losses at AIG (estimates ranged from $40 billion to almost $100 billion) as well as the complicated corporate structure and the cross guarantees, I cannot see a responsible entity making a firm non-contingent bid in anything like the time frame required-especially without some sort of a US government guarantee.

In short, a public sector-financed bailout was required because of the uncertainty and the market disruptions that defaults by AIG would have caused.

The financial crisis also precipitated a number of other non-bank bailouts. The structures of the bailouts of GM, Chrysler and both Fannie and Freddie are of relevance in assessing the AIG bailout. The structure of the bailouts of the automobile companies and the two GSEs were specified in legislation. The Fed played no role in the GM and Chrysler bailouts, and only a minor role in the Fannie and Freddie bailouts.

In the case of AIG, public money supplied by the Fed was used, but Congress played no role in setting the terms and conditions. Furthermore, Paulson has testified that he (and presumably Treasury) played no role in setting the terms of the bailout.

Given the Congressional involvement in the other bailouts, the use of public monies and de facto nationalization of a private company in the case of AIG, the absence of any Congressional role in setting the terms and conditions of the bailout raises red flags. Defenders of the Fed’s role in the AIG bailout have argued that the risk to the economy was too high and that Congress could not have acted quickly enough, however Congress was able to pass the legislation establishing the conservatorship for Fannie and Freddie in an expedited fashion.

What explains the difference between the GSE bailouts on the one hand and the AIG bailout on the other? While people will disagree, the most logical explanation is that it was politically advantageous for sitting Congressmen to enact bailouts for the GSEs (and the auto companies), while it would have been a political negative to support a bailout for AIG despite the probable systemic repercussions.
Hence the argument for the Fed’s involvement in the AIG bailout is based on the premise that Congress would be its dysfunctional self. While these defenders of the bailout hail the Fed for stepping in when the Congress would not have able to act, the bailout implicitly required the Fed to engage in activities previously exercised by Congress and the Executive branch.

In assuming a power previously exercised via the legislative process, the Fed acted as an enabler, allowing the Congress to avoid its responsibilities. The enabler role was not new to the Fed. The Fed, by asserting that monetary policy alone could guarantee full employment and price stability, also allowed the Congress and the Executive branch to avoid the responsibility for designing and implementing sensible fiscal, Dollar and trade policies, as well as maintaining a robust financial regulatory regime.

The bailout also involved the Fed taking actions well beyond its historical role. It had never closed down a bank or taken responsibility for managing or restructuring any firm. The FDIC has had the responsibility for managing failed banks. Furthermore, many observers wanted the Fed to act as bankruptcy judge in haircutting the claims of selected classes of creditors. However, it is not the role of a central bank to act as bankruptcy judge: picking winners and losers among claimants to assets of insolvent banks or financial institutions.

Paulson, the then Secretary of the Treasury, also asserted in testimony that the terms of the bailout were punitive and were set by the Fed. This position was supported by Geithner in his testimony. If, on the one hand, it was clear that AIG, including insurance subsidiaries, was about to fail a market test and go into bankruptcy, then how was allowing the then current owners to own retain 20% ownership of an ongoing firm punitive? On the other hand, if AIG was viable, what justified taking an 80% ownership interest in it?

More importantly, it is not proper for the Fed, or any governmental agency, to in effect try, convict and decide on the punishment for acts that were not prohibited by law or regulation. Some argued that punishment was deserved and served a social goal, i.e., reducing moral hazard. However, national security is a social goal, but it would be inappropriate for the NSA to make decisions about steps to promote national security, e.g., widespread wiretapping, if not permissible under the law and without oversight from the Congress or the courts.

The bailout could have proceeded in a more transparent and democratic fashion. The Fed could have had required a letter of agreement from Treasury (and/or from the Congressional leadership) stating that the Fed was proceeding with provided liquidity against appropriately hair-cutted-collateral, while Congress and the Executive branch specified terms of the bailout or conservatorship. This would have allowed the bailout to go forward and would have provided any interested parties with avenues of appeal via the legislative process. It would also have placed the ultimate responsibility for the terms of the bailout where they belong: in the political sphere.

During crises, decisions have to be made quickly and with incomplete and flawed information. The bursting of financial bubbles will, by their very nature, give rise to crises and decisions that will in hindsight appear less than optimal, even foolish.

Avoiding or preventing the next bubble is more important than ex post analyzing the failures in the response to the prior bubbles. The post-crisis second-guessing of decisions made during the crisis has drowned out a more import discussion. The Fed and the other regulators learned a lesson at great expense during the 1980s. The lesson was that it is better to avoid bank failures and crises than clean up after them. A more productive discussion would focus on how they forgot that lesson. 

October 23, 2014

How The Federal Reserve Is Purposely Attacking Savers

There's something we 'regular' citizens wrestle with that the elites never seem to: a sense of moral duty.

For example, following the collapse of the housing bubble, many people struggled with mortgages they could no longer afford to pay, fearing the shame of default. Many believed defaulting was wrong somehow; that it was their moral obligation to pay their mortgages, no matter how dire their personal situation. And of course, the mortgages lenders did their utmost to reinforce this perception.

In a perfect world, we would honor our debts and obligations, every one of us. But the world is an imperfect place ,and moral obligation is something that almost never enters into the decision matrix of our society's richest. Or the banking industry.

For them, the number one (and two, and three...) rule is that whatever is expedient and makes the most money is the right thing to do.

For the bottom 99%, it’s like playing with a stricter set of rules than your opponent: you’re not allowed to hit below the belt, and they’ve brought a baseball bat into the ring.

Note how this guy had to fight through his middle class conditioning before coming to a sense of peace over his decision to enter into a short sale on his house:
Sep 29, 2014

The closest I ever came to acting like a rich person was two years ago when I short-sold my primary residence. I might have been able to keep it but strategic default made life easier. I owed about $400,000 on a house that short-sold for $150K. The bank lost more than a quarter of a million dollars, and I lost at least $80K in down payment and property improvements.

I was taught growing up to “keep my word” and that your handshake “meant something.” Yet businessmen and individual wealthy people make decisions that are far less moral than a short sale. People “incorporate” so they can avoid legal responsibility for individual actions.

It works great. You can stiff creditors, declare bankruptcy, pollute daily and raid pensions to enrich individual executives. If it all goes wrong, like it has so often for Donald Trump, you can keep your mansions and individual fortunes.

I entered the shark-infested waters of high finance with a short sale. It was the worst ethical decision, but the finest, most profitable business moment, of my adult life. It was an informative, even transformative, experience.

This poor guy has a very bad case of ‘middle class morality’. It's a very real phenomenon. All our lives, we are all taught (programmed?) to stay within the true and narrow groove of middle class life, pay our bills, and be on the hook should things go awry.

Not everybody holds that view, however. As he continues in the piece, the author discovers something important along the way:
I always knew business was getting over on me, but I had no idea the extent until I started looking to short-sell. I first learned all I could aboutprivatehome financing. I called up some shady investment groups around town and questioned them at length. I didn’t end up using them, but they were frank, informative and unashamed.

“Who would pay 11 percent on a home loan?” I asked.

“Rich people,” said “Bill” from the legal loan-sharking company. “The rich have terrible credit.”

Rich people = bad credit: Just let that sink in.

Bill told me in roundabout ways that rich people never pay a bill if there is any way around it. If something goes wrong in an investment or a business, they always preserve their own assets first.
Rich people have terrible credit. They know that there’s a system and it has rules. And, for them, these rules can (and should) be optimized for their own benefit. So they do anything and everything that works to their advantage.

There’s a reason and a logic to that which I can appreciate, but it makes me wonder where the rest of us obtained our deep-seeded beliefs about duty and responsibility towards debts.

Similar to rich people, banks do not have any entangling moral restrictions on their behaviors. That absence allows them to get away with extraordinary misdeeds, none more obvious and damaging than those that the Federal Reserve has perpetrated on the nation, specifically, and the world, more broadly.

To understand why, we first have to discuss something called Financial Repression.

Financial Repression

In my recent interview with Daniel Amerman, to whom I will credit much of the concise thinking and for unearthing the sources that I will weave throughout the remainder of this piece (please read his excellent article on Financial Repression here), the truly immoral intent of the Fed's policies really sank in.

In response to the Fuzzy Numbers chapter (18) of the Crash Course, reader JBarney pondered the following:
Thanks for putting this update together. I think one of the problems is there are so many moving parts, so many manipulated numbers it is difficult to get a clear picture. The way it is organized here is helpful.

However,I can't help but wonder about all of the implications of these numbers for the real economy and people's lives. One of the sections which really hits home was the impact inflation has on all of this. If these are the numbers now, what will it be like when things really start to change?
The answer is that while inflation always steals from savers, it really does its dirty work when the central bank and government conspire to create a condition of pervasive and unavoidable negative real interest rates.

This is the heart of Financial Repression: an environment in which you literally cannot save money without paying a penalty.

The main takeaway of Chapter 18 on Fuzzy Numbers is not that the government fibs a little now and then (okay,all the time) merely because that's politically expedient, but it does so in service to a larger and more pernicious aim: forcing people to accept an inflation rate that is higher than either their income growth and/or the market's safe rate of return.

As soon as you are locked into a negative interest rate regime, your capital is losing purchasing power. But simple accounting rules dictate that loss of wealth had to go somewhere. So where did it go? To somebody else.

Negative real interest rates transfer money from every saver to every over-extended borrower. This is especially true with the government (largely because of its special revolving door relationship with the Fed, which both issues the money out of thin air and then buys government debt forcing rates into negative territory).

It's really that simple. The Fed has openly and actively suppressed rates -- not to help the credit markets, as they claim, but to engineer a condition of Financial Repression. Because that's what the government needs to stealthily take your wealth to pay down the prior debts it accumulated.

Thus 'negative real rates' are the essential component of transferring wealth from the many to the few, with the 'few' being defined as the government, Wall Street, and others who exploit leverage and liabilities at sufficient scale to be on the right side of that wealth transfer.

This well-known phenomenon is a thoroughly accepted and well-described practice of governments and central banks everywhere. One of the better descriptions of it comes to us courtesy of the BIS in this working paper published in 2011.
From the abstract:
Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts.

A subtle type of debt restructuring takes the form of “financial repression.”

Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks.

In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s.

Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. 
Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation.

Inflation need not take market participants entirely by surprise and, in effect,it need not be very high(by historic standards).

For the advanced economies in our sample, real interest rates were negative roughly ½ of the time during 1945-1980. For the United States and the United Kingdom our estimates of the annual liquidation of debt via negative real interest rates amounted on average from 2 to 3 percent of GDP a year.
Let me decode that.
  • Step 1: Governments get into trouble by borrowing too much.
  • Step 2: Rather than pay this down honestly via cutting spending (unpopular) or by defaulting (even more unpopular), the government conspires with the central bank to slowly liquidate the stack of obligations by forcing negative real interest rates on everyone.
  • Step2bHang on one second...it wouldn’t work if people could dodge the Financial Repression, so a ring fence has to be built out of capital controls and explicit rate caps on and across the whole spectrum of interest-bearing securities.
  • Step 3: Sit back and wait for everyone with savings to contribute their purchasing power to those who issued the debts, be those public or private entities.
And this is exactly what has happened. All of the talk about the Fed focusing on unemployment or inflation or whatever are red herrings. What the Fed is really trying to do is to create a set of macro conditions that will allow the federal government to slowly crawl out from under a pile of debt and entitlement obligations that it literally can not pay by honest, above board means.

I guess if we were to imagine a "Step 4" in the above process, it would be to wait for the head of the central bank to come out and deliver a speech in which she expresses a grandmotherly concern for the wealth gap that naturally results from all this, but to deflect attention away from this being a direct and understood consequence of the Fed's intentional goal of financial repression and towards some failure on the part of those who have been targeted to donate to the cause of bailing out the profligate and rewarding the borrowers.

Oh, wait. That did just happen. Here it is, Step 4, courtesy of Janet Yellen last week:

Federal Reserve Chair Janet Yellen on Friday expressed deep concern over widening economic inequality in the country and called for tackling issues such as early childhood education and encouraging entrepreneurship to help narrow the gap.

[Comment:Oh boy...must contain my emotions...did she really just deflect the consequences of the Fed's policy of financial repression towards 'early childhood education? Yep. That's like a burglar saying that we need to invest in better metallurgical processes as the means of preventing doors from being kicked in so easily.]

In a speech at the Federal Reserve Bank of Boston, Yellen said steady growth in inequality over the past several decades represents the most sustained rise since the19thcentury.Living standards for most Americans have been “stagnant,” while those at the very top have enjoyed significant wealth and income gains, she said.

[Comment: Glad the Fed finally noticed that those at the very top have been making out like bandits! This was something I said explicitly would happen as a consequence of future Fed printing back in 2008 in the Crash Course, before the printing even started. How is it that I knew that this would happen back in 2008 and the Fed is just now noticing this observationally? Is my research department better than theirs? In fact this is a very well known and easy to understand process. That the Fed is feigning ignorance speaks volumes about how ignorant they believe we all are. This is a sure sign that we are trapped in a dysfunctional relationship with an abusive partner.]

“I think it is appropriate to ask whether this trend is compatible with values rooted in our nation’s history,among them the high value Americans have traditionally placed on equality of opportunity,” Yellen said in prepared remarks.

[Comment: Once we accept that the Fed is openly and specifically creating the wealth gap as a matter of active and ongoing policy, which it is, then it's actually more appropriate to ask if the Federal Reserve is compatible with values rooted in our nation's history. The answer, obviously, is "no."]

The problem of inequality is an unusual topic for the leader of the Fed, if only because the central bank’s ability to address the issue is limited.

[Comment: Stop right there Washington Post! You've just inserted an assertion that might as well have come straight from a PR press release from the Fed. I, for one, refuse that claim and reject it completely right here and on grounds that hardly have to be substantiated, but I will just for fun. When the Fed buys 'assets' (really debt instruments) from major financial firms using freshly printed money they are,by definition, buying those assets at steadily increasing prices which means that those who hold the largest amounts of these assets get the richest. When the Fed secondarily targets the stock market as something to 'go up' and the top 5% own 82% of all stocks, then the Fed's role is anything but 'limited.' It is direct and proportional and they are 100% responsible for any and all gains that accrue to the top via the 'miracle' of asset inflation. Period. End of story. See also any of the innumerable charts plotting the S&P 500's rise along with the growth in the Fed balance sheet for further confirmation. Sorry Washington post, assertion denied!!]

Yellen listed four factors that can influence economic opportunity: investing in education for young children, making college more affordable, encouraging entrepreneurship and building inheritance.

[Comment:OMG. She just blamed the victims and did it in a very let them eat cake kind of way. How aggravating(!). According to Yellen, if people are finding themselves getting poorer what they need to do is stop scrimping on their kids, become an entrepreneur and then somehow go back in time and have rich parents. This statement of hers calls for pitchforks and torches. Literally. Without a shred of decency, she has shifted all blame from the Fed to the victims. How corrupt or morally adrift does someone have to be to blame their victims? In a criminal case this would be used as evidence of sociopathic if not psychopathic behavior and used by a prosecutor to call for a maximum sentence to prevent a dangerous individual from running loose in society. And rightly so. Such individuals are poor prospects for rehabilitation.]

Yellen did not address in her prepared text whether the Fed has contributed to inequality.

[Comment:No surprise there. Ted Bundy never acknowledged the harm he caused either.]
At this point, based on Yellen's testimony, I think it's time to say what everybody is already thinking: the Fed Chairwoman is literally displaying psychopathic tendencies by blaming her victims. I'm serious: if the Fed were an individual, we’d have no problem identifying its behaviors in psychologically pathological terms.

I understand that some, or perhaps many, will excuse this last point by saying that the Fed cannot possibly state the truth because doing so would create loss of confidence or public anger. But I submit that the so-called "white lie" defense is utter nonsense.

A greater harm is done by lying than by telling the truth. You can get away with small lies for a while, but they never actually go away, they just sit there corrosively undermining the very foundation of trust upon which civilized society rests. Large lies just do more damage over a shorter period of time, and that’s exactly where we are today. This explains much in terms of people’s general sense of unease despite an apparently reasonable economy and awesome living standards (by any historical measure).

Here's what truth would sound like if I were to re-write Yellen's speech:
My fellow Americans. Decades of poor fiscal restraint and accommodative monetary polices have brought us to an uncomfortable juncture.

My intention today is not to cast blame – there will be plenty of time for that later – but to take stock of where we are so that we can all decide on the best course forward, openly and honestly, as should be the case in a democracy.

There are no easy choices at this point, only a rather poor range of options spanning from somewhat unpleasant to potentially catastrophic.

The heart of the matter is simply this: the US government has built up an extraordinary amount of public debt, and an even larger pile of unfunded liabilities.

There’s simply no way for those to all be paid back under current terms. And given recent trajectories in play with respect to economic growth and deficit spending patterns, those debts and liabilities are only growing larger with time.

Quite simply our choices are these:
  1. Pay down the debt by taking in more revenue than expenses. This is also known as austerity and given the size of the debts and other obligations, several decades of severe belt tightening would be required. This program would be extremely painful for nearly everybody and would require massive tax hikes coupled to major spending cuts.
  2. Default on the debts and obligations. This simply means not paying people, investors, institutions and countries what we have promised to pay. Down this path lies the potential for massive destruction of our financial and political systems, so we have chosen to not entertain this path any further than to mention it exists.
  3. Do nothing and wait for a fiscal and monetary accident to happen. This is a guaranteed disaster that could result in the sudden and permanent decline of opportunity in this country that would be so painful we cannot even predict the possible outcomes.
  4. Engineer conditions where negative real rates of interest slowly allow the government’s obligations to fall relative to inflation. Over the span of decades this is the least painful route and our country has been down this path before.
We’ve selected path #4 as the least bad option. Since 2009 our policies have been geared towards #4 and we see no alternative besides staying on that path for as long as necessary. The alternative is the literal bankruptcy of our nation and we cannot and will not allow that to happen. Not on our watch.

While path #4 is the least objectionable of them all, it comes with its own share of unfortunate consequences and injustices. At its heart, negative real interest rates are an effective tax on savers and those whose incomes fail to keep pace with the inflation we are creating as an overt act of policy. This generalized and widespread loss of purchasing power takes a little bit from everyone, rather than a lot from a few systemically important institutions such as your federal government, which spreads the pain widely, and therefore causes the least disruptions to our daily lives.

Path #4 has a name: Financial Repression. This policy combines negative real interest rates with various forms of capital controls and tax policy to assure that nobody can evade it.

Obviously this is not fair, nor is it in alignment with our national narrative of prudence and hard work being rewarded because, truth be told, it rewards the profligate and those who produce nothing of real value but can play the game of high finance well. Yet here we are without any better options before us, and so we reluctantly chose Financial Repression.

One other distasteful ‘feature’ of the program of financial repression we’ve been putting you all through is that the rich get richer. Until or unless there is a massive change to the taxation and wealth re-distribution programs of the federal government, the Federal Reserve’s program of Financial Repression will continue to deliver an ever-larger gap between the wealthy and everyone else.

Such is the nature of the compounding function combined with the inequity of who gets first access to the newly created funds we make available in order to drive the interest rate curve into negative territory.

Are there any risks to this program? Well, the largest of them really needs to be discussed. Financial Repression has worked in the past, but it has only worked because we experienced both inflation and economic growth in equal measures.

Today, for reasons that we are still studying, neither the wage growth necessary to incite the sort of inflation we need nor economic growth have arrived as we thought they would.

If economic growth does not return, then the entire program of financial repression could well fail, and fail spectacularly. Everything depends on a return of economic growth sufficient to service the vast increases in debts that will result from the program.

But if that growth does not materialize? If the world is now stuck in a ‘New Mediocre’ of low growth then one risk is the possibility of a crisis that will be rooted in a permanent loss of confidence in debts of all forms, but government debt specifically. Down that road lie currency crises, and a wide variety of related financial upheavals the final result of which is what most will experience as a massive destruction of wealth.

We are working hard to assure that these risks are well contained, but you should be aware that they exist

After all, this is all of our futures that we are experimenting with and we do not have a playbook that we can follow here in 2014. We are in wholly uncharted territory. The exact arrangement of conditions we see across the global landscape is brand new.

We’re sorry to have to be in the position of engineering Financial Repression, but we felt there were no other options before us and we hope that you agree that a slight yearly discomfort to almost everyone is preferable to a major disruption to our way of life, our political system, and the possibility of worse things.

Is this fair? No. Was it avoidable? Yes. Is there anything we can be doing differently today? Not that we are aware of. The choices are between bad, worse and utterly terrible. We're choosing the bad path, and we hope you’ll agree that this is the best we can do at this point.

But you deserve the truth because it’s already completely obvious and available for anybody with access to a computer. Since we are all in this together and we’re all being asked to sacrifice in some way, it's much better that we all agree on the treatment plan.

It’s not a perfect plan, far from it. But considering the alternatives, this is the best one on the table.

If you want to make it more fair, more equitable, and with an eye towards building to a future in which we can all share some hope, you’ll need to turn to your policy makers and ask them to work from the fiscal side to correct what they can. Without a profound realignment of priorities, we’ll just get more of the same and, truth be told, eventually more of the same turns into a fiscal and monetary disaster about which nothing can be done except absorb the pain and loss that it will bring.


Context is everything. The growing gap between the very wealthy and everyone else is a consequence of Fed policy.

Whether you decide to be shocked, angry, or scared by Janet Yellen’s recent speech is up to you. Personally, I'm pissed off at being lectured to that falling further behind the super wealthy is my fault for not investing enough in my kids, not being entrepreneurial enough, and not having wealthy parents.

That level of ‘blame the victim’ is psychopathic, utterly appalling, and I reject it on every level. Worse, the level of trust destruction that happens with such a tone-deaf speech stains our entire national leadership. It is the modern version of Let them eat cake.

Once an institution, be it royalty of old or the Fed today, gets so far off the rails that they cannot locate their own role in the misery they see around them, it’s a sign of a huge problem for that society.

Ms. Yellen should not be allowed by anyone to get away with such a patently and provably false set of arguments. She should have been soundly booed off the stage and the President should be asking for her resignation immediately.

But we’re so far down the rabbit hole that almost nobody blinked an eye at the speech, and thought it perfectly normal.

For you personally, you need to be aware that the debts, deficits and liabilities across the entire OECD world are continuing to grow at a far faster pace than GDP, and far faster than oil production and discoveries of low-cost oil reservoirs (those schooled in net energy understand this to be the real issue), and that the most likely outcome, someday, will be an extraordinary financial accident.

It will be called something else -- a period of wealth destruction -- but for those who can see it coming, it will actually be period of massive wealth transfer.

And we'll keep up our efforts on how to see clearly amidst the intentional obfuscation, to help those aware to the situation avoid ending up on the wrong side of that transfer.

October 22, 2014

19 Very Surprising Facts About The Messed Up State Of The U.S. Economy

Barack Obama and the Federal Reserve are lying to you.  The "economic recovery" that we all keep hearing about is mostly just a mirage.  The percentage of Americans that are employed has barely budged since the depths of the last recession, the labor force participation rate is at a 36 year low, the overall rate of homeownership is the lowest that it has been in nearly 20 years and approximately 49 percent of all Americans are financially dependent on the government at this point.  In a recent article, I shared 12 charts that clearly demonstrate the permanent damage that has been done to our economy over the last decade.  The response to that article was very strong.  Many people were quite upset to learn that they were not being told the truth by our politicians and by the mainstream media.  Sadly, the vast majority of Americans still have absolutely no idea what is being done to our economy.  For those out there that still believe that we are doing "just fine", here are 19 more facts about the messed up state of the U.S. economy...

#1 After accounting for inflation, median household income in the United States is 8 percent lower than it was when the last recession started in 2007.

#2 The number of part-time workers in America has increased by 54 percent since the last recession began in December 2007.  Meanwhile, the number of full-time jobs has dropped by more than a million over that same time period.
#3 More than 7 million Americans that are currently working part-time jobs would actually like to have full-time jobs.

#4 The jobs gained during this "recovery" pay an average of 23 percent less than the jobs that were lost during the last recession.

#5 The number of unemployed workers that have completely given up looking for work is twice as high now as it was when the last recession began in December 2007.

#6 When the last recession began, about 17 percent of all unemployed workers had been out of work for six months or longer.  Today, that number sits at just above 34 percent.

#7 Due to a lack of decent jobs, half of all college graduates are still relying on their parents financially when they are two years out of school.

#8 According to a new method of calculating poverty devised by the U.S. Census Bureau, the state of California currently has a poverty rate of 23.4 percent.

#9 According to the New York Times, the "typical American household" is now worth 36 percent less than it was worth a decade ago.

#10 In 2007, the average household in the top 5 percent had 16.5 times as much wealth as the average household overall.  But now the average household in the top 5 percent has 24 times as much wealth as the average household overall.

#11 In an absolutely stunning development, the rate of small business ownership in the United States has plunged to an all-time low.

#12 Subprime loans now make up 31 percent of all auto loans in America.  Didn't that end up really badly when the housing industry tried the same thing?

#13 The average cost of producing a barrel of shale oil in the United States is approximately 85 dollars.  Now that the price of oil is starting to slip under that number, the "shale boom" in America could turn into a bust very rapidly.

#14 On a purchasing power basis, China now actually has a larger economy than the United States does.

#15 It is hard to believe, but there are 49 million people that are dealing with food insecurity in America today.

#16 There are six banks in the United States that pretty much everyone agrees fit into the "too big to fail" category.  Five of them have more than 40 trillion dollars of exposure to derivatives.

#17 The 113 top earning employees at the Federal Reserve headquarters in Washington D.C. make an average of $246,506 a year.  It turns out that ruining the U.S. economy is a very lucrative profession.

#18 We are told that the federal deficit is under control, but the truth is that the U.S. national debt increased by more than a trillion dollars during fiscal year 2014.

#19 An astounding 40 million dollars has been spent just on vacations for Barack Obama and his family.  Perhaps he figures that if we are going down as a nation anyway, he might as well enjoy the ride.

If our economy truly was "recovering", there would be lots of good paying middle class jobs available.

But that is not the case at all.

I know so many people in their prime working years that spend day after day searching for a job.  Most of them never seem to get anywhere.  It isn't because they don't have anything to offer.  It is just that the labor market is absolutely saturated with qualified job seekers.

For example, USA Today recently shared the story of 42-year-old Alex Gomez...
"I've had to seriously downgrade my living situation," said Alex Gomez, a 42-year-old with a master's degree in entrepreneurship. Gomez lost his last full-time job in 2009 and has been looking for work since a short-term contract position ended in 2012. 
Gomez's home was foreclosed on, so the Tampa resident lives with three roommates in a college neighborhood. He drained his 401(k) trying to save his house, and he has around $150,000 in student loans. His mother is tapping her 401(k) to pay his rent. Gomez subsists on that and about $200 a month in food stamps. 
"I have been applying and looking for pretty much anything at this stage," he said. Although he's looking for work in engineering or data management, "I applied to a supermarket as a deli clerk because I used to be a deli clerk as a teenager," he said. He was told he was overqualified and turned down.
Does Alex Gomez have gifts and abilities to share with our society?
Of course he does.

So why can't he find a job?

It is because we have a broken economy.

We are in the midst of a long-term economic decline and the system simply does not work properly anymore.

And thanks to decades of very foolish decisions, this is only the start of our problems.
Things are only going to get worse from here.

October 21, 2014

Goldman Makes It Official That the Stock Market is Manipulated, Buybacks Drive Valuations

It’s remarkable that this Goldman report, and its writeup on Business Insider, is being treated with a straight face. The short version is current stock price levels are dependent on continued stock buybacks. Key sections of the story:
Goldman Sachs’ David Kostin believes a temporary pullback may explain why the S&P 500 has tumbled from its all-time high of 2,019 on Sept. 19. 
“Most companies are precluded from engaging in open-market stock repurchases during the five weeks before releasing earnings,” Kostin notes. “For many firms, the beginning of the blackout period coincided with the S&P 500 peak on September 18. So the sell-off occurred during a time when the single largest source of equity demand was absent. Buybacks dip during earnings reporting months, which have seen 1.2 points higher realized volatility than in other months during the past 25 years.”… 
“We expect companies will actively repurchase shares in November and December,” he writes. “Since 2007, an average of 25% of annual buybacks has occurred during the last two months of the year.”

 Notice how the bulk of buybacks are concentrated in the fourth quarter, with the obvious intent of goosing prices at year end so as to lead to higher executive pay for “increasing shareholder value”? In fact, these companies are being gradually liquidated. Issuing debt, which public companies have done in copious volumes since the crash, and using it to buy shares is dissipating corporate assets. They are over time shrinking their businesses. That is also reflected in aggressive headcount cuts and cost-saving measures. Even though analysts like to tout the cash that companies have sitting on their balance sheets as a source of potential investment, as we’ve discussed in previous posts, public companies are so terrified of even a quarterly blip in earnings due to incurring expenses relating to long-term investments that they’d rather do nothing, or go the inertial path of cutting costs to show higher profits.

But with borrowing the big source of this corporate munificence to the share-owning classes, this is a self-limiting game. But the end game could be a long time in coming. First, you have economists who believe that the stock market directly drives consumer spending, echoing the Fed’s confidence in the wealth effect. For instance, see this argument from Roger Farmer (hat tip Bruegel blog):
There is a close relationship between changes in the value of the stock market and changes in the unemployment rate one quarter later. My research here, and here shows that a persistent 10% drop in the real value of the stock market is followed by a persistent 3% increase in the unemployment rate. The important word here is persistent. If the market drops 10% on Tuesday and recovers again a week later, (not an unusual movement in a volatile market), there will be no impact on the real economy. For a market panic to have real effects on Main Street it must be sustained for at least three months.
Yves here. The problem is that correlation is not causation. Significant and sustained stock market declines are almost always the result of Fed tightening. The usual lag between an interest rate cycle turn and a stock market peak historically was roughly four months, but in our new normal of seemingly permanent heavy-duty central bank meddling, old rules of thumb are to be used with great caution. Nevertheless, Greenspan was obsessed with what drove stock prices, and the Fed is unduly solicitous of asset price levels, no doubt because people like Janet Yellen have to leave their DC bubble in order to meet actual unemployed people.

Mike Whitney reminds those who manage to miss it that the Fed is so concerned about the actual and psychological impact of stock market prices that it immediately talked investors into getting back into the pool when the market started misbehaving badly last week. From Counterpunch:
For those readers who still think that the Fed doesn’t meddle in the markets: Think again. Friday’s stock surge had nothing to do with productivity, price, earnings, growth or any of the other so called fundamentals. It was all about manipulation; telling people what they want to hear, so they do exactly what you want them to do. The pundits calls this jawboning, and the Fed has turned it into an art-form. All [St. Louis Fed President James] Bullard did was assure investors that the Fed “has their back”, and , sure enough, another wild spending spree ensued. One can only imagine the backslapping and high-fives that broke out at the Central Bank following this latest flimflam…. 
It’s too bad the Fed can’t put in a good word for the real economy while they’re at it. But, oh, I forgot that the real economy is stuffed with working stiffs who don’t warrant the same kind of treatment as the esteemed supermen who trade stocks for a living. Besides, the Fed doesn’t give a rip about the real economy. If it did, it would have loaded up on infrastructure bonds instead of funky mortgage backed securities (MBS). The difference between the two is pretty stark: Infrastructure bonds put people to work, circulate money, boost economic activity, and strengthen growth. In contrast, MBS purchases help to fatten the bank accounts of the fraudsters who created the financial crisis while doing bupkis for the economy. Guess who the Fed chose to help out? 
Do you really want to know why the Fed isn’t going to end QE? Here’s how Nomura’s chief economist Bob Janjuah summed it up: 
“I want to remind readers of a message that may be buried in the past: When QE1 ended, the S&P 500 fell just under 20% in a roughly three-month period before the QE2 recovery. 
When the QE2 ended, the S&P 500 fell about 20% in a three-month period before the next Fed-inspired bounce (aided by the ECB). QE3 is ending this month…” 
Is that why the Fed started jawboning QE4, to avoid the inevitable 20 percent correction?
Whitney continues with one of our favorite tropes: that all QE has done is elevate asset prices. That has not led to a recovery in anything much beyond the balance sheets of the top cohorts and the income of the top 1%. Even worse, it has provide cover for the Administration falling in with investor-favoring austerity, in the form of reducing deficit spending when it ought to be increasing it to take up the considerable and costly slack in the economy.

It’s not surprising to see the Fed double down on a failed strategy. The central bank had apparently finally recognized in 2013 that QE was not helping the real economy, and they needed to exit the policy to reduce the resulting economic distortions. But they lost their nerve during last summer’s taper tantrum, and turned cowardly again in response to a mere stock market hissy fit.

The Fed believes that what is good for the wealthy is good for the US, and that when they are in danger of suffering financially, the central bank should break glass and administer monetary relief. Even though the Fed may think it is serious about ending QE and eventually raising rates, as they say in Venezuela, “They have changed their minds, but they have not changed their hearts.”

October 20, 2014

Updated Secret Trans-Pacific Partnership Agreement (TPP)

WikiLeaks has released a second updated version of the Trans-Pacific Partnership (TPP) Intellectual Property Rights Chapter. The TPP is the world's largest economic trade agreement that will, if it comes into force, encompass more than 40 per cent of the world's GDP. The IP Chapter covers topics from pharmaceuticals, patent registrations and copyright issues to digital rights. Experts say it will affect freedom of information, civil liberties and access to medicines globally. The WikiLeaks release comes ahead of a Chief Negotiators' meeting in Canberra on 19 October 2014, which is followed by what is meant to be a decisive Ministerial meeting in Sydney on 25–27 October.

Despite the wide-ranging effects on the global population, the TPP is currently being negotiated in total secrecy by 12 countries. Few people, even within the negotiating countries' governments, have access to the full text of the draft agreement and the public, who it will affect most, none at all. Large corporations, however, are able to see portions of the text, generating a powerful lobby to effect changes on behalf of these groups and bringing developing country members reduced force, while the public at large gets no say.

Julian Assange, WikiLeaks' Editor-in-Chief, said:
The selective secrecy surrounding the TPP negotiations, which has let in a few cashed-up megacorps but excluded everyone else, reveals a telling fear of public scrutiny. By publishing this text we allow the public to engage in issues that will have such a fundamental impact on their lives.
The 77-page, 30,000-word document is a working document from the negotiations in Ho Chi Minh City, Vietnam, dated 16 May 2014, and includes negotiator's notes and all country positions from that period in bracketed text. Although there have been a couple of additional rounds of talks since this text, little has changed in them and it is clear that the negotiations are stalling and that the issues raised in this document will be very much on the table in Australia this month.

The last time the public got access to the TPP IP Chapter draft text was in November 2013 when WikiLeaks published the 30 August 2013 bracketed text. Since that point, some controversial and damaging areas have had little change; issues surrounding digital rights have moved little. However, there are significant industry-favoring additions within the areas of pharmaceuticals and patents. These additions are likely to affect access to important medicines such as cancer drugs and will also weaken the requirements needed to patent genes in plants, which will impact small farmers and boost the dominance of large agricultural corporations like Monsanto.

Nevertheless, some areas that were highlighted after WikiLeaks' last IP Chapter release have seen alterations that reflect the controversy; surgical method patents have been removed from the text. Doctors' groups said this was vitally important for allowing doctors to engage in medical procedures without fear of a lawsuit for providing the best care for their patients. Opposition is increasing to remove the provision proposed by the US and Japan that would require granting of patents for new drugs that are slightly altered from a previous patented one (evergreening), a technique by the pharmaceutical industry to prolong market monopoly.

The new WikiLeaks release of the May 2014 TPP IP text also has previously unseen addendums, including a new proposal for different treatment for developing countries, with varying transition periods for the text to take force. Whilst this can be viewed as an attempt to ease the onus of this harsh treaty on these countries, our diplomatic sources say it is a stalling tactic. The negative proposals within the agreement would still have to come into force in those countries, while the governments that brought them in would have changed.

Despite the United States wanting to push to a resolution within the TPP last year, this bracketed text shows there is still huge opposition and disagreement throughout the text. At this critical moment the negotiations have now stalled, and developing countries are giving greater resistance. Despite the huge lobbying efforts, and many favorable proposals for big pharmaceutical companies, they are not getting entirely what they wish for either. Julian Assange said:

The lack of movement within the TPP IP Chapter shows that this only stands to harm people, and no one is satisfied. This clearly demonstrates that such an all-encompassing and divisive trade agreement is too damaging to be brought into force. The TPP should stop now.
Current TPP negotiation member states are the United States, Japan, Mexico, Canada, Australia, Malaysia, Chile, Singapore, Peru, Vietnam, New Zealand and Brunei.

October 17, 2014

Impact of FATCA – and the Case for Physical and Regional Diversification

The height of idiocy: US Government hijacks the whole Swiss banking system ... True story ... One of our SMC members just received a package from HSBC giving him and his wife a deadline to comply with FATCA—US' global tax law ... Suddenly they had just four weeks to prove that they were not US taxpayers, all because at one point they had purchased a service that gave them a US phone number. And now they, as Canadian citizens and residents, have to submit a fully completed W8BEN IRS form, along with a government issued photo ID and a detailed letter of explanation to make it very clear that they were not in fact Americans. – Sovereign Man 

Dominant Social Theme: There's no problem with FATCA – and there are reasons these rules have been put in place.

Free-Market Analysis: This article is a strongly worded warning about negative ramifications regarding FATCA.

As such, it's a bracing affirmation of the kind of sensible reporting that circulates on the Internet beyond the filters of mainstream media. It also provides us with yet more reasons to consider prudent diversification – physically and regionally as well as from an asset class standpoint. More on that below.

Certainly, it is unfortunate that FATCA is not a continued subject of discussion by the mainstream Western media given the impact that it will likely have on banks around the world as well as US expats and others who wish to hold overseas assets. GATCA, upcoming, holds the prospect of even more harm, but we'll leave that for another day.

Mainstream reporting regarding FATCA was wretched at the outset and has not improved with age. In fact, many Western outlets tend to ignore the subject entirely, which is odd given FATCA's worldwide impact.

Here's an excerpt from a FATCA supplement posted earlier this year at the Washington Post. It is written from the point of view apparently of Chinese government officials and is entitled, "China, US pact to curb offshore tax evasion."

The agreement between China and the United States for US financial accounts registered at banks in China to send their tax reports to the US Internal Revenue Service (IRS) to curb offshore tax evasion will have positive effects for China, experts said.

The agreement will also enable Beijing to obtain information on mainland taxpayers in the US to help fight against tax evasion and corruption. 

"No doubt, the news is positive and will aide China's anti-corruption efforts in its financial institutions," said Zeng Zhaoning, an economist at Xi'an Shiyou University, in a June 29 report by Huashang Daily, which is based in Shaanxi province. "The wealthy in China are obtaining foreign nationalities for their children and spouses to illicitly transfer income to foreign financial institutions in an attempt to escape tax reviews by the Chinese government." 

Beijing Economic Research Institute Chairman Gong Chengyu said that overall, Chinese citizens in the United States have more accounts than US citizens in China, "so in the long run, it is more beneficial for China". 

Under the agreement announced on June 26 by the US Treasury, US financial accounts will report their taxes directly to the Chinese government, which will then file them to the IRS. In the past, the accounts were only required to be reported to the foreign country's government. 

The two countries agreed on the terms, but are reviewing before officially signing it. The new agreement will remove the threat of blacklisting or penalties that have been hanging over Chinese financial institutions, including institutions in Hong Kong, the US and other subsidiaries in the Chinese mainland. 

The US government's implementation of the 2010 Foreign Account Tax Compliance Act (FATCA) is to curb offshore taxes that were previously not reported. Around 80,000 banks and other financial institutions have agreed to start reporting to the IRS on US-owned foreign accounts by July 1. 

While this was announced as a paid supplement, it has the hallmarks of much mainstream reporting regarding FATCA. It emphasizes the determination to catch tax evaders and positions FATCA as a necessary attempt to do so. The larger ramifications are downplayed or not brought up at all.

Yet, as the recent post at the international 'Net publication Sovereign Man (excerpted above) shows clearly, the ramifications of this invasive and comprehensive law have yet to be fully explored.

Here's more:

It used to be that foreigners were vying to become US citizens, but today they're begging not to be confused as one. In aiming to make itself the warden of the world, the US government has become very comfortable with reaching beyond its borders. 

Historically, the pursuit of global dominance involved taking over others' territories with guns blazing. Today, there's more finesse, but the intentions are the same. FATCA, the new Manifest Destiny, is probably the most arrogant piece of legislation ever enacted, at least in modern times. 

Assuming that the entire world should be subject to its own arcane and excessive tax legislation, FATCA requires foreign banks to sabotage their relationships with their clients and breach their own privacy standards to comply with the US government's will. 

This overreaching piece of legislation demands that they reveal the information of US citizens with accounts over $50,000. Otherwise the banks will be frozen out of the US banking system and slapped with a 30% withholding tax—effectively killing their business. Those that resist can even face criminal charges. ... 

This is the economic equivalent of a military occupation. Between compliance documentation, and facing massive fines and potential criminal charges, it's no mystery as to why foreign financial institutions are going out of their way to avoid US customers. 

And increasingly they're looking for alternatives to the whole system as well. If you're a foreign bank that gets reminded constantly of the potential penalties, breaches and charges that you could face simply for doing business, it's only prudent that you hedge your bets and look to minimize your exposure to the US dollar and the US banking system. 

The US thus just continues to shoot itself in the foot. 

We beg to differ only with this last point. From the creation of the BRICS (by Goldman Sachs) to the explosion of fracking technology to expansive African and Middle East warring and Keynesian monetary stimulation (that benefits mostly investors rather than workers), we're fairly convinced that there are other agendas at work.

We've expressed this in the past. It seems to us that the Anglosphere itself is being hollowed out; many productive businesses, for instance, have already moved to Asia and China. In fact, Asia is being touted as the next industrial breadbasket of the world.

A coincidence? FATCA is not surely not "just" bad or invasive legislation. It has the additional impact of making US institutions and even the US dollar itself objects of intense concern on a global scale.

It all may add up to a kind of campaign against US interest and the dollar – a campaign that will result in the creation of a more international monetary system including a global regulator, global taxes and global trading marts.

One could even speculate that the sudden enthusiasm for cannabis legalization is in part intended to provide international agencies with more credible taxing authority. In any event, Sovereign Man is correct: Diversification these days involves more than asset classes. It also involves physical regions.

The Daily Bell has posted several reports and editorials about this recently – with a special focus on Colombia. As it so happens, an airline travel magazine – American Way – recently published an extraordinary article on Colombia as an "inviting tourist destination." You can read the whole article here.

Here's an excerpt.

Colombia has become an inviting tourist destination and the toast of South America ... If you were prone to understatement, you might say that Colombia has had something of an image problem for most of the last 50 years. With the country variously divided by political strife, torn apart by guerrilla warfare and terrorized by drug traffickers, it seemed until recently that Colombia's biggest export was the steady stream of dark headlines it supplied to the global press. What a difference a decade makes. 

Since former President Álvaro Uribe ­disarmed paramilitary forces, cracked down on the drug trade and pushed leftist ­guerrilla groups to the far corners of the country, ­Colombia has been radically transformed. Today, the economy is the only thing that is going boom, as it outpaces that of the United States. Foreign investment last year was up twelvefold from a decade ago, to $12 billion, and the number of international tourists has more than tripled in the last decade. Not surprisingly, the outlook of Colombians has risen right along with their fortunes; they were ranked as the happiest people on the planet in 2012 and 2013 in polls conducted by the WIN Gallup International Association. 

Evidence of this new feel-good era is on display most anywhere you look in Bogotá, but I see it first at my hotel — the achingly trendy new Click Clack, a 60-room haven of hip in the city's affluent northern reaches that has become a beacon to the city's smart set. Here, on any night of the week, you can find a parade of chic, young and young-at-heart Bogotanos exiting their shiny new ­Rovers and BMWs to descend the sleek lobby staircase to the buzzy restaurant downstairs or to catch the elevator up 10 stories to the Apache Rooftop Bar, the rollicking nightclub where they stand packed shoulder-to-shoulder sipping cocktails to a pulsing backbeat spun out by a disc jockey into the early-morning hours. 

"I'm very proud of my country, because after 45 years of violence, everybody is pushing hard to show the better side of ­Colombia — who we really are," says Juan Felipe Cruz, the hotel's 31-year-old co-owner, over a sublime plate of cured salmon with crème fraîche and under a matte-black chandelier of an inverted coffee cup the size of a VW Beetle. "In 2001, my father told me there was no future for me here and sent me to Switzerland," Cruz says. "He'd been kidnapped by guerrillas and had suffered a lot. Now, he says he lives in a country he's never seen. It's true: Colombia today is another country."

... In the early 1990s, medellín was a city terrorized by drug traffickers and had the highest homicide rate in the world. But in the 21 years since police shot cocaine kingpin Pablo Escobar dead on the roof of his ­Medellín hideout, violent crime has ­plummeted and the city has transformed itself into a ­marvel of modernity. It has a spotless public-transportation system of cable cars and trains that run with Swiss efficiency, ­world-class museums, restaurants and shopping, and last year it beat out New York and Tel Aviv, Israel for the "City of the Year" title bestowed by the Urban Land ­Institute, ­Citigroup and The Wall Street Journal. Throw in an average annual temperature of 72 ­degrees and a stunning setting on the verdant slopes of the central Andes and you can see why the locals, who have a deserved reputation for their fierce civic pride, crow that there's no place on Earth they'd rather be. 

... On my last night in Colombia, I return to Bogotá and am invited to the opening of ­Cacio & Pepe, a new Italian restaurant where young professionals fill the red ­banquettes and crowd the parquet floors. I remark to designer Laura Urrutia and her husband, Felipe Boshell, my hosts, that I've rarely encountered a people as welcoming as Colombians. "We have a happy culture and an innocent culture in spite of our problems," Felipe says. "We give visitors a warm welcome because we were isolated from the world for so long. Colombia is such a well-kept secret that we're just really glad they're here!" 

Conclusion In this era when geopolitics is increasingly confusing and dangerous, regional – physical diversification – is surely as important as asset diversification. Please conduct your own due diligence, of course. You may wish to consider Colombia as you do.