August 31, 2012

What To Expect From Bernanke At J-Hole

Expectations for tomorrow's J-Hole speech by the venerable Ben Bernanke vary from the mundane "things-we-can-still-do; monitoring-situation" to the exuberant "we'll-print-our-way-out-of-this-mess-no-matter-what-and-I've-got-your-back-for-anything-more-than-a-1%-drop-in-the-Russell". We suspect, like Morgan Stanley's Vince Reinhart that a lot of people are going to be grossly disappointed as the FOMC (C for Committee) meeting is so close and the election being just around the corner means playing-down any miracle-making. Instead we suspect it will be more of the same - disappointment in economic performance, could do better, closely monitoring, Fed-has-tools; i.e. a replay of most of his recent speeches in tone. Reinhart does see some room for surprise though - especially on conditional policy rules (and the potential problems with over-reaching their mandate).

Vincent Reinhart, Morgan Stanley: The Message from the Mountains

We have had low expectations for significant news from Chairman Bernanke’s Jackson Hole address for some time for two reasons.

•First, he respects that the Federal Open Market Committee is a committee. That is, monetary policy actions are group decisions and it is inappropriate to front run the outcome of a democratic process.
•Second, he wants to keep a relatively low profile during an election year when the Federal Reserve is already a hot-button campaign issue. His speeches and testimonies over the past few months—even his semi-annual report on monetary policy—have been short, factual, and uneventful.

What does he have to do? He has to convey that the Fed has been disappointed in the economy’s performance, that policymakers are inclined to provide additional accommodation soon unless there is a significant and sustained improvement, and that they will closely monitor the situation. Essentially, all he needs to do is repeat portions of the statement and minutes from the July-August meeting. Along the way, he will highlight that it is a beautiful venue for a conference, that they are about to hear interesting papers, and that many fiscal challenge remain unanswered.

The main possibility for surprise is if he addresses the ongoing work within the Fed on conditional policy rules. The last set of minutes referred several times to discussions of rules and more open-end policy commitments. Up to now, the Fed has been using its policy instruments in an unconditional way, in that it announces a program of fixed duration and fixed amount. Most academic work, as will be discussed in the formal program at Jackson Hole, suggests that a rule linking the policy instrument to economic outcomes or the outlook performs better.

The idea is that the Fed could agree, for instance, to keep the funds rate target at zero as long as they have an economic forecast that is short of their mission. The problem is that the mission at the heart of Fed policy-making is ambiguous. In the Federal Reserve Act, the Congress tells the Fed to foster maximum employment and stable prices but is silent on how to weigh deviations from the two objectives or how quickly those deviations should be eliminated. The monetary policymakers at the Fed are a diverse group of people who disagree on how to fill this silence. If they can come to terms with this issue, then they can offer more open-ended assurance to financial market participants and the public at large.

Chairman Bernanke is unlikely to offer a Solomonic solution, but his speech would be more interesting if he relayed where they are in the process.

August 30, 2012

Payoff in the Pit of the Plutocracy

Jeff Connaughton was a lobbyist, a Senate aide and a White House lawyer. He says he came to Washington, D.C. as a Democrat and left as a Plutocrat.

Now he’s written a book – The Payoff: Why Wall Street Always Wins (Prospecta Press, August 20, 2012.)

This book is about corporate crime – although that phrase doesn’t appear anywhere in its 288 pages.

It is in fact one of the best books on how corporate criminals manipulate the system to get away with their crimes.

One way is to enforce silence among the elites who know how the system works.

“Party cohesion and the desire to make a munificent living in DC go a long way to enforce silence,” Connaughton writes.

But Connaughton is silent no more.

“I’m willing to burn every bridge,” he writes. “Now that I’ve mutinied and fled to a remote place, I want to set flame to the ship that would take me back there.”

Connaughton says there have been no Wall Street prosecutions because the Obama Justice Department failed “to take a timely, targeted, all-in approach to the problem.”

“The truth is, the Justice Department never made investigating these actions a high priority,” he writes. “It never formed strike forces of investigators and lawyers that had sufficient resources and backing to doggedly pursue the obvious potential wrongdoers as long as it took to bring a fraud case.”

Prosecutors never used provisions in the Sarbanes-Oxley Act, which put in place tough criminal sanctions in the wake of Enron and other cases of massive corporate frauds, to indict those executives responsible for misleading financial reports.

“If Obama had appointed aggressive trial lawyers – and (Vice President Joe) Biden knew plenty of them – to these Justice Department positions and backed their efforts, there’s a good chance they would’ve hunted the worst Wall Street fraudsters relentlessly.”

“If the explanation for the inadequate effort is corruption (the administration could not afford to anger Wall Street contributors), the revolving door, or a belief that the health of the financial industry is more important than legal accountability, then we have an actual double standard. I don’t know the explanation, but in terms of faith in our institutions, it may not matter whether the double standard is real or apparent. That double standard has torn the social and moral fabric of our country in a way I find to be unforgivable.”

Connaughton says that two sources were telling him that Christine Varney, the assistant attorney general for the Antitrust Division, “was complaining to friends that Rahm Emanuel, then White House chief of staff, had sent her a message – in effect, throttle back on antitrust enforcement, because the top priority is economic recovery.”

“I was concerned that Attorney General Holder had gotten the same message about investigating Wall Street crime,” he writes.

Connaughton quotes Secretary of the Treasury Timothy Geithner as saying – “The stuff that seemed appealing in terms of…Old Testament justice…penalize the venal, would have been dramatically damaging to the basic strategy of putting out the panic, getting growth back, making people feel more confident in the future.”

“Geithner’s statement would seem to indicate that he believes utilitarian outcomes justify overlooking potentially criminal behavior by banks,” Connaughton writes.

Connaughton worked as chief of staff for Senator Ted Kaufman (D-Delaware.) Kaufman was appointed as Biden’s replacement and dedicated his two years in office to demanding accountability for Wall Street’s crimes.

During one meeting with Justice Department Criminal Division Chief Lanny Breuer, Breuer said the department was dependent on the “pipeline” to bring forward cases against Wall Street banks and their executives.

“That’s when I lost my temper,” Connaughton writes. “‘Lanny, you need to go down into your pipeline and make sure the FBI and U.S. attorney’s offices are making this a top priority. Organize and shake your pipeline hard and get it to bring you cases. Don’t just sit back and wait.’”

“I also couldn’t resist invoking our mutual history in the White House Counsel’s office and even exhorting him to emulate the tactics of our former antagonist,” he writes. “‘You need to be like Ken Starr. You need to target some of these guys like they were drug kingpins, just like Starr targeted Clinton, and squeeze every junior person around them until you can get one to flip and give evidence against the senior people.”

The scene at the Securities and Exchange Commission (SEC) was not much better.

SEC Enforcement Division Director Robert Khuzami, when asked about federal judges rebuking the SEC for paltry fines, said to Kaufman: “I’m not losing any sleep over them.”

And SEC chair Mary Schapiro wasn’t much more responsive.

“Near the end of the [October 2009] meeting [Kaufman] told [SEC Chairman Mary] Schapiro, ‘I don’t believe you’re going to do anything about high-frequency trading.’ Looking him straight in the eye, she replied, ‘You just watch.’”

“We watched for nearly three years,” Connaughton writes. “It wasn’t until July 2011 and June 2012 that the SEC approved minimalist rules that would force market participates to collect the data that would enable the SEC to begin – begin – the process of understanding HFT’s impact on markets. In effect, Ted and I and America are still watching and waiting for the SEC to take meaningful action.”

“If my tenure as Ted’s chief of staff taught me anything, it’s that the C in SEC doesn’t stand for the speed of light.”

Kaufman introduced legislation with Senator Sherrod Brown (D-Ohio) to break up the big banks.

But Brown-Kaufman could muster only 33 votes in the Senate.

“Senator Diane Feinstein – one of the most liberal members of the Senate – asked [Senator Dick] Durbin, the majority whip, ‘What’s this amendment?’ [referring to the Brown-Kaufman amendment to break up the mega-banks]. According to Durbin, he replied: ‘To break up the banks.’ Giving the thumbs-down sign, Feinstein said bemusedly: ‘This is still America, isn’t it?’

Connaughton and Senator Kaufman tried to get enforcement authorities to move aggressively against Wall Street criminality. They tried to break up the big banks. To no avail.

They were up against The Blob.

And The Blob won.

“The Blob – its really called that – refers to the government entities that regulate the finance industry – like the Banking Committee, Treasury Department, and SEC – and the army of Wall Street representatives and lobbyists that continuously surrounds and permeates them,” Connaughton writes. “The Blob moves together. Its members are in constant contact by e-mail and phone. They dine, drink, and take vacations together. Not surprisingly, they frequently intermarry. No lobbying restrictions yet promulgated can prevent pillow talk between Blob spouses.”

Connaughton holds out hope for reform – but not until there is another Wall Street crisis.

In the meantime, he says it’s time to “stop voting for the lesser of two evils” – and stand on principle.

He has burned his bridges.

And he wants you to burn yours, too.

August 29, 2012

The 'Euphoric' Economy And Why 'They' Didn't See It Coming

We are often asked for glossaries or background posts to help in the comprehension of how-we-got-here?, where-here-is?, and where-we-are-going? We hope that our posts, while diverse in nature, build upon one another and provide an educational platform for all levels of market/economy participant (active traders, passive investors, and working / non-working citizens alike) but as far as a succinct primer on how broken the status quo is and the 'euphoric' economy that very few could see through their Keynesian "debt doesn't matter" blinders, Steve Keen's introductory lecture at UWS is perhaps the most complete soup-to-nuts discussion we have seen recently. From the OECD's total ignorance to Bernanke's 'Great Moderation' miss; from economic 'religion' to science; and from Keynes to Minksy, Keen explains, in language even Chuck Schumer could understand, how more debt doesn't solve too much debt, how stability breeds instability, and why the US won't be finished deleveraging until 2025 (at this rate).

This brief lecture seems extremely apropos given we appear to be on the eve of yet another embarkation on the Keynesian 'stimulate' experiment - as everyone waits with baited breath for the next morsel of Fed/ECB/BoE/BoJ/PBOC juice...

Given the Australian audience, and the purpose of the clip, there is some 'selling' of his University course but quite frankly, his discussion of the various 'players' in the field of economics over time provides not just a 'reading' program but critically the concept that economics is not in equilibrium but is dynamic - as if common sense hadn't already persuaded you of this...

August 28, 2012

Spain's Economic Collapse Results In Whopping 5% Deposit Outflow In July

Yesterday, Spain was kind enough to advise those who track its economy, that things in 2010 and 2011 were in fact worse than had been reported, following an adjustment to both 2010 and 2011 GDP "historical" data. Today, we learn that Q2 data (also pending further downward adjustments), contracted by 0.4% sequentially in Q2, in line with expectations, but somehow, and we have to figure out the math on this, the drop on a Year over Year basis was far worse than expected, printing at -1.3% on expectations of just a -1.0% decline. However, while its economic collapse is well known by all, the surprise came in the deposits department which imploded by a whopping 5% in July, plunging to 1.509 trillion euros at end-July from 1.583 trillion in the previous month. Keep in mind this is after the June 29 European summit which supposedly fixed everything. Turns out it didn't, and the people are no longer stupid enough to believe anything Europe's pathological liar politicians spew.The good news: Greek deposits saw a dead cat bounce after collapsing by ridiculous amounts in the past several years: at this point anyone who puts their money in Greek banks must surely realize that the probability of getting even one cent back is equal odds with going to Vegas and at least having a good time while watching one's money burn.

Reuters first has some data on Spain's relentless depression:

Spain's economy shrank further in the second quarter of the year and a slump in domestic spending accelerated, signalling a protracted recession as the country presses on with efforts to slash its public deficit.

Gross domestic product fell by 0.4 percent in the second quarter of the year, according to final data that confirmed a preliminary reading. But on an annual basis it dropped by 1.3 percent, worse than initial estimates of 1.0 percent.

Spain's economy fell back into recession in the first quarter of the year, when output fell 0.3 percent, and government estimates show GDP will probably fall for this year and next year as it pushes through further measures aimed at slashing a bloated deficit.

The data came a day after Spain said its economy performed less well than expected in both of the last two years.

On Tuesday, the National Statistics Institute, INE, also revised down 2011 fourth quarter GDP to -0.5 percent from -0.3 percent.

Close to record high borrowing costs and an economy showing little sign of picking up any time soon is nudging Spain closer to calling for a European bailout, which analysts say is only a matter of time.

"With much more fiscal austerity in the pipeline and unemployment at astronomic highs, the risks are clearly tilted towards a more protracted recession," said Martin van Vliet, economist at ING.

He expected Spain to make a formal request for additional external financing in mid-September or October. Spain has already negotiated up to 100 billion euros in aid for its ailing banks.

Keep expecting buddy: as long as the ECB ponzi scheme allows Spanish banks to buy Spanish bonds, repo to the ECB, and pretend all is fine, keeping yields at or around 6%, Rajoy will never demand a bailout.

As for the deposits...

A rush by consumers and firms to pull their money out of Spanish banks intensified in July, with private sector deposits falling almost 5 percent as Spain was sucked into the centre of the euro zone debt crisis.

Private-sector deposits at Spanish banks fell to 1.509 trillion euros at end-July from 1.583 trillion in the previous month.

However, in a more positive sign, Greek banks stopped bleeding deposits in July after June elections decreased the worst fears of the country dropping out of the common currency bloc, European Central Bank data showed on Tuesday.

Speculation about Greece possibly quitting the euro was intense in May when anti-bailout parties saw a strong showing in elections, but the Greek central bank said the process had reversed after the elections.

Then again, with both nations and banks now entirely reliant on central banks for funding, who needs deposits... or taxes?

August 27, 2012

New Real Estate Train Wreck Coming: Securitized Rentals

No matter how bad things get, it turns out they can always get worse. Wall Street is about to foist a new “innovation” on investors that even the ratings agencies won’t touch.

Greedy, reckless, and just plain lazy mortgage originators, servicers, and trustee took what was actually a not unreasonable idea, that of mortgage securitizations, and turned it into a loss-bomb. Remember, that movie did not have to end badly. First, participants in the private label mortgage securitization market did for the most part comply with the requirements of their contracts for the first decade plus of that product’s existence. It was their wanton disregard for their own products which have led to the chain of title mess and difficulties in foreclosing that still plagues that market. Second, securitization markets that developed later than the US market (most notably, in of all places Russia and Eastern Europe) and featured some improvements on the US template have not seen the abuses of borrowers and investors suffered here and got through the global downturn reasonably well. However, the sell side has completely refused to implement the sort of reforms necessary to make the product safe for investors. So the US mortgage is and is likely to remain on government life support for the next decade.

So what have the “innovators” decided to do? Foist an even worse product on hapless investors. Remember, mortgage securitizations in concept are a decent idea and with proper protections, fees, and incentives, can be a useful and attractive product. Securitizing rental income streams for a large number of single family homes is a completely different proposition. The concept is clearly still being fleshed out, since a story on it in Reuters was unclear as to whether the “bonds” would also be entitled to the proceeds of the eventual sale of the house. I imagine that the private equity investors who are targeting this market are pushing for that, since fobbing off the problem of the home sale to the securitized vehicle is tantamount to a full cashout. They’d get initial tenants in, no matter how good or bad, and effectively flip the house to the securitization.

The newly-found convervatism of the ratings agencies may (stress only may) put a damper on this market. The ratings agencies are not willing to rate the initial deals, and want to see some history before they hazard a rating. Even then, some regard this product as sufficiently risky so as not to merit high ratings even if it were to become established. From Reuters:

Over the past three months, Fitch, S&P, DBRS and Morningstar have each published initial assessments of the potential risks of the new asset class. But no agency has yet published official criteria for the product.

Fitch said that such transactions are unlikely to merit a rating above Single A — and even that would require sufficient historical rental-payment data or a solid record from the property’s operator/manager.

Moody’s issued its first report on the subject on Thursday, but said that since it had not seen a formal proposal yet, it was too early to tell exactly what rating it would assign a transaction. However, it noted that even extra credit enhancement would not mitigate a lack of historical rental-payment data, and therefore some transactions might not merit top grades.

“We would like to see the specific underwriting criteria that the operator is using to choose these tenants,” Kruti Muni, a Moody’s analyst, told IFR.

“Obviously the operators would rely on income information, the existence of security deposits, history of utility payments, etc. The diversity of the geography of the pools of homes is significant as well.”

Moody’s also said that before assigning a rating, it would need to know detailed information about the operator, and would conduct a review of the operator’s performance, its experience and its ability to perform its role in the transaction, which includes determining tenant default rates and re-leasing periods.

As Dave Dayen notes:

It’s simply incredible that, even with so many variables involved, Fitch would give these deals something even as high as single-A. You need data on default rates, vacancy periods, the impact of local economic forces on rentals, the various property managers and operators who would be handling the rental units in the deal, etc., etc…

There’s just no reason to believe that hedge funds and PE firms with no history of being landlords will be able to ensure a steady stream of revenue out of this. Moreover, one economic shock could blow up this market as easily as the housing bubble popped. We already know that the US economy is due to take a step back in 2013 at best, if not a full-blown recession as a result of the fiscal cliff. Add that into the mix with 9% unemployment or above (the expected range in the event of a recession), and suddenly hundreds of thousands if not millions of Americans fall behind on their rent. The securities start to sour. And this could become a full-blown financial crisis just like in 2007-2008.

To amplify Dayen’s concerns, this looks like an effort to fob risk off onto yield-despterate investors. Rental markets are tight now, precisely due to how many homes are behind held in REO inventories or have had the homeoweners leave, yet the servicer had not actually had the trust take title to the home. But those former owners need housing, so we have a real estate version of musical chairs, with families looking for rentals before the forecloses homes have been converted to rentals. Once the conversion process is further along, it isn’t hard to imagine that rent rates will be lower in many markets and vacancy periods will be longer. Similarly, some homeowners lost their houses due to financial stress. Some of them may not even be able to make their rent payments reliably. We saw how in the 2006-2007 period, mortgage were securitized even when the borrower had defaulted in the first three months. It isn’t hard to imagine that we will see equally weak tenant rental streams sold into these securitizations.

The other looming horrorshow is, if you think mortgage servicers were unresponsive, consider how bad rental securitization servicers are likely to be. Their incentives will be to delay in responding to tenant problems in the hope that the tenant will spend the time and money required. And God only knows what happens if they apply payments incorrectly, a not-infrequent problem. One difference here is that mismanaged rentals pose a threat to the home value of the neighbors, and here, the local community does have some recourse, in that it can impose minimum rental standards, which would provide tenants with some recourse. If some communities were to go that route, it might lead to enough uncertainty regarding rental costs and income so as to deter the ratings agencies from ever assigning ratigns, which would presumably limit the size of this product considerably.

As with mortgages, the impulse of the financial community is to find even more ways to skim fees off the top of income streams and leave investors holding the bag. And if investors are dumb enough to be fooled again, after the disaster of mortgage securitizations, they will have gotten what they deserve.

August 24, 2012

FDIC Sues Goldman, JPMorgan Over Mortgage-Backed Securities

Goldman Sachs & Co. and units of JPMorgan Chase & Co. (JPM) and Ally Financial Inc. overstated the quality of loans underlying mortgage-backed securities they sold to the failed Guaranty Bank in Austin, Texas, according to lawsuits brought by the FDIC as its receiver.

In three separate complaints filed in state court in Austin on Aug. 17, the Federal Deposit Insurance Corp. alleged those institutions and others sold about $5.4 billion worth of certificates to Guaranty Bank.

“The defendants made numerous statements of material fact about the certificates and, in particular, about the credit quality of the mortgage loans that backed them,” according to each of the FDIC complaints. “Many of those statements were untrue.”

Guaranty Bank, which had 103 branches in Texas and 59 in California, was closed by the Office of Thrift Supervision three years ago today. Its branches were acquired by BBVA Compass of Birmingham, Alabama, the FDIC said in a statement issued then.

BBVA Compass also acquired almost all of Guaranty’s $12 billion in deposits, the insurer said, while entering into a loss-share transaction with the FDIC on about $11 billion of the bank’s assets.

Claiming the certificate sellers breached Texas securities law by making misleading or untrue statements about loans backing those certificates, the FDIC said in one complaint that it seeks at least $900 million in damages from Goldman Sachs, Ally Financial’s Residential Funding Securities LLC and from units of Deutsche Bank AG and JPMorgan Chase.

Separate Complaint

A separate complaint seeks damages of more than $677 million in damages from JPMorgan Securities LLC, Bank of America (BAC) Corp.’s Merrill Lynch Pierce Fenner & Smith Inc. securities unit and a brokerage unit of Royal Bank of Scotland Group Plc.

Finally a third complaint seeks almost $560 million in damages from Bank of America, its Countrywide Securities unit and other defendants.

Thomas Kelly, a spokesman for JPMorgan Chase, declined to comment on the litigation. David Wells, a Goldman Sachs spokesman, also declined to comment. Both institutions are based in New York.

Shirley Norton, a spokeswoman for Charlotte, North Carolina-based Bank of America, didn’t immediately reply to a voice-mail message seeking comment. Gina Proia, a spokeswoman for Ally Financial, didn’t immediately reply to an e-mail message seeking comment.

The cases are Federal Deposit Insurance Co. as receiver for Guaranty Bank v. Ally Securities LLC, D-1-GN-12-002522; FDIC v. Countrywide Securities Corp., D-1-GN-12-002516 and FDIC v. JPMorgan Securities Inc., D-1-GN-12-002517, Travis County, Texas, District Court (Austin).

August 23, 2012

Eric Sprott: The Financial System’s Death Knell?

On July 18th, 2012, the German government sold US$5.13 billion worth of 2-year bonds at an average yield of -0.06%. Please note the negative symbol in front of that yield number. What this means is that the German government was able to borrow money for less than nothing. When those specific bonds expire in two years’ time, the German government will pay back the original $5.13 billion minus 0.06%. Expressed another way, investors knowingly and willingly bid the German government $5.13 billion in exchange for bonds that will pay no interest and are guaranteed to lose them money on expiration.1 Welcome to the new status quo.

Germany is not alone. Over the past six months, the countries of Netherlands, Switzerland and France have also issued short-term government debt at negative yields. Like Germany, they’ve been able to do this because European bond investors are so shell shocked that they’d rather park money in a bond that’s guaranteed to only lose a miniscule amount rather than risk losing more in a PIIGS bond that actually pays some interest. In addition, many investors view German, French and Dutch bonds to be cheap options on the break-up of the Eurozone. If the EU currency union collapses, euro-denominated bonds issued by those specific countries may be paid back in re-issued deutschmarks, francs or guilders, which will be far more valuable than the euros that were spent to buy the bonds in the first place… or at least that’s the idea. As a result of this thinking, the bond market auctions for these select countries have seen overwhelming demand, making NIRP (Negative Interest Rate Policy) the new ZIRP (Zero Interest Rate Policy).

The NIRP acronym is misleading, however, because unlike ZIRP, NIRP isn’t actually an official “policy” per se, but rather a symptom of a broken financial system increasingly starved for good ‘collateral’. Aside from those speculating on a Eurozone currency collapse, a large portion of the bond investors participating in NIRP bond auctions are the banks. As the euro crisis has dragged on, banks in perceived “strong” countries like Germany and Switzerland have seen record inflows of deposits from banks in peripheral EU countries, like Spain. As most of these “strong country” banks have been hesitant to lend those deposits out (for obvious reasons), they are forced to park them in short-term government bonds. Moreover, new rules imposed by various regulators such as Basel III have forced all banks to hold a larger percentage of their balance sheet in government bonds, regardless of their country of domicile. The result has been a mad dash into the bond auctions of select “safe” countries just as the pool of available AAA-bonds has been drastically reduced. Banks are piling into NIRP bond auctions today because they have nowhere else to go. This is why nobody seems to be alarmed by the recent ubiquity of NIRP bond auctions – they are merely thought to be a short term phenomenon that will pass in time… just like zero-percent interest rates were supposed to be when they were widely introduced four years ago (sigh).

NIRP is different than ZIRP, however. NIRP causes outright financial destruction. Economies can hardly survive extended periods of ZIRP rates, let alone survive a long-term NIRP environment. It just doesn’t work. Institutional investors like pension plans and life insurance companies cannot earn enough “spread” to function properly. And many aren’t allowed to buy different asset classes that might produce a better “spread”, even if they wanted to. They are stuck holding the AAA government debt issuers – positive-yield, or not.

Negative rates also punish the individual investor. Try going online and using one of the banks’ retirement savings simulators and plugging in a negative expected return – you’ll break the program. The same also goes for the investment advisory business. When so-called safe-haven bonds start to consistently produce a negative return, try charging advisory fees to clients while recommending a 50% allocation to negative-yielding government debt. Advisors can try it for a while, but investors won’t put up with it for long.

The recent emergence of NIRP auctions are a signal that the relationship between governments, banks and investors has broken down. While the market still presumes that NIRP is a short-term phenomenon confined primarily to Europe, the dearth of AAA-assets coupled with banks’ captive bond purchasing suggests it may be structurally enforced for a long time to come. There’s even the potential for NIRP to emerge in the US bond market. As Bloomberg reports, the gap between US bank deposits and loans hit a record $1.77 trillion at the end of July 2012, representing an expansion of 15% since May.2 “Banks have already bought $136.4 billion in Treasury and government agency debt this year, more than double the $62.6 billion purchased in all of 2011, pushing their holdings to an all-time high of $1.84 trillion.”3 The current 2-year US Treasury bill is yielding a paltry 0.29%. If something exciting happens in Europe, what’s to stop the bond market’s typical knee-jerk move into US Treasuries from pushing that yield down past zero? Not much. We could be there before the end of the year, especially if the banks continue to gorge on ongoing US Treasury auctions in the meantime.

The question now is how well the financial system can cope in a relentless low-to-no yield environment for bonds. The last four years of low rates have already wreaked much damage to ‘spread’-dependent industries. One need only look at the insurers: In its latest Q2 report, after reporting an 88% drop in Q2 year-over-year earnings, Sun Life Financial stated that if current interest rates persist its profits for the period from 2013 to 2015 could be hurt by up to CAD$500 million.4 Manulife recently reported a Q2 loss of CAD$300 million, which was mainly attributed to a CAD$677 million charge it took to revalue long-term investment assumptions to account for falling bond yields.5

The pension plans are also deteriorating: According to recent reports from BNY Mellon and Mercer, the funded status of US corporate pension plans hit a record low in July 2012. Benefits Canada writes, “The average funded status dropped 2.9 percentage points to 68.7%… while the latest figures from Mercer show that the aggregate deficit in pension plans sponsored by S&P 1500 companies grew US$146 billion during July, to a record high of US$689 billion.”6 That’s a one-month increase of 27%.7 In the pension business, lower yields on long-term AAA bonds results in higher plan liabilities, plain and simple. As Reuters reporter Jim Saft writes, “To give an idea of exactly how powerful the effect of falling rates is on pension liabilities, consider that, according to Mercer, though US shares rose 1.4 percent in July, the 30-55 basis point fall in discount rates drove an increase in liability of between 3 and 11 percent. In a single month.”8

It’s even worse for the public pensions. According to the Washington Post, new pension accounting rules imposed by bond-rating firm Moody’s are expected to “triple the gap between what states and municipalities report they have in their funds and what they have promised to pay out retirees.”9 If implemented, that new public pension gap will balloon to $2.2 trillion. Michael Fletcher from the Washington Post writes, “Among other things, the new accounting rules from Moody’s and the Governmental Accounting Standards Board (GASB) limit the rate of return on future investments that pension funds can assume for accounting purposes. Most government pension funds assume a 7 percent to 8 percent return, which critics say overstates future investment income.”10 With the US 10-year bond now paying less than 2% a year, assuming a 7-8% return isn’t an overstatement, it’s a fantasy. Chart 1 shows how the last four years of low-to-no rates has impacted the average Canadian pension plan. Extend that trend another four years and we might as well redefine the entire purpose of pensions altogether.


a. Solvency position is equal to assets divided by liabilities.
Source: Mercer (Canada) Limited. Last observation: May 2012.

Banks are also suffering from NIRP and ZIRP, as evidenced by the performance of Wall Street’s five biggest banks thus far in 2012. Bloomberg writes, “JPMorgan Chase & Co. (JPM), Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley had combined first-half revenue of $161 billion, down 4.5 percent from 2011 and the lowest since $135 billion in 2008. The firms blamed the decline on low interest rates and a drop in trading and deal-making.”11 (Emphasis ours.) Banks make money on the spread between the interest they charge on loans and the interest they pay on our deposits (this is called the net-interest margin). Chart 2 shows the impact low rates have had on the net-interest margin for the Big 6 Canadian banks, and how tightly correlated their profits are to bond yields themselves. The average net-interest margin for the Big 6 was 2.55% in fiscal Q2 2012, while the average yield on the Canadian 5-year Treasury bond was 1.54%. According to our calculations, for every 100 basis point decline in the 5-year Treasury yield, the Banks’ net-interest margin will fall roughly 20 basis points. All else equal, a 1% drop in 5-year bond yields will result in a -15.6% impact on the banks’ net income. Like the insurers, the persistence of low bond yields hurts their profit margins… and the more deposits the banks take on, the more they are inadvertently forced to participate in short-term bond auctions – thereby supporting the very market causing the margin compression in the first place. It’s a vicious catch-22.

Source: Bloomberg, Big 6 Canadian Banks’ Financial Reports.

From a government perspective – especially governments like Germany who currently issue short-term debt for less than nothing, the current abundance of NIRP and ZIRP bond auctions represent a sweet irony. Here we are, on the interminable verge of collapse in Europe, and at a time when Western governments have never been more indebted, and bond investors are lining up to pay for the pleasure of owning their bond paper! It’s actually quite ridiculous. But no matter how much pain the current low-to-no yield environment causes the rest of the financial industry, governments will not do anything to change their current set-up. No government is incentivized to proactively raise their bond auction yields for the sake of savers, and barring the surprise emergence of major inflation, no central bank would ever raise interest rates and risk curtailing their expensive efforts to foster growth through money-printing. The banks’ continuing need for safe “collateral” means they’ll buy government bonds at virtually any price, leaving the governments with a “captive” buyer for their bonds. It’s almost perfect for the governments… and as it now stands, unless the banking system diversifies into different forms of AAA-collateral (like gold), or until we experience a default or major inflation – both clearly negative events, investors will be forced to survive with a AAA-bond market that pays absolutely nothing, just like Japanese investors have suffered through for the past twenty years.

Under widespread NIRP, pensions, annuities, insurers, banks and ultimately all savers will suffer a slow but steady decline in real wealth over time. Just as ZIRP has stuck around since the early 2000’s, NIRP may be here to stay for many years to come. Looking back at how much widespread damage ZIRP has caused since its introduction back in 2002, it’s hard not to expect that negative interest rates will cause even more harm, and at a faster clip. In our view, NIRP represents the death knell for the financial system as we know it today. There are simply too many working parts of the financial industry that are directly impacted by negative rates, and as long as NIRP persists, they will be helplessly stuck suffering from its ill-effects.

Although it’s been a quiet summer for “hard assets” like gold and silver, this low-to-no rate environment should prove to be beneficial for them over time. The tide is definitely turning in their favour. Various bond commentators have recently come out in support of hard assets, including PIMCO’s Bill Gross, who opined in his August month-end letter that, “Unfair as it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades.”12 NIRP and ZIRP are critical components of that solution, and are here to stay until something unpredictable disrupts the current relationship between the banks and government bond auctions. In our view, the factors that have led to the emergence of NIRP bond auctions are the same factors that will drive demand for physical gold in the coming months: savers have nowhere to go for a “safe” return. It’s only a matter of time before they realize they’ve overlooked a unique financial asset that would perfectly suit their needs. When they do, we would strongly advise them to take delivery.

a. Solvency position is equal to assets divided by liabilities.
Source: Mercer (Canada) Limited. Last observation: May 2012.

August 22, 2012

What Jules Kroll Is Not Saying About Ratings Agencies

Time and again, the traditional agencies' analyses have lacked any foresight, even after the lessons of the subprime mortgage debacle. It's hard to trust companies that have repeatedly gotten it so wrong. A year after S&P downgraded long-term U.S. Treasuries, investors are still buying them up, and little else has changed: Interest rates remain low, and Dow Jones industrials are high. Then, take Greece. In 2009, Moody's said that fears about Greece's financing were "misplaced," according to the New York Times, only to go on to downgrade Greece's debt. We all know the fallout from that. These were the same firms that gave Enron an "investment grade" rating back in 2001, just before it filed for bankruptcy. And lest you've forgotten by now, they also gave Lehman Brothers a favorable rating before its collapse. – Reuters

Dominant Social Theme: What American ratings agencies need is transparency, accountability and more numerative substance.

Free-Market Analysis: Jules Kroll is back in town. The man, who is really a myth, single-handedly invented private, white collar, corporate investigations. Now he wants to reinvent the US ratings agency industry.

Standard and Poor's, Moody's and Fitch Ratings ran into trouble after the earthshattering financial crash of 2008. All three were busily providing ratings for lots of money right up until the West's economy virtually shattered overnight.

In fact, there really wasn't much the big three could do or say. Unlike many other market participants, their job was uniquely focused on predicting risk and, given what occurred, it probably wasn't possible to formulate an adequate defense.

They've been trying to brazen it out ever since but one assumes their position is eroding. Brussels is beginning to investigate whether the agencies have the resources and plain competence to evaluate risk. This is actually a fair question to ask.

But beyond this, the agencies are in a bind because their business is essentially an artful one. It deals with a gray area that goes well beyond the numbers. And as such, the agencies are lightening rods for resentment and irritation. A downgrade costs money and can kill a business deal.

When the agencies were seen as in a sense infallible, such power was granted simply because the agencies acted like a force of nature. They existed, and there was no real recourse.

But now, given that virtually every entity large or small in the Western world would have probably unraveled without what is by now US$50 TRILLION in loans and outright giveaways by the world's central banks, there isn't much of a defense to muster.

Kroll is right to perceive a new business opportunity, given the fundamental injury the business has received. What is less clear is why Kroll believes he has invented a better mousetrap.

He is, nonetheless, and in this Reuters editorial he explains it. But first, a little more about the man – who would be a formidable entrant in any industry. Here, from Wikipedia:

Jules B. Kroll invented the modern corporate investigations industry when he founded Kroll, Inc. in 1972. Kroll Inc. was ultimately sold to Marsh & McClennan Companies for $1.9b in 2004. In 2009, Kroll founded two successor firms, Kroll Bond Rating Agency and K2 Intelligence. KBRA is the first independent bond rating agency formed since the credit crisis in 2008.

Kroll intends to offer "clear and transparent" ratings and to restore "trust" in an industry badly in need of some. In the editorial, which is engagingly part opinion and part promotion, Kroll lays out the problem that the current crop of US ratings agencies have and then proposes his solution. Here's how he positions it:

Credit rating agencies should adopt a new business model that includes transparency, accountability and strong analytics as its cornerstones. When my firm employed this model, our average report produced anywhere from 30 to 50 percent more content than a firm like Moody's. We are able to routinely provide timely, forward-looking research so investors and the public can make more informed decisions. If a rating turns out to be wrong, we will say so.

This new approach will work. Markets don't trust the old model, not just because it's been wrong so often but also because it is conducted in a vacuum. Traditional rating agencies go into a back room and come out with a letter grade that increasingly appears to be chosen out of thin air. But a model that includes full and public disclosure of the methodology used to reach the rating, and long-term accountability for whether the rating was right or wrong, will restore confidence. It won't happen overnight, but little by little, it will happen.

With due respect to Mr. Kroll, who's been extraordinarily successful, this strikes us as a somewhat simplistic approach to resuscitating the ratings business.

He does make good points in the editorial about the persistent problems that the big three US agencies face. Interestingly, he uses the market itself as his touchstone, pointing out that the agencies are becoming irrelevant not because they are right or wrong but because investors aren't listening anymore.

After Moody's downgraded the ratings of 15 global banks, he explains, US bank stocks actually went up. "When the sovereign debt of Germany, the Netherlands and Luxembourg were downgraded on July 23, U.S. stocks remained largely unchanged."

Just look at the US Treasury bond market following Standard & Poor's downgrade of the United States: "Investors are making key investment decisions using their own analysis."


From our point of view (admittedly not Kroll's), the problems that the ratings agencies face simply stem from their unwillingness to adopt an Austrian, free-market economic model.

It would be interesting to press the agencies on the economic model they DO follow. Probably you'd get the old runaround. You'd be told that your rating was linked to your financial position, business prospects, etc. But if you persisted in asking them how they DEFINED the money they're evaluating, you'd probably get nowhere fast.

Even Kroll doesn't get into it. He talks about a deeper level of evaluation but we'd bet this merely entails more number-crunching and more "transparency."

Ask Kroll whether there is a danger in government printing too much money and he might say yes. Ask him how much is too much, and if he's telling the truth he'd have to admit that he doesn't know. The ratings agency business, in the end, is "smoke and mirrors." It was issuing healthy ratings to bankrupt businesses and country's right up to the collapse.

Kroll's idea that more intensive statistical analysis will make a difference doesn't address the fundamental problem at all. The problem has to do with monopoly fiat central banking. Until the agencies, Kroll's included, are willing to forthrightly state that every ten years or so excessive money printing will cause a crash and drive numerous firms out of business, their models will be flawed.

But it will never happen because we live in an era of faux-economics. The power elite that has set up this mad and miserable system intends for it to do exactly what it's done. Those at the top could care less about the current ratings system or those agencies that purvey it. Not really.

Kroll ends this way:

The solution is not to banish credit ratings to the scrap heap of history. Nor to eliminate an important tool for valuing debt and keeping capital markets solvent. What we really need is a new model to restore credibility to the industry once again. Put simply, ratings are too important to not be trusted.

Credit rating agencies can offer an important assessment of public-sector institutions, the structured finance sector and other market conditions more broadly. When these analyses are conducted thoroughly and independently, they are valuable. For example, if demand for a state's general obligation bonds - which credit agencies rate - exceeds the bonds available, a state can reduce interest rates and potentially save millions over the life of the bonds.

Conclusion: God help us.

August 21, 2012

Corrupt banks engaged in ‘organized LIBOR’

Visiting British friends reminded me that all summer, the press has occa­sionally covered the “LIBOR Scandal,” but many stories have been a lot of “inside-baseball”-style financial confusion. Actually, the situ­ation affects regular working people much more than has been noted.

Besides making a mockery of the “free market,” LIBOR – specif­i­cally, manip­u­lating LIBOR – costs us money in many ways. LIBOR – London Interbank Offered Rate – is supposed to gauge the average interest rate banks charge when they lend to each other. Ideally a measure of banks’ trust in their solvency, LIBOR is used as a foun­dation for other rates, like adjustable-rate mort­gages or complex financial deriv­a­tives. But: Big Banks don’t use data based on veri­fiable facts; there’s no check or balance.

So that ideal dissolved in June, when Britain’s Barclays bank admitted that it had routinely and repeatedly under­stated the rate for years. They did so in two ways. First, Big Banks conspired to move LIBOR levels (up or down) to benefit banks’ invest­ments, not customers. Next, during the 2008 financial crisis, Big Banks appear to have under­re­ported LIBOR to seem stronger.

LIBOR affects us because it changes the cost of money, whether personal or commercial borrowing. It influ­ences credit cards, student loans, mort­gages and more. Interest rates that banks charge are usually figured as LIBOR plus an addi­tional amount.

Barclays’ CEO resigned, and it’ll pay $453 million in fines to settle charges of LIBOR manip­u­lation as far back as 2005. More banks will probably be impli­cated. About 20 Big Banks contributed to LIBOR – including three giant U.S. outfits: Bank of America, Citi­group and JPMorgan Chase – at least some­times involving them­selves in the scheme, as well as possibly the Bank of England, the U.S. Federal Reserve, and the U.K. government, according to material Barclay’s disclosed.

“This is a very, very signif­icant event,” said Gary Gensler, chair of the U.S. Commodity Futures Trading Commission (CFTC), one of the regu­lators inves­ti­gating the scandal, in Time magazine. “LIBOR is the mother of all financial indices, and it’s at the heart of the consumer-lending markets. There have been winners and losers on both sides [of the LIBOR deals], but collec­tively we all lose if the market isn’t perceived to be honest.”

However, the CFTC neither charged Barclays with a crime nor required resti­tution to victims. Still, Barclays’ activ­ities may be felonies under federal RICO statutes. The Rack­eteer Influ­enced and Corrupt Orga­ni­za­tions Act autho­rizes victims to recover triple damages.

Another gigantic conse­quence of the banks’ manip­u­lation is that it hid 2008’s financial crisis for months. The scandal repre­sents a financial system that remains secret and under-regulated – four years after that crisis – further eroding people’s under­standable distrust of Big Banks.

Econ­omist, author and former Labor Secretary Robert Reich said, “Just when you thought Wall Street couldn’t sink any lower – when its myriad abuses of public trust have already spread a miasma of cynicism over the entire economic system, giving birth to Tea Partiers and Occu­piers and all manner of conspiracy theories; when its excesses have already wrought havoc with the lives of millions of Amer­icans, causing taxpayers to shell out billions (of which only a portion has been repaid) even as its top exec­u­tives are back to making more money than ever; when its vast political power (via campaign contri­bu­tions) has already evis­cerated much of the Dodd-Frank law that was supposed to rein it in, including the so-called ‘Volker’ Rule that was sold as a milder version of the old Glass-Steagall Act that used to separate investment from commercial banking – yes, just when you thought the Street had hit bottom, an even deeper level of public-be-damned greed and corruption is revealed.”

The extent of the fraud and its conse­quences is incredible.

Attorney Ellen Brown, chair of the Public Banking Institute and author of Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free, said, “The losers have been local govern­ments, hospitals, univer­sities, and other nonprofits. For more than a decade, banks and insurance companies convinced them that interest-rate swaps would lower interest rates on bonds sold for public projects such as roads, bridges and schools.”

Heather Slavkin writing for AFL-CIO Now said, “Around $10 trillion in loans is indexed to LIBOR [and] when you add in all types of financial products including complex instru­ments like deriv­a­tives, LIBOR is the index for around $800 trillion in financial instruments.”

That $800 trillion is 11 times the Gross Domestic Products of every nation on Earth, according to 2011 figures from the Inter­na­tional Monetary Fund.

Again, Big Banks could face criminal pros­e­cution, civil lawsuits and regu­latory penalties, but how did it happen for so many years? Were regu­lators them­selves – admit­tedly dealing with weaker laws than decades past – incom­petent or corrupt? Further, will pros­e­cutors do their job and go after such corporate ille­gality? After this inter­na­tional cartel?

August 20, 2012

Attorney For Goldman Sachs CEO Is Eric Holder's 'Best Friend'

The crony connections just keep on coming over at Eric Holder’s Department of Justice.

Last week, the Justice Department announced that it will not prosecute Goldman Sachs or any of its employees in a financial probe.

Could that be because the attorney for Goldman Sachs CEO Lloyd Blankfein was none other than Attorney General Eric Holder’s “best friend” and former personal attorney, Reid Weingarten?

Or because in 2008, Goldman Sachs employees donated $1,013,091 to Barack Obama?

Or because Goldman Sachs is the former client of Eric Holder’s and Assistant Attorney General Lanny Breuer’s law firm, Covington & Burling?

The conflicts of interest and cronyism at Holder’s Department of Justice are so many that it took a 27-page report by the Government Accountability Institute to catalog them all.

And lest one forget: Holder's best friend Reid Weingarten--who previously represented child rapist Roman Polanski--is also the lawyer for former MF Global treasurer Edith O’Brien. On Thursday, the New York Times reported that Holder's Justice Department will not be criminally charging Jon Corzine or any MF Global executives in that case either.

Weingarten, who calls himself a “hard-core child of the ‘60s,” apparently has a soft spot for Wall Street fat cats. "I feel like I'm in the French Revolution, defending the nobility against the howling mob," Weingarten told Bloomberg in 2002.

So, to recap, Goldman Sachs, which donated $1,013,091 to Barack Obama in 2008 and whose CEO is represented by Holder's best friend, will not face prosecution.

Nor will Obama bundler Jon Corzine, who raised at least $500,000 for Barack Obama.

Indeed, Eric Holder’s Department of Justice has not charged, prosecuted, or convicted a single top Wall Street executive.

Alas, pay-to-play justice and the Chicago Way are alive and well.

August 17, 2012

Spain Out of Options

Yves here. We’ve flagged in earlier posts how the Spanish banking crisis has the potential to become destabilizing politically, as if Spain wasn’t already at considerable risk of upheaval. Spanish depositors were pushed to convert their deposits into preference shares, which they were told were just as safe. This was a simple desperation move by the banks to save their own skins, customers be damned, by raising equity from the most unsophisticated source to which they had access. And now that that gambit failed, these shareholders are due to have those investments wiped out unless the Spanish authorities can cut a deal to spare them. Don’t hold your breath.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness

I mentioned back in early July that Spain had a serious political problem brewing because the draft Memorandum of Understanding for the Spanish banking system clearly stated that:

Banks and their shareholders will take losses before State aid measures are granted and ensure loss absorption of equity and hybrid capital instruments to the full extent possible.

From a market perspective this is absolutely the correct thing to do. Equity is a risky business. You take a punt, the banks falls over, your money it gone, fair enough. But in Spain it’s not that simple because of something I commented on in April:

The key in a banking crisis is to keep the confidence of depositors. But while many countries relied on capital injections and government guarantees, Spanish banks have added a unique twist of effectively turning some depositors into equity holders. That puts customers on the front line.

Some banks started by persuading depositors to switch from low, interest-bearing accounts into preference shares, which paid a fixed, higher interest rate. The benefit for the banks was that these securities counted as core capital under banking rules. UBS says Spanish banks issued €32 billion ($42.7 billion) of such instruments from 2007 to 2010.

But as the crisis deepened, these instruments became illiquid, trading at deep discounts. At the same time, they ceased to count as core capital under new rules known as Basel III. So banks have encouraged investors to convert preference shares into either common stock or mandatory convertible notes, which pay a high initial yield before later converting into stock.

And so now, under the watchful eye of the Spanish regulators, depositors in Spanish banks had been converted into equity holders and these same people were about to see their savings eaten up by the first stages of a banking bailout.

Although there are other factors involved, I think this is one of the primary reasons Mariano Rajoy has been so hesitant to move forward with any bailout, and it comes as no surprise that he is now attempting to negotiate a way out for these people:

The Spanish government is in talks with Brussels to allow tens of thousands of retail clients who bought risky savings products from now nationalized lenders to avoid losing their investments as part of Spain’s bank bailout.

In place of inflicting large losses on small savers who purchased savings products linked to preference shares in in the lenders known as cajas, the Spanish government is negotiating a compromise where they will suffer an instant haircut, and then be repaid in full over time by their banks, people familiar with the talks said.

The decision to inflict losses on holders of high interest preference shares and subordinated debt in rescued savings banks has been highly controversial in Spain, with the terms of the country’s bank rescue not distinguishing between professional and retail investors.

Apart from the obvious question of whether they will actually get a deal, the other question is will the banks be in any position to make those payments in the future. As WSJ reports, the banking system looks increasingly flakey as deposits continue to leave the country and the hole is filled by ECB:

Spanish banks borrowed a record amount from the European Central Bank in July, as other sources of funding evaporated further in the weeks following the announcement of a €100 billion ($123 billion) bailout for the country’s financial industry.

Bank of Spain data indicated that net ECB borrowing rose to €375.55 billion from €337.21 billion in June. It was the 10th straight month of increases, highlighting how the country’s lenders are having more and more difficulty financing themselves through private investors.

Spain’s traditional funding sources have been dwindling as the economy sinks deeper into a downturn. During the Spanish construction boom of the past decade, German and other European banks were more than willing to fund the rapid expansion of the Spanish banking system, inflating the country’s credit bubble.

And the latest report from Tinsa makes it very clear that the bubble’s deflation is far from over:

The IMIE General index registered a year-on-year decline of 11.2% in July, pushing the index down to 1577 points. The cumulative decline in house prices since the market peaked in December 2007 is 31%.

In terms of the cumulative decline in house prices by region since peak prices, there was a 37.2% fall in July for the “Mediterranean Coast”; followed by 33.5% for “Capitals and Major Cities”, 32.1% for “Metropolitan Areas”, 29.2% for the “Balearic and Canary Islands” and 25.9% for “Other Municipalities”, which comprises the remainder.

Mariano Rajoy is expected to meet Herman Van Rompuy, Angela Merkel, Mario Monti and Finland’s President, Sauli Niinistoe, over the next few weeks in order to discuss his country’s future. It is, however, increasingly obvious that he will have little choice to accept whatever he is given, and I have to question again exactly how long he has left in politics.

August 16, 2012

Marcy Wheeler: Standard Chartered Bank Admits Promontory’s Estimates of Its Iran Business Were Wrong

Yves here. A few quick comments on the New York state settlement. Some readers are unhappy that there wasn’t a prosecution. First, as we’ve written before, criminal prosecutions of big financial firms put them out of business (tons of customers are forbidden to do business with them) so they settle pronto (prosecuting individuals is another matter completely). Second, Lawsky is only a banking regulator and does not have prosecutorial powers. To do that, he would have needed Eric Schneiderman’s cooperation. But Lawksy’s boss, Andrew Cuomo and Schneiderman are rivals. And Schneiderman has thrown his lot in with the Obama Administration, which has been ferociously trying to undermine Lawsky. As Neil Barofksy noted in a Bloomberg story:

“I can’t think of another case where there has been such uniformity among federal regulators undercutting an enforcement case”

Marcy’s observation below is very important, and is being glossed over or even denied in the mainstream media. The Wall Street Journal has one of its all too common alternative reality editorial page pieces. Key snippet:

Of the $250 billion of transactions at issue, it now appears that $249 billion and change were legal at the time they occurred.

In a word, no.

By Marcy Wheeler. Cross posted from emptywheel

Standard Chartered just settled with NY’s Superintendent of Financial Services. The settlement–for $340 million and a monitor of SFS’ choosing–is less than some reports said the settlement might have been.

But here’s the detail I’m most interested in:

The New York State Department of Financial Services (“DFS”) and Standard Chartered Bank (“Bank”) have reached an agreement to settle the matters raised in the DFS Order dated August 6, 2012. The parties have agreed that the conduct at issue involved transactions of at least $250 billion. [my emphasis]

Just .1% fine, so not that big. But an admission that the scope of the fraud and the Iran business really did amount to $250 billion.

I find that interesting for two reasons. First, because it’s going to cause all kinds of headaches for the folks at Treasury who would like to let SCB off easy but ordinarily base settlements on the amount of the underlying activity.

More importantly, for me, because it demonstrates what a sham the Get Out of Jail Free industry is. A former OCC head and his minions at Promontory Financial Group claimed to have added it all up and determined that SCB only hid $14 million of transactions from Iran. SCB now says that Promontory was wrong.

By orders of magnitude.

Granted, SCB–and most of the people who pay Promontory to soft-pedal their crimes and risk–tried not to admit it had gotten that estimate from Promontory. Going forward, I expect we’ll see Promontory’s clients hide their involvement even more.

Still, this is a useful demonstration of how corrupt the Get Out of Jail Free industry is.

August 15, 2012

Goldman Sachs Free to Keep Stealing

Goldman again got off scot-free. On August 9, the Justice Department dropped criminal fraud charges. Evidence the equivalent of enough firepower to sink a carrier battle group was buried and forgotten. More on what happened below.

Black's Law Dictionary says:

"Fraud consists of some deceitful practice or willful device, resorted to with intent to deprive another of his right, or in some manner to do him an injury."

It includes "all acts, omissions, and concealments which involve a breach of legal or equitable duty, trust, or confidence justly reposed, and are injurious to another, or by which an undue and unconscientious advantage is taken of another."

The legal dictionary calls fraud:

"A false representation of a matter of fact - whether by words or by conduct, by false or misleading allegations, or by concealment of what should have been disclosed - that deceives and is intended to deceive another so that the individual will act upon it to her or his legal injury."

Criminal and civil frauds differ by level of proof required. The former needs a "preponderance of evidence." The latter must prove intent and be "beyond a reasonable doubt."

Goldman settled SEC charges for pennies on the dollar. What a business. Steal a fortune. Pay a pittance back. Goldman writes it off as operating cost.

Wall Street's business model reflects fraud and grand theft. Goldman steals with the best of them. Take away dirty money and the whole system collapses. It operates at the expense of investors and societies.

It profits hugely by swindling clients it calls "muppets." Small time con artists rip off marks. Goldman loots on a grand scale. Even nations are plundered for profits. It makes money the old-fashioned way. It steal and get away with it unaccountably.

No avenue with potential is ignored. It's an equal opportunity predator. Chairman/CEO Lloyd Blankfein calls it "doing God's work." Which one he didn't say. The Supreme Court ruled he and other Wall Street giants are immune from clients pursuing security fraud charges. Washington alone can sue.

Wall Street's culture encourages fraud. It's rewarded handsomely practically risk-free. The price for getting caught is chump change. It pales compared to fortunes stolen. Betting against Goldman faces long odds. Casino ones pay off better.

In April 2010, the SEC filed civil, not criminal, fraud charges. Goldman and one of its vice presidents was accused of defrauding investors by misstating and omitting key facts about junk assets tied to subprime mortgages.

Huge profits were made as the housing market faced collapsed. Structured and marketed synthetic collateralized debt obligations (CDOs) paid off big. Their performance depended on subprime residential mortgage-backed securities (RMBS).

Goldman withheld vital information from investors. Doing so let the firm and hedge fund investor John Paulson make huge profits. They correctly bet against the housing market. They were touting junk as safe investments that collapsed.

Charges involved violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5. The SEC sought "injunctive relief, disgorgement of profits, prejudgment interest, and financial penalties."

It settled for pennies on the dollar. It closed the books for $550 million. It amounted to about four 2009 revenue days. It hardly mattered. No executive was fined or imprisoned. Goldman was free to keep stealing. Headlines left details most vital to reveal unexplained. Only scammed clients understand.

In April 2011, the Senate Permanent Subcommittee on Investigations released a report on how banking giants, federal regulators, and credit rating agencies conspired to crash the subprime mortgage market.

Around 40% of it discussed Goldman. It sold an alphabet soup of securitized junk. Garbage included mortgaged-backed securities (MBSs), collateralized mortgage obligations (CMOs), and various other assets structured to fail.

Combined, they sliced, diced, packaged, repackaged, and sold them in tranches to sophisticated and ordinary investors. Many bought them unwittingly through mutual funds, 401(k)s, pensions, and other investments.

The Senate listed federal security law violations. Goldman wasn't alone. Other major Wall Street banks conspired with financial partners to steal and get away with it. Justice Department officials and prosecutors got enough evidence to hang them.

Committee chairman Carl Levin said the panel's two-year probe found "a financial snake pit rife with greed, conflicts of interest and wrongdoing." He recommended prosecution. He added:

"In my judgment, Goldman clearly misled their clients and they misled Congress."

On August 9, the Justice Department said it conducted "an exhaustive review of the report." It concluded that "based on the law and evidence as they exist at this time, there is not a viable basis to bring a criminal prosecution with respect to Goldman Sachs or its employees in regard to the allegations set forth in the report."

In other words, fraud charges don't matter. Whatever Goldman does is OK. Stealing is how it does business. Obama officials find no fault. Goldman expressed relief it's all over.

It knows Democrat and Republican Justice Department prosecutors won't lay a glove on them. It's free to make money by stealing it.

Its only obligation is regular campaign contribution kickbacks, insider trading tips, other ways for pols to profit and get rich, and financial officials like Bernanke, Geithner, and others at Treasury and the Fed getting sweet revolving door jobs out of Washington when or if they plan to leave.

Each side helps the other. Political and Wall Street crooks conspire to keep a sweet racket going. Corruption is a way of life. Congress, administrations, the judiciary, and scoundrel media go along. Laws are only for ordinary people. Predators are free to prey.

Accountability never mattered. Now it's laughable on its face. Bad as things are now, expect much worse ahead. Massive fraud before 2007 crisis conditions exacerbated hard times. Far greater trouble looms. Financial wars lay waste like ravaging armies.

It's the system, stupid. Profiteering from plunder is too repugnant to tolerate. It's lawless, dysfunctional, and corrupt. It's too far gone to fix. Building a world fit to live in requires tearing it down and starting over. Nothing less can work.

August 14, 2012

Currency and Credit Schemes Blow Up ... and Go Green

Sports reporter, boozer, prime minister . . . and social credit galore ... Bitter faction fights, backroom fixers and the perils of minority government shaped Australian prime minister John Curtin's early political career. It resonates uncannily with today's political scene, although the Douglas Credit Party that sprang up to help Depression-era battlers is now an irrelevant blip in history. Playwright Ingle Knight has clearly pored over Curtin's life and times to shape it into this new play. At certain moments - such as when Major C. H. Douglas's oddball social credit scheme is mentioned for the umpteenth time - it feels like a historical reading, rather than a full-blooded theatrical experience. Curtin's personal and political battles to fulfill that destiny are neatly handled in this modest production. As for the over-liberal references to the social credit philosophy that so appealed in Depression-ravaged Western Australia, they at least remind one how much times have changed in Curtin's electorate. – The Australian

Dominant Social Theme: These crank money programs are not important at all!

Free-Market Analysis: The Australian recently reviewed a play (see above excerpt) focusing on the life and times of Australian Prime Minister John Curtin's early career. While Curtin is not of special interest to us, Major C.H. Douglas certainly is, as is the statement implying "how much times have changed."

Unfortunately, times haven't changed. Depression looms around the world. As we know from experience, Major Douglas's theories have re-emerged.

His theories caught on during the Depression and the world's gradual monetary expansion after World War II. Wikipedia summarizes some of the main points thusly:

Douglas proposed ... augmenting consumers' purchasing power through a National Dividend and a Compensated Price Mechanism. According to Douglas, the true purpose of production is consumption, and production must serve the genuine, freely expressed interests of consumers.

Each citizen is to have a beneficial, not direct, inheritance in the communal capital conferred by complete and dynamic access to the fruits of industry (consumer goods) assured by the National Dividend and Compensated Price.

Consumers, fully provided with adequate purchasing power, will establish the policy of production through exercise of their monetary vote. In this view, the term economic democracy does not mean worker control of industry. Removing the policy of production from banking institutions, government, and industry, Social Credit envisages an "aristocracy of producers, serving and accredited by a democracy of consumers."

Condensing this, we come up with the idea that Douglas wanted government to print money (pure fiat) and put it in the hands of consumers directly.

Douglas disagreed with another economic (non-mainstream) sage who emerged around the same time, Silveo Gesell. Gesell wanted scrip to be issued that depreciated over time in order to provide people with an incentive to spend as much as possible, believing that increasing the velocity of money would increase prosperity.

Douglas wrote about Gesell as follows:

Gesell's theory was that the trouble with the world was that people saved money so that what you had to do was to make them spend it faster. Disappearing money is the heaviest form of continuous taxation ever devised. The theory behind this idea of Gesell's was that what is required is to stimulate trade—that you have to get people frantically buying goods—a perfectly sound idea so long as the objective of life is merely trading. (Wikipedia)

This is an interesting point that Douglas makes. Gesell's idea of disappearing money does indeed constitute a radical tax. But disappearing money was only one of Gesell's ideas. We learn from Wikipedia that Gesell's ideas were apparently threefold. You could call them the three Fs:
•Freigeld (free money) .... All money is issued for a limited period ... Long-term saving requires investment in bonds or stocks.
•Freiland (free land) ... All land is owned by public institutions and can only be rented, not purchased (a position of alternative economist Henry George).
•Freihandel (Free Trade) ... Free Trade has long been a mainstream position now, but the anti-globalization movement largely opposes it.

Gesell's ideas are very interesting, though obviously dirigiste. But for the rest of this article, we will return to Douglas because back in 2008, the Socialist Party of Great Britain posted an article entitled "Major Douglas rides again: The revival of currency crankism." In the space we have left, we'll try to analyze it.

It begins as follows:

In the course of our nearly one hundred years of socialist activity, one of the ideas that we have had to deal with from time to time has been currency crankism—the idea that economic and social problems are caused by some flaw in the monetary system and that what is required to put things right is not to get rid of the profit system that is capitalism but mere monetary reform (of one kind or another, depending on which particular school the currency crank belongs to).

Between the wars the most popular school of currency crankism in Britain was Social Credit, based on the ideas of Major Douglas (as he was known). His explanation for the slump—of poverty amidst potential plenty, of unmet needs alongside idle factories and widespread unemployment, of piles of unsold goods being destroyed—was simple, not to say simplistic: it was due to a lack of purchasing power, to people not having enough money to buy what they needed or to constitute a market worth catering for.

The solution, too, was simplistic: distribute purchasing power free to people in the form of a "social dividend" paid by the government. Douglas believed that banks could "create credit" by the mere stroke of a pen, but that they deliberately kept money scarce so as to be able to charge a higher rate of interest. Hence his solution that the banks should be taken over by the government and their supposed power to create credit exercised but in the general interest, as "social credit".

The article finds fault with Douglas on several grounds. Its authors argue that slumps actually arise "when, because of falling profit prospects, capitalist firms choose not to spend all their profits on fully renewing or on expanding production."

The article also argues that banks cannot "create credit" as they are "essentially only financial intermediaries, borrowing money at one rate of interest from people with cash to spare and lending this at a higher rate to those needing money to spend or invest, their profits coming from the difference between the two interest rates."

Being a socialist magazine, the (predictable) conclusion reached is that the problems of capitalism "will only end when the means of production are brought into common ownership and democratic control so that they can be oriented towards directly satisfying people's needs."

Obviously, from a free-market point of view, we'd disagree with this; but as always, the socialist perspective is interesting to read because of its analysis of capitalism's problems. The most fascinating part of the article is yet to come, however, and begins with references to an article by Derek Wall entitled, "Social Credit: The Ecosocialism of Fools", in Capitalism, Nature, Socialism.

Wall's article is all about the joining of forces between currency and credit schemes and proponents of various forms of green polity!

This is just what we've observed ourselves and have been writing about recently. We've written two articles on the subject now, plus this one:

Are 'Green' Reciprocal Exchange and Credit Systems Part of a Larger Elite Promotion?

Paper Money and the UN Perfect Together? More Currency and Credit Exchange Supported by the UN

Here's more from the Socialist Party article:

The modern-day followers of Major Douglas are well ensconced in the Green Party: "Brian Leslie, whose parents were members of the Social Credit Greenshirts during the 1930s, chairs the Green Party Economics Working Group.

The newsletter, Sustainable Economics, is almost entirely concerned with social credit and Party economics speaker Molly Scott Cato advocates monetary reform... Frances Hutchinson, a former member of the Green Party left grouping, the Association of Socialist Greens, has revived the Douglas Social Credit Secretariat... Wilfred Price, a member of the Greenshirts in the 1930s, joined the Ecology Party (now the Green Party) in the early 1980s and powerfully spoke for social credit as a form of green politics."

Currency cranks find it easy to infiltrate the Green Party because of the tendency amongst its members and supporters to blame "big banks" and international financial institutions for ecological problems and the ravages of capitalist globalisation. The Green Party has, for instance, lined up alongside the Tories, the UKIP and other reactionaries in the "defend the pound" camp because it sees the euro as an international (in the sense of anti- national) currency.

Now, just because these systems are popular in green eco-communities (many affiliated with the UN) doesn't necessarily speak to their utility or practicality. In fact, we're long on the record as arguing for competing currencies.

But within a free-market context, we believe gold and silver will find their rightful place as they have throughout history's larger monetary context. Before the Civil War in the US and in Scotland there are successful evidences (as Selgin and White have argued) for free banking, wildcat banking and a variety of monetary solutions.

Conclusion: The bottom line is that without a free market in money, there is no way of knowing how much money is enough and how much is too much. Absent some sort of private, free-market monitor, presumably one that includes freely traded gold and silver, there is no way to judge monetary volume.

August 13, 2012

Judge: 90% of Credit Card Lawsuits Can’t Prove Borrower Owes Money

As they work through a glut of bad loans, companies like American Express, Citigroup and Discover Financial are going to court to recoup their money. But many of the lawsuits rely on erroneous documents, incomplete records and generic testimony from witnesses, according to judges who oversee the cases.

Lenders, the judges said, are churning out lawsuits without regard for accuracy, and improperly collecting debts from consumers. The concerns echo a recent abuse in the foreclosure system, a practice known as robo-signing in which banks produced similar documents for different homeowners and did not review them.

“I would say that roughly 90 percent of the credit card lawsuits are flawed and can’t prove the person owes the debt,” said Noach Dear, a state civil court judge in Brooklyn, who said he presides over as many as 100 such cases a day….

The problem, according to judges, is that credit card companies are not always following the proper legal procedures, even when they have the right to collect money. Certain cases hinge on mass-produced documents because the lenders do not provide proof of the outstanding debts, like the original contract or payment history.

At times, lawsuits include falsified credit card statements, produced years after borrowers supposedly fell behind on their bills.

But the big reason that the credit card companies can ride roughshod over the law is that so few consumers contest these cases. The article reports that 95% go uncontested, meaning the lender will win a default judgment and can then garnish wages or bank account balances.

And if you think it’s bad with the credit card companies, it’s even worse with the bottom feeders. A colleague has a sister who lives in Texas, where the statute of limitations on unpaid debts is four years. Apparently a hedge fund is backing a company that buys bad debts from credit card companies, debt they’ve already written off, shortly before the statue of limitations is about to expire, for pennies on the dollar. They then file suit. They don’t even plan to spend any money fighting, they just intent to win default judgments. So if you hire a lawyer and merely file an answer, you win. But a remarkably high percentage of people fail to do that.

And for the credit card companies, the critics can substantiate their doubts about the accuracy of documentation. For instance:

In 2010, Discover sued Taryn Gregory for more than $7,000 in credit card debt. Ms. Gregory, of Commerce, Ga., had fallen behind on her bills, but said she had accumulated only $4,000 in debt.

After the suit was filed, Ms. Gregory, a 41-year-old child care assistant, asked Discover for proof of the balance. The resulting documents, which were reviewed by The New York Times, have inconsistencies. One statement, for example, says it was produced in 2004, but advertisements on the bottom of the document bear a 2010 date.

We’ve gone back over 300 years, to the ugly time before the 1677 Statute of Frauds. And the worse is too few people seem to appreciate how destructive that is not just to commerce, but to faith in the authority structure.

August 10, 2012

A Step Towards Gold Confiscation

In attempting to stimulate risk appetite by taking “safe” assets out of the market, the Fed has actually achieved precisely the opposite of stimulating productive investment. First, it has turned bond markets into a race to the bottom as bond flippers end up piling into the very assets that the Fed is trying to discourage ownership of — because who care about low yields when the Fed will jump in at an even lower price floor, thus assuring the bond flippers a profit? Second it has energised other safe asset markets (such as gold) as longer term investors look for alternatives to preserve their purchasing power in the context of a global economic depression.

The Fed is firing at the wrong target; the real problem — the thing that is causing investors to scramble for safe assets — is an economic depression brought on by (among other non-monetary causes) the deleveraging costs of an unsustainable debt bubble. Without addressing the problem of excess total debt — and quantitative easing aims to increase lending — the Fed is firing blanks.

However, there seems little prospect that the Fed will listen to the debt-watchers who actually predicted the crisis. The likelihood is that the Fed will continue to attempt to take safe assets out of the market. And after treasuries, what will the Fed try to take out of the market?

Izabella Kaminska writes in FT Alphaville:

Fed purchases are the equivalent of hoarding the system’s supply of safe assets on the Fed’s own balance sheet, and in so doing preventing private investors — especially money market investors – from investing in the assets on favourable terms.

While this is mostly the point of QE — the idea, after all, is to stimulate risk appetite and cause investors to change their portfolios — a continued lack of risk appetite means the money created, rather than flowing into risky securities as hoped, is only crowding out the last remaining safe securities in the market instead. The consequences are negative rates and principal destruction — a lethal combination that is arguably far more dangerous and deflationary than no QE at all.

The idea that the Treasury could once again become the gold buyer of last resort, in exchange for liquidity, is interesting to say the least. Not only would such a strategy ease the squeeze in the Treasury market, it would do so without compromising the liquidity effects of QE.

What’s more it could help to support and stabilize the gold price, while taking zero-yielding safe assets out of the system in favour of yield bearing ones — giving money markets a fighting chance for survival in terms of yields.

While gold purchases have never been communicated as official central bank policy, there’s no denying that a shift in this direction is taking place. Be that wittingly or unwittingly.

A little behind the curve.

Last September I noted:

Bernanke has already heavily targeted yields on treasuries which have absorbed liquidity that has departed from productive ventures. But in recent years gold has offered a significantly increased yield over treasuries.

So what’s a central banker who wants to force investors into productive ventures to do? You can’t print gold — but you can buy it, and take it out of the marketplace.

And as the price of gold (in fiat) continues to rise, buying gold is exactly what central bankers may do.

Just as Roosevelt went out of his way to remove gold from the marketplace, the central bankers of today may eventually determine to do the same thing.

The main question if such an event were to occur is just how “compulsory” such purchases might be.

August 9, 2012

Knight's Berserk Algo Bought $2.6 Million Worth Of Stock Every Second

While we already presented, courtesy of Nanex, the modus operandi of the Knight berserker algo, there was one outstanding question. What was the bottom line. And no, not how much the loss on Knight's Income Statement would be as a result of this glimpse into what really happens in the market: we already knew that would be $440 million. The question is what is the notional amount of stock that this algo bought in the 45 minutes in which it was operational. We now know: $7 billion. Or $155 million per minute. Or $2.6 million per second. Or, assuming the algo impacted just 150 stocks as previously reported, it was buying on average $17,333 in each name every second. Or, assuming an average stock price of the universe of 150 stocks of $30/share, the Knight algo lifted the offer roughly 600 times each second. For 45 minutes straight! That's right - the market making algorithm of a designated market maker which is responsible for 10% of the order flow in the US stock market, entered a pre-programmed mode (because the computer was told to do whatever it did by someone, and not without reason) that saw it buy up $2.6 million worth of stock every second.

Now there has long been speculation that HFTs are a central planner's best friend because they traditionally provide not only a floor to the stock market, but a gradual levitation bias especially in a low volume environment (as well as liquidity its advocates claim, but that is total BS - HFT only provides volume and churn - liquidity disappears at the drop of a bat when real selling pressure appears). They do this not because they are evil instruments of Bernanke collusion (although who knows) but simply because they accelerate and accentuate legacy momentum bias, which at least historically, has been up. Now in the aftermath of the Knight debacle we can also extrapolate what would happen if, say, reality were to creep in one day, and all those mutual and hedge funds which have carbon-based life forms making the buy and sell decisions suddenly decided to sell. Well, at $7 billion in 45 minutes, or 1/10th of the trading day, this means that had the Knight algo been running all day, it could have bought $70 billion worth of stock. Throw in the remaining flow routers, aka DMMs in the market which account for the remaining 90% of order flow, and we get a total of $700 billion in vacuum tube mediated purchasing power.

In other words, this is the market "worst case" shock absorber, or inverse escape velocity, that Bernanke has at his disposal if things turn sour. That said, with hedge funds, aka fast money, holding about $3 trillion in unlevered assets, and about $6-9 trillion with leverage (ignoring plain vanilla slow mutual funds), and one can see why not even the HFT levitation bid would be sufficient to offset a wholesale market dump.

There is one last open question remaining on Knight: what discount did Goldman extract out of the firm to rid it of its residual position which as the WSj explains declined slightly from its peak as "traders worked frantically Aug. 1 to sell shares while trying to minimize losses due to a software problem, ultimately paring the total position to about $4.6 billion by the end of the trading day" (one wonders if the market would have just blown up if the Knight algo were to run in reverse, and just take out layer after layer of bids to unwind the inventory asap). We now know thanks to the WSJ:

Knight avoided that scenario by agreeing in the early morning hours last Thursday to sell the portfolio to Goldman Sachs Group Inc., after rejecting an offer from UBS.

The terms sought by the banks reflected how dire Knight's situation was: UBS wanted an 8% to 9% discount on the position, according to people familiar with the matter.

The equities trading desk at UBS, headed by Mike Stewart, bid for the portfolio around 6:30 p.m. Wednesday, people familiar with the discussions said. Mr. Stewart was a former colleague of Knight Chief Executive Thomas Joyce's at Merrill Lynch. The talks with UBS fell apart later that night.

Goldman ultimately negotiated buying the portfolio at a 5% discount, or about $230 million less than the value of the stocks, the people said. That amount, not previously reported, represents more than half the loss Knight disclosed on Thursday that it incurred as a result of the technology errors.

The deal with Goldman allowed Knight to move ahead. Last weekend, Knight negotiated a rescue package with six financial firms that injected $400 million in capital in exchange for securities that can convert to ownership of 73% of the trading firm.

And now you know why having cash on your balance sheet in a ZIRP environment may well be the best investment, because just like Goldman, one never knows just where a slam dunk distressed opportunity could come from in exchange for an immediate 5% pick up.

More importantly, the Goldman deal demonstrates what the true liquidity cost is in this market when one wishes to do a wholesale stock transaction (either BWIC or OWIC): it is not less than 5% and tops out at 9%.

Keep that in mind, because if and when the day when VWAPing in and out of positions is no longer possible, each and every fund will have no choice but to assume a guaranteed 5% minimum (up to 9%) haircut on one's entire portfolio of allegedly liquid stocks.

We dread to think what the wholesale implied liquidity premium is on less liquid products than stocks, which nowadays is virtually everything...

* * *

Finally, we leave readers with yet another transformative animation from Nanex, after our first rendition of the "rise of the machines" back in February left many speechless, and which recently appears to have been rediscovered by some of the slower elements in the blogosphere. Why: because it's pretty, and we feel like it. And because it once again confirms that only vacuum tubes with infinite balance sheets should be gambling in this loaded market.

August 8, 2012

Fed Bankrupting Consumers While Enriching Wall Street as a Matter of Policy?

Majority of Wall Street dealers still expect Fed QE3 ... Despite improved hiring last month, most Wall Street economists still expect the Federal Reserve to do more to stimulate growth this year, with the majority looking for action as soon as September. The median of forecasts from a Reuters poll of 17 primary dealers - the large financial institutions that do business directly with the Fed - showed a 63 percent chance the central bank will for the third time expand its balance sheet via large-scale bond purchases. If the Fed does act, 13 said they thought it would do so at its next policy meeting in September, up from eight in a July 6 Reuters poll of 16 dealers. There are 21 primary dealers. Friday's poll was conducted after a government report showed employers added 163,000 new jobs. − Reuters

Dominant Social Theme: We are doing all we can to benefit the average consumer and job-holder.

Free-Market Analysis: Here is a question that needs answering: Why is the Fed giving away money freely to big professional investors that hold massive amounts of government bonds ("quantitative easing") while starving small businesspeople and investors of loans?

In this article, we'll try to provide an answer. Let's re-examine the business cycle in order to set the stage for our analysis.

It is government that creates recessions and depressions to begin with via the overprinting of money. Over time, the booms grow stronger as more and more money is pumped into the economy. The busts likewise grow deeper. The current bust is among the deepest in recent memory.

Many paper-money pundits have advocated reinflation via Fed money printing. In fact, the New York Times' Paul Krugman wrote the following in 2002:

The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Read this statement carefully. Is there anything about it that strikes you as playful? Krugman quotes a top official with one of the largest bond complexes in the world to back up his statements. He doesn't seem the least bit facetious to us. But nonetheless in 2009, Krugman felt compelled to offer the following explanation:

And I was on the grassy knoll, too ... One of the funny aspects of being a somewhat, um, forceful writer is that I'm regularly accused of all sorts of villainy ... The latest seems to be that I called for the creation of a housing bubble — in fact, the bubble is my fault!

Guys, read [the article] again. It wasn't a piece of policy advocacy, it was just economic analysis. What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble. And that's just what happened.

Krugman is being evasive here, in our view. He is very obviously a reflationist, someone who believes that government monopoly money printing can provide the boost an economy needs to regain prosperity.

For this reason, the Fed's Ben Bernanke (also an avid reflationist) has printed lots of money for purposes of "quantitative easing" 1&2. The easing has not done much to stimulate the larger economy, however, which is why there is speculation that Bernanke will shortly embark on a QE3.

This brings us to our second point. Incredibly enough, the Fed itself is paying big banks interest on money it has printed and deposited in its money center banks. The Fed is essentially paying banks .25 percent NOT to lend. In an article in the New York Times, economic commentator Bruce Bartlett noted the following:

The Fed can penalize banks for holding excess reserves by charging them interest rather than paying them interest. This has been done in other countries." ... On July 5 the central bank of Denmark announced that it would begin charging an interest rate of 0.2 percent on reserves.

Bartlett also noted it was "puzzling" as to why the Fed continued to basically discourage banks from making loans.

So here is a question that needs answering: Can the Fed reflate the larger dollar economy by encouraging its biggest banks to lend? Could it have done so directly after the bust of 2008?

Remember, at the time the Fed rushed tens of trillions around the world in supposed short term loans. This money, it is said, effectively unfroze locked-up liquidity and allowed the current money structure to survive.

But the larger economy STILL hasn't recovered. Likely, it is simply not feasible to reflate right away after a large bust. One can perhaps provide stability via liquidity, but this is a bit like putting a corpse on ice. It doesn't stink ... but it's not alive, either.

It was the opinion of no less an acute observer of the markets than Murray Rothbard that when a big bust occurred, such as took place in 1929, reflation was not particularly possible, immediately anyway.

It was Rothbard's contention that "deflation" would have to take place within the larger economy before a recovery. Rothbard granted that deflation – a contraction of the money supply – would inevitably have the effect of lowering prices.

But the key for Rothbard lies in the following statement from his famous book, Man, Economy and State: "Circulating credit can contract only as far down as the total amount of specie in circulation. In short, its maximum possible limit is the eradication of all previous credit expansion."

For this reason, Rothbard did not fear deflation so much as some, as he believed the process was the natural and inevitable result of central banking's artificial booms.

Okay. Let's review what we've established in our free-market analysis thus far.

We've established that the initial global crisis was caused by the overprinting of money. We've also established that four years later, the Fed is still trying to reflate the US economy ... or so politicians and Fed spokespeople proclaim every day.

But four years into a monumental economic bust, the Fed has shown no great urgency to force its banks to lend to the end-of-the-line consumer. Instead, there is talk of yet another quantitative easing that will somehow, we are sure, enrich the larger financial industry without having an impact on the employment-starved US economy.

If the Fed wanted to provide money to average consumers to reflate the US economy, it would do so by getting funds into consumers' hands. This seems self-evident. Instead, the Fed has actually paid banks not to lend!

One could argue that the Fed is actually trying to let the economy unwind with these tactics. And actually, we'd be in favor of that. But we don't believe for a second.

In the past, we've pointed out that it is most difficult to reflate aggressively after a large bust. Yet we are four years into this thing. It is time to say, therefore, what others for one reason or another have not: The Fed is TRYING to keep the economy on ice.

Of course, those at the top won't admit it for a lot of reasons, including the necessity of providing President Barack Obama with a pretense of monetary activity.

But the activity is not working.

Or rather it is benefitting the financial world that is basically owned and controlled by a tiny power elite. This elite is trying to create formal world government and uses tools of war, economic depression and general chaos to generate globalist change.

Yes, there would seem to be an elite dominant social theme here: "We are doing all we can, though it is not enough." In fact, the idea is perhaps to starve Western economies of cash (it's happening in Europe, too) in order to create conditions more conducive to world government.

If we are correct, this is a big and bold gamble the elites are taking in the 21st century during what we call the Internet Reformation ... when all eyes are on them. Having created misaligned economies via central banking, the elites have now embarked on a surreptitious program of retarding economic recovery.

Of course, from a free-market point of view, we are not big fans of reflating the current economy, which does nothing but support the plans of the power elite.

In a sense, the citizens of the West have perhaps got the worst of all worlds ... a depressed economy that is still in the grip of monopoly central banking.

Conclusion: Is this what Bernanke and his central banking colleagues are REALLY up to?