International Finance

Random Observations

What an exceedingly strange period in our economic and financial history! Amidst a non-recovery economic recovery we have below par growth and high unemployment. Coupled with economic weakness we have above trend inflation. Let us consider some of the odder stories from last week:

Ben Bernanke and QE3

The first two exercises in quantitative easing have had mixed to negative consequences. While the stock market has almost doubled from its low, the “real economy” has languished. We can further document the relationship between QE and poor economic performance with a look at price hikes in key commodities such as food and energy.

Yet here is Dr. Ben Bernanke before Congress, once again selling us a product repair that simply does not work. On Wednesday, he made it clear that QE3 was part of his thinking. And even he is not altogether sure. On Wednesday, he backed away from an immediate move to start a third round of Fed money printing and bond buying. See QE3 Guaranteed to Fail

Is there any reason that Dr. Bernanke still holds his job? While his supporters point to a rise in stocks, the “real economy” has suffered. Aren’t there better candidates for his job, who will try some new ideas? Are money printing and market manipulation the only ideas that any of our leaders can come up with? And to further the irritation with our Princeton economic guru, note that stocks used to rise and fall on company earnings and the economic outlook, not on which side of the bed the Fed chairman woke up on.

Don’t Worry Be Happy: Just Disregard Europe’s Problems

David Goldman in Inner Workings points out that the financial crisis in Europe will not be a rerun of Lehman’s 2008 meltdown:

Under the headline “A Fate Worse Than Banking Crisis” my friend John Dizard at the Financial Times points out that any run on Europe’s banks would be instantly countered by swap lines from the Fed and ECB. His point (one I have been making for some time) is that the scope of the European banking problem is well known and that mechanisms have long been in place to deal with the worst-case scenario. Not so with Lehman, where a sort of China syndrome applied: no-one knew the amount of contingent liabilities that might be affected. See Once Again: It’s Not Lehman II

Mr. Goldman continues to calmly assure us that European problems will not create another financial meltdown:

My conclusion: there is no reason to panic over the present kerfluffle, but there is no reason to own any exposure to southern Europe. Ever again. See Hopeless, But Not Serious: Once Again.

It’s too early to blow the “all clear” whistle on capital markets, but today’s recovery in the major US stock indices reassures me that this is not another financial crisis on the September 2008 scale, just a particularly nasty negotiation after which Italians, Greeks and Spaniards will end up poorer (along with Minnesota teachers, Wisconsin firemen and New Jersey policemen). It was amusing to see the usual suspects among the Street strategists issue dire warnings about increased tail risk just as markets turned around. See Ken Lewis, George Soros and Other Hedgehogs

So Mr. Goldman is assuring us of financial recovery based on one day of a US stock market rally? His prognostications eerily remind me of 2007 and the assurances from Ben Bernanke, Hank Paulson and other financial luminaries that the subprime crisis was well contained. Stock markets rallied then too, only to decline disastrously a year later.

Yesterday was a stark reminder of how unsafe Europe really is:

Greece 2 year interest rate on sovereign date: 34.5%
Portugal 2 year: 21.2%
Ireland 2 year : 23.3%
Italy 2 year : 4.65%
Spain 2 year: 4.55%

America is only marginally safer than Europe. American research firm Egan-Jones recently also downgraded US Treasury debt. See Europe is *Not* “Safe”

Are We Better Off Now Than In 2008?

We live in a financially interconnected world, and I am not at all reassured by Mr. Goldman. I doubt that anyone knows what the effect of a bankruptcy in Portugal or Italy would have on world financial markets. Could anyone have predicted that the 2008 financial crisis would take down AIG and Lehman and send US banks scurrying to the Treasury for TARP funds? Do we think the world and the major financial institutions can better weather a storm now than in 2008? While I may not know, I am more fearful that Bernanke, Goldman, Dimon and Blankfein do not know either, and they are out there making predictions and advocating policy.

Europe, China and the US have spent trillions of dollars trying to bolster their economies. What if we have used all our money-printing ammunition and the next crisis is even worse?

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American Society / Corporate Behavior / International Finance / Political — 0 Comments
21
May 11

Abusing the Public’s Trust

Have national and internal political leaders had all their internal governors removed? We have had more sordid revelations of leaders’ sexual misconduct than we can turn into television dramas. And it doesn’t seem to matter whether these scurrilous doings are coming from leaders who lean to the left or the right. 1. John Ensign, US Senator from Nevada resigns in disgrace over an affair with a member of his campaign staff. 2. Arnold Schwarzenegger, former California governor, admits to fathering an out of wedlock child while married to Maria Shriver, mother of his four other children. 3. Newt Gingrich plans a run for President after admitting to various sexual indiscretions with Congressional aides while he was married. The list of figures is long and undistinguished, going back to Bill Clinton, John Edwards, Gary Hart, Ted Kennedy, and others.

Dominique Strauss-Kahn

Dominique Strauss-Kahn, President of the International Monetary Fund (“IMF”), was arrested in New York last week on charges of a criminal sexual act, attempted rape and unlawful imprisonment. He was alleged to have brutally attacked a maid in his $3000 a night suite at the Sofitel in mid-town New York. Mr. Strauss-Kahn was apprehended in his airplane seat (Air France First Class) as he prepared to return to Paris. See I.M.F Chief, Apprehended at Airport, Is Accused of Sexual Attack

Mr.Strauss-Kahn claims the sex with the maid was consensual. The investigators and the courts will sort it all out. More interesting is why there is not more of a public uproar about the extravagant lifestyle of this public servant. The IMF, an intergovernmental organization, oversees the world financial system and stabilizes exchange rates. Financial support comes from its 188 member nations. The United States provides over 16% of its financial support. As IMF President, Mr. Strauss-Kahn is paid approximately $420,000 tax free, with a $75,000 expense allowance.

Why is Mr. Strauss-Kahn staying in a $3000 per night suite? Why is he flying first class to Paris at public expense? The Air France website lists a first class round trip from Paris to New York at over $15,000. You think Mr. Strauss-Kahn could have crossed the Atlantic in business class or, heaven forbid, coach? Ironically, Mr. Strauss-Kahn is a leading figure in the French Socialist Party. Perhaps his personal socialist credo does not extend to travel arrangements.

An Overweening Sense of Entitlement

Our political leaders have anointed themselves modern day royalty. They bombard us with speeches about fiscal prudence, austerity and the sanctity of family. But their behavior speaks volumes as to what they really think of us: the rules are for us, not them. We are useful dupes to be manipulated and lied to, or at the very least soaked financially for our ability to enhance their lifestyles. How insulting that in the midst of an economic depression we get to pick up the bill for their personal extravagance.

Some Rules to Live By

It is not such a far distance to extend this criticism to our business leaders as well. As a former business leader, I felt a responsibility to my company and my employees. As a senior manager, I had great leeway in selecting hotels, restaurants and transportation. Except for air flights where I often could not obtain an advance purchase discount ticket, my basic rule was that I would not charge the company for any travel arrangement I was not prepared to pay for in my personal life. Thus, I would not take a limo to the airport, but used a local taxi service for one third the price. I stayed in modest hotels and chose a standard room. [Note: I stayed at the same Sofitel as Mr. Strauss-Kahn on a business trip, and the bill for a very nice standard room with tax was less than $300. Those suites must be something!] Dinner out was at a type of restaurant that I would take my family. I wanted my employees to understand that we were part of a profit making business. Our jobs were not in existence to enhance our lifestyle at company expense. Rather, we were fiduciaries of corporate funds and we needed to do our part to control expenses.

While sexual misconduct gets the headlines, it is the rape of the taxpayer (which does not get the headlines) which should be drawing equal public ire.

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American Society / International Finance / law / The Federal Reserve — 0 Comments
28
Nov 10

How Many Branches of Government?

“The Federal Reserve is an example not just of run-of-the-mill hubris but of the far more profound Pathology of Power.

The rule of law has been supplanted in the U.S. by self-serving propaganda campaigns serving State and financial Elites: this is the Pathology of Power.” The Federal Reserve and the Pathology of Power

Ben Bernanke is out of control. “Out of control” is an oft-used phrase, but in this case the term describes an important actor with a limited statutory role who is usurping the power of both the legislative and executive branch.

Back in school we learned that we had three branches of government, the legislative, the executive and the judicial. Each had checks and balances to ensure that power was not abused. We now have a fourth branch, the imperial Federal Reserve. Without our permission, this rogue branch is dictating economic policy for the United States. Mission creep is taking the Fed from its dual mandates of employment and stable prices to its own self-proclaimed mandate: economic stimulation (in direct contravention of the views of the newly elected Congress and the American public) and dollar devaluation. In QE2 it also has taken on the role of guardian of stock market prices. See Who Elected Ben Bernanke?

By law the Federal Reserve has two economic mandated goals: full employment and stable prices. The US Treasury, part of the executive branch, has a separate and distinct role, and is responsible for maintaining the value of the dollar and debt issuance. Venturing into the world of quantitative easing the Federal Reserve is usurping the role of the Treasury through debt issuance and the Congressional role of fiscal policy through back door economic stimulus.

Crossing a New Line

Michael Shedlock has long maintained that the Federal Reserve was the least competent part of government. Dr. Bernanke never saw the economic crisis; however, he maintained that past folly would not stop the Fed from grabbing even more power and bungling any economic recovery.

The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing. Fed Uncertainty Principle

In a recent speech at the European Central Bank, Chairman Bernanke launched into a direct attack on Chinese exchange rate policy:

Federal Reserve Chairman Ben Bernanke put aside traditional central bank niceties and launched a direct attack on the slow pace of China’s steps to strengthen its currency.

In a speech prepared for a conference at the European Central Bank on Friday morning, Bernanke said that China’s decision to undervalue the yuan has essentially thrown a monkey wrench into the global economic recovery. Bernanke Turns Up Heat on China Currency Policy

Dr. Bernanke then tied the Chinese policy to weak employment in the US:

“On its current economic trajectory, the United States runs the risk of seeing millions of workers unemployed or underemployed for many years,” Bernanke said.

The Fed could not rule out the possibility that unemployment “might rise further in the near term,” he said. This could bring an end to the tepid U.S. recovery, he said.

He pointed his finger at China’s slow adjustment of its exchange rate. Bernanke Turns Up Heat on China Currency Policy

Other Areas for Dr. Bernanke’s Deft Policymaking

If Dr. Bernanke is willing to lay the blame of high US unemployment on the Chinese perhaps he should also recommend changes to the US’s legislative regime that makes hiring difficult:

Why not dismantle collective bargaining rights?
What about those pesky environmental laws?
Why do we need all these inefficient workplace mandates such as equal employment opportunity, family and medical leave, veterans’ rights, etc.?
Why do we need a minimum wage?
What about the newly imposed Obamacare costs?
Why not change tax policy which favors overseas profits?

We have a timid, economically naive President and a divided Congress. Into the breach steps Dr. Bernanke, filled with academic sagacity, theory and dogma. Remember this is a man who said the subprime crisis was well contained, and who could not detect a housing bubble.

When Congress inquires into outlandish Federal Reserve policies, Chairman Bernanke brandishes as a mighty shield the need for independence. Even an audit of their books is viewed as a mortal threat. Well Dr. Bernanke, perhaps it would be better to stick with your narrowly defined and legitimate role and jettison the imperial “fourth branch” of government nonsense.

Note to Dr. Bernanke: If you want to be overly political and wield unauthorized power, expect your independence to be severely clipped. You cannot have it both ways.

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American Society / Banking / Economics / Financial / International Finance / Political / The Federal Reserve — 0 Comments
24
Nov 10

Who Pays?

Early in my career I learned a valuable lesson. In the course of a transaction, a question arose as to how much in pension assets were to be transferred to the buyer’s plan. The pensions for employees transferring with the business were guaranteed and never in jeopardy. The only question was who would pay to fully fund the pension plan, the buyer, one large company or the seller, another large company?

Much disinformation exists about the roots and causes of our current financial crisis. Republicans blame Democrats, and vice versa. Banks blame government policy, and vice versa. Homeowners blame lenders, and vice versa. The US government faults the failure of the Chinese to let the yuan rise in value. The blame game is endless.

Government and its supporters have promised financial salvation in little understood programs such as TARP, TALF, QE1 and QE2. By design these programs are meant to confuse and mislead legislators and the public. The pseudo science of Federal Reserve and Treasury Keynesian technocrats has produced few if any promised results. I believe that these programs have been deliberately designed to hide their designers’ true agendas: socializing losses among taxpayers, and allowing malefactors to keep profits and undeserved, out-sized executive bonuses. Non-stop government propaganda again supports keeping the truth from the public. See 1984 in 2010. What is missing from the discussion is the proper allocation of both blame and responsibility. And logically flowing from that absent conversation would be the fundamental question now: who should pay?

Ireland’s current financial crisis foreshadows what could happen here.

Ireland Pays and Pays

After steadfastly considering a bailout, the Irish government stated that it intended to negotiate a bailout package with the EU and the IMF. Reports indicate the package could exceed $85 billion Euros ($149b). The government would take over one bank and take a majority stake in another bank. Report Asia One News

The central bankers have extracted financial concessions from the Irish government. Ireland must operate under an austerity budget with increased property and taxes on the wealthy coupled with a ten percent or more budget cut each year for the next four years. It is expected that the current government will be dissolved and new elections held.

How Did Ireland Get Into This Mess?

Like many economies, Ireland’s recent prosperity was built on a real estate boom.

Much of its growth was built around the property market, but since 2008 this has suffered a dramatic collapse.

House values have fallen by between 50% and 60%, and bad debts – mainly in the form of loans to developers – have built up in the country’s main banks. This almost wrecked the institutions, leaving them needing bailing out by the government at a cost of 45bn euros (£39bn; $60.1bn).

This has opened a huge hole in the Irish government’s finances – which will see it run a budget deficit equivalent to 32% of GDP this year. See BBC Q&A: Irish Republic Finances

When the property market collapsed the government stepped in to save its banks:

As several of the banks have been part-nationalised, most of their massive debt is now actually government debt.

And the great majority of this debt is owed to foreign lenders, which the Irish banks (and therefore the Irish government) simply cannot afford to default on. See BBC Q&A: Irish Republic Finances

Thus, the government saved foreign holders of Irish debt and the private Irish bank bondholders. The losers are the Irish taxpayer and their economy.

The US Taxpayer Also Pays and Pays

Seemingly innocuous words and phrases such as “bailout,” “government guarantee,” “quantitative easing” or “Troubled Asset Relief Program” hide the true nature of the governmental objective. Whether it is Bank of America, General Motors, General Electric, Citicorp or Chrysler, these are enormous businesses that made bad decisions. The litany is long and undistinguished: lending irresponsibly (no income, no job loans); using too much leverage (Bear and Lehman); selecting the wrong products (SUVs during the oil price crisis) or misleading accounting (GE pension accounting). All of these were private businesses pursuing profits. Shareholders and bondholders of these enterprises willingly invested, hoping for share appreciation, dividends and interest payments. They understood the risk that businesses could go bankrupt, or dividends and interest suspended.

The rallying cry of “save the banks” or “save GM” is really a way of transferring losses from the business and its investors to the taxpayer. With QE2 we face the prospect of the taxpayer/consumer paying the hidden tax of higher inflation. Just after QE2 was announced the Fed revealed its true purpose: saving the banks yet again by requiring a second round of bank stress tests.

A Moment of Morality

Karl Denninger provides an unvarnished view of the morality of the Irish bailout, the parallels to the US and what must happen:

Looting becomes impossible to sustain eventually. Now the Irish Government thinks that the Irish people should pay for being robbed!

It’s not enough to get ripped off – now the government wants to tax the people to pay for the stealing that they allowed to happen in the first place.

This is no different than what happened in Greece or the United States for that matter, and it will continue to happen until the people stand up and refuse to accept it.

Further, and far more importantly, shifting the bad debt around doesn’t get rid of it. It simply tries to impose the cost on the nation as a tax – a tax that cannot be paid, and won’t be paid.

To the Irish people: You must choose between putting a stop to this – no matter what it takes to enforce that demand – and literal debt peonage and servitude imposed upon you for the sins of a handful of rich bastards that robbed all of you. See Another Lie Exposed: Ireland

Behind all these fancy financial terms and maneuverings there is a moral dimension. Judeo-Christian theology is based on concepts of reward and punishment. Capitalism follows the same path. Rewarding financial elites who misbehaved, and punishing hardworking, prudent taxpayers, runs contrary to a moral core. The programmatic maneuverings blur the distinction between right and wrong. Further, from an economic viewpoint it encourages moral hazard, that is, risk taking without fear of punishment. Ultimately, the populace refuses to accept this new burdensome status quo and real trouble starts.

Until now, we in the US have accepted the status quo that we must save banks, auto companies and insurance outfits and further burden taxpayers. Has anyone in authority explained why, or offered any other alternatives? If we don’t ask these questions soon, we face a weekend like Ireland is experiencing right now: looking down the gun barrel of austerity and increased taxes or worse.

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Banking / Business / Economics / Financial / International Finance / The Federal Reserve — 0 Comments
17
Nov 10

Unintended Consequences of QE2

In several previous posts we have discussed why QE2 is wrong-headed and potentially disastrous. Let’s look at some of the unintended consequences since its announcement on November 3.

Bond Market

The stated goal of QE2 was to lower interest rates to stimulate spending. The methodology was the purchase of intermediate term (5-15 years) Treasury securities. Looking at last month’s performance of the Treasury market we see the following: five-year (current yield – 1.46%; one month ago 1.13%); ten-year (current yield -2.83%; one month ago – 2.51%); 30-year (4.23%; one month ago – 3.95%). Source – Yahoo Finance, November 17^th. Similarly, QE2 has triggered a crash in the municipal bond market. Yields have risen one-half percent since November 5^th. See Tax- Exempt Muni Bonds Tumble; Munis Continue Collapsing. Increases in interest rates only favor banks over the real economy. See Bond Market to Bernanke: F@&k You

The G-20 Meeting

QE2 has set off a currency war. Our trading partners recognize that the Federal Reserve is flooding the world with US dollars. To avoid importing inflation, these countries are contemplating erecting protectionist measures such as controls on imported capital. Writing for the Asia Times, David Goldman captures the international turmoil:

…Never before has the world displayed the sort of public contempt for American policy that Germany, China and others expressed last week. Wolfgang Schaueble’s Spiegel interview last week describing quantitative easing as “clueless,” followed by Federal Chancellor Angela Merkel’s open attack on it during the G20 meetings, is entirely new, as is the Chinese and other Asian threat to simply keep dollars out.

The rest of the world is right and the Fed is wrong. QE2 is turning into Titanic I. The Fed has been exporting inflation through excess money creation; holders of dollars buy foreign currency, which forces foreign central banks to intervene on foreign exchange markets by selling their own currency. The foreign central banks create new local currency in order to buy the unwanted dollars and stabilize their exchange rates, which adds to inflationary pressures in their countries. They use the dollars they have bought to buy Treasuries. See Exchange Controls and Deflation

Since countries such as Japan and China are major purchasers of US Treasury securities, alienating these purchasers will have the unintended consequence of further driving up US interest rates. Mr. Goldman advises investors to avoid financial markets and stick to cash during this turbulent period. In a disingenuous defense of QE2 William Dudley, President of the New York Federal Reserve Bank, claimed that: “I don’t think we knew that the dollar would necessarily weaken.” Before implementing a controversial policy as QE2, shouldn’t Professor Bernanke and his cohorts have considered a falling dollar and rising commodity prices?

Cost Push Inflation

Living through the 1970’s, cost push inflation, where input prices compressed profit margins, was a major cause of the steep bear market in stocks. Carefully massaged current government inflation statistics need to be taken with a grain of salt. In the real world companies as diverse as Kraft, Dean Food, Kimberly Clark and Campbell Soup have cited cost pressures, and reported poor quarterly results. Kimberly Clark’s announcement cited its “highest-ever cost inflation…” And So it Begins… (Cost-Push Margin Compression)

The already beleaguered consumer is experiencing real world inflation at the checkout counter:

There might not have been a second round of quantitative easing, if Federal Reserve Chairman Ben Bernanke shopped at Walmart.

A new pricing survey of products sold at the world’s largest retailer showed a 0.6 percent price increase in just the last two months, according to MKM Partners. At that rate, prices would be close to four percent higher a year from now, double the Fed’s mandate. See Walmart: Inflation is Up

Stocks are now priced for perfection, the market’s way of telling us that investors have not considered rising inflation. Declining profit margins will result in price earnings multiple shrinkage and a falling stock market. See The Cliff

Misallocation of Capital

Since the US does not have exchange controls, the Federal Reserve cannot control where its newly created dollars are invested. We have identified commodity speculation as one area for these funds. See 1984 in 2010. Further, money is being invested in emerging markets instead of the US economy.

Despite the belief that the Federal Reserve can create unlimited amounts of dollars, any society has limited capital resources. These can either be invested wisely in new productive enterprises or squandered through speculation. QE2 encourages the latter. By artificially attempting to suppress interest rates the following occurs:

You get asset and credit bubbles – every time. The reason is simple: You have paid someone to perform an uneconomic activity. That is, an activity which would not be performed by free actors in a free market system because it would inevitably lead to loss becomes profitable due to intentional interference in the market.

Maintenance of such a thing over time requires that “someone” be given incentives to perform non-economic activities. This in turn fuels asset bubbles and that, in turn, leads to cycles of booms and busts. See Dishonesty All Around – Monetary and Security

Constant intervention in the economy will only lead to an inevitable bust.

Real Solutions

We are headed down a dangerous path: not only dangerous to our financial portfolios, but dangerous to our security. Currency wars and protectionism lead to real wars. The history of the 1930s is a dramatic example.

The ways out of this quagmire are painful. They involve writing down debt, losses to bondholders, a failure of several “too big to fail banks” and a shock to the equity markets. The pain will be great, but swift. Remaining on our current course will be worse.

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Economics / International Finance / law / Political / The Federal Reserve — 0 Comments
6
Nov 10

Who Elected Ben Bernanke?

Everyone was focused this week on the mid-term election results. Instead, we need to focus on another event just as crucial, but less understood by the American public. Our unelected Federal Reserve Chairman, Ben Bernanke, launched QE2, the outright government purchase of US treasury securities. The highlights:

- The Fed is buying $600 billion of Treasuries (in the 5-10 year part of the curve) through mid-2011 and another $250-300 billion via coupon reinvestments, which they were going to do anyway.

- The key “number” for the markets is that $600 billion figure, which is about $75 billion per month. See Rosenberg Joins Chorus of those Accusing Bernanke of Asset (Read Stock) Price Targeting

In Ben Bernanke’s self-justifying op-ed in the Washington Post, he explained his main goal:

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion. What the Fed did and Why: Sustaining the Recovery and Supporting Price Stability

Dr. Bernanke remained confident he could reverse this policy at the appropriate time.

Nowhere in the Federal Reserve’s mandate is the elevation of stock prices. Why not target wages and house prices? Further, the Fed will be continuing to purchase tainted and suspect mortgage backed securities. These securities are the heart of the current Foreclosuregate controversy. The Fed is paying full value for a security that may be worth pennies on the dollar.

Unintended Consequences of the Policy

Focusing on stock prices is a little like ordering dessert before focusing on the nutritional value of the main course. Before now, profits, dividends, discounted cash flow and future growth prospects determined what happened to a company and its stock price. Now will we have Federal Reserve whim determine stock prices? QE2 sets the markets up for another enormous bear market when the Fed stops QE2, or when stock-dislocating events overtake the Fed.

The unintended consequences are both legion and wealth destroying: a weak dollar with surging import prices; soaring inflation in critical commodities such as oil and grain; compressed profit margins caused by higher input costs; further punishment of savers and retirees; trade wars with other nations whose economies wilt under a weakened dollar; and market-wide unstable speculation.

Karl Denninger in Bernanke’s Folly: The End Game explains that the Fed policy is essentially a gigantic hidden tax on businesses and consumers. The end result will be a downward spiraling economy with businesses forced to lay off more workers to offset higher input costs – anything but the virtuous cycle Dr. Bernanke so fervently seeks.

The Constitution and the Election

Economic blogs are abuzz with QE2 analysis. One particular area has been overlooked: the break down in our political system and Constitutional protections. Dr. Bernanke has usurped the taxing and budgeting authority of Congress. QE1 and 2 put the taxpayer squarely on the hook for all Federal Reserve losses. The Treasury is required to make good on Fed losses. So without writing a bill or holding a hearing, Dr. Bernanke launched his quantitative easing campaign and effectively dismantled the legislative process. John Hussman warns of the danger of this reckless usurping of Congress’ role:

Now, since standing behind insolvent debt in order to make it whole is strictly an act of fiscal policy, one would think that under the Constitution, it would have been subject to Congressional debate and democratic process. But the Bernanke Fed evidently views democracy as a clumsy extravagance, and so, the Fed accumulated $1.5 trillion in the debt obligations of these insolvent agencies, which effectively forces the public to make those obligations whole, without any actual need for public input on the matter.” See Lessons from a Lost Decade

The Farce of the Mid-Term Elections

Tea Party activists are publicly miserable about out of control federal spending, bank bailouts and economic stimulus. Before the new Congress convenes, Dr. Bernanke has unilaterally established economic policy for both Congress and the Administration. Where is the outrage? The Tea Party is so worried about liberty and free market capitalism, why have they not protested the dubious economic policies of an unelected new economic Czar, Dr. Bernanke? After all Dr. Bernanke and the Federal Reserve Governors have the same methods and goals as the former Soviet State Planning Committee.

More practically, why has Congress not held hearings and asked Dr. Bernanke some pointed questions:

Why did QE1 not work?
When you stopped QE1 in March of this year the markets fell and the economy retreated. Is there a reasonable possibility that you can ever stop the QE policy without a market crash?
Have we just signed on to perpetual QE? If not, explain your exit strategy.
What will be the effect on our trading partners and will your policy lead to a currency war?
Please outline other risks in your policy and weigh these against the benefits.
How much of QE2 will go into foreign market speculation?
QE did not work in Japan for the last 20 years. Why will it work here?

Academic Theory

Dr. Bernanke is an academic theoretician. He taught at Princeton and now heads the Federal Reserve. He has never run a business in the real world. Quantitative easing is a theory and like all theories needs to be tested and proven. We do not approve introduction of a new drug without stringent tests and proofs. Dr. Bernanke is not playing with one drug; he is playing with our entire economy and political system. QE1 in the United States and QE in Japan for twenty years proved to be failures. Why are we repeating failed strategy?

If he is going to target stock prices, then I still have some underwater stock options from a former employer. Perhaps the good doctor could salvage my company’s stock too. When one usurps normal market mechanisms, why not?

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American Society / Economics / Financial / International Finance / Municipal Finance / Political / State Finance — 0 Comments
10
Jun 10

Bailout Nation Lives

Where is the coordination of economic policy among the Federal Reserve, the Treasury and Congress? In testimony before Congress, Ben Bernanke, Chairman of the Federal Reserve warned against large budget deficits:

The Fed chief repeated his call for lawmakers to come up with a long-term plan to reduce the federal budget deficit, which is projected to widen to a record $1.55 trillion this fiscal year. “Unless we as a nation make a strong commitment to fiscal responsibility, in the longer run, we will have neither financial stability nor healthy economic growth,” he said. See Bernanke Says Fed Prepared to Counter Effects of Europe Crisis

It is clear that bailouts are not consistent with fiscal responsibility. But it seems the Administration and Congress are tone deaf to these no more bailout pleas.

No Constituency Left Behind

We have analyzed the bailout actions of the Bush and Obama administrations. See Are We a Socialist Country? It has been a long and undistinguished progression from Bear Stearns, AIG, American Express, GM, Chrysler, GE and others. We have collectively decided that banks, insurance, automotive, industrial, credit card and other companies are too systemically important to fail, and are therefore bailout worthy.

Despite all protestation the Obama Administration appears to be on a constant search for new bailout candidates:

- A $23B Bailout for Teachers – Education Secretary Arne Duncan urged Congress to support a $23b jobs bill to prevent teacher layoffs.

- Why Leave Out Pension Funds? – Senator Casey, D-PA proposes affording two large multi-employer Teamster pension plans federal protection. The estimated cost would be $8-10b.

- US Largesse Goes Global – Through IMF membership, the US taxpayer will be funding the bailout of Greece and other European nations. IMF Chairman Boutros-Ghali pointed out the perilous financial position of the IMF and the need for more member capital contributions. Rep. McMorris Rodgers, R-CA highlights the hidden cost to us:

“This should give pause to Treasury Secretary Geithner and others who boasted that the IMF’s bailout bonanza wouldn’t cost U.S. taxpayers a dime,” said Rep. McMorris Rodgers. “In truth, the cost to U.S. taxpayers goes up every few weeks. After the Greek bailout, it stood at about $7 billion; after the EU bailout, it stood at about $60 billion. Now – based on Mr. Boutros-Ghali’s comments – we’re talking at possibly $100 billion or more. This has got to stop.” See Congresswoman McMorris Rodgers Responds to IMF Statement Europe Bailout will Cost US Taxpayers 100 billion+

- As we have pointed out, Fannie Mae and Freddie Mac are uncapped, growing, perpetual bailouts. See Shredding the Social Fabric.

The Hidden Costs of Bailouts

Politicians are constantly on the prowl for a free lunch. Bailouts and promises of “little cost to the taxpayer” provide that seemingly free repast. A closer look at the bailout phenomenon shows us its high and hidden price tag. A look at some unintended consequences:

Bailouts only add to the burgeoning federal deficit.
Ultimately, they will be paid for either through higher taxes, higher inflation or both.
We are eroding financial discipline. GM was roundly criticized for giving away a new Corvette to a Detroit Tiger, who pitched a near perfect game.
Likewise, we are eroding fiscal discipline in states and municipalities, which should be cutting budgets and raising taxes rather than seeking bailouts.
We are compromising our most basic federal system of separation of powers, as a state and local function, education, becomes a federal ward.
We are encouraging moral hazard with reckless and profligate behavior (and prudent behavior is punished).
Bailouts beget other bailouts, as it become impossible to draw the line when future constituencies come to Washington for their bailout.
Today’s funding of bailouts limits the flexibility of the Administration to respond to future, more serious crises.

Fundamentally, bailouts are unfair, as one group is leveraging its political clout to earn a bailout at the expense of innocent taxpayers. Rewarding the profligate and the irresponsible makes little sense as public policy. It is time to end the bailouts.

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26
May 10

The Failure of the Technocrats

The Bible has some great story lines. The inhabitants of Babel built a huge tower to the heavens to challenge the Master of the Universe. Of course they failed; the tower first burned and then was swallowed up by the earth. And the Master punished them with a fitting and eternal dilemma: the world’s people no longer were able to understand each other. They would forever after have seventy different languages, live in different locations, and most importantly have different mindsets and worldviews. My own additional take on the moral of the story: when man believes he can control the entire universe and challenge the Deity, he is asking for trouble and retribution from the Master.

It is not unreasonable to postulate that we have made technology and its enhancements into a deity of sorts. Without question, in several ways, man is pushing the ethical boundaries of its use of technology This is not anti-technology rant, as there is much good in technological innovation, but rather a comment on hubris and limits. Perhaps it is worth thinking about whether or not we are courting some divine retribution of our own.

The Financial Crisis

At the core of the financial crisis is the naïve belief that we can control risk with numbers and computers. The inherently risky subprime crisis and debacle is the most spectacular example. Look at the components: first, mathematical modeling of historical default rates. Next, customer “choice” in risk level, when really the product carried risk level for everyone. Then, bogus “protections” in the form of derivative “insurance” and “AAA ratings” that offered no protection at all. Mathematicians used their own models to demonstrate the safety of their products. Their marketing departments brilliantly sold us on core assumptions that were not true: US house prices would always increase in price; subprime mortgages would default at the same historical rates; homeowners would do everything possible to hang onto their homes; and counterparties underwriting the risk would be fine to pay creditors in the event of massive default.

As we now know, these assumptions were horribly wrong. Mathematicians and Wall Street learned little from the 1998 failure of Long Term Capital Management where interest rate, equity and currency modeling diverged from historical patterns. The result was near destruction of the financial system.

Deepwater Horizon

It is now more than five weeks after the Deepwater Horizon oil spill, and we appear no closer to staunching the spill at the source. Americans have given little thought to the complexity of drilling in 5000 feet of water into 13000 feet of rock. Oil and gas pressures are enormous and literally destroyed the blow out preventers. The US Coast Guard has characterized the process to cap the well as challenging as the Apollo 13 rescue. We do not even have a good estimate how much oil is spilling each day. The original 5000 barrel per day estimates have been supplanted by scientific estimations of 40,000 to 100,000 barrels per day; a disaster the magnitude of the Exxon Valdez occurring every couple of days.

Our thirst for oil has led us to the outer boundaries of man’s capability to control the consequences.

Enter the Technocrats

Perhaps it is time to re-think the role of technocrats in society. We have believed the mainstream media’s propaganda that with the right science, math or technology we can control the universe. This attitude is no more in evidence than in the hubris of Bernanke, Geithner, Summers and Obama that they have conquered natural economic cycles and protected us from another depression.

In fact, we do not know if we have entered a second downturn. However, we should be highly skeptical if not outright disdainful of any all-knowing group of technocrats. Man is having trouble controlling “smaller events” like one oil well or one country’s subprime market. Our own economy is complex and exists within a more complex backdrop of global events like a crashing Euro, Chinese inflation, diminishing energy resources, conflict in the Middle East and other interlocking problems.

Adjusting a couple of economic dials through deficit spending, bailouts and artifice will probably end in tears. The European Commission and the Obama Administration would be better served re-reading the Tower of Babel story and holding off self-congratulations in any language.

We have heard “mission accomplished” one too many times.

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11
May 10

Extend, Pretend and Crash?

After Monday’s European Union’s (“EU”) trillion dollar bailout, Zero Hedge’s headline encapsulated what had transpired: “Even Keynes Is Spinning in His Grave.” “Extend and pretend” is now official worldwide economic dogma, as embodied in this unprecedented bailout. Why extend and pretend? Has anything really changed?

Pretending as Public Policy

We live in an age of irresponsibility. We seem to be responding to all types of crises with sluggish denial and finger pointing. From Katrina to the Financial Crisis to the Deepwater Horizon oil rig disaster, government massages the news, assigns culprits and acts only when pushed by market events or an outraged public. Instead of thoughtful, real and comprehensive solutions the policy is “extend or pretend.” More plainly, the goal is to conjure a stop gap solution and pray that time and luck will save the day.

A History of Extend and Pretend

At the end of the Bush Administration, the financial crisis lent itself to “extend and pretend” policymaking. The fractious, polarized political culture made it ever easier to opt for this policy choice. Obama, if anything a master politician, has adhered to these same choices. Let’s look at how “extend and pretend” continues even now:

- Mark to Market Accounting – Facing pressure from the banks and Congress, in April 2009, the SEC suspended the mark to market accounting rules for bank assets. Given mounting foreclosures in the housing market, it is highly likely that the banks are not properly valuing these assets. Pundits believe that many major banks are insolvent.

- The Federal Reserve – Through the TARP and other bail out programs, as of March 31, 2010, the Federal Reserve balance sheet has expanded to over $2 trillion, mainly in dubious mortgage backed securities. Once again, analysts are questioning the worth of these securities and the Fed’s solvency.

- Government Sponsored Enterprises (“GSEs”) –We are ignoring the hapless Fannie Mae and Freddie Mac agencies in the midst of our stock market and banking dramas. Despite the vaunted financial reform efforts, we haven’t even considered crafting a solution to the GSE mess. Instead of reform, on Christmas Eve 2009, the Administration extended unlimited financial assistance to these businesses. Buried in our naïve enthusiasm for the ECB bailout is a painful reminder of taxpayer obligations. Fannie Mae posted a quarterly loss of $11.5b and needs at least $8.4b from the government to continue.

- General Motors – After proudly proclaiming in a national ad campaign that they had re-paid loans to the government, Senator Grassley found that the company merely tapped a US Treasury escrow account to repay its TARP loan.

Extend and Pretend Goes Global

Today’s EU trillion dollar bailout is more of the same. The three part program is to create a 750 billion Euro fiscal support program, buy bonds in dysfunctional markets (quantitative easing) and enter into swap lines with the Federal Reserve to obtain dollars. This is “extend and pretend” taken to an entirely new level. It is not even clear or sure whether the EU can obtain IMF approval to move forward. Problem countries will require austerity measures. In sum, this is exponential “extend and pretend,” as troubled governments pretend to have a program to calm their markets and citizens. And even if they enact these programs they do not deal with underlying structural issues in the EU, where too little income supports too much debt.

It All Comes Down to Honesty

The political elites in the US and Europe do not want to face the economic realities. Honesty and candor with electorates are in short supply. Instead of leaders we have a class of venal and calculating politicians. Happy to solve the problems of today with band aids, they invite greater calamities, where the patient may be lucky to make it out of intensive care and may yet succumb to massive infection.

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4
May 10

Goldilocks and Scary Headlines

In the previous bull market cycle, Larry Kudlow of CNBC touted the perfect “goldilocks economy.” While not using the terms goldilocks economy, Michael Hanson, economist for Bank of America, is again touting a benign investment environment. He predicts that over the next several years the economy will grow at 2.5-3.5 percent, interest rates will remain low and inflation will be subdued. He also maintains that the growing federal deficit is the only “minor” concern. B of A’s wealth management approach appears to be the fairly standard mantra: emphasize tax efficiency, and diversify among various asset classes.

This blog does not provide advice as might your investment adviser, guru or astrologist. However, I find something deeply disturbing about the aforementioned advice and forecasts. The core of this philosophy is that past is prologue, and the next fifty years will look just like the past twenty-five. But asset diversification strategy did not take into account that in 2007 and 2008, with the exception of US treasury securities, all markets declined simultaneously. Robert Prechter of Elliott Wave called this phenomenon “It’s All One Market.” And indeed diversification assured portfolio losses of 40% or more.

The Real World Intrudes

Counter to the “goldilocks” world view espoused by CNBC and wealth management firms, messy facts keep cropping up daily. Recent cautions for any investor or policy maker:

More than a Million in the U.S. May Lose Job Benefits – Congress is concerned with federal deficits and extended unemployment benefits. They believe that these benefits are a disincentive to finding work, and they are disinclined to extend the 99 week ceiling. Thus, 1 million people face an immediate loss of benefits with an estimated loss of 400,000 per month thereafter.

Morgan Stanley: Strategic Defaults Reach 12% – These are the mortgage holders with the capacity to pay, and yet choose to default. Twelve per cent of all mortgage defaults in February 2010 were of the strategic variety. As I predicted, “bailout nation” has given license to strategic defaulters to just walk away from their underwater home values. See Flirting with Economic and Political Breakdown.

Is the UK Preparing to follow the PIIGS into the Abyss

With $2 Trillion in 3 Year Funding Needs by the PIIGS, the IMF is Helpless to Do Anything but Sit Back and Watch

Spanish Unemployment Rate Tops 20%

Containment Fails: European CDS Explode as Market Looks to Future Bail Outs, Bank Runs

Mainstream media keeps reassuring the public that the crisis in Greece is well contained. But just remember how Ben Bernanke assured the financial markets that our subprime crisis was also well contained. Government financial profligacy is having major repercussions in the European financial markets. Bailouts of private banks, out of control public sector salaries and pensions, overregulation, and (with the assistance of American investment banks) financial chicanery to hide public indebtedness debt have come home to roost. Credit spreads, the difference between the gold standard German bonds and other European government debt, especially the “PIIGS” (Portugal, Ireland, Italy, Greece, Spain), have widened to alarming numbers. Even the UK has experienced widening of credit spreads against German bonds. Eurozone unemployment is soaring. Despite EU and IMF efforts to bail out Greece, credit spreads again widened today and the Euro plunged.

Justice Department Opens Goldman Sachs Criminal Investigation Sources Say – The significance here is not whether or not the government can prove that Goldman committed crimes. Rather, the importance of the investigation is that the tide has turned. Financial firms will be on the defensive and unfortunately their most profitable products operate on the edge of the law. Inevitably, more government oversight will cut profitability and remove one more support from the already fragile economic recovery. See also Watershed Event in the Financial Crisis – SEC v. Goldman.

Uncertainty Abounds

Risk and reward need to correlate. Perhaps diversification and the rosy scenarios of years past will win out. But this small selection of troubling headlines suggests otherwise. I would view the diversification thesis very skeptically. As they used to say on television’s Hill Street Blues: “Hey, let’s be careful out there.”

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