Posts Tagged: Ben Bernanke

American Society / Corporate Behavior / Political — 0 Comments
6
Jul 11

Recycling Losers

A curious feature of institutional behavior is the tendency to hire or retain executives who have failed in their jobs.  A prime example of such behavior is the hiring of baseball managers.  Baseball is enthralled with the familiar.  So it seems the best way to get a manager’s job is to be fired from one.   Despite their undistinguished records, managers like Jim Fregosi (win/loss record 1028-1095); Jerry Narron (291-341); Grady Little (385-290); Dallas Green (454-478) and a host of others were fired by one club, and then hired by another.  Many were given veteran clubs with proven stars, and yet they could not win championships.  Anecdotally, baseball was often accused of recycling old white men.  But recent reforms in baseball have demonstrated an equality of mediocrity if you will, as baseball has recycled minority managers with losing records.

The same dysfunctional thinking occurs in American business.   After being fired in the wake of the Bank of America merger, John Thain went from leadership at Merrill Lynch to head the CIT group.  Robert Rubin remained as Chairman of Citicorp after the financial crisis (although he resigned in 2009).  Lloyd Blankfein at Goldman Sachs and Jamie Dimon at J.P. Morgan continue in their positions.

President Obama assembled his financial team and shamelessly recycled flawed people: Ben Bernanke (Federal Reserve Chairman); Timothy Geithner (Secretary of the Treasury); Lawrence Summers (Head of the Council of Economic Advisers); Robert Rubin (economic adviser) and Jeffrey Immelt (President’s Economic Recovery Advisory Board).   Without cataloging their financial sins, clearly each of them contributed in a major way to the near collapse of the American financial system.

Failing Upward

In an aptly named article, Failing Upward, Yves Smith highlights the hiring of Madelyn Antoncic as Treasurer of the World Bank.   Ms. Antoncic’s previous position was Chief Risk Officer of the bankrupt Lehman Brothers:

The World Bank has appointed Madelyn Antoncic as its new vice president and treasurer.

Ms Antoncic served as Lehman Brothers’ chief risk officer from 2002 to 2007 and following the collapse of the bank, stayed on for a year as managing director and senior advisor at the Lehman Estate, helping to maximise value for creditors….

Commenting on the appointment, World Bank Group president Robert B Zoellick, says: “Known for her forthrightness, I am delighted Madelyn is taking up this important role.” See Failing Upward

Ms. Smith concludes that large financial institutions are comfortable hiring familiar people for big jobs, no matter how poorly they have previously performed.

Forthright but Ineffective

Robert Zoellick praises Ms. Antoncic’s forthrightness.  Another analyst comments that she “was likely the only person on Lehman’s executive committee who had any sense.”   See World Bank Taps Ex Risk Officer as Treasurer. But we then learn that senior management knew that the firm was taking on too much risk.   What was Ms. Antoncic’s role in controlling risk; indeed what did she know?  Was not controlling risk essentially her job?

So where was Antoncic to reign in such risk during that time? Well, she was being kicked out of executive meetings where risk was being discussed. Antoncic, with her PhD in economics and a prior 12 year stint at Goldman Sachs, might have know Lehman was taking too much risk but her opinion was blatantly disregarded when she was removed from Lehman’s executive committee in 2007. See World Bank Taps Ex Risk Officer as Treasurer

So Ms. Antoncic, the lonely voice of reason, was kicked off the executive committee. I do not know Ms. Antoncic, but her behavior raises important management questions.  Did she resign from Lehman?  Did she inform the Board of Directors or government regulators that the bank was taking on too much risk and might collapse?  No, she continued to collect her paycheck, a monument to her ineffectiveness and her questionable ethics.  If she was one of my employees, I would have fired her.  Forthright but ineffective just does not cut it.

Too Comfortable

Executives become too comfortable.   Instead of hiring a challenging subordinate who can bring fresh ideas, they are more likely to hire a loyal unchallenging stalwart who can maintain the status quo.  In a more cynical view of things, I would suspect that Mr. Zoellick found the right employee in Ms. Antoncic.  She would be beholden to him, be loyal to a fault and never challenge his decisions. Unfortunately, these are valued traits in corporate America and in government and can be summarized: “go along and get along.”

In my own experience I watched poor performing executives fail and then be promoted to a larger assignment.  I once quipped that you could not be promoted until you made at least a $500m dollar mistake.   That would demonstrate that you were a real player.  Obviously, Ms. Antoncic was a “real player.”  It took a real talent to be part of team which bankrupted a major investment bank and nearly crashed the entire economy.

The financial crisis will remain intractable as long as we continue to recycle the same financial players and government advisers who got us into this mess.  We need smart people with new ideas and different energy who can get us out this quagmire.  It is going to take the truly exceptional Board of Directors, CEO or US President to get rid of the wrong people, locate and hire the right people, and break with the past.    Perhaps it is time to afflict the too comfortable.

 

 

 

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Foreign Policy / Justice System / Political / The Federal Reserve — 0 Comments
13
Feb 11

Restoring Federal Reserve Accountability

In We Cannot Separate Politics and Economics. And Those Who Speak Out Against Bad Policy are Helping the Economy…And Our Individual Investments; Washington’s blog makes an important point about the poor state of economic analysis.  Modern economists naively analyze the economy without regard to the interplay of politics:

Some people criticize the injection of politics into economic discussions.

But economic historians tell us that economists used to understand and accept that economics is wholly interrelated with politics, and that politics affects our economy. They note that modern economists have artificially tried to somehow separate the two, like Descartes tried to separate the mind from the body.

Indeed, the father of modern economics – Adam Smith – talked a lot about politics in relation to economics. Washington’s Blog

Recognizing the inter-connectedness of politics and economics, the discipline was originally referred to as “political economy.”  In fact Georgetown University has a political economy major.

The blog goes on to criticize the multi-trillion dollar expenditures on the Iraq and Afghanistan wars and the consequent deleterious effect on the economy.  Moreover, for the last ten years we have undermined any semblance of a free market by living under a state of economic emergency.   We have massively lost trust in government.  With the financial crisis and lack of prosecutions the public has also lost trust in our financial institutions, the SEC and the Justice Department.  But what is missing from this excellent analysis is the role of the Federal Reserve.

The Federal Reserve: Earnest Technocrats or Politicians in Disguise?

The Federal Reserve has a limited statutory mandate: maintain full employment and price stability.  Under Ben Bernanke the Federal Reserve has gone far afield from that mandate:

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?

Bernanke has crossed into the realm of political decision making:

  • Ultra low short-term interest rates have fattened bank profits at the expense of retirees, pension funds and insurance companies.
  • QE2 money printing has set off a speculative binge in commodities hurting consumers.
  • QE2 has hurt the value of the dollar, favoring US exporters over foreign importers.
  • Higher import prices have hurt consumers since we have de-industrialized America.  Consequently, we are dependent on cheap foreign-made goods.
  • QE2 has exported inflation to foreign countries. Revolutions in the governments of our allies, Egypt and Tunisia, are not a coincidence.  Higher food prices in impoverished economies are a breeding ground for unrest. See A Perfect Storm in Egypt
  • QE2 has set off currency wars and raised global tensions with China, the EU countries, Brazil, and emerging economies.
  • QE2 permits the Federal Reserve to purchase a major portion of newly issued Treasury debt.  This permits continuance of unprecedented federal budget deficits.  Thus, Congress avoids making the necessary tough budget cutting decisions.
  • QE2 has also perversely raised the all important 10-year Treasury note yield by 1.25%, thus increasing mortgage rates and retarding any housing recovery.

Holding the Federal Reserve Accountable

The Federal Reserve cherishes its vaunted independence.  This independence was predicated on adhering to a technocratic, apolitical agenda of controlling money supply to provide a background for economic growth.  The Federal Reserve is now overtly operating in a political role: it determines winners and losers in the economy (banks favored over savers), the value of the dollar (exporters favored over importers and consumers), and financial speculators (the wealthy over the middle class and Wall Street over Main Street).  It is also interfering in foreign policy, exporting inflation in key commodities to foreign countries (many of which are our allies) and triggering a potential currency war and protectionism.  Finally, Dr. Bernanke recently lectured Congress about deficits: a topic far afield from the role of the Federal Reserve. See Bernanke Makes Sure Fed Reminds Congress Deficits Bigger Than QE2

Let me repeat: Ben Bernanke was not elected and he is not a benign technocrat.  Politics and economics are intertwined.   He was wrong about the housing crisis, the financial crisis and QE1.  Our politicians must rein him in and restore economic policy control to elected officials.

Some would argue that encroaching on Federal Reserve independence would undermine the institution hurting economic policy.  The military is under the control of civilian political leadership and there is no uproar over “military independence.”  If the military can be under political control then the Fed can be too.  The real issue is accountability and the Federal Reserve has little, if any accountability.  Conversely, it will also make our profligate elected officials equally accountable for economic policy.

It will not be easy or elegant, but it will begin to restore trust in our government and economy.

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American Society / Business / Political — 0 Comments
30
Dec 10

Are We Getting the Government We Deserve?

There is an old labor relations saying: “companies get the unions that they deserve.”   In plainer words, poorly managed companies, constantly at war with their employees, tend to spawn highly aggressive, combative unions.   Put most succinctly, bad management yields bad labor relations.

In this context, let’s look at our series of rolling economic crises.  Our government’s response to each one has been to encourage or spawn “bubbles.”   (1.) Federal Reserve chairman Greenspan recognized the internet bubble.  Instead of squelching the identified “irrational exuberance,” he continued to encourage speculation.  (2.) Responding to the internet market crash, the Greenspan Fed spawned the housing bubble.  (3.) With housing now in shambles, the Bernanke Fed is openly trying to create a stock bubble. See Who Elected Ben Bernanke?

My hypothesis is that our political leaders do not have the courage to speak truth to the electorate.  Economies need recessions as a curative for financial and business excess. Without these necessary corrections, the seemingly easy way out of low interest rates, easy credit and promises of speculative riches becomes public policy.  If we are a populace seeking easy fixes to complex problems, we get a government that acts accordingly.

Spending is Easy, Savings is Hard

In Retirement Account Fantasy and Middle Class Erosion – 1 of 3 Americans Has Zero Dollars in a Retirement Account (“Retirement Account Fantasy”) the author exposes our dangerously low level of retirement savings.

1 out of 3 Americans has zero in any retirement account (not one slowly eroding dollar).  Half of Americans have $2,000 or less which puts them one month away from needing government assistance. See Retirement Account Fantasy

In a recent insurance company survey, 84% of young adults (18-29) and 60% of adults (30%) recognize that they need at least a million dollars to retire.   Actual retirement savings are nowhere near that:

The median retirement account for US households is $2,000.  This is why the vast majority of retirees depend on Social Security as their primary source of funds in old age even though Social Security was never designed to be a long term pension system.  The average retirement account is closer to $50,000 a year but this is heavily skewed by the top 1 percent that keep most of their funds in stock wealth.  See Retirement Account Fantasy

Thus, we have a failed retirement savings system which only exacerbates the shortfall in social security funding.  In turn, the government will be forced to borrow even more to fund future social security payments.

Ants and Grasshoppers

The author of Retirement Account Fantasy lays the blame for the retirement savings shortfall on our low income growth, income inequality and Wall Street pilfering.  While these observations are true they describe the patient’s symptoms, not causes.  The causes are a lack of savings and true investment rather than speculation.  Government has only worsened this problem through accommodative monetary and economic policies.  Zero interest rates are a disincentive to save and invest.

Prior to 2008, there was comparatively low unemployment and GDP growth.  Like the ant in the fable of the Ant and the Grasshopper, workers could have chosen to over save and under spend.  That would have required living in a home one could afford, and spending money that one actually had.  Instead, during this period we had our national savings rates turn negative.  Debt (especially housing debt) became a virtue and cash an anathema.

Instead of a policy of shared sacrifice and thrift, the government encouraged consumer spending, especially on expensive items such as McMansions and SUVs as a means to achieve economic salvation. See The Greediest Generation – Where has Shared Sacrifice Gone?

Reflecting more on the issue, I believe there is a deeper societal issue.  We live in an age of instant gratification.  If a web page loads too slowly, we need a better “app” or a better device.  If a marriage does not meet our expectations, we divorce our “life long” partner and look for a new one.  We suffer poorly even minor hardships.  Faced with a recession, we ask government to bail us out.

What happened to the ethic of earlier generations:  savings equals freedom: freedom to leave a job, start your own business, transfer to a new location, avoid government assistance, or simply to retire by choice while healthy and vigorous.

Right now government openly favors financial elites who are the merchants and promoters of debt.   But the way out of the financial crisis requires personal sacrifice and discipline.  Unfortunately, we seem to lack that will; thus, we get the government we deserve: easy fixes, easy money, short lived artificial booms and long-lived genuine crashes.

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American Society / Banking / Business / Political / The Federal Reserve — 0 Comments
13
Dec 10

Exploding Myths, Eroding Confidence

In this country, the American dream is with us from birth.  What is that dream?  Get a good education, work hard, be honest, and one will succeed.  What is success? A good income, one’s own home, a college education for the children, and a comfortable retirement.

There are obvious quantifiable effects from the financial crisis, such as reduced retirement savings, reduced income or job loss.  What about the qualitative effect: loss of confidence?   Every society has its dreams and mythology.  The financial crisis has exploded many of our collective myths and turned the dream into a nightmare.

Exploding Myths

Let’s touch on a few of the exploding myths:

1.      Myth: House prices only go up. Reality: Nationwide, from a peak in July 2006, house prices have declined 28.6 percent (Case-Shiller Index).  Many experts say that house prices will suffer a further decline. See Home Prices Falling at Faster Rate, New Report Shows.

2.      Myth: America is a capitalist society, supporting competition and free enterprise. Reality: We have a form of state capitalism bordering on fascism.  The government now bails out large, private corporations which get into financial trouble: Citibank, GE, GM, Chrysler, AIG and others.

3.      Myth: The Federal Reserve can fine tune the economy to avoid recessions.  Reality: Neither Alan Greenspan nor Ben Bernanke foresaw the internet stock bubble, the subprime crisis or the 2008 stock market crash.  We have suffered two 50% stock market declines in the last decade, and for the last two years we are living in a perpetual recession.

4.      Myth: Keynesian and monetarist economic remedies can pull us out of a recession.  Reality: The Federal Reserve and the Administration have tried every Keynesian and monetarist nostrum from economic stimulus programs, cash for clunker tax credits, home buyer tax credits and the outright printing of money (QE1 and QE2).  None of these programs has reduced unemployment or restored economic growth.

5.      Myth: Buying and holding stocks for the long-term is the road to true wealth.  Reality: In the last ten years the stock market has not appreciated.

6.      Myth: The US financial markets are the most open and transparent in the world.   Reality:  Insider trading scandals (Galleon Group), false accounting (Enron, WorldCom), financial firms secretly trading against their client (Goldman), perfect trading records for quarters at a time (Goldman, Bank of America, Morgan Stanley), high frequency trading and flash crashes all confirm for us the murky and duplicitous nature of our markets.   Our sole clarity is that they are run for the benefit of professionals and insiders to the detriment of the retail investor.

7.      Myth: Congress represents the American people.  Reality: Congress represents major corporations and unions who in turn contribute to selective political campaigns.   Winners in healthcare and financial reform were the major banks, investments firms, health care insurers and pharmaceutical companies, not the American public.

8.      Myth: A good education is the key to getting ahead. Reality: Eighty percent of  last year’s college graduates did not have a job upon graduation.  See A Dismal Outlook: Recent College Graduates and the Job Market.  Unemployment is close to ten percent and underemployment close to 17%.  If you listen to Dr. Bernanke’s advice to get a good education, you have a better chance utilizing that education in Mumbai or Shanghai, not in the United States.

9.      Myth: A combination of savings, home price equity appreciation and social security will support a comfortable retirement.  Reality: The financial crisis has decimated retirement savings and eliminated or diminished any gains from home equity.  Given the massive social security unfunded liabilities and the unwillingness of Congress to consider tax increases, even social security is in no way a sure thing upon one’s retirement.  Many individuals may never retire.

10.   Myth:   Everyone will have affordable health care.  Reality: Health insurance premiums have soared since the passage of Obamacare.  See ObamaCare Raising Health Insurance Premiums.  Moreover, with the cut in Medicare reimbursements and increased paperwork, many doctors refuse to accept Medicare reimbursements.

Myths are for Children

A “harmless” myth told to a child may have little consequence.  But the above myths are not being told to children, they are being foisted on an American population with lives and fortunes at stake.  And these false myths are at the core of our society.

One of the most dangerous myths is that debt does not matter.  Myth perpetuation can exist for a while,  but there are always consequences.

“Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! – confidence collapses, lenders disappear, and a crisis hits.” [Quote from "This Time is Different: Eight Centuries of Financial Folly"]

Bang is the right word. It is the nature of human beings to assume that the current trend will work out, that things can’t really be that bad. The trend is your friend … until it ends.  See Unintended Consequences

Myths are exploding and confidence is eroding.  Things need to change, before “bang!”

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American Society / Banking / Financial / Political / The Federal Reserve — 0 Comments
6
Dec 10

Often Wrong, But Never in Doubt

Dr. Bernanke was on 60 Minutes last night to again defend his second attempt at quantitative easing.  QE2 has already spawned inflation in commodities from oil to cotton and sugar.   Nevertheless, Dr. Bernanke assured the CBS interviewer that he was absolutely sure that he could control inflation within “15 minutes” by raising interest rates.

Why are “smart” public figures like Dr. Bernanke so spectacularly wrong?  Why are they selected in the first place?  Why are they reappointed?

Predict Early, Often and Incorrectly

The core competencies for economists are prediction and anticipation of economic events, and description of their consequences.  In stewarding our economy, I wonder how Professor Bernanke would grade Chairman Bernanke in these core competencies.   James Quinn in Bernanke is 100% Sure catalogs the Chairmen’s dismal predictive record:

“We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.” – 7/1/2005

“Housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise.” – 2/15/2006

March 28th, 2007 – Ben Bernanke: “At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained,”

May 17th, 2007 – Bernanke: “While rising delinquencies and foreclosures will continue to weigh heavily on the housing market this year, it will not cripple the U.S.”

June 20th, 2007 – Bernanke: (the subprime fallout) “will not affect the economy overall.”

October 15th, 2007 – Bernanke: “It is not the responsibility of the Federal Reserve – nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions.”

February 29th, 2008 – Bernanke: “I expect there will be some failures. I don’t anticipate any serious problems of that sort among the large internationally active banks that make up a very substantial part of our banking system.”

June 9th, 2008 – Bernanke: Despite a recent spike in the nation’s unemployment rate, the danger that the economy has fallen into a “substantial downturn” appears to have waned.

July 16th, 2008 – Bernanke: (Freddie and Fannie) “…will make it through the storm”, “… in no danger of failing.”,”…adequately capitalized”

September 19th, 2008 – Bernanke: “most severe financial crisis” in the post-World War II era. Investment banks are seeing “tremendous runs on their cash,” Bernanke said. “Without action, they will fail soon.”

Too Smart For His Own Good

Dr. Bernanke had a stellar academic career: high school valedictorian, near perfect SAT scores, summa cum laude Harvard graduate, PhD in economics from MIT.  Teaching positions at Stanford, NYU and Princeton followed.   So we have to ask:  if he is so smart how can he be so wrong? Source – Conservapedia

I have worked with many academically gifted individuals.  I have learned never to confuse or to prize academic brilliance over good judgment, predictive capability, wisdom or excellent decision making.   Academics in our country favor proficiency in standardized tests and memorization skills.  But these educational measures in no way tell us about a person’s practicality, initiative, creativity, leadership, integrative thinking and emotional intelligence. Academic proficiency also does not guarantee wisdom.

In fact, many of those who reach the pinnacle of academic achievement lack the basic life skills that would constitute leadership skills.  An insular education, a lack of street smarts, reinforced by an academic establishment focused on quantitative benchmarks instead breed arrogance.  The ultimate unfortunate outcome is the talented academic’s misguided belief that he is the smartest person in any room.  And the further tragedy is the common outcome that he is often wrong but never in doubt.

Leaders of organizations often select individuals like Dr. Bernanke because, with his stellar credentials, it is simply easier and more defensible. It takes a lot more work in the hiring process to find potential or proven leadership qualities such as character and creativity.   Further, picking a less credentialed candidate puts the hiring manager at risk should the hire prove problematic.  Why was the manager taking such a chance?  That manager can always defensively invoke the stellar credentials in the event of a bad outcome.

As for Dr. Bernanke, his perpetually reinforced “brilliance” blinds him to the real world and its economic conditions.  And certainly to the possibility that he may be wrong about anything.

Playing the Game

There is one other dark underside to the ability of people like Alan Greenspan and Dr. Bernanke to rise to power.  While they may not have necessary leadership skills, they often have enough political skills to attach themselves to the right candidate or power structure.  The ability to network at high levels of government and corporations becomes an extremely important skill.

Over the long term, success in politics and government requires a certain moral flexibility.  That is, the academic recognizes that to reach the highest levels of power he must learn to flatter superiors, go along and get along.

If Dr. Bernanke displayed true independence, he would depart from the Keynesian party line of money printing to solve all crises. He would refuse to bail out the banks.  And he would not be able to hold onto his Chairmanship for very long.  He would be too threatening to his Wall Street patrons and the Obama administration.

The Useful Dupe

Why is there no penalty for Dr. Bernanke’s poor prognostications or failing economic stewardship?  Because he serves a useful purpose.  His presence allows his powerful financial patrons from recognizing well-deserved losses.  And he then provides to them an endless supply of overt and covert (QE2) bailout funds.

Dr. Bernanke serves a second little discussed purpose.  President Obama has many economic failings, but he does have political skills well-developed within the Chicago political machine.  If the economy goes down the tubes, who better to take the fall than Dr. Bernanke, a card carrying Republican and certified genius?   Moreover, Wall Street threatened that the markets would crash if Bernanke was not reappointed.  If they do, who better to pin the crisis on than the good doctor?

Should the inevitable crisis hit, you can almost hear the Administration now.  “While we had our misgivings we went along with TARP, guarantees, bailouts, and QE 1, 2, 3 etc.”  Thus, we will be treated to the spectacle of Dr. Bernanke continuing to steer the economy from one crisis to another:  the perfect useful dupe and probably too arrogant to realize it.

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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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11
Oct 10

You Say You Want a Revolution Part II

In my last blog we described the seeds of the next American revolution.  See You Say You Want a Revolution Part I. Paul Farrell outlined the incompetence of the Republican and Democratic parties and the greed of Wall Street.  One institution targeted for dissolution is the Federal Reserve:

…the Fed cannot survive. Why? Not because the Fed is at the center of America’s economic problems, beyond repair, a dying institution. But because the Fed is a pawn of Wall Street’s Happy Conspiracy, which is incapable of seeing the train wreck that it set up.

This out-of-control, conspiracy of greedy Wall Street bankers, corporate CEOs, corrupt politicians and Forbes 400 billionaires will, in the near future, trigger the third catastrophic meltdown of the 21st century, a collapse that paradoxically can transform America into a new, stronger post-capitalist economy … but only after a revolution and brutal class warfare. But few will talk about what’s coming.  The Fed is Dead, Maybe by 2012

You Should Always Tell the Truth

Nassim Taleb, author of The Black Swan, believes that the Federal Reserve will not exist in 25 years.   Mr. Farrell demurs, warning that it will happen much sooner as fallout from the second American Revolution.

It’s inevitable: Wall Street banks control the Federal Reserve System; it’s their personal piggy bank. They’ve already done so much damage, yet have more control than ever.

Warning: That’s a set-up. They will eventually destroy capitalism, democracy, and the dollar’s global reserve-currency status. They will self-destruct before 2035 … maybe as early as 2012 … most likely by 2020.  The Fed is Dead, Maybe by 2012

Taleb uses two simple formulas to determine the veracity and competence of our politicians, business leaders and academicians: do they tell the truth (not half truths or other deceptions) and prior to 2008 did they foresee the financial crisis?

Taleb’s view is that you cannot trust anyone in government. He cites two US Treasury Secretaries:  Timothy Geithner and Henry Paulson.  Geithner cherry picks dates and misleads about the economic recovery.  Paulson warned President Bush about the financial crisis in 2006, but failed to warn the public.  Worse, Paulson’s public declarations in 2007 and 2008 led the investing public to believe in the strength of the US economy and that the housing bubble was well contained.  The Fed Chairman, Ben Bernanke, made the same deceptive statements.

Turning to economists, Taleb focuses on Paul Krugman who never anticipated the financial crisis.  Moreover, his economic proscription of exchanging private debt for public debt only creates moral hazard. Our grandchildren will be burdened with our debt.

He heaps special scorn upon President Obama and the Senate for reappointing Bernanke after his miserable track record.  Bernanke remains in his position despite failing to revive the economy.  Taleb believes that Bernanke is a shaman, “whose methods make ‘homeopath and alternative healers look empirical and scientific.”  The Fed is Dead, Maybe by 2012

A Recipe for Collapse

Charles Hugh Smith in The Recipe for Collapse,  supports Mr. Farrell’s proposition that we are heading for another collapse.  The following mixture all but assures a coming collapse: central planning (the Federal Reserve); encouraging speculation through reducing the safe return on capital to below the inflation rate (zero interest rate policy); creating bubbles in real estates, stocks, bonds and commodities (e.g., nine million vacant homes); corrupting the power elites to continue financial skimming and speculation (watering down the financial reform bill); concentrating wealth and power in a small elite; promoting debt and leverage so that the economy will collapse with ever increasing amounts of debt; continuing to promote failed economic remedies (stimulus, zero interest rates); making corruption, cronyism, embezzlement, insider trading and fraud endemic; concentrating media in a few hands; devoting an increasing share to internal security or military adventures; making an ever greater number of laws hampering productive enterprise, and raising the hopes of the general population that they can get rich quickly (housing, stocks) only to have their dreams deflated or dashed.

So You Want a Revolution

The Administration, the media and the financial elite are unwittingly marching down the path to revolution.  What I find most disturbing is that we re-cycle and give prominence to the same public figures that got us into this mess:  Ben Bernanke at the Federal Reserve, Timothy Geithner formerly of the Federal Reserve Bank of New York and now Treasury, Barney Frank in Congress, Paul Krugman at the New York Times and a host of others.   We need some new thinking and directions, not a repetition of the same tired nostrums which have not, and probably never, worked.

So we are at the crossroads of a revolution.  Revolutions do not have to be violent.  But it would take revolution to upset the smug, intellectually and morally bankrupt status quo.  We need some leaders who regularly speak truth.  Only when we make a complete break from the past, do we have the possibility of a brighter future.

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6
Oct 10

Why is Charles Schwab the Only One Concerned About Zero Interest Rates?

Charles Schwab, father of discount brokerage, again raised the insanity of a zero interest rate policy.  Writing in the Weekend Edition of the Wall Street Journal, Enough with the Low Interest Rates, Mr. Schwab succinctly states his views:  the Federal Reserve’s experiment with near-zero interest rates,  begun after the credit crisis of 2008, has now become counterproductive.

As a temporary fix it served its purpose. It was an emergency antibiotic appropriate for the illness. But continuing with the experiment is disfiguring the economy and fueling doubt. Healthy economies find their own equilibrium based on market forces of supply and demand. When people don’t think market forces are driving the economy and believe instead that it is being driven by excessive government intervention, they don’t take the risks an economy requires.

It’s time to stop the experiment and return to monetary normalcy.

Interestingly, Mr. Schwab wrote an op-ed piece six months ago for the Journal on low interest rates; Low Interest Rates are Squeezing Seniors.  His argument: “[t]oday’s historically low interest rates may be feeding banks’ profitability, but they are financially starving our seniors.” Despite his first article, the interest rate on the benchmark 10-year Treasury bond has declined from just under 4% to just under 2.5%.  Source Yahoo Finance.  Perhaps in order to achieve a better result, Mr. Schwab should write on weekdays when Mr. Bernanke can read the Journal at his Federal Reserve office.

In the most recent op-ed, Mr. Schwab makes the following points:

  • Near zero interest rates weigh on both business and consumer confidence.
  • Banks are able to make money through the carry trade (borrowing short term money at low interest rates and buying higher yielding, longer dated treasury securities).
  • The carry trade impedes making loans in the real economy and slows the velocity of money.
  • Savers, especially retirees are hurt, with diminished spending power.
  • Society is driven to seek out riskier investments to try to improve yield.
  • Job growth, consumer spending, business investments are not improving.
  • Small business is unable to borrow since banks merely “sit on” excessive reserves.
  • Banks are afraid to lend for 30-year mortgages since they are fearful of a future increase in interest rates once this “temporary” zero interest rate regime ends.

Mr. Schwab believes that the economy is ready to heal, if institutions just let interest rates find their market-based level.

It Is More Than Confidence

Mr. Schwab identifies that low interest rates are a problem.  He views the problem as one of confidence.   That is, the Federal Reserve, by keeping interest rates artificially low, signals to the markets that the economy is weak and in need of the perpetual stimulus of low interest rates.  In contrast, I believe that we have a different problem, constant government tinkering and meddling in the economy.  The economy could heal if the Administration and the Federal Reserve would stop picking the economic winners and losers, and let market forces perform their historical function of allocating capital and punishing the profligate.  Instead, the Federal Reserve has chosen the following path:

  • Favoring banks over savers
  • Preventing creditors from suffering any losses, not permitting the bankrupt to go bankrupt
  • Artificially propping up the housing market
  • Artificially propping up the stock market
  • Depressing the yield on virtually all debt instruments

This is not just supposition; it is confirmed in an October 4 speech by Brian Sack, Executive VP of the Markets Group at the NY Federal Reserve Bank.  Through manipulating interest rates, Mr. Sack believes that he has found the magic cure for the economy: “[t]hese effects on Treasury yields appear to have been transmitted into lower rates on private credit instruments and higher asset prices more broadly.”   Managing the Federal Reserve’s Balance Sheet. The Federal Reserve believes that it can levitate stock market and housing prices with no consequence.

Hubris

“Whom the gods would destroy, they would first make mad.” Medea by Euripides

On Monday October 4, Mr. Bernanke made two speeches and Mr. Sack made one.   It is not a matter of confidence impeding the economy as postulated by Mr. Schwab.  First, it is the hubris of the Federal Reserve that it can control a $14 trillion economy and $50 trillion dollars of US assets through zero interest rates or asset purchase programs.  They may have better luck trying to control the tides.  Second, it is crony capitalism, where politically connected financial institutions, public sector unions and unionized industries such as auto manufacturing are favored to the detriment of savers and Main Street.   Finally, it is the refusal to allow debt to be written off, homeowners default, banks and companies fail, or the stock market to fall to cleanse the system.

As we have discussed before, all irrational structures fail.  See Why Do all Irrational Structures Fail? Unfortunately in capitalism there is no free lunch; artificially bolstering the markets will fail too.   Hardships occur. But the self correctives of lower prices for housing, stocks and bonds and higher interest rates are the only way to re-start the economy.  More than financial chicanery, a return to the basics will restore the confidence that Mr. Schwab seeks.  Mr. Schwab should not be the only one criticizing Federal Reserve policy.

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30
Jun 10

He Who is Wise Does Not Work for the Fed

Who is wise? He who learns from all men, as it is written (Psalm 119:99) “I have gained understanding from all my teachers.” Chapter 3 (Ethics of the Fathers)

Kartik Athreya, an economist with a PhD from the University of Iowa, published a paper on the Richmond Virginia Federal Reserve’s website: Economics is Hard.  Don’t Let Bloggers Tell You Otherwise.  The gist of the paper is that bloggers with little formal economics training are performing a disservice to the public with their uneducated commentaries.  I will let some of Dr. Athreya’s comments speak for themselves (thanks to zerohedge.com, Fed Economist: Bloggers are Stupid):

The general public are (sic) simply being had by the bulk of the economic blogging crowd. In this essay, I argue that neither non-economist bloggers, nor economists who portray economics — especially macroeconomic policy — as a simple enterprise with clear conclusions, are likely to contribute (sic) any insight to discussion of economics….

Writers who have not taken a year of PhD coursework in a decent economics department (and passed their PhD qualifying exams), cannot meaningfully advance the discussion on economic policy.

The response of the untrained to the crisis has been even more startling. I listen to Elizabeth Warren on the radio fearlessly speculating about the nature of credit market dysfunction, and so on.

The general public are (sic) simply being had by the bulk of the economic blogging crowd.

There has been much excellent commentary on this clearly offensive piece.  I would like to make some additional observations.

Credentials are the Last Bastion of the Incompetent and Insecure

Dr. Athreya invokes his University of Iowa PhD to squelch economic criticism from the uncredentialed.   The credential game is always dangerous.  What is an Iowa PhD compared to other economic faculty powerhouses like MIT, Harvard, Chicago, Stanford or Princeton?  Comparing one’s credentials is an endless and fruitless game.  Why not focus on competence, judgment, creativity and insight?

Competent professionals do not have to wave around credentials.  A moment of non-traditional wisdom from the movie Cool Runnings: “…a gold medal is a wonderful thing. But if you’re not enough without one, you’ll never be enough with one.”  If you are not confident in your own opinions and views, no fancy credential or set of professional initials, e.g. MD, JD, or PhD, is going to impress a patient or client.

My experience has always been that when attorneys start with their law school bona fides, law review membership or fancy clerkship, the legal advice that follows will be less than stellar.   Just as “patriotism is the last refuge of the scoundrel,” fancy credentials are the last bastion of the incompetent and the insecure.

PhD’s Got Us Into This Mess

Two of the most prominent PhD economists, Alan Greenspan and Ben Bernanke, never predicted the current great financial crisis.  They never warned us about the low interest rate policies, easy money, ill-conceived tax cuts, loose fiscal policy and dangerous lending practices that led us to this economic quagmire.  Dr. Bernanke assured Congress and the American public that the subprime crisis was well contained.  See Bernanke: I was Wrong About Subprime Crisis. Dr. Greenspan encouraged Americans to avoid fixed rate mortgages and take out adjustable rate mortgages (“ARMs”).  And lo and behold, ARMs were a major culprit in the slide toward too much unaffordable homeowner debt.   When these ARMs reset from their initial low “teaser rates” to higher market rates these unsuspecting homeowners simply lost their homes. See Don’t Take Mortgage Advice from Alan Greenspan.

The Pseudoscience of Economics

Economics is as much art as science.  In the Organic Economy, I wrote about the fallacy of econometric mathematical modeling.   The use of mathematics disguises the fact that economies are often too complex for modeling, as money collides with unpredictable human behavior.   It is pure hubris to believe that professionally trained economists have a monopoly on economic forecasting.

The Decline of the Free Press

The First Amendment ethos to support a vigorous press is integral to a well functioning American society. Starting with Ben Franklin’s musings on independence to the (originally anonymous) Federalist Papers, and continuing with today’s investigative journalism, an adversarial and aggressive press keeps government and other powerful interests in check.

But now great newspapers have either gone out of business or have pared their staffs. A recent report detailed the dearth and dying gasps of investigative journalism:

Thirty-seven percent of newspapers had no full-time investigative or projects reporter on their staffs. The majority had two or fewer, and only 10 newspapers had four or more investigative or projects reporters working for them.

In addition, 61 percent of the newspapers had no investigative or projects team. Of those, 16 percent had teams in the past, but they have been disbanded. Sixty-two percent of the newspapers surveyed did not have a single editor specifically charged with working on investigations. See Today’s Investigative Reporters Lack Resources.

Television news is now more “infotainment” than hard-hitting reporting.  We are left with a neutered corporate media, and a compromised press.  Rather than independence, they are more interested in not offending their sponsors.  They eschew the expensive, risky and controversial path of investigative journalism and criticism, whether it be print, visual or virtual.

Bloggers and alternative media like Rolling Stone (see e.g. Wall Street’s Bailout Hustle) have filled this investigative void.  Often for free or very little compensation, bloggers have taken on the powers that be.  Bloggers expose and criticize dangerous and often wrong economic policies.

Trust Me; I am a PhD Economist

The economics profession has a long way to go to earn the trust of the American public.  Attacking bloggers reveals a “weak hand.”  Instead of spending public money writing a paper with a ridiculous premise (note the paper has been removed from the Richmond Fed’s website), perhaps some of the bloggers have it right.

And so, to Dr. Athreya (and other Fed academicians) from a non-PhD blogger:  it is time to step down from that academic pedestal, display some humility and learn from all men and women (even the blogging ones).

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2
Feb 10

Timothy Geithner and Plausible Deniability

Congressional hearings often make wonderful theater.  Last week at the House Oversight and Government Reform Committee, the American public heard testimony from Timothy Geithner, former head of the Federal Reserve Bank of New York and now US Treasury Secretary and Henry Paulson, former US Treasury Secretary.  Both men’s testimony relied on one premise: if we did not bail out AIG and pay its counterparties 100 cents on the dollar, the financial world as we know it would have ended,  i.e., the US would have plunged into a second Great Depression.  By written statement, Fed Reserve chair Ben Bernanke informed the Committee of his full support for this decision.  In person, Henry Paulson agreed.  However, both men said they had nothing to do with the decision.  Further, Mr. Geithner testified that he had relied on his staff or details of the bailout.  And even further than that, he later distanced himself from the decision whether nor not to disclose the details of the bailout. America was treated to the concept of “plausible deniability.”

Plausible Deniability

Working in a corporation one gets a firsthand look at the concept of “plausible deniability.”  Plausible deniability works something like this: a crisis starts; an important decision must be made; a senior executive is charged with making a decision; the senior executive delegates much of the preparatory work to  staff or a trusted lieutenant; the staff or trusted lieutenant ultimately makes a recommendation which later becomes “The Decision. “  If or when something goes wrong in the future, the senior executive denies involvement and places the blame on the staff or the trusted lieutenant.  Almost every time, the superiors of the senior executive accept this scenario.  The senior executive survives.

Let’s Get Real

Harry Truman said “the buck stops here,” meaning that the most senior executive has ultimate responsibility for a decision.  Perhaps with President Clinton or at some time it became fashionable for the senior person to distance himself from the decision so that he would have plausible deniability.  Further, it was expected that subordinates would “throw themselves on their swords” to preserve their boss.

It stretches credulity that the three most senior financial executives in government, The Chairman of the Federal Reserve, the President of the New York Federal Reserve and the Treasury Secretary did not know the intimate details of the AIG bailout.  At stake at the time was $62b of taxpayer money to effect this phase of the bailout.  All three men agree that if the bailout did not take place financial Armageddon would have ensued.

More is expected of our public servants. We appointed these individuals because of their unique skills, judgment and character. Apparently, these individuals were unavailable in the AIG crisis to make critical decisions.  Based on these stated actions, I deplore the confirmation of Ben Bernanke.  Moreover, I would ask for the resignation of Timothy Geithner.

It is time that high level government officials took responsibility and become the watchdog of the public purse. Trying to blame subordinates should elicit the response from the public: “that dog won’t hunt!”

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