[papabear]

http://www.counterpunch.org/martens03162009.html
March 16, 2009

Jon Stewart's Epiphany
Has a Comedian Just Saved America?
By PAM MARTENS

As testimony to how Orwellian life has become under the outrages of Wall Street hubris, last week saw a comedian, who poses as an anchor on a fake news show, grab the reins of the Wall Street investigation from the actual investigators in Congress.

Either Jon Stewart is the smartest man in America or he has incredible instincts. In a week’s time, he has zeroed in, like a heat-seeking missile, on the core of Wall Street’s malady. How insightful of Stewart, host of Comedy Central’s “The Daily Show,” to rationalize that the core of Wall Street’s corruption might well be the same core that it has drawn the darkest curtain around: trading.

Stewart is the son of an educational consultant mother (Marion Leibowitz), physicist father (Donald Leibowitz) and trading technology guru brother (Larry Leibowitz) an executive at the New York Stock Exchange. He’s got a smart family and he’s equally smart, advancing the national debate on a comedy channel.

After a week of explosive commentary and video clips of questionable reporting at the cable business network, CNBC, Stewart interviewed Jim Cramer on Thursday, March 12. Cramer hosts CNBC’s “Mad Money” show which promotes itself as an advocate for the small investor while, at the same time, suggesting lots of buying and selling of specific stocks. Stewart used the highly anticipated interview to show a devastating clip revealing Cramer to be the embodiment of the market manipulators that he rails against on his show. Acknowledging on the clip that he would never say something like this on TV, Cramer states:

“You know, a lot of times when I was short at my hedge fund and I was positioned short, meaning I needed it down, I would create a level of activity beforehand that could drive the futures. It doesn’t take much money.”

Allow me to translate:

You know, a lot of times when I was making a large bet that prices would decline in a specific stock or bond or derivative when I worked in the largely unregulated world of private money called hedge funds, and I needed to give that decline a little unseen assistance to make my bets profitable, I would go into the futures market to trade. That’s because I could put down as little as 4 to 10 percent of the money I needed for the trade and borrow the balance in what is called a margin account.

The academics and economists (none of whom ever worked a day on Wall Street) have been telling us in OpEds and speeches and testimony before Congress that the crumbling Wall Street structure results from bundled subprime mortgages, collateralized debt obligations, credit default swaps, and asset backed securities.

Trillions of dollars of taxpayers’ funds have been spent on the premise that these toxic assets are the problem. The fate of a nation has been staked on that analysis: that if we get these assets off the balance sheets of the major firms, the credit spigots will begin to flow once again, the banks will once again trust each other and lend to each other, and investors will resume buying stocks and bonds with their confidence in the system restored.

Stewart’s weeklong commentary and clips helped to dramatically expose this logic as bogus. None of the toxic instruments would have grown to a problem capable of collapsing the country’s financial system if their trading had been regulated, transparent and fairly reported on by mainstream media. The security instruments were never the problem; how they were traded was the problem. For example, the mortgage and debt securities were, in reality, junk bonds but they were tradedas triple A. They were not traded on an exchange where price discovery would have shown them to be junk bonds, they were traded in an opaque over the counter market. In the case of credit default swaps, they were traded in a market created by the very firms who needed to hide for as long as possible (while executives reaped windfall compensation and bonuses) the dubious pricing of the securities and gargantuan amounts being issued. (See CounterPunch column “How Wall Street Blew Itself Up.”)

Wall Street is supposed to have an early warning system that if something is amiss it will self correct in time to avoid a collapse of the system. That early warning system is known as price action. In other words, the trading price of Citigroup, Merrill Lynch, Lehman Brothers, Bear Stearns, Freddie Mac, Fannie Mae and AIG should have begun a downward trajectory years ago as these firms loaded up on leveraged junk. There is only one possible scenario, in my opinion, to explain why this did not happen: trading in the market was rigged. Thanks to Jim Cramer, the public now knows how easy it is to get stock prices to move up or down. (As one more example, see “Wall Street Powerhouses Invested Alongside Madoff.”)

To be a fair marketplace, the trading price of stocks and bonds must represent the composite wisdom of all market participants who have the same opportunity to ferret out information from public sources. When trading is internalized at the big Wall Street firms (meaning they are allowed to match customer stock orders in-house), when they are able to create and clandestinely operate their own trading venues off the radar screens of the regulators, when they are able to create offshore vehicles like Structured Investment Vehicles to hide bets gone bad, there is no longer any composite wisdom. There is only dumbed down information which the public possesses from CNBC and the superior information available to those operating inside the clandestine system. (See Maria Bartiromo and the Co-Branding of CNBC and Citigroup.)

The big Wall Street firms that taxpayers are bailing out even gobbled up some of the largest specialist firms. Those are the folks who are required to maintain fair and orderly markets on the regulated stock exchanges. But here’s what the specialists are really doing, according to charges disclosed on March 4, 2009 by the Securities and Exchange Commission (SEC):

“…from 1999 through 2005, the firms violated their basic obligation as specialists to serve public customer orders over their own proprietary interests. As specialist member firms on one or more of the regional and options exchanges, the firms had a duty to match executable public customer or ‘agency’ buy and sell orders and not to fill customer orders through trades from the firm's own accounts when those customer orders could be matched with other customer orders. However, the firms violated this obligation by filling orders through proprietary trades rather than through other customer orders, thereby causing millions of dollars of customer harm.”

The $70 million in disgorgement and penalties the SEC charged 14 specialist firms (some of which are owned by Wall Street powerhouses like Goldman Sachs and Citigroup) is now effectively coming out of the taxpayers’ pocket since these are two firms enrolled in the taxpayer cash for toxic asset trash bailout bonanza. In other words, the public investor is now paying back the money that was stolen from the public investor in the continuing Wall Street saga of heads I win, tails you lose. Is it any wonder it takes a comedian to deal with this stuff.

The speed at which Congress begins daily sessions investigating trading of both toxic and non toxic securities will determine the speed at which this country begins to rebuild from the ashes.

After the 1929 crash and as the nation entered the Great Depression in the early 1930s, the Senate convened hearings by the Committee on Banking and Currency that peeled back month after month from 1932 to 1934 previously impenetrable layers of trading fraud. Each layer of fraud opened a window into the next layer. The hearings did not focus on assets, toxic or otherwise, it focused on the trading of assets: how Wall Street created dark pool operators (today’s hedge funds) to trade on inside information and manipulate prices; how some of the most respected men on Wall Street had participated in trading frauds; how some of the largest firms were secretly manipulating stock prices; how respected business columnists were taking bribes from Wall Street players to move trading prices.

I’ve often pondered just how it was that every large brokerage firm had the same idea at almost the same time in the early 1990s: to put a TV set airing CNBC in every stockbroker’s office. The managers came around and offered the broker a deal they couldn’t refuse: a deeply discounted price on the TV and the firm would install it hanging from the edge of the ceiling so it wouldn’t take up precious desk space. Out of 55 brokers in my office at the time, only myself and one other broker declined. Can you think of any other industry that wants its workers sitting around watching TV instead of working? Unless, of course, what CNBC is telling brokers to buy and sell is actually considered part of the work day by the Wall Street masters.

As you ponder that, consider this excerpt from testimony given at the Friday, June 3, 1932 Senate hearings:

William A. Gray, Counsel to the Committee: So that the committee may understand the matter which I am now going to present, permit me to say that I am going to show by Mr. Lion himself that he is a publicity man, and that for a period of three years he was acting for numerous brokerage houses in the city of New York, that he furnished through various journals, including radio speeches, publicity for certain stocks, pools which were then being operated by the brokerage houses, he being paid for such by cash and by being given calls on the particular stocks in questions, at prices that he could sell them to his advantage, the brokerage house of course giving him credit for same in an account which he carried and settling with him the same as they would settle with any other person who had actually bought and sold, he not being required to put up any cash at all. Now, Mr. Lion, please give us your full name.

Mr. Lion: David M. Lion…

Mr. Gray: What is your business?

Mr. Lion: Financial publicity.

Mr. Gray: How long have you been engaged in that business?

Mr. Lion: Five years or more.

Mr. Gray: Prior to engaging in that business and for the past five years have you at any time conducted a paper of your own?

Mr. Lion: Yes.

Mr. Gray: What was the name of that paper?

Mr. Lion: The Stock and Bond Reporter…

Mr. Gray: How long did you continue the use of the radio for the purpose of disseminating information about stocks?

Mr. Lion: I used it all of 1929…

Mr. Gray: Now, you did not do your own radio talking, did you?

Mr. Lion: No, sir.

Mr. Gray: What was the name of the man you employed to do your radio talking?

Mr. Lion: I employed William J. McMahon…

Mr. Gray: Who is he?

Mr. Lion: He was an economist…

Mr. Gray: Each of his talks was devoted to a particular stock, wasn’t it?

Mr. Lion: No.

Mr. Gray: Sometimes only one stock?

Mr. Lion: Yes, sir…

Mr. Gray: But when he ended up his talk as a usual thing he referred to a particular stock and boosted it. That is true, isn’t it?

Mr. Lion: Yes, sir.

Mr. Gray: And he was a salaried man on your staff for that purpose, wasn’t he?

Mr. Lion. Yes, sir.

Jon Stewart has opened the floodgates. Let the hearings begin.

[papabear]

http://www.counterpunch.org/whitney03162009.html
March 16, 2009

Welcome to the TALF
Bernanke's Witness Protection Program
By MIKE WHITNEY

Fed chief Ben Bernanke's new funding facility is a real doozy. In fact, if the Term Asset-Backed Loan Facility or TALF, which is set to launch on Thursday, doesn't convince the American people that it's time to take a wrecking ball to the Central Bank and start over, than nothing will. Bernanke and his co-conspirator at Treasury, Timothy Geithner, are planning to revive the shadow banking system by dumping $2 trillion into the same over-leveraged, derivatives-based garbage that blew up the financial system in the first place. All the blabbering about a "good bank-bad bank" remedy appears to have been a diversion. This is how Bloomberg sums it up:

"Geithner’s program has three main elements: Injecting fresh government capital into some of the country’s biggest financial institutions; establishing a public-private partnership to handle as much as $1 trillion of banks’ bad assets; and starting a credit facility with the Federal Reserve of as much as $1 trillion to promote lending to consumers and businesses.

The Treasury hopes to unfreeze credit markets by providing new incentives to banks and investors to resume trading in mortgage securities and other troubled assets. U.S. regulators are conducting a new series of examinations to make sure banks have enough capital to accept losses when selling these assets, while also planning to provide government financing to the investors who might buy them." (Bloomberg News)

That's right; $1 trillion for Bernanke's TALF and another trillion for Geithner's so called "Public-Private Partnership". That's $2 trillion down a derivatives sinkhole just to preserve the illusion that the banks are still solvent. Bernanke has decided to shrug off the advice of nearly every reputable economist in the country, most of whom are pushing for a government takeover of the failing banks (nationalization), just to toss his shifty banking buddies a lifeline. It doesn't bother him that the public till has already been looted and that his action will leave the next generation of Americans bobbing in a pool of red ink.

Last week, investors backed away from Bernanke's TALF, even though the Fed promised to provide up to 95 percent of the funding (through low interest loans) to investors willing to buy distressed assets backed by student loans, car loans and credit card debt. The potential investors "objected to the level of scrutiny that dealers would have over their books, arguing that the dealers' rules attached too many strings. Dealers were saying they take plenty of risk to facilitate the program and need to be protected in situations where the collateral or the client made mistakes or wound up ineligible." (Wall Street Journal")

This is how crazy it's gotten. Why shouldn't the Fed have the right to look at the books and see if these financial institutions are solvent or not? Should they just take their word for it?

But that's only half the story. When the WSJ says that dealers need to "be protected in situations where the collateral or the client made mistakes or wound up ineligible", what they mean to say is that they expect the Fed to make up for any losses on securities which are explicitly banned from the program. This is no small matter, since the Fed cannot legally buy any asset that is less than triple A, and yet, everyone knows the TALF will end up being a dumping ground for all kinds of toxic waste.

So who will pay when financial institutions sell double A or lower securities that they KNOW are ineligible for the program? As it stands now, the taxpayer, because the Fed caved in to industry pressure. In other words, the interests of the people who put up a measly 5 percent of the original investment will take precedent over those who put up 95 percent. This is the kind of sleazy dealmaking that is going on behind the scenes of this bailout fiasco. The Fed is so desperate to launch its facility and keep these Wall Street scamsters and bank extortionists in business, they're willing to underwrite the fraudulent sale of rotten securities. It's outrageous!

But there's even more to this swindle than that--much more. According to the Wall Street Journal:

"Wall Street dealers, including J P Morgan Chase & Co. and Barclays PLC's Barclays Capital, have created vehicles to participate in the TALF that would allow investors in the program to circumvent many of the restrictions laid out by the Fed. The vehicles resemble collateralized debt obligations, or CDOs, and use some of the financial engineering that was partially responsible for the collapse of the credit markets. The Fed, eager to get what it hopes will be a $1 trillion program up and running, has blessed the vehicles because they open the TALF up to a much larger group of investors." (TALF is reworked after investors balk, Liz Rappaport, Wall Street Journal)

Great. More CDOs. Just what we need.

Keep in mind that the Fed's funding is in the form of "non recourse loans" already, which means that if the dealers decide to walk away, the losses are transferred to the taxpayers balance sheet, no questions asked. But even that is not good enough for the Wall Street crooksters. They want to create a whole new security buffer-zone for themselves by dredging up the Frankenstein of structured debt-instruments--the notorious CDO--so they can "circumvent" the rules and plead innocent when B grade garbage is sold through the TALF. This isn't a financial rescue plan, it's a witness protection program for self acknowledged con artists and snake oil salesmen.

Again, the Wall Street Journal:

"Under the new proposal, a bank such as Barclays or J.P. Morgan would set up a trust to buy securities with money borrowed from the Fed. The trust would then sell investors securities in the trust. Those securities would give returns similar to the TALF loan, but without the strings attached....The dealers say they could create markets for these derivative securities to trade."

The Fed's culpability in this boondoggle is undeniable. Bernanke and his wily friend at Treasury have given their full support to a plan that does nothing but move trillions of dollars of toxic waste from one balance sheet to another while foisting the liability onto the American taxpayer. And don't be misled by the term "trust" in the Journal's report. In this instance, "trust" refers to an Enron-type, off-balance sheets Structured Investment Vehicle (SIV) which is designed to keep investors in the dark about the real condition of the financial institutions that run them. SIV's are the banks sausage-making units which hold hundreds of billions of dollars of undercapitalized complex securities, like mortgage-backed securities (MBS) and collateralized debt obligations (CDO). These are the same debt-instruments which greased the skids for the current downward death-spiral.

Wall Street Journal:

"The vehicles also would make it easier for investors that aren't eligible for TALF loans to buy into the program, like investors that are restricted by their investment guidelines from using borrowed money to buy securities. Smaller hedge funds that can't vie for large allocations of deals could also buy in through these vehicles."

Sure, what the heck. Why worry about "eligibility" or "restrictions"?

We don't need a financial rescue plan that isolates the toxic waste and writes down the losses. We don't need to protect the taxpayer or the depositor. We'll just keep asset prices in the stratoshpere for a while longer by adding a little more helium and pretending that private institutions really want this mortgage-backed sludge. That way, we can keep the public from knowing what's really going on." This seems to be the general line of reasoning at the Fed and Treasury.

Wall Street Journal:

"Some investors have raised concerns, however, noting that the structure puts these dealers at an advantage in bidding and influencing the price of new offerings. They also say the derivative securities present old and familiar problems, such as keeping the end holder of the risk of the TALF securities several steps away from the pricing of that risk."

The economy is sliding headlong into another Great Depression because of the mispricing of risk, the sale of complex and unregulated derivatives, the vast and unsustainable use of leverage, and shadowy and fraudulent off-balance sheets operations. When the TALF is launched on Thursday, all of these same activities will be reignited with the explicit blessing of the Central Bank. It is a reckless, wacky plan to keep the banks in private hands and to keep asset prices inflated beyond their true market value.

Bernanke and Geithner are moving ahead with their plan despite the clearly articulated guidelines set out by the world's finance ministers and central bankers who convened over the weekend in Sussex, England. Number 7 of the G-20's Communiqué reads:

"We have also agreed to: regulatory oversight, including registration, of all Credit Rating Agencies whose ratings are used for regulatory purposes, and compliance with the International Organization of Securities Commissions (IOSCO) code; full transparency of exposures to off-balance sheet vehicles; the need for improvements in accounting standards, including for provisioning and valuation uncertainty; greater standardization and resilience of credit derivatives markets; the FSF’s sound practice principles for compensation; and the relevant international bodies identify non-cooperative jurisdictions and to develop a tool box of effective counter measure."

It couldn't be much clearer than that. But don't expect "compliance" from Geithner or Bernanke. They have no intention of reworking their plans to meet the demands of the G-20. No way. Multilateralism and cooperation might sound great in speeches, but it's not what drives policy.

The TALF and the "Public-Private Partnership" are another slap in the face of the international community. They violate the spirit and the letter of the G-20 communique. It will be interesting to see if foreign holders of US Treasurys endure this latest insult in silence or if there's a sudden stampede for the exits. There's a sense that the world is getting fed up with the Fed's financial chicanery and would like to chart a different course. Enough is enough.

[papabear]

http://www.counterpunch.org/hudson03172009.html
March 17, 2009

The Cash-for-Trash Economy
Mr. Bernanke Spreads the Fire
By MICHAEL HUDSON

On the March 15 CBS show “60 Minutes”, Federal Reserve Chairman Ben Bernanke used a false analogy already popularized by President Obama in his quasi-State of the Union Speech. He likened the financial sector to a house burning down – fair enough, as it is destroying property values, leading to foreclosures, abandonments, stripping (for copper wire and anything else recoverable) and certainly a devastation of value. The problem with this analogy was just where this building was situated, and its relationship to “other houses” (e.g., the rest of the economy).

Mr. Bernanke asked what people should do if an irresponsible smoker let his bed catch fire so that the house burned down. Should the neighbor say, “it’s his fault, let the house burn”? That would threaten the whole neighborhood with fire, Mr. Bernanke explained. The implication, he spelled out, was that economic recovery required a strong banking and financial system. And this is just what he said: The economy cannot recover without yet more credit and debt. And that in turn requires trillions and trillions of dollars given by “the neighbors” to the bad irresponsible man who burned down his own house. This is where the analogy goes seriously off track.

But watching “60 Minutes,” my wife said to me, “That’s just what Mr. Obama said the other night. What do they do – have a meeting and agree on what metaphor to popularize?” They seem to have an image that will lock Americans into supporting a policy even though they don’t like it and many feel like letting the financial house (A.I.G., Citibank, and Bank of America/Countrywide) burn down.

What’s false about this analogy? For starters, banking houses are not in the same neighborhood where most people live. They’re the castle on the hill, lording it over the town below. They can burn down and leave the hilltop revert “back to nature” rather than having the whole down gaze up at a temple of money that keeps them in debt.

More to the point is the false analogy with U.S. policy. In effect, the Treasury and Fed are not “putting out a fire.” They’re taking over houses that have not burned down, throwing out their homeowners and occupants, and turning the property over to the culprits who “burned down their own house.” The government is not playing the role of fireman. “Putting out the fire” would be writing off the debts of the economy – the debts that are “burning it down.”

To Mr. Bernanke the “solution” to the debt problem is to get the banks lending again. He’s spreading the debt-fire. The government is to lend the “threatened neighbors” enough money so that credit customers of the financial “house on the hill” can to pay it the stipulated interest charges they owe. It is not burning down at all; the neighborhood’s money (in this case, tax money) is being burned up.

Mr. Bernanke explained to the Sunday evening audience that his policy aimed at helping the economy return to “normalcy.” Fully in line with what Mr. Paulson was saying last summer, “normalcy” is defined as a new exponential growth in the volume of debt. He talked about “sustainable” recovery. But “the magic of compound interest” is not sustainable. It’s all a false metaphor.

Mr. Bernanke then left the realm of metaphor altogether to give an outright false explanation of the balance of payments and the upcoming Gang of 20 meetings in Europe. On Friday, China’s premier expressed worry over the health of the American economy, in which China had recycled nearly $2 trillion of its dollar inflows in order to prevent the yuan from rising in price against the dollar. The fear is that despite this heavy recycling of dollars by foreign central banks, the U.S. exchange rate will still weaken as the trade balance continues unabated and, just as seriously, U.S. military spending keeps on pumping dollars into the world economy as war spreads eastward from Iraq to Afghanistan and Pakistan.

The way Federal Reserve Chairman Bernanke explained the problem on CBS, America had to keep its markets attractive to “Chinese savers.” The image being conjured up again and again is that there is a world “savings surplus.” That is supposed to be what flooded the large U.S. banks and Wall Street with so much money that they were obliged to move it into riskier and riskier investments. “They made us do it” was the message not quite spelled out.

One would think that Mr. Bernanke knows nothing at all about the balance of payments or how the global monetary system works. Here’s what really has been happening. The U.S. economy itself pumps “savings” into foreign central banks by spending abroad on military bases. (60 Minutes showed robot fork-lift machines moving around $40-million loads of U.S. currency through the New York Federal Reserve Bank the way that similar machines have been doing in Iraq to buy off local supporters and political groups.) U.S. consumers likewise buy more than the country is exporting. When these surplus dollars are turned over to foreign banks for domestic currency, the banks turn them over to the central bank – which has a problem.

Remember when an earlier U.S. Secretary, John Connolly, said “It’s our deficit, but their problem”? He meant that the U.S. was spending funds (at that time mainly in Southeast Asia) that ended up in foreign central banks, which faced a dilemma: If they let “the market” handle these dollars, their own currency would rise. That would threaten to price their exports out of world markets, and hence would cause domestic unemployment. So foreign governments chose to recycle their dollar inflows by keeping them in dollars – mainly in U.S. Treasury bills and then, when the supply began to run out, in federal agency securities such as Fannie Mae and Freddie Mac.

So the “fire” in the international sphere was the U.S. military-spending deficit and trade deficit. This doesn’t have much to do with Chinese consumers saving too much. Central banks were doing the quasi-saving, by being stuck with surplus U.S. dollars like a hot potato. But one rarely hears public officials mention the nation’s military deficit. It is as if foreign saving comes first, then a “market-based” decision to place these in the U.S. economy, “the engine of world growth.” What actually comes first is the U.S. balance-of-payments deficit, pumping surplus dollars into the economy – which foreign central banks find themselves obliged to recycle within the dollar sphere. (This is the phenomenon I discuss in Super Imperialism: The Economic Strategy of American Empire, and Global Fracture.)

As for the surplus credit that Wall Street lent out, it is created out of thin air. At least Mr. Bernanke was clear about this, when he explained that the Fed “creates deposits” for its member banks just as these banks “create deposits” for their own customers at a stroke of the computer keyboard.

The bottom line is that the American public is being fed a carefully crafted mythology (no doubt “market tested” on “response groups” to see which images fly best) to mislead the American public into misunderstanding the nature of today’s financial problem – to mislead it in such a way that today’s policies will make sense and gain voter support.

But this mythology is based on false analogies, not economic reality. It is designed to make Wall Street appear as a savior, not an arsonist – and to depict the Fed and Treasury as protecting the welfare of American citizens by shoveling billions of dollars at the banks whose gambles have caused the crisis.

While Mr. Bernanke’s “60 Minutes” interview was being broadcast, the government was releasing the counterparties on the winning side of the Wall Street casino in bets that A.I.G. lost. To deflect the widespread voter disapproval of giving $160 billion to A.I.G., the Treasury finally released the names of the “counterparties” who ended up with the funds A.I.G. paid out to winning betters. Confirming rumors that had been circulating for the past few months, Mr. Paulson’s own company, Goldman Sachs, headed the list at $13 billion! Followed by Merrill Lynch ($7 billion), Bank of America ($5 billion), Citigroup ($23 billion and the much-loathed junk-mortgage lender Wachovia ($1.5 billion). So as Treasury Secretary, Mr. Paulson turns out to have represented not the U.S. interest but that of his own firm and its Wall Street neighbors.

These neighbors were given U.S. Treasury bonds in “cash for trash” transactions. The rest of the economy will be paying interest on this debt for a century to come. This is what causes “debt deflation.” Revenue is diverted from spending on goods and services to pay interest and taxes. So the Treasury is spreading the fire, not putting it out.

[papabear]

http://www.counterpunch.org/morici04032009.html
Another 663,000 Jobs Lost in March
Girding for a Depression
By PETER MORICI

Today, the Labor Department reported the economy lost 663,000 payroll jobs in March. The economy is shifting to permanently lower levels of production and employment, as the recession nears turns into a depression.

Unemployment reached 8.5 percent, and adding in discouraged adults who have left the labor force and part-time workers who would prefer to work full time, the real unemployment rate is closer to 17 percent.

Simply, investors and employers lack confidence in the overall likely effects of Treasury Secretary Geither’s plans to stabilize banks and President Obama’s stimulus package and budgets proposals.

Lacking confidence that the demand for what Americans make and sell will recover significantly, anytime soon, businesses are girding for a long siege—slashing employment and dividends and other hunkering down. They are preparing for a depression and the eclipse of American leadership.

The economy has shed 5.1 million jobs since December 2007, as the full weight of the banking crisis and trade deficit on oil and with China punish employment in autos, other manufacturing, construction and the broader economy. This drives down employment, wages and consumer spending and is creating a negative feedback cycle that threatens to cast the U.S. economy into something akin to Japan’s lost decade or worse.

Fundamental structural problems—poorly managed banks, wasteful uses for imported oil and the lopsided rules for competition with China and other Asia mercantilists—have come home to roost and threaten to topple American prosperity.

Unemployment increased to 8.5 percent in March and is headed for 10 percent. In 2009, unemployment and the trade deficit are reducing GDP by some $400 billion or about $2500 per worker.

Factoring in discouraged workers, unemployment is about 11 percent. Add workers in part time positions that cannot find full time employment and the hidden unemployment rate is about 16.7 percent.

A Permanent Contraction and Double Digit Unemployment

The economy contracted at about a 6.3 percent annual rate in the fourth quarter of 2008, and will contract further through most of 2009. The huge stimulus package will lift GDP a few percentage points in 2010 and 2011, but it will likely not prove enough to halt contraction over all. Even if the economy grows for a time, thanks to stimulus spending, it will fall back into recession.

The stimulus package will temporarily add about 2 to 2.5 million jobs, and only slow the pace of job losses. Unemployment will shoot past 10 percent once the effects of stimulus spending wears off in 2012, and perhaps sooner.

Increasingly, the economic slowdown looks more like a depression than a recession. Recessions are like stock market corrections—after a time, equity prices rebound without government intervention.

Federal Reserve interest rate cuts and stimulus spending and tax rebates shorten recessions and ease their impact. However, those policies will not end the current slump, because it is grounded in fundamental structural dysfunctions in U.S. banking, energy and trade policies.

A depression is not self-correcting. The economy shifts down to permanently lower levels of production and sales, high unemployment rates become chronic, and federal deficits become narcotic—federal deficits dull the senses but don’t cure the disease.

Employers in high tech, retailing, manufacturing, publishing, and elsewhere are not temporarily furloughing workers; rather they are restructuring employment downward, permanently, for what they expect to be smaller markets for their products for several years.

Without systemic reforms, the more than six million jobs lost in 2008 and 2009 will not be regained for many years. The crisis requires quick and bold action, and it requires more than a politically conceived stimulus package. It also compels radical changes in how Washington regulates banks and fosters international competition and wealth creation.

Unfortunately, the stimulus package is poorly structured and will prove too expensive for the 2 to 2.5 million jobs it creates for two years and then again disappear. The banking and trade policies President Obama is pursuing will drive the U.S. economy deeper in debt to Middle East oil exporters, China and other foreign creditors, throw the economy deeper into recession and destroy as many as 10 million jobs before the calamity has completely run its course by the middle of the next decade.

The Face of a Modern Depression

The economy need not reach the depths of the Great Depression to encounter permanent stagnation and evoke the pathos of vanished dreams—leaving older Americans without retirement incomes and scrounging for menial jobs and young workers without hope of promising careers.

Yet, without systemic reforms, unemployment will soar well above 10 percent, many college graduates will not find meaningful work, high school graduates will be trapped in low wage jobs and dependent on federal government largess, and older workers, abandoned by companies without adequate health care and pensions, will accept low wage jobs to supplement social security and work beyond the age of 70. Retirement will be for government workers and a few otherwise fortunate private sector workers but more generally, retirement will be the stuff of history books.

Roosevelt Administration stimulus spending—huge deficit spending—eased the pain but failed to end the Great Depression. Roosevelt’s policies did not put the U.S. economy on a track for growth, and President Obama’s policies will force Americans to relieve those frustrations.

In the 1930s, the economy suffered three false recoveries only to fall back into depression, because New Deal policies worsened structural problems that pulled the economy down in the first place. For example, the New Deal proliferated monopoly pricing, extended the life of undersized farms, raised structural savings rates, and created a system of home lending too dependent on federally sponsored banks—a system that ultimately contributed to the current crisis.

World War II and the Vietnam wars gave the U.S. economy reprieves from repeated downturns, but President Truman endured two recessions, President Eisenhower two recessions, Kennedy one recession and Nixon two recessions. Then surging oil prices created the Great Inflation. Only when President Carter began deregulation of the economy with the airlines, and Presidents Reagan, Bush and Clinton continued this process culminating with repeal of Glass-Steagall in 1999, did the economy enjoy the Great Moderation—an unprecedented, sustained period of growth with fewer recessions and less inflation.

During the Administration of George W. Bush, the abuse of free markets by the banks, domestically, and China, internationally through currency manipulation, high tariffs on imports and export subsidies, created the present crisis. George W. Bush ignored these threats to the benefits of free markets and open trade. Now President Obama is repeating his predecessor’s mistakes by not altering approaches to banking reform and trade and appears poised to the blunders of President Roosevelt by reregulating the economy and pushing out the frontiers of the state.

It is important to remember that the U.S. economy is built on industry and innovation and doubling the Department of Education or beefing up municipal bureaucracies does little to expand manufacturing or R&D. Making the Federal Reserve the systemic regulatory does nothing to dismantle the destructive compensation practices on Wall Street.

President Obama’s stimulus package is too weighed down with political baggage that will not boost employment—a bigger budget for the National Endowment for the Arts, extended welfare benefits, unemployment insurance for part-time workers—or create private sector jobs—extensive expansion of the Department of Education and fiscal relief for state and local governments that have added employment during the current contraction. Virtually all the jobs the stimulus package will create will not be permanent and those that are permanent will overwhelmingly be in government. In the end, someone has to pay taxes, but President Obama’s stimulus package won’t create many new taxpayers—in fact, it may leave us with few of them.

Many of the reforms proposed by President Obama, such as more welfare for the banks, restrictions on carbon emissions that apply to U.S. manufacturers but not their Chinese competitors, and the Employee Freedom of Choice Act which will eliminate secret ballots to select unions, threaten to strangle private initiative much as did the Roosevelt era reforms.

The challenges facing President Barack Obama could not be clearer. The current economic slowdown has two structural causes—bad management practices at the large money center banks and the huge foreign trade deficit. Either address those or preside over economic decline.

Courting Armageddon

The stimulus package will give the economy a temporary lift, but after the money is spent, unemployment will rise again and continue at unacceptable levels indefinitely without successively larger stimulus packages and huge federal borrowing from China and Middle East oil states. The economy is in a depression, not a recession.

To accomplish lasting prosperity, President Obama will have to fix the banks and the trade deficit. Obama must create a bad bank to work out perform triage on mortgages—work out mortgages for homeowners that are in trouble but can be saved, foreclose on those that can’t be reasonably assisted, and let mature those that will be otherwise repaid. Then the banks can sell new shares, repay their TARP assistance and once again make new loans to worthy homebuyers and businesses. Obama must make certain that banks do not continue to squander federal largess by paying outsized executive salaries and bonuses, acquiring other banks and pursuing new high-return, high-risk lines of businesses in merger activity, carbon trading and complex derivatives.

Questionable mortgage and other loan-backed securities must be completely removed from the books of commercial banks, and commercial banks must be separated in their ownership and control from other financial services, such as riskier investment banking, securities trading and hedge fund operations. Freed of these distractions, commercial banks could again raise private capital and repay TARP funds to the Treasury—essentially, purchase back the Treasury’s preferred shares in the commercial banks.

The yet unspent TARP money could be used to capitalize a “bad bank” or “aggregator bank” that would provide assistance to those distressed homeowners that can be reasonably assisted, undertake necessary foreclosures where homeowners simply cannot repay even with reasonable assistance, and service the vast majority of mortgages that left alone will be repaid. This would limit foreclosures to manageable numbers and put a floor under the decay in housing values. The bad bank would likely turn a profit, as did the Resolution Trust Corporation during the Savings and Loan Crisis and the Home Owners’ Loan Corporation during the Great Depression.

Instead, Secretary Geithner proposes a scheme to further enrich hedge funds and bankers instead of reforming the banking system.

Money spent on imported oil and imports of Chinese goods cannot be spent in the United States. Quite simply, those dollars don’t come back to purchase U.S. exports in sufficient amounts, and the resulting trade deficits are a huge structural drag on the demand for U.S. goods and services. That is why huge federal deficits are needed to keep the economy going but can’t be sustained indefinitely. Ultimately, trade deficits on oil and with China must be dramatically reduced to achieve adequate demand for U.S. production and employment and accomplish sustainable economic growth.

Most of President Obama’s energy proposals entail generating, transmitting and using electricity more efficiently. However most electricity is generated using domestic coal, natural gas and nuclear power; and reducing the oil import bill will require higher mileage standards for automobiles. Carmakers can build more efficient internal combustion engines and alternative propulsion vehicles; however, with cars lasting more than 15 years, incentives must be provided to get the gas guzzlers off the road sooner. A clunker subsidy based on the age of the vehicle and miles-per-gallon gained could encourage the rapid replacement of low mileage trucks, and SUVs; incentives to purchase fuel efficient vehicles could do more to stimulate the economy than tax rebates, increasing the budget of the National Endowments to the Arts and similar agencies, and hiring more local government bureaucrats.

China continues to print yuan and sell those for U.S. dollars in foreign exchange markets to keep the value of its currency artificially low. This makes exports artificially cheap in U.S. markets, U.S. exports artificially expensive in China, and causes U.S. manufacturers to shift production to China in industries where its low-cost labor provides little advantage, like automobiles and advanced automotive components.

If China refuses to stop currency manipulation to prop up its exports and to shut out imports, the Obama Administration should tax dollar-yuan conversion in direct proportion to China’s currency market intervention.

At his confirmation hearing Treasury Secretary Geithner acknowledged China is manipulating its currency and promised to work toward a realignment of currency values. But since then, Vice President Bidden backed off this position, much as did Democratic Senator Charles Schumer from his bill to take action against currency manipulation during the Bush presidency.

Near term, a stimulus package focused on infrastructure is critical for resuscitating growth. The recent round of tax rebate checks ended up in savings accounts or spent at the Wal-Mart on Chinese goods, and did little to create jobs or accelerate growth. Whereas projects to repair roads, rehabilitate schools and refurbish public buildings would create high-paying jobs at home and provide a legacy in capital improvements that assist growth now and in the future.

However, stimulus spending, alone, won’t fix what’s broke. Without fixing the banks, energy and trade with China, the stimulus package will give the economy a temporary lift, but then unemployment will rise again. Keeping Americans employed would then require progressively larger stimulus packages and foreign borrowing. Eventually, the foreign line of credit would run out, and widespread unemployment, depression and economic decline would follow.

Wages and Unemployment

In March, wages rose three cents per hour, or less than 0.2 percent. Wage pressures pose little threat to accelerate inflation.

The unemployment rate was 8.5 percent in March, up from 8.1 percent in February. However, these numbers belie more fundamental weakness in the job market. Discouraged by a sluggish job market, many more adults are sitting on the sidelines, neither working nor looking for work, than when George Bush became president. Factoring in discouraged workers, who have left the workforce, and those forced into part time employment owing to the lack of full time work, the unemployment rate is about 16.7 percent.


Manufacturing, Construction and the Quality of Jobs

Going forward, the economy will add some jobs for college graduates with technical specialties in business, health care, education, and engineering. However, for high school graduates without specialized technical skills or training and for college graduates with only liberal arts diplomas, jobs offering good pay and benefits remain tough to find. For those workers, who compose about half the working population, the quality of jobs continues to spiral downward.

Historically, manufacturing and construction offered workers with only a high school education the best pay, benefits and opportunities for skill attainment and advancement. Troubles in these industries push ordinary workers into retailing, hospitality and other industries where pay often lags.

Construction employment fell by 126,000 in March. This is a terrible indicator for future GDP growth. Retailing shed 48,000 jobs, and financial services lost 25,000 jobs.

Manufacturing lost 161,000 jobs, and over the last 108 months, manufacturing has shed 5.0 million jobs. The trade deficit with China and other Asia exporters are the major culprits.

Adding Up the Costs

The dollar is too strong against the Chinese yuan, Japanese yen and other Asian currencies. The Chinese government intervenes in foreign exchange markets to suppress the value of the yuan to gain competitive advantages for Chinese exports, and the yuan sets the pattern for other Asian currencies. Similarly, Beijing subsidizes fuel prices and increasingly requires U.S. manufacturers to make products in China to sell there.

Ending Chinese currency market manipulation and other mercantilist practices are critical to reducing the non-oil U.S. trade deficit, and instigating a recovery in U.S. employment in manufacturing and technology-intensive services that compete in trade. Neither Presidents Bush and Obama nor Congressional leaders like Charles Rangel and Charles Schumer have been willing to seriously challenge China on this issue.

Either President Obama must get behind a policy to reverse the trade imbalance with China, or preside over the wholesale destruction of many more U.S. manufacturing jobs. These losses have little to do with free trade based on comparative advantage. Instead, they derive primarily from currency practices that make Chinese products artificially cheap in U.S. and other markets and Chinese restrictions on imports. These Chinese policies deprive Americans of jobs in industries where they are truly internationally competitive.

Each dollar spent on imports that is not matched by a dollar of exports reduces domestic demand and employment, and shifts workers into activities where productivity is lower. Productivity is at least 50 percent higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into these industries would increase GDP.

Were the trade deficit cut in half, the movement of workers and capital into more productive export and import-competing industries would increase by at least $400 billion or about $2500 for every working American. Workers’ wages would not be lagging inflation, and ordinary working Americans would more easily find jobs paying higher wages and offering decent benefits.

Put another way, the trade deficit is reducing 2009 GDP by $400 billion or about $2000 billion per worker.

Manufacturers are particularly hard hit by this subsidized competition. Through recession and recovery, the manufacturing sector has lost 5.0 million jobs since 2000. Following the pattern of past economic recoveries, the manufacturing sector should have regained about 2.5 million of those jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing.

Longer-term, persistent U.S. trade deficits are a substantial drag on productivity growth. U.S. import-competing and export industries spend three-times the national average on industrial R&D, and encourage more investments in skills and education than other sectors of the economy. By shifting employment away from trade-competing industries, the trade deficit reduces U.S. investments in new methods and products, and skilled labor.

Cutting the trade deficit in half would boost U.S. GDP growth by one percentage point a year, and the trade deficits of the last two decades have reduced U.S. growth by one percentage point a year.

Lost growth is cumulative. Thanks to the record trade deficits accumulated over the last 10 years, the U.S. economy is about $1.5 trillion smaller. This comes to about $10000 per worker.

The Eclipse of American Leadership

In the end, without assertive steps to fix trade with China, as well as fix the banks and curtail oil imports, the Bush years will seem like a walk through the park compared to job and real income losses Americans will suffer during the Obama years.

Had the Administration and the Congress acted responsibly to reduce the deficit, American workers would be much better off, tax revenues would be much larger, and the federal deficit could be eliminated without cutting spending.

The damage grows larger each month, as the Administration and Congress dally and ignore the corrosive consequences of the trade deficit.

The choices for the new president are simple. It’s either recovery or depression. Fix the banks, trade with China and energy policy or preside over American decline and the eclipse of American leadership at the hands of China.

[papabear]

http://www.counterpunch.org/whitney04062009.html
April 6, 2009

A Glide-Path to Destitution
Bernanke's Financial Rescue Plan
By MIKE WHITNEY

Fed chief Ben Bernanke has embarked on a radical and ruinous financial rescue plan. According to Bloomberg News, the Fed has already lent or committed $12.8 trillion trying to stabilize the financial system after the the bursting of Wall Street's speculative mega-bubble. Now Bernanke wants to dig an even bigger hole, by creating programs that will provide up to $2 trillion of credit to financial institutions that purchase toxic assets from banks or securities backed by consumer loans. The Fed's generous terms are expected to generate a flurry of speculation which will help strengthen the banking system while leaving the taxpayer to bear the losses. It is impossible to know what the long-term effects of Bernanke's excessive spending will be, but his plan has the potential to trigger hyperinflation or spark a run on the dollar.

Bernanke's zero-percent interest rates, multi-trillion dollar lending facilities and bank bailouts do not fit within the Fed's narrow mandate of "price stability and full employment". There are also myriad problems with Bernanke's lending facilities which are nothing more than a crafty way of transferring wealth from the Fed to private industry via low interest loans. The Central Bank is not supposed to "pick winners" as it is blatantly doing. Businesses outside the financial sector cannot exchange their downgraded garbage with the Fed for semi-permanent, rotating loans; so why should underwater investment banks and hedge funds get special treatment? The facilities represent a gift to financial institutions giving them an unfair advantage.

Besides the $2 trillion for the Term Asset-Backed Lending Facility (TALF) and the Public-Private Investment Program (PPIP), the Fed will also provide a multi-billion dollar backstop for the FDIC as bank closures continue to snowball and more reserves are needed to shore up the system. That means that the Fed's balance sheet could mushroom to over $4 trillion by the end of 2010. The Treasury has already agreed in principle to assume full responsibility for the Fed's lending facilities (as well as the bailouts of AIG and Bear Stearns) as soon as the financial system stabilizes. By providing loans and US Treasuries to failing companies, instead of capital, Bernanke has sidestepped Congress, thus, undermining the spirit and the letter of the law. Congress has approved a mere $1.5 trillion of the nearly $13 trillion for which taxpayers are now responsible.

The recent 22 percent uptick in the stock market is a sign that Bernanke's monetary stimulus is beginning to kick in. Oil rose from $33 per barrel to over $50 in little more than a month. Other raw materials have followed oil. The dollar has plunged every time the stock market has gone up. These are all signs of nascent inflation which is likely to accelerate after the current period of deleveraging ends. Food and energy prices will rise sharply and the dollar will come under greater and greater pressure. This is Bernanke's nightmare scenario; a surge in inflation that forces him to raise rates and kill the recovery before it ever begins. The Fed's unwillingness to be proactive in dealing with credit bubbles has created a situation where there are no easy answers or pain-free solutions.

Bernanke's approach to the crisis has been wrongheaded from the get-go. It makes no sense to commit nearly $13 trillion to prop up a grossly oversized financial system while providing less than $900 billion stimulus for the real economy. The whole plan is upside-down. It's consumers, homeowners and workers that create demand (consumer spending is 72 per cent of GDP) and yet, they've been left to twist in the wind while the bulk of the resources has been directed to financial speculators who are responsible for the mess. Middle class families have seen their retirements slashed in half and their home equity vanish, while their jobs become increasingly less secure. The Fed and the Treasury should be focused on debt relief, mortgage cram-downs, jobs programs and open-ended support for state and local governments. Rebuilding the financial infrastructure for extending more credit to people that are already underwater is beyond shortsighted; it’s cruel. The financial system needs to shrink to fit the new reality of a smaller economy. That means that Bernanke should aggressively mark-down the dodgy collateral he's been accepting (the collateral should reflect current market prices) and force many of the weaker institutions into bankruptcy. This is the fairest and fastest way to shake the deadwood from the financial system. Keeping asset prices artificially inflated only puts off the inevitable day of reckoning.

The IMF Communique to the G 20:

“The prolonged financial crisis has battered global activity beyond what was previously anticipated. Global GDP is estimated to have fallen by unprecedented 5 per cent in the fourth quarter, led by the advanced economies, which contracted by 7 per cent. GDP declined by around 6 per cent in both the United States and Europe, while it plummeted at a post-war record of 13 per cent in Japan. Growth also plunged across a broad swath of emerging economies … against this backdrop, global activity is expected to contract in 2009 for the first time in 60 years.”

Bernanke's monetary stimulus strategy will do little to mitigate the severity of the contraction which has already gripped every sector of the economy. Credit more than doubled in the first few years of the new millennium. In fact, total system credit jumped from $1.75 trillion in 2000 to $4.4 trillion in 2007. At the same time, the Current Account Deficit--which averaged about $100 billion per year during the 1990s-- ballooned to $788 billion in 2006. Clearly, the Fed's flood of low interest credit coupled with unsustainable deficits put the country on course for a major catastrophe. (Greenspan still says he never saw it coming) Now that the bubble has burst, Bernanke, has gone into panic-mode, is frantically firehosing the entire financial system with liquidity, but with little effect. Here's the economist Henry Liu:

"Globally, the dollar-denominated financial system has seen its equity market capitalization value fall by between 40-60 per cent by February 2009....On October 31, 2007, the total market value of publicly-traded companies around the world was $62.6 trillion. By December 31, 2008, the value had dropped nearly half to $31.7 trillion. The gap of lost wealth, $30.9 trillion, is approximately the combined annual Gross Domestic Product of the US, Western Europe, and Japan.... Family net worth hit a record high of $64.36 trillion in 2nd quarter of 2007. By 4th quarter 2008, it fell to $51.48 trillion, a loss of $12.88 trillion.

To restore the wealth lost in the current financial crisis, the Treasury would have to monetize some $30 trillion of toxic assets, almost ten times what the Geithner Treasury is currently contemplating, and twice the size of current US annual GDP. Add to that about $10 trillion of value lost in the collapse of commodity prices and another $10 trillion in real property values, and we have a wealth loss of $50 trillion."
(Obama’s Politics of Change and US Policy on China, Asia Times.)

Nearly half of the world's wealth has been consumed in one gigantic capital bonfire. No amount of "quantitative easing" will undo the damage to the economy. Here's a clip from Merrill Lynch's David Rosenberg adding more perspective to Liu's comments:

"Government cannot prevent nature from taking its course. While an additional $1.15 trillion expansion of the Fed’s balance sheet is large as a stand-alone event, it really is just a drop in the bucket when one considers that there is still almost $8 trillion of combined household and business sector credit that must be unwound in order to mean-revert the private sector-to-GDP ratio (which is still close to a record-high). Once again, the government is cushioning the blow, but cannot prevent nature from taking its course.

(We) feel much more confident that corporate earnings are going to slide again this year....The economy continues to contract … job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. US exports have slumped as a number of major trading partners have also fallen into recession”. This is with the Fed funds rate effectively at zero. It’s pretty clear that the Fed does not see any flicker of light at the end of the tunnel just yet. Mr. Market may be in for yet another surprise." (Interview with David Rosenberg, Tech Ticker)

The system-wide contraction can't be stopped by supporting financial institutions that made bad bets or took on perilous amounts of debt leaving them deep in the red. Fed lending should be aimed at companies that need temporary help only, like rolling over loans or getting through a rough patch while inventories are trimmed and consumers retrench. Similarly, the stimulus (monetary or fiscal) shouldn't be used to reflate assets or to try to reverse the market correction, but to maintain aggregate demand, take up slack in the sluggish economy, create jobs, and soften the blow for the victims of Wall Street's bubblenomics. Bernanke has used monetary stimulus in precisely the way it should not be used, to keep asset prices artificially high despite the cooling off in the stock market, falling corporate profits, and the steeply rising unemployment. There should be a sharp reduction in the amount lending to financial institutions, reflecting the decline in the value of the underlying assets which are now priced at roughly 30 cents on the dollar. Bernanke's job is to wind-down these positions, not perpetuate the problem at the taxpayer's expense.

According to Bloomberg:

"The Federal Reserve’s top two officials assured that they will pull back their emergency- credit programs once the crisis fades, even as they prepare to flood the system further with an excess of $1 trillion.

Chairman Ben Bernanke said Friday in Charlotte, North Carolina that the Fed must retain the flexibility to withdraw its record cash injections to restrain prices. Vice Chairman Donald Kohn said in Wooster, Ohio, “the trick will be unwinding this balance sheet in a timely way to avoid inflation.”

This is pure fiction. Bernanke has no exit strategy because the collateral the Fed now holds on its books will never regain anything near its original value. Securitization turned 80 per cent of shaky subprime loans into AAA assets for which the Fed is now providing full value vis a vis its low interest loans. The Fed chief has made the same bad bet that the financial institutions made, and is now adding to that mistake by buying $750 billion in junk loans from Fannie and Freddie and $300 billion in US Treasurys to push investors out of the safety of cash back into the market. It's lunacy. All of this is putting more and more pressure on the dollar which could experience severe dislocation if Bernanke does not make a reasonable attempt to do what is necessary to resolve the banks, shore up consumer spending, shut down underwater financial institutions (auction their toxic assets through a RTC government-run facility) and stop trying to reassemble a broken system.

Bernanke has no plan for expanding conventional lending or strengthening the parts of the system that still work. All his efforts have been focused on salvaging insolvent banks and restarting securitization. Securitization--transforming pools of loans into securities---was Wall Street's Golden Goose, a privately-owned credit-generating mechanism which created windfall profits by selling radioactive waste to over-trustful investors. Securitization is the epicenter of the shadow banking system, the mostly-unregulated universe of opaque debt-instruments, off balance sheet operations, and massively over-leveraged financial institutions. Securitization broke down after subprime mortgages began defaulting in record numbers sending risk-adverse investors scuttling for the exits. To illustrate how frozen the securitzation market is at present, here's the Wall Street Journal:

"Outside the market where the Fed is a buyer for securities backed by mortgage loans that conform to Fannie and Freddie standards, there hasn't been a new deal since 2007, according to FTN Financial, a fixed-income broker dealer." (Wall Street Journal, Credit Markets Still Navigate in a Choppy Sea of Liquidity)

Repeat: "No new deals since 2007."

Again from the Wall Street Journal:

"Banks and other finance companies making loans for autos, credit cards and college tuition are having virtually no success in selling those loans to other investors, a potent sign of just how tight credit markets remain.

The market for selling such loans — by packaging, or securitizing, them into bonds — had just one $500 million deal for all of October, according to Barclays Capital. That compares with $50.7 billion worth of deals made one year earlier, according to market-research firm Dealogic.” (Bond Woes Choke off some Credit to Consumers, Wall Street Journal, Robin Sidel)

Securitzation is dead, and yet, Bernanke and Geithner want to shovel another $2 trillion into this black hole hoping to lure investors back to the market. Why? Because Wall Street financiers and bank mandarins see securitization as an efficient model that can be exported into any market around the world. The repackaging of debt into complex instruments, that can be stealthily created in off balance sheet operations requiring smaller and smaller slices of capital, is the essential flimflam product that Wall Street intends to use to dominate global financial markets. Keeping securitization alive is ultimately about economic power. That is why Bernanke will spare no expense trying to resuscitate this failed system.

What's so destructive about securitzation is that it allows the banks to create credit out of thin air through unregulated, clandestine operations, which eliminate transparency and makes it impossible for the Fed to control the money supply. David Roache explains how this works in an excerpt from his book "New Monetarism" which appeared in the Wall Street Journal:

"The reason for the exponential growth in credit, but not in broad money, was simply that banks didn't keep their loans on their books any more-and only loans on bank balance sheets get counted as money. Now, as soon as banks made a loan, they "securitized" it and moved it off their balance sheet.

There were two ways of doing this. One was to sell the securitized loan as a bond. The other was "synthetic" securitization: for example, using derivatives to get rid of the default risk (with credit default swaps) and lock in the interest rate due on the loan (with interest-rate swaps). Both forms of securitization meant that the lending bank was free to make new loans without using up any of its lending capacity once its existing loans had been "securitized."

So, to redefine liquidity under what I call New Monetarism, one must add, to the traditional definition of broad money, all the credit being created and moved off banks' balance sheets and onto the balance sheets of nonbank financial intermediaries. This new form of liquidity changed the very nature of the credit beast. What now determined credit growth was risk appetite: the readiness of companies and individuals to run their businesses with higher levels of debt. (Wall Street Journal)

The banks have been creating trillions of dollars of credit without maintaining adequate capital reserves to back them up. That explains why the banks were so eager to provide mortgages to millions of loan applicants who had no documentation, no income, no collateral and a bad credit history. They believed there was no risk, because they were making enormous profits without tying up any of their capital.

THE ECONOMY'S LIFE'S BLOOD IN PRIVATE HANDS

As Barack Obama says, "Credit is the economy's life's-blood". It should not be part of a secretive process which is kept off-book and controlled by men whose solitary goal is fattening the bottom line for short-term gain. The reason securitization failed is because the banks put profit above their responsibility to perform due diligence on their loans. In other words, securitization created incentives for fraud, which is why the system eventually collapsed. Still, Bernanke is determined to do Wall Street's bidding and spend another $2 trillion trying to rev up the securitization engine.

A recent letter by the Federal Reserve Bank of Dallas, "Fed Confronts Financial Crisis by Expanding Its Role as Lender of Last Resort" helps to shed some light on the Fed's real intentions:

"In a modern financial system, securities-funded lending has replaced the banking system as the predominant credit source for households and nonfinancial firms. Because of this development, it can be appropriate to extend the lender of last resort role to temporarily support some nonbank credit sources....

It’s against this backdrop that the Fed has extended its role as lender of last resort beyond banks. Since late 2007, the central bank has supported key credit flows funded by securities, extending loans on nonfinancial corporations’ commercial paper, residential mortgage-backed securities and nonbank financial companies’ loans to consumers and businesses.

The Fed actions recognize the dramatic shift toward debt funded through securities markets. At the end of 1979, securities funded about 33 percent of household, nonfinancial corporate and nonfarm business debt. By the third quarter of 2008, that figure had risen to around 64 percent .

A closer look reveals that household debt became significantly more dependent on market funding, largely reflecting the increased importance of asset-backed securities (ABS) in funding mortgages and consumer loans. Even the share of nonfinancial corporate debt funded by securities rose considerably over the same period—from 57 per cent to 76 per cent."

76 percent! Is it any wonder why the global economy has been sucked into a bottomless abyss; why auto sales are down 40 per cent or more, why global trade is down 35 per cent or more, why unemployment is skyrocketing, manufacturing is stalling and consumer confidence is plunging?

The Fed has allowed an unregulated and untested privately-controlled "credit generating" shadow banking system to infect the broader economy and create a nation of credit addicts which are entirely at the mercy of unpredictable market fluctuations. Is this how the economy's "life's blood" should be distributed?

The only reason this occult system was allowed to flourish--with the tacit support of the Fed and the Treasury-- was because it threw open the profit-sluicegates for the banks and Wall Street speculators who made more money than anyone ever thought possible. Clearly, this is what motivates Bernanke and Geithner. These are their real constituents.

[justforboa]

As Barack Obama says, "Credit is the economy's life's-blood".

Actually, it's savings that's the lifeblood of the economy.

[papabear]

http://www.counterpunch.org/whitney04202009.html
April 20, 2009

Here It Comes Again!
Housing Bust Comes Roaring Back, Worse Than Ever
By MIKE WHITNEY

Due to the lifting of the foreclosure moratorium at the end of March, the downward slide in housing is gaining speed. The moratorium was initiated in January to give Obama's anti-foreclosure program -- a combination of mortgage modifications and refinancing -- a chance to succeed. The goal of the plan was to keep up to 9 million struggling homeowners in their homes. But it's clear now that the program will fall well-short of its objective. (Legislation for cram-downs, that is, allowing judges to reduce the face-value of the mortgage, is still bogged-down in Congress. Most economists believe that cramdowns are the only way to keep people from abandoning their homes when they are underwater on their loans.)

In March, housing prices fell faster than anytime in the last two years. Trend-lines are now steeper than ever before, nearly perpendicular. Housing prices are not falling, they're crashing and crashing hard. Now that the foreclosure moratorium has ended, Notices of Default (NOD) have spiked to an all-time high. These Notices will turn into foreclosures in 4 to 5 months time. Market analysts predict there will be 5 million more foreclosures between now and 2011. Soaring unemployment and rising foreclosures ensure that hundreds of banks and financial institutions will be forced into bankruptcy. 40 percent of delinquent homeowners have already vacated their homes. There's nothing Obama can do to make them stay. Worse still, only 30 per cent of foreclosures have been relisted for sale suggesting major hanky-panky at the banks. Where have the houses gone? Have they simply vanished?

Here's a excerpt from the SF Gate explaining the mystery:

"Lenders nationwide are sitting on hundreds of thousands of foreclosed homes that they have not resold or listed for sale, according to numerous data sources. And foreclosures, which banks unload at fire-sale prices, are a major factor driving home values down.

"We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market," said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. "California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You'd have further depreciation and carnage."

In a recent study, RealtyTrac compared its database of bank-repossessed homes to MLS listings of for-sale homes in four states, including California. It found a significant disparity - only 30 percent of the foreclosures were listed for sale in the Multiple Listing Service. The remainder is known in the industry as "shadow inventory." ("Banks aren't Selling Many Foreclosed Homes" SF Gate)

If regulators were deployed to the banks that are keeping foreclosed homes off the market, they would probably find that the banks are actually servicing the mortgages on a monthly basis to conceal the extent of their losses. They'd also find that the banks are trying to keep housing prices artificially high to avoid heftier losses that would put them out of business. One thing is certain, 600,000 "disappeared" homes means that housing prices have a lot farther to fall and that an even larger segment of the banking system is insolvent.

Here is more on the story "California Foreclosures About to Soar...Again"

"Are you ready to see the future? Ten’s of thousands of foreclosures are only 1-5 months away from hitting that will take total foreclosure counts back to all-time highs. This will flood an already beaten-bloody real estate market with even more supply just in time for the Spring/Summer home selling season...Foreclosure start (NOD) and Trustee Sale (NTS) notices are going out at levels not seen since mid 2008. Once an NTS goes out, the property is taken to the courthouse and auctioned within 21-45 days....The bottom line is that there is a massive wave of actual foreclosures that will hit beginning in April that can’t be stopped without a national moratorium."

JP Morgan Chase, Wells Fargo and Fannie Mae have all stepped up their foreclosure activity in recent weeks. Delinquencies have skyrocketed. According to the Wall Street Journal:

"Ronald Temple, co-director of research at Lazard Asset Management, expects home prices to fall 22% to 27% from their January levels. More than 2.1 million homes will be lost this year because borrowers can't meet their loan payments, up from about 1.7 million in 2008." (Ruth Simon, "The housing crisis is about to take center stage once again" Wall Street Journal)

Another 20 percent carved off the aggregate value of US housing means another $4 trillion loss to homeowners. That means smaller retirement savings, less discretionary spending, and lower living standards. The next leg down in housing will be excruciating; every sector will feel the pain. Obama's $75 billion mortgage rescue plan is a mere pittance; it won't reduce the principle on mortgages and it won't stop the bleeding. Policymakers have decided they've done enough and refuse to lift a finger to help. They don't see the tsunami looming in front of them plain as day. The housing market is going under and it's going to drag a good part of the broader economy along with it. Stocks, too.

The Headless Chicken Keeps on Running…

The Fed's $12.8 trillion of monetary stimulus has triggered a six week-long surge in the stock market. Think of it as Bernanke's Bear Market Rally, a torrent of capital gushing from every leaky valve and rusty pipe in the financial system. The Fed's so-called "lending facilities" are a joke; stocks rocket into the stratosphere while the broader economy is stretched out corpse-like on a cold marble slab. Is this an economic recovery or just more of Bernanke's "no down" zero-percent "no doc" faux prosperity?

Bernanke has provided generous "100 cents on the dollar" loans for Triple A mortgage-backed collateral that is now worth 30 cents on the dollar. The Fed stands to lose trillions of dollars on these loans because the assets will never regain their original value. Eventually the taxpayer will have to pony up the difference in higher taxes, fewer public services and a weaker dollar.

Naturally, some of Bernanke's liquidity has made its way into the stock market where the prospects for maximizing profit are still the best. The Fed's debtors didn't borrow the money just to stick it in a dusty vault in their offices. They've put it where they think it will do them some good. At the same time, the relentless systemwide contraction continues apace and hasn't been eased by Bernanke's low interest rates or lending programs. All of the economic indicators point to a deepening recession that will last for two years or more. Here's a clip from a recent statement from the IMF:

"Recessions associated with financial crises have typically been severe and protracted. Financial crises typically follow periods of rapid expansion in lending and strong increases in asset prices. Recoveries from these recessions are often held back by weak private demand and credit reflecting, in part, households’ attempts to increase saving rates to restore balance sheets. They are typically led by improvements in net trade, following exchange rate depreciations and falls in unit costs.

Globally synchronized recessions are longer and deeper than others. Excluding the present, there have been three episodes since 1960 during which 10 or more of the 21 advanced economies in the sample were in recession at the same time: 1975, 1980 and 1992…Recoveries are usually sluggish, owing to weak external demand..."

The recession will be a long uphill slog regardless of developments in the stock market. Bernanke admitted as much last Thursday when he said that the collapse of U.S. lending will cause “long-lasting” damage to home prices, household wealth and borrowers’ credit scores.

“One would be forgiven for concluding that the assumed benefits of financial innovation are not all they were cracked up to be....The damage from this turn in the credit cycle -- in terms of lost wealth, lost homes, and blemished credit histories -- is likely to be long-lasting.”

Unlike Treasury Secretary Geithner, Bernanke has been surprisingly candid in his analysis of the crisis. That doesn't mean that his policies have been worker-friendly; far from it. But he has been honest about the shortcomings of deregulation and financial innovation. So far, the meltdown has wiped out more than $11 trillion of household wealth, ignited soaring unemployment, and pushed millions of people from their homes. As Bernanke admits, the country will not quickly bounce back.

Economists Kenneth Rogoff and Carmen Reinhart have conducted a study on the last 18 international financial crises and compiled their findings in a document called: "Is the 2007 U.S. Subprime Financial Crisis So Different?" What they discovered was that "rising public debt is a near universal precursor of other post-war crises" and that countries that experienced large capital inflows were particularly vulnerable to crises. By 2006, two-thirds of the world's surplus capital was flowing into the United States via its current account deficit. This flood of foreign capital kept interest rates low, housing and equity prices high, and Wall Street flush with money. Now foreign investment is drying up, housing prices are falling, the secondary market is frozen, and deflation is setting in across all sectors of the economy. Rogoff and Reinhart believe that "recessions that follow in the wake of big financial crises tend to last far longer than normal downturns, and to cause considerably more damage. If the United States follows the norm of recent crises, as it has until now, output may take four years to return to its pre-crisis level. Unemployment will continue to rise for three more years, reaching 11–12 percent in 2011." (Newsweek, "Don't Buy the Chirpy Forecasts")

The proliferation of opaque, unregulated debt-instruments (MBSs, CDOs, CDSs) also played a big role in the present crash by reducing transparency and increasing systemic instability. Here's Rogoff and Reinhart in their Newsweek article "Don't Buy the Chirpy Forecasts:

"Assuming the U.S. continues going down the tracks of past financial crises, perhaps the scariest prospect is the likely evolution of public debt, which tends to soar in the aftermath of a crisis. A base-line forecast, using the benchmark of recent past crises, suggests that U.S. national debt will rise by $8.5 trillion over the next three years. Debt rises for a variety of reasons, including bailout costs and fiscal stimulus. But the No. 1 factor is the collapse in tax revenues that inevitably accompanies a deep recession."

Tax revenues are already falling sharply across the country as the recession deepens. In fact, Bloomberg News reports that “State and local sales-tax revenue fell more sharply in the fourth quarter of 2008 than at any time in the past half century"… (Corporate and personal income taxes are also declining at a record pace.) This makes it impossible to predict the ultimate cost of the crisis. But what makes it even harder is that Treasury Secretary Timothy Geithner refuses to remove toxic assets from the banks balance sheets using the usual "tried and true" methods. A recent report from a congressional oversight committee (The Warren Report) revealed that there are three ways to fix the banking system; liquidation, reorganization and subsidization. Geithner has rejected all three of these preferring to implement his own make-shift Public Private Investment Program (PPIP) which is thoroughly untested, has no base of public or political support, and is clearly designed to shift the toxic debts of the banks onto the taxpayer through publicly-funded non recourse loans. (Geithner's plan will allow the banks to establish off-balance sheet operations so they can buy their own bad assets from themselves using 94 per cent public money) The whole thing is a obvious swindle papered-over with gibberish.

So far, less than $10 billion has been transacted through Giethner's PPIP; a mere drop in the bucket. The IMF estimates that the banks and other financial institutions may be holding up to $4 trillion in toxic assets. At the current rate, Geithner's strategy will take a century to succeed. The Treasury Secretary knows his plan won't fix the banking system; he's just hoping that the economy rebounds before the government is forced to nationalize the big banks. It's just a stalling ploy, but, even so, there are risks. As the economy worsens, the likelihood of another financial meltdown or a run on the dollar increases. Foreign central banks and investors are getting antsy and are starting to rattle Geithner's cage. In recent months China has slowed its purchases of US Treasuries, traded tens of billions of USD in currency swaps, and gone on a spending spree for raw materials; all to protect itself from weakness in the dollar. According to Bloomberg:

"People's Bank of China Zhou Xiaochuan called for the establishment of a "super-sovereign reserve currency" last month after Chinese Premier Wen Jiabao said he's worried a weaker US dollar may hurt China's investments. Inflation and a depreciating dollar would erode the value of US holdings owned by international investors."

Again, Bloomberg:

“China, Japan and Korea should establish a routine mechanism to diversify the region’s reserve currencies away from the dollar, the China Securities Journal reported, citing central bank adviser Fan Gang. The Asian countries need to consider setting up a transitional arrangement to help reduce reliance on the dollar before the problems in the international financial system are resolved."

Geithner's foot-dragging could be extremely costly for America's long-term economic prospects. The Treasury Secretary should be tackling the toxic assets problem head-on and stop the dilly-dallying.

[papabear]

http://www.counterpunch.org/morici04222009.html
April 22, 2009

Be Cautious on the Upside
Housing Sales and Fixing the Economy
By PETER MORICI

It seems an article of faith that the first signs of recovery will emerge in the housing market. March data for existing and new homes sales, due out Thursday and Friday, will be trumpeted crocuses of spring if those beat expectations.

Banks report new mortgages are up. If those are more than homeowners refinancing at lower rates, then existing homes sales should dart up from the tepid 4.72 million annual pace recorded in February. The consensus forecast is 4.65 million, and my electronic Ouija board spits out 4.74 million. Something above 5 million would be cause for jubilation.

Buyer traffic on new home lots was weak in March but economists, including this one, are forecasting sales steady at about 340 thousand. Something above 360 thousand would instigate new optimism.

Even with upside surprises, remain cautious.

Supplies of unsold new homes exceed a full year’s supply, housing starts continue to languish, and a burst of new construction is months away.

During the bubble, easy credit made homes and autos artificially inexpensive, and Americans are overstocked on bedrooms and wheels. It will take some time for population growth to create demand for significantly more dwellings and vehicles.

Habits are radically changing. Americans are dinning at home more, spending less on entertainment, and setting limits when they visit supermarkets and malls.

Horror of horrors, those that still have jobs are putting more into retirement and savings accounts.

If Americans are no longer recklessly spending more than they earn, then the Obama Administration will have find other ways to fire up demand for American-made goods and services.

During the bubble, the trade deficit rocketed to more than $700 billion or 5.1 percent of GDP. That was almost all oil to fuel autos and imports from China that exceeded exports by nearly five to one.

To achieve sustainable growth, Americans need to drive more fuel efficient vehicles, and buy less from, or sell more to, China.

Obama’s programs to create green jobs will use domestic coal and gas more efficiently to generate electricity and manufacture products, but those won’t solve the auto MPG problem anytime soon.

We have technologies to produce much more fuel efficient vehicles. However, with autos lasting more than 15 years, quickly changing the fleet requires incentives—a clunker subsidy to put recent-vintage, low-MPG vehicles into the crusher. Replace those Tahoes with crossovers.

Similarly, no sensible person wants blind protectionism, but Obama like Bush is reluctant to challenge China’s economic development strategy of undervaluing its currency, subsidizing exports and blocking imports of competitive American products. Now, China is exporting the worst effects of the recession, and maintaining six percent growth, by upping its export incentives.

It’s high time for a recalibration of trade policy to ensure trans-Pacific commerce is based on comparative advantage, not Chinese foreign policy ambitions.

Those harm the U.S. economy and make it more difficult for U.S. diplomats to offer democracy and markets to a world increasingly skeptical of American values.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.

[papabear]

http://www.atimes.com/atimes/Global_Economy/KE05Dj05.html
May 5, 2009



The mirage of recovery
By Hossein Askari and Noureddine Krichene

Over recent days, observing a sudden increase in car sales and record profits of "bankrupt" banks, Federal Reserve chairman Ben Bernanke has announced that recovery of the US economy was under way. Treasury Secretary Timothy Geithner echoed the same message and even "globalized" his prediction of a recovery for the world economy. President Barack Obama saw "glimmers of hope". While these three top US policymakers were rushing to announce recovery, economist Paul Krugman exuded skepticism, saying "do not count your recoveries before they are hatched".

US policymakers' optimism seems to be founded on their grandiose reflationary programs. Obama has launched an unprecedented stimulus package at US$787 billion, followed by the largest US fiscal deficit ever, at $1.85 trillion, or 13% of gross domestic product (GDP). Underlying the stimulus package and the fiscal deficit was a Harvard income multiplier of 1.5, implying an increase in the US real GDP by about $4 trillion, or a record 30% per year. The basic economics advocated by the Obama team were simple: trillions of dollars in stimulus package and government expenditures would boost real aggregate demand for consumption and investment and automatically lead to economic recovery and full employment. Their mechanical multiplier model provided a strong reason for Obama to announce a premature economic recovery.

Bernanke's optimism is the result of the aggressive monetary policy that he forced under the George W Bush administration and has continued to expound under Obama, irrespective of the devastation it has caused to the banking sector and subsequent fiscal bailouts. Bernanke has gained the reputation of the doctor of the "Great Depression" and proponent of monetary anarchy. For him and his school of thought, inflation seems to be of little concern. His aggressive monetary policy has sent the US economy, and with it the world economy, into financial collapse and recession.

Yet, doctor Bernanke kept strong faith in his aggressive anti-Great Depression medicine. Besides forcing interest rates to zero, never seen in the monetary history of the US, he decided to unleash money supply by expanding the credit of the Federal Reserve from $700 billion prior to August 2007 to $2.3 trillion by end April 2009. Doctor Bernanke's reasoning was simple: zero interest rates combined with unlimited credit to the sub-prime markets ought to hike up aggregate demand in such a powerful way that it blasts away recession and secures fast growth and full employment.

The recent cheers for Geithner were based on similar reasoning, however, transplanted at the world economic level. A Group of 20 stimulus package of $5 trillion, on the top of a commitment by the G-20 countries to undertake the most expansionary fiscal and monetary policy, combined with free lending to any country in any amount, that would in their view guarantee a fast and strong world economic recovery.

Neither G-20 policymakers nor the US seem to recognize that the current recession was the product of overly expansionary fiscal and monetary policies during the past decade. Obviously, these policies yielded a temporary high demand-led economic growth during the 2002-2007 period accompanied by the highest commodity price inflation in recent memory; however, they also triggered a food and energy crisis, general bankruptcies in form of meltdown of sub-prime loans, an economic recession and trillion of dollars of bailouts in the US and Europe that socialized financial losses. These bailouts will weigh on economic growth for a long time in the future.

These same policies are now being replayed around the world. The supporters of these policies claim to be innovative as if for the first time in history they were implementing voluminous fiscal expansion and the free printing of money. Yet these policies were used time and again in the past with startling examples such as the German hyperinflation in 1920-23, Latin American hyperinflations in 1950-1985, and the more recent Mobutu and Mugabe hyperinflations.

In all cases where these policies were tried, there was devastating inflation, a substantial decline in real income and a considerable impoverishment and social malaise. Notwithstanding historical evidence against rapid monetary and fiscal expansionism, G-20 policymakers and the US now believe in success of super inflationary policies.

US policymakers diagnosed the current crisis as lack of demand for goods and services and large excess savings in the form of a piling up of food and energy goods in the US, and totally dismissed the large external deficits that reached about 6% of GDP in recent years and negative national savings. They believed in deflation when housing, food, and energy inflation was crippling the economy. The refusal to link the Bush administration's war spending and excessively expansionary fiscal and monetary policies and the current financial crisis has been a main stratagem in the speeches of Fed officials.

Bernanke blamed the financial crisis on China and on oil exporters who invested their balance of payments surplus in the US, leading to low interest rates and a credit boom in the US, thus denying Fed influence on interest rates and credit creation. Certainly, Bernanke did not understand that China and oil exporters do not decide the US current account deficit.

Often, Bernanke has noted that the Fed's mandate from the Congress was to promote maximum sustainable employment and stable prices. The failure of the Fed to achieve either or both objectives has been quite recurrent over the past decades. Bernanke's aggressive policy since August 2007 has even triggered stagflation: rising unemployment and inflation. It would be more natural to have a central bank with one single mandate - to preserve the value of money.

Bernanke has simply dismissed traditional central banking and decided, based on his own Great Depression doctrine, to go beyond the twin mandates that were prescribed by the Congress and to create high-risk instruments that go beyond traditional government bonds held by a central bank for open market operations. No central bank has the mandate to lend directly to non-depository banks or to the private sector. That would constitute a violation of standard central banking practice. No government in the world would allow its central bank to violate its mandate and hold assets other than government bonds and member banks' discounts. The arbitrary and overly discretionary power of Bernanke can be illustrated by the following passage from Bernanke:
More recently, the Federal Reserve has also initiated a lending program, with the cooperation of the Treasury, designed to free up the flow of credit to households and small businesses. Among the forms of credit on which the program is currently focused are auto loans, credit card loans, student loans, and loans guaranteed by the Small Business Administration. We are currently reviewing other types of credit for possible inclusion in this program. ... Restoring stability to the market for housing and home mortgages has been a particular area of concern. To address this problem, the Fed has employed a third type of policy tool - namely, buying securities in the open market. The FOMC [Federal Open Market Committee] has approved purchases of well over $1 trillion this year of mortgage-related securities guaranteed by the government-sponsored mortgage companies, Fannie Mae and Freddie Mac. Buying mortgage-related securities helps to drive down the interest rates that consumers pay on mortgages, and, indeed, the rate on a traditional 30-year fixed-rate mortgage has recently fallen to less than 5%, the lowest level since the 1940s. (Speech delivered at Morehouse College, Atlanta, Georgia, on April 14, 2009.)
Bernanke does not seem to understand the nature of credit. A bank lends deposits it receives from its depositors and from repayments of loans. When borrowers do not pay back, the bank no longer has the capital to lend. Bernanke interpreted the credit freeze as a liquidity problem and had little idea about the extent of frozen portfolios. His massive liquidity injection translated into a mountainous buildup of banks' holding of excess reserves that reached $862 billion as of end-April 2009 against less than $2 billion prior to September 2008.

Bernanke was fooling the public by saying he wanted to free up the flow of credit to households and small business, forgetting that most of outstanding loans to households and small business were simply lost and written down. He forgot the bailouts he extended under the Troubled Asset Relief Program to banks in replacement of lost portfolio. He was oblivious about the nature of credit.

Banks accord credit to borrowers from the savings of their depositors. The Fed does not receive deposits from households; it is not intermediating between savings and lending and therefore cannot be considered to be freeing up credit. It is purely creating money out of thin air. As such, the Fed has become a taxing authority that confiscates wealth and redistributes it to lucky borrowers. The new mandate for taxation and redistribution has been self-attributed by Bernanke. Other new mandates were insuring the highest car sales and highest credit card, student, and small business loans. Bernanke has also extended his role to the housing market, with the aim of preventing a downward adjustment of housing prices and pushing down interest rates. Bernanke wanted to renew the speculative euphoria that characterized the housing market under his predecessor Alan Greenspan.

Bernanke does not believe in any regulation of the financial system. By pushing trillion of dollars in liquidity to the sub-prime market, he is likely to bankrupt the Fed within a few short years. Loans pushed on borrowers will never be repaid. Moreover, consumer loans by definition finance consumption. Contrary to investment loans that generate income for their repayment, consumer loans generate no income and cannot be repaid. A stress test applied to the Fed itself would surely predict a huge lost portfolio.

While banks have already been bankrupted and are no longer ready to play out in the hands of Bernanke again, he has decided to go on his own, turning a central bank into an all-encompassing institution, showering free money to consumers and reaching out once again to ninja's - no income, no job, no asset, borrowers. The injection of over $1.25 trillion in mortgages is already setting off another speculative wave, with speculators surging everywhere after high commissions and profits and enticing borrowers into cheap loans that are secured by Bernanke's Fed.

Bernanke considered the rise in car sales as a sign of economic recovery. When Bernanke has become himself the car dealer of the US, handing out luxury cars for free, could this rise in car sales be considered as a sign of recovery? Certainly, the rise in car sales did not reflect savings and growth in the economy. It only reflected Bernanke's overly cheap monetary policy. Bernanke's successor will be saddled with trillions of dollars in bad loans and faced with uncontrollable inflation. A Fed saddled by a mountain of bad debt should be the cause of serious concern for Obama.

Most astonishing of Bernanke's magic tricks is to turn bailout banks into record-profit-making banks in such a record time, while Geithner is still setting up his toxic asset banks. The TARP money served to pay bonuses to managers. Why not use some for paying bonuses to stockholders? Moreover, the Fed is paying an interest on excess reserves held by banks following massive liquidity injection. That interest could be considered as another subsidy to banks that contributes to create illusory profits and the mirage of economic recovery. Banks' profits are not rising from real economic activity and are pure bailout money and subsidies from the state.

How much credibility could be accorded to the soothsayers Bernanke and Geithner? It would be safer to talk about recovery when it really has occurred and strengthened over a period of a few quarters, not through distorted indicators such as those manipulated by Bernanke, but through real GDP growth and a pick up in general employment. If durable growth occurs in such incredible fiscal and monetary chaos, then the disastrous experience of countries that undertook these policies would be baffling. Namely, Zimbabwe should not have experienced four digit inflation and its employment and real income should have grown at highest possible rates.

High US inflation, while not admitted by US policy makers, has eroded real income, had reduced dramatically food consumption, and has certainly caused rising unemployment. The more an economy is inflated, the more its real activity is deflated and the more unemployment rises. The creation of money out of thin air could lead to starvation. Others have called it counterfeiting. Counterfeiters could bring as much stimulus and confiscation as does Bernanke's money creation.

Paul Volcker applied prudent central banking soon after his appointment as Fed chairman in 1979 and achieved a durable recovery in a financial environment of strong and healthy banks by tightening monetary policy and allowing the federal funds rate to remain at 19% for several quarters. He did not invent tricks. Bernanke had caused financial disorder by pushing his theory of anti-Great Depression ever since he was appointed as a governor in 2002 and later as a chair of the Fed in 2006.

He announced recovery with zero interest rates, bankrupted financial system, unorthodox central banking, and most expansionary money creation in the US history. He has kept on inventing tricks and showing genius and innovation. Certainly there is a huge dichotomy between Volcker's plain-vanilla prudent banking and Bernanke's advanced and dangerous financial engineering. But it can be easily solved when we recognize that all roads lead to Rome.

While the Volcker recovery proved to be real, the Bernanke pick-up has so far been a mirage. Bernanke has announced that the Fed credit is to expand to $4 trillion by end-2009. Besides the effects of a breakout of the swine flu, over the coming months and years we also have the results of the Bernanke credit breakout to look forward to.

Hossein Askari is professor of international business and international affairs at George Washington University. Noureddine Krichene is an economist at the International Monetary Fund and a former advisor, Islamic Development Bank, Jeddah.

[papabear]

http://www.atimes.com/atimes/Global_Economy/KE05Dj01.html
CREDIT BUBBLE BULLETIN
The greatest cost
Commentary and weekly watch by Doug Noland

An astute analyst posed the following question last week: "The current debate is centered on whether the [US Federal Reserve] can take back the liquidity in time in order to prevent inflation. Suppose it can. Suppose they execute this perfectly. But if the Fed is able to flood the system with the liquidity (thus reducing the severity of the downturn) and take it back before it causes inflation, it seems there is a free lunch. We get something for nothing. So, assuming a perfectly executed game plan by the Fed, is there a cost? Do they keep rates low for a time, only to raise them a lot a year down the road - is that the cost? Or is there another cost?"

I'm short on time today, so I'll attempt a brief response.

First of all, while it often appears otherwise, finance provides no free lunch. The mispricing of credit and misperceptions of risk in the marketplace have deleterious effects, although their true impact may remain unexposed for years. Indeed, the more immediate (and always seductive) consequences of loosened financial conditions tend to be reduced risk premiums, higher asset prices, and a boost to economic "output". Conventional analysis of monetary policymaking still focuses on "inflation" and "deflation" risks. I would strongly argue that our contemporary world has already validated the analysis that acute financial and economic fragility are major costs associated with market pricing distortions.

When the Federal Reserve collapsed interest rates following the bursting of the technology bubble, the results seemed constructive. Stock and real estate prices inflated; a robust economic recovery ensued. There was at the time some recognition of the potential for real estate excesses. But this was seen as such a small price to pay in the fight against the scourge of deflation. It was not until 2007 that the nature of the true costs of a massive "reflation" began to come to light.

Many would today argue that it was simply a case of the Fed's failure to take the punchbowl away in time. Such analysis misses a key facet of bubble dynamics. Once the mortgage finance bubble gained a foothold, there was absolutely no way policymakers were going to be willing to risk bursting such a consequential bubble.

I see ample support for my view that bubble dynamics have taken root throughout government finance. This unprecedented inflation includes Federal Reserve Credit, Treasury borrowings, agency debt, mortgage-backed securities issued by government-sponsored enterprises (GSEs) such as home-loan guarantors Fannie Mae and Freddie Mac, Federal Housing Administration and Federal Deposit Insurance Corporation insurance, massive pension and healthcare obligations, the myriad new market support programs, and so forth. This government finance bubble is domestic as well as global. Amazingly, the scope of the unfolding bubble dwarfs even the mortgage finance bubble. And, importantly, it is reasonable to presume that the Federal Reserve will find itself in the familiar position of being trapped by the risk of bursting a historic bubble.

So I see the probabilities as very low that the Fed will reverse course and impose tightened liquidity conditions upon the marketplace. Actually, reflationary pressures may force the Fed to increase its Treasury holdings in an effort to maintain artificially low interest rates. At the same time, I don't see higher inflation as the greatest cost associated with this predicament. Much greater risk lies with the acute systemic fragility that I believe is inherent to major bubbles.

Similar to mortgage finance 2002-2007, the marketplace is significantly mispricing the cost - and failing to recognize the risks - of a massive inflation of government finance. And while every bubble has its own dynamics and nuances, the unfolding government finance bubble has even more precarious Ponzi finance dynamics than the mortgage bubble.

The markets are on tract to accommodate US$2 trillion or so of Treasury issuance this year. This incredible amount of debt creation is in the range I would expect necessary to temporarily stabilize the US ("services") bubble economy. Importantly, this amount of new finance both plugs financial holes and works to stabilize inflated income levels. From last week's income data, one can see that personal income was up 0.3% year on year to $12.04 trillion. And while 0.3% is very meager growth, without massive government fiscal and monetary expansion (inflation) the economy would have suffered a destabilizing income contraction. Keep in mind that personal income has inflated 65% since 1998 and 33% from 2003.

I'll try to explain my belief that dangerous Ponzi finance dynamics are in play with the current course of policymaking. First, I view panicked policymakers as seeing no alternative than to try to sustain the current (deeply maladjusted) economic structure. A more natural course of economic adjustment - from finance and consumption-driven bubble economy to a more balanced system - was going to be much too painful to endure. So a massive government inflation was commenced in desperation - with the grandiose objective of revitalizing securities markets, housing prices, and the overall US economy. I just don't see how this reflation goes much beyond stoking a susceptible artificial recovery.

First and foremost, with government finance now completely dominating the credit system, I can't even begin to contemplate how this process might nurture an effective allocation of financial and real resources. Indeed, I see today's manifestations of credit bubble dynamics as an extension of similar mispricing, misperceptions, and over-issuance that led to last autumn's near financial collapse.

Admittedly, the massive extension of government credit and obligations works wonders in stabilizing a devastatingly impaired system. Inflationism is always seductive; trillions of dollars worth is absurdly seductive. Yet this extra layer of debt does little to effect change to the underlying economic structure. Actually, a strong case can be made that it only delays and sidetracks the necessary adjustment process. And, importantly, this enormous additional layer of system debt exacerbates system vulnerability.

At the end of the day, a system is made or lost on the soundness of its underlying economic structure. I posit that a sound economic structure is reliant upon only moderate credit growth and risk intermediation. Our system requires massive credit expansion and intensive risk intermediation. I would also posit that there are no benefits - only escalating costs - to throwing massive credit inflation upon an unhealthy economic structure. And, returning to Ponzi dynamics, one of the major costs to such inflationism is a massive expansion of non-productive credit - obligations that are created without a corresponding increase in real economic wealth producing capacity. The debt can only be serviced by the creation of more debt obligations.

The danger is that markets too easily and for too long accommodate massive credit expansion during the boom. Federal Reserve policies are fundamental to this dynamic. But at some point and out of the Fed's control, as Wall Street learned, greed inevitably turns to fear and a reversal of speculative flows marks the onset of the bust. And it's the massive inflation of non-productive credit that ensures the unavoidable crisis of confidence. Can the underlying economic structure service the mounting debt load or, instead, is it the massively inflating debt load that is sustaining a vulnerable economy? And it is in this vein that I fear the government finance bubble is on track to destroy the creditworthiness of the entire economy. And this Ponzi dynamic is the greatest cost to what I fear is a continuation of unsound policymaking.

[papabear]

http://www.atimes.com/atimes/Global_Economy/KF17Dj02.html



THE BEAR'S LAIR
Speculative games stage comeback
By Martin Hutchinson

Citigroup has been restructured with US$50 billion of public money without significant reform to its operations, the hedge fund industry had its best month in nine years in May and Goldman Sachs is said to be considering giving up its banking license.

The world's monetary and fiscal authorities appear by their feckless policies to have pulled off a feat that I didn't think was possible: resuscitating a financial services bubble that came close to wrecking the world economy, and may still do so on a delayed-action basis.

John Allison, chairman of BB&T Group (about the best-run major US regional bank), spoke on Thursday to the Competitive



Enterprise Institute, saying that apart from a gold standard (which he thought unlikely), the financial services business and the country in general needed to change its motivations from short-termism and altruism to enlightened long-term self-interest.

While his altruism/self-interest point is a long-standing one (which to the extent that it means not making "affordable housing" loans to people who can't afford housing, I agree with), the long-term/short-term point is different. It's a product of environment, not of innately bad philosophies. If a country's government engineers market conditions that lavishly reward foolish short-termism, foolish short-termism is what that country will get. Only by changing market structures, rules and incentives will behavior be changed.

In a well-run financial system, the free market automatically rewards prudence and punishes short-term greed and folly. That's not the system the United States has had since at least 1995, and it's certainly not the system that has been produced by the multiple bailouts and stimulus packages since last autumn.

For a start, examine the housing market, the cause of the initial debacle. The combination of commission and other incentives to lend to borrowers who couldn't afford to pay and effective state guarantees of the loans they didn't pay produced a vast wave of toxic "subprime" lending. In a normal market, subprime loans would be a self-liquidating problem because lenders who made them would quickly go bust. Here, lenders who made them were guaranteed by Fannie Mae and Freddie Mac, who themselves were guaranteed by the taxpayer, as it turned out. Any losses that remained were passed off to foreign innocents through securitization.

This system of pass-the-parcel would have broken down last year, except that the government has now ensured its continuance by taking over Fannie Mae and Freddie Mac, making them major conduits for its efforts to "help" the mortgage market, handing out tax subsidies to new homebuyers and attempting to perpetuate the thoroughly unsound securitization market through purchases of up to $1 trillion of dodgy mortgage paper, again at the expense of the taxpayer.

A system that would have collapsed, forcing the reversion to the old, much sounder practice of making home loans directly through local institutions, has been artificially perpetuated. Not only will this cause repeated crises in the home loans market going forward, it will also be considerably more expensive for homebuyers - as I demonstrated in a previous column, the cost of home loans, expressed as a margin over the relevant Treasury securities, increased by about 0.2% as a result of the invention of the new and supposedly more efficient securitization market. Wall Street's rent seeking has, in other words, been subsidized.

Credit default swaps (CDS) were the most dozy extreme of all the dozy new products Wall Street invented during the period it pretended to believe the efficient market hypothesis. Structurally, they were a simple offshoot of derivative technology, although it is notable that they did not come into frequent use during the first 1980s flowering of that technology because it was clear even then that there was no sound way to crystallize the credit swap obligation created by a default.

The "auction" procedure used in the Lehman Brothers and other bankruptcies is obviously inadequate because it uses an auction of a few million dollars to determine the fate of obligations worth billions.

It became clear in the Lehman bankruptcy that CDS could be used to force a company into insolvency, particularly a financial institution with high leverage. The large amount of CDS outstanding and the low cost of credit protection against a good quality borrower give "shorts" seeking to push a house into bankruptcy an immensely useful tool that they previous lacked.

The obvious step at that point would have been to ban CDS, since they generate such a destructive conflict of interest. Instead, the Fed subsidized the market, by bailing out AIG, the least intelligent of the CDS writers, to the tune of $180 billion, thus allowing Goldman Sachs and other houses to profit on the various bankruptcies sufficiently as to pay out everybody's bonuses for the year.

Naturally, since none of the majors lost significant money through CDS, the market went on playing the game. CDS were used to accelerate the bankruptcies of General Growth Properties and Abitibi-Bowater within the past few months and played a significant and negative role in the prolonged restructuring of General Motors.

Now a small house, Amherst Holdings, has beaten the Wall Street titans at their own horrid game, according to the Wall Street Journal. It found a pool of $29 million of particularly repulsive California subprime mortgages, then sold $130 million notional of CDS on them, pocketing around $100 million in premiums, since this waste was so toxic the big houses were prepared to pay up to 80% to insure against it. Clear so far? It sold insurance for four-and-a-half times the maximum possible loss. But hey, that's finance.

Then it quietly went round and paid all the debts of the lucky homeowners owing the $29 million. At that point, since there were no defaults, it was able to keep the $100 million in premiums (net of the loan repayments, a $70 million profit). Simple, really! Wall Streeters are furious and, inevitably, suing, but in fact Amherst's coup was a perfectly legitimate use of this corrupt and foolish structure, far more so than many of the shenanigans undertaken by the likes of Goldman Sachs - after all, Amherst's operation PREVENTED a number of defaults and foreclosures.

George Soros says CDS should be banned. I worry about the periodontal damage caused by teeth-grinding when I find myself agreeing with Soros, but in this case, he's right (he was right on the pound in 1992 as well; fortunately for my dental care, he's been right on no other occasion that I can recall). However, not only have the feds made no move against CDS, they have subsidized the market to the tune of $180 billion of our money, thus ensuring the toxic technique's return to luxuriant growth.

The Troubled Asset Relief Program (TARP) bank capital injections have also contributed to the market's further degradation. They totally failed to discriminate between good and bad banks, so that the worst banks received the most money, without any steps being taken to remove their management or shut down their operations. Essentially, $50 billion of our money has been invested in Citigroup and $45 billion in Bank of America (the perpetrator of the two most foolish acquisitions of the last decade, in Countrywide and Merrill Lynch.) By rewarding incompetence in this way (for example allowing Vikram Pandit to keep both his job and the $600 million with which Citi purchased his failing hedge fund), the government has insured that we will get more of it, since the benefits from the juicy bonuses in good times are so great and the slaps on the wrist when the structure comes crashing down so painless.

Jeff Skilling of Enron was given a 25-year jail sentence for Enron's failure; that was grossly disproportionate to his offense but did ensure that future Enron perpetrators would be discouraged. The fate of Pandit, Ken Lewis of Bank of America and the AIG honchos offers no such deterrent to incompetent looting of the financial system.

A further effect of the TARP process has been to cause a number of perfectly healthy banks to slash their dividends - notably US Bancorp and Allison's BB&T. Should management of those banks, which have now repaid TARP, fail to restore their dividend forthwith while engaging in empire-building acquisitions of battered competitors, the "widows and orphans" who traditionally invest in bank shares because of their reliable income will be further discouraged, and shareholder control of banks will be left still more tightly in the hands of hedge funds and other cowboys.

Finally, we come to monetary and fiscal policy during the crisis. Monetary policy, which had been far too loose for the preceding 13 years, bore a large part of the responsibility for the period's excesses. If the monetary system is managed so that leverage is perpetually rewarded, it's not surprising that intelligent and aggressive bankers will devise new and ever more unsound means to create excessive leverage.

However, monetary policy has been loosened unimaginably further since the crisis, with the monetary base being more than doubled. It is very clear that only evidence of rampant inflation - which we can expect the Bureau of Labor Statistics to suppress for as long as possible - will cause the Fed to return to an appropriately tight monetary policy.

Thus the incentives for Wall Street to indulge in endless speculative games will still be present, complete with the implied taxpayer bailout when it goes wrong. No wonder Goldman Sachs is thinking of abandoning its banking license - why dawdle along with only 15-to-1 leverage when you have tasted the heady joys of 30-to-1 at taxpayer expense. It's also unsurprising that hedge funds have enjoyed their best month for nine years - for dodgy short-term speculators, Happy days are indeed here again!

As for fiscal policy, it is now clear that President Barack Obama's initial "stimulus" was one of the most counterproductive policy initiatives ever perpetrated, both economically and politically. That stimulus pushed the US budget deficit definitively above 9% to 10% of GDP, at which there is no firm assurance of financing it. Thus, it's likely that Obama will spend most of his presidency fighting to restrain an excessive budget deficit, while suffering the adverse economic effects of higher interest rates and "crowding out" that it brings.

Had he held back initially, Obama could probably have pushed through his expensive healthcare reform and his expensive "cap and trade" environmental policy without the bond markets taking too much notice, with any adverse effects of large deficits on the economy postponed until his favored policies were safely and irreversibly in place.

As it is, he will have a much more difficult task to push them through and will do so against a much more skittish bond market and a much more uncertain economic environment. Such a waste of a presidency, just to give House Speaker Nancy Pelosi her lavish helping of pork. (Of course, those of us who oppose both his healthcare and his environmental policies will rejoice, but from the viewpoint of Obama and his supporters he has risked his presidency becoming a colossal failure.)

There will be another crash of course, there always is. But before it happens, some very unpleasant people will have made further speculative billions and doomed the US economy to a decade of stagflation.

[papabear]

http://blogs.ft.com/maverecon/2009/06/afte...serve-currency/
After the Crisis: Macro Imbalance, Credibility and Reserve-Currency
June 6, 2009 4:23pm

Today’s guest blogger is Dr. André Lara Resende, a well-known Brazilian economist. His fascinating contribution was brought to my attention by Dr. Mônica de Bolle, another outstanding Brazilian economist whom I first met when I was an external examiner for her LSE PhD thesis. I am particularly intrigued by Lara Resende’s argument that this downturn is different from all past downturns, including the Great Depression of the 1930s, because of the continuing high level of private sector indebtedness, and that under these conditions neither monetary policy nor Keynesian fiscal policies are likely to be effective. But judge for yourself.

[papabear]

http://www.atimes.com/atimes/Global_Economy/KG08Dj03.html
How wrong can you get?
By The Mogambo Guru

I was surprised that Barron's reported that the banks show their total reserves fell from US$896 billion to $848 billion, which is a simple math problem that seems custom-made for my abilities in that regard.

And to prove it, I deftly subtract one from the other and get - voila! - $48 billion, which is not only factually correct, but more than enough to quiet any naysayer saying, "Nay, I say!" as regards my computational skills.

Then, to add that essential touch of surreal whimsy that seems to permeate all things fiscal and monetary these days, I additionally note that not only did total reserves go down in the banks by $48



billion to $828 billion, but I will note that total reserves one year ago were a miniscule $41 billion! Hahahaha! They fell last week by more than they totaled one year ago! Hahaha!

In fact, required reserves are only now starting to rise from "nearly zero" to "slightly more than zero", and banks are now "required" to have a miniscule $56 billion in reserves against their zillions of dollars in assets and liabilities, while meanwhile, a mere couple of lines up on the same Barron’s page, the Federal Reserve reports that "Reserves FR banks" went down by an astonishing $125 billion last week to $692.6 billion! Wow! Big move!

These huge tsunamis of money, joining all the other tsunamis of money sloshing back and forth around the banks and the world, around and around, getting everything all wet, are not only ruining the patio furniture and making a mess of everything, but are such that even the World Bank has revised its estimates, and now says the global economy will contract by 2.9% this year instead of their previous forecast of 1.7%, which is an error of 41%.

Well, when I show up at an executive board meeting sporting a 41% error on a forecast I made just a few months ago, all I hear is people all demanding that I be fired or killed for bringing the company to the edge of bankruptcy and ruination, which of course I seize upon to show that precision economic forecasting is a ridiculous exercise everywhere you go, especially since economics is, just as the Austrian school of economics always said it was, human behavior with a huge random element, which is not even to mention Taleb's Black Swan Hypothesis of unforeseen catastrophic events making a complete mockery of using bell-curve probabilities to forecast long-term expected results.

It's like expecting, but not getting, what you would expect from the statement from the Federal Open Market Committee after its recent meeting, which apparently showed that they are incredulous of the generally low level of intelligence of Americans, which they demonstrated when they said, "As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year," which I figure would be $238 billion a month for the remaining six months of the year, which would normally make my heart start fibrillating with fear at the inflationary implications of such irresponsible monetary policy.
My snotty interpretation is that by saying "as previously announced" they mean, "we say again so that you can't say we didn't tell you that you morons are sitting there while we at the Federal Reserve are going to buy up the losses of our friends at a rate of $12,500 for every one of the 100 million non-government workers in the USA, which is admittedly a lot of money at $12,500 each, but which is almost certainly grossly understated so that we are going to keep coming back for more and more and more! Hahaha! Suckers!!"

Whether or not they meant that, it turns out that I was right, and this is all part of some nefarious plan, as they later slipped in, almost as an afterthought, that "In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn", which made my eyes pop out painfully when I realized that this means that we are suddenly talking about buying up almost $350 billion a month in worthless assets and handing over the cash to the lucky current holders (who are making out like bandits!) of those toxic assets, which means that these guys will suddenly have a lot of cash in their pockets looking for a home, and the prices of something, or some things, are going to go up as this $350 billion of new cash Per Freaking Month (PFM) gets plowed into "investing" in some asset or another.

This is where some people think it gets tricky, but it is not. This is, in fact, the easy part, as all you have to do is buy gold, silver and oil when your government is acting so impossibly stupid.

At least, that is the lesson of the last 4,500 years of history! And like the saying goes, "The race is not always won by the swiftest, nor the battle by the strongest, but that is the way to bet!" which is just another way of saying, "Whee! This investing stuff is easy!"

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter - an avocational exercise to heap disrespect on those who desperately deserve it.

[papabear]

http://www.atimes.com/atimes/Global_Economy/KG14Dj06.html
Krugman best taken in reverse
By Chan Akya

If all the economists were laid end to end, they'd never reach a conclusion. - George Bernard Shaw

There are numerous versions of Shaw's dictum, boiling down to one thing - no matter how many economists one consults, the actual answer is almost never found, not even one that can be worked with profitably. An argumentative bunch, economists are forever derided for being a dismal bunch who see a cloud in every silver lining and an accident around every corner.

Still, even within this dismal bunch of people who are almost always wrong, there is one bunch that stands out with its habitual, if not predictable, wrongheadedness. That group is of course the folks who call themselves Keynesian economists, followers of a mystic religion formed in the earlier part of the last century and today attempts to pass itself on as a legitimate



science. John Maynard Keynes was wrong about nearly everything, but in not following a lot of his own advice managed to turn a quick penny now and then, he garnered an aura of success where none should have legitimately existed.

As I wrote in a previous article, "the best thing about Keynes is that he is dead".

Leading acolyte who lags
This article, though, isn't about Keynes or Keynesian economics, but about the increasingly silly pronouncements coming out of the columns of America's leading exponent of Keynesian economics, namely Paul Krugman of the New York Times.

Now, perhaps I must confess two incidental points here: first, that there was a time when I was quite impressed with Krugman's acumen and his ability to make sense out of a complex series of numbers. Perhaps the most celebrated of his pieces was one in the mid-90s wherein he exposed the Asian economic "miracle" as nothing more than the effect of increased factor inputs; that is, that taking away the factor inputs (land, labor, capital, and raw materials) would inevitably end the miracle; indeed altering the prices of these inputs would do the same.

As it happened, once capital costs became prohibitive in the aftermath of the Asian financial crisis, the miracle did fall on its face and its most important illusion, that foreigners could benefit from interest rate arbitrages in Asian local currencies, evaporated with it as currencies sharply fell against the US dollar. This was an important statement, and one that went against the consensus of the day, which had been assiduously promoted by the International Monetary Fund as well as Asian regimes.

As foreigners pulled out of the local debt markets of Asia, currencies collapsed and soon investing behavior for the region had also changed so that all savings "had" to be in the so-called hard currencies, including the US dollar, and a few years later the euro. As a matter of policy, Asian central bankers also came to eschewing any currency rises against the US dollar.

In the aftermath of the crisis, I attended some lectures that included Krugman as a keynote speaker; these polemics, as I recall them, were generally in favor of the free market and the need for Asian governments to sell their banks to foreigners.

Today's version of the same person is a different kettle of fish. By now having pinned his lapel on left-leaning economics as a response to eight years of George W Bush, Krugman, winner of the 2008 Nobel Prize for economics, has also forgotten the very points that he made in Asia 12 years ago.

The second point I must confess to is that in general I do not read the New York Times, or its online version; in fact, most of the times that I find myself perusing its website is when redirected by one of the news aggregator websites (Huffington Post, Drudge Report and so forth).

But on a nice sunny day in the beginning of July, waiting in an airport lounge somewhere, I had no choice but to pick up a copy of the International Herald Tribune, the recycled international version of the New York Times. As always, a quick scan through to the editorial pages found the grimacing (smiling?) visage of Krugman staring back at me. His prose was as nonsensical as it had become of late, but one sentence really caught my attention

From his article titled "That 30s Show", dated July 2, 2009

And the deeper the hole gets, the harder it will be to dig ourselves out. The job figures weren't the only bad news in Thursday's report, which also showed wages stalling and possibly on the verge of outright decline. That's a recipe for a descent into Japanese-style deflation, which is very difficult to reverse. Lost decade, anyone?

Dig ourselves out? This is a bit of modern media phraseology that escapes me completely. If you are in a hole, the way I think about it is that you instantly STOP digging, not continue digging (unless you wish to proceed through Earth's hot core and end up coming out in China; which I believe a number of Americans have been trying lately, but that's a different story). Physically and logically, it isn't actually possible to DIG yourself out of a hole; what you need to do is to FILL the hole hopefully in a safe enough manner that those in the hole can walk out of it.

The US Federal Reserve under former chairman Alan Greenspan had to confront the aftermath of the technology bubble and decided to DIG itself out of the hole caused by job losses in the higher technology sector by lowering interest rates and essentially creating an asset bubble that helped to foster higher employment but didn't actually improve the net worth position of Americans. This is the reason millions of Americans chased the dream of easy money through house-flipping, and the Republican Party attempted to capitalize on the trend in order to move leverage down from large construction and homebuilding companies (typically Republican donors) to the poor of America, who typically voted Democrat.

As I wrote before on these pages (see Deaf frogs and the Pied Piper, Asia Times Online, September 30, 2008), Greenspan got away with it because of slavish Asian central bankers, who were following the dictum of Krugman ironically enough and moving away from investing through their local bond markets into investing purely in US government debt. This in turn propped up the stupid policies of the Fed, caused the US housing bubble and so on ... but funnily enough, the intervention of Asian central bankers isn't mentioned in describing the mechanics of the above bubble.

Indeed, the moral pendulum somehow swung to the point of free markets being blamed for the crisis, rather than as being seen as the victims of manipulation (the Fed) and intervention (Asian central banks). In this new "Mad Max reality" it is the Keynesians who are the saviors, led by their cheerleader-in-chief, one Paul Krugman.

Reading other articles posted recently also don't help make sense of where Krugman is going with his pet theories. Take more of his July 2 article cited above:

Wait - there's more bad news: the fiscal crisis of the states. Unlike the federal government, states are required to run balanced budgets. And faced with a sharp drop in revenue, most states are preparing savage budget cuts, many of them at the expense of the most vulnerable. Aside from directly creating a great deal of misery, these cuts will depress the economy even further.

Wonderful, and right there, all readers should appreciate the use of the word "unlike" in the second sentence. Cutting through the jargon, what Krugman is saying here is that states in the US do not print the dollar currency, but since the federal government does, different rules apply for the management of debt and deficits.

That view is nonsensical of course - the only way to issue debt is to convince someone else that you are good for it come the time to make interest and principal repayments. US states, starting with California, have quickly come to realize that their wells could run dry rather quickly so why does anyone believe that the story is magically different for the US federal government?

There are only two possible answers: Convince someone else to buy all your debt (developing countries, commodity exporters and so forth) or print your own money (thereby debasing its purchasing power). The US government is clearly doing both - witness the rounds of "investor" meetings being done by Treasury Secretary Tim Geithner in Asia even as the Fed openly has started purchasing US government securities.

In a very short while, the US government could find that the strike by creditors afflicting California could adversely impact federal debt too.

But I digress. Here is Krugman again, in an article titled "The Stimulus Trap" dated July 9:

As soon as the Obama administration-in-waiting announced its stimulus plan - this was before Inauguration Day - some of us worried that the plan would prove inadequate. And we also worried that it might be hard, as a political matter, to come back for another round. ... Unfortunately, those worries have proved justified. The bad employment report for June made it clear that the stimulus was, indeed, too small. But it also damaged the credibility of the administration's economic stewardship. There's now a real risk that President Obama will find himself caught in a political-economic trap. ... And that's what the Obama administration should be doing right now with its fiscal stimulus. (It's important to remember that the stimulus was necessary because the Fed, having cut rates all the way to zero, has run out of ammunition to fight this slump.) That is, policy makers should stay calm in the face of disappointing early results, recognizing that the plan will take time to deliver its full benefit. But they should also be prepared to add to the stimulus now that it's clear that the first round wasn't big enough.

This stuff is delightful, if a geeky, guilty pleasure. Right in the beginning, Krugman pre-determines that the sole method of fighting an economic downturn is to expand the fiscal stimulus. And when that policy fails obviously in the next few months, his refrain isn't so much about "Is that the RIGHT policy?", but rather that "It was the WRONG amount".

There is the mumble about the Fed having no more ammunition because interest rates are close to zero; quite ignoring the fact that the failure of the economy to rebound at zero interest rates suggests obvious structural flaws, that shouldn't be made worse by Japan-style pump priming. He goes in the article as below:

Unfortunately, the politics of fiscal policy are very different from the politics of monetary policy. For the past 30 years, we've been told that government spending is bad, and conservative opposition to fiscal stimulus (which might make people think better of government) has been bitter and unrelenting even in the face of the worst slump since the Great Depression ... But there's a difference between defending what you've done so far and being defensive. It was disturbing when President Obama walked back ... [Vice president Joe] Biden's admission that the administration "misread" the economy, declaring that "there's nothing we would have done differently." There was a whiff of the Bush infallibility complex in that remark, a hint that the current administration might share some of its predecessor's inability to admit mistakes. And that's an attitude neither Mr Obama nor the country can afford ... What Mr Obama needs to do is level with the American people. He needs to admit that he may not have done enough on the first try. He needs to remind the country that he's trying to steer the country through a severe economic storm, and that some course adjustments - including, quite possibly, another round of stimulus - may be necessary.

I loved the bit about the Bush infallibility complex in the statement, but it should have been directed not so much at the poorly advised Mr Obama, as the people advising him; an august group of Keynesians that includes Krugman himself. It is they who have ridden the infallibility complex that has failed to make the most important observations about the US economy:
1. Leverage needs to shrink across the economy, not merely get shifted around between the hands of private individuals and the US government;
2. When consumption is almost three-quarters of any economy, you cannot cut leverage without hurting consumption. So live with it;
3. For the economy to generate profits, it probably needs to become smaller, a lot smaller.

Recycling waste
All that said, Krugman's uselessness is actually quite useful, with the right application. To turn George Bernard Shaw's maxim on its head, it is futile to follow any gaggle of economists not because they are wrong as a group but because individually some of them are right sometimes, but not always. It is almost impossible to find someone who is right all the time, but failing that it would be great to find someone who is wrong all the time.

Unfortunately for all of us, Krugman's pronouncements don't actually have enough market views thrown in for any of us to make money by taking the opposite view. The good news, though, is that it appears, with Fed chairman Ben Bernanke on a very short leash, he may be succeeded by Larry Summers in January 2010, and it could well be Krugman's new beat to take over the job that Larry Summers leaves - namely as head of the US president's economic advisory team.

Now, if only we could convince him to make market suggestions while in that new job (for example, "the economy will rebound in two quarters so the US government can cut borrowings"), then it would be trivially easy to position on the opposite trade (that is, "borrowings will continue to rise"). But don't tell him any of that.

[papabear]

http://www.bloomberg.com/apps/news?pid=206...id=a2mAhkgbWDXc
Bernanke Says Commercial Property May Pose Risk for Economy (You think?)

By Scott Lanman

July 22 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said a potential wave of defaults in commercial real estate may present a “difficult” challenge for the economy, without committing to additional steps to aid the market.

Bernanke, testifying before the Senate Banking Committee today, urged lenders to modify “problem” mortgages to avert defaults. Christopher Dodd, the Connecticut Democrat who chairs the panel, told Bernanke that “some have suggested” the commercial market “may even dwarf the residential mortgage problems” in the U.S.

The state of commercial real estate was one of the most- asked-about subjects in questioning by lawmakers so far in Bernanke’s two days of testimony on the economy. Bernanke said today in the Senate and yesterday at the House Financial Services Committee that it’s too early to tell how effective the Fed’s main initiative in the area will be.

The Term Asset-Backed Securities Loan Facility, a Fed emergency program that lends to investors to purchase securities backed by consumer and business loans, began accepting commercial mortgage-backed securities as collateral last month.

Fed policy makers will extend the TALF, currently scheduled to expire Dec. 31, should they judge financial markets are still “some distance from normal operation,” Bernanke said today.

TALF Extension

“We will certainly be monitoring the situation, and if markets continue to need support, we will be extending the final date of that program,” Bernanke said.

It “may be appropriate” for the government and Congress to consider “fiscal” steps to support the industry, Bernanke said today. Ideas for fresh support for the market could include government guarantees for commercial mortgages, Bernanke also said today, while noting no proposal on the subject has emerged.

U.S. commercial property prices fell 7.6 percent in May from a month earlier, bringing the total decline to 35 percent since the market’s peak, Moody’s Investors Service said in a report this week. Commercial properties in the U.S. valued at more than $108 billion are now in default, foreclosure or bankruptcy, almost double than at the start of the year, Real Capital Analytics Inc. said earlier this month.

Yesterday, more than a half-dozen members of the House panel mentioned or asked Bernanke about the topic, with Chairman Barney Frank saying there’s a “great deal of fear” that a wave of commercial defaults will produce economic problems similar to those caused by residential mortgages.

“As the recession’s gotten worse in the last six months or so, we’re seeing increased vacancy, declining rents, falling prices -- and so, more pressure on commercial real estate,” Bernanke said yesterday. “We are somewhat concerned about that sector and are paying very close attention to it. We’re taking the steps that we can through the banking system and through the securitization markets to try to address it.”

One of the main issues for the industry is that the market for debt backed by commercial mortgages “has completely shut down,” the Fed chief said yesterday.

[papabear]

http://www.counterpunch.org/whitney08102009.html
August 10, 2009
It's a Planned Demolition
There is No Recession

By MIKE WHITNEY

Credit is not flowing. In fact, credit is contracting. When credit contracts in a consumer-driven economy, bad things happen. Business investment drops, unemployment soars, earnings plunge, and GDP shrinks. The Fed has spent more than a trillion dollars trying to get consumers to start borrowing again, but without success. The country's credit engines are slowing to a crawl.

Fed chairman Ben Bernanke has increased excess reserves in the banking system by $800 billion, but lending is still slow. The banks are hoarding capital in order to deal with the losses from toxic assets, non performing loans, and a $3.5 trillion commercial real estate bubble that's following housing into the toilet. That's why the rate of bank failures is accelerating. 2010 will be even worse; the list is growing. It's a bloodbath.

The standards for conventional loans have gotten tougher while the pool of qualified credit-worthy borrowers has shrunk. That means less credit flowing into the system. The shadow banking system has been hobbled by the freeze in securitization and only provides a trifling portion of the credit needed to grow the economy. Bernanke's initiatives haven't made a bit of difference. Credit continues to shrivel.

The S&P 500 is up 50 per cent from its March lows. The financials, retail, materials and industrials are leading the pack. It's a "Green Shoots" bear market rally fueled by the Fed's Quantitative Easing (QE) which is forcing liquidity into the financial system and lifting equities. The same thing happened during the Great Depression. Stocks surged after 1929. Then the prevailing trend took hold and dragged the Dow down 89 per cent from its earlier highs. The S&P's March lows will be tested before the recession is over. Systemwide deleveraging is ongoing. The economy is resetting at a lower rate of activity.

No one is fooled by the fireworks on Wall Street. Consumer confidence is still falling. Everyone knows things are bad. Everyone knows the mainstream press is lying. The restaurants and malls are empty, the homeless shelters are bulging, and even the big-box stores have stopped hiring. The only "green shoots" are on Wall Street where everyone gets a handout from Uncle Sugar.

Bernanke has pulled out all the stops. He's lowered interest rates to zero, backstopped the entire financial system with $13 trillion, propped up insolvent financial institutions and monetized $1 trillion in mortgage-backed securities and US sovereign debt. Nothing has worked. Wages are falling, banks are cutting lines of credit, retirement savings have been slashed in half, and home equity losses continue to mount. Living standards can no longer be bandaged together with VISA or Diners Club cards. Household spending has to fit within one's salary. That's why retail, travel, home improvement, luxury items and hotels are all down double-digits. The money has dried up.

According to Bloomberg:

"Borrowing by U.S. consumers dropped in June for the fifth straight month as the unemployment rate rose, getting loans remained difficult and households put off major purchases. Consumer credit fell $10.3 billion, or 4.92 percent at an annual rate, to $2.5 trillion, according to a Federal Reserve report released today in Washington. Credit dropped by $5.38 billion in May, more than previously estimated. The series of declines is the longest since 1991.

“A jobless rate near the highest in 26 years, stagnant wages and falling home values mean consumer spending... will take time to recover even as the recession eases. Incomes fell the most in four years in June as one-time transfer payments from the Obama administration’s stimulus plan dried up, and unemployment is forecast to exceed 10 percent next year before retreating."

What a mess. The Fed has assumed near-dictatorial powers to fight a monster of its own making, and achieved nothing. The real economy is still dead in the water. Bernanke is not getting any traction from his zero-percent interest rates. His monetization program (QE) is just scaring off foreign creditors. On Friday, Marketwatch reported:

"The Federal Reserve will probably allow its $300 billion Treasury-buying program to end over the next six weeks as signs of a housing recovery prompt the central bank to unwind one its most aggressive and unusual interventions into financial markets, big bond dealers say."

Right. Does anyone believe the housing market is recovering? In the first 6 months of 2009, there have already been 1.9 million foreclosures.
The Fed is abandoning the printing presses (presumably) because China told Geithner to stop printing money or they'd sell their US Treasuries. It's a wake-up call to Bernanke that the power is shifting from Washington to Beijing.

That puts Bernanke in a pickle. If he stops printing; interest rates will skyrocket, stocks will crash and housing prices will tumble. But if he continues, China will dump their Treasurys and there will be a run on the dollar. What to do? Either way, the malaise in the credit markets will persist and personal consumption will continue to sputter.

The basic problem is that consumers are buried beneath a mountain of debt and have no choice except to curtail their spending and begin to save. Currently, the the ratio of debt to personal disposable income, is 128 per cent, just a tad below its all-time high of 133 per cent in 2007. According to the Federal Reserve Bank of San Francisco's "Economic Letter: US Household Deleveraging and Future Consumption Growth":

"The combination of higher debt and lower saving enabled personal consumption expenditures to grow faster than disposable income, providing a significant boost to U.S. economic growth over the period. In the long run, however, consumption cannot grow faster than income because there is an upper limit to how much debt households can service, based on their incomes. For many U.S. households, current debt levels appear too high, as evidenced by the sharp rise in delinquencies and foreclosures in recent years. To achieve a sustainable level of debt relative to income, households may need to undergo a prolonged period of deleveraging, whereby debt is reduced and saving is increased.

“Going forward, it seems probable that many U.S. households will reduce their debt. If accomplished through increased saving, the deleveraging process could result in a substantial and prolonged slowdown in consumer spending relative to pre-recession growth rates." ("U.S. Household Deleveraging and Future Consumption Growth, by Reuven Glick and Kevin J. Lansing, FRBSF Economic Letter")

A careful reading of the FRBSF's Economic Letter shows why the economy will not bounce back. It's mathematically impossible. We've reached peak credit; consumers have to deleverage and patch their balance sheets. Household wealth has slipped $14 trillion since the crisis began. Home equity has dropped to 41 per cent (a new low) and joblessness is on the rise. By 2011, Deutsche Bank AG predicts that 48 per cent of all homeowners with a mortgage will be underwater. As the equity position of homeowners deteriorates, banks will further tighten credit and foreclosures will mushroom.

The executive board of the IMF does not share Wall Street's rosy view of the future, which is why it issued a memo that stated:

"Directors observed that the crisis will have important implications for the role of the United States in the global economy. The U.S. consumer is unlikely to play the role of global “buyer of last resort”— other regions will need to play an increased role in supporting global growth."

The United States will not be the emerge as the center of global demand following the recession. Those days are over. The world is changing and the US role is getting smaller. As US markets become less attractive to foreign exporters, the dollar will lose its position as the world's reserve currency. As goes the dollar, so goes the empire. Want some advice: Learn Mandarin.

Sagging Employment: A "recoveryless" recovery

July's employment numbers came in better than expected (negative 247,000) lowering total unemployment from 9.5 per cent to 9.4 per cent. That's good. Things are getting worse at a slower pace. But what's striking about the BLS report is that there's no jobs surge in any sector of the economy. No signs of life. Outsourcing and offshoring are ongoing, and downsizing the path to profitability. That's why revenues are down while profits are up. Businesses everywhere are anticipating weaker demand. The jobs report is a one-off event; a lull in the storm before the layoffs resume.

Unemployment is rising, wages are falling and credit is contracting. All the money is flowing upwards to the gangsters at the top. Here's an excerpt from a recent Don Monkerud article that sums it all up:

"During eight years of the Bush Administration, the 400 richest Americans, who now own more than the bottom 150 million Americans, increased their net worth by $700 billion. In 2005, the top one per cent claimed 22 per cent of the national income, while the top ten per cent took half of the total income, the largest share since 1928.

“Over 40 per cent of GNP comes from Fortune 500 companies. According to the World Institute for Development Economics Research, the 500 largest conglomerates in the U.S. "control over two-thirds of the business resources, employ two-thirds of the industrial workers, account for 60 per cent of the sales, and collect over 70 per cent of the profits."

... In 1955, IRS records indicated the 400 richest people in the country were worth an average $12.6 million, adjusted for inflation. In 2006, the 400 richest increased their average to $263 million, representing an epochal shift of wealth upward in the U.S." ("Wealth Inequality destroys US Ideals" Don Monkerud, consortiumnews.com)

Working people are not being crushed by accident, but according to plan. It is the way the system is designed to work. Bernanke knows that sustained demand requires higher wages and a vital middle class. But Bernanke works for the banks, which is why the Fed's monetary policies reflect the goals of the investor class. Bubblenomics is not the way to a strong/sustainable economy, but it is an effective tool for shifting wealth from one class to another. The Fed's job is to facilitate that objective, which is why the economy is headed for the rocks.

The financial meltdown is the logical outcome of the Fed's monetary policies. That's why it's a mistake to call the current slump a "recession". It's not. It's a planned demolition.

[papabear]

http://www.atimes.com/atimes/Global_Economy/KH25Dj02.html
Pick-up in store - without US shoppers
Commentary and weekly watch by Doug Noland

The global reflation thesis has been somewhat under fire of late. Chinese stocks dropped about 25% from trading highs set earlier this month. An abrupt slowdown in bank lending - and even discussion of more stringent bank capital requirements - has many now questioning the underpinnings of Chinese recovery. Here at home, a bevy of data on household spending, confidence, and job losses point to stubborn consumer frugality. Can global reflation make headway without a recovery in US consumption?

As the year has progressed, optimistic adherents to the global reflation/recovery thesis have multiplied. Of late, however, the reflation protagonists have been roused. Many hold the view that the Chinese situation is much more tenuous than advertised. Moreover, this camp views global recovery as impossible in the era of the stingy American consumer. Talk of deflation risk has turned more boisterous.

My view differs from both the bullish consensus reflation viewpoint and that of the protagonists/"deflationists". To cut to the chase, I do believe a period of global reflation can evolve in the face of weak US consumption, and while a troubled bond market would likely halt reflation in it tracks, a downtrodden American consumer is an impediment to be hurdled with a powerful boost from ultra-easy global "money". Indeed, deep underlying US fragility - and resulting market assurance that the Fed is indefinitely wedded to ultra-loose policy - is a critical facet of my global reflation thesis.

Fundamentally, it is my view that the nexus of global reflation emanates from irreparable structural impairment to the international dollar reserve system. The global dollar monetary "regime" some time back stopped functioning as a disciplining or restraining force for credit systems around the world. Today, even in this nervous post-crisis landscape, the prospect of an unending expansion of dollar reserves works to foment synchronized credit and speculative excesses. The deeply maladjusted US bubble economy ensures heavy ongoing non-productive US debt issuance that manifests as enormous trade and speculative dollar financial flows - to further inundate the saturated world. The unfolding breakdown in this dollar "system" is the genesis of global inflationary forces.

I've read and listened to the view that an imminent dollar rally will rejuvenate global deflation. While the dollar and currency markets will surely fluctuate, I view nothing on the horizon that will alter the fundamental issue of massive outgoing dollar flows. Policymaking is now trapped in a scheme of promoting excess in the name of system stabilization. The Federal Reserve is poised to again retain a loose policy stance for a far too extended period, and there will be no let up in the massive issuance of federal (Treasury, agency, and government-sponsored entities' mortgage-backed securities) debt.

A central aspect of my global reflation thesis holds that China, Asia and the "emerging" economies are this cycle's asset class with the strongest inflationary biases - hence the areas most prone to immediate and spectacular inflationary manifestations. These "hot-money" magnets then work to rejuvenate animal spirits throughout the global leveraged speculating community, with rapidly recovering credit systems and economies spurring a more general rebound in global activity. The more commodity-oriented and manufacturing-driven economies are the first to benefit. The services and housing-centric US economy badly lags in this reflationary scenario.

Many analysts who do recognize US vulnerability also see troubling aspects to the Chinese economy and financial system. I see them also; they just don't alter my fear that China has likely entered a precarious period where credit, speculation, and spending excesses tend to really run amuck.

Expect increasing concern from China's policymakers - and lots of tinkering (bank capital requirements, lending restraint pronouncements, warnings against speculation, interest-rate adjustments, etc). Also expect markets in China and around the world to grapple mightily with the course of Chinese policy responses.

Keep in mind that the terminal phase of credit bubble excess is notorious for outflanking fainthearted policymaking. It is indeed acute financial, economic and social vulnerabilities that I suspect will restrain Chinese policymakers from applying the type of tough measures necessary to rein in traditionally unwieldy late-cycle excesses.

It is the combination of deep structural issues and vulnerabilities in the US and China that have the reflation antagonists and deflationists energized. They see confirmation in their view from recent US economic data and Chinese developments. Yet it remains a preeminent challenge of credit bubble analysis to recognize that fundamental issues can inhibit, repress and check excess - but there are circumstances when system maladjustment and fragility instead tend to cultivate a backdrop of policymaking and market tolerance.

As I've written over the years, major credit bubbles invariably evolve from some underlying source of monetary disorder. Stable and sound credit systems are simply not breeding grounds for bubbles. The greatest bubbles are fashioned when profound money and credit distortions meld with policymaker confusion and acquiescence. As we've witnessed - at home, in China and around the world - acute financial and economic fragility has engendered a backdrop of unprecedented global policymaking accommodation.Predictably accommodating policymakers have cultivated an environment of synchronized global marketplace reflation accommodation.

It is with this analysis in mind that I am analytically forced to give global reflation the strong benefit of the doubt. I will be dismissive of deflation chatter as long as the markets readily accommodate trillions of US debt issuance here at home and tolerate excesses within domestic credit systems across the globe.

At the end of last week, the dollar index traded below 78 and crude traded above $74. The bond market is understandably unsettled. Ten-year yields traded at 3.72% on July 27, dropped to 3.48% on July 31, jumped to 3.85% on August 7, sank to 3.43% yesterday and closed today at 3.57%.

I'll posit that artificially low interest rates everywhere are global reflation's greatest champion. It is the nature of bubbles that the longer markets misprice risk the greater the pain when the bubble eventually bursts. Credit and market analysis could not be more challenging or fascinating.

[papabear]

http://www.counterpunch.org/baker08262009.html
GreenspanFest '09
The Reappointment of Bernanke

By DEAN BAKER

The world’s central bankers met in Jackson Hole last weekend for their annual gathering. Undoubtedly one of the main topics of discussion was the reappointment of Ben Bernanke as Federal Reserve Board chairman. His reappointment would almost certainly win the support of the vast majority of attendees. This should raise serious concerns.

This is the same group that in 2005 devoted their meeting to an Alan Greenspan retrospective (seriously). The world’s leading thinkers and practitioners of monetary policy debated whether Alan Greenspan was the greatest central banker of all time.

I’m not sure how the polling on this question turned out, but four years later the world is facing the worst economic downturn since the Great Depression because of Alan Greenspan’s failed monetary policy. Greenspan either did not recognize an $8 trillion housing bubble, or did not think it was a big enough deal to demand his attention. The collapse of this bubble gave us the financial panics of 2008 and, more importantly, led to the falloff in demand that produced the downturn.

None of this should have been a surprise to people who understand monetary policy. The housing bubble should have been easy to recognize. There was a 100-year long trend in which nationwide house prices in the United States had just tracked the overall rate of inflation. At the peak of the bubble in 2006, house prices had risen by more than 70 percent after adjusting for inflation.

There were no changes in the fundamentals of the supply or demand of housing that could provide a remotely plausible explanation for this unprecedented run-up in prices. Furthermore, rents were not outpacing inflation. If the run-up in house prices was being driven by fundamentals, then there should have been at least some upward pressure on prices in the rental market.

The bubble was very evidently driving the economy by the time of Greenspanfest ’05. The residential construction sector had expanded to more than 6 percent of GDP, an increase of more than 2 percentage points (@$300 billion a year) from its normal level. The $8 trillion in housing bubble wealth was also propelling consumption. Assuming a wealth effect of 6 cents on the dollar, the bubble wealth was generating close to $500 billion a year in increased consumption.

It was inevitable that both the construction and consumption demand would disappear when the bubble burst. What did Greenspan and his acolytes think would make up this lost demand?

Even the financial crisis was entirely predictable although the exact course of events could not be known to someone who lacked access to the information held by central bankers. Housing is always a highly leveraged asset and it was no secret that it had become much more so during the bubble years.

Down payment requirements were thrown out the door, as homebuyers often purchased homes with no money down; in many cases even borrowing more than the appraised value of a bubble-inflated house price. The explosion of subprime and Alt-A loans was also not classified information. How could any economist have been surprised by the flood of defaults and the resulting stress on banks following the collapse of the bubble? This was as predictable as the sunset at the end of the day.

But the attendees of GreenspanFest ’05, most of whom are back to attend GreenspanFest ’09, apparently were surprised. Remarkably, almost none of the attendees suffered any consequences from the failure to see the largest financial bubble in the history of the world. In the United States alone, 25 million people are either unemployed or underemployed in large part because of the failure of the GreenspanFest attendees to do their job. Yet, the GreenspanFest attendees are not among those fearing unemployment. The official slogan of GreenspanFest ’09 is: “who could have known?”

Ben Bernanke has moved very effectively in the last year to prevent the collapse of the financial system. However, even in this area there have been serious issues of unnecessary secrecy and failed regulation. (Isn’t Goldman Sachs supposed to be a bank holding company now?)

But more importantly, Bernanke is waist deep in responsibility for this mess. Before becoming Fed chairman in January of 2006 he had served on the Board of Governors since 2002, and had been head of President Bush’s Council of Economic Advisors from June of 2005. After Greenspan, there was probably no one else better positioned to combat the bubble.

The attendees of GreenspanFest ’09 may not want to be so rude as to discuss their culpability for this disaster, but that should not prevent the rest of us from raising the topic. It would be an insult to the tens of millions of people who have lost their jobs, their homes, and/or their life savings to see Bernanke reappointed. Failure should have consequences, even for central bank chairmen.

[papabear]

http://blog.atimes.net/?p=1136
Stock Market Rally or Dollar Devaluation?
August 21st, 2009
By David Goldman

[papabear]

http://www.atimes.com/atimes/Global_Economy/KH28Dj02.html
Bernanke, the patch-it banker
By Axel Merk

The good news about the nomination of Ben Bernanke for a second term as head of the United States Federal Reserve is that we know what we are getting and may be able to prepare for the risks his continued leadership may pose to inflation and the dollar. The bad news - more of the same.

Until recently, banking was a relatively simple business, as exemplified by the 3-6-3 rule: pay your depositors 3%; lend to them at 6%; and be off to the golf course by 3pm. This model began to fall apart in the 1970s for most corporate banks, but what hasn't changed is that central bankers typically like to keep things as simple as possible by moving levers such as interest rates and money supply.

One reason central bankers like to keep things simple is because



they are (as tough as it might be for some to admit) pawns like the rest of us in a dynamic economy. At times, they may try to intervene in the markets to assert their power, but in the long-run such activity may be akin to sipping water from the ocean using a straw.

Central bankers do have the power to pave the way for an economy. However, they traditionally do not have the power to decide where and how the asphalt will be laid; central banks control how much asphalt (currency) to produce, but producing asphalt and laying a road are completely different skill sets, something the Fed is learning the hard way. Incidentally, judging by Bernanke's feverish foray into currency production and allocation, we wouldn't be surprised if Bernanke believes himself to be central bankers' equivalent of Bob the Builder.

In all seriousness though, we believe central banking is more predictable than it may seem, and Bernanke is more predictable than most. It appears to us that he is applying what he has written in his books about the Great Depression to today's markets. A plausible alternative to Bernanke's nomination would have been Lawrence Summers, director of the White House's National Economic Council. We have previously referred to Summers, known for his, at times, abrasive style, as a "loose cannon"; this is not intended as a personal criticism but a reflection of a character trait that is traditionally not desirable in a central banker, as unpredictability can raise the cost of borrowing for everyone.

With Bernanke, in contrast, we have a pretty good understanding of the policies we are likely to get. But before we rejoice over predictability, let's put some light on the dark side of transparency in the policies pursued.

Over the long run, if central bankers pursue their policies credibly, they may be able to control inflation. That's why a lot of attention is paid to what central bankers say and do. However, there are a couple of myths about inflation. The greatest myth out there may be that inflation is primarily a function of the slack in the economy, or what economists refer to as the output gap.

This is a fairy tale promoted by Bernanke, amongst others. In our humble opinion, and our understanding of the facts, inflationary expectations, not the output gap, are what drives inflation. If people believe there may be inflation, they will ask for higher wages, try to raise prices - causing inflation.

From our perspective, the best way for a central bank to keep inflationary expectations low is through the pursuit of sound monetary policy; a policy that focuses on price stability. Most central banks have the pursuit of price stability as their primary, if not only, goal. The Fed, in contrast, also has maximum sustainable employment as a secondary goal. A key reason why other central banks, such as the European Central Bank (ECB), do not state employment as a goal is because economists generally believe that an environment that fosters price stability is the most appropriate way to achieve maximum sustainable growth, and hence, maximum sustainable employment.

Why would Bernanke then keep pounding the table that inflation isn't an issue because there is such slack in the economy? Because in the absence of sound monetary policy, a central bank might get away with a few transgressions as long as it can remain credible that it hasn't taken its eyes off inflation. In our humble opinion, that is what Bernanke's focus on transparency is all about: managing expectations.

Expectations management is important. Until 2007, the Fed would only need to utter a few words and the markets would move: the cheapest and most effective monetary policy is one where no money is printed, no interest rate targets are changed, but where a few words help guide the markets.

In early 2008, volatility in the markets started to explode, setting the stage for what we now call the bursting of the credit bubble. The Fed needed to engage in an emergency rate cut of 0.75% in January 2008, lowering interest rates to 3.5% at the time: talk was not good enough anymore, the Fed needed to act. Since then, the Fed has printed well over US$1 trillion to pave the way for an economic recovery (economists talk about increasing the Fed's balance sheet which can be seen as the equivalent of a virtual printing press). In each phase, Fed policy has become more expensive to implement, as credibility in the Fed appears to have eroded.

In our assessment, there have been two common threads in Bernanke's tenure: he has followed his own textbook approach to handling the financial crisis, and he has completely underestimated the political implications of the policies pursued. In many ways the term "ivory tower academic" comes to mind. The relevance here is that many policies engaged in by Bernanke have veered off the path of what central banking is all about: rather than supplying the asphalt, he is patching up the roads.

If Bernanke were truly patching roads with freshly produced asphalt, Bob the Builder would quite likely be rather unhappy that someone is stepping on his turf. Bob the Builder is the construction expert; Ben ought only be the supplier of raw materials. Translated to monetary policy, the Fed's credit-easing programs, those programs providing specific credit to, say, the mortgage market, are fiscal, not monetary policy. By engaging in fiscal policy, the Fed is inviting political scrutiny.

If the Fed were to focus on traditional monetary policy, the setting of interest rates or targeting money supply, the private sector - subject to guidance from laws and regulations passed by Congress - decides where credit is allocated. Bernanke seems to want his policies to be more targeted; we are afraid that he may achieve the opposite. The more political scrutiny he invites, the less effective policies may become as the credibility of the Fed may be further eroded.

Lobbying for the Fed to become a more active super-regulator further exacerbates the political meddling in the Fed's affairs. Similarly, the massive hiring that the Fed has been engaged in suggests that all the new programs the Fed has implemented may be around for some time.

Not too surprisingly, we don't think the Fed's announced exit strategy is very credible. There are two components to our doubts: some of the activities the Fed has been engaged in may be far more difficult to unwind (or "neutralize") than it would have us believe; and secondly, we do not believe the economic recovery will be sustainable enough to allow for a decisive exit of the credit-easing programs.

We cannot imagine the Fed raising interest rates as high as 20% the way former Fed chairman Paul Volcker did in the early 1980s to weed out inflation - there is simply too much leverage in the consumer today.

The conclusion we draw from the Fed's talk about exit strategies and focus on inflation is mostly just that: talk. While we understand why the Fed is talking - to manage inflationary expectations - we believe the Fed may be playing with fire at our expense.

Indeed, following Bernanke's textbook, our interpretation is that the Fed may want to have inflation; and to get there, he may want a cheaper dollar, a substantially cheaper dollar.

Bernanke has repeatedly stressed how going off the gold standard during the Great Depression jump-started economic activity by allowing the price level to rise (read inflation). Fast-forward to today and think about all those homeowners "underwater" with their mortgages. We could allow those who cannot afford their homes to downsize, that is, allowing market prices to clear by allowing foreclosures and bankruptcies, amongst others. However, that option seems to be political suicide. An alternative is to induce inflation, allowing the price level to rise; the Fed may not be able to control what prices will rise, but seems to be betting on home-price inflation.

Looking at what at the Fed does, rather than what the Fed says, we believe it is actively working on a weaker dollar. In discussing the Fed's programs, the media seems to focus on the low mortgage rates and government bond yields that lower the cost of borrowing. The flip side of such activities, however, is that the securities the Fed buys, be they Treasury bonds, mortgage-backed securities, or others, are intentionally overvalued as a result of the Fed's interventions.

Why would a rational buyer be interested in these securities? We believe many of the Fed's programs replace, rather than encourage, private-sector activity. It doesn't take a rocket scientist to make the connection to the dollar: foreigners may not be attracted to US securities if they are not properly compensated for the risk they are taking. Indeed, it is not just foreigners we should be concerned about: from what we hear, US institutions are increasingly hedging their US dollar risk, something unheard of in a developed country in years past.