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Your Sleazy Government At Work

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May 31, 2010

Although the cartoon above appeared in my local paper, it came to my attention only because Barry Ritholtz posted it on his website, The Big Picture.  Congratulations to Jim Morin of The Miami Herald for creating one of those pictures that’s worth well over a thousand words.

Forget about all that oil floating in the Gulf of Mexico.  President Obama, Harry Reid and “Countrywide Chris” Dodd are too busy indulging in an orgy of self-congratulation over the Senate’s passage of a so-called “financial reform” bill (S. 3217) to be bothered with “the fishermen’s buzzkill”.  Meanwhile, many commentators are expressing their disappointment and disgust at the fact that the banking lobby has succeeded in making sure that the taxpayers will continue to pick up the tab when the banks go broke trading unregulated derivatives.

Matt Taibbi has written a fantastic essay for Rolling Stone, documenting the creepy battle over financial reform in the Senate.  The folks at Rolling Stone are sure getting their money’s worth out of Taibbi, after his landmark smackdown of Goldman Sachs and his revealing article exposing the way banks such as JP Morgan Chase fleeced Jefferson County, Alabama.  In his latest “must read” essay, Taibbi provides his readers with an understandable discussion of what is wrong with derivatives trading and Wall Street’s efforts to preserve the status quo:

Imagine a world where there’s no New York Stock Exchange, no NASDAQ or Nikkei:  no open exchanges at all, and all stocks traded in the dark.  Nobody has a clue how much a share of  IBM costs or how many of them are being traded.  In that world, the giant broker-dealer who trades thousands of IBM shares a day, and who knows which of its big clients are selling what and when, will have a hell of a lot more information than the day-trader schmuck sitting at home in his underwear, guessing at the prices of stocks via the Internet.

That world exists.  It’s called the over-the-counter derivatives market. Five of the country’s biggest banks, the Goldmans and JP Morgans and Morgan Stanleys, account for more than 90 percent of the market, where swaps of all shapes and sizes are traded more or less completely in the dark.  If you want to know how Greece finds itself bankrupted by swaps, or some town in Alabama overpaid by $93 million for deals to fund a sewer system, this is the explanation:  Nobody outside a handful of big swap dealers really has a clue about how much any of this shit costs, which means they can rip off their customers at will.

This insane outgrowth of  jungle capitalism has spun completely out of control since 2000, when Congress deregulated the derivatives market.  That market is now roughly 100 times bigger than the federal budget and 20 times larger than both the stock market and the GDP.  Unregulated derivative deals sank AIG, Lehman Brothers and Greece, and helped blow up the global economy in 2008.  Reining in derivatives is the key battle in the War for Finance Reform.  Without regulation of this critical market, Wall Street could explode another mushroom cloud of nuclear leverage and risk over the planet at any time.

At The New York Times, Gretchen Morgenson de-mystified how both the Senate’s “financial reform” bill and the bill passed by the House require standardized derivatives to be traded on an exchange or a “swap execution facility”.  Although these proposals create the illusion of reform – it’s important to keep in mind that old maxim about gambling:  “The house always wins.”  In this case, the ability to “front-run” the chumps gives the house the power to keep winning:

But the devil is always in the details — hence, two 1,500-page bills — and problems arise in how the proposals define what constitutes a swap execution facility, and who can own one.

Big banks want to create and own the venues where swaps are traded, because such control has many benefits.  First, it gives the dealers extremely valuable pretrade information from customers wishing to buy or sell these instruments.  Second, depending on how these facilities are designed, they may let dealers limit information about pricing when transactions take place — and if an array of prices is not readily available, customers can’t comparison-shop and the banks get to keep prices much higher than they might be on an exchange.

*   *   *

Finally, lawmakers who are charged with consolidating the two bills are talking about eliminating language that would bar derivatives facilities from receiving taxpayer bailouts if they get into trouble.  That means a federal rescue of an imperiled derivatives trading facility could occur.  (Again, think A.I.G.)

Surely, we beleaguered taxpayers do not need to backstop any more institutions than we do now.  According to Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, Va., only 18 percent of the nation’s financial sector was covered by implied federal guarantees in 1999.  By the end of 2008, his bank’s research shows, the federal safety net covered 59 percent of the financial sector.

In a speech last week, Mr. Lacker said that he feared we were going to perpetuate the cycle of financial crises followed by taxpayer bailouts, in spite of Congressional reform efforts.

“Arguably, we will not break the cycle of regulation, bypass, crisis and rescue,”  Mr. Lacker said, “until we are willing to clarify the limits to government support, and incur the short-term costs of confirming those limits, in the interest of building a stronger and durable foundation for our financial system.  Measured against this gauge, my early assessment is that progress thus far has been negligible.”

Negligible progress, 3,000 pages notwithstanding.

When one considers what this legislation was intended to address, the dangers posed by failing to extinguish those systemic threats to the economy and what the Senate bill is being claimed to remedy  –  it’s actually just a huge, sleazy disgrace.  Matt Taibbi’s concluding words on the subject underscore the fact that not only do we still need real financial reform, we also need campaign finance reform:

Whatever the final outcome, the War for Finance Reform serves as a sweeping demonstration of how power in the Senate can be easily concentrated in the hands of just a few people.  Senators in the majority party – Brown, Kaufman, Merkley, even a committee chairman like Lincoln – took a back seat to Reid and Dodd, who tinkered with amendments on all four fronts of  the war just enough to keep many of them from having real teeth.  “They’re working to come up with a bill that Wall Street can live with, which by definition makes it a bad bill,” one Democratic aid eexplained in the final, frantic days of negotiation.

On the plus side, the bill will rein in some forms of predatory lending, and contains a historic decision to audit the Fed.  But the larger, more important stuff – breaking up banks that grow Too Big to Fail, requiring financial giants to pay upfront for their own bailouts, forcing the derivatives market into the light of day – probably won’t happen in any meaningful way.  The Senate is designed to function as a kind of ongoing negotiation between public sentiment and large financial interests, an endless tug of war in which senators maneuver to strike a delicate mathematical balance between votes and access to campaign cash.  The problem is that sometimes, when things get really broken, the very concept of a middle ground between real people and corrupt special interests becomes a grotesque fallacy.  In times like this, we need our politicians not to bridge a gap but to choose sides and fight.  In this historic battle over finance reform, when we had a once-in-a-generation chance to halt the worst abuses on Wall Street, many senators made the right choice.  In the end, however, the ones who mattered most picked wrong – and a war that once looked winnable will continue to drag on for years, creating more havoc and destroying more lives before it is over.

The sleazy antics by the Democrats who undermined financial reform (while pretending to advance it) will not be forgotten by the voters.  The real question is whether any independent candidates can step up to oppose the tools of Wall Street, relying on the nickels and dimes from “the little people” to wage a battle against the kleptocracy.




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I Knew This Would Happen

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May 27, 2010

It was almost a year ago when I predicted that President Obama would eventually announce the need for a “second stimulus”.  Once the decision was made to drink the Keynesian Kool-Aid with the implementation of last year’s economic stimulus package, we were faced with the question of how much to drink.  As I expected, our President took the half-assed, yet “moderate” approach of limiting the stimulus effort to less than what was admitted as the cost of the TARP program, as well as approving  the waste of stimulus funds on “pork” projects, ill-suited to stimulate economic recovery.  In that July 9, 2009 piece, I discussed the fact that liberal economist, Paul Krugman, was not alone in claiming that $787 billion would not be an adequate amount to jump-start the economy back to firing on all cylinders.  I pointed out that a survey of economists conducted by Bloomberg News in February of 2009 revealed a consensus opinion that an $800 billion stimulus would prove to be inadequate.  The February 12, 2009 Bloomberg article by Timothy Homan and Alex Tanzi revealed that:

Even as Obama aims to create 3.5 million jobs with a stimulus plan, economists foresee an unemployment rate exceeding 8 percent through next year.

As we now reach the mid-point of that “next year”, the unemployment rate is at 9.9 percent.  Those economists were right.  Beyond that, some highly-respected economists, including Robert Shiller, are discussing the risk of our experiencing a “double-dip” recession.  As a result, Larry Summers, Director of the President’s National Economic Council, is advocating the passage of a new set of spending measures, referred to as the “second stimulus”.  To help offset the expense, the President has asked Congress to grant him powers to cut unnecessary spending, as would be accomplished with a “line item veto”.  The Financial Times described the situation this way :

The combined announcements were made amid rising concern that centrist Democrats, or those representing marginal districts, might vote against the spending measures, which include more loans for small businesses, an extension of unemployment insurance and aid to states to prevent hundreds of thousands more teachers from being laid off.

*   *   *

Taken together, Mr Summers’s speech and Mr Obama’s announcement show an administration walking a fine line between the need to signal strong medium-term fiscal discipline and not jeopardising what they fear may be a fragile recovery.

Because they couldn’t get it right the first time, the President and his administration have placed themselves in the position of seeking piecemeal stimulus measures.  If they had done it right, we would probably be enjoying economic recovery and a boost in the ranks of the employed at this point.  As a result, this half-assed, piecemeal approach will likely prove more costly than doing it right on the first try.  With mid-term elections approaching, deficit hawks have their knives sharpened for anything that can be described as an “entitlement” (unless that entitlement inures to the benefit of a favored Wall Street institution).  Harold Meyerson of The Washington Post challenged the logic of the deficit hawks with this argument:

Those who oppose the jobs bills in the House and Senate this week should be compelled to answer some questions, starting with:  Absent more stimulus, what do they see as the plausible engine of economic recovery?  What effect will laying off as many as 300,000 teachers have on the education of American children?  And, more elementally, don’t they know there’s a recession on?

Marshall Auerback of the Roosevelt Institute picked up where Harold Meyerson left off, as this recent posting at the New Deal 2.0 website demonstrates:

In fact, full employment is also the best “financial stability” reform we could implement, because with jobs growth comes higher income growth and a corresponding ability to service debt.  That means less write-offs for banks and a correspondingly smaller need to provide government bailouts.

Fiscal austerity, by contrast, won’t cut it.  Our elites seem think that you can cut “wasteful government spending” (that is, reduce private demand further) and cut wages and hence private incomes and not expect major multiplier effects to make things significantly worse.  Of course, that “wasteful”, “unsustainable” spending never seems to apply to the Department of  Defense, where we always seem to be able to appropriate a few billion, whenever necessary.  “Affordability” principles never extend to the Pentagon, it appears.

The fact that we are still in the midst of a severe recession (rather than a robust economic recovery as is often claimed) accounts for the rationale asserted by Larry Summers in advocating a second stimulus amounting to approximately $200 billion in spending measures.  Here’s how Summers explained the proposal in a May 24 speech at the Johns Hopkins School of Advanced International Studies:

It has in recent years been essential for the federal deficit to increase as the economy has gone into recession and has been severely constrained by demand.

And I cannot agree with those who suggest that it somehow threatens the future to provide truly temporary, high-bang-for-the-buck jobs and growth measures.

Rather, assuring as rapid a recovery as possible strengthens our future economy, our future prosperity, with many benefits, including a greater ability to manage our debts.

On the other hand, those who recognize the fiscal and growth benefits of strong expansionary policies must also recognize that it is simultaneously desirable to provide confidence that deficits will come down to sustainable levels as recovery is achieved.  Such confidence both spurs recovery by reducing capital costs and reduces the risk of financial accidents.

To put the point differently:  It is not possible to imagine sound budgets in the absence of economic growth and solid economic performance.

*   *   *

It is important to recognize that the ultimate consequences of stimulus for indebtedness depend critically on the macroeconomic conditions.  When the economy is demand constrained, the impact of a dollar of tax cuts or expansionary investment will be at its highest and the impact on deficits at its lowest.
*   *   *

In areas where the government has a significant opportunity for impact, it would be pennywise and pound foolish not to take advantage of our capacity to encourage near-term job creation.   This explains the logic of the Recovery Act’s success and the rationale for taking additional targeted actions to increase confidence in our economic recovery.

Consider the package currently under consideration in Congress to extend unemployment and health benefits to those out of work and support to states to avoid budget cuts as a case in point.

It would be an act of fiscal shortsightedness to break from the longstanding practice of extending these provisions at a moment when sustained economic recovery is so crucial to our medium-term fiscal prospects.

So, here we are at the introduction of the second stimulus plan.  Despite the denial by President Obama that he would seek a second stimulus, he has Larry Summers doing just that.  Last year, the public and the Congress had the will – not to mention the sense of urgency – to approve such measures.  This time around, it might not happen and that would be due to the leadership flaw I observed last year:

President Obama should have done it right the first time.  His penchant for compromise — simply for the sake of compromise itself — is bound to bite him in the ass on this issue, as it surely will on health care reform — should he abandon the “public option”.  The new President made the mistake of assuming that if he established a reputation for being flexible, his opposition would be flexible in return.  The voting public will perceive this as weak leadership.  As a result, President Obama will need to re-invent this aspect of his public image before he can even consider presenting a second economic stimulus proposal.

At this point, Obama’s “flexibility” is often viewed by the voting public as a lack of existential authenticity, sincerity or — worse yet –  credibility.  As a result, I would expect to see more articles like the recent piece by Carol Lee at Politico, entitled, “Obama:  Day for ‘partnership’ passed”.

Here comes the makeover!




Moment Of Truth

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May 24, 2010

Now that the Senate has passed its own version of a financial reform bill (S. 3217), the legislation must be reconciled with the House version before the bill can be signed into law by the President.  At this point, there is one big problem:  the President doesn’t like the bill because it actually has more teeth than an inbred, moonshine-drinking, meth head.  One especially objectionable provision in the eyes of the Administration and its kindred of the kleptocracy, Ben Bernanke, concerns the restrictions on derivatives trading introduced by Senator Blanche Lincoln.

Eric Lichtblau and Edward Wyatt of The New York Times wrote an article describing the current game plan of financial industry lobbyists to remove those few teeth from the financial reform bill to make sure that what the President signs is all gums:

The biggest flash point for many Wall Street firms is the tough restrictions on the trading of derivatives imposed in the Senate bill approved Thursday night.  Derivatives are securities whose value is based on the price of other assets like corn, soybeans or company stock.

The financial industry was confident that a provision that would force banks to spin off their derivatives businesses would be stripped out, but in the final rush to pass the bill, that did not happen.

The opposition comes not just from the financial industry.  The chairman of the Federal Reserve and other senior banking regulators opposed the provision, and top Obama administration officials have said they would continue to push for it to be removed.

And Wall Street lobbyists are mounting an 11th-hour effort to remove it when House and Senate conferees begin meeting, perhaps this week, to reconcile their two bills.  Lobbyists say they are already considering the possible makeup of the conference panel to focus on office visits and potential fund-raising.

The article discussed an analysis provided to The New York Times by Citizens for Responsibility and Ethics in Washington, a nonpartisan group:

The group’s analysis found that the 14 freshmen who serve on the House Financial Services Committee raised 56 percent more in campaign contributions than other freshmen.  And most freshmen on the panel, the analysis found, are now in competitive re-election fights.

“It’s definitely not accidental,” said Melanie Sloan, the director of the ethics group. “It appears that Congressional leaders are deliberately placing vulnerable freshmen on the Financial Services Committee to increase their ability to raise money.”

Take Representative John Adler, Democrat of New Jersey.  Mr. Adler is a freshman in Congress with no real national profile, yet he has managed to raise more than $2 million for his re-election, more than any other freshman, the analysis found.

That is due in large part, political analysts say, to his spot on the Financial Services Committee.

An opinion piece from the May 24 Wall Street Journal provided an equally-sobering outlook on this legislation:

The unifying theme of the Senate bill that passed last week and the House bill of last year is to hand even more discretion and authority to the same regulators who failed to foresee and in many cases created the last crisis.  The Democrats who wrote the bill are selling it as new discipline for Wall Street, but Wall Street knows better.  The biggest banks support the bill, and the parts they don’t like they will lobby furiously to change or water down.

Big Finance will more than hold its own with Big Government, as it always does, while politicians will have more power to exact even more campaign tribute.  The losers are the overall economy, as financial costs rise, and taxpayers when the next bailout arrives.

At The Huffington Post, Mary Bottari discussed the backstory on Blanche Lincoln’s derivatives reform proposal and the opposition it faces from both lobbyists and the administration:

The Obama Administration Wants to Kill the Best Provisions

Lincoln’s proposal has come under fire from all fronts.  Big bank lobbyists went ballistic of course and they will admit that getting her language pulled from the bill is still their top priority.  Behind the scenes, it is also the top priority of the administration and the Federal Reserve.  Believe it or not the administration is fighting to preserve its ability to bailout any financial institutions that gets in trouble, not just commercial banks.  Yep that is right.  Instead of clamping down Wall Street gambling, the administration wants to keep reckless institutions on the teat of the Federal Reserve.

The battle lines are drawn.  The biggest threat to the Lincoln language now is the Obama administration and the Federal Reserve.  There will no doubt be a move to strip out the strong Lincoln language in conference committee where the House and Senate versions of the bank reform bill now go to be aligned.

Meanwhile, President Obama continues to pose as the champion of the taxpayers, asserting his bragging rights for the Senate’s passage of the bill.  Jim Kuhnhenn of MSNBC made note of Obama’s remark, which exhibited the Executive Spin:

The financial industry, Obama said, had tried to stop the new regulations “with hordes of lobbyists and millions of dollars in ads.”

In fact, the lobbyists have just begun to fight and Obama is right in their corner, along with Ben Bernanke.




Banking Lobby Tools In Senate Subvert Reform

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May 20. 2010

The financial pseudo-reform bill is being exposed as a farce.  Thanks to its tools in the Senate, the banking lobby is on the way toward defeating any significant financial reform.  Although Democrats in the Senate (and the President himself) have been posing as reformers who stand up to those “fat cat bankers”, their actions are speaking much louder than their words.  What follows is a list of the Senate Democrats who voted against both the Kaufman – Brown amendment (to prevent financial institutions from being “too big to fail”) as well as the amendment calling for more Federal Reserve transparency (sponsored by Republican David Vitter to comport with Congressman Ron Paul’s original “Audit the Fed” proposal – H.R. 1207 – which was replaced by the watered-down S. 3217 ):

Akaka (D-HI), Baucus (D-MT), Bayh (D-IN), Bennet (D-CO), Carper (D-DE), Conrad (D-ND), Dodd (D-CT), Feinstein (D-CA), Gillibrand (D-NY), Hagan (D-NC), Inouye (D-HI), Johnson (D-SD), Kerry (D-MA), Klobuchar (D-MN), Kohl (D-WI), Landrieu (D-LA), Lautenberg (D-NJ), Lieberman (ID-CT), McCaskill (D-MO), Menendez (D-NJ), Nelson (D-FL), Nelson (D-NE), Reed (D-RI), Schumer (D-NY), Shaheen (D-NH), Tester (D-MT), Udall (D-CO) and Mark Warner (D-VA).

I wasn’t surprised to see Senator Chuck Schumer on this list because, after all, Wall Street is located in his state.  But how about Senator Claire McCaskill?  Remember her performance at the April 27 hearing before the Senate Permanent Subcommittee on Investigations?   She really went after those banksters – didn’t she?  Why would she suddenly turn around and support the banks in opposing those two amendments?   I suppose the securities and investment industry is entitled to a little payback, after having given her campaign committee $265,750.

I was quite disappointed to see Senator Amy Klobuchar on that list.  Back on June 19, 2008, I included her in a piece entitled “Women to Watch”.  Now, almost exactly two years later, we are watching her serve as a tool for the securities and investment industry, which has given her campaign committee $224,325.  On the other hand, another female Senator whom I discussed in that same piece, Maria Cantwell of Washington, has been standing firm in opposing attempts to leave some giant loopholes in Senator Blanche Lincoln’s amendment concerning derivatives trading reform.  The Huffington Post described how Harry Reid attempted to use cloture to push the financial reform bill to a vote before any further amendments could have been added to strengthen the bill.  Notice how “the usual suspects” – Reid, Chuck Schumer and “Countrywide Chris” Dodd tried to close in on Cantwell and force her capitulation to the will of the kleptocracy:

There were some unusually Johnsonian moments of wrangling on the floor during the nearly hour-long vote.  Reid pressed his case hard on Snowe, the lone holdout vote present, with Bob Corker and Mitch McConnell at her side.  After finding Brown, he put his arm around him and shook his head, then found Cantwell seated alone at the opposite end of the floor.  He and New York’s Chuck Schumer encircled her, Reid leaning over her with his right arm on the back of her chair and Schumer leaning in with his left hand on her desk.  Cantwell stared straight ahead, not looking at the men even as she spoke.  Schumer called in Chris Dodd, who was unable to sway her.  Feingold hadn’t stuck around.  Cantwell, according to a spokesman, wanted a guarantee on an amendment that would fix a gaping hole in the derivatives section of the bill, which requires the trades to be cleared, but applies no penalty to trades that aren’t, making Blanche Lincoln’s reform package little better than a list of suggestions.

*   *   *

“I don’t think it’s a good idea to cut off good consumer amendments because of cloture,” said Cantwell on Tuesday night.

Other amendments offered by Democrats would ban banks from proprietary trading, cap ATM fees at 50 cents, impose new limits on the payday lending industry, prohibit naked credit default swaps and reinstate Glass-Steagall regulations that prohibit banks from owning investment firms.

“We need to eliminate the risk posed to our economy by ‘too big to fail’ financial firms and to reinstate the protective firewalls between Main Street banks and Wall Street firms,” said Feingold in a statement after the vote.  Feingold supported the amendment to reinstate Glass-Steagall, among others.

“Unfortunately, these key reforms are not included in the bill,” he said.  “The test for this legislation is a simple one — whether it will prevent another financial crisis.  As the bill stands, it fails that test.  Ending debate on the bill is finishing before the job is done.”

Russ Feingold’s criticisms of the bill were consistent with those voiced by economist Nouriel Roubini (often referred to as “Doctor Doom” because he was one of the few economists to anticipate the scale of the financial crisis).  Barbara Stcherbatcheff of CNBC began her report on Dr. Roubini’s May 18 speech with this statement:

Current efforts to reform financial regulation are “cosmetic” and won’t prevent another crisis, economist Nouriel Roubini told an audience on Tuesday at the London School of Economics.

The current mid-term primary battles have fueled a never-ending stream of commentary following the same narrative:  The wrath of the anti-incumbency movement shall be felt in Washington.  Nevertheless, Dylan Ratigan seems to be the only television commentator willing to include “opposition to financial reform” as a political liability for Congressional incumbents.  Yves Smith raised the issue on her Naked Capitalism website with an interesting essay focused on this theme:

Why have political commentators been hesitant to connect the dots between the “no incumbent left standing” movement and the lack of meaningful financial reform?

Her must-read analysis of the “head fakes” going on within the financial reform wrangling concludes with this thought:

So despite the theatrics in Washington, I recommend lowering your expectations greatly for the result of financial reform efforts.  There have been a few wins (for instance, the partial success of the Audit the Fed push), but other measures have for the most part been announced with fanfare and later blunted or excised.  Even though the firestorm of Goldman-related press stiffened the spines of some Senators and produced a late-in-process flurry of amendments, don’t let a blip distract you from the trend line, that as the legislative process proceeds apace, the banks will be able to achieve an outcome that leaves their dubious business models and most important, the rich pay to industry incumbents, largely intact.

As always, it’s up to the voting public with the short memory to unseat those tools of the banking lobby.  Our only alternative is to prepare for the next financial crisis.




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Avoiding The Stock Market

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May 18, 2010

In the wake of the stock market’s “flash crash” on May 6, there have been an increasing number of reports that retail investors (“Ma and Pa”) are pulling their money out of stocks.  Beyond that, some commentators have stepped forward to speak out and advise retail investors to steer clear of the stock market, due to the volatility caused by “high-frequency trading” or HFT.  One recent example of this was Felix Salmon’s video message, which appeared at The Huffington Post.

HFT involves a practice wherein firms are paid a small “rebate” (approximately one-half cent per trade) by the exchanges themselves when the firms buy and sell stocks.  The purpose of paying firms to make such trades (often selling a stock for the same price they paid for it) is to provide liquidity for the markets.  As a result, retail investors would not have to worry about getting stuck in a “roach motel” – not being able to get out once they got in – after buying a stock.  Many firms involved in high-frequency trading (Goldman Sachs, RGM Advisors, Tradebot Systems and others) have their computer servers “co-located” in the same building as the exchange, in order to get each of their orders processed a few nanoseconds faster than orders coming from further distances (albeit at the speed of light).  The Zero Hedge website has been critical of HFT for quite a while.  They recently published this informative piece on the subject, pointing out how HFT firms caused the catastrophe on May 6:

. . .  when the selling in size commences they all just shut down.  So much for providing liquidity when it is needed.

At The Market Ticker website, Karl Denninger explained how HFT platforms often use “predatory algorithms” to drive a stock’s price up to the full extent of a customer’s limit order (a practice called “frontrunning”):

Let’s say that there is a buyer willing to buy 100,000 shares of BRCM with a limit price of $26.40.  That is, the buyer will accept any price up to $26.40.

But the market at this particular moment in time is at $26.10, or thirty cents lower.

So the computers, having detected via their “flash orders” (which ought to be illegal) that there is a desire for Broadcom shares, start to issue tiny (typically 100 share lots) “immediate or cancel” orders – IOCs – to sell at $26.20.  If that order is “eaten” the computer then issues an order at $26.25, then $26.30, then $26.35, then $26.40.  When it tries $26.45 it gets no bite and the order is immediately canceled.

Now the flush of supply comes at, big coincidence, $26.39, and the claim is made that the market has become “more efficient.”

Nonsense; there was no “real seller” at any of these prices!  This pattern of offering was intended to do one and only one thing – manipulate the market by discovering what is supposed to be a hidden piece of information – the other side’s limit price!

The extent to which frontrunning takes place was the subject of a recent conversation between Larry Tabb of Tabb Group and Erin Burnett on CNBC.  The Zero Hedge website provided this analysis of the video clip:

The funniest bit of the exchange occurs at 3:35 into the clip, when Tabb publicly discloses that front-running is not only legal but occurs all the time on open exchanges. When Erin Burnett, who unfortunately still thinks that the Deutsche Mark is used in Germany, asks who is doing the front running, Tabb says “It could be anyone.”

A recent piece by Josh Lipton at the Minyanville website focused on the activity of retail investors since the recent “flash crash”:

Specifically, during the past week through May 12, your friends and neighbors pulled $2.8 billion out of US stock funds, according to the latest data from the professional number crunchers at Lipper FMI.

To put that stat in context, we called up Robert Adler, the head of Lipper FMI Americas, for a chat this morning.  He tells us that’s the most investors have pulled out, in fact, since March 11, 2009.

At the same time, says Adler, investors plowed $16.6 billion into money-market funds.  “That’s the first inflows money market funds have seen in the last 16 weeks,” he says.

*   *   *

“There was an about-face this past week by investors,” Adler says, noting that such outflows from both equity and bond funds, and a sharp reversal in money market funds, demonstrate a clear and dramatic shift in sentiment.

The analyst is quick to emphasize, however, that one week doesn’t make a trend.  “We have to wait another week to see whether this was simply event driven or if this is the beginning of a new trend,” he says.

The current risk-aversion experienced by retail investors is compounded by the ugly truth that stocks are currently overvalued.  Shawn Tully of Fortune made this very clear in a May 17 commentary, wherein he provided us with a sage bit of prognostication:

Here’s how I see the odds.  The chances are about one in three that we suffer a huge, wrenching correction in the next year or two similar to the one in 1987.  That possibility is so high because stocks are so startlingly expensive.  Another high probability event is that markets go on a long sideways grind, with smaller drops along the way.  What’s extremely unlikely is that the market rises substantially from current levels and stays there for any extended period.

Whatever happens in the next couple of years, the odds are overwhelming that investors who buy stocks today will reap puny returns for 10 years.  For example, if you’d purchased shares at today’s PE of 22 in early 2003, you would have gotten a return of around 3% a year, barely enough to compensate for inflation, let alone buy the blood pressure medication you’d need to survive the scary ride of stock ownership.

Now let’s look out a decade or two.  The evidence is extremely strong that price matters, and matters a lot:  except in rare cases, buying stocks when they are pricey — when the Shiller PE exceeds 20 — leads to puny returns ten years later.

Not that you’d ever know that from the happy talk from Wall Street.  So screen the noise out, and follow the numbers.  They’ll eventually get better for investors.  But to get back there, we may revisit October of 1987.

Considering the unlimited number of awful news events unfolding in America and around the world right now, we could be headed for a market crash much worse that that of October, 1987.  Cheers!



Ron Paul Criticizes Fed Audit Compromise

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May 13, 2010

The Federal Reserve had two big wins this week.  At least their most recent win made some sense.  Bloomberg BusinessWeek put it this way:

U.S. senators voted 90-9 yesterday to void a provision in regulatory-overhaul legislation that would have stripped the Fed of oversight of 5,000 banks with less than $50 billion in assets.  A day earlier, senators rejected a measure to allow continuous congressional audits of Fed policies.

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Bernanke may now have a freer hand to decide when and how fast to unwind record monetary stimulus begun during the financial crisis, while being less vulnerable to criticism that the Fed favors large Wall Street financial institutions.  The Senate votes also removed a threat to the 12 regional Fed banks from a provision that would have limited the supervision of many of them to a few banks or none at all.

The amendment to the financial reform bill allowing the 12 regional Federal Reserve banks to maintain oversight of banks with less than $50 billion in assets was a bipartisan effort by Senators Kay Bailey Hutchison (R-Texas) and Amy Klobuchar (D- Minnesota).  The downside to the passage of this amendment is that it has provided the Fed with back-to-back legislative victories.  One day earlier, Congressman Ron Paul’s “Audit the Fed” amendment was replaced by a rewritten, compromise amendment, sponsored by Senator Bernie Sanders.  Senator Sanders is now being criticized for caving in to pressure exerted by President Obama, who opposed ongoing scrutiny of the Federal Reserve, under the pretext that continuous audits would interfere with the Fed’s purported “independence” in setting monetary policy.  The Sanders compromise proposed a one-time audit of the Fed to uncover information including the loans made to financial institutions by the Fed in response to the financial crisis of 2008.  The Sanders amendment was passed in a 96-0 vote.  Subsequently, Senator David Vitter (R-Louisiana) proposed an amendment (#3760) containing the stronger language of Ron Paul’s H.R. 1207, allowing for repeated audits of the Fed.  The Vitter amendment was defeated by 62 Senators opposing the measure, with only 37 Senators supporting it.  You can see how each Senator voted here.  Ultimately, the complete financial reform bill — S. 3217 (Restoring American Financial Stability Act of 2010) –  will be subject to approval by the Senate and reconciliation with the House version (H.R. 4173) before it can be signed into law by the President.

On May 11, Congressman Ron Paul expressed his displeasure with the Sanders compromise in a statement from the floor of the House of Representatives.  The New American website has the video and text of Congressman Paul’s statement here.  Ron Paul emphasized that the Fed’s use of currency swaps to facilitate the bailout fund for the sovereign debt crisis in the European Union, has provided the latest example of the need for a continuous audit of the Fed’s activities:

The reason this is so disturbing is because of the current events going on in the financial markets. We are right now involved in bailing out Europe and especially bailing out Greece, and we’re doing this through the Federal Reserve.  The Federal Reserve does this with currency swaps and they do this literally by giving loans and guarantees to other central banks, and they can even give loans to governments.  So this is placing the burden on American taxpayers — not by direct taxation, but by expanding the money supply this is a tax on the American people because this will bring economic hardship to this country. And because we’ve been doing this for so many years the economic hardship is already here [and] we’ve been suffering from it.

But the problem comes that once you have a system of money where you can create it out of thin air there’s no restraint whatsoever on the spending in the Congress.  And then the debt piles up and they get into debt problems as they are in Greece and other countries in Europe.  And how they want to bail them out?  With more debt.  But what is so outrageous is that the Federal Reserve can literally deal in trillions of dollars.  They don’t get the money authorized, they don’t get the money appropriated, they just create it and they get involved in bailing out their friends, as they have been doing for the last two years, and now they’re doing it in Europe.  So, my contention is that they deserve oversight.  Actually they deserve to be reined in where they can’t do what they’re doing.

*   *   *

Now, what has this led to?  It has led to tremendous pressure on the dollar.  The dollar is the reserve currency of the world; we bail out all the banks and all the corporations.  We’ve been doing it for the last couple years to the tune of trillions of dollars….

The real truth is that the dollar is very, very weak, because the only true measurement of the value of a currency is its relationship to gold. …  In the last ten years, our dollar has been devalued 80 percent in terms of gold.  That means, literally, that just means that we have printed way too much money, and right now we’re just hanging on, the world is hanging on to the fact that the dollar is still usable. …

So we face a very serious crisis.  To me it is very unfortunate that we are not going to have this audit the Fed bill in the Senate.  It has passed in the House, possibly we can salvage it in conference and make sure this occurs.  But since the Federal Reserve is responsible for the business cycle and the inflation and for all the problems we have it is vital that we stand up and say, you know, its time for us to assume the responsibility because it is the Congress under the Constitution that has been authorized to be responsible for the value of the currency.

At the Financial Times, John Taylor pointed out that not only is the Fed’s decision to provide currency swaps a bad idea – it might actually aggravate the EU’s problems:

Making matters worse for the future of monetary policy is the Fed’s active participation in the European bail-out.  The US central bank agreed to provide loans – technically called swaps – to the ECB so that the ECB can more easily make dollar loans in the European markets.  In order to loan dollars to the ECB, the Fed will have to increase the size of its own balance sheet.  Such swap loans were made to the ECB back in December 2007, but they did not help end the crisis or prevent the panic of autumn 2008.  Instead, they merely delayed inevitable action to deal with deteriorating bank balance sheets, thereby making the panic worse.

Was it necessary for the Fed to participate in the European bail-out?  At least as evidenced by quantitative measures such as the spread between 3-month Libor and the overnight index swap (OIS), the funding problem in the interbank markets is far less severe now than in December 2007.  The international loans also raise questions about the Fed’s independence at a time when many in Congress are calling for a complete audit of the Fed.  Even though monetary policy does not warrant such an audit, extraordinary measures such as the loans to the ECB do.  By taking these extraordinary measures, the Fed is losing some of its independence as well as adding to the perception that the ECB is losing its independence.

At some point, everyone will be forced to admit that “Fed independence” is a myth.




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EuroTARP Faces Criticism

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May 10, 2010

Who would have thought that Mother’s Day would coincide with the announcement of a 720-billion-euro bailout fund to resolve the sovereign debt crisis in the European Union?  Here’s how The New York Times broke the story:

In an extraordinary session that lasted into the early morning hours, finance ministers from the European Union agreed on a deal that would provide $560 billion in new loans and $76 billion under an existing lending program.  Elena Salgado, the Spanish finance minister, who announced the deal, also said the International Monetary Fund was prepared to give up to $321 billion separately.

Officials are hoping the size of the program — a total of $957 billion — will signal a “shock and awe” commitment that will be viewed in the same vein as the $700 billion package the United States government provided to help its own ailing financial institutions in 2008.

The package was much higher than expected, and represented an audacious step for a bloc that had been criticized for acting tentatively, and without unity, in the face of a mounting crisis.

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Financial unease has been mounting.  Riots in Greece, ever-tightening terms of credit and the unexplained free fall in the American stock market last Thursday have compounded the sense that the European Union’s inability to address its sovereign debt crisis might lead to the type of systemic collapse that followed the fall of Lehman Brothers.

The debt crisis began with Greece teetering toward default, and fear quickly spread about other weak economies like Portugal, Spain and even Italy.  Previous efforts by the European Union to shore up investor confidence were viewed as too little, too late, with the markets making clear that they were looking for a bolder plan.

Ambrose Evans-Pritchard of The Telegraph provided us with an informative, yet critical look at the plan:

The walls of fiscal and economic sovereignty are being breached.  The creation of an EU rescue mechanism with powers to issue bonds with Europe’s AAA rating to help eurozone states in trouble — apparently €60bn, with a separate facility that may be able to lever up to €600bn — is to go far beyond the Lisbon Treaty.  This new agency is an EU Treasury in all but name, managing an EU fiscal union where liabilities become shared.  A European state is being created before our eyes.

No EMU country will be allowed to default, whatever the moral hazard.

*   *   *

For now, the world has avoided a financial cataclysm that would have been as serious and far-reaching as the collapse of Lehman Brothers, AIG, Fannie and Freddie in September 2008, and perhaps worse given the already depleted capital ratios of banks and the growing aversion to sovereign debt.

*   *   *

The answer to this — if the objective is to save EMU — is for Germany to boost its growth and tolerate higher ‘relative’ inflation.  This would allow the South to close the gap without tipping into a 1930s Fisherite death spiral.  Yet Europe will have none of it.  The weekend deal demands yet more belt-tightening from the South.  Portugal is to shelve its public works projects.  Spain has pledged further cuts.  As for Germany, it is preparing fiscal tightening to comply with the new balanced budget amendment in its Grundgesetz.

While each component makes sense in its own narrow terms, the EU policy as a whole is madness for a currency union.  Stephen Lewis from Monument Securities says Europe’s leaders have forgotten the lesson of the “Gold Bloc” in the second phase of the Great Depression, when a reactionary and over-proud Continent ground itself into slump by clinging to deflationary totemism long after the circumstances had rendered this policy suicidal.  We all know how it ended.

Back here in the United States, Karl Denninger of The Market Ticker pulled no punches in criticizing the idea of attempting to solve a debt crisis by creating more debt:

This package was calculated to bring about a market reaction similar to what our Federal Reserve and Congress did in 2008 and 2009.  The problem is that the ECB and EU are not similarly situated, in that they don’t have (in the opinion of the market) a solid balance sheet to lever up upon.  Indeed, the problem is within the sovereign balance sheets upon which the EU and ECB rest, and as such this little “program” announced this evening leads me to wonder:

Do they really think the markets are stupid enough to fall for this line of Ouroboros nonsense?

I guess we shall see if, in the coming days, the markets discern the truth of where the funding has to come from, and that in point of fact it is the very nations that are in trouble that have to – somehow – manage to both cut their fiscal deficits and sell more debt (which increases those deficits) to fund their package.

Indeed, I suspect Bernanke and his pals “re-opened” the swap lines not because of current dollar funding problems (there aren’t any) but because he knows this won’t and can’t work, as unlike in the US there is no strong balance sheet to which the debt can be transferred and then refinanced at a lower rate, unlike in the US.

Ben Bernanke would probably hate to see all his hard work at devaluing the dollar go to waste.  One of his worst nightmares would likely involve the dollar’s rise above the value of the euro.   American exports to Europe would become too expensive for those 55-year-old retirees.  Europeans wouldn’t be taking their holidays in America this summer because it would become too expensive, given the new exchange rate.  Whether or not EuroTARP really works as intended, there are plenty of people on Wall Street anticipating a huge rebound in stock prices this week.




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Doctor Doom Writes A Prescription

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May 6, 2010

As I discussed on April 26, expectations for serious financial reform are pretty low.  Worse yet, Lloyd Blankfein (CEO of Goldman Sachs) felt confident enough to make this announcement, during a conference call with private wealth management clients:

“We will be among the biggest beneficiaries of reform.”

So how effective could “financial reform” possibly be if Lloyd Bankfiend expects to benefit from it?  Allan Sloan of Fortune suggested following the old Wall Street maxim of “what they promise you isn’t necessarily what you get” when examining the plans to reform Wall Street:

President Obama talks about “a common sense, reasonable, nonideological approach to target the root problems that led to the turmoil in our financial sector and ultimately in our entire economy.”  But what we’ll get from the actual legislation isn’t necessarily what we hear from the Salesman-in-Chief.

Sloan offered an alternative by providing “Six Simple Steps” to help fix the financial system.  He wasn’t alone in providing suggestions overlooked by our legislators.

Nouriel Roubini (often referred to as “Doctor Doom” because he was one of the few economists to anticipate the scale of the financial crisis) has written a new book with Stephen Mihm entitled, Crisis Economics:  A Crash Course in the Future of Finance.  (Mihm is a professor of economic history and a New York Times Magazine writer.)  An excerpt from the book recently appeared in The Telegraph.  The idea of fixing our “sub-prime financial system” was introduced this way:

Even though they have suffered the worst financial crisis in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel.  Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.

*   *   *

Since its founding, the United States has suffered from brutal banking crises and other financial disasters on a regular basis.  Throughout the 19th and early 20th centuries, crippling panics and depressions hit the nation again and again.  The crisis was less a function of sub-prime mortgages than of a sub-prime financial system.  Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out.  The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.

Roubini and Mihm had nothing favorable to say about CDOs, which they referred to as “Chernobyl Death Obligations”.  Beyond that, the authors called for more transparency in derivatives trading:

Equally comprehensive reforms must be imposed on the kinds of deadly derivatives that blew up in the recent crisis.  So-called over-the-counter derivatives — better described as under-the-table — must be hauled into the light of day, put on central clearing houses and exchanges and registered in databases; their use must be appropriately restricted.  Moreover, the regulation of derivatives should be consolidated under a single regulator.

Although derivatives trading reform has been advanced by Senators Maria Cantwell and Blanche Lincoln, inclusion of such a proposal in the financial reform bill faces an uphill battle.  As Ezra Klein of The Washington Post reported:

The administration, the Treasury Department, the Federal Reserve, and even the FDIC are lockstep against it.

The administration, Treasury and the Fed are also fighting hard against a bipartisan effort to include an amendment in the financial reform bill that would compel a full audit of the Federal Reserve.  I’m intrigued by the possibility that President Obama could veto the financial reform bill if it includes a provision to audit the Fed.

Jordan Fabian of The Hill discussed Congressman Alan Grayson’s theory about why Treasury Secretary Tim Geithner opposes a Fed audit:

But Grayson, who is known for his tough broadsides against opponents, indicated Geithner may have had a role in enacting “secret bailouts and loan guarantees” to large corporations, while New York Fed chairman during the Bush administration.

“It’s one of the biggest conflict of interests I have ever seen,” he said.

With the Senate and the administration resisting various elements of financial reform, the recent tragedy in Nashville provides us with a reminder of how history often repeats itself.  The concluding remarks from the Roubini – Mihm piece in The Telegraph include this timely warning:

If we strengthen the levees that surround our financial system, we can weather crises in the coming years. Though the waters may rise, we will remain dry.  But if we fail to prepare for the inevitable hurricanes — if we delude ourselves, thinking that our antiquated defences will never be breached again — we face the prospect of many future floods.

The issue of whether our government will take the necessary steps to prevent another financial crisis continues to remain in doubt.




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Printing More Fish

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May 3, 2010

I include myself among those who are astonished by the number of people who believe that the economy is well on the road to recovery.  The cheerleaders on television never seem to have trouble convincing a certain number of people that all is well.  Nevertheless, the recent stock market activity, particularly on Thursday, April 29 – when the specter of debt contagion from Greece sent many to Walgreen’s for their first-time purchase of Depends – provided evidence that there is plenty of denial about our uncertain economic situation.  It seems as though most people are convinced that America can money-print its way out of any problem that comes along.  They must believe that if Ben Bernanke’s printing press beat the financial crisis it can defeat everything from climate change to terrorism.  But what about the economic impact from the recent oil rig disaster in the Gulf of Mexico?  Do people believe that Ben Bernanke can just print more fish and save the seafood industry?

David Kotok is the Chief Investment Officer for Cumberland Advisors.  His grim outlook concerning the consequences from the Deepwater Horizon tragedy are obviously too painful for the magical thinking crowd to consider for more than a nanosecond.  The Business Insider website provided us with some glimpses of what Mr. Kotok sees resulting from what many people prefer to view as simply “another oil spill – possibly as bad as that caused by the Exxon Valdez”.  From Mr. Kotok’s perspective, there is a dimension of economic turmoil about to result from the recent catastrophe that could send our precariously-situated economy into a double-dip recession:

Thousands of small and independent businesses as well as larger public companies in tourism are hurt here.  This is not just about the source of half the nation’s shrimp.  That is already a casualty.  It’s also about the bank loans for the $200,000 shrimp boat and the house the boat owner and/or his employees live in and the fact that this shock piles on a fragile financial system that is trying to recover from a three-year financial crisis.

*   *   *

Federal deficit spending will certainly rise by tens, and maybe hundreds, of billions as emergency appropriations are directed at larger and larger efforts to clean up this mess.  At the same time, federal and state revenues tied to Gulf-region businesses will fall.

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We expect to see the deterioration of the economic statistics for the US to reveal the onset of this oil-slick crisis in May, and the negative impact will intensify during the summer months.  A “double-dip” recession probably has been made more likely by this tragedy.

As the great multitude of media outlets spin the story to fit the usual narratives (“lessons learned”, “finger pointing”, “Obama’s Katrina”, “Halliburton’s latest controversy”, etc.) the most important story – the likely economic consequences of this event – is being ignored by the mainstream media for as long as possible.  As usual, Wall Street’s favorite chumps – those who believe that macroeconomic events are irrelevant to what happens in the stock market – are poised for another bloodbath.  This time, Ben Bernanke’s printing press won’t serve as the ultimate panacea.  Fish can’t be printed.




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