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A Look Ahead

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December 7, 2009

As 2010 approaches, expect the usual bombardment of prognostications from the stars of the info-tainment industry, concerning everything from celebrity divorces to the nuclear ambitions of Iran.   Meanwhile, those of us preferring quality news reporting must increasingly rely on internet-based venues to seek out the views of more trustworthy sources on the many serious subjects confronting the world.  On October 29, I discussed the most recent GMO Quarterly Newsletter from financial wizard Jeremy Grantham and his expectation that the stock market will undergo a

“correction” or drop of approximately 20 percent next year.   Grantham’s paper inspired others to ponder the future of the troubled American economy and the overheated stock market.  Mark Hulbert, editor of The Hulbert Financial Digest, wrote a piece for the December 5 edition of The New York Times, picking up on Jeremy Grantham’s stock performance expectations.  Hulbert noted Grantham’s continuing emphasis on “high-quality, blue chip” stocks as the most likely to perform well in the coming year.  Grantham’s rationale is based on the fact that the recent stock market rally was excessively biased in favor of junk stocks, rather than the higher-quality “blue chips”, such as Wal-Mart.  Hulbert noted how Wal-mart shares gained only 14 percent since March 9, while the shares of the debt-laden electronics services firm, Sanmina-SCI, have risen more than 600 percent during that same period.  Hulbert pointed out that the conclusion to be reached from this information should be pretty obvious:

As an unintended consequence, Mr. Grantham said, high-quality stocks today are about as cheap as they have ever been relative to shares of firms with weaker finances.

It’s almost a certain bet that high-quality blue chips will outperform lower-quality stocks over the longer term,” he said.

My favorite reaction to Jeremy Grantham’s newsletter came from Paul Farrell of MarketWatch, who emphasized Grantham’s broader view for the economy as a whole, rather than taking a limited focus on stock performance.  Farrell targeted President Obama’s “predictably irrational” economic policies by presenting us with a handy outline of Grantham’s criticism of those policies.  Farrell prefaced his outline with this statement:

So please listen closely to his 14-point analysis of the rampant irrationality at the highest level of American government today, because what he is also predicting is another catastrophic meltdown dead ahead.

At the first point in the outline, Farrell made this observation:

If Grantham ever was a fan, he’s clearly disillusioned with the president.   His 14 points expose the extremely irrational behavior of Obama breaking promises by turning Washington over to Wall Street, a blunder that will trigger the Great Depression 2.

Farrell’s discussion included a reference to the latest article by Matt Taibbi for Rolling Stone, entitled “Obama’s Big Sellout”.  The Rolling Stone website described Taibbi’s latest essay in these terms:

In “Obama’s Big Sellout”, Matt Taibbi argues that President Obama has packed his economic team with Wall Street insiders intent on turning the bailout into an all-out giveaway.  Rather than keeping his progressive campaign advisers on board, Taibbi says Obama gave key economic positions in the White House to the very people who caused the economic crisis in the first place.  Taibbi also points to the ties Obama’s appointees have to one main in particular:  Bob Rubin, the former Goldman Sachs co-chairman who served as Treasury secretary under Bill Clinton.

Since the article is not available online yet, you will have to purchase the latest issue of Rolling Stone or wait patiently for the release of their next issue, at which time “Obama’s Big Sellout” should be online.  In the mean time, they have provided this brief video of Matt Taibbi’s discussion of the piece.

The new year will also bring us a new book by Danny Schecter, entitled The Crime of Our Time.  Mr. Schecter recently discussed this book in a live interview with Max Keiser.  (The interview begins at 16:55 into the video.)  In discussing the book, Schecter explained how “the financial industry essentially de-regulated its own marketplace.  They got rid of the laws that required disclosure and accountability …” and created a “shadow banking system”.  Shechter’s previous book, Plunder, has now become a film that will be released soon.  In Plunder, he described how the subprime mortgage crisis nearly destroyed the American economy.  The interview by Max Keiser contains a short clip from the upcoming film.  Danny also directed the movie based on (and named after) his 2006 book, In Debt We Trust, wherein he predicted the bursting of the credit bubble.

It was right at this point last year when Danny’s father died.  The event is easy for me to remember because my own father died one week later.  At that time, I was comforted by reading Danny’s eloquent piece about his father’s death.  Danny was kind enough to respond to the e-mail I had sent him since, as an old fan from his days at WBCN radio in Boston, during the early 1970s, my friends and I tried our best to provide Danny with any leads we came across.  These days, it’s good to see that Danny Schechter “The News Dissector” is still at it with the same vigor he demonstrated more than thirty-five years ago.  I look forward to his new book and the new film.



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Watching For Storm Clouds

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October 26, 2009

As the economy continues to flounder along, one need not look very far to find enthusiastic cheerleaders embracing any seemingly positive information to reinforce the belief that this catastrophic chapter in history is about to reach an end.  Meanwhile, others are watching out for signs of more trouble.  The recent celebrations over the return of the Dow Jones Industrial Average to the 10,000 level gave some sensible commentators the opportunity to point out that this may simply be evidence that we are experiencing an “asset bubble” which could burst at any moment.

October 21 brought the latest Quarterly Report from SIGTARP, the Special Investigator General for TARP, who is a gentleman named Neil Barofsky.  Since the report is 256 pages long, it made more sense for Mr. Barofsky to submit to a few television interviews and simply explain to us, the latest results of his investigatory work.  In a discussion with CNN’s Wolf Blitzer on that date, Mr. Barofsky voiced his concern about the potential consequences that could arise because those bailed-out banks, considered “too big to fail” have continued to grow, due to government-approved mergers:

“These banks that were too big to fail are now bigger,” Barofsky said.  “Government has sponsored and supported several mergers that made them larger and that guarantee, that implicit guarantee of moral hazard, the idea that the government is not going to let these banks fail, which was implicit a year ago, is now explicit, we’ve said it.  So if anything, not only have there not been any meaningful regulatory reform to make it less likely, in a lot of ways, the government has made such problems more likely.

“Potentially we could be in more danger now than we were a year ago,” he added.

In comparing where the economy is now, as opposed to this time last year, we haven’t seen much in the way of increased lending by the oversized banks.  In fact, we’ve only seen more hubris and bullying on their part.  Julian Delasantellis expressed it this way in his October 22 essay for the Asia Times:

Now, a year later, things have turned out exactly as expected – except that the roles are reversed.  The rulemakers have not disciplined the corrupted; it’s more accurate to say that the corrupted have abased the rulemakers.  If the intention was that the big investment banks would settle down into a sort of quiet, reserved suburban lifestyle, the reality has been that they’ve acted more like former gangsters placed into the US government’s witness protection program, taking over the numbers racket on the Saturday pee-wee soccer fields.

*   *   *

Obviously, there can’t be any inflation, or any real long-term earnings growth for consumer and business-oriented banks for that matter, as long as the economic crisis continues to destroy capital faster than Obama can ask Bernanke to print it.

These issues are of little concern to operations such as Goldman and Morgan, with their trading strategies and profit profiles essentially divorced from the real economy.  But down here on planetary level, as the little league baseball fields don’t get maintained because the businesses who funded the work go out of business after having their loans called, after elderly people with chest pains have to wait longer for one of the few ambulances on station after rescue service cutbacks, life is changing, changing for the long term, and it sure isn’t pretty.

“Proprietary trading” by banks such as Goldman Sachs and JP Morgan Chase, forms an important part of their business model.  This practice involves trading by those banks, on their own accounts, rather than the accounts of customers.  The possibility of earning lavish bonus payments helps to incentivize risk taking by the traders working on the “prop desks” of those institutions.  Gillian Tett wrote a report for the Financial Times on October 22, wherein she discussed an e-mail she received from a recently-retired banker, who stays in touch with his former colleagues — all of whom remain actively trading the markets.  Ms. Tett observed that this man was “feeling deeply shocked” when he shared his observations with her:

“Forget about the events of the past 12 months … the punters are back punting as aggressively as ever,” he wrote.  “Highly leveraged short-term trades are back in vogue as players … jostle to load up on everything from Reits [real estate investment trusts] and commercial property, commodities, emerging markets and regular stocks and bonds.

“Oh, I am sure the banks’ public relations people will talk about the subdued atmosphere in banking, but don’t you believe it,” he continued bitterly, noting that when money is virtually free — or, at least, at 0.5 per cent — traders feel stupid if they don’t leverage up.

“Any sense of control is being chucked out of the window.  After the dotcom boom and bust it took a good few years for the market to get its collective mojo back [but] this time it has taken just a few months,” he added.  He finished with a despairing question:  “Was October 2008 just a dress rehearsal for the crash when this latest bubble bursts?”

*   *   *

Yet, if you talk at length to traders — or senior bankers — it seems that few truly believe that fundamentals alone explain this pattern.  Instead, the real trigger is the amount of money that central bankers have poured into the system that is frantically seeking a home, because most banks simply do not want to use that cash to make loans.  Hence, the fact that the prices of almost all risk assets are rallying — even as non-risky assets such as Treasuries bounce too.

Now, some western policymakers like to argue — or hope –that this striking rally could be beneficial, in a way, even if it is not initially based on fundamentals.  After all, the argument goes, if markets rebound sharply, that should boost animal spirits in a way that could eventually seep through to the “real” economy.

On this interpretation, the current rally could turn out to be akin to the firelighter that one uses to start a blaze in a pile of damp wood.

*   *   *

So I, like my e-mail correspondent, am growing uneasy.  Perhaps, the optimistic “firelighter-igniting-the-damp-wood” scenario will yet come to play; but we will probably not really know whether the optimists are correct for at least another six months.

Gillian Tett’s “give it six months” approach seems much more sober and rational than what we hear from many of the exuberant commentators appearing on television.  Beyond that, she reminds us that our current situation involves a more important issue than the question of whether our economy can experience sustained growth:  The continued use of leveraged risk-taking by TARP beneficiaries invites the possibility of a return to last year’s crisis-level conditions.  As long as those banks know that the taxpayers will be back to bail them out again, there is every reason to assume that we are all headed for more trouble.



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Offering Solutions

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October 22, 2009

Many of us are familiar with the old maxim asserting that “if you’re not part of the solution, you’re part of the problem.”  During the past year we’ve been exposed to plenty of hand-wringing by info-tainers from various mainstream media outlets decrying the financial crisis and our current economic predicament.  Very few of these people ever seem to offer any significant insight on such interesting topics as:  what really caused the meltdown, how to prevent it from happening again, whether any laws were broken that caused this catastrophe, whether any prosecutions might be warranted or how to solve our nation’s continuing economic ills, which seem to be immune to all the attempted cures.  The painful thorn in the side of Goldman Sachs, Matt Taibbi, recently raised an important question, reminding people to again scrutinize the vapid media coverage of this pressing crisis:

It’s literally amazing to me that our press corps hasn’t yet managed to draw a distinction between good news on Wall Street for companies like Goldman, and good news in reality.

*   *   *

In fact the dichotomy between the economic health of ordinary people and the traditional “market indicators” is not merely a non-story, it is a sort of taboo — unmentionable in major news coverage.

That quote inspired Yves Smith of Naked Capitalism to write a superb essay about how “access journalism” has created a controlled press.  What follows is just a small nugget of the great analysis in that piece:

So what do we have?  A media that predominantly bases its stories on what it is fed because it has to.  Ever-leaner staffing, compressed news cycles, and access journalism all conspire to drive reporters to focus on the “must cover” news, which is to a large degree influenced by the parties that initiate the story.  And that means they are increasingly in an echo chamber, spending so much time with the influential sources they feel they must cover that they start to be swayed by them.

*   *   *

The message, quite overly, is: if you are pissed, you are in a minority.  The country has moved on.  Things are getting better, get with the program. Now I saw the polar opposite today.  There is a group of varying sizes, depending on the topic, that e-mails among itself, mainly professional investors, analysts, economists (I’m usually on the periphery but sometimes chime in).  I never saw such an angry, active, and large thread about the Goldman BS fest today.  Now if people who have not suffered much, and are presumably benefitting from the market recovery are furious, it isn’t hard to imagine that what looks like complacency in the heartlands may simply be contained rage looking for an outlet.

Fortunately, one television news reporter has broken the silence concerning the impact on America’s middle class, caused by Wall Street’s massive Ponzi scam and our government’s response – which he calls “corporate communism”.  I’m talking about MSNBC’s Dylan Ratigan.  On Wednesday’s edition of his program, Morning Meeting, he decried the fact that the taxpayers have been forced to subsidize the “parlor game” played by Goldman Sachs and other firms involved in proprietary trading on our coin.  Mr. Ratigan then proceeded to offer a number of solutions available to ordinary people, who would like to fight back against those pampered institutions considered “too big to fail”.  Some of these measures involve:  moving accounts from one of those enshrined banks to a local bank or credit union; paying with cash whenever possible and contacting your lawmakers to insist upon financial reform.

My favorite lawmaker in the battle for financial reform is Congressman Alan Grayson, whose district happens to include Disney World.  His fantastic interrogation of Federal Reserve general counsel, Scott Alvarez, about whether the Fed tries to manipulate the stock markets, was a great event.  Grayson has now co-sponsored a “Financial Autopsy” amendment to the proposed Consumer Financial Protection Agency bill.  This amendment is intended to accomplish the following:

– Requires the CFPA conduct a “Financial Autopsy” of each state’s bankruptcies and foreclosures (a scientific sampling), and identify financial products that systematically led to a large number of bankruptcies and foreclosures.
– Requires the CFPA report to Congress annually on the top financial products (the companies and individuals that originated the products) that caused consumer bankruptcies and foreclosures.
– Requires the CFPA take corrective action to eliminate or restrict those deceptive products to prevent future bankruptcies and corrections

– The bottom line is to highlight destructive products based on if they are making people “broke”.

From his website, The Market Ticker, Karl Denninger offered his own contributions to this amendment:

This sort of “feel good” legislative amendment will of course be resisted, but it simply isn’t enough.  The basic principle of equity (better said as “fairness under the law”) puts forward the premise that one cannot cheat and be allowed to keep the fruits of one’s outrageous behavior.

So while I like the direction of this amendment, I would put forward the premise that the entirety of the gains “earned” from such toxic products, when found, are clawed back and distributed to the consumers so harmed, and that to the extent this does not fully compensate for that harm such a finding should give rise to a private, civil cause of action for the consumers who are bankrupted or foreclosed.

It’s nice to know that bloggers are no longer the only voices insisting on financial reform.  Ed Wallace of Business Week recently warned against the consequences of unchecked speculation on oil futures:

Is today’s stock market divorced from economic reality?  Probably.  It is a certainty that oil is.  We know that because those in the market are still putting out the same tired and incorrect logic that they used successfully last year to push oil to $147 a barrel while demand was plummeting.

Because oil is not carrying a market price that fairly reflects economic conditions and demand inventories, overpriced energy is siphoning off funds that could be used for corporate expansion, increased consumerism and, in time, the recreation of jobs in America.

Did you think that the “Enron Loophole” was closed by the enactment of the 2008 Farm Bill?  It wasn’t.  The Farm Bill simply gave more authority to the Commodity Futures Trading Commission to regulate futures contracts that had been exempted by the loophole.  In case you’re wondering about the person placed in charge of the Commodity Futures Trading Commission by President Obama  —  his name is Gary Gensler and he used to work for  …  You guessed it:  Goldman Sachs.



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The Longest Year

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September 14, 2009

As I write this, President Obama is preparing another fine-sounding, yet empty speech.  His subject this time is financial reform.  You may recall last week’s lofty address to the joint session of Congress, promoting his latest, somewhat-less-nebulous approach to healthcare reform.  He assured the audience that the so-called “public option” (wherein a government-created entity competes with private sector healthcare insurers) would be an integral part of the plan.  Within a week, two pieces of political toast from the Democratic Party (Nancy Pelosi and Harry Reid) set about undermining that aspect of the healthcare reform agenda.  This is just one reason why, on November 2, 2010, the people who elected Democrats in 2006 and 2008 will be taking a “voters’ holiday”, paving the way for Republican majorities in the Senate and House.  The moral lapse involving the public option was documented by David Sirota for Danny Schechter’s NewsDissector blog:

House Speaker Nancy Pelosi for the first time yesterday suggested she may be backing off her support of the public option – the government-run health plan that the private insurance industry is desperately trying to kill.  According to CNN, Pelosi and Senate Majority Leader Harry Reid “said they would support any provision that increases competition and accessibility for health insurance – whether or not it is the public option favored by most Democrats.”

This announcement came just hours before Steve Elmendorf, a registered UnitedHealth lobbyist and the head of UnitedHealth’s lobbying firm Elmendorf Strategies, blasted this email invitation throughout Washington, D.C. I just happened to get my hands on a copy of the invitation from a source – check it out:

From: Steve Elmendorf [mailto:steve@elmendorfstrategies.com]
Sent: Friday, September 11, 2009 8:31 AM
Subject: event with Speaker Pelosi at my home
You are cordially invited to a reception with

Speaker of the House
Nancy Pelosi

Thursday, September 24, 2009
6:30pm ~ 8:00pm

At the home of
Steve Elmendorf
2301 Connecticut Avenue, NW
Apt. 7B
Washington, D.C.

$5,000 PAC
$2,400 Individual

Again, Elmendorf is a registered lobbyist for UnitedHealth, and his firm’s website brags about its work for UnitedHealth on its website.

The sequencing here is important: Pelosi makes her announcement and then just hours later, the fundraising invitation goes out. Coincidental?  I’m guessing no – these things rarely ever are.

I wrote a book a few years ago called Hostile Takeover whose premise was that corruption and legalized bribery has become so widespread that nobody in Washington even tries to hide it. This is about as good an example of that truism as I’ve ever seen.

Whatever President Obama proposes to accomplish in terms of financial reform will surely be met with a similar fate.  Worse yet, his appointment of “Turbo” Tim Geithner as Treasury Secretary and his nomination of Ben Bernanke to a second term as Federal Reserve chairman are the best signals of the President’s true intention:  Preservation of the status quo, regardless of the cost to the taxpayers.

On this first anniversary of the demise of Lehman Brothers and the acknowledgment of the financial crisis, many commentators have noted the keen observations by Simon Johnson, a former chief economist at the International Monetary Fund, published in the May, 2009 issue of The Atlantic.  The theme of Johnson’s article, “The Quiet Coup” was that the current economic and financial crisis in the United States is “shockingly reminiscent” of those experienced in emerging markets (i.e. banana republics and proto-capitalist regimes).  The devil behind all the details in setting these systems upright after a financial crisis is the age-old concept of moral hazard or more simply:  sleaze.  In making the comparison of the United States to the emerging market countries he encountered at the IMF, Mr. Johnson began this way:

But there’s a deeper and more disturbing similarity:  elite business interests — financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse.  More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive.  The government seems helpless, or unwilling, to act against them.

Here are a few more passages from “The Quiet Coup” that our political leaders would be well-advised to consider:

Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason:  it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change.  As an unnamed senior bank official said to The New York Times last fall, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.”  But there’s the rub:  the economy can’t recover until the banks are healthy and willing to lend.

*   *   *

The second problem the U.S. faces—the power of the oligarchy— is just as important as the immediate crisis of lending.  And the advice from the IMF on this front would again be simple:  break the oligarchy.

Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.

Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business.  Where this proves impractical—since we’ll want to sell the banks quickly— they could be sold whole, but with the requirement of being broken up within a short time.  Banks that remain in private hands should also be subject to size limitations.

Mr. Johnson pointed out the need to overhaul our current antitrust laws – not because any single institution controls so much market share as to influence prices – but because the failure of any one “to big to fail” bank could collapse the entire financial system.

One of my favorite reporters at The New York Times, Gretchen Morgenson, observed the anniversary of the Lehman Brothers failure with an essay that focused, in large part, on a recent paper by Edward Kane, a finance professor at Boston College, who created the expression: “zombie bank” in 1987.   This month, the Networks Financial Institute at Indiana State University published a policy brief by Dr. Kane on the subject of financial regulation.  In her article:  “But Who Is Watching Regulators?”, Ms. Morgenson summed up Professor Kane’s paper in the following way:

This ugly financial episode we’ve all had to live through makes clear, Mr. Kane says, that taxpayers must protect themselves against two things:  the corrupting influence of bureaucratic self-interest among regulators and the political clout wielded by the large institutions they are supposed to police. Finally, he argues, taxpayers must demand that the government publicize the costs of efforts taken to save the financial system from itself.

Although you may have seen widely-publicized news reports about an “overwhelming number” of academicians opposing the current efforts to require transparency from the Federal Reserve, Professor Kane provides a strong argument in favor of Fed transparency as well as scrutiny of the Treasury and the other government entities enmeshed the complex system of bailouts created within the past year.

At thirty-eight pages, his paper is quite a deep read.  Nevertheless, it’s packed with great criticism of the Federal Reserve and the Treasury.  We need more of this and when someone of Professor Kane’s stature provides it, there had better be people in high places taking it very seriously.  The following are just a few of the many astute observations made by Dr. Kane:

Agency elitism would be evidenced by the extent to which its leaders use crises to establish interpretations and precedents that cover up its mistakes, inflate its powers, expand its discretion, and extend its jurisdiction. According to this standard, Fed efforts to use the crisis as a platform for self-congratulation and for securing enlarged systemic-risk authority sidetracks rather than promotes effective reform.

*   *   *

A financial institution’s incentive to disobey, circumvent or lobby against a particular rule increases with the opportunity cost of compliance. This means that, to sort out the welfare consequences of any regulatory program, we must assess not only the costs and benefits of compliance, but include the costs and benefits of circumvention as well.

*   *   *

Realistically, every government-managed program of disaster relief is a strongly lobbied and nontransparent tax-transfer scheme for redistributing wealth and shifting risk away from the disaster’s immediate victims.  A financial crisis externalizes – in margin and other collateral calls, in depositor runs, and in bank and borrower pleas for government assistance – a political and economic struggle over when and how losses accumulated in corporate balance sheets and in the portfolios of insolvent financial institutions are to be unwound and reallocated across society.  At the same time, insolvent firms and government rescuers share a common interest in mischaracterizing the size and nature of the redistribution so as to minimize taxpayer unrest.

In principle, lenders and investors that voluntarily assume real and financial risks should reap the gains and bear the losses their risk exposures generate.  However, in crises, losers pressure government officials to rescue them and to induce other parties to share their pain.

The advocates of crony capitalism and their tools (our politicians and regulatory bureaucrats) need to know that we are on to them.  If the current administration is willing to facilitate more of the same, then it’s time for some new candidates to step forward.




The Forgotten Urgency Of Financial Reform

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September 10, 2009

With all the fighting over healthcare reform and the many exciting controversies envisioned by its opponents, such as:  death panels, state-sponsored abortions and illegal aliens’ coming to America for free breast implants, the formerly-urgent need for financial reform his slipped away from public concern.  Alan Blinder recently wrote a piece for The New York Times, lamenting how the subject of financial reform has disappeared from the Congressional radar:

After all we’ve been through, and with so much anger still directed at financial miscreants, the political indifference toward financial reform is somewhere between maddening and tragic.  Why is the pulse of reform so faint?

Blinder then discussed five reasons why.  My favorite concerned lobbying:

Almost everything becomes lobbied to death in Washington.  In the case of financial reform, the money at stake is mind-boggling, and one financial industry after another will go to the mat to fight any provision that might hurt it.

Mr. Blinder expressed concern that these three important changes would be left out of any financial reform legislation:  a) resolving the problem of having financial institutions that are “too big to fail”, b) cleaning up the derivatives mess and c) creating a “systemic risk regulator”.   (All right — I rearranged the order.)

In case you’re wondering just what the hell a “systemic risk regulator” is, Blinder provided the readers with a link to one of his earlier articles, which said this:

The main task of a systemic-risk regulator is to serve as an early-warning-and-prevention system, on the prowl for looming risks that extend across traditional boundaries and are becoming large enough to have systemic consequences.

*   *   *

Suppose such a regulator had been in place in 2005.  Because the market for residential mortgages and the mountain of securities built on them constituted the largest financial market in the world, that regulator probably would have kept a watchful eye on it.  If so, it would have seen what the banking agencies apparently missed:  lots of dodgy mortgages being granted by nonbank lenders with no federal supervision.

If the regulator saw those mortgages, it might then have looked into the securities being built on them.  That investigation might have turned up the questionable triple-A ratings being showered on these securities, and it certainly should have uncovered the huge risk concentrations both on and off of banks’ balance sheets.  And, unless it was totally incompetent, the regulator would have been alarmed to learn that a single company, American International Group, stood behind an inordinate share of all the credit-default swaps — essentially insurance policies against default — that had been issued.

Blinder shares the view, expressed by Treasury Secretary “Turbo” Tim Geithner, that the Federal Reserve should serve as systemic risk regulator, because “there is no other alternative”.  Unfortunately, President Obama is also in favor of such an approach.  The drawback to empowering the Fed with such additional responsibility was acknowledged by Mr. Blinder:

On the other hand, some members of Congress are grumbling that the Fed has already overreached, usurping Congressional authority.  Others contend that it has performed so poorly as a regulator that it hardly deserves more power.

Federal Reserve Chairman Ben Bernanke discussed this issue himself back on March 5, in a speech entitled:  “Financial Reform to Address Systemic Risk”.  Near the end of this speech, Bernanke discussed the subject objectively, although he concluded with a pitch to get this authority for his own realm:

Some commentators have proposed that the Federal Reserve take on the role of systemic risk authority; others have expressed concern that adding this responsibility would overburden the central bank.  The extent to which this new responsibility might be a good match for the Federal Reserve depends a great deal on precisely how the Congress defines the role and responsibilities of the authority, as well as on how the necessary resources and expertise complement those employed by the Federal Reserve in the pursuit of its long-established core missions.

It seems to me that we should keep our minds open on these questions.  We have been discussing them a good deal within the Federal Reserve System, and their importance warrants careful consideration by legislators and other policymakers. As a practical matter, however, effectively identifying and addressing systemic risks would seem to require the involvement of the Federal Reserve in some capacity, even if not in the lead role.     .  .   .   The Federal Reserve plays such a key role in part because it serves as liquidity provider of last resort, a power that has proved critical in financial crises throughout history.  In addition, the Federal Reserve has broad expertise derived from its wide range of activities, including its role as umbrella supervisor for bank and financial holding companies and its active monitoring of capital markets in support of its monetary policy and financial stability objectives.

This rationale leads me to suspect that Mr. Bernanke might be planning to use his super powers as: “liquidity provider of last resort” to money-print away any systemic risks that might arise on his watch in such a capacity.  This is reminiscent of how comedian Steve Smith always suggests the use of duct tape to solve just about any problem that might arise in life.

In the September 8 edition of The Wall Street Journal, Peter Wallison wrote an article entitled:  “The Fed Can’t Monitor ‘Systemic Risk’”.   More important was the subtitle:  That’s like asking a thief to police himself.  Wallison begins with the point that President Obama’s inclusion of granting such powers to the Fed as the centerpiece of his financial regulatory reform agenda “is a serious error.”  Wallison seemed to share my concern about Bernanke’s “duct tape” panacea:

The problem is the Fed itself can create systemic risk.  Many scholars, for example, have argued that by keeping interest rates too low for too long the Fed created the housing bubble that gave us the current mortgage meltdown, financial crisis and recession.

Vesting such authority in the Fed creates an inherent conflict of interest.  Mr. Wallison explained this quite well:

Tasking the Fed with that responsibility would bury it among many other inconsistent roles and give the agency incentives to ignore warning signals that an independent body would be likely to spot.

Unlike balancing its current competing assignments — price stability and promoting full employment — detecting systemic risk would require the Fed to see the subtle flaws in its own policies.  Errors that are small at first could grow into major problems.  It is simply too much to expect any human institution to step outside of itself and see the error of its ways when it can plausibly ignore those errors in the short run.  If we are going to have a systemic-risk monitor, it should be an independent council of regulators.

When the dust finally settles on the healthcare reform debate, perhaps Congress can approach the subject of financial reform  . .  .  if it’s not too late by that point.



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Fed Up With The Fed

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July 20, 2009

Last week’s news that Goldman Sachs reported $3.44 billion in earnings for the second quarter of 2009 provoked widespread outrage that was rather hard to avoid.  Even Jon Stewart saw fit to provide his viewers with an informative audio-visual presentation concerning the role of Goldman Sachs in our society.  Allan Sloan pointed out that in addition to the $10 billion Goldman received from the TARP program, (which it repaid) Goldman also received another $12.9 billion as a counterparty to AIG’s bad paper (which it hasn’t repaid). Beyond that, there was the matter of “the Federal Reserve Board moving with lightning speed last fall to allow Goldman to become a bank holding company”.   Sloan lamented that despite this government largesse, Goldman is still fighting with the Treasury Department over how much it should pay taxpayers to buy back the stock purchase warrants it gave the government as part of the TARP deal.  The Federal Reserve did more than put Goldman on the fast track for status as a bank holding company (which it denied to Lehman Brothers, resulting in that company’s bankruptcy).  As Lisa Lerer reported for Politico, Senator Bernie Sanders questioned whether Goldman received even more assistance from the Federal Reserve.  Because the Fed is not subject to transparency, we don’t know the answer to that question.

A commentator writing for the Seeking Alpha website under the pseudonym:  Cynicus Economicus, expressed the opinion that people need to look more at the government and the Federal Reserve as being “at the root of the appearance of the bumper profits and bonuses at Goldman Sachs.”  He went on to explain:

All of this, hidden in opacity, has led to a point at which insolvent banks are now able to make a ‘profit’.  Exactly why has this massive bleeding of resources into insolvent banks been allowed to take place?  Where exactly is the salvation of the real economy, the pot of gold at the end of the rainbow of the financial system?  Like the pot of gold and the rainbow, if we just go a bit further…..we might just find the pot of gold.

In this terrible mess, the point that is forgotten is what a financial system is actually really for.  It only exists to allocate accumulated capital and provision of insurances; the financial system should be a support to the real economy, by efficiently allocating capital.  It is entirely unclear how pouring trillions of dollars into insolvent institutions, capital which will eventually be taken out of the ‘real’ economy, might facilitate this.  The ‘real’ economy is now expensively supporting the financial system, rather than the financial system supporting the real economy.

The opacity of the Federal Reserve has become a focus of populist indignation since the financial crisis hit the meltdown stage last fall.  As I discussed on May 25, Republican Congressman Ron Paul of Texas introduced the Federal Reserve Transparency Act (HR 1207) which would give the Government Accountability Office the authority to audit the Federal Reserve as well as its member components, and require a report to Congress by the end of 2010.  Meanwhile, President Obama has suggested expanding the Fed’s powers to make it the nation’s “systemic risk regulator” overseeing banks such as Goldman Sachs, deemed “too big to fail”.  The suggestion of expanding the Fed’s authority in this way has only added to the cry for more oversight.  On July 17, Willem Buiter wrote a piece for the Financial Times entitled:  “What to do with the Fed”.  He began with this observation:

The desire for stronger Congressional oversight of the Fed is no longer confined to a few libertarian fruitcakes, conspiracy theorists and old lefties.  It is a mainstream view that the Fed has failed to foresee and prevent the crisis, that it has managed it ineffectively since it started, and that it has allowed itself to be used as a quasi-fiscal instrument of the US Treasury, by-passing Congressional control.

Since the introduction of HR 1207, a public debate has ensued over this bill.  This dispute was ratcheted up a notch when a number of economics professors signed a petition, urging Congress and the White House “to reaffirm their support for and defend the independence of the Federal Reserve System as a foundation of U.S. economic stability.”  An interesting analysis of this controversy appears at LewRockwell.com, in an article by economist Robert Higgs.  Here’s how Higgs concluded his argument:

All in all, the economists’ petition reflects the astonishing political naivite and historical myopia that now characterize the top echelon of the mainstream economics profession. Everybody now understands that economic central planning is doomed to fail; the problems of cost calculation and producer incentives intrinsic to such planning are common fodder even for economists in upscale institutions.  Yet, somehow, these same economists seem incapable of understanding that the Fed, which is a central planning body working at the very heart of the economy — its monetary order — cannot produce money and set interest rates better than free-market institutions can do so.  It is high time that they extended their education to understand that central planning does not work — indeed, cannot work — any better in the monetary order than it works in the economy as a whole.

It is also high time that the Fed be not only audited and required to reveal its inner machinations to the people who suffer under its misguided actions, but abolished root and branch before it inflicts further centrally planned disaster on the world’s people.

Close down the Federal Reserve?  It’s not a new idea.  Back on September 29, when the Emergency Economic Stabilization Act of 2008 was just a baby, Avery Goodman posted a piece at the Seeking Alpha website arguing for closure of the Fed.  The article made a number of good points, although this was my favorite:

The Fed balance sheet shows that it injected a total of about $262 billion, probably into the stock market, over the last two weeks, pumping up prices on Wall Street.  The practical effect will be to allow people in-the-know to sell their equities at inflated prices to people-who-believe-and-trust, but don’t know.  Sending so much liquidity into the U.S.economy will stoke the fires of hyperinflation, regardless of what they do with interest rates.  In a capitalist society, the stock market should not be subject to such manipulation, by the government or anyone else.  It should rise and fall on its own merits.  If it is meant to fall, let it do so, and fast.  It is better to get the economic downturn over with, using shock therapy, than to continue to bleed the American people slowly to death through a billion tiny pinpricks.

So the battle over the Fed continues.  In the mean time, as The Washington Post reports, Fed Chairman Ben Bernanke takes his show on the road, making four appearances over the next six days.  Tuesday and Wednesday will bring his semiannual testimony on monetary policy before House and Senate committees.  Perhaps he will be accompanied by Goldman Sachs CEO, Lloyd Bankfiend, who could show everyone the nice “green shoots” growing in his IRA at taxpayer expense.

More Bad Press For Goldman Sachs

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July 16, 2009

They can’t seem to get away from it, no matter how hard they try.  Goldman Sachs is finding itself confronted with bad publicity on a daily basis.

It all started with Matt Taibbi’s article in Rolling Stone.  As I pointed out on June 25, I liked the article as well as Matt’s other work.  His blog can be found here.  His article on Goldman Sachs employed a good deal of hyperbolic rhetoric which I enjoyed  —  especially the metaphor of Goldman Sachs as a “great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money”.  Nevertheless, many commentators took issue with the article, especially focusing on the subtitle’s claim that “Goldman Sachs has engineered every major market manipulation since the Great Depression”.  I took that remark as hyperbole, since it would obviously require over 120 megabytes of space to document “every major market manipulation since the Great Depression” — so I wasn’t disappointed about being unable to read all that.  Some of Taibbi’s critics include Megan McArdle from The Atlantic and Joe Weisenthal at Clusterstock.

On the other hand, Taibbi did get a show of support from Eliot “Socks” Spitzer during a July 14 interview on Bloomberg TV.  Mr. Spitzer made some important points about Goldman’s conduct that we are now hearing from a number of other sources.  Spitzer began by emphasizing that because of the bank bailouts “Goldman’s capital was driven to virtually nothing — because we as taxpayers gave them access to capital — they made a bloody fortune” (another vampire squid reference).  Spitzer voiced the concern that Goldman is simply going back to proprietary trading and taking advantage of spreads, following its old business model.  He argued that, a result of the bailouts:

. . . their job should be, from a macroeconomic perspective, to raise capital and put it into sectors that create jobs.  If they’re not getting that done, then why are we supporting them the way we have been?

This sentiment seems to be coming from all directions, in light of the fact that on July 14, Goldman reported second-quarter profits of 3.44 billion dollars — while on the following day, another TARP recipient, CIT Group disclosed that it would likely file for bankruptcy on July 17.  On July 16, The Wall Street Journal ran an editorial entitled:  “A Tale of Two Bailouts” comparing Goldman’s fate with that of CIT.  The article pointed out that since Goldman’s risk is subsidized by the taxpayers, the company might be more appropriately re-branded as “Goldie Mac”:

We like profits as much as the next capitalist.  But when those profits are supported by government guarantees or insured deposits, taxpayers have a special interest in how the companies conduct their business.  Ideally we would shed those implicit guarantees altogether, along with the very notion of too big to fail.  But that is all but impossible now and for the foreseeable future.  Even if the Obama Administration and Fed were to declare with one voice that banks such as Goldman were on their own, no one would believe it.

If there is a lesson in this week’s tale of two banks, it’s that it won’t be enough to give the Federal Reserve a mandate to “monitor” systemic risk.  Last fall’s bailouts are reverberating through the financial system in a way that is already distorting the competition for capital and financial market share.  Banks that want to be successful will also want to be more like Goldman Sachs, creating an incentive for both larger size and more risk-taking on the taxpayer’s dime.

Robert Reich voiced similar concern over the fact that “Goldman’s high-risk business model hasn’t changed one bit from what it was before the implosion of Wall Street.”  He went on to explain:

Value-at-risk — a statistical measure of how much the firm’s trading operations could lose in a day — rose to an average of  $245 million in the second quarter from $240 million in the first quarter. In the second quarter of 2008, VaR averaged $184 million.

Meanwhile, Goldman is still depending on $28 billion in outstanding debt issued cheaply with the backing of the Federal Deposit Insurance Corporation.  Which means you and I are still indirectly funding Goldman’s high-risk operations.

*   *   *

So the fact that Goldman has reverted to its old ways in the market suggests it has every reason to believe it can revert to its old ways in politics, should its market strategies backfire once again — leaving the rest of us once again to pick up the pieces.

At The Huffington Post, Mike Lux reminded Goldman that despite its repayment of $10 billion in TARP funds, we haven’t overlooked the fact that Goldman has not repaid the $13 billion it received for being a counterparty to AIG’s bad paper or the “unrevealed billions” it received from the Federal Reserve.  This raises a serious question as to whether Goldman should be allowed to pay record bonuses to its employees, as planned.  Didn’t we go through this once beforePaul Abrams is mindful of this, having issued a wake-up call to “Turbo” Tim Geithner and Congress.

As long as we keep reading the news, each passing day provides us with yet another reminder to feel outrage over the hubris of the people at Goldman Sachs.

Reality Check

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July 13, 2009

Have you become sick of hearing about the “green shoots”?   Back on March 15, Federal Reserve Chairman Ben Bernanke appeared on 60 Minutes and made the self-serving, self-congratulatory claim that “green shoots” could be found in the economy.  I guess we’re supposed to thank him for all the extra money printing he had mandated, to facilitate this claimed result.  While we normal people continued to cope with ongoing job losses, an almost nonexistent job market, unavailable mortgages, a constipated real estate market and fear about the future   . . .   Chairman Bernanke was trying to sell us on some good news.  Since that time, the expression “green shoots” has been the mantra for those pundits who, for whatever reason, want the naive public to believe in the emperor’s new clothes.  The usual motive for chatting up the “green shoots” is to encourage a widespread popular return to investing in the stock market and by so doing, make life more rewarding for those at brokerage firms.

This week brings us a “reality check” that will come in the form of earnings reports from the second quarter of 2009, required for disclosure by publicly-held corporations, traded on our nation’s stock exchanges.  Recent news reports have focused on the fact that despite the “bear market rally” that began in May, last week’s drop in stock prices revealed widespread investor concern that the truth will not support all the hype they have been reading since the spring.  Here’s what E.S. Browning had to say in the July 8 edition of The Wall Street Journal:

Expectations for the current earnings season are very low, and investors are worried companies will give weak outlooks for the second half of the year.

“We kind of think the market got ahead of itself.  It ran too fast, too hard, and we are soon going to be staring at second-quarter earnings reports that are not going to be pretty,” said Janna Sampson, who helps oversee $1.3 billion as co-chief investment officer of OakBrook Investments in Lisle, Ill.

After the market bottomed March 9, investors increasingly embraced risky assets, bidding up stocks, especially those of smaller companies with little or no profit.

Those unfortunate investors were hit by two “sucker punches”.  The first was the often-repeated claim that “stocks are now a bargain  . . .  we’ve hit the bottom so now is the time to BUY!”  The second sucker punch involved the use of high-speed trading programs (such as the one recently stolen from Goldman Sachs) to run up the prices on stocks and exploit “retail investors” such as you and me.  An astute explanation of this process was recently published by Sal Arnuk and Joseph Saluzzi of Themis Trading.  You can read that report here.  What’s even more interesting about the computer program used by (and stolen from) Goldman Sachs, is the statement made by Assistant U.S.Attorney Joseph Facciponti, as quoted in the July 6 article by David Glovin and Christine Harper for Bloomberg News:

“The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways,” Facciponti said, according to a recording of the hearing made public today.

So Goldman Sachs has a computer program that allows the user to “manipulate the markets in unfair ways”?  That’s quite a revelation!  If that weren’t bad enough  . . .  according to a recent report by Tyler Durden at Zero Hedge, Goldman Sachs is not the only kid on the block with a high-frequency trading program.

Alexendra Twin of CNN (in addition to providing us with a schedule of earnings reports and other important economic data to be released over this week and next) pointed out another important reason for last spring’s stock market rally, which is not likely to be a factor this month:

Last quarter, analysts and corporations alike ratcheted down forecasts, setting up a period in which a greater percentage of companies than usual beat forecasts.  But this quarter could be different.  Fewer companies have been cutting forecasts and analysts haven’t budged as much either, giving corporations less of an opportunity to defy expectations.

“The question is whether we’ll see a similar surprise factor this time,” said John Butters, senior research analyst at Thomson Reuters. “If companies haven’t cut and analysts haven’t cut, can results beat forecasts?”

My take on this process is a bit more cynical:  the system is being “gamed” by companies’ providing artificially low estimates for future earnings, in order to win at what commentator Bill Fleckenstein calls “beat the number”.

Once we have read about all these reports  —  will we finally stop hearing about “green shoots”?  I have my money on bad economic news, as I continue to maintain my position in the SRS exchange-traded fund.  Nevertheless, I’m keeping one hand on the ripcord, ready to bail out at any minute.

The Scary Stuff

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July 6, 2009

During the past week, a good number of Americans had been soothing themselves in Michael Jackson nostalgia  . . .  others watched tennis, many were intrigued by the military coup in Honduras and everyone tried to figure out what was going on in Sarah Palin’s mind.  Meanwhile  . . .  there was some really scary stuff in the news.  With Fourth of July behind us, it’s time to start looking forward to Halloween.  We need not look very far to get a good scare.  Those of us who still have jobs are afraid they may lose them.  Those who have lost their jobs wonder how long they can stay afloat before chaos finally takes over.  Many wise people, despite their comfortable positions in life (for now) have been discussing these types of problems lately.  Their opinions and outlooks are getting more and more ink (or electrons) as the economic crisis continues to unfold.

As we look at the current situation,  let’s check in with the guy who has the biggest mouth.  During an interview on ABC’s This Week with George Stephanopoulos, Vice-President Joe Biden admitted that “we and everyone else misread the economy”:

Biden acknowledged administration officials were too optimistic earlier this year when they predicted the unemployment rate would peak at 8 percent as part of their effort to sell the stimulus package.  The national unemployment rate has ballooned to 9.5 percent in June  —  the worst in 26 years.

This was basically a concession, validating the long-standing criticism by economists such as Nouriel Roubini (a/k/a “Dr.Doom”) who refuted the administration’s view of this crisis.  Many economists (including Roubini) have emphasized the administration’s unrealistic perception of the unemployment problem as a primary flaw in the “bank stress tests” as established by Treasury Secretary “Turbo” Tim Geithner.  Now we’re finding out how ugly this picture really is.  Here are some points raised by Dr. Roubini on July 2:

The June employment report suggests that the alleged “green shoots” are mostly yellow weeds that may eventually turn into brown manure.  The employment report shows that conditions in the labor market continue to be extremely weak, with job losses in June of over 460,000.

*   *   *

The other important aspect of the labor market is that if the unemployment rate is going to peak around 11 percent next year, the expected losses for banks on their loans and securities are going to be much higher than the ones estimated in the recent stress tests.  You plug an unemployment rate of 11 percent in any model of loan losses and recovery rates and you get very ugly losses for subprime, near-prime, prime, home equity loan lines, credit cards, auto loans, student loans, leverage loans, and commercial loans — much bigger numbers than what the stress tests projected.

In the stress tests, the average unemployment rate next year was assumed to be 10.3 percent in the most adverse scenario. We’ll be already at 10.3 percent by the fall or the winter of this year, and certainly well above that and close to 11% at some point next year.

*   *   *

The job market report is essentially the tip of the iceberg.  It’s a significant signal of the weaknesses in the economy.  It affects consumer confidence.  It affects labor income.  It affects consumption.  It affects the willingness of firms to start increasing production.  It has significant consequences of the housing market.  And it has significant consequences, of course, on the banking system.

*   *   *

But eventually, large budget deficits and their monetization are going to lead — towards the end of next year and in 2011 — to an increase in expected inflation that may lead to a further increase in ten-year treasuries and other long-term government bond yields, and thus mortgage and private-market rates.  Together with higher oil prices driven up in part by this wall of liquidity rather than fundamentals alone, this could be a double whammy that could push the economy into a double-dip or W-shaped recession by late 2010 or 2011.   So the outlook for the US and global economy remains extremely weak ahead.  The recent rally in global equities, commodities and credit may soon fizzle out as an onslaught of worse-than-expected macro, earnings and financial news take a toll on this rally,which has gotten way ahead of improvement in actual macro data.

All right  .  .  .   So you may be thinking that this is exactly the type of pessimism we can expect from someone with the nickname “Dr. Doom”.  However, if you take a look at the July 2 article by Tom Lindmark on the Seeking Alpha website, you will find some important concurrence.  Mr. Lindmark discussed his own observation about the unemployment crisis:

All of these people do have to find jobs again sometime and I suspect, as do many others, that the numbers understate the extent of the problem.  There are a lot of people working for ten or twelve bucks an hour that used to make multiples of those numbers.  That’s what you do to survive.   So as we all probably know intuitively, the truth is worse than the picture the numbers paint.

Lindmark included the reactions of several economists to the latest unemployment data, as quoted from The Wall Street Journal Real Time Economics Blog.  It’s more of the same — not happy stuff.  Federal Reserve Chairman Ben Bernanke’s self-serving, self-congratulatory claim that “green shoots” could be found in the economy was made during a discussion on 60 Minutes back on March 15.  That’s what you call:   “premature shoots”.

Just in case you aren’t getting scared yet, take a look at what Ambrose Evans-Pritchard had to say in the Telegraph UK.  He draws our reluctant attention to the possibility that there might just be a violent reaction from the masses, once the ugliness of our situation finally sets in:

One dog has yet to bark in this long winding crisis.  Beyond riots in Athens and a Baltic bust-up, we have not seen evidence of bitter political protest as the slump eats away at the legitimacy of governing elites in North America, Europe, and Japan.  It may just be a matter of time.

One of my odd experiences covering the US in the early 1990s was visiting militia groups that sprang up in Texas, Idaho, and Ohio in the aftermath of recession.  These were mostly blue-collar workers, —  early victims of global “labour arbitrage” — angry enough with Washington to spend weekends in fatigues with M16 rifles.  Most backed protest candidate Ross Perot, who won 19pc of the presidential vote in 1992 with talk of shutting trade with Mexico.

The inchoate protest dissipated once recovery fed through to jobs, although one fringe group blew up the Oklahoma City Federal Building in 1995.  Unfortunately, there will be no such jobs this time.  Capacity use has fallen to record-low levels (68pc in the US,71 in the eurozone).  A deep purge of labour is yet to come.

*   *   *

The Centre for Labour Market Studies (CLMS) in Boston says US unemployment is now 18.2pc, counting the old-fashioned way.  The reason why this does not “feel” like the 1930s is that we tend to compress the chronology of the Depression.  It takes time for people to deplete their savings and sink into destitution.  Perhaps our greater cushion of wealth today will prevent another Grapes of Wrath, but 20m US homeowners are already in negative equity (zillow.com data).  Evictions are running at a terrifying pace.

Some 342,000 homes were foreclosed in April, pushing a small army of children into a network of charity shelters.  This compares to 273,000 homes lost in the entire year of 1932. Sheriffs in Michigan and Illinois are quietly refusing to toss families on to the streets, like the non-compliance of Catholic police in the Slump.

*   *   *

The message has not reached Wall Street or the City.  If bankers know what is good for them, they will take a teacher’s salary for a few years until the storm passes.  If they proceed with the bonuses now on the table, even as taxpayers pay for the errors of their caste, they must expect a ferocious backlash.

Do you think those bankers are saying “EEEEEK!” yet?  They probably aren’t.  Many other similarly-situated individuals are likely turning the page to have a look at the action in “emerging markets”.  Nevertheless, Mr. Evans-Pritchard, in another piece, exposed the hopelessness of those expectations:

Russia is sinking into a swamp of bad loans.

The scale of credit rot in the Russian banking system exposed by Fitch Ratings this week is truly staggering.  The report is yet another cold douche to those betting that the BRICs (Brazil, Russia, India, and China) can pull us out of our mess.

So there you have it.  You wanted to see Thriller again?  Now you have it in real life.  This time, neither Boris Karloff nor Michael Jackson will be around to keep it “lite”.  This is our reality in July of 2009.  Hang on.

Painting The Tape

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July 2, 2009

Would you be willing to wager your life savings on pro-wrestling matches?  That is basically what you are doing when you invest in the stock market these days.  The game is being rigged.  If you are just a “retail investor” or “little guy”, you run the risk of having your investment in this “bear market rally” significantly diminish in the blink of an eye.  Regular readers of this blog (all four of them) know that this is one of my favorite subjects.  In my posting on May 21, I recalled feeling a little paranoid last December when I wrote this:

Do you care to hazard a guess as to what the next Wall Street scandal might be?  I have a pet theory concerning the almost-daily spate of “late-day rallies” in the equities markets.  I’ve discussed it with some knowledgeable investors.  I suspect that some of the bailout money squandered by Treasury Secretary Paulson has found its way into the hands of some miscreants who are using this money to manipulate the stock markets.  I have a hunch that their plan is to run up stock prices at the end of the day before those numbers have a chance to settle back down to the level where the market would normally have them.  The inflated “closing price” for the day is then perceived as the market value of the stock. This plan would be an effort to con investors into believing that the market has pulled out of its slump.  Eventually the victims would find themselves hosed once again at the next “market correction”.  I don’t believe that SEC Chairman Christopher Cox would likely uncover such a scam, given his track record.

After my last posting about this subject on May 21, I have continued to read quite a number of opinions by authoritative sources, echoing my belief that the stock market is being manipulated.  Tyler Durden at Zero Hedge has been quite diligent about exposing incidents of “tape painting”.  Some examples appear here and here.  In case you don’t know what is meant by “painting the tape”, here is a definition:

An illegal action by a group of market manipulators buying and/or selling a security among themselves to create artificial trading activity, which, when reported on the ticker tape, lures in unsuspecting investors as they perceive an unusual volume.

After causing a movement in the security, the manipulators hope to sell at a profit.

As one might expect, this activity is more easily accomplished on days when trading volume is low.  On June 11, Craig Brown had this to say about the subject on the Seeking Alpha website:

I have read some posts about some suspicions on perhaps some entities painting the tape. Volume has been light so it is something that could happen. We will see if these conspiracy theories play out.

Regular readers of Zero Hedge (it’s on my blogroll, at the right) had the opportunity to see some televised interviews during the past few days, when professionals have complained about “tape painting” in the equities markets.  On Monday, June 29, we saw on (of all places) CNBC, a discussion with Larry Levin, a futures trader on the Chicago Mercantile Exchange.  I would consider CNBC the last place to criticize “pumping” of stock prices, since their commentary often seems designed to do just that.  Nevertheless, watch and listen to what Larry Levin had to say at 2:22 into this video clip.  He explains that “this market continues to be propped up by government intervention and manipulation” and he unequivocally accuses the Obama administration of acting to “prop this market up on a daily basis”.  Again, on Wednesday, July 1, visitors to the Zero Hedge website had the opportunity to see this June 30 clip from Bloomberg TV, wherein Joe Saluzzi of Themis Trading noted that “you’ve got government forecasts that are intentionally misleading us, constantly”.    He went on to emphasize that the trading volume we see every day is “fictitious — it’s not real”.  He explained the potential hazards to retail investors caused by trading programs that “artificially inflate the prices” of stocks, although a “news event” could cause that program trading to abruptly reverse, erasing a valuable portion of the retail investors’ assets.

On June 24, Bret Rosenthal posted an article on the HedgeCo.net website, entitled:  “Coping With Government-Sponsored Market Manipulation”.  Here’s some of what he had to say:

We must not allow the government manipulations to cloud our judgement and sucker us into investments that have no hope of success over time.  Example:  the government-sponsored rally in the financials over the last 3+ months was clearly created to help the banking sector raise capital.  Again, if you wish to argue this point I suggest you go down to the water’s edge and scream at the tide.  Massive amounts of capital were raised through the secondary markets for financial companies in the last 30 days.  This is a simple fact. Now that this manipulation is complete and private capital has been sucked in where will the equity markets go?

The best advice for the retail investor, attempting to navigate through the current “bear market rally” was provided by Graham Summers, Senior Market Strategist at OmniSans Investment Research, in this July 1 posting at the Seeking Alpha website:

This rally has sucker punched the shorts countless times now, particularly when it comes to late-day market manipulation.  In a nutshell, every time stocks begin showing signs of breaking down, someone steps in, usually during the final 30 minutes of trading, to push the market back into positive territory.  So while economic fundamentals indicate we’ve come much too far too fast, it’s hard to make money trading based on this information.

*   *   *

To rephrase the above thoughts, stocks are currently trading where they should be a full year from now assuming that the economy turns around this fall.  This hardly makes a strong case for greater gains or more upward momentum.  But it’s hard to go short with the historic rig that is currently taking place in the market.

So my advice to anyone right now is to stay put.  This week is a wash anyhow due to it being short and due to performance gaming:  portfolio managers and institutional investors pushing stocks higher so they can close out the quarter with gains on their positions.  Indeed, yesterday’s market volume on the NYSE was the lowest we’ve seen since January 5, 2009.

So don’t open any new positions for now.  This week will be exceedingly choppy.  And with volume drying up to a trickle, there is potential for some violent swings as the big boys play around with their end of the quarter shenanigans.  You don’t want to be on the wrong side of one of those swings.

Meanwhile, I’ve been watching my investment in the SRS exchange-traded fund (which inversely tracks the IYR real estate index, at twice the magnitude) unwind during the past few days, erasing the nice profit I made just after getting into it.  Will I bail?  Nawww!  I’m waiting for that “news event” to turn things around.