As President Obama wraps-up his second term, people are looking back to reassess his handling of the Great Recession. During his first year in office, our Disappointer-In-Chief introduced his own version of “trickle-down economics” by way of a bank bailout scheme called the Public-Private Investment Program (PPIP or “pee-pip”).
Despite his July 15, 2008, campaign promise that if he were elected, there would be “no more trickle-down economics”, the President and the Federal Reserve embarked on a course of bailing out the banks, rather than distressed businesses or the taxpayers themselves.
As this writer pointed out on Sept. 21, 2009, Australian economist Steve Keen published a report from his website explaining how the “money multiplier” myth, fed to Obama by the very people who facilitated the financial crisis, would be of no use in the effort to strengthen the economy.
Concerns that the United States could be doomed to a Japan-like addiction to monetary stimulus gimmicks have amped-up enthusiasm for the Fed to become more aggressive about raising interest rates. Meanwhile, many economists contend that tightening monetary policy before the economy reaches a robust state could plunge the nation back into recession.
In April 2016, former Federal Reserve Chairman Ben Bernanke advocated the use of “helicopter money” as a last-resort strategy to jump-start a stalled economy. This provoked a response from economist Steve Keen emphasizing that Bernanke and other mainstream economists have shared a flawed belief that the public’s expectations for a healthy rate of inflation could cause such inflation to occur. In other words: “Inflationary expectations cause inflation.”
Steve Keen consistently emphasizes the need to understand how excessive private debt causes severe economic contraction and financial crises. Specifically, when the level of private debt exceeds GDP by 150% and that level continues to grow – disaster awaits.
So what can be done to keep the debt-to-GDP ratio in check? In this video, Steve Keen and Edward Harrison of the Credit Writedowns website explain how Ben Bernanke’s helicopter could be sent on a debt reduction mission.
You can’t avoid reading about it. The stock market is sinking . . . Treasury bond yields are spiking . . . The TAPER is coming!
The panic began in the wake of Jon Hilsenrath’s May 10 Wall Street Journal report (after the markets closed on that Friday afternoon) concerning a new strategy by the Federal Reserve to “wind down” its quantitative easing program. The disclosure was carefully timed to give investors an opportunity to process the information and get used to the idea before the next opening bell of the stock market.
By the time the stock market reopened on Monday, May 13 – the first trading day after Jon Hilsenrath’s article – there was a surprising report on April Retail Sales from the Commerce Department’s Census Bureau. The report disclosed that retail sales had unexpectedly increased by 0.1 percent in April, despite economists’ expectations of a 0.3 percent decline. As a result, the Taper report had no significant impact on stock prices – at least on that day.
The Wall Street Journal report carried plenty of weight because of Jon Hilsenrath’s role as de facto “press secretary” for Ben Bernanke, as I discussed in my last posting. Since the WSJ article’s publication, there has been a steady stream of commentary about the threats posed by the Taper. Nevertheless, the word “taper” was never used in Hilsenrath’s article. In fact, the article included an explanation by Philly FedHead (and FOMC member) Charles Plosser, that the Fed has “a dial that can move either way”. The dial could be set to a particular level with either an increase or a decrease.
Regardless of whatever the Fed may have planned, the flow of commentary has focused on the notion that the Fed is about to taper back on its bond buying. The current incarnation of quantitative easing (QE 4) involves the Fed’s purchase of $45 billion in bonds and $40 billion in mortgage-backed securities every month. We are supposed to believe that the Fed will gradually ease back on the bond purchases – whether it might begin with a reduction to $40 billion or $35 billion in monthly purchases . . . the Fed will gradually taper the amount down to zero.
Despite what you may have read or heard about the taper, it’s not going to work that way. Beyond that, taper is not really an appropriate way to describe the Fed’s plan. In other words:
There was one thing Jon Hilsenrath did say in my interview with him on TV last night that I think is very important and clears up a big misconception. He explained that Bernanke himself will not be using the term “taper” that everyone else is bandying about. The reason why is that the Fed does not want to create the impression that one policy move will necessarily be attached to three or four others. In other words, suppose the Fed were to drop its rate of monthly asset purchases from $85 billion to some less number in one of the next meetings. This could be a one-off action with nothing else behind it, designed to temper the market’s expectations and gauge the effects.
I’d remind you that what Bernanke, as a self-styled “student of the Depression” fears the most, is a premature tightening a la FDR in 1937-1938, just as the nation was finally on the mend. If you think that this central bank, which has just spent the last six years patiently reflating the economy, is about to yank the rug out from under it at the last moment, then you haven’t been paying attention.
The wave of panic which followed Jon Hilsenrath’s May 10 article about the Fed’s plans for its quantitative easing program has yet to be calmed by Hilsenrath’s clarification about how the Fed’s new strategy is likely to proceed. As Napoleon once said:
“Men are Moved by two levers only: fear and self interest.”
We recently saw a demonstration of how important the quantitative easing program has been to investors. On Thursday, May 9, both the Dow Jones Industrial Average and the S&P 500 fell from intraday record highs during the last 90 minutes of the session. Philadelphia Federal Reserve president Charles Plosser announced that he would join forces with Kansas City FedHead Esther George to advocate attenuation of the quantitative easing program at the June 18 FOMC meeting. The news definitely spooked the stock market.
Friday’s report from Hilsenrath/Bernanke gave investors a chance to process what was being disclosed and to get comfortable with the idea that quantitative easing will not go on forever. The leak was obviously timed to provide a decent interval before the stock market opened again. There is no definite plan in place to end the quantitative easing program by any particular date, nor is there a planned date for the inception of the wind-down being discussed. Here is a bit of how Hilsenrath explained what is taking place:
Officials are focusing on clarifying the strategy so markets don’t overreact about their next moves. For example, officials want to avoid creating expectations that their retreat will be a steady, uniform process like their approach from 2003 to 2006, when they raised short-term interest rates in a series of quarter-percentage-point increments over 17 straight policy meetings.
Hilsenrath’s quote of Dallas FedHead Richard Fisher’s explanation of the plan was beautiful: “I don’t want to go from wild turkey to cold turkey“.
Bruce Krasting was the first to begin spreading panic and misinformation about Hilsenrath’s report. Here’s an example:
The Fed’s new plan is to taper off QE over the balance of the year.
Of course, the foregoing statement is completely untrue. Hilsenrath never said that. Does Bruce Krasting have his own source on the Federal Reserve Board, who is leaking secret information to him?
Perhaps we might see some of Bernanke’s foes initiate a Congressional inquiry into the “Tapergate scandal”. What did Jon Hilsenrath know and when did he know it?
For a long time, Hilsenrath’s role as Ben Bernanke’s de facto press secretary has been a subject of cynical commentary. Many have joked that Hilsenrath will replace Bernanke when he retires. At Bernanke’s press conferences which follow the FOMC meetings, I keep expecting to hear the moderator announce that the next question will come from Jon Hilsenrath of The Wall Street Journal . . . Hilsenrath would then take the microphone and say:
You know, Ben – that last question just reminded me of another matter which would be really important to these people . . .
Meanwhile, back in the real world, stock market investors are being confronted with the challenge of taking baby steps toward the idea of life without quantitative easing. At the same time – as Jon Hilsenrath explained – the Fed is attempting to reach a decision on when to begin such a tapering effort.
Quantitative easing is back. For those of you who still aren’t familiar with what quantitative easing is, I have provided a link to this short, funny cartoon, which explains everything.
The first two phases of quantitative easing brought enormous gains to the stock market. In fact, that was probably all they accomplished. Nevertheless, if there had been no QE or QE 2, most people’s 401(k) plans would be worth only a fraction of what they are worth today. The idea was that the “wealth effect” provided by an inflated stock market would both enable and encourage people to buy houses, new cars and other “big ticket” items – thus bringing demand back to the economy. Since the American economy is 70 percent consumer-driven, demand is the engine that creates new jobs.
It took a while for most of us to understand quantitative easing’s impact on the stock market. After the Fed began its program to buy $600 billion in mortgage-backed securities in November of 2008, some suspicious trading patterns began to emerge. I voiced my own “conspiracy theory” back on December 18, 2008:
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”.
Felix Salmon eventually provided this critique of the obsession with closing levels and – beyond that – the performance of a stock on one particular day:
Or, most invidiously, the idea that the most interesting and important time period when looking at the stock market is one day. The single most reported statistic with regard to the stock market is where it closed, today, compared to where it closed yesterday. It’s an utterly random and pointless number, but because the media treats it with such reverence, the public inevitably gets the impression that it matters.
In March of 2009, those suspicious “late day rallies” returned and by August of that year, the process was explained as the “POMO effect” in a paper by Precision Capital Management entitled, “A Grand Unified Theory of Market Manipulation”.
By the time QE 2 actually started on November 12, 2010 – most investors were familiar with how the game would be played: The New York Fed would conduct POMO auctions, wherein it would purchase Treasury securities – worth billions of dollars – on an almost-daily basis. After the auctions, the Primary Dealers would take the sales proceeds to their proprietary trading desks, where the funds would be leveraged and used to purchase stocks. Thanks to QE 2, the stock market enjoyed another nice run.
This time around, QE 3 will involve the purchase of mortgage-backed securities, as did QE 1. Unfortunately, the New York Fed’s new POMO schedule is not nearly as informative as it was during QE1 and QE 2, when we were provided with a list of the dates and times when the POMO auctions would take place. Back then, the FRBNY made it relatively easy to anticipate when you might see some of those good-old, late-day rallies. The new POMO schedule simply informs us that “(t)he Desk plans to purchase $23 billion in additional agency MBS through the end of September.” We are also advised that with respect to the September 14 – October 11 time frame, “(t)he Desk plans to purchase approximately $37 billion in its reinvestment purchase operations over the noted monthly period.”
It is pretty obvious that the New York Fed does not want the “little people” partaking in the windfalls enjoyed by the prop traders for the Primary Dealers as was the case during QE 1 and QE 2. This probably explains the choice of language used at the top of the website’s POMO schedule page:
In order to ensure the transparency of its agency mortgage-backed securities (MBS) transactions, the Open Market Trading Desk (the Desk) at the New York Fed will publish historical operational results, including information on the transaction prices in individual operations, at the end of each monthly period shown in the table below.
In other words, the New York Fed’s idea of transparency does not involve disclosure of the scheduling of its agency MBS transactions before they occur. That information is none of your damned business!
For the past few years, a central mission of this blog has been to focus on Washington’s unending efforts to protect, pamper and bail out the Wall Street megabanks at taxpayer expense. From Maiden Lane III to TARP and through countless “backdoor bailouts”, the Federal Reserve and the Treasury Department have been pumping money into businesses which should have gone bankrupt in 2008. Worse yet, President Obama and Attorney General Eric Hold-harmless have expressed no interest in bringing charges against those miscreants responsible for causing the financial crisis. The Federal Reserve’s latest update to its Survey of Consumer Finances for 2010 revealed that during the period of 2007-2010, the median family net worth declined by a whopping thirty-eight percent. Despite the massive extent of wealth destruction caused by the financial crisis, our government is doing nothing about it.
I have always been a fan of economist John Hussman of the Hussman Funds, whose Weekly Market Comment essays are frequently referenced on this website. Professor Hussman’s most recent piece, “The Heart of the Matter” serves as a manifesto of how the financial crisis was caused, why nothing was done about it and why it is happening again both in the United States and in Europe. Beyond that, Professor Hussman offers some suggestions for remedying this unaddressed and unresolved set of circumstances. It is difficult to single out a passage to quote because every word of Hussman’s latest Market Comment is precious. Be sure to read it. What I present here are some hints as to the significance of this important essay:
The ongoing debate about the economy continues along largely partisan lines, with conservatives arguing that taxes just aren’t low enough, and the economy should be freed of regulations, while liberals argue that the economy needs larger government programs and grand stimulus initiatives.
Lost in this debate is any recognition of the problem that lies at the heart of the matter: a warped financial system, both in the U.S. and globally, that directs scarce capital to speculative and unproductive uses, and refuses to restructure debt once that debt has gone bad.
Specifically, over the past 15 years, the global financial system – encouraged by misguided policy and short-sighted monetary interventions – has lost its function of directing scarce capital toward projects that enhance the world’s standard of living. Instead, the financial system has been transformed into a self-serving, grotesque casino that misallocates scarce savings, begs for and encourages speculative bubbles, refuses to restructure bad debt, and demands that the most reckless stewards of capital should be rewarded through bailouts that transfer bad debt from private balance sheets to the public balance sheet.
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By our analysis, the U.S. economy is presently entering a recession. Not next year; not later this year; but now. We expect this to become increasingly evident in the coming months, but through a constant process of denial in which every deterioration is dismissed as transitory, and every positive outlier is celebrated as a resumption of growth. To a large extent, this downturn is a “boomerang” from the credit crisis we experienced several years ago. The chain of events is as follows:
Financial deregulation and monetary negligence -> Housing bubble -> Credit crisis marked by failure to restructure bad debt -> Global recession -> Government deficits in U.S. and globally -> Conflict between single currency and disparate fiscal policies in Europe -> Austerity -> European recession and credit strains -> Global recession.
In effect, we’re going into another recession because we never effectively addressed the problems that produced the first one, leaving us unusually vulnerable to aftershocks. Our economic malaise is the result of a whole chain of bad decisions that have distorted the financial markets in ways that make recurring crisis inevitable.
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Every major bank is funded partially by depositors, but those deposits typically represent only about 60% of the funding. The rest is debt to the bank’s own bondholders, and equity of its stockholders. When a country like Spain goes in to save a failing bank like Bankia – and does so by buying stock in the bank – the government is putting its citizens in a “first loss” position that protects the bondholders at public expense. This has been called “nationalization” because Spain now owns most of the stock, but the rescue has no element of restructuring at all. All of the bank’s liabilities – even to its own bondholders – are protected at public expense. So in order to defend bank bondholders, Spain is increasing the public debt burden of its own citizens. This approach is madness, because Spain’s citizens will ultimately suffer the consequences by eventual budget austerity or risk of government debt default.
The way to restructure a bank is to take it into receivership, write down the bad assets, wipe out the stockholders and much of the subordinated debt, and then recapitalize the remaining entity by selling it back into the private market. Depositors don’t lose a dime. While the U.S. appropriately restructured General Motors – wiping out stock, renegotiating contracts, and subjecting bondholders to haircuts – the banking system was largely untouched.
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If it seems as if the global economy has learned nothing, it is because evidently the global economy has learned nothing. The right thing to do, again, is to take receivership of insolvent banks and wipe out the stock and subordinated debt, using the borrowed funds to protect depositors in the event that the losses run deep enough to eat through the intervening layers of liabilities (which is doubtful), and otherwise using the borrowed funds to stimulate the economy after the restructuring occurs. We’re going to keep having crises until global leaders recognize that short of creating hyperinflation (which also subordinates the public, in this case by destroying the value of currency), there is no substitute for debt restructuring.
For some insight as to why the American megabanks were never taken into temporary receivership, it is useful to look back to February of 2010 when Michael Shedlock (a/k/a“Mish”) provided us with a handy summary of the 224-page Quarterly Report from SIGTARP (the Special Investigator General for TARP — Neil Barofsky). My favorite comment from Mish appeared near the conclusion of his summary:
Clearly TARP was a complete failure, that is assuming the goals of TARP were as stated.
My belief is the benefits of TARP and the entire alphabet soup of lending facilities was not as stated by Bernanke and Geithner, but rather to shift as much responsibility as quickly as possible on to the backs of taxpayers while trumping up nonsensical benefits of doing so. This was done to bail out the banks at any and all cost to the taxpayers.
Was this a huge conspiracy by the Fed and Treasury to benefit the banks at taxpayer expense? Of course it was, and the conspiracy is unraveling as documented in this report and as documented in AIG Coverup Conspiracy Unravels.
On January 29 2010, David Reilly wrote an article for Bloomberg BusinessWeek concerning the previous week’s hearing before the House Committee on Oversight and Government Reform. After quoting from Reilly’s article, Mish made this observation:
Most know I am not a big believer in conspiracies. I regularly dismiss them. However, this one was clear from the beginning and like all massive conspiracies, it is now in the light of day.
The idea of secret banking cabals that control the country and global economy are a given among conspiracy theorists who stockpile ammo, bottled water and peanut butter. After this week’s congressional hearing into the bailout of American International Group Inc., you have to wonder if those folks are crazy after all.
Wednesday’s hearing described a secretive group deploying billions of dollars to favored banks, operating with little oversight by the public or elected officials.
That “secretive group” is The Federal Reserve of New York, whose president at the time of the AIG bailout was “Turbo” Tim Geithner. David Reilly’s disgust at the hearing’s revelations became apparent from the tone of his article:
By pursuing this line of inquiry, the hearing revealed some of the inner workings of the New York Fed and the outsized role it plays in banking. This insight is especially valuable given that the New York Fed is a quasi-governmental institution that isn’t subject to citizen intrusions such as freedom of information requests, unlike the Federal Reserve.
At least in the Eurozone there is fear that the taxpayers will never submit to enhanced economic austerity measures, which would force the citizenry into an impoverished existence so that their increased tax burden could pay off the debts incurred by irresponsible bankers. In the United States there is no such concern. The public is much more compliant. Whether that will change is anyone’s guess.
Most investors have been lamenting the recent stock market swoon. The Dow Jones Industrial Average has given up all of the gains earned during 2012. The economic reports keep getting worse by the day. Yet, for some people all of this is good news . . .
You might find them scattered along the curbs of Wall Street . . . with glazed eyes . . . British teeth . . . and mysterious lesions on their skin. They approach Wall Street’s upscale-appearing pedestrians, making such requests as: “POMO?” . . . “Late-day rally?” . . . “Animal Spirits?” These desperate souls are the “POMO junkies”. Since the Federal Reserve concluded the last phase of quantitative easing in June of 2011, the POMO junkies have been hopeless. They can’t survive without those POMO auctions, wherein the New York Fed would purchase Treasury securities – worth billions of dollars – on a daily basis. After the auctions, the Primary Dealers would take the sales proceeds to their proprietary trading desks, where the funds would be leveraged and used to purchase high-beta, Russell 2000 stocks. You saw the results: A booming stock market – despite a stalled economy.
Since I first wrote about the POMO junkies last summer, they have resurfaced on a few occasions – only to slink back into the shadows as the rumors of an imminent Quantitative Easing 3 were debunked.
The recent spate of awful economic reports and the resulting stock market nosedive have rekindled hopes that the Federal Reserve will crank-up its printing press once again, for the long-awaited QE 3. Economist John Hussman discussed this situation on Monday:
At this point, the S&P 500 has achieved a cumulative total return of less than 10% since April 2010. Meanwhile, of course, there remains a great deal of faith in the “Bernanke put,” because even though it’s fairly obvious that QE has done nothing durable for the economy or the financial markets over the last couple of years, a hit of QE might at least be good for a few months of “risk on” delirium. If the American public can’t get thoughtful economic leadership, at least Wall Street’s speculative junkies can hope for a little taste of Q from Sugar Daddy.
One of the problems with QE here, however, is that it would essentially represent fiscal policy for the benefit of speculators, at taxpayer expense. To see this, note that the 10-year Treasury yield is now down to less than 1.5%. One wonders how Bernanke would be able to argue, with a straight face, that this is not low enough. Nevertheless, a 10-year bond has a duration of 8 years – meaning that each 100 basis point fluctuation in interest rates is associated with a change of about 8% in the price of the bond. So if you buy the bond and hold it for a full year, an interest rate change of of 1.5/8 = .1875, or less than 20 basis points, is enough to wipe out the annual interest and leave you with a negative total return.
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“QE3 – subsidizing banks and bond speculators at taxpayer expense” – there’s a pithy slogan. That doesn’t mean the Fed will refrain from more of its recklessness (which will be nearly impossible to reverse when it becomes necessary to do so), but does anyone actually believe by now that QE would improve the economy, durably elevate risky assets beyond a few months, or materially relieve global debt strains?
Obviously, the POMO junkies have no such concerns. Beyond that, the Federal Reserve’s “third mandate” – keeping the stock market bubble inflated – will be the primary factor motivating the decision, regardless of whether those asset prices hold for more than a few months.
The POMO junkies are finally going to score. As they do, a tragic number of retail investors will be led to believe that the stock market has “recovered”, only to learn – a few months down the road – that the latest bubble has popped.
Comments Off on Get Ready for the Next Financial Crisis
It was almost one year ago when Bloomberg News reported on these remarks by Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group:
“There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis,” Mobius said at the Foreign Correspondents’ Club of Japan inTokyotoday in response to a question about price swings. “Are the derivatives regulated? No. Are you still getting growth in derivatives? Yes.”
I have frequently complained about the failed attempt at financial reform, known as the Dodd-Frank Act. Two years ago, I wrote a piece entitled, “Financial Reform Bill Exposed As Hoax” wherein I expressed my outrage that the financial reform effort had become a charade. The final product resulting from all of the grandstanding and backroom deals – the Dodd–Frank Act – had become nothing more than a hoax on the American public. My essay included the reactions of five commentators, who were similarly dismayed. I concluded the posting with this remark:
The bill that is supposed to save us from another financial crisis does nothing to accomplish that objective. Once this 2,000-page farce is signed into law, watch for the reactions. It will be interesting to sort out the clear-thinkers from the Kool-Aid drinkers.
During the past few days, there has been a chorus of commentary calling for a renewed effort toward financial reform. We have seen a torrent of reports on the misadventures of The London Whale at JP Morgan Chase, whose outrageous derivatives wager has cost the firm uncounted billions. By the time this deal is unwound, the originally-reported loss of $2 billion will likely be dwarfed.
Former Secretary of Labor, Robert Reich, has made a hobby of writing blog postings about “what President Obama needs to do”. Of course, President Obama never follows Professor Reich’s recommendations, which might explain why Mitt Romney has been overtaking Obama in the opinion polls. On May 16, Professor Reich was downright critical of the President, comparing him to the dog in a short story by Sir Arthur Conan Doyle involving Sherlock Holmes, Silver Blaze. The President’s feeble remarks about JPMorgan’s latest derivatives fiasco overlooked the responsibility of Jamie Dimon – obviously annoying Professor Reich, who shared this reaction:
Not a word about Jamie Dimon’s tireless campaign to eviscerate the Dodd-Frank financial reform bill; his loud and repeated charge that the Street’s near meltdown in 2008 didn’t warrant more financial regulation; his leadership of Wall Street’s brazen lobbying campaign to delay the Volcker Rule under Dodd-Frank, which is still delayed; and his efforts to make that rule meaningless by widening a loophole allowing banks to use commercial deposits to “hedge” (that is, make offsetting bets) their derivative trades.
Nor any mention Dimon’s outrageous flaunting of Dodd-Frank and of the Volcker Rule by setting up a special division in the bank to make huge (and hugely profitable, when the bets paid off) derivative trades disguised as hedges.
Nor Dimon’s dual role as both chairman and CEO of JPMorgan (frowned on my experts in corporate governance) for which he collected a whopping $23 million this year, and $23 million in 2010 and 2011 in addition to a $17 million bonus.
Even if Obama didn’t want to criticize Dimon, at the very least he could have used the occasion to come out squarely in favor of tougher financial regulation. It’s the perfect time for him to call for resurrecting the Glass-Steagall Act, of which the Volcker Rule – with its giant loophole for hedges – is a pale and inadequate substitute.
And for breaking up the biggest banks and setting a cap on their size, as the Dallas branch of the Federal Reserve recommended several weeks ago.
This was Professor Reich’s second consecutive reference within a week to The Dallas Fed’s Annual Report, which featured an essay by Harvey Rosenblum, the head of the Dallas Fed’s Research Department and the former president of the National Association for Business Economics. Rosenblum’s essay provided an historical analysis of the events leading up to the 2008 financial crisis and the regulatory efforts which resulted from that catastrophe – particularly the Dodd-Frank Act. Beyond that, Rosenblum emphasized why those “too-big-to-fail” (TBTF) banks have actually grown since the enactment of Dodd-Frank:
The TBTF survivors of the financial crisis look a lot like they did in 2008. They maintain corporate cultures based on the short-term incentives of fees and bonuses derived from increased oligopoly power. They remain difficult to control because they have the lawyers and the money to resist the pressures of federal regulation. Just as important, their significant presence in dozens of states confers enormous political clout in their quest to refocus banking statutes and regulatory enforcement to their advantage.
Last year, former Kansas City Fed-head, Thomas Hoenig discussed the problems created by the TBTFs, which he characterized as “systemically important financial institutions” – or “SIFIs”:
… I suggest that the problem with SIFIs is they are fundamentally inconsistent with capitalism. They are inherently destabilizing to global markets and detrimental to world growth. So long as the concept of a SIFI exists, and there are institutions so powerful and considered so important that they require special support and different rules, the future of capitalism is at risk and our market economy is in peril.
Although the huge derivatives loss by JPMorgan Chase has motivated a number of commentators to issue warnings about the risk of another financial crisis, there had been plenty of admonitions emphasizing the risks of the next financial meltdown, which were published long before the London Whale was beached. Back in January, G. Timothy Haight wrote an inspiring piece for the pro-Republican Orange County Register, criticizing the failure of our government to address the systemic risk which brought about the catastrophe of 2008:
In response to widespread criticism associated with the financial collapse, Congress has enacted a number of reforms aimed at curbing abuses at financial institutions. Legislation, such as the Dodd-Frank and Consumer Protection Act, was trumpeted as ensuring that another financial meltdown would be avoided. Such reactionary regulation was certain to pacify U.S. taxpayers.
Unfortunately, legislation enacted does not solve the fundamental problem. It simply provides cover for those who were asleep at the wheel, while ignoring the underlying cause of the crisis.
More than three years after the calamity, have we solved the dilemma we found ourselves in late 2008? Can we rest assured that a future bailout will not occur? Are financial institutions no longer “too big to fail?”
Regrettably, the answer, in each case, is a resounding no.
The 9 largest U.S. banks have a total of 228.72 trillion dollars of exposure to derivatives. That is approximately 3 times the size of the entire global economy. It is a financial bubble so immense in size that it is nearly impossible to fully comprehend how large it is.
The multi-billion dollar derivatives loss by JPMorgan Chase demonstrates that the sham “financial reform” cannot prevent another financial crisis. The banks assume that there will be more taxpayer-funded bailouts available, when the inevitable train wreck occurs. The Federal Reserve will be expected to provide another round of quantitative easing to keep everyone happy. As a result, nothing will be done to strengthen financial reform as a result of this episode. The megabanks were able to survive the storm of indignation in the wake of the 2008 crisis and they will be able ride-out the current wave of public outrage.
As Election Day approaches, Team Obama is afraid that the voters will wake up to the fact that the administration itself is to blame for sabotaging financial reform. They are hoping that the public won’t be reminded that two years ago, Simon Johnson (former chief economist of the IMF) wrote an essay entitled, “Creating the Next Crisis” in which he provided this warning:
On the critical dimension of excessive bank size and what it implies for systemic risk, there was a concerted effort by Senators Ted Kaufman and Sherrod Brown to impose a size cap on the largest banks – very much in accordance with the spirit of the original “Volcker Rule” proposed in January 2010 by Obama himself.
In an almost unbelievable volte face, for reasons that remain somewhat mysterious, Obama’s administration itself shot down this approach. “If enacted, Brown-Kaufman would have broken up the six biggest banks inAmerica,” a senior Treasury official said. “If we’d been for it, it probably would have happened. But we weren’t, so it didn’t.”
Whether the world economy grows now at 4% or 5% matters, but it does not much affect our medium-term prospects. The US financial sector received an unconditional bailout – and is not now facing any kind of meaningful re-regulation. We are setting ourselves up, without question, for another boom based on excessive and reckless risk-taking at the heart of the world’s financial system. This can end only one way: badly.
The public can forget a good deal of information in two years. They need to be reminded about those early reactions to the Obama administration’s subversion of financial reform. At her Naked Capitalism website, Yves Smith served up some negative opinions concerning the bill, along with her own cutting commentary in June of 2010:
I want the word “reform” back. Between health care “reform” and financial services “reform,” Obama, his operatives, and media cheerleaders are trying to depict both initiatives as being far more salutary and far-reaching than they are. This abuse of language is yet another case of the Obama Administration using branding to cover up substantive shortcomings. In the short run it might fool quite a few people, just as BP’s efforts to position itself as an environmentally responsible company did.
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So what does the bill accomplish? It inconveniences banks around the margin while failing to reduce the odds of a recurrence of a major financial crisis.
In particular, the transaction appears to have been a type of proprietary trade – which is to say, a trade that a bank undertakes to make money for itself, not its clients. And these trades were supposed to have been outlawed by the “Volcker Rule” provision of Obama’s financial reform law, at least at federally-backed banks like JP Morgan. The administration is naturally worried that, having touted the law as an end to the financial shenanigans that brought us the 2008 crisis, it will look feckless instead.
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But it turns out that there’s an additional twist here. The concern for the White House isn’t just that the law could look weak, making it a less than compelling selling point for Obama’s re-election campaign. It’s that the administration could be blamed for the weakness. It’s one thing if you fought for a tough law and didn’t entirely succeed. It’s quite another thing if it starts to look like you undermined the law behind the scenes. In that case, the administration could look duplicitous, not merely ineffectual. And that’s the narrative you see the administration trying to preempt . . .
When the next financial crisis begins, be sure to credit President Obama as the Facilitator-In-Chief.
Regular readers of this blog know that I frequently discuss my skepticism about the true state of America’s economy. It gets painful listening to the “usual cheerleaders” constantly tell us about the robust state of our economy. The most recent Federal Reserve Beige Book serves as the Bible for these true believers. One need only check in on a few of the websites listed on my blogroll (at the right side of this page) to find plenty of opinions which run contrary to the current dogma that America is on its way to a full economic recovery.
My view is that the stock market has gotten way ahead of itself. Easy money has caused people to pile into risk assets as risk seeks return in a zero-rate environment. The real economy is nowhere near as robust as the increase in shares would have you believe. Moreover, even the falling earnings growth is telling you this.
Bottom line: The US economy is getting a sugar high from easy money, economic stimulus, and the typical cyclical aides to GDP that have promoted some modest releveraging. But the underlying issues of excess household indebtedness, particularly as related to housing and increasingly student debt, will keep this recovery from being robust until more of the debts are written down or paid off. That means the cyclical boost that comes from hiring to meet anticipated demand, construction spending, and increased capital spending isn’t going to happen at a good clip. Meanwhile, people are really struggling.
The hope is we can keep this going for long enough so that the cyclical hiring trends to pick up before overindebted consumers get fatigued again. Underneath things are very fragile. Any setback in the economy will be met with populist outrage – that you can bet on.
In the first two installments, I laid out the reasons why the U.S. economy, despite current strong consumer spending and the recent euphoria of investors over stocks, will weaken into a recession as the year progresses, led by renewed consumer retrenchment.
If my forecast pans out, the Federal Reserve and Congress may be compelled to take further action to bolster the economy.
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Meanwhile, a number of economic indicators are pointing in the direction of a faltering economy. The Economic Cycle Research Institute index remains in recession territory. The ratio of coincident to lagging economic indicators, often a better leading indicator than the leading indicator index itself, is declining. Electricity generation, though influenced by the warm winter, is falling rapidly.
One of the most popular blogs among those of us who refuse to drink the Kool-Aid being served by the “rose-colored glasses crowd” is Michael Panzner’s Financial Armageddon. In a recent posting, Mr. Panzner underscored the fact that those of us who refuse to believe the “happy talk” are no longer in the minority:
no matter how you break it down — whether by party/ideology, household income, age, or any other category — the majority of Americans agree on one thing: there is no recovery.
But the fact that things haven’t returned to normal isn’t just a matter of (public) opinion. As the Globe and Mail’s Market Blog reveals in “These Are Bad Days for Garbage,” the volume of waste being created nowadays essentially means that, despite persistent talk (from Wall Street, among others) of a renaissance in consumer spending, people are continuing to consume less and recycle more than they used to.
Many people (especially commentators employed by the mainstream media) prefer to avoid “dwelling on negativity”, so they ignore unpleasant economic forecasts. Others appear trapped in a new-age belief system, centered around such notions as the idea that you can actually cause the economy to go bad by simply perceiving it as bad. Nevertheless, the rest of us have learned (sometimes the hard way) that effective use of one’s peripheral vision can be of great value in avoiding a “sucker punch”. Keep your eyes open!
As the election year progresses, we are exposed to wildly diverging predictions about the future of the American economy. The Democrats are telling us that in President Obama’s capable hands, the American economy keeps improving every day – despite the constant efforts by Congressional Republicans to derail the Recovery Express. On the other hand, the Republicans keep warning us that a second Obama term could crush the American economy with unrestrained spending on entitlement programs. Meanwhile, in (what should be) the more sober arena of serious economics, there is a wide spectrum of expectations, motivated by concerns other than partisan politics. Underlying all of these debates is a simple question: How can one predict the future of the economy without an accurate understanding of what is happening in the present? Before asking about where we are headed, it might be a good idea to get a grip on where we are now. Nevertheless, exclusive fixation on past and present conditions can allow future developments to sneak up on us, if we are not watching.
Those who anticipate a less resilient economy consistently emphasize that the “rose-colored glasses crowd” has been basing its expectations on a review of lagging and concurrent economic indicators rather than an analysis of leading economic indicators. One of the most prominent economists to emphasize this distinction is John Hussman of the Hussman Funds. Hussman’s most recent Weekly Market Comment contains what has become a weekly reminder of the flawed analysis used by the optimists:
On the economy, our broad view is based on dozens of indicators and multiple methods, and the overall picture is much better described as a modest rebound within still-fragile conditions, rather than a recovery or a clear expansion. The optimism of the economic consensus seems to largely reflect an over-extrapolation of weather-induced boosts to coincident and lagging economic indicators — particularly jobs data. Recall that seasonal adjustments in the winter months presume significant layoffs in the retail sector and slow hiring elsewhere, and therefore add back “phantom” jobs to compensate.
Hussman’s kindred spirit, Lakshman Achuthan of the Economic Cycle Research Institute (ECRI), has been criticized for the predictiction he made last September that the United States would fall back into recession. Nevertheless, the ECRI reaffirmed that position on March 15 with a website posting entitled, “Why Our Recession Call Stands”. Again, note the emphasis on leading economic indicators – rather than concurrent and lagging economic indicators:
How about forward-looking indicators? We find that year-over-year growth in ECRI’s Weekly Leading Index (WLI) remains in a cyclical downturn . . . and, as of early March, is near its worst reading since July 2009. Close observers of this index might be understandably surprised by this persistent weakness, since the WLI’s smoothed annualized growth rate, which is much better known, has turned decidedly less negative in recent months.
Unlike the partisan political rhetoric about the economy, prognostication expressed by economists can be a bit more subtle. In fact, many of the recent, upbeat commentaries have quite restrained and cautious. Consider this piece from The Economist:
A year ago total bank loans were shrinking. Now they are growing. Loans to consumers have risen by 5% in the past year, which has accompanied healthy gains in car sales (see chart). Mortgage lending was still contracting as of late 2011 but although house prices are still edging lower both sales and construction are rising.
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At present just four states are reporting mid-year budget gaps, according to the National Conference of State Legislatures; this time last year, 15 did; the year before that, 36. State and local employment, which declined by 655,000 between August 2008 and last December – a fall of 3.3% – has actually edged up since.
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Manufacturing employment, which declined almost continuously from 1998 through 2009, has since risen by nearly 4%, and the average length of time factories work is as high as at any time since 1945. Since the end of the recession exports have risen by 39%, much faster than overall GDP. Neither is as impressive as it sounds: manufacturing employment remains a smaller share of the private workforce than in 2007, and imports have recently grown even faster than exports as global growth has faltered and the dollar has climbed. Trade, which was a contributor to economic growth in the first years of recovery, has lately been a drag.
But economic recovery doesn’t have to wait for all of America’s imbalances to be corrected. It only needs the process to advance far enough for the normal cyclical forces of employment, income and spending to take hold. And though their grip may be tenuous, and a shock might yet dislodge it, it now seems that, at last, they have.
A great deal of enthusiastic commentary was published in reaction to the results from the recent round of bank stress tests, released by the Federal Reserve. The stress test results revealed that 15 of the 19 banks tested could survive a stress scenario which included a peak unemployment rate of 13 percent, a 50 percent drop in equity prices, and a 21 percent decline in housing prices. Time magazine published an important article on the Fed’s stress test results. It was written by a gentleman named Christopher Matthews, who used to write for Forbes and the Financial Times. (He is a bit younger than the host of Hardball.) In a surprising departure from traditional, “mainstream media propaganda”, Mr. Matthews demonstrated a unique ability to look “behind the curtain” to give his readers a better idea of where we are now:
Christopher Whalen, a bank analyst and frequent critic of the big banks, penned an article in ZeroHedge questioning the assumptions, both by the Fed and the banks themselves, that went into the tests. It’s well known that housing remains a thorn in the side of the big banks, and depressed real estate prices are the biggest risk to bank balance sheets. The banks are making their own assumptions, however, with regards to the value of their real estate holdings, and Whalen is dubious of what the banks are reporting on their balance sheets. The Fed, he says, is happy to go along with this massaging of the data. He writes,
“The Fed does not want to believe that there is a problem with real estate. As my friend Tom Day wrote for PRMIA’s DC chapter yesterday: ‘It remains hard to believe, on the face of it, that many of the more damaged balance sheets could, in fact, withstand another financial tsunami of the magnitude we have recenlty experienced and, to a large extent, continue to grapple with.’ ”
Even those that are more credulous are taking exception to the Fed’s decision to allow the banks to increase dividends and stock buybacks. The Bloomberg editorial board wrote an opinion yesterday criticizing this decision:
“Good as the stress tests were, they don’t mean the U.S. banking system is out of the woods. Three major banks – Ally Financial Inc., Citigroup Inc. and SunTrust Banks Inc. – didn’t pass, and investors still don’t have much faith in the reported capital levels of many of the rest. If the Fed wants the positive results of the stress tests to last, it should err on the side of caution in approving banks’ plans to pay dividends and buy back shares – moves that benefit shareholders but also deplete capital.”
So there’s still plenty for skeptics to read into Tuesday’s report. For those who want to doubt the veracity of the banks’ bookkeeping, you can look to Whalen’s report. For those who like to question the Fed’s decision making, Bloomberg’s argument is as good as any. But at the same time, we all know from experience that things could be much worse, and Tuesday’s announcement appears to be another in a string of recent good news that, unfortunately, comes packaged with a few caveats. When all is said and done, this most recent test may turn out to be another small, “I think I can” from the little recovery that could.
When mainstream publications such as Time and Bloomberg News present reasoned analysis about the economy, it should serve as reminder to political bloviators that the only audience for the partisan rhetoric consists of “low-information voters”. The old paradigm – based on campaign funding payola from lobbyists combined with support from low-information voters – is being challenged by what Marshall McLuhan called “the electronic information environment”. Let’s hope that sane economic policy prevails.
Comments Off on Goldman Sachs Remains in the Spotlight
Goldman Sachs has become a magnet for bad publicity. Last week, I wrote a piece entitled, “Why Bad Publicity Never Hurts Goldman Sachs”. On March 14, Greg Smith (a Goldman Sachs executive director and head of the firm’s United States equity derivatives business in Europe, the Middle East and Africa) summed-up his disgust with the firm’s devolution by writing “Why I Am Leaving Goldman Sachs” for The New York Times. Among the most-frequently quoted reasons for Smith’s departure was this statement:
It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail.
In the wake of Greg Smith’s very public resignation from Goldman Sachs, many commentators have begun to speculate that Goldman’s bad behavior may have passed a tipping point. The potential consequences have become a popular subject for speculation. The end of Lloyd Blankfein’s reign as CEO has been the most frequently-expressed prediction. Peter Cohan of Forbes raised the possibility that Goldman’s clients might just decide to take their business elsewhere:
Until a wave of talented people leave Goldman and go work for some other bank, many clients will stick with Goldman and hope for the best. That’s why the biggest threat to Goldman’s survival is that Smith’s departure – and the reasons he publicized so nicely in his Times op-ed – leads to a wider talent exodus.
After all, that loss of talent could erode Goldman’s ability to hold onto clients. And that could give Goldman clients a better alternative. So when Goldman’s board replaces Blankfein, it should appoint a leader who will restore the luster to Goldman’s traditional values.
Goldman’s errant fiduciary behavior became a popular topic in July of 2009, when the Zero Hedge website focused on Goldman’s involvement in high-frequency trading, which raised suspicions that the firm was “front-running” its own customers. It was claimed that when a Goldman customer would send out a limit order, Goldman’s proprietary trading desk would buy the stock first, then resell it to the client at the high limit of the order. (Of course, Goldman denied front-running its clients.) Zero Hedge brought our attention to Goldman’s “GS360” portal. GS360 included a disclaimer which could have been exploited to support an argument that the customer consented to Goldman’s front-running of the customer’s orders. One week later, Matt Taibbi wrote his groundbreaking, tour de force for Rolling Stone about Goldman’s involvement in the events which led to the financial crisis. From that point onward, the “vampire squid” and its predatory business model became popular subjects for advocates of financial reform.
Despite all of the hand-wringing about Goldman’s controversial antics – especially after the April 2010 Senate Permanent Subcommittee on Investigations hearing, wherein Goldman’s “Fab Four” testified about selling their customers the Abacus CDO and that “shitty” Timberwolf deal, no effective remedial actions for cleaning-up Wall Street were on the horizon. The Dodd-Frank financial “reform” legislation had become a worthless farce.
Exactly two years ago, publication of the report by bankruptcy examiner Anton Valukas, pinpointing causes of the Lehman Brothers collapse, created shockwaves which were limited to the blogosphere. Unfortunately, the mainstream media were not giving that story very much traction. On March 15 of 2010, the Columbia Journalism Review published an essay by Ryan Chittum, decrying the lack of mainstream media attention given to the Lehman scandal. This shining example of Wall Street malefaction should have been an influential factor toward making the financial reform bill significantly more effective than the worthless sham it became.
Greg Smith’s resignation from Goldman Sachs could become the game-changing event, motivating Wall Street’s investment banks to finally change their ways. Matt Taibbi seems to think so:
This always had to be the endgame for reforming Wall Street. It was never going to happen by having the government sweep through and impose a wave of draconian new regulations, although a more vigorous enforcement of existing laws might have helped. Nor could the Occupy protests or even a monster wave of civil lawsuits hope to really change the screw-your-clients, screw-everybody, grab-what-you-can culture of the modern financial services industry.
Real change was always going to have to come from within Wall Street itself, and the surest way for that to happen is for the managers of pension funds and union retirement funds and other institutional investors to see that the Goldmans of the world aren’t just arrogant sleazebags, they’re also not terribly good at managing your money.
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These guys have lost the fear of going out of business, because they can’t go out of business. After all, our government won’t let them. Beyond the bailouts, they’re all subsisting daily on massive loads of free cash from the Fed. No one can touch them, and sadly, most of the biggest institutional clients see getting clipped for a few points by Goldman or Chase as the cost of doing business.
The only way to break this cycle, since our government doesn’t seem to want to end its habit of financially supporting fraud-committing, repeat-offending, client-fleecing banks, is for these big “muppet” clients to start taking their business elsewhere.
In the mean time, the rest of us will be keeping our fingers crossed.
TheCenterLane.com offers opinion, news and commentary on politics, the economy, finance and other random events that either find their way into the news or are ignored by the news reporting business. As the name suggests, our focus will be on what seems to be happening in The Center Lane of American politics and what the view from the Center reveals about the events in the left and right lanes. Your Host, John T. Burke, Jr., earned his Bachelor of Arts degree from Boston College with a double major in Speech Communications and Philosophy. He earned his law degree (Juris Doctor) from the Illinois Institute of Technology / Chicago-Kent College of Law.