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Still Wrong After All These Years

June 21st, 2010 Posted in Uncategorized

Jun, 21 2010

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June 21, 2010

I’m quite surprised by the fact that people continue to pay serious attention to the musings of Alan Greenspan. On June 18, The Wall Street Journal saw fit to publish an opinion piece by the man referred to as “The Maestro” (although – these days – that expression is commonly used in sarcasm). The former Fed chairman expounded that recent attempts to rein in the federal budget are coming “none too soon”. Near the end of the article, Greenspan made the statement that will earn him a nomination for TheCenterLane.com’s Jackass of the Year Award:

I believe the fears of budget contraction inducing a renewed decline of economic activity are misplaced.

John Mauldin recently provided us with a thorough explanation of why Greenspan’s statement is wrong:

There are loud calls in the US and elsewhere for more fiscal constraints. I am part of that call. Fiscal deficits of 10% of GDP is a prescription for disaster. As we have discussed in previous letters, the book by Rogoff and Reinhart (This Time is Different) clearly shows that at some point, bond investors start to ask for higher rates and then the interest rate becomes a spiral. Think of Greece. So, not dealing with the deficit is simply creating a future crisis even worse than the one we just had.

But cutting the deficit too fast could also throw the country back in a recession. There has to be a balance.

* * *

That deficit reduction will also reduce GDP. That means you collect less taxes which makes the deficits worse which means you have to make more cuts than planned which means lower tax receipts which means etc. Ireland is working hard to reduce its deficits but their GDP has dropped by almost 20%! Latvia and Estonia have seen their nominal GDP drop by almost 30%! That can only be characterized as a depression for them.

Robert Reich’s refutation of Greenspan’s article was right on target:

Contrary to Greenspan, today’s debt is not being driven by new spending initiatives. It’s being driven by policies that Greenspan himself bears major responsibility for.

Greenspan supported George W. Bush’s gigantic tax cut in 2001 (that went mostly to the rich), and uttered no warnings about W’s subsequent spending frenzy on the military and a Medicare drug benefit (corporate welfare for Big Pharma) — all of which contributed massively to today’s debt. Greenspan also lowered short-term interest rates to zero in 2002 but refused to monitor what Wall Street was doing with all this free money. Years before that, he urged Congress to repeal the Glass-Steagall Act and he opposed oversight of derivative trading. All this contributed to Wall Street’s implosion in 2008 that led to massive bailout, and a huge contraction of the economy that required the stimulus package. These account for most of the rest of today’s debt.

If there’s a single American more responsible for today’s “federal debt explosion” than Alan Greenspan, I don’t know him.

But we can manage the Greenspan Debt if we get the U.S. economy growing again. The only way to do that when consumers can’t and won’t spend and when corporations won’t invest is for the federal government to pick up the slack.

This brings us back to my initial question of why anyone would still take Alan Greenspan seriously. As far back as April of 2008 – five months before the financial crisis hit the “meltdown” stage — Bernd Debusmann had this to say about The Maestro for Reuters, in a piece entitled, “Alan Greenspan, dented American idol”:

Instead of the fawning praise heaped on Greenspan when the economy was booming, there are now websites portraying him in dark colors. One site is called The Mess That Greenspan Made, another Greenspan’s Body Count. Greenspan’s memoirs, The Age of Turbulence, prompted hedge fund manager William Fleckenstein to write a book entitled Greenspan’s Bubbles, the Age of Ignorance at the Federal Reserve. It’s in its fourth printing.

The day after Greenspan’s essay appeared in The Wall Street Journal, Howard Gold provided us with this recap of Greenspan’s Fed chairmanship in an article for MarketWatch:

The Fed chairman’s hands-off stance helped the housing bubble morph into a full-blown financial crisis when hundreds of billions of dollars’ worth of collateralized debt obligations, credit default swaps, and other unregulated derivatives — backed by subprime mortgages and other dubious instruments — went up in smoke.

Highly leveraged banks that bet on those vehicles soon were insolvent, too, and the Fed, the U.S. Treasury and, of course, taxpayers had to foot the bill. We’re still paying.

But this was not just a case of unregulated markets run amok. Government policies clearly made things much worse — and here, too, Greenspan was the culprit.

The Fed’s manipulation of interest rates in the middle of the last decade laid the groundwork for the most fevered stage of the housing bubble. To this day, Greenspan, using heavy-duty statistical analysis, disputes the role his super-low federal funds rate played in encouraging risky behavior in housing and capital markets.

Among the harsh critiques of Greenspan’s career at the Fed, was Frederick Sheehan’s book, Panderer to Power. Ryan McMaken’s review of the book recently appeared at the LewRockwell.com website – with the title, “The Real Legacy of Alan Greenspan”. Here is some of what McMacken had to say:

. . . Panderer to Power is the story of an economist whose primary skill was self-promotion, and who in the end became increasingly divorced from economic reality. Even as early as April 2008 (before the bust was obvious to all), the L.A. Times, observing Greenspan’s post-retirement speaking tour, noted that “the unseemly, globe-trotting, money-grabbing, legacy-spinning, responsibility-denying tour of Alan Greenspan continues, as relentless as a bad toothache.”

* * *

Although Greenspan had always had a terrible record on perceiving trends in the economy, Sheehan’s story shows a Greenspan who becomes increasingly out to lunch with each passing year as he spun more and more outlandish theories about hidden profits and productivity in the economy that no one else could see. He spoke incessantly on topics like oil and technology while the bubbles grew larger and larger. And finally, in the end, he retired to the lecture circuit where he was forced to defend his tarnished record.

The ugly truth is that America has been in a bear market economy since 2000 (when “The Maestro” was still Fed chair). In stark contrast to what you’ve been hearing from the people on TV, the folks at Comstock Partners put together a list of ten compelling reasons why “the stock market is in a secular (long-term) downtrend that began in early 2000 and still has some time to go.” This essay is a “must read”. Further undermining Greenspan’s recent opinion piece was the conclusion reached in the Comstock article:

The data cited here cover the major indicators of economic activity, and they paint a picture of an economy that has moved up, but only from extremely depressed numbers to a point where they are less depressed. And keep in mind that this is the result of the most massive monetary and fiscal stimulus ever applied to a major economy. In our view the ability of the economy to undergo a sustained recovery without continued massive help is still questionable.

As always, Alan Greenspan is still wrong. Unfortunately, there are still too many people taking him seriously.

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Ignoring The Root Cause

June 17th, 2010 Posted in Uncategorized

Jun, 17 2010

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June 17, 2010

The predominant criticism of the so-called “financial reform” bill is its failure to address the problems caused by the existence of financial institutions considered “too big to fail”. In an essay entitled, “Creating the Next Crisis” economist Simon Johnson discussed the consequences of this legislative let-down:

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 in America,” a senior Treasury official said. “If we’d been for it, it probably would have happened. But we weren’t, so it didn’t.”

* * *

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.

One would assume that an important lesson learned from the 2008 financial crisis was the idea that a corporation shouldn’t be permitted to blackmail the country with threats that its own financial collapse would have such a dire impact on society-at-large that the corporation should be bailed out by the taxpayers. The resulting problem is called “moral hazard” because such businesses are encouraged to act irresponsibly by virtue of the certainty that they will be bailed out if their activities prove self-destructive.

Gonzalo Lira wrote a piece for the Naked Capitalism blog, explaining how the moral hazard resulting from the “too big to fail” doctrine is facilitating a state of corporate anarchy:

In a nutshell, in this era of corporate anarchy, corporations do not have to abide by any rules — none at all. Legal, moral, ethical, even financial rules are irrelevant. They have all been rescinded in the pursuit of profit — literally nothing else matters.

As a result, corporations currently exist in a state of almost pure anarchy — but an anarchy directly related to their size: The larger the corporation, the greater its absolute freedom to do and act as it pleases. That’s why so many medium-sized corporations are hell-bent on growth over profits: The biggest of them all, like BP and Goldman Sachs, live in a positively Hobbesian State of Nature, free to do as they please, with nary a consequence.

Good-old British Petroleum – the latest beneficiary of the “too big to fail doctrine” — can rely on its size to avoid any sanctions it considers unacceptable because too many “small people” might lose their jobs if BP can’t stay fat and happy. Gonzalo Lira’s analysis went a step further:

Worst of all, BP realizes that, if it finally cannot get a handle on the oil spill disaster, they can simply fob it off on the U.S. Government — in other words, the people of the United States will wind up cleaning BP’s mess. BP knows that no one will hold it accountable — BP knows that it will get away with it.

* * *

This era of corporate anarchy is reaching a crisis point — we can all sense it. Yet the leadership in the United States and Europe is making no effort to solve the root problem. Perhaps they don’t see the problem. Perhaps they are beholden to corporate masters. Whatever the case, in his speech, President Obama made ridiculous references to “clean energy” while ignoring the cause of the BP oil spill disaster, the cause of the financial crisis, the cause of the spiralling health-care costs — the corporate anarchy that underlines them all.

This era of corporate anarchy is wrecking the world — literally, if you’ve been tuning in to images of the oil billowing out a mile down in the Gulf of Mexico.

Mr. Lira discussed how a leadership void has been helping corporate anarchy overtake democratic capitalism:

Obama is a corporatist — he’s one of Them. So there’ll be more bullshit talk about “clean energy” and “energy independence”, while the root cause — corporate anarchy — is left undisturbed.

The failure of President Obama to take advantage of the opportunity to address this “root cause” in his Oval Office address concerning the Deepwater Horizon disaster, inspired Robert Reich to make this comment:

Whether it’s Wall Street or health insurers or oil companies, we are approaching a turning point. The top executives of powerful corporations are pursuing profits in ways that menace the nation. We have not seen the likes not since the late nineteenth century when the “robber barons” of finance, oil, and the giant trusts ran roughshod over America. Now, as then, they are using their wealth and influence to buy off legislators and intimidate the regions that depend on them for jobs. Now, as then, they are threatening the safety and security of our people.

One of my favorite commentators, Paul Farrell of MarketWatch, recently warned us about the consequences of allowing corporate anarchy to destroy democratic capitalism:

The rise of uncontrolled corporate greed killed the “Invisible Hand,” the “soul” of capitalism that Adam Smith saw in 1776 as a divine force serving “the common good.” Today the system has no moral compass. Wall Street’s insatiable greed has destroyed capitalism from within, turning America’s economy into a soulless zombie.

The “Invisible Hand” Adam Smith saw as essential to capitalism in “The Theory of Moral Sentiments” died in endless battles fought by 261,000 lobbyists each wanting a bigger piece of the $1.7 trillion federal budget pie plus favorable laws protecting, vesting and increasing the power and wealth of their special interest clients. Future historians will call this ideological battle replacing democracy the new “American Capitalists Anarchy.”

* * *

As a New York Times reviewer put it: Nations like “China and Russia are using what he calls ‘state capitalism’ to advance the interests of their companies at the expense of their American rivals.” Global pandemic?

Unfortunately while America wastes trillions to bail out inefficient too-stupid-to-fail banks, our competition is bankrolling healthy state-controlled corporations to destroy us . . .

If we ever reach the point when the watered-down “financial reform” bill finally becomes law, the taxpayers should insist that their government move on to address the “root cause” of corporate anarchy by taking up campaign finance reform. That should be one hell of a fight!

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The Poisonous Bailout

June 10th, 2010 Posted in Uncategorized

Jun, 10 2010

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June 10, 2010

The adults in the room have spoken. The Congressional Oversight Panel – headed by Harvard Law School professor Elizabeth Warren – created to oversee the TARP program, has just issued a report disclosing the ugly truth about the bailout of AIG:

The government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace.

Note the present tense in that statement. Not only did the bailout have a poisonous effect on the marketplace at the time –it continues to have a poisonous effect on the marketplace. The 300-page report includes the reason why the AIG bailout continues to have this poisonous effect:

The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America‘s largest financial institutions and to assure repayment to the creditors doing business with them.

And that, dear readers, is precisely what the concept of “moral hazard” is all about. It is the reason why we should not continue to allow financial institutions to be “too big to fail”. Bad behavior by financial institutions is encouraged by the Federal Reserve and Treasury with assurance that any losses incurred as a result of that risky activity will be borne by the taxpayers rather than the reckless institutions. You might remember the pummeling Senator Jim Bunning gave Ben Bernanke during the Federal Reserve Chairman’s appearance before the Senate Banking Committee for Bernanke’s confirmation hearing on December 3, 2009:

. . . you have decided that just about every large bank, investment bank, insurance company, and even some industrial companies are too big to fail. Rather than making management, shareholders, and debt holders feel the consequences of their risk-taking, you bailed them out. In short, you are the definition of moral hazard.

With particular emphasis on the AIG bailout, this is what Senator Bunning said to Bernanke:

Even if all that were not true, the A.I.G. bailout alone is reason enough to send you back to Princeton. First you told us A.I.G. and its creditors had to be bailed out because they posed a systemic risk, largely because of the credit default swaps portfolio. Those credit default swaps, by the way, are over the counter derivatives that the Fed did not want regulated. Well, according to the TARP Inspector General, it turns out the Fed was not concerned about the financial condition of the credit default swaps partners when you decided to pay them off at par. In fact, the Inspector General makes it clear that no serious efforts were made to get the partners to take haircuts, and one bank’s offer to take a haircut was declined. I can only think of two possible reasons you would not make then-New York Fed President Geithner try to save the taxpayers some money by seriously negotiating or at least take up U.B.S. on their offer of a haircut. Sadly, those two reasons are incompetence or a desire to secretly funnel more money to a few select firms, most notably Goldman Sachs, Merrill Lynch, and a handful of large European banks.

Hugh Son of Bloomberg BusinessWeek explained how the Congressional Oversight Panel’s latest report does not have a particularly optimistic view of AIG’s ability to repay the bailout:

The bailout includes a $60 billion Fed credit line, an investment of as much as $69.8 billion from the Treasury Department and up to $52.5 billion to buy mortgage-linked assets owned or backed by the insurer through swaps or securities lending.

AIG owes about $26.6 billion on the credit line and $49 billion to the Treasury. The company returned to profit in the first quarter, posting net income of $1.45 billion.

‘Strong, Vibrant Company’

“I’m confident you’ll get your money, plus a profit,” AIG Chief Executive Officer Robert Benmosche told the panel in Washington on May 26. “We are a strong, vibrant company.”

The panel said in the report that the government’s prospects for recovering funds depends partly on the ability of AIG to find buyers for its units and on investors’ willingness to purchase shares if the Treasury Department sells its holdings. AIG turned over a stake of almost 80 percent as part of the bailout and the Treasury holds additional preferred shares from subsequent investments.

“While the potential for the Treasury to realize a positive return on its significant assistance to AIG has improved over the past 12 months, it still appears more likely than not that some loss is inevitable,” the panel said.

Simmi Aujla of the Politico reported on Elizabeth Warren’s contention that Treasury and Federal Reserve officials should have attempted to save AIG without using taxpayer money:

“The negotiations would have been difficult and they might have failed,” she said Wednesday in a conference call with reporters. “But the benefits of crafting a private or even a joint public-private solution were so superior to the cost of a complete government bailout that they should have been pursued as vigorously as humanly possible.”

The Treasury and Federal Reserve are now in “damage control” mode, issuing statements that basically reiterate Bernanke’s “panic” excuse referenced in the above-quoted remarks by Jim Bunning.

The release of this report is well-timed, considering the fact that the toothless, so-called “financial reform” bill is now going through the reconciliation stage. Now that Blanche Lincoln is officially the Democratic candidate to retain her Senate seat representing Arkansas – will the derivatives reform provisions disappear from the bill? In light of the information contained in the Congressional Oversight Panel’s report, a responsible – honest – government would not only crack down on derivatives trading but would also ban the trading of “naked” swaps. In other words: No betting on defaults if you don’t have a potential loss you are hedging – or as Phil Angelides explained it: No buying fire insurance on your neighbor’s house. Of course, we will probably never see such regulation enacted – until after he next financial crisis.

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Living Up To A Title

June 7th, 2010 Posted in Uncategorized

Jun, 07 2010

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June 7, 2010

It was back on April 9, 2009 – before President Obama had completed his third month in office – when I first referred to him as the “Disappointer-in-Chief”. I concluded that piece with this gloomy prediction:

If President Obama does not change course and deviate from the Geithner-Summers plan before it’s too late, his legacy will be a ten-year recession rather than a two-year recession without the PPIP. Worse yet, the toughest criticism and the most pressure against his administration are coming from people he has considered his supporters. At least he has the people at Fox News to provide some laughable “decoy” reports to keep his hard-core adversaries otherwise occupied.

Just two weeks earlier — on March 23, 2009 – I had been discussing the widespread apprehension over Obama’s planned bailout of the largest banks (the so-called “Financial Stability Plan” which later morphed into the PPIP). At that point, Frank Rich of The New York Times made a premature use of the term “Obama’s Katrina moment”.

With the arrival of Obama’s real “Katrina moment” — by way of the Deepwater Horizon blowout – we are again hearing a chorus of criticism directed against the Obama administration, not unlike what we heard during those first few months. Now that our new President has established a track record of bad decisions, let’s take a look at some reactions from people the Fox News will insist are loyal Obama supporters. First we had Maureen Dowd of The New York Times, who delivered a one-two punch to the man she has called “Barry” (when mad at him) on May 29 and June 1:

In the campaign, Obama’s fight flagged to the point that his donors openly upbraided him. In the Oval, he waited too long to express outrage and offer leadership on A.I.G., the banks, the bonuses, the job loss and mortgage fears, the Christmas underwear bomber, the death panel scare tactics, the ugly name-calling of Tea Party protesters.

Too often it feels as though Barry is watching from a balcony, reluctant to enter the fray until the clamor of the crowd forces him to come down. The pattern is perverse. The man whose presidency is rooted in his ability to inspire withholds that inspiration when it is most needed.

Ouch! If that weren’t enough, Ms. Dowd’s June 1 punch had to hurt:

This president has made it clear that he’s not comfortable outside whatever domain he’s defined. But unless he wants his story to be marred by a pattern of passivity, detachment, acquiescence and compromise, he’d better seize control of the story line of his White House years. Woe-is-me is not an attractive narrative.

Also at The New York Times, Frank Rich expressed his impatience with the President – now that the real “Katrina moment” has arrived:

We still want to believe that Obama is on our side, willing to fight those bad corporate actors who cut corners and gambled recklessly while regulators slept, Congress raked in contributions, and we got stuck with the wreckage and the bills. But his leadership style keeps sowing confusion about his loyalties, puncturing holes in the powerful tale he could tell.

* * *

No high-powered White House meetings or risk analyses were needed to discern how treacherous it was to trust BP this time. An intern could have figured it out. But the credulous attitude toward BP is no anomaly for the administration. Lloyd Blankfein of Goldman Sachs was praised by the president as a “savvy” businessman two months before the Securities and Exchange Commission sued Goldman. Well before then, there had been a flood of journalistic indicators that Goldman under Blankfein may have gamed the crash and the bailout.

It’s this misplaced trust in elites both outside the White House and within it that seems to prevent Obama from realizing the moment that history has handed to him. Americans are still seething at the bonus-grabbing titans of the bubble and at the public and private institutions that failed to police them. But rather than embrace a unifying vision that could ignite his presidency, Obama shies away from connecting the dots as forcefully and relentlessly as the facts and Americans’ anger demand.

Back on December 14, I pointed out how the so-called “race card” has not been a free pass for the Disappointer-in-Chief:

As we approach the conclusion of Obama’s first year in the White House, it has become apparent that the Disappointer-in-Chief has not only alienated the Democratic Party’s liberal base, but he has also let down a demographic he thought he could take for granted: the African-American voters. At this point, Obama has “transcended race” with his ability to dishearten loyal black voters just as deftly as he has chagrined loyal supporters from all ethnic groups.

The most recent example of this phenomenon appeared in the form of an opinion piece by Tony Norman of the Pittsburgh Post-Gazette. Here is some of what Mr. Norman had to say:

At a Memorial Day dinner I attended, there wasn’t just disappointment with Mr. Obama’s inability to find his inner Huey Long — there was an undercurrent of genuine anger.

It went far beyond the handling of the BP crisis. As far as anyone can tell, there isn’t much to distinguish Mr. Obama’s policies in Afghanistan and Iraq from his predecessor’s.

Beyond the Deepwater Horizon, Mr. Obama has been a disappointment on civil liberties, banking reform, military spending, the drug war, Middle East policy, immigration and the environment. Political gamesmanship and calculation of the rankest kind continue. Even his latest Supreme Court nominee shows every indication of being as colorless as the president has proven to be in recent months. It’s too much to expect this president to champion a progressive Supreme Court candidate.

Meanwhile, the corrupt culture of Wall Street continues to set the agenda, thanks to cowardly Democrats and nihilistic Republicans. Accountability is as much a dirty word for Mr. Obama as it was for President George W. Bush.

* * *

Honestly, other than the particularities of the historical record, it no longer makes sense to blame Mr. Bush for much when Mr. Obama has done little — other than improvise a less belligerent foreign policy — to distinguish himself from the 43rd president.

I won’t spoil the rest of Mr. Norman’s article. Just be sure to read it. (Hint: It includes some nice speculation about how the new President was likely pulled aside by some members of the plutocracy, who gave him “The Talk”.)

Meanwhile, the Presidential disappointments continue. It appears as though we are going to wait for God to stop the oil from gushing into the Gulf of Mexico. Since we have left it to God to do the wetlands protection and the clean-up, this shouldn’t be too surprising. I’m beginning to suspect that President Obama’s religious ideas are even more far-out than those of President Bush. – It’s just that President Obama doesn’t talk about them.

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Your Sleazy Government At Work

May 31st, 2010 Posted in Uncategorized

May, 31 2010

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May 31, 2010

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

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

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

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

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

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

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

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

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

* * *

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

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

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

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

Negligible progress, 3,000 pages notwithstanding.

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

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

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

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

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Moment Of Truth

May 24th, 2010 Posted in Uncategorized

May, 24 2010

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May 24, 2010

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Obama Administration Wants to Kill the Best Provisions

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

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

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

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

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

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Banking Lobby Tools In Senate Subvert Reform

May 20th, 2010 Posted in Uncategorized

May, 20 2010

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May 20. 2010

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

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

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

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

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

* * *

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

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

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

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

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

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

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

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

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

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

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

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Avoiding The Stock Market

May 18th, 2010 Posted in Uncategorized

May, 18 2010

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May 18, 2010

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

* * *

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

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

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

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

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

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

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

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

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Ron Paul Criticizes Fed Audit Compromise

May 13th, 2010 Posted in Uncategorized

May, 13 2010

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May 13, 2010

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

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

* * *

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

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

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

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

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

* * *

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

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

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

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

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

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

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

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EuroTARP Faces Criticism

May 10th, 2010 Posted in Uncategorized

May, 10 2010

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May 10, 2010

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

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

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

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

* * *

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

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

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

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

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

* * *

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

* * *

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

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

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

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

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

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

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

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

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