It’s the Fed, Stupid!

A Messaging Tip For The Donald: It’s The Fed, Stupid!

The Fed’s core policies of 2% inflation and 0% interest rates are kicking the economic stuffings out of Flyover AmericaThey are based on the specious academic theory that financial gambling fuels economic growth and that all economic classes prosper from inflation and march in lockstep together as prices and wages ascend on the Fed’s appointed path.

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Book Review: Makers and Takers

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

Crown Business; 1st edition (May 17, 2016)

Ms. Foroohar does a fine job of journalistic reporting here. She identifies many of the failures of the current economic policy regime that has led to the dominance of the financial industry. She follows the logical progression of central bank credit policy to inflate the banking system, that in turn captures democratic politics and policymaking in a vicious cycle of anti-democratic cronyism.

However, her ability to follow the money and power is not matched by an ability to analyze the true cause and effect and thus misguides her proposed solutions. Typical of a journalistic narrative, she identifies certain “culprits” in this story: the bankers and policymakers who favor them. But the true cause of this failed paradigm of easy credit and debt is found in the central bank and monetary policy.

Since 1971 the Western democracies have operated under a global fiat currency regime, where the value of the currencies are based solely on the full faith and credit of the various governments. In the case of the US$, that represents the taxing power of our Federal government in D.C.

The unfortunate reality, based on polling the American people (and Europeans) on trust in government, is that trust in our governmental institutions has plunged from almost 80% in 1964 to less than 20% today. Our 2016 POTUS campaign reflects this deep mistrust in the status quo and the political direction of the country. For good reason. So, what is the value of a dollar if nobody trusts the government to defend it? How does one invest under that uncertainty? You don’t.

One would hope Ms. Foroohar would ask, how did we get here? The essential cause is cheap excess credit, as has been experienced in financial crises all through history. The collapse of Bretton Woods in 1971, when the US repudiated the dollar gold conversion, called the gold peg, has allowed central banks to fund excessive government spending on cheap credit – exploding our debt obligations to the tune of $19 trillion. There seems to be no end in sight as the Federal Reserve promises to write checks without end.

Why has this caused the complete financialization of the economy? Because real economic growth depends on technology and demographics and cannot keep up with 4-6% per year. So the excess credit goes into asset speculation, mostly currency, commodity, and securities trading. This explosion of trading has amped incentives to develop new financial technologies and instruments to trade. Thus, we have the explosion of derivatives trading, which essentially is trading on trading, ad infinitum. Thus, Wall Street finance has come to be dominated by trading and socialized risk-taking rather than investing and private risk management.

After 2001 the central bank decided housing as an asset class was ripe for a boom, and that’s what we got: a debt-fueled bubble that we’ve merely re-inflated since 2008. There is a fundamental value to a house, and in most regions we have far departed from it.

So much money floating through so few hands naturally ends up in the political arena to influence policy going forward. Thus, not only is democratic politics corrupted, but so are any legal regulatory restraints on banking and finance. The simplistic cure of “More regulation!” is belied by the ease with which the bureaucratic regulatory system is captured by powerful interests.

The true problem is the policy paradigm pushed by the consortium of central banks in Europe, Japan, China, and the US. (The Swiss have resisted, but not out of altruism for the poor savers of the world.) Until monetary/credit policy in the free world becomes tethered and disciplined by something more than the promises of politicians and central bankers, we will continue full-speed off the eventual cliff. But our financial masters see this eventuality as a great buying opportunity.

Helicopter Money

Central bank “Helicopter Money” is to the economy what helicopter parents are to their unfortunate children. This from Bloomberg View:

`Helicopter Money’ Is Coming to the U.S.

Aug 5, 2016 5:41 AM EDT

Several years of rock-bottom interest rates around the world haven’t been all bad. They’ve helped reduce government borrowing costs, for sure. Central banks also send back to their governments most of the interest received on assets purchased through quantitative-easing programs. Governments essentially are paying interest to themselves.

What is Helicopter Money? 

Since the beginning of their quantitative-easing activities, the Federal Reserve has returned $596 billion to the U.S. Treasury and the Bank of England has given back $47 billion. This cozy relationship between central banks and their governments resembles “helicopter money,” the unconventional form of stimulus that some central banks may be considering as a way to spur economic growth.

I’m looking for more such helicopter money — fiscal stimulus applied directly to the U.S. economy and financed by the Fed –no matter who wins the Presidential election in November.

It’s called helicopter money because of the illusion of dumping currency from the sky to people who will rapidly spend it, thereby creating demand, jobs and economic growth. Central banks can raise and lower interest rates and buy and sell securities, but that’s it. They can thereby make credit cheap and readily available, yet they can’t force banks to lend and consumers and businesses to borrow, spend and invest. That undermines the effectiveness of QE; as the proverb says, you can lead a horse to water, but you can’t make it drink.

Furthermore, developed-country central banks purchase government securities on open markets, not from governments directly. You might ask: “What’s the difference between the Treasury issuing debt in the market and the Fed buying it, versus the Fed buying securities directly from the Treasury?” The difference is that the open market determines the prices of Treasuries, not the government or the central bank. The market intervenes between the two, which keeps the government from shoving huge quantities of debt directly onto the central bank without a market-intervening test. This enforces central bank discipline and maintains credibility.

In contrast, direct sales to central banks have been the normal course of government finance in places like Zimbabwe and Argentina. It often leads to hyperinflation and financial disaster. (I keep a 100-trillion Zimbabwe dollar bank note, issued in 2008, which was worth only a few U.S. cents as inflation rates there accelerated to the hundreds-of-million-percent level. Now it sells for several U.S. dollars as a collector’s item, after the long-entrenched and corrupt Zimbabwean government switched to U.S. dollars and stopped issuing its own currency.)

Argentina was excluded from borrowing abroad after defaulting in 2001. Little domestic funding was available and the Argentine government was unwilling to reduce spending to cut the deficit. So it turned to the central bank, which printed 4 billion pesos in 2007 (then worth about $1.3 billion). That increased to 159 billion pesos in 2015, equal to 3 percent of gross domestic product. Not surprisingly, inflation skyrocketed to about 25 percent last year, up from 6 percent in 2009.

To be sure, the independence of most central banks from their governments is rarely clear cut. It’s become the norm in peacetime, but not during times of war, when government spending shoots up and the resulting debt requires considerable central-bank assistance. That was certainly true during World War II, when the U.S. money supply increased by 25 percent a year. The Federal Reserve was the handmaiden of the U.S. government in financing spending that far exceeded revenue.

Today, developed countries are engaged not in shooting wars but wars against chronically slow economic growth. So the belief in close coordination between governments and central banks in spurring economic activity is back in vogue — thus helicopter money.

All of the QE activity over the past several years by the Fed, the Bank of England, the European Central Bank, the Bank of Japan and others has failed to significantly revive economic growth. U.S. economic growth in this recovery has been the weakest of any post-war recovery. Growth in Japan has been minimal, and economies in the U.K. and the euro area remain under pressure.

The U.K.’s exit from the European Union may well lead to a recession in Britain and the EU as slow growth turns negative. A downturn could spread globally if financial disruptions are severe. This would no doubt ensure a drop in crude oil prices to the $10 to $20 a barrel level that I forecast in February 2015. This, too, would generate considerable financial distress, given the highly leveraged condition of the energy sector.

Both U.S. political parties seem to agree that funding for infrastructure projects is needed, given the poor state of American highways, ports, bridges and the like. And a boost in defense spending may also be in the works, especially if Republicans retain control of Congress and win the White House.

Given the “mad as hell” attitude of many voters in Europe and the U.S., on the left and the right, don’t be surprised to see a new round of fiscal stimulus financed by helicopter money, whether Donald Trump or Hillary Clinton is the next president.

Major central bank helicopter money is a fact of life in war time — and that includes the current global war on slower growth. Conventional monetary policy is impotent and voters in Europe and North America are screaming for government stimulus. I just hope it doesn’t set a precedent and continue after rapid growth resumes — otherwise, the fragile independence of major central banks could go the way of those in banana republics.

Economic Policy Report Card: C-

Today’s headlines:

Still anemic: U.S. growth picks up to only 0.8%

U.S. economic growth between January and March was 0.8% compared to the same time frame a year ago. That’s better than the initial estimate of 0.5%, which came in April, but still pretty sluggish.


US created 38,000 jobs in May vs. 162,000 expected

Job creation tumbled in May, with the economy adding just 38,000 positions, casting doubt on hopes for a stronger economic recovery as well as a Fed rate hike this summer.

The Labor Department also reported Friday that the headline unemployment fell to 4.7 percent. That rate does not include those who did not actively look for employment during the month or the underemployed who were working part time for economic reasons. A more encompassing rate that includes those groups held steady at 9.7 percent.

The drop in the unemployment rate was primarily due to a decline in the labor force participation rate, which fell to a 2016 low of 62.6 percent, a level near a four-decade low. The number of Americans not in the labor force surged to a record 94.7 million, an increase of 664,000.

growth chart

We’ve been predicting such disappointing results of ineffectual monetary and fiscal policies since this blog began back in August of 2011. And providing corroborating evidence along the way. Yet our policy experts continue to double-down on failed policies.

The problem is that when a nation inflates asset bubbles like we did with commodities, houses, stocks, and bonds over the past 20 years, there is no silver-lining policy correction that does not involve some  economic pain for the body politic. We had that awakening in 2008, but since then we have merely jumped on the same train by pumping out cheap credit for 8+ years.

Perhaps a medical metaphor works here. When prescribing antibiotics to combat an infection one can use small doses to avoid side-effects or one large overkill dose to knock-out the offending bacteria. The first treatment is the conservative, prudent approach that seeks a gradual recovery. The second risks a sudden shock to the system that kills off the infection so the patient can begin healing.

In medicine we’ve discovered that the gradual treatment can enable the bacteria to evolve and resist the antibiotics, making them ineffectual. In a nutshell, this is what we have done with economic policy, especially monetary policy that has distorted interest rates for more than 15 years.

The conservative approach marked by bailouts and government bail-ins has kept the patient flat on his back for 8 years. The more disciplined approach would have shocked the economy severely but gotten the patient out of the recovery room much quicker. We’ve seen that with other countries, like Iceland, that were forced to swallow their medicine in one quick dose.

But, of course, that would have meant a lot of politicians would have lost their cozy jobs. That may happen anyway after the next election.

This is Us

Somehow we cling to the hope that debt on our side of the world works differently than debt on the other side of the world.  And then we wonder why GDP constantly falters and consumer spending is so reticent.

Beijing can rely only on stimulus. Extraordinary spending in March produced only a one-month bump—and that blip came at a high price. The government in March piled up debt at least four times faster than it created nominal GDP…eventually rapid credit creation must produce a disaster. Already, the country’s debt-to-GDP ratio is well north of 300 percent…

China’s Economy Is Past the Point of No Return

by Gordon G. Chang

After a near-disastrous start to the year and a one-month recovery in March, the Chinese economy looks like it’s now headed in the wrong direction again. The first indications from April show the country was unable to sustain upward momentum.

Even before the first dreadful numbers for last month were released, Anne Stevenson-Yang of J Capital Research termed the uptick the “Dead Panda Bounce.”

The economy is essentially moribund as there is not much that can stop the ongoing slide. A contraction is certain, and a severe adjustment downward—in common parlance, a crash—looks likely.

At the moment, China appears healthy. The official National Bureau of Statistics reported that growth in the first calendar quarter of this year was 6.7 percent. That is just a smidgen off 6.9 percent, the figure for all of last year. Moreover, the quarterly result cleared the bottom of the range of Premier Li Keqiang’s growth target for this year, 6.5 percent.

The first-quarter 6.7 percent was too good to be true, however. And there are two reasons why we should be particularly alarmed.

First, China’s statisticians appear to be just making the numbers up. For the first time since 2010, when it began providing quarter-on-quarter data, NBS did not release a quarter-on-quarter figure alongside the year-on-year one. And when NBS got around to releasing the quarter-on-quarter number, it did not match the year-on-year figure it had previously reported.

NBS’s 1.1 percent quarter-on-quarter figure for Q1, when annualized, produces only 4.5 percent growth for the year. That’s a long distance from the 6.7 percent year-on-year growth that NBS reported for the quarter.

Even China’s own technocrats do not believe their own numbers. Fraser Howie, the coauthor of the acclaimed Red Capitalism, notes that the chief of a large European insurance company, who had just been in meetings with the People’s Bank of China, said that even the Chinese officials were joking and laughing in derision when they talked about official reports showing 6 percent growth.

Second, the central government simply turned on the money taps, flooding the economy with “gobs of new debt,” as the Wall Street Journal labeled the deluge.

The surge in lending was one for the record books. Credit growth in Q1 was more than twice that in the previous quarter. China created almost $1 trillion in new credit during the quarter, the largest quarterly increase in history. [The Fed has created $3.5+ trillion and counting during our non-recovery.]

Of course, Chinese banks tend to splurge in Q1 when they get new annual quotas, but this year’s lending exceeded all expectations.

The Ministry of Finance also did its part to refloat the economy. Its figures show that in March, the central government’s revenue increased 7.1 percent while spending soared 20.1 percent.

All that money produced good results—for one month. In April, the downturn continued. Exports, in dollar terms, fell 1.8 percent from the same month last year, and imports tumbled 10.9 percent. Both underperformed consensus estimates. A Reuters poll, for instance, predicted that exports would decline only 0.1 percent, while imports would fall 5 percent.

Exports have now dropped in nine of the last ten months, and imports, considered a vital sign of domestic demand, have fallen for eighteen straight months.

Both figures show a marked deterioration from March, when exports jumped 11.5 percent and imports fell 7.6 percent.

The trade figures followed extremely disappointing surveys of the manufacturing sector. The official Purchasing Managers’ Index came in at 50.1, down from March’s 50.2, barely above the 50.0 that divides expansion from contraction.

The widely followed Caixin survey registered at 49.4, down from March’s 49.7. April was the fourteenth straight month of contraction in this more representative—and far more reliable—survey.

Beijing will release additional numbers in the next two weeks, but its reported figures—especially those showing consumer prices, retail sales and industrial output—have obviously become less accurate in recent months. By now, with the first indications for April, it’s clear the economy did not turn the March spike into a recovery.

That has grave implications for Beijing, as Chinese technocrats have evidently lost control of the economy. For one thing, they are no longer helped by strong external demand, and there is little prospect of relief in coming months. As Zhou Hao of Commerzbank told the Wall Street Journal, “China is on its own.”

And alone, Beijing can rely only on stimulus. Extraordinary spending in March produced only a one-month bump—and that blip came at a high price. The government in March piled up debt at least four times faster than it created nominal GDP.

Although debt does not work the same way in China’s state-directed economy as it does in freer ones, eventually rapid credit creation must produce a disaster. Already, the country’s debt-to-GDP ratio is well north of 300 percent, as Barron’s, referring to Victor Shih’s calculations, notes. Soros in January said the ratio could be as high as 350 percent, and Orient Capital Research in Hong Kong suggests 400 percent.

Whatever it is, China is just about at the limits of the debt it can bear, as growing defaults—and a stark warning from the Communist Party itself on Monday—indicate.

There are many problems, but state firms, backed by Beijing’s spend-like-there’s-no-tomorrow approach, are investing capital, and private ones are not. Leland Miller and Derek Scissors note that their China Beige Book survey of 2,200 Chinese businesses shows that in the first quarter, capital expenditure by lumbering state firms was “stable from a year ago” while private companies “cut back substantially.”

That is an issue because virtually no one thinks an even bigger state sector is a good idea. Yet Chinese leaders have opted for one because, as a practical matter, they have no choice. Structural economic reform, which everyone knows is necessary, would lower growth rates too far, well below zero. That’s politically unacceptable, so they continue with a strategy that must result in a crash, simply because it buys time.

It is no coincidence that Chinese leaders are now pressuring analysts and others to brighten their forecasts and not report dour news, to show zhengnengliang—“positive energy”—a sure indication Beijing has run out of real options.

China, therefore, has passed not only an inflection point but also the point of no return. There are no longer off ramps on the road leading over the cliff.

And that thud you just heard when the first April numbers were issued? That was the big black-and-white bear hitting the floor.

America’s Bank – A Review

Interesting book review with highlights of the history of the Federal Reserve. We should keep in mind that all financial crashes are rooted in excess credit creation. Unconstrained credit creation has now become the primary strategy of our central banks.

An All Too Visible Hand

When Wilson signed the Federal Reserve Act into law in 1913, the very idea of a macroeconomy—something to be measured and managed—was yet to be invented

By James Grant

The Federal Reserve is America’s problem and the world’s obsession. When will Janet Yellen choose to lift the federal-funds rate from its longtime resting place of zero, thereby upending or not upending (it depends on whom you ask) individuals and markets in all four corners of the earth? Her subjects await a sign. While tapping their feet, they may ponder how things ever came to this pass. How, indeed, did such all-powerful body come into existence in the first place—and why?

Roger Lowenstein’s “America’s Bank,” which chronicles the passage of the 1913 Federal Reserve Act, is victor’s history. Its worldview is that of today’s central bankers, the bailers-out of markets, suppressors of interest rates and practitioners of money conjuring. In Mr. Lowenstein’s telling, what preceded the coming of the Federal Reserve was a financial and monetary dark age. What followed was the truth and the light.

It sticks in the craw of good Democrats that, in 1832, their own Andrew Jackson vetoed the rechartering of the Second Bank of the United States, the predecessor of the Federal Reserve. Just as galling is the fact that Old Hickory’s veto message is today counted as one of America’s great state papers. In it, Jackson denies to Congress the power to delegate its constitutionally given duty to “coin money and regulate the value thereof.” To do so, Jackson affirmed, would render the Constitution a “dead letter.”

America’s Bank

By Roger Lowenstein

Mr. Lowenstein contends that, in the creation of the Federal Reserve 80 years later, Congress and the people commendably put that hard-money Jacksonian claptrap behind them. Mandarin rule is the way forward in monetary policy, he suggests—the Ph.D. standard, as one might call it, under which former tenured economics faculty exercise vast discretionary power over the value of money and the course of interest rates, financial markets and business activity. Give Mr. Lowenstein this much: As the world awaits the raising of the Fed’s minuscule interest rate, the questions he provokes have never been timelier. Not for the first time the thoughtful citizen must wonder: What’s money and who says so?

When Woodrow Wilson signed the Federal Reserve Act into law in 1913, the dollar was defined as a weight of gold. You could exchange the paper for the metal, and vice versa, at a fixed and statutory rate. The stockholders of nationally chartered banks were responsible for the solvency of the institutions in which they owned a fractional interest. The average level of prices could fall, as it had done in the final decades of the 19th century, or rise, as it had begun to do in the early 20th, without inciting countermeasures to arrest the change and return the price level to some supposed desirable average. The very idea of a macroeconomy—something to be measured and managed—was uninvented. Who or what was in charge of American finance? Principally, Adam Smith’s invisible hand.

How well could such a primitive system have possibly functioned? In “The New York Money Market and the Finance of Trade, 1900-1913,” a scholarly study published in 1969, the British economist C.A.E. Goodhart concluded thus: “On the basis of its record, the financial system as constituted in the years 1900-1913 must be considered to have been successful to an extent rarely equalled in the United States.”

The belle epoque was not to be confused with paradise, of course. The Panic of 1907 was a national embarrassment. There were too many small banks for which no real diversification, of either assets or liabilities, was possible. The Treasury Department was wont to throw its considerable resources into the money market to effect an artificial reduction in interest rates—in this manner substituting a very visible hand for the other kind.

Mr. Lowenstein has written long and well on contemporary financial topics in such books as “When Genius Failed” (2000) and “While America Aged” (2008). Here he seems to forget that the past is a foreign country. “Throughout the latter half of the nineteenth century and into the early twentieth,” he contends, “the United States—alone among the industrial powers—suffered a continual spate of financial panics, bank runs, money shortages and, indeed, full-blown depressions.”

If this were even half correct, American history would have taken a hard left turn. For instance, William Jennings Bryan, arch-inflationist of the Populist Era, would not have lost the presidency on three occasions. Had he beaten William McKinley in 1896, he would very likely have signed a silver-standard act into law, sparking inflation by cheapening the currency. As it was, President McKinley signed the Gold Standard Act of 1900, which wrote the gold dollar into the statute books.

The doctrine that interest rates are the Federal Reserve’s to manage has come to be regarded, at least by the mandarins, as settled science. It was not so when the heroes of Mr. Lowenstein’s story were conspiring to create a new central bank. Abram Piatt Andrew Jr. took to the scholarly journals to denounce the government’s attempts to pin down money-market interest rates.

Indiana-born, Andrew came East to study, taught economics at Harvard and lent his talents to the National Monetary Commission in 1909 and 1910—the group that conducted the field work to prepare for the grand banking reform. Somewhere along the line, he conceived the idea that the money market should be free of federal manipulation. As prices had been rising—a gentle inflation had begun just before the turn of the 20th century—interest rates should have followed prices higher. That they did not was the complaint that Andrew laid at the doorstep of the government.

Andrew contended that the Treasury Department—under Lyman J. Gage, who served from 1897 to 1902, and his successor, Leslie M. Shaw, who resigned in 1907—“succeeded in keeping the money rate of interest below the rate which would have been ‘normal’ or ‘natural.’ . . . They had kept alive a continuously excessive demand for credit by making it available at less than the normal cost. They had sown the wind and their successor was to reap the whirlwind.”

It is an indictment that comes ready-written against the Federal Reserve’s policy today. Interest rates are prices. Far better that they be discovered in the marketplace than administered from on high. One has to wonder what Andrew would say if he were spirited back to earth to read a random edition of this newspaper in the seventh year of the Fed’s attempt to create prosperity through the technique of zero-percent interest rates. He might want a quiet word with Ms. Yellen.

Andrew is not the only vivid personality in this tale of unintended consequences. Mr. Lowenstein entertainingly limns a gallery of them: Paul Warburg, a German-banker immigrant eager to import European ideas into his adopted country; Carter Glass, an irritable Virginia newspaperman turned congressman (later senator) and currency reformer; Nelson Aldrich, a suspiciously affluent Rhode Island senator and central-bank exponent; Robert Owen, a former Indian agent from the Oklahoma Territory who pushed the Federal Reserve Act through the Senate; William Gibbs McAdoo Jr., the Treasury secretary who married the boss’s daughter; that boss himself, Woodrow Wilson; and Frank Vanderlip, president of what today is Citigroup.

Vanderlip, not alone among his fellow agitators for a central bank, was keen on the gold standard and “fervent,” as Mr. Lowenstein puts it, in his “denunciations of government control.” Here is a fine piece of irony. Government control is exactly what the authors of the Federal Reserve Act unintentionally achieved, though Andrew, at least, might have anticipated this public-policy reversal. He noticed that, under Leslie Shaw’s meddling stewardship in the early years of the 20th century, the Treasury had shifted government deposits to private institutions in times of crisis. “Outside relief in business, like outdoor charity,” as Mr. Lowenstein quotes him saying, “is apt to diminish the incentives to providence, and to slacken the forces of self-help.”

Centralized government control arrived in force with the Banking Act of 1935. It established the centralization of monetary power within the Federal Reserve Board in Washington, and it repealed the so-called double-liability law on bank stocks: No more would the holders of common stocks in failed banks be assessed to help defray the debts of the institutions in which they had invested. Anyway, there would be precious few failures to deal with, proponents of the new thinking contended. Knowing that the Federal Deposit Insurance Corp. stood behind their money, depositors would give up running; they would rather walk to the bank.

The new doctrines repulsed H. Parker Willis, a key player during the organization of the Fed and later a professor of banking at Columbia University. “It is far better, both for the depositor and the banker,” said Willis of the FDIC, “that the actual net irreducible losses growing out of bank failure should fall where they belong. The universal experience with this kind of insurance—if it may be called—has pointed to the danger of increasing losses as the result of bad banking management induced by belief in deposit guarantee.”

Willis didn’t imagine the half of it. On top of deposit insurance evolved the notion that some banks—Citi, for instance—were too big to fail. They must be nurtured through subsidy and bank-friendly monetary policy: low money-market interest rates, for example. It happened that the Citigroup that evolved from Vanderlip’s National City Bank became a ward of the state in 2008. The massive federal bailout of Citi exacted many costs, including a level of regulatory micromanagement that Vanderlip could not have begun to conceive.

J.P. Morgan Chase, which did not fail in 2008, recently went public to describe the intensity of the federal oversight it labors under. More than 950 employees, it revealed, are dedicated to complying with 750 requirements laid down by 21 government entities to achieve and maintain capital adequacy. The Fed itself is high among those demanding overseers. The workers shuffle 20,000 pages of documentation and manipulate 225 econometric models.

The rage to micromanage spans the world. “It can’t be,” the head of Sweden’s Nordea Bank was quoted forlornly saying last year in the Financial Times, “that the only purpose of banking is to stop banks from going bankrupt.” Oh, yes it can.

One thinks back to the supposed financial dark ages when, in 1842, New Orleans bankers, setting down a kind of operational manifesto, succeeded in committing the essentials of safe and sound banking practice to one side of one page. They prospered by simple maxims—e.g., do what you will with your own capital but do not abuse the depositor’s funds—well after the Civil War. Some may protest that banking has become more complex since those days. The boggling, 23,000-page length of the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 (complete with supporting rules) would suggest that it has become 23,000 times more complex. I doubt that.

The legislation to which President Wilson affixed his signature in 1913—Mr. Lowenstein observantly notes that he signed with gold pens—included no intimation of the revolutionary techniques of monetary control that would come into being after 2008: zero-percent interest rates, “quantitative easing,” and central-bank-sponsored bull markets in stocks and real estate, among others.

The great value of “America’s Bank” is the comparison it invites between what lawmakers intend and what they achieve. The act’s preamble described a modest effort “to provide for the establishment of the Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper and to establish a more effective supervision of banking in the United States and for other purposes.” “And for other purposes”—our ancestors should have known.

Money For Nothing?


…there is now a nagging fear that credibility in central bankers is being lost. Investors, it seems, are losing confidence in the Fed.

You think? I believe the definition of insanity is to keep doing the same thing over and over and expecting a different result. It seems to me the Fed has sidelined itself and the future path of the economy will be determined by markets, and it won’t all be good. As Stockman says (see second article below), the global economy in many respects is at peak debt, thus the global private and public sectors are both struggling to de-leverage. The only borrowers are national governments and those speculating in asset markets.

Thus, the Fed’s efforts to boost inflation to 2% have been for naught and merely goosed asset markets and resource misallocation. For the global economy to re-balance from peak debt requires debts to be written down, something that occurs with bankruptcy accompanied by price deflation. Forestalling instead of managing these corrections only means a larger correction at some point in the future.

On another note, our experience is confirming the weakness of Friedman’s monetarism. Inflation is not purely a monetary phenomenon – more important, it is a behavioral one based on demographics and the perceived level of uncertainty and risk regarding the future of the economy and policy distortions.

Markets reflect the collective intelligence of humans; they’re not all stupid.

Why Wall Street’s Stimulus Junkies Weren’t Thrilled by the Fed’s Rate Decision

By Anthony Mirhaydari
It wasn’t supposed to be like this.

In a massively hyped Federal Reserve policy announcement Thursday — one that threatened to end the nearly seven-year experiment with interest rates near 0 percent and usher in the first rate hike since 2006 — Chair Janet Yellen and her cohorts gave Wall Street exactly what they wanted: No change, in line with futures market odds.

And yet stocks drifted lower, even as the action in the currency and commodities market was as expected, with the dollar falling hard and gold up 0.8 percent. Why?

Cutting to the quick: Investors, it seems, are losing confidence in the Fed.

While the Wall Street stimulus junkies should’ve been happy with the continuation of the status quo, there is now a nagging fear that credibility in central bankers is being lost — something that RBS’ Head of Macro Credit Research Alberto Gallo took to Twitter this afternoon to reiterate.

Moreover, the Summary of Economic Projections by Fed officials revealed that, at the median, policymakers now only expect a single rate hike by the end of 2015. The futures market is now pricing in a 49 percent chance of a hike at the December meeting (although Yellen noted that the October meeting was “live” and could result in a hike should markets and economic data improve).

But the kicker — the one that pushed large-cap stocks lower into the closing bell — was the appearance of a negative interest rate projection by a Fed policymaker on the newly released “dot plot.” Someone, it seems, expects federal funds policy rate to be in negative territory at the end of 2016. Four officials don’t expect any hikes this year at all.

Not only does this undermine confidence in the state of the economy, but it calls into question the efficacy of the Fed’s ultra-easy monetary policy stance that has been in place, to varying degrees, since 2008. Moving forward, it will be critical for the bulls to recover from Thursday’s intra-day selloff. The day’s action resulted in a very negative “shooting star” technical pattern that signals buying exhaustion and often precedes pullbacks.

In their statement, Federal Open Market Committee members fingered recent global economic weakness and financial market turbulence as giving reason to believe that inflation would take longer to return to their 2 percent target. So the new dot plot shows the median rate projection for the end of 2015 falling to 0.375 percent from 0.625 percent as of June; to 1.375 percent for 2016 vs. 1.625 percent before; and 2.625 percent for 2017 from 2.875 percent. The long-term neutral rate declined to 3.5 percent from 3.75 percent, signifying ongoing structural problems in the economy holding down its potential growth rate.

But a tree should be judged by the fruit it produces. In this case, median household incomes are stagnating despite all the Fed has already done, including three bond-buying programs and the “Operation Twist” maturity extension program. With corporate profits rolling over and global growth stagnating, people are wondering: Is this all the Fed and its central banking counterparts can do? Fresh threats, such as another possible debt ceiling showdown on Capitol Hill this autumn and an election in Greece, are approaching.

As for what comes next, Societe Generale Chief U.S. Economist Aneta Markowska suggests a replay of the late 2013 experience surrounding the beginning of the end of the QE3 bond-buying program: “Our scenario is reminiscent of 2013 when the ‘taper tantrum’ spooked the Fed in September, a government shutdown spooked the Committee in October, and the fog finally lifted by December when the taper was finally announced.”

If the Fed left rates unchanged, there were some new wrinkles in its statement. In explaining their decision, Fed officials elevated issues like global economic growth and the dollar’s valuation seemingly above its traditional mandate regarding labor market health. J.P. Morgan Chief U.S. Economist Michael Feroli believes investors shouldn’t read too much into the new factors being cited. In a paraphrase of the infamous rant by former Arizona Cardinals coach Dennis Green: Yellen is a dove. She is who we thought she was. And until higher inflation becomes a clear and present problem, this continual moving of the goalposts for Fed rate hikes — deferring until more data comes in — looks set to continue.

But that may no longer be enough to keep stocks happy.



David Stockman is not a fan of the Fed. In fact he claims that the Fed is on a “jihad” against retirees and savers.

The former Reagan budget director and author of “The Great Deformation: The Corruption of Capitalism in America” visited Yahoo Finance ahead of the Fed announcement to discuss his predictions and the potential impact of today’s interest rate decision. “80 months of zero interest rates is downright crazy and it hasn’t helped the Main Street economy because we’re at peak debt,” he says.

Businesses in the U.S. are $12 trillion in debt. That’s $2 trillion more than before the crisis, but “all of it has gone into financial engineering—stock buybacks, mergers and acquisitions and so forth,” according to Stockman. “The jig is up; [the Fed] needs to get on with the business of allowing interest rates to find some normalized level.”

While Stockman believes that the Fed should absolutely raise rates today, he isn’t so sure that they will (Note: they did not). But even if they do, he says they’ll muddle the effect by saying “‘one and done’ or ‘we’re going to sit back and watch this thing unfold for the next two or three months.’”

This all fuels an inflationary bubble on Wall Street, according to Stockman. “This massive money printing we’ve had has never gotten out of the canyons of Wall Street. It’s sitting there as excess reserves.”

According to Stockman, the weakness of the U.S. economy has been due to a lack of investment over the past 15 years and inflated labor costs in America that can’t compete on a global scale. “Simply printing more money and keeping interest rates at zero do not help that problem.”

Zero interest policies, says Stockman, are leading to the global economic turmoil we are currently experiencing. “In the last 15 years China took its debt from $2 trillion to $28 trillion… it’s a house of cards with an enormous overcapacity and enormous speculation and gambling that is beginning to roll over,” he says. “It’s just the leading edge of a global deflation that I think is underway as a consequence of all this excess credit growth that we’ve had.”

If the Fed raises rates and doesn’t mince words there’s going to be a long-running market correction, says Stockman. If the Fed doesn’t raise rates there will be a short-term relief rally but eventually the markets will lose confidence in the central bank bubble and we’ll be in store for a “huge correction.”

The Debt Driven Economy


The problem is that like all Keynesians they do not know the difference between fiat credit, which is manufactured out of thin air by fractional reserve commercial banks or money-printing central banks, and honest debt that is funded out of genuine savings from current income by households and business.

Krugman’s Dopey Diatribe Deifying The Public Debt

Actually, dopey does not even begin to describe Paul Krugman’s latest spot of tommyrot. So here are his own words—–least it appear that the good professor is being unfairly caricaturized. In a world drowning in government debt what we desperately need, by golly, is more of  the same:

That is, there’s a reasonable argument to be made that part of what ails the world economy right now is that governments aren’t deep enough in debt.

Yes, indeed. There is currently about $60 trillion of public debt outstanding on a worldwide basis compared to less than $20 trillion at the turn of the century. But somehow this isn’t enough, even though the gain in public debt——-from the US to Europe, Japan, China, Brazil and the rest of the debt-saturated EM world—–actually exceeds the $35 billion growth of global GDP during the last 15 years.

But rather than explain why economic growth in most of the world is slowing to a crawl despite this unprecedented eruption of public debt, Krugman chose to smack down one of his patented strawmen. Noting that Rand Paul had lamented that 1835 was the last time the US was “debt free”, the Nobel prize winner offered up a big fat non sequitir:

Wags quickly noted that the U.S. economy has, on the whole, done pretty well these past 180 years, suggesting that having the government owe the private sector money might not be all that bad a thing. The British government, by the way, has been in debt for more than three centuries, an era spanning the Industrial Revolution, victory over Napoleon, and more.

Neither Rand Paul nor any other fiscal conservative ever said that public debt per se would freeze economic growth or technological progress hard in the horse and buggy age. The question is one of degree and of whether at today’s unprecedented public debt levels we get economic growth—–even at a tepid rate—–in spite of rather than because of soaring government debt.

A brief recounting of US fiscal history leaves little doubt about Krugman’s strawman argument.  During the eighty years after President Andrew Jackson paid off the public debt through the eve of WWI, the US economy grew like gangbusters. Yet the nation essentially had no debt, as shown in the chart below, except for temporary modest amounts owing to wars that were quickly paid down.

In fact, between 1870 and 1914, the US economy grew at an average rate of 4% per year——the highest and longest sustained growth of real output and living standards ever achieved in America either before or since. But during that entire 45 year golden age of prosperity, the ratio of US public debt relative to national income was falling like a stone.

In fact, on the eve of World War I, the US had only $1.4 billion of debt. That is the same figure that had been reached before the Battle of Gettysburg in 1863.

That’s right. During the course of four decades, the nominal level of peak Civil War debt was steadily whittled down; the Federal  budget was in balance or surplus most of the time; and at the end of the period a booming US economy had debt of less than 5% of GDP or about $11 per capita!

In short, nearly a century of robust economic growth after 1835 was accompanied by hardly any public debt at all. The facts are nearly the opposite of Krugman’s smart-alecky insinuation that today’s giant, technologically advanced economy would not have happed without all of today’s massive public debt.

Indeed, on a net basis every dime that was added to the national debt between Jackson’s mortgage burning ceremony in 1835 and 1914 was 100% war debt that never contributed to domestic economic growth and was mostly repaid during peacetime. In effect, Rand Paul was right: In a modern Keynesian sense, the US was “debt free” during the 80 years when it emerged as a great industrial powerhouse with the highest living standard in the world.

Thereafter, there were two huge surges of wartime debt, but those eruptions had nothing to do with peacetime domestic prosperity;  and they were quickly rolled back after the war-time emergencies ended. Its plain to see in the graph below.

During WWI, for example, the national debt soared from  $1.4 billion to $27 billion, but the great Andrew Mellon, as Secretary of the Treasury during three Republican administrations, paid that down to less than $17 billion, even as the national income nearly doubled during the Roaring Twenties. That meant the public debt was back under 20% by the end of the 1920s.

To be sure, for the last 70 years the Keynesian professoriate has been falsely blaming the severity and duration of the Great Depression on Herbert Hoover’s balanced budget policies during 1930-1932. But none has ever charged that paying down the WWI debt had actually caused the Great Depression. Nor have the Keynesian economic doctors ever claimed that had Mellon not paid down the peak WWI debt ratio of about 45% of GDP that the Roaring Twenties would have roared even more mightily!

Likewise, the national debt did soar from less than 50% of GDP in 1939, notwithstanding the chronic New Deal deficits, to nearly 120% at the 1945 WWII peak. But this was not your Krugman’s beneficent debt ratio, either. Nor is it proof, as per his current diatribe, that the recent surge to $18 trillion of national debt has been done before and has proven helpful to economic growth.

Instead, the 1945 ratio was a temporary and complete artifact of a command and control war economy. Indeed, the total mobilization of economic life by agencies of the state during WWII was so complete that Washington had essentially banished civilian goods including new cars, houses and most consumer durables, and had also tightly rationed everything else including sugar, butter, meat, tires, shoes, shirts, bicycles, peanut brittle and candied yams.

With retail shelves empty the household savings rate soared from 4% of disposable income in 1938-1939 to an astounding 35% by the end of the war.

Consequently, the Keynesians have never acknowledged the single most salient statistic about the war debt: namely, that the debt burden actually fell during the war, with the ratio of total credit market debt to GDP declining from 210 percent in 1938 to 190 percent at the 1945 peak!

This obviously happened because household and business debt was virtually eliminated by the wartime savings spree, dropping from 150 percent of GDP in 1938 to barely 60 percent by 1945, and thereby making vast headroom for the temporary surge of public debt.

In short, the nation did not borrow its way to victory via a Keynesian miracle.  Measured GDP did rise smartly because half of it was non-recurring war expenditure. But even then, the truth is that the American economy “regimented” and “saved” its way through the war.

Once the war mobilization was over Washington quickly reduced it massive wartime borrowing, and set upon a 35 year path of drastically reducing the government debt burden relative to national output. Looking at the chart’s veritable ski-slope from 120% of GDP in 1945 to barely 30% of GDP when Reagan took office in 1980 you would think that the US economy should have been buried in depression during that period if Professor Krugman silly syllogisms are to be given any credit.

Of course, just the opposite is true.  The greatest sustained period of post-war real GDP growth occurred between 1955 and 1973, with real output growth averaging nearly 3.8% per annum. But after that, as shown by the relative growth rates of real final sales in the chart below, the trend rate of growth steadily eroded. Thus, economic prosperity actually reached its highest level precisely when the national debt ratio was speeding down that ski-slope.


Indeed, during the very period when the fiscal deficit got out of control during the early 1980’s owing to the Reagan Administration’s impossible budget equation of soaring defense, deep tax cuts and tepid restraint on domestic spending, young professor Krugman was toiling away in the White House as a staff member of the Council of Economic Advisors.

During the dark days of the 1981-1982 recession when the economy was collapsing and the deficit was soaring I heard some pretty whacky ideas from the White House economists on how to reverse the tide. But never once did I hear professor Krugman argue that with the GDP at about $3.5 trillion while the public debt stood at less than $1.5 trillion or about 40% of GDP that it was time to turn on the deficit spending after-burners and get the national debt up to 100% of GDP forthwith.

No, this whole case for mega-public debt has emerged since 2008. For crying out loud,  before the great financial crisis Krugman was one of the noisiest voices in the chorus denouncing George Bush’s massive tax cuts on the grounds that they would add to the national debt, which was then $6 trillion, not $18 trillion.

The fact is, the financial crisis was caused by the massive money printing campaigns of the Fed in the years after Greenspan assumed the helm in 1987. The resulting falsification of money market interest rates and distortion of prices and yields in the capital markets gave rise to serial booms and busts on Wall Street. But these financial market deformations had virtually nothing to do with fiscal policy and most certainly did not reflect an insufficiency of public debt.

These destructive busts——the dotcom crash, the 2008 mortgage bust and Wall Street meltdown and the stock market plunge just now getting underway——-are owing to the fact that Wall Street has been turned into a gambling casino by the Federal Reserve and the other major central banks.

But rather than acknowledge that obvious reality, Krugman actually manages to turn it upside-down. To wit, he argues that repairing the nation’s busted financial markets after September 2008 required the creation of  “safe assets” in the form of government debt so that investors would presumably have a place to hide from Wall Street’s toxic waste:

Beyond that, those very low interest rates are telling us something about what markets want. I’ve already mentioned that having at least some government debt outstanding helps the economy function better. How so? The answer, according to M.I.T.’s Ricardo Caballero and others, is that the debt of stable, reliable governments provides “safe assets” that help investors manage risks, make transactions easier and avoid a destructive scramble for cash.

Now that puts you squarely in mind of the young boy who killed his parents and then threw himself on the mercy of the courts on the grounds that he was an orphan. That is, having experienced a runaway financial bubble owing to excessive monetization of the public debt during the Greenspan era, the nation’s economy now needed even more public debt in order to subdue the very Wall Street gamblers that the Fed’s printing presses had unleashed.

Every phrase in the above quoted passage is nuts, even if it is attributable to an MIT rocket scientist, who is apparently handsomely paid for publishing pure drivel. After all, investors on the free market have known how to manage genuine financial risk from time immemorial; they didn’t need today’s vast emissions of public debt to help them.

In fact, treasury notes and bonds have no logical relationship to honest hedging in the first place. The most salient case of treasury based hedging was the spectacular blow-up of Long Term Capital in 1998. In that particular instance, the gamblers who ran a trillion dollar book of speculative assets including tens of billions of high yield Russian debt blew themselves up shorting the treasuring market to hedge their interest rate risk. Then, during the panicked investor flight to safety in August 1998, their giant losses on risky assets were compounded by even larger losses on their short treasury hedge.

In fact, the real point about the government debt market in today’s central bank rigged financial system is that it has become a venue for state sponsored thievery. That is to say, when the Fed pegs the front end of the curve at zero for 80 months running and then pours $3.5 trillion of fiat purchasing power into buying the rest of the treasury curve, including mortgage-backed agency securities, in order to boost bond prices and lower yields, it is creating a  virtually risk free arbitrage for Wall Street gamblers. And that serves no public purpose whatsoever, except to transfer massive windfall profits to the most adept gamblers among the 1%.

Professors Krugman and Caballero  actually think this helps?

The problem is that like all Keynesians they do not know the difference between fiat credit, which is manufactured out of thin air by fractional reserve commercial banks or money-printing central banks, and honest debt that is funded out of genuine savings from current income by households and business.

Allocating genuine savings to public versus private capital investment almost always results in a diminution of productivity and efficiency, thereby reducing society’s wealth and living standards, not raising them. That’s because governments are invariably controlled by squeaky wheel special interest groups and lobbies which succeed in gaining in the halls of Congress what they cannot justify in the private market. Amtrak, subsidized mass transit and bus services, corps of engineers water projects and export subsidies to Boeing and GE are obvious cases in point.

But our Keynesian professors have no sense of allocative efficiency. They think that any spending—-including having the unemployed dig holes with tablespoons and fill them up with teaspoons—– adds to GDP:

One answer is that issuing debt is a way to pay for useful things, and we should do more of that when the price is right. The United States suffers from obvious deficiencies in roads, rails, water systems and more; meanwhile, the federal government can borrow at historically low interest rates. So this is a very good time to be borrowing and investing in the future……..

You can’t make this stuff up. And here’s the rest of it for the purpose of any remaining doubt.

The Ironies of ZIRP


This is an excellent explanation of the behavioral illogic of Zero Interest Rate Policies being imposed by the major central banks of the world. If only they paid more attention to how they were increasing perceived risks and uncertainty in markets.

From Barrons:

Low Interest Rates: A Self-Defeating Strategy

Instead of encouraging spending and boosting the economy, low rates can lead people to squirrel more money away to meet their retirement or other goals.

April 17, 2015
When I think back on all the crap I learned in grad school, it’s a wonder I can think at all, to paraphrase Paul Simon. And that also goes for what was drummed into me as an undergraduate, way back when we used Kodachrome film to take photographs with Nikon cameras, instead of iPhones (and Eastman Kodak was among the elite 30 Dow industrials).Among those shibboleths was that low interest rates always stimulate the economy. Reduced borrowing costs make it easier for folks to buy houses and companies to invest and expand. Lower yields on savings cut the incentives for consumers to stash their cash in the banks like Scrooge and instead make them more inclined to go out and spend and have a good time. And all that spending should tend to push up prices and, in due time, set up the next cycle of rising rates.

And if interest rates ever hit zero, money would be free, which should mean the economy should be like an open bar—a real party. Then think about what would happen if rates went where they never had gone before—below zero percent and into negative territory. Lenders would be paying borrowers, rather than the other way around.

This isn’t some alternate universe, but rather what’s actually happening in Europe. As The Wall Street Journal reported last week, some borrowers in Spain had the rates on their mortgages fall below zero, which meant the bank owed them money. That comes as approximately one-third of all European government bonds carry negative yields.

Those are mainly short-to-intermediate maturities whose yields have followed the European Central Bank’s minus 0.20% deposit rate into negative territory. But, by week’s end, the benchmark 10-year German bund yield seemed inexorably headed below zero, as it set another record closing low of 0.073%, according to Tradeweb. At that return, investors would double their money in a mere 1,000 years.

But the boom that the textbooks predict is nowhere in evidence. That’s not a surprise to Jason Hsu, vice chairman and co-founder of Research Affiliates and also a card-carrying Ph.D. and adjunct professor at UCLA. As a frequent visitor to Japan over more than a decade, he’s had a chance to observe firsthand the effect of near-zero interest rates.

In the complete opposite of what classical economics teaches, low returns actually have induced Japanese consumers to spend less, he says. As the aging population saves more to get to a threshold of assets needed for retirement, firms seeing no spending are loath to spend, invest, or hire. “This is a bad spiral that never was predicted,” Jason explains (appropriately enough, over a sushi lunch).

This had always been assumed to reflect both the demographics and cultural traits of Japan. But that world view will have to be revised, as there’s evidence of the same thing happening in Europe, he adds, with Germans reacting to zero interest rates by saving more. This behavioral dimension helps explain the tepid payoff from the unprecedented “financial repression” that has taken interest rates to zero and below.

The restraints on spending from forcing savers to save more in a low-rate environment has been a theme sounded by a number of critics, including David Einhorn, the head of Greenlight Capital, a hedge fund. At a recent Grant’s Interest Rate Observer conference, he quoted Raghuram Rajan, the head of India’s central bank, who, in a lecture at the Bank for International Settlements in 2013, spoke of the plight of someone nearing retirement and facing losses on savings (from two bear markets this century) and low prospective returns. That “can imply low real interest rates are contractionary—savers put more aside as interest rates fall in order to meet the savings they think they will need when they retire.” Indeed, according to a widely cited estimate by Swiss Re, U.S. savers have foregone some $470 billion in interest earnings since 2008.

That conundrum was quantified in a report by David P. Goldman, head of Americas research at Reorient Capital in Hong Kong. A saver who accumulates assets for retirement through stocks would want to “annuitize” or convert that wealth into a stream of income for retirement. “But the amount of income investors can expect to receive from an equity portfolio converted into bonds actually has fallen over the past 18 years,” he writes.

At the peak of the stock market in 2000, Goldman calculates that one unit of the Standard & Poor’s 500 annually earned the real equivalent of $1,900 (adjusted for inflation, in 1982 dollars) when invested in Baa (medium-grade) corporate bonds. At the market’s recovery in 2007, one unit of the S&P would earn $1,300; now, it’s only $1,100.

The same goes for home prices. A house bought for $500,000 in 2000 and sold today and reinvested in Baa bonds would yield $16,000 annually in 1982 dollars, versus $22,000 when it was bought 15 years ago. Bottom line: “Assets have soared, but the prospective interest on these assets has shrunk.”

Which means that even the affluent top 20% of Americans (who accounted for 61% of domestic consumption in 2012, up from 53%, according to data cited by Goldman) who actually have assets are more cautious about spending than a naïve view of the wealth effect might suggest, he concludes.

To be fair, what we learned about interest rates and the economy were predicated on “normal” levels. A decline in mortgage rates from, say, 7% to 5% could reliably be counted on to set off a rebound. That would lower the monthly payment on a $300,000, 30-year loan by nearly 25%, to around $1,600 from $2,000. First-time home buyers then might qualify to get into a house; the sellers could trade up to nicer digs; those who stayed put could refinance and cut their payment or take down more money to pay off other debt or spend on a car, boat, or college tuition.

It may be that, as interest rates—which represent the time value of money [plus the risk premium for uncertain outcomes]—approach zero, their impact is distorted, just as time is distorted as the speed of light is approached, according to Einstein.

Financial repression that has depressed rates to levels that are unprecedented in history is having unpredictable effects, which shouldn’t be entirely unexpected. Even if we didn’t learn about them in school.

The Making of Financial Policy


The following is excerpted from an article by Jay Cost:

How about Wall Street reform? Obama likes to pose as a people-versus-the-powerful crusader, but he staffed his administration with friends of the big banks. Unsurprisingly, that has enormously influenced policy.

David Skeel, a professor at the University of Pennsylvania Law School, writes about the framework “that would eventually become the Dodd-Frank legislation,” in particular the resolution rules that enables Treasury to intervene when too-big-to-fail institutions fall into distress.  He explains:

Both the resolution rules and the overall framework read as if they had been written by Timothy Geithner in consultation with the large banks he had worked with as head of the New York Fed. Geithner would get all of the powers that he and former Treasury Secretary Henry Paulson wished they had when they intervened with Bear Stearns, Lehman Brothers, and AIG. But the framework also did not overly ruffle the feathers of the largest financial institutions. There was no call to break them up…While systemically important status might subject the biggest institutions to greater oversight, it also would bring benefits in the marketplace. They could borrow money more cheaply than could smaller competitors, because lenders would assume they would be protected in the event of a collapse, as the creditors of Bear Stearns and AIG were.

The suspicion that the legislation might be a little too accommodating to the largest banks was further aroused by the discovery that David, Polk & Wardell, “a law firm that represents many banks and the financial industry’s lobbying group,” as the New York Times put it…had been deeply involved in the early drafting of the legislation. Treasury had worked from a draft first written by Davis Polk, and the legislation literally had the law firm’s name on it when Treasury submitted it to Congress, thanks to a computer watermark that Treasury had neglected to delete.

That’s not all. In Confidence Men, Ron Suskind reports that Obama instructed Geithner to develop a plan to break up Citi — as a warning to the other banks and a signal to the broader marketplace that the government was in charge, not the banks. But, per Suskind, Geithner disobeyed Obama, and never put together the plan. He suffered no consequences.

The best that can be said about this president and Wall Street is that, when it mattered most, he was a passive observer in his own administration. He allowed shills to write a bill enormously favorable to the biggest interests.

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