Financial Moral Hazard

If we believe this Houdini act then we have only ourselves to blame.

How Many Bank Bailouts Can America Withstand?

The architects of the 2008 rescues pretend they’ve been vindicated.

Ten years after the financial crisis of 2008, the architects of the bailouts are still describing their taxpayer-backed rescues of certain financial firms as great products which were poorly marketed to the American people. The American people still aren’t buying.

A decade ago, federal regulators were in the midst of a series of unpredictable and inconsistent interventions in the financial marketplace. After rescuing creditors of the investment bank Bear Stearns and providing a partial rescue of its shareholders in March of 2008, the feds then shocked markets six months later by allowing the larger Lehman Brothers to declare bankruptcy. Then regulators immediately swerved again to take over insurer AIG and use it as a vehicle to rescue other financial firms.

Within days legislative drafts were circulating for a new bailout fund that would become the $700 billion Troubled Asset Relief Program. Throughout that fall of 2008 and into 2009, the government continued to roll out novel inventions to support particular players in the financial industry and beyond. Some firms received assistance on better terms than others and of course many firms, especially small ones outside of banking, received no help at all.

In the fall of 2008, Ben Bernanke chaired the Federal Reserve, Timothy Geithner ran the New York Fed and Hank Paulson served as U.S. Treasury secretary. Looking back now, the three bailout buddies have lately been congratulating themselves for doing a dirty but important job. They recently wrote in the New York Times:

Many of the actions necessary to stem the crisis, including the provision of loans and capital to financial institutions, were controversial and unpopular. To us, as to the public, the responses often seemed unjust, helping some of the very people and firms who had caused the damage. Those reactions are completely understandable, particularly since the economic pain from the panic was devastating for many.

The paradox of any financial crisis is that the policies necessary to stop it are always politically unpopular. But if that unpopularity delays or prevents a strong response, the costs to the economy become greater. We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration.

The authors say that their actions saved the United States and the world from catastrophe, but of course this claim cannot be tested. We’ll never get to run the alternative experiment in which investors and executives all have to live with the consequences of their investments. But Stanford economist John Taylor has made the case that massive ad hoc federal interventions were among the causes of the conflagration. On the fifth anniversary of the crisis he noted that in 2008 markets deteriorated as the government was taking a more active role in the financial economy, which may have contributed to a sense of panic:

…the S&P 500 was higher on September 19—following a week of trading after the Lehman Brothers bankruptcy—than it was on September 12, the Friday before the bankruptcy. This indicates that some policy steps taken after September 19 worsened the problem… Note that the stock market crash started at the time TARP was being rolled out… When former Treasury Secretary Hank Paulson appeared on CNBC on the fifth anniversary of the Lehman Brothers failure, he said that the markets tanked, and he came to the rescue; effectively, the TARP saved us. Appearing on the same show minutes later, former Wells Fargo chairman and CEO Dick Kovacevich—observing the same facts in the same time—said that the TARP… made things worse.

CNBC reported at the time on its Kovacevich interview:

TARP caused the crisis to get “much greater,” he added.

“Shortly after TARP, the stock market fell by 40 percent,” he continued. “And the banking industry stocks fell by 80 percent. How can anyone say that TARP increased the confidence level of an industry, when its stock market valuation fell by 80 percent.”

Perhaps the argument can never be resolved. What is known but is conveniently left out of the Times op-ed is an acknowledgment of the role that regulators played in creating the crisis by encouraging financial firms to invest in mortgage debt, to operate with high leverage and to expect help in a crisis. The Times piece includes no mention of Mr. Bernanke and his Fed colleagues holding interest rates too low for too long, or the massive risks at Citigroup overseen by Mr. Geithner’s New York Fed, or the mortgage bets at AIG approved by the Office of Thrift Supervision at Mr. Paulson’s Treasury Department.

Foolish regulators creating bad incentives was nothing new, though Beltway blunders had rarely if ever occurred on such a scale. What was of course most shocking for many Americans in 2008 was observing so many of their tax dollars flowing into the coffers of large financial institutions. For months both the financial economy and the real economy suffered as Washington continued its ad hoc experiments favoring one type of firm or another.

In 2009 markets began to recover and, thanks in no small part to years of monetary expansion by the Federal Reserve, stock investors enjoyed a long boom. But when it comes to economic growth and wages for the average worker there was no such boom, just an era of discouraged Americans leaving the labor force. And by keeping interest rates near zero for years, the Fed punished savers and enabled an historic binge of government borrowing.

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That federal borrowing binge was also enabled by the rescue programs. The basic problem was that once Washington said yes to bailing out large financial houses, politicians could hardly say no to anyone else. It was no coincidence that just months after enacting the $700 billion TARP, lawmakers enacted an $800 billion stimulus plan. So began the era of trillion-dollar annual deficits. Since the fall of 2008, federal debt has more than doubled and now stands at more than $21 trillion.

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The expansion of government also included record-setting levels of regulation, which limited economic growth. A financial economy heavily distorted by federal housing policy was cast as the free market that failed, and decision-making affecting every industry was further concentrated in Washington.

Messrs. Bernanke, Geithner and Paulson make the case that they saved the financial system but failed to sell the public on the value of their interventions. It’s a sale that can never be made. Even if the bailouts hadn’t led to an era of diminished opportunity and skyrocketing federal debt, Americans would have resisted the idea that our system requires occasional instant welfare programs for wealthy recipients chosen by un-elected wise men.

The bailout buddies are now urging the creation of more authorities for regulators to stage future bailouts. The Trump administration should do the opposite, so that bank investors finally understand they will get no help in a crisis.

This column isn’t sure how many bailouts of financiers the American political system can withstand but is certain that such efforts will never be welcomed by non-financiers.

***

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Bank Bailout 3.0

I’d have to agree with this. As we’ve said all along, saving the banking system was necessary, saving the bankers was not. Now we’re set up for the next bailout of the financial elite. What a great casino this is: heads they win, tails we lose.

The bank bailout of 2008 was unnecessary. Fed Chairman Ben Bernanke scared Congress into it

By Dean Baker

This week marked 10 years since the harrowing descent into the financial crisis — when the huge investment bank Lehman Bros. went into bankruptcy, with the country’s largest insurer, AIG, about to follow. No one was sure which financial institution might be next to fall.

 

The banking system started to freeze up. Banks typically extend short-term credit to one another for a few hundredths of a percentage point more than the cost of borrowing from the federal government. This gap exploded to 4 or 5 percentage points after Lehman collapsed. Federal Reserve Chair Ben Bernanke — along with Treasury Secretary Henry Paulson and Federal Reserve Bank of New York President Timothy Geithner — rushed to Congress to get $700 billion to bail out the banks. “If we don’t do this today we won’t have an economy on Monday,” is the line famously attributed to Bernanke.

The trio argued to lawmakers that without the bailout, the United States faced a catastrophic collapse of the financial system and a second Great Depression.

Neither part of that story was true.

Still, news reports on the crisis raised the prospect of empty ATMs and checks uncashed. There were stories in major media outlets about the bank runs of 1929.

No such scenario was in the cards in 2008.

Unlike 1929, we have the Federal Deposit Insurance Corporation. The FDIC was created precisely to prevent the sort of bank runs that were common during the Great Depression and earlier financial panics. The FDIC is very good at taking over a failed bank to ensure that checks are honored and ATMs keep working. In fact, the FDIC took over several major banks and many minor ones during the Great Recession. Business carried on as normal and most customers — unless they were following the news closely — remained unaware.

 

The prospect of Great Depression-style joblessness and bread lines was just a scare tactic used by Bernanke, Paulson and other proponents of the bailout.

Had bank collapses been more widespread, stretching the FDIC staff thin, it is certainly possible that there would be glitches. This could have led to some inability to access bank accounts immediately, but that inconvenience would most likely have lasted days, not weeks or months.

 

Following the collapse of Lehman Bros., however, the trio promoting the bank bailout pointed to a specific panic point: the commercial paper market. Commercial paper is short-term debt (30 to 90 days) that companies typically use to finance their operations. Without being able to borrow in this market even healthy companies not directly affected by the financial crisis such as Boeing or Verizon would have been unable to meet their payroll or pay their suppliers. That really would have been a disaster for the economy.

However, a $700-billion bank bailout wasn’t required to restore the commercial paper market. The country discovered this fact the weekend after Congress approved the bailout when the Fed announced a special lending facility to buy commercial paper ensuring the availability of credit for businesses.

 

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Without the bailout, yes, bank failures would have been more widespread and the initial downturn in 2008 and 2009 would have been worse. We were losing 700,000 jobs a month following the collapse of Lehman. Perhaps this would have been 800,000 or 900,000 a month. That is a very bad story, but still not the makings of an unavoidable depression with a decade of double-digit unemployment.

 

The Great Depression ended because of the massive government spending needed to fight World War II. But we don’t need a war to spend money. If the private sector is not creating enough demand for workers, the government can fill the gap by spending money on infrastructure, education, healthcare, childcare or many other needs.

There is no plausible story where a series of bank collapses in 2008-2009 would have prevented the federal government from spending the money needed to restore full employment. The prospect of Great Depression-style joblessness and bread lines was just a scare tactic used by Bernanke, Paulson and other proponents of the bailout to get the political support needed to save the Wall Street banks.

 

This kept the bloated financial structure that had developed over the last three decades in place. And it allowed the bankers who got rich off of the risky financial practices that led to the crisis to avoid the consequences of their actions.

 

While an orderly transition would have been best, if the market had been allowed to work its magic, we could have quickly eliminated bloat in the financial sector and sent the unscrupulous Wall Street banks into the dustbin of history. Instead, millions of Americans still suffered through the Great Recession, losing homes and jobs, and the big banks are bigger than ever. Saving the banks became the priority of the president and Congress. Saving people’s homes and jobs mattered much less or not at all.

 

Dean Baker is senior economist at the Center for Economic and Policy Research and the author of “Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer.”

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A Financial Crisis Is Coming?

A provocative article in USNWR. We’ve been warning about unsustainable asset prices built on unsustainable debt leverage for the past 8 years (which only means we were waaaaay too early, but not necessarily wrong!) For all this time we’ve been focused on growing total debt to GDP ratios, which means we’re not getting much bang for all that cheap credit, trying to borrow and spend our way to prosperity.

The PE ratios of equities and housing reflect a disconnect with fundamental values based on decades of market data. For example, one cannot really pay 8-10x income on residential housing for long, or pay near to 50% of income on rents, as many are doing in our most pricey cities.

Nose-bleed asset prices on everything from yachts to vacation homes to art and collectibles to technology stocks and cryptocurrencies are indicative of excessive global liquidity. Soaking up that liquidity to return to long-term trend lines will be a long, jarring process. Nobody really knows whence comes the reckoning since we have perfected a particularly successful strategy of kicking the can down the road.

A Crisis Is Coming

All the ingredients are in place for a catastrophic economic and financial market crisis.

By Desmond Lachman Opinion Contributor USNWR, Feb. 14, 2018, at 7:00 a.m.

MY LONG CAREER AS A macro-economist both at the IMF and on Wall Street has taught me that it is very well to make bold macroeconomic calls as long as you do not specify a time period within which those calls will occur. However, there are occasions, such as today, when the overwhelming evidence suggests that a major economic event will occur within a relatively short time period. On those occasions, it is very difficult to resist making a time-sensitive bold economic call.

 

So here goes. By this time next year, we will have had another 2008-2009 style global economic and financial market crisis. And we will do so despite Janet Yellen’s recent reassurances that we would not have another such crisis within her lifetime.

 

There are two basic reasons to fear another full-blown global economic crisis soon: The first is that we have in place all the ingredients for such a crisis. The second is that due to major economic policy mistakes by both the Federal Reserve and the U.S. administration, the U.S. economy is in danger of soon overheating, which will bring inflation in its wake. That in turn is all too likely to lead to rising interest rates, which could very well be the trigger that bursts the all too many asset price bubbles around the world.

A key ingredient for a global economic crisis is asset price bubbles and credit risk mispricing. On that score, today’s financial market situation would appear to be very much more concerning than that on the eve of the September 2008 Lehman-bankruptcy. Whereas then, asset price bubbles were largely confined to the U.S. housing and credit markets, today, asset price bubbles are more pervasive being all too much in evidence around the globe.

 

It is not simply that global equity valuations today are at lofty levels experienced only three times in the last one hundred years. It is also that we have a global government bond market bubble, the serious mispricing of credit risk in the world’s high yield and emerging market corporate-bond markets and troublesome housing bubbles in major economies like Canada, China, and the United Kingdom.

 

Another key ingredient for a global economic crisis is a very high debt level. Here too today’s situation has to be very concerning. According to IMF estimates, today the global debt-to-GDP level is significantly higher than it was in 2008. Particularly concerning has to be the fact that far from declining, over the past few years Italy’s public debt has risen now to 135 percent of GDP. That has to raise the real risk that we could have yet another round of the Eurozone debt crisis in the event that we were to have another global economic recession.

 

Today’s asset price bubbles have been created by many years of unusually easy global monetary policy. The persistence of those bubbles can only be rationalized on the assumption that interest rates will remain indefinitely at their currently very low levels. Sadly, there is every reason to believe that at least in the United States, the period of low interest rates is about to end abruptly due to an overheated economy.

The reason for fearing that the U.S. economy will soon overheat is not simply that it is currently at or very close to full employment and growing at a healthy clip. It is rather that it is also now getting an extraordinary degree of monetary and fiscal policy stimulus at this very late stage of the cycle.

Today, U.S. financial conditions are at their most expansionary levels in the past 40 years due to the combination of very low interest rates, inflated equity prices and a weak dollar. Compounding matters is the fact that the U.S. economy is now receiving a significant pro-cyclical boost from the unfunded Trump tax cut and from last week’s two-year congressional spending pact aimed at boosting military and disaster-relief spending.

 

Today, in the face of an overheated U.S. economy, the Federal Reserve has an unenviable choice. It can either raise its interest rate and risk bursting the global asset price bubble, or it can delay its interests rate decision and risk incurring the wrath of the bond vigilantes who might sense that the Federal Reserve is not serious about inflation risk. In that event, interest rates are apt to rise in a disorderly fashion, which could lead to the more abrupt deflating of the global asset bubble.

 

This time next year, it could very well turn out that today’s asset price bubbles will not have burst and we will not have been thrown into another global economic recession. In which event, I will admit that I was wrong in having been too pessimistic about the global economic outlook. However, I will fall back on the defense that all of the clues were pointing in the opposite direction.

QE Pains and Gains

Reprinted from Bloomberg.

The Unintended Consequences of Quantitative Easing

Asset inflation doesn’t have to be bad. Flush governments could invest in education and infrastructure.
August 21, 2017, 11:00 PM PDT

Quantitative easing, which saw major central banks buying government bonds outright and quadrupling their balance sheets since 2008 to $15 trillion, has boosted asset prices across the board. That was the aim: to counter a severe economic downturn and to save a financial system close to the brink. Little thought, however, was put into the longer-term consequences of these actions.

From 2008 to 2015, the nominal value of the global stock of investable assets has increased by about 40 percent, to over $500 trillion from over $350 trillion. Yet the real assets behind these numbers changed little, reflecting, in effect, the asset-inflationary nature of quantitative easing. The effects of asset inflation are as profound as those of the better-known consumer inflation.

Consumer price inflation erodes savings and the value of fixed earnings as prices rise. Aside from the pain consumers feel, the economy’s pricing signals get mixed up. Companies may unknowingly sell at a loss, while workers repeatedly have to ask for wage increases just to keep up with prices. The true losers though are people with savings, which see their value in real purchasing power severely diminished.

John Maynard Keynes famously said that inflation is a way for governments to “confiscate, secretly and unobserved, an important part of the wealth of their citizens.” Critically, inflation creates much social tension: “While the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at the confidence in the equity of the existing distribution of wealth.”

Asset inflation, it turns out, is remarkably similar. First, it impedes creative destruction by setting a negative long-term real interest rate. This allows companies that no longer generate enough income to pay a positive return on capital to continue as usual rather than being restructured. Thus the much-noted growth of zombie companies is one consequence of asset price inflation. Thus also the unreasonable leverage and price observed in real estate, with the credit risks it entails for the future.

Second, it also generates artificial winners and losers. The losers are most found among the aging middle class, who, in order to maintain future consumption levels, will now have to increase their savings. Indeed, the savings made by working people on stagnant wages effectively generates less future income because investable assets are now more expensive. The older the demographics, the more pronounced this effect. Germany, for instance, had a contraction of nearly 4 percent of gross domestic product in consumer spending from 2009 to 2016.

The winners are the wealthy, people with savings at the beginning of the process, who saw the nominal value of their assets skyrocket. But, as with consumer inflation, the biggest winner is the state, which now owns through its monetary authority, a large part of its own debt, effectively paying interest to itself, and a much lower one at that. For when all is accounted for, asset inflation is a monetary tax.

The most striking similarity between consumer price inflation and asset inflation is its potential to cause social disruption. In the 1970s workers resorted to industrial action to bargain for wage increases in line with price increases.

Today, the weakened middle class, whose wages have declined for decades, is increasingly angry at society’s wealthiest members. It perceives much of their recent wealth to be ill-gotten, not resulting from true economic wealth creation [and they are correct], and seeks social justice through populist movements outside of the traditional left-right debate. The QE monetary disruption almost certainly contributed to the protest votes that have been observed in the Western world.

The central banks now bear a large responsibility. If they ignore the political impact of the measures they took, they will exacerbate a politically volatile situation. If, on the other hand, the gains made by the state from QE can be channeled to true economic wealth creation and redistribution, they will have saved the day.

This is entirely possible. Rather than debating how and how fast to end quantitative easing, the central bank assets generated by this program should be put into a huge fund for education and infrastructure. The interest earned on these assets could finance real public investment, like research, education and retraining. [That’s fine, but it does little to compensate for the massive transfer of existing wealth that is causing the political and social dislocations, such as unsustainable urban housing costs.]

If the proceeds of QE are invested in growth-expanding policies, the gain will help finance tomorrow’s retirements, and the government-induced asset inflation can be an investment, not simply a tax.

Interesting Money Graphics

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One cannot take these graphs at face value, for example, the long $ decline from 1933 to the present has also been the Pax Americana where the US has dominated geopolitics. Also, the Roman denarius was a commodity based currency, while the US$ is a fiat currency backed by US government taxing power over US assets.

But the larger issue of the costs of empire over time are instructive. One should dig deeper in analysis, but not be too complacent. Especially in light of the currency manipulations of the current age.

At Long Last, the Fed Faces Reality

The Fed faces reality? After 8 years, I’m not holding my breath…

Unconventional monetary policy—including years of ultralow interest rates—simply hasn’t delivered.

By GERALD P. O’DRISCOLL JR.

WSJ, Dec. 15, 2016 

As was widely anticipated, Federal Reserve officials voted Wednesday to raise short-term interest rates by a quarter percentage point—only the second increase since the 2008 financial crash. The central bank appears to have finally confronted reality: that its unconventional monetary policy, particularly ultralow rates, simply has not delivered the goods.

In a speech last week, the president of the New York Fed, William Dudley, brought up “the limitations of monetary policy.” He suggested a greater reliance on “automatic fiscal stabilizers” that would “take some pressure off of the Federal Reserve.” His proposals—such as extending unemployment benefits and cutting the payroll tax—were conventionally Keynesian.

Speaking two weeks earlier at the Council on Foreign Relations, Fed Vice Chairman Stanley Fischer touted the power of fiscal policy to enhance productivity and speed economic growth. He called for “improved public infrastructure, better education, more encouragement for private investment, and more effective regulation.” The speech, delivered shortly after the election, almost channeled Donald Trump.

Indeed, the markets seem to be expecting a bigger, bolder version of Mr. Fischer’s suggestions from the Trump administration.

• Infrastructure: Mr. Trump campaigned on $1 trillion in new infrastructure, though the details are not fully worked out. The left thinks green-energy projects—such as windmill farms—qualify as infrastructure. Living in the West, I’d prefer to build the proposed Interstate 11, a direct line from Phoenix, to Las Vegas and then to Reno and beyond.

• Education: Nominating Betsy DeVos to lead the Education Department shows Mr. Trump’s commitment to real education reform, including expanded school choice. Much of America’s economic malaise, including income inequality and slow growth, can be laid at the feet of deficient schools. Although some students receive a world-class education, many get mediocrity or worse.

• Private investment and deregulation: Mr. Trump promises progress on both fronts. He is filling his cabinet with people—including Andy Puzder for labor secretary and Scott Pruitt to lead the Environmental Protection Agency—who understand the burden that Washington places on job creators.

Businesses need greater regulatory certainty, and reasonable statutory time limits should be placed on environmental reviews and permit applications. That, along with tax cuts, would do the trick for boosting investment.

All that said, central bankers have a role to play as well. The Fed’s ultralow interest rates were intended to be stimulative, but they also squeezed lending margins, which further dampened banks’ willingness to loan money.

There’s a strong case for a return to normal monetary policy. The prospects for economic growth are brighter than they have been in some time, and that is good. The inflation rate may tick upward, which is not good. Both factors argue for lifting short-term interest rates to at least equal the expected rate of inflation. Depending on one’s inflation forecast, that suggests moving toward a fed-funds rate in the range of 2% to 3%.

The Fed need not act abruptly, but it also does not want to get further behind the curve. Next year there will be eight meetings of the Federal Open Market Committee. A quarter-point increase at every other meeting, at least, would be in order.

This could produce some blowback from Congress and the White House. Paying higher interest on bank reserves will reduce the surplus that the Fed returns to the Treasury—thus increasing the deficit. But the Fed could ease the political pressure if it stopped resisting Republican lawmakers’ effort to introduce a monetary rule, which would curb the central bank’s discretion and make its policy more predictable. This isn’t an attack on the central bank’s independence, as Fed Chair Janet Yellen has wildly argued, but an exercise of Congress’s powers under the Constitution.

The one big cloud that darkens this optimistic forecast is Mr. Trump’s antitrade stance. Sparking a trade war could undo all the potential benefits that his policies bring. David Malpass, a Trump adviser and regular contributor to these pages, argues that trade deals like the North American Free Trade Agreement are rife with special benefits for big companies, but that they do not work for America’s small businesses. The argument is that Mr. Trump wants to renegotiate these deals to make them work better. I hope Mr. Malpass is correct, and that President-elect Trump can pull it off.

But for now, a strengthening economy offers a chance to return to normal monetary policy. Fed officials seem to have come around to that view. With any luck, Wednesday’s rate increase will be only the first step in that direction.

It’s The Fed, Stupid! Again.

Really, I wish we could get serious…

Trump Tees Up a Necessary Debate on the Fed

Sixty percent of stock gains since the 2008 panic have occurred on days when the Fed makes policy decisions.

By RUCHIR SHARMA

Wall Street Journal, Sept. 28, 2016 6:43 p.m. ET

The press spends a lot of energy tracking the many errors in Donald Trump ’s loose talk, and during Monday’s presidential debate Hillary Clinton expressed hope that fact checkers were “turning up the volume” on her rival. But when it comes to the Federal Reserve, Mr. Trump isn’t all wrong.

In a looping debate rant, Mr. Trump argued that an increasingly “political” Fed is holding interest rates low to help Democrats in November, driving up a “big, fat, ugly bubble” that will pop when the central bank raises rates. This riff has some truth to it.

Leave the conspiracy theory aside and look at the facts: Since the Fed began aggressive monetary easing in 2008, my calculations show that nearly 60% of stock market gains have come on those days, once every six weeks, that the Federal Open Market Committee announces its policy decisions.

Put another way, the S&P 500 index has gained 699 points since January 2008, and 422 of those points came on the 70 Fed announcement days. The average gain on announcement days was 0.49%, or roughly 50 times higher than the average gain of 0.01% on other days.

This is a sign of dysfunction. The stock market should be a barometer of the economy, but in practice it has become a barometer of Fed policy.

My research, dating to 1960, shows that this stock-market partying on Fed announcement days is a relatively new and increasingly powerful feature of the economy. Fed policy proclamations had little influence on the stock market before 1980. Between 1980 and 2007, returns on Fed announcement days averaged 0.24%, about half as much as during the current easing cycle. The effect of Fed announcements rose sharply after 2008 when the Fed launched the early rounds of quantitative easing (usually called QE), its bond purchases intended to inject money into the economy.

It might seem that the market effect of the Fed’s easy-money policies has dissipated in the past couple of years. The S&P 500 has been moving sideways since 2014, when the central bank announced it would wind down its QE program.

But this is an illusion. Stock prices have held steady even though corporate earnings have been falling since 2014. Valuations—the ratio of price to earnings—continue to rise. With investors searching for yield in the low interest-rate world created by the Fed, the valuations of stocks that pay high dividends are particularly stretched. The markets are as dependent on the Fed as ever.

Last week the Organization for Economic Cooperation and Development warned that “financial instability risks are rising,” in part because easy money is driving up asset prices. At least two regional Fed presidents, Eric Rosengren in Boston and Esther George in Kansas City, have warned recently of a potential asset bubble in commercial real estate.

Their language falls well short of the alarmism of Mr. Trump, who in Monday’s debate predicted that the stock market will “come crashing down” if the Fed raises rates “even a little bit.” But it is fair to say that many serious people share his basic concern.

Whether this is a “big, fat, ugly bubble” depends on how one defines a bubble. But a composite index for stocks, bonds and homes shows that their combined valuations have never been higher in 50 years. Housing prices have been rising faster than incomes, putting a first home out of reach for many Americans.

Fed Chair Janet Yellen did come into office sounding unusually political, promising to govern in the interest of “Main Street not Wall Street,” although that promise hasn’t panned out. Mr. Trump was basically right in saying that Fed policy has done more to boost the prices of financial assets—including stocks, bonds and housing—than it has done to help the economy overall.

The increasingly close and risky link between the Fed’s easy-money policies and financial markets has been demonstrated again in recent days. Early this month, some Fed governors indicated that the central bank might at long last raise interest rates at its next meeting. The stock market dropped sharply in response. Then when decision time came on Sept. 21 and the Fed left rates unchanged, stock prices rallied by 1% that day.

Mr. Trump was also right that despite the Fed’s efforts, the U.S. has experienced “the worst revival of an economy since the Great Depression.” The economy’s growth rate is well below its precrisis norm, and the benefits have been slow to reach the middle class and Main Street. Much of the Fed’s easy money has gone into financial engineering, as companies borrow billions of dollars to buy back their own stock. Corporate debt as a share of GDP has risen to match the highs hit before the 2008 crisis.

That kind of finance does more to increase asset prices than to help the middle class. Since the rich own more assets, they gain the most. In this way the Fed’s policies have fueled a sharp rise in wealth inequality world-wide—and a boom in the global population of billionaires. Ironically, rising resentment against such inequality is lifting the electoral prospects of angry populists like Mr. Trump, a billionaire promising to fight for the little guy. His rants may often be inaccurate, but regarding the ripple effects of the Fed’s easy money, Mr. Trump is directly on point.

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.

Read more

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.

The Guardian view on central bankers: growing power and limited success

I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment.

– John Maynard Keynes

This editorial by The Guardian points out the futilities of current central banking policy around the world. Unfortunately, they only get it half right: the prescience of Keynes’s first sentence is only matched by the absurdity of his second sentence. Calculate the marginal efficiency of capital? Directing investment? Solyndra anyone? The captured State is the primary problem of politicized credit…

Reprinted from The Guardian, Thursday 25 August 2016

To find the true centre of power in today’s politics, ignore the sweaty press releases from select committees, look past the upcoming party conferences – and, for all our sakes, pay no mind to the seat allocations on the 11am Virgin train to Newcastle. Look instead to the mountains of Wyoming, and the fly-fishers’ paradise of Jackson Hole.

Over the next couple of days, the people who set interest rates for the world’s major economies will meet here to discuss the global outlook – but it’s no mere talking shop. What’s said here matters: when the head of the US Federal Reserve, Janet Yellen, speaks on Friday, the folk who manage our pension funds will take a break from the beach reads to check their smartphones for instant takes.

This year the scrutiny will be more widespread and particularly intense. Since the 2008 crash, what central bankers say and do has moved from the City pages to the front page. That is logical, given that the Bank of England created £375bn of new money through quantitative easing in the four years after 2009 and has just begun buying £70bn of IOUs from the government and big business. But the power and prominence of central banks today is also deeply worrying. For one, their multibillion-pound interventions have had only limited success – and it is doubtful that throwing more billions around will work much better. For another, politicians are compelling them to play a central role in our politics, even though they are far less accountable to voters. This is politics in the garb of technocracy.

Next month is the eighth anniversary of the collapse of Lehman Brothers. Since then the US central bank has bought $3.7tn (£2.8tn) of bonds. [Note: We’re going on $4 trillion of free money pumped into the financial sector, folks] All the major central banks have cut rates; according to the Bank of England’s chief economist, Andy Haldane, global interest rates are at their lowest in 5,000 years. Despite this, the world economy is, in his description, “stuck”. This government boasts of the UK’s recovery, but workers have seen a 10% drop in real wages since the end of 2007 – matched among developed economies only by Greece. Fuelling the popularity of Donald Trump and Bernie Sanders is the fact that the US is suffering one of the slowest and weakest recoveries in recent history. In April, the IMF described the state of the global economy as “Too Slow for Too Long”.

Having thrown everything they had at the world economy, all central bankers have to show is the most mediocre of score sheets. When it comes to monetary policy, the old cliche almost fits: you can lead a horse to water, but you cannot make it avail itself of super-low interest rates to kickstart a sustainable recovery. Two forces appear to be at work. First, monetary policy has been used by politicians as a replacement for fiscal policy on spending and taxes, when it should really be complementary. Second, major economies – such as Britain after Thatcher’s revolution – have become so unequal and lopsided that vast wealth is concentrated in the hands of a few who use it for speculation rather than productive investment. QE has pushed up the price of Mayfair flats and art by Damien Hirst. It has done next to nothing for graphene in Manchester. [Does it take a rocket scientist to figure this out?]

All this was foreseen by Keynes in his General Theory: “I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment.”

Eighty years on, it is time those words were heeded by policymakers. In Britain, that means using state-owned banks such as RBS and Lloyds to direct loans to those industries and parts of the country that elected and accountable politicians see as being in need. Couple that with a tax system that rewards companies on how much value they add to the British economy, and the UK might finally be back in business.

The State, run by the political class and their technocrats? Yikes!!! Will we ever learn?