The Fed is (probably) insolvent; bank margins to suck more

John Hussman has come and said what many have believed for some time now, that the Fed is probably insolvent (here).

The Fed has become the dumping ground for bad assets. Here’s what happens: they take them in from the banks at some highly notional (what is called “mark to unicorn”) value and hold them as “reserves” against the bank’s putatively active lending; which may or may not occur because the Fed now pays interest on reserves even as the reserves are likely deteriorating in value.

The Fed is the proverbial carpet under which the bad debt of the banking system is swept. Hence, the creditors and owners of banks and bank holding companies are relieved of having to recognize losses, and the fiction of “simulative monetary policy” is maintained. As Zero Hedge is fond of pointing out, the only known transmission mechanism from loose money to anything is to asset bubbles, the current one being stocks again, with a bubblet appearing in real estate.

This is capitalism without failure writ large. The antidote, in the view of the “Washington [/New York] consensus” (to borrow a term) is “more of the same.”

Like Bernanke, Janet Yellen didn’t a thing coming of the last crisis (even though the world-wide ramp-up of housing pricing made front page news in “The Economist,” as I recall.

And I can say from personal experience that many in retail banking wondered what would happen to Consumption when the housing ATM was shut off.

Thus I believe MMT will win out in the end, as war and/or infrastructure projects demand funding. Whether a major inflation or hyperinflation gets going remains an open question to me, as I believe an inflation (wage-price spiral) is a labor market phenomenon accommodated by monetary policy, and there seems little indication that the PTB have any intention of raising anybody’s wages.

Bad debts, those destined for charge-off, don’t go away by themselves; they have to be charged off. A major deflation will occur when that reconciliation finally takes place. Even if accounting fiction remains in place, the fact that such debts when returned to the banking system do not contribute revenues tells us bank margins are going to get a lot thinner in the future. A bank may be able to dress up its balance sheet but not so much its income statement.

Ben’s bubble theory of monetary stimulus

Via:  www.zerohedge.com

I am quoting liberally because this coverage of today’s press conference gets to the heart of the matter, that the only tool the Fed has to deal with an economy struggling under a debt load it can’t handle is to inflate it out.  But Ben, the American people are scared stiff of the stock market and have come to the conclusion that Wall Street is a rigged game, are scared stiff of buying a home (if they can come up with the down payment).  The other prescient insight, this one offered by Charles Hugh Smith also on zero, is that the only monetary surprises left are negative, which taken together with the fact that last several stock market advances have been undergirded by QE or Twist activities, could mean either that (1) the market will take off now for an extended upward leg, or (2) it won’t; it will collapse as the economy undeniably goes into recession.  Speaking on behalf of John Q. Public, who is quaking in his boots about holding on to his job and possibly his house, I don’t find those odds appealing.  We are heading into a period of unprecedented monetary instability.

The Punchline In His Own Words: Bernanke Advocates Blowing Asset Bubbles As The Antidote To Depression

If there was one absolutely must see moment exposing everything that is broken with the Fed's brand new policy of QE-nfinity, it was this exchange between Reuters' Pedro da Costa and the Chairman. It explains, beyond a reasonable doubt, that the only goal the Fed now has is to reflate the stock market bubble to previously unseen levels, to focus on generating jobs although not for everyone but only for Wall Street, consequences be damned, because by the time the consequences arrive, and they will (just recall that subprime is contained) they will be some other Fed chairman's problem. Bernake's term mercifully runs out in January 2014.

From the official transcript:

QUESTION: My question is -- I want to go back to the  transmission mechanism, because speaking to people on the sidelines of the Jackson Hole conference, that seemed to be the concern about the remarks that you made, is that they could clearly see the effect on rates and they could see the effect on the stock market, but they couldn't see how that had helped the economy.

So I think there's a fear that over time this has been a policy that's helping Wall Street, but not doing that much for Main Street. So could you describe in some detail, how does it really different -- differ from trickle-down economics,where you just pump money into the banks and hope that they lend?

BERNANKE: Well, we are -- this is a Main Street policy, because what we're about here is trying to get jobs going. We're trying to create more employment. We're trying to meet our maximum employment mandate, so that's the objective. Our tools involve -- I mean, the tools we have involve affecting financial asset prices, and that's -- those are the tools of monetary policy.

There are a number of different channels -- mortgage rates, I mentioned other interest rates, corporate bond rates, but also the prices of various assets, like, for example, the prices of homes. To the extent that home prices begin to rise, consumers will feel wealthier, they'll feel more -- more disposed to spend. If house prices are rising, people may be more willing to buy homes because they think that they'll, you know, make a better return on that purchase. So house prices is one vehicle.

Stock prices -- many people own stocks directly or indirectly. The issue here is whether or not improving asset prices generally will make people more willing to spend.

One of the main concerns that firms have is there's not enough demand. There are not enough people coming and demanding their products. And if people feel that their financial situation is better because their 401(k) looks better or for whatever reason -- their house is worth more -- they're more willing to go out and spend, and that's going to provide the demand that firms need in order to be willing  to hire and to invest.

And there you have it.

Pictures of monetary instability

Via:  FT

In line with my thesis that the coming years will feature a degree of monetary instability unprecedented in human history, beginning with ubiquitous negative real rates that are the scourge of banks….

Negative rates as a precursor to the death of banking

Posted by Izabella Kaminska on Jul 31 16:02.

FT Alphaville has presented its case on negative rates and zero deposit rates here andhere (amongst other places).

What we believe is that rather than stimulating the lending market — and the economy along with it — such a rate policy could have a disastrous impact on collateral markets and money market funds, not to mention the net interest income of lending institutions. All of which could unleash a protracted deflationary spiral.

The move could also presage the death of banks and lending institutions completely. […]

Check out the pictures of some major yield curves around the world:

UK:

Australia:

Switzerland:

If you buy the argument that central banks this far gone down the path of excessive accommodation lo this past forty years have only one option left to serve their masters, the fiscal authorities and the creditors, inflate or die, then keep in mind that historically, the quickest way to get an inflation going is to start a big war.

I am beginning to see why Charles Nenner says there is no free will—yet I retain hope that there is.

A scorcher of a commencement speech

A modern-day prophet Isaiah speaks to the graduates.

The obtuseness of Krugman and Bernanke

Via:  www.nytimes.com

Here’s Paul Krugman on the Spanish bailout:

Oh, wow — another bank bailout, this time in Spain. Who could have predicted that?

The answer, of course, is everybody. In fact, the whole story is starting to feel like a comedy routine: yet again the economy slides, unemployment soars, banks get into trouble, governments rush to the rescue — but somehow it’s only the banks that get rescued, not the unemployed.

Just to be clear, Spanish banks did indeed need a bailout. Spain was clearly on the edge of a “doom loop” — a well-understood process in which concern about banks’ solvency forces the banks to sell assets, which drives down the prices of those assets, which makes people even more worried about solvency. Governments can stop such doom loops with an infusion of cash; in this case, however, the Spanish government’s own solvency is in question, so the cash had to come from a broader European fund.

Bernanke, who studied the Great Depression, and Krugman, are both “mainstream economists,” meaning that they don’t acknowledge that the distribution in America is broken, making AgD-based macro policy a joke; and they both also seem not to realize that debts that will not be repaid do not belong on banks’ balance sheets, nor do they deserve taxpayer-funded bailouts.  Bernanke seems to have missed the fact that we have something called “deposit insurance” now, so that when banks fail depositors are not wiped out and AgD does not have to collapse (for that reason).

I’ve written before that Paul Krugman is too close to New York to think independently, and the column referenced above confirms that belief.

The sooner the bad debt is written off the sooner aggregate demand can recover.  Nationalize the banks, put them into receivership, do what it takes, protect the people’s deposits, but don’t bail them out.  Putting any more bad debt on taxpayers is criminal. 

The mainstream economists do not know the meaning of “bad debt,” and like the accounting profession, have deluded themselves into believing current balance sheets.  The time-honored traditions of honest banking require debts that have no realistic chance of being repaid to be written off the books.  None of these economists seem to know anything about honest banking.

From all reports the [largely unregulated] Spanish banking system is a house of cards.  The Spanish real estate bubble was worse than anybody’s.  And Krugman says we should bail them out?

The banks have cried wolf too much already.  Shut them up. 

And the same goes for Krugman, Bernanke, and the would-be rock star econo-whore from Columbia who shills for the Republicans. 

The propaganda of the kleptocracy has sunk in so deep it has become very, very difficult to avoid infection of one’s own thinking.  Beware.

Late add:  see John Hussman’s recent comment “The Heart of the Matter” for evidence that the authorities haven’t learned anything

Desperation behind the unemployment numbers

Via:  www.hussman.net

Beginning first with Alan Greenspan, and then with Ben Bernanke, the Fed has increasingly pursued policies of suppressing interest rates, even driving real interest rates to negative levels after inflation. Combine this with the bursting of two Fed-enabled (if not Fed-induced) bubbles - one in stocks and one in housing, and the over-55 cohort has suffered an assault on its financial security: a difficult trifecta that includes the loss of interest income, the loss of portfolio value, and the loss of home equity. All of these have combined to provoke a delay in retirement plans and a need for these individuals to re-enter the labor force.

In short, what we've observed in the employment figures is not recovery, but desperation. Having starved savers of interest income, and having repeatedly subjected investors to Fed-induced financial bubbles that create volatility without durable returns, the Fed has successfully provoked job growth of the obligatory, low-wage variety. Over the past year, the majority of this growth has been in the 55-and-over cohort, while growth has turned down among other workers. Meanwhile, overall labor force participation continues to fall as discouraged workers leave the labor force entirely, which is the primary reason the unemployment rate has declined. All of this reflects not health, but despair, and explains why real disposable income has grown by only 0.3% over the past year. […]

Regardless of the fact that QE has had no durable economic benefits […], and does little but to repeatedly lay fresh wallpaper over the rotting edifice that is the global banking system, the main effect of QE has been to provide temporary support for the most speculative corners of the financial market after they have been pummeled.

President’s men: debt disaster coming

Via:  www.washingtonpost.com

Obama's debt commission warns of fiscal 'cancer'

By Dan Balz
Washington Post Staff Writer
Monday, July 12, 2010; A02

BOSTON -- The co-chairmen of President Obama's debt and deficit commission offered an ominous assessment of the nation's fiscal future here Sunday, calling current budgetary trends a cancer "that will destroy the country from within" unless checked by tough action in Washington.

The two leaders -- former Republican senator Alan Simpson of Wyoming and Erskine Bowles, White House chief of staff under President Bill Clinton -- sought to build support for the work of the commission, whose recommendations due later this year are likely to spark a fierce debate in Congress.

"There are many who hope we fail," Simpson said at the closing session of the National Governors Association annual meeting. He called the 18-member commission "good people with deep, deep differences" who know the odds of success "are rather harrowing."

(Graphic: President Obama's proposed 2011budget explained)

Bowles said that unlike the current economic crisis, which was largely unforeseen before it hit in fall 2008, the coming fiscal calamity is staring the country in the face. "This one is as clear as a bell," he said. "This debt is like a cancer."

The commission leaders said that, at present, federal revenue is fully consumed by three programs: Social Security, Medicare and Medicaid. "The rest of the federal government, including fighting two wars, homeland security, education, art, culture, you name it, veterans -- the whole rest of the discretionary budget is being financed by China and other countries," Simpson said.

"We can't grow our way out of this," Bowles said. "We could have decades of double-digit growth and not grow our way out of this enormous debt problem. We can't tax our way out. . . . The reality is we've got to do exactly what you all do every day as governors. We've got to cut spending or increase revenues or do some combination of that."

Bowles pointed to steps taken recently by the new coalition government in Britain, which also faces an acute budgetary problem, as a guide to what the commission might use in its recommendations. That would mean about three-quarters of the deficit reduction would be accomplished through spending cuts, and the remainder with additional revenue.

Most Republicans in Congress are opposed to any tax increases, which has made the work of the commission far more difficult. Bowles and Simpson appealed for support to the governors, who have been forced by their states' constitutions to balance their budgets with deep spending cuts and, in many cases, tax increases.

Bowles and Simpson said the commission would have had a stronger hand politically had it been created by Congress, rather than through an executive order. Simpson was pointed in his criticism of seven Republicans who once co-sponsored such a measure but who helped block it in the Senate.

"As far as I can discern, it was to stick it to the president," Simpson said. "That's where we are in Washington." He later added that all seven "have now come to us to say, 'We're ready to help.' "

The presentation by Simpson and Bowles, which included repeated statements of determination to produce a bipartisan set of recommendations, drew praise from the governors.

"I don't know that I've every heard a gloomier picture painted that created more hope for me," said Arkansas Gov. Mike Beebe (D).

Washington Gov. Chris Gregoire (D) said that many governors fear that the commission's recommendations will result in more demands on the states.

Bowles, who noted that the 1997 balanced-budget agreement between the Clinton White House and the Republican-controlled Congress included many provisions that put more burdens on the states, said that wasn't likely.

"I don't think you're going to see a lot of devolution coming from us because the states are all broke," he said.

Simpson also warned that the November elections could add another wild card to the work of the commission. "I have no idea what's going to happen on Election Day but it's going to be disruptive . . .," he said. "It's going to be a big wake-up call around the whole United States. I have no idea where it's going, but thank heaven we have a month then to work through the wreckage."

See also:  Niall Ferguson's Complete And Definitive Guide To The Sovereign Debt Crisis

Obomba is Wall Street’s Sugar Daddy

Wow, this is the MSM now!  Can revolution be far behind?  Or will Congressional whores be true to their Johns?

William Black on our corrupt regulators

This is much-watch, especially if you’ve been seduced into drinking some of Obama’s financial reform Kool-Aid.  Obomba has proven himself a spineless cut-out for the military-industrial-financial Establishment many times over.  He may have good intentions, he may face a fecally-impacted Washington, he may face death threats every day, he may be doing all he thinks he can do given the cards he’s been dealt, but the fact remains that no significant reform of a broken America is taking place. 

Bill Black lays the blame where it belongs, on the industry-captive (industry-whore) regulators who had the power to preclude and then to clean up the mess all along:  Alan Greenspan, Ben Bernanke, Tim Geithner, Larry Summers, and so on ad nauseum. 

“Sell? To whom?”

Via:  The Fed's Anti-Inflation Exit Strategy Will Fail – Allan Meltzer in the WSJ

Prof. Meltzer demeans himself by even addressing the Fed’s ridiculous proposition that by paying interest on reserves the Fed can control excess reserves.  Where is the reserves interest going to come from?  This is just another underhanded way to try to recapitalize the bad banks (not all banks are insolvent).

Meltzer instead suggests the Fed use the traditional method of selling securities to suck in high-powered money.  But what are they going to sell, and to whom (the “Wall Street question”)?  The Fed has taken in untold and literally unknown amounts of garbage as if it were worth being reserves—they won’t even tell us what it is or how much of it has already charged off!

If and when inflation becomes a problem (when the next Big War gets going) the Fed won’t have the balls to reign in anything, would be my guess.  And we know the Whole Sick Crew of neoclassical economic advisors to the President are on record as welcoming an inflation to “lower the debt load.”

In the meantime the only thing that will restore a healthy middle class to America is an explicitly redistributionist rebalancing of aggregate demand.  Let the ruling class that has engineered the economy and the tax system to its own benefit for the past generation start to pay its own bills—especially the gigantic Wall Street bailouts, the largest transfer of wealth from ordinary Americans to the wealthy in history. 

[I hate to admit it, but a rebalancing of aggregate demand that put more money in the hands of the middle class would also increase the odds of a “benign” mild wage-price inflation getting going.  Combine this with a concerted effort to get big American corporations to knock their preening executives off their pedestals—who strut through the halls wearing expressions that say, “We are gods, oh ye puny cube-dwellers!  Do not think that you are even the same species as we!  You will never join our club!”—and get pay ratios in America back toward something that doesn’t cause gagging, and the economy might just pick up steam….]

Raise marginal tax rates on the super-rich to where they were in the 1950s (see this), the last time the federal debt load was this high.

I called my Senators today and told them to dump Bernanke.

P.S.  The Fed always has reserve requirements to reign in excess reserves.

P.P.S.  If the Fed had not bailed out the banks, and instead had provided unlimited deposit protection, what would have happened?  There would be a large amount of high-powered money in the hands of the public rather than in the banks.  The public could have made runs on as many banks as they liked, and the banks that lost their deposit base failed, and there would have been no massive wealth transfer to the investors in the failed banks—but the executives of the banks that levered up irresponsibly would be out of work, instead of cracking jokes to Congress about financial crises being something that come around every seven years, and paying themselves record bonuses.  Would this have been inflationary?  No.  People are reducing their marginal propensity to consumer, and increasing precautionary demand for money.  When things calmed down, they just would have put the money back in a bank.

Princeton economics department merits an “F”

Keep these idiots in the ivory tower. Here is an entertaining and damning video featuring Bernanke and Krugman trumpeting their total ignorance of the real world in the mid 2000’s. And the Fed is going to be our “systemic risk regulator”? It’s our systemic risk creator! h/t patrick.net

Keynsians vs. Austrians video from eclipptov

Krugman (probably) wrong again; Hussman scores

Krugman Sees 30-40% Chance of U.S. Recession in 2010 – Proving once again that he knows nothing about business conditions or how the real economy actually operates, Paul Krugman is forecasting a significant chance of “recession” in 2010.  Now, the definition of “recession” is political, made by the National Bureau for Economic Research, usually well after the event; and Krugman is an Establishment insider, so he may know something I don’t, namely that the NBER is planning on changing their “definition,” which usually tracks the slope of Industrial Production and a few other primary economic series pretty well.  My recession forecasting model, which forecast the 2001 and 2007-? recessions from a year or more in advance, says “no recession in sight” (in the traditional NBER sense), but rather, a basically L-shaped chugging ahead at some finite positive slope.  Here’s the chart from the last update:

Sometimes I just want to grab Krugman by the neck and yell, “The economy doesn’t go into recession with the yield curve as steeply sloped as it is now, Paul!”

My best-guess is still that we’ll limp along for a couple of years, weathering the next waves of rate-reset defaults on exotic mortgages, until the next debt-deflationary collapse around 2013.  That is when the fiat money hits the fan.

The best way to get an inflation (or hyperinflation) going, historically, has been to be at war.  It is my working hypothesis that all the idiotic fiat monetary authorities of the world are conspiring to inflate their way out of their unmanageable debt loads, so we should see all the monetary Wizards gathering with all the Daddy Warbucks by mid-decade to expand our endless wars.

That is, unless a new government is put in place.

Timothy Geithner Meets Vladimir Lenin - John Hussman on the Fed and Treasury’s overstepping their legal authorities and the likely consequences for taxes paid by the American people.  Must reading.  Remember, Tim Geithner “forgot” to pay $35,000 in federal taxes.  Raise marginal rates on incomes over $1 million to 90 percent!  Bring the ruling class back down to earth!  Let them know that they are not gods!

Ben Bernanke as the Wizard of Oz

Is it all just a Ponzi scheme? – Sprott Asset Management  h/t zerohedge.com  Must reading.

Not only does the Fed not tell us what’s charging off on the asset side of its balance sheet, of all the crap they’ve taking in, but the Treasury’s accounting for purchases of Treasury securities suggests the Fed has been much busier than they have admitted, monetizing US federal debt, and that international demand for our sovereign debt is much weaker than most imagine.

I called my Senators and told them not to reappoint Bernanke.  Even though I have a Ph.D. in economics and lots of industry experience, I have trouble fathoming what’s going on.  But some things stand out:  WaMu failed and the depositors were just fine.  They found people to run the bank.  Most big banks have infrastructures that run themselves largely independently of the wheeling and dealing that occupies the fat cats.  As Barry Ritholtz and I and others have pointed out, the bailouts represented the largest wealth transfer in the history of the world.  And in this case the transfer of wealth was upwards, from taxpayers to the generally well-heeled bond and equity investors—and the very well compensated managements—of the rescued institutions.  This was truly obscene.

And now Ben Bernanke has apparently decided that he needs to rescue the US government.  This is pretend and extend on a massive scale.

I surmise that the monetary authorities of the world are trying to orchestrate a global debt jubilee through rampant coordinated inflation, perhaps hyperinflation once it gets going—and that the Vampire Squids of the world, the Goldman Sachs and as a class the well-heeled speculators of the world with deep pockets and even deeper access to leverage, are just salivating over the opportunity to lever up again after the next debt-deflationary collapse circa 2013 (and there must be another debt-deflation because we still carry all that bad debt on the books).  Debts that can’t be repaid get charged off sooner or later—unless the Fed buys them and never tells us about them, in yet another secret monetary transfer to the wealthy!

This reminds me of the cyclic universe theories, in which the universe goes from big bang up and down to big bust in a new singularity, over and over again.  For surely the next leveraged rip-off by the moneyed class in the almost inevitable inflation to come will enable further strangulation of honest working people around the world, and further increases of inequality, that primary cause of the current collapse of effective demand.

For most people, money in the bank is a deposit, not a loan.  It’s money.  The feds could have insured deposits up to $250,000 or more and let all the big bankrupt financials collapse and most people wouldn’t have noticed any more than a change in the sign on the bank. And then with all the bad debt and the bad managements cleared out of the system, we might have started to work towards having sound money. 

But that would have required a kind of backbone and commitment to principle that our federal government and the Fed don’t have. 

The Fed blew it, and continues to blow it, if Sprott’s analysis is correct.  Volatility of all kinds is bound to increase once the inflation begins.  We are in the eye of the storm.

Zombie government

hat tip Zero Hedge

Dead government walking – Sprott

China likes gold

Via:  Telegraph

China, Bernanke, and the price of gold

By Ambrose Evans-Pritchard Economics Last updated: September 7th, 2009

China has issued what amounts to the "Beijing Put" on gold. You can make a lot of money, but you really can't lose.

I happened to see quite a bit of Cheng Siwei at the Ambrosetti Workshop, a gathering of politicians and global strategists at Lake Como, including a dinner at Villa d'Este last night at which he listened very attentively as a number of American guests tore President Obama's economic and health policy to shreds.

Mr Cheng was until recently Vice-Chairman of the Communist Party's Standing Committee, and is now a sort of economic ambassador for China around the world — a charming man, by the way, who left Hong Kong for mainland China in 1950 at the age of 16, as young idealist eager to serve the revolution. Sixty years later, he calls himself simply "a survivior".

What he said about US monetary policy and gold – this bit on the record – would appear to validate the long-held belief of gold bugs that China has fundamentally lost confidence in the US dollar and is going to shift to a partial gold standard through reserve accumulation.

He played down other metals such as copper, saying that they could not double as a proxy currency or store of wealth.

"Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not stimulate the market," he said.

In other words, China is buying the dips, and will continue to do so as a systematic policy. His comment captures exactly what observation of gold price action suggests is happening. Every time it looks as if the bullion market is going to buckle, some big force steps in from the unknown.

Investors long-suspected that it was China. We later discovered that Beijing had in fact doubled its gold reserves to 1054 tonnes. Fait accompli first. Announcement long after.

Standing back, you can see that the steady rise in gold over the last eight years to $994 an ounce last week – outperforming US equities fourfold, even with reinvested dividends – has roughly tracked the emergence of China as a superpower in foreign reserve holdings (now $2 trillion).

As I have written in today's paper, Mr Cheng (and Beijing) takes a dim view of Ben Bernanke's monetary experiments at the Federal Reserve.

"If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies," he said.

This line of argument is by now well-known. Less understood is how much trouble the Fed's QE policies are causing in China itself, where they have vicariously set off a speculative boom on the Shanghai exchange and in property. Mr Cheng said mid-level house prices are now ten times incomes.

"If we raise interest rates, we will be flooded with hot money. We have to wait for them. If they raise, we raise."

"Credit in China is too loose. We have a bubble in the housing market and in stocks so we have to be very careful, because this could fall down."

Of course, China cold end this problem by letting the yuan rise to its proper value, but China too is trapped. Wafer-thin profit margins on exports mean that vast chunks of Chinese industry would go bust if the yuan rose enough to close the trade surplus. China's exports were down 23pc in July from a year before even at the current exchange rate, and exports make up 40pc of GDP. "We have lost 20m jobs in this crisis," he said.

China's mercantilist export strategy has led the country into a cul-de-sac. China must continue to run its trade surplus. It must accumulate hundreds of billions more in reserves. Ergo, it must buy a great deal more gold.

Where is the gold going to come from?

The bubble at the end of the age

Before commenting on the stock market, which everyone cares about, I must indulge a small obsession with the way that mainstream economists are able to ignore relevant research in psychology even when they are doing inherently psychological work themselves, and even when the relevant work in psychology was actually published by an economist—but in a journal with “psychology” in the title. 

I refer of course to the article by Robert Shiller in Sunday’s New York Times, “An Echo Chamber of Boom and Bust,” which apparently resulted from Shiller talking to himself in his office.  In their book on “animal spirits” Shiller and Akerlof ignore a seminal article in the Journal of Economic Psychology relating “animal spirits” to the first law of psychology, the Wundt Curve describing sensitivity to adaptation level. (see this and this).  The obscure economist who wrote these papers might reasonably be really pissed off at the arrogance of Shiller and Akerlof.  I have it on good authority that Shiller declined to respond to correspondence on the subject.

Paul Samuelson once said words to the effect that, "As economists, we don’t care what other people think of our work—we write for ourselves.”

I’m just a blogger, as Calculated Risk likes to say (and CR is someone who does respond to emails, BTW). 

As August has come to a close and a lot of folks are looking for a stock market pullback (and yours truly is slightly bloody from a small –2 beta position on the NDX), I thought it would be appropriate to update the Coppock Guide and my own “animal spirits” of the stock market oscillator that are both monthly models. 

The picture is pretty astoundingly bullish on a pure emotion basis.  Of course, it would require a veritable tsunami of liquidity to float the market on top of an economy that is in a depression.  But that’s what we have a Federal Reserve and Goldman Sachs for! 

Here’s the picture:

Click on graph to see bigger image in new window.

Now, I am as blown away as anyone to think that the U.S. stock market would have the unmitigated chutzpah to complete a gigantic head-and-shoulders pattern by climbing another ~50 percent from today’s levels, but this is what the emotional nature of the market wants, and it’s what Ben Bernanke would most like to deliver.  It might happen after the current pull back, as more economic indicators stabilize, and the dollar rallies on weakness in foreign economies.

It could be the bubble at the end of the age for America.  The way things are going the next collapse, due by my reckoning in 2013 or 2014, will be worse than this one.  The stock market will see new lows, in real terms if not in nominal terms.  If, as many expect, the government responds to fiscal bankruptcy by starting a big hot war and getting an inflation or hyper-inflation going, the stock market could continue to go up.

Next “animal spirits” update will be after the unemployment rate data is released on Friday.

How can change come?

For me the litmus test of whether Bernanke will ultimately fail and lead the country into deeper depression—or whether he will reform the financial system—begins with this:  now that the immediate crisis is averted, over coming months does he weed out the bad debts and bad banks, letting the losses fall where they should according to law, or will he attempt to sweep them under the carpet as I suggested yesterday, to try to make them disappear into the black hole of the Fed?  The latter would complete the massive transfer of wealth from ordinary Americans to the financial elite that Hank Paulson initiated.  If Bernanke temporizes and “lets zombie banks run” we are assured a prolonged liquidity trap, more asset bubbles as the Goldman Sachs’s and other trading banks take advantage of free money from the Fed, and a grinding immiseration of the national psyche. 

• The troubling side of Ben Bernanke - Ambrose Evans-Pritchard h/t Yves
• Dismantle Bernanke's 'Happy Conspiracy' ... now! – MarketWatch h/t Mish
• Which Bernanke? Whose Bubble? – Baseline Scenario
• The case against Bernanke – Financial Times
• Audit The Fed "Dangerous"? – Market Ticker 

My proposal for fiscal policy is to provide livable workfare and health benefits to the unemployed before spending a nickel on anything else.  Ron Paul suggests bringing troops home to pay for national health insurance—that at this moment in history to cut everyone loose as his libertarian principles would require would be inhumane.  If the fiscal stimulus is distributed anything like the financial bailouts were, it will go to the richest Americans.  The political system has been corrupted by money and serves moneyed interests above all others. 

Let’s forget macroeconomic models, “fiscal stimulus” and “quantitative easing.”  Let’s concentrate on the American people.  The nation is a fiscal basket case—and the people don’t trust the government to spend their money any more.  They didn’t agree with the bailouts and no one listened to them.  They’re right to be concerned with the deficits.  They don’t trust the financial markets any more.  They have no idea how to invest their growing savings.

Let’s stop all the academic nonsense and help out the American people.  The American empire is showing all the classic signs of elitist, hubristic collapse.  It never ceases to amaze me how even commentators on the left can ignore what’s going on right under their noses while debating macroeconomic figments.  In this context the way that most of academic economics has circled its wagons to support Bernanke is particularly pathetic.  They did the same for Greenspan, while it was the “tinfoil hats” who were critical.

How does change come when the President and Congress are so clearly compromised?

The Fed as black hole into which losses disappear?

Via:  Slate  When all this bad debt that the Fed is taking in begins to default, and the Fed has to write down the loss, are the “selling” bank’s reserves reduced accordingly?  Or is this really a sale?  Does the Treasury have to come up with the scratch, or do the losses disappear forever in the black hole that is the Fed? 

The Next Credit Bubble Is Now
Are you ready for a replay?
By Heidi N. Moore
Posted Tuesday, August 25, 2009 - 1:07am

Mortgage-backed securities—and the bankers who loved them—wreaked havoc last year, helping to pitch us into the deepest downturn since the Great Depression. Are you ready for a replay?

Gird your loins. The signs are growing that there's a new Wall Street gold rush under way—for those complex bundles of mortgage loans that fueled banks' profits between 2005 and 2007. This year, prices for mortgage-backed securities are rocketing as federal stimulus dollars flood the market. But the difference with this "boom" is the center of gravity has shifted: from giddy, cowboy bankers to the Federal Reserve. The Fed is so eager to save banks, create a demand for these securities, and stabilize the housing market that it's taking troubled loans and mortgages onto its own books. The problem is the Fed may be in well over its head.

The Fed is cleaning up the old mortgage securities in the market—mostly old residential mortgage loans backed by Fannie Mae and Freddie Mac. But it will soon be on the hook for new ones, too, as troubled commercial mortgages are expected to fail en masse in a crash. The institution has already received $2.3 billion in requests to buy commercial mortgages. Indeed, investors are so eager to dump their commercial mortgage-backed securities on the Fed that they have spurred an outcry against Standard & Poor's, which has said it may tighten its ratings requirements to keep the more problematic loans out of government hands. Put simply, the holders of such securities don't want anything to stand in the way of getting on the federal gravy train.

Both types of assets are creating a shadow boom in unworthy debt, based on the same excessive leverage and questionable financial judgment of the last credit bubble. Plus the Fed is making some of the same mistakes as banks did in 2005-07. The banks forgot they were in the "moving" business-of underwriting mortgage-backed securities—and got into the "storage" business of keeping those securities on their books. That's where the Fed is now. It has not yet articulated an exit strategy to dump up to $800 billion of mortgages from its balance sheet.

And if you thought U.S. banks holding all those sketchy mortgages was a bad idea, wait until you see what happens when the center of our country's money supply is saddled with bad debt. The Fed could bail out the banks; no one can bail the Fed out.

It's partly a matter of sheer dollars. The Fed has dug itself in deep, spending $64 billion over the last four weeks and $741 billion this year as it plans to purchase $1.25 trillion of securities backed by agencies like Fannie Mae and Freddie Mac.

At the same time, prices for some residential mortgage-backed securities have jumped 40 percent or more this year to as high as 85 cents on the dollar, even though 9.24 percent of all U.S. mortgages are now delinquent. Analysts have warned that mortgage prices are overvalued. And when about one in every nine is heading for delinquency, buyers have to question the quality of all the bundles they are buying, no matter how highly rated. That is especially true as fewer and fewer homeowners manage to catch up on missed payments. Fitch Ratings, for instance, found that only 6.6 percent of homeowners holding prime loans managed to catch up on late payments as of July. As the Wall Street Journal noted, "That compares to an average of 45% for the years 2000 through 2006."

While the mortgage market is getting worse, the Fed is getting in deeper. In fact, the Fed never owned a Fannie-or-Freddie-backed mortgage before 2009 and now controls about 15 percent of that market, according to Credit Suisse (CS). No wonder Fannie and Freddie shares pitched precipitously upwards in Monday trading, by as much as 50 percent.. Perhaps investors are getting wise that the agencies are in for a long and very lucrative ride as the federal government supports their debt.

Plus, the Fed's buying spree has attracted the attention of investors looking to cash out on mortgage-backed securities: Everyone from Beijing to veteran investors is getting in on the action. Financial firms are forming real estate investment trusts—or pools of capital that buy mortgages-to buy distressed mortgages fast. Investors like hedge fund Third Point entered the market with a $160 million investment in the second quarter and quickly made a $20 million profit. John Costas, a former UBS employee who founded a fund that nearly took down the Swiss bank with bets on subprime mortgages, has just started a new firm to trade mortgages again. Of course, what Wall Street wants is a replay of the early 1990s, when savvy buyers of troubled mortgage-backed securities made a fortune by holding onto the toxic assets until the market came roaring back.

But the Fed should be driving a harder bargain instead of paying richly enough to create a boom. Not surprisingly, the hype for mortgage-backed securities is all in classic bubble language: Wall Street is just happy to have some business to do. Analysts goad on "vulture" investors in distressed mortgage securities by predicting returns of "several hundred percent" for savvy buyers who jump into the market now. Like many bubbles, however, those returns won't last forever. Eventually, supply and demand will fall out of whack again.

If the Fed wants to save banks and consumers by buying these securities, Wall Street is happy to play along. This boom will be hard to stop—and impossible to regulate—because it is spurred by the Fed. On the surface, everyone wins: Banks get to dump some bad assets and gain fees for selling them to the Fed. The Fed gets to enact a stimulus that helps the banks and gets the mortgage markets moving. Politicians can be delighted that Fannie and Freddie are getting some love, because they lend to consumers and that in turn wins votes. But, as we found out during the last boom, something that feels great at first can feel terrible later.

The latest Fed bubble

Via:  Fortune  The answer to the question below is “yes.”  And this is appearing in the mainstream financial press!  That’s cause for some hope, although it’s doubtful the prostitutes in Congress will have the courage to sacrifice their rich financial donor dollars to do the right thing.  Can there be any doubt that “activist monetary policy” accompanied by complete ignorance of financial intermediary management skills can do no more than cause continuous consumer price inflation until consumers are tapped out, and then blow serial asset price bubbles?  The Federal Reserve System, our systemic risk Creator….  Alan Greenspan created the pre-conditions for this depression, Ben Bernanke will destroy our currency “fixing” it using his magic hammer.  Worse yet is that central banks throughout the world are imitating our idiots.  Monetary chaos looms.

Stocks: The latest Fed bubble

Are the government programs supporting the financial sector reinflating global stock markets even as economies stumble?

By Colin Barr, senior writer

Last Updated: August 12, 2009: 3:52 AM ET

NEW YORK (Fortune) -- The Federal Reserve has spent the past year cleaning up after a housing bubble it helped create. But along the way it may have pumped up another bubble, this time in stocks.

To head off the worst downturn since the Great Depression, the central bank has slashed interest rates while funneling money to banks.

The Fed has mostly won praise for its efforts. The pace of job losses has slowed, and there has been a modest recovery in output.

At the same time, stocks have bounced back with startling speed. Since global markets hit their bottom in March, the S&P 500 has jumped 51% -- even as the outlook for economic recovery remains dim.

"This is the most speculative momentum-driven equity market since the early 1930s," Gluskin Sheff economist David Rosenberg wrote in a note to clients Monday.

Of course, stocks have rallied in part because investors perceive the worst-case scenario -- a 1930s-style Depression -- is off the table. And while the gains have been remarkable, they come after an even bigger decline. The S&P is still down 16% since Lehman Brothers collapsed in September.

But while most people take the rise in stocks as a hopeful sign for the economy, some see evidence that the Fed has been financing a speculative mania that could end in another damaging rout.

Recent weeks have brought huge rallies in some of the lowest-quality stocks -- including firms such as AIG (AIG, Fortune 500), Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) that are being propped up by the government and are unlikely to return to health any time soon.

What's more, this year has brought an 80% surge in emerging market stocks, while the dollar has posted a 10% decline since March. A declining dollar and surging emerging markets were the hallmarks of the credit-fueled bull run earlier this decade.

"We have put the band back together on a lot of this," said Howard Simons, a strategist at Bianco Research in Chicago. "That couldn't have happened without liquidity."

Though liquidity is admittedly a nebulous concept, there's no question that central bankers around the globe have poured huge amounts of money into the markets to ease the financial crisis. Given free money, investors' appetite for risk shoots higher and they gobble up stocks.

That's good, except when the outlook for economic growth doesn't seem to support the higher stock values.

"Many observers are wondering whether the strong stock market rebound since mid-March is already a forerunner of the next recovery or simply driven by a reflux of liquidity into riskier asset markets," Deutsche Bank Research analyst Sebastian Becker wrote in a report last month.

Rosenberg, who notes that consumer credit has dropped an unprecedented five straight months, said it's far from clear the recession is over. He says the risk of a market relapse later this year is high.

Simons said another factor that could work against recovery is that short-term interest rates could soon head higher, judging by action in futures markets. That could raise companies' borrowing costs at a time when policymakers have committed to holding rates near zero to restore economic growth.

Fed officials have stressed that they will start to unwind their financial support programs at the earliest sign of inflation. Given the cost of cleaning up after the last bubble, Becker writes that "this time, policymakers are unlikely to remain inactive should they suspect the formation of another asset price bubble."

But it's clear that bankers are loath to pull back on their support for the financial system before it's clear the economy has staged a stronger recovery. And the Fed has a long and painful history of ignoring asset price inflation.

"The central bankers have this textbook belief that the only inflation is the kind that appears in consumer price indexes," said Simons. "They don't believe what they're doing could cause an asset price bubble."

For now, Fed chief Ben Bernanke and other central bankers can console themselves for now with stable consumer price inflation readings in major economies.

But comparing the bankers with a driver pulled over for speeding for the umpteenth time, Simons said, "At some point, you have to say maybe your speedometer's broken."

Markets built on sand

Via:  George Washington  Can you spot which shell the bean is under?  Nice job, George.

The Real Economy Versus the Make-Believe World of the Government and Financial Giants

 

In the real economy, unemployment is at Depression-era levels (see this, this and this).

In the real economy, bank loan loss rates will be higher than the Depression.

In the real economy, government revenue is at its lowest level since the Depression, and most states are on the verge of bankruptcy.

In the real economy, the world economy is crashing faster than during the Depression (and see this).

But in the make-believe world of the government and the financial giants, the recession is over.

How do they do it?

Well, as I noted a couple of days ago, the boys use:

• High-frequency trading, program trading-based frontrunning, and other computer-based manipulation of the markets

• Creation and manipulation of bubbles

• The Plunge Protection Team

• Intervention in the gold, currency markets, and bond markets

• Bear raids, naked short selling, and credit default swap holders driving companies into bankruptcy

In addition:

• Years ago, the government reporting some basic economic indicators like M3, and moved away from real economic indicators like U-6 unemployment and inflation and substituted economic indicators like "U-3" and "core inflation" to cover up what is really happening

• Normal accounting and reporting rules have been suspended, so that companies can pretend that worthless derivatives, CDOs, subprime mortgages and other "toxic assets" are worth perhaps time times more than they are really worth. Indeed, as of 2006, "President George W. Bush has bestowed on his intelligence czar ... broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations." One or more treasury department officials also actively allowed banks to "cook their books"

• Bernanke is apparently almost single-handedly responsible (using the Fed's network of primary dealers) for the current rise in the stock market

• The government also uses its preferred dealers to launder money through the Exchange Stabilization Fund (ESF), to prop up the dollar or otherwise game currencies

• The largest derivatives holders use their Counterparty Risk Management Policy Group (CRMPG) to literally collude - exchange secret information and formulate coordinated mutually beneficial actions - all with the government's blessings

• Wall Street analysts just ignore fines, penalties and expenses in earnings projections (in the words of a Bloomberg commentary, they "Keep Telling Big Earnings Lie")

• The sales of U.S. Treasury bonds are heavily gamed. Indeed, as Rob Kirby and Ellen Brown point out, Bernanke and the boys apparently use hedge funds in the Cayman Islands to launder huge sums of dollars printed by the Fed to secretly buy U.S. treasuries:

In 2005, ... this scheme evidently went into high gear, when China and Japan, the two largest purchasers of U.S. federal debt, cut back on their purchases of U.S. securities. Market "bears" had long warned that when foreign creditors quit rolling over their U.S. bonds, the U.S. economy would collapse. They were therefore predicting the worst; but somehow, no disaster resulted. The bonds were still getting sold. The question was, to whom? The Fed identified the buyers as a mysterious new U.S. creditor group called "Caribbean banks." The financial press said they were offshore hedge funds. But Canadian analyst Rob Kirby, writing in March 2005, said that if they were hedge funds, they must have performed extremely poorly for their investors, raking in losses of 40 percent in January 2005 alone; and no such losses were reported by the hedge fund community. He wrote:

The foregoing suggests that hedge funds categorically did not buy these securities. The explanations being offered up as plausible by officialdom and fed to us by the main stream financial press are not consistent with empirical facts or market observations. There are no wide spread or significant losses being reported by the hedge fund community from ill gotten losses in the Treasury market. . . . [W]ho else in the world has pockets that deep, to buy 23 billion bucks worth of securities in a single month? One might surmise that a printing press would be required to come up with that kind of cash on such short notice.⁴

In September 2005, this bit of wizardry happened again, after Venezuela liquidated roughly $20 billion in U.S. Treasury securities following U.S. threats to that country. Again the anticipated response was a plunge in the dollar, and again no disaster ensued. Other buyers had stepped in to take up the slack, and chief among them were the mysterious "Caribbean banking centers." Rob Kirby wrote:

I wonder who really bought Venezuela's 20 or so billion they "pitched." Whoever it was, perhaps their last name ends with Snow [referring to then-Treasury Secretary John Snow] or Greenspan.

Those incidents were apparently just dress rehearsals for bigger things to come. In late 2005, the Federal Reserve (or "Fed") announced that beginning in March 2006, it would no longer be publishing figures for M3 (the largest measure of the money supply). M3 has been the main staple of money supply measurement and transparent disclosure for the last half-century, the figure on which the world has relied in determining the soundness of the dollar. But the curtain was now to drop. What was it that we weren't supposed to know? March 2006 was also the month Iran announced it would begin selling oil in Euros. Some observers suspected that the Fed was gearing up to use newly-printed dollars to buy back a flood of U.S. securities dumped by foreign central banks. Another possibility was that the Fed had already been engaging in massive dollar printing to conceal a major derivatives default and was hiding the evidence. [See this and this.]

But the problem isn't just that the government and financial giants are hiding the bad news in the real economy.

The bigger problem is that the government has been strengthening the parasite - the fake economy of derivatives and securitization and leverage and cut-outs and front men and cooked books - and poisoning the real economy.