National Press Club Building newssstand, Washington, D.C.
Ilargi: I had planned to dive a bit deeper into the employment reports, but there's no time right now. Besides, with a Stoneleigh piece below, who’ll complain? Still, here's two things about the jobs situation for you to think about.
- This week's ISM Manufacturing Index indicates that the services sector contracted quite strongly. The BLS report issued on Frday, however, claims that 86,000 jobs were added in the sector (52,000 of which are purely temporary jobs).
- The number of Americans in the category Persons Not in the Labor Force rose by almost 300,000 just in the last month. Estimates are that over 3 million people have "disappeared" in this fashion in 2009. The BLS throws out everyone who it claims has not searched for work in the past 4 weeks, though they are unemployed.
Curious, if you ask me, and with at least a whiff of deliberate embellishment.
Just some things to chew on. Here's Stoneleigh:
Stoneleigh: A Golden Double-Edged Sword
Given the fervour over gold, and the fact that our view of it differs from that of many other commentators, it seems fitting to review our position on gold ownership. Firstly, the goldbugs are right that physical gold is real money (unlike paper gold, which is just another Ponzi scheme). It has held its value for thousands of years and will continue to do so over the long term. However, that does not mean that gold prices cannot fall or that purchasing gold now is the right way for everyone to preserve capital. Timing is critical, and people's circumstances are different. Those circumstances determine their freedom of action, both now and in the future.
Gold has recently seen a sharp speculative spike on fear as to the future of fiat currencies. The price shot up to over $1200/ oz, with a rise (nearly vertical recently) of over $300/oz in a matter of months. Sentiment has reached an extreme of 97% gold bulls, leaving very few additional people to drive the existing trend further. It has become almost universal received wisdom that gold can only rise in price (and the US dollar continue to fall) given current circumstances. In other words, herding behaviour has taken the trend just about as far as it can for the time being. (Of course, denominated in other currencies, the move has looked quite different.)
Commodity tops, like equity bottoms, are often sharp, as fear is an acute emotion. The reversal, when it comes, is also typically a sharp move. While the longer term future of fiat currencies is indeed bleak, that should be tomorrow's fear, not today's. When fear gets ahead of itself, it sets the stage for a pronged move in the opposite direction. That happened with equities in March and is what I would argue is about to happen to gold.
What begins as a speculative reversal is likely to be extended by the effects of deflation during the next stage of the decline, which in my view is rapidly approaching. Deflation knocks the price support out from under almost everything, as people sell whatever they can in order to raise scarce cash. 'Whatever they can' is the operative phrase. They won't be able to sell what they would like to, as no one will want what they would like to off-load. They will have to sell things of enduring value, such as precious metals. Those who are forced to sell at the wrong time will end up selling a valuable asset at a bargain basement price.
Buyers for most things will be few and far between, as those who still have cash will be unwilling to part with it. The vast majority of the effective money supply is credit, and credit is evaporating. As that happens, it will become increasingly apparent how little actual cash there is, and how important access to it will be. Rising unemployment and cuts in benefits will make access to cash more and more problematic. The value of cash, relative to available goods and services, will rise. While fiat currency has no long term future, cash will be king while deflation lasts. Liquidity will mean flexibility in an uncertain world, and that will translate into opportunity at the most critical time in all our lives.
Internationally, the US dollar should temporarily be the biggest beneficiary of a substantial flight to safety. The dollar should therefore rise not only in relation to goods and services domestically, but also in relation to other currencies. Those who hold dollars can therefore expect to do very well, provided, that is, that they manage not to lose them to a systemic banking crisis.
Those who buy gold now will be paying a premium price for it compared to what they might pay once deflation has exerted its effects. They might be buying at such a premium only to have to turn around and sell at a loss if they have not addressed their situation from a big-picture perspective. Holding debt, or not having sufficient liquidity in reserve, are the main reasons one could be forced to sell at a bad time. People need to deal with those circumstances before they consider buying gold. Some will be able to deal with the higher priority factors and still buy gold as an insurance policy, but others will not. The fewer one's resources, the harder the choices one will have to make, as it simply will not be possible to do everything. (Pooling resources with others will get you further down the list of possible preparations.)
Liquidity will be vital to cover living expenses in the absence of credit, especially as we move further towards a pay-as-you-go future. Eliminating debt is important given that servicing debt will become increasingly difficult. The ability to service debt depends on both access to scarce cash and interest rates. Interest rates on private debt are likely to diverge sharply from the prevailing rate on short term government debt. In other words, credit spreads will widen dramatically. While the short term government rate will be very low, at least in nominal terms, private debt will attract a much greater risk premium as deflation accelerates. All rates will be higher in real terms than in nominal terms, as the real rate will be the nominal rate minus negative inflation. This factor will keep central bankers mired in the liquidity trap (pushing on a string), and will magnify the burden of debt for everyone else.
If you hold too little liquidity or are in debt, you could easily be forced to sell any precious metals you hold at the worst possible time. In general terms, I would not suggest holding precious metals unless you are reasonably confident that you will not need to rely on the wealth they represent for many years. If you can hold metals for the long term, they will be very valuable indeed. Gold should hold its value better than silver, as a greater proportion of silver's value is related to its industrial uses, and those attributes will be undervalued during a depression.
I would expect gold to bottom early in this depression, but I doubt if it will be possible for ordinary people to buy it at its nadir. During the last depression, gold was confiscated without compensation, and I think it likely that the same thing will happen again. A ban on owning gold would not stop you from owning it, but it would make ownership far riskier, and would make trading it for anything else you might need a very dangerous business indeed. You would have to go through 'informal channels', where these exist, and trying to do that with something representing a very concentrated source of value is generally unwise, to put it mildly.
Gold ownership is very much a double-edged sword. Personally, I think it far more important for those who have surplus resources to put those resources into obtaining as much control as possible over the essentials of their own existence. There are many hard assets one could buy now that may not be available later - assets that you could use to feed yourself, keep yourself warm or provided clean water. This is a much more important use for your wealth than owning something you intend to bury in a hole in the ground and sit on. Gold ownership really only makes sense for those who are wealthy enough not to have to make hard choices between competing priorities. If you can afford to do it all without making compromises, then gold is a good insurance policy. If you are not in such a fortunate position, that kind of insurance may be a luxury you can't afford.
Ilargi: Even though we no longer call it our Fall Fund Drive, we're still open for donations, as our advertisers are for your visits.
Everyone Is Long Gold
According to this chart from Citi's Alan Heap today, gold traders are the most net-long they've been this decade, as indicated by the yellow line below. We'll go out on a limb and bet that they are also the most net-long in decades even given the massive run up in gold over the last few years.
New York Fed Starts to Unwind Stimulus
The Federal Reserve Bank of New York on Thursday took its first step toward unwinding the stimulus it has provided to markets over the past two years. To pull cash from the system, the Fed sold $180 million in Treasurys in three-day tri-party reverse repurchases. In a reverse repo, the Fed sells securities with an agreement to buy them back later at a higher rate. The Fed received $180 million in bids.
The highest rate accepted was 0.16%, which was on par with the three-day repo market rate of 0.16%, according to Ira Jersey, U.S. interest-rate-strategy group head at RBC Capital Markets. The delivery date is Friday. The Fed earlier this week said it would implement small-scale reverse repos over coming weeks but said the operations have no implication for monetary policy. Rather, the Fed said the operations are being conducted to ensure operational readiness at the Fed, tri-party repo clearing banks J.P. Morgan Chase and Bank of New York Mellon, and primary dealers, the lead group of banks that deal directly with the central bank.
Reverse repos are one tool the Fed has at its disposal when the economy and financial markets have improved enough for it to drain cash from the system. The Fed uses short-term repurchase and reverse repurchase agreements to temporarily affect the size of the Federal Reserve System's portfolio and influence day-to-day trading in the federal-funds market. The operation comes on the heels of a series of reverse repo tests that have been done by the bank over recent weeks.
"The idea is they want to get all their ducks in a row and be ready (to pull cash) when the time is necessary," Mr. Jersey said, adding that there's no point in doing large scale reverse repos as long as the Fed is still purchasing assets. The Fed is in the process of buying nearly $1.75 trillion of Treasury, agency and agency mortgage-backed securities through its securities purchase programs.
Depressed Americans Quit The Labor Force
One caveat to today's jobs report -- which overall was excellent -- is the fact that Americans continue to leave the work force, and that these people aren't included in headline rate.
Said the BLS:
About 2.3 million persons were marginally attached to the labor force in November, an increase of 376,000 from a year earlier. (The data are not seasonally adjusted.) These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.
As you can see, that number remains at a record high, and eventually they'll be coming back.
US Services Sector Turns Sharply Lower
The U.S. services sector is once again contracting according to the Institute for Supply Management's (ISM) Non-Manufacturing Index.
The latest November index value came in at 48.7, surprising consensus economists who expected it to be 51.5. Any value below 50 indicates a contraction of activity, according to the ISM.
This makes it very clear that the services sector improvement we've seen all year has suddenly reversed, after only briefly breaking above the key 50-level. See detailed tables about the latest November report here.
Initial jobless claims fall 5,000 to 457,000
Total number collecting benefits rises to 9.6 million
In a sign of improving labor markets, new claims for state unemployment benefits dropped for a fifth straight week, the Labor Department reported Thursday. But a large increase in the number of people collecting checks indicates hiring remained sluggish. The number of Americans filing for state unemployment benefits fell by a seasonally adjusted 5,000 to 457,000 in the week ending Nov. 28. It's the fewest initial claims since September 2008.
Claims in the previous week were revised lower by 4,000 to 462,000. Economists surveyed by MarketWatch had expected initial claims to rise to about 480,000. See our complete economic forecast and calendar. The figures come just a day before the Labor Department reports on November's unemployment rate. Economists expect the jobless rate to remain at a 26-year high of 10.2%, with 100,000 nonfarm payrolls lost. It would be the fewest jobs lost since January 2008.
In Thursday's report, the Labor Department said the four-week average of new claims fell 14,250 to 481,250, the lowest in 13 months. The four-week average smoothes out distortions caused by one-time events, such as bad weather, holidays or strikes. The most recent data were collected in the Thanksgiving week. The seasonal factors attempt to adjust for the shortened workweek, but cannot do so perfectly. The number of people filing continuing claims rose by a seasonally adjusted 28,000 to 5.47 million in the week ending Nov. 21.
Compared with a year ago, initial claims are up 7.5%, while continuing claims are up 38%. The number of people collecting extended benefits under federal programs rose by 327,000 to 4.53 million in the week ending Nov. 14. The figures on extended benefits are not seasonally adjusted. The total number of people claiming benefits rose by 527,000 from 9.08 million to 9.61 million, as a new program for extended benefits kicked in. In some states, unemployed workers can now collect for up to 99 weeks, far exceeding the typical 26-week benefit period.
More than half of workers getting benefits exhaust their regular state benefits after 26 weeks. More than a third of the 15.7 million people who are officially classified as unemployed have been out of work longer than 26 weeks. Job losses have been unusually steep in the latest recession and little evidence suggests employees will start hiring on a mass scale anytime soon. Those who exhaust their benefits or who are ineligible to collect are still classified as unemployed if they are actively looking for a job.
Matt Taibbi: Obama Baited And Switched Us, And Let Wall Street Take Over The White House
Continuing his crusade against Wall Street, Matt Taibbi takes aim at the Obama administration. He accuses the President of running as a progressive, but then allowing Robert Rubin and various Wall Street allies dictate policy. Can't say we disagree.
Jobs Summit Charade: Is the government out of money, or is Obama completely misguided?
The government of the largest economy has run short of money. At least that is what Mr. Obama sought to convey at his “jobs summit” yesterday. The President said he would entertain “every demonstrably good idea” for creating jobs, but he cautioned that “our resources are limited.”
What a confidence-inspiring notion. How can we possibly solve the problem of unemployment in these circumstances? The preposterousness of the statement is only matched by the paucity of economic understanding that it manifests.
For the millionth time, Mr. President, a government which issues its own sovereign currency cannot go broke. It cannot “run out of dollars”.
Does any other entity in the world issue US dollars? No. The national government does this under monopoly conditions. If you or I tried to do it, we would go to jail for counterfeiting. The government money monopoly was invented to mobilize resources to serve what government perceived to be the public purpose. Of course, it is only in a democracy that the public’s purpose and the government’s purpose have much chance of alignment, but this presupposes at least a working understanding of how a modern monetary system operates.
So here’s how it really works:
Any US dollar government deficit exactly EQUALS the total net increase in the holdings US dollar financial assets of the rest of us — businesses and households, residents and non residents — what’s called the ‘non government’ sector. In other words, government deficits = increased ‘monetary savings’ for the rest of us. It doesn’t matter if the financial assets are owned by American citizens or by Chinese manufacturers. The government spends money by electronically crediting bank accounts and those funds show up in the bank accounts held by the rest of us — the non-government sector.
This is accounting fact, not theory or philosophy. There is no dispute. It is basic national income accounting.
So, for example, if the government deficit was $1 trillion last year, it means the net increase in savings of financial assets for everyone else combined was exactly $1 trillion. We, as the non-government sector can then take that $1 trillion of financial assets and spend it on REAL assets, whether building a home, developing a business, shopping for a new car or laptop, or deciding to save the money by buying a Treasury bill. The expenditures on real assets create additional wealth in the economy, which in turn helps to reduce unemployment, and enhance incomes.
Think of this like a poker game at a casino. The “casino” (government) issues 100 chips, each representing $1.00. The chips are divided equally four ways. At the end of the evening, the distribution of those chips might well be different. 2 people might have lost everything, the third might have come about ahead by 15 chips and now has 40 and the fourth player might well have done even better, and gained a further 35 chips to give him 60. The aggregate amount of chips has not changed. There are still 100 chips, but they have been distributed differently.
The casino, however, being the government, is never short of chips. The casino can always create additional chips, much like an electronic scoreboard at a football game can “create” additional points at will on a scoreboard. To speak of “a shortage of resources” or an insufficiency of “public dollars to fill the hole of private dollars that was created as a consequence of the crisis” (as the President said yesterday), reflects a complete abdication of responsibility on the part of Obama. “The hole in private dollars”, which the President describes, is just the fall in private spending brought about by people wanting to save more money. That “hole” means that productive capacity will become unused and the jobs that could have been applied to that capacity are lost. This is why we have an unemployment rate that has almost trebled in the past 2 years.
The 15.7 million unemployed Americans are certainly not a limited resource — although they are a depleting resource the longer they stay unemployed. And unemployed they will remain in the absence of increased spending. So where does that spending come from?
At a recent symposium, Intel boss Paul Otellini, a contributor to both parties, expressed concern about the “amount of variability in the system” created by the state of policy flux in healthcare, energy and tax policy. “It is very difficult to make a hiring decision,” he said. General Electric chief executive Jeffery Immelt, added he would just like to “know what the rules are.” Fair enough. A business, unlike a government, does face external funding constraints. Get a decision wrong and the business cannot compensate by creating more currency. The problem is that income growth is dependent on aggregate demand (spending) growth. If spending growth falters, then output and income growth falters and the capacity to save by the private sector is compromised.
But the government doesn’t have to wait. A sovereign issuer of its own currency has all the capacity it needs. The budget deficits (net public spending) can maintain growth in demand to keep income growing and hence support private saving. Budget deficits should aim to fill in that “hole in private savings” and not allow aggregate demand to “fall through it”, which would lead to income and employment collapses. Government spending has to rise so as to ensure that firms are willing to maximize the use of their productive capacity, which in turn generates further employment. You don’t need a job summit to figure that one out, Mr. President.
The only “resource deficiency” here is one of political courage.
The Obama Administration continues to fantasize that it can get away with creating Potemkin prosperity of levitating asset prices via trillions of dollars of financial guarantees to Wall Street in lieu of deploying fiscal resources needed to lay the groundwork for the real thing.
If the President really believed that the government’s capacity was genuinely limited, then why bother holding a jobs summit at all? Or, at the very least, why not hold it in China, so that our Chinese “bankers”, who allegedly “fund” government expenditures, can vet each program and then decide whether they will continue to “finance” us. What’s next? Declaring wars only in times of national budget surpluses when we can “afford” to go to war?
You can see where the President’s incoherence leads. Our problem is a lack of jobs, not a lack of resources. The solution is more government spending. The only unemployment increase worth applauding would be the sacking of the President’s entire economics team, all of whom persistently regurgitate deficit myths that constrain output and employment and prevent us from recouping genuine prosperity.
Chinese official slams banks over derivatives
A senior Chinese official who oversees the country’s largest state-owned enterprises has publicly slammed western investment banks for “maliciously” peddling complicated derivative products that caused huge losses for Chinese companies over the last year. In Beijing’s strongest criticism on the matter to date, Li Wei, vice director of the State-owned Assets Supervision and Administration Commission, singled out Goldman Sachs, Morgan Stanley, Merrill Lynch and Citigroup in a long and highly critical article in the latest issue of an official Communist party newspaper.
The large losses suffered by Chinese state companies were “closely associated with the intentionally complex and highly leveraged products that were fraudulently peddled by international investment banks with evil intentions,” Mr Li asserted. “To a certain extent some international investment banks were the chief criminals and the root of ruin for the Chinese enterprises who encountered this financial derivatives Waterloo.” In his article, Mr Li said 68 of the 130-odd state companies controlled directly by Sasac had been buying derivatives to speculate or hedge against rising commodity prices and fluctuating currencies and interest rates, even though some of them were not authorised to do so.
These 68 companies had booked total combined net losses of Rmb11.4bn on the Rmb125bn worth of financial derivatives products they had bought by the end of October 2008, Mr Li said. The government has not previously revealed the full extent of losses suffered by Chinese companies that made ill-fated bets on over-the-counter, mostly offshore, derivatives. In September, Sasac warned that some of the contracts were illegal and might be invalidated, a move that prompted some western banks to agree quietly to renegotiate contracts behind closed doors.
Air China, China Eastern Airlines, Cosco, China Railway Engineering Corp, China Railway Construction Corp and Citic Pacific were among the companies that lost the most from buying complex derivatives. Some of the biggest losses came from the airlines and shipping companies’ purchases of options to hedge against rising oil prices between June and August last year, when oil hit a historic peak of more than $140 a barrel. When prices fell during the financial crisis, these companies were saddled with large losses, partly because they had chosen riskier – and cheaper – derivatives products to hedge against rising prices.
Mr Li said the most important reason for the derivatives losses was unnecessary speculation and attempts at arbitrage by these state companies. He also cited weak risk management procedures, a lack of expertise and intentional breaking of rules that restrict most kinds of financial derivatives in China. But he said China should “not give up eating for fear of choking” and that it was imperative for Chinese companies to keep using financial derivatives.
Geithner: Can Shift "Substantial" Bailout Funds to Jobs
The Obama administration can shift "substantial" resources from bank bailouts to job creation and will soon spell out the case for doing so, Treasury Secretary Timothy Geithner said on Friday. Interviewed on Bloomberg television's "Political Capital with Al Hunt," Geithner said money from the $700-billion Troubled Assets Relief Program will be available.
"We're going to explain that we're going to have substantial savings, that we're going to have very substantial resources that we can make available to support not just the immediate priorities the country faces in spurring investment in job creation, but also to meet our long-term fiscal challenges," he said. Bloomberg issued quotes from the interview.
President Obama is to lay out job creation strategies in a speech next Tuesday morning, a potential venue for specifying how much TARP money the White House might redirect from its original purpose of propping up ailing financial institutions. Geithner said money was being repaid in greater volumes by banks and that he expected $175 billion to come back by the end of next year. "That's substantially more than we anticipated even just a few months ago," Geithner added.
On other topics, Geithner repeated his opposition to a tax on financial transactions because companies would find ways to get around it and rejected the idea that Goldman Sachs didn't need government financial help last year when the financial crisis was raging. All the banks were struggling and the whole financial system was at risk. "None of them would have survived a situation in which we had let that fire try to burn itself out," Geithner said.
In response to a question, he said he backed the idea of having Congress consider new ways to choose a president of the New York Federal Reserve Bank, one of the most powerful positions in U.S. central banking and the job that Geithner held before he was chosen for Treasury chief. Asked if the New York Fed president should be nominated by the President and subject to Senate confirmation to ease concerns that Wall Street had undue influence, Geithner said it would be "very appropriate" for lawmakers to review the selection process. "I would be very supportive of the Congress looking at changes to the governance structure," Geithner said.
Geithner as Martyr to an Ungrateful Nation: Bo Cutter’s Tragicomic Portrayal of Tim as a ‘Man for all Seasons” (Part 2)
by Wlillam K. Black
This is the second installment in my comments on Bo Cutter’s essay defending Treasury Secretary Geithner. Bo was a managing partner of Warburg Pincus, a major global private equity firm and led President Obama’s Office of Management and Budget (OMB) transition team. He was Bob Rubin’s deputy at the National Economic Council. The first installment discussed Bo’s extraordinary indictment of the finance industry.
Bo views Geithner as a martyr subjected to unfounded, ungrateful attacks for his actions that prevented the Second Great Depression. Bo doesn’t have much use for Americans that are upset with the senior managers of the finance industry. (This is a bit weird because Bo denounces these senior managers as universally incompetent, cowardly, and unethical.)
[L]iberals hate [Geithner] because he did not take over or dismember the banks, and publicly execute their senior managements.
This passage tells us nothing about liberals, but much about Bo and his peers’ fears of the public. The finance leaders know they are guilty of destroying much of the global economy — while growing extraordinarily wealthy in the process. They know that their primary means of destruction was accounting “control fraud.” They cannot understand why the public has not turned on the finance industry and demanded that the fraudulent financial leaders be prosecuted and their immense gains from fraud recovered. They also cannot understand why we allow the continued existence of systemically dangerous institutions (SDIs). Geithner, Paulson, and Bernanke have warned that the failure of any SDI could cause a global crisis. Under their logic, SDIs are ticking time bombs that will cause recurrent global crises. Geithner, like Paulson, is making the SDIs much larger and much more dangerous by using them to acquire other large, failed financial institutions. This policy is insane. Virtually no one (that isn’t on their payroll) supports the continued existence of SDIs and no one publicly argues they should be made even larger — but that is our policy. Bo is the authentic voice of giant finance: the idea of shrinking the giant banks to this community is so painful, so personal that it is equivalent to “dismemberment.” (It also shows that the giant finance is predisposed to view itself and its allies as tragic martyrs.)
Bo is only getting started with Geithner’s martyrdom and the ingratitude of the murderous mob to this modern martyr.
And no one thinks he is tall enough. If you read the accounts of Secretary Geithner’s hearings last week, you know this is all classic Washington behavior. If there is one thing at which the glibocracy in DC excels, it is coming out of the hills after the battle is over and shooting the wounded. This is Washington today, a system in total gridlock, in which counting coup is the central activity.
So, Geithner is picked on by nearly everyone, not given any respect because he is short, and now that he is wounded the D.C. denizens are out to shoot him. Despite our scorn, Geithner continues to step into the breach on our behalf. Bo was a senior federal official in crises and found his peers to be cowards: “the crowd of people willing to join you in taking responsibility gets smaller by the second.”
This is why he is so impressed by Geithner:
Then, beginning with his assumption of the Treasury job in November — long before he was confirmed, so he was clearly going to be beaten up on every action he took, but he went ahead and took them — he was at the lead of every major decision made in the recovery effort. (During this presidential transition period, it would have been easy to keep away from the decisions by saying that power was still in the hands of President Bush. But the Bush Administration by that point was completely spent. Someone had to step up and Tim Geithner did.)
Unlike Bo’s cowardly heroes, Geithner is a hero — repeatedly taking the lead in responding to the crises even when he knew that if he did so “he was clearly going to be beaten up on every action he took.” Geithner was abused for using stress tests.
His use of stress tests, which was roundly laughed at by everyone, worked, helping enormously to make much more transparent and less scary the situations all of the major banks were in.
The purported stress tests [see here, here, and here] did make banking seem “less scary” because they were not real and were part of the Geithner/Summers/Bernanke coverup strategy. The SDIs demanded that the accounting rules on loss recognition be junked — and the trio acceded to that travesty. Bo tells us why the SDIs demanded that they be able to hide their massive losses when he explains why he supports the Bush/Obama administration bailouts of AIG’s counterparties: “most of the banks had either insufficient or no capital.” To put it more bluntly, most of them were insolvent and the remainder had so little capital that they posed intense, global systemic risk. The Bush and Obama administration have followed a three-part strategy towards these insolvent and crippled SDIs: (1) cover up the losses through (legalized) accounting fraud, (2) launch an “everything is great” propaganda campaign (the faux stress tests were key to this tactic), and (3) provide a host of secret taxpayer subsidies to the SDIs. This strategy is the opposite of making banks “much more transparent.” The strategy is not shaped by finance, but by politics. Both administrations have sought to keep the American people from knowing about these cover-ups and secret subsidies because they know that we would not tolerate either policy. The cover-ups and secret subsidies are not simply awful financial policies; they are also a betrayal of democracy. When Bernanke writes that the sky will fall if the Fed is subject to audit it is precisely because he knows that the Fed’s policies cannot withstand scrutiny by anyone serving the interests of the citizens (as opposed to the interests of the SDIs). (John 3:20 “For every one that doeth evil hateth the light.”)
Bernanke may believe that when he acts in the interests of the SDIs he is acting in our interests. Charlie Wilson (GM President and President Eisenhower’s nominee as Secretary of Defense): “I thought that what was good for our country was good for GM, and vice versa.” But that’s the point; the Fed and so many of its senior officials such as Bernanke and Geithner are dangerous because the institution identifies too completely with the SDIs. Like Bo, they also see us as murderous populists that cannot be trusted to make democratic decisions about SDIs. Calling Geithner’s and Bernanke’s cover-ups and secret subsidies “transparency” is Orwellian. The best one can say is that Paulson, Geithner, and Bernanke decided (undemocratically) that it had become necessary to destroy capitalism and democracy in order to save them.
Bo’s final claim in support of his martyrdom motif is:
Tim Geithner acted. He acted at the moment action was required … with the fullknowledge that he would face exactly what he is now facing.
Get off his back.
Luckily, I like Star Trek so I have experience puzzling through time paradoxes similar to the one Bo presents here. Geithner had “full knowledge … that he would face exactly what he is now facing.” What he’s facing is calls for him to resign his position as Treasury Secretary. He became Treasury Secretary in 2009. Bo, however, emphasizes:
Starting from late 2007, as the crisis began to unfold, Geithner was at the spear point of every issue and, along with Bernanke, was a creative policy maker who clearly saw the immense dangers we faced and stretched all of the powers of the Federal Reserve Board to find solutions no one else could.
So, Geithner acted “from late 2007″ with “full knowledge” that his actions would be so unpopular that it would destroy his career and that he “would face exactly what he is now facing” (calls for him to resign as Treasury Secretary). Geithner’s career went ballistic after “late 2007.” In 2009, President Obama appointed him Treasury Secretary and has moved to reappoint Bernanke as Fed Chairman. Those are the two most prestigious financial positions in the world. Exactly which aspect of being promoted to his dream job made Geithner a martyr? Where can we sign up for similar martyrdom? Tevye’s response to Perchik’s claim that “money is the world’s curse” applies to Bo’s claim that Bernanke’s promotion makes him a martyr.
May the Lord smite me with it. And may I never recover. [Fiddler on the Roof.]
All time paradoxes are, of course, paradoxical and Bo’s doesn’t disappoint. How exactly did Geithner know in “late 2007″ that (1) Obama would be elected President, (2) would appoint Geithner as his Treasury Secretary, and (3) that he would face calls in 2009 to resign as Treasury Secretary?
Why Praise Faux Martyrs When Ed Gray is Available?
If Bo wants to praise a real regulatory martyr — one who got the finance and regulatory issues correct early enough to prevent an economic crisis, reregulated successfully in the face of virulent, powerful opposition, and who did so despite knowing that it would destroy his career at a point where he was in financial distress the obvious candidate is Ed Gray. As Paul Volcker wrote about Ed Gray in a post-publication blurb for my book, The Best Way to Rob a Bank is to Own One:
Bill Black has detailed an alarming story about financial and political corruption….the lessons are as fresh as the morning newspaper. One of those lessons really sticks out: one brave man with a conscience could stand up for us all.
Paul Volcker was Ed Gray’s only pillar of support for his reregulation of the S&L industry. When Gray became Federal Home Loan Bank Board Chairman in 1983 the S&L industry was coming out of the first (interest rate risk) phase of the debacle but descending into an even more severe second phase of accounting control fraud. The National Commission on Financial Institution Reform, Recovery and Enforcement’s 1993 report on the causes of the debacle explained the characteristic failure pattern:
The typical large failure was a stockholder-owned, state-chartered institution in Texas or California where regulation and supervision were most lax…. [It] had grown at an extremely rapid rate, achieving high concentrations of assets in risky ventures…. [E]very accounting trick available was used to make the institution look profitable, safe, and solvent. Evidence of fraud was invariably present as was the ability of the operators to “milk” the organization through high dividends and salaries, bonuses, perks and other means (NCFIRRE 1993: 3-4).
In 1983, the S&L accounting control frauds grew at an average rate of 50%. The Texas state S&L Commissioner was sleeping with prostitutes provided by the second worst control fraud in the nation - Vernon Savings (known as “Vermin” to its federal regulators). The California state commissioner, according to the documents, was secretly in business with the worst control fraud in the nation - Charles Keating’s Lincoln Savings. Texas and California approved over 300 new S&L charters. Most of them were troubled real estate developers with severe conflicts of interest. Many of them were control frauds. The rate of applications for new charters was expanding.
Gray’s predecessor, Richard Pratt (a theoclassical finance professor) led the deregulation of the industry at a time of mass insolvency. He also largely desupervised the industry. He gimmicked the accounting rules to cover up losses and create fictional income. He cut the number of examiners. There were no criminal referrals or prosecutions of senior S&L officials. The industry was completely out of control. A regional bubble in commercial real estate was already growing in 1983.
Gray reregulated and re-supervised the industry. He ended most regulatory accounting abuses. He doubled the number of examiners and supervisors (over the vigorous objection of OPM and OMB). We began targeting the worst control frauds for closure while they were still reporting record profits and minimal losses. We adopted a rule restricting growth aimed at the Achilles’ heel of every Ponzi scheme - the need to grow massively. Gray brought in experienced regulators with a track record of vigor, courage, and professionalism and put them in place in the Dallas (Joe Selby) and San Francisco (Mike Patriarca) because they were the two worst regions. We deliberately burst the Southwest’s commercial real estate bubble.
Gray put in place a system of criminal referrals and made supporting criminal prosecutions a top priority. The agency (and here great credit must also be given to OTS Director Ryan and the Department of Justice and FBI) effort was so successful that over 1000 “priority” felony convictions of senior S&Ls insiders were obtained - the most successful effort in history against elite white-collar criminals.
We almost always resolved serious failures in a manner that wiped out entirely “risk capital” (shareholders and subordinated debt holders). Gray blocked Texas’ and California’s land rush style grants of hundreds of new charters by refusing to approve FSLIC insurance for any new S&Ls in those states. Gray did all this with the certain knowledge (which he often stated to us) that it would end his career. He was in his 50s and he was in financial distress, so he knew the sacrifice he would make would be severe.
Gray took on, simultaneously, the Reagan administration (particularly Don Regan and the OMB), a majority of the members of the House (who co-sponsored a resolution calling on us not to reregulate), House Speaker Jim Wright, five U.S. Senators (the “Keating Five”), the S&L trade association (which some political scientists rated the third most powerful in the U.S., his two fellow Bank Board members, much of the agency (including two of our economists that met secretly with Keating’s lawyers), and most of the media (which sometimes referred to him as “Mr. Ed” - from the TV program about the talking horse). Charles Keating sued him in his personal capacity for $400 million. The administration threatened to prosecute him for closing too many insolvent S&Ls (under the Anti-Deficiency Act). The administration tried to appoint two members chosen by Charles Keating (the most notorious S&L control fraud) to the agency (which would have given them majority control of the three-person Bank Board). (Pause for two minutes and consider how catastrophic it would have been if the administration had succeeded in giving control of the agency to that decade’s most notorious control fraud.) He served as a “mole” for Keating and proposed to amend the direct investment rule (which Lincoln Savings had violated by more than $600 million) that would have had the effect of exempting it from enforcement. Lincoln’s lawyers drafted the amendment (which, of course, never mentioned Lincoln). I blew the whistle on Keating’s mole, which eventually led him to resign. After I blew the whistle (but before he resigned), the administration nominated him for a full term. The day after he resigned four U.S. Senators (the “Keating Five” minus Senator Riegle) met with Gray to pressure him not to take enforcement action against Lincoln’s massive violation of the direct investment rule.
Don Regan tried very hard to force Gray to resign. He refused, so Treasury Secretary Baker met secretly with Speaker Wright (who, at the behest of Texas control frauds, was holding our proposed bill to recapitalize the FSLIC insurance fund hostage in order to prevent us from securing the funds to close more of the control frauds). Baker and Wright reached a cynical deal: the administration would not reappoint Gray to a new term and would not oppose Wright’s demands for “regulatory forbearance” (which included debasing - again - the accounting rules and adopting other measures drafted by attorneys for the control frauds designed to make it far harder to close insolvent S&Ls. Wright agreed that he would support a $15 billion FSLIC recapitalization bill (instead of the $5 billion bill that the industry and control frauds supported. Wright got the better of the deal because his allies spread the word that the Speaker didn’t really support the $15 billion bill and the House voted for the $5 billion bill.
Gray remains unemployed and unemployable today. But he doesn’t have to avoid mirrors.
Unlike Geithner, Paulson, and Bernanke, Gray acted before the epidemic of accounting control fraud produced a bubble so large that it produced a general economic crisis. Consider what would have happened had Gray not reregulated and resupervised the industry beginning in November 1983. The roughly 300 control frauds in 1984 would have grown at 50% annually and scores of new Texas and California frauds would have entered each year. The result would have been a commercial real estate bubble of epic proportions. Such a bubble would have taken down not only the S&L industry, but also the banking industry (which had massive commercial real estate exposure) and would have severely damaged the insurance industry (which provides much of the permanent/takeout financing for commercial real estate). We cannot yet demonstrate when a bubble will collapse, but we know that accounting control fraud epidemics are capable of extending the life of financial bubbles and hyper-inflating them for several years. The direct losses among S&Ls, absent Gray’s reregulation, would have been over a trillion dollars within five years. The losses to banks and insurance companies would have exceeded the S&L losses. Losses of that magnitude would have caused a severe recession.
It also needs to be stressed that subprime and alt-a loans, qualifying loans based on teaser rates, bonuses to loan officers based on volume (not loan quality), inflated appraisals, and accounting control fraud are not new. They always end badly. Mike Patriarca lead the supervisory effort in 1990-92 that prevented a nonprime lending crisis by forbidding lending practices that we have long known end in disaster. He then left federal service and went into business.
You might think that the first two calls Geithner, Paulson, Summers, Rubin, and Bernanke would have made once they finally realized there was a crisis would have been to Ed Gray and Mike Patriarca to see how successful reregulation is accomplished and how one successfully prosecutes the accounting control frauds that drove the current crisis. But, if you think that you probably also think that the one regulator that stood openly in support of Gray’s reregulation of the industry — Paul Volcker — would be President Obama’s primary economic advisor. Instead, Summers, Geithner, and Bernanke have marginalized Volcker. The Bush and Clinton anti-regulatory Wrecking Crews remain in power in the Obama administration despite a dismal record. They are never held accountable. Bo wants them left in power. He wants us to stop criticizing their failures, to apologize to them for our ingratitude, and to honor them for the terrible career sacrifices they have (mythically) made to protect us from harm.
I disagree. I urge us to learn the lessons not simply of regulatory failures but regulatory and prosecutorial successes (the Gray and Ryan years). Mike Patriarca is in his prime. Put him in charge of a major regulatory agency immediately. Paul Volcker is a national treasure that petty, power-hungry failures (yes, I mean Summers) are wasting.
Oh, and Jim Baker, Jim Wright, and John McCain should show some class and apologize for the shoddy treatment they handed out. Let me be clear on this last point - they shouldn’t apologize for the shoddy treatment of Ed Gray the man - they should apologize for the damage they caused our nation when they took their policy advice from major political contributors (that were leading control frauds) and impeded Gray’s substantive reforms that were essential to protecting our citizens.
Why Bernanke Should Be Fired
Frankly speaking, reappointing Bernanke would be a reward for many failures, both as an economic theorist, and as Fed Chairman.
Back in 2003, Mr. Bernanke was a member of Alan Greenspan’s Federal Reserve Board of Governors. The housing bubble was already blooming, but, at that time, there was still an opportunity to keep it under control. Primarily, the nascent bubble was the result of ultra-low interest rates, championed by Mr. Bernanke, and agreed to by Greenspan. Transcripts of the Fed Meetings at that time indicate that Bernanke was a driving force behind the huge increase in so-called "liquidity" and abnormally low interest rates. He continued to support keeping rates abnormally low when his then-boss, Alan Greenspan, began to slowly raise them, in 2003. Indeed, until 2004, he not only wanted to keep rates abnormally low, but, more disturbing, he wanted to reduce rates below 1%. Had Bernanke gotten his way, the housing bubble would have been even bigger than it was, and the resulting collapse we are now experiencing would have been even deeper.
But, the mistakes didn’t end there. During his confirmation hearings in 2005, Bernanke stated:
With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly.
As we all now know, derivatives were a key factor that caused the current Financial Crisis. Many others were warning about the dangers inherent in uncovered derivative obligations. Yet, Benjamin Bernanke, supposedly a knowledgeable economist, was entirely oblivious to the danger. But, that's not all. There’s much more.
Bernanke didn’t stop being wrong after his appointment to the position of Federal Reserve Chairman. He continued being incorrect, time and time again. Here is a small sampling of statements he has made, during the Financial Crisis, which show he was out of touch with reality, and unable to competently perform his job functions.
- March 28, 2007: “The impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.”
- May 17, 2007: “We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”
- Feb. 28, 2008, on the potential for bank failures: “Among the largest banks, the capital ratios remain good and I don’t expect any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system.”
- June 9, 2008: “The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”
- July 16, 2008: Fannie Mae and Freddie Mac are “adequately capitalized” and “in no danger of failing.”
The primary duty of the Chairman of the Federal Reserve is NOT to create dollars out of thin air, and give them away to favored banks at near-zero interest rates. On the contrary, the Fed Chair is supposed to act to protect the economy of the United States of America.
Protecting our economy includes, perhaps most importantly, protecting the value of the U.S. dollar. With a worthless dollar, getting people employed and wages paid doesn’t mean very much. Preserving the value of the dollar, and protecting the nation from runaway inflation is critical to the long term health of the economy. Chairman Bernanke has utterly failed to do fulfill his job duties, and instituted policies that will, eventually, destroy the value of the U.S. dollar.
Starting in September, 2008, he began a massive half-trillion dollar program called “central bank liquidity swapping” which transferred about $567 billion dollars to European and other central banks for distributiion to banks that had been short on the dollar prior to the implosion of Lehman Brothers. Had he not done this, the value of the dollar would have gone up far higher than it would have otherwise. The foreign banks that had bet against it would have been severely “burned”. That would have taught a severe lesson to all those who, in the future, might decide to short the dollar, deterring such speculation.
No doubt, the dollar’s value would have returned to normal in a few more months, but those same big foreign banks would never have been reckless enough to short the dollar again. Instead, as with later bailouts of American banks, Bernanke reinforced the level of moral hazard. Foreign banks shorting the dollar now are confident that the Federal Reserve, under Ben Bernanke, will always come to their aid in a pinch. The level of moral hazard is far greater now than before. This has proven lethal to the dollar as it has become vulnerable again. Once again, foreign banks are shorting it, and it is collapsing under the weight of near-zero interest rates, a flood of newly printed so-called "liquidity", and a renewed carry trade. Speculators on Wall Street are siphoning hundreds of billions of dollars out of the American economy, placing them overseas, doing nothing productive except collecting interest differentials, and draining much needed capital from domestic businesses.
Inside the U.S.A., Bernanke has already nearly doubled the monetary base. Based on his announced plans, by March, I expect the monetary base to have tripled. The massive dollar printing program that he has embarked on is as reckless as any possible activity can possibly be. It has panicked the foreign exchange market, and given great strength to both the banks now shorting the dollar, and the gold and commodities market as hedges against a weakened dollar. The U.S. dollar is plummeting at a time when it would, normally, be rising strongly, thanks to Benjamin Bernanke. Meanwhile, the price of gold and critical commodities such as oil soar. Runaway commodity prices will destroy any possibility of our economy having a sustainable recovery.
To make matters worse, Bernanke has given away trillions of dollars to the combination of internationally oriented American and foreign banks who control the Federal Reserve. He has supplied them with so-called “loans” that are, in reality, nothing less than gifts, because many of them are perpetually renewed, given at nearly zero interest rates, and non-recourse. The "banks" have used this money to play with their balance sheets, engage in carry trade, and create new bubbles in the stock and commodities markets. In the long run, by printing trillions of new funny-money dollars, Bernanke will have rewarded speculators and punished careful savers and retirees on a fixed income.
As an example of the harm that Bernanke’s policies can do to America, we need look no further than the implementation of the ideas of one of his “soulmates” and strong supporters, former Fed Board Member, and Columbia University Economist Frederic Mishkin. Mr. Mishkin belongs to the same school of Keynesian dollar printing gusto. They were “allies” on the Board of Governors, and Mishkin continually makes public statements in support of current Fed policies.
In late 2006, Mishkin was a consultant to the Iceland Chamber of Commerce, and did a careful study of the Icelandic economy. He even wrote a detailed paper about it, concluding that the Icelandic Central Bank was conducting a well designed monetary policy, that Iceland’s banks and its economy were stable and would continue to be stable for years to come, and that Iceland would be likely to continue to grow as time passed. A little over a year later, Iceland’s economy imploded.
I am sorry to say that men like Benjamin Bernanke and Frederic Mishkin, and others who think like them, are some of the most dangerous men in America today. Their policies will destroy our beloved nation from within. This nation would be wise to close down all of the Federal Reserve’s monetary policy and regulatory functions. Fears that, in the absence of the Fed, there will be runaway money printing, are unjustified. Indeed, it is the Fed that started printing excessive numbers of dollars, and began the massive dollar devaluation since the turn of the previous century. During the period between 1776 and 1913, aside from many mini-booms and busts, Congress showed that it was more capable of running monetary policy than the Federal Reserve. Indeed, during that time period, other than during the Civil War period, there was little inflation, and the dollar retained a majority of its value.
The Federal Reserve should be retained only for the things it has managed to do in a competent fashion. This includes ACH transfers and Fed wires, but not much more. Yet, if we do not close it down entirely, we must, at least, find someone willing to do what is needed to protect our nation from economic implosion. The history of this Fed Chairman shows that he is not willing, and never will be willing to take the hard steps needed to withdraw liquidity from the system and raise interest rates.
The next Fed Chairman must be a person willing to quickly raise interest rates before it is too late, resorb reserves back from the banks, and severely curtail monetary accomodation, slowly but surely reducing the monetary base back to the $900 billion we started with at the beginning of this Financial Crisis. We must reverse all of the dollar destructive policies put in place by men like Bernanke and Mishkin.
If, on the other hand, we let Bernanke continue in his position as Fed Chairman, there is little doubt that the U.S.A. will become another Iceland. There will be one significant difference, however. The American economy is at the center of the world economy, and the U.S. dollar is the world's reserve currency. It's implosion will not be a mere "blip" on the economic map, like that of Iceland. When the U.S. dollar collapses, it will trigger a chain reaction event most similar, in historical context, to the Fall of Rome. Indeed, much like what happened immediately preceded the collapse of the Rome, monetary authorities are debasing the currency, and citizens are reacting by buying gold, and putting it in secret places.
Bunning Doesn't Like Bernanke Much
China wary of gold 'bubble’ danger after quietly doubling its reserves
The Chinese authorities have given the clearest indication to date that they view the surge in gold to an all-time high of $1,217 (£730) an ounce as a speculative frenzy. Hu Xiaolian, the vice-governor of the central bank, said Beijing would not buy gold indiscriminately. “We must keep in mind the long-term effects when considering what to use as our reserves,” she said. “We must watch out for bubbles forming on certain assets and be careful in those areas.”
China announced this year that it had quietly doubled its gold reserves to 1,054 tonnes, the world’s fifth largest holding. India has also joined the rush, gobbling up half the IMF’s gold sale. News that the rising powers of Asia are shifting a chunk of their fast-growing reserves into gold in a flight from Western paper currencies has emboldened investors to take out large gold bets on the futures markets or through exchange traded funds (EFT), leading to the parabolic rise in price over recent weeks.
However, officials in Beijing are aware that China’s $2.3 trillion reserves are now so enormous that the central bank cannot buy much gold without distorting the price, so they have adopted a de facto policy of buying in a calibrated fashion each time prices fall back to their rising trend line – “buying the dips” in trading parlance. Experts say that China is putting a floor under the gold price but does not chase rallies once they are under way.
There is also a double-edged twist to news that Barrick Gold, the world’s biggest gold mining company, has closed the final 3m ounces of its notorious hedge book ahead of schedule. While the move is a bet that prices will continue to rise, it also means that Barrick has been a big buyer of gold lately. These purchases have now stopped. One of the key drivers behind the spike this autumn has been removed. BNP Paribas said yesterday that the current rally may have another two months or so to run, advising clients to stay invested as a form of “financial-calamity” insurance.
The “quasi-sovereign” default by Dubai serves as a powerful backdrop to gold fever, reminding funds that many countries, starting with Greece, Latvia, Ukraine, Bulgaria and Vietnam, are also on thin ice and may face debt difficulties over the next year. Ken Rogoff, the IMF’s former chief economist and author of a history of defaults, told Jeff Randall on Sky News that so many countries are in trouble that it is hard to know where the crisis could hit next. Once one sovereign state veers into default, clusters of others usually follow.
Trouble for the mighty repo
by Gillian Tett
What is the latest regulatory headache worrying Wall Street? The answer might surprise some non-bankers. For apart from bonuses, capital rules and credit derivatives, the issue currently provoking alarm is the state of the mighty repurchase, or so-called “repo”, market. On Wednesday, Washington’s House financial services committee approved a bill to regulate systemic risk. And while the issue which initially grabbed most attention was the proposal for a systemic regulator, buried in the bill was a proposal that when any large bank fails in the future, it should be placed into a resolution regime, with creditors losing up to 20 per cent of the value of the debt.
At first glance, the idea hardly looks shocking. After all, it is a fundamental principle of free markets that creditors should suffer when companies fail. And the 20 per cent haircut idea is not new: the FDIC resolution regime already imposes such a haircut on the creditors of small American banks (and as a result the FDIC is supporting this initiative). Nevertheless, some Wall Street grandees are horrified. Until now, haircuts have never been applied to the repo market – or the place where banks raise short-term funds by lending out assets – since small banks do not generally use that sector much. Meanwhile those big banks which rely heavily on repo market funding, such as Morgan Stanley or Goldman Sachs (to name but two) were not covered by the FDIC rules.
But some senior bankers fear that if haircuts are suddenly introduced, it could potentially spark a surge in the cost of repo funding, or even cause that source of funding to shrivel dramatically. Or as the head of one large bank says: “The implications will be horrendous...doing this would be madness.” Is this just more bank whingeing? In truth it is hard to tell. Some of the politicians backing the bill are apt to claim that it would be no bad thing if repo funding costs rose, since it might prevent banks from using the crazy levels of leverage seen during the credit boom. They also point out that it is high time creditors were forced to take a closer look at the health of banks.
Fair enough. But the problem is that even if it might seem sensible to introduce more discipline in the long term, it is also reasonable to expect that imposing haircuts could create unwelcome instability. After all, one key reason why Bear Stearns and Lehmans failed last year was that panic erupted in the repo world. And if that amount of panic could erupt even without creditors facing possible haircuts - meaning that loans were fully secured against assets – who knows what might occur with a haircut in place. And it is not just the banks which are alarmed about that idea: some officials at the US Federal Reserve are also quietly agitating to squash the haircut idea.
Whether they succeed remains to be seen. But it is worth watching very closely to see what happens next. For quite apart from the (potentially important) funding implications for banks, the tale also offers a telling moral about a more subtle shift in the political economy. Over the last year, government bureaucrats on both sides of the Atlantic have scurried to produce reform plans, on topics ranging from credit derivatives to resolution regimes. And while those ideas have sometimes been imperfect, they have been moderately predictable – and bureaucrats on both sides of the Atlantic have generally tried to coordinate their efforts. Hence that dizzy plethora of Basel committees at work today.
But now that politicians are getting increasingly involved in the process, the potential for last minute surprises is starting to rise. Bureaucratic in-fighting is rising. Hence the sudden appearance of the haircut in this week’s bill. Or just look at the saga that erupted earlier this year, when politicians in Europe slipped a last-minute clause into a credit ratings agency measure, demanding that issuers be given advance warning before ratings were changed. It was only later that bureaucrats realised that this effectively blew apart their attempts at trans-Atlantic co-ordination, since giving this advance warning contravenes American insider trading rules.
The net consequence of this is rising policy fragmentation, and a world where the policy making process is also becoming less consistent and predictable. And while that may simply be a passing phase, I rather doubt it, given the tensions that could erupt as a result of fiscal strains. The bottom line is that investors had better keep reading the fine print of the new reform bills, even in the once-dull “repo” world. And if anyone thinks they can forecast with complete certainly what financial policy will look in the future, don’t believe them; the spectrum of possible outcomes in the current regulatory debate looks very wide indeed.
Top Tips for 2010, courtesy of Goldman Sachs
Hot off the press, I have just received the “Top Ten Trades” for 2010 from Jim O’Neill – Manchester United fanatic, eternal optimist, China lover, and head of the markets team at the Goldman Sachs. Bizarrely, there are only eight of them but let’s not be fussy, and some of these are incomprehensible to all but quant anoraks. So here are a few.
Long Russian Equities – on the grounds that GDP will recover from its collapse of 9.5pc of GDP this year to growth of 4.5pc next year, along with 60pc earnings growth. Russian stocks have lagged other emerging markets. (For a good reason, one might quibble, since President Medvedev himself says the country has succumbed to “legal nihilism”. Of course, Goldman Sachs was expecting Russia to boom this year – not to go into depression – but lets not quibble about that either).
Long Sterling (against the Kiwi dollar of all things): Actually, that is a great idea – the pound and the kiwi are massively misaligned by historical measures. GS says New Zealand’s central bank will raise rates more slowly than markets think. The Bank of England will tighten more, by 300 basis points by late 2011.
Short Turkish credit because rates will rocket to tackle rising inflation.
Short Spain/Long Ireland: This is interesting. Goldman Sachs says both countries are “boom-bust” property disasters but Ireland “looks better placed to outgrow its debt” and has shown “greater resolve” in taking the axe to spending. Spain’s “behind-the-scenes” bank cleansing is not credible. I agree totally. Goldman Sachs plays this through 5-year credit default stops (CDS). Don’t ask me how to do it. This is hedge fund stuff.
Long Polish zloty (against the Japanese yen). The zloty is “clearly undervalued”. Meanwhile, Jim O’Neill thinks the yen is dogfood. Perhaps, but I am not sure that Goldman Sachs is right in betting on intervention by the Bank of Japan to drive it down – at least not yet. Are the Kabuki artists at the BoJ and the Hatoyama government capable of any action at all, other than hurling abuse at each other?
Touchingly, Goldman Sachs is keeping its faith in Great Britain. The UK economy will be the second-fastest growing economy in the G5 in 2010, at 1.9pc behind the US at 2.1pc. It will be the fastest in 2011 by a long shot at a galloping 3.4pc. Wow. Thank you, Jim.
He may amazingly be right. We devalued 30pc on leaving the Gold Standard 1931 and went on to be the star performer (with Sweden) of the 1930s. That outcome looked pie in the sky to most people in 1931, or 1932, or even early 1933, but it was very clear by 1934. By then the tables had turned entirely. Those with lots of gold who felt so pleased with themselves at the start (ie France), suffered the most – but it took six years.
This is not to say that devaluations are good, but there are certain very rare moments when they can be. This is one of them. The effects of currency shifts may be slow, but they are very powerful.
By the way, did anybody see that Mercedes is relocating a fifth of its C Class plant to Alabama for cost reasons?
Fears grow about overheated US debt market
Some of the most controversial financing practices of the credit-bubble years – from cov lite loans to Pik toggle notes and dividend recap exercises – have returned to Wall Street, stoking fears that debt markets are growing overheated. The techniques fell into disrepute during the financial crisis because they were based to varying degrees on the same rosy expectations that encouraged companies and consumers to assume what proved to be crippling levels of debt.
In a cov light – short for covenant light – loan, borrowers are granted credit with few, if any, conditions. Pik toggle transactions make it possible for debt to be repaid with more debt – payment-in-kind notes. In a dividend recap, companies take on additional debt to pay dividends to their owners. The reappearance of such instruments in recent weeks has stirred concerns that government efforts to stimulate lending are having unintended consequences, encouraging lenders to take positions based on “best-of-all-possible-worlds” assumptions. “We have had a huge rally in debt,” said Dino Kos, a former New York Federal Reserve Bank official and now a managing director of Portales Partners, a research boutique. “Everything needs to be just right for that rally to be validated.”
The return of cov lites was highlighted last month when Pinnacle Foods, owned by Blackstone, took on $900m of such debt to help finance its $1.3bn purchase of Birds Eye Foods. Days before, Wall Street witnessed the first Pik toggle deal since the crisis – a $250m financing for JohnsonDiversey, a cleaning services company. Meanwhile, several dividend-recap attempts have been mounted, including one involving the Booz Allen Hamilton consultancy, which is arranging $350m in loans that is likely to help pay a $550m dividend to Carlyle, its private equity owner. Carlyle said that after the proposed dividend, Booz Allen would have less leverage than when Carlyle bought it.
Tops Friendly Markets, a grocery chain, was using about a third of a $300m bond to pay a dividend to its owners, Morgan Stanley Private Equity, a Morgan Stanley executive said. Goodman Global, a maker of heating and cooling systems, has approached lenders seeking permission to use older borrowings to pay its owners – including Hellman & Friedman – a $115m dividend, according to the Standard & Poor’s leveraged commentary and data division. Fed policymakers have signalled their concerns about the impact of low rates on market practices. In the minutes of its November meeting, the Federal Open Market Committee noted “the possibility that some negative side effects might result from the maintenance of very low short-term interest rates including the possibility of excessive risk-taking”.
Nakheel Sukuk Saw Unusual Selling
Unusual selling of Nakheel's $3.5 billion Islamic bond in the lead-up to Dubai's announcement last week that it would seek to restructure Nakheel's owner, Dubai World, suggest some holders may have had an inkling they wouldn't get repaid as expected in December, a data firm said Wednesday. According to Data Explorers, a company that tracks how much of a company's stock or bonds are out on loan, about 75% of institutions holding the sukuk sold their position between the end of August and the end of November.
"It's an extraordinary sell-off in a bond so close to maturity, when there was no indication of a problem refinancing. The data suggests they had some information that it was a good time to sell," said Data Explorers managing director Julian Pittam. Before Dubai's surprise announcement last week that it wants creditors to give Dubai World and Nakheel at least six months to restructure, the Nakheel sukuk traded at around 110% of face value, reflecting its approaching maturity on Dec. 14. After the news, it dropped as low as 40% of par.
If Nakheel doesn't get creditors to agree to a stay on their claims, the borrower could be declared in default after Dec. 14, marking the largest-ever sukuk default and the first in the United Arab Emirates. A group of the sukuk holders, including New York-based hedge-fund firm QVT Financial LP, have appointed London-based law firm Ashurst to represent them in the matter. A December 2006 report on the Nakheel sukuk sale in Euroweek, a trade publication for capital markets, said about 100 accounts bought the notes. Of those, more than half were banks. By geography, about 40% of the issue was placed in the Middle East and 40% in Europe.
ECB begins to turn off the liquidity tap
The European Central Bank has begun to turn off the liquidity tap and prepare for a gradual retreat from ultra-low interest rates over the next year, raising its economic growth forecast for 2010 to 0.8pc. Jean-Claude Trichet, the ECB's president, said this month's offering of 12-month loans to the banking system would be the last of its kind and the cost of borrowing would be linked to the ECB's benchmark floating rate, currently 1pc. "Not all our liquidity measures are needed to the same extent as in the past. The market is going better and better"," he said.
Carsten Brzeski from ING said it was a key turning point in the sequence of the global financial crisis. "The gentle exit has begun. Today's message to banks was crystal clear: do your homework, free refills are coming to an end". The move to knock away emergency support for banks is likely to hit some countries harder than others, creating intra-EMU tensions between North and South. There are particular worries about Greece and Ireland, where banks have relied massively on ECB support because they cannot raise money cheaply on the open market. The ECB has let them use a wide range of low-grade mortgage debt as collateral for loans. Private markets are unlikely to be so forgiving, raising the risk of a roll-over crisis for weak lenders.
Julian Callow from Barclays Capital said Mr Trichet's comments were surprisingly "hawkish", implying an upward shift in the EONIA overnight rate charged for interbank operations. The ECB's council appears to have been divided over the move. Mr Trichet said there had been "consensus", the ECB's coded term for dissent. He was at pains to insist that the bank was not about to change its interest rate policy, acutely aware that the recovery is still fragile. Private credit and the M3 broad money supply have both been contracting recently. While the eurozone grew 0.4pc in the third quarter, data released yesterday showed that most of this was driven by inventory restocking. Consumption fell by 0.2pc over the three months, suggesting that the region is still a long way from self-sustained growth.
ECB to unwind support for banks
The European Central Bank’s emergency financial market support measures are set to be unwound from this month after Jean-Claude Trichet, ECB president, rebuffed International Monetary Fund calls to err on the side of delaying “exit strategies”. The ECB moved on Thursday to limit demand for one-year liquidity in an operation that will take place later this month and told eurozone banks that other, shorter-term liquidity-boosting operations would be scaled back in 2010. Mr Trichet cited improved financial market conditions and said liquidity would remain “extremely abundant” for many months. A final, unlimited offer of six-month liquidity in March will tide banks over until at least September 2010. The ECB also took account of the continuing weakness of some eurozone banks.
However, the measures were bolder than financial markets expected, highlighting ECB fears that some banks have become over-dependent on the unlimited provision of liquidity, which it sees as boosting banks profits and threatening asset price bubbles. The ECB was “firmly on the descent path” said Julian Callow, European economist at Barclays Capital. “It’s ‘cabin crew take your seats for landing’.” Currently some €670bn in ECB liquidity is outstanding – compared with typical pre-crisis levels of about €450bn. The ECB’s 22-strong governing council apparently split on parts of the complex package of measures, before reaching what Mr Trichet described as a “consensus” deal. It created initial confusion in financial markets with investors unclear whether the steps amounted to a loosening or tightening of monetary policy. But Mr Trichet said the decision to link the interest rate on 12-month liquidity supplied this month to future changes in the main policy rate was meant to be “neutral”.
Dominique Strauss-Kahn, the IMF’s managing director, had urged policymakers to err “on the side of caution, as exiting too early is costlier than exiting too late”. But Mr Trichet said policymakers should be “exactly balancing” the risks of acting too late with those of acting too soon. The ECB president described the central bank’s action as “a progressive, timely, gradual phasing out” of the exceptional measures taken to shore-up the eurozone financial system after the collapse of Lehman Brothers last year. The steps announced on Thursday were “not signalling anything as regards a hardening of our monetary policy – absolutely nothing”. Mr Trichet said policymakers should not exaggerate “the gravity of what is happening in Dubai”, which he described as a “relatively modest event”.
Nicolas Sarkozy hails EU finance chief appointment to 'clamp down on City of London'
French President Nicolas Sarkozy has hailed the appointment of EU's new finance chief as a chance to clamp down on City of London excesses, in a direct rebuke to the British government's handling of the economic crisis. In a speech in the south of France, Mr Sarkozy said the appointment of Michel Barnier was a victory for European economic modelling. Mr Sarkozy blamed the "free-wheeling Anglo-Saxon" model, favoured by Britain and the United States, for the global economic downturn while praising European thinking which "had nothing to do with excesses of financial capitalism".
But Alistair Darling, the Chancellor, delivered a blunt warning to Mr Barnier against interfering with regulations governing the City of London, saying any foreign meddling by the EU would breed "confusion". In his speech, Mr Sarkozy failed to hide his satisfaction at the chance to try and control British banks and financial services through his former agriculture minister. "Do you know what it means for me to see for the first time in 50 years a French European commissioner in charge of the internal market, including financial services, including the City [of London]?" Mr Sarkozy said in La-Seyne-Sur-Mer. "I want the world to see the victory of the European model, which has nothing to do with the excesses of financial capitalism."
Mr Barnier's role as Europe's new internal markets commissioner gives him power over financial regulatory reform, with France seen as favouring a tough stance on issues like bonuses and curbs on hedge funds. Mr Barnier, whose new role allows him to oversee a radical revamp of financial regulations to prevent any new economic crisis, has stressed he knows the importance of the City of London for growth in Britain and Europe. But some British financial service leaders and Downing Street fear Mr Barnier will push for stricter regulation at the expense of the City. On the eve of a meeting of EU finance ministers in Brussels, to discuss financial sector reform, Mr Darling said it would be "self-defeating" to drive out business to other, less tightly regulated, jurisdictions.
Writing in The Times, Mr Darling said it was "undeniably in Europe's interest that Britain's financial hubs, the City of London and Edinburgh, flourish". "We must resist measures, however superficially alluring, that could undermine the effective functioning of our cherished single market," he wrote. "National supervisors, such as the FSA, must remain responsible for supervising individual companies." He added: "Making companies directly accountable to more than one authority is a recipe for confusion.
Mr Darling said the city was building on its strengths, he argued it was "too simplistic to argue that financial centres in Europe are just competing among themselves". "The reality is the real competition to Europe's financial centres comes from outside our borders. And that London, whether others like it or not, is New York's only rival as a truly global financial centre," Mr Darling said. "No other centre in Europe offers the same range of services: banking, insurance, fund management, law and accountancy. "It is in all of Europe's interests that they prosper alongside their close European partners." In an interview on French television, Lord Turner, the chairman of the Financial Services Authority, played down the appointment as he tried to defuse any row with France. "I'm sure Mr Barnier will be attempting to work out what is effective regulation for the good of the whole of Europe," he said.
French official unemployment flat at 9.1%
The unemployment rate in France's mainland stands at 9.1 percent in the third quarter, virtually stable compared to the second quarter, the official statistics bureau INSEE announced on Thursday. There were 2.58 million people registered jobless in the third quarter, marking a first flat of unemployment rate from the end of last March.
The 2008 first quarter witnessed a unemployment rate of near seven percent, a record low in the past 25 years. However, during the following one year and a half, the number of jobless people in mainland France increased by 60,000. Although the unemployment didn't go worse and the economy showed timid but consecutive resilience in the past two quarters, the recession still has great pressure to French labor market.
Right in October, the number of jobless people surged more than 50,000, totaling the unemployed population in the mainland to 2.63million and pushing the rate close to 9.3 percent. The European Commission forecasted early this month that France will experience this year an economic contraction by 2.2 percent, with an unemployment rate of 9.5 percent at the year end. It also predicted an economic growth of 1.2 percent next year for France, but the unemployment rate will climb further to 10.2 percent. French Primer Minister Francois Fillon has made it clear that if France couldn't realize a growth of over two percent, new job opportunities are hard to see.
Bubble warning from Bank of England's chief economist
Spencer Dale believes that the longer that quantitative easing continues, the greater the risk that markets get out of control. Spencer Dale, the Bank of England's chief economist, today warned of the risk of a new bubble inflating in frenzied financial markets, as the economy moves into "renewed expansion." Speaking at a business breakfast in Billericay, Essex, Dale endorsed the optimistic forecast in the Bank's latest quarterly inflation report, which showed GDP growth bouncing back rapidly over the next two years, to hit a robust 4% in 2011. "The economy appears to have turned," he said, adding that evidence from business surveys and the Bank's own local contacts suggested that, "we are likely to be moving into a period of renewed expansion."
Dale voted against the £25bn extension of the Bank's radical quantitative easing policy, to a total of £200bn, at last month's monetary policy committee meeting. He used today's speech to explain his decision, saying the longer that QE persists, the greater the risk that markets get out of control. "I fully recognised the potential benefits of a more expansionary policy given the downside risks to the economy. However, I was also wary of the potential risks of such a policy," he said. "I was conscious that the current stance of monetary policy – in which Bank Rate is very low and substantial amounts of liquidity are being injected into the economy – increases the likelihood that asset prices may move out of line with their fundamental values and that this could be costly to rectify were it to occur. It is a risk that we need to be alert to."
But in an upbeat assessment of the current economic environment, Dale also praised the performance of the Bank and other policymakers around the world in helping to prevent the sub-prime crisis sparking a 21st century Great Depression. "I have little doubt that one of the key factors contributing to the quicker stabilisation of activity this time around has been the speed and decisiveness with which policy throughout the world responded to the twin threats of a failing banking system and falling confidence," he said. In a boost for Labour, as Alistair Darling prepares to deliver his autumn pre-budget report next week, Dale added that the government's emergency spending measures had also contributed to the imminent recovery. "The temporary reduction in VAT and the car scrappage scheme have boosted household spending and provided short-term support to retailers and the car industry." He conceded that the small and medium sized businesses in his audience were unlikely to have been helped directly by QE - but claimed they may have benefited indirectly, for example through reduced lending rates.
Greeks bearing economic burdens
Sotiria rarely complains about her workload. At the office where the Greek public sector employee aged in her forties records value added tax payments, supervisors take a relaxed view of breaks for coffee and shopping, she says. If a family member falls sick, she stays home. “I don’t feel bad, because there are always plenty of other people around to cover for me,” she says. “Nobody here has too much to do.” Stories of such insouciance in Greece’s bloated state sector are creating alarm across Europe. As the Continent emerges from the worst recession since the 1930s, the precarious and unsustainable state of Greek public finances is threatening a fresh crisis for the region’s 11-year-old monetary union.
Last week, the difference between the interest rates on Greek and German government bonds soared to a seven-month high as financial markets fretted about the possibility of default and the stability of Greece’s banks. If European Union leaders thought they had navigated the storms of the past two years, they could yet be proved wrong. The EU helped shore up Latvia, Romania and Hungary. But unlike those countries, Greece is a member of the eurozone, Europe’s most successful experiment in financial integration. And for all its treaties, there are no clear rules on how to react. “The EU has elaborate crisis prevention measures; it doesn’t have a crisis management apparatus,” says Jean Pisani-Ferry from the Brussels-based Bruegel think-tank.
But the increasing frustration in Brussels, other capitals and at the European Central Bank in Frankfurt suggests at least a few policymakers might favour throwing the book at Greece. “This is a game of chicken and we don’t know who will lose their nerve first,” says Daniel Gros of the Centre for European Policy Studies, another Brussels research institute. Is Greece really heading for nemesis? Around the world, governments abandoned fiscal restraint to combat crisis. But elsewhere, for instance in Ireland, governments are now acting to bring budgets back under control. Greece’s crisis has taken on a different dimension, largely because of the behaviour of the Athens government.
Most blatantly, Greece misled the world about the acuteness of its fiscal plight. Back in March, the situation looked bad – but manageable. The European Commission forecast that the Greek public sector deficit this year would be above the 3 per cent limit set under EU rules and “exceed 4 per cent in 2010”. At the time, officials were concerned the actual numbers would be higher. Nobody, however, was prepared for the shock unveiled by the Socialist government elected in October. Statistical revisions showed the public finances so much worse that the Commission changed its projections to a deficit of 12.7 per cent this year and 12.2 per cent in 2010.
Worries have been compounded by the new government’s apparent dithering. Brussels wants George Papaconstantinou, finance minister, to rewrite his 2010 budget, which relies heavily on curbing tax evasion rather than cutting spending. In a letter to the Financial Times published on Wednesday, he said Athens was “fully committed to . . . the necessary steps to restore our credibility and finances”. But his claims that a tax crackdown on wealthy Greeks will be decisive in cutting the deficit next year to 9.1 per cent ring hollow with many – especially as his new revenue collection team has yet to be appointed.
Last December, youth discontent fuelled by the economic situation led to rioting in Athens – and the Socialists are reluctant to reverse a campaign pledge to protect incomes and boost welfare payments. Moreover, Greece’s economy looked sickly before the events of the past few weeks. Prior to the global slowdown, the country was growing at annual rates of 4 per cent or more, with consumption boosted by the low interest rates it enjoyed as a eurozone member. But Europe’s recession has exposed a massive loss of competitiveness. Unit labour costs have soared more than 40 per cent since Greece joined the eurozone in 2001, while in Germany they remained almost constant before edging up this year.
On almost every measure, Greeks have been living beyond their means. The current account deficit reached almost 15 per cent of gross domestic product last year, making the US deficit of 5 per cent look modest. External public debt now exceeds GDP. With hindsight, it is clear that a lax fiscal policy was also pumping up an economy based largely on just two sectors – shipping and tourism. Now, “Greece’s mix of problems is unique in the eurozone – a large budget deficit, rising debt and an unsustainable pension system”, says George Pagoulatos, a professor at Athens Economics University.
Since joining the euro, Greece has regularly flouted the deficit and debt limits set in the zone’s “stability and growth pact” that is meant to correct for the lack of a single eurozone fiscal authority. Scant progress has been made in reforming the country’s public sector, which added 50,000 mostly low-skilled employees in 2004-09. Public sector wages are again set to rise, by 5-7 per cent in 2010. “Wage cuts may not be needed, because the economy isn’t projected to shrink significantly next year, but there should be an immediate freeze on salaries and recruitment,” says Yiannis Stournaras, a former chief economic adviser at the finance ministry and now a professor at Athens University.
On pensions, expected big increases in expenditure relative to the size of its economy make Greece more vulnerable than other EU countries to an ageing population. “It’s the largest of the fiscal imbalances and the system will become unsustainable within a decade,” says Mr Stournaras. Athens is launching a “dialogue” with trade unions on reducing the number of state pension funds from 13 to three and implementing a long-postponed plan to raise the retirement age for women to an equalised 65. The unions foiled previous pension reform efforts and are gearing up for strikes and street protests. “We’re going to war with the government,” says Aleka Papariga, leader of the still influential Greek Communist party.
What will happen next? European finance ministers on Wednesday issued a fresh reprimand to Greece, pressing ahead with a process that could lead to financial sanctions. One possibility would be for the Commission to withhold “cohesion funds” meant to help Greece catch up with richer countries. Leaving the eurozone is not an option for Athens: the cost of servicing foreign debt would simply escalate. Beyond that, Greece’s fate will depend on the reaction in the markets and actions taken by Athens.
Nor is timing on its side. The eurozone has a “no bail-out” clause, which prevents collective liability for debts incurred by a member. In February – when the crisis was at its most intense – Peer Steinbrück, then Germany’s finance minister, admitted that in the worst case “we would have to take action”. That eased pressure on the weakest members, including Ireland. But Mr Steinbrück has since been replaced and his promise now carries little weight; in the eyes of conservative European policymakers, it increased the risk of “moral hazard” – rewarding bad behaviour.
“It is one thing if you are in the middle of a systemic crisis. Then you can’t allow anyone to fail and don’t worry about moral hazard,” says Mr Gros at Ceps in Brussels. “Now we are out of the woods and it may be a good time to reduce moral hazard.” In a research note last week, Deutsche Bank economists wrote that Greece’s continuing violation of the rules “may have changed the minds of EU authorities ... We believe that they may have to set an example for other countries in trouble”.
If the cost of servicing debt rose too high, Greece could have to turn to the International Monetary Fund. The rigorous conditionality attached to help given by the Fund could provide a framework to implement reform – and allow the government to deflect the responsibility for harsh but necessary measures. But Mr Papaconstantinou says it is “out of the question” that Athens would turn to the IMF. “The new government is determined to put the economy back on a path of fiscal sustainability in the context of the EU rules.” Greece’s small size – it accounts for less than 3 per cent of eurozone GDP – plays to its disadvantage. The Deutsche Bank note argues that the EU could ring-fence Greek debt, using a special fund to reduce the impact of a default beyond its borders.
Still, that is a scenario that EU policymakers would rather not contemplate. Even if containable, a Greek default would send worrying signals about the resilience of monetary union. Instead, the hope is that the markets force Athens to bring public finances under control. The stability pact is still regarded as “an anchor for policymakers”, says Erik Nielsen, economist at Goldman Sachs. A comfort for EU authorities is that investors’ increased risk awareness means they are – at last – imposing discipline on governments. Prior to the economic crisis, Greece escaped punishment from financial markets. That is no longer the case. It may not be too long before even bored Greek public sector employees notice.