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October 20, 2011

Ten Years of Central Bank Policy

Filed under: Ben Benanke — baseball91 @ 5:33 AM

Quantitative Easing as one grand conspiracy with the ongoing central bank policy?

We were living in the information age—or too much the disinformation age? There was a difference between legitimate economic growth and debt-induced demand. The failed leadership of not just a Republican president and a Democrat president, but a Congress that over ten years passed the bailout, passed the Patriot’s Act, and has funded without a rise in taxes the ongoing wars in Iraq and Afghanistan.

And with the monetary policy which has funded these wars, on the backs of all economies which used the hegemony of the US dollar, was it intervention or manipulation with monetary policy, to get a party re-elected? Someone left the cake out in the rain, and it took so long to make it, it took so long to bake it, and we’ll never have that recipe again.

The dishonesty of it all. All of this liquidity created by going into debt, at below two percent interest, in the aftermath of September 11, during the invasion of Iraq and into the election, as this Fed took historic fiscal and monetary strides on the back of the bubble, with this cheap money policy. TrimTabs tracks liquidity flows in the market, and the source of approximately $600 billion net new cash which had lifted the market capitalization overall by $6 trillion in 2009 could not be identified from traditional players by TrimTabs. The money, Charles Biderman said in a statement, had not come from retail investors, foreign investors, hedge funds or pension funds. It was more than eighteen months ago when Charles Biderman, chief executive of TrimTabs Investment Research, said, “We cannot identify the source of the new money that pushed stock prices up so far so fast.” So market manipulations by governments? Charles Biderman did admit he held no evidence of market manipulation, though he had his suspicions. Who was manipulating the market? When such manipulation by the Federal Reserve and the Treasury Department clearly was illegal.

Home equity loans. All the speculators and the scalpers on e-bay. Clearly there was manipulation of one market– the real estate market — which all began with the Fed’s monetary policy. So how many other markets were manipulated?

The Federal Reserve chief knows that the stock market is the world’s largest thermometer. What happens to journalists who center their perspective on serving the interests of power and gaining proximity to it, aligning their beliefs and priorities with those of the state. People who speak not to those in power but report on the truth? Did you trust themselves strategic partners who sponsored the broadcasts? On cable networks? Did you know that the paradigm set up had arranged for Fox Sports Networks to get $48 million per year direct from your cable company? The cable system approved by local governments. The governments like in the city of Minneapolis which had a mayor promoting — after the horse was out of the barn — another new stadium.

The dishonesty of it all. What happens to governments which spent so much on security? But quit regulating with the power vested in commissions? The television media, its sponsors, and all of the many spin doctors living close by with an ability to provide and package information, filter unwanted noise and offer dynamic real-time insight – all in the context of total transparency–as a precursor to the next generation. The lobbyists. American media always want to fit events in the region into an American narrative.

The only difference, writes Todd Harrison, “between intervention and manipulation is one of advanced communication. When the Bank of Japan telegraphs their actions and buys yen, it’s intervention. If they don’t communicate their actions, then it’s manipulation. It’s a subtle yet important distinction that is the difference when discussing central bank policy.” He wrote in 2005, “In particular, I’m concerned that one of two things must happen in the years ahead. Either the US dollar must further devalue, as it has to the tune of 25% since 2002, or asset classes will deflate in synch. I’m unsure if these are mutually exclusive events but we’ll likely jockey between the two as we figure it out. I will also offer that the greenback will serve as a proxy of isolationism as America delicately dances through a difficult war and sets protectionist policies in place.” That dollar is now down forty percent.

Instead of building a counter narrative with any kind of vision of different perspective, journalists too often perpetuate the dominant ideology. In my locale, the NBC affiliate is leading the news each night with stories about building a new billion dollar stadium for the Minnesota Vikings – with government money. As the elites of the world, the top one percent, owns almost 40% of all wealth in the United States, as compared to 13 percent twenty-five years ago.

What happens to government and systems of governments which spent so much time disseminating illusion? It had been the media which had produced too much of the present day “values” as opposed to those who could critically resolve problems.


August 10, 2011

The Downgrade

German philosopher Arthur Schopenhauer: “All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.” About a rolling depression. As James Fallow wrote five years ago, “As it comes to the old parties, the story boils down to this: in the age of television, Democrats can’t win except when everything is handed to them or goes their way, while Republicans can’t govern without breaking the bank.”

Seaworthy vessels do not sink. There are boat inspectors who check out sinkability of those vessels. Likewise, the sole job of credit-rating agencies like Moody’s Investment Service, Fitch Rating and Standard & Poor’s is to gauge creditworthiness. As market concerns about France’s triple-A credit rating increased, shares in French banking stocks plunged Wednesday on renewed market jitters over their exposure to Greek debt. “If the maturity of Greek government bonds is extended to 2024, this could mean further depreciation of the assets of French banks that are exposed to Greek debt,” said the trader, who spoke on condition of anonymity.

Société Générale SA was trading down 17% at €21.61, as spokeswoman for Société Générale said, “”We categorically deny all market rumors.”

Loan demand, wise men and women argue, is so, those low interest rates won’t go higher anytime soon. So the downgrade by Standard and Poor’s of U. S. debt logically means a shift in credit quality. The rules of the game have not changed, only the grading system. “If the AAA is no longer AAA, then everything else has to get downgraded,” Edward Dempsey explained. And I wondered if Dempsey learned this from watching the effect of expansion on major league baseball.

The credit-rating agencies whose sole job is to gauge the creditworthiness of bonds, all reiterated that France has a stable outlook, with an unchanged triple-A credit rating. France’s credit rating was thrust into the spotlight Monday when cost of insuring its debt against default spiked. Amidst concerns France may be the next triple-A-rated sovereign to suffer a credit downgrade, as another leader came unexpectedly back from holiday to call a meeting with key cabinet ministers along with Bank of France governor Christian Noyer, President Nicolas Sarkozy sought to defend France’s credibility, saying France will do whatever it takes to ensure meeting its deficit-reduction targets.

Not long ago, consumers leveraged their homes to maintain a lifestyles in an era of limited wage growth. Subsequently the U.S. government took on debt to bail out the economy. However the U. S. government now collects less tax revenue than in did in 2008, yet its debt is trillions higher. The current scenario witnessed falling income levels and rising debt levels worldwide. Something has to give.

“They know,” Edward Dempsey writes, “which is why they are desperately trying to create inflation… to pay that debt back with cheaper money.”

In France, new concerns were triggered that the government may turn to banks to help reduce its deficit. During the latest round of global sell-off, changes were implemented to the Euro currency bloc’s bailout mechanism, along with a new bailout package for Greece. Before a July 21st summit, France’s minister for European Affairs had said initiatives weighing a tax on banks to resolve the Greek debt crisis would be discussed, though no mention was ever made in the conclusions of that summit.

In China, money meanwhile continues to flow in, as the government reported on Tuesday that consumer prices jumped 6.5% in July, its fastest pace in three years. With all these other export-dependent Asian economies, since Friday’s downgrade by Standard & Poor’s of the credit rating of the United States, foreign investors have been unloading shares in Korea – Asia’s fourth-largest economy attracting so much capital in recent years, heavily dependent on exports, accounting for roughly more than half of the country’s GDP. Those foreign investors hold about one-third of the market’s total capitalization in Korea. How long before China feels the affects of a recession which is in transition toward an European Depression?

On August 3, the Obama administration released its own eight-page national strategy for countering domestic violent extremism.
Religion Blogs

2015 POST SCRIPT: That Obama plan for domestic tranquility seems to have shown up, as U. S. Marshalls have taken to the night sky to monitor at night the Somali community. After nightfall, as the innocent are afflicted by those with power and the money to hire these low-flying planes from LCB Leasing of Bristow, Virginia, like last night over the mosque on University Avenue located in the capital city. So this was the ague what followed Kristallnacht? “Canards,” with both senses of the meanings of the word but more like the wing-like projection on a Cessna. Note the suspicion of others who speak a foreign language, with silence about stolen cellphone data by U S Marshalls, in their coverup with planes registered to these independent contractors like RKT Productions of Bristow, Virginia. So similar to living with domestic abuse on all sides of the great divide. Not racial profiling but the profiling of Creed by the United States Marshalls, so much like the 250 armed protestors who showed up yesterday outside a mosque in Arizona. See the attached article about the abnormal distemper called “Morbus.” Ague. Chilling cover-ups since at least 2007 of this program based upon suspicion of others who speak in foreign tongues — or pray differently than I pray– is the 21st Century kind of xenophobia on North American shores, with those with kingly power wondering about the inner goings-on of its subjects. From out of the plague of September 11th had come not only the Patriot Act, but the thinking that it was somehow Patriotic to spy on your fellow Americans. And the described Cessna flying over St Paul, Minnesota had occurred on the night before the Patriot Act was to expire.

June 19, 2010

The People’s Bank: It’s All about Chinese Currency

Filed under: Ben Benanke,Business,China,currency,Hu Jintao — baseball91 @ 6:16 PM
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In a signal to financial markets one week prior to the Group of 20 meeting in Canada, the central bank of China announced in statement that it would allow greater flexibility in the value of the renminbi, the currency of China. Lacking any detail on how both the timing and the manner much the currency might rise, there is sensitivity in China especially to inflated housing prices and the competitiveness of Chinese exports in world markets, with millions of jobs in Chinese export factories. In its statement today, as five years before, the People’s Bank of China would be setting the value of the renminbi in relation to a basket of various currencies, not just the US dollar.

Historically, in July 2005, China had announced the decision of is central bank’s decision to begin allowing the renminbi to rise against the dollar. Over the next three years, the renminbi did then rise 21 percent up until the point of the bubble burst on Wall Street in September 2008. In a defensive measure, iInformally the central bank of China had repegged the renminbi at 6.83 to the dollar in July 2008, as the global financial system came apart, with the ensuing sliding worldwide demand for its goods triggered by the global financial crisis.

As stated, the timing and the manner of how much the currency might rise was not addressed. With the 2005 announcement, the new currency policy was accompanied by a one-time two percent rise in the currency against the dollar, to be followed by further gradual appreciation of the renminbi. But here was a government whose performance actually followed what it said. Though there was a missing transparency, the leadership in China did not go chasing oil spills for backdrops for news conferences, as has been the case in the United States since 1980.

Per the stated Chinese self-confidence from the statement on the People’s Bank of China website: “The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability.”

With $2.4 trillion in currency reserves, China’s problem was not much different than mine. If you had money, you had to put it somewhere. Playing the currency market itself, China’s exit from the dollar peg would suggest a protection of the holding which China has in the euro which its leaders had met to discuss duing the financial crisis of Greece. Because the euro is expected to gather strength when currency markets open Monday.

The underlying statement seems to be about increased economic activity in China, where according to customs bureau data overseas sales jumped 48.5 percent in May 2010 from one year ago. According to customs bureau data, exports exceeded imports by $19.5 billion.

According to a Business Week interview with People’s Bank of China’s policy board advisor Li Daokui, “China has ended its crisis-mode exchange-rate policy as the economy recovers strongly and inflationary pressure continues to build. The yuan’s future trend depends on the euro’s movement, and the trends of other major currencies.”

Historically, Chinese culture has had a distrust of foreigners. Along that lines, vice foreign minister Cui Tiankai the day before this announcement said the value of the renminbi was not a subject for global discussion, with similar recent responses to foreign pressure indicating strong nationalistic sensitivities about currency policy by Chinese officials.

May 11, 2010

Using the American Express Card

They were careless people, Tom and Daisy—they smashed up things and creatures and then retreated back into their money or their vast carelessness, or whatever it was that kept them together, and let other people clean up the mess they had made. —F. Scott Fitzgerald, The Great Gatsby

If it was not bad enough when taxpayers are liable for the recent $23.7 trillion the Fed and Treasury handed out. Now comes word that the Federal Reserve Bank is participating in the rescue of the Greek government, along with the International Monetary Fund, the Japan Central Bank and the European Central Bank. The New York Times noted today that the sovereign debt crisis came on after an admission that the level of Greek debt was much higher than previously reported, due to bad management. The value of the euro, dropping from US $1.36 on January 21st to US $1.26 by the end of last week, was eroded by the debt issues of Greece, Portugal and Spain.

With the inability of these nations to share a single treasury, tax system or budgetary authority, the euro is largely a concept. A crisis, which centered seemingly on the recognition of the illusion of the currency, when those European countries lacking a coordinated financial backing for the euro, controlled by the independent European Central Bank much like the Federal Reserve, was resolved Sunday on nearly a one trillion dollar rescue fund to deal with the European debt problems.

While Americans argue about offering health care coverage to illegal immigrants, The Federal Reserve Bank was offering more than good words to these European political problems. This news is not going to play well in Peoria.

April 15, 2010

Those Tea Parties

In his book, “The Three Trillion War,” Nobel laureate Joseph Stiglitz and co-author Linda J. Bilmes state that the total economic impact of the Iraq War may be $4 trillion or more. And that was before the United States escalated things in Afghanistan.

Former White House economist Lawrence Lindsey was fired as economic adviser to President Bush partly because of his estimate of the dollar cost of the Iraq war. In an excerpt of his own book in Fortune magazine five years after, Lindsey wrote his projections were partly right. “My hypothetical estimate got the annual cost about right. But I misjudged an important factor: how long we would be involved.” Mr. Lindsey also stated his belief that one reasons the administration’s efforts were so unpopular was the choice not to engage in an open public discussion of the consequences of war, including its economic cost.”

Congressional Democrats had predicted the Iraq war would cost about $93 billion, not including reconstruction. Peter R. Orszag, director of the Congressional Budget Office, said, “It’s clear that operations in Iraq and Afghanistan have gone on longer and have been more expensive than the projections initially suggested,”

So far this has been a tax-free Iraq War, and not included in the Congressional Budget, as I recall a piece that was written in 2002. According to an item that ran on the MSN news page, the cost was carried over. I see little media coverage since that time indicting where the war shows up in the president’s budget.

William Nordhaus from Yale University wrote in the New York Review of Books in December 2002 in an article entitled “The Economic Consequences of War,” about the the long-term management of the economy, with the management of planning cycles. “The fabulous Nineties—with soaring stock market, falling unemployment, declining defense spending, budget surpluses, and bubbly optimism—were followed by the Bush administration which made no serious public estimate of the costs of the coming war. The public and the Congress are unable to make informed judgments about the realistic costs and benefits of the upcoming conflict when none are given. Particularly worrisome is the promise of postwar occupation, reconstruction, and nation-building in Iraq. If American taxpayers decline to pay the bills, this would leave a mountain of rubble and mobs of angry people in Iraq and the region. Closely related is a second syndrome, frequently found in past conflicts, of entering war prepared militarily but not economically. The finances of the nation have deteriorated sharply since George W. Bush took office. The annual federal budget has deteriorated by $360 billion from the spring of 2001 to the fall of 2002, and, even with a short war, budget deficits are likely to mount in coming years. The Bush administration has not prepared the public for the cost or the financing of what could prove to be an expensive venture.”

Nor has the Obama Administration. Market participants, wrote William Nordhaus in “The Story of the Bubble,” at this point do “remember how they lost $6 trillion on absurd and wildly overvalued speculations. A similar exuberance is unlikely to recur in the near future. More likely is an economy in which large federal budget deficits lead to cuts in existing civilian programs and doom critical priorities such as comprehensive health care.”

That tax-free Iraq War, as conceived by the Bush White House, was one ongoing economic consequences of war. There was now the subsequent tax-free Afghan War. These wars would soon change American history. Would you like to come over for tea?

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March 22, 2010

The Love Boat

“A little nervous,” about his return. Tiger Woods was a little nervous, on how his fans would react. When he returned. Like he had many fans left. I wonder if he was “a little worried” about Elin, and how she would react when he returned.

Relevance. In the land of beauty, if not truth. Health care reform in Lala Land. Planned by community organizers. Years after the Love Boat was canceled. Someday the Love Boat had to return to land. In the world of reality TV, somehow this bill had passed.

Ah, the need for good rating, when there still was a television network to operate. In the Age of Beauty, this golfer was a real beauty. CBS would be airing much of the Masters golf tournament in April, where Tiger Woods returns to the game. “Depending on the specifics, we are interested in an extended interview without any restrictions on CBS,” said CBS Sports spokeswoman LeslieAnne Wade.

Tiger was giving a 5 minute limit this week to the Golf Channel. For an interview. Maybe like he planned to give to his old swarm of swarmy friends. ESPN took him up on the limited offer. Saying the chance to get Tiger Woods on the record answering questions for the first time was more important than a five-minute time limit, ESPN was there. Their purpose was entertainment and sports. It was what the initials stood for. Not unlike the hired help that Tiger had gone in pursuit for his entertainment. But ESPN was allowed to choose its reporter for the interview. Golf reporter Tom Rinaldi went. Hey, but ESPN made no agreement on what could or could not be asked, Rinaldi said. Woods’ representatives offered the interview to ESPN on Thursday, in response to a long-standing request for a one-on-one, said Vince Doria, the network’s senior vice president and director of news.

In response to a long-standing request for a one-on-one, said Vince Doria, ESPN senior vice president and director of news, Woods’ representatives offered an interview to ESPN on Thursday. The sleaze was still visible. Maybe that was why former White House press secretary Ari Fleischer had elected to withdraw from the paid services of Tiger Woods, according to his e-mail to the Associated Press. Perhaps he already had given enough years in his life, in service o his country, to having to address sex issues of other clients.

Ah, limited truth. Health care reform. For the uninsured. For those who try to use emergency rooms for primary care. What would be covered? Dental insurance? Were not my teeth part of my body? And what about treatment programs for addicts? Would that be covered? Funded by the working public. Why not?

The new society, modeled after the world of Europe at the start of a new century. Modeled upon the Europe that was dying. Modeled upon an urgency not unlike getting Tiger on the record answering questions for the first time. This Congress that was not unlike the last session which had passed funding for TARP legislation. Speaking of sleaze. And the $787-billion package of tax cuts and spending in the Troubled Asset Relief Program. The first Recovery Act before this one.

“A little nervous.” I think the majority of Americans this morning were, like Tiger, just a little nervous. Worried about the day the Love Boat returned to the real world. Those first days back after going through recovery. In the days of hope and change, we were all a little nervous. Over how this all would work out. With all the friendliness of those people conducting IRS audits, only this time reviewing my health care. Speaking of docs. As the Love Boat was hoping to find port. A lot seemed to have changed. At home. Since the Love Boat departed.

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February 18, 2010

Declarations of Bankruptcy

With the Wednesday anniversary of the $787-billion package of tax cuts and spending in the Recovery Act, in defense of the stimulus, President Obama said, “One year later, it is largely thanks to the Recovery Act that a second Depression is no longer a possibility.” Democratic and Republican leaders in Washington marked America’s legalized corruption by sniping at each other. Bankrupt after 8 years of the leadership of George Bush, Republican lawmakers stepped up their attacks on what was the Paulson-Bush stimulus plan, calling it wasteful and ineffective.

From an article by Simon Johnson in the Atlantic, America’s Legalized Corruption

“The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.”

From the transcript of Frontline on February 16, 2010:

We didn’t truly know the dangers of the market, because it was a dark market,” says Brooksley Born, the head of the Commodity Futures Trading Commission [CFTC] — an obscure federal regulatory agency — who not only warned of the potential for economic meltdown in the late 1990s, but also tried to convince the country’s key economic powerbrokers to take actions that could have helped avert the crisis.

They were totally opposed to it,” Born says. “That puzzled me. What was it that was in this market that had to be hidden?

They being the same people advising the current president. Then Assistant Treasury Secetary Lawrence Summers, Treasury Secretary Robert Rubin, as well as Alan Greespan heading up the Federal Reserve. And who did Timothy Geithner worked for through this all? As Henry Paulson got his start working in the Nixon White House; was it for Erhlichman or Haldeman? He learned under the best of hatchet men.

It had taken 40 years of the media making us all world experts, and this expertise along with the lobbyists had bankrupted American government. It was why I felt uncomfortable having my retirement accounts with Fidelity, with Merrill Lynch, with Morgan Stanley. They all had hijacked the government of the United States, through the Democratic Party and the Republican Party.

One year later, President Obama was sounding a lot like George Bush, announcing victory in Iraq. Or Henry Paulson and Ben Ben Bernanke, with their similar pronouncements all along, when the Bush Administration on July 13, 2008 rescued Fannie Mae, Freddie Mac, or Bear Stearns. When that second Depression “was no longer a possibility.”

The Congressional Oversight Panel, chaired by Harvard law professor Elizabeth Warren, warned on the same anniversary date that it remains “deeply concerned” that commercial loan losses could jeopardize the stability of many banks, particularly the nation’s mid-size and smaller banks. Highlighting yet one more hurdle for this country’s fragile economy, a wave of commercial real estate loan failures could threaten over the next few years America’s already-weakened financial system. The Congressional Oversight Panel was formed as part of oversight for the Troubled Asset Relief Program.

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September 6, 2009

In the Shadows of Those Cloakrooms

Twelve months ago, there was talk of a revolution coming in the financial markets, which was financially supported by the 3500 lobbyists in Washington, for both parties. There was a new form of fascism in those stories at the time. That is if “fascism” was a word about comforts, with government offering instruction how all of us could live easier. With the help of former Goldman Sachs officers in government, government was now deciding, 12 months later, who were saved, which among us were rescued, at least amongst financial institutions. The free market had been replaced.

If the revolution in the financial markets was not enough, how did you feel as Congress was coming back from summer recess, from all the dog and pony shows, to address not the health care crisis but how, with a nation with an aging populace, to pay for health care. At a point in time when government through Medicare had not exactly been covering the cost of new technology in hospitals, was not paying a fair share. Yet health care itself had never been better.

In the debate, there are people who desire government to decide all of the issues of health care. How much to pay medical institutions, when government was not, had not been, reimbursing hospitals the true cost of taking care of patients with Medicare. Government now wanted to mandate the amount of reimbursement for all procedures, and somehow distribute the cost throughout the entire population in the form of premiums. People who thought government was honest seemed to support the concept. Did they know about the 3500 lobbyists in Washington who had been working for more than a generation to make sure the system was not fair? How had these health care reform supporters felt about the bailouts? (In the case of my Congressional Representative, Betty McCollum supported both the bailout and health care reform.)

Like in those financial bailouts, government was now deciding, if Betty McCollum got her way, who would be saved, which among us would be rescued, amongst both health care institutions, and their patients. Suddenly aware that government knew it had the power to print money, increase property taxes in the states, and if the need were come, to confiscate everything, now they would decided every health care procedure. We had yet to hear specifics how Washington would replace those Blue Cross Blue Shield claims people to make the same kind of every day decisions with all the love and care I found when I went to renew my license plate tabs.

The timing was not real good in September 2009, less than 12 months after the revolution in the financial markets. Not when this discussion seemed more like elective surgery. With a lot of swine flu around. I hoped the vote might be postponed for 6 to 12 months. Until the patients had a lot more strength. Until the president had the courage to introduce the specifics of a bill himself, with some accountability, rather than rely on Congress or the 3500 lobbyists in Washington to take the citizens to a health care destination. Congress had not done a very good job dealing with triage in the last crisis, but that might have been due to a president who just wanted to get out of office after creating the mess himself rather than actually lead.

I wonder if somewhere in those August dog and pony shows from New Hampshire to Montana, if the president heard someone ask when he might introduce the actual legislation that might work. If Congress had spent the time to approve his appointment so he had enough staff to work on a bill.

August 2, 2009

Those Dog Days of August

There was a true revolution in the world markets last September that anyone buying stocks last week seems to have missed. The new world order was now all about social engineering on capitalism. It was only the start, back in September. Bill Gross is the Warren Buffet of the bond market and his PIMCO website with current outlook is must reading.

The Two Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash is by Charles R. Morris, a former banker who “comes to his conclusions based on objectivity, knowledge, and lucid thought.” He wrote this book before the 2008 market collapse which I have not read. I have however read a few pieces by Mr. Morris over the last 12 months, as he is on occasion featured in the Jesuit magazine America.

Credit is the air that financial markets breathe, and when the air is poisoned, there’s no place to hide.” –
Charles R. Morris

With an estimate that 20% of the population was really unemployed, there is no reason for the optimism reflected at July’s end in the Wall Street indexes. The procedure for identifying ends of a recession is by looking at when the contraction ends. Per the Wall Street Journal, “The elements that will drive a recovery –rising wages, consumer demand, production and sales — haven’t appeared.”

Government fears throughout the world are that of deflation, because they have no arrows in their quiver to fight it, when it occurs. Paul Virgen wrote on July 31st in the Wall Street Journal that economists surveyed by Dow Jones Newswires estimate the Commerce Department’s GDP report later today likely would show a contraction of about 1.5% for the second quarter, a less-severe decline than the first quarter’s 5.5% figure.

For me the word contraction is a synonym for “DEFLATION.”

Credit markets froze between September 15th and October 7th when Congress was voting on bailouts, while the battle of ideology was going on between the credit markets and the equity markets as reflected in the spread of about 3.0 percent in the LIBOR rate which one bank charged another bank. That is 3.0 higher than the Fed rate at the time, an unheard of differential. Banks in that environment, no matter the moves put on by the Treasury, were not buying in to the bailout in October 2008. When everything was overvalued, why lend money? So government came to the rescue. Because of government fear about DEFLATION.

I continue to live in a neighborhood where real estate values have barely budged, where the bubble has not burst. The American illusion persists. About values.

Read the current Atlantic Monthly piece about Dr. Doom. Learn about the economist, Hyman Minsky. Read Paul Krugman’s piece now 4 years old. ‘The news that the US housing bubble is over won’t come in the form of plunging prices….” He won the last Pulitizer prize in economics.

On May 2009, Paul McCulley of PIMCO wrote, “The longer people make money by taking risk, the more imprudent they become in risk-taking. While they’re doing that, it’s self-fulfilling on the way up. If everybody is simultaneously becoming more risk-seeking, that brings in risk premiums, drives up the value of collateral, increases the ability to lever and the game keeps going. Human nature is inherently pro-cyclical, and that’s essentially what the Minsky thesis is all about.”

Hyman Minsky was an economist who has gained a lot of disciples over the past few years. He wrote about bubbles that occur in an economy. He theorized that a bubble begins with displacement caused by a significant invention, like the internet. A displacement creates profitable opportunities in any given affected sector but, rather than invention alone, financial innovation is necessary for access to cheap credit before a kick-off to an over-trading phase. Euphoria ensues as people pile into the sector, with a driving demand to affect higher prices, often with borrowed money. Ponzi’ investors join in speculation that someone will buy their assets at higher prices. But markets eventually, whether due to lenders tightening lending criteria or insiders selling out, hit a peak. Panic then sets in. With a stampede out of the market, bankruptcies ensue.

That was why credit markets froze in September 2008. Bankers who have always been conservative. Do you know any? They were not buying into the social engineering on capitalism. There was a revolution in capitalism with this bailout. No one wanted to purchase shares in these banks that were illiquid. Based on the value of real estate, there was a bubble. A huge illusion about valuations of homes. The banks owned all the real estate. And it is said that the banks in Europe were in worse shape. In September 2008, bankers neither trusted the balance sheet of another bank nor the government. Thus the state of the credit markets. Bankers understood too well the persisting illusion.

By the end of October 2008, more than half of the U.S. banks were pretend banks. With no capital. Citibank. Bank of America. Wachovia. The bailout has worked to avoid an immediate collapse that would have had consequences worse than in Russia in 1906. Or in Russia in 1917. The panic, the revolution did not occur as a result of a couple years of events. Immediately.

“If drugs continue to be injected which mask symptoms rather than address the disease (medicine in the form of debt destruction), the likelihood of a seismic readjustment increases in kind, writes Todd Harrison, about the dollar. “As governments take on more risk” as they price assets on behalf of the market and transfer debt from private to public, “the common denominator, or release valve, becomes the currency.”

Some facts:

World GDP $47 trillion
World stock valuation $121 trillion
Bond market $85 trillion
Credit derivatives $473 trillion

There would be turmoil in currencies in the coming year as a consequence of the political fallout over American debt, before this was over. It was all because there was $460 trillion to $560 trillion in derivatives, and there is not enough money in the world to keep the system of capitalism going. The social engineering last September was all about government trying to keep capitalism going. Those derivatives, not backed up by reserves. When the laws of survival of the fittest in the market place had been always about letting systems collapse.

These news items in July 2009 you might have missed:

“Joining the growing chorus questioning the U.S. dollar’s unofficial position as global reserve currency, in India, chairman of the Prime Minister’s Economic Advisory Council, Suresh Tendulkar, is urging India to diversify its foreign-exchange reserves and hold fewer dollars,” according to Bloomberg News.

“Zeng Peiyan, the head of China Center for International Economic Exchanges and the former Chinese Vice-Premier, in a speech in Beijing on Friday called for a new system to ensure the stability of the major reserve currencies,” the China Daily reported.

“To prevent speculative and manipulative attacks on their currencies, the world’s central banks must acquire and hold dollar reserves in corresponding amounts to their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. This creates a built-in support for a strong dollar that in turn forces the world’s central banks to acquire and hold more dollar reserves, making it stronger.” –2008 piece by Henry Liu

“Tensions mounting between the People’s Bank of China’s economic concerns over China’s holdings of dollars, with the earlier call by central bank chief Zhou Xiaochuan for the development of a new super-sovereign currency largely taking the place of the dollar, and the Chinese government, with their “diplomatic reasons” for toning down their criticism, said Stephen Gallo, head of market analysis at Schneider Foreign Exchange. The Chinese government is still more happy to play to the tune of the Bernanke-Geithner camp which sees leaning against the wind in order to protect the U.S. dollar as a necessary evil,” Gallo said.”

And in April 2009, the head of the China Banking Regulatory Commission issued a statement published on its website that banks need to guard against making risky loans and instead focus more on sustainable lending practices. Banks must be “on high alert for the accumulation of hidden risks as loans surge,” Liu Mingkang said. According to published reports in remarks made at the Boao Forum for Asia, Chinese Premier Wen Jiabao last spring called for more surveillance of countries that issue major reserve currencies. That would be the United States. This statement comes on the heels of discussion at the G20 meeting of a new world currency. There is growing distrust of America and the politics involved in our currency. Last spring in an essay published on the central bank’s web site, the head of the People’s Bank of China, Zhou Xiaochuan, proposed the creation a new international reserve currency. Seeking to expand currency swap agreements that are seen as a step toward eventually making the yuan more of a global reserve asset, Wen said, “We should give full play to bilateral currency swap agreements and will study expanding currency swaps in scale and to more countries.”

“There is no chance that a nation as reputationally scarred and maimed as the US is today, could extract any true ‘alpha’ from foreign investors for the next 25 years or so. So the US will have to start to pay a normal market price for the net resources it borrows from abroad. It will therefore have to start to generate primary surpluses, on average, for the indefinite future. A nation with credibility as regards its commitment to meeting its obligations could afford to delay the onset of the period of pain. It could borrow more from abroad today, because foreign creditors and investors are confident that, in due course, the country would be willing and able to generate the (correspondingly larger) future primary external surpluses required to service its external obligations. I don’t believe the US has either the external credibility or the goodwill capital any longer to ask, Oliver Twist-like, for a little more leeway, a little more latitude. I believe that markets – both the private players and the large public players managing the foreign exchange reserves of the PRC, Hong Kong, Taiwan, Singapore, the Gulf states, Japan and other nations – will make this clear.

“Keynesian demand stimulus may work for a while (a couple of years, say). When the consequences for the public debt of both the Keynesian stimulus and the realization of the losses from the assets and commitments the Fed and the Treasury have taken onto their balance sheets become apparent, the demand stimulus will fade and may be reserved as precautionary behavior takes over in the private sector. My recommendation is to go easy on the fiscal stimulus. The US government is ill-placed financially and fiscally, to engage in short-term fiscal heroics. All they can really do is pray for a stronger-than-expected revival of global demand, without any major stimulus from the US.” -Willem H. Buiter of the European Institute, Professor of European Political Economy, London School of Economics and Political Science

William McChesney Martin was the Fed’s chairman from 1951 through 1970. Martin said his job as central-bank chief was “to take away the punchbowl just as the party gets going” to keep the economy from overheating. Paul McCulley said that the government’s efforts to aid financial firms in effect are reversing this well-known quip. “Now they are actually creating ‘punchbowl banks’ where you have the equity coming in from the Treasury,” McCulley said. “They are de facto banks owned by the Treasury and funded by the Fed. If the U.S. is putting its ‘full faith and credit’ behind the liabilities of the various financial institutions, then I want to be a co-investor with Uncle Sam, which is another way of saying I want to invest with the American taxpayer. It sounds a little like socialism only because it is.” The government’s attempts to revive lending have led policy makers to use taxpayer money to recreate “the shadow banking system,” he said.

According to Pimm Fox and Daniel Kruger, “So far, that has included expanding the Fed’s assets to $2.2 trillion, injecting $270 billion of capital into what Paul McCulley called ‘punchbowl banks,’ and promising to buy $600 billion in mortgage securities related to government-sponsored enterprises.” The government’s attempts to revive lending have led policy makers to use taxpayer money to recreate “the shadow banking system,” he said. Before the start of the financial crisis in August 2007, that comprised institutions which lacked access to the Fed’s discount window and whose customer accounts were not insured by the Federal Deposit Insurance Corp.

So that 12 months later, we are all back to where the world was, with just a little more transparency, recreating “the shadow banking system.”
Money always seemed to affect the outcome of elections.

In June 2009 there was a summit of the world’s four largest emerging economies, as leaders from of China, India Russia, and Brazil met in Yekaterinburg, Russia to discuss reforming the global financial system and lessening reliance on the United States. These four countries hold nearly 40 percent of the world’s currency reserves and make up 15 percent of the global economy.

A joint BRIC (Brazil, Russia, India, China) statement issued before the summit expressed a commitment to advance the reform of international financial institutions so as to reflect changes in the world economy. The statement said. “The emerging and developing economies must have a greater voice and representation in international financial institutions,” calling for a greater role for developing nations in global financial institutions and the United Nations. Leaders discussed investing their reserves in one another’s bonds, swapping reserve currencies and increasing the role of Special Drawing Rights, an international reserve asset. Discussions took place earlier in the day in the Urals city at a meeting of the Shanghai Cooperation Organization about the creation of a supranational currency and lessening global reliance on the U.S. dollar. President Dmitry Medvedev was an outspoken a critic of the current world financial system, reserving his most bold comments for the Shanghai Cooperation Organization. “There cannot be a successful global currency system if the financial instruments it uses are denominated in only one currency, which is the case today. And that currency is the dollar.”

But the idea of replacing the dollar found little traction with China, which holds $2 trillion in foreign currency reserves.

Other notable quotes this year, not dealing with currency:

“With stocks tied to bonds, bonds tied to housing, housing tied to the credit crisis, and everyone hitched to the government, this was all like the conga line to the poor house.” -Craig Rappaport, wealth manager at Janney Montgomery Scott

Bob Prince hedge fund manager of Bridgewater Associates, on downward spirals: “The pressure on corporate margins is now passing through to employment cuts. Employment cuts will reduce incomes which will raise defaults. Rising defaults will hinder bank capital adequacy, which will constrain credit growth, which will slow spending, which will hurt profit margins, then employment. This chain of events was virtually sealed when demand dropped off the table in October, although it was highly probable earlier this year when credit conditions deteriorated rapidly. We are now in the middle of it and there really isn’t much that anyone can do besides hang on.”

“My transgenerational stock market outlook is this: stocks are cheap when valued within the context of a financed-based economy once dominated by leverage, cheap financing, and even lower corporate tax rates. That world, however, is in our past not our future. More regulation, lower leverage, higher taxes, and a lack of entrepreneurial testosterone are what we must get used to – that and a government checkbook that allows for healing, but crowds the private sector into an awkward and less productive corner. Dow 5,000? We don’t have to go there if current domestic and global policies are focused on asset price support and eventual recapitalization of lending institutions. But 14,000 is a stretch as well. One only has to recognize that roughly 20% of bank capital is now owned by the U.S. government and that a near proportionate share of profits will flow in that direction as well. Better to own corporate bonds than corporate stocks, but that’s a story for another Investment Outlook.” -William H. Gross , Managing Director, PIMCO, December 1, 2008

Bill Gross, in October 2008: “What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August 2007.

I have never taken creative accounting….full disclosure. But anyone who was investing might recognize that the greatest opportunity to make money is now in the credit markets and not equities.

Now about the political consequences over the social engineering on capitalism which would be studied in history books in a thousand years, if the world survived this mess……. oh, that’s another lecture.

July 25, 2009

The Minsky Watch

There has been a lot of public discourse over the last year of systemic risk without any real systemic re-pricing of risk in my neighborhood, which would have a deflationary affect. Now my home is located within a few blocks of some famous people, like Joe Mauer and Garrison Keiller. From my own research, the homes around here have barely budged in valuation over the past year. Home now selling for $575,000 that would not have brought $325,000 since the time I moved into the neighborhood in the 1990s. In times when the financial system economy was not overlooking the precipice, trapped in a classic debt-deflation cycle as it seemed now in which falling asset prices and declining consumer demand transmit deflation through the economy. It had not really happened much yet in my neighborhood.

A number of publications have referred to real unemployment to be near 20%, despite the $787 billion stimulus package. State budgets are drowning in red ink, soon to deepen with jobless claims and Medicaid bills, hesitant to spend consumers as paychecks shrink and jobs disappear. I would not be buying stocks with this kind of economic forecast, yet this week the indexes on Wall Street sprouted up like Iowa corn.

The speculators still abound. People who are gambling with their money in these times, as they had gambled turning real estate in this decade. In May 2009, Paul McCulley of PIMCO wrote, “The longer people make money by taking risk, the more imprudent they become in risk-taking. While they’re doing that, it’s self-fulfilling on the way up. If everybody is simultaneously becoming more risk-seeking, that brings in risk premiums, drives up the value of collateral, increases the ability to lever and the game keeps going. Human nature is inherently pro-cyclical, and that’s essentially what the Minsky thesis is all about.”

Hyman Minsky is an economist who has gained a lot of disciples over the past few years. He wrote about bubbles that occur in an economy. He theorized that a bubble begins with displacement caused by a significant invention like the internet. A displacement creates profitable opportunities in any given affected sector but, rather than invention alone, financial innovation is necessary for access to cheap credit before a kick-off to an over-trading phase. Euphoria ensues as people pile into the sector, with a driving demand to affect higher prices, often with borrowed money. Ponzi’ investors join in speculation that someone will buy their assets at higher prices. But markets eventually, whether due to lenders tightening lending criteria or insiders selling out, hit a peak. Panic then sets in. With a stampede out of the market, bankruptcies ensue.

James Fallow’s opening paragraph in this months Atlantic Monthly is: “On March 28, 2007, Federal Reserve Chairman Ben Bernanke appeared before the congressional Joint Economic Committee to discuss trends in the U.S. economy. Everyone was concerned about the ‘substantial correction in the housing market,’ he noted in his prepared remarks. Fortunately, ‘the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.’ Better still, ‘the weakness in housing and in some parts of manufacturing does not appear to have spilled over to any significant extent to other sectors of the economy.’ On that day, the Dow Jones industrial average was above 12,000, the S&P 500 was above 1,400, and the U.S. unemployment rate was 4.4 percent. That assurance looks bad in retrospect, as do many of Bernanke’s claims through the rest of the year: that the real-estate crisis was working itself out and that its problems would likely remain ‘niche’ issues. If experts can be this wrong—within two years, unemployment had nearly doubled, and financial markets had lost roughly half their value—what good is their expertise? And of course it wasn’t just Bernanke, though presumably he had the most authoritative data to draw on. Through the markets’ rise to their peak late in 2007 and for many months into their precipitous fall, the dominant voices from the government, financial journalism, and the business and financial establishment under- rather than overplayed the scope of the current disaster.”

Paul McCulley delivered a speech to the 17th Annual Hyman Minsky Conference on April 17, 2008. He stated, “Since August 2007, the shadow banking system – defined as any levered lender who does not have access to (1) deposit insurance and/or (2) the Fed’s discount window – experienced a modern-day run, with asset-backed commercial paper holders refusing to roll over their paper. It has not been fun. It has not been pretty.” And he saw that it was not over, as the ensuing 15 months proved. Whereas James Fallow cited Federal Reserve Chairman Ben Bernanke discussion of trends in the U.S. economy on March 28, 2007, Paul McCulley of PIMCO on April 17, 2008, 25 weeks before the Lehman Brother collapse, talked about a lot of things that Bernanke publicly was oblivious to.

Paul McCulley of PIMCO wrote on April 17, 2008: “Which brings us back to where I began: Minsky’s insight that financial capitalism is inherently and endogenously given to bubbles and busts is not just right, but spectacularly right. And when the financial regulators are not only asleep but actively cheerleading financial innovation outside their direct purview, a disaster is in the making, as the last year has taught us. We have much to learn and relearn from the great man as we collectively restore prudential common sense to bank regulation – both for conventional banks and shadow banks.

In May 2009, Paul McCulley wrote, “Human nature is inherently pro-cyclical, and that’s essentially what the Minsky thesis is all about. He says ‘from time to time, capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out of control. In such processes the economic system’s reactions to a movement of the economy amplify the movement – inflation feeds upon inflation and debt-deflation feeds upon debt-deflation.'”

Paul McCulley on April 17, 2008: “Whatever moment you pick for the Moment, we have since been traveling the reverse Minsky journey: moving backward through the three-part progression, with asset prices falling, risk premiums moving higher, leverage getting scaled back and economic growth getting squeezed. Minsky’s Ponzi debt units are only viable as long as the levered assets appreciate in price. But when the price of the assets decline, as we’ve seen in the U.S. housing market, Minsky tells us we must go through the process of increasing risk-taking in reverse – with all its consequences.

“The recent Minsky moment comprised three bubbles bursting: in property valuation in the U.S., in mortgage creation, again, principally in the U.S., and in the shadow banking system, not just in the U.S. but around the world. The blowing up of these three bubbles demanded a systemic re-pricing of all risk, which was deflationary for all risk asset prices. These developments are, as Minsky declared, a prescription for an unstable system – to wit, a system in which the purging of capitalist excesses is not a self-correcting therapeutic process, but a self-feeding contagion: debt deflation.

“Fittingly, the last debt unit on the forward Minsky journey is called a Ponzi unit, defined as a borrower who has insufficient cash flow to even pay the full interest on a loan, much less pay down the principal over time. Now, how and why would such a borrower ever find a lender to make him a loan? Simple: as long as home prices are universally expected to continue rising indefinitely, lenders come out of the woodwork offering loans with what is called negative amortization, meaning that if you can’t pay the full interest charge, that’s okay; they’ll just tack the unpaid amount on to your principal. At the maturity of the loan, of course, the balloon payment will be bigger than the original loan.

“As long as lenders made loans available on virtually non-existent terms, the price didn’t really matter all that much to borrowers; after all, housing prices were going up so fast that a point or two either way on the mortgage rate didn’t really matter. The availability of credit trumped the price of credit. Such is always the case in manias. It is also the case that once a speculative bubble bursts, reduced availability of credit will dominate the price of credit, even if markets and policymakers cut the price. The supply side of Ponzi credit is what matters, not the interest elasticity of demand.

“Clearly the explosion of exotic mortgages in recent years have been textbook examples of Minsky’s speculative and Ponzi units. But they seemed okay, as long as expectations of stably rising home prices were realized. Except, of course they cannot forever be realized. At some point, valuation does matter! How could lenders ignore this obvious truth? Because while it was going on, they were making tons of money. Tons of money does serious damage to the eyesight. And our industry’s moral equivalent of optometrists, the regulators and the rating agencies, are humans too.

“As long as the forward Minsky journey was unfolding, rising house prices covered all shameful underwriting sins. Essentially, the mortgage arena began lending against asset value only, rather than asset value plus the borrowers’ income. The mortgage originators, who were operating on the originate-to-distribute model, had no skin in the game – no active interest – because they simply originated the loans and then repackaged them.
But who they distributed these packages to, interestingly enough, were the shadow banks. So we had an originate-to-distribute model and no skin in the game for the originator, and the guy in the middle was being asked to create product for the shadow banking system.

“The system was demanding product. Well, if you’ve got to feed the beast that wants product, how do you do it? You have a systematic degradation in underwriting standards so that you can originate more. But as you originate more, you bid up the price of property, and therefore you say, “These junk borrowers really aren’t junk borrowers. They’re not defaulting.” So you drop your standards once again. And you take prices up. And you still don’t get a high default rate. The reason this system works is that you, as the guy in the middle, had somebody bless it: the credit rating agencies. A key part of keeping the three bubbles (property valuation, mortgage finance and the shadow banking system) going was that the rating agencies thought the default rates were low because they were low. But they were low because the degradation of underwriting standards was driving up asset prices.

“Both regulators and rating agencies were beguiled by very low default rates during the period of soaring home prices. It all went swimmingly, dampening volatility in a self-reinforcing way, until the bubbles created by financial alchemy hit the fundamental wall of housing affordability.

“Ultimately, fundamentals do matter! We have a day of reckoning, the day the balloon comes due, the margin call, the Minsky Moment.

“If the value of the house hasn’t gone up, then Ponzi units, particularly those with negatively-amortizing loans, are toast. And if the price of the house has fallen, speculative units are toast still in the toaster. Ponzi borrowers are forced to “make position by selling out position,” frequently by stopping (or not even beginning!) monthly mortgage payments, the prelude to eventual default or jingle mail. Ponzi lenders dramatically tighten underwriting standards, at least back to Minsky’s speculative units – loans that may not be self-amortizing, but at least are underwritten on evidence that borrowers can pay the required interest, not just the teaser rate, but the fully-indexed rate on ARMs.
From a microeconomic point of view, such a tightening of underwriting standards is a good thing, albeit belated. But from a macroeconomic point of view, it is a deflationary turn of events, as serial refinancers, riding the back of presumed perpetual home price appreciation, are trapped long and wrong. And in this cycle, it’s not just the first-time homebuyer that is trapped, but also the speculative Ponzi long: borrowers who weren’t covering a natural short – remember, you are born short a roof over your head, and must cover, either by renting or buying – but rather betting on a bigger fool to take them out (“make book”, in Minsky’s words). The property bubble stops bubbling and when it does, both the property market and the shadow banking system go bust.

“The asset class imploded violently, when the conventional basis of valuation was undermined for the originate-to-distribute (to the shadow banking system) business model.

“And the implosion was on Wall Street and next on Main Street, with debt-deflation accelerating in the wake of a mushrooming mortgage credit crunch, notably in the subprime sector, but also up the quality ladder. Yes, we are now experiencing a reverse Minsky journey, where instability will, in the fullness of time, restore stability, as Ponzi debt units evaporate, speculative debt units morph after the fact into Ponzi units and are severely disciplined if not destroyed, and even hedge units take a beating. The shadow banking system contracts implosively as a run on its assets forces it to delever, driving down asset prices, eroding equity – and forcing it to delever again. The shadow banking system is particularly vulnerable to runs – commercial paper investors refusing to re-up when their paper matures, leaving the shadow banks with a liquidity crisis – a need to tap their back-up lines of credit with real banks or to liquidate assets at fire sale prices. Real banks are in a risk-averse state of mind when it comes to lending to shadow banks, lending when required by backup lines but not seeking to proactively increase their footings to the shadow banking system but, if anything, reduce them. Thus, the mighty gulf between the Fed’s liquidity cup and the shadow banking system’s parched liquidity lips.

“The entire progression self-feeds on the way down, just like it self-feeds on the way up. It’s incredibly pro-cyclical. The regulatory response is also incredibly pro-cyclical. You have a rush to laxity on the way up, and you have a rush to the opposite on the way back down. And essentially, on the way down, you have the equivalent of Keynes’s paradox of thrift – the paradox of delevering. It can make sense for each individual institution, for a shadow bank or even a real bank, to delever, but collectively, they can’t all delever at the same time.

“Along the way, policymakers slowly have recognized the Minsky Moment followed by the unfolding reverse Minsky journey. But I want to emphasize “slowly,” as policymakers, collectively, tend to suffer from more than a thermos full of denial. Part of the reason is human nature: to acknowledge a reverse Minsky journey, it is first necessary to acknowledge a preceding forward Minsky journey – a bubble in asset and debt prices – as the marginal unit of debt creation morphed from hedge to speculative to Ponzi. That is difficult for policymakers to do, especially ones who claim an inability to recognize bubbles while they are forming and, therefore, don’t believe that prophylactic action against them is appropriate. But framing policies to mitigate the damage of a reverse Minsky journey requires that policymakers openly acknowledge that we are where we are because they let the invisible, if not crooked, hand of financial capitalism go precisely where Professor Minsky said it would go, unless checked by the visible fist of counter-cyclical, rather than pro-cyclical, regulatory policy.

“That’s not to say that Minsky had confidence that regulators could stay out in front of short-term profit-driven innovation in financial arrangements. Indeed, he believed precisely the opposite. Minsky wrote these words in 1986:

“In a world of businessmen and financial intermediaries who aggressively seek profit, innovators will always outpace regulators; the authorities cannot prevent changes in the structure of portfolios from occurring. What they can do is keep the asset-equity ratio of banks within bounds by setting equity-absorption ratios for various types of assets. If the authorities constrain banks and are aware of the activities of fringe banks and other financial institutions, they are in a better position to attenuate the disruptive expansionary tendencies of our economy.”

Three years later, we can only bemoan that his sensible counsel was ignored and the economy experienced the explosive growth of the shadow banking system, or what Minsky cleverly called “fringe banks and other financial institutions.”
Minsky’s insight that financial capitalism is inherently and endogenously given to bubbles and busts is not just right, but spectacularly right. We have much to learn and relearn from the great man as we collectively restore prudential common sense to bank regulation – both for conventional banks and shadow banks.

“Meantime, we’ve got a problem: we’re on a reverse Minsky journey. The private sector wants to shrink and de-risk its balance sheet, so someone has to take the other side of the trade to avoid a depression – the sovereign. We pretend that the Fed’s balance sheet and Uncle Sam’s balance sheet are in entirely separate orbits because of the whole notion of the political independence of the central bank in making monetary policy. But when you think about it, not from the standpoint of making monetary policy but of providing balance sheet support to buffer a reverse Minsky journey, there’s no difference between Uncle Sam’s balance sheet and the Fed’s balance sheet. Economically speaking, they’re one and the same.

“I think we’re pretty well advanced along this reverse Minsky journey, and it’s a lot quicker than the forward journey for a very simple reason. The forward journey is essentially momentum-driven; there is a systematic relaxation of underwriting standards and all that sort of thing, but it doesn’t create any pain for anybody. The reverse journey, however, does create pain, otherwise known as one giant margin call. The reverse journey comes to an end when the full faith and credit of the sovereign’s balance sheet is brought into play to effectively take the other side of the trade. No, I’m not a socialist; I’m just a practical person. You’ve got to have somebody on the other side of the trade. The government not only steps up to the risk-taking and spending that the private sector is shirking, but goes further, stepping up with even more vigor, providing a meaningful reflationary thrust to both private sector risk assets and aggregate demand for goods and services.

Thus, policymakers have a tricky balancing act: let the deflationary pain unfold, as it’s the only way to find a bottom of undervalued asset prices from presently overvalued asset prices, while providing sufficient monetary and fiscal policy safety nets to keep the deflationary process from spinning out of control. Debt deflation is a beast of burden that capitalism cannot bear alone. It ain’t rich enough, it ain’t tough enough.

“Capitalism’s prosperity is hostage to the hope that policymakers are not simply too blind to see.

“As long as we have reasonably deregulated markets and a complex and innovative financial system, we will have Minsky journeys, forward and reverse, punctuated by Minsky Moments. That is reality. You can’t eliminate the Minsky journeys. It’s a matter of having the good sense to have in place a counter-cyclical regulatory policy to help modulate human nature.

“Not to say that Minsky had confidence that regulators could stay out in front of short-term profit-driven innovation in financial arrangements. Indeed, he believed precisely the opposite:

“In a world of businessmen and financial intermediaries who aggressively seek profit, innovators will always outpace regulators; the authorities cannot prevent changes in the structure of portfolios from occurring. What they can do is keep the asset-equity ratio of banks within bounds by setting equity-absorption ratios for various types of assets. If the authorities constrain banks and are aware of the activities of fringe banks and other financial institutions, they are in a better position to attenuate the disruptive expansionary tendencies of our economy.”

“While asset prices, and notably property prices, were soaring, it was all quite dandy. Which, of course, propelled the Forward Minsky Journey. There were no regulatory cops on the beat, only regulatory czars in corner offices, actively accommodating growth in the shadow banking system. Most fundamentally, regulatory authorities ignored the systemic liquidity risk imposed by the shadow banking system versus the conventional banking system: without access to either deposit insurance or the Fed’s discount window, and mostly void of any meaningful term financing, the shadow was a sitting duck for a classic run on liquidity. And ever since last August, that has been precisely what has unfolded, punctuated by the run on Bear Stearns last month.

“Along the way, the Fed has taken gallant and bold steps to inject liquidity into the markets, creating lending facility after lending facility. But up until last month, when the Fed opened the discount window to investment banks, who are the largest shadow banks of all, the Fed’s role as liquidity provider of last resort was simply not effective, however valiant it may have been. Channeling liquidity to conventional banks, in hopes that they would pass it along to shadow banks, simply did not work very well, though it did have the salutatory effect of allowing some banks to (reluctantly) expand their balance sheets so as to absorb assets being disgorged by shadow banks.

“As the Bear Stearns rescue forcefully demonstrated, the Fed had no choice but to open the discount window to investment banks, to facilitate the takeover of Bear in particular and even more importantly, to prevent a cascading of runs. This was a moment of truth and clarity, if there ever was one. I applaud the Fed for doing what it had but no choice to do. At the same time, the Fed’s action demands a complete re-think of the bifurcated regulatory regime for conventional banks and investment banks.

James Fallow: “The difference was partly ‘debt versus equity.’ That is, a loss of stock-market value is damaging, but defaults on loans which put banks themselves in trouble had a ‘multiplier’ effect. The difference between this crash and others, Nouriel Roubini said, was that the speculative bubble involved so much more of the economy than the term ‘subprime’ could suggest. ‘It was subprime, it was near-prime, it was prime mortgages. It was home-equity-loan lines. It was commercial real estate, it was credit cards, and it was auto loans. When there’s a credit crunch, for every dollar of capital the financial institution loses, the contraction of credit has to be 10 times bigger.’

“‘Bernanke should have known better. But it’s not really about him. It’s in everybody’s interest to let the bubble go on. Instead of the wisdom of the crowd, we got the madness of the crowd. So when the proverbial stuff hit the fan in the summer of 2007, the Fed and the Bush administration were initially taken by surprise,’ Nouriel Roubini concluded. ‘Their analysis had been wrong. And they didn’t understand the severity of what was to come. And all along, their policy was two steps behind the curve. We’ve had a model of growth in which over the last 15 or 20 years, too much human capital went into finance rather than more-productive activities. It was a growth model where we over-invested in housing, the most unproductive form of capital. We have been in a growth model based on bubbles, and the model has broken down, because we borrowed too much. The only time we are growing fast enough is when there is a big bubble.

And so the government now more than doubled note and bond offerings to $963 billion in the first half of 2009 as it tries to end the recession. It may sell another $1.1 trillion by year-end, according to Barclays. The second-half sales would be more than the amount sold in all of 2008.

“Unless we demonstrate a strong commitment to fiscal sustainability, we risk having neither financial stability nor durable economic growth,” Fed Chairman Ben Bernanke said this week in semi-annual testimony before the House Financial Services Committee. Bernanke said “limited inflation pressures” will allow policy makers to keep interest rates near zero for an “extended period.”

“‘The Fed is now embarked on a policy,’ Nouriel Roubini said, ‘in which they are in effect directly monetizing about half of the budget deficit. The public debt is going up, and the federal government is covering about half of that total by printing new money and sending it to banks. In the short run, that monetization is not inflationary.” But banks are holding much of the money themselves. ‘They are not re-lending it. So that money is not going anywhere and is becoming inflationary.’”

But at some point the recession will end—Roubini’s guess is 2011–and banks will want to lend the money. People and businesses will want to borrow and spend it, James Fallow’s piece concludes.

Writes Alan Blinder, a Princeton University professor of economics and public affairs, in the Wall Street Journal: “Economic conditions are dreadful at the bottom of a deep recession. Jobs are scarce. Layoffs abound. Businesses scramble for penurious customers. Companies go bankrupt. Banks suffer loan losses. Tax receipts plunge. Government budget deficits balloon. All this and more in what now looks to be the country’s worst recession since 1938. So why is everyone so blue when the U.S. economy is hitting bottom. The good news also is the bad news. As the economy hits bottom, it’s a long uphill climb to get out.

Paul McCulley of PIMCO and Bill Gross of PIMCO and Mohamed El-Erian at PIMCO have had a better public perspective than Mr. Bernanke has over the past two years. As did Nouriel Roubini. It is hard to believe his name will be put in nomination at the soon to end current term as Fed chief, no matter his performance since September 2008. Even though the real-estate crisis was working itself out and its problems likely remained ‘niche’ issues, and had not approached my neighborhood.

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