Friday, September 19, 2014

Anything Goes - Again

Frederick J. Sheehan Jr. is a consultant to institutional investors. He advises on asset allocation, portfolio risk management, and asset strategies to meet long-term liability commitments. He is an advisor to investment firms and endowments.  He is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and is currently working on a book about Ben Bernanke. He writes a blog at

Lee Thomas Smith, National Association of Building Owners and Contractors annual convention, 1926

So intense was real estate speculation in 1925, one-eighth of the national economy was devoted to building in 1925. [This was also true of the property mania in 1890. - FJS] "Buildings were being put up through the endeavors of bond houses to sell bonds, whether the buildings were needed or not. During 1925, $675,000,000 of real estate bonds were sold in this country... an increase of more than 1,000 per cent in the last five years."

A celebrity economist who anticipated CNBC, 1927:

 "Now you can't have any exhaustion of credit in this country under the Federal Reserve Act; you have got 100% reserve at all times... Under the Federal Reserve Act the United States has an absolutely unlimited supply of credit, smashing all the cycle theories. The United States is in a new era and only a student of the Federal Reserve System, the greatest the world has ever seen, will understand." [My italics - FJS]

Professor Joseph Lawrence, star economics professor at Princeton University, 1929:

"The consensus of millions of people whose judgments decide the price levels in the stock market tells us that these stocks are not overvalued....Who then are these men with such a universal wisdom that it gives them the right to veto the judgment of this intelligent multitude?"

Financial World, April 29, 1929:

"It may be well again to stress the all-important point that the Federal Reserve has in its power to change interest rates downward at any time it sees fit to do so and thus to stimulate business."

Miller Huggins, New York Yankees manager, May 14, 1929

"I don't think the Yanks are going to catch the Athletics.... They've been getting fairly high salaries and they've taken a lot of money out of baseball, a whole lot of money. They have stock market investments and these investments are giving them excellent returns at the moment. When they pick up a newspaper now, they turn to the financial page first and the sports page later. These things aren't good for a club...."  


It has been estimated that corporations (including U.S. Steel, General Motors, AT&T, and Standard Oil of New Jersey) had lent $5 billion to New York Stock Exchange purchases by September 1929. They were drawn to the call loan market as rates rose to 10%. In consequence, total securities loans rose from $12.4 billion on October 3, 1928 to $16.9 billion a year later. To appreciate the magnitude in relation to the economy, the gross domestic product in 1929 was $104 billion. Even though only 2.5 million Americans owned shares, a disproportionate concentration of funds had been directed at the stock market.

New York Times, September 6, 1929: "Fisher Denies Crash is Due":

"The present high level of stock prices are...largely brought about through ...investment diversification made possible to the investor by investment trusts." [Economists seem never to learn that what they call diversification is usually a concentration of leveraged speculation. - FJS]

New York Times, September 6, 1929:  "Brokerage Office Set Up On Pebble Beach Golf Course":

"Golf enthusiasts who are following the course of the national amateur championship at Pebble Beach, Cal., may watch the stock market while keeping up with the play. A temporary brokerage office, housed in a tent...has been established by the firm of E.F. Hutton & Co.... The temporary office has had a lively bit of business from the crowd following the players and from some of the players, too, many of whom are ardent followers of market quotations."

New York Times, September 9, 1929 (probably written by Alexander Dana Noyes):

There were numerous "considerations now which must nowadays modify ideas about the future. One is the power and protective resources of the Federal Reserve."


New Yorker, October 12, 1929:

"[M]any contractors of estimable standing are ready to take over the "secondary financing" of not-too-large operations, meaning they will put up most of the cash necessary to complete the building, over and above what the first mortgage provides. They do this in order to keep their operation from falling apart. This loan for the building, which is really a second mortgage, is discounted at some 'big, friendly bank', so that the contractor's money is not tied up after all..."

Business Week, October 19, 1929:

"There is...reassurance that, in the fact that, should business show any further signs of fatigue, the banking system is in a good position now to administer any needed tonic from its excellent Reserve system."

Lewis Mumford, 1930

"Among the many blessings of the Depression, one must count the diminution of such opportunities." [Skyscrapers. FJS]

The New Republic, 1932:

"[W]inter evenings were cruelly revealing, for when the sun set before the close of daily business it was all too apparent how many of these towers stood 'black and untenanted against the stars...With some few exceptions, the newest New York may be described as a sixty-story city unoccupied above the twentieth floor."

New York Times, August 21, 1934 "The Future of the Skyscraper":

"Even before the great crash and great depression the skyscraper was under suspicion from the standpoint of sound economics."

Cole Porter (1934) "Anything Goes":

If driving fast cars you like,
If low bars you like,
If old hymns you like,
If bare limbs you like,
If Mae West you like,
Or me undressed you like,
Why, nobody will oppose!
When ev'ry night,
The set that's smart,
Is intruding in nudist parties in studios, Anything goes!

Porter was writing about a different decade.  

Friday, September 12, 2014

Tail Risk

Frederick J. Sheehan Jr. is a consultant to institutional investors. He advises on asset allocation, portfolio risk management, and asset strategies to meet long-term liability commitments. He is an advisor to investment firms and endowments.  He is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and is currently working on a book about Ben Bernanke. He writes a blog at

          In a recent memo to Oaktree Capital clients, Chairman Howard Marks writes about "the time I spent advising a sovereign wealth fund about how to organize for the next thirty years. My presentation was built significantly around my conviction that risk can't be quantified a priori. Another of their advisors, a professor from a business school north of New York, insisted it can. This is something I prefer not to debate, especially with people who're sure they have the answer but haven't bet much money on it."

This is an excellent illustration of the investment mind today. It treasures mathematical models that produce certainty. The finance professor is talking through his hat, but he need not fear an academic challenge. This is what the tenured teach and, alas, what students take to their jobs.

Businesses and investment funds are managed in the belief that risk - which is in the future (there is no risk to what has already happened) - can be captured down to the last dollar by a professor's model. A problem here, for those who have not spent time within this world, is they do not believe it. They cannot really accept that a highly acclaimed asset manager is confined - and generally, content to be confined - within the parameters as described.

Since it is difficult, if not impossible, to convince a sensible person this is really how institutional money decisions are made, the following question may help: "Do they - the professors, the CFOs, the investment managers, the Federal Reserve, for that matter, which is similarly attired - really believe they can know the future with such impossible precision, or, do they conduct their operations within such parameters because they want to believe they are authorities of the future?" The latter possibility is more believable.

Since this is the accepted method of managing businesses and funds, the allocation of resources and investments runs through the same pipe. When asset markets are flooded with artificial dollars, as is the case today, allocations rise (no one wants to be left out), fill the tank, spill in all directions, without regard for academic and central banking assurances, until they mock the gods. "All correlations go to one," wrote Marty Fridson, currently CIO at Lehmann, Livian, Fridson Advisors LLC.

Fridson made that statement about Long-Term Capital Management's mistaken models that engulfed world finance in 1998. Here we are, nearly 20 years later. That lesson has been ignored. World finance is far more leveraged and vulnerable than then. It is, to a degree, understandable why professors and central bankers are immune to reality. As Howard Marks wrote, they "haven't bet much money on it." That is not true for companies and investors.  


The fact that the institutional world measures and applies risk incorrectly leaves corporate managers and investors vulnerable. The real risk, which was probably the first thought of the sensible person, is described by Howard Marks as a "permanent loss from which there won't be a rebound."

Yes. Finally, a statement that makes sense.

Marks offers his explanation for why academics (and the CFOs and CIOs they taught), are walking hand-in-hand to the graveyard: "Volatility is the academic's choice for defining and measuring risk. I think this is the case largely because volatility is quantifiable and thus usable in the calculations and models of modern finance theory. In [Marks' book, The Most Important Thing] I called it 'machinable.'" Our world loves machines to make decisions, or has given up fighting them.

The past two decades' APA (Asset Price Administration) has instilled an assumption in those who continue to run with the markets there is no such thing as a permanent loss. The S&P 500 fell 54% from 2007 to 2009. Today, it's higher than ever, and rising.

There are millions of Americans who have suffered permanent losses and will never recover. They bought the bubble, or a no-no-no mortgage, or had to sell their stocks in 2008 to make sure they could pay their bills. To rub their noses in the dirt, their interest rates have been confiscated on what savings may remain.

The risk of permanent loss is often called "tail risk." Joe Calandro and I have written about tail risk in the attached paper:  "Investment, Corporate Risk Management, and Tail Risk." It was published in the July 2014 Gloom, Boom and Doom Report.

Of infinitely greater importance, we describe how we manage a company's or fund's tail risk, which we are glad to discuss with potential customers. 

Saturday, September 6, 2014

What Does the Media Do?

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009), which was translated and republished in Chinese (2014). He is researching a book about Ben Bernanke. He writes a blog at

          What do reporters do all day? In "Exclusive!" "Shocking!" "Extra, Read All About It!" breaking news,  published the damning testimony of (in 2008 - in all cases) Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben S. Bernanke, and New York Federal Reserve President Timothy Geithner in "Sell Financial Stocks - and Bonds" (September 5, 2014). Quoting from their own words, from the "The Plaintiff's Corrected Proposed Finding of Fact," in Starr International Co. v. United States,the trio broke the law when they nationalized AIG, and, showed they had no idea what they were doing.

            Now, those conclusions are opinion. And as stated in "Sell Financial Stocks - and Bonds" the evidence is the "Plaintiff's case, of course, and protests will be aired on the witness stand starting in late September." (The upcoming trial is discussed in the article.)

            The question of the day is: why hasn't a media organization written about this? A search through Google, etc. came up with nothing. That is not definitive, but if one media outlet gets hold of an important story, the others follow.

            The Wall Street Journal published a story on August 26, 2014, which made it plain the "The Plaintiff's Corrected Proposed Finding of Fact" was in the public domain. From the story: Mr. Bernanke is quoted making the statement in a document filed on August 22 with the U.S. Court of Federal Claims as part of a lawsuit linked to the 2008 government bailout of insurance giant AIG."

            The Bernanke quote was his standard: "I stopped the worst financial crisis since [fill in the blank]." He has lived off this assertion since 2009, never providing evidence. Bernanke's quotes are from - you may have guessed - page one of the document.

            Why didn't anyone read through the 99 pages? Page one was the least newsworthy of all. Why didn't other media outlets display even a modicum of their self-acclaimed "investigative journalism" and call court? Will they cover the trial? Starr International Co. v. United States is set to start September 29.

Friday, September 5, 2014

Sell Financial Stocks - and Bonds

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009), which was translated and republished in Chinese (2014). He is researching a book about Ben Bernanke. He writes a blog at

RESERVE YOUR SEATS: On August 26, 2014, for what seems the fiftieth time, the U.S. Court of Federal Claims rejected the U.S. government's attempt to extinguish Starr International Co. v. United States. Judge Thomas Wheeler said the case brought by Hank Greenberg's AIG (specifically, Starr International Co., which owned 12.5% of the shares on September 15, 2008) will go to trial on September 29, 2014. Wheeler stated: "The complexity of the submissions and the factual disagreements strongly point to the need for a trial." According to Reuters, "a U.S. Department of Justice spokeswoman declined to comment." On the other hand, David Boies, the Attorney of Record from Boies, Schiller & Flexner, LLP, representing Starr International, did comment: "The decision speaks for itself." Former AIG Chairman Hank Greenberg has sued the U.S. government for $25 billion as compensation for the shares owned by Starr International. According to Reuters, "The trial is expected to last six weeks.")

:           The news sounds reassuring: "U.S. bank regulators plan to adopt rules on [September 3, 2014] forcing big banks to hold more assets that they could sell easily in a credit crunch, a requirement that is closely linked to the experience of the 2007-2009 financial crisis." It is possible the rules will work.

            However, no formula will capture rising or falling confidence in a financial company at some future date. We are vectoring towards another 2008. Confidence, on the part government and Federal Reserve officials, financial institutions, and the public, are intertwined. When financial institutions are afraid to lend to each other liquid assets will be held for dear life.

            There are two topics in store. First, changes to financial institution bankruptcy law may prompt a bank run. Second, depositions in Starr International Company, Inc. v. United States [the AIG lawsuit - see: "David Boies vs. Citizen Ben S. Bernanke," and "The Professor Who Did Not Save the World"] should awaken investors to our "policy makers" disintegration when we needed a leader. (It is significant when the bureaucratic meritocracy rose to positions of leadership, it changed its role to that of "policymakers." That it did not and does not want to lead is the reason it is spent.)

            In the discussion about financial institution bankruptcy (topic number one), it is well to keep in mind consequences are magnified by topic number two. As a footnote, it is inconceivable the government and Fed models, such as those used to calculate the September 3, 2014, bank liquidity rules, include an exponential factor that kicks in when the combined worries of a Dodd-Frank "call" and a heavy-handed government rescue mission hit simultaneously.

            The changes to financial firm bankruptcy are not new. They are part of the Dodd-Frank legislation. After taking a poll (of three) it was agreed investors and bank depositors are not conscious of the changes. ("Conscious of" - banks may have sent notices, 10Ks and certainly security offerings served notice, but memories fade.)

Since this is not new, a summary will be brief. It is also a transcription of Paul Singer's description at the Grant's Interest Rate Observer conference in April 2012. Singer is CEO of Elliot Management Corporation and a lawyer. He explained: "Dodd-Frank radically changed bankruptcy law to enable the FDIC to seize financial companies which are thought to be in danger of default. Prior law for decades required, of course, actual default or a voluntary filing by management. The seizure process in Dodd-Frank takes two - count them - two days, and is essentially unreviewable and unappealable. The FDIC is also ordered, pursuant to Dodd-Frank, to toss out management and seek damages from people, including third parties, who are 'responsible' for the financial condition of the troubled company. It also enables the FDIC to transfer assets willy-nilly out of the corporate entities where they reside, thus making the analysis of one's counterparty impossible, and to discriminate among classes of creditors similarly situated if the FDIC thinks it will fulfill some higher good.... Thus creditors, counterparties, clearing customers and trading partners of financial companies which become troubled, post Dodd-Frank, have only one rational response to potential trouble or perceived trouble, given the opacity and leverage I have mentioned before: instantly stop trading, sell claims, pull assets, basically run for the hills."

            Now, for the bad news: The depositions in Starr International v. United States show a government that did not wait for Dodd and Frank to muster 10,000 pages (and counting) of bureaucratic snooping. In the pinch, Secretary of the Treasury Hank Paulson, Fed Chairman Ben Bernanke and (then) New York Federal Reserve President Tim Geithner acted willier and nillier than (we may hope) the FDIC will behave, and without legal authority (as you will read below), during the 2008 financial crisis.  

The public view was described last week by Reuters: "The bailout saved AIG from [the possibility of] filing for bankruptcy. The Federal government took 92% of AIG's shares in return for $152 billion that the Fed and Treasury eventually pumped into the insurer." [Bracketed comment in Reuters dispatch added. - FJS]

Reading "The Plaintiff's Corrected Proposed Finding of Fact," it looks as though the bailout forced AIG into an unnecessary bankruptcy; hence the bracketed insertion in the Reuters description above. This is the Plaintiff's case, of course, and protests will be aired on the witness stand starting in late September.

Note #1: the wording from the Finding of Fact is sometimes what a layman may call "telegraphic;" I have left it as is. Note #2: Only a handful of the Findings of Facts are discussed below. There are well over 100. The legal case may address others. 

Returning to the scene of the confusion, then-New York Federal Reserve President Tim Geithner described the drama (in deposition) on September 15, 2008: "Of the twenty-five largest financial institutions at the start of 2008, thirteen had either failed (Lehman, WaMu), received government help to avoid failure (Fannie, Freddie, AIG, Citi, BofA), merged to avoid failure (Countrywide, Bear, Merrill, Wachovia), or transformed their business structure to avoid failure (Morgan Stanley, Goldman.)" 

The United States (as stated in the lawsuit) would not hear of outside parties that were willing to bridge or supply capital needed by AIG. Quoting the Finding of Fact: "Sovereign wealth funds, including the Government of Singapore Investment Corporation (GIC) and the Chinese Investment Corporation (CIC) expressed interest in investing in AIG."
Specifically, "The Chinese Investment Corporation (CIC) expressed interest in investing in AIG. Defendant discouraged the CIC and representatives of the Chinese Government from assisting AIG. At 12:25 p.m. on September 16, 2008, [it was relayed to Secretary of the Treasury Hank Paulson].... CIC was 'prepared to make a big investment in AIG, but would need Hank to call [Chinese Vice Premier] Wang Qishan.' The Chinese 'were actually willing to put up a little bit more than the total amount of money required for AIG.'" [Italics added. - FJS]

            "On September 16, 2008, [Under Secretary of International Affairs David] McCormick spoke to Paulson about the Chinese interest in investing in AIG. McCormick then told [Taiya] Smith [Paulson's deputy chief of staff and executive secretary] that Treasury "did not want the Chinese coming in at this point in time on AIG."

"Later that day, Smith met with Chinese Government officials in California during Joint Commission on Commerce and Trade in Yorba Linda, California. During that meeting, 'all [the Chinese officials] wanted to talk about was AIG.' Smith spent one or two hours explaining what was happening with AIG. She conveyed the message that Treasury did not want the Chinese to invest in AIG." [Italics added - FJS]

Senator Hillary Clinton took time off from her presidential campaign to save the floundering insurance company: ""On September 17, 2008, United States Senator Hillary Clinton called Paulson "on behalf of Mickey Kantor, who had served as Commerce secretary in the Clinton administration and now represented a group of Middle Eastern investors. These investors, Hillary said, wanted to buy AIG. 'Maybe the government doesn't have to do anything,' she said.'" Paulson told Senator Clinton, 'this was impossible unless the investors had a big balance sheet and the wherewithal to guarantee all of AIG's liabilities.'"

Since the price of oil was descending from its recent high of $150 a barrel, it was worth investigating whether they had "a big balance sheet." As for "the wherewithal to guarantee all of AIG's liabilities," Paulson had no idea what the liabilities were worth - he could not explain to counsel why the government seized AIG: "Paulson: The 'taking of equity in companies that receive government assistance' is 'a punitive condition.'"
Treasury Secretary Hank Paulson

Several outside parties were calculating values, but from the evidence, no one within "The United States" did so. None of the witnesses could tell David Boies where the "79.9% of AIG shareholder's equity" - the original figure wrought - came from. (Geithner: "I am not certain I understand the reason why it was not more than that. I don't know why it was not less than that." Paulson: "I didn't focus on how that number was determined, although I clearly focused on the number and remember discussing it." FRBNY: "did not conduct an independent analysis regarding the appropriate terms for Government assistance to AIG." Bernanke: A. "I don't know." Bernanke left as he entered - a space-cadet, paper-shuffler.)

There were, however, several parties that calculated the value of "AIG," from different perspectives and for different reason.

For instance: "According to BlackRock, an independent advisor working on behalf of AIG, 'Collateral posted to counterparties under the CDS in the portfolio is over $29 billion, far in excess of the projected net cash flows in BlackRock's stress case.' BlackRock estimated that AIG's projected net cash flows for the life of the CDS contracts, discounted at LIBOR, ranged between negative $7.3 billion in a base case and negative $15.2 billion in a stress case."

Also, "New York State Superintendent of Insurance Dinallo testified that even 'if there had been a run on the securities lending program with no Federal rescue, our detailed analysis indicates that the AIG life insurance companies would not have been insolvent'" [Italics added. - FJS]

In addition: "KKR's [Kohlberg, Kravis - FJS] Derrick Maughan provided sworn testimony that if 'AIG, the company, or the Fed as lender of last resort, had wished they could have stabilized the company through Government invention support [sic], and then introduced private capital.'"

There were other avenues offered to prevent AIG's nationalization: "BlackRock 'presented three options for FRBNY to consider.... [This included] counterparties cancelling their credit default swaps and selling the underlying CDOs to an FRBNY-financed SPV, for total consideration of par, comprised of previously posted collateral, cash, and mezzanine note in the SPV'; the obligation to perform under the credit default swaps 'transferred from AIG to an SPV guaranteed by the FRBNY'; and creation of an 'SPV to purchase the underlying CDOs from AIGFP's counterparties, in connection with a termination of the related credit default swaps'"

Apparently, no option matched nationalization. New York State was ready to save AIG. "Around noon on September 15, 2008, New York Governor David Paterson announced that he had 'directed' the New York State Insurance Department to permit AIG to access approximately $20 billion in liquid assets from certain AIG insurance subsidiaries. He also urged the federal government to be involved in some type of arrangement, whereby AIG would have the necessary resources and bridge loans to tide AIG over until it could resolve its liquidity problems."

"On September 16, 2008, Dinallo reiterated Governor Paterson's offer to allow AIG to upstream $20 billion from its insurance subsidiaries. Geithner responded, "No, we're good." As a result, Dinallo was 'led to believe definitively that we were no longer part of the fix.'" "Good" at what?

If you ever watched Chairman Bernanke brush aside Congressional inquiries about the Federal Reserve exceeding its authority during testimony, he would invoke Section 13(3) of the Federal Reserve Act. This always shut the congressman up, even though, on at least two occasions, he leaned back for a Fed staff member to remind him the number of the section: "13(3)."

In the Finding of Fact, Paulson and Geithner are quoted far more than Bernanke except for some hysterical recollections, including: "September and October of 2008 was the worst financial crisis in global history, including the Great Depression." That could be true, but is a wild assertion without support (which Bernanke has never in his life supplied), a successful tactic that guided Time magazine to name him Thing of the Year.  

            On the other hand, Tim Geithner offered a more convincing assessment, that "2008" was "the worst financial crisis since the Great Depression." Chairman Bernanke accomplished a rare feat. He was a less reliable witness than Tim Geithner.

Another example of Bernanke's fevered understanding: "Of the 13 most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two." He said this at least once before, when he testified during the FCIC investigation. After the FCIC transcript was released, it was noted this was a ridiculous comment. Yet, he persists. If the government approached every financial institution's potential insolvency as it did AIG, the government would have owned 6,000 banks in three days' time.

One finding shows AIG's nationalization - the government acquiring equity ownership from shareholders - was an ad lib operation by the trio. The finding states: "The Federal Reserve had no authority to purchase or hold equity," the facts include (there are many more):

Geithner: "Under section 13(3) of the Federal Reserve Act, the Fed is prohibited from taking equity or unsecured debt positions in a firm".

Bernanke: "The Federal Reserve is authorized under the Federal Reserve Act to extend credit in various forms, but is not authorized to purchase equity securities of financial institutions."

Bernanke: "We had only one tool, and that tool was the ability of the Federal Reserve under 13(3) authority to lend money against collateral. Not to put capital into a company but only to lend against collateral."

Paulson, referring to the Federal Reserve: "They legally couldn't do preferred. They legally could only make a loan."

 "FRBNY General Counsel Thomas Baxter wrote to Federal Reserve General Counsel Scott Alvarez confirming "we agree that there is no power" for the Federal Reserve "to hold AIG shares."

"FRBNY's independent auditor Deloitte: "FRBNY cannot legally control a commercial company, and therefore it is not appropriate for them to consolidate an entity it cannot legally own."

Another Finding eliminates the only other legal conduit for AIG's nationalization. "In September 2008, Treasury had no authority to purchase or hold equity." Some of the many facts that confirm Bernanke, Paulson, and Geithner broke the law. Nay, they trampled our protection from tyranny with jackboots. Facts follow: 

"The "Treasury Department as of September of  2008 had no budgetary authority to invest in equities, securities of any financial institution."

"FRBNY counsel to Federal Reserve Board officials on September 17, 2008, concerning 'Issues with regard to the NY Fed/Treasury's equity participation in AIG,' Treasury 'consider[s] themselves legally unable to assume ownership. This leaves the NYFed as Treasury's place to house the equity position.'"

"September 17, 2008 report of Treasury's external counsel at Wachtell: 'Treasury legal is telling, as per doj, that they cannot hold voting shares.'"

"TARP Chief Investment Officer Jim Lambright: In 'September when the Fed extended the credit facility, the government didn't have an equity tool.'"

"Board of Governors Legal Division: "'We understand that the Treasury lacks the legal authority to hold directly voting stock of AIG.'"

"Paulson: 'Q. And prior to TARP's approval, Treasury did not have the authority to purchase equity, either. Right?
 A. Correct.'"

            Given the cleavage from reason by our policy makers (one last, irresistible Fact: no one from AIG was allowed in the room during its nationalization), consider: (1) interests you may hold in financial institutions and (2) Paul Singer's description of the now legal means to redistribute those interests. Financial firms are more leveraged than is generally understood. Sell their securities.

Friday, August 29, 2014

Handing Out Money

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009), which was translated and republished in Chinese (2014). He is researching a book about Ben Bernanke. He writes a blog at

To be clear on the main point of "The Killing Fields": The world's central banks have been working for well over a year on handing out money to the people. Their intention is to avoid the intermediate step of operating through commercial banks. The Federal Reserve, for example, generates (through electronic dollar credits to the banks) "money" (as the word is used today) in operations between the New York Fed and the primary dealers. After these electronic dollars are credited to banks, the money does not always get lent out or go where the central banks would like. The central banks are trying to get legislation that will permit direct currency transfers to the people. 

Thursday, August 28, 2014

The Killing Fields

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009), which was translated and republished in Chinese (2014). He is researching a book about Ben Bernanke. He writes a blog at

            The house organ for the Council of Foreign Relations, Foreign Affairs, has published its final solution under the title: "Print Less and Transfer More: Why Central Banks Should Give Money directly to the People."  Written under the names Mark Blyth and Eric Lonergan, but trumpeting the establishment voice of, say, Martin Wolf, they state: "It's well past time, then, for U.S. policymakers - as well as their counterparts in other developed countries -  to consider a version of Friedman's helicopter drops.... Many in the private sector don't want to take out any more loans; they believe their debt levels are already too high. That's especially bad news for central bankers: when households and businesses refuse to rapidly increase their borrowing, monetary policy can't do much to increase their spending.... Governments must do better. Rather than trying to spur private-sector spending through asset purchases or interest-rate changes, central banks, such as the Fed, should hand consumers cash directly.... The transfers wouldn't cause damaging inflation, and few doubt that they would work. The only real question is why no government has tried them."

           This is a fairly standard view among celebrity economists these days, possibly worth commemorating since the CFR has joined the deluge, although, there are adult members of the CFR who should denounce this position. Money printing by Bernanke and kin has been ad hoc from the beginning, as the ecstatic and clairvoyant B├╝rgermeisteramt made clear when ZIRP besotted the world (see: "Meet Your Investment Manager").

            That "few doubt [handing out money] would work" is true within academia and has-been institutions. History has recorded the contrary. Chase van der Roehr, writing in the August 19, 2014, edition of Bloomberg Briefs, noted "it now takes $37,403 added to the Fed's balance sheet to stimulate the creation of a new job. That number stood at $7,600 in August 2008 and has deteriorated steadily ever since."

            The median new job pays much less, so the $37,403-to-1 ratio, after being adjusted for a constant quality, is infinite. "[F]ew doubt that they would work" since those polled are entirely ignorant of all but each others' opinions.

            Printing money has never worked, the grander the scale the worse the calamity. The French state in 1790 was falling deeper into debt. The Assembly first confiscated Church property, found itself deeper in debt, authorized a 400 million assignat print, with a pledge that no more currency would be issued. The poor grew poorer, starved, and cries of "We need more money!" elicited another 800 million assignats. This ended in collapse, including the redemptive pleasure of Assemblymen rolled on tumbrels through the streets of Paris to their end.

            Germany in the early 1920s suffered central banker Rudolf Haverstein's delusion. As jobs disappeared along with food, Haverstein worked the presses to death. (Ludwig von Mises recalled hearing "the heavy drone of the Austrian Bank's printing presses which were running incessantly day and night to produce new bank notes in Vienna." Austria was following Germany's lead; a temptation it still suffered from in the 1930s.)

The historian Alan Bullock wrote: "[The inflation] had the effect, which is the unique quality of economic catastrophe, of reaching down and touching every single member of the community in a way in which no political event can. The savings of the middle classes and working classes were wiped out at a single blow with a ruthlessness which no revolution could ever equal..."

Today, Japan's fascinating yen-printing campaign imitates the same blue print. It is ending with the people unable to pay for food; or much else; Nissan, Toyota, and Honda moving to Mexico; so eliciting hysterical government responses. Bloomberg reporter Katsuyo Kuwako captured the moment in "Japanese Women Armed with Chainsaws Head to the Hills under Abe's Plan." Kuwako reported Comrade "Junko Otsuka quit her job in Tokyo and headed for the woods, swapping a computer for a bush cutter and her air-conditioned office for the side of a mountain. She was part of a new wave of women taking forestry jobs, the result of economic, social and environmental policies sprouting in Prime Minister Shinzo Abe's Japan. Otsuka... said she's fine with the 20 percent pay cut to be the first female logger at Tokyo Chainsaws.... [Abe] set a goal of... revitalizing regional economies and enhancing women's roles."
Adam Posen -
Heavyweight Inflationist
Japanese economic policy is dictated from the United States. Maybe it should not be a surprise to read Junko's elation at a 20% pay cut to "[enhance] women's roles." After all, somehow the Conference Board was able to report U.S. consumer confidence is at a seven-year-high on August 26, 2014. Adam Posen, quad-author along with Ben S. Bernanke of Inflation Targeting: Lessons from the International Experience, is truly a man of the moment as money experiments go extraterrestrial. Posen was quoted in "We Are All Lab Rats Now" featured in "May 2014: Crematorium" (earlier visage and caption thrown in for free). Lord Circumference harassed Financial Times readers in March with his Trotskyite reforms in Japan:  "Increasing female labour force participation is the right priority for structural reform. At least three million women who could work are neither in employment nor looking for a job. A few million more are squandering their capabilities in limited roles...." 
Comrade Lara - Not so fine with Lenin's 20 percent cut.

Repeating the conclusion of "Meet Your Investment Manager," this crowd has so bungled every decision the possibility rises that a run-for-the-exits will be halted by markets being closed. If so, that would be trial-and-error too, as we saw in 2008. It is important to develop a strategy that can respond as circumstances change to preserve assets. 

Wednesday, August 20, 2014

Meet Your Investment Manager

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009), which was translated and republished in Chinese (2014). He is researching a book about Ben Bernanke. He writes a blog at

         There is little else left in the asset-pricing world than central bankers. The redoubtable Ben Hunt, chief risk officer at Salient investment managers ($20 billion under management), wrote on David Stockman's Contra Corner: "I've spent the past few weeks meeting Salient clients and partners across the country.... When I had conversations [with clients and partners] six months ago, I would get a fair amount of resistance to the notion that narratives dominate markets and that we're in an Emperor's New Clothes world. Today, everyone believes that market price levels are largely driven by monetary policy and that we are being played by politicians and central bankers using their words for effect rather than direct communication. No one requires convincing that markets are unsupported by real world economic activity. Everyone believes that this will all end badly, and the only real question is when."

This might be referred to as "End-of the-Cycle Mispricing, but, what a cycle! End-of-the-Cycle Mispricing discussed the derangement of prices, in all assets. Money managers as a whole have not considered protection for their funds when everyone runs for the door at once. The "catastrophic bond" paper linked to the discussion was specific, but, there are plenty of avenues to construct such protection.

What follows is a transcription of just how ignorant, moreover, willingly ignorant, and, it may be, enthusiastically ignorant, was the Bernanke Fed when it decided that holding interest rates at zero percent would be its policy. Before plunging through the looking glass, here is the conclusion: If ever there was a time to protect one's assets from further FOMC derangement, this is it. If you do not (and cannot) design a Personal Protection Plan, buy cash, gold nuggets, and silver eagles. 

Reading the transcript from the December 15-16, 2008, FOMC meeting, it is clear the Federal Open Market Committee was embarking on its zero-interest rate policy (ZIRP - which is still all we've got) as an experiment.

By way of background, the FOMC had cut the Fed funds rate cut from 5.25% on June 29, 2006 to 1.00% on October 29, 2008. Most of reduction had been over the previous few months as the pillars fell: Bear Stearns, Merrill Lynch, Lehman Brothers, Goldman Sachs, and Morgan Stanley. The last two converted to commercial banks and received government protection as well as deposit-taking authorization.

The December meeting addressed whether the funds rate should be cut to zero (ZIRP), or, to some halfway house. As has been true throughout Bernanke's chairmanship, the 284-page debate could only have been held in the Eccles Building. The funds rate had been trading below the declared rate for a couple of months. One can only imagine the ecstasy at the Fed on December 12, 2008, when the funds rate traded at 0.00%: the "zero-bound." This had been Professor Bernanke's ad pitch since the early 1990s.

Two members of the Committee stand out as particularly itchy to get on with it, Chairman Bernanke and (then) San Francisco Federal Reserve President Janet Yellen. Bernanke broke with precedent by speaking first. Normally, the Chairman opens with a few remarks but waits until all FOMC members (plus non-voting regional presidents) have voiced their opinions before holding forth.

            In synopsis, there was no debate, not because fed funds were trading at zero already. The FOMC was discussing Fed policy. In Bernanke's words: "[W]e are at a historic juncture.... [o]f necessity, moving towards new approaches.... [T]his is a work in progress." One might wonder if the Fed chairman had created the "necessity" so that he could breathlessly declare this "historic juncture," and he could experiment with his textbook diagrams: His "work in progress."

            Through his great experiment, Bernanke seems not to have blanched at heaving new innovations from the Eccles Building without knowing what might follow. At the October 28-29, FOMC meeting, about three weeks after the Fed first paid banks interest on their reserves, Federal Reserve Governor Elizabeth Duke reported: "I asked [the banks] specifically this question about interest rates on reserves, and every single one of them said: 'We haven't had time to even focus on it. We don't even know what's going on with that.'" Bernanke responded: "Learning theory in practice. Thank you very much."

            You may remember the many borrowing windows opened by the Fed in 2008. The transcript shows there was little coherence to these conduits. At the December meeting, Bernanke said: "We have adopted a series of programs, all of which involve some type of lending or asset purchase.... [of] which even I do not know all of the acronyms anymore." Anymore? A viewer of Bernanke during Senate testimony would question whether he knew what they did to begin with.

St. Louis Federal Reserve President James Bullard lamented later in the same meeting: "I would like to see us work harder, maybe much harder, on the metrics for success of these facilities [the various borrowing windows - FJS] and perhaps rework or discontinue facilities that may not be meeting expectations.... Frankly, I am not sure in all cases what the purpose of the programs is. We have a lot of them out there. We have ideas. We should quantify that. We should be assessing, and then we should turn around and say, 'This one is working. This one is not working.' I would like to see a lot more in that direction. I understand that we haven't done it so far...." The Bernanke Fed tendency might be summed: "Assess the facilities? Why bother? Open another one."

Everyone had their say at the December meeting, During the Greenspan and Bernanke pontificates, members who disagreed with the FOMC vote were talking to a wall. In the meeting under discussion, the topic was whether to confiscate the People's interest rates (and interest earnings) or not.

The chairman opened: "I'd like to ask your indulgence. There's an awful lot here, and I'd like to go first this time and try to clear out some underbrush and to lay down some issues in the hope that it will perhaps focus our discussion a bit more." The message is unmistakable: the FOMC would vote to ZIRP the American people.

There were several members who contested ZIRP. The FOMC member chosen for exposition here is St. Louis Federal Reserve President James Bullard. This choice is two-fold. His concerns were worries a college professor might express, one who talked about - in fact, Bernanke hid behind - models, the "literature," and theory. Bullard has also been selected since he holds the bone fides Bernanke cherishes. Bullard's papers have been published in the American Economic Review, Journal of Monetary Economics, Macroeconomic Dynamics, and Journal of Money, Credit, and Banking.
The St. Louis Fed president explained his demurral: "I do not find the Reifschneider-Williams paper, which I know carries some weight around here, very compelling, so let me give the brief reasons behind that. For one thing, you are taking a model and you are extrapolating far outside the experience on which the model is based. That might be a first pass, but that is probably not a good way to make policy, and I wouldn't base policy on something like that."

What (you may not have the slightest interest in knowing), is the Reifschneider-Williams paper? David Reifschneider and John C. Williams wrote a paper in 2000, "Three Lessons for Monetary Policy in a Low-Inflation Era." The paper describes "limits to policy accommodation attributable to the lower bound on rates." The person who described the paper in that phrase will be identified later, though anyone who's been around the past few years probably has a hunch.

The second of Bullard's concerns: "There are also important nonlinearities. This whole debate is about nonlinearities as you get to the zero bound, and in my view, they are not taken into account appropriately in this analysis. You have households and businesses that are going to understand very well that there is a zero bound. It has been widely discussed for the past year. They are going to take this into account when they are making their decisions, so you have to incorporate that into the analysis. That is a tall order-there are papers around that try to do that, and many other assumptions have to go into that."

The fellow who has been widely published on macroeconomic matters went on: "The third thing I think is important is that, in other contexts, gradualism or policy inertia is actually celebrated as an important part of a successful, optimal monetary policy. Mike Woodford, in particular, has papers on optimal monetary policy inertia, and many others have worked on it. In those papers, it is all about making your actions gradual and making sure that they convey some benefit to the equilibrium that you will get.

"All of a sudden, in this particular analysis, when you are facing a zero bound, that [taking a gradual, deliberate approach towards a zero percent interest rate - FJS] goes out the window, and I don't think that it is taken into account appropriately in the analysis.

"Also, it is thrown out the window exactly at a time when you might think that the inertia and the gradualism are most important, which would be in time of crisis when you want to steer the ship in a steady way." Yes, you might think.

Bullard had plenty more to say at the December 2008 meeting. Others who zapped ZIRP were Dallas Federal Reserve President Richard Fisher, Philadelphia President Charles Plosser, and Richmond President Jeffrey Lacker. One of Plosser's many admonitions: "We still do not understand why having interest rates on reserves isn't working to keep the funds rate at its target, and there may well be unintended consequences of moving our target to zero, beyond those well articulated in the Board's staff notes." Plosser's audience had no interest in whether FOMC steps actually worked or not. Bernanke had already said, regarding Governor Duke's lack of knowledge by the banks: "Learning theory in practice. Thank you very much."

I could probably list another hundred - certainly at least fifty - other objections stated at that meeting against establishing a zero-interest rate policy. Today, at least a thousand problems created by ZIRP are throttling us.

There is not the slightest chance Chairman Yellen will lift rates. The market will do that. Yellen, then San Francisco Federal Reserve President, did not acknowledge any reason to deliberate over ZIRP: "I see few advantages to gradualism, and certainly whenever we approach the zero bound, I think the funds rate target should be quickly reduced toward zero. [Outside of the Eccles Building, it was 0.00% - FJS] As to the level of the lower bound, my default position is that we should move the target funds rate all the way to zero because that would provide the most macroeconomic stimulus."  From current speeches, it is obvious she still believes that final sentence.

            The answer to the pop quiz: Who said the Reifschneider-Williams paper describes "limits to policy accommodation attributable to the lower bound on rates?" Nobody. That is footnote number 24 to Ben S. Bernanke's speech on August 31, 2012, at Jackson Hole, Wyoming, "Monetary Policy since the Onset of the Crisis." He committed murder in his footnotes to speeches. The claim to which he attached the footnote is as improbable as he is, and Bernanke is abusing the paper (as Bullard warned the FOMC) by extrapolating its conclusions to a situation (ZIRP) which is "far outside the experience on which the model is based" to bilge his way past the crowd at Jackson Hole. That is never hard to do. Some investment manager.
            Given the FOMC's ad lib policymaking, it is difficult to believe they have any idea what to do when - yes, when - the run on the markets start, other than to close markets. This is the time to construct an avenue of personal protection.