Tuesday, June 28, 2011

The Education Gap

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) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

On June 22, 2011, the Federal Open Market Committee (FOMC) concluded a two-day meeting. This was followed by the obligatory press release. That statement was followed by a press conference featuring Federal Reserve Chairman Ben S. Bernanke. CNBC, in the person of Maria Bartiromo, interviewed three former FOMC members later in the day:

LEE HOSKINS, President of the Cleveland Federal Reserve branch, 1987-1991.

WILLIAM FORD, President of the Atlanta Federal Reserve branch, 1980-1983.

ROBERT HELLER, Federal Reserve Board of Governors, 1986-1989.

There was no disagreement among the three. There was one subject that all three emphasized: Simple Ben's QEII-Money-Flooding-Zero-Interest-Rate Policy (MFZIRP) has left the economy in a worse state than if he had done nothing at all.

Following are some of their comments:

LEE HOSKINS: I think the Fed is doing great damage by running negative real interest rates so long. That's a misallocation of capital.... The Fed made it real clear today they don't control employment and they don't control real GDP. They should stick with trying to control the one thing they can and that's inflation.

[At this point, BARTIROMO, sounding a bit like Bernanke might in a similar discussion, asked what the Fed should do about the fragile economy. HOSKINS continued, repeated what he had already said, in a manner that suggested he was speaking to a four-year-old]: The Fed doesn't control real growth, they don't control employment. The only thing over time the Fed can control is inflation. If we try to saddle the Fed with a bunch of other responsibilities, we're going to hurt the one thing that the Fed can control over time. If they control inflation, then the business community and individuals will make decisions that will expand the economy. But, the uncertainty surrounding negative real interest rates and what [they do] to capital markets and the dollar seem to be a real negative to this policy.

WILLIAM FORD: Nothing the Fed has done has helped positive GDP growth. It has not fixed the housing crisis by lowering rates to historic low levels. It has not promoted business investment, borrowing and spending. It's killed the dollar without helping exports a lot and that's causing inflation of import prices to go up. Most importantly, they are hurting America's elderly people by having 14 trillion of personal savings accounts of all kinds subject to interest rates that are 5 percent below where they normally are two years after the recession is over. That's costing elderly people about $300 billion. It's reduced GDP because they don't have the money to spend.

BARTIROMO asked ROBERT HELLER about the "reacceleration the chairman [i.e., Bernanke] is expecting in the second half." The second half of 2011 commences this Friday:

HELLER: There's a bit of regeneration of the strength in Silicon Valley. A lot of it is really based on Twitter and Facebook. That isn't real strength in the overall economy, teenagers talking to each other more....Overall, I think the economy will have a hard time facing the headwinds. The Fed should be running positive real interest rates.

Monday, June 27, 2011

Inflation Asides

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) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

A note from a reader:

In 1977 I accidentally ran into a high school friend of mine who had taken an advanced degree in mathematics and statistical analysis. He was working for [Federal Reserve Chairman Arthur] Burn's Fed. He informed me that he was working on a new methodology of calculating the inflation rate. When I asked what it was based on he demurred saying it was "Classified Secret." I was truly stunned. He did imply that, when done, the new methodology would greatly reduce the reported value. Sure enough, during the Volcker Fed, the new methodology was introduced and has been modified since then to greatly reduce the reported numbers. It made the Volcker effort at controlling inflation seem much more effective than it actually was.

However, if one takes 1965 as the starting year for the present acceleration of inflation it can be shown that, on average, the cost of living has gone up about 1400%. And, the total money supply has also grown - up to 2008 - about the same. So, a person willing to do the research can always by-pass short-term obfuscation and see the truth through widely available published costs of living.

Furthermore, there is qualitative inflation on top of the quantitative. Now, the Fed constantly claims that a rise in costs is offset by a rise in quality and so cancels out. This has been true in the field of micro-electronics. However, in key areas of food and housing this is not so. In particular many food costs have been hidden by a reduction in amount and quality of the item. Just look at the reduction in the size of a can of tuna fish since 1965. The best tuna has gone down from 8.5 to 5.0 oz while rising over 1600% in price while the quality has suffered so that producers use every trick in the book to make lesser cuts of the fish look like albacore. So the actual rise in price is much, much more than the nominal rise.

Another thoughtful note from a reader:

Thanks for your good work. I just read your piece "Sick Minds" on Safe Haven and it occurs to me that a price index should only measure price changes of a fixed basket of goods. A consumer price index should be based on how the median household spends its income at time A and how those prices change going forward. That includes taxes! Another price index should be generated for the median household of seniors.

The current gov't approved methods are for a subsistence price index (SPI).

Clearly the government can't be trusted to provide meaningful statistics and this should be farmed out to universities. Government meddling into how the statistics are generated should be outlawed. The universities should face peer review on whatever series they are charged with generating. Get rid of the BLS and the other government statistics generators and fund the universities for this work.

My reply:

Thanks, I agree with what you write with one reservation: whether the academics could be trusted. Celebrity economists - the Fedheads, Nobels, CNBC heroes - would be the go-to "experts" who would fashion the peer structure. These supercilious windbags already live off government money that funds their economic departments, academic chairs funded by Interests (the Alan Greenspan Chair in Economics at New York University, funded by hedge-fund manager John Paulson, who made his fortune off the mortgage collapse), their web of memberships on corporate boards, their insatiable appetite for continual exposure on CNBC, the money they receive to write studies for vested interests (e.g., the Stiglitz, Orzag(s) thumbs-up for Fannie Mae; Mishkin's celebration of Iceland's banking system) - I hope that someday this scandal is seen for what it is, at which point the academics could be trusted to establish such a peer review.

If we reached that point, we might also be able to trust the BLS, but I'm with you in trashing it. I think Sir John Cowperthwaithe, Britain's financial secretary to Hong Kong in the 1950s, was on to something. He did not allow his government to collect statistics for fear the statistics themselves would define policy. In the U.S., this is seen in our infatuation with "growth" no matter the human and material wreckage choking in the gutter, a sure sign of our government's and of the economic establishment's senility.

Thursday, June 23, 2011

Sick Minds

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) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

- June 22, 2011 - "Lawmakers are considering changing how the Consumer Price Index is calculated, a move that could save perhaps $220 billion and represent significant progress in the ongoing federal debt ceiling and deficit reduction talks.

"According to congressional aides familiar with the discussions, the proposal would shift how the Consumer Price Index is calculated to reflect how people tend to change spending patterns when prices increase. For example, consumers tend to drive less when gas prices increase dramatically.

"Such a move is widely seen by economists as resulting in a slower rise in inflation. That would impact an array of federal programs that are linked to CPI including the Social Security program and income tax brackets set by the federal government."

Social Security payments must be reduced. Promises were made - by lawmakers - that are beyond the government's (the taxpayer's) ability to pay. The latest scheme is a ploy by cowardly elected representatives who surreptitiously cut benefits for those most in need: the old and the frail.

First, the logic is indefensible: Gasoline prices rise; higher prices are unaffordable; people drive less; less gasoline is consumed; the Bureau of Labor Statistics (BLS) reduces the weighting of gasoline in the Consumer Price Index (CPI) calculation; this cuts gasoline's (and, other products that are rising in price) influence on the CPI; the Consumer Price Index falls. Ergo, Chairman Ben S. Bernanke, in a future and "dreary" press conference (the adjective used by the Wall Street Journal to describe his session with reporters on June 22, 2011), states that inflation is falling.

Second, as mentioned above, this is hidden from public view. The official, government CPI which is used to increase Social Security benefits (e.g., if the CPI rises by 2.0%, next year's Social Security checks go up 2.0%), will understate costs, reduce the ability to buy gas further, which will reduce gasoline's proportion in the CPI even more.

By the way, this also reduces the inflation credited to owners of TIPS, or TIIS (Treasury Inflation-Protected Securities). The change reduces the value of TIPS.

It would be interesting to know if the amount spent on gasoline actually falls. The amount of gas (in gallons) might be less, but the increase in price could mean the dollars spent are proportionately greater to total costs. You can be sure the BLS has devised a method that has eliminated the possibility, which leads to:

Third, this latest scam is part of a long-running ploy to reduce Social Security benefits without inconveniencing politicians. Chapter 12 of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession is the history of Social Security and inflation manipulations between 1983 and the mid-1990s. From Alan Greenspan's 1983 Social Security Commission through Michael Boskin's contorted changes to the CPI measurement (1995), Social Security payments have already been reduced well below what they should be. One estimate, by Richard Karn, author of Emerging Trends Report, calculates that Social Security checks would have been 43% higher by 2006 if not for the chicanery of the scandalous Boskin Commission, a decade before.

Fourth, this latest effort shows the talk about reducing the deficit, cutting spending, and reaching an agreement on the debt ceiling is exactly that - talk. (As if you needed to be told.) Lawmakers may pat themselves on the back for this gift from the BLS, but a $220 billion spending cut is a drop in the ocean (and, probably a projection over the next 20 or 50 years). Social Security needs to be addressed by increasing, and by a substantial amount, the age at which retirement benefits can first be collected. Starving the old and the frail is not only a sick policy, it is also camouflage to win the next election.

Friday, June 17, 2011

What They Are Saying

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) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

It was not difficult for an observer to understand Armageddon beckoned by 2006, as long as the observer listened to practitioners rather than theorists. The theorists: government bureaucrats and their sycophants, clog the media's arteries. Those who listened to practitioners were prepared in 2007.

The same is true today. Following are two groups of practitioner opinions: those from 2006 and 2007; then, those today.


"The enormous monetization of hard assets has created a massive amount of liquidity....Together with [the rising demand for income in the developed world], these factors are reducing the relative expectations on equity..."

-Sam Zell, in December 2005, who cashed out with a $39 billion sale of Equity Office Properties to Stephen Schwartzman, December 2006

"We have low interest rates, tons of money in both private equity and debt markets.... But when it ends, it ends badly. One of those signs is when dummies can get money and that's where we are now."

-Stephen Schwartzman, February 2006, who paid Sam Zell $39 billion sale for Equity Office Properties in December 2006 - then really cashed out.

"Clearly I'm exaggerating here, but what's the difference between a $30 billion and a $300 billion deal? It's just a few more phone calls."

-Ed Keon, Prudential Securities, September 2006

"The world is flooded with too much capital. It is virtually impossible to find any asset class that offers attractive value to investors."

-Goldman Sachs, "Outlook for 2007", January 2007

"[Carlyle] Group's fabulous profits are not solely a function of our investment genius but..... [from] the availability of enormous amounts of cheap debt."

-Bill Conway, co-founder, Carlyle Group, memo to employees, early 2007

"This is better than it gets for the private equity industry....Of all the bubbles, the bubble in the credit market today is one of the greatest - it is beyond any rational measure."

-Steven Rattner, Quadrangle Group, April 2007

"The private equity world is in its golden era right now."

-Henry Kravis, July 2, 2007. Spoken when Kohlberg Kravis Roberts & Co. (KKR) and Texas Pacific Group (TPG) received financing for the peak buyout in 2007: the Texas Utilities $45 billion LBO. It is fine to censure Henry, but the banks were willing.


"Unlike then [late 2008 and early 2009]... we have hardly any room for maneuver. Policy rates are already at zero and central bank balance sheets are bloated. Although private sector debt has started to decline, public debt has taken its place, with sovereign fiscal positions already on an unsustainable path in a number of countries. In short, macroeconomic policy is in a vastly worse position than it was three years ago, with little capacity to combat a new crisis..."

-Bank for International Settlements Annual Report, June 28, 2010

"There's some crap getting done. It's surprising to me this early in the cycle that some of that could be happening."

-David Jacob, executive vice president, S&P,Grant's Interest Rate
Observer, February 11, 2011

"The steep rise in farmland prices we have seen in recent years creates the potential for an agricultural credit problem down the road."

-Federal Deposit and Insurance Commission, March 2011

"Carl Icahn is returning all his capital to his investors: 'Given the rapid run-up over the past few years and our on-going concerns about the economic outlook, I do not want to be responsible to limited partners through another possible market crisis.'"

-Carl Icahn, March 9, 2011, The King Report

"I really find it amazing that we're almost back to where it was, where there is so much leverage finance going on. There's just way to much leverage, way too much risk-taking with other people's money."

-Carl Icahn, May 27, 2011, interview on CNBC

"'Banks are leveraged 20 to 1 and their portfolios are mainly comprised of government bonds and mortgages,' the founder of Sprott Asset Management said. 'House prices keep going down, the number of people underwater keeps getting worse. That leverage is going to work massively against anyone whose lender is in that area. The dominoes are starting to fall.'"

-Eric Sprott, Sprott Capital Management, May 13, 2011, Bloomberg Hedge Fund Briefs

"Mr. Carney said... that the world is by no means out of its financial crisis and won't be for years. Systemic risk remains high..."

-"Mr. Carney" is Bank of Canada Governor Mark Carney - who holds the equivalent position to Federal Reserve Chairman Ben S. Bernanke. This was said at an "off-the-record" meeting but a dishonorable attendee squealed. It is worth noting that Mark Carney is a veteran of Goldman, Sachs & Co., so understands the financial system, unlike his American counterpart who would only recognize a financial crisis if someone stole his ATM card.

"Should you worry more about losing money or missing opportunities? That's an easy one for me. First, the macro uncertainties tell me we won't be seeing a highly effervescent economy or market environment. Second, people's increasingly aggressive behavior tells me to seek cover. And third, since I don't see many compelling cheap assets, I doubt there will be gains big enough to make us kick ourselves for having invested too cautiously."

-Howard Marks; Chairman, Oaktree Capital; Memo to Oaktree clients;
May 25, 2011

"'Another financial crisis is 'inevitable,' Mark Mobius, head of Templeton's Emerging Markets Group told CNBC Tuesday. 'The financial problems caused by the subprime mortgage crisis 'have not really been solved. Banks that were too big to fail have gotten bigger. Bank balance sheets around the world are not that healthy. So you have the situation which, if not corrected, will result in another crisis.'"

-June 7, 2011, CNBC.com

FLASHBACK: "Mark Mobius, the portfolio manager at Templeton Emerging Markets group, said in Paris that recent volatility of Internet stocks could be indicating a crash for the sector. 'I think we are nearing the time, that is my guess, and it will be big,' Reuters quoted him as saying. 'Some stocks will be 90 percent or 50 percent down.'"

-New York Times, March 30, 2000.

"'It's probably the most attractive financing that we've ever done, Kravis said.... The financial markets rebounded much faster than the economy.' "

-Henry Kravis, talking about funding for Del Monte takeover,
March 4, 2011, Bloomberg

FOUR DAYS LATER, March 8, 2011, Wall Street Journal: "A humiliating endgame for the largest leveraged buyout in history may come sooner than investors had anticipated.... Even owners Kohlberg Kravis Roberts & Co. and TPG have acknowledged the deal has become an albatross. KKR has already written down the $8 billion equity investment by 80%."

-The banks are more willing than ever.

CORRECTION: The subtraction calculation (net birth-deaths) in the government's Employment Situation Report is more byzantine than shown in Playing Old Maid. One part of the equation has been seasonally adjusted and one has not. The spirit of the distortion remains unchanged.

Tuesday, June 7, 2011

The Consumption Bust

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) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

There is no end to the indicators showing the consumer is up against it. Negative home-equity, incomes, layoffs, food inflation - oh, this is a tale of woe. And so, the plaintive cry: "Is this the bottom?" That seems doubtful, actually impossible, given the math.

There will be no addition or subtraction here, but an observation. The bottom - for stocks and people - does not follow a panic. An example is the stock market bottom in March 2009. After a panic (stocks) or a spree (spending), a long period of lethargy and revulsion follow. Then the juices flow again.

The government preempted this cycle after the Internet crash, mortgage bust, and with its stock market boost in March 2009. From there, the S&P 500 doubled. That was fun for some, but it defied nature. Wither QE3?, is the question of the hour. For those who are hopeful the Fed will leave us alone, there are signs the cycle is drifting towards recovery. That is - the requisite period of lethargy is upon us.

The following comes by way of my youngest sister, last seen playing Old Maid at the age of four (Playing Old Maid); now, doing her part to keep America alive, by shopping.

She called me after leaving Target, a go get'em retail chain fulfilling its patriotic duty: It sold $67 billion of paraphernalia last year. My sister's exit conversation follows:

Target cashier
: "Did you find everything you wanted?"

: "No."

Target Cashier
: "That's OK. You saved some money."

Saturday, June 4, 2011

Playing Old Maid

When my youngest sister was four-years-old, we taught her how to play Old Maid. She learned quickly but played the game like - a four-year-old. When she was dealt the Old Maid, her little thumb would push it a couple of inches above the others in her hand. She did this with a giggle since her maneuver was tricking us (in her 4-year-old mind) into taking the Old Maid. She succeeded; someone would remove it from her hand so that she could say: "Ha, Ha, you have the Old Maid!"

Today, the Bureau of Labor Statistics (BLS) has a four-year-old mind. This morning, June 3, 2011, it released its monthly Employment Situation Report. The very first words were: "Non-farm employment changed little (+54,000) in May..." Nowhere in the 38-page report does the BLS state that the addition of 54,000 jobs was actually a loss of 152,000 jobs.

The BLS invented 206,000 jobs. The Bureau has constructed an equation called the "Net Birth/Death Model." Its purpose is to count "Business births." That is, new jobs in new businesses net the number of lost jobs in "Business deaths": companies that went out of business.

This figure plays a large role in how Americans are told to think about the economy. CNBC did not look beyond the first sentence this morning when it announced The Number: +54,000. It did not mention the 206,000 net birth-death jobs. The Wall Street talking heads who were then interviewed were also ignorant. Last month, on May 6, 2011, the BLS April Employment Situation Report opened: "Non-farm payroll employment rose by 244,000 in April..." The +175,000 net birth/death jobs were not mentioned by Bubble TV and maybe not by any other major media outlet.

There are those who say the net birth/death (NBD) figure is a sophisticated calculation. No doubt it is; but is it accurate? If it is, why does the BLS never mention that NBD jobs were added when it manufactured The Number? Why does it so diligently hide it?

The initiative for the NBD calculation addressed a real problem. The BLS is not equipped to include "business births" in its monthly Employment Situation Report. It makes sense to adjust The Number, but the BLS, like most of Washington, is detached from the economy.

In June 2011, it is ridiculous to conclude the U.S. economy is adding more jobs than it is losing. Yesterday, on June 2, 2011, the National Federation of Independent Business (NFIB), a trade group of smaller businesses, released its latest survey results. (I have found the direction of the trend in the monthly NFIB survey offers a good indication of the direction of the economy.)

Some of the highlights from the June 2, 2011, NFIB release:

"Chief economist for the National Federation of Independent Business (NFIB) William C. Dunkelberg, issued the following statement on May job numbers, based on NFIB's monthly economic survey:

"After solid job gains early in the year, progress has slowed to a trickle. The two NFIB indicators-job openings and hiring plans-that predict the unemployment rate both fell, suggesting that the rate itself will rise.

"Meaningful job creation on Main Street has collapsed.

"With one in four owners still reporting 'weak sales' as their No. 1 business problem, there is little need to add employees, especially with the uncertainty about future labor costs arising from new regulation and legislation."

The Bureau of Labor Statistics pushes the Old Maid above the other cards in its hand each month. It takes five seconds to type "net birth death" into the BLS website's search engine and read this month's NBD number. Yet, it is not mentioned by the media or by Wall Street talking heads. The Bureau of Labor Statistics has every reason to look at America and proclaim: "Ha, Ha, you have the Old Maid!"