Saturday, October 27, 2012


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" (, 2009)

There are many reasons to fear unhedged exposure in the U.S. stock market. Recent corporate conference calls have explored weak or falling revenues. Drooping trade among Asian countries has forewarned of weakness. In the U.S, Europe and Asia, reports describe slumping sales of necessities that may need to be reclassified as luxuries. To rub it in, investment by companies has been scaled back and large layoffs have not slackened.

            There are also reasons to leverage one's position in the stock market. The stated "pro" arguments seem to imply support from central banking. The buy recommendations spring from either a belief in the genius of M.I.T economists, or, in a less ethereal realm, the central banks' announcement of unlimited currency production. Federal Reserve Chairman Ben S. Bernanke is fan of lifting stock prices to grow an economy. The inclination to leverage stocks has at least one stock jockey in high places.

            Following is an excursion that should satisfy the stock-market bulls. The logic has wider application. To wit, one need give no thought to "whether or not" the Fed will continue along the same expansive course. It will. Until it collapses.

This has been stated often here. It was enough to read Bernanke's Essays of the Great Depression (no link - you don't want to read it) years ago, along with the author's cross-referenced essays to Mishkin, et al. A first-time visitor to Paris will note characteristics the life-long resident will miss. In the case of Bernanke & Co., this non-economist was struck by the lack of mental activity, the absence of curiosity, the flight to abstraction, the child-like belief in professorial divine guidance, and the factual mistakes. The latter were generally inconsequential, but the essays are read by contemporaries before publication. This outsider concluded these are not well-read men or women. (We can discuss their mathematical weaknesses another time.)

A chronology of untrammeled Federal Reserve power expansion begins with the September 12, 1961, FOMC meeting. Federal Reserve Chairman William McChesney Martin asked the 12-member committee to vote in favor of currency swaps (dollars-for-sterling). Dallas Federal Reserve President Watrous Irons demanded specific legal authorization via an amendment to the Federal Reserve Act. Governor James Robertson stated the proposal "involves very sensitive international diplomatic operations," so is a job for Treasury. Governor Abbot Mills: "I have no great faith that operations of this kind can be conducted successfully or without serious danger to the independent status of the system." Only three of the 12 voting members (including Martin) expressed verbal approval. It was tabled and finally voted through about six months later. Even after the vote, some FOMC members continued to voice their opposition.

We move to 2008. The Federal Reserve took several actions that, at the very least, demanded "specific legal authorization via an amendment to the Federal Reserve Act." The uneasiness of operating outside the law in 1961 was no more. The Fed and many other government-protected fiefdoms act arbitrarily. The action itself defines new law.

On Friday, March 14, 2008, the Federal Reserve (New York branch) made a $30 billion non-recourse loan to J.P. Morgan to stem the Bear Stearns failure. This was illegal (See John Hussman: "Why is Bear Stearns trading at $6 instead of $2")  Of course, Hussman did not know that such a loan was illegal until the moment it was announced. We have learned since that whatever the Federal Reserve does, is.

(Unrelated but possibly interesting: March 14, 2008, 2:32 P.M, MarketWatch: "Bear Stearns bailed out by Fed, J.P. Morgan." Bloomberg, March 14, 2008: "Bear Stearns Credit Rating Cut Three Levels by S&P." S&P was "concerned about Bear's ability to generate sustainable revenues in an ongoing volatile market environment.")

At such moments, the Fed silences dissidents with a solid wall of noise. Its P.R. coordinates celebrity voices who write in the New York Times, Financial Times, Wall Street Journal, and Washington Post. (The Economist publishes anonymously, but it too is an excellent source for understanding current establishment priorities.) Presumably the equivalent appears on TV.

A recent example: Over the first two or three weeks of October, the Wall of Noise wrote ardent love letters to the residential real estate market in the U.S. The reason is not immediately evident. This twisting of public opinion often becomes clear in hindsight.

Hussman was not the only dissenter; there were others who saw government lawlessness cloaked as national emergency. On Monday, March 17, 2008, Bloomberg interviewed Bank of Israel Governor (equivalent to "Chairman" in the U.S.), Stanley Fischer (see: "Bernanke to Get on Top of Credit Squeeze, Says Israel's Fischer.") The article opened: "Federal Reserve Chairman Ben S. Bernanke has the skills to guide the U.S. economy through a credit squeeze, now in its eighth month, said Bank of Israel Governor Stanley Fischer: 'You can inject liquidity in the economy and it happens that Ben Bernanke is an expert on this issue,' Fischer, 64, who advised the Fed chief on his doctoral thesis at the Massachusetts Institute of Technology in the 1970s.... That the Fed will get on top of this, I don't doubt.'" [Italics mine - FJS]

            From the annual, Jackson Hole, central-banking carnival, you may have seen pictures of Ben Bernanke strolling with an older man. The older man seems to do the talking. That man is Stanley Fischer.

Fischer is a long-time advocate of unlimited currency production. As discussed in "The 8% Solution" Stanley Fischer, when he was First Deputy Managing Director of the International Monetary Fund, wrote a paper: "Maintaining Price Stability." In the very first sentence, he pledged: "The fundamental task of a central bank is to preserve the value of the currency." Only five paragraphs later, Fischer wrote: "Barro (1995) and Sarel (1996) do not find a clear negative relationship below 8 percent inflation..." That is, as long as the negative interest rate remains at eight percent or below, inflation is not a burden to economic growth.

That the populace would suffer not a twit if prices were rising by 8% per annum while earning nothing on its savings is an affront to common sense. But Fischer was writing neither to the populace nor to common sense. Returning to "Barro (1995) and Sarel (1996)," how did the combo unearth such path-breaking news? Their authority was "Fischer (1993)." Along with Bernanke's Essays of the Great Depression, here is more junk that economists call scholarship, or, when they really want to intimidate the unwashed: "the literature." (Chairman Bernanke, on August 31, 2012: "Some have taken the lack of progress [blah, blah, blah - FJS].... The literature on this issue is extensive, and I cannot fully review it today." Of course, Bernanke neither reviewed the Literature fully nor did he mention a single word from the sacred texts.

One more peek at the Wall of Noise was August 25, 2009. That was the day President Obama announced his reappointment of Bernanke to the Fed chairmanship. (Senate confirmation would come later.) Among the cheerleaders, Roger Altman, former Treasury official under Bill Clinton and rainmaker in the General Motors bankruptcy (Evercore Partners), wrote in the August 24, 2009, Financial Times: "The Federal Reserve has come under unprecedented attack in recent weeks, largely triggered by its proposed designation as America's primary financial regulator.... [T]here are populists and others who just dislike a strong central bank. They want to curtail its independence and/or derail the reappointment of Ben Bernanke, Fed chairman, to a new term....Last year's disaster made clear that system-wide regulation is mandatory. The Fed is the only qualified party." Why would a financial newspaper, widely trusted, so bearing a duty to trustworthiness, publish pure propaganda? We'll come to that. (On October 11, 2012, the Financial Times editorial page published Roger Altman's "A Housing Boom Will Lift the U.S. Economy." We'll come to that, too, in about 80 years.)

On August 26, 2009, Bloomberg was handed the P.R. script and published an announcement that Bernanke could roll the dice. In  "Bernanke May Redefine Fed Mission in Financial Market Stability," Bloomberg opened: "Ben S. Bernanke's renomination allows him to redefine the Federal Reserve's mission as he expands its power over financial markets and pulls back on a credit surge the central bank used to keep the economy from collapse, economists say. Bernanke's agenda during the next four years will include elevating the Fed's role in reducing excessive risk in major financial institutions, figuring out how to curtail asset bubbles, and scaling back $1.2 trillion of monetary stimulus. 'He will have the opportunity to permanently change the structure of the Federal Reserve system,' said Vincent Reinhart, a former director of the Fed's Monetary Affairs Division who's now a resident scholar at the American Enterprise Institute, a Washington-based research group."

Reinhart is now chief United States economist at Morgan Stanley. Oh, for the days of Barton Biggs, Byron Wien, Andy Xie, and Stephen Roach!

Ben Bernanke has touted appreciating assets to trigger the economy. On appearance, the stock market is outside the Fed's purview. A paper penned by the Dallas Federal Reserve in May 2003: "Monetary Policy in a Zero-Interest-Rate Economy," included a table on page seven of domestic securities the Fed could, by law, purchase. There is (though the paper is apparently no longer on the Dallas Fed's website) also a list of "not allowed." Included are corporate bonds, mortgages, and equities. Whether by amendment or ignorance, the Fed is now buying $40 billion of mortgages a month. There must be corporate bonds among the Maiden Lane residue and assorted bric-a-brac hiding on the Fed's balance sheet.

As to equities, the Bank of Israel announced, on March 1, 2012 (via Reuters), it "has begun to invest about $1.5 billion of its foreign exchange reserves in U.S. stocks to diversify its risk."  That was 2% of the Bank's assets. Israel is not alone. Several central banks are now buying stocks. The Swiss National Bank stock allocation rose to 9% of assets earlier this year.

This trend, by the way, is an almost infallible indicator of a sunset market. Western central banks started to sell their gold in the late-1990s from around $250 to maybe $500 an ounce. A favorite is the declaration of Alaska's state treasurer, at the exact moment gold peaked at $850 an ounce in January 1980: "Alaska finds itself in the unenviable position of selling today's most valuable commodity--oil--in exchange for a wasting asset: cash. As state treasurer it is my job to reinvest the money and, ladies and gentlemen, I have not been able to find anything that will consistently maintain the appreciable rate of oil except for one thing--gold." If only he had bought stocks.

As we all know, the U.S. stock markets have not cottoned to Bernanke's September 2012 QEEEEEEE. It is tempting to think the lack of enthusiasm might disturb the Fed chairman but his testimony and press conferences leave one wondering if he thinks the stock market is a cattle-trading scene from Bonanza.

But bulls have more worldly central-banking resources. Stanley Fischer, once Vice Chairman of Citicorp, has now upped the target for the Bank of Israel's purchases of U.S. stocks to 10% of assets. According to an October 9, 2012, report from Reuters "Central Banks, Faced With Paltry Bond Returns Buy More Stocks" this will reach a total of $8 billion. That may not seem like much, but Fischer is well-acquainted with the expansion of central-bank balance sheets.

If an endorsement to exponentially expand and buy up the global, stock market was needed, the Financial Times published an unsigned editorial on October 13, 2012. The title was "Helicopter Money: Extreme Money-Printing Should Be Openly Discussed." The anonymity betrays the muddy, boot prints of bon vivant and the "staggeringly well connected" Martin Wolf, the FT's genius-in-residence. This CBE recipient (Order of the British Empire, an honor bestowed on the staggeringly well-connected Alan Greenspan, CBE) did not have the courtesy to warn his Sovereign that Her Commonwealth was about to come a cropper in 2008, or, in 2003, when the reckoning was already obvious to non-geniuses. Wolf had a valid excuse. The Financial Times' genius admitted to not having anticipated the financial collapse. Not having done so, and apparently not having learned even now that central bank money-printing was the direct cause, he wants to drop currency from helicopters.

Maybe this is good for the stock market but even geniuses miscalculate. 

Friday, October 5, 2012

Beyond Repair

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" (, 2009)

Spain is beyond repair. This is also true of the United States. Following is a bottom-up view of the insatiable parasites clinging to the rump of the Spanish economy and how such gruesome imagery applies elsewhere.

            A Bloomberg story on September 27, 2012, resembled many others since the mid-'oughts: "Spain's Boom-Era Building Gear Sold as Developers Cut Off." This does not need much explanation but a connection is offered: though QE3 is designed, and will (in cases) lift asset prices, gravity rather than levitation is the natural direction of assets.

Construction equipment manufactured during the Spanish housing boom now lounges and pouts, or jets to countries where housing bubbles still offer a thrill. For the connoisseur of booms-and-busts, Berlin, Oslo, and Hong Kong may be peaking. None are likely to match the sheer weight the defunct construction industry loads on the Spanish economy. Bloomberg described its proportions: "The property bonanza that ended in 2008 has left around 2 million unsold homes in Spain, representing supply that will take a decade to absorb.... Spain's construction and real estate industry, which represented 18 percent of gross domestic product before the financial crisis, now accounts for 11 percent and building permits plummeted 87 percent last year from the 2004 peak." [That it has only shrunk from 18% to 11% means the state is spending madly to keep it, and the banks, operating. - FJS] "Work started on fewer than 4,500 houses in February this year, a 94 percent decline from the October 2006 peak."

Towards the bottom of the article, a modern financing mechanism was advanced: "Almost half of Spain's 67,000 developers are insolvent but not bankrupt after getting additional financing from banks, according to R.R. de Acuna & Asociados, a property consulting firm. Extending the lives of companies is becoming harder for banks after Prime Minister Mariano Rajoy's government demanded they set more money aside to cover losses on real estate loans." [My italics. - FJS] That the fantastically over-occupied development sector "is insolvent but not bankrupt" should not be a surprise, at least to Americans, where the same has been true of money-center banks, General Electric and General Motors.

The question arises how the encumbered Spanish banks are extending the lives of the developers. Rifling the archives, Bloomberg also met with Fernando Rodriguez de Acuna, president of R.R. de Acuna & Asociados on July 22, 2009. At that earlier meeting, Sharon Smythe (the author of both articles) learned: "The nation's banks lent about 318 billion euros to domestic real estate companies and also were forced to accept billions of euros of real estate assets in exchange for canceling debt with insolvent developers." The banks accepted the property back from the developers in lieu of payment for the loans.

Fernando Rodriguez de Acuna went on to say (in 2009): "Those assets are sterile, or constantly falling in value, so the banks have to get them off of their books or else they will damage their balance sheets in coming years." One could sigh at Mr. Rodriquez' innocence, but he was not alone in thinking the banks could not indefinitely pretend they held real assets.

         The banks are slowly admitting losses, but Bloomberg's summary is of a slow recognition. Even so, write-downs have left the banks stranded: unable to make loans. Up until now, it appears, the banks and the government were able to carry the building gear manufacturers.

We know bank write-downs in Europe have been limited to window dressing. We may presume the assets that were "sterile, or constantly falling in value," are worth a nominal amount today. Referring to the September 27, 2012, Bloomberg brief in which "Prime Minister Mariano Rajoy's government demanded [banks] set more money aside to cover losses on real estate loans": Money from where? Who would invest in an insolvent bank that is pretending its capital is not impaired? An unaccountable international organization is the best bet.

Let's suppose, first, the ECB is allowed to capitalize banks. We will skip over (second) the Spanish government's "bad bank" plan, and assume it takes wing. Even so, in this most optimistic of scenarios, the revived lending capacity will fund, not strong and growing businesses, but: the Spanish government.

The government's deficit gap is growing fast. On September 25, 2012, Spain reported the January through August deficit rose from 3.81% of GDP in 2011 to 4.77% GDP in 2012. The Spanish government - in the second or third year of "austerity" - has spent 8.9% more euros in 2012 than in 2011. Tax revenues have fallen by 4.6% in 2012. 

The ECB needs to distribute euros at an extraordinary pace to retain the fa├žade of a continent that is not bankrupt.

Of the many reasons the deficit is getting worse, coddling the insolvent but not bankrupt building industry is one. A total of 4,500 houses were built in February. Not all the developers build houses but, when it takes five or ten companies to build one house each month, tax revenues will fall. Living as if this is 2006 will push Spain back to 1492. It is interesting that economists, who sold the world on "GDP" and "productivity," have trapped workers of the world in the most unproductive jail cell imaginable.

Across the ocean, Washington runs business in the United States. This is why employment gains have been in government jobs. This is why the favored financial industry is still far too large for a functioning economy. This is why the capital-equipment industries that invest after projecting demand over the next 10 years are not investing at all. These companies have historically produced most of the high-paying jobs; their absence is the reason new jobs are in the worst paying fields (except for government, which pays a solid, middle-class wage: None of that hedonically-adjusted, ex-food, ex-gas, pay-plan at the BLS.)

Federal Reserve policy props up dead and malignant businesses. Its no-interest-rate gambit is manna for bad companies that contaminate good companies. Good businesses do not hire. They do not invest. In past times, they only had a vague notion of the Federal Reserve chairman since they had business to conduct. Now, they are no less dependent on the ministrations of Bernanke than the Soviet steel industry was to KGB requests. They sit around wondering what Bernanke will do to them next and what this all means. Introspective CEOs are un-American (if not un-Spanish.) The economies run by Rajoy and Bernanke are headed down the same path as the failed enterprises that hopped to the orders of Beria and Malenkov.