Political Science

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)

Frederick Sheehan will speak at the Committee for Monetary Research and Education (CMRE) dinner on Thursday, May 17, 2012. It will be held at The Union League Club in New York. He will discuss "How We Got Here."

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"The French are a free people, who will not allow their future to be determined by the pressure of markets or finance."

-French presidential candidate François Hollande, Ecole Nationale d'Administration (ENA), class of 1980, April 19, 2012

            Hollande expressed an ardent belief of every ENA graduate (popularly known as énarques, a popularity not often witnessed beyond the campus gates.) Economics professors from Harvard, Princeton, and Oxbridge also dismiss markets. They went so far as to claim all markets identify the right price all the time, thus avoiding the need to understand them. Markets are there to be used: a means to institute public policy. Such policies are imposed by the ruling few.

The Bretton Woods gold standard constrained the ambitions of superior persons. When President Nixon defaulted on the United States' gold payment obligation in 1971, he opened the floodgates to Policy Making without Consequences.
In Debt and Delusion: Central Bank Follies That Threaten Economic Disaster (1999), Peter Warburton wrote: "It is easy to forget that, as recently as in the 1960s, the government budgets of the OECD countries were in approximate balance and that net issues of debt were comparatively rare. The outstanding stock of debt in public hands was a meager $800 billion at the end of 1970....While Italy, Ireland, and Belgium were already experimenting with deficit finance in 1970, the USA avoided its first budgetary lapse until 1975."
The developed world (OECD countries) recorded their last balanced budget in 1973, with 12 of the 18 countries in surplus. Rising oil prices was the primary culprit for the 1973 blemish. Discovering markets were no longer constrained by the gold fulcrum; politicians, government bureaucrats, and academic opportunists conducted their social experiments with greater liberty. Previously, governments could only spend so much before the markets said "enough." Coming to understand their new dispensation slowly, then in a hurry, the technocrats found the costs of their experiments on populations could be absorbed by the rising tide of debt. Restraint in policy reformation, as in most every other human endeavor, was fading in the western world.

Government debt has accumulated year-after-year, akin to regulations imposed from Brussels and Washington. The comparison is not gratuitous. Impositions; crony handouts; and abstract, social improvement programs that should have been quarantined in the Ph.D graveyard; carry costs. According to the OECD, the government net financial liabilities had risen to 52.2% of GDP in Germany by 2010. In France, the figure was 58.9%; in Austria, 44.0%; in the Netherlands, 34.4%. Since budgets had been in balance, these numbers rose from approximately zero in 1970.

The percentage of debt-to-GDP might be likened to a dependency ratio of the bureaucracies. They have been more than willing to use the bond markets to finance their indulgences, but now are turning against them. Other European politicians and Brussels bureaucrats have also blustered about and interfered in stock, bond and credit-default swap markets. (The U.S. énarques have imposed their pricing model in every market, another terminally ill construct.)

Gideon Richman was skeptical of Hollande's resolve in the April 24, 2012, Financial Times. Of Hollande's demand for French freedom from the markets: "Which is all very well, unless you need to borrow billions from those vile markets to meet your campaign promises, such as the creation of 60,000 new jobs for teachers (a key constituency for the Socialist Party.)"

Presidential candidate François Hollande, as is true of Federal Reserve Chairman Ben Bernanke, believes he can order nature around. Both have lived inside the fishbowl their entire adult lives. Hollande was an ENA classmate of Dominique de Villepin: poet, biographer of Napoleon, and former Prime Minister of France; and of Ségoléne Royal, the losing Socialist candidate (to Nicholas Sarkozy) in the 2007 presidential race. Hollande and Royal went so far as to produce four children together as tribute to the class of '80. Their allegiance was so fervent they never stopped to get married. (As happens in the best of classes, they barely speak today.)

From the halls of the ENA to the Eccles building, it is inconceivable that 30 years - really a century or more - of social uplift, advancement, and progress - is in the hands of the markets. We read: "Euro Crisis Back Again." Where had it gone? The bad debt grows and can only be smothered by ever-larger quantities of ECB loans, since commercial banks either will not or can not lend.

The énarques (the class as a type, not only the French) are entirely responsible. They imposed the ECB and euro by preventing referendums in most European countries. They instituted the policies from which it is now impossible to retreat. This is true in the United States, too.

All channels of the European banking system now flow through the ECB. Jim Bianco (Bianco Research) told me it is not possible for the ECB to reduce its control of the plumbing. The ECB cannot back away from its pivotal, interbank lending position, since it would be immediately apparent which banks were trouble banks - better banks would only lend to worse banks (if at all) by charging a higher rate of interest. A run on the bad banks would follow. The banks and official channels cannot announce phony rates, because of the legal trouble banks now face from charges that they fixed LIBOR rates.

Bernard Connolly, the economist who foresaw the End before the Beginning: that is, before the ECB was founded, wrote in the The Rotten Heart of Europe: The Dirty War for Europe's Money (1995):

"As we have seen, German monetary leadership in Europe has been simultaneously embraced in France, if only by the Vichy tendency in the French elite, as necessary expiation for past sins (suffering being inflicted on ordinary people, who do not matter, not on the elite themselves) and bitterly resented. By hamstringing the ability of the French governments to act on behalf of the French people - or, to put it more realistically, by giving them an excuse for not so acting - that embrace has destroyed political legitimacy in France. It has contributed to a contempt for democratic politics so profound, among both rulers and ruled, that the survival of the Fifth Republic may be brought into doubt in the next few years, 'Europe' or no 'Europe.'"

Over the last few months, governments have been pushed out of office in Ireland, Greece, Portugal, Spain, Italy, and now (on April 23, 2012) in the Netherlands. In each case, the standing government was unable to persuade the voters that it stood for the people rather than being subservient to or in league with the bureaucrats in Brussels. The uncomprehending "policy makers" (it is significant that Bernanke loves to refer to himself under that label, rather than as an economist) have dug their own grave.

I met with Bernard Connolly recently in New York. He believes the fate of France is now in Germany's hands. As for Southern Europe, the banking systems will collapse, governments will lose whatever legitimacy they still retain, with war and bloodshed to follow.

Gold

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)

Gold and silver will both rise far above their current levels. "When" is unknowable. "Why" is due to the unremitting and insolent amorality of central bankers and their practices. If not Simple Ben at the Fed, his compatriots across the globe are a daily source of confusion, contradiction, and stupidity.

The stupidity may be real or it may have evolved from an unwillingness to think, as George Orwell wrote of Stanley Baldwin's and Neville Chamberlain's abdication of responsibility in the 1930s: "What is to be expected of them is not treachery or physical cowardice, but stupidity, unconscious sabotage, an infallible instinct for doing the wrong thing.... Only when their money and power are gone will the younger among them begin to grasp what century they are living in."

It is important - for those who care about the ascent of gold - to understand it does not matter why they are stupid. It matters that their stupor will continue until the current monetary and credit system is paralyzed. We can be sure of that. Orwell explained: "Clearly there was only one escape for them - into stupidity. They could keep society in its existing shape only by being unable to grasp that any improvement was necessary."

The central bankers have no other policy than to support asset prices. They have elevated and taken control of markets beyond the point of withdrawal. There is no way back.

As discussed in "Peak Imbalances are Falling," foreign central banks have bought over $5.5 trillion of U.S. Treasury securities: the reason 10-year U.S. Treasury bonds yield 2.0%. Interest rate suppression is also fundamental to Eurocrat domination. The two attempts at salvaging the European banking system (over one trillion euros lent by the ECB to European banks in December 2011 and February 2012) have failed. The stock price of Banco Santander, the Spanish bank advertised as not exposed to Spanish real estate, has fallen back to the level of mid-December 2011. The country's banking system is kaput. Again, there is no way back.

Bianco Research in Chicago calculates the balance sheets of the world's six largest central banks are now twice the size of 2006. With $13.2 trillion of assets, they will double their size again, if they can. For as long as they can, there will be times when confidence in Bernanke and Draghi knock gold and silver for a loop. At some point ("When"), the emperor will where no clothes. Central banking currencies will be rejected. Gold, and gold stocks (hang in there, any day now), will be the currency of choice.

In Frozen Desire (1997), James Buchan wrote: "I have watched the most able men and women in my generation, who might have created unexampled monuments in moral philosophy, mathematics, or engineering, waste their time in a prattle of non-accelerating inflation rates of unemployment.... [E]conomics...has retreated into algebra. A profession that begins with priests [alchemists]... ends with hermits. Political economy is now, I suspect, in the same condition in which Scholastic learning found itself on the eve of the Discoveries. It is about to explode."

The Professor Who Did NOT Save the World

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)

"The Fed's efforts prevented a 'total meltdown' of the financial system at a time when fears of a second Great Depression were 'very real,' Mr. Bernanke said Tuesday at the third of his four lectures at George Washington University in Washington."

- Wall Street Journal, "'Fed Prevented Total Meltdown,' Bernanke Said," March 28, 2012.

This is not true.

Each of Federal Reserve Chairman Ben S. Bernanke's four lectures at George Washington University was unfortunate in its own way. In his third assault on history, logic, and common sense, "The Federal Reserve's Response to the Financial Crisis," Simple Ben made it clear he still cannot think his way through the 2008 financial crisis.

The sequence of events follows: On September 15, 2008, Lehman Brothers, an investment bank, failed. This triggered claims on credit default swaps. These derivatives pay the holder a specified amount of money when a company defaults. American International Group (AIG), an insurance company, had sold credit default swaps to protect the buyer if Lehman Brothers failed. (Credit default swaps are often labeled "insurance." As an analogy to insurance, this description is helpful; but they lack a key feature of insurance (insurable risk), one reason they should be banned.) It was time to pay, but AIG did not have the resources to do so. In the mythology of the moment, Ben's World introduced a waterfall of Old Testament proportions: AIG would fail, and the entire financial system would follow, without a government bailout.

On September 16, 2008, the U.S. government "seized control of AIG" (quoting from the September 17, 2008, Wall Street Journal). The Federal Reserve lent AIG $85 billion which allowed AIG to honor its credit default swaps.

On Sunday, September 21, 2008, "Morgan Stanley and Goldman Sachs applied to the Fed to become bank holding companies." The applications were "approved with extraordinary speed." (Financial Crisis Inquiry Commission Report) This was "in tandem with the Department of Justice," a caper that has been insufficiently explored.

The mythology is just that. I thank David A. Stockman, former director of the Office of Management and Budget under President Reagan, for the analytical assistance and for the pleasure of reading an early draft of his book: The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy.

Those who held insurance policies with AIG or its subsidiaries never bore risk of non-payment. The policies were backed by nearly $900 billion of high-quality assets. Most of AIG's capital sat in AIG's insurance subsidiaries, sequestered from bankruptcy claims.

It might be possible that Ben Bernanke, Treasury Secretary Hank Paulson, and New York Federal Reserve President Timothy Geithner - the trio who robbed the taxpayers - did not understand insurance regulation. It is implausible that staff lawyers and regulators did not understand the insured were whole. It is simply impossible, four years later, for Simple Ben to think "we prevented the total meltdown" (as he stated at George Washington University). Lacking this myth, the $700 billion Troubled Asset Relief Program (TARP) is understood as unnecessary. It was a lifeline to crony capitalists.

Those who bought a credit default swap from AIG purchased a contract with the holding company, where there was practically no capital. The credit default swap contracts held by Goldman Sachs (for instance) were, from a practical view, worthless. Goldman might salvage itself from the residue apportioned in bankruptcy court (if AIG's holding company went under, which it surely would have), but Goldman's failure would not have been a loss to the economy. Investment banks do not hold customer deposits. The only capital they were raising was to securitize dubious mortgages which were, by now, the problem of pension and hedge funds. Their other playgrounds are self-serving.

In any case, Goldman Sachs CEO Lloyd Blankfein told the FCIC (Financial Crisis Inquiry Commission) his firm would not have failed: "We had tremendous liquidity throughout the period. But there were systemic events going on, and we were very nervous. If you are asking me what would have happened but for the considerable government intervention, I would say we were in - it was more a nervous position than we wanted [to be] in. We never anticipated the government help. We weren't relying on those mechanisms...."

The FCIC Report states that Goldman's liquidity pool "had fallen from about $120 billion on the previous Friday [September 13] to $57 billion on Thursday [September 18.]" Even at the depressed market prices of mid-September 2008, Goldman Sachs held $220 billion of long-term debt and preferred stock as well as $60 billion of common stock. Morgan Stanley held $190 billion and $25 billion of the same. These last two investment banks held one-half a trillion dollars of long-term capital at the moment Bernanke and Paulson performed their Chicken Little routine on Capital Hill - and Hank Paulson rose to the top of Goldman Sachs for his exploits as an investment banker.

If the capital was overvalued (and, it was), the investment banks could have raised more debt and equity from investors. If this proved impossible, the banks could have liquidated their assets at fire-sale prices. If Goldman's $1.1 trillion of assets were so mispriced that the bank could not survive, then it should have been liquidated. The assets would have been bought by better managed firms that had not resorted to the death-defying - but extremely profitable - wholesale funding markets and that leveraged their balance sheets at 40:1 or 80:1. The "Big Five" investment banks deserved to go out of business and it would have helped the economy. They destroy capital.

We will never know what might have happened. Bernanke and Paulson terrorized the American people who terrorized their congressmen into authorizing the $700 billion TARP. This stopped the short-term funding panic.

Bernanke has never gotten around to explaining just how the commercial banking system would collapse. Some large banks were worthless (Washington Mutual), some were and still are questionable enterprises (Citigroup), but most are viable. The FDIC increased its deposit insurance from $100,000 to $250,000 on October 3, 2008. If the chain of CDS defaults felled a depository institution such as Citigroup, the federal government would make depositors whole up to the $250,000 limit.

Yet, four years later, the chairman of the Federal Reserve misled GWU's finest: "[N]ow, the failure of AIG in our estimation would have been basically the end. It was interacting with so many different firms. It was so interconnected with both the U.S. and the European financial systems, global banks."

From the beginning, Bernanke has justified his interference with such vagaries. Thus, Ben's waterfall of tears: just as it is impossible to follow a pint of water over a cataract, Bernanke has yet to describe the sequence of failures after Goldman Sachs and Morgan Stanley (e.g.: would it have been commercial banks, asset-backed commercial paper? - neither argument would pass muster).

He was questioned at length on these very points before the Financial Crisis Inquiry Commission (FCIC) on November 17, 2009. The Fed fought the release of this transcript to the public. One can understand why. The Top Secret document exposes the Federal Reserve chairman to Double-Secret Probation. His ignorance of markets, banking, and insurance regulation is obvious; his inability to explain the chasm is manifest; though, the evidence gathers dust.

On page 28 and 29 of the FCIC transcript, our dedicated interest-rate suppressor told the Committee: "The reason AIG was set up the way it was originally, the financial products division ["Financial products division" was the profit center that sold CDS - FJS], which did the CDS, attached itself precisely because it was a large, highly-rated insurance company with lots of assets. Therefore it could sell CDS without what would otherwise be sufficient capitalization and protections because the counterparties would know that this was a highly rated firm with lots and lots of assets. It was precisely because of that reason when [AIG] financial products [division] had to sell - had to come up with the collateral - and was facing a run on its positions, that the Fed - that there existed the collateral, the assets that the Fed could lend against." [My italics - FJS]

This is not true. (It is also difficult to read. The editorial board here decided multiple [sic] entries would distract. If you don't get it the first time, try, try again.)

First, the financial products division, which sold the CDS (Bernanke was correct about this), was in AIG's holding company. If the holding company declared bankruptcy, the insurance subsidiaries would have remained unscathed.

The distinction between the holding company and the subsidiaries seems to thwart his claim that "[t]herefore it [AIG financial products] could sell CDS without what would otherwise be sufficient capitalization and protections because the counterparties would know that this was a highly rated firm with lots and lots of assets." Bernanke words this clumsily. Still, it looks as though he thinks buyers of AIG's credit-default swaps were looking to the collateral that rested in the insurance subsidiaries. He should be placed back in the witness stand to explain what he is trying to say.

Lacking subpoena powers, it is the opinion here that "lots and lots of assets" was not: "precisely... [the] reason" AIG so successfully sold worthless credit-default swaps. It is probable, knowing the tenor of the times, that investment banks and other purchasers did so precisely because they could. The premium that Goldman (and the others) paid AIG for the CDS looked extremely cheap. In fact, the CDS were sold to Goldman at market-clearing prices precisely because there was (for all intents and purposes) nothing to back the contracts.

The November 17, 2011, FCIC transcript, as well as his four lectures at George Washington University, demonstrate that his economics are assertions. It is not long into Essays on the Great Depression that his lackadaisical approach becomes apparent. It really is not economics at all, more accurately he parrots the Politics of Assertion. He does not explain the "total meltdown" beyond AIG, Goldman Sachs, and a jumble of financial instruments that every cab driver heard on the radio in September of 2008.

In the 89-page FCIC transcript, Chairman Bernanke consistently avoided the tributaries by substituting a life raft of "et ceteras." Just what was the sequence that would have shut the Bailey Savings & Loan, caged the payment system, sealed insurance policy payments? As the list of 29 "et ceteras" attest, his mind can only comprehend the problems of AIG - a wholly imaginary understanding, at that - and the difficulties of overnight funding suffered by highly leveraged hedge funds (veiled behind the white-shoe anachronism of "investment bank").

Please judge the Princeton professor's mental limits yourself:

P. 8 "...my own view is that if the system had been adequately stable, had strong enough supervision, et cetera, et cetera..."

P. 9 "...a striking aspect of these securitizations is that these vehicles, these special purpose

vehicles, et cetera..."

P. 9 "...financed by very short-term paper, overnight type money, commercial paper, et cetera..."

P.12 "...the investment banks, which were a huge problem, of course, Bear and Lehman and Merrill, et cetera..."

P. 14 "...the ad hoc responses to Lehman and AIG, et cetera..."

P. 16 "...would have exposure to a SIV which held subprime mortgages, et cetera, et cetera..."

P. 16 "...the Fed should be looking at non-bank subs, et cetera..."

P. 26-27 "...the financial impact of the collapse of AIG on so many financial institutions in this period of intense crisis already, plus the impact on insurance markets, et cetera, et cetera..."

P. 28 "...our ingenuity of finding merger partners, et cetera..."

P. 33 "...for each one of these firms and had asked for reports on what are the principal risks, you know, within these firms, et cetera..."

P. 34 "...strengthening the infrastructure, central counterparties, et cetera..."

P. 38 "...critical parts of the company to continue functioning, is able to override existing collateral or employment agreements, et cetera, et cetera..."

P. 45 "...to operate as counterparties to international firms, et cetera, et cetera..."

P.49 "...evolution in the types of businesses, and their risk management, et cetera."

P.50 "...was it a function of regulatory change, et cetera?"

P.61 "...were assigning contracts to others without telling the original - et cetera, et cetera."

P. 64 "...you don't have to know who you're trading with because the central counterparty will, through use of margins of capital, et cetera..."

P.64 "...so long as those counterparties themselves are well managed and have enough capital, et cetera..."

P.74 "...system set up in a crazy way, which was we were supposed to make rules for mortgage brokers, et cetera..."

P.80 "...I would prefer having a systematic risk council [!!!!! - FJS] which is responsible for the overall system [!!!!! - FJS] and looks for emerging risks and coordinates and information, et cetera, et cetera..."

P.86 "...I should have mentioned a lot of the other things we did to protect the asset-backed securities market, the commercial paper market, money market mutual funds, et cetera, et cetera..."

The 29 et ceteras might be a habit of speech, though they consistently appear at the moment Bernanke has identified a river pouring into the waterfall. Each time, the curious student is left untutored: et cetera, et cetera. The suspicion that there was no waterfall - and therefore, not the potential for a "total meltdown" (to remain consistent, these were icy waters) - is supplemented by Simple Ben's 27 "and so ons."

For example:

P.3 "...the macroeconomic background that led to the risk-taking and so on..."

P.11 "...forced the banks to take them back on their balance sheets or to support them and so on..."

P.11 "...did not take into account the appropriate correlation between - across the categories of mortgages and so on."

That leaves 75 pages and 24 "and so ons" for the dedicated phenomenologist.

Of course, Bernanke is a hero. From the same Wall Street Journal article quoted earlier:

"The failure of AIG, in our estimation, would've been basically the end," Mr. Bernanke said. "We were quite concerned that if AIG went bankrupt, that we would not be able to control the crisis any further."

Americas still shivers at the thought.

America will panic when it becomes obvious that Et Cetera, who has increased the Federal Reserve's balance sheet from around $800 billion in 2008 to about $2.8 trillion of assets today, has not thought through how it is going to withdraw the dollars it created to buy those assets. And-So-on's explanations of how he will do so, before inflation runs wild, are off-the-cuff Et Ceteras.

Gold, silver, and other hard assets are the obvious precaution.

Bernanke is not alone. The "1980s trained economists... a very complacent group" (see: Samuelson Flunked Bernanke) hold a monopoly on policy. The Politics of Assertion triumphed. Bernanke, Mankiw, Steiglitz, Hubbard, the Romers (husband and wife) - it goes on and on and was described in a 1944 novel by Evelyn Waugh:

"The trouble with modern education is you never know how ignorant people are. With anyone over fifty you can be fairly confident what's been taught and what's been left out. But these young people have such an intelligent, knowledgeable surface, and then the crust breaks and you look down into the depths of confusion you didn't know existed."

Samuelson Flunked Bernanke

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)

The forecasting proficiency of central bankers is a topical issue. At least, a friend asked if I could help with a list of Federal Reserve Chairman Ben S. Bernanke's predictions. The list stops in 2008, although he has been no more accurate since then. I sent the list to a few others. To those lucky recipients, I attached Paul Samuelson's opinion of Ben S. Bernanke. It is the response (below) of one correspondent to Samuelson's statement that is most telling.

Bernanke has been a Federal Reserve governor since 2002. He was named Chairman in early 2006. He served as chairman of the president's Council of Economic Advisors from June 2005 until early 2006.

Here we go:

"[T]he recent capital inflow [has shown up in] higher home prices. Higher home prices in turn have encouraged households to increase their consumption. Of course, increased rates of homeownership and household consumption are both good things."

-March 10, 2005

"[I]ncreases in home values, together with a stock-market recovery that began in 2003, have [aided]...[t]he expansion of U.S. housing wealth, much of it easily accessible to households through cash-out refinancing and home-equity lines of credit."

-March 10, 2005

Interviewer: Ben, there's been a lot of talk about a housing bubble, particularly, you know, from all sorts of places. Can you give us your view as to whether or not there is a housing bubble out there? What is the worst-case scenario if in fact we were to see prices come down substantially across the country?

Bernanke: Well, I guess I don't buy your premise. It's a pretty unlikely possibility. We've never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don't think it's gonna drive the economy too far from its full employment path, though.

-Interview on CNBC, July 1, 2005

"The housing market has been very strong for the past few years.... It seems to be the case, there are some straws in the wind, that housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise but not at the pace that they had been rising. So we expect the housing market to cool but not to change very sharply."

-February 15, 2006

"In 1994, fewer than 5 percent of mortgage originations were in the subprime market, but by 2005 about 20 percent of new mortgage loans were subprime....[T]he expansion of subprime lending has contributed importantly to the substantial increase in the overall use of mortgage credit. From 1995 to 2004, the share of households with mortgage debt increased 17 percent, and in the lowest income quintile, the share of households with mortgage debt rose 53 percent."

-November 1, 2006. In case you are wondering if Simple Ben approved or disapproved of this development, the title of his speech says it all: "Community Development Financial Institutions: Promoting Economic Growth and Opportunity"

"[O]ur banks are well capitalized and willing to lend."

-June 5, 2006

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Some views on derivatives:

Senate Banking Committee Chairman Paul Sarbanes: Warren Buffett has warned us that derivatives are time bombs, both for the parties that deal in them and the economic system. The Financial Times has said so far, there has been no explosion, but the risks of this fast-growing market remain real. How do you respond to these concerns?

Bernanke: I am more sanguine about derivatives than the position you have just suggested. I think, generally speaking, they are very valuable. They provide methods by which risks can be shared, sliced and diced, and given to those most willing to bear them. They add, I believe, to the flexibility of the financial system in many different ways. With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly. The Federal Reserve's responsibility is to make sure that the institutions it regulates have good systems and good procedures for ensuring that their derivatives portfolios are well managed and do not create excessive risk in their institutions.

-November 15, 2005

"To an important degree, banks can be more active in their management of credit risks and other portfolio risks because of the increased availability of financial instruments and activities such as loan syndications, loan trading, credit derivatives, and securitization."

-June 12, 2006

"[M]any large banking organizations are sophisticated participants in financial markets, including the markets for derivatives and securitized assets. In monitoring and analyzing the activities of these banks, the Fed obtains valuable information about trends and current developments in these markets. Together with the knowledge obtained through its monetary-policy and payments activities, information gained through its supervisory activities gives the Fed an exceptionally broad and deep understanding of developments in financial markets and financial institutions."

[Chairman Bernanke testified before the Financial Crisis Inquiry Commission on November 17, 2009.This was at the beginning of the FCIC's investigation. Bernanke offered suggestions of what he thought the FCIC should investigate. Among Bernanke's comments: "I'm a little concerned still about systemic risk that comes from financial products or financial markets that aren't adequately seen or understood by a banking supervision kind of institutional approach. And I wish you'd comment on that. I mean, nobody really, totally saw the problems with securitization or OTC derivatives."]

"If you have two investment banks doing an over-the-counter derivatives transaction, presumably they both are well-informed and they can inform that transaction without necessarily any

government intervention."

-February 27, 2008

"Since September 2005, the Federal Reserve Bank of New York [led by New York Federal Reserve President Timothy Geithner - FJS] has been leading a major joint initiative by both the public and private sectors to improve arrangements for clearing and settling credit default swaps and other OTC derivatives.... I don't think the system is broken, but it does need some improvement in execution."

-July 10, 2008

[ November 17, 2009, before the FCIC: "So I guess my own view is that if the system had been adequately stable, had strong enough supervision, et cetera et cetera, it could have dealt with this problem or other problems without collapsing." Note: "This" problem: if the crisis was due, which Simple Ben did not concede, to Federal Reserve policy.]

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"At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained"

-March 28, 2007

"While rising delinquencies and foreclosures will continue to weigh heavily on the housing market this year, it will not cripple the U.S."

-May 17, 2007

"We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."

-May 17, 2007

"We have not seen major spillovers from housing onto other sectors of the economy."

-June 21, 2007

"For the most part, financial markets have remained supportive of economic growth. However, conditions in the subprime mortgage sector have deteriorated significantly."

-July 18, 2007

The "expected impact from weaker housing... may flare in the future, today" - in the words of Ben Bernanke - "it is contained."

-July 18, 2007

"Bernanke said [subprime mortgages] were 'market innovations' and 'sometimes there are bumps' in the new-product road. 'We'll see how this works out."

-July 18, 2007

"I'd like to know what those damn things are worth," [CDOs - FJS] Mr. Bernanke said. Until investors "are confident in their evaluations, they are not going to be willing to fund these vehicle."

-October 15, 2007

"It is not the responsibility of the Federal Reserve - nor would it be appropriate - to protect lenders and investors from the consequences of their financial decisions."

-October 15th, 2007

"I expect there will be some failures. I don't anticipate any serious problems of that sort among the large internationally active banks that make up a very substantial part of our banking system."

-February 27th, 2008

"Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."

-June 9th, 2008

[Freddie and Fannie] "...will make it through the storm", "... in no danger of failing","...adequately capitalized."

-July 16th, 2008

[This is the] "most severe financial crisis" in the post-World War II era. Investment banks are seeing "tremendous runs on their cash.... Without action, they will fail soon."

-September 19th, 2008

November 17, 2009 before the FCIC:

MR. BERNANKE: "But I think not withstanding the claims of one or two people out there who are now sort of living on the fact that they - quote - anticipated the crisis [A little jealous, Ben? - FJS], I would still say that the intersection of these things, the "perfect storm" aspect was so complicated and large, that I was certainly not aware, for what it's worth - and it could just be my deficiency - but I was not aware of anybody who had any kind of comprehensive warning. There are people identified - and the trouble is and particularly in this blogosphere we live in now - at any given moment, there are people identifying 19 different problems, crises."

VICE CHAIRMAN THOMAS "And some of them may be right at some point."

NOTE: It was at this point that Captain Queeg, when testifying in court, grabbed for his steel balls.

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COMMISIONER THOMPSON: "So no calamity of this magnitude occurs without there being some early signals that something is going wrong. In the case of this calamity, what were the signals? Why did we -and had we acted on them, might we have averted the disaster?

MISTER BERNANKE: "Well, I don't know, I have to think about that."

Note: Could not the FCIC have reached its conclusion at that moment? It interviewed a few hundred witnesses and wrote a 500-page summary, but was not the master cylinder identified? - FJS

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The Atlantic, June 17, 2009, Interview with Paul Samuelson - the man who established MIT as a magnet for economics. He wrote the best-selling economics textbook in history. The interview was conducted just before Samuelson died: "The 1980s trained macroeconomics - like... Ben Bernanke and so forth -- became a very complacent group, very ill adapted to meet with a completely unpredictable and new situation, such as we've had.... I looked up Bernanke's PhD thesis, which was on the Great Depression, and I realized that when you're writing in the 1980s, and there's a mindset that's almost universal, you miss a lot of the nuances of what actually happened during the depression."

A reply, from a friend who knew Paul Samuelson:

"The biggest surprise here--and perhaps the most damning--is Paul Samuelson's dismissive comments about Bernanke and his "...very complacent group, very ill adapted.... [that you] miss a lot of the nuances of what actually happened during the depression." That Samuelson, whom I knew when I was at MIT as generally a mild-mannered and kindly gentleman, should have checked Bernanke's PhD thesis done in Samuelson's department (for Stanley Fischer, governor of the Israeli Central Bank, but then an MIT Prof.) and then ended up stating such--for him--negative comments about Bernanke is extremely significant."

Mister In-Between is 100% Sure

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)

"This isn't right. This isn't even wrong"

-Wolfgang Pauli, Cambridge University physicist, attempting to read a colleague's paper.

60 MINUTES: "Can you act quickly enough to prevent inflation from getting out of control?"

BERNANKE: "We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now."

60 MINUTES: "You have what degree of confidence in your ability to control this?"

BERNANKE: "One hundred percent."

"60 Minutes," December 5, 2010

Federal Reserve Chairman Ben Bernanke's lecture series at George Washington University is most unfortunate. Whether he believes what he is saying or not, he is a punch bowl of contaminated mead.

The first instinct, at least here, is to let it pass. Wolfgang Pauli's exasperation came to mind when reading capsules of the Fed chairman's lectures. Where to start? Where to end? To what purpose.

The last, first. The purpose here is to throw light on a mind so inadequately prepared, yet 100% sure, of extracting the world from an unprecedented gamble. The gamble is Bernanke's dry run of his professorial emissions. The professor's chalkboard smog is the basis for his current policy. Real interest rates are below zero and the central bank is creating immeasurable quantities of dollar bills that Bernanke is sure will right the U.S. economy while not sacrificing his wandering price stability.

"Immeasurable," since Bernanke and other members of the FOMC do not know when they will stop. Listen to their contradictory speeches. We are not witnessing the introduction of an economic theory. We are chips in a poker championship.

Rather than address my stated purpose by rehabilitating either Bernanke's disfigured explanation of the 1930s or how the gold standard functioned - the disentanglements alone would require pages - we will look at one of his simpler claims. Following is an effort in pointillism.

Two of the man's characteristics will be addressed in what follows. First, his inability to anticipate. Second, his limited understanding of the past, which is a cause of his inability to anticipate.

On March 22, 2012, the Fed chairman told students at George Washington University: "The decline in house prices by itself was not obviously a major threat." To clarify this statement, Bernanke was responding to a question about the housing bubble. He was addressing the aftermath, when prices fell. He concluded that falling house prices, by themselves, were not obviously a major threat to the economy, and, presumably to the financial system that serves to finance that economy.

Wolfgang Pauli would probably agree that Bernanke's attempt at clarification is neither right nor wrong. It is meaningless. As a general statement, rising house prices do not constitute a bubble. Nor, are falling house prices synonymous with a crash. The most important distinction is the degree of borrowing that contributed to the upswing. Of the recent housing enthusiasm, Panderer to Power made this clear. During the Greenspan-Bernanke chairmanship, the U.S. did not experience a housing crash, it suffered a mortgage collapse.

Bernanke claims the "decline in house prices by itself was not obviously a major threat [before it crashed in 2007 - FJS]." The man was either unaware of how housing finance was conducted in the U.S. during bubble years or considered it irrelevant.

As a Federal Reserve Board member (from 2002 to the present day, with a short sabbatical as economic adviser to President Bush) Bernanke completely missed the coming mortgage collapse. He admits that. He also claims nobody else saw it coming. The Federal Reserve chairman, like all cloistered academic economists, would never condescend to read a newspaper, so would not see what the average bartender knew. Anyone reading the following knew that houses were the new momentum trade that replaced the dot.com fandango:

August 8, 2001, Wall Street Journal, Headline: "'Subprime' Could Be Bad News for Banks: Riskier Loans, Now Prevalent in Industry, Show Problems" We read: "American Express so far this year has taken more than $1 billion in junk-bond-related write-downs."

August 31, 2001, Wall Street Journal, Headline: "Is Appraisal Process Skewing Home Values?" We read: "Appraisers are frequently encouraged to fudge the numbers." From Mark Vitner, an economist at First Union Corp., the "upward spiral of prices becomes self-reinforcing." The Wall Street Journal reporter concluded: "Some believe home prices are beginning to act like technology stocks. Mr. Vitner says they're moving up so fast that any value seems reasonable."

September 3, 2001, Forbes magazine, Cover: "WHAT IF HOME PRICES CRASH?" Picture on the cover of a young couple: "Their house lost $1 million in value. It could happen to you. It could happen to a lot of people and wreck the economy." We learn that their house - in Palo Alto, California, fell in value from $2 million to $1million over 7 months.

March 28, 2002, Economist, cover story: "The houses that saved the world" We read: "...homes have kept the world economy aloft."

April 18, 2002, Wall Street Journal,Headline: "Reverse-Mortgage Rules May be Loosened" We read: "Congress is looking to loosen the rules on reverse mortgages. The move could allow millions of seniors to extract far more money from their homes than is possible - though to some critics that isn't necessarily a good thing."

July 22, 2002, Business Wire, Reporting on recent testimony of Federal Reserve Chairman Alan Greenspan: "We've looked at the bubble question and we've concluded that it is most unlikely."

July 22, 2002, Business Wire, Same article, quoting National Association of Home Builders Chief Economist David Seiders: "The time has come to put this issue to rest. The nation's home builders have said it, the Realtors(R) have said it, and now Alan Greenspan has said it once again, in no uncertain terms: there is no such thing as a current or impending house price bubble."

The web of interests was obvious by 2002. Princeton professor Ben S. Bernanke joined the Federal Reserve Board on August 5, 2002.

At that point, the question that occupied the alert observer was how long the web could keep spinning. When Ben Bernanke joined the Federal Reserve Board in 2002, he dragged his "zero-bound" twaddle to FOMC meetings, and soon enough the Fed was launching helicopters, suffering conundrums, and holding real rates below zero.

And now, on March 23, 2012, the man running the Federal Reserve, who not only could not see the housing bubble but can not rotate his mind to believe anyone else did, is "100% sure" he will extract the world from a money-printing escapade that has increased central bank balance sheets from about $4 trillion in 2008 to about $13 trillion in 2013 (these numbers are from memory), and not destabilize the world price structure.

The second characteristic of the Bernanke mind to be addressed is his historical illiteracy. Given the quoted statement made to George Washington University students, he does not know how financing contributed to previous housing booms and busts. We will look at one state, where, it is 100% clear that fly-by-night finance was the leading cause of post-binge trauma.

The population of Los Angeles rose from 10,000 in 1880 to 50,000 in 1890. Yet, a severe real estate bust wiped out most of the wealth in 1887 and 1888. David Starr Jordan described the boom and bust in California and the Californians: "[A]lmost every bluff along the coast, from Los Angeles to San Diego and beyond was staked out in town lots." He continued: "Every resident bought lots, all the lots he could hold. The tourist took his hand in speculation. [My italics - FJS] Corner lots in San Diego, Del Mar, Azusa, Redlands, Riverside, Pasadena, anywhere brought fabulous prices. A village was laid out in the uninhabited bed of a mountain torrent, and men stood in the streets in Los Angeles... all night long, to wait their turn in buying lots. Land, worthless and inaccessible, barren cliffs' river-wash, sand hills, cactus deserts' sinks of alkali, everything met with ready sale. The belief that Southern California would be one great city was universal. [The far-sighted investor was correct, but lost his shirt in 1888. - FJS] The desire to buy became a mania. 'Millionaires of a day,' even the shrewdest lost their heads, and the boom ended, as such booms always end in utter collapse."

"Tourists" includes speculators from the east, north, and south, drawn to the latest California gold rush. It was not only Los Angeles. Kansas City crested in 1888, Chicago in 1890, and the country as a whole in 1888-1889. When everyone from Alan Greenspan to Standard & Poor's swatted down bubble concerns ("real estate slumps are local affairs"), the nation's participation in regional manias was not considered. Other significant features of L.A. in the 1880s were a price collapse when the population rose 500%, and, no central bank existed to prod the insolvency.

Los Angeles boomed in the 1920s as did its real estate. The sun, movies and discovery of oil in Los Angeles County encouraged wagon trains from the East. Across the country, speculators were drawn to real estate between 1920 and 1925.

In Ten Years on Wall Street, Barnie Winkelman set the stage: "The shortage of offices, apartment houses, and dwellings which had resulted from the protracted holiday from construction during the World War, had brought on a wave of building. In its wake came the flotation of real-estate bonds running into hundreds of millions, financing practices which embodied the worst practices of Wall Street bond flotation, and saddled millions of school teachers, physicians, widows, the aged and infirm, who had forsworn stocks on the Exchange and railroad and industrial bonds, with realty obligations infinitely less substantial. On back of these over-appraised real estate liens were second mortgage loans held by individuals and building and loan associations. The collapse of many building and loan associations in 1925 marked the gradual recession in real estate prices....."

That's enough. Upon reading "financing practices which embodied the worst practices of Wall Street," you knew how this would turn out. The Florida land boom and bust (1926) is synonymous with the decade. Today, the degree of national participation is not so celebrated. Nor, that the residential real estate building boom across the country generally peaked at the same time. Real spending on new, private, non-farm housing fell 89% from its peak in 1926 to its trough in 1933.

A chart of Los Angeles County residential real estate activity points nearly straight up between 1920 and 1925. (Lewis A. Maverick, "Cycles in Real Estate Activity: Los Angeles County") Chicago also achieved its personal best in 1925, though New York was just warming up, particularly in the commercial area, rising until 1930. (The average price of office-building bonds fell from $1,000 upon issue to $187 in 1932.) Even with the booming Southern California economy, the graph of L.A. County real estate activity falls from 1926 through 1930, and presumably beyond.

The 1970s was a boom time for houses, but much of those gains were lost to inflation. House prices rose 8.0% a year during the decade, while the consumer price index rose at a 7.4% rate. (Nationally, house prices rose 17.7% in the first nine months of 1979; the CPI passed 16% that year.)

California was a star performer where house prices rose 20% in 1974, 17% in 1975, and 28% in 1976. (The standard belief that lower interest rates will solve house troubles is taken for granted. The prime rate rose from 9.50% in early 1974 to 15.50% in late 1979.) William Greider wrote in Secrets of the Temple: "People were not buying houses to live in or even as long-term investments. They were buying homes in order to sell them."A builder in Contra Costa County (California) found that 60% of his sales were to speculators. In San Diego alone the number of realtors doubled between 1975 and 1979. A condominium bought in Irvine Ranch (California) for $87,000 was sold for $117,000 - two weeks before the mortgage closing was completed. We need not tarry here; this is so old that it's new.

The 1970s boom was followed by a bust, but not of today's dimensions. One reason being that mortgage lending did not rocket off its moorings, either in terms offered or in the variety of lenders. In the early 1980s, homeowners' average equity (nationally) equaled 70% of house market values.

The 1980s savings-and-loan catastrophe left the Southern California mortgage market in a miserable state. The S&L boom was the product of relaxed regulations, funny finance, and dreadful accounting - all of which should have been evident to Ben S. Bernanke in 2002. According to the San Diego Union Tribune: "When the bubble burst in 1989, some home prices fell 10 to 20 percent, while the price of raw land dropped even more. End result: As real estate analysts see it, local developers, builders, bankers, planners and home buyers all made a fatal assumption three years ago. [They splurged near the peak. - FJS] .... [I]n 1987, 1988 and 1989 prices soar[ed], doubling from $89,000 to $198,000. The average price now stands at $95,000 per acre and [a market analyst] doesn't think it will recover even half its former, inflated value any time soon."

The market analyst may have been correct if not for L. William Seidman. He headed the Resolution Trust Corporation (RTC), which closed the bad banks and disposed of the busted real estate at fire sale prices. We should have followed the same blueprint today, but have done exactly the opposite. Thus, instead of clearing the market, we have millions of houses floating in limbo.

Upon completion of his assignment, Seidman shut down this federal agency. He was very critical of Bernanke's (and Paulson's) TARP (Troubled Asset Relief Program). Comparing TARP to the RTC: "What we did, we took over the bank, nationalized it, fired the management, took out the bad assets and put a good bank back in the system." Comparing Seidman's purging of bad banks to Bernanke's handling of the Too-Big-to-Fail Banks (which hold much larger quantities of assets today than in 2008), is, again, cause to believe Bernanke has no idea what he is doing.

Like Sisyphus, California real estate prices pushed and pushed harder up the hill from 1995 to 2005. This is too well known to recall here. Some reminders: The median price for an existing, single-family house in California rose from $237,060 in 2000 to $542,720 in 2005. That this was a mortgage bubble par excellence, and not so much a housing bubble, can be seen in the evolution of financing: Mortgages written in California responded to Bernanke's "zero-bound policy" in spectacular form. Only 2% of home mortgages were of the non-principal paying "interest-only" version in 2002. This rose to 47% in early 2004 and to 67% by late 2004. In February 2012, the median price for an existing, single-family house in California was $266,600, and falling at a 7% annual rate.

Doug Noland, author of the Prudent Bear's Credit Bubble Bulletin, wrote untiringly during the boom years of the "moneyness of credit." (He still writes every week and is still well worth reading.) Noland wrote that the Fed and Wall Street refused to understand the explosion of credit and credit derivatives were behaving like money and inflating house prices. This should have been understood. It was the ability to buy (sort of) a house without showing up with one penny at the closing that gave Sisyphus his third and fourth wind.

Bernanke has shown no understanding of either the quantity or the quality of credit. Yet, he is 100% sure of his infallibility.