Wednesday, February 23, 2011

A Municipal Score Card

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)

Meredith Whitney has kicked up a storm with her 600-page, municipal-bond report. She was one of the first analysts on Wall Street who warned the banks were going to topple well before they toppled. (Standard & Poor's downgraded Bear Stearns three notches - to BBB - on March 14, 2008, two days before J.P. Morgan acquired Bear's carcass.) Whitney told 60 Minutes on December 19, 2010: "You could see...50 to 100 sizable [municipal] defaults.... This will amount to hundreds of billions of dollars' worth of defaults." The municipal bond CABAL (issuers, fund managers, analysts, the municipalities) denounced Whitney and her predictions.

In concert with the times, the debate is superficial. It is not even a debate but a tryout for the Society of Mind-Numbing Auctioneers. The drift on Bubble TV goes something like this:

Bubblehead announcer: "You there - at the other end of the camera! Wha' da' you think of Whitney's hundred defaults?"

Muni Expert #1: (everyone on Bubble is an Expert): "No. That's extreme. Municipalities are having their problems, but they know it and are taking action..."

Bubblehead Announcer: "So - how many - 10?

Muni Expert #1: "It is hard to put a number on it, but I estimate [pause] none."

Bubblehead Announcer: "Yo! Number two! - Zero or 10?

Muni Expert #2: "Between zero and 20."

Bubblehead Announcer: "I have 20 defaults, 20 defaults, 20 defaults, He-e-e-re! Hey, producer! [Offstage] Will you give me 30? No? [Turning to the camera] There you have it folks. Whitney is a scaremonger who is trying to make money off your fears!"

These discussions do not enlighten. The typical municipal bond investor - and that is to whom the following is addressed - is older, may or may not still be working (the following will be directed more towards the retiree), has accumulated a pool of assets, and that pool is heavily weighted towards municipal bonds. This investor depends upon coupon income as a major source for spending. Municipal bonds are often preferred by this cohort because the stream of income is usually not taxed at the federal, state, or local level. Also, it is a top choice because investment advisers tell old people this is the safest investment. That statement is probably correct, historically, but then, "House prices have never gone down across the U.S." was the pitch line into 2007. (The demise of the house market is intertwined with the drum beat to destiny in the municipal bond market, for obvious reasons. But members of the CABAL ignore this.)

Newspapers are filled with stories of towns running out of money, municipal employee layoffs, reduced services, and taxes being raised. The resolution to these disputes will be as varied as the municipalities engaged in such struggles.

There are helpless cases, probably those identified by Whitney. She is an excellent analyst. Whether her forecast for the size and timing of defaults is accurate does not matter other than to a municipal bond insurer and credit-rating agency. It is whether the retiree receives the expected coupon payment from a specific bond or portfolio of bonds that is of first consequence.

There are four competitors in this struggle for municipal funds; the battle among them will potentially deny the bondholder full payment. It would be convenient if the parties could be split into four pieces of a pie, the pie being of a fixed size. There are two means, however, by which the pie may inflate, meaning new cash inflows that could delay the immediate prospect of defaults. These will be discussed next, after which the fixed pie will lie center stage.

First of the two is the bond market. Municipalities will continue to issue bonds until they cannot. Currently they can, notwithstanding some recent problems of specific issuers.

Today, many bonds are issued to meet not only current expenses (vs. capital expenditures), but also projected expenses in future years. This evolution is presumably not stated in bond offerings, but is known sotto voce. (Friendly city hall clerks are good sources for such information.) Municipal bonds were traditionally floated for capital requirements: construction, for instance. It was considered reckless, if not illegal, to sell bonds to pay this month's salaries. Today, it should be assumed that a cash-poor city will use bond proceeds for immediate needs - if it can get away with it. This is fraud. See the Miami Herald from February 17, 2011 "Audit: Miami Misused Millions in Public Works Funds."

Second, is the federal government. There has been talk of federal bailouts for states and cities. If the federal government is to pick up expenses for Illinois; California; New York City; Harrisburg, Pennsylvania; and a hundred others, the cost will be enormous. The federal government has plugged non-federal gaps at an increasing pace since the $787 billion stimulus bill was passed in 2009. It has also established avenues to keep paying state and city bills after the $787 billion is depleted.

This will not be sufficient though, so let us assume a Big Bailout Bill is proposed. This may or may not pass. If it passes, the pie (flows to the mendicants) will grow. This should help boost the municipal bond market, but it should be remembered that we will live to see the moment when yields of 10-year, U.S. Treasury bonds double, possibly precipitated by such a reckless Bill as this. When yields double (this is not a question of "if"), municipal bondholders may satisfy themselves that coupon income will still be paid, but that will only be of momentary consolation given the chaos of a broken bond market.

If such a Bill does not pass, Federal Reserve Chairman Ben Bernanke may buy a trillion dollars worth of municipal bonds before Congress acts. Some congressional committee would then interrogate this unaccountable public servant, doubting the legal authority for his purchases. Bernanke; in his vague, impenetrable mien; will claim he had authorization and cannot reveal which securities the Fed bought since disclosure would endanger the solvency of the parties involved. ("Parties" - including the balance sheet of the Federal Reserve.) The New York Federal Reserve Bank will publish 12 papers, simultaneously, with both historical and legal justification for the Fed's purchase of municipal bonds. That will be that. Assuming the bond market shuts down (it will, at some unknowable point) and the Feds, as well as the Fed, do not inflate the pie, the fixed pie with the four parties can be viewed as follows. (Eventually, the deleverging U.S. economy will shrink this fixed pie. Tendencies during the time when America is miniaturizing will probably resemble those discussed below.)

#1 - Bondholders - want to be paid interest and principal. (General Obligation bonds are addressed here. The distinction from Revenue bonds is explained on page 20, footnote 20 of The Coming Collapse of the Municipal Bond Market.) Aside from not being paid, most bondholders do not want to be scared. ("Most" - because some thrive on these fears.) Fears can be precipitated by potential default. Prices are likely to fall when default threatens. For example, see six-month charts of California and New York State municipal bond funds. Very few bonds in California have defaulted, possibly none in the funds. Therefore, all interest and principal payments may be current. There are many investors who will not be reassured (and, already, in California and New York are dismayed) should the market value of their investments fall 20%.

The fact that many municipal bond investors are not sophisticated, and look to these assets as their source of retirement income, means this market could be particularly subject to panic. On the other hand, the highly vulnerable investors may be too petrified to act.

Default may mean no more than a few missed payments that will be paid later. (A technical default means no missed payments at all, but it would be surprising if the Bubble media is able to explain this material distinction to its viewers and readers, who may be deaf to legal talk when their remaining assets are plunging in value.) The holder of a bond in default may not listen to promises that missed payments will be paid in the future, no matter how likely. The sales pitch is often that "municipal bonds are the safest of all investments." These investors have heard this before (stocks, houses), so may have lost heart.

Therefore, the bondholders are not interested in grievances of public employees, the loss of municipal services, or, a tripling of tax rates to avoid default. The municipal investor being discussed needs this money.

#2 - Municipality - the state, town, county, or other administrative district does not want to change its mode of operation. It would like to continue building monuments to folly, hiring campaign workers in permanent jobs, awarding higher benefits to employees, and selling bonds since tax receipts do not meet this largesse. See: Illinois is not Peter Pan.

Some, of course, know better and are cutting expenses and attempting to corral employee benefits. Some were always managed well. But those in the headlines pretend to address current circumstances with no intention of balancing their budgets. They have more to lose by doing the right thing - such as, laying off workers, or, halting the construction of a new $100 million high school that is intended to provide 3,000 union construction jobs. Often, this is the reason schools, stadiums, museums, and other white elephants have been built.

The ostriches with their heads in the sand can not conceive of a time when the bond market will shut down. They have little motivation to close funding gaps. The ostriches are also very American; specifically, the vintage of Americans who have been swept into the post-modern guise that everything will work out well. In this case, the federal government will fill the gaps. They may be right, but for how long?

Municipalities hold a trump card that has not received much attention. Many state and city expenses are mandated by the federal government. Congress imposes new regulations that include more school administrators, demand access ramps, the expansion of health benefits, and on it goes, but the Feds do not fund these declarations of magnanimity. In 1970, Medicare cost the states $2 billion. The estimate for 2008 was $158 billion. Some state or city is bound to tell the Feds "you pay for it, or we're stopping it." From a spectator's point-of-view, the scuffle that follows will be engaging.

#3 - Employees - want to keep what they have and many want more. The United States is a large country so it is hard to generalize about the stubbornness on either side. Recent histrionics in Wisconsin, including the juvenile comments by President Obama, represent the aggressive union position. The unions will not budge. In such situations, when the negotiation of benefits and pay fails, court decisions will intercede. Bondholders are the least of the unions' concerns. In such circumstances it is prudent for bondholders to expect the sort of vilification heaped on the owners of General Motors' debt.

As a reminder, the Obama administration and the unions accused hedge funds of forestalling justice. The greedy Greenwichites claimed General Motors' bonds were a contractual arrangement (a bond being a contract). This would not do and a ukase was imposed on hedge fund managers that satisfied the President, a graduate of Harvard Law School.

Crucial to the propaganda campaign was the false representation that hedge funds owned most of the bonds. In fact, a large contingent of GM bondholders fit the profile of the municipal investor. General Motors' bondholders wanted their day in court.

The Family and Dissident Bondholders group was denied official status to represent bondholders by the bankruptcy court. [In re General Motors Corp., 09-50026, U.S. Bankruptcy Court, Southern District of New York (Manhattan).]

The group was overwhelmed by the machinery of the state. A spokesman for the Unofficial Committee of Family & Dissident GM Bondholders said: "The committee members today simply lack the resources needed to mount an effective appeals process on the accelerated basis that would be required here." The "accelerated basis" indicates the Dissident Bondholders were denied Due Process, a potential hazard to municipal bondholders.

Peter Kaufman, president of the Gordian Group LLC, an adviser to the Family and Dissident Bondholders, stated: "It's a tragedy. Twenty-seven billion dollars of bonds, many if not the majority of which are owned by mom and pop, have been essentially wiped out."

Not many municipal bond managers and brokerage firms have considered such a reoccurrence when municipal workers tread the same path. The mom-and-pop holder of a Wisconsin general obligation bond should be prepared to sell in a hurry. In fact, mom and pop should not own Wisconsin general obligation bonds today. Wisconsin sold 10-year bonds in January, 2011, with a yield-to-maturity of 3.75%. Given our state of affairs, which includes Ben Bernanke's campaign to ruin the dollar, the entire structure of interest rates will double at some point. Consumer inflation is at least double the 10-year yield today - 7.5%. Mom, pop, grandma, and grandpa are not being paid an adequate yield given the risks, and given that these securities only repay a fixed amount of dollars. Bonds do not go Verticalnet.

The militant public employee and compromised court scenario is the worst case. There are many municipalities where pay and benefits remained within reason. There are other states and cities with more important troubles. There are some with no problems.

#4 - Taxpayers - are not happy. Homeowners are often paying more in property taxes now than before house prices fell 10% - 50%. States have also raised sales taxes and imposed fees on the most basic services. The citizenry is awakening to the mismanagement and criminal racketeering that created the fiscal abyss Meredith Whitney so ably quantified.

Taxpayers grit their collective teeth as they are learning of outrageous pension and health benefits awarded to their neighbors, the contractual skullduggery between city officials and parking-garage managers, and the fleecing of the taxpayers through incompetence that is barely conceivable to any bystander with an IQ above 70. To all appearances, the taxpayer is facing an infinite tax bill since general obligation bonds are sold with the promise that the issuing authority will "in good faith use its taxing power as may be required for the full and prompt payment of debt service."

This belief is another reason legislators are slow to act and that some public-sector unions are unwilling to negotiate pay and benefits. This is in contradiction to the workers best interests, but they will be the last to accept the Deleveraging of America. Taxpayer resentment is building, a pustule with the ulceric properties that may corrode this mountain of municipal malpractice.

Tuesday, February 15, 2011

The Weak and the Slow Get Crushed

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)

"We do not now have a problem.... Inflation made here in the U.S. is very, very low"

-Federal Reserve Chairman Ben S. Bernanke, February 10, 2011

"Inflation is a means by which the strong can more effectively exploit the weak.... [Inflation] introduces an element of deceit into our economic dealings.... [T]he increasing uncertainty in providing privately for the future pushes people who are seeking security toward the government."

-Federal Reserve Governor Henry C. Wallich, Fordham University,
Commencement Address, June 28, 1978

The topic is not whether Chairman Bernanke is strong, weak, or biodegradable. Rather, when inflation is rising, it is necessary to take matters into ones' own hands, or, get crushed. Those who remain whole during inflationary periods act early.

What follows are summaries of recent quarterly earnings reports (not necessarily a company's fiscal fourth quarter. "Fourth quarter" has been substituted when necessary to eliminate confusion.). Inflation is a major burden. Most of these companies have headquarters in the United States, although they buy and sell worldwide. (Whatever distinction Simple Ben is attempting with "inflation made here" is as trivial as the man.)

The corporate snapshots raise questions.

First, why is the stock market still going up? A possible reason is the Fed's affirmative action program that boosts undeserving failures. Another is the possibility that rising costs are temporary. Or, it may be that the mind of the market is that of the village idiot. No doubt, other propositions should be considered.

Second, is whether companies can pass rising costs to their customers. DuPont believes it can; Kimberley-Clark and Campbell's are suffering erosion. DuPont and the two retail producers sell to different markets. Their remarks support the supposition that consumers at the top are spending while the lower income groups are retreating. The comments of Whole Foods intimate its ability to raise prices, which would support the upstairs, downstairs thesis.

The point of these profiles is to show how inflation and deflation fall unevenly. It is the relative movement of prices and wages that matter. Some win and some lose. This is true of companies and for individuals. It is true of investments and for consumption. Federal Reserve Governor Henry C. Wallich went on to tell the Fordham University class of 1978 that, during inflationary periods, contracts are no longer made to "be kept in terms of constant values" but, one party understands this better than the other. He might have said (and maybe he did), if ever it is necessary to think for oneself, this is the time. Shorting Bernanke's statements and the repetitious cheerleading on Bubble TV are steps in the right direction.

What follow are from wire service synopses or corporate press releases. Questions that remain may have been addressed in quarterly earnings reports or in quarterly analyst conference calls.

DuPont & Co. - Fourth quarter sales rose 15%; net profits fell 15%. "DuPont forecast raw-material and freight costs to be some 4% to 5% higher this year than last, moderating from the 6% rise seen in 2010. [Executives] were confident they would be able to pass these on to end users. Ethane, chlorine, solvents, and pigments were seen as the key areas of cost pressure."

Procter & Gamble - Sales rose 2%; net profits fell 25.5%. "P&G, which sells everything from Tide detergent to Olay skin-care products, said its commodities bill will cost $1 billion for the fiscal year that ends in June, more than double what it had expected."

Kimberley-Clark - "Organic sales, which exclude the impact of acquisitions and currency fluctuations, rose 3% in the quarter, helped by higher prices of about 2%... but, it continues to see weakness in key categories such as diapers, paper towels, and toilet tissue.... Continued consumer frugality is now sending more consumers to private-label and low-priced products, such as Procter & Gamble's (PG) Bounty Basics line, [which] are gaining share, hurting Kimberley-Clark, which makes Huggies diapers, Scott paper towels, and Cottonelle toilet paper."

Colgate-Palmolive - "Colgate's profit fell [in the fourth quarter] 1%...squeezed by higher commodity costs and money paid to promote its products."

3M Company - Fourth quarter sales rose 10%; net profit fell 0.7%. "Margins declined under rising material costs and weakening sales in the company's health care and graphics businesses.... 3M said it intends to recover higher material expenses through price increases, which include Scotch tape, Post-It notes, furnace filters, sand paper, automotive components, and thousands of other household and industrial items."

Pepsico - [Pepsi-Cola, Frito-Lay, Quaker, Tropicana, Gatorade] - Full-year reported earnings per share increased 4 percent; fourth quarter earnings per share declined 6 percent. CEO Nooyi was pleased with the results, but acknowledged she is "mindful of three realities: (1) A weak consumer landscape given the poor macroeconomic picture, especially the high level of unemployment in key developed markets; (2) High levels of cost inflation for the coming year, driven by broad and pronounced commodity inflation; and, (3) A potentially difficult competitive pricing environment, particularly in beverages." Hugh Johnson, Pepsi's CFO, talked about cost inflation of 8% to 9.5%: "That type of inflation has a pretty strong impact."

Goodyear- [tires, blimps] Net fourth quarter sales rose 14%; with a $177 million fourth quarter loss. "Raw material prices costs are likely to rise 25% to 30% in the first quarter of 2011 and rubber prices have risen 40% since October [2010]."

Whirlpool - [Maytag, Kitchen Aid] Fourth quarter sales fell 1%; profits fell 61%. It is "seeking to offset cost increases for such items as steel, copper and plastics..."

Electrolux - [refrigerators, washers] "Operating income in North America and Europe declined as the company was hit by higher costs for raw materials and lower sales prices." "The costs for our most important raw materials continue to increase," Electrolux CEO Mr. McLoughlin, said in a statement. "In addition to increased costs for steel, we also see considerable increases in resins (used in plastics) and base metals. We have signed contracts for a significant part of this year's raw material requirements."

Whole Foods - [grocer to the Junior League] Sales for identical stores rose 9.0% in the fourth quarter; earnings rose 59%. "The Company expects higher costs in the second quarter mainly due to increases in wages and investments in other initiatives." No mention of higher food costs. Is it able to pass them on to customers?

Campbell Soup Co. - [besides soups, Pepperidge Farm, Prego, Goldfish, V8] In the quarter ending October 31, 2010: "Soup sales fell 5%.... Condensed-soup sales dropped 1%, while ready-to-serve soups slid 13%." Presumably, ready-to-serve soups cost more than condensed-soups, another indication of tighter budgets, though Campbell's did not mention consumer budgets or material costs as a reason for the poor quarter (in the Wall Street Journal summary). Its new initiative: "The challenge for us now is to create some taste adventure." Another adventure will be the 10% increase of tin over the past month - January, 2011. According to the Wall Street Journal (January 31, 2011): "Heinz, Campbell Soup and General Mills [are companies where] tin can prices can represent somewhat important input costs."

The Journal's January 31, 2011, tin report addressed the circumstances of all companies and consumers in the first sentence: "You just never know what the market is going to throw at you next."

Tuesday, February 8, 2011

Uncle Ben Wants You! - To Buy Stocks

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)

Federal Reserve Chairman Ben S. Bernanke reviewed his Quantitative Easing, Second Inning (QE2) at the National Press Club on Thursday, February 3, 2011. His conclusion: "The economic recovery that began in the middle of 2009 appears to have strengthened in recent months..."

Chairman Bernanke endorsed QE2 as the sparkplug. The current Bernanke interpretation should be compared to benefits the chairman promised on November 4, 2010. "Promised" is the correct word since he claimed (via his Washington Post manifesto) that QE2 "would" - not "should," or "probably" - produce specific results. The future is chalk full of contingencies, but not to the myopic chairman. See: Ben Bernanke: The Chauncey Gardiner of Central Banking.

Bernanke's words from the Washington Post, on November 4, 2010:

"Easier financial conditions will

1 - promote economic growth. For example,

2 - lower mortgage rates will make housing more affordable, and

3 - allow more homeowners to refinance.

4 - Lower corporate bond rates will encourage investment.

5 - And higher stock prices will boost consumer wealth and help increase confidence..."

[Bold and underline mine - FJS]

The Fed's device to create "easier financial conditions" is the purchase of $600 billion of U.S. Treasury securities. The Fed has bought about one-third of the total. Bernanke declared QE2 a success before the National Press Club:

"A wide range of market indicators supports the view that the Federal Reserve's securities purchases have been effective at easing financial conditions. For example:

1 - equity prices have risen significantly,

2 - volatility in the equity market has fallen,

3 - corporate bond spreads have narrowed...

4 - Yields on 5- to 10-year Treasury securities initially declined markedly as markets priced in prospective Fed purchases; these yields subsequently rose, however, as investors became more optimistic about economic growth...."

[Bold and underline mine - FJS]

Bernanke, who told 60 Minutes: "I've never been on Wall Street," now asserts rates have risen due to Wall Street's optimism. This is par for the man. Those acquainted with Simple Ben's Essays on the Great Depression are familiar with his negligence or suppression of evidence.

As for lower interest rates, the yield on 10-year Treasury bonds rose from 2.48% on November 4, 2010, to 3.65% on February 4, 2011. That is a 47% boost, during the period in which the Federal Reserve bought approximately $200 billion of Treasury bonds, to reduce mortgage rates. On February 3, Bernanke did not mention mortgage rates among his "wide range of market indicators" that validate QE2.

Since November 4, 2010, Freddie Mac 30-year fixed-rate mortgage rates have risen from $4.10% to 4.81%. Housing - which accounted for 40% of new jobs during the ersatz-boom - is sinking, partially due to the higher rates since Bernanke's November 4, 2010, manifesto. Hence, the Fed chairman never mentioned his housing promise before the National Press Club.

For investors, more important than his omissions was an addition to his list of accomplishments. That is: "volatility in the equity market has fallen." Bernanke thereby signaled that Wall Street may rely on the "Bernanke Put." By accomplishing this feat of falling volatility (to novitiates, the fluctuation of security prices is being controlled by the Fed) Bernanke told Big Money to leverage into the riskiest speculations. (Also for novitiates - it is true, volatility also increases when prices go haywire to the upside, but it is only falling prices that concern speculators, and Bernanke.)

Bernanke's briefing was reminiscent of times past, during pep talks by his predecessor, former Federal Reserve Chairman Alan Greenspan. Echoes from a similar "all clear" speech by the former Maestro led to a search in Doug Noland's archives, author of the indispensable Credit Bubble Bulletin, and manager of the Prudent Bear Fund, now housed within Federated Investors, Inc. On September 26, 2003, Noland wrote:

"To understand today's environment it is important to appreciate that the Fed looked at potential debt collapse last year and said, "We'll have absolutely none of that!" Team Bernanke/Greenspan aggressively cut rates and signaled to the market that they were willing to flood the system with liquidity to resolve the dislocation (couched in terms of fighting "deflation" - much more palatable than fearing "debt collapse"). The rest is history. The leveraged speculators and derivative players began to reverse their short positions, setting in motion a self-reinforcing return of liquidity and Credit availability (not to mention one heck of a speculative stock market run). Not only did the derivative players reverse bearish bets, The Powerful Force began aggressively taking leveraged long positions. It was one of history's most precipitous Busts to Booms.

"A few weeks ago hedge fund manager extraordinaire Leon Cooperman was on "Kudlie and Cramie." His fund is up big this year, and Mr. Cooperman was pleased to explain his very successful bet on the junk bond market. "The government wanted us to own them," if I recall his comment accurately....The Fed wanted the speculators to buy. Success stories are easy to find these days throughout the leveraged speculating community. Everyone is fat, happy and complacent.

"Our policymakers have made it perfectly clear - to the home owner, to the stock jockey, to the global bond players, to the derivatives trader - that leverage is the way to easy profits. And Everyone has been rushing full-throttle to play inflating asset markets...

"[V]irtually no one voices concern about the speculative excess running roughshod throughout the stock, bond and emerging markets, as well as the California/national housing markets. The "good" news is that Everyone is keen to expand holdings (inflationary bias). The bad news is that these holdings are growing exponentially and their liquidation will be a big problem. There will be no one to take the other side of the trade."

In closing: The Bernanke Put may work for awhile. Or, it may not. There was no one to "take the other side of the trade" in 2000, 2007 and 2008. All government support operations, in the end, fail. The Romans learned that. Investors should hold downside protection.

Bernanke is losing credibility. One measure is the reverence of the retail community towards the Federal Reserve chairman. Yesterday, on February, 7, 2011, the "Yahoo! Finance" website sported an image of Bernanke dolled up as Bart Simpson. This was Yahoo's verdict of Bernanke's National Press Club speech. As Bernanke sags, so goes the dollar. (It might be recalled that a cartoon drawing of Alan Greenspan, when chairman of the Fed, high-fived Bart Simpson on the show. This was a very different image.)

Hard assets are anti-dollars. Several mining companies will announce fourth quarter earnings over the next two weeks. For the most part, their profits should be higher than previous periods since costs are not rising nearly as fast as the price of gold, silver, copper, and other rocks - the goods they sell. Some of these companies will probably announce higher dividend payouts. Dividends are in favor at the moment. A portion of those who think Ben Bernanke is a recreation of Bart Simpson will sell dollars and buy mining shares.

Wednesday, February 2, 2011

They Missed the Money

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market"(, 2009)

The Federal Crisis Inquiry Commission (FCIC) had as much chance of satisfying the public as the Warren Commission did of closing the debate on the Kennedy assassination. The FCIC published its report on January 27, 2011. This was the "Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States." The FCIC itself could not come to a conclusion. The Democrats wrote for the majority, the Republicans for the minority, and a think-tank fellow motored off on a tangent of his own.

By the way, these conclusions, cleaved by the politics of the season, demonstrate the immaturity of Washington. It does not represent. The members could not forsake their hobbyhorses to address the time bomb that, unaddressed, will explode. A half-century's accumulation of bad debt tumbled over in 2008 and a much larger mountain of waste and ruin lies ahead.

My gripe: the FCIC found the greatest fault with the effects rather than the cause. This is true of all three conclusions. The cause of the crisis was too much money and credit. An economy needs enough credit to operate but not so much that speculation runs the country. (This, of course, is so obvious that it might seem a waste to write, but the so-called policymakers rev the cyclotron faster and faster.)

Among the "Conclusions" of the Financial Crisis Inquiry Commission Report, the majority averred: "[I]t is the Commission's conclusion that excess liquidity did not need to cause the crisis. It was the failures outlined above - including the failures to rein in the excesses in the mortgage and financial markets - that were the principal cause of the crisis."

Readers may remember Advice to the Financial Crisis Inquiry Commission: How to Question Alan Greenspan. This was a letter I wrote before the FCIC's hearing on subprime lending, addressed to FCIC Chairman Phil Angelides, in anticipation of former Federal Reserve Chairman Alan Greenspan's testimony. Paragraph number three follows:

The Federal Reserve is Cause, Not Effect, for Abuses in Subprime Lending

There would have been no lending of any sort without the Federal Reserve. The Fed prints the money that enters the economy. It has a monopoly. Counterfeiters know that.

Credit springs from money. The commercial banking system produces credit, by and large. The Federal Reserve sets reserve requirements on commercial bank credit growth. If the Fed sets the bank reserve ratio at 10:1, a bank cannot lend more than $10 for every $1 on deposit. That effectively limits the growth of credit.

The Federal Reserve has the authority to increase or decrease bank reserve requirements at any time. During Alan Greenspan's chairmanship, the Fed reduced bank reserve requirements several ways; it never increased them. The result of the Greenspan Fed's money and credit expansion: commercial banks, having run out of proper projects to fund, lent to investment banks, hedge funds, private-equity funds, subprime mortgage lenders, and commercial property speculators. (An investment bank may have lent to a non-bank mortgage company, but it first had to borrow from the commercial banking system.)

The Federal Reserve, under Alan Greenspan, both printed every dollar that entered the economy and had sole authority to set bank reserve requirements. If the Fed had reduced reserve requirements, this would have restricted the lending that proved so destructive.

There is, of course, much more than I have written above for a full understanding of money and credit, but Alan Greenspan will not attempt to enlighten the commission....

Greenspan's testimony was indeed reprehensible, but let him rust.

In 2011, Federal Reserve Chairman Ben S. Bernanke is the cause of various asset-price inflations. He is increasing money at a rate far beyond Alan Greenspan's worst excesses. The overinvestment (also called "liquidity" or "speculation") has destroyed potential returns of promising enterprises. To distill the current investment environment: "I have a better chance of a triple buying Chinese dot.coms than investing in a profitable solution to world hunger, and the Fed's rigged the markets, so I'm making money fast before everyone realizes Vegas is a squarer deal."