Who's Fool?

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)

Legislation to modify debit-card interchange fees cannot compete with celebrity gossip. Yet, exhausted carcasses are carried on stretchers from the senate office buildings. The Huffington Post explained: "A full 118 ex-government officials and aides are currently registered to lobby on behalf of banks in the fee fight... Retailers have signed up at least 124 revolving-door lobbyists.... The flood fills the hallways with lobbyists and deluges the airwaves with ads. For weeks, Washington's Metro system has been papered with... ads on trains and station walls."

It is not surprising that lobbying efforts have changed the minds of 19 senators who formerly aligned themselves with consumers and small banks (to which the lower fees do not applDurbin Chuck Schumer debit card swipe fees Federal Reserve Visa MasterCard J.P. Morgan Chase Jamie Dimon American Bankers Association Barney Frank NAACP Christian Coalition y.) The legislators have now hopped in bed with Too-Big-to-Fail Banks. That is politics as we know it. What might be confusing is the about-face of Federal Reserve Chairman Ben S. Bernanke. He, too, is cohabitating with Wall Street. Yet - and this is the astounding twist - it was under his signature that the new regulations were written.

Before discussing the legislation, a few words on the financial stakes. Annual debit-card interchange fees (generally called "swipe" fees, and, please note: this tussle does not include credit cards) in the United States were $16 billion in 2009. The 10 largest banks collected $8 billion. In the opposite corner are businesses and consumers. Interchange fees are the second largest expense, after labor, for retailer Target Corporation. It is not clear, but looks as though this includes debit- and credit-card costs. Studies in countries where swipe fees have been capped show more than half of the cut show up in lower retail prices, so the consumer wins. The process of when, and by whom, fees are paid and received is below.

The history of the legislation is straight-forward. An amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act required the Federal Reserve to decide whether debit card interchange fees are "reasonable." This is referred to as the "Durbin amendment," named after Senator Richard Durbin of Illinois, who proposed the change. The Fed's study was added to the Federal Register on December 28, 2010 (officially: Federal Reserve System 12 CFR Part 235 Debit Card Interchange Fees and Routing; Proposed Rule). The paper was issued by the "Board of Governors of the Federal Reserve System," of which Ben Bernanke is the chairman. The research was the work of others, but the conclusion bears his signature. Just as a partner at an accounting firm is responsible for an audit he signs, this is Bernanke's opinion.

The swipe fee is incurred at the point a debit card is used to pay for a transaction. Many financial institutions issue debit cards. Most banks in the United States are in either the Visa or MasterCard network.

Visa and MasterCard set the swipe fees in their networks. The merchant (Target, for example) pays the interchange fee to the card-issuing bank (Chase, for example). The customer does not see it, but this is an expense (a reduction in revenue received) for Target or a laundromat. The merchants increase the price of tires and laundry in compensation. At the same time, this is revenue for the issuing entity, whether J.P. Morgan (under the Chase brand name), or the Bailey Building and Loan.

The Federal Reserve's study found "reasonable" fees should be decreased. In 2009, the "average interchange fee for all debit transactions was 44 cents per transaction....Issuers reported median per-transaction total processing costs for all types of debit and prepaid card transactions was 11.9 cents." (Fed study.) The Fed proposed a cap of 12 cents per transaction. This fee allows "for the recovery of per-transaction variable costs for a large majority of covered issuers (approximately 80 percent)."

Costs per transaction are, in part, a matter of scale. The aforementioned Chase, for instance, should have much lower per transaction costs than the Bailey Building and Loan. The Fed, in its study, proposed that banks with less than $10 billion in assets be exempted from its proposed cap. They would continue to receive the average cost per transaction of 44 cents (assuming the 2009 level).

The Fed's study was unsympathetic to large issuers with poor cost controls. The Federal Reserve Board of Governors' 12 CFR Part 235 states: "The Board does not believe it is reasonable for the interchange fee to compensate an issuer for very high per-transaction costs." Footnote 23 (to 12 CFR, etc.) offers a good reason for this position. It states that PIN debit transactions (this does not include checkbook transactions) rose from 7 cents per transaction in the late 1990s to 23 cents in 2009. PIN transactions have been increasing in proportion to checkbook transactions.

Whether the Board of Governors considered the implications of footnote 23 is theirs to know, but it throws a dishrag on the near unanimous opinion that technology has created efficiencies and reduced costs, the latter often taking the form of fewer employees. There is also the question of why, in the land of whiz-bang digitality, debit-card fees are among the highest. There are no - 0.0000% - fees in Canada, the country with the highest debt-card usage rate in the world. It follows that Canadian banks are willing issuers of debit cards and that they make money without a swipe fee.

Technology has reduced the cost of PIN (electronic) transactions. This raises the query of whether inept bank management and derivative trading have been spread across unrelated portions of the Too-Big-to-Fail banks' profit centers. The Federal Reserve should conduct another study to unearth such gerrymandering, given the large banks' passion for circuitous accounting.

Recall that on December 28, 2010, Ben Bernanke submitted the Fed's proposal to reduce swipe fees. On February 17, 2011, the chairman of the Board of Governors testified before the Senate Banking Committee. Now, he did not think cutting fees was a good idea. He warned that merchants (stores) might refuse to accept debit cards issued by small banks because those banks receive higher interchange fees. Bernanke also cautioned that card networks might be unwilling to operate a "two-tier" system with different interchange fees (the 12 basis points cap for banks with assets over $10 billion and 44 basis points for banks with assets under $10 billion).

We have arrived at the fun part: motives. Motives are rarely clear, usually confused, so everyone is qualified to play. The long-term contention held here, that Ben Bernanke is a dimwit; a pedestrian, college administrator who allotted prime parking spaces to influential faculty; has not persuaded many. (For those still willing to give it a try, please see: Orwell Targets Bernanke: An Unteachable Hole in the Air and Ben Bernanke: The Chauncey Gardiner of Central Banking.) Critics of this conclusion may be right: their contention being that Bernanke and the Fed serve the bankers and, likewise, some politicians are also lackeys: look at their campaign contributions. Senator Durbin implicitly agreed when he said of fellow senator Chuck Schumer from New York (an opponent of the amendment): "Listen, I know the zip code for Wall Street and I know what state it's in."

On the same day (February 17) Senator Durbin fired off a reply to the Fed chairman. In brief: 1 - In January, Visa had already announced it was designing a 2-tier interchange fee system, 2 - This was not virgin territory since both Visa and MasterCard already had several different tiers for such categories as corporate cards, supermarkets, utility bills, and overseas payments, 3 - merchants could not reject bank cards from smaller banks. It is in their contract with Visa or MasterCard: "Merchants are subject to severe penalties if they decline to accept a network's card on the basis of the card's issuer." (Durbin letter to Bernanke.)

Chairman Bernanke, who, again, authorized the rule changes, had now, on February 17, testified against the rule changes, for reasons that did not apply to the rule changes.

It is the latter part that is nearly inexplicable. How could Bernanke show up at a Senate hearing and not know his contentions were factually wrong? He has 220 Ph.D.'s at the Fed who live and breath to impress the Fed mandarins. Surely, Fed staffers shared their research (most of which can be read on Visa's and MasterCard's websites) with the chairman. How did he graduate from the third grade? One possibility, for both his F-minus performance and third-grade promotion, is a parallel briefing by the American Bankers Association.

Between December, 2010, and February 17, 2011, a massive battle was waged. A small mountain of letters and press releases passed between lobbyists, senators, and special-interest groups. The "nays" won where it matters: senators and the Fed chairman changed sides.

The ABA wrote to Senator Durbin on February 8, 2011. It aligned itself with the small banks for the obvious reason that arguing for the interests of J.P. Morgan or Citigroup is not a vote-getter. The ABA claimed merchants would discriminate against small banks since those banks with assets under $10 billion would still charge 44 cents per transaction (all else remaining equal), a greater depletion of the merchant's revenues than the new 12 cent cap for large banks.

Senator Durbin replied to the ABA on February 11, 2011. He reminded the ABA (which must have known) that Visa's contract with merchants prohibits such discriminatory behavior and that Visa had already announced (on January 7, 2011) it "would implement different interchange rate schedules for large and small banks." Six days later, Simple Ben tried to wing the same bag of baloney at the same senator.

So, a possible explanation of F-Minus Bernanke: his argument did not matter. "The Fed chairman opposes the Durbin amendment," was parroted through the hallways and on the airwaves, all that was needed for day-trading politicians to hide in the tall grass.

Before moving on to Bernanke's, most-recent, May 12, 2011, testimony, it is worth a moment to illuminate the characters Bernanke has aligned himself with. On April 5, 2011, J.P. Morgan Chase's CEO, Jamie Dimon, before the Council of Institutional Investors, stated the Durbin amendment was "counterproductive" and "downright idiotic." This is fine thanks to the government that; if not for the good graces of Geithner, Paulson, and Bernanke; might have thrown Jamie Dimon in a high-security federal penitentiary where he would now be smashing large rocks into little rocks as punishment for his bank's reckless behavior leading up to the 2008 financial evaporation.

Dimon whined that J.P. Morgan would have to raise other fees to compensate for its projected losses. Good. Maybe it is so uncompetitive it will abandon the debit card business. It could do us all a favor by shutting down the rest of its Too-Big-to-Fail-or-Save business lines at the same time.

J.P. Morgan Chase also terrorized America's children when it banned them from Disneyworld. A notice to its customers states: "Congress recently enacted a new law known as the Durbin Amendment that significantly impacts debit cards. As a result of this law, we will be changing our debit rewards program. After July 21, 2011, you will no longer earn Disney Dream Reward Dollars when you use your Disney Rewards Debit Card."

Senator Durbin replied to Dimon's tantrum on April 12, 2011. He wrote that those who pay the most for higher swipe fees are the poor. Twenty-five percent of Americans do not have a bank account, pay with cash, so (quoting the Huffington Post) there is "no question that the resulting higher prices [that retailers charge to compensate for swipe fees] hit the poor hardest of all." Durbin reminded Dimon that last year his bank had $17.4 billion in profits and he was paid $20.8 million. Bernanke has chosen some fine bedfellows.

It is a strange mix now serving the Morgan Interests: a mothballed phrase from a century ago that is more fitting now than then. These include the ABA, the NAACP, the Christian Coalition, Barney Frank (co-author of the Dodd-Frank Act), Grover Norquist, and leading Tea Party groups Freedom Works and Americans for Prosperity (from the Huffington Post, which has done an excellent job of covering the story). Also, the Independent Community Bankers of America (ICBA), the trade association for small banks, is lobbying against the small banks, probably to protect the ICBA Bancard, a money-maker of such grand proportions that it would be subject to the rate caps. (Simon Johnson, New York Times, May 12, 2011)

On May 12, 2011, Bernanke testified again before the Senate Banking Committee. When questioned, the chairman stated: "Well, it's going to affect the revenues of the small issuers and it could result in some smaller banks being less profitable or even failing." Barney Frank is using Bernanke's misgivings as an excuse to sandbag his own bill. Senator "Durbin is as exasperated by Frank as he is by Bernanke. "I don't understand it," he says. "I wrote [Barney Frank] a letter and asked him... 'What are you doing?' We had long talks when we were writing this thing, [when we] worked on it together." (Huffington Post)

Ben Bernanke is of a type. Anyone who has worked at a state house or city hall or court house has met him. The type is common, too, on college campuses where merit is judged by conformity of thought, submissive allegiance to the hierarchy (see BB's nauseating, "thanks to you, we won't do it again," to Milton Friedman, November 8, 2002), and obedience to the bureaucracy.

George Orwell wrote that the intelligentsia is "power hungry" and (individually) "is capable of the most flagrant dishonesty, but he is also - since he is conscious of serving something bigger than himself - unshakeably certain of being right." Orwell observed from a front-row seat as the apparently powerful shuddered under the heel and whip like cotton-picking slaves. Writing in 1944: "Hitler's puppet government are not workingmen, but a gang of bankers," and other specimens of the type under review.

The type was described by Giorgio Bassani in his novel, The Garden of the Finzi-Continis. Set in Ferrara, Italy, in the late 1930s, a rising mediocrity in the Fascist University Students Association (Gino Ciariani, by name) halted a tennis tournament because a Jewish player was winning. In the words of an observer at the tennis match, (with a few substitutions, in brackets, to replace Gino Giariani with Ben Bernanke): "It was all too obvious: dimwit that he was... [H]is sole thought, from the first moment he had entered [MIT's graduate school of economics], had been to make a career, and for this reason he had never overlooked the opportunity, in public or in private, to lick the feet of [academic economists]. The moment [Hank Paulson] or some other big shot of the group put him in his place, he promptly tucked his tail between his legs, capable, to win forgiveness and be restored to favor, of even the most humble services: running to the tobacconist's to buy the secretary a pack of Giubek's, [starving elderly Americans by confiscating their interest rate so Jamie Dimon could make more money].... [A] worm of that sort... surely hadn't missed the opportunity to show off, once again, for the party officials!"

The China Trade

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)

In an Undercollateralized World concluded by quoting Michael Lewitt. Lewitt, the proprietor of Harch Capital Management in Boca Raton, Florida, wrote in the May issue of his monthly letter, The Credit Strategist:

"Readers interested in owning the Chinese currency can walk into the Bank of China in New York or Los Angeles and open a remnimbi-denominated account. While these accounts originally had limits on size, The Credit Strategist understands that these limits have now been lifted and meaningful amounts of money can be invested. These accounts are insured up to $250,000 by the FDIC (there must be some irony in that.)"

A friend, after reading Lewitt's comment, let me know he had just been to the Bank of China in New York (at 410 Madison Avenue, corner of 48^th Street). He had met with his banker, had transferred funds to a higher-yielding certificate of deposit: higher-yielding, that is, than he could receive at a U.S. bank. Note Lewitt's comment, above, about the irony of Bank of China accounts being insured by the FDIC.

It was explained to my friend that the Bank of China's "bookkeeping and mailing functions are slow these days because they've been overwhelmed with applications for new accounts and they are having trouble keeping up."

My friend expects the remnimbi, thus his account, to appreciate against the dollar. I expect the same but have an even higher degree of confidence that once CNBC gets wind of the trend, we will be seeing, and reading, "remnimbi-in-a-bubble" stories from every media outlet in the country.

In an Undercollateralized 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 world is undercollateralized. This is the single most important feature of the 2011 economy. Sixty years ago, if assets were worth less than loans, it was possible to work our way into the black. In 1950, 59% of U.S. corporate profits were from manufacturing; 9% were from finance. The roles of manufacturing and finance have reversed. Thus, we witness the desperate attempts to forestall what cannot be prevented. Yet, the world must deleverage. Banks must write off loans. Loans to bankrupt developers and companies must be called. Living standards must fall.

The authorities are doing all they can to prevent the necessary deleveraging. That is the context in which Michael A.J. Farrell, CEO of Annaly Capital Management (NLY- NYSE), spoke to investors during his company's first quarter 2011 conference call:

"[T]he change that is happening in the financial markets is a chaotic mess. I believe the simultaneous execution of radical monetary policy, fiscal policy, and financial regulatory reform is introducing rather than reducing systemic risk in the global financial system by ignoring the simplest lesson of the scientific method. Rather than change one variable in a complex system and test the outcome, regulators and policymakers are changing virtually all of them at the same time: QRM [quantitative risk management], risk retention, the Volcker Rule, Basel III capital rules, derivatives clearing and related margin requirements. GSE reform. FAS 166 and 167. Zero-bound fed funds policy and QE2. Deficit financing, structural budgetary imbalances, and debt limit debate."

Where will this end? Michael Lewitt, proprietor of Harch Capital Management in Boca Raton, Florida, discussed the consequences of our leaders' catastrophic policies in the May issue of his monthly letter, The Credit Strategist:

"Rather than confronting sources of volatility, policymakers have sought to smooth out volatility at all costs. Unfortunately, these costs are proving to be very high and will ultimately prove prohibitive. Pressures build inside complex systems until they can no longer be suppressed. When these pressures can no longer be contained, they tend to erupt with far greater violence than had they been allowed to adjust earlier.

Lewitt continued. Federal Reserve Chairman Greenspan and Bernanke "convinced investors the Fed would bail them out if the economy or markets got into serious trouble. As a result, investors engaged in increasingly reckless behavior..." The result: "Rather than saving the markets, Mr. Greenspan's philosophy and approach guaranteed their failure." One of the consequences is "the build-up of unsustainable debt levels."

We are overleveraged, undercollateralized, and accentuating these unsustainable imbalances. Lewitt notes, "the Federal Reserve has accounted for 101 percent of the net Treasury bond issuance during the first four months of 2011." He goes on: "The U.S. government has been the largest purchaser of Treasuries, promulgating a Ponzi scheme of unprecedented scale."

The U.S. Treasury issues debt and QE2 buys it. Lewitt notes that 10-year Treasury yields have fallen from 3.59% on April, 11 2011, to 3.15% on May 6, 2011.

Since the Fed is the sole net buyer, the 10-year-yield is not a real interest rate. (It has not been a true market for years, but never more so than now.) This is also true of the zero-percent short-term yield, one of the trial balloons listed by Michael Farrell. Interest rates are integral to the pricing of assets. A country without an interest rate has a stock market with a price, but not a value.

The future-focused investor should estimate the value of stocks, commodities, and bonds as if interest rates were 5% higher. That day will come to pass: when assets seek the price of their true collateral. This is not widely appreciated. For instance, the recent dive in silver prices has been acclaimed as a bubble that popped. That might be true, if paper contracts were worth the value they purport to represent. There is not enough silver in the world to meet derivative claims - of ETFs, forward contracts, and so on. When this misrepresentation is widely recognized, physical silver will attract panic buying.

Silver is a fairly small market, so this may go unnoticed. That will be a shame for the majority since everyone holds a paper claim that is not worth the money it is written on. Dollar bills, still flowing forth from the Federal Reserve (more exactly: from the U.S. Treasury's Bureau of Printing and Engraving), are losing value every minute. Treasury securities are undercollateralized: the Treasury spends $3 for every $2 it receives in tax payments.

What to do? One idea comes by way of footnote #8 in this month's The Credit Strategist: "Readers interested in owning the Chinese currency can walk into the Bank of China in New York or Los Angeles and open a remnimbi-denominated account. While these accounts originally had limits on size, The Credit Strategist understands that these limits have now been lifted and meaningful amounts of money can be invested. These accounts are insured up to $250,000 by the FDIC (there must be some irony in that.)"

Barney Frank's Turn at Bat

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)

Congressman Barney Frank from Massachusetts is not worth a blog. That goes for his recent proposal, too. It is worth a moment to understand the inconsequentiality of Frank's mischief and, more importantly, the amount of time that can be saved by ignoring Fed pronouncements. To come to the point: there is not one word flushed from the Federal Reserve machinery that bears on monetary policy other than the Fed chairman's propaganda.

Frank advertised his disordered mind on May 3, 2011, by proposing that Federal Reserve bank presidents not be allowed a vote on the Federal Open Market Committee (FOMC). Why he hoisted this bludgeon, and why now, are matters for speculation. Here goes: The obnoxious butterball is up to his eyeballs in misdeeds including Fannie, Freddie, and favors - and threats - offered in return for contributions that are a central feature of the Dodd-Frank bill. He therefore cannot refuse a request from more powerful parties.

Federal Reserve Chairman Ben Bernanke wants the FOMC to report unanimous decisions, unanimous decisions that are identical to past decisions: zero-interest rates and full authorization for his open spigot. Regional Federal Reserve presidents have been giving speeches suggesting that Chairman Bernanke is impoverishing the 99% of Americans suffocating in the ninth circle. The Powers have decided bank presidents need to be shut up. Barney got the call: "It's your turn, sport. Whip up some legislation that will break their kneecaps with a baseball bat."

There is no reality to this. Bernanke faces no opposition. We will come to that. Frank's proposed legislation stands little chance of passing. Over the years, neutering the Fed presidents or abolishing the FOMC has been proposed several times, at a point when vested interests want the Federal Reserve to cut interest rates. Congressmen Wright Patman, Henry Reuss, and Henry Gonzales threatened the Fed with dismemberment. In those cases, the politicians walloped the Fed chairman. Subsequently, the FOMC loosened monetary policy. Inflation followed. In the present case, the Fed chairman is already goose-stepping to the cartel's drumbeat. It is FOMC members' voices that are being silenced.

A succinct example is that of Senator Robert Byrd, addressing Federal Reserve Chairman Paul Volcker on December 18, 1982: "To whom are you accountable?" Volcker: "Well, the Congress created us and the Congress can uncreate us." Byrd then drafted a "reform legislation that would give Congress genuine leverage on monetary policy." (Greider, Secrets of the Temple)

MarketWatch reports Barney Frank defended his motion by claiming Fed presidents are "totally inconsistent with any kind of theory of democracy." Stalin had a better appreciation for democracy.

From the Federal Reserve website: "The Federal Open Market Committee (FOMC) consists of twelve members - the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis." The seven governors (by statute: there are currently five) work at the Eccles building on Constitution Avenue in Washington in offices "with a wall of bookshelves and a fireplace handsomely faced in black marble, usually a sofa and chairs around it." (Greider) They are nominated by the President and approved by the Senate. The politicians do not vote for the regional presidents. This offers hope of independence given their distance from the City of Central Planning.

The presidents represent and live in the 12 Federal Reserve districts around the country (Richmond, Kansas City, Minneapolis, etc.). Thomas Hoenig, president of the Kansas City branch recently warned a bubble in farm prices may be building. (See: Kansas City Fed Chief Sees Farmland Bubble.) As reported at Farmland.com on April 7, 2011, he is urging the Fed (FOMC) to raise interest rates to save farmers from the same fate as former homeowners in Las Vegas.

Frank had no idea what he was talking about: "It undermines legitimacy when you have literally people [sic] who are in the financial industry picking people to vote on setting interest rates." Thomas Hoenig started working for the Federal Reserve Bank of Kansas City in 1973, upon graduating from college.

If Frank's proposal were passed, not much would change. The Federal Reserve presidents are showpieces on the FOMC, other than the New York president, who, by tradition, behaves like an overweight, bench-warming, third-string, junior-high-school catcher who yells at the first-stringers for not hustling.

Dallas Federal Reserve President Richard Fisher was quoted in Sidelights to 1994. Refreshing as it is to read his denouncement of Ben Bernanke's kleptomania, he does not influence FOMC votes.

During the Greenspan years, the Greenspan Fed was just that. The only renegade governor was Larry Lindsay. Yet, even Lindsay, who, at every meeting, tenaciously instructed other FOMC members of how the Fed was disemboweling the middle class, and who really did understand economics, had no influence when it came to a vote.

Maybe the Bernanke FOMC is different. (We cannot read FOMC transcripts until five years after the event. Bernanke has been chairman since January, 2006.) This is difficult to imagine, since the governors' public statements mimic Bernanke's calcified dogma - not a word out of place. When dissident presidents such as Thomas Hoenig (who is not even a voting member of the FOMC) or Charles Plosser (Philadelphia, who does vote) give speeches that offer hope of sanity, it is safe to assume their positions are of no consequence to FOMC policy.

Now we come to the real reason Bernanke is the FOMC. Reading dozens of FOMC transcripts is tedious, but revealing. In the end, it saves time since one then understands the meaninglessness of the FOMC. (The call comes in: "You have to watch Laurence Meyer [former Fed governor] debating David Einhorn on CNBC. You won't believe how stupid Meyer is." Oh no, I know how stupid Meyer is. But, the temptation to watch the clip is great: Wow, I had forgotten he was that stupid.)

For those who have not read the transcripts (come on, admit it), it is difficult to imagine how little is discussed that could influence current policy. The meetings follow unvarying rituals, as carefully scripted as the Tridentine Mass.

It is also difficult to convey the most striking observation that comes from reading thousands of pages from transcripts. That is, the FOMC's lassitude. The rousing warnings by Fed presidents reverberate within the Cone of Silence. (In addition to those mentioned above; a round of applause, please, for Jerry Jordan, Cleveland President; Cathy Minehan, Boston; and Michael Moscow, Chicago; who badgered Greenspan in the 1990s about the stock market bubble.)

Readers may remember the television show Get Smart, in which the glass Cone-of-Silence was lowered from the ceiling to prevent Kaos agents (the enemy) hearing conversations of Control's (our side) secret agents. The Cone-of-Silence never worked. Control agents couldn't hear each other because their voices echoed so violently inside the Cone. Likewise, none of the members of the FOMC syndicate acknowledged the dissidents existence. If the troublemakers had not shown up, not one word from these Stepford Wives would have changed.

Each FOMC member has a chance to talk at meetings. Greenspan (also a voting member) would then talk, just before a vote was taken. Usually a vote (on interest rates or protocol) was taken at each FOMC meeting. Greenspan led the discussants to his preferred choice, which might be "Alternative A" or "Alternative B."

This understates the irrelevance of the Federal Open Market Committee. Before each meeting, Greenspan met privately with voting member of the FOMC to ensure a unanimous vote. (Laurence Meyer, A Term at the Fed).

After Greenspan finished talking, and before the vote, the Vice Chairman of the FOMC - always the president of the New York Federal Reserve branch - would speak. William J. McDonough was the New York president and vice chairman of the FOMC in the late 1990s. Following are the first words out McDonough's mouth at a succession of meetings, a period when the Greenspan FOMC set a super-loose policy that led to the finale of the Nasdaq bubble. Yet, their desiccated minds and faces, the color and texture of a gray, cardboard box after a basement flood, sat and gathered mildew.

Vice-Chairman McDonough:

August 18, 1998: "Thank you Mr. Chairman. I think your analysis was exactly right in regard to where we should be with the federal funds rate; that is Alternative "B."

September 29, 1998: "Mr. Chairman, I want to agree with your proposal to cut the fed funds rate by 25 basis points."

November 17, 1998: "Thank you, Mr. Chairman. I agree fully and rather enthusiastically with your recommendation."

December 22, 1998: "Mr. Chairman, I interpret that, as I'm sure you intended, as a recommendation for "B," symmetric, which I heartily endorse...."

February 2-3, 1999: "Mr. Chairman, I fully support your recommendation."

March 30, 1999: "Mr. Chairman, I not only support but applaud your recommendation."

May 18, 1999: "Mr. Chairman, I fully support your recommendation."

June 29, 1999: On page 64 of the transcript: "Mr. Chairman, I fully support your conclusions." On page 91 of the transcript: "Mr. Chairman, I fully support your conclusions."

August 30, 1999: "Mr. Chairman, I fully support your recommendation."

November 16, 1999: "Mr. Chairman, I fully agree with both the reasoning behind your recommendations and with the recommendation itself."

The vote followed. The Greenspan Alternative almost always received a unanimous vote. The same is true of Bernanke. Policy set during the reign of Charles the Simple was more animated.

Sidelights to 1994

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)

Some odds & ends, tangential to "Is It 1994 Again?"


LURING THE UNSOPHISTICATED into the stock market was considered a risk by Federal Reserve Chairman Alan Greenspan in 1994. So much so, that protecting the individual investor was a mandate of the Fed. (The Fed advertises and then omits new mandates faster than spring fashions. My favorite is the brainstorm of former Fed governor Frederic Mishkin in 2007: "The modern science of monetary policy proceeds under the assumption that the central bank's purpose is to maximize the well-being of households in the economy; the objective function specifies exactly what should be maximized.") On May 27, 1994, Greenspan told the Senate Banking Committee it was for this very reason that he - his FOMC - had started raising rates in February, 1994: "Lured by consistently high returns in capital markets, people exhibited increasingly a willingness to take on market risk by extending the maturity of their investments." The People had shifted assets out of bank deposits and the like. The avuncular Fed chairman, by raising rates, was shepherding his sheep: "[S]ome of those buying the funds perhaps did not fully appreciate the exposure of their new investments to the usual fluctuations in bond and stock prices."

Given this acknowledgement, the Fed later violated its Investor Protection Mandate when it did not raise margin requirements: a means to reduce credit to the stock market, but, as much so, a warning of forbearance to those who do "not fully appreciate the exposure of their new investments." The Federal Reserve has absolute authority to raise margin requirements at any time. The Dow rose from 3,757 on May 27, 1994 to over 11,000 in early 2000; the Nasdaq from 733 to over 5,000. During these manic years, households served as sacrificial lambs to finance an economy that was funded by rising stock and bond prices.

In comparison, Ben Bernanke's Fed has explicitly stated its objective to artificially raise stock prices. Brian Sack, Manager of the System Open Market Account for the Fed (he runs the Fed's applicable trading operations) told a group of bond managers on October 4, 2010: "Nevertheless, balance sheet policy can... [add] to household wealth by keeping asset prices higher than they otherwise would be."

Bond managers were thus enlightened, but this announcement eluded the average American. Rigging prices was not universally applauded within the Fed. In a speech on November 8, 2010, Richard Fisher, president of the Federal Reserve Bank of Dallas, warned: "The rich and the quick are certainly able to exploit these circumstances to get richer. I have no problem with market operators making money; I did so myself in my previous life as a funds manager.... But I take no comfort, and see considerable risk, in conducting monetary policy that has the consequence of transferring income from the poor and the worker and the saver to the rich."

In a speech on April 8, 2011, in Dallas, the former investment manager said: "[B]y taking interest rates to zero and making money cheap and abundant so as to reliquefy the economy, those who invested the most conservatively - tucking their savings away in the safest of vehicles, like CDs, money market funds, and Treasury bills and notes - saw the income earned on their hard-earned savings dramatically reduced."


SETTING INTERST RATES TOO LOW and encouraging credit to grow too fast in the 1990s, the Federal Reserve has attempted to cover that policy error with more of the same, by controlling more markets. After nearly two decades of laying greater deceptions on earlier deceptions, only an economist could think the greater they contort nature the closer we approach perfection.

Aldous Huxley (Brave New World) wrote in 1937: "[E]conomic planning inevitably leads to more economic planning, for the simple reason that the situation is so complex that planners cannot fail to make mistakes. Mistakes have to be remedied by improvisation and rapid enforcement of new plans. It is probable these new plans will also contain mistakes, which must in turn be remedied by yet other plans. And so on. Now, where planning has come to be associated with an increase in power of the executive (and unfortunately this has been the case in all democratic countries), every fresh access of planning activity, necessitated by mistakes in earlier plans, takes the country yet another step towards dictatorship."

Huxley was not an economist but he could apply his mind to circumstances (foreseeing a war), probable government policies, and the consequences of those policies. Huxley was not advocating or ruing the future. He wrote as an observer. When it was noted that Huxley had become disillusioned, Max Beerbohm (I think) replied - paraphrasing from memory now: "Aldous cannot be disillusioned. He's never had an illusion."

This is in contrast to Ben Bernanke - or, whichever policymaker is under review - who lives entirely within his illusions. Simple Ben could not escape his abstractions even if he so desired. Of course, he will never be inclined to reconstruct his thinking since it is the security of his illusions that permit him to sleep so well at night. (As was put to me: "If you think Bernanke is losing any sleep over all this, you're wrong.")


CONGRESS DECIDED THIS DERIVATIVE STUFF, whatever it was, had gone far enough. The House Banking Committee held hearings in the spring of 1994. It called witnesses. George Soros testified on April 14, 1994. He was already famous, which gave him credibility. (Soros was also a superb investment manager, but it is fame and not skill that impresses Congress and Americans, in general.) He told the Congressmen: "There are so many [derivatives], and some of them are so esoteric, that the risks involved may not be properly understood even by the most sophisticated investors, and I'm supposed to be one of them."

After the Congressional study was completed, Alan Greenspan dismissed it. Brooksley Born should have read the newspaper summary. She might have understood that the study was for show and Alan Greenspan, as well as other regulators, were more interested in protecting bank profits than the financial system.

"Derivatives Get a Key Supporter," by Saul Hansell, New York Times, May 26, 1994:

"Strongly disagreeing with a new Congressional study, the chairman of the Federal Reserve Board, Alan Greenspan, said today there was "negligible" risk that the rapidly growing market for financial derivatives might someday require a taxpayer bailout.

"In testimony before a House subcommittee, Mr. Greenspan and other senior financial regulators said there was no need for new legislation to supervise derivatives.

"Derivatives are highly profitable products offered by banks and brokerage firms to corporations and investors.... Several large companies recently reported losses from unusual derivative transactions that combined normal hedging of risks with speculative bets on interest rates."

Note that Greenspan reminded the House Banking Committee the derivatives they might regulate were "highly profitable products offered by banks and brokerage firms." Brooksley Born did not stand a change of regulating derivatives with Greenspan and Congress running a protection service for the top growth industry in America.

Another slant: Congress decided Alan Greenspan knew more about derivatives than did George Soros.


ALAN GREENSPAN'S SO-CALLED AUTOBIOGRAPHY, The Age of Turbulence, has been described as a vital historical document. As a study of American finance in 1994, the book is negligent.

Greenspan reports (The Age of Turbulence) that he made an extraordinary contribution to central banking in 1994. All past Fed efforts to manage the "inevitable downturn" (after the growth phase of the business cycle) by "tightening rates at the first sign of inflation" had failed. This (past) approach "had never averted a recession." The Greenspan Fed opted for "a more radical approach: moving gently and preemptively before inflation even appeared." In Greenspan's words: "For decades, analysts had wondered whether the dynamics of the business cycle ruled out the possibility of a 'soft landing' for the economy - a cyclical slowdown without the job losses and uncertainty of a recession."

Whether any of the former central banker's claims to such evolutionary thinking and success should be regarded as such can be decided elsewhere. Greenspan's synopsis is of importance for what he does not say. The Age of Turbulence never mentions the 1994 markets. Therefore, we do not read that the FOMC believed it was already too late in raising rates at the December 1993 meeting. (Larry Lindsay: "[W]e all agree that the 3 percent [funds] rate is unsustainable. We all know it is too late.") This sits uncomfortably beside Greenspan's Age of Turbulence claim of a "radical approach: moving gently and preemptively before inflation even appeared."

Given that Greenspan never discusses the markets of 1994, we do not read of Greenspan's self-proclaimed ability to pop a bubble in 1994 (some of which is quoted in "Is It 1994 Again?" He made the declaration five times at FOMC meetings in 1994 and 1995.) He cannot mention this (in conjunction with his character) since, in 1999, he would wave the white flag and state it was impossible to identify a bubble in advance

As for the author's accomplishment, as construed in The Age of Turbulence: Was his fascinating and nerve-wracking "radical approach," which, if true, is worthy of a permanent display in the central banking hall-of-fame, actually a diversion from a more candid admission - that the 1994 rate hikes were largely driven by fear of asset bubbles?

The discussion of 1994 in The Age of Turbulence does not include the words "derivatives," "Orange County," or "Procter & Gamble." The consequences of Inverse IO CMOs must be learned elsewhere. Instead, the chairman closes the year in his hometown, canceling a dinner reservation at his favorite restaurant, Le Perigord on East Fifty-second Street, called away as he was by Bob Rubin to make more hall-of-fame decisions regarding the next "foreign financial crisis."

Did anybody really read his book?