Wednesday, April 25, 2012

Political Science

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."

"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.

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.

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.

Thursday, April 19, 2012


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

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.

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."

Tuesday, April 10, 2012

The Professor Who Did NOT Save the World

"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 " 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 " 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 " 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 " 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."