Saturday, January 25, 2014


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)

When markets tumble, the immediate cause is often baked into the cake years before. The structural (decades old) trouble with large, U.S. publicly traded companies is managements that care first, second, and third about boosting the stock price today: carpe diem, and so forth.

In 2013, IBM's net income was $16.5 billion. The company spent $13.9 billion repurchasing its own shares during the year: 84% of its profits were used for these purchases. Buying back shares, all else equal, boosts per share earnings, thus the share price.

            This has been the modus operandi for U.S. corporations since early the early Greenspan era. The Wall Street Journal explored the paucity of corporate investment on January 22, 2014: "Identity Crisis: Does IBM Love Itself or Hate Itself?" The Journal found: "For the last 20 years, IBM has been an avid, methodical buyer of its own stock. In 1993, it had 2.3 billion shares outstanding. Today it has 1.1 billion...."

This mode of operation has been great for shareholders, including corporate insiders. From a $51.75 opening in 1993, IBM closed at $188.43 on January 21, 2014 (down from $215 in March 2013.) The Journal explained investor satisfaction: "Buybacks push up earnings per share. They flaunt management's confidence in the future. And they are a reason why retail investors have held on so lovingly to IBM stock."

After this reassurance to retail investors, should there be any left, the Journal dug deeper: Large U.S. corporations "are pitching their billions into buybacks, nearly $1 trillion from the 100 largest companies in the S&P since 2008. [This sounds too low. -FJS] In the 12 months ending in September, the total dollar amount of all corporate buybacks increased by 15% from a year earlier, according to S&P Dow Jones Indices. Cheap money from the U.S. Federal Reserve helps sweeten this deal.... The danger is that those buybacks have been substituting for substantive future investment, be it software engineers, new products, or extra marketing.... [This] stymies the economic growth originally intended by the Fed."

The stock market is a mood ring for faith in the Fed. If Fed policy is seen as failing, or more likely, the consequences of Fed policy become obvious, even though they will remain misattributed, trouble will follow.

Dallas Federal Reserve President Richard Fisher knows the Fed hollowed out America. On January 14, 2014, in a speech to that he has discussed at "recent FOMC meetings, pointing to some developments that signal we have made for an intoxicating brew as we have continued pouring liquidity down the economy's throat."

Fisher ticked off some consequences of ZIRP (zero-percent interest rates) policy : Among them: that "[s]hare buybacks financed by debt issuance that after tax treatment and inflation incur minimal, and in some cases negative, cost; has a most pleasant effect on earnings per share apart from top-line revenue growth. Dividend payouts financed by cheap debt that bolster share prices. The 'bull/bear spread' for equities now being higher than in October 2007. Stock market metrics such as price-to-sales ratios and market capitalization as a percentage of gross domestic product at eye-popping levels not seen since the dot-com boom of the late 1990s. Margin debt that is pushing up against all-time records."

One who remains unmoved by Fisher is Federal Reserve Board Chairman Ben S. Bernanke. On January 16, 2014, he told an audience at the Brookings Institute: "[T]he markets currently seem to be broadly within the metrics of market valuation- valuation seems to be broadly within historical ranges. The financial system is strong. The key financial institutions are well-capitalized."

With its $71 trillion derivatives book, J.P. Morgan could not be well capitalized with all the bank equity in the world, but leverage is not among Bernanke's concerns. One of the finest market analysts, Alan Newman, wrote in his latest issue of Crosscurrents: "The sheer arrogance of optimistic sentiment is outrageous. There is more talk of a melt-up than even a mere pullback. Various sentiment measures are at levels either not seen in decades or never seen before. December margin stats will be released next week and we again expect a record exposure to leverage. We are aghast that the Federal Reserve sits by and does nothing to discourage risk taking as this ridiculous euphoria unfolds."

Before returning to the Fed's shortcomings, it is worth recalling Newman's bona fides: "In the February 28, 2000 issue of Crosscurrents, we called for a Nasdaq crash and even specified a 'target under 3000....possibly as soon as mid-April.' Nasdaq was then 4578, so we were looking for roughly a 35% collapse in only six weeks. It was one helluva call to make with tech stocks screaming to the upside every session and in fact, we were off by ten days and 470 points from the absolute peak.  However, by April 17th, Nasdaq had indeed collapsed by 36% from 5048 to 3227. We feel the exact same way now." 

Chairman Bernanke's estimation of markets is perfectly useless, except - this is a key "except" - the markets levitate from the belief in Fed magic. Simple Ben has recently been all over the place talking about himself. His undoubted intention is to remind the world how much it owes him for its redemption before he departs.

The Associated Press captured Bernanke's incomprehension of any world outside his own models in "Bernanke Likens '08 Financial Crisis to a Car Crash." From the AP: "In his final public appearance as chairman of the Federal Reserve [that of January 16 - FJS], Ben Bernanke took a moment to reflect on the 2008 financial crisis and compared it to surviving a bad car crash. During an interview Thursday at the Brookings Institution, Bernanke recalled some 'very intense periods' during the crisis, similar to trying to keep a car from going over a bridge after a collision. The government had just taken over mortgage giants Fannie Mae and Freddie Mac. Lehman Brothers had collapsed. He recalled some sleepless nights working with others to try and contain the damage. 'If you're in a car wreck or something, you're mostly involved in trying to avoid going off the bridge. And then, later on, you say, 'Oh my God!' Bernanke said."

            Out of nowhere. "Oh, my God!" He remains completely unaware (otherwise, he would not have reminisced in such an affable manner) that he was the master cylinder for the car crash. Yes, Alan Greenspan laid the foundation, the brickwork, and the decrepit plumbing, but Bernanke built the structure with plywood. The nominal value of derivative contracts held by U.S. commercial banks (those over which the Fed had direct regulatory authority) leapt from $33 trillion at the end of 1998 to $101 trillion at the end of 2005, about the time Greenspan left office. This was roughly a 17% annual increase. By the second quarter of 2007, 18 months later, the nominal value rose by 50% - to $153 trillion in derivatives. With the exception of Richard Fisher and couple of other regional presidents, Bernanke's detachment from reality is rivaled by the Chinese wall that separates the investing world from the vapid minds that inspire public devotion to stocks.

            Demonstrating his circular abstractedness, Bernanke rambled on about the car crash that has ruined millions at the Brookings Institute even though he had warned of just that danger from excessive leverage in an earlier paper: "Using high leverage to improve corporate performance is much like encouraging safe driving by putting a dagger, pointed at the driver's chest, in every car's steering wheel; it may improve driving but may lead to disaster during a snowstorm."

            Simple Ben might at least take credit for his A+ paper, but various Bernankes Babel about. It is impossible to reconcile the world of Alan Newman with his quackery, so we must suffer Bernanke's coterie, including John Williams, president of the San Francisco Fed bank (a non-voting FOMC member in 2014). At the same January 16 Brookings seminar, Williams asserted: "Obviously, we've all learned the lessons of the past decade or so. We follow very carefully what's happening in financial markets, both in the banking part of the financial system but most importantly...this is a capital markets-based economy." A few minutes later: "Our models that we use do not take seriously that there's a complex financial system out there that can have endogenous changes in leverage, in risk-taking. And I would also add to that our models tend to assume highly rational agents who have a full understanding of things. So bubbles never occur."

            Are you still long the stock market?

            At the Brookings meeting, Harvard economist Martin Feldstein remarked: "John [Williams] reminds us that the standard textbook theory implies that LSAPs [large-scale asset purchases/QE] cannot affect asset prices and interest rates. We now know that that theory is wrong."

            The constant, media, frighten-parents-to-death campaign never mentions the mind-altering propaganda taught in economics classes at American universities.

            Williams, confidently rebutted Feldstein, since there is never a consequence to an economist who reveals himself an imbecile: "My answer to your question is I don't think that the low interest rates were an important contributor to the housing bubble. I think fundamentally flawed aspects of our regulatory environment were the key part of that story about the housing bubble."

The fundamental flaw in the regulatory carcass was the regulations in 2002 through 2007 that were not enforced. (Nicole Gelinas' book, After the Fall: Saving Capitalism from Wall Street and Washington, was very good on this.) The suffocating additional structure praised by Bernanke and Williams will put every bank other than the Big Five out of business.

            In the end, Williams addressed the Feldstein thesis: that maybe zero percent interest rates could encourage some excitability: "I do think that we have to have open minds about understanding how low interest rates for a long period of time do affect risk-taking, leverage and asset prices." As with subprime, Williams could not have been unaware of the Fed's mission when it lowered rates to zero. Williams was at the San Francisco Fed for at least the past decade. He could not have missed the subprime-loan scramble in California prior to the "bad car crash." So, he denies it.

Another Brookings attendee, former Federal Reserve Governor Donald Kohn minced no words, back in October 2009, when he was vice chairman of the Federal Reserve System: "[R]ecently the improvement, in risk appetites and financial conditions, in part responding to actions by the Federal Reserve and other authorities, has been a critical factor in allowing the economy to begin to move higher after a very deep recession.... Low market interest rates should continue to induce savers to diversify into riskier assets, which would contribute to a further reversal in the flight to liquidity and safety that has characterized the past few years."

A clearer statement of the Fed's successful swindling of old people's savings has only been made by William Dudley, Ben Bernanke, Janet Yellen, Stanley Fischer, Eric Rosengren, Brian Sack, Charlie Evans, Narayano Kocherlakota: In other words, the Federal Reserve has not been shy to state publicly its impoverishment policy.

Richard Fisher gave an insider's version in his January 14 speech: "When money available to investors is close to free and is widely available, and there is a presumption that the central bank will keep it that way indefinitely, discount rates applied to assessing the value of future cash flows shift downward, making for lower hurdle rates for valuations. A bull market for stocks and other claims on tradable companies ensues; the financial world looks rather comely."

Fisher listed signs of ninth-inning, bond markets. My January 16, 2014 "Enjoy it While it Lasts," is similar: "In the bond market, investment-grade yield spreads over 'risk free' government bonds becoming abnormally tight.'Covenant lite' lending becoming robust and the spread between CCC credit and investment-grade credit or the risk-free rate historically narrow. I will note here that I am all for helping businesses get back on their feet so that they can expand employment and America's prosperity: This is the root desire of the FOMC. But I worry when 'junk' companies that should borrow at a premium reflecting their risk of failure are able to borrow (or have their shares priced) at rates that defy the odds of that risk. I may be too close to this given my background. From 1989 through 1997, I was managing partner of a fund that bought distressed debt... Today, I would have to hire Sherlock Holmes to find a single distressed company priced attractively enough to buy."

Note: This diatribe was mostly written on Wednesday, January 22, 2014, so the stock market sell off on January 23 and January 24 came after. The tumble may be of no immediate consequence. The odds that stocks will make up for the Thursday and Friday sell-off on Monday morning with jumbo orders from New York to Chicago is high. Even so, we are getting closer to the day when gamed markets will not cooperate.