Wednesday, February 26, 2014

Those FOMC Transcripts: Watch Out Below

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 Reserve releases transcripts of FOMC (Federal Open Market Committee) meetings after a five-year wait. The 2008 transcripts were made public late, last week. The FOMC is the monetary policymaking body within the Federal Reserve System. Having read at least 10 years of transcripts when writing about Greenspan and his Fed, there is a lingering question of what might have been redacted before the public release as well as what might be said outside the boardroom so as to escape transcription. Every once in awhile some forward-thinking FOMC attendee (a rarity, to be sure) will remind the mob: "Remember, that comment will be public in five years."

The FOMC transcripts also do not include "other meetings at which smaller groups of Fed officials, working with the Treasury Department, arranged the bailouts of bankrupt Bear Stearns, the American International Group (NYSE: AIG), and housing service entities Fannie Mae and Freddie Mac. Nor do the transcripts include notes from the meetings at which policy makers decided to let Lehman fail." (FOXBusiness, "Fed Releases Transcripts from 2008 Meetings")

Nevertheless, the initial stories across news channels were full of ridicule and indignation at the FOMC's real-time ignorance as banks and markets collapsed. We are fortunate that two of the scheduled FOMC gatherings happened to be on March 18, 2008, and September, 16, 2008, immediately after the collapse of Bear Stearns and Lehman Brother, respectively. The FOMC also held a conference call on March 10, 2008, days before the Bear Stearns failure. The conversations from each show a body more incapable of making connections, translating their macro models to the real world, than a five-year-old. (I remember clearly: a five-year-old walking into the kitchen, looking at the September 16, 2008, New York Times, seeing a large picture of an ex-Lehman employee carrying her belongings out of the building, and asking: "Daddy, are we in a Depression?")

The story of the 2008 transcripts will fade. It must: to preserve faith in the Fed and the stock market. If the Fed was thought unable to "make connections," as it so clearly failed to do in 2008, this might cause a reduction in market exposure (from 99% to 98% leverage). Market authorities remind investors of "considerations which must nowadays modify ideas about the future. One is the power and protective resources of the Federal Reserve." (New York Times, September 9, 1929).

The Fed has been awarded greater power and resources than ever before (to put it mildly) since 2008, yet, the results of its "learning by doing" experiments show the FOMC is no wiser than when Chairman Ben S. Bernanke, Great Depression scholar and legend in his own mind, gathered his flock on September 16, 2008. In the same monologue, the professor claimed: "I think that our policy is looking actually pretty good" and "I am decidedly confused and very muddled about this." He might seem to possess the wiring of a schizophrenic, but there actually is no contradiction in the professor's mind. It is we who wander without full knowledge.

The Fed, ECB, IMF, and fellow travelers operate under the presumption any disturbance can be corrected by central bankers. Their model says so. The Dynamic Stochastic General Equilibrium (DSGE) model made it certain the Fed would not take action before the 2007 financial implosion. The economist Bernard Connolly wrote to his clients in 2006 (when at AIG) the Federal Reserve would not - could not - act beforehand. The holy DSGE model was the reason Bernanke could feel kinda' good when he was confused and muddled. The model provides a central-banking solution for all human errors. Connolly wrote on February 4, 2008, the "DSGE contention that negative demand disturbances (although perhaps exhibiting some serial correlation) rather soon revert to an expected value of zero, is, in conditions of intertemporal disequilibria, nothing more than a fairy tale..." This is difficult to absorb, especially in such an abbreviated form, but it is way the world works (currently). All of Connolly's work from that period can be read at his firm's website, "Hamiltonian Associates," under the "AIG" tab.

The vote was unanimous at that September 16, 2008, meeting: to do nothing, leave the funds rate at 2.0%. Within days, Bernanke and Hank Paulson were terrorizing congressmen and Americans: the end was nigh. In case you have forgotten the general panic, an example was at a Whole Foods outlet where a woman of means turned and asked "I'm worried. Do you think we're in a Depression?" The customer so queried told the worrywart: "You'll have to ask my daughter." Which she did. This customer's five-year-old daughter, having given some thought to her confusion on the morning after Lehman's failure, replied: "Some parts of the country are in a depression, but we are not, at least, yet." This response relieved the anxiety of the woman of means.

The point is not whether the five-year-old was correct or not, but that she had given more thought to current events than the entire FOMC bureaucracy. Chairman Bernanke spoke for those who worshiped the DSGE model at the October 7, 2008 meeting: "It's more than obvious that we have an extraordinary situation.... I should say that this comes as a surprise to me." This is to be expected. Financial markets are not part of the model.

Since 2008, central bankers have been "learning by doing," as Simple Ben told a Jackson Hole, Wyoming audience on August 31, 2012. His speech carried the title of "Monetary Policy Since the Onset of the Crisis." The speech made clear the model was holier than ever. ("It is likely that the crisis and the recession have attenuated some of the normal transmission channels of monetary policy relative to what is assumed in the models...") Reliable sources report the DSGE model is still sacred at the Yellen Fed. In fact, the younger generation of economic Ph.D's who now tweak the input have often learned nothing else in their post-graduate work.

            It is important for the rest of humanity to comprehend the consequences. No action will be taken to prevent what cannot happen. The media sometimes veers towards the fatal FOMC flaw but lacks a full understanding. Thus, Binyamin Appelbaum, writing about the 2008 transcripts in the February 21, 2014, New York Times, explained: "The Fed's understanding of the crisis, however, was clouded by its reliance on indicators that tend to miss sharp changes in conditions. The government initially estimated, for example, that the economy expanded in the first half of 2008 because it basically assumed that some economic trends, like the pace of business creation, had continued apace. The Fed also relied on economic models that assumed the existence of smoothly functioning financial markets, limiting its ability to project the consequences of a breakdown."

            Appelbaum does not quite understand the assumption "of smoothly functioning financial markets" is imbedded in FOMC policy. Financial markets are not part of the DSGE model since "negative demand disturbances" of financial markets "rather soon revert to an expected value of zero." Therefore, they do not exist and FOMC transcripts from 2009 through 2014 will show discussions by the hallowed professors made no allowance for reality and were "nothing more than a fairy tale."

An unrelated note. From the February 26, 2014 Wall Street Journal: "LONDON - Last summer, Adrian Eady, a banker with Royal Bank of Scotland, was nearly crushed hauling a crate of feta cheese off a forklift truck in a North London warehouse."

Does anyone understand what's going on? 

Monday, February 24, 2014

Disintegration: An Interview with The Daily Bell

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)

Fred Sheehan on the Futility of Wall Street, the Coming Derivatives Disaster and the Craziness of Keynes With Anthony Wile - February 23, 2014
The Daily Bell is pleased to present this exclusive interview with Fred Sheehan Introduction:
Frederick J. Sheehan Jr. is an investor, investment adviser, writer, and public speaker. His website is He 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 co-author, with William A. Fleckenstein, of Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve (McGraw-Hill, 2008). He writes regularly for Marc Faber's Gloom, Boom & Doom Report, most recently co-authoring with Joseph Calandro Jr. "Catastrophe Insured: Cat Bonds," (November 2013, GB&D Report). Sheehan and Calandro have designed a value-based, actively-managed, catastrophe-bond strategy. He serves as an advisor to investment firms and endowments. He is the former Director of Asset Allocation Services at John Hancock Financial Services. He lives in the Boston area.
Daily Bell: How did you evolve from a director of asset allocation services to a person who obviously sees through the investment charade? 

Fred Sheehan:  By the mid-1990s, distortions were growing more difficult to understand. The artificiality of jobs, for one. The hollowing out of the economy. The enormous layoffs of mid-level office workers at the beginning of that decade, auto companies, and the like, seemed like a hole where millions of mid-level workers had disappeared. I'd hear they had been earning a $70,000-a-year salary but now were scurrying for $40,000 a year. How could this work, support families? 

I came to understand, by the huge increase in credit. It was interesting to me when I read FOMC transcripts from those years that Fed governor Larry Lindsey instructed the Greenspan Fed, at every meeting between roughly 1993 through 1995, at some length, that the average family was receiving less in cash pay, saving less, borrowing more. He even calculated on his own how the lower-income quintiles were falling behind. They couldn't make ends meet. Sub-prime lending was becoming the norm. He had some experience with sub-prime lending at an inner-city agency and kept telling the board that subprime lending requires a lot of handholding. It cannot be done on a large scale. Nobody listened, of course. The hot subprime lenders of the '90s collapsed in 1997. Lindsey had left by then. Greenspan, of course, remained.

This was, looking back now, after Fannie Mae and Freddie Mac had turned themselves into enormous consumers and producers of credit. The exponential growth of their balance sheets was essential to controlling the credit collapse of 1994. It was also the time when the Federal Reserve effectively eliminated reserve ratios for banks. "Anything goes," and so it went.

Daily Bell: You seem to be an Austrian economist at this point. Correct? 

Fred Sheehan: I am inclined to believe the only formal economics taught in the past 80 years in the U.S. of any use were the "home economics" courses taught to high school girls many moons ago. I did not receive such training, but the Austrian economists are the only school that makes common sense. 

The central teachings of Austrian economics are commonly understood. It is the hieroglyphics called "economics" at colleges today that is rubbish. It will join the ash heap of history.

The Austrians taught - and do teach, on isolated campuses - that an accumulation of debt in excess of what can be paid back has consequences, either in default or inflation. To someone dropping in from 1910, that might seem so fundamental, it isn't even worth mentioning. Oh, what that out-of-date relic has missed.

Second, Ludwig von Mises was right: "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved." (Chapter XX: Interest, Credit Expansion, The Trade Cycle, § 8 ,  The Monetary or Circulation Theory of the Trade Cycle

We may not have passed that point of no return in 2008, even though our recently retired Fed chairman, Simple Ben Bernanke, saved his skin by making that claim over and over. If not for his nationalizing America, he continually reminded us, "the world would have ended."

I think we have passed that point today. The central bank balance sheets absorbed enough bad paper (bonds, mortgages, CDOs, Maiden Lane) to assert the solvency of the world's banking system by 2009. Having done nothing to restore the foundations of banking over the past five years, the central banks are in no position to absorb the "final and total catastrophe." Their credit-ability is on borrowed time.

They did nothing because they are not economists, they are bureaucrats: the mammoth growth of the bureaucracy across the twentieth century shackled humanity, but never solved a single problem.

Daily Bell: Where do you see the stock market headed? Why?

Fred Sheehan: All asset markets are disengaged from their foundations. They have been elevated by governments and their central banks. Central banks have done so by prodding savers into stocks and bonds. They have set artificially low borrowing rates. These artificially low rates are the source of so many perversities that are not immediately evident but have fractured the structure of companies, industries and the stock market. With Treasury rates so low, the issuance of investment grade, junk, covenant lite, PIKs and almost every other category of sloppy finance that met its maker in 2007 set new world records in 2013. The present and future consequences should be obvious. 

Regarding your question about stocks, U.S. stocks were up about 30% last year. U.S. stock market capitalization rose $13 trillion in 2013. On what? "Record earnings," we hear.

But sales growth was zip. Three reasons for this strange combination in 2013 were a lack of capital investment, the substitution of operating earnings for GAAP earnings and stock buybacks. These all boosted earnings-per-share.

Capital spending is zero or negative. The amount being spent on new equipment is probably less than the depreciation of old equipment. Without keeping up, companies rust. Andrew Smithers wrote in The Road to Recovery (2013) that in the U.S., since 2008, "the proportion of cash flow invested in capital equipment has been the lowest on record." (p. 18) 

The substitution of operating earnings for GAAP earnings produces flattering P/E ratios. Wall Street rattles off operating earnings since these do not include one-time write-offs. It used to be that one-time write-offs were occasional. Now, companies are constantly admitting to asset write-downs. "Restructuring charges" are generally an admission that management has destroyed shareholder equity: mergers and acquisitions gone bad, terrible investments.

For such performance, management thinks it deserves stock-option payouts. To do so, the A team needs to get the share price up. Thus, the share buyback ritual. Management reduces the number of shares. This cuts the number of shares across which the earnings are spread. Ergo, earnings-per-share rises and Wall Street says "buy."

This is how it has worked: Investment-grade companies issued over $1 trillion of debt last year, 2013. The money has not gone into investment, but we know U.S. corporations have bought back $1 trillion worth of stock nearly every year since 2008. (Gloom, Boom & Doom Report, December 2013, p. 7, quoting Bill Gross) So what did companies do with all that borrowing?

In 2013, share buybacks accounted for 75% of the increase in S&P 500 earnings. (Andy Lees, 1/14/14, my notes from 2/5/14) In the third quarter alone, these companies bought back $128 billion of shares: the most for any quarter since 2007. (Wall Street Journal, December 24, 2013) (That reckless year, again.) Buybacks and dividends for the third quarter were $207 billion, also the highest in any quarter since 2007. (Wall Street Journal, December 24, 2013) Most every measure - price: sales, price: earnings - was higher at the end of 2013 than at the beginning. 

Harry Singleton, who ran Teledyne for several decades, offered a casebook study of how to manage the number of common stock shares in existence. He bought shares back from the market when he gauged Teledyne stock was cheap. He sold more stock to the public when he thought it was expensive. Companies - and analysts - remain untutored on this point. Companies should buy back shares when they are undervalued, not overvalued, when the company is trading at an 8:1 P/E ratio, not 40:1.

None of the three practices I have discussed is sustainable: lack of capital spending, substitution of operating for GAAP earnings, or borrowing to reduce equity.

Daily Bell: Is the US stock market "rigged" to go up?

Fred Sheehan: The riggers have stated so. Adding a trillion dollars a year of Monopoly money to the financial system is one of their methods. Separating savings from the desperate is another. On the latter, we have their word. A couple of instances: 

Vice Chairman of the Federal Reserve Board (at the time) Donald Kohn, in October 2009: "[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.... 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." (Donald Kohn, speech, October 2009)

Now, who decided the Federal Reserve, or anybody , should be prodding "risk appetites"? As I say, these are not economists; they are bureaucrats, and a bureaucrat's job is to sustain and grow the bureau. If I ran the country for a day, I'd put them all in Army boots and make them march across Afghanistan. 

Here's another. New York Federal Reserve President William Dudley, in October 2010: "We have tools that can provide additional stimulus.... [P]urchases of long-duration assets [by the New York Fed will] pull down the level of long-term interest rates.... [L]ower long-term rates would support the value of assets, including houses and equities and household net worth." How might that help the economy? Dudley explained, by "boosting consumption in households that can refinance their mortgages at lower rates." In other words, borrowing home equity and splurging again.

Aside from Dudley's wand-waving and interference in our lives, he was wrong. The Fed bought up long-term bonds. In its latest round, QE3, it lost control of the long-term bond market. The 10-year Treasury rose from 1.4% on July 27, 2013, to 3% a few weeks ago. It's around 2.7% now. It has backed off from 3%, in my estimation, because the various carry trades, particularly those that have borrowed in yen, gold, and emerging markets are in trouble.

When the markets tumble, the cry follows: "There was no warning." But please note: The Fed has lost control of the long-term Treasury market.

Daily Bell: When did a financial system operated by a few for the benefit of a few turn into a system the support of which has become a national US priority?

Fred Sheehan: It is necessary to retain control. The economy is in a depression: Just look at median wages, costs of living (not calculated by the government). Costs are spiraling and the people are suffering. The QE nonsense helps to leverage speculators' positions, but not much else.

Daily Bell: Why is the system conflated with stability? Wouldn't people be better off if the system collapsed and people saw it for what it was?

Fred Sheehan: I am reluctant to say what makes people better off since nothing has done more damage to the West than the Progressive Movement and Reformers who decided they knew what was best for the people. I won't continue on that topic other than to note sandwiching the activities of two Princeton administrators, Woodrow Wilson and Simple Ben, could reduce an ungainly subject into a coherent thesis.

Back to your proposition, the financial system will collapse, not that it's a "system" any longer. The central planners are left with the need to continually expand credit to paper over the losses. When that ceases to work: "poof."

Daily Bell: We suggest this because the system is going to collapse anyway. Your thoughts?

Fred Sheehan: I think you are correct. It is filled with irreconcilable contradictions. Even if it is sometime off, one should prepare.

Daily Bell: Let's talk about John Maynard Keynes. Can you describe his theories?

Fred Sheehan: No. He is a mass of contradictions. He was a political opportunist of the highest order. Younger readers can learn a lot from his antics. That's how you make it to the top today.

His General Theory is difficult to understand. Benjamin Anderson, an economist of the first order, explained that Keynes' General Theory was slapdash journalism. (My description, not Anderson's.) 

In Economics and the Public Welfare, he, the Good Ben (Anderson), as opposed to the Ben Who Got Away, wrote a chapter on Keynes, mostly about his General Theory. Keynes used economic terms and words through the book with different meanings in different chapters and did not reconcile - did not even mention - that he had used the same word with a different meaning earlier. Anderson also wrote how Keynes interchangeably mixes static and dynamic models to "prove" some point. 

To take one term, following are different and unreconciled uses of "interest rate":

Early in General Theory Keynes writes the rate of interest can be identified with the "rate of time-discounting, that is, the ratio of exchange between present and future goods." (Benjamin Anderson, Economics and the Public Welfare, 1948, p. 348) 

Later in General Theory Keynes writes "the rate of interest depends on liquidity preference and the quantity of money." Keynes also states (at this point) that interest is paid not for inducing men
to save but for inducing men not to hoard ." 

A bit later, Keynes claims that "the supply of money in relation to liquidity preference will govern the whole complex of interest rates, long and short..." (Anderson, p. 394)

Plunging on, Keynes wrote the Fed's open-market policy in 1933 and 1934, a policy of only buying short-term securities, may have had the effect (quoting from General Theory) "confined to the very short-term rate of interest and have very little reaction on the much more important long-term rates of interest." 

Anderson was lost as to the influence and success of the book. In Economics and the Public Welfare , Anderson thinks the consensus he heard in London was as good as any. That is, the British government's early management of The Great War accounted for Keynes's success: "England, in the first two and one half years of the war, had the terrible volunteer system under which her best and finest rushed first into the battlefield. And this included very many of the younger men and even men no longer young who would normally become, in a short time, the leaders of industry and finance." The result, "was that in the City in the middle 1920s you would find a few fine old veterans who remembered the ancient wisdom of London, and who would find their grandsons 'miseducated by Keynes.' " 

This makes sense to me. In any case, the deterioration of thinking across the twentieth century (and counting) is a fact.

American Keynesians, which may or may not have much to do with Keynes, have used the label to increase monetary stimulus with no limit. Economics is a dreadful example of the deterioration of thinking. But again, the crop in control was not taught economics; it was trained to build its bureaucracies.

Now, one word about Keynes that may surprise readers. It at least surprised me. William McChesney Martin, head of the Fed from 1951-1971, and my hero among central bankers, kept a quote in his desk. It comes from John Maynard Keynes, spoken in 1948: "The U.S. is becoming a high cost, high living country." (Robert P. Bremner, Chairman of the Fed: William McChesney Martin Jr., 2004, p. 146)

Daily Bell: We think his system may have been set up as a deliberate fraud. In other words, it justifies state interference in the marketplace. He created his General Theory
with this in mind. Your reaction?

Fred Sheehan: Keynes was a nationalist. In his autobiography, Felix Somary, and Austrian (later Swiss) economist, banker and diplomat, wrote of Keynes in the late 1920s: "He came to Berlin with a speech titled 'The End of Laissez-Faire', a lot of vulgarities that the [German] nationalists greeted with fervour....Keynes was English through and through, and his entire mind was influenced by the difficult situation his country was then going through....And now Keynes justified these" German critics of free trade "and shook the field of economics itself: the science of economics appeared to be merely a cover for temporary local economic policies." (Felix Somary, The Raven of Zurich, 1986; first translation in English, St. Martin's Press, p. 146) 

In the German edition to the General Theory, Keynes added an introduction, with my underlining: "The theory of aggregated production, which is the point of the following book, nevertheless
can be much easier adapted to the conditions of a totalitarian state [eines totalen Staates] than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory. Since it is based on fewer hypotheses than the orthodox theory, it can accommodate itself all the easier to a wider field of varying conditions. Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries where a large degree of laissez-faire still prevails, nevertheless it remains applicable to situations in which state management is more pronounced. For the theory of psychological laws which bring consumption and saving into relationship with each other, the influence of loan expenditures on prices, and real wages, the role played by the rate of interest-all these basic ideas also remain under such conditions necessary parts of our plan of thought." (John Maynard Keynes, September 7, 1936, Foreword to General Theory, German edition.)

Daily Bell: Why doesn't the mainstream media explain this better?

Fred Sheehan: That is too complicated a question for a good answer, at least by me.Laziness, certainly, is a reason. Living within its own fishbowl. Never leading, always following. Pressure from so many points on the compass. Defense Secretary James Schlesinger said, "The press can never rise above a cliché."

Really, it wouldn't take much for a newspaper to hire someone who knows how government numbers, such as GDP, unemployment, inflation, are constructed. Just subscribe to John Williams's ShadowStats. Today, every such announcement is an accumulation of misrepresentations that have built up for decades - in the authorities' favor, and in direct contradiction to the interests of the readers. Wouldn't the revelations make good copy?

And since I'm on the topic, wouldn't readers be more interested in reading how Bernanke, Yellen, or all those other awful people running and ruining our lives just made an announcement in direct contradiction to what they stated three months ago? It wouldn't even have to be a story. Just cut-and-paste quotes on the front page. Readers would love to have a good laugh at the phonies' expense.

Daily Bell: You've written, "The stock market is a mood ring for faith in the Fed." What did you mean?

Fred Sheehan: The stock market rises and falls depending on the degree to which those who invest and speculate believe the Fed is in control. The leverage is so tremendous now, and the collateral has been rehypothecated so many times, some of the participants have no idea how to get it back. Art Cashin at UBS, who's been as close to the market as anyone over the past 50 years, wrote on February 5 that, "The carry trade is unwinding upon speculators who have little or even zero equity as margin." This is a faith-based market.

Daily Bell: Ben Bernanke recently 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." What is wrong with Mr. Bernanke? Doesn't he understand what he's done?

Fred Sheehan: I doubt it, but my opinion of what rolls around that tiny brain is unimportant.A very brief history of this simple man from which readers can make their own judgments: He was born in Dillon, South Carolina. This only child won the seventh-grade South Carolina spelling bee championship. He received praise for delivering the correct answers. He was good at test-taking. He matriculated to Harvard, majored in economics, and graduated in 1975. Harvard's reputation is inversely related to the distance from where one was raised. To Ben, graduating from Harvard meant he had been anointed. He talks much more often of himself as a "policy maker" than as an "economist." He should have gone back to Dillon, South Carolina and ruined his hometown but left the rest of alone. What a mess he's made!

Back to the seventies. Nothing the economists were selling worked. They were a joke. A student at Harvard Business School (at that time) told me you could get a room rocking with laughter by saying "Phillips curve." There was a flight from the Harvard and MIT economics departments to remote and less humiliating campuses, such as Texas. The late-1970s was a difficult job market for a college grad. This created an incentive to remain at school, but to find a godfather who would sponsor a student for a doctoral thesis in economics was difficult. The professors in such a position got the pick of the litter. They chose those students who were good test-takers, those who took careful notes in class and regurgitated them on exams. The favored few not only repeated what they were told, but also, the combination is key - those whose minds were content with life as it is engraved in a textbook. The students produced by M.I.T., Harvard and a few other sources of agitprop, include most of the names who figure most prominently in the roster of "policymakers." They have never been correct about anything

I'm not talking now just of the Fed or economics; the mediocrity covers the range of "experts."

Bernanke has never gotten anything right. He would not know that, however. One of his doctoral advisers at M.I.T. was Stanley Fischer, vice chairman presumptive of the Federal Reserve Board.

Bear Stearns had been purchased by J.P. Morgan on March 16, 2008. Stanley Fischer was running the Bank of Israel at the time. Fischer was interviewed by Bloomberg on March 17, 2008. This looked very much like a coach revving up a demoralized team during halftime. Bear Bryant among central bankers. He offered Ben Bernanke advice: "You can inject liquidity into the economy and Ben Bernanke is an expert on this issue." Later: "That the Fed will get on top of this, I don't doubt." And: "Ben Bernanke is an outstanding economist." Go, team.

In the late-1970s, Fischer wrote papers that anticipated the inflationary endgame. The game continues. In the 1990s, while at the IMF, he wrote a paper that spoke kindly of a negative 8% interest rate. Ben has undoubtedly been told by his adviser what a swell job he has done. Stanley Fischer started buying U.S. common stocks for the Bank of Israel in 2013. Go, team.

So, to get back to your question: No, I doubt Ben has considered the possibility of miscalculation.

Yet he has been unerringly and exactly wrong in how each of his QEs would work. But, from the coach: "Ben Bernanke is an outstanding economist." Fischer was also adviser to Mario Draghi and Greg Mankiw. Mervyn King sat in the adjoining cubicle to Bernanke.

This is depressing. I'm stopping here.

Simple Ben is now at the Brookings Institution. These well-regarded institutions have shown no awareness of their precarious standing. This goes for the media, too.

When the inflation endgame comes a cropper, an accumulation of pent-up frustration and anger will attenuate their influence and threaten their existence.

Daily Bell: You've written that JP Morgan has a $71 trillion derivatives book. Is it sustainable?

Fred Sheehan: As long as the emperor wears no clothes. Any time J.P. Morgan's derivative book moves by 10 basis points, it has absorbed the firm's capital. How many times a day does that happen? As I say, it will go on until it doesn't.

Daily Bell: You've written of Bernanke that 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." What did you mean by this?

Fred Sheehan: Greenspan caused the credit bubble. He is the man. Not Lloyd Blankfein or Jamie Dimon. They are irresponsible, but without the Federal Reserve's money creation under Greenspan, the banks could not have fostered the credit bubble and Jamie Dimon would be running a Greek pizza joint on 8th Avenue now.

Daily Bell: You've actually written a book about Greenspan, Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve.  Can you tell us about it?

Fred Sheehan: It will take some time before the book is understood, but the ascendancy and influence of Alan Greenspan is the central illustration of the end of the modern age. That age has now passed. 

I will borrow the first paragraph from a speech I delivered: "Alan Greenspan was the right Federal Reserve chairman for his times. His reputation was a creation of inflation, and this was a century of inflation. His knowledge was superficial when America tended toward superficiality. He was a creation of publicity in an age that craved celebrities. He was inarticulate at a time when minds were growing more confused. He took short cuts to the top when Americans more readily took the easy route."

Alan Greenspan, the man, is not interesting. It is his capacity to illuminate the passing of the modern age, from the material to the abstract, that makes the book worth reading.

Daily Bell: We believe that the globalists who want a more international world are trying to drive the stock market still higher. They want one last Wall Street Party before a chaotic blow off that sets the stage for world money and a worldwide central bank. Your perspective?

Fred Sheehan: The globalists will be sorely disappointed. You are probably correct in what they want. The opposite is happening. We are in a period of disintegration. For instance, the Eurocrats have so abused any trust - any willingness among the people to sacrifice to the greater good - that their only future is to be filleted and served alongside a plate of Brussels sprouts.The globalists are aligned with vast bureaucracies filled with the sort of self-satisfied, test-taking, personally ambitious, know-nothings who only serve their own interests. They have no sense of duty, honor, self-sacrifice, all of which are necessary to achieve what they wish. They will crumble.

Daily Bell: When this market unwinds will derivatives go with it?

Fred Sheehan: We don't need derivatives, except to hedge maybe some basic materials such as corn or gold. 

Derivatives are the greatest propaganda device ever devised for the propagation of central banking and Too-Big-to-Fail Banks. The possibility of a derivative avalanche is like the Giant Rat of Sumatra, in the Sherlock Holmes oeuvre: "a story for which the world is not yet prepared."

In 2008, the parties who were mismatched or on the losing end of a derivative arrangement could have been told to sit down and cancel out exposures. What was left, and still exposed, would have needed more capital. If it was General Electric, GE could have issued 10 billion shares of stock. Lord knows, that's the last thing GE wanted to do. As David Stockman makes clear in The Great Deformation , the government's bailout of GE was for the greater good of Jeff Immelt's stock options. If GE still could not clear itself from insolvency, it had valuable assets that financially sound industrial companies would have bought. This goes for Too-Big-To-Fail banks, too. They had plenty of valuable assets in their portfolios that could have been sold, while the institutions were liquidated. We don't need huge banks. We need local banks that know local businesses. 

Derivatives are a topic Simple Ben Bernanke was never prepared to discuss, and, he never addressed them. Read through, if you have the time and stomach, Bernanke's explanations of Lehman Brothers' and AIG's drama.

Here he is before the Financial Crisis Inquiry Commission (FCIC) on November 17, 2009: "Two days [after Lehman's failure], AIG, again, we felt that its failure would threaten the stability of the global financial system. Among other things, they had as counterparties many of the world's largest bank financial institutions, many of the world's largest banks." (FCIC Transcript, November 17, 2009)

Here is the moldy prof before the students of George Washington U. on March 28, 2012: "[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."

No one had caught up with the imposter. He signed off in January 2014 with the same "it would have been the end of the world" if I hadn't saved it. Your question arises, again, about the media's lack of interest when there is such an obvious, and simple, story to engage the public's perplexity and anger.

The derivatives were sold by AIG's Financial Products Division, a holding company of AIG. AIG's insurance policies were not the least bit endangered. Bernanke told the FCIC the "reason AIG was set up the way it was originally, the financial products division, which did the CDS, attached itself precisely because it was a large, highly-rated insurance company with 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] 

Not one word of this is true. There was no run on AIG's collateral since the collateral was entirely separated from the holding company. And derivatives remain the Giant Rat of Sumatra.

Daily Bell: Is central banking close to extinction?

Fred Sheehan: I hesitate because it is hard to separate the wish from the fact, but they could not have done a better job of setting themselves up for elimination. Their credit-ability is all that's left.

Daily Bell: Is the Internet making it harder for elites to promote their worldview and practice their manipulations?

Fred Sheehan: I don't know. We like to think because the source of news is no longer so centralized, that such publications as The Daily Bell are the fax of the 21st century. (Faxes from Eastern Europe in 1989 were often the source of truth during the uprisings.) But, I wonder if we are writing to ourselves. As I said before, that bunch is doing itself in. The sort of people who have gravitated to globalcrat positions will defend their personal benefit package to the final G-20 love-in.

Daily Bell: Will the 21st century excavate itself from this merciless, monopolist central banking system?

Fred Sheehan: Let me reword this into the question of whether the currencies we use will remain monopolies of the state. 

I do not think so. You had an excellent interview with Larry Parks on this subject to which I can add nothing.

Daily Bell: If so, how so? Via a gold standard of some sort?

Fred Sheehan: I am sure gold will be a medium of exchange when fiat currency
fails. But how that might be written into law, I do not know.

Daily Bell: Thank you.

Thursday, February 13, 2014

At the Margin

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)

John Hussman (Hussman Funds) wrote in his February 3, 2014, Weekly Market Comment: "The latest data from the NYSE shows equity margin debt at a new all-time high. Relative to GDP, the current 2.6% level was eclipsed only once - at the March 2000 market peak."

            The ratio of margin debt is usually - at least, often - calculated in comparison to the market value of stocks. Later in his Comment, Hussman explains his choice: "We use GDP here because margin debt to GDP has a much higher correlation with actual subsequent market returns than say, margin debt/market capitalization (which destroys information by muting the indicator exactly at points when prices are extremely elevated or depressed)."

            The March 2000 peak was an example of our so-called policymakers clamming up. Their duty is exactly the opposite. Quoting from Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve, by William A. Fleckenstein and Frederick Sheehan: "On February 17, 2000, the subject of margin debt came up when the chairman testified before the House Banking Committee, just as it had three weeks earlier, when Greenspan had appeared before the same committee of the Senate. Despite having been thoroughly interrogated on the subject by an obviously concerned Senator Schumer on January 26, Greenspan reiterated the view that he shared in his previous testimony, that raising margin requirements would have no effect on stock prices.

            "In response to the question from Senator Schumer during the January Senate appearance, Greenspan had staked out his views on the subject, stating that raising margin requirements would discriminate against the small investor and, furthermore, studies had 'suggested the level of stock prices has nothing to do with margin requirements.'

The Fleckenstein & Sheehan response: "I have no idea what studies he was referring to...." We then wrote of a couple of possibilities, far-fetched, instead of writing that Greenspan had lied. After the crash, Greenspan gave the most noxious speech of his life at Jackson Hole, Wyoming, on August 30, 2002. Blameless as always, the worm tacked on a footnote: "Some have asserted that the Federal Reserve can deflate a stock-price bubble - rather painlessly - by boosting margin requirements. The evidence suggests otherwise. First, the amount of margin debt is small, having never amounted to more than about 1-3/4 percent of the market value of equity..."

First, the amount does not matter, since the problem lies with the level of the ratio and rate of advance. Hussman writes: "[T]he main usefulness of this measure isn't for any fixed correlation with subsequent returns - numerous valuation measures do much better - but for its extremes. This is particularly true when margin debt advances rapidly over a span of several quarters relative to prices, GDP and other measures." Hussman's chart shows advances similar in 2000, 2007, and in 2013 and 2014. (Total margin debt had risen 45% between October 1999 and February 2000.)

Although "numerous valuation measures do much better," Hussman notes: "Prior spikes in margin debt/GDP in June 1968, December 1972, August 1987, March 2000, and October 2007 were followed by a bear market losses of at least one-third of market value shortly thereafter."

As to valuation measures: "In the context of the most extreme bullish sentiment in decades, and reliable valuation metrics about double their historical norms prior to the late-1990's bubble (price/revenue, market cap/GDP, Tobin's Q, properly normalized price/forward operating earnings, price to cyclically-adjusted earnings), we view present market conditions as dangerously speculative."

Most everyone knows we are at the edge, in their gut, if not their mind. Experts are paid to say otherwise. Again, the closer the cliff, those who are paid to keep investors in the game, and at necessarily greater feats of leverage, will make ever more reassuring claims.

It is my sense the Federal Reserve is losing its credibility with the public. Woe betide us the day it loses credit-ability. As with anxiety about stocks, this may be latent. It will pour forth when leverage retreats. Newly inducted Federal Reserve Chairman Janet Yellen offered testimony before the Senate Banking Committee for the first time yesterday, February 11, 2014. She was full of reassurances: "The economic recovery gained greater traction in the second half of last year." Asset prices are not at "worrisome levels." In questions and answers, she said something like "stocks are savings." (If anyone has the actual quote, please let me know.) This is to be expected. To forestall the complete loss of Fed creditability, more direct contradictions to the truth will be asserted.

In September 1996, bespattering his fellow FOMC comrades with an excess of machismo (should such be possible), the "greatest central banker who ever lived" - Alan Greenspan, in the words of Alan Blinder - claimed:  "I recognize that there is a stock market bubble problem at this point. . . . We do have the possibility of raising major concerns by increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it."

From John Hussman's February 3, 2014, Weekly Comment:

"Just a note - I'll be speaking at the Wine Country Conference in Sonoma, CA on May 1st & 2nd, 2014, along with Mike "Mish" Shedlock, David Stockman, Stephanie Pomboy, Steen Jakobsen, Chris Martenson, Mebane Faber, Jim Bruce and others. This year's conference will benefit high-impact programming for individuals on the autism spectrum and their families, primarily local efforts through the Autism Society of America. As many of you know, my 19-year old son JP has autism, so the cause is very close to my heart. Last year's conference benefited the Les Turner ALS Foundation. It's a great event in a beautiful location. Hope to see you there. For more information, please visit Thanks - John"

Friday, February 7, 2014

The View from Madrid

Fernando del Pino writes "Independent views on Spain, Europe and the big picture of politics and money” one of the few realistic appraisals written from Europe today. Running Away from Reality is anathema to the nomenclatura since its untroubled disposition runs faster and faster from the encroaching reality. To read more of his essays, his website is

Running away from reality

In a society that’s incessantly pulling all sorts of rights out of its hat, the right to not suffer is the father of them all. We feel entitled to keep our jobs, our health, our home and our leisure, demanding in fact to be carefree. We don’t want our lifestyle to depend on how hard we work or how much we save, and neither do we want our wrong decisions to have any consequences. In our delirium, we feel we have the right to know the future or even to decide when life should start (that of others, of course) and also when death should come (usually that of others as well). In brief, we want the security that we will be able to avoid pain. The problem is that, in life, pain is as undesirable as it is inevitable, and security, in the words of Helen Keller, is “a superstition that does not exist in nature”. However, man persists in his chimerical search for the security that will keep him free from suffering. Citizens demand that from their ruling classes, who promise ever more extravagant rights and certainties, constantly fleeing reality and truth. And in this hysterical, unbridled race to reach an evanescent security, liberty is thrown into the dust like a bothersome burden.

The free man must be responsible for his behavior without being able to blame anyone else when things go wrong. He must live in discomfort and uncertainty and accept the authorship of all his decisions. This is hard. That’s why as soon as the sweet illusion of freedom gives way for the bitter taste of responsibility and effort which that very freedom bears with it, man revolts against the latter. Some 3500 years ago, the Jewish people, having been oppressed for generations by slavery, was freed by Moses, who took them out of Egypt in order to lead them to the Promised Land. But just a few short days after their last minute’s escape from Pharaoh’s claws in the Red Sea, as the harshness of the desert started to put a dent in their spirit, the Jews forgot the humiliations, whippings, hardships and indignity of their slavery, cursed their freedom and blamed their liberator for freeing them, to the extent that Moses was nearly stoned: “Why did we not die at Yahweh’s hand in Egypt, where we used to sit round the flesh pots and could eat to our heart’s content!”. The security of a hot meal and a loaf of bread seemed worth more than the recently recovered freedom.

It goes without saying that throughout History all power seekers and power holders have taken good note of this story. They have come to realize that all they need to have the people surrender their liberty is to promise them security: a certainty – liberty – in exchange for a promise – security; an extremely valuable good in exchange for a chimera. And over and over again, the people have fallen into the same trap.

Today, under the disguise of a promise of physical security, governments treat each of us as if we were suspected criminals and not free citizens with rights: they record our conversations, intercept our mails, take our fingerprints and as many pictures as they deem necessary, do body searches and leave us half naked when we travel as if it were business as usual, and ruthlessly hunt down as traitors those who uncover these practices.

As far as economic security is concerned, totalitarian communism was an extreme of this barter: the people lost their liberty and never found any security, except for the certainty of being poor under a merciless tyranny. The fraudulent Welfare State proposed something similar (do you believe that the wording of Social “Security” is casual?): it promised a paradise of “free” pensions, healthcare and education in exchange for giving up our freedom to save (thus relieving us off the uncomfortable responsibility of doing so). We surrendered our savings to the politicians, those incurable squanderers, well known for anything but respecting either their word or other people’s money! And now that, even after burying us under a mountain of taxes and perpetual debts, public money is scarce and nearing extinction, where is the promised security to be found? We must understand once and forever more that security is not only liberty’s enemy, but an impediment to prosperity. In fact, security and prosperity are antonyms.

The 2008 financial crisis was mostly caused by politicians and central bankers wanting to avoid the suffering caused by economic cycles. Due to the irritating fact that pained voters tend not to reelect incumbent governments, what better promise could they make than that of trying to end recessions and live in a plateau of permanent prosperity? We still believe the charlatans who, in politics or in central banking, assure us that they can get rid of the uncertainty that terrifies us so much. We long for a control that simply does not exist, and these are the consequences: perversely, the chimeric search for security brings much more suffering than what it pretended to avoid in the first place.

In 1891, Pope Leo XIII prophetically forewarned us in his wise Encyclical Rerum Novarum about the evils that are now upon us: “To suffer and to endure, therefore, is the lot of humanity; let them strive as they may, no strength and no artifice will ever succeed in banishing from human life the ills and troubles which beset it. If any there are who pretend differently – who hold out to a hard-pressed people the boon of freedom from pain and trouble, an undisturbed repose, and constant enjoyment – they delude the people and impose upon them, and their lying promises will only one day bring forth evils worse than the present”.

We have to accept insecurity and pain as something inherent to human nature and promptly mistrust anyone promising the opposite, in the conviction that that promise only seeks to fool the unsuspecting. An economic and political system focused on avoiding the inevitable, promising an inexistent security, is due to fail and headed for poverty. That’s why we should make peace with the reality of uncertainty and suffering and not try to escape from both. Only from the deep acceptance of these realities, will the trembling, fragile ember of hope that has always raised the human being up from his falls catch fire again. The history of man is the successful story of a flexible adaptation to an ever changing, ever insecure environment. As a country, we should look suffering in the eye, without fear, and dedicate all our energies to adapting to the new reality instead of continuously running away from it.
Fernando del Pino Calvo-Sotelo