What Does the Media Do?

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), which was translated and republished in Chinese (2014). He is researching a book about Ben Bernanke. He writes a blog at www.AuContrarian.com.

What do reporters do all day? In "Exclusive!" "Shocking!" "Extra, Read All About It!" breaking news, AuContrarian.com  published the damning testimony of (in 2008 - in all cases) Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben S. Bernanke, and New York Federal Reserve President Timothy Geithner in "Sell Financial Stocks - and Bonds" (September 5, 2014). Quoting from their own words, from the "The Plaintiff's Corrected Proposed Finding of Fact," in Starr International Co. v. United States,the trio broke the law when they nationalized AIG, and, showed they had no idea what they were doing.             Now, those conclusions are opinion. And as stated in "Sell Financial Stocks - and Bonds" the evidence is the "Plaintiff's case, of course, and protests will be aired on the witness stand starting in late September." (The upcoming trial is discussed in the article.)             The question of the day is: why hasn't a media organization written about this? A search through Google, etc. came up with nothing. That is not definitive, but if one media outlet gets hold of an important story, the others follow.             The Wall Street Journal published a story on August 26, 2014, which made it plain the "The Plaintiff's Corrected Proposed Finding of Fact" was in the public domain. From the story: Mr. Bernanke is quoted making the statement in a document filed on August 22 with the U.S. Court of Federal Claims as part of a lawsuit linked to the 2008 government bailout of insurance giant AIG."             The Bernanke quote was his standard: "I stopped the worst financial crisis since [fill in the blank]." He has lived off this assertion since 2009, never providing evidence. Bernanke's quotes are from - you may have guessed - page one of the document.             Why didn't anyone read through the 99 pages? Page one was the least newsworthy of all. Why didn't other media outlets display even a modicum of their self-acclaimed "investigative journalism" and call court? Will they cover the trial? Starr International Co. v. United States is set to start September 29.

Sell Financial Stocks - and Bonds

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), which was translated and republished in Chinese (2014). He is researching a book about Ben Bernanke. He writes a blog at www.AuContrarian.com.

RESERVE YOUR SEATS: On August 26, 2014, for what seems the fiftieth time, the U.S. Court of Federal Claims rejected the U.S. government's attempt to extinguish Starr International Co. v. United States. Judge Thomas Wheeler said the case brought by Hank Greenberg's AIG (specifically, Starr International Co., which owned 12.5% of the shares on September 15, 2008) will go to trial on September 29, 2014. Wheeler stated: "The complexity of the submissions and the factual disagreements strongly point to the need for a trial." According to Reuters, "a U.S. Department of Justice spokeswoman declined to comment." On the other hand, David Boies, the Attorney of Record from Boies, Schiller & Flexner, LLP, representing Starr International, did comment: "The decision speaks for itself." Former AIG Chairman Hank Greenberg has sued the U.S. government for $25 billion as compensation for the shares owned by Starr International. According to Reuters, "The trial is expected to last six weeks.")

:           The news sounds reassuring: "U.S. bank regulators plan to adopt rules on [September 3, 2014] forcing big banks to hold more assets that they could sell easily in a credit crunch, a requirement that is closely linked to the experience of the 2007-2009 financial crisis." It is possible the rules will work.

            However, no formula will capture rising or falling confidence in a financial company at some future date. We are vectoring towards another 2008. Confidence, on the part government and Federal Reserve officials, financial institutions, and the public, are intertwined. When financial institutions are afraid to lend to each other liquid assets will be held for dear life.

            There are two topics in store. First, changes to financial institution bankruptcy law may prompt a bank run. Second, depositions in Starr International Company, Inc. v. United States [the AIG lawsuit - see: "David Boies vs. Citizen Ben S. Bernanke," and "The Professor Who Did Not Save the World"] should awaken investors to our "policy makers" disintegration when we needed a leader. (It is significant when the bureaucratic meritocracy rose to positions of leadership, it changed its role to that of "policymakers." That it did not and does not want to lead is the reason it is spent.)

            In the discussion about financial institution bankruptcy (topic number one), it is well to keep in mind consequences are magnified by topic number two. As a footnote, it is inconceivable the government and Fed models, such as those used to calculate the September 3, 2014, bank liquidity rules, include an exponential factor that kicks in when the combined worries of a Dodd-Frank "call" and a heavy-handed government rescue mission hit simultaneously.

            The changes to financial firm bankruptcy are not new. They are part of the Dodd-Frank legislation. After taking a poll (of three) it was agreed investors and bank depositors are not conscious of the changes. ("Conscious of" - banks may have sent notices, 10Ks and certainly security offerings served notice, but memories fade.)

Since this is not new, a summary will be brief. It is also a transcription of Paul Singer's description at the Grant's Interest Rate Observer conference in April 2012. Singer is CEO of Elliot Management Corporation and a lawyer. He explained: "Dodd-Frank radically changed bankruptcy law to enable the FDIC to seize financial companies which are thought to be in danger of default. Prior law for decades required, of course, actual default or a voluntary filing by management. The seizure process in Dodd-Frank takes two - count them - two days, and is essentially unreviewable and unappealable. The FDIC is also ordered, pursuant to Dodd-Frank, to toss out management and seek damages from people, including third parties, who are 'responsible' for the financial condition of the troubled company. It also enables the FDIC to transfer assets willy-nilly out of the corporate entities where they reside, thus making the analysis of one's counterparty impossible, and to discriminate among classes of creditors similarly situated if the FDIC thinks it will fulfill some higher good.... Thus creditors, counterparties, clearing customers and trading partners of financial companies which become troubled, post Dodd-Frank, have only one rational response to potential trouble or perceived trouble, given the opacity and leverage I have mentioned before: instantly stop trading, sell claims, pull assets, basically run for the hills."

            Now, for the bad news: The depositions in Starr International v. United States show a government that did not wait for Dodd and Frank to muster 10,000 pages (and counting) of bureaucratic snooping. In the pinch, Secretary of the Treasury Hank Paulson, Fed Chairman Ben Bernanke and (then) New York Federal Reserve President Tim Geithner acted willier and nillier than (we may hope) the FDIC will behave, and without legal authority (as you will read below), during the 2008 financial crisis.  

The public view was described last week by Reuters: "The bailout saved AIG from [the possibility of] filing for bankruptcy. The Federal government took 92% of AIG's shares in return for $152 billion that the Fed and Treasury eventually pumped into the insurer." [Bracketed comment in Reuters dispatch added. - FJS]

Reading "The Plaintiff's Corrected Proposed Finding of Fact," it looks as though the bailout forced AIG into an unnecessary bankruptcy; hence the bracketed insertion in the Reuters description above. This is the Plaintiff's case, of course, and protests will be aired on the witness stand starting in late September.

Note #1: the wording from the Finding of Fact is sometimes what a layman may call "telegraphic;" I have left it as is. Note #2: Only a handful of the Findings of Facts are discussed below. There are well over 100. The legal case may address others. 

Returning to the scene of the confusion, then-New York Federal Reserve President Tim Geithner described the drama (in deposition) on September 15, 2008: "Of the twenty-five largest financial institutions at the start of 2008, thirteen had either failed (Lehman, WaMu), received government help to avoid failure (Fannie, Freddie, AIG, Citi, BofA), merged to avoid failure (Countrywide, Bear, Merrill, Wachovia), or transformed their business structure to avoid failure (Morgan Stanley, Goldman.)" 

The United States (as stated in the lawsuit) would not hear of outside parties that were willing to bridge or supply capital needed by AIG. Quoting the Finding of Fact: "Sovereign wealth funds, including the Government of Singapore Investment Corporation (GIC) and the Chinese Investment Corporation (CIC) expressed interest in investing in AIG."

Specifically, "The Chinese Investment Corporation (CIC) expressed interest in investing in AIG. Defendant discouraged the CIC and representatives of the Chinese Government from assisting AIG. At 12:25 p.m. on September 16, 2008, [it was relayed to Secretary of the Treasury Hank Paulson].... CIC was 'prepared to make a big investment in AIG, but would need Hank to call [Chinese Vice Premier] Wang Qishan.' The Chinese 'were actually willing to put up a little bit more than the total amount of money required for AIG.'" [Italics added. - FJS]

            "On September 16, 2008, [Under Secretary of International Affairs David] McCormick spoke to Paulson about the Chinese interest in investing in AIG. McCormick then told [Taiya] Smith [Paulson's deputy chief of staff and executive secretary] that Treasury "did not want the Chinese coming in at this point in time on AIG."

"Later that day, Smith met with Chinese Government officials in California during Joint Commission on Commerce and Trade in Yorba Linda, California. During that meeting, 'all [the Chinese officials] wanted to talk about was AIG.' Smith spent one or two hours explaining what was happening with AIG. She conveyed the message that Treasury did not want the Chinese to invest in AIG." [Italics added - FJS]

Senator Hillary Clinton took time off from her presidential campaign to save the floundering insurance company: ""On September 17, 2008, United States Senator Hillary Clinton called Paulson "on behalf of Mickey Kantor, who had served as Commerce secretary in the Clinton administration and now represented a group of Middle Eastern investors. These investors, Hillary said, wanted to buy AIG. 'Maybe the government doesn't have to do anything,' she said.'" Paulson told Senator Clinton, 'this was impossible unless the investors had a big balance sheet and the wherewithal to guarantee all of AIG's liabilities.'"

Since the price of oil was descending from its recent high of $150 a barrel, it was worth investigating whether they had "a big balance sheet." As for "the wherewithal to guarantee all of AIG's liabilities," Paulson had no idea what the liabilities were worth - he could not explain to counsel why the government seized AIG: "Paulson: The 'taking of equity in companies that receive government assistance' is 'a punitive condition.'"
 

Treasury Secretary Hank Paulson

Several outside parties were calculating values, but from the evidence, no one within "The United States" did so. None of the witnesses could tell David Boies where the "79.9% of AIG shareholder's equity" - the original figure wrought - came from. (Geithner: "I am not certain I understand the reason why it was not more than that. I don't know why it was not less than that." Paulson: "I didn't focus on how that number was determined, although I clearly focused on the number and remember discussing it." FRBNY: "did not conduct an independent analysis regarding the appropriate terms for Government assistance to AIG." Bernanke: A. "I don't know." Bernanke left as he entered - a space-cadet, paper-shuffler.)

There were, however, several parties that calculated the value of "AIG," from different perspectives and for different reason.

For instance: "According to BlackRock, an independent advisor working on behalf of AIG, 'Collateral posted to counterparties under the CDS in the portfolio is over $29 billion, far in excess of the projected net cash flows in BlackRock's stress case.' BlackRock estimated that AIG's projected net cash flows for the life of the CDS contracts, discounted at LIBOR, ranged between negative $7.3 billion in a base case and negative $15.2 billion in a stress case."

Also, "New York State Superintendent of Insurance Dinallo testified that even 'if there had been a run on the securities lending program with no Federal rescue, our detailed analysis indicates that the AIG life insurance companies would not have been insolvent'" [Italics added. - FJS]

In addition: "KKR's [Kohlberg, Kravis - FJS] Derrick Maughan provided sworn testimony that if 'AIG, the company, or the Fed as lender of last resort, had wished they could have stabilized the company through Government invention support [sic], and then introduced private capital.'"

There were other avenues offered to prevent AIG's nationalization: "BlackRock 'presented three options for FRBNY to consider.... [This included] counterparties cancelling their credit default swaps and selling the underlying CDOs to an FRBNY-financed SPV, for total consideration of par, comprised of previously posted collateral, cash, and mezzanine note in the SPV'; the obligation to perform under the credit default swaps 'transferred from AIG to an SPV guaranteed by the FRBNY'; and creation of an 'SPV to purchase the underlying CDOs from AIGFP's counterparties, in connection with a termination of the related credit default swaps'"

Apparently, no option matched nationalization. New York State was ready to save AIG. "Around noon on September 15, 2008, New York Governor David Paterson announced that he had 'directed' the New York State Insurance Department to permit AIG to access approximately $20 billion in liquid assets from certain AIG insurance subsidiaries. He also urged the federal government to be involved in some type of arrangement, whereby AIG would have the necessary resources and bridge loans to tide AIG over until it could resolve its liquidity problems."

"On September 16, 2008, Dinallo reiterated Governor Paterson's offer to allow AIG to upstream $20 billion from its insurance subsidiaries. Geithner responded, "No, we're good." As a result, Dinallo was 'led to believe definitively that we were no longer part of the fix.'" "Good" at what?

If you ever watched Chairman Bernanke brush aside Congressional inquiries about the Federal Reserve exceeding its authority during testimony, he would invoke Section 13(3) of the Federal Reserve Act. This always shut the congressman up, even though, on at least two occasions, he leaned back for a Fed staff member to remind him the number of the section: "13(3)."

In the Finding of Fact, Paulson and Geithner are quoted far more than Bernanke except for some hysterical recollections, including: "September and October of 2008 was the worst financial crisis in global history, including the Great Depression." That could be true, but is a wild assertion without support (which Bernanke has never in his life supplied), a successful tactic that guided Time magazine to name him Thing of the Year.  

            On the other hand, Tim Geithner offered a more convincing assessment, that "2008" was "the worst financial crisis since the Great Depression." Chairman Bernanke accomplished a rare feat. He was a less reliable witness than Tim Geithner.

Another example of Bernanke's fevered understanding: "Of the 13 most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two." He said this at least once before, when he testified during the FCIC investigation. After the FCIC transcript was released, it was noted this was a ridiculous comment. Yet, he persists. If the government approached every financial institution's potential insolvency as it did AIG, the government would have owned 6,000 banks in three days' time.

One finding shows AIG's nationalization - the government acquiring equity ownership from shareholders - was an ad lib operation by the trio. The finding states: "The Federal Reserve had no authority to purchase or hold equity," the facts include (there are many more):

Geithner: "Under section 13(3) of the Federal Reserve Act, the Fed is prohibited from taking equity or unsecured debt positions in a firm".

Bernanke: "The Federal Reserve is authorized under the Federal Reserve Act to extend credit in various forms, but is not authorized to purchase equity securities of financial institutions."

Bernanke: "We had only one tool, and that tool was the ability of the Federal Reserve under 13(3) authority to lend money against collateral. Not to put capital into a company but only to lend against collateral."

Paulson, referring to the Federal Reserve: "They legally couldn't do preferred. They legally could only make a loan."

 "FRBNY General Counsel Thomas Baxter wrote to Federal Reserve General Counsel Scott Alvarez confirming "we agree that there is no power" for the Federal Reserve "to hold AIG shares."

"FRBNY's independent auditor Deloitte: "FRBNY cannot legally control a commercial company, and therefore it is not appropriate for them to consolidate an entity it cannot legally own."

Another Finding eliminates the only other legal conduit for AIG's nationalization. "In September 2008, Treasury had no authority to purchase or hold equity." Some of the many facts that confirm Bernanke, Paulson, and Geithner broke the law. Nay, they trampled our protection from tyranny with jackboots. Facts follow: 

"The "Treasury Department as of September of  2008 had no budgetary authority to invest in equities, securities of any financial institution."

"FRBNY counsel to Federal Reserve Board officials on September 17, 2008, concerning 'Issues with regard to the NY Fed/Treasury's equity participation in AIG,' Treasury 'consider[s] themselves legally unable to assume ownership. This leaves the NYFed as Treasury's place to house the equity position.'"

"September 17, 2008 report of Treasury's external counsel at Wachtell: 'Treasury legal is telling, as per doj, that they cannot hold voting shares.'"

"TARP Chief Investment Officer Jim Lambright: In 'September when the Fed extended the credit facility, the government didn't have an equity tool.'"

"Board of Governors Legal Division: "'We understand that the Treasury lacks the legal authority to hold directly voting stock of AIG.'"

"Paulson: 'Q. And prior to TARP's approval, Treasury did not have the authority to purchase equity, either. Right?

 A. Correct.'"

            Given the cleavage from reason by our policy makers (one last, irresistible Fact: no one from AIG was allowed in the room during its nationalization), consider: (1) interests you may hold in financial institutions and (2) Paul Singer's description of the now legal means to redistribute those interests. Financial firms are more leveraged than is generally understood. Sell their securities.

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" (Aucontrarian.com, 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? 

Enjoy it While it Lasts

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

"Enjoy it while it lasts"

-Sir Alan Greenspan, June 13, 2007,after suggesting "the global liquidity boom, which he dates back to the end of the Cold War, is nearing its end."

            "The fragile five" appears with rising frequency in the financial columns. This warning to stand aside, much as the "Asian contagion," in 1997, is bound to boomerang on Wall Street since Wall Street will keep selling as long as demand exists. At that time, U.S. investment banks were distributing sub-prime, Thai auto-loan securitizations to Greenwich. The hedge funds leveraged such securities into a Fed-led, Wall Street bailout in October 1998. The question of whether the Long-Term Capital Management (LTCM) rescue party should be considered a bailout was answered conclusively in Alan Greenspan's Age of Turbulence scrapbook: "[A]n orderly liquidation of [LTCM] was by no stretch of the imagination a bailout." Greenspan's assertions of blamelessness when he is guilty-as-charged are the foundation for his fortune.

He has also profited handsomely from being wrong. This may seem a strange causality, and, in fact, a distinction should be made. Greenspan has been wrong because his public statements have already been vetted and approved by every hack, Wall Street economist. "Wall Street economist," is a shorthand substitute for myriad establishment totems who earn their living by saying what the majority wants to believe.

This makes the bewilderment of the Bernanke Fed in June 2007 all the more, er, bewildering. ("The 'expected impact from weaker housing...may flare in the future, today - in the words of Ben Bernanke - it is contained.'" - July 18 2007, MarketWatch)

            In January 2014, Simple Ben is about to leave us, no wiser after seven more years as Federal Reserve chairman. Sounding more askew than ever at his December 18, 2013, press conference, the future civil-service pension recipient spoke as directly and honestly as we have come to expect: "[T]here are concerns about effects on asset prices, although I would have to say that's another thing that future monetary economists will want to be looking at very carefully."

            The fragile five - Brazil, India, Indonesia, South Africa, and Turkey - are suffering from investment outflows. As risk trades head home (to the Upper East Side and Mayfair), possible contagion through U.S. markets rivals the startling array of market upheavals that were widely expected on June 13, 2007.

            A bucket filled with reports of doomed credit excesses sits beside this desk. To condense, and also to offer ammo when the academic bureaucrats sit before Senate panels and mumble "We had no warning," I follow with newspaper articles by a single newspaper, the Financial Times, and by a single reporter, Tracy Alloway. The pre-2007 activities were described in Panderer to Power with a similar intent: to show anyone with even a nodding acquaintance with credit and leverage the credit bubble was doomed, long before 2007. By 2004 (in fact, much earlier), the collapse of Fannie Mae, the corruption of mortgage lending, the criminal actions that inflated the credit bubble, were already obvious (and footnoted in Panderer to Power, for any ambitious district attorney.)

In the December 11, 2013, Financial Times, Tracy Alloway warned: "The global search for yield has spurred some of the loosest lending conditions in credit markets since before the crisis, the Bank for International Settlements has warned." The BIS, the central banker's central bank, also issued a barrage of warnings before 2007. On December 14, Alloway was again on her soapbox: "Central banks have flooded the financial system with cash, driving investors to park their money in higher-yielding securities and largely obfuscating the true state of underlying markets." She then referred to the same BIS report: "In an era of cheap and easy money, investors are encouraged to buy bonds from troubled companies and thereby suppress the default rate." Who can forget: "House prices never go down?" Once again, central bankers have laid 312,000 traps for unsuspecting grannies who were enticed from their interest-bearing (roughly: 0.4%) CD or passbook savings account because they had to eat.

            "Surge in Boom-Era Debt is Signal for Overheating," was the title of an October 19, 2013, Alloway scolding: "Five years of the Federal Reserve's ultra-low interest rates have made the market for loans to highly indebted companies white-hot in recent years as investors clamour for the higher yielding assets and corpora[tions] rush to finance old debt." Here we see the consequence of low rates to both investors and to investment-grade, corporate bond issuers. Businesses run for-profit are losing sales to failed competitors [sic] kept in motion by Ben Bernanke's nationalization decisions.

            Kicking off the new year (January 1) Alloway's title prophesized: "2014 Outlook: Sugar High." She reported from a tea at the New York Athletic Club where "waiters bearing trays of cookies fanned out among the bankers and investors," as Leonard Tannenbaum, chief executive of Fifth Street Management sounded like Tracy Alloway: "I believe there's another cycle coming. So have a cookie. I want you to enjoy the sugar high - while it lasts."

The columnist, along with co-author Michael Mackenzie, picked up where Tannenbaum left off: "Issuance of syndicated leveraged loans - those made to companies that already carry high debt loads - reached $535.2 billion in 2013. That is just shy of the $604.2billion sold in 2007, at the height of the last credit bubble. Meanwhile, loans that come with fewer protections for lenders, known as "covenant-lite," accounted for almost 60 per cent of loans sold in 2013, compared with a 25 per cent share in 2007. Sales of "payment-in-kind" notes, which give borrowers an option to repay lenders with more debt reached $11.5 billion in 2012 [2013? - FJS] - a post-crisis high."

The Alloway & Mackenzie team quoted Russ Koesterich, chief investment strategist at BlackRock: "There are no bargains in fixed income. [Not true. There are pockets of mispriced bonds, probably too small for BlackRock. - FJS] We have seen a return to a lot of the practices that made people nervous in 2007 such as PIKs and cov-lite." Alloway & Mackenzie went on to write "'junk,' or high-yield, bonds surged to a record in 2013 as companies rushed to refinance and investors snapped up the resulting assets. Issuance of junk bonds rated 'triple C' - the lowest designation - jumped to $15.3 billion, surpassing the pre-crisis peak."

The preceding articles are a sampling, without introducing the stories written by other Financial Times reporters, such as Vivianne Rodriques. The practical lessons to be understood include: (1) a 0.4% yielding CD may be just the place to wait now, (2) no government (or aligned) official is worth listening to on these points, (3) the closer we get to the credit collapse, official pronouncements will grow more reassuring, and (4) when the stock market started falling after mid-2007, it went down by 50%. The Fed bailed out the stock market. This time, the Fed is the credit most vulnerable to collapse.

The Stock Market

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

            Thomson Reuters (This Week in Earnings, December 6, 2013) notes another New World Record. We are breaking plenty these days. This often foretells a Grand Finale. For the fourth quarter of 2013, 103 companies in the S&P 500 have announced negative earnings revisions. Only nine have disclosed positive profit assessments. The ratio of negative-to-positive, 11.4:1, exceeds the previous high (negative-to-positive ratio) of 6.8:1.

            This is worth consideration. The 6.8:1 silver medalist was during the first quarter of 2001. Early 2001 was unpleasant. More importantly, for a ratio comparison, the unpleasantness was by then a protracted, dismal bust, and was not news, except to Alan Greenspan, who announced to the FOMC at its January 30-31, 2001, meeting that: "there is little evidence of which I'm aware that long-term profit expectations have deteriorated to any significant extent." A century from now, interested parties will need to address the dilemma of who possessed the tinier minds: members of the FOMC or the world that stood still in fear of its pronouncements, debating the layers of analysis that never existed at the Fed prior to post-meeting announcements.

          As a reminder of the moment: "By the end of 2000, the Nasdaq Composite had fallen 51 percent and the Philadelphia Internet Index had lost 77 percent from its peak. All told, investors in U.S. stocks had lost trillions of dollars and were constantly reminded of this by the wonder of technology's multicolored screens that flashed instant calculations of their attenuated portfolio holdings."  (Panderer to Power, pgs. 235-236).

          Announcements by companies of adjusted earnings predictions in a different direction usually lag a sharp break (from recession to rebound, or its opposite.) The first quarter 2001 reassessments were made by companies in the midst of liquidation, most of which had accumulated during the boom: "On December 4, 2000, Cisco Systems Chairman John Chambers delivered his annual speech to Wall Street analysts. 'I have never been more optimistic about the future of our industry as a whole, or of Cisco.' In January, Cisco Systems announced the value of its inventory rose from $1.2 billion to $2.0 billion in the previous quarter.Companies announced plans (or hopes) to reduce inventories by the end of 2002. This unwinding across the whole economy would take years to complete-unless some artificial paper printing inflated prices.... In April 2001, John Chambers admitted, "[T]his may be the fastest any industry our size has decelerated." Chambers was paid $279 million in 1999 and 2000 for his foresighted leadership." (Panderer to Power, pgs. 235, p. 237-238)

Since these moments of abrupt break are so easily forgotten, yet, so traumatic, some more color: "Hewlett Packard was 'buffered by the slowing economy in just about every segment of our business. Sales from dot.coms [are] essentially zero.' Gateway's sales 'plummeted below already lowered estimates.' The CEO of Nortel admitted, 'We now expect the U.S. market slowdown to continue well into the fourth quarter of 2001.' Lucent's CEO warned, 'We have serious execution problems,' after which, he immediately restored public confidence in his execution acumen by firing 10,000 workers. Oracle's CFO made the head-scratching admission, 'I haven't a clue what will happen,' and, 'We're still trying to figure out what happened last quarter.'" (John Hancock Quarterly Market Review, April 1, 2001. Thanks, Andrea)

So, what might we hear from CEO's in the first quarter of 2013? A schizophrenia exists in which "we're in a bubble" is stated, even by some central-banking bureaucrats. At the same time, the word from the Street is cheery. The S&P 500, Dow, and Russell 2000 periodically post new highs; there seems to be no concern (or knowledge) that 10-year Treasury yields have doubled since before Bernanke's QEIII trillion-dollar, asset-buying commenced in the fall of 2012. Corporate earnings as a percent of sales are the highest since records were first collected in 1947. From the mouths of the Experts, this is a good thing. So, why might we be on the verge of another first quarter 2001?

            Stock prices are artificial. They have been lifted by central-bank asset buying and the belief the Fed will not permit markets to fall. This same trust emptied the brokerage accounts of believers twice in the past 13 years, but it goes on. Zero Hedge recently reported the days on which the New York Fed has engaged in POMOs (Permanent Open Market Operations) of $5 billion or greater, between April 2009 and April 2013, the S&P 500 rose 540%. On days when POMOs were less than $5 billion, the index rose 15%. On days without POMOs, returns were -2%. (The New York Fed lists the daily schedules for POMOs with estimated sizes several days in advance. The Fed wires the electronic, keyboard money to primary dealers who relay electronically conjured money to recipients.)

            Andy Lees reports: "Asset prices have...continued to soar. Margin debt is at record levels in absolute terms, and is towards record levels as a percent of market cap. A week or two back I was told that hedge funds are running a gross exposure of about 258%. If I remember correctly, derivatives and financial sector lending is predominantly off balance sheet. What appears to be happening therefore is that the loan growth is driving or supporting asset prices, but it is being funded, at least in part, by taking liquidity out of the real economy, similar to the late 1920's. Why would a bank lend to the real economy where there is disinflation and the weakest nominal GDP growth outside of recession, rather than to the financial economy where there is massive asset price inflation and the banks can make returns very quickly?"

Andy Lees described one path through which the world's asset markets are inflated, by layers of leverage upon leverage upon leverage. The central bankers remain completely unaware of this since their holy DSGE model (dynamic stochastic general equilibrium model) does not acknowledge the existence of financial markets.

Lees' comment, "liquidity out of the real economy," is most apparent in falling household incomes. Falling incomes partially answers the reason for record profits. A large part of the increase in profit margins is due (as a percentage of revenues) to a reduction of salaries, taxes, investment, and interest payments on debt. The last would never happen except in a National Socialist economy, one that keeps setting New World Records in corporate debt issuance with practically no carrying cost (interest payments). When the Fed abandons its attempt to control the yield curve (see comment about the 10-year direction, above), interest payments will leave many a CFO admitting: "We have serious execution problems."

Companies also have serious liquidation problems of their capital investment. The first run at the third quarter GDP report pegged corporate investment at -0.1%. Record debt accumulation with negative investment is truly New Era management, but, as in many New Eras past, one that will vanish with a "poof." The main route for the debt is to repurchase common shares. Fewer shares with record profits raises stock prices and prods the cash-out rate of stock options by senior management: the 1%.

           We may be heading into a melt up (the opinion of some long-time market watchers), followed by a reckoning when it becomes apparent so many companies have been hollowed out. To note the obvious, after the central bankers lose the yield curve, their ability to support markets (first, the mortgage melt up, then, 2008 and onward) will also go "poof."

Mr. Hyde and Mr. Hyde

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

           Stanley Fischer is in the pipeline for the vice chairmanship of the Federal Reserve Board of Governors. In this capacity, he would bang heads to gather FOMC votes for (Presumptive) Fed Chairman Janet Yellen. According to the New York Times, Fischer would "exert a moderating influence on Ms. Yellen," (" For No. 2 at Fed, White House Favors Central Banker in the Bernanke Mold.")

            This is neither the job of the vice chair nor the inclination of the man.

            First, Fed vice chairmen do the dirty work, clearing the path for the chairman.

            Following are comments by Vice Chairman William McDonough at FOMC meetings in 1998 and 1999. The Chief Whip hectored FOMC members just after Chairman Greenspan told FOMC members how to vote:

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

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

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

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

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

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

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

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

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

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

            The new vice chair will do the same. Stanley Fischer has midwifed the inflationary endgame for nearly 40 years. He will be sitting just where he belongs to prevent missteps in the grand plan. This does not mean he will succeed, but he understands the Greatest Flood since Noah's Ark must keep rising or we are sunk.

Second, Chairman Yellen will face formidable foes at the FOMC meetings in 2014. There are 12 Federal Reserve districts, 12 Fed district Presidents, but only five votes by Presidents at each meeting. (The seven Governors always vote.) Chairman Bernanke could not suffer dissention in 2013, even if he wished."Dissention is Overrated" on January 10, 2013, made this clear. Fed talk-show banter before FOMC meetings is unnecessary in 2013.

In 2014, Presidents Fisher (Dallas) and Plosser (Philadelphia) will fight the Fed chairman. A (Presumptive) Vice Chairman Fischer will press to gun inflation at a faster clip than even Janet Yellen would dare. Stanley Fischer is the most influential money printer in the world. His former students include Ben Bernanke, Mervyn King, Frederic Mishkin, and Mario Draghi. He is where he belongs.

            Fischer is not a man of half measures. He has received much attention here, such as on October 13, 2011, "The 8% Solution." The more salient comments from that diatribe:

The following sequence is a lesson in how bureaucracies insinuate their failures into accepted policy.

Stanley Fischer, current Governor of the Bank of Israel, doctoral Ph.D. thesis adviser to Ben S. Bernanke and to Greg Mankiw (at MIT), with stops at every institution of impeccable prestige among the anointed (chief economist at the World Bank, Vice Chairman of Citigroup) professed in 1997 that: "The fundamental task of a central bank is to preserve the value of the currency." That is the first sentence in "Maintaining Price Stability," a paper published when Fischer was First Deputy Managing Director of the International Monetary Fund. Five paragraphs later (wasting no time) Fischer wrote: "Barro (1995) and Sarel (1996) do not find clear negative relationship below 8 percent inflation..." [For the incredulous and perplexed reader, Fischer believes price inflation can run at an 8% rate, interest rates can hibernate at zero, and the real economy will be sound. This was back in 1997. Knowing how these creatures work, 16% inflation with no interest is probably the equilibrium rate today. - FJS]

We can be sure the conclusion rested on the result of some computer model. Barro (1995) and Sarel (1996) cited as their authority Fischer (1993), which is noted later in Fischer (1997).

In 2001, IMF economic researchers Mohsin S. Khan and Abdelhak S. Senhadji wrote a staff paper "Threshold Effects in the Relationship between Inflation and Growth." The authors declare "[F]irst identified by Fischer (1993)" [addressing inflation below an 8 percent rate], "inflation does not have a significant effect on growth, or it may even show a slightly positive effect." Note the change since the (1997) Fischer, from whom they quote: from "do not find clear negative relationship below 8 percent inflation," to "it [8% inflation] may even show a slightly positive effect." This sequence was arranged by Sheehan (2011).

The press blurbs that appeared the morning of December 12, 2013, were designed to relieve the wary of concerns that Professor Fischer might be an inflationist. The Washington Post fell in line: "[B]y September 2009 Fischer was raising interest rates." This was as head of the Bank of Israel. What was happening in Israel at that moment has not been investigated, but Israel does not have the ability to print money with abandon. (It has in the past, and suffered.) The United States is the reserve currency of the world that lifts all ships during a storm (so far), including Israel's.

In fact, on March 17, 2008, Bank of Israel headmaster Stanley Fischer offered Ben Bernanke advice in a Bloomberg interview. "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."

We might surmise Ben Bernanke would only remain a great economist if he conjured a few trillion dollars into existence. (He has.)

The Bloomberg reporter expressed concerns to which the central planner replied in central-banker jive: "Fischer rejected the view that the Fed was orchestrating a bailout that would encourage investors to take greater risk in the future."

There is not a chance Fischer believed this. What else were they going to other than chase bond, stock, and post-human art markets?

           

The theoretician loftily claimed Bernanke would raise interest rates "long before inflation got out of hand." Of course, Fischer had no idea what Bernanke would or could do, since no central banker (nor anyone else) knows how to exit. At first, Dr. Jekyll could change back from Mr. Hyde, but then, could only remain Mr. Hyde.

            The Bloomberg story was published at a dire moment. Bear Stearns had failed. Its carcass was purchased by J.P. Morgan on March 16, 2008. It is not a coincidence the professor who understood the inflationary end game in 1980 reminded his lifelong tenured servant of what to do. (Go forth and multiply.)

            The most celebrated economist MIT ever produced expressed misgivings about Ben Bernanke's scholarship, specifically, the Ph.D. thesis anointed by Stanley Fisher. (It is my understanding that Robert Solow was primarily responsible for Simple Ben's paper.)

Not too long before he died, Paul Samuelson - the man who established MIT as a magnet for economics, was interviewed by The Atlantic (June 17, 2009). Samuelson wrote the best-selling economics textbook in history. In the interview, Samuelson reflected: "The 1980s trained macroeconomics - like... Ben Bernanke and so forth -- became a very complacent group, very ill adapted to meet with a completely unpredictable and new situation, such as we've had....  I looked up Bernanke's PhD thesis, which was on the Great Depression, and I realized that when you're writing in the 1980s, and there's a mindset that's almost universal, you miss a lot of the nuances of what actually happened during the depression." [My italics. - FJS]

Samuelson, having administered a failing grade to the trainees, must have been appalled by the trainers. (Paul Samuelson was among the most intelligent economists of the twentieth century. After Samuelson defending his Ph.D. thesis, one of the professors, Joseph Schumpeter, turned to the other two, and asked: "Well, gentlemen, did we pass?" What happened after might help explain how economics went off the rails around mid-century. The American Keynesianism that Samuelson espoused was beneath him and certifiably incorrect.)

Simple Ben's Essays on the Great Depression ignore all economists who wrote before 1980. In the book, Bernanke mentions 139 names - 135 of whom are economists, mostly macroeconomists, and most having written after 1980. Their papers cross-reference each others. His essays never cite Benjamin Anderson (who was Chase Bank's in-house economist, writing about the mistakes being made a decade before the Depression), Ludwig von Mises (who also predicted a depression), as well as many others who wrote "on-the-spot," analyses in the 1930s.

            If Binyimin Appelbaum's "Young Stanley Fischer and the Keynesian Counterrevolution," is correct, the Vice Chairman Apparent sowed the seed that burned history and economics books written before 1980. Appelbaum, in the December 12, 2013, New York Times, writes that a 1977 paper written by Fischer led to a "counterrevolution." Fischer asserted "[c]entral banks...have the power to stimulate economic activity. Monetary policy can help economies recover from recessions.... [T]he new school [built on Fischer's paper - FJS] came to dominate central banking. Monetary policy makers, embracing its justifications of their powers, use New Keynesian models to plan and assess their campaigns."

            It is natural to ask "why" Fischer has been chosen to join the Fed. Without being there, it is impossible to know. The Obama administration's record of ad lib decisions is such a delightful packet of whimsy.

            "What" is more important. Fischer has no better idea how to "taper" (i.e.: extract the central banks from shoveling larger quantities of speculating, leveraged, uncollateralized credit across the globe). The Bernanke Fed cares most about stock market levitation. We can be sure Stanley Fischer knows this. He allocated 10% of the Bank of Israel's balance sheet to U.S. equities in 2012.  "Central Banks, Faced With Paltry Bond Returns Buy More Stocks" The new vice chairman will not be shy to introduce imaginative asset implosion prevention measures at the FOMC.