Visions of Gallantry

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

In "The Stock Market" (December 22, 2013), there is a mathematical problem with the following: "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%." If true, and it is not, the market never goes down. Nevertheless, even a non-calculating observer knows of the strong relationship between POMO operations and the stock market over the past few years. Most important is the artificiality of pushing up the stock market and its inevitable deflation.

In what could have been a turning point of mass recognition, the S&P 500 fell 9 points (-0.5%) in the minute after the Fed announced it was tapering (December 18, 2013). An unseemly burst of buying pushed the Index up 35 points (1.8%) in the next six minutes. It added another 15 points by the close: up 2.8% from that moment of peril. The S&P 500 closed at a new, all-time high of 1810. The mafia is more subtle than our central planners. That is the point: whatever They do, is authorized. This plunge-and-protect operation received practically no attention. If the authorities are so frightened when the market is near its all-time high, how will they panic when the market falls 10%?

As Federal Reserve Chairman Ben S. Bernanke gets set to depart, his personal self-worth was set forth in a speech to commemorate the 100^th anniversary of the Federal Reserve System. Bernanke buckled his panic attacks in 2007 and 2008 to Paul Volcker's money tightening belt in the early 1980s. Believing himself a combination of The Desert Fox and Joan of Arc, Simple Ben plastered his audience with this soggy discharge: "[O]ne value that strikes me as having been at least as important as any other has been the Federal Reserve's willingness, during its finest hours [Mon Dieu! - FJS], to stand up to political pressure and make tough but necessary decisions." Not content with this general (and ridiculous) claim, he followed with a vile and ignorant self-portrait: "I keep in my office one of the 2-by-4s mailed to the Fed during Paul [Volcker's] tenure, which communicates some distinctly unfavorable views of high interest rates and their effects. More recently, of course, the Federal Reserve took controversial but necessary measures to arrest what was arguably the worst financial crisis in American history."

It may be forgotten, but Simple Ben's initial rate cut that has led to our ruin was in response to Jim Cramer's CNBC attack on August 3, 2007. It should be noted that, on that date, the S&P 500 was down 7% from its all-time high. A sample of Cramer's bile: "[T]he Fed is asleep...My people [??? - FJS] have been in the game for 25 years...these firms are going out of business...open the darn [discount] window." David Stockman writes in The Great Deformation: "[W]ithin days of the rant that shook the Eccles Building, the Fed slashed its discount rate, abruptly ending its tepid campaign to normalize the money markets."

We know the rest. The bravest act of Bernanke's life was telling some patrons at South of the Border the restaurant had run out of apple pie.

Ben Bernanke's personal myth is his own affair. Our affair is the cocoon in which Bernanke and the yes-men draped around him have secluded themselves. Bernanke was not overstating what he believes in this self-characterization. Nor, would economists under the age of 120 disagree. (A friend who raised the possibility that Ben Bernanke may not be on top of his game was upbraided after a meeting: "He graduated from MIT, you know.")

            It so happens that Joseph Epstein, graduate of the University of Chicago, teacher for three decades at Northwestern University, and past editor of the American Scholar, wrote Bernanke's biography in the December 21, 2013, edition of the Wall Street Journal. He does not mention the Fed chairman. He may not have the seventh-grade, spelling-bee champion in mind. Epstein's was an essay on the rise of the meritocracy, with the title: "The Late Great American Wasp:"

Here they are, our leaders:

Meritocracy in America starts (and often ends) in what are thought to be the best colleges and universities. On the meritocratic climb, one's mettle is first tested by getting into these institutions-no easy task in the contemporary overcrowded scramble for admission. Then, of course, one must do well within them. In England, it was once said that Waterloo and the empire were built on the playing fields of Eton. The current American imperium appears to have been built at the offices of the Educational Testing Service, which administers the SATs.

Whether Republican or Democrat, left or right, the leading figures in U.S. public life today were good at school. Bill Clinton had Georgetown, Oxford (as a Rhodes scholar) and Yale Law School on his résumé; Barack Obama had Columbia and Harvard Law School. Their wives, respectively, had Wellesley and Yale Law School and Princeton and Harvard Law School. [Senator] Cruz went to Princeton and thence to Harvard Law School. Players all-high rollers in the great American game of meritocracy. Their merit resides, presumably, in having been superior students.

But is the merit in our meritocracy genuine? Of the two strongest American presidents since 1950-Harry S. Truman and Ronald Reagan-the first didn't go to college at all, and the second went to Eureka College, a school affiliated with the Christian Church (Disciples of Christ) in Eureka, Ill. The notion of Harry Truman as a Princeton man or Ronald Reagan as a Yalie somehow diminishes them both.

Apart from mathematics,* which demands a high IQ, and science,* which requires a distinct aptitude, the only thing that normal undergraduate schooling prepares a person for is... more schooling. Having been a good student, in other words, means nothing more than that one was good at school: One had the discipline to do as one was told, learned the skill of quick response to oral and written questions, figured out what professors wanted and gave it to them.

Having been a good student, no matter how good the reputation of the school-and most of the good schools, we are coming to learn, are good chiefly in reputation-is no indication of one's quality or promise as a leader. A good student might even be more than a bit of a follower, a conformist, standing ready to give satisfaction to the powers that be so that one can proceed to the next good school, taking another step up the ladder of meritocracy.

What our new meritocrats have failed to evince-and what the older WASP generation prided itself on-is character and the ability to put the well-being of the nation before their own. Character embodied in honorable action is at the heart of the novels and stories of Louis Auchincloss, America's last unembarrassedly WASP writer. Doing the right thing, especially in the face of temptations to do otherwise, was the WASP test par excellence. Most of our meritocrats, by contrast, seem to be in business for themselves.

Trust, honor, character: The elements that have departed U.S. public life with the departure from prominence of WASP culture have not been taken up by the meritocrats. Many meritocrats who enter politics, when retired by the electorate from public life, proceed to careers in lobbying or other special-interest advocacy. University presidents no longer speak to the great issues in education but instead devote themselves to fundraising and public relations, and look to move on to the next, more prestigious university presidency.

A financier I know who grew up under the WASP standard not long ago told me that he thought that the subprime real estate collapse and the continuing hedge-fund scandals have been brought on directly by men and women who are little more than "greedy pigs" (his words) without a shred of character or concern for their clients or country. Naturally, he added, they all have master's degrees from the putatively best business schools in the nation.

Thus far in their history, meritocrats, those earnest good students, appear to be about little more than getting on, getting ahead and (above all) getting their own. The WASP leadership, for all that may be said in criticism of it, was better than that.

The WASPs' day is done. Such leadership as it provided isn't likely to be revived. Recalling it at its best is a reminder that the meritocracy that has followed it marks something less than clear progress. Rather the reverse."

*Lord [Nigel] Lawson, who served as Financial Secretary to the Treasury and as Chancellor of the Exchequer under Prime Minister Margaret Thatcher, at Davos in 2012: "There is a complete failure of modern economics to have any value at all. Economics has been supplanted by mathematicians who can't hack it as mathematicians and become economists. It has no connection to practical policy decisions whatever. It helps the investment banks to construct models which proved disastrous and were a contributory factor to the banking meltdown."

            This is the least reported proclamation in the history of Davos love-ins.

Shooting Stars

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)

Following is a question-and-answer session between Congressman Scott Garrett from New Jersey and Federal Reserve Chairman Ben S. Bernanke before the House Committee on Financial Services, February 27, 2013.

It is puzzling why the Federal Reserve chairman is consistently unprepared to answer questions that fall directly inside the brief he has created for himself. It might be there is no need to understand questions such as those asked by Congressman Garrett, since nobody in the media seems to see through the fraud, either. In any case, this shows again Simple Ben has no idea what he is doing.

The reason for relaying this Q&A is not to explore the measureless depths of Bernanke's ignorance. Instead, the attraction is the final paragraph in which Congressman Garrett speaks. He has an exquisite grasp of how Federal Reserve policy has ruined markets. But, his time was up.

The Chair now recognizes the gentleman from New Jersey, Mr. Garrett, for 5 minutes.

Mr. GARRETT I thank the chairman and I thank Chairman Bernanke. Let me just try to run through in minutes three areas, what you talked about on remittances, what you talked about as far as some of the positive results, and if we have time, some of the effects of the somewhat current loose monetary policy on an international state. So, on remittances, I think you already said that the remittances are here, but they are potentially to go down in the future. If you look at the consolidated balance sheet of the Federal Reserve, we have capital of less than $55 billion, and assets of more than $3 trillion, so that means that all you need is about a 1 quarter of 1 percent increase in the interest rates, and you basically wipe out what you basically have right now, which is a 55 to 1 ratio, and you wipe that out. [Since that date, higher rates have wiped out the Federal Reserve's capital six times over. - FJS] So what is your prediction actually on that going forward with regard to interest rates wiping that ratio out and the effect on remittances to Congress? Can you be more specific on the numbers?

Mr. BERNANKE Certainly. So currently, as I have said, we have in the last 4 years, remitted $290 billion; we currently have more than $200 billion of unrealized capital gains on our balance sheet.  The capital issue is irrelevant. We have additional funding behind the capital. [That is, "we can print more dollars." He has. - FJS] We have $3 trillion of liabilities which are not callable liabilities, like cash, for example.

Mr. GARRETT. I guess I would just ask you if you could follow up on detail on that, because that is not the way I understand it, but I would ask you to put that in writing.

Mr. BERNANKE The main reality here is that if interest rates rise very quickly, then there may be a period where we don't pay any remittances at all to the Treasury. That is the actual outcome. That is important. Under most, and I would say virtually all scenarios, we will be sending remittances to the Treasury substantially higher than the norms established before the crisis.

Mr. GARRETT Since my time is limited, what we are looking at here is around $90 billion in remittances if-you said we could actually see that almost go down to eliminate it. Right now, we are trying to do a sequester at $85 billion. So it sort of puts us in perspective as to what the effect could be as far as your policies there. With regard to the positive indications that you have indicated, you said the stock market and the housing market have gone up because of your monetary policy, but previously you said that the Fed's monetary policy actions earlier this decade, in 2003-2005, did not contribute to the housing bubble in the United States. So which is it? Is monetary policy by the Fed not a cause of inflationary prices of housing, as you have said in the past, or is it a cause of inflating prices of housing? Can you have it both ways?

Mr. BERNANKE. Yes.

Mr. GARRETT. You can?

Mr. BERNANKE. Yeah, we can have it both ways, because they are different phenomena. The mortgage rate, um, uh, is a quantitative thing, so, house prices are going up a reasonable amount, given the strengthening of the housing market, given the strengthening of the economy, given where mortgage rates are. But the amount of movement in mortgage rates, mortgage rates in the early part of this, last decade were around 6 percent. That can't explain why house prices rose as much as they did. Maybe it was a small contribution, but it certainly can't explain the big run-up and then decline.

Mr. GARRETT. But, so now it is. [This was Garrett's dismissal of a man who had no idea what he was saying. - FJS]

So the other area you indicated why we should say your policies are working in a cost-benefit analysis is the stock market. I am sure you are familiar with Milton Friedman's work that says that people only really consume off of their permanent income, which basically means that you don't consume increased consumption because your stocks have gone up in the marketplace. And to that point, I know Mrs. Capito [Congresswoman Shelley Moore Capito, West Virginia, see below for Q&A - FJS] asked the question as to what seniors should do in this situation, and you said, take it out of some fixed assets and put it into the stock market. Heaven forbid that my 90-year-old mother would take her money out of fixed markets and put it in the stock market. I think that is probably the worst advice that is out there. And when you consider that a 1 percent increase in the stock market only has infinitesimal, maybe a 100 percent increase in GDP [sic], I really don't understand: a, how you can give that advice; b, how you can suggest that an increase in the stock market is a positive indicator of your work in a cost-benefit analysis to the rest of the economy.

Mr. BERNANKE. I was, I was not giving financial advice. I apologize if I gave that impression. I was just saying-

Mr. GARRETT. But she was asking you-

Mr. BERNANKE. -that generally-

Mr. GARRETT. She was asking you the question, what should you be doing to benefit the seniors, what should we say to the seniors. And your comments were-

Mr. BERNANKE. What I was saying was that the economy will get stronger because of good policies and that in turn will cause rates to rise in a sustainable way. If we were to raise rates prematurely, we would kill the recovery and rates would come down and we would have a long-term situation with very low rates.

Mr. GARRETT. But wouldn't you have provided for the certainty in the marketplace so you could have more price transparency? Earlier, you said that some risk-taking in the market is appropriate. That was one of your opening comments. Sure, risk-taking is appropriate, but it is appropriate when there is actual price discovery. When you have a market that is distorted, as it is right now by the Fed's monetary policy, you really don't have true price discovery. And so when you do risk-taking now, it is based upon I not really knowing what the appropriate value is of land prices, equity markets prices, so risk-taking now is worse than risk-taking is when the Fed's actions do not distort the marketplace. If you would say-

Chairman HENSARLING. The time of the gentleman has expired.

THE Q&A BETWEEN CONGRESSWOMAN SHELLEY MOORE CAPITO AND HIM:

MRS. CAPITO: Many of us are in that sandwich generation trying to help our parents, and our parents are doing a pretty good job trying to help themselves, but they're relying on their good planning and investments if they have been lucky enough to invest. And the dividend and interest availabilities to them are crushing our seniors as they see their healthcare costs go up. And some of the policies that you put forward I think, and that the Fed has, has caused concern for those of us who are concerned about seniors who don't have the ability to get another job, that's played out for them. What, what can I tell my seniors back home that is going to give them some optimism that they're going to be able to rely on that good planning that they had to carry them through the senior years?

HIM: Well I would say first that savers have many hats. They may own fixed income instruments like bonds, but they may also own stocks or a house or a business. All those other assets benefit when the economy strengthens and those values have gone up. The stock market is roughly doubled as you know in the past few years.

This was quite specific advice to Mrs. Capito. Besides crawling into Lucifer's den before answering Congressman Garrett, why is this nincompoop telling old people to buy stocks AFTER the stock market has doubled? We might give him the benefit of the doubt that, since Bernanke has banished "actual price discovery" in all markets, and thinks he can do so forever, he will double Mrs. Capito's money over the next few years.

Of course Chairman Bernanke is not the only lifetime bureaucrat to offer carpe diem financial advice.

Following is the good word of David Stockman, author of the masterpiece,  The Great Deformation: The Corruption of Capitalism in America . He was interviewed by Market Watch on April 3, 2013. Eric Rosengren is the President of the Boston Fed.

DAVID STOCKMAN: If you have your money in a 401(k) but you get it out of the stock market or ETFs or bond funds that have duration exposure, and you stay very liquid even if you're making almost no return, thanks to Ben Bernanke, who's crucifying the savers of America on a cross of ZIRP, at least you're safe. In the world ahead, there is such a huge collapse coming in the financial markets, the third one since 2000, it's better to preserve your capital, stay liquid, keep your head down, don't borrow money unless you absolutely have to. That is very discouraging because people would like to earn a return on their savings.

When we have this character Rosengren up in Boston saying, it's a good thing, we are trying to induce people to go into risk assets. Who in the hell is Rosengren to tell old ladies of America they have to buy junk bonds because the Fed tells them to!!!!! If the old ladies feel safer in a CD, they ought to be able to earn something besides dog food money on it. There is going to be a revolt against these arrogant mandarins running the Fed, they will rue the day they arrogated to themselves such massive power. [Italics are my irrational exuberance - FJS]

Knitting. Still Knitting.

 

David Boies v. Citizen Ben S. Bernanke

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)

           A splendid opportunity is in the offing, though it is premature to expect the earth to quake. As background, Hank Greenberg, former chairman of AIG, is suing the United States. The case itself is not the subject here. Starr International Company, in which Greenberg is housing his lawsuit, was the largest shareholder in AIG on September 16, 2008, the day when the U.S. government "seized control of AIG" (quoting from the September 17, 2008, Wall Street Journal).

            Federal Reserve Chairman Ben S. Bernanke played a central role in the seizure. He was subpoenaed to testify (in STARR INTERNATIONAL COMPANY, INC., v. UNITED STATES) on its behalf and on behalf of a class of others similarly situated plaintiffs.

            Bernanke ducked the deposition. The UNITED STATES (the Department of Justice) argued the "deposition would interfere with Mr. Bernanke's important duties in managing the nation's economy and fiscal policy." [My underlining - FJS]

Before returning to this jarring admission from America's National Socialist headquarters, Judge Thomas Wheeler's anger v. the UNITED STATES is offered as background.

A Bloomberg headline on May 17, 2013: "AIG Judge Asks if U.S. Scared Board from Starr Lawsuit." The curious judge was Thomas Wheeler, who expressed "concern" that the U.S. scared off American International Group from joining a lawsuit by Maurice "Hank" Greenberg, its former chairman, challenging the insurer's 2008 federal bailout." Wheeler had a "lingering concern" that a "request by AIG and the government to dismiss [Hank] Greenberg's lawsuit" was a product of the government "intimidating" the "AIG directors who took their seats during the bailout."  

Such a judge, glued athwartship v. the UNITED STATES' attempt to arrogate his courtroom, was unlikely to let the Federal Reserve chairman skip town. And he didn't. In the United States Court of Federal Claims, No. 11 - 779C (Filed: July 29, 2013), Judge Wheeler wrote: "The Court is persuaded that Mr. Bernanke is a key witness in this case, and that his testimony will be highly relevant to the issues presented. Because of Mr. Bernanke's personal involvement in the decision-making process to bail out AIG, it is improbable that Plaintiff would be able to obtain the same testimony or evidence from other persons or sources.... Indeed, the Court cannot fathom having to decide this multi-billion dollar claim without the testimony of such a key government decision-maker.... Defendant [the UNITED STATES' Department of Justice - FJS] contends that Plaintiff should be required to pursue other avenues of discovery first before seeking Mr. Bernanke's testimony. In its July 23, 2013 reply, Defendant also asserts that a deposition would interfere with Mr. Bernanke's important duties in managing the nation's economy and fiscal policy." [My underlining: Note "cannot fathom" - Judge Wheeler is ripping mad - FJS]

Defendant's motion for a protective order is DENIED.

                                                      IT IS SO ORDERED

                                          s/Thomas C. Wheeler

                                          THOMAS C. WHEELER

           

There is so much that is wrong with all of this: The Federal Reserve chairman, 1 - managing the economy and, 2 - running fiscal policy. Leaving aside his eternal bumbling, the Federal Reserve chairman is a bureaucrat with no authority to do either. Fiscal policy is for Congress. Bernanke should be planted in front of a congressional inquiry at this very moment, to explain himself. The Justice Department wrote the "too busy" plea to Judge Wheeler. Instead, it should read what it wrote and draw up charges against the Federal Reserve Chairman. Reading through Judge Wheeler's comments on May 17, 2013, and July 29, 2013, the Justice Department is guilty of obstructing Starr International's case against the UNITED STATES.

Why might that be? Probably because of the central charge: the UNITED STATES exceeded its authority by commandeering AIG without compensation to anyone. If the UNITED STATES is found guilty by the courts, it "should" (it is unwise to say "will" regarding legal decisions and precedent anymore) place restrictions on the government's gargantuan appetite for whatever it wants to control.

The UNITED STATES may also be attempting to preclude an open investigation that will show how Federal Reserve Chairman Ben S. Bernanke, Secretary of the Treasury Henry Paulson and New York Federal Reserve President Timothy Geithner mishandled the 2008 financial crisis. This is not a secret. Books by Sheila Bair and David Stockman, as well as the Financial Crisis Inquiry Report (by the FCIC) have already done so. Yet, the media continues to report how we "must thank Bernanke (or the others) for saving us from a nuclear winter." These advocates have avoided the evidence.

A segment of Bernanke's ignorance was discussed in "The Professor Who did NOT Save the World." In summary: "Those who held insurance policies with AIG or its subsidiaries never bore risk of non-payment."

Bernanke still had no understanding of AIG's structure a year later when he testified before the Financial Crisis Inquiry Commission. The professor did no homework. Lack of preparation by Bernanke is no longer even surprising. His various testimony is shot through with errors.

The FCIC transcript quotes Bernanke on page 28 and 29: "The reason AIG was set up the way it was originally, the financial products division ["Financial products division" was the profit center that sold CDS - FJS], which did the CDS, attached itself precisely because it was a large, highly-rated insurance company with lots of assets. Therefore it could sell CDS without what would otherwise be sufficient capitalization and protections because the counterparties would know that this was a highly rated firm with lots and lots of assets. It was precisely because of that reason when [AIG] financial products [division] had to sell - had to come up with the collateral - and was facing a run on its positions, that the Fed - that there existed the collateral, the assets that the Fed could lend against." [My italics - FJS]

This is all wrong.

The two dopes, that would be former Fed Chairman Greenspan and Bernanke, have never been cornered by the various Congressional and Senatorial Committees. Retired Congressman Ron Paul was a persistent irritant  to the Fed chairmen but he was not a lawyer and not equipped with a good court room attorney's ability to make mincemeat of a fumbling witness. Starr International Company is represented by David Boies, who, if he is at all worthy of his reputation, will twist Bernanke (presumably, he is also questioning Paulson and Geithner) into a pretzel of incomprehensibility. The favorable disposition of Judge Wheeler is wind at his back. Should Boies need any help in how to question the head of the Fed, please send him this way. 

Real and Illusory Credit

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)

 "When Ro-Ro goes No-No" expounded upon the ultimate futility of conjuring illusory wealth. Bernard Connolly's analysis, "Rethinking the Rogoff-Reinhoff Thesis," made the case. Connolly wrote This Time is Different: Eight Centuries of Financial Folly, "is largely an exercise in measurement rather than theory (while many of the data in the book are new, little or none of the theory is), it can give rise - and has given rise - to dangerously misleading popular interpretations of the data which its authors had so painstakingly assembled." Connolly then offered the theory; what follows is complementary data.

A cheat sheet: The annual increases in U.S. non-financial credit - 1995: $654 billion; 1997: $793 billion; 1998: $999 billion; 1999 $1.012 trillion; 2002: $1.429 trillion; 2004: $2.096 trillion; 2006: $2.388 trillion: 2007: $2.552 trillion. Between 1995 and 2007, non-financial credit in the U.S. inflated from $13.141 TN to $32.621 trillion, or 148%. (From the Prudent Bear "Credit Bubble Bulletin," May 3, 2013.

This is what Federal Reserve Chairman Ben S. Bernanke calls "The Great Moderation." He and his comrades have attempted to erase what we have learned since the dawn of time. We await their proclamation that the months have been changed to Vendemaire, Brumaire, and Frimaire. In the end, they cannot pin nature under their tommyrot research, that will decay to dry rot.    

The 1920s bubble is instructive. From David Stockman's The Great Deformation: The Corruption of Capitalism in America: "[T]he financial bubble was not just domestic. It began way back in 1914 when the 'guns of August' suddenly transformed the United States into the arsenal and granary of the world and an instant, giant global creditor."

America had been a debtor nation for 300 years. American citizens owed Europeans $3 billion in 1914; Europeans owed Americans $3 billion in 1919. The U.S. bustled with commercial activity before the War; Europe was in ruins after the peace. In the words of historian William E. Leuchtenburg: "These figures represent one of those great shifts in power that happens but rarely in the history of nations."

Stockman continues: "A crucial element of the postwar stabilization process, especially in central Europe and commodity-producing nations of Latin America, was the $10 billion of foreign loans underwritten by Wall Street. That was the equivalent of $1.5 trillion in today's economy, and went to borrowers ranging from the Kingdom of Denmark and German industrialists to municipalities from Hamburg to Rio de Janeiro."

Wall Street bond houses played a role not much different from the People's Bank of China in recent years (or Cisco and Intel during the Internet years). This was vendor financing: lending currency so that others would have the funds to buy the lenders' products. Foreigners, for the most part struggling or devastated by the Great War, received Wall Street funding to buy U.S. crops, cars, and radios. On the home front, booming foreign sales spurred capital investment, consumer spending, an unsustainable real-estate escapade, and, of course, the Crash That Made the Decade Famous, in stocks.

Credit flowed. The credit system had been nationalized during World War I, through the fortuitous creation of the Federal Reserve System. In outline, the Fed boosted credit through two initiatives.

First, it greatly reduced reserve requirements of the banks. The average reserve requirements of all banks prior to the Federal Reserve Act were estimated at 21.09%. By the 1920s, the Fed, having distinguished between demand and time deposits, had reduced the reserve ratio against demand deposits (to 7% - 13%) and against time deposits (to 3%).

Banks lent as one might expect. Demand deposits did not grow in the 1920s. Between 1921 and 1929, commercial loans - those loans for commerce and industry that fulfill the traditional function of banks - fell, from $12,844,000 to $12,814,000. Time-deposit lending, with lower reserve requirements, boomed. Real-estate speculation and securities lending were part-and-parcel to degenerate gambling propensities encouraged by Prohibition. Between 1921 and 1929, loans on securities rose from 19% to 28% of bank assets; loans on real estate rose from 3% to 8%. (Commercial loans fell from a 53% composition of all Federal Reserve member banks' balance sheets to 36%.)

Mortgage debt rose through the decade, from $8 billion in 1919 to $27 billion in 1929. The fastest acceleration in new mortgage debt was between 1924 and 1927 (even though construction peaked in 1926) when mortgage debt rose from $15.5 billion to $24.2 billion - a 57.4% rise, or, a 16.3% annual rise. (Not all of this was bank lending.) Are you paying attention Canada? (See "Time to Go Short: Here Come Those Experts Again." Yep, any minute now.

A second Fed initiative was open-market operations. Today, the Fed enters the market every day, fixing interest rates while electronically transferring dollars it has created. These are open-market operations. Benjamin Strong grew addicted to more and bigger open-market operations through the decade. (Don't they all?). He had initially opposed such personal intervention most vehemently: "What I can't understand is the willingness of thoughtful, studious men who presumably have been brought up in the spirit of American institutions and should be imbued with their principles, proposing a scheme to Congress which in effect delegates avowedly and consciously this vast power for price fixing to a small group of men who, in an economic sense, might come to be regarded as nothing short of a super-government. It is undemocratic, absolutely contrary to the spirit of America institutions, and so dangerous in its possible ultimate developments that I cannot see the slightest merits for its proposal."

Such shenanigans were not contemplated when the Federal Reserve System was rushed into law. Only "real bills" were accepted for rediscount. Government bonds need not apply. By 1927, Benjamin Strong was freelancing as America's super-government. Federal Reserve governor Adolph Miller testified to Strong's mad-scientist scheme in 1932: "[T]he Federal Reserve [put] money into the markets, not because member banks asked for it by offering paper for rediscount, but in pursuance of a policy of our own which in effect said, 'We shall not wait to be asked to provide increased money through rediscounts; we will operate upon our own responsibility....'"

Returning to Bernard Connolly's interpretation of This Time is Different, today's fantasy credit will crumble. It is backed by fanciful dreams, but not by money. James P. Warburg, a financial adviser to President Franklin Roosevelt who then became a fierce opponent of FDR's whimsical schemes, wrote in The Money Muddle (1934): "Credit cannot create money for capital investment. The credit machinery can only direct the flow of capital into productive investment, but the capital must be there - it must have been created, or be in the process of creation, by the savings out of incomes. Credit can, and frequently does, anticipate the creation of capital, but when it does, the capital it creates 'out of thin air' will again vanish into the air, if the anticipated savings do not materialize."

Rediscounted commercial bills are backed by trade or inventory. It's the real thing. Strong and Bernanke's bilge is backed by faith or absent-mindedness.

The populace at large was party to the imbalances. Between 1923 and 1929, worker's wages rose 11%, which did not keep pace with corporate profits (up 62%) and dividends (up 65%). Radio sales rose from $60 million to $852 million. Along with cars, vacuum cleaners, refrigerators, silk stockings and movie tickets (by 1918, the movie business was already one of the ten largest industries in America) there was a lot more money spent than earned.

How was all this purchased? "Installment" debt financed 75% of all radio purchases and 60% of all automobiles and furniture. [Margaret Mitchell wrote of 1926: "Everyone I knew had a car, a radio, an electric ice box and a baby that they were buying on time (everybody except me!)."] Over 40% of department store sales were purchased on credit by 1926. Margin loans blossomed in the second half of the decade. At $16 billion in October 1929, this source of instability equaled about 18% of stock market capitalization. Rising demand for credit raised borrowing rates.

Bank customers, both individuals and corporations, instructed banks to lend their deposits in the call-loan market. It has been estimated that corporations (including U.S. Steel, General Motors, AT&T, and Standard Oil of New Jersey) had lent $5 billion to New York Stock Exchange purchases by September 1929. They were drawn to the call-loan market as rates rose to 10%. In consequence, total securities loans increased from $12.4 billion on October 3, 1928 to $16.9 billion a year later. Foreign banks also lent in New York, while neglecting the local tool-and-die manufacturer in Linz or Pinsk or Omsk.

This has a modern ring to it. The Internet years. The mortgage scramble. And now, the central bankers' Disney dust. Assets far and near are bubbling. What will happen to inventory chains and their suppliers when those buying on time falter?

Reading the weekly list of international issuers in Doug Noland's Credit Bubble Bulletin could be interpreted as a shift of wealth from the west to the east or bubbleitus spread to countries with oddly distributed consonants.

A comparison:

Week of April 10, 2009:

"International debt issues this week included Korea $3.0bn, KFW $3,0bn, Suncorp $2.5bn, and Hutchinson Whampoa $1.5bn."

Week of April 26 2013:

"International issuers included African Development Bank $2.17bn, Boligkreditt $1.0bn, Costa Rica $1.0bn, Neder Waterschapsbank $900 million, Toronto Dominion Bank $2.25bn, Transport de Gas Peru $850 million, Schaeffler Finance $850 million, Panama $750 million, Turkiye Bankasi $750 million, Uralkali $650 million, Sinochem $600 million, Promsvyazbank $600 million, Saci Falabella $600 million, Andrade Gutier $500 million, Korea Resources $500 million, Credit Bank of Moscow $500 million, Far Eastern Shipping $500 million, Banco Sudameris $300 million and International Bank of Reconstruction & Development $250 million."

            After 1929, the phony credit evaporated. Stockman writes: "[T]he trouble was that this prosperity was neither organic nor sustainable. In addition to the debt-financed demand for American exports, stock market winnings and the explosion of consumer debt generated exuberant but unsustainable purchases of big-ticket durables at home. So, when the stock market finally broke, this financially fueled chain of economic explosion snapped and violently unwound.

            "The first victim was the foreign bond market, which was the subprime canary in the coal mine of its day. Within a few months of the crash, new issuance had dropped 95 percent from its peak 1928 levels, causing foreign demand for U.S. exports to collapse. Worse still the price of the nearly $10 billion of foreign bonds outstanding also soon plunged to less than ten cents on the dollar, meaning the collapse was of the same magnitude as the subprime mortgage collapse of 2008."

            The interlinking relationships of the economy were now collapsing in unison rather than inflating. Stockman continues: "Needless to say, [the] 75 percent shrinkage of auto sales cascaded through the auto supply chain, including metal working, steel, glass, rubber, and machine tools.... The collapse of these 'growth' industries also caused a withering cutback in business investment. Plant and equipment spending tumbled by nearly 80 percent between 1929 and 1933, while nearly half of all the production inventories extant in 1929 were liquidated over the next three years. The unprecedented liquidation of working inventories - from $38 billion to $22 billion - amounted to nearly a 20 percent hit to GDP before the cycle reached bottom.  

            "Overall, nominal GDP had been $103 billion in 1929 but by 1933 had shrunk to only $56 billion. Yet the overwhelming portion of this unprecedented contraction was in exports, inventories, fixed plant and equipment, and consumer durables. [Bernanke and Yellen claim open-market money printing in 1931 would have sparked an economic recovery. This is their foundation for quantitative easing. - FJS] These components declined by $33 billion during the four years after 1929 and accounted for fully 70 percent of the decline in nominal GDP."

            In this spirit, it is worth looking further into Bernard Connolly's critique of Rogoff-Reinhart's non-theory: "The underlying problem is dynamic inefficiency, which reduces future consumption possibilities; and this, in turn, means that much of the recent and current capital formation, notably in the United States, has been based on excessively optimistic expectations of future demand. To prevent a hole from emerging as today becomes tomorrow, more and more incentives to keep on bringing spending forward from the future have to be given, whether in the form of reduced 'risk-free' bond yields, or attempts to ease credit conditions, or fiscal 'stimulus." Such attempts "to bring spending forward and to avoid a near-term collapse simply reduce the (realistically) anticipated rate of return on capital still further, in a vicious downward spiral."

            In June 2012, the Federal Reserve released its Survey of Consumer Finances. It showed the wealth of American family was $77,000 in 1992, rose to $126,000 in 2007, and fell back to $77,000 in 2010. The Fed is responsible for this Ferris wheel. Quoting page 2 of Panderer to Power: "From the time Greenspan was named Federal Reserve chairman until he left office, the nation's debt rose from $10.8 trillion to $41.0 trillion. He usually referred to the "debt" as "wealth." This image matched what he was selling - first stocks, then houses. He expanded money and credit; he oozed praise for derivatives. The larger volume of credit shrunk the consequences of immediate losses. It was easy to overlook areas of the economy that had shriveled and the instability of finance that compounded over the past half-century. In early 2007, this massive inflation of paper claims, many of which were claims on abstractions rather than on material assets, tottered then collapsed: the first to go was the subprime mortgage market."

            On April 24, 2013, the Republic of Rwanda issued a $400 million, 10-year Eurobond with a yield of 6.875%. The issue attracted more than $3 billion, "allowing bankers to tighten the yield to just 6.875 per cent, comfortably below the 7 per cent to 7.5 per cent that had initially been expected." (Financial Times) Some potential buyers of this single-B issue were deterred because of its small size. Bonds below a $500 million limit are excluded from "influential" bond indices. Half of the foreign currency flowing into Rwanda last year came from foreign remittances. (Rwandans working abroad.) Ten percent of GDP is foreign aid.

            Except for the (suspect) higher coupon, the symmetrical return to Earth of the Rwandan bond issue will not differ much from 10-year U.S. Treasuries.

Speaking Up for Deformity

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

In a favorable review of David Stockman's The Great Deformation: The Corruption of Capitalism in America, a critic winds down with a sigh. Stockman's prescriptions are "blue sky" and will not be adopted by today's Washington.

            Of course they won't, but, since he generally agreed with Stockman's take, what does the commentator want? A friend opines the reviewer "is like a lot of people out there who understand economic orthodoxy and how far off course we are" and struggles to imagine "how we can maintain [our] collective standard of living."

            Such a course is impossible. Leaving aside how far living standards have already fallen, the economy and our process of thinking have become so deformed there is no way back without a shattering of such illusions and of living standards. The United States is one among most nations with accumulated imbalances of finance, trade, profits, jobs and non-jobs that have reached such distorted levels because of the post-1971, non-redeemable, paper-money, printing experiment. There is no precedent and there is no getting around the need for markets to clear.

            The insiders will pretend they are still in charge until the end. They started to lose control around 1985. It was still possible to redeem our foul misadventure at that juncture, painful as it would have been. Paul Volcker's unpopular medicine between 1979 and 1982 demoralized large sections of the United States, many pockets long since confused by the inflationary 1970s. The Reagan administration then started to appoint establishment economists to the Federal Reserve Board. At FOMC meetings, the votes of pliant economists made economics popular again. So doing, we are in the muck today.

            "A Quarrel in a Far-Away Country between People of Whom We Know Nothing," (March 21, 2013) was, of course, Prime Minster Joseph Chamberlain's comment surrounding Germany's invasion of Czechoslovakia in 1938. To expand: "How horrible, fantastic, incredible it is that we should be digging trenches and trying on gas-masks here because of a quarrel in a far-away country between people of whom we know nothing. It seems still more impossible that a quarrel that has already been settled in principle should be the subject of war."

            Taken alone, this statement rings true. (The "in principle" is quite a stretch.) The same could be said of Federal Reserve Chairman Ben S. Bernanke's many bizarre comments, which, on their own, are neither wrong nor interesting.

            In 1940, George Orwell wrote of World War II: "After 1936, of course, the thing was obvious to anyone except an idiot." In 1938, upon returning to England from continental Europe, Orwell had written about the "familiar streets, the posters telling of cricket matches and Royal weddings, the men in bowler hats, the pigeons in Trafalgar Square, the red busses, the blue policemen - all sleeping the deep, deep sleep of England, from which I sometimes fear that we shall never wake till we are jerked out of it by the roar of bombs." The bombs flattened London in 1940.

What Orwell wrote of the establishment figures in 1940 need not be changed to describe recent Presidents, Prime Ministers, Secretaries of the Treasury, Senate and Congressional Banking Committee members, unaccountable central bankers, other sordid, government bureaucrats, think tanks, professional-certification money-machines, tenured professors, and editorial boards: "They had to feel themselves true patriots, even while they plundered their countrymen. Clearly there was only one escape for them - into stupidity. They could keep society in its existing shape only by being unable to grasp that any improvement was necessary." (We might amend Orwell to account for the international loyalties of bean counters and bureaucrats rather than to their fellow countrymen.)

            Again, Orwell could have been writing about the litany of trusted leaders who have betrayed us: "What is to be expected of them is not treachery or physical cowardice, but stupidity, unconscious sabotage, an infalliable instinct for doing the wrong thing. They are not wicked, or not altogether wicked; they are merely unteachable. Only when their money and power are gone will the younger among them begin to grasp what century they are living in."

            The Great Deformation: The Corruption of Capitalism in America names names and describes the atrocious position the U.S. finds itself in today. It is pure Bernankeism to wish (or believe) we can maintain our standard of living without redemption many magnitudes beyond the severity of that which could have sufficed in 1985.

In 1933, Winston Churchill wrote to a colleague who accused him of being old fashioned: "I think we differ principally in that you assume the future is a mere extension of the past whereas I find history full of unexpected turns and retrogressions. The mild and vague liberalism of the early twentieth century, the surge of fantastic hopes and illusions that followed the armistice of the Great War have already been superceded by a violent reaction against Parliamentary and election procedure by the establishment of dictatorships real or veiled in almost every country. Moreover the loss of our external connections, the shrinkage of our foreign trade and shipping brings the surplus population of Britain within measurable distance of utter ruin. We are entering a period when the struggle for self-preservation is going to present itself with great intenseness to thickly populated industrial countries. In my view, England is now beginning the period of struggle and fighting for its life.... Your ideas are twenty years behind the times."

Martin Gilbert, author of the book in which this letter is published, then writes: "The times were indeed moving rapidly; on April 7, [1933],Hitler formally imposed Nazi rule on each of the German states, ending their century-old autonomy."

Churchill's influence was muffled through the decade. The Baldwin and Chamberlain governments held him at a distance, John Reith of the BBC kept him off the air, and Geoffrey Dawson, editor of the Times, suppressed his warnings. He was nearing 60 and who wanted to listen to this windbag anyway? It was easy to dismiss him as a has-been. In 1935, no doubt creating more distance between himself and the cabinet, Churchill warned the House of Commons: "[W]hen the situation was manageable it was neglected, and now that it is thoroughly out of hand we apply too late the remedies which then might have affected a cure. There is nothing new in this story. It is as old as the sibylline books. It falls into that long, dismal catalogue of the fruitlessness of experience and the confirmed unteachability of mankind. Want of foresight, unwillingness to act when action would be simple and effective, lack of clear thinking, confusion of counsel until the emergency comes, until self-preservation strikes its jarring gong - these are the features which constitute the endless repetition of history."

Kicking off National Poetry Month, this morning's Wall Street Journal (April 1, 2013), published excerpts from W.H. Auden's "September 1, 1939," the day Germany invaded Poland. It starts:

I sit in one of the dives

On Fifty-second Street

Uncertain and afraid

As the clever hopes expire

Of a low dishonest decade:

Waves of anger and fear

Circulate over the bright

And darkened lands of the earth,

Obsessing our private lives;

The unmentionable odour of death

Offends the September night.

Orwell and Churchill make for compelling reading today because they looked into the future, understood it, and warned the public despite indifference or hostility.

Among the investment managers who saw the mortgage meltdown well in advance was Paul Singer, general partner of the hedge fund, Elliot Associates. In 2006, Singer made a presentation at the fall Grant's Interest Rate Observer Conference. A majority of those present probably anticipated the housing crash, but Singer understood the form it would take. Having dug through tranches of highly sought CDOs, Singer showed that, in one example, and given certain assumptions, a 4% fall in housing prices would wipe out 84% of the principal. His presentation astonished some of the long-time, mortgage-bears present.

Singer spoke again at the April 2012 Grant's Interest Rate Observer Conference. His financial prognosis is consistent with Stockman's dim view of the economy in The Great Deformation. Singer told his audience there is one big difference between next time and the last time, the last time being that in which money-losing tranches in CDOs caught such worthies as Standard & Poor's and the banks sound asleep. This time, the "guarantors of last resort" in 2007-2009 - sovereign governments and their willing accomplices - are under suspicion: "So at some point in this process of impaired growth, restive underemployed populations being egged on by politicians who get points and votes by riling people up against others, and investors inability to earn a return on savings," said Singer - "at some point, investors, Arab revolt-style en masse, may say quietly to themselves, but perhaps at a crystallizing moment: 'Enough.'"