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.

From the Greenspan Put to the Kohn Put: Our Brilliant Central Bankers

Federal Reserve Vice Chairman Donald Kohn announced his retirement on March 1, 2010. In his obligatory lament, Federal Reserve Chairman Ben S. Bernanke was half right: "The Federal Reserve and the country owe a tremendous debt of gratitude to Don Kohn." What is good for the Fed is generally not good for the country. The influence of Donald Kohn supports this view.

A rarity, Kohn rose through the ranks of the Federal Reserve System. After 32 years of grunt work, he was named a Federal Reserve governor in 2002 and assigned the vice chairmanship in 2006. He participated in Federal Reserve Open Market Committee (FOMC) meetings long before his governorship. He had been a staff economist (Director of Monetary Affairs) and Secretary at FOMC meetings.

Donald Kohn will be smothered in praise from now until his June retirement. The media will quote celebrity economists who will deify the celebrity vice chairman. Alan Greenspan was "the greatest central banker who ever lived," according to former Federal Reserve Vice Chairman Alan Blinder at a 2005 conference. These farewell hosannas are necessarily vague and meaningless, as was the March 6, 2010, appraisal of Kohn in the Economist: "Mr. Kohn is widely considered one of the most experienced and thoughtful central bankers in the world." Given the worldwide failure of central bankers, this may well be true, so a critique of Kohn's brilliance is necessarily specific.

October 15, 1998: Fanning the Greenspan Put

The FOMC held a conference call on October 15, 1998. This remains the most infamous FOMC discussion on record. It was held shortly after Wall Street paid over $3 billion to bail out Long-Term Capital Management (LTCM), a hedge fund. The Nasdaq Composite Index fell 20% from mid-July to mid-October. It had boomed for the past three-and-one-half years (a 160% return), but the Fed decided a hiatus would not do.

In the wake of the conference call, the Fed announced a surprise rate cut at 3:14 p.m. The bond market had already closed for the day, stock-option contracts expired the next day, and investors panicked. A frenzy of buying pushed the S&P 500 futures up 5% in five minutes. The Nasdaq Composite rose from 1,540 on October 14, 1998 to 4,069 on December 31, 1999.

Donald Kohn's contribution, as Secretary of the FOMC, was to announce at the meeting's conclusion: "We are not constrained by the practice followed after regularly scheduled FOMC meetings where the release time is set for 2:15 p.m. We will try to move through the process of preparing the press release as rapidly as possible."

It was after this surprise rate cut that the "Greenspan Put" came into common use. A put option is bought by investors to limit losses when the market falls. Now, instead of buying protection, the Greenspan Put inspired such confidence that speculators replicated the borrowing and leveraging of LTCM. Kohn's faux pas, if that is what it was, served the interests of the Fed but not those of the American people. Around $5 trillion was lost by investors after the Greenspan Stock-Market Put failed in 2000.

Joining the Inflation Targeting Team

The Fed's deflation team was beefed up on August 5, 2002. Both Ben Bernanke and Donald Kohn were appointed as Fed governors, and to the FOMC. Bernanke had devoted his adulthood to inflationary economics. His book, which he wrote with three other economists, Inflation Targeting: Lessons from the International Experience made clear that an economy should always be inflating.

At Bernanke's first FOMC meeting (August 13, 2002), it was the other newcomer, Donald Kohn who sounded as if he was reading from Bernanke's book: "I don't see a zero real rate as a natural bound for monetary policy." He not only was unconcerned about real rates below zero, Kohn stated the opposite case: [I]nflation is already as low as I would like to see it go." He intimated that real rates were already below zero (when inflation exceeds the borrowing rate), and stated a desire for even lower real rates.

This was an about face. At the May 2002, Donald Kohn, speaking as a staff economist, had warned the committee it would soon need to address a fed funds rate hike from "its currently unsustainably low level." He also told the FOMC the fed funds rate "will have to be tightened at some point to forestall increasing inflationary pressures."

Donald Kohn has been an asset inflator since his coming out party at the August 2002 meeting. Although (the current) Chairman Bernanke has led the charge against deflation at all costs, Donald Kohn has been a loyal sidekick.

The FOMC had started cutting the fed funds rate in 2001 and did so until 2003, when it stopped at 1.0%. There are few precedents to a 1.0% borrowing rate. When we sift through the wreckage in future years, the zero-percent school will deserve a healthy portion of the blame.

"[H]ouseholds Have Bought More and Larger Houses and Cars, Have Taken on More Debt..."

Ignorance will not be an excuse. Donald Kohn knew what he was doing. After the Greenspan Stock-Market Put had failed, the FOMC instituted the Greenspan Home-Equity, Cash-Out Put. On April 1, 2004, Kohn spoke at Widener College in Chester, Pennsylvania. He opened by reminding his audience of the gratitude it owed the Federal Reserve: "Starting in January of 2001, the Federal Reserve moved to counter [the weak economy] by lowering the funds rate.... This prompt and aggressive action undoubtedly served to limit the decline in economic activity, and, in fact, the recent recession was one of the mildest on record." Attendees among the cohort that had lost the $5 trillion may not have appreciated this P.R. stunt.

Kohn acknowledged there were dissenters to the Fed's current 1.0% fed funds rate: "[S]ome observers have been calling for the Federal Reserve to begin the tightening process sooner rather than later." They were concerned "that the Federal Reserve, by keeping the funds rate so low and signaling that it is likely to stay low for a while, is sowing the seeds for different kinds of future problems. In particular, these critics worry that a continued environment of low interest rates is giving rise to economic imbalances - excessive indebtedness, and elevated prices of houses, equities, and bonds - that in the longer run will come back to haunt us."

Since the financial meltdown, the Fed has recited from its handbook: "No one saw it coming." The credit crash in 2007 had been widely anticipated and in all its severity. The question was not "if," but "when." The media quotes the Fed without correction, and so, Ben Bernanke was recently awarded another term as chairman.

Kohn dismissed concerns before the Pennsylvania college audience: "[H]ouseholds have bought more and larger houses and cars, have taken on more debt, and generally have spent more than would have been the case if interest rates had been higher.... [T]hese developments... are by-and-large the intended and logical consequences of the Federal Reserve's efforts to reduce economic slack through low interest rates."

Should there be credit "adjustments", Kohn assured his audience: "Commercial banks remain highly profitable and well capitalized...." They were only well capitalized as long as they remained highly profitable.

Of course, Kohn praised the Fed's regulatory vigilance: "Banking supervisors at the Federal Reserve, for example, in the course of the ongoing examination process, have been paying close attention to the sorts of vulnerabilities we have reviewed and have been discussing these risks with the commercial banks they oversee."

Regulation: "It's a Very Hard Sell to the Banks."

On March 4, 2008, Vice Chairman Kohn testified before the Senate Banking Committee about the "Condition of the U.S. Banking System." He made an honest admission: "I don't know that we fully appreciated all the risks out there." He also made a self-serving claim: "I'm not sure anybody did, to be perfectly honest."

Kohn was among the slow minded. In October 2007, Kohn had predicted that once "we get through the near-term weakness caused by the extra downleg from the housing contraction and any spillover from tighter credit conditions, I am looking for moderate growth with high levels of employment."

At the March 2008 hearing, Kohn acknowledged that banks had not priced certain risks appropriately, but "It's a very hard sell to the banks." Senator Richard Shelby, a member of the committee, was not amused: "It's a hard sell to the banks, yes, but you are the supervisor of all the bank holding companies, and you are also the central bank.... So you have not just a little bit of power, but a lot of power." Shelby asked Kohn if the Fed "was afraid of the banks they regulate." Kohn responded in the negative. If this was true, a classroom of rookie bank tellers would have done - and would do - a better job supervising the banks.

Donald Kohn was talking through his hat on September 9, 2009. Again, selling the virtues of the Fed, he claimed the Fed's myriad bailouts (not his description) over the past year had followed the "precepts derived from the work of Walter Bagehot [author of Lombard Street, a central-banking blueprint from Queen Victoria's time.] Those precepts hold that central banks can and should ameliorate financial crises by providing ample credit to a wide set of borrowers, as long as the borrowers are solvent, the loans are provided against good collateral, and a penalty rate is charged." [Italics added]

Bagehot's precepts were stated correctly but Fed practices contradicted the Victorian author. Kohn betrayed a complete ignorance of what the Fed was doing. Kohn and Company had provided loans against collateral that was so damaged it was necessary for the Fed to buy it from the banks and hide it from the public on its own books. We still do not know what the Fed bought and this is probably the main reason the central bank is resisting an audit. As for charging a "penalty rate," the Fed has charged a negative real rate of interest (below the rate of inflation). A double-digit interest rate would meet Bagehot's requirement.

The Kohn Put: Inducing "Savers to Diversify into Riskier Assets"

This past fall, the Kohn Put was announced. Maybe because he was speaking to the choir - at a Federal Reserve conference - he explicitly stated the Fed's grand plan. "[R]ecently the improvement, in risk appetites and financial conditions, in part responding to actions by the Federal Reserve and other authorities, has been a critical factor in allowing the economy to begin to move higher after a very deep recession.... Low market interest rates should continue to induce savers to diversify into riskier assets, which would contribute to a further reversal in the flight to liquidity and safety that has characterized the past few years."

In other words, the Federal Reserve is attempting to rescue itself as it did in 1998 and in 2002. Afraid the LTCM failure would cause financial institutions to freeze, the October 15 Greenspan Put inflated confidence and the stock market. In 2002, Federal Reserve governors, in speech after speech, terrorized Americans into believing it had to lift prices or the United States would suffer another Great Depression. This was the rationale for the 1% fed funds rate, the means by which the Fed inflated another asset bubble, the mortgage market, to compensate for its earlier mistake. And now, with the housing market and economy in despair, Kohn has announced the Fed's zero percent interest-rate policy will induce savers into the stock market and the already inflated municipal and federal government bond markets.

Presidential adviser Larry Summers and Secretary of the Treasury Tim Geithner are leading the search for Donald Kohn's replacement. We can be sure this pair of insiders will identify a candidate who will serve the Federal Reserve first and the American people last.