Frederick 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).
“Miami's tradition of unruly official behavior is finally bringing painful consequences. After years of reckless financial management and a bribery scandal that produced federal charges against three top city officials, South Florida's largest city stands on the edge of bankruptcy.”
-Time, December 16, 1996, “Gloom Over Miami”
The odor from low tides is often strongest near mud flats. Credit bubbles are similarly disposed. During the high tide of the telecom boom, Global Crossing and WorldCom borrowed with abandon. When revenues did not rise to cover borrowing costs, their lamentable accounting practices smelled like a clam digger’s paradise.
The municipal borrowing boom of the past decade is no different. States and municipalities borrowed $137 billion in 2003 and $215 billion in 2007. This scramble in itself was enough to cause concern. These were flush times. Tax receipts by states and local governments rose from $975 billion in 2003 to $1,304 trillion in 2007. (See The Coming Collapse of the Municipal Bond Market in the Articles section of the Aucontrarian.com website for details.) Municipalities were borrowing at record levels when taxes were producing a flood tide of revenues.
This indicates mismanagement on a broad scale. The municipal bond holder might look at the telecommunications boom for similarities. The great telecom scramble in the 1990s ended after the millennium in a bad stench of bankruptcy, fraud, prison terms and the demise of one accounting firm (Arthur Anderson) that abetted these scandals.
Gary Winnick founded Global Crossing in 1997. He had no technology background. Winnick watched a video to learn how to lay cable. He was a good enough salesman (having developed his techniques with Michael Milken at the latter’s famous x-shaped trading desk at Drexel, Burnham, Lambert) to raise billions of dollars. He intended to build 71,000 miles of undersea, high-speed, fiber-optic cable, linking 159 cities in 19 countries and able to reach 85% of the world’s telecom market. According to Forbes magazine, Winnick made a billion dollars – for himself – in 18 months. Global Crossing filed for bankruptcy in 2002.
Bernie Ebbers was chosen as WorldCom’s CEO in 1985. The company was called Long Distance Discount Services, Inc. (LDDS), with headquarters in Hattiesburg, Mississippi. Ebbers was not much of a technology whiz either. At his trial in 2005, Ebbers told the courtroom: "I don't know technology and engineering. I don't know accounting.”
Ebbers spent money faster than he could raise it (a trait of soon-to-be-busted municipalities). An abbreviated list of the WorldCom family is a short tour through the 1990s. It bought Advanced Communications Corp. (1992), Metromedia Communication Corporation (1993), IDB Communications Group, Inc (1994), Williams Technology Group, Inc. (1995), MFS Communications Company (1996), UUNet Technologies, Inc., (1996), CompuServe (1997), and then the largest combination in U.S. corporate history ($37 billion) when it merged with MCI in 1997. It became the United States’ second biggest long distance telephone company (after AT&T).
WorldCom filed for bankruptcy in 2002. It is probably of little solace to investors that Ebbers is serving a 25-year jail term. Arthur Anderson, its accounting firm, a pillar of American corporate respectability, dismissed its 28,000 employees in 2002 as revelations of accounting fraud at WorldCom, Global Crossing, and Enron ruined the century-old company’s credibility.
The high tide of municipal finance is retreating. Occasional whiffs of the mud flats are drifting ashore. The Securities and Exchange Corporation (SEC) is probing the City of Miami’s “major bond offerings between 2006 and 2009 and questionable financial transfers to balance the budget.”
Continuing with the Miami Herald’s summary, the hometown newspaper reminded readers of its own investigation in July 2009 that unearthed “the root causes of an emerging financial meltdown [that] focused on a series of questionable money transfers from capital-project accounts to the general fund.”
Many bond investors rely upon rating agency evaluations. Given the agencies’ recent follies, there is already a degree of risk linked to this approach. (Many fund managers who bought WorldCom stock relied on the rating agencies and on Wall Street “buy” recommendations.) The Miami Herald ratchets up the risk profile: “[T]he SEC is exploring whether the city misrepresented its true financial condition when [the agencies examined the city’s books before the city] went to market to float bonds for major projects.”
The regrettable behavior has its precedents. In 1996, Miami suffered a fiscal crisis when the city “tried to hide a $68 million shortfall by shifting money between hundreds of capital accounts.” In January 2010, “Miami leaders are already projecting a $45 million budget shortfall this year that could force the city to deplete its reserves and sell key assets to stay afloat.” (Miami Herald, January 31, 2010)
This shell game seems to be in the municipal handbook. In When America Aged, Roger Lowenstein described the City of San Diego’s accounting manipulations in the mid-1990s. They were orchestrated by city manager Jack McCrery: “He moved expenses around, shifted personnel, offset one account against another. A favorite McCrery tactic was to charge the water or sewer departments for laying pipes under city streets, which effectively transferred costs from the general fund to water and sewer (which had the power to assess fees). [City of San Diego] council members complained they didn’t understand his machinations, that he never explained the budget… but the truth was they were happier not knowing what McCrery was up to.”
This happy ignorance is by no means a preserve of municipal fiduciaries. The Ebbers’ defense (“I don't know accounting”) will be a common excuse when state and city finances unravel. Recently, the star-studded and highly compensated Citigroup board was not familiar with SIVs or CDOs when it mattered, and sat by as Citi’s stock fell over 95% between 2007 and 2009.
If all goes well, municipal bond holders receive 4% non-taxable interest payments. It might be worth foregoing this coupon income until the tide starts to rise again. Zero percent (in Bernanke-starved money market funds) is better than a 20% loss.
Friday, February 19, 2010
Thursday, February 11, 2010
Alan Greenspan: Party Boy
Frederick 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).
“It's important to remember that equity values, stock prices, are not just paper profits. They actually have a profoundly important impact on economic activity. And if stock prices start continuing down, I would get very concerned.”
-Former Federal Reserve Chairman Alan Greenspan, Meet the Press, February 7, 2010
Alan Greenspan is as confused in retirement as when he ran the Fed. Most mortals, quoted as often as Greenspan, would justifiably worry such contradictions of past contentions would ricochet around the media. Vice President Dan Quayle made front page news when he misspelled “potato.” This is the sort of trivial mistake the media can grasp, or, all it thinks its audience can understand.
Alan Greenspan’s about-face on the Fed’s capacity to battle stock market bubbles cost investors several trillion dollars, yet he remains a fixture on the Washington party circuit (Fortune, February 5, 2010). He can say whatever comes into his head since he is still feted by those who matter. He talks on Meet the Press (where he was deferentially addressed as “Dr. Greenspan”) and collects large fees as a dinner speaker.
Like Ted Williams’ head, Alan Greenspan’s reputation is frozen. The skull of the baseball great (Williams) was set in ice when he died. It is to come alive a century from now (or, something equally peculiar is promised). Likewise, Alan Greenspan’s foibles have been frozen into a series of clichés designed to leave the party circuit undisturbed.
The former chairman’s battered legacy actually flatters the man: his errors were “idealistic.” So, have another drink, Alan. We’re all idealistic in Washington. (Ayn Rand asked a half-century back: “Do you think Alan might basically be a social climber?”)
The banks take the blame. They deserve it, but financial firms are more a symptom than a source. The bank cliché is convenient for both politicians and the most malignant contributor to our national woes, the Federal Reserve.
Worse though, than the money lost in the stock market debacle, is the lost decade (and counting). After the stock market burst, Chairman Greenspan attempted to reflate the economy with his one-percent, adjustable-rate mortgage bubble. The consequences need no comment.
The most scandalous aspect of Greenspan’s declaration on Meet the Press last weekend is not that he denied the link between the stock market and the economy when he was Fed chairman (in 1999). Far worse is that long before 1999, he had consistently emphasized the link. His contortions can be seen in a three-act sequence:
Act #1: When Greenspan knew a plunging stock market could sink an economy.
December 28, 1959, in the New York Times, Alan Greenspan explained “that a break in stock market trends was not just a harbinger of boom or recession, as is commonly held, but a crucial factor in causing a boom or a recession.”
March 1959, in Fortune magazine: “[O]ver-confidence finds exuberant expression in a bull stock market…. Once stock prices reach the point at which it is hard to value them by any logical methodology, [Greenspan] warns, stocks will be bought, as they were in the late-1920’s – not for investment but to be unloaded at a still higher price. The ensuing break could be disastrous.”
March 28, 1995, at a Federal Reserve Open Market Committee (FOMC) meeting – GREENSPAN: “I think the downside risks [to the economy] are basically coming from the possibility of significant increases in stock and bond prices…..Ironically, the real danger is that things may get too good. When things get too good, human beings behave awfully."
STAGE NOTE: By 1996, fears were rising of a stock market bubble. The Wall Street Journal wrote on November 25, 1996: “Federal Reserve Board Chairman Greenspan isn't talking about the stock market these days. In fact, the word among Fed officials is: don't use the word ‘stock’ and ‘market’ in the same sentence. No one wants the blame for the crash.”
Greenspan gave his famous “irrational exuberance” speech (regarding the stock market) on December 5, 1996. He testified before Congress and the Senate in early 1997, warning both bodies (in his way) of the stock market bubble. The congressmen and the senators told him to mind his own business. He never discussed the bubble again in public, and even forbid the FOMC from talking about it in 1998.
Greenspan then hid in his own bubble.
Act #2: Greenspan couldn’t see bubbles and they might not matter anyway.
It was on June 17, 1999, that the Federal Reserve chairman unveiled his thesis: that the Federal Reserve could not identify a bubble ahead of time and it would therefore make no attempt to do so. This was entirely new and near the peak of the greatest stock market bubble of all time.
(FLASHBACK – FOMC meeting on September 24, 1996 – GREENSPAN: “I recognize that there is a stock market bubble problem at this point....We do have the possibility of raising major concerns by increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it.”)
In his June 1999 testimony before Congress, he told Congress don’t worry, be happy:
“While bubbles that burst are scarcely benign, the consequences need not be catastrophic for the economy…. while the stock market crash of 1929 was destabilizing, most analysts attribute the Great Depression to ensuing failures of policy.” (Note: Greenspan had never before attributed the Depression to ensuing policy failures. For instance, see his interview with Fortune above).
The chairman’s contention became known as The Greenspan Doctrine in the media and among so-called economists. With little rebuttal, he contributed addenda to his Doctrine, such as in 2002, when he added a footnote to a speech in Jackson Hole, Wyoming. Discussing the aftermath of the 1987 stock-market crash: “[I]n line with later episodes, the failure of the collapse to have an economic impact seems to have contributed to subsequent higher stock prices.” According to this wrinkle, stock market crashes are good for stock prices. (The footnotes to Federal Reserve governor speeches contain amazing contentions.)
Act #3: Greenspan warns stock market bubbles can cripple an economy.
SETTING: Alan Greenspan retired from the Federal Reserve in early 2006. Among other post-retirement warnings that the stock market and the economy are Siamese twins:
Interview with Reuters, September 30, 2007: "[U]nless stock prices resume their pace of increase of earlier this year, U.S. consumer spending and GDP will be under pressure from declining household wealth."
Again, Meet the Press, February 7, 2010: “It's important to remember that equity values, stock prices, are not just paper profits. They actually have a profoundly important impact on economic activity. And if stock prices start continuing down, I would get very concerned.”
Why is he still on TV?
Whether it is appropriate to invite Greenspan on television is for the media to decide. More of a muddle is why he still attracts an audience. He is as consistently wrong as during his Fed chairmanship.
In October 2006, Greenspan claimed: “Most of the negatives in housing are probably behind us. It's taking less out of the economy."
On February 7, 2010, he told Meet the Press: “I don’t think [home prices will] decline from here. In other words, they seem to be bottoming out.”
On the same day, he also told Meet the Press: “The recession is over.”
Look out below.
Frederick Sheehan writes a blog at Aucontrarian.com
“It's important to remember that equity values, stock prices, are not just paper profits. They actually have a profoundly important impact on economic activity. And if stock prices start continuing down, I would get very concerned.”
-Former Federal Reserve Chairman Alan Greenspan, Meet the Press, February 7, 2010
Alan Greenspan is as confused in retirement as when he ran the Fed. Most mortals, quoted as often as Greenspan, would justifiably worry such contradictions of past contentions would ricochet around the media. Vice President Dan Quayle made front page news when he misspelled “potato.” This is the sort of trivial mistake the media can grasp, or, all it thinks its audience can understand.
Alan Greenspan’s about-face on the Fed’s capacity to battle stock market bubbles cost investors several trillion dollars, yet he remains a fixture on the Washington party circuit (Fortune, February 5, 2010). He can say whatever comes into his head since he is still feted by those who matter. He talks on Meet the Press (where he was deferentially addressed as “Dr. Greenspan”) and collects large fees as a dinner speaker.
Like Ted Williams’ head, Alan Greenspan’s reputation is frozen. The skull of the baseball great (Williams) was set in ice when he died. It is to come alive a century from now (or, something equally peculiar is promised). Likewise, Alan Greenspan’s foibles have been frozen into a series of clichés designed to leave the party circuit undisturbed.
The former chairman’s battered legacy actually flatters the man: his errors were “idealistic.” So, have another drink, Alan. We’re all idealistic in Washington. (Ayn Rand asked a half-century back: “Do you think Alan might basically be a social climber?”)
The banks take the blame. They deserve it, but financial firms are more a symptom than a source. The bank cliché is convenient for both politicians and the most malignant contributor to our national woes, the Federal Reserve.
Worse though, than the money lost in the stock market debacle, is the lost decade (and counting). After the stock market burst, Chairman Greenspan attempted to reflate the economy with his one-percent, adjustable-rate mortgage bubble. The consequences need no comment.
The most scandalous aspect of Greenspan’s declaration on Meet the Press last weekend is not that he denied the link between the stock market and the economy when he was Fed chairman (in 1999). Far worse is that long before 1999, he had consistently emphasized the link. His contortions can be seen in a three-act sequence:
Act #1: When Greenspan knew a plunging stock market could sink an economy.
December 28, 1959, in the New York Times, Alan Greenspan explained “that a break in stock market trends was not just a harbinger of boom or recession, as is commonly held, but a crucial factor in causing a boom or a recession.”
March 1959, in Fortune magazine: “[O]ver-confidence finds exuberant expression in a bull stock market…. Once stock prices reach the point at which it is hard to value them by any logical methodology, [Greenspan] warns, stocks will be bought, as they were in the late-1920’s – not for investment but to be unloaded at a still higher price. The ensuing break could be disastrous.”
March 28, 1995, at a Federal Reserve Open Market Committee (FOMC) meeting – GREENSPAN: “I think the downside risks [to the economy] are basically coming from the possibility of significant increases in stock and bond prices…..Ironically, the real danger is that things may get too good. When things get too good, human beings behave awfully."
STAGE NOTE: By 1996, fears were rising of a stock market bubble. The Wall Street Journal wrote on November 25, 1996: “Federal Reserve Board Chairman Greenspan isn't talking about the stock market these days. In fact, the word among Fed officials is: don't use the word ‘stock’ and ‘market’ in the same sentence. No one wants the blame for the crash.”
Greenspan gave his famous “irrational exuberance” speech (regarding the stock market) on December 5, 1996. He testified before Congress and the Senate in early 1997, warning both bodies (in his way) of the stock market bubble. The congressmen and the senators told him to mind his own business. He never discussed the bubble again in public, and even forbid the FOMC from talking about it in 1998.
Greenspan then hid in his own bubble.
Act #2: Greenspan couldn’t see bubbles and they might not matter anyway.
It was on June 17, 1999, that the Federal Reserve chairman unveiled his thesis: that the Federal Reserve could not identify a bubble ahead of time and it would therefore make no attempt to do so. This was entirely new and near the peak of the greatest stock market bubble of all time.
(FLASHBACK – FOMC meeting on September 24, 1996 – GREENSPAN: “I recognize that there is a stock market bubble problem at this point....We do have the possibility of raising major concerns by increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it.”)
In his June 1999 testimony before Congress, he told Congress don’t worry, be happy:
“While bubbles that burst are scarcely benign, the consequences need not be catastrophic for the economy…. while the stock market crash of 1929 was destabilizing, most analysts attribute the Great Depression to ensuing failures of policy.” (Note: Greenspan had never before attributed the Depression to ensuing policy failures. For instance, see his interview with Fortune above).
The chairman’s contention became known as The Greenspan Doctrine in the media and among so-called economists. With little rebuttal, he contributed addenda to his Doctrine, such as in 2002, when he added a footnote to a speech in Jackson Hole, Wyoming. Discussing the aftermath of the 1987 stock-market crash: “[I]n line with later episodes, the failure of the collapse to have an economic impact seems to have contributed to subsequent higher stock prices.” According to this wrinkle, stock market crashes are good for stock prices. (The footnotes to Federal Reserve governor speeches contain amazing contentions.)
Act #3: Greenspan warns stock market bubbles can cripple an economy.
SETTING: Alan Greenspan retired from the Federal Reserve in early 2006. Among other post-retirement warnings that the stock market and the economy are Siamese twins:
Interview with Reuters, September 30, 2007: "[U]nless stock prices resume their pace of increase of earlier this year, U.S. consumer spending and GDP will be under pressure from declining household wealth."
Again, Meet the Press, February 7, 2010: “It's important to remember that equity values, stock prices, are not just paper profits. They actually have a profoundly important impact on economic activity. And if stock prices start continuing down, I would get very concerned.”
Why is he still on TV?
Whether it is appropriate to invite Greenspan on television is for the media to decide. More of a muddle is why he still attracts an audience. He is as consistently wrong as during his Fed chairmanship.
In October 2006, Greenspan claimed: “Most of the negatives in housing are probably behind us. It's taking less out of the economy."
On February 7, 2010, he told Meet the Press: “I don’t think [home prices will] decline from here. In other words, they seem to be bottoming out.”
On the same day, he also told Meet the Press: “The recession is over.”
Look out below.
Frederick Sheehan writes a blog at Aucontrarian.com
Friday, February 5, 2010
Ben Bernanke: The Very Model of a Modern Pliant Bureaucrat
Frederick 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).
Federal Reserve Chairman Ben S. Bernanke was a safe bet to win the Senate’s vote for a second term. “Safe” is what the senators want and Bernanke passed the test. He is not a man inclined to make bold decisions. A former university administrator, his institutional mind will be just as slow to foresee the next financial crisis as it was incapable of forecasting the last.
Despite obvious signs the financial system was about to burst, Congress had no desire to touch Fannie Mae, Freddie Mac, and the banks’ expanding mortgage securitization machine (i.e., derivatives), that made Washington and Wall Street so rich.
Having replaced Alan Greenspan as chairman on February 1, 2006, Bernanke performed according to script. He dismissed the worrywarts. In June 2006, Chairman Bernanke told an International Monetary Fund (IMF) gathering: “[O]ur banks are well capitalized and willing to lend.” In the same month, he stamped his imprimatur on the most destitute sector of the economy: “U.S. households overall have been managing their personal finances well.” In November 2006, he calmed fears about subprime lending. Before an audience promoting community development, Bernanke celebrated the rise of subprime mortgages: from only 5 percent of the market in 1995, 20 percent of new mortgage loans were subprime by 2005. (He did advise “greater financial literacy” for “borrowers with lower incomes and education levels.”)
In May 2007, Chairman Bernanke gave an appraisal one expects from a short-sighted bureaucrat: “[W]e believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”
Bernanke’s specialty is organization. Filing subprime mortgages into a manila folder appealed to the chairman’s tidy mind. John Cassidy discussed Bernanke’s strength in the New Yorker: “In 1996, Bernanke became chairman of the Princeton economics department, a job many professors regard as a dull administrative diversion from their real work. Bernanke, however, embraced the chairmanship…. [Bernanke] bridged a long-standing departmental divide between theorists and applied researchers….” A colleague explained Bernanke’s considerable skill: “Ben is very good at… giving people the feeling they have been heard in the debate….”
Bernanke gives senators the same feeling (with some admirable exceptions, who know Bernanke’s cordial and vague representations are a variant on his predecessor’s, Alan Greenspan). The IMF did not want to hear America’s banks were undercapitalized. The community developers did not want to know subprime lending was an odious racket that was bound to topple. The nation’s most revered economist assured audiences that all was fine.
On December 3, 2009, the Senate Banking Committee held a reconfirmation hearing (prior to the full Senate voting on Bernanke’s second term). The Fed chairman was given great credit for leading the nation through the recent financial crisis. Committee members congratulated Chairman Bernanke for his brilliant restoration of the U.S. financial system.
He was reprimanded, however, for not anticipating the crisis and expressed requisite contrition. Bernanke thought banks should have held more capital and that the banking system had not employed adequate risk management controls. Committee members nodded in solemn agreement.
In truth, the too-big-to-fail banks are bigger, more unstable, and even more undercapitalized than before the bubble burst in 2007. As for risk management tools, Bernanke is full of talk but has done nothing to restrain either the growth of derivatives or to require reserves be held against derivative exposure.
At the December 3 hearing, the Fed chairman stated that he did not see any asset bubbles emerging. This seemed to reassure the senators who ignored the fatuity of even asking his opinion given that he thought banks were well-capitalized in 2006 and did not see the housing bubble.
As night follows day, Bernanke ignores a signal akin to one the derivative markets offered ahead of the 2007 meltdown. Then, there were wide expectations of loan defaults. Investors hedged this risk in the credit-default swap (CDS) market. The CDS market grew from $14 trillion to $42 trillion from January 2006 to June 30, 2007. Any line of business growing at such a rate should alarm bank regulators.
Ben Bernanke, the nation’s leading bank regulator, did not understand that banks could not honor trillions of dollars of claims once the defaults occurred. It was the CDS market that left Bear, Stearns; Lehman Brothers; Goldman, Sachs; and AIG either insolvent or close to it.
Today, galloping derivative growth has moved to interest-rate protection. The fear is of a government bond bubble. Ten-year Treasury bonds yield 3.7% during the greatest money-printing experiment in the nation’s history. Investment managers are protecting themselves against a higher 10-year Treasury yield. (With interest-rate derivative contracts, banks will have to pay the purchasers if rates rise to a specified level.)
During the first six months of 2009, the volume of contracts offering protection against rising yields of Treasury bonds with maturities of 5 years or longer rose from $109 trillion to $150 trillion. When rates rise, banks may once again default on their commitments.
Bernanke aims to please. He told the senators in December 2009 a reevaluation of his zero-percent fed funds rate “will require careful analysis and judgment.” The chairman will raise the rate “in a smooth and timely way.” This paralysis to action fits the stereotype of a municipal data-entry clerk. Bernanke certified his tremulous loyalty when he told an audience on November 16: “It is inherently extraordinarily difficult to know whether an asset’s price is in line with its fundamental value…. It’s not obvious to me in any case that there’s any large misalignments currently in the U.S. financial system.”
Only an apparatchik could believe an economy with zero-percent interest rates is in balance. The purchasers of interest-rate protection (which is not cheap) believe differently, but Ben Bernanke is the man for the Senate. The chairman’s mandate for his second term is to ignore the obvious, deflect attention from the megabanks’ inherent instability, and to accept blame for his ignorance after the deluge.
Frederick Sheehan writes a blog at Aucontrarian.com.
Listen to interviews with Frederick Sheehan:
1 - Thursday, February 4, 4:30 – 5 PM EST, on Bloomberg radio with Pimm Fox on his show Taking Stock
2 - Saturday, February 6 with Jim Puplava at Financial Sense. The one hour interview will be posted at 3 PM EST: http://www.financialsense.com/fsn/main.php
3 - Sunday, February 7, 10 -11 AM EST, with Jim Campbell on Yale University radio WYBC – 1340 AM and streaming live at WYBC.com. Simulcast on Yale’s Internet channel: WYBCX.com
Federal Reserve Chairman Ben S. Bernanke was a safe bet to win the Senate’s vote for a second term. “Safe” is what the senators want and Bernanke passed the test. He is not a man inclined to make bold decisions. A former university administrator, his institutional mind will be just as slow to foresee the next financial crisis as it was incapable of forecasting the last.
Despite obvious signs the financial system was about to burst, Congress had no desire to touch Fannie Mae, Freddie Mac, and the banks’ expanding mortgage securitization machine (i.e., derivatives), that made Washington and Wall Street so rich.
Having replaced Alan Greenspan as chairman on February 1, 2006, Bernanke performed according to script. He dismissed the worrywarts. In June 2006, Chairman Bernanke told an International Monetary Fund (IMF) gathering: “[O]ur banks are well capitalized and willing to lend.” In the same month, he stamped his imprimatur on the most destitute sector of the economy: “U.S. households overall have been managing their personal finances well.” In November 2006, he calmed fears about subprime lending. Before an audience promoting community development, Bernanke celebrated the rise of subprime mortgages: from only 5 percent of the market in 1995, 20 percent of new mortgage loans were subprime by 2005. (He did advise “greater financial literacy” for “borrowers with lower incomes and education levels.”)
In May 2007, Chairman Bernanke gave an appraisal one expects from a short-sighted bureaucrat: “[W]e believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”
Bernanke’s specialty is organization. Filing subprime mortgages into a manila folder appealed to the chairman’s tidy mind. John Cassidy discussed Bernanke’s strength in the New Yorker: “In 1996, Bernanke became chairman of the Princeton economics department, a job many professors regard as a dull administrative diversion from their real work. Bernanke, however, embraced the chairmanship…. [Bernanke] bridged a long-standing departmental divide between theorists and applied researchers….” A colleague explained Bernanke’s considerable skill: “Ben is very good at… giving people the feeling they have been heard in the debate….”
Bernanke gives senators the same feeling (with some admirable exceptions, who know Bernanke’s cordial and vague representations are a variant on his predecessor’s, Alan Greenspan). The IMF did not want to hear America’s banks were undercapitalized. The community developers did not want to know subprime lending was an odious racket that was bound to topple. The nation’s most revered economist assured audiences that all was fine.
On December 3, 2009, the Senate Banking Committee held a reconfirmation hearing (prior to the full Senate voting on Bernanke’s second term). The Fed chairman was given great credit for leading the nation through the recent financial crisis. Committee members congratulated Chairman Bernanke for his brilliant restoration of the U.S. financial system.
He was reprimanded, however, for not anticipating the crisis and expressed requisite contrition. Bernanke thought banks should have held more capital and that the banking system had not employed adequate risk management controls. Committee members nodded in solemn agreement.
In truth, the too-big-to-fail banks are bigger, more unstable, and even more undercapitalized than before the bubble burst in 2007. As for risk management tools, Bernanke is full of talk but has done nothing to restrain either the growth of derivatives or to require reserves be held against derivative exposure.
At the December 3 hearing, the Fed chairman stated that he did not see any asset bubbles emerging. This seemed to reassure the senators who ignored the fatuity of even asking his opinion given that he thought banks were well-capitalized in 2006 and did not see the housing bubble.
As night follows day, Bernanke ignores a signal akin to one the derivative markets offered ahead of the 2007 meltdown. Then, there were wide expectations of loan defaults. Investors hedged this risk in the credit-default swap (CDS) market. The CDS market grew from $14 trillion to $42 trillion from January 2006 to June 30, 2007. Any line of business growing at such a rate should alarm bank regulators.
Ben Bernanke, the nation’s leading bank regulator, did not understand that banks could not honor trillions of dollars of claims once the defaults occurred. It was the CDS market that left Bear, Stearns; Lehman Brothers; Goldman, Sachs; and AIG either insolvent or close to it.
Today, galloping derivative growth has moved to interest-rate protection. The fear is of a government bond bubble. Ten-year Treasury bonds yield 3.7% during the greatest money-printing experiment in the nation’s history. Investment managers are protecting themselves against a higher 10-year Treasury yield. (With interest-rate derivative contracts, banks will have to pay the purchasers if rates rise to a specified level.)
During the first six months of 2009, the volume of contracts offering protection against rising yields of Treasury bonds with maturities of 5 years or longer rose from $109 trillion to $150 trillion. When rates rise, banks may once again default on their commitments.
Bernanke aims to please. He told the senators in December 2009 a reevaluation of his zero-percent fed funds rate “will require careful analysis and judgment.” The chairman will raise the rate “in a smooth and timely way.” This paralysis to action fits the stereotype of a municipal data-entry clerk. Bernanke certified his tremulous loyalty when he told an audience on November 16: “It is inherently extraordinarily difficult to know whether an asset’s price is in line with its fundamental value…. It’s not obvious to me in any case that there’s any large misalignments currently in the U.S. financial system.”
Only an apparatchik could believe an economy with zero-percent interest rates is in balance. The purchasers of interest-rate protection (which is not cheap) believe differently, but Ben Bernanke is the man for the Senate. The chairman’s mandate for his second term is to ignore the obvious, deflect attention from the megabanks’ inherent instability, and to accept blame for his ignorance after the deluge.
Frederick Sheehan writes a blog at Aucontrarian.com.
Listen to interviews with Frederick Sheehan:
1 - Thursday, February 4, 4:30 – 5 PM EST, on Bloomberg radio with Pimm Fox on his show Taking Stock
2 - Saturday, February 6 with Jim Puplava at Financial Sense. The one hour interview will be posted at 3 PM EST: http://www.financialsense.com/fsn/main.php
3 - Sunday, February 7, 10 -11 AM EST, with Jim Campbell on Yale University radio WYBC – 1340 AM and streaming live at WYBC.com. Simulcast on Yale’s Internet channel: WYBCX.com
Monday, January 25, 2010
Municipal Meltdown: Teacher Pensions, Bondholder Coupons, Go to Court
"While the Illinois Constitution protects vested pension benefits, that promise, like all the state's obligations, is only as good as its ability to pay."
-Crain's Chicago Business
"Illinois Enters a State of Insolvency" cried a January 18, 2010 headline from Crain's Chicago Business: "As Illinois' fiscal crisis deepens, the word 'bankruptcy' is creeping more and more into the public discourse."
Illinois' lack of discipline is no surprise; it is in the vanguard of the spendthrift states. Revenues are falling and expenses are rising.
The Land of Lincoln, without authority to print greenbacks, is in arrears. Over $5 billion of state bills were unpaid at the end of 2009. Over $1.4 billion in Medicaid claims have not been processed. More than $2.25 billion in short-term financing is coming due. Crain's continued: "State employees, even legislators, are forced to pay their medical bills upfront because some doctors are tired of waiting to be paid by the state."
There is a good chance several states will face a similar predicament in 2010. On January 15, CNNMoney quoted a college professor: "It is surprising that political leaders don't seem to take seriously the magnitude of the problems."
Maybe it is not surprising. Most states are required to balance their budgets each year, but this is often accomplished with a good deal of hokum. For instance, states borrow in the bond market to tide themselves over, then ignore bond covenants and slip funds raised to build highways into the operating budget.
The Obama administration's fiscal stimulus is an additional means to delay the inevitable. Illinois received a 22% pay raise from the federal government as a beneficiary of the stimulus bill. Legislators probably assume, if worse comes to worse, they can go back to the Federal government.
A good part of the country makes this assumption, including too-big-to-fail banks, retired municipal workers and municipal bondholders. Most experts will discount warnings of financial forfeiture. Experts are recognized as such because they say what their audience wants to hear. Americans should discount the experts.
On January 13, the U.S. Treasury Department released an updated Monthly Treasury Statement for December 2009. Scrolling down to Table 3, estimated revenues for the fiscal year (which ends September 30, 2010) are $2.2 trillion. Budget outlays are expected to be $3.7 trillion. This is the type of financial rectitude practiced by President Mugabe in Zimbabwe.
The $1.5 trillion deficit for the current fiscal year needs to be funded, but the market for Treasury securities has a limit, certainly if it expects to sell securities at 3.7% (the current yield on a 10-year Treasury bond). If the U.S. dollar is to avoid Zimbabwe's predicament, where the annual inflation rate passed 200-million-percent some time ago, the negligent states will be told to solve their own troubles.
This will leave many people in a fix, including public sector retirees. It has long been assumed by most government workers, particularly those in unions, that their pensions are guaranteed. This is not true. Every state has legal recourse. (See page 9 of "The Coming Collapse of the Municipal Bond Market" on my website, AuContrarian.com).
Crain's may be one of the first to contemplate the fragility of these benefits: "The sharp rise in pension payments is the biggest factor pushing Illinois toward what a legislative task force last November called "a 'tipping point' beyond which it will be impossible to reverse the fiscal slide into bankruptcy."
Crain's quotes a "little-noticed report" produced by a legislative task force that addressed the state's pension problems. The report-that-nobody-wanted-to-read claimed: "the radical cost-cutting and huge tax increases necessary to pay all the deferred costs from the past would become so large that many businesses and individuals would be driven out of Illinois, thereby magnifying the vicious cycle of contracting state services, increasing taxes, and loss of the state's tax base."
Crain's goes on to explain the problem of a destitute state, legal claims not withstanding: "While the Illinois Constitution protects vested pension benefits, that promise, like all the state's obligations, is only as good as its ability to pay." [My italics.]
Americans are not used to limits. There is always a solution to a problem. Most often, ignoring it, then borrowing and spending more has worked. (Illinois has borrowed to meet contributions for worker pensions. Other states have done the same.) Today, dollars to pay the legally binding benefits are growing scarce. Crain's quotes a Chicago research organization: "All the obligations of the state, whether vested or not, will be competing for funding with the other essential responsibilities of state government. Even vested pension rights are jeopardized when a government is insolvent." [My italics.]
Bondholders, high-school teachers, university professors (and students), day-care directors and building contractors should take precautions now to ensure their last dollar is not negotiated in a court room.
Frederick 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, November 2009).
-Crain's Chicago Business
"Illinois Enters a State of Insolvency" cried a January 18, 2010 headline from Crain's Chicago Business: "As Illinois' fiscal crisis deepens, the word 'bankruptcy' is creeping more and more into the public discourse."
Illinois' lack of discipline is no surprise; it is in the vanguard of the spendthrift states. Revenues are falling and expenses are rising.
The Land of Lincoln, without authority to print greenbacks, is in arrears. Over $5 billion of state bills were unpaid at the end of 2009. Over $1.4 billion in Medicaid claims have not been processed. More than $2.25 billion in short-term financing is coming due. Crain's continued: "State employees, even legislators, are forced to pay their medical bills upfront because some doctors are tired of waiting to be paid by the state."
There is a good chance several states will face a similar predicament in 2010. On January 15, CNNMoney quoted a college professor: "It is surprising that political leaders don't seem to take seriously the magnitude of the problems."
Maybe it is not surprising. Most states are required to balance their budgets each year, but this is often accomplished with a good deal of hokum. For instance, states borrow in the bond market to tide themselves over, then ignore bond covenants and slip funds raised to build highways into the operating budget.
The Obama administration's fiscal stimulus is an additional means to delay the inevitable. Illinois received a 22% pay raise from the federal government as a beneficiary of the stimulus bill. Legislators probably assume, if worse comes to worse, they can go back to the Federal government.
A good part of the country makes this assumption, including too-big-to-fail banks, retired municipal workers and municipal bondholders. Most experts will discount warnings of financial forfeiture. Experts are recognized as such because they say what their audience wants to hear. Americans should discount the experts.
On January 13, the U.S. Treasury Department released an updated Monthly Treasury Statement for December 2009. Scrolling down to Table 3, estimated revenues for the fiscal year (which ends September 30, 2010) are $2.2 trillion. Budget outlays are expected to be $3.7 trillion. This is the type of financial rectitude practiced by President Mugabe in Zimbabwe.
The $1.5 trillion deficit for the current fiscal year needs to be funded, but the market for Treasury securities has a limit, certainly if it expects to sell securities at 3.7% (the current yield on a 10-year Treasury bond). If the U.S. dollar is to avoid Zimbabwe's predicament, where the annual inflation rate passed 200-million-percent some time ago, the negligent states will be told to solve their own troubles.
This will leave many people in a fix, including public sector retirees. It has long been assumed by most government workers, particularly those in unions, that their pensions are guaranteed. This is not true. Every state has legal recourse. (See page 9 of "The Coming Collapse of the Municipal Bond Market" on my website, AuContrarian.com).
Crain's may be one of the first to contemplate the fragility of these benefits: "The sharp rise in pension payments is the biggest factor pushing Illinois toward what a legislative task force last November called "a 'tipping point' beyond which it will be impossible to reverse the fiscal slide into bankruptcy."
Crain's quotes a "little-noticed report" produced by a legislative task force that addressed the state's pension problems. The report-that-nobody-wanted-to-read claimed: "the radical cost-cutting and huge tax increases necessary to pay all the deferred costs from the past would become so large that many businesses and individuals would be driven out of Illinois, thereby magnifying the vicious cycle of contracting state services, increasing taxes, and loss of the state's tax base."
Crain's goes on to explain the problem of a destitute state, legal claims not withstanding: "While the Illinois Constitution protects vested pension benefits, that promise, like all the state's obligations, is only as good as its ability to pay." [My italics.]
Americans are not used to limits. There is always a solution to a problem. Most often, ignoring it, then borrowing and spending more has worked. (Illinois has borrowed to meet contributions for worker pensions. Other states have done the same.) Today, dollars to pay the legally binding benefits are growing scarce. Crain's quotes a Chicago research organization: "All the obligations of the state, whether vested or not, will be competing for funding with the other essential responsibilities of state government. Even vested pension rights are jeopardized when a government is insolvent." [My italics.]
Bondholders, high-school teachers, university professors (and students), day-care directors and building contractors should take precautions now to ensure their last dollar is not negotiated in a court room.
Frederick 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, November 2009).
Monday, January 18, 2010
Economists Serving their Political Masters
On January 14, 2010, an academic economist took a rare stance. Tenured professors rarely lift the veil from numbers that governments invent. In “Don’t Like the Numbers? Change ‘Em,” Michael J. Boskin, Ph.D., formerly, an economics professor at Harvard and Yale; formerly, chairman of the Counsel of Economic Advisers in the George H.W. Bush administration; currently, T. M. Friedman Professor of Economics at Stanford University; research associate at the National Bureau of Economic Research; senior fellow at the Hoover Institution; and board member of the Exxon Mobil Corporation, Oracle Corporation and Vodafone PLC (among others), wielded his sword.
The Wall Street Journal devoted a half page to Boskin’s list of offenders. Politicians are interfering with the Gross Domestic Product calculations in France and Venezuela. They have toyed with the inflation rate in Argentina. In the U.S., the Obama administration has taken the phony numbers game “to a new level.” Here, Boskin is writing of the current adminstration’s calculations of jobs “created or saved” from its stimulus bill.
The “created or saved” job calculation is nonsense, but the very last person one would expect to decry the miscarriages is Michael J. Boskin.
In the early 1990s, Senator Patrick Moynihan from New York warned his fellow legislators about rising social security commitments. Then the worm crawled out of his hole, so to speak. Federal Reserve Chairman Alan Greenspan testified before the Senate and House Budget Committee on January 10, 1995. He told the Committee the inflation rate was probably overestimated by 0.5% to 1.5%.
If Greenspan was correct, this was a godsend. Social security payments are increased each year at an inflation rate calculated by the federal government: the change in the Consumer Price Index (CPI). If the CPI could be increased at a lower rate in the future, benefits would rise more slowly, without Congressional action. This would reduce government spending and delight politicians, who knew of the looming crisis in social security but did not want to imperil their careers by reducing benefits, or, in this case, by cutting the rate at which social security benefits were raised each year.
The Boskin Commission was duly formed. Michael Boskin was the right man for the job. He had served as chairman of the President's Council of Economic Advisers (CEA) from 1989 to 1993, a post previously held by such government functionaries as Arthur Burns and Alan Greenspan.
Jumping to the conclusion, the Boskin Commission, as it was known (formally, the "Advisory Commission to Study the Consumer Price Index") found that inflation was overstated by 1.1%. Several recommendations were made by the Commission to the Budget Committee. These were instituted with great efficiency by the Bureau of Labor Statistics.
The changes have lopped off far more than 1.1% in most years since 1997. From the time the changes were instituted through 2008, the compounding of an artificially low Consumer Price Index reduced payments to social security recipients by about half (according to John Williams, author of the newsletter Shadow Government Statistics).
How the CPI calculation was changed is not important here. (Chapter 12 of my book Panderer to Power is devoted to the Boskin Commission.) One adjustment may help to understand Boskin’s contribution to the impoverishment of older Americans. “Hedonic adjustments” by government number crunchers substitute imaginary prices for prices actually paid. Hedonic adjustments (purportedly, the “quality improvement” of an item) reduce the CPI. (Hedonic adjustments had been employed before the Boskin Commission, but sparingly. Afterwards, even the prices of textbooks – if they had color graphics – were adjusted for quality.)
Steve Leuthold, founder and chief investment officer of the Leuthold Group, calculated the price of a new car in the U.S. had risen from $6,847 in 1979 to $27,940 in 2004. Using hedonic adjustments, the government calculated the price of a new car had risen from $6,847 in 1979 to $11,708 in 2004.
The Boskin Commission was one scandal that economists actually denounced. Greg Mankiw, chairman of George W. Bush’s Council of Economic Advisers from 2001-2003, said at the time “the debate about the CPI was really a political debate about how, and by how much, to cut real entitlements.”
Barry Bosworth of the Brookings Institute called the revised CPI an “ ‘immaculate conception’ version of deficit reduction in which spending is cut without Congress taking the blame.”
Jack Triplett of the Brookings Institute extended the argument: “What I liked least about the Commission Report was exactly what made it so influential – its guesstimate of 1.1 percentage points of bias….The Commission (and others that have followed) used ad hoc reasoning to come up with a number….”
Jacob Ryten, from the Canadian statistical office, wrote in the same vein: “Without the guesstimates, the Commission Report was just another dry, academic study to be perused by professionals…Conversations with Committee members suggest that some, at least, were ill at ease themselves with guesstimates….My personal preference is to resist the seductive blandishments of politics and politicians….”
Jack Triplett chided the Report as succumbing “to the lure of political statements in its choice of language to describe the effect of CPI measurement errors on Social Security expenditures…. Professionals at any rate, should understand that improving the accuracy of the CPI is not the same thing as improving the basis for allocation to the dependent population….”
Professionals, at any rate, have seen fit to keep Michael Boskin at the summit after he succumbed to “seductive blandishments of politics and politicians.” It cannot be said that Boskin dishonored his profession, since he is still a superstar. Other professions institute bodies such as the American Bar Association and the American Medical Association that take action against negligence.
Federal Reserve Chairman Ben S. Bernanke, another pliant alumnus of the CEA, sits before the Senate claiming there is no inflation in the economy. He uses the CPI as his measure, taking the additional step of removing food and energy costs.
Near the end of his Wall Street Journal effort, Boskin wrote of the Obama job numbers: “One piece of good news: The public isn’t believing much of this out-of-control spin.” He’s probably correct, but spinning the number of jobs “created or saved” has no consequence, other than to increase the public’s distrust of government. The distortion of the CPI should have been censured by his profession, if it is that.
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) His blog is at AuContrarian.com
The Wall Street Journal devoted a half page to Boskin’s list of offenders. Politicians are interfering with the Gross Domestic Product calculations in France and Venezuela. They have toyed with the inflation rate in Argentina. In the U.S., the Obama administration has taken the phony numbers game “to a new level.” Here, Boskin is writing of the current adminstration’s calculations of jobs “created or saved” from its stimulus bill.
The “created or saved” job calculation is nonsense, but the very last person one would expect to decry the miscarriages is Michael J. Boskin.
In the early 1990s, Senator Patrick Moynihan from New York warned his fellow legislators about rising social security commitments. Then the worm crawled out of his hole, so to speak. Federal Reserve Chairman Alan Greenspan testified before the Senate and House Budget Committee on January 10, 1995. He told the Committee the inflation rate was probably overestimated by 0.5% to 1.5%.
If Greenspan was correct, this was a godsend. Social security payments are increased each year at an inflation rate calculated by the federal government: the change in the Consumer Price Index (CPI). If the CPI could be increased at a lower rate in the future, benefits would rise more slowly, without Congressional action. This would reduce government spending and delight politicians, who knew of the looming crisis in social security but did not want to imperil their careers by reducing benefits, or, in this case, by cutting the rate at which social security benefits were raised each year.
The Boskin Commission was duly formed. Michael Boskin was the right man for the job. He had served as chairman of the President's Council of Economic Advisers (CEA) from 1989 to 1993, a post previously held by such government functionaries as Arthur Burns and Alan Greenspan.
Jumping to the conclusion, the Boskin Commission, as it was known (formally, the "Advisory Commission to Study the Consumer Price Index") found that inflation was overstated by 1.1%. Several recommendations were made by the Commission to the Budget Committee. These were instituted with great efficiency by the Bureau of Labor Statistics.
The changes have lopped off far more than 1.1% in most years since 1997. From the time the changes were instituted through 2008, the compounding of an artificially low Consumer Price Index reduced payments to social security recipients by about half (according to John Williams, author of the newsletter Shadow Government Statistics).
How the CPI calculation was changed is not important here. (Chapter 12 of my book Panderer to Power is devoted to the Boskin Commission.) One adjustment may help to understand Boskin’s contribution to the impoverishment of older Americans. “Hedonic adjustments” by government number crunchers substitute imaginary prices for prices actually paid. Hedonic adjustments (purportedly, the “quality improvement” of an item) reduce the CPI. (Hedonic adjustments had been employed before the Boskin Commission, but sparingly. Afterwards, even the prices of textbooks – if they had color graphics – were adjusted for quality.)
Steve Leuthold, founder and chief investment officer of the Leuthold Group, calculated the price of a new car in the U.S. had risen from $6,847 in 1979 to $27,940 in 2004. Using hedonic adjustments, the government calculated the price of a new car had risen from $6,847 in 1979 to $11,708 in 2004.
The Boskin Commission was one scandal that economists actually denounced. Greg Mankiw, chairman of George W. Bush’s Council of Economic Advisers from 2001-2003, said at the time “the debate about the CPI was really a political debate about how, and by how much, to cut real entitlements.”
Barry Bosworth of the Brookings Institute called the revised CPI an “ ‘immaculate conception’ version of deficit reduction in which spending is cut without Congress taking the blame.”
Jack Triplett of the Brookings Institute extended the argument: “What I liked least about the Commission Report was exactly what made it so influential – its guesstimate of 1.1 percentage points of bias….The Commission (and others that have followed) used ad hoc reasoning to come up with a number….”
Jacob Ryten, from the Canadian statistical office, wrote in the same vein: “Without the guesstimates, the Commission Report was just another dry, academic study to be perused by professionals…Conversations with Committee members suggest that some, at least, were ill at ease themselves with guesstimates….My personal preference is to resist the seductive blandishments of politics and politicians….”
Jack Triplett chided the Report as succumbing “to the lure of political statements in its choice of language to describe the effect of CPI measurement errors on Social Security expenditures…. Professionals at any rate, should understand that improving the accuracy of the CPI is not the same thing as improving the basis for allocation to the dependent population….”
Professionals, at any rate, have seen fit to keep Michael Boskin at the summit after he succumbed to “seductive blandishments of politics and politicians.” It cannot be said that Boskin dishonored his profession, since he is still a superstar. Other professions institute bodies such as the American Bar Association and the American Medical Association that take action against negligence.
Federal Reserve Chairman Ben S. Bernanke, another pliant alumnus of the CEA, sits before the Senate claiming there is no inflation in the economy. He uses the CPI as his measure, taking the additional step of removing food and energy costs.
Near the end of his Wall Street Journal effort, Boskin wrote of the Obama job numbers: “One piece of good news: The public isn’t believing much of this out-of-control spin.” He’s probably correct, but spinning the number of jobs “created or saved” has no consequence, other than to increase the public’s distrust of government. The distortion of the CPI should have been censured by his profession, if it is that.
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) His blog is at AuContrarian.com
Friday, January 15, 2010
Groveling at the Fed: Greenspan and Bernanke
Groveling at the Fed: Greenspan and Bernanke
Federal Reserve Chairman Ben S. Bernanke gave a speech on January 3, 2010 that was incomprehensible. The address itself will be discussed later. It is important first to consider the precedent of Federal Reserve chairmen making absurd claims – and getting away with it.
A place to start is Alan Greenspan’s 2002 speech in Jackson Hole, Wyoming. The then Federal Reserve chairman explained that central banks could not identify bubbles because “only history books and musty archives gave us clues to the appropriate stance for the policy.” There are several problems with this excuse, not to mention his even less credible fiddle-faddle. More important though, is that the chairman’s address was disseminated with very little opposition along channels of communication. Economists cheered or remained silent. With a few notable exceptions, the media reported Greenspan’s speech as if it was a press release, which it was.
More up-to-date is Alan Greenspan’s appearance before Congress in October 2008. He had left the Fed in January 2006. In 2008, he testified about his contribution to the worldwide financial meltdown.
Greenspan was “shocked” to find a “flaw” in his “ideology.” He discussed his model that impugned “40 years or more of considerable evidence.” His model miscalculated the “self-interest of lending institutions” that he believed protected shareholder interests. Greenspan explained his naiveté was the reason he had not regulated banks properly.
Greenspan’s mistake was so often repeated that it acquired an official status. There are (at least) three official bodies that profit from this hallucination. First, the politicians. Since the Federal Reserve is the nation’s leading bank regulator, the politicians who inflated the credit bubble (e.g, through Fannie Mae, Freddie Mac, Countrywide Credit, banks that securitized mortgages, the National Association of Homebuilders) have not been held to account. The politicians are free to toy with petty financial regulation, while Fannie, Freddie and lethal derivatives are compounding as before.
The second body is the Federal Reserve. In a more mature world, after such a display of catastrophic incompetence, the Fed would be disbanded. Instead, since Greenspan’s mistake was due to his model’s flaw (not a fault of the former Federal Reserve chairman) and because bankers’ standards of integrity fell so far below Greenspan’s impeccable conduct that he could not comprehend such behavior, the Federal Reserve has been handed a parking ticket.
The third body is Alan Greenspan. He has been exempted from his responsibility for the ongoing liquidation of America. The former chairman has received blame, but still receives accolades. Greenspan continues to speak for large fees. His prophecies are still quoted across the media and the recently endowed Alan Greenspan Chair in Economics at New York University demonstrate that groveling can get you anywhere.
Greenspan has remained relatively unscathed because he is still useful. In this case, to the politicians and every economist who is using Greenspan’s error to promote more regulation. There will be many opportunities for both politicians and economists to get rich from new legislation.
Alan Greenspan’s self-proclaimed “ideology” is essential to his innocence, to the Fed’s exemption from failure and to the politicians’ fevered attempts to separate themselves from responsibility. Despite the incessant noise about Greenspan’s ideology, he never had one. He’s never even had an idea.
The publicity is of a man who acquired his free-market ideology sitting at the feet of Ayn Rand. This is reported over and over by the media. He didn’t know what Rand was talking about.
Nathaniel Brandon, Rand’s number one acolyte in the 1950s and also the Randian closest to Greenspan, wrote years later: “Now, looking at [Alan], I wondered to what extent he was aware of Ayn’s opinions.” Complimenting Ayn on some passage, Greenspan might say, “On reading this…one tends to feel…exhilarated.” Platitudes and assurances also mesmerized the nation 50 years later.
Today, for the media to suggest Greenspan did not operate from a free-market ideology would throw open the question of why Greenspan blew up the banking and credit systems. It would introduce the possibility that he was prone to act as the large financial institutions would like him to act. It would also reveal the extent to which he – and Bernanke – say what politicians want them to say.
On January 3, 2010, Federal Reserve Chairman Ben S. Bernanke stated low interest rates set by the Federal Reserve from 2002 to 2006 did not play a part in the housing bubble. Instead, he claimed, it was loose regulation that has left a good part of the country on the cusp of poverty. This interpretation cannot even be classified as poor economics, but it is good politics. In January, the Senate is scheduled to vote on a second four-year-term for Bernanke as Fed chairman. Like Greenspan, Bernanke is useful. He will probably receive another term.
Frederick 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, November 2009).
Federal Reserve Chairman Ben S. Bernanke gave a speech on January 3, 2010 that was incomprehensible. The address itself will be discussed later. It is important first to consider the precedent of Federal Reserve chairmen making absurd claims – and getting away with it.
A place to start is Alan Greenspan’s 2002 speech in Jackson Hole, Wyoming. The then Federal Reserve chairman explained that central banks could not identify bubbles because “only history books and musty archives gave us clues to the appropriate stance for the policy.” There are several problems with this excuse, not to mention his even less credible fiddle-faddle. More important though, is that the chairman’s address was disseminated with very little opposition along channels of communication. Economists cheered or remained silent. With a few notable exceptions, the media reported Greenspan’s speech as if it was a press release, which it was.
More up-to-date is Alan Greenspan’s appearance before Congress in October 2008. He had left the Fed in January 2006. In 2008, he testified about his contribution to the worldwide financial meltdown.
Greenspan was “shocked” to find a “flaw” in his “ideology.” He discussed his model that impugned “40 years or more of considerable evidence.” His model miscalculated the “self-interest of lending institutions” that he believed protected shareholder interests. Greenspan explained his naiveté was the reason he had not regulated banks properly.
Greenspan’s mistake was so often repeated that it acquired an official status. There are (at least) three official bodies that profit from this hallucination. First, the politicians. Since the Federal Reserve is the nation’s leading bank regulator, the politicians who inflated the credit bubble (e.g, through Fannie Mae, Freddie Mac, Countrywide Credit, banks that securitized mortgages, the National Association of Homebuilders) have not been held to account. The politicians are free to toy with petty financial regulation, while Fannie, Freddie and lethal derivatives are compounding as before.
The second body is the Federal Reserve. In a more mature world, after such a display of catastrophic incompetence, the Fed would be disbanded. Instead, since Greenspan’s mistake was due to his model’s flaw (not a fault of the former Federal Reserve chairman) and because bankers’ standards of integrity fell so far below Greenspan’s impeccable conduct that he could not comprehend such behavior, the Federal Reserve has been handed a parking ticket.
The third body is Alan Greenspan. He has been exempted from his responsibility for the ongoing liquidation of America. The former chairman has received blame, but still receives accolades. Greenspan continues to speak for large fees. His prophecies are still quoted across the media and the recently endowed Alan Greenspan Chair in Economics at New York University demonstrate that groveling can get you anywhere.
Greenspan has remained relatively unscathed because he is still useful. In this case, to the politicians and every economist who is using Greenspan’s error to promote more regulation. There will be many opportunities for both politicians and economists to get rich from new legislation.
Alan Greenspan’s self-proclaimed “ideology” is essential to his innocence, to the Fed’s exemption from failure and to the politicians’ fevered attempts to separate themselves from responsibility. Despite the incessant noise about Greenspan’s ideology, he never had one. He’s never even had an idea.
The publicity is of a man who acquired his free-market ideology sitting at the feet of Ayn Rand. This is reported over and over by the media. He didn’t know what Rand was talking about.
Nathaniel Brandon, Rand’s number one acolyte in the 1950s and also the Randian closest to Greenspan, wrote years later: “Now, looking at [Alan], I wondered to what extent he was aware of Ayn’s opinions.” Complimenting Ayn on some passage, Greenspan might say, “On reading this…one tends to feel…exhilarated.” Platitudes and assurances also mesmerized the nation 50 years later.
Today, for the media to suggest Greenspan did not operate from a free-market ideology would throw open the question of why Greenspan blew up the banking and credit systems. It would introduce the possibility that he was prone to act as the large financial institutions would like him to act. It would also reveal the extent to which he – and Bernanke – say what politicians want them to say.
On January 3, 2010, Federal Reserve Chairman Ben S. Bernanke stated low interest rates set by the Federal Reserve from 2002 to 2006 did not play a part in the housing bubble. Instead, he claimed, it was loose regulation that has left a good part of the country on the cusp of poverty. This interpretation cannot even be classified as poor economics, but it is good politics. In January, the Senate is scheduled to vote on a second four-year-term for Bernanke as Fed chairman. Like Greenspan, Bernanke is useful. He will probably receive another term.
Frederick 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, November 2009).
Tuesday, December 1, 2009
SENATE TO BERNANKE: “IN THE NAME OF GOD, GO!”
On December 3, 2009 the Senate Banking Committee will hold a hearing to vote on Federal Reserve Chairman Ben Bernanke's nomination to serve a second term as Federal Reserve chairman. Chairman Bernanke’s first four-year term began on February 1, 2006. He was nominated by President Obama to serve a second term as chairman in August 2009.
This speech is offered to any senator who would like children to recite this denunciation in classrooms 300 years from now.
[Note: Bracketed comments are not intended for the senator’s remarks. Time allotted for each senator to speak is short and the attention span of listeners is even shorter. Bracketed comments are background information for the senator.]
Chairman Bernanke,
You are the chief regulator of the U.S. banking system. You have more authority than other agencies over the entire U.S. financial system. Specifically, the Federal Reserve directly supervises U.S. bank holding companies.
I make this precise definition of your authority because I anticipate a disingenuous distinction you are likely to make. That is, “Senator, the Federal Reserve only has authority over the bank holding companies, not over the banks. Banks are regulated by the Comptroller of the Currency or the Federal Deposit Insurance Corporation.”
As you well know Chairman Bernanke, that is a false distinction. A bank owned by a holding company is, obviously, a part of the holding company. You can investigate practices and loans of banks by investigating your holding companies. If you reply, “investigating banks from the holding company level does not give a clear picture of the risks taken by banks” – then why didn’t you do anything about it? Since 2007, the government has put $45 billion – not million – dollars into Citigroup, alone. If you did not think the Comptroller of the Currency and the Federal Deposit Insurance Corporation were doing an adequate job, it was your duty to tell this committee.
But, I do not think you were capable of warning us. This is an important reason you should not be Federal Reserve chairman: you do not understand banking. I want to review some of what the nation’s head bank regulator should have known by the end of 2006.
You had been chairman 11 months, having replaced Alan Greenspan on February 1, 2006.
The Federal Deposit Insurance Commission (FDIC) reported that construction loans, land development loans, and direct mortgages held by commercial banks had grown 87% from December 31, 2000 to June 30, 2006: from $1.6 trillion to $3 trillion: three trillion dollars of mortgages, construction and land development loans sat on the banking systems’ books. [These are direct loans. This does not include mortgage securities on bank books: another $1 trillion.]
The growth alone would have alerted a curious mind. Such a mind would have sought a measurement of the quality of those loans. Some information that was readily available to you:
The median price for an existing, single-family house in California rose from $237,060 in 2000 to $542,720 in 2005.
How could Californians buy houses? You answered the question yourself in a November 2006 speech: “In 1994, fewer than 5 percent of mortgage originations were in the subprime market, but by 2005 about 20 percent of new mortgage loans were subprime.” You thought this was a good thing. In the same speech, you also said with approval: “[T]he expansion of subprime lending has contributed importantly to the substantial increase in the overall use of mortgage credit. From 1995 to 2004, the share of households with mortgage debt increased 17 percent, and in the lowest income quintile, the share of households with mortgage debt rose 53 percent.” Mr. Chairman, how could you say this with approval? [If Bernanke claims he gave a warning during this speech, this is correct. He advised “greater financial literacy” for “borrowers with lower incomes and education levels.”]
From other public statements, you thought the banking system was in great shape. In June 2006, you told an International Monetary Fund conference: “[O]ur banks are well capitalized and willing to lend.” Since you as Federal Reserve chairman did not grasp the insatiable appetite of your bankers to lend, you did not understand the capital was insufficient.
By the time you spoke to the IMF, daily newspapers had already reported that lenders were rounding up pools of illegal aliens who had bought blocks of houses, and criminals who ran mortgage rackets. The latter group did not need to be rounded up since they were already in prison. [See Denver Post, July 14, 2005: Colorado banks lured illegal aliens into loans that were insured by the federal government. “They didn’t even have to come up with any money. They just moved in” and some immediately defaulted, moaned the local District Attorney. Also, see Denver Post, January 7, 2007, “Four People Plead Guilty in Mortgage Fraud Conspiracy,” Prisoners had received 100% loans for houses with inflated house prices.]
We know the carnage in the mortgage market since then. Yet, in October 2007, you told a group of central bankers and economists you did not know if there had been a housing bubble. [John Cassidy, “Anatomy of a Meltdown,” New Yorker, December 1, 2008]
Another blot on your record is the leverage throughout the financial system. Again, I anticipate your denial: that you only hold authority over the banking system. But, you hold the only position that can ration credit, so can substantially influence stability in our financial system.
Let me remind you of the machinery you control: The Federal Reserve adds or subtracts money to the economy. You do this by adding or subtracting dollars held by the commercial banks. You also set limits on how much credit the banks can extend to the economy. You have options to restrict lending. Most often the Federal Reserve has done so by setting reserve ratios. But more directly, you are the country’s leading bank regulator. From my own study of bank balance sheets – both their growth and deteriorating quality since you became chairman – I conclude, once again, that you do not understand banking. [As stage prop, senator could slap a stack of bank quarterly reports held by intern.]
Anticipating one of your smirky, pompous rebuttals, don’t tell me: “I remind you, senator, that we live in a global economy with a global financial system. The Federal Reserve does not have as much control as you claim.” Such specious arguments might close debate with an ambitious, non-inquisitive, Ivy League economic student. I am talking about reality: you have more control over money than the other central banks combined. The dollar is still the world’s reserve currency, despite your prolific printing efforts to debase it. As the world’s reserve currency, at least until you destroy the dollar’s status, it is only the United States that can print money in any quantity it so desires.
I will return, now, to the consequences of credit produced by the Federal Reserve. When Bear Stearns and Lehman Brothers had leveraged the balance sheet by over 30:1, it was the accommodating policies of the Federal Reserve that allowed them to borrow that much money. It was the accommodating policies of the Federal Reserve that permitted banks to offload mortgages to non-banks, such as Fannie Mae and Freddie Mac. This permitted the banks to constantly offer more mortgages, of poorer and poorer quality, confident that they could immediately sell them. This was the greatest relay operation since Tinkers-to-Evers-to-Chance. [Particularly appropriate if delivered by Senator Bunning.] You stated the banks were well capitalized. You probably believed this, since you do not understand banking.
Chairman Bernanke, you may claim you had no authority over investment banks, but the credit they leveraged originated in your banking system. This is also true for non-bank mortgage lenders such as New Century: every dollar it borrowed – so that it might finance new mortgage loans – was first lent from the banking system. This permitted New Century to make $56 billion in mortgage loans during 2005. By 2006, New Century was making loans on which the borrowers immediately defaulted. The carnage is strewn across the country.
You also showed no signs of understanding the consequences of your banks lending to private-equity firms. We can approximate this growth by looking at leveraged loans: that is, loans to finance buyouts. These were often companies that private equity firms leveraged with large amounts of debt.
In 2006, the year you became chairman, you had all the information you needed to know trouble was ahead. The Comptroller of the Currency issued a report in October 2006 that credit risk rose for 5% of the banks making leveraged loans in 2005 and had increased for 69% of banks in 2006. Bank loans to finance leveraged syndicated deals rose from $200 billion in 2005 to $360 billion in 2006 to $570 billion in the first half of 2007. Many of the companies bought were so leveraged they could not meet interest payments a few months after the buyout.
Yet, you stood by. Do not tell me the Federal Reserve has no authority over where banks lend – you not only can persuade but you have precedent – In 1980, when Paul Volcker was chairman, the Federal Reserve restricted bank credit used for acquisitions. Instead, the government-subsidized credit you were producing was going straight into the hands of stupid, greedy, malevolent bankers [senator chooses one – ‘greedy’ seems to be in vogue] and private-equity firms.
You did not have to guess at the irresponsibility and low motives of your bankers. In March 2007, a Wall Street Journal reporter told the world: “Hedge-fund managers, buyout artists, and bankers get paid for short-term performance. The long-term consequences of their actions are, conveniently, someone else’s problem. People inside the big banks…. Don’t want to get caught missing the next big deal. Their banks, and their own bonuses, might suffer. So they ply ahead.” [Note on italics: delivered with passion.]
What were the consequences? According to Moody’s, acquired companies have been “crippled.” In the next few months, many of these companies must refinance the debt loaded onto their balance sheets. Many will not be able to borrow. They will be forced into bankruptcy, and possibly, into liquidation. The unemployment rate is a reflection of your truancy, Chairman Bernanke.
[Circuit City was forced to liquidate. Mervyn’s Department Store – liquidated. Linen’s ‘n Things – vaporized. Those jobs are gone. Many other very large employers, such as Clear Channel Communications and Harrah’s Entertainment are in bankruptcy court. The list is long and growing. Some will make it, some will not.]
The banks that made these loans, too, have been crippled. They wrote off $3.8 billion of leveraged loans in 2007 and another $54.4 billion in 2008. 2009 promises to be a bonanza. It is the taxpayers who are paying for the banks’ ineptitude. It was your job to stop it.
Instead, you are behaving like Oedipus when he understood his act of perversion. But, instead of gouging your eyes out, you drove interest rates to zero. Zero! The backbone of America, those who saved prudently and asked the government for nothing, cannot earn enough interest to buy Spam. The insurance companies, another backbone to prudent households in our country, cannot earn enough interest to pay policyholders: they are being forced to either buy riskier assets and hope for the best, or, join Circuit City in liquidation. Community banks, one more source of stability, are being driven out of business because you have saved and subsidized the megabanks that should have been liquidated and that can now prey on smaller non-subsidized banks.
This is your legacy, Mr. Chairman. As is the derivative mess. I agree that your predecessor has much to answer for here. But look at the record since you acquired power: The nominal value of derivative contracts held by U.S. commercial banks leapt from $33 trillion at the end of 1998 to $101 trillion at the end of 2005, about the time Mr. Greenspan left office. This was roughly a 17% annual increase. By June 30, 2007, seventeen months you’re your chairmanship, the nominal value had risen another 50% - to $153 trillion.
Most importantly – and this may be the greatest deficiency in your magnificently woeful record – credit derivatives rose from $14 trillion to $42 trillion from January 2006 to June 30, 2007. The inability of banks to honor these contracts led to the bailout of Goldman, Sachs, AIG and who knows what else. [Leave Treasury Secretary Geithner’s recent credit-default swap hallucinations aside. He may have changed his story again during this hearing.] At least, that is what every American with a pulse believes, and will continue to believe, since you so desperately try to avoid an audit. This is a black eye on the face of the United States. Americans believe you have protected the worst financial manipulators while unemployment and disillusionment rise.
Mr. Chairman, it is time to give the American people hope that they are represented in Washington. It is also time to give them hope the Federal Reserve chairman knows what he’s doing! Your notice for dismissal was written over 300 years ago, when Oliver Cromwell scolded the Long Parliament: “You have sat here too long for any good you have been doing. Depart, I say, and let us have done with you. In the name of God, go!”
On December 3, 2009 the Senate Banking Committee will hold a hearing to vote on Federal Reserve Chairman Ben Bernanke's nomination to serve a second term as Federal Reserve chairman. Chairman Bernanke’s first four-year term began on February 1, 2006. He was nominated by President Obama to serve a second term as chairman in August 2009.
This speech is offered to any senator who would like children to recite this denunciation in classrooms 300 years from now.
[Note: Bracketed comments are not intended for the senator’s remarks. Time allotted for each senator to speak is short and the attention span of listeners is even shorter. Bracketed comments are background information for the senator.]
Chairman Bernanke,
You are the chief regulator of the U.S. banking system. You have more authority than other agencies over the entire U.S. financial system. Specifically, the Federal Reserve directly supervises U.S. bank holding companies.
I make this precise definition of your authority because I anticipate a disingenuous distinction you are likely to make. That is, “Senator, the Federal Reserve only has authority over the bank holding companies, not over the banks. Banks are regulated by the Comptroller of the Currency or the Federal Deposit Insurance Corporation.”
As you well know Chairman Bernanke, that is a false distinction. A bank owned by a holding company is, obviously, a part of the holding company. You can investigate practices and loans of banks by investigating your holding companies. If you reply, “investigating banks from the holding company level does not give a clear picture of the risks taken by banks” – then why didn’t you do anything about it? Since 2007, the government has put $45 billion – not million – dollars into Citigroup, alone. If you did not think the Comptroller of the Currency and the Federal Deposit Insurance Corporation were doing an adequate job, it was your duty to tell this committee.
But, I do not think you were capable of warning us. This is an important reason you should not be Federal Reserve chairman: you do not understand banking. I want to review some of what the nation’s head bank regulator should have known by the end of 2006.
You had been chairman 11 months, having replaced Alan Greenspan on February 1, 2006.
The Federal Deposit Insurance Commission (FDIC) reported that construction loans, land development loans, and direct mortgages held by commercial banks had grown 87% from December 31, 2000 to June 30, 2006: from $1.6 trillion to $3 trillion: three trillion dollars of mortgages, construction and land development loans sat on the banking systems’ books. [These are direct loans. This does not include mortgage securities on bank books: another $1 trillion.]
The growth alone would have alerted a curious mind. Such a mind would have sought a measurement of the quality of those loans. Some information that was readily available to you:
The median price for an existing, single-family house in California rose from $237,060 in 2000 to $542,720 in 2005.
How could Californians buy houses? You answered the question yourself in a November 2006 speech: “In 1994, fewer than 5 percent of mortgage originations were in the subprime market, but by 2005 about 20 percent of new mortgage loans were subprime.” You thought this was a good thing. In the same speech, you also said with approval: “[T]he expansion of subprime lending has contributed importantly to the substantial increase in the overall use of mortgage credit. From 1995 to 2004, the share of households with mortgage debt increased 17 percent, and in the lowest income quintile, the share of households with mortgage debt rose 53 percent.” Mr. Chairman, how could you say this with approval? [If Bernanke claims he gave a warning during this speech, this is correct. He advised “greater financial literacy” for “borrowers with lower incomes and education levels.”]
From other public statements, you thought the banking system was in great shape. In June 2006, you told an International Monetary Fund conference: “[O]ur banks are well capitalized and willing to lend.” Since you as Federal Reserve chairman did not grasp the insatiable appetite of your bankers to lend, you did not understand the capital was insufficient.
By the time you spoke to the IMF, daily newspapers had already reported that lenders were rounding up pools of illegal aliens who had bought blocks of houses, and criminals who ran mortgage rackets. The latter group did not need to be rounded up since they were already in prison. [See Denver Post, July 14, 2005: Colorado banks lured illegal aliens into loans that were insured by the federal government. “They didn’t even have to come up with any money. They just moved in” and some immediately defaulted, moaned the local District Attorney. Also, see Denver Post, January 7, 2007, “Four People Plead Guilty in Mortgage Fraud Conspiracy,” Prisoners had received 100% loans for houses with inflated house prices.]
We know the carnage in the mortgage market since then. Yet, in October 2007, you told a group of central bankers and economists you did not know if there had been a housing bubble. [John Cassidy, “Anatomy of a Meltdown,” New Yorker, December 1, 2008]
Another blot on your record is the leverage throughout the financial system. Again, I anticipate your denial: that you only hold authority over the banking system. But, you hold the only position that can ration credit, so can substantially influence stability in our financial system.
Let me remind you of the machinery you control: The Federal Reserve adds or subtracts money to the economy. You do this by adding or subtracting dollars held by the commercial banks. You also set limits on how much credit the banks can extend to the economy. You have options to restrict lending. Most often the Federal Reserve has done so by setting reserve ratios. But more directly, you are the country’s leading bank regulator. From my own study of bank balance sheets – both their growth and deteriorating quality since you became chairman – I conclude, once again, that you do not understand banking. [As stage prop, senator could slap a stack of bank quarterly reports held by intern.]
Anticipating one of your smirky, pompous rebuttals, don’t tell me: “I remind you, senator, that we live in a global economy with a global financial system. The Federal Reserve does not have as much control as you claim.” Such specious arguments might close debate with an ambitious, non-inquisitive, Ivy League economic student. I am talking about reality: you have more control over money than the other central banks combined. The dollar is still the world’s reserve currency, despite your prolific printing efforts to debase it. As the world’s reserve currency, at least until you destroy the dollar’s status, it is only the United States that can print money in any quantity it so desires.
I will return, now, to the consequences of credit produced by the Federal Reserve. When Bear Stearns and Lehman Brothers had leveraged the balance sheet by over 30:1, it was the accommodating policies of the Federal Reserve that allowed them to borrow that much money. It was the accommodating policies of the Federal Reserve that permitted banks to offload mortgages to non-banks, such as Fannie Mae and Freddie Mac. This permitted the banks to constantly offer more mortgages, of poorer and poorer quality, confident that they could immediately sell them. This was the greatest relay operation since Tinkers-to-Evers-to-Chance. [Particularly appropriate if delivered by Senator Bunning.] You stated the banks were well capitalized. You probably believed this, since you do not understand banking.
Chairman Bernanke, you may claim you had no authority over investment banks, but the credit they leveraged originated in your banking system. This is also true for non-bank mortgage lenders such as New Century: every dollar it borrowed – so that it might finance new mortgage loans – was first lent from the banking system. This permitted New Century to make $56 billion in mortgage loans during 2005. By 2006, New Century was making loans on which the borrowers immediately defaulted. The carnage is strewn across the country.
You also showed no signs of understanding the consequences of your banks lending to private-equity firms. We can approximate this growth by looking at leveraged loans: that is, loans to finance buyouts. These were often companies that private equity firms leveraged with large amounts of debt.
In 2006, the year you became chairman, you had all the information you needed to know trouble was ahead. The Comptroller of the Currency issued a report in October 2006 that credit risk rose for 5% of the banks making leveraged loans in 2005 and had increased for 69% of banks in 2006. Bank loans to finance leveraged syndicated deals rose from $200 billion in 2005 to $360 billion in 2006 to $570 billion in the first half of 2007. Many of the companies bought were so leveraged they could not meet interest payments a few months after the buyout.
Yet, you stood by. Do not tell me the Federal Reserve has no authority over where banks lend – you not only can persuade but you have precedent – In 1980, when Paul Volcker was chairman, the Federal Reserve restricted bank credit used for acquisitions. Instead, the government-subsidized credit you were producing was going straight into the hands of stupid, greedy, malevolent bankers [senator chooses one – ‘greedy’ seems to be in vogue] and private-equity firms.
You did not have to guess at the irresponsibility and low motives of your bankers. In March 2007, a Wall Street Journal reporter told the world: “Hedge-fund managers, buyout artists, and bankers get paid for short-term performance. The long-term consequences of their actions are, conveniently, someone else’s problem. People inside the big banks…. Don’t want to get caught missing the next big deal. Their banks, and their own bonuses, might suffer. So they ply ahead.” [Note on italics: delivered with passion.]
What were the consequences? According to Moody’s, acquired companies have been “crippled.” In the next few months, many of these companies must refinance the debt loaded onto their balance sheets. Many will not be able to borrow. They will be forced into bankruptcy, and possibly, into liquidation. The unemployment rate is a reflection of your truancy, Chairman Bernanke.
[Circuit City was forced to liquidate. Mervyn’s Department Store – liquidated. Linen’s ‘n Things – vaporized. Those jobs are gone. Many other very large employers, such as Clear Channel Communications and Harrah’s Entertainment are in bankruptcy court. The list is long and growing. Some will make it, some will not.]
The banks that made these loans, too, have been crippled. They wrote off $3.8 billion of leveraged loans in 2007 and another $54.4 billion in 2008. 2009 promises to be a bonanza. It is the taxpayers who are paying for the banks’ ineptitude. It was your job to stop it.
Instead, you are behaving like Oedipus when he understood his act of perversion. But, instead of gouging your eyes out, you drove interest rates to zero. Zero! The backbone of America, those who saved prudently and asked the government for nothing, cannot earn enough interest to buy Spam. The insurance companies, another backbone to prudent households in our country, cannot earn enough interest to pay policyholders: they are being forced to either buy riskier assets and hope for the best, or, join Circuit City in liquidation. Community banks, one more source of stability, are being driven out of business because you have saved and subsidized the megabanks that should have been liquidated and that can now prey on smaller non-subsidized banks.
This is your legacy, Mr. Chairman. As is the derivative mess. I agree that your predecessor has much to answer for here. But look at the record since you acquired power: The nominal value of derivative contracts held by U.S. commercial banks leapt from $33 trillion at the end of 1998 to $101 trillion at the end of 2005, about the time Mr. Greenspan left office. This was roughly a 17% annual increase. By June 30, 2007, seventeen months you’re your chairmanship, the nominal value had risen another 50% - to $153 trillion.
Most importantly – and this may be the greatest deficiency in your magnificently woeful record – credit derivatives rose from $14 trillion to $42 trillion from January 2006 to June 30, 2007. The inability of banks to honor these contracts led to the bailout of Goldman, Sachs, AIG and who knows what else. [Leave Treasury Secretary Geithner’s recent credit-default swap hallucinations aside. He may have changed his story again during this hearing.] At least, that is what every American with a pulse believes, and will continue to believe, since you so desperately try to avoid an audit. This is a black eye on the face of the United States. Americans believe you have protected the worst financial manipulators while unemployment and disillusionment rise.
Mr. Chairman, it is time to give the American people hope that they are represented in Washington. It is also time to give them hope the Federal Reserve chairman knows what he’s doing! Your notice for dismissal was written over 300 years ago, when Oliver Cromwell scolded the Long Parliament: “You have sat here too long for any good you have been doing. Depart, I say, and let us have done with you. In the name of God, go!”
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