Alert: Paulson, Bernanke Testimony

Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson are scheduled to testify today before the House Financial Services Committee.

Is Kashkari A Chump?

Congress beats up on Neel Kashkari. I would be impressed if they treated Ben Bernanke this way.

Dean Baker With the Big Question

Are Ben Bernanke and Henry Paulson crony capitalists?

Federal Reserve Announces It Will Alter Formulas Used to Determine Interest Rates Paid on Required Reserves and Excess Reserves

As I previously indicated, the Fed Funds rate is not as important a factor in money supply growth as it was in the past, now that the Fed is paying interest on bank reserves. But, Bernanke does like to monkey with his "new tools". So we have a bit of Fed monkeying with the new tools, today.

The Fed announced today that it will alter the formulas used to determine the interest rates paid to depository institutions on required reserve balances and excess reserve balances.

Previously, the rate on required reserve balances had been set at the average target federal funds rate established by the Federal Open Market Committee (FOMC) over a reserves maintenance period minus 10 basis points. The rate on excess balances had been set as the lowest federal funds rate target in effect during a reserve maintenance period minus 35 basis points. Under the new formulas, the rate on required reserve balances will be set equal to the average target federal funds rate over the reserve maintenance period. The rate on excess balances will be set equal to the lowest FOMC target rate in effect during the reserve maintenance period. These changes will become effective for the maintenance periods beginning Thursday, November 6.

The Board judged that these changes would help foster trading in the funds market at rates closer to the FOMC's target federal funds rate.

The Coming Collapse Of Treasury Security Prices

FT has a solid article this morning on the huge Treasury offerings that will be required because of the "bailouts".

Among the points made:

Before the recent upheavals, the US budget deficit for the fiscal 2009 financial year starting this month was estimated between $400bn and $450bn. Some economists now expect that figure to reach $1,000bn, which would be a record. That will push Treasury debt sales sharply higher...

“It is pretty conservative to say that the cost of the bail-out will be $1,000bn and by the time all the programmes have been tallied, it could be $2,500bn,” says Jamie Jackson, portfolio manager at RiverSource Investments...

This is all going to mean greater frequency of issuance and a return of previously discontinued issues such as the three-year note and possibly the seven. At a minimum, dealers expect the return of the three-year note, which was suspended in May 2007. The sale of 10-year notes is expected to move to a monthly schedule from being sold twice every quarter at present. New sales of 30-year bonds are seen occurring every three months...

From a logistical standpoint, the quarterly sale of debt in November and this week’s sales are a major test for the thinning ranks of primary dealers. These are the banks and securities broker-dealers that participate in Treasury auctions.

From 20 primary dealers at the end of 2007, Bear Stearns, Lehman Brothers and Countrywide have fallen by the wayside this year. The list will shrink to 16 once Merrill Lynch is absorbed by Bank of America.

Fewer dealers at a time when banks are preserving their balance sheets before the end of the year has contributed to an erosion in liquidity for buying and selling current and older Treasury securities. That backdrop could lead to poorly received auction sales, with yields for new notes being awarded at much higher levels, driving up the cost for the Treasury and taxpayers...

Tom di Galoma, head of trading at Jefferies & Co says: “No one has any balance sheet room and supply is a concern for the rest of the quarter.”..

Treasury in recent weeks has been selling securities in a buyers market as the flight to quality has caused enormous demand of Treasury securities. This will all change when the market stabilizes. Not only will there be less demand for Treasury securities, but there is likely to be major liquidation of currently held Treasury positions. A flight from Treasury securities is a very real possibility. This will also have negative ramifications for the dollar.

The only way to stem the collapse of the Treasury market would be for the Fed to step in and become an aggressive buyer of Treasury securities. This would be an exceptionally inflationary move. Bernanke has been running an erratic money supply operation since he has taken over, so it is impossible to guess how inflationary he is willing to get to protect Treasury rates. It is likely to result in a combination of some Fed buying coupled with a climb in rates.

The noose on government money operations is tightening again. For savvy traders, it will be a huge money making opportunity. For the average Joe, plumber or not, it will be a lower standard of living as rates climb, inflation climbs and Treasury borrowing crowds out private sector borrowing.

Martin Feldstein On The Money Supply and Current Crisis

Martin Feldstein, chairman of the Council of Economic Advisers under President Reagan and the George F. Baker Professor of Economics at Harvard University, recently penned a WSJ Op-Ed calling for a program to stop a downward overshooting of house prices and the resulting mortgage defaults. A mortgage-replacement loan program may be the best way to achieve that, he wrote.

Since the latest leg of the downturn in the mortgage market, and now the overall economy, seems to be the result of the fact that the Federal Reserve crashed money supply growth over the summer, I have often wondered what Feldstein's take was on the Fed's activities this summer. I got the chance to ask him. Feldstein was a part of a panel that included Wilbur Ross Jr., Juan Williams and Ron Insana, before 4,000 at the AFP conference.

During the panel discussion, Feldstein stated that the Federal Reserve was doing an excellent job providing liquidity to the system but it wasn't working and that is why further measures, such as his "mortgage-replacement loan program" needed to be implemented.

During the Q & A, I asked him how he could say that the Fed was providing liquidity to the system since M2 growth crashed over the summer from a March peak of 12.5% annualized growth to growth of only 1.5% annualized in September. I further stated to him that, in addition, over the summer the Fed was sterilizing the cash infusions they were making by selling off Treasury securities, thus maintaining a net liquidity neutral stance as part of its various rescue operations.

Feldstein did not answer the question about where he saw liquidity coming from the system over the summer( How could he, since there wasn't any net liquidity added to the system?), but he did address the fact that money growth slowed over the summer. He said it likely occurred because of the problems in the economy (which in his view apparently took time for the Fed to adjust too.) He then said that money supply M2 was back growing at an annualized rate of 4.5%, which was correct. He said that this was about the correct growth rate given current GDP growth. This is a hoot, since money supply in September was at 1.5% annualized, and it then jumped to 2.3%, and now is at 4.5%, the Fed clearly has its foot on the monetary accelerator. I don't believe money supply at 4.5% is anything but a very brief transition point. Within weeks money supply growth could be at double digit rates. Indeed, the money supply numbers due out this Thursday could show M2 growth much higher than 4.5%. Feldstein clearly hasn't figured out that Ben Bernanke's Fed is clueless. When he does, I wonder what his prescription for the economy will be?

SIGNIFICANT DEVELOPMENT: Money Supply Climbing, Again

The fuel that sparks the economy, money supply growth, is climbing again.

As recently as September 15, money supply growth was nosediving.

In September, money supply [M2] growth [three month-annualized] bottomed at 1.5% annualized growth.

In the 3 to 4 weeks since then, money supply has shown sustained growth. This week M2 three month annualized money growth is at 4.1%. Money growth has more than doubled. Though, it is still nowhere near the 12.1% growth in March of this year.

But the change in growth to the upside suggests that Ben Bernanke has opened the floodgates to fill the system with money. This will throw off all the forecasts made by economists who are making projections of a deep and long recession. The recession should be short and brief. The true long term threat is likely to be inflation. That said, Bernanke has run one of the most unpredictable erratic Fed operations ever. IF Bernanke slows printing again, all bets are off and we are back into major recession mode.

Cluless Bernanke Speaks

Fed Chairman Ben Bernanke spoke today before the Economic Club of New York and topped previous efforts at displaying the fact that he can often be clueless.

Bernanke said the Fed will consider discarding its long- standing aversion to interfering with asset-price bubbles and warned that the banking business may be concentrated in too few companies, according to Bloomberg.

Of course, as I have pointed out before:

Those who call for regulators to supervise the financial industry fail to get that government is spelled g-o-v-e-r-n-m-e-n-t, not g-o-d.

In 2004, New York Federal Reserve economists Jonathan McCarthy and Richard W. Peach wrote a paper Is There A Bubble in The Housing Market Now? Their answer was decidedly, "No".


I issued a reply to their paper:

...the record climb in housing prices is, indeed, a bubble... the Federal Reserve study fails to consider past declining interest rates as a cause of the bubble. The faulty conclusions reached by Federal Reserve economists Jonathan McCarthy and Richard W. Peach may make many potential new home buyers comfortable about a purchase, when, in fact, we are very near the top of a housing market that will experience substantial declines in prices...

Just how does Bernanke square this embarrassing performance with his call to have the Fed identify and somehow "intervene" when asset bubbles occur, when the evidence points to the fact that they completely misssed the housing bubble?

His contention that the banking industry is too concentrated flies completely in the face of what the Treasury is now doing to "battle" the financial crisis. The Treasury just gave $125 billion to the top nine banks in the country. If you are concerned about concentration, you don't give the top nine banks $125 billion,

Further, he continues to contend that he is adding liquidity to the financial system:

The Federal Reserve responded to these developments in two broad ways. First, following classic tenets of central banking, the Fed has provided large amounts of liquidity to the financial system to cushion the effects of tight conditions in short-term funding markets.

In fact, as I have pointed out here, here, here, here, here,here, here and here, money supply growth has been collapsing. Bernanke, for all practical purposes, has not been adding any liquidty to the system.

Does the Chairman have any clue as to what is going on around him?

Ben Bernanke's Confusion

Fed Chairman Ben Bernanke has an Op Ed in today's WSJ which indicates one of two things, he is either very confused about the crisis around him, or he is trying to confuse the rest of us.

Writes Bernanke:

Over the past year, the Federal Reserve has actively used all its powers and authority to try to help our economy through this difficult time.

Absolutely FALSE. As I have consistently stated, this crisis is about the Fed creating an economy dependent on more and more new money pumped into the system, and that the Fed stopped creating new money approximately four months ago. As I warned during the entire period here, here, here, here, here,here, here and here.

Central banks around the world have also consulted closely and cooperated in unprecedented ways to reduce strains in financial markets and to bolster our economies. We will continue to do so. However, clearly the time had come for a more comprehensive and broad-based solution...I also find it heartening that we are seeing not just a national response but a global response to the crisis, commensurate with its global nature

This is code for expanded coordinated global inflation. We are all Zimbabweans now.

History teaches us that government engagement in times of severe financial crisis often arrives very late usually at a point at which most financial institutions are insolvent or nearly so. In these conditions, the consequences and costs of inertia and inaction can be staggering.

What history really teaches and what Robert Higgs has clearly detailed in Crisis and Leviathan is used by the state to expand the state.

The Congress and the administration acted at a time when the great majority of financial institutions, though stressed by highly volatile and difficult market conditions, remain capable of fulfilling their critical function of providing new credit for our economy. Their prompt passage of the financial rescue legislation made possible the critical measures that will be announced this morning. These steps will allow us to restore more normal market functioning, and encourage private capital to further support the reinvigoration of financial markets.

Oh yeah, Ben, passing out $125 billion (Half the Congress approved first tranche) to the nine largest healthy banks was necessary.

As in all past crises, at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets.

No Ben, as in all past crises, the root cause has been central bank manipulation of the money supply.

More Details On 'Wall Street' Sequel

As if Henry Paulson and Ben Bernanke are not enough entertainment, FOX is fast tracking a 'Wall Street' sequel.

Michael Douglas will return as Gordon Gekko, according to Variety. Bud Fox is history.

Allan Loeb will write the screenplay. In addition to screenwriting, Loeb is a licensed stockbroker who once worked at the Chicago Board of Trade.

ALERT: Plunge Protection Team Press Briefing Tuesday Morning

The following is a Treasury Press Release on tomorrow's press biefing:

Secretary Henry M. Paulson, Jr., Federal Reserve Chairman Ben Bernanke, and FDIC Chairman Sheila Bair will be joined by the other members of the President's Working Group on Financial Markets to make statements in the Treasury Department Cash Room at 8:30 a.m. (EDT) on October 14, 2008 on a series of comprehensive actions to strengthen public confidence in our financial institutions and restore functioning of our credit markets. Following the on-camera statement Treasury officials will conduct an off-camera, background briefing in the same room.

Who
Treasury Secretary Henry M. Paulson, Jr.
Federal Reserve Chairman Ben Bernanke
FDIC Chairman Sheila C. Bair
SEC Chairman Christopher Cox
CFTC Chairman Walter Lukken
OCC Comptroller John Dugan
OTS Director John M. Reich

Tape Blows Cover On True Treasury Intentions

The new kid at the Treasury hasn't quite learned you really can't talk in public about what you are really up to at Treasury. New Interim Assitant Secretary of the Office of Stability, Neel Kashkari, has been caught on tape providing the true details of what Treasury is up to. This will get him muzzled pretty fast, but it provides us the opportunity to see the scheming going on at Treasury.

Kashkari's statements were posted on YouTube, and now appear to have been removed.

WSJ reviewed the tapes and reports first on the fact that Kashkari considers the executive pay caps demanded by Congress a joke:

As the biggest market intervention in U.S. history made its way through Congress, Neel Kashkari, the Treasury official named this week to run the program, offered assurances to 800 financial-industry players.

Attempts by Congress to make beneficiaries pay for their mistakes, such as placing caps on executive pay, were "quite reasonable" and "a pretty modest hindrance to you," he told them, according to a recording of the Sept. 28 conference call made public on video-sharing Web site YouTube.

Kashkari told participants in the call that lawmakers' interest in limiting executive compensation was "emotional" and "probably the most difficult part of the negotiation" with Congress.

When one industry participant said the caps might discourage participation, Kashkari noted their limited scope, which he called "a pretty modest hindrance to you coming into the program," WSJ reports.

WSJ also reports that the conference call took place the night before the House rejected the rescue plan, on September 28. The plan passed days later on October 3.

The dates are important because Kashkari, according to WSJ, also reported to the financial insiders that, "Our preference would be to try to help healthy banks become even healthier." (My emphasis.)

Remember, the entire focus, at the time, was on buying up bad mortgages and there was no news out publicly about Treasury helping "healthy banks"?

Indeed, I just did a search of the New York Times database and the first time the words "healthy bank" come up in a search is on October 9, where NYT reports that as Part of a NEW "Plan B" that Treasury may take positions in banks, even healthy ones.

This is how NYT reported the story (My emphasis):

Having tried without success to unlock frozen credit markets, the Treasury Department is considering taking ownership stakes in many United States banks to try to restore confidence in the financial system, according to government officials...

The American recapitalization plan, officials say, has emerged as one of the most favored new options being discussed in Washington and on Wall Street. The appeal is that it would directly address the worries that banks have about lending to one another and to other customers.

Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it...including healthy ones.

This new interest in direct investment in banks comes after yet another tumultuous day in which the Federal Reserve and five other central banks marshaled their combined firepower to cut interest rates but failed to stanch the global financial panic.

As Bob Murphy has pointed out, they haven't even bought one mortgage yet, so how could they have failed at attempting to unlock the supposed frozen market?

"New interest"? "New options" "After yet another tumultuous day"? Then why was Kashkari talking about these details to the securities industry, even BEFORE the first House vote?

A database search of WSJ pretty much shows the same thing, the first time "healthy bank" is used with regard to the takeover of banks is October 10. The only other relevant search that comes up is an Op-Ed piece on 9-26 by John Paulson , a respected Wall Street investment manager--not the Treasury Secretary--, who discusses the Treasury's plan to buy mortgages from all banks. And he would certainly be shocked to hear that two days after his Op-Ed that Kashkari said the Treasury's preference was to help healthy banks, given that John Paulson wrote in his Op-Ed:

By allowing all banks to sell their worst assets to Treasury at inflated prices, taxpayers would be subsidizing healthy banks which have access to private capital (Goldman Sachs, J.P. Morgan, Wells Fargo, and Bank of America, for example) as well as banks that don't have a private alternative. But under a Preferred plan, only banks that don't have a private alternative will be given federal assistance. This would reduce the outlay otherwise required to solve the crisis.

Folks, we have a smoking gun here, you would have to be blind not to see that the Bernanke-induced crisis is being used by Paulson to funnel money to Goldman Sachs and his other crony favorites. The plan all along was to help out "healthy banks". It's on tape from the interim Assistant Secretary of Stability. Yeah, crisis and fear alright. Every time they utter those words, they move more of the $700 billion closer towards Goldman Sachs' vault.

UPDATE: There is a poor quality audio tape of the conference call on YouTube. Here is Part 3 where at the 9:00 minute mark the mention is made that healthy banks will be preferred. Thanks, Anthony.

Bowyer On Bernanke’s Pretend Rate Cut

The thing about Fed Chairman Ben Bernanke is that he does things in such a complex convoluted manner that few traders realize what he is or isn't up to. Hell, many economists don't realize what he is up to.

At least, Jerry Bowyer gets that today's Fed Funds rate cut is a fake Fed cut:

Today’s rate cut was late and small. Really, the cut was not actually a cut at all. Bernanke had already been pumping enough money into the system to lower the rate at least to 1.5%. What changed today is that it was made official. We didn’t get more money today – we got an announcement of what had already been happening...

But, notice that even Bowyer doesn't discuss the extraordinary power to pump money that Bernanke now has because of the Fed's new ability to pay interest on reserves left at the Fed.

Bernanke Confirms Ramifications Of Fed's New Ability To Pay Interest On Bank Reserves

In a speech today before the National Association for Business Economics 50th Annual Meeting in Washington, D.C., Fed Chairman Bernanke confirmed my earlier analysis today of the ramifications of the Fed's new ability to pay interest on bank reserves. From Bernanke's speech today:

The Federal Reserve has also been granted a new authority, the ability to pay interest on bank reserves, which will allow us to expand our lending as needed to support the system while better managing the federal funds rate...

The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding. Recently, however, our liquidity provision had begun to run ahead of our ability to absorb excess reserves held by the banking system, leading the effective funds rate, on many days, to fall below the target set by the Federal Open Market Committee. This problem has largely been addressed by a provision of the legislation the Congress passed last week, which gives the Federal Reserve the authority to pay interest on balances that depository institutions hold in their accounts at the Federal Reserve Banks. The Federal Reserve announced yesterday that it will pay interest on required reserve balances at 10 basis points below the target federal funds rate, and pay interest on excess reserves, initially at 75 basis points below the target. Paying interest on reserves should allow us to better control the federal funds rate, as banks are unlikely to lend overnight balances at a rate lower than they can receive from the Fed; thus, the payment of interest on reserves should set a floor for the funds rate over the day. With this step, our lending facilities may be more easily expanded as necessary.

Bottom line, the ability to pay interest on reserves is a new highly powerful tool for the Fed to use. It will result in the Fed having the ability to increase reserves without necessarily changing the Fed Funds rate. This is not a taser gun, it is a bazooka--and has the potential to be a very inflationary tool.

Alert: Bernanke Speaks This Afternoon

Fed Chairman Ben Bernanke is scheduled to speak this afternoon on the economic outlook and developments in financial markets.

The Very Clueless New York Times

Today's NYT carries a story reported by Andrew Ross Sorkin, Diana B. Henriques, Edmund L. Andrews and Joe Nocera. It was written by Nocera. There was additional reporting by Jenny Anderson, Nelson D. Schwartz, Eric Dash, Louise Story, Michael M. Grynbaum, Carter Dougherty and Vikas Bajaj.

Written in the style of a cheap paperback thriller, it recounts the recent activity by Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke and other government officials in dealing with the current financial crisis. Yet none of these reporters reported on the key elements behind the crisis. For starters, not a word about the poorly structured balance sheets of the firms in trouble. Simply put, the financial incompetents borrowed short-term and lent out long term--a mismatch of assets and liabilities that was an accident waiting to happen. Properly matched assets and liabilities would have gone a long way toward eliminating the runs on most of the investment banks.

Botching this, the NYT reporting gets worse. They report a ridiculous statement made by Bernanke:

That Thursday evening, however, time was of the essence. In a hastily convened meeting in the conference room of the House speaker, Nancy Pelosi, the two men presented, in the starkest terms imaginable, the outline of the $700 billion plan to Congressional leaders. “If we don’t do this,” Mr. Bernanke said, according to severl participants, “we may not have an economy on Monday.

But fail to point out that while Bernanke is begging Congress for $700 billion, he has authority at the Federal Reserve to buy as much of whatever he wants, whenever he wants. Indeed, when the House failed to pass the bill on Monday, the Fed went in and pumped $630 billion into the system.

Ultimately, this crisis is about the Fed creating an economy dependent on more and more new money pumped into the system, and that the Fed stopped creating new money approximately four months ago. As we warned during the entire period here, here, here, here, here, here, here and here.

Am I justified in calling this the VERY CLUELESS NYT? I think so.

NYT put 11 reporters on this story and they all missed the mismatched balance sheets of the institutions in trouble, they failed to point out that while Bernanke is begging for $700 billion, the Fed can print $700 billion everyday if it wants to, and they failed to point out the immediate cause of the crisis--Bernanke's crashing of the money supply over the last four months.

-Robert Wenzel

McCain Would Fire SEC Chair Cox

Republican presidential candidate John McCain, campaigning in Iowa Thursday, is expected to call for the firing of Securities and Exchange Commission (SEC) Chairman Chris Cox.

In his prepared remarks, Sen. McCain (Ariz.), without naming Cox, said the chairman has “betrayed the public’s trust.”

“If I were president today, I would fire him,” McCain will say, according to his prepared remarks.

This is swatting a gnat while a tiger and lion are headed towards you. McCain doesn't have a clue.

This crisis is a Paulson and his lapdog, Bernanke, operation.

Except for his nonsense about short-sellers, Cox has been incompetently benign during this entire crisis. Incompetently benign in a bureaucrat is not a bad thing.

-Robert Wenzel

"Private Sector Solution to AIG's Situation Is Dead"

CNBC is reporting that a private sector solution to AIG's situation is dead. It looks like some type of government bailout will occur.

This should come as no surprise. We called it a dead deal when it was announced. However, what should come as a surprise (and alarm)is the Fed even asking Goldman Sachs and J. P. Morgan to attempt to raise $70 to $75 billion for AIG in this market.

This is scary in that it shows the Fed has no sensitivity to the markets at all. We repeat, Bernanke is C-L-U-E-L-E-S-S.

-Robert Wenzel

The Morning Ahead

The factors to monitor in the morning are near overwhelming.

To start, we have an FOMC meeting. Will the Fed cut rates?

Henry Paulson is scheduled to testify before Congress in the morning, and later in the day he is scheduled to give a speech at the Brookings Institute about the economy and housing. He is likely to be very cautious at both venues about what he says. Will he by accident trigger more downside action?

Lehman has filed for Chapter 11 and other banks have continued to trade with it. Yet, despite being in Chapter 11, and presumably under court supervision, Lehman continues to push for a shotgun sale of its money management firm, among other assets. How will this activity sit with the bankruptcy judge and other bankers?

The Merrill Lynch acquisition by Bank of America looks shaky. Will the deal still be alive by the end of the day? How tight of an acquisition contract was John Thain able to draw up in such an intense, short term period?

What news will develop from the AIG situation?

How will the markets react to the downgrade of WaMu?

Will the panic in the investment bank arena spread to the two remaining major independent players, Morgan Stanley and, the very well connected, Goldman Sachs? 

How bad will things get overnight in overseas trading?

Have a good nights sleep.

-Robert Wenzel

A Positive From The Crisis: Banks Getting Back To Basics

The current financial crisis is the result of aggressive Fed money printing during the Greenspan era and the early Bernanke era, and the faulty econometric equations designed by "quants".

The quants and their econometric equations will be thrown under the bus. That will not be the fate for Fed Chairman Bernanke. Although it is unclear that Bernanke understands he is exacerbating the crisis by his current slow monetary policy, his slowed monetary policy is producing a needed cleansing of malinvestments caused by the previous money printing. This is the exact prescription that proponents of the Austrian School of economics would recommend. It is unlikely that Bernanke is a closet Austrian, it is more likely that he is clueless.

Thus, the crisis atmosphere will continue as the money growth remains tame. As a bonus, the crisis period is doing wonders for clearing out the bad actors in the banking industry. It is much like a dentist drilling a tooth to remove decay. The pain is no fun, but the result is appreciated. All the decay must be removed before the pain stops. It's likewise for the economy.

Bernanke, of course, will not allow the dentist to complete his work, at some point he will jump out of his chair, spit into the nearby sink, smack the drill out of the dentists hand and start printing money again. At such time, the remnants of decay will remain in his teeth, and it will spread further.

But Bernanke has not yet jumped from his chair and the cleansing period continues, as the WSJ points out in an article about bankers getting back to basics, here.

-Robert Wenzel

It's Time The Fed Adopts Volcker Religion

By Robert Wenzel

Federal officials and market players are struggling with the same issues, WSJ reports.Why haven't the steps taken so far calmed the system? What can policy makers do next?

In our book, the answer is simple. The boom was fueled by the Fed's money printing under Alan Greenspan and the early Ben Bernanke.

As we have been emphasizing in lone wolf fashion--with no regulator or other commentator coming close to mentioning this most important event of the current crisis environment--the Fed over the recent months has for all practical purposes stopped printing money. That's why the market continues to struggle.  The Fed has turned this from just a mortgage crisis, to the beginnings of a major full-fledged economic crisis.

Over the last three months M2 money supply has been growing at a 1.8% annualized rate. This can be compared to earlier this year when M2 annualized money growth was over 10%. In fact, as recently as March, three month annualized money growth was at 12.7%. Few seem to recognize the dramatic shift downward.

A lot of headline watching commentators are even reporting that the Fed is adding gobs of liquidity through their bailout operations, when in fact the Fed has been sterilizing its bailout operations, including the Term Auction Facilities, by either liquidating or loaning out the Treasury securities already in their portfolio.

WSJ reflects current beliefs when it reports:

The Federal Reserve has already slashed interest rates to counteract a deepening credit freeze and instituted its broadest expansion of lending facilities since the Great Depression to keep financial markets functioning.

As mentioned the lending facilities have been sterilized so as not to increase money supply. And we should have learned from the Volcker period that you don't target interest rates to impact the economy, you target money supply. The current Bernanke Fed has seemingly, without being completely aware, slipped into interest rate targeting.

At this point we must add that ideally the Fed shouldn't be monkeying and manipulating the money supply at all, but in realworld economik if the Fed is going to be messing with the money supply, they should be good at it. This means reverting back to Volcker's rejection of targeting interest rates, and instead targeting money supply. In Volcker's case, he targeted money supply to fight inflation, in Bernanke's case, money supply targeting is required to battle economic crisis.

This economy isn't going anywhere until Bernanke gets Volcker "Target The Money Supply" Religion. Failure to do so will lead to an enormous economic crisis which in one sense can be viewed as a cleansing of the mal-investments caused by the money manipulations of Greenspan and Bernanke. However, in the land of realworld economik, the crisis is likely to lead to untold suffocating new regulations, restrictions etc., given that the two current presidential candidates, John McCain and Barak Obama, display no knowledge of the fundamental workings of an economy. 

Robert Wenzel is an economic consultant and Editor & Publisher of EconomicPolicyJournal.com. He can be reached at rw@economicpolicyjournal.com.

Hot Buzz: Government Moves On Fannie, Freddie

It appears that the  goverment is about  to pump capital into Fannie Mae and Freddie Mac, in what is sure to be a near takeover of the two agencies. 

A meeting was held this afternoon at the Federal Housing Finance Agency. Richard Syron CEO of Freddie Mac and Daniel Mudd CEO of Fannie Mae were summoned to it, according to Deborah Soloman and Damian Paletta at WSJ.  Also attending were the Fed's Ben Bernanke and Treasury Secretary Henry Paulson.

Reportedly, Mudd and Syron will be axed as part of the Treasury move.

An announcement could come as early as this weekend.

Specific details of Treasury's plan and specifics of the capital infusion are not yet available. The plan is expected to involve "a creative use" of Treasury's authority, according to WSJ. More than likely common stock shareholders will be crushed, with their shares diluted down to near worthlessness.

It looks like a done deal, more details here.

Insiders Are Ready To Start Bank Buying Binge

Randal Quarles, the ultimate insider,--current managing director of Carlyle Group, former Treasury Undersecretary and former Treasury liaison to the Plunge Protection Team, who, since early in the year, has accurately called the play by play developments in the banking crisis (See Carlyle Group's Plan to Takeover the Banking Industry)-- told Reuters that he expects to see Private Equity start buying into the banking sector before the year is up:

Private equity firms have been eyeing troubled banks and thrifts as investment opportunities as the credit crisis has taken a toll on share prices.

Randal Quarles, managing director at Carlyle Group CYL.UL, one of the world's largest buyout firms with $83 billion under management, forecasts that many of the investments will be minority stakes -- which can be accomplished without dramatic changes in the Fed's rules.

Quarles, previously undersecretary of the U.S. Treasury, said there could be an uptick in investment activity before the end of the year.

"It is going to be hard to raise (capital) in the public markets, particularly for depository institutions," he said. "I think that's going to drive a lot of private equity deals."

Interesting situation, we have a very smart guy in Quarles ready to take the plunge in bank stocks, while we have Bernanke about to the torpedo the entire economy (see Crashing Money Supply Numbers Signal Depression). If Bernanke doesn't start pumping M2 money and if Quarles starts buying without that M2 money pumping, Quarles is going to have his ass handed to him, courtesy of Bernanke.

On the other hand, if Benanke figures out that he has launched a torpedo at the economy, he may actually start printing money again and Quarles will make a fortune.

Stay tuned. We are watching money supply very closely and will report on what we see.

Crashing Money Supply Numbers Signal Depression

It is now clear that Ben Bernanke has no clue as to how to control the money supply.

We have been commenting in recent weeks regarding the slowdown in money supply. It has been growing at approximately 2.5% (M2SA) over the last three months on an annualized basis, earlier this year it was growing at double digit rates. This is a dramatic downturn. The numbers out yesterday show no end to the money growth slowdown, in fact, three month annualized growth (M2SA) has dipped further to 2.2.%.

While there is a lot to be said for a no growth money supply that results in a recession to clear the system, the Fed doesn't believe this and neither does Bernanke. They are eternal money pumpers, who consistently want to prop up the economy and never have a recession. Thus, it is truly bizarre that they would allow money growth to collapse. They simply have their eye on the wrong ball. They are watching the Fed Funds rate and believe they are providing huge amounts of liquidity to the system because of the 2.0% Fed Funds target. But the fact that money supply at this target rate is not climbing suggests that the real interest rates must be lower.

Indeed, the actions of M1 suggest this is exactly the case. Since what is climbing is M1. Three month annualized M1SA is growing at 5.8%. And what is exploding is demand deposit money (a part of M1). Three month annualized demand deposits are growing at 9.5%. This suggests there is huge fear in the system, and depositors prefer keeping their money in demand deposits as opposed to M2 components such as saving accounts and retail money market funds, which are displaying no growth. Clearly, this situation tells you that depositors prefer what they perceive is safety over yield.

Only a much lower interest rate would reverse the current situation, or perhaps non-sterilized loans and purchases of bank collateral provided by those using the Term Auction Facility. If this isn't done soon then the economy and stock market will worsen by leaps and bounds, including a major eye opening stock market crash.

LaTi: Osama bin Laden Caused the Mortgage Crisis

That's what the Los Angeles Times wants you to think.

LaTi takes readers on a wild ride this morning.

First LaTi tells us that the FBI saw the threat of the mortgage crisis:

Long before the mortgage crisis began rocking Main Street and Wall Street, a top FBI official made a chilling, if little-noticed, prediction: The booming mortgage business, fueled by low interest rates and soaring home values, was starting to attract shady operators and billions in losses were possible.

"It has the potential to be an epidemic," Chris Swecker, the FBI official in charge of criminal investigations, told reporters in September 2004. But, he added reassuringly, the FBI was on the case. "We think we can prevent a problem that could have as much impact as the S&L crisis," he said

Of course, the mortgage crisis is a lot worse than a few bad brokers. The FBI may have spotted some bad seeds moving into the mortgage brokerage industry, but they always move into the hot areas. They are probably operating in the homeland security sector, now. The real criminals were the money pumpers, Greenspan and Bernanke.

But Lati wants us to think it was a few morally challenged brokers, so they proceed:

In 2007, the number of agents pursuing mortgage fraud shrank to around 100. By comparison, the FBI had about 1,000 agents deployed on banking fraud during the S&L bust of the 1980s and '90s...

The tepid response reflects a broad realignment of law-enforcement priorities at the Justice Department in which mortgage fraud and other white-collar crimes have been subordinated to other Bush administration priorities...

Of course, the new priorities are to snoop on Americans to see if any are candidates for waterboarding. So we end up with the resource and priority challenged FBI, going after the morally challenged brokers

Absent a major shift in priorities and resources...it is likely that the Justice Department and the FBI will continue on their current path of focusing on simple cases...

What does Lati want us to think other than it is all Osama bin Laden's fault, causing the reassignment of agents that were responsible for protectng us against the mortage crisis?

It's a nutty theory, but when you don't know basc economics, that's what you get.

Fireworks at Jackson Hole: Buiter Let's It Rip

At the Jackson Hole, Wyoming Federal Reserve conference, London School of Economics professor and former Bank of England and European Bank for Reconstruction and Development official, Willem Buiter, ripped into the manner in which the Federal Reserve, the European Central and Bank of England have handled the current financial crisis. His remarks were particularly critical of the Federal Reserve claiming the the Fed is too close to Wall Street:

Cognitive regulatory capture of the Fed by Wall Street resulted in excess sensitivity of the Fed not just to asset prices (the ‘Greenspan- Bernanke put’) but also to the concerns and fears of Wall Street more generally.

The Fed listens to Wall Street and believes what it hears. This distortion into a partial and often highly distorted perception of reality is unhealthy and dangerous.

He charged that all three banks went well beyond what was necessary to stabilise the financial sector:

All three central banks have gone well beyond the provision of emergency liquidity to solvent but temporarily illiquid banks. All three have allowed themselves to be used as quasifiscal agents of the state, providing subsidies to banks and other highly leveraged institutions, and assisting in their recapitalisation, while keeping the resulting contingent exposure off the budget and balance sheet of the fiscal authorities. Such subservience to the fiscal authorities undermines the independence of the central banks even in the area of monetary policy.

He listed three factors contributing to the Fed's poor performance in handling the crisis:

[T]hree factors contribute to Fed’s underachievement as regards macroeconomic stability. The first is institutional: the Fed is the least independent of the three central banks and, unlike the ECB and the BoE, has a regulatory and supervisory role; fear of political encroachment on what limited independence it has and cognitive regulatory capture by the financial sector make the Fed prone to over-react to signs of weakness in the real economy and to financial sector concerns.

The second is a sextet of technical and analytical errors: (1) misapplication of the ‘Precautionary Principle’; (2) overestimation of the effect of house prices on economic activity; (3) mistaken focus on ‘core’ inflation; (4) failure to appreciate the magnitude of the macroeconomic and financial correction/adjustment required to achieve a sustainable external equilibrium and adequate national saving rate in the US following past excesses; (5) overestimation of the likely impact on the real economy of deleveraging in the financial sector; and (6) too little attention paid (especially during the asset market and credit boom that preceded the current crisis) to the behaviour of broad monetary and credit aggregates.

All three central banks have been too eager to blame repeated and persistent upwards inflation surprises on ‘external factors beyond their control’, specifically food, fuel and other commodity prices. The third cause of the Fed’s macroeconomic underachievement has been its tendency to use the main macroeconomic stability instrument, the Federal Funds target rate, to address financial stability problems. This was an error both because the official policy rate is a rather ineffective tool for addressing liquidity and insolvency issues and because more effective tools were available, or ought to have been. The ECB, and to some extent the BoE, have assigned the official policy rate to their price stability objective and have addressed the financial crisis with the liquidity management tools available to the lender of last resort and market maker of last resort.

It is difficult to argue with Buiter on these points. Indeed, the Fed's reliance on the Fed Funds rate target as its chief monetary tool is currently ignoring the fact that there is little growth in the money supply. Ignoring money growth is also a charge Buiter makes of the Fed: "too little attention paid...to the behaviour of broad monetary and credit aggregates."

Unfortunarly, reports out of Jackson Hole suggest that rather than take Buiter's critque to heart and learn from it, members of the Fed and others have chosen to attack the analysis:

Fed Governor Frederic Mishkin said Buiter's paper fired ``a lot of unguided missiles,'' and former Vice Chairman Alan Blinder ``respectfully disagreed'' with his analysis of the central bank's crisis management.....Mishkin lashed out against Buiter's assertion that the Fed's rate reductions may cause higher consumer prices.``I wish he had actually read some of the literature on optimal monetary policy, because it might have been very helpful in this context,'' said Mishkin, who collaborated with Bernanke on inflation research in the 1990s. Mishkin, a leading advocate of the Fed's effort to sustain economic growth through rapid rate reductions, said research shows that ``what you need to do is act more aggressively.''

2007 Bernanke versus 2008 Bernanke

Paul Kedrosky created word clouds for Ben Bernanke's 2007 and 2008 speeches in Jackson Hole. Here are the results. The larger a word appears the more often that word was used:

2007 Bernanke Speech

2008 Bernanke Speech


As Kedrosky notes, it's pretty obvious that Bernanke's focus has moved from concern about the housing market to concern about the financial system. Note that "inflation" finally makes an appearance, although tiny, in 2008. Also note the heavy use of regulators and regulation in 2008.

The Curious Beliefs On Current Monetary Policy: A Depression Warning

As we pointed out below, Fed chairman Bernanke believes the Fed is currently conducting an easy money policy.This despite the fact that as recently as Mar.2008 three month annualized money growth (M2) was climbing at annualized rate of 12.6%, but has since collapsed to the point where as of Aug. 21 three month annualized money growth (M2) is increasing at only a 2.5% annualized rate.

This is simply a remarkable drop in money growth that will lead to a depression, if not reversed.

It can be argued that a halt to money growth pyrotechnics is a good thing, and we would concur that the end to money supply manipulations by the central bank can be a positive if it is adopted as a long term attempt at stable monetary policy. However, the clueless nature of the current slowdown in money growth could lead to a depression whereby radical government policies are adopted to "cure" the recession. Such new polices are apt to further stifle the economy and prolong any downturn by years.

Thus, Bernanke's misunderstanding of current money supply policy is shocking. More shocking is that many other economists, if not most, hold this inaccurate belief. In today's WSJ, economist Gerald O'Driscoll warns of potential inflation and writes that "Now Fed Chairman Ben Bernanke has decided to try to... spend the Fed's reputational capital on an easy credit policy."

They hold this inaccurate belief because interest rates are low. Generally, such low rates would result in huge money increases. However, if real interest rates are lower than fed fund rates, which appears to be the current case for no-risk government securities, money growth will not occur.

If this policy is not soon reversed, we repeat, we are headed for a depression. It will make the current housing crisis look like boom times.

Ben The Blind

In a truly remarkable speech at the Federal Reserve Bank of Kansas City's Annual Economic Symposium at Jackson Hole, Wyoming, Fed Chairman Ben Bernanke demonstrated cluelessness across the spectrum of his remarks.

Let start at the top. Bernanke says:

The Federal Reserve's response to this crisis has consisted of three key elements. First, we eased monetary policy substantially, particularly after indications of economic weakness proliferated around the turn of the year. In easing rapidly and proactively, we sought to offset, at least in part, the tightening of credit conditions associated with the crisis and thus to mitigate the effects on the broader economy. By cushioning the first-round economic impact of the financial stress, we hoped also to minimize the risks of a so-called adverse feedback loop in which economic weakness exacerbates financial stress, which, in turn, further damages economic prospects.

Although the Fed has cut interest rates, this is not easing monetary policy. Easing monetary policy occurs when, well, money growth policy is eased. In the last three months, money supply growth, far from being eased, has collapsed. From double digit money supply growth earlier this year, the money growth over the past three months has grown at a remarkably slow 2.5% annualized rate.

For Bernanke to say monetary policy has eased he seemingly must not be aware that money supply growth has slowed to a trickle, that the Fed has sterilized the bailouts it has conducted by selling or loaning out Treasury securities, and that in the face of the current financial crisis the real interest appears to have collapsed which is behind the fact that, despite Fed interest rate cuts, money supply has not grown.

Bernanke also speaks on the Bear Stearns collapse:

The collapse of Bear Stearns was triggered by a run of its creditors and customers, analogous to the run of depositors on a commercial bank. This run was surprising, however, in that Bear Stearns's borrowings were largely secured--that is, its lenders held collateral to ensure repayment even if the company itself failed. However, the liquidity of markets in mid-March was so severe that creditors lost confidence that they could recoup their loans by selling the collateral. Many short-term lenders declined to renew their loans, driving Bear to the brink of default.

Clearly, something else was going on with Bear Stearns, given the fact that, as Bernanke points out, Bear's securities were collateralized. Either Ben isn't capable of drawing the conclusion from these facts that the Bear collapse appears to have been orchestrated, most likely by Treasury Secretary Paulson. Or he was in on the game and is now just blowing smoke, or he has chosen to stick his head in the sand on this one.

Bernanke also tells us that there is consideration as to whether the Fed should supervise the entire financial system:

Going forward, a critical question for regulators and supervisors is what their appropriate "field of vision" should be. Under our current system of safety-and-soundness regulation, supervisors often focus on the financial conditions of individual institutions in isolation. An alternative approach, which has been called systemwide or macroprudential oversight, would broaden the mandate of regulators and supervisors to encompass consideration of potential systemic risks and weaknesses as well.

At least informally, financial regulation and supervision in the United States already include some macroprudential elements. As one illustration, many of the supervisory guidances issued by federal bank regulators have been motivated, at least in part, by concerns that a particular industry trend posed risks to the stability of the banking system as a whole, not just to individual institutions. For example, following lengthy comment periods, in 2006, the federal banking supervisors issued formal guidance on underwriting and managing the risks of nontraditional mortgages, such as interest-only and negative amortization mortgages, as well as guidance warning banks against excessive concentrations in commercial real estate lending. These guidances likely would not have been issued if the federal regulators had viewed the issues they addressed as being isolated to a few banks. The regulators were concerned not only about individual banks but also about the systemic risks associated with excessive industry-wide concentrations (of commercial real estate or nontraditional mortgages) or an industry-wide pattern of certain practices (for example, in underwriting exotic mortgages). Note that, in warning against excessive concentrations or common exposures across the banking system, regulators need not make a judgment about whether a particular asset class is mispriced--although rapid changes in asset prices or risk premiums may increase the level of concern. Rather, their task is to determine the risks imposed on the system as a whole if common exposures significantly increase the correlation of returns across institutions.

Of course, Bernanke may tout some supervisory guidance in 2006, but the fact of the matter is that in 2004, New York Federal Reserve economists Jonathan McCarthy and Richard W. Peach wrote a paper, Is There A Bubble in The Housing Market Now? Their answer was decidedly, "No". The Fed is not God, the solution to the financial crisis is not more supervision, it should be less supervision. The more alternatives and creative routes people take, the less likely that we will see the huge macro-collapses of the current day where regulators funnel all players in the same direction.

In conclusion, from all possible angles Bernanke is missing key points. His monetary policy is driving the economy toward a huge economic crisis, which in itself would not be a bad thing, if the economy would be allowed to adjust from the crisis period in a laissez faire manner and wipe out previous malinvestments. However, Bernanke and other government operators are apt to step in with new regulations that will cause things to go from very bad to even worse.

This is all simply very alarming.

Alert: Fed Chairman Bernanke Speaks at Jackson Hole, Thursday

Each year since 1978, the Federal Reserve Bank of Kansas City has sponsored a symposium on an important economic issue facing the U.S. and world economies. Symposium participants include prominent central bankers, finance ministers, academics, and financial market participants from around the world.

Fed Chairman Ben Bernanke speaks Thursday at the symposium.