FedUpUSA

Archive for April 27th, 2010

Bernanke Is Getting Scared….

Posted by Karl Denninger

You have to love this sort of utter claptrap…

“Achieving long-term fiscal sustainability will be difficult, but the costs of failing to do so could be very high,” Bernanke said in remarks prepared for a speech today to a White House commission on the budget deficit. “Increasing levels of government debt relative to the size of the economy can lead to higher interest rates, which inhibit capital formation and productivity growth — and might even put the current economic recovery at risk.”

Really Ben?

We need to review a few graphs again.

Let’s start with this one:

This is the true deficit, measured simply by the amount of Treasury debt (including intergovernmental games) outstanding.

Of note is that it has never decreased materially since 2001.

Why is this important?  Because every dollar that the government borrows and spends is one dollar that pulls forward demand from tomorrow and spends it today.

This game continues, as it did in the housing market, right up until you can’t get any more credit to do it with. 

But more importantly as you put forward this sort of distortion in the market the economy becomes habituated to that deficit spending and incorporates it into GDP!

This then turns that deficit spending into a mandate on an ongoing basis lest you have a recession – or worse.

Now let’s look at how big that distortion has become, as a percentage of GDP:

This is where your problem begins.  While government deficits have varied over time, during the 2000 decade they became both embedded in the economy and at a high and continuing level of about 4-5% of GDP.

That is, the so-called “recovery” in 2003-2007 was false; it did not consist of organic demand from the marketplace, but rather it consisted of government’s fraudulently inflated demand.

Contrast this with the 1990s when private demand rose fast enough that the government was able to slowly withdraw stimulus via deficit spending, to the point that it actually approached zero!  That’s REAL economic growth.

But now we’ve gone even further, and in the last two calendar years have put up nearly 10% and nearly 12% of GDP distortions, respectively.  Let me remind everyone that in the world of economics a 10% economic contraction is the formal definition of economic Depression; ergo, we have been in one for the last two years and are today!

The Obama administration estimates budget deficits will total $5.1 trillion over five years and hit a record $1.6 trillion in the year ending Sept. 30. The $1.4 trillion deficit in 2009 was equal to 9.9 percent of gross domestic product, the largest share since the end of the World War II.

Bernanke spoke to the National Commission on Fiscal Responsibility and Reform, established by President Barack Obama to identify policies to reduce the deficit to a sustainable level. The commission’s mandate is to propose a plan to balance the budget, except for interest payments on debt, by 2015.

That cannot happen without the economy undergoing the very adjustment in matching of output and final private demand that the government has spent ten years trying to avoid.

This is the ugly truth that Bernanke doesn’t want to speak of, but he knows it to be true.  But neither he, nor the government budget folks, are willing to come out and tell the people the truth – since 2003 we have managed to compound a 58% distortion to our $14 trillion GDP!

To say that the adjustment occasioned by withdrawal of that support would be catastrophic would be the understatement of the year.  We never got anywhere near this level of distortion in the 1920s and 30s – the distortion reached about 25%, top to bottom.  The adjustment produced what we call The Great Depression.

Let me be clear: We have a $14 trillion economy that has accumulated a fifty eight percent net deficit, or more than double the distortions that had to be absorbed in the 1930s.

It is obvious that sudden withdrawal of that support would lead to an instantaneous and catastrophic economic collapse.

If you’re wondering why I have spent three years arguing strenuously against the policies that our government adopted to try to “stem” the crisis, you now should understand – we are now absolutely dependent on the ability to maintain this level of distortion and will be able to withdraw it only slowly, if at all.

Any event that causes us to have to withdraw it suddenly WILL RESULT in the loss of our economy and republic.

This is not speculation – it is hard mathematical fact.

The risk taken on by those who promulgated and adopted these policies is criminally negligent.  Of course since the actors who did so work for the Federal Government criminal negligence isn’t punishable as it’s not a felony to do this as a government employee, even though such acts in the private sector certainly are punishable.

This is the precise set of actions that has led Greece to find itself in the box it is now in.  Portugal is headed down the same road, as is Spain, Ireland and Italy.  All five are at risk of economic collapse.

We are inexorably headed for the same result if we do not accept the economic adjustment that is necessary to bring both private demand and GDP into balance.

There are means available to massively stimulate private demand but none of them include federal deficit spending.  I have covered some of these in the past, including my particular favorite, adoption of The Fair Tax.  Sadly such real reform is radically and diametrically opposed by the interests in Washington DC as doing so removes the tax system as a means of social engineering, control, and corporate lobbying.

Ben Bernanke has reason to be “concerned”, as he notes.

In truth, ladies and gentlemen, he is not “concerned” – he is terrified.  He, like I, is well-aware of the above graphs and facts, and since he knows how to use a calculator (or even a paper and pencil) he also knows the extent of the economic distortion that has been built up over nearly a decade of borrow and spend politics.

Our opportunity to solve this problem will expire, and as Greece has discovered that expiration is likely to come with little or no warning, and once it arrives there will be no real options available to us that avoid a disorderly economic collapse.

Much postulation in the past couple of months about how ‘bond market vigilantes are dead.’  I think those that believe that ought to ask the governments of Greece, Portugal and Ireland.  The cost for funding their ever-increasing debt is going parabolic.

Greek 10-year bond maturing May 19th now trading with a yield of 26% according to Bloomberg.

I’m pretty sure I have a credit card with less than 26% interest. 

Greek 2-year bond at 14.7%.

Greece Bondholders to Face ‘Significant’ Losses, Citigroup Says

April 27 (Bloomberg) — Greece is likely to default or inflict “significant” losses on bondholders unless it receives more generous terms on its planned aid package, according to Willem Buiter, chief economist at Citigroup Inc.

Suffering Greek Contagion Pressures EU Bonds

Portugal risks becoming the new Greece.

With a higher debt burden and a slower 10-year growth rate than Greece, Western Europe’s poorest country is being punished by investors as the sovereign debt crisis spreads. The risk premium on Portuguese bonds rose to more than double the past year’s average this month. Portugal’s credit default swaps show investors rank its debt as the world’s eighth-riskiest, worse than for Lebanon and Guatemala.

Meanwhile, the Greek stock market seems to be having a bit of trouble today.  As of this writing, down over 6% on the day.

ATHEX

I’m sure it’s all contained though….like subprime….

h/t Padrino

UPDATE  11:26 AM ET:

Well, goodness, that didn’t take long:

GREECE SOVEREIGN CREDIT RATINGS CUT TO JUNK BY S&P

S&P CUTS PORTUGAL RATINGS TO ‘A-/A-2′; OUTLOOK NEGATIVE

On Our Rotten Financial System

Posted by Karl Denninger

So today Goldman will come before the Senate Permanent Committee on Investigations – with Lloyd himself, along with “Fabulous Fab” on the witness panel.

Blankfein’s prepared testimony makes some interesting claims:

“We didn’t have a massive short against the housing market, and we certainly did not bet against our clients,” Blankfein says in prepared remarks released by the company. “Rather, we believe that we managed our risk as our shareholders and our regulators would expect.”

Uh, Lloyd, are you sure?

Carl Levin, a Michigan Democrat who leads the Senate’s Permanent Subcommittee on Investigations, released documents that he said showed the company “put its own interest and profit ahead of the interests of its clients,” a conflict he called on Congress to end. Lloyd Blankfein, Goldman Sachs’s chairman and chief executive officer, will dispute that assertion and argue the firm was merely managing its own risk.

Yep. 

It’s amusing how Goldman claims it “lost money” on some of these deals.

So what?

The question is not whether there were residual pieces of trash that Goldman wound up (unwillingly) eating when they couldn’t sell them.  The question is whether or not Goldman (and everyone else) should have had the ability to put these deals together in the first place, and how it came to be that trillions of dollars of alleged “AAA” paper was better suited for use in the men’s bathroom stalls!

Levin said:

“This market is not free until it is free of self-dealing and until it is free of conflict of interest,” Levin, 75, said at a press briefing yesterday. “It is not free until it ends the gambling operation that results in gambling debts that the public ends up paying.”

That can’t happen until we see handcuffs Senator. 

“The SEC and the courts will resolve the legal question of whether Goldman’s actions broke the law,” Levin said. “The question for us is whether Goldman’s actions in 2007 were appropriate and whether we should act, legislatively, to bar similar actions in the future.”

17 pages Senator.  They’re called “Glass Steagall”, and that law absolutely barred the conduct that led to and caused this crisis.

Let’s be frank: Creating these sorts of toxic deals is, for these institutions, simply a reach for fees.  They don’t care if they perform so long as they don’t get stuck with the trash.  A particular transaction was even referenced as “one shi&&y deal” by Goldman employees, according to some internal emails:

“Boy that timberwo[l]f was one shi**y deal,” Montag, who is now Bank of America Corp.’s president of global banking and markets, said in a June 22, 2007, e-mail to Daniel Sparks, who ran Goldman Sachs’s mortgage business at the time, according to the panel’s statement. Within five months of Timberwolf’s debut, the CDO had lost 80 percent of its value, and it was liquidated in 2008, according to the panel.

The CDO was among securities that Goldman Sachs sold to clients after deciding the New York-based firm needed to reduce its mortgage holdings, Carl Levin, a Michigan Democrat who leads the panel, said in the statement. Chief Executive Officer Lloyd Blankfein and six other current and former executives will testify tomorrow in front of the panel about practices in mortgage securities markets before they collapsed.

And of course such conduct, and the people who commit it, aren’t fired.  Mr. Montag is now Bank of America’s president of Global Banking and Markets.  “Market discipline” doesn’t, it appears, extend to forcing people to eat their own cooking and when they sell things they know smell like dead fish to clients, it’s all ok.

Perhaps it is under the law, but whether it should be is another matter.

It is often argued that if we don’t permit this sort of “innovation” that our economy and businesses will suffer.  Really?  Who suffers?  Wall Street?  Can we reasonably have an economy where 1/3rd of all profits made in the nation are “earned” by asset-stripping other people?  That’s what even the good deals do – they turn over a part of the transactional flow of some business to the wall street banks, which then keep it for themselves. 

The bad deals, like this one referenced, are even worse in that they siphon off fees from someone who later loses all their money!

This is not restricted to Goldman, by the way.  Indeed, let’s examine another deal that the government was intimately involved in, this first reported by Zerohedge in the form of the Fannie Mae Preferred offering that was foisted on the market just weeks before the firm blew up.

The underwriters, who coincidentally received 3.15% of $2 billion, or $63 million bucks, include Merrill Lynch (now absorbed), Citibank (rescued), Morgan Stanley, UBS (who has a running spat with the IRS about assisting Americans in illegally evading taxes) and Wachovia (which collapsed in a ball of fire that was contained only by forced marriage to Wells Fargo.) 

Why was this deal so insanely toxic?  It was issued on May 19th of 2008, and paid exactly one coupon before Fannie was absorbed into conservatorship. 

And unlike the “sophisticated investors” who bought CDOs and other similar trash from the big banks, this deal was bought by literal widows and orphans, along with community banks.

I would argue that it should have never been brought to the market in the first place, as before it was offered I had opined (in public in fact) that Fannie and Freddie were both insolvent.

Indeed, on March 8th of 2008 I called out the games in a letter written to President Bush and others in which I said (among other things):

Mr. Bernanke and The Fed have lowered the Fed Funds Target from 5.25% to 3% over the last few months and the “slosh”, or free funds available in the Fed Banking System, has nearly doubled over that time. Yet this additional liquidity has done nothing to address the problem and won’t because the issue is not one of inadequate liquidity; rather it is a desperate move to hide the fact that a significant number of financial institutions in our nation are, if forced to mark all their paper to the market and recognize their exposure to off balance sheet vehicles, insolvent.

At the root of the matter, Mr. President, is a lack of trust caused by the intentional acts of these institutions, and lack of regulatory enforcement by both the Federal Reserve and other agencies such as the OTS and OCC.

We have fixed exactly nothing since then.  We have only papered over the insolvencies with government fiat currency, claiming they’re “loans” – and they are in a sense – they’re forced purchases of bankrupt companies by the taxpayer which we are now liable for.

Wall Street created this monster with the full knowledge and permission of the government. 

Despite laws prohibiting executives from signing off on fraudulent financial statements – that is, any financial statement that does not make a full and fair exposition of the firm’s financial position (Sarbanes-Oxley) these executives have not been prosecuted.  “I didn’t know” is not a defense under Sarbox – if you’re in the executive suite of a public firm you have an affirmative duty to know. 

So why have not the former CEOs of Bear Stearns and Lehman been indicted?  Why have not the CEOs of the other big banks that failed, all of whom proclaimed that everything was fine right up until they blew sky high? 

As for all these hinky deals that the big banks did, if this crisis has taught us one thing it is that if there’s a way to game a rule or regulation it will be gamed.  So long as these firms can find a way to play “heads we win, tails taxpayers lose” they will do so.  So long as they can effectively force companies to forfeit 30% of every dollar of GDP produced in this nation to them, they will do so.

So long as firms with access to federal assistance of any sort, whether it be The Fed window, overnight repo loans from or by firms with Fed Clearing access, or the privilege of deposit-taking and fractional loan-making exists, these firms will leverage government-provided backstops to their own benefit for the purpose of fee extraction. 

These fees do not benefit society as a whole.  They are in fact a tax on top of all other taxes that firms and thus individuals pay.  This burden is, today, roughly 30% of GDP, and our nation and its economy simply cannot afford to redirect this vast amount of wealth to a handful of rich and powerful people on Wall Street, whether their acts are founded in illegal conduct or not.

17 pages Senator.  That’s all it takes.

Reinstate Glass-Steagall and force all these banks to spin off the parts of their organizations that are in conflict.  All institutions that want access to any sort of public safety net, whether it be Fed Discount loans or FDIC insurance may not trade in or on the securities and insurance markets – OTC or otherwise – period.

Force all instruments onto a public exchange, including all CDS, without exception.  This immediately forces nightly margin supervision which prevents the sort of detonations that happened with AIG and others, and absolutely bars contagion, as no firm can maintain a position that it cannot back with capital.

It is often said that if we do this firms will “flee” to other nations that don’t have such restrictions.  No they won’t – not if we refuse to grant them access to our securities markets and the firms in them unless they comport with these rules worldwide no matter where they are headquartered. 

America is a vast economy.  Yes, China is growing, but we’re still a plurality of world GDP. 

Firms will threaten Senator, but if the law is crafted such that if they want access to our markets in any form or fashion they must comply worldwide with separation of function and exchange clearing, they will comply.

Yes, they’ll make “less money”, and that’s their argument against such changes. 

But let’s be frank – every dollar Wall Street “makes” it in fact extracts.  That is, Wall Street creates nothing.  It siphons off capital from other production – that’s all it can do, since it creates not one car, television, or cellular phone.  Indeed, every dollar of fees extracted by Wall Street and every dollar of interest paid to those firms is one dollar that cannot be returned to the economy in the form of innovation for the production of goods and services.

The essential functions of clearing payments and matching those who wish to loan capital with those who wish to borrow it is ministerial.  All the hinky deals alleged to “spread risk” have now been proved to do no such thing, but instead are complex simply so as to be difficult to understand and thus easy to intentionally misprice. 

That mispricing is fraud Senator, whether it can be legally labeled as such or not, and until we put a stop to it we will continue to have these bouts of crisis, each worse than the last.

Our government and society cannot withstand another banking system attack run, and it is imperative that The Senate, along with prosecutors, put a stop to it both through legislation and prosecution.

We have one last chance to stop it.  If we do not at this time do so, and another ”market failure” occurs, our economy and even our political system – that is, our society and republican form of government – will fall.

Those are the stakes, and the question before you now is whether the bribery that is rampant in Washington (although we call it “lobbying”) will win, or whether you will rise to the occasion and uphold the oath of office that you, along with every other member of Congress, took before being seated.

FT Buries the Lede on Ex-SEC Officials and Goldman

By Ryan Chittum

I did a double-take this weekend while reading the Financial Times.

The paper put out a story headlined “Handling of Goldman case under attack” that said “several former high-ranking SEC officials”—almost all of them unnamed—were bashing the SEC for charging Goldman Sachs (an Audit funder) in the Abacus scandal.

Which is pretty revealing if you think about it, but not in the way the FT intended. Here’s its lede:

The high stakes legal confrontation between the US Securities and Exchange Commission and Goldman Sachs has been mishandled by both sides and probably should have been avoided, former high-ranking SEC officials told the Financial Times.

So ex-SEC dawdlers don’t like confrontation and say the SEC should have sought a settlement, presumably for pocket change like the one Judge Rakoff rejected—and one that would avoid airing Goldman’s dirty laundry.

But it’s worse than that, because look at how the FT describes these eight ex-officials (emphasis mine):

“I think the case will come back to bite the SEC. Goldman is really struggling and something awful could happen,” said one former top official who, like most of those interviewed, asked for anonymity because their employers either work for Goldman or are being probed by the SEC.

You just have to chew on that one for a minute. We’ve heard talk of regulatory capture, but this one of the best examples I’ve seen of how it works.

And it’s a bad case of missing the real story. The FT stuffs that info in the seventh paragraph and doesn’t flesh it out at all.

Somebody ought to take a stab at it.

Readers of FedUpUSA knew what the rest of America is about to find out:  Health Care was NEVER about health.  It was always about tax revenues.

SP Futures Daily Chart

The Federal Reserve and the Administration seem intent on creating another bubble, or rather reflating an old one in US dollar heavy financial assets, in order to prolong the mother of all bubbles, the credit in US dollars bubble.

They are doing it selectively, with the banks carefully apportioning the excess liquidity into financial assets held by a relatively fewer amount of Americans who own stocks, while savers are heavily penalized.

When the credit bubble begins to totter things will become quite chaotic, and the panic this next time around may be terrific, dwarfing that so-easily forgotten repentance and regret of 2007-8. More than panic: hysteria.

I think it is now too late for a real reform. The Democrats have squandered their mandate from the people, and the Republicans are crony capitalists marching in lock step with the Banks, who seem to be in control once again. But I could be mistaken, and would be glad if I am.

When the US dollar and economy roll over it will make quite a wave that will swamp many boats. But these things take time. Once they start to happen, it moves slowly at first, but then gains a momentum and becomes almost unstoppable.

I am not quite sure how much water the USS Leviathan has already taken on, and how big the hole might be. But I firmly believe that the iceberg has been struck, the damage done, and the process has begun. The lifeboats are being quietly provisioned and reservations taken for the officers and crew, and the upper decks.

Again, these things take time, and there is always hope until the end. But there is less and less that can be done as the process continues to unfold, with no serious repairs, and only distractions for the passengers, and encouragingly false announcements, from the bridge.