(OT) US Fed to "Taper" QE by $10 Billion, Stock Market Soars

The quantitative easing (QE) that was started in September 2012 will continue at $75 billion a month, instead of $85 billion.

Much like the federal budget forged by GOP's Paul Ryan and Dem Senator Patty Murray, which does nothing of actually reducing deficit but only reducing the rate of deficit increase.

After the initial plunge on the FOMC announcement, the US stock market swung the other direction and ended the day at all-time high (Dow, S&P500):

As yet another sign of great "recovery", the mortgage application plunged to the 13-year low (from Zero Hedge):

Bullish for the stock market!

The Bernanke Fed said:

Reflecting cumulative progress and an improved outlook for the job market...

Cumulative progress of 0.1% taking from 99.9%, and an improved outlook for the job market expressed by the lower unemployment rate, because they stop counting people whose unemployment benefit has run out even though they are still looking for jobs.

The unemployment rate is set to dramatically fall next year, as the Ryan-Murray budget deal is making sure of it by cutting the extended unemployment benefit beyond 26 weeks.

Bullish for the stock market! Just keep buying the risk assets, as almost all bearish investors have thrown in the towel. Even people like Hugh Hendry, who is effectively saying, "Nothing matters but trends."

Japanese yen has turned even lower against US dollar, at 104 yen per dollar. Hello more carry trade.

Nikkei futures (in yen) to 15,895, more than 300 points higher than Wednesday's (Japan time) cash close (15,587):

Economically ignorant Prime Minister Abe (just like his US counterpart) will exclaim, "See, my Abenomics is working!"

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Case Against Ben Bernanke

Big Ben Bernanke's Senate confirmation hearing has started.

I am not too thrilled to have him around any longer, or for that matter to have the Federal Reserve.

This is the person who proclaimed there was no housing bubble. Bernanke insisted that the subprime mortgage problem was contained and there would be no spill-over into other mortgage types. Into a broader economy? Of course not, are you kidding? He insisted that banks had a credit/liquidity problems and nothing more, while all along it was a solvency problem. He told the Congressional leaders that unless they gave him and buddy Paulson $700 billion the world would collapse and cease to exist, and then yanked the liquidity from the struggling financial market which facilitated the fantastic tanking of global stock markets and then economies, as some speculated.

After the crash of the stock market and credit market, he proceeded to double the balance sheet of the Federal Reserve supposedly to help the economy recover. The economy at large has done no such thing, decidedly not because of the money thrown by the Fed. Bulk of Bernanke's money went to the nation's biggest commercial banks (including hastily converted banks like Goldman Sachs and Morgan Stanley, and a host of insurance companies and credit card companies), who simply parked the money at the Fed as "excess reserves".

By the Fed's own admission, that excess reserves were not meant to be loaned out from the beginning when the Fed started buying up assets other than Treasury bills/notes/bonds last fall. The Fed immediately started paying interest on the excess reserves so that the banks would keep the money at the Fed. It has been the Fed's policy that the excess reserves be kept at the Fed. New York Fed has even produced a research paper discussing why banks are holding so many excess reserves. The Fed needed the money there on the Fed balance sheet so that they could justify the ballooning asset portfolio of agency bonds (that no one else wants) and agency MBS (that no one else wants), commercial papers, corporate bonds, whatever else they took in as collateral, even a shopping mall and a hotel chain.

He claims it is important for the Fed to be "independent" from meddling politicians but if you look at his institution's balance sheet it is full of fiscal policy items to expressly assist the government: monetization of the government debts through open market operations; buyer of last resort for agency bonds and MBS in order to lower the mortgage rates; various lending programs to help financial firms. Definition of "financial" seems pretty broad, as John Deere, a tractor company, issued bonds with FDIC debt guarantee program, which is supervised by the Federal Reserve.

In this administration, just like the previous one, incompetency is to be rewarded. So I have no doubt that he will be confirmed for his second term. Never mind that only 21% of likely voters support his confirmation, according to Rasmussen. But when have the general public counted for anything to the politicians, other than to collect taxes from?

(Zero Hedge's poll is even worse. Only 11% think he should be reappointed.)

I am still wondering why Bernanke wanted the second term so badly. I guess it's the face issue. His predecessor, Alan Greenspan, had the job for 19 years. Paul Volcker had 8 years. A one-term Fed chairman who presided over the worst stock market and economic collapse since the Great Depression doesn't look too good on his resume.

(I would much like to see him as the last chairman of the Fed.)

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Bernanke's Town Hall Meeting

A town hall meeting sponsored by the Federal Reserve?? I've never heard such a thing, how about you? It actually happened on Sunday, in Kansas City, Missouri.

The Fed Chairman in a town hall meeting. What was he selling?

Bernanke: Economy to bounce back stronger
(7/26/2009 CNN Money)

"NEW YORK (CNNMoney.com) -- Federal Reserve Chairman Ben Bernanke said Sunday that lessons learned from the recession and the financial crisis will help make the economy stronger than it was before the crisis.

"The Fed chairman answered questions from members of the public as well as moderator Jim Lehrer of PBS at a town hall event sponsored by the Federal Reserve Bank of Kansas City, Mo.

"The silver lining in this whole thing is that people are starting to save more, since they saw what happened with 401(k) investments," Bernanke said. "People are adopting good habits, so not only will we will be back on track, but the economy will be stronger than it had been before this started."

Hmmmm, do I see a semi-visible hand of the Fed's new lobbyist from Enron?

Bernanke says the economy will be stronger. How? He doesn't say. Just fluffy and vague words to allay vague fears by the mass: Things happen, but this, too will pass.

"Facing questions from many concerned consumers, Bernanke sought to assure the audience by noting that "recessions happen." Though he said this is the worst recession since the Great Depression, he also said that, like all prior economic downturns, this one will end too.

"Bernanke said the economy is beginning to show signs of improvement, but recovery will be gradual. He said gross domestic product will likely rise by the end of the year into 2010, but job growth will lag. He conceded, "economic forecasts make weather forecasts look like physics," but said unemployment will top out above 10% before falling back in the second half of next year."

All he could offer is that the economy has recovered from recessions before, so it will recover someday from the curent one. And we are supposed to breathe a sigh of relief?

But the real purpose of this silly exercise (town hall meeting) is not to discuss the economy or the supposed recovery that's coming. The article continues:

"He declined to say outright that he opposes efforts by Congress and the Obama administration to create a separate consumer financial protection agency. But he said there were drawbacks to it, including possible "duplicative efforts" in monitoring. And he defended the Fed as being "very active" in the last three years on the consumer protection issue.

"Bernanke was even more defiant about a congressional proposal to audit Fed monetary policy and actions. He said politics need to remain separate from the Fed to ensure that inflation and financial stability remain in balance.

""It is incredibly important that the Fed maintain its independence -- it is so critical to the stability of economy," Bernanke said. "I don't think people realize that Congress' bill would allow the Government Accountability Office to be able to audit Fed decisions. That's not congruent with independence.""

This was the whole point of this town hall meeting: to sell the Federal Reserve as an independent, benevolent overseer of the U.S. financial matters; to lobby for more powers for the Fed and attack the Audit the Fed bill in the House (H.R. 1207) which now has 276 co-sponsors.

The Federal Reserve, to be sure, is indeed audited by an accounting firm (Deloitte). However, according to the Forbes article on July 21, (BTW, this Forbes article is very misleading; more later in another post)

"The law currently disallows auditing of three areas: the swap lines the Federal Reserve arranges with other central banks and international financing organizations; the actual deliberations and decisions of monetary policy (such as how much to raise and lower interest rates); and transactions made under the Federal Open Market Committee's direction."

Under the third - transactions made under the Fed Open Market Committee's direction - is where the garbage resides: TALF, TSLF, TAF, PDCF, OMO, ABCPMMMFLF (or AMLF for short), CPFF, etc, etc. Do we know who's getting these loans and how much? What are the collaterals? How are they priced? How about Maiden Lane LLC to "manage" Bear Stearns and AIG "assets"? Do we know what are those assets and how they are priced?

"Too big to fail" best describes the Federal Reserve.

Just last week, the U.S. Treasury Department auctioned off $65 billion of 70-day Cash Management Bill, which happen to carry higher interest rate than the equivalent regular Treasury bill, just so that the Federal Reserve can use the money for whatever that they've been doing. And the chairman is telling the taxpayers who foot the bill to just trust him.

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Ron Paul at Cato Institute 6/24/09: Audit the Fed

Is Cato Institute changing its tune? Texas Congressman Ron Paul spoke today at Cato Institute, which has been pro-Fed.

Ron Paul at Cato: ‘Audit the Fed’ (6/24/09 Cato Institute)

"When Texas Congressman and former Republican presidential candidate Ron Paul speaks about transparency in the Federal Reserve, he sums up his argument with one simple question. Why not?

“Why in the world should this much power be given to a Federal Reserve that has the authority to create $1 trillion secretly?” Ron Paul asked a standing room-only crowd today at the Cato Institute."

A standing room-only crowd. Nice. The above link has an audio podcast of Ron Paul's opening remark.

I hope the Institute is changing, and this is not a co-opting strategy to dilute H.R. 1207 (Audit the Fed bill).

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Jim Cramer: We Have Too Much Democracy Here

In case you didn't know. Here's a totally livid Jim Cramer rebutting the "allegation" of "cover-up" by Ben Bernanke regarding the "pressure" on Bank of America regarding Merrill Lynch purchase, by trashing the "baseless" accuser (Congressman Darrell Issa) and complaining we have too much democracy.

"The man [Bernanke] had a complete open book.."

[I didn't know they have audited the Fed already. Then why is Bloomberg suing the Fed?]

"They can make this completely baseless charge, that tells me we've got a little too much democracy here."

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Cause and Effect: Washington to Main Street to Wall Street

The president had finished his speech today about his new proposal (yet another) on the sweeping reform (and another) in the nation's financial institutions.

The prepared text of the speech was already available before the speech (here), so I took a look.

It's basically the same as what was leaked by an anonymous administration official on Tuesday night and reported on this post here.

After the preamble about the administration's favorite topics (energy, education, and heath care, which quickly made me wonder what they've got to do with financial reform), the president starts to talk about financials. And I start having problems right away. I quote:

"It is an indisputable fact that one of the most significant contributors to our economic downturn was an unraveling of major financial institutions and the lack of adequate regulatory structures to prevent abuse and excess. A culture of irresponsibility took root from Wall Street to Washington to Main Street. "

Is it? Indisputable? Fact? An unraveling of major financial institutions didn't quite occur until after September 2008. The nation's economists tell us that the U.S. went into the economic recession in December 2007. How could an unraveling in September 2008 contribute to a recession started in December 2007?

But more importantly, I think he got the flow mixed up. If I were to craft the last sentence, it would read: "A culture of irresponsibility took root" from Washington to Main Street to Wall Street.

The super easy money policy of the Federal Reserve actually started in the 90's to get out of the mini recession in the early 90's. The Federal Reserve didn't come up with this idea on its own. It was guided by the policies of Washington. It contributed significantly to the sharp rise in all asset prices in the mid to late 90's and to the dot-com bust in 2000. (Read this article written in September 1999. The writer predicted an imminent stock market crash at the time when Dow was high but the global political and economic indicators as he saw them were deteriorating.)

Then this policy was re-instituted anew in 21st century in order to get out of the recession in the wake of the dot-com bust and 9/11.

One of the main focus of Washington for nearly 2 decades has been home ownership. Home ownership was increasingly treated as American Dream, and some kind of "right" of the U.S. residents. President Clinton started it by rewriting the rules for Fannie and Freddie, and then broadened Carter-era Community Reinvestment Act and unveiled his National Homeownership Strategy. "Having your own home is the ultimate expression of optimism," the president said. (See this video from 1994 speech before National Association of Realtors.)

Please watch this video of President Bush back in 2002. He was proposing taxpayer-funded (he spoke so softly when he said the word taxpayer) down payment fund for low income buyers, affordable housing in "certain" neighborhoods (i.e. inner city), "streamlining" the application process so that "fine print" doesn't discourage the buyers (and now Washington is saying the bankers lied), bringing in the real estate industry in, encouraging measures to create a sustained commitment by the private sector. 5.5 million new, minority home owners was Mr. Bush's goal. He challenged the private sector to get after this goal, get focused. $440 billion more capital would be available for minority home owners from Fannie and Freddie, and FHA, who would also quickly securitize the loans made by the banks so that the banks could make more loans.

Is there still any doubt that it all came from Washington?

The government passed a series of legislation to make home ownership "affordable". Now people who wouldn't have qualified for mortgages before or who never thought of owning a home could be the home owners. American Dream. This was the Main Street component of the flow.

Then came the banks. There was clearly a huge demand from the Main Street for mortgages, and the government legislation and various schemes by non-profit organizations put increasing pressure on the banking system to come up with innovation to satisfy this demand. And satisfy they did, with innovation.

They came up with mortgage plans that allowed the borrower a super-low teaser rate, no money down, interest only mortgages. They sold off these mortgages off to Fannie and Freddie who quickly securitized them. Banks securitized the mortgages themselves, too, creating complex bond securities that were supposed to reduce risk by slicing up the mortgages and bundling back together. Prime mortgage slice and sub-prime slice together, but supposedly risk well managed. Investors who wanted more risk and higher return could opt for the lower tranches of mortgage-backed securities.

Then, housing advocate organizations, emboldened by the government measures and pressure, grew more aggressive. Here's an article from October 2007, describing how one such organization, Neighborhood Assistance Corp. of America under Bruce Marks, effectively forced Countrywide (now part of Bank of America) to modify at-risk loans. The very fact that the deal was announced in Washington D.C. shows it was a political issue, not economic or financial.

The hilarious story I heard involved Washington Mutual: a Hispanic man walked in to a WaMu branch, wanted to get a mortgage. The bank gave him the mortgage after reviewing a photograph of him dressed as a mariachi singer.

The housing market, by all indicators, topped in 2006. Smarter investors in real estate, particularly in residential real estate, got out then. But the party continued, on inertia, and people were fooled by continued low-interest and easy access to credit. It's not just Main Street people, but Washington people, too. The policy makers, the Fed officials, they all continued the mantra of "Everything is fine", "Our financial system is sound". Pundits on financial news channels like CNBC openly derided a few people who sounded alarm. (Remember this? These people openly laughed at Peter Schiff and they said Merrill Lynch was ridiculously cheap at $76 and recommended WaMu.)

Washington and its enabler Federal Reserve started it. Main Street and Wall Street followed. Main Street started to buckle first. Two years later, Wall Street collapsed, because the pillars, or the foundation, substrate that supported Wall Street (i.e. Main Street), collapsed. The economists say the current recession started in December 2007. The spectacular collapse of Wall Street didn't happen until September 2008, with a scare of Bear Stearns in March 2008 along the way (which feels like such a trivial event right now, but at that time it felt like the whole world was collapsing).

Who's still standing? Washington.

If the new policy is to be crafted on the assumption, in my mind wrong assumption, that it all started because of Wall Street's greed which dragged Main Street and unwilling Washington into the mess and recession, the policy will not address the core issue (= Washington) at all. I doubt therefore it will achieve the desired result - stable financial system - unless "stable" means "dead" or "near-dead".

The title of the speech says "21st Century Financial Regulatory Reform". Piling more regulation and more bureaucracy doesn't seem to me to be 21st century thing. I cannot help feeling that the speech writer missed the date by nearly a century.

Here's the plan itself, from the Treasury Department special website (www.financialstability.gov). (So that's another new czar right there: Financial Stability Czar.)

The stock market, with 45 minutes to trade, has remained listless. Dow Jones Industrial Average is up 22 points to 8,526, S&P 500 up 1 point to 913, Nasdaq up 17 points to 1,813. Nasdaq's outperformance is not surprising, as it has more companies far less affected by the government regulations and controls.

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How will Federal Reserve Pull Back Support?

This is a yesterday's headline from CNBC. I couldn't help laughing when I saw the headline.

As Economy Starts to Recover, Fed Weighs When to Pull Back (6/15/09, CNBC)

"As economy starts to recover..." When? The article says the Federal Reserve thinks it will be the 3rd quarter of this year, hopefully.

"The U.S. economy looks poised for a return to weak growth in the second half of the year and the Federal Reserve is giving careful thought to how to pull back its support when the time is right, Fed officials said Monday."

What is "weak growth"? Can you define that?

Amid the dribbles from the various Fed presidents, this caught my attention:

"Evans [Chicago Fed], a voting member of the Fed's policy panel, said some of the central bank's programs, especially those that provide back-up for short-term loans, will shrink naturally as market conditions improve.

"But he also said a "significant portion" of the Fed's balance sheet will likely not do so, which will force the central bank to develop what is likely to be a multi-pronged exit strategy."

Short-term loans will shrink naturally? Really? The Federal Reserve has been lending out U.S. Treasuries to the borrowers in exchange for whatever assets they can come up with as a collateral. The criteria for the collateral has gotton very loose over time, and the Federal Reserve has refused to discuss who the borrowers are, and what kind of collateral the Fed is getting.

So when the time is right, those borrowing institutions will gladly return the perfectly good Treasuries in exchange for the assets of dubious quality back onto their balance sheets.

Does that make sense?

"A significant portion" of the balance sheet that Mr. Evans refers to must be everything else but the short term loans:

Here are some major items on the asset side of the Fed's balance sheet. I don't think there has been any material change since May.

• Treasuries marked at face value: $622 billion
• Agency debt from Fannie and Freddie marked at face value: $84 billion
• Mortgage-backed securities guaranteed by Fannie and Freddie and Ginnie Mae: $427 billion
• Assets from various LLCs (Maiden Lane stuff, Bear Stearns, AIG) marked at "fair value" (or you could say mark-to-model, as there is apparently no market for them other than fire sale): $62 billion

Other than Treasuries, it's hard for me to believe that these assets could fetch a good price, or the price that the Fed wants to sell at (which I assume to be very very close to face value).

To remove excess liquidity, instead of reducing the asset side of the balance sheet, the Fed could try not to reduce the liability side, so that they don't need to sell the assets. I think that means excess reserve, which is currently at $816 billion. The Fed could raise reserve requirement for the banks, so that the banks will have to continue to park their money there. Or they could the combination of the two: sell some assets, and raise the reserve requirement.

However, raising the reserve requirement would mean loans that banks could make to businesses and consumers. How would that help the economy recovering weakly?

Any other options? I would like to hear from the Fed soon. If weak growth may be coming in the 3rd quarter, as the Fed says, that's July-August-September. July is less than a half month away.

Another day of quiet selloff in the stock market. The market doesn't seem to believe in "green shoot" all of a sudden. Dow Jones Industrial Average is down another 95 from yesterday, at 8,516. S&P 500 down almost 10, to 913. Nasdaq is down 15 to 1,801.

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Why Bernanke Was Upset: Federal Debt vs GDP

This blog is not about chart technical analysis (that's mostly for my other blog) but I make an exception once in a while when the chart in question concerns a macro economic picture. The US dollar long-term chart the other day was one, so were several charts of Treasury yields.

Here's another that I found on Yahoo Finance Teck Ticker (6/4/09): Bernanke Freaks Out About Obama's Spending and Debt Plans

The article and the accompanying video is about Ben Bernanke's testimony on Wednesday before the House Budget Committee, where the Fed chairman warned against ballooning federal deficit.

The page has a chart of Gross Federal Debt as percentage of GDP, and that's what caught my attention. It is a very bullish chart. Which means it is very, very ominous for the country.

The chart shows a cup and handle breakout with the target value of 100 (the vertical distance from the bottom of the cup to the right side of the cup). Besides, the flat-top formation from year 2010 onward is considered one of the most powerful, bullish formation; i.e. explosive growth from there.

The Fed chairman is right to be freaking out. After all, Federal Reserve is an independent entity, and he would want to protect his institution and its member banks from the destructive force of the federal deficit his institution is obliged to monetize.

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What's on the Fed's Balance Sheet?

One of my long weekend's readings was the Federal Reserve's latest balance sheets (May 20, 2009). (I'm probably semi-autistic and) I just like to absent-mindedly look at the numbers. So the following is just my leisurely observation and not a rigorous balance sheet analysis, which I will leave it to Representative Paul and his co-sponsors (his "Audit the Fed" bill, by the way, now has 179 co-sponsors.) Besides, my knowledge of financial accounting was almost all cleared from my cache as soon as the final exam at B-school was over...

The Fed's balance sheet is over $2 trillion. The following spreadsheet simply shows major line items in their consolidated balance sheet. (As such, they are not supposed to balance.) The Fed does seem to be between a rock and a hard place.

First, take a look at a Liability item, "Federal Reserve notes". That's our currency. According to the Fed's consolidated statements, Federal Reserve notes are backed by Treasury securities, federal agency debt (Fannie and Freddie), and mortgage-backed securities (guaranteed by Fannie and Freddie), which are accordingly on the Assets side. The latter two are held at face value.


I hope you are all comfortable with "face value" of the debts issued and/or guaranteed by Fannie Mae and Freddie Mac, because they are part of collateral held against Federal Reserve Notes. Even with the recent purchase of Treasuries by the Fed, Treasuries alone are not enough to cover the entire currency circulated. No wonder US dollar is declining.

Then, take a look at another Liability item, "Deposits from Depository institutions". That's the bank reserves, including huge excess reserves (actually almost all of it). Right now, the Fed is paying interest to the banks for keeping the reserves at the Fed. Sooner or later, once inflation hits, these reserves will be withdrawn and put to work to earn higher returns. The Fed will have to reduce the Asset side of the balance sheet to compensate for the decline in the liabilities. That means they have to sell either Treasuries, agency debts (that no one will want), or mortgage-backed securities (will anyone want those?). Treasuries may get a decent price still, but the other two won't get sold at face value. That will put further downward pressure on the US dollar.

Or how about those term auction stuff and other LLCs that they created (most of LLCs are managed by the New York Fed)? If they gets unwound, what will happen to the liabilities side? Which items will get unwound? And what are the consequences? We don't even know what's in these LLCs.

On top of all that, the Fed wants to issue its own debt.

What a mess.

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Dollar Hits New Multimonth Low, Threatening Long-Term Support Level

"Dollar hits new multimonth low vs euro, pound, yen", from Breitbart.com.

"The dollar kept falling Friday, notching fresh multimonth lows against the euro, pound and yen as a warning that Britain's debt level may result in its credit rating being cut ricocheted into worries about the massive U.S. deficit.

"Because Britain is pursuing similar policies to the U.S.—with both the Bank of England and the Federal Reserve injecting billions of dollars in their economies by buying assets from banks—the move also weighed on U.S. assets and the dollar. Treasurys sold off Thursday, and continued to do so Friday.

"Earlier this month, the Obama administration hiked its forecast for this year's federal deficit to $1.84 trillion. The deficit is approaching $1 trillion for the budget year that began Oct. 1.

"Big deficits mean the government has to borrow more, which could put its credit rating at risk. They can also put upwards pressure on inflation, thus cutting the purchasing power of the dollar."

You can read the rest in the link I provided at the top of the post.

But here, to put things in perspective, I called up the long-term chart of the US Dollar Index (spot) and put in the key long-term economic events. It is a monthly chart from November 1985, with tiny dots indicating the pre-Nov 1985 index level (which I roughly connected).

US Dollar ended this week with five consecutive down days. Four out of the past 5 weeks saw US Dollar decline. So far, we've had five consecutive months decline, with the pace of decline accelerating. Right now, it is on the long-term support level at 80.

As you can also see in the chart, we may have the first case of "Economic Bust and US$ Bust" in this current recession. Not a very pleasant thought.

---------------------
FYI, Plaza Accord was to devalue US Dollar against German Mark and Japanese Yen, in order to reduce the US deficit and make US exporters competitive. The move was to counter the effect of artificially strengthened US dollar under Paul Volcker.

Plaza Accord also led to the real estate bubble in Japan in the late 80's, as the Japanese government tried to stimulate the economy suffering the effect of strong yen with cheap credit.

Louvre Accord was to stop the decline of US Dollar. Plaza Accord worked too well, I suppose.

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Unintended (and Predictable) Consequences

Credit card reform bill

• Intention: To protect consumers from "unfair and abusive" practices by credit card companies.
  
• What many consumers are already getting: Notice from credit card companies for increased rates and fees, reduction of borrowing limit, or outright cancellation.
  
• What all consumers will eventually get: higher rates across the board, regardless of their spending and paying habits.

Federal Reserve's decision to buy longer-term Treasuries

• Intention: To keep the interest rates on longer-term loans low.
  
• What's happened: Fed becoming the buyer of last resort. 10-year and 30-year Treasury yields have gone up.
  

Bank "Stress Test"

• Intention: To restore public confidence
  
• What's happened:
  - The test itself, and the test results are perceived as joke or worse.
  - Has helped banks to raise capital at a much higher level, which has made investors more suspicious of the test's intention.

The White House and Congressional outrage over AIG bonuses

• Intention: To show that they share the outrage by average citizens over excessive compensation by an entity on life support with taxpayers' money
  
• What's happened:
  - Initially it was working, until the word got out that AIG may have been used to funnel tens of billions of dollars to the US and foreign banks. The sheer size of AIG bailout ($170 billion) started to get more attention, too.
  - The punitive 90% tax rate proposed by Congress for AIG employees who received bonuses was perceived as setting a dangerous precedent.

Chrysler's bankruptcy/restructuring

• Intention: To restructure Chrysler into a viable, competitive business; to protect US workers [=UAW workers] and keep the jobs in the US.
  
• What's happened so far:
  - Fiat is getting a free lunch with no money down.
  - 1st-lien secured bond holders got half of unsecured claim holders (totally ditching the bankruptcy law).
  - Investors will be wary of investing in any troubled US company receiving any form of US government aid.
  - It looks more and more like Chapter 7, not 11. Chrysler and soon-to-be bankrupt GM are shutting down their dealerships which will result in job loss and bankruptcies.
  - GM says it will import cars made in China.

I hope they were at least "unintended".

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Government Considers Stripping SEC of Powers

Bloomberg.com reports that "U.S. Considers Stripping SEC of Powers in Regulatory Overhaul".

"The Obama administration may call for stripping the Securities and Exchange Commission of some of its powers under a regulatory reorganization that could be unveiled as soon as next week, people familiar with the matter said.

"The proposal, still being drafted, is likely to give the Federal Reserve more authority to supervise financial firms deemed too big to fail."

So far, I don't like this at all. Whatever the shortcomings, whatever the past and present mistakes, SEC is UNDER THE US GOVERNMENT'S JURISDICTION. Whereas the Federal Reserve, it is an INDEPENDENT entity owned by its member banks. The US government does not have formal authority over it. Remember, we can't even audit its books!

Oh wait, at least I was not alone in thinking it would be a mistake:

"“It would be a terrible mistake,” said Stanley Sporkin, a former federal judge and enforcement chief at the SEC. “Whatever the SEC has done or didn’t do, it is still the premier investor protection agency around.” "

It was the then-Treasury Secretary Paulson who wanted to expand the Fed's role in regulating the financial industry in March 2008. Now we are moving very fast in that direction:

"Geithner was set to discuss the proposals at a dinner last night with Summers, former Fed Chairman Paul Volcker, ex-SEC Chairman Arthur Levitt and Elizabeth Warren, the Harvard University law professor who heads the congressional watchdog group for the $700 billion Troubled Asset Relief Program."

There are people who argue against it on conflict of interest:

"Opponents of giving the Fed more authority, such as former SEC chief Levitt, have said the central bank’s focus on keeping the financial system solvent may trump efforts to punish companies for violating securities laws."

As the article points out, it doesn't help SEC when two of their attorneys are being investigated for possible (looks like probable) insider trading.

Don't waste a good crisis, the White House Chief of Staff says. Indeed.

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Who, Me? Yes You, Mr. Greenspan

Peter Schiff writes in the article that appeared in Lewrockwell.com [emphasis mine]:

"... in a speech this Tuesday before the National Association of Realtors, Sir Alan “the-bubble-blower” claimed that his low interest rate policies in the early and middle years of this decade had no effect on mortgage rates or real estate prices. As a result, he claims no responsibility for the subprime mortgage crisis.

"His primary defense is that mortgage rates were a function of long-term interest rates which were simply not responding to the movement in short-term rates, which he did control. While it is true that the flow of capital from foreign creditors with excess dollars did keep long rates low despite rising short rates, this “conundrum” was not the leading factor in the housing bubble. Although rates on thirty-year fixed rate mortgages are based on long-term bonds, by 2005 such loans had become an endangered species. The housing bubble was all about adjustable-rate mortgages with 1–7 year teaser rates primarily based on the Fed funds rate.

"Greenspan expresses exasperation now, as he did then, that his careful nudging of interest rates higher by quarter-point increments did not translate into corresponding increases in long-term rates... If the “measured pace” of his quarter-point hikes were too slow to produce the desired effect, why didn’t Greenspan jack up the pressure?

"The bottom line is that Greenspan fathered the housing bubble and now he refuses to acknowledge kinship of his wayward child. His denial of responsibility is an act of stunning bravado, and is a testament to his ability to turn even the simplest of situations into an impenetrable tangle of theories and statistics. The private sector jokers who now hold top dishonors in our pack of economic villains are easily trumped by the Maestro. The fact that Greenspan still has any credibility shows just how little understanding the general public, including Wall Street and the media, actually have about this crisis."

Well said. I have nothing to add.

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Federal Reserve and Transparency Don't Go Together

Forbes has an article titled "The Federal Reserve Needs To Be Boring Again" by Thomas F. Cooley. The purpose of the article must be to counter the growing call for transparency of the Federal Reserve, whether it is from Bloomberg, Fox News (suing Treasury), Representative Ron Paul (his bill now has 162 co-sponsors), or Senator Bernie Sanders.

"... let's focus on why it is important to have an independent central bank. The answer is quite obvious. An independent central bank can focus on monetary policies for the long term--that is, policies targeting low and stable inflation and a monetary climate that promotes long-term economic growth. Political cycles, alas, are considerably shorter. Without independence, the political cycle would subject the central bank to political pressures that, in turn, would impart an inflationary bias to monetary policy."

Obvious? Policy targeting low and stable inflation? Then why has US dollar lost 94% of its purchasing power since 1933? 76 years is a long time and the Fed has been in existence the whole period and more, but according to the professor short-term-thinking politicians are to blame.

What does he mean by "independence" anyway? "Being unaccountable"?

Commenting on the bills currently in the Congress that call for transparency, he says with unmasked sarcasm:

"Great! Obviously, monetary policy is so falling-off-a-log simple that your elected representatives can insert themselves via the demand for transparency into decisions of true complexity and subtlety. Why am I not feeling reassured?"

That's a good one. We have left the monetary policy to the "independent", competent Fed who supposedly knows the true complexity and subtlety, and look what has taken us.

Professor Cooley is basically saying "Trust us, like you trusted us for the past 90-plus years. You don't know anything but we do".

I've lost the will to summarize the article any longer. If you want to see the article for some reason, please follow the link at the top of the post. If you do, please make sure to read the comment section. Many of the comments are much more intelligent, informative, and erudite than the article itself.

According to Forbes, Professor Cooley is "the Paganelli-Bull professor of economics and Richard R. West dean of the NYU Stern School of Business, writes a weekly column for Forbes". He is also a member of the Council of Foreign Relations and serves on the Board of Thornburg Mortgage, which filed for bankruptcy on May 1. He is also responsible for bringing about MBA/MS in Mathematics in Finance degree program at NYU, to breed the next generation of "super quant" managers for the Wall Street. He is also a consultant to the Federal Reserve Banks of New York and Minneapolis.

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1-Month Gold Lease Rate Is Negative

I've never seen anything like this. The chart is from Kitco.com, showing gold lease rates for various duration since May 2008 to present. 1-Month lease rate is negative. So the entity that lend gold (usually a central bank, in the case of the US it is Federal Reserve) effectively gives you money so that you borrow gold from them and sell it in the open market. Borrowers are bullion banks (including Goldman Sachs, JP Morgan Chase, Deutsche Bank), large mining companies, and jewelry manufacturers. The latter two do this as a hedging operation, and the bullion banks claim they are also doing it as a hedging operation. (Gold bugs are always suspicious of their claim, though.)

These bullion banks and other firms borrow gold at a very low lease rate and sell it in the open market (= short gold), and invest the proceed in securities that yield higher returns. Sound familiar? It should; this is a carry trade. Lease rates have never been high, but now the shortest duration lease rate is negative. What does that mean? I don't know. Anyone know? Any guess?

Here's my guess: Federal Reserve, by charging negative lease rate for 1-month lease of gold, seems to want to encourage gold shorting. They want the physical gold price down. So they can sell short-term Treasuries at a higher price? From the chart, 1-month lease rate went below zero around mid March. Looking at the gold chart, it seems to have been successful in driving down the price of gold until mid April. Since then, gold is slowly edging up again.

I also read the rumor that Goldman Sachs and JP Morgan Chase are accumulating call option positions on gold and silver futures contracts. Hedge against their short position? Now I'm really confused...

**More on the topic, I found this article by James Turk, founder of Goldmoney.com:
A Short History of the Gold Cartel

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30-Year Treasury Bond Auction Today

Today is the auction day for 30-year Treasury Bond ($14 billion), the last of the batch for the week. The top chart is the 6-month chart of 30-year Treasury yield, the bottom chart is today's intraday chart. Traders (I suppose) have been slamming the yield (conversely, bidding the price up) hard since the opening, as the stock market heads south and gold price reverses to the south.

The market is under pressure from "less bad" unemployment numbers. Go figure. It could be from ever-dribbling "stress test" result pressure. Who knows.. It's Mercury Retrograde. See the post below.)

Supply pressure and buoyant stock markets around the world have been pressuring the Treasury yields (yield goes up as the Treasury note/bond price goes down), and the yields on 10-year notes and 30-year bonds are back to the Fed's pre-quantitative easing days (i.e. before December 1, 2008).

The Federal Reserve is the buyer of last resort, and some people are fearing that it may become the only buyer.

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Bank Stress Test Seen As Political Move

The results of the "stress test" for the nation's 19 financial institutions are due to be disclosed on Thursday, but ever since last Friday "people familiar with the test" and anonymous officials as well as financial analysts have been dribbling the numbers. First, it was only one bank out of 19. Then 2, 4, 14, 10. Warren Buffet has said the test doesn't mean much. The once-Dr. Doom, now calling himself Dr. Realist Roubini has said not to believe it. Every time the name of the bank comes up who needs to raise capital, that bank stock shoots up (e.g. Wells Fargo the other day and today, Bank of America today).

Here's an AP article on the issue, and it raises several valid points:

The stress test is not really to test the health of financial institutions, but it is basically a PR event:

"Regulators and internal auditors routinely use stress tests to manage bank risk. The tests, typically done in private, help guide investments and ensure the banks' stability. Normally, regulators disclose their evaluations and remedies with banks behind closed doors. By contrast, critics say, the Fed's approach seems designed for public consumption."

"One-size-fits-all" approach is not the right one to actually assess the health of the diverse set of financial institutions:

"Providing more information about the health of banks is a worthy goal, said William Seidman, who ran the Federal Deposit Insurance Corp. during the savings-and-loan crisis. But he said the best way to do so would be to tailor the tests to each firm. Among the 19 firms being stress-tested are an insurer, an auto finance giant and banks with diverse business models. [It includes credit card companies, too.]

"Applying the same scenarios to 19 firms makes little sense, Iyer agreed. A"one-size-fits-all approach" doesn't take account of the strengths and weaknesses of each bank's assets.
"I am very skeptical that we will learn much about the true conditions of these banks," he said."

Forcing the banks to boost their capital reserve may not be the answer to the problem:

"Federal Reserve Chairman Ben Bernanke told lawmakers Tuesday that the tests will help banks develop plans to raise their capital buffers if necessary. The extra capital would ensure the banks could keep lending even if the recession worsened.

"Yet there's no guarantee that forcing banks to boost their capital reserves will have the desired result, Seidman said.

"Iyer said he worries the tests have become too tangled in fears of political or economic aftershocks to do much good.

""I'm a little concerned that somewhere in there, we've lost complete sight of the meaning of this exercise," he said."

Here's the list of 19 financial institutions, by the way.

• J.P. Morgan Chase & Co. (JPM)
• Citigroup (C)
• Bank of America Corp. (BAC)
• Wells Fargo & Co. (WFC)
• Goldman Sachs Group (GS)
• Morgan Stanley (MS)
• MetLife (MET)
• PNC Financial Services Group (PNC)
• US Bancorp (USB)
• Bank of NY Mellon Corp. (BK)
• SunTrust Banks Inc. (STI)
• State Street Corp. (STT)
• Capital One Financial Corp. (COF)
• BB&T Corp. (BBT)
• Regions Financial Corp. (RF)
• American Express Co. (AXP)
• Fifth Third Bancorp (FITB)
• Keycorp (KEY)
• GMAC LLC

My BIG question is: What happens if the bank disagrees with the government's findings and refuse to raise capital? Is the government going to take over the recalcitrant bank?

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Monetary Base resuming the sharp rise? And negative interest rate coming? (update)

Looks like adjusted monetary base is spiking up again, after a brief dip. If this is unleased onto the market, don't tell me it won't have any effect on inflation.

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And here's an update to a nutty idea by the Harvard economist about a week ago on how to encourage spending (or how to make money unattractive to hold). Well, he wasn't so nutty after all.

According to Financial Times, the Federal Reserve's internal analysis prepared for the last policy meeting says "The ideal interest rate for the US economy in current conditions would be minus 5 per cent." Of course a central bank cannot technically cut the rate below zero. The actual plan based on the analysis would include expansion of asset purchase by the Fed well beyond the amount that has been authorized so far (over $1 trillion) and types of assets authorized, in order to intentionally cause inflation so that individuals and corporations who hold money would see their holdings decrease by 5% each year - so that they would spend money as soon as possible before it further loses value.

If you have $100 today, it will be effectively worth $95 in a year. In 3 years, it will be about $85. In 5 years, $77. In 10 years, $59. If they overshoot their target and we end up having -7% effective rate, $100 today will be only $80 in 3 years, $69 in 5 years, $48 in 10 years.

It would be a terra incognita for sure. Not even the Weimar Republic inflated intentionally.

Peter Schiff's take is on his blog. Here's the link.

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Bloomberg Commentary

Fed’s Flood May Leave Democracy Needing Bailout: Kevin Hassett

"Many economists believe that helping financial institutions turn their less liquid assets into hard cash is a key step toward returning them to good footing. The best way to achieve that in a democracy would be for Congress to appropriate the funds to acquire the assets and for Treasury to borrow the money that it needs.

But Congress is unwilling to appropriate enough money, so Treasury and the Fed have cooked up a work-around: the Fed buys the assets instead. Since the Fed exists outside of the normal budget process, no permission from elected officials is required. "

The economic activities are not the only area affected by the monetary policies.

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