FedUpUSA

Archive for January, 2010

Bernanke: Now The Administration Owns The Mess

Posted by Karl Denninger

So we got our “Bernanke” reconfirmation on two votes, the first the “real” one and the second the one that everyone is trying to “count.”

Let’s first look at the real vote – the vote for Cloture, without which there would have been no confirmation vote at all.

The following Senators voted YEA on Cloture and stand for election this November.

AK:Murkowski (R)
AR:Lincoln (D)
CA:Boxer (D)
CT:Dodd (D)
GA:Isakson (R)
HI:Inouye (D)
IN:Bayh (D)
MD:Mikulski (D)
NC:Burr (R) YEA
ND:Dorgan (D) YEA
NH:Gregg (R) YEA (Retiring – to a Goldman affiliate!)
NV:Reid (D) YEA
NY:Schumer (D) YEA (Wall Street’s Chief Whore)
OK:Coburn (R) YEA
OR:Wyden (D) YEA
UT:Bennett (R) YEA
VT:Leahy (D) YEA
WA:Murray (D) YEA

Ignore the actual confirmation vote.  Some of the clowns in the Senate, like Babs Boxer, tried to obfuscate reality by voting for Cloture and then voting “Nay” on the final vote itself, in an attempt to play “I voted against it before I voted for it.”  This sort of symbolic malarkey must not be allowed to stand.

More importantly though is that Bernanke is now officially President Obama’s child.  He put him up for renomination, he did not pull that nomination, and he personally lobbied for his reconfirmation.  He owns it.

There are many who believe that Bernanke “saved us from another Depression.”  I will note that there were many in 1930 who thought we had been “saved” as well.  They were wrong.

They were wrong for the same reason they’re wrong this time.  From SIGTARP’s latest report:

It is hard to see how any of the fundamental problems in the system have been addressed to date.

• To the extent that huge, interconnected, “too big to fail” institutions contributed to the crisis, those institutions are now even larger, in part because of the substantial subsidies provided by TARP and other bailout programs.

• To the extent that institutions were previously incentivized to take reckless risks through a “heads, I win; tails, the Government will bail me out” mentality, the market is more convinced than ever that the Government will step in as necessary to save systemically significant institutions. This perception was reinforced when TARP was extended until October 3, 2010, thus permitting Treasury to maintain a war chest of potential rescue funding at the same time that banks that have shown questionable ability to return to profitability (and in some cases are posting multi-billion-dollar losses) are exiting TARP programs.

• To the extent that large institutions’ risky behavior resulted from the desire to justify ever-greater bonuses — and indeed, the race appears to be on for TARP recipients to exit the program in order to avoid its pay restrictions — the current bonus season demonstrates that although there have been some improvements in the form that bonus compensation takes for some executives, there has been little fundamental change in the excessive compensation culture on Wall Street.

• To the extent that the crisis was fueled by a “bubble” in the housing market, the Federal Government’s concerted efforts to support home prices — as discussed more fully in Section 3 of this report — risk re-inflating that bubble in light of the Government’s effective takeover of the housing market through purchases and guarantees, either direct or implicit, of nearly all of the residential mortgage market.

Stated another way, even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car.

Yep.

That report is 224 pages, and ought to be required reading.  But the executive summary above that I have excerpted is the base of it all.

There is one place that I disagree with Barofsky – that is the “reinflation” of the housing bubble.  That’s simply not going to happen, because the bubble itself was (as are all bubbles) predicated on false credit quality claims. 

Bubbles all depend on credulity.  That is, they rely on the ability to find more and more suckers upon which one can offload over-rated securities, each of which is worth less than claimed (and in some cases literally “worthless”!)  They pop when the number of suckers is exhausted and the mad scramble for chairs begins as the music suddenly stops.  Those left holding a bag with no sucker to offload it to go bankrupt and since the essence of bubble economics is the overuse of leverage the bagholders inevitably are geared and those who lent them their money are imperiled as well.

The natural check and balance on such behavior is the risk of bankruptcy.  That fear prompts underwriting and proper margin supervision, thereby limiting the impact to those who actually speculated.

But we have failed on two accounts: We first allowed regulated banks and insurance companies to speculate, effectively allowing private parties to gamble with the credit of The United States, where they keep the winnings but pass on the losses to the taxpayer.  Then, when the bust came, instead of punishing those who gambled and lost by forcing them through bankruptcy (even if it meant the taxpayer would take a huge hit) we instead took the hit but left those who did the evil things with operating businesses!

Bernanke is one of the chief architects of this structure.  He has repeatedly engaged in “bubble economics” with scant regard for the common taxpayer – the citizens of this nation.  Instead, his focus is on the few thousand brigands found in New York, who are plundering our society to the limit of their ability.

The last two weeks have treated us to a few ugly realities in regard to where the markets are and what Bernanke has done.  By pumping a literal trillion dollars into the markets via his above-market-price purchase of mortgage and treasury securities along with a zero interest rate for short-term fed borrowing he has engendered a monstrous stock market bubble.  This has come about due to the inherent disconnect between real valuations and yields in markets where he has interfered (when you overpay for something you drive its yield down.) 

But that stock bubble has in turn been predicated on growth numbers that simply cannot arrive in the real world.  The realization that “we’ve been had” may be coming now – but whether it is now, a month from now or six months from now, it will come, and instead of producing a flattening of the market (which would be the likely outcome were we trading in the 800s or even low 900s now on the S&P) the potential for an outright crash instead exists as people run for the door.

We should know better – after all, the same dynamic took hold in the housing market.  But that sort of dynamic was ignored then (“subprime is contained”) and is being ignored now (“I don’t see any asset bubbles”) by Bernanke, and will continue to be – right up until the market implodes.

Perhaps this is his (and President Obama’s) intent.  After all, our dear President intends to send a nearly $4 trillion Federal Budget to Congress in the coming days, while we are running a deficit of nearly half that.  With China increasingly unwilling (or unable) to continue to recycle hundreds of billions annually back to US Debt (a losing strategy for them in the longer term as they’ll never be paid off) and both Japan and England drowning under their own debt issuance one has to wonder exactly where Obama and Bernanke think they can source the over $1.5 trillion in net issuance they need to continue the charade.

Perhaps the answer is nothing more complex than intentionally cranking the stock market one more time, then crashing it again, scaring everyone into Treasuries.  Recent changes in money-market fund rules to permit them to throw up gates without prior approval of the SEC may be part of this, as may the rumblings about “annuitizing” people’s retirement accounts.  Anyone care to take a bet on there being some sort of “conversion to something safe” option being thrown about if and when the stock market dives once more?

In any event the key items here are that we now have a “hit list” of Senators that must go from their seats come November, and a reminder that President Obama can no longer blame what I believe is an upcoming collapse of the stock market – a multi-year affair that will be much worse than what we suffered in 2008 and early 2009 – on President Bush.  He had the opportunity to name either Volcker or John Taylor (to name two) to the position that Bernanke has, and decided instead to go with the guy who has been a chief architect of the “Brigand-and-Loot-Em” society – for better or worse, it’s all his now.

Bonne chance mes amis.

Yes Bankers Will Cheat (STILL) – Compensation

Posted by Karl Denninger

You just knew they wouldn’t play by the rules, right?

Investment bankers in the U.S. have begun using equity derivatives to convert restricted shares paid as bonuses into cash, side-stepping new guidelines on remuneration which were designed to prevent bankers cashing out for at least three years, according to a headhunter.

The bankers are using over-the-counter equity derivatives strategies such as call options, put options and collars to monetise their shares now, albeit at a discount to what they would receive if they waited for the restrictions to lift.

The purpose of these rules was to insure that the banksters were actually promoting sustainable operation of the business instead of looting people, which could detonate the company’s share price before they could cash out.

So instead they’re taking a sizable haircut.

What does this tell you about the “sustainability” of their practices?

And why over-the-counter derivatives?  They’re bilateral and thus there is no exchange record of what they’ve done.

Time to break up these banks right damn now folks.  Break ‘em all up, shut ‘em down, stop this crap right now.

Oh, and if you’re in the markets?  That’s the clearest indication I’ve ever seen that the very people inside know that it’s all going to blow up.

Again.

Before they could otherwise cash their bonuses out.

Ignore the actions of those on the inside at your peril.

Swiss Bleating: Now We’re Getting Somewhere

Posted by Karl Denninger

Gee, now The Swiss are warning that UBS could “collapse” if UBS lost it’s US banking license:

“The actions of UBS in the United States are very problematic. Not just because they are punishable but also because they threaten all of the bank’s activities,” Eveline Widmer-Schlumpf told Le Matin Dimanche newspaper.

“The Swiss economy and the job market would suffer on a major scale if UBS fails as a result of its licence being revoked in the United States,” she said.

Let’s boil this down, shall we?

Is UBS a US company that locates itself in Switzerland for the express purpose of evading US law or is it a Swiss company that happens to do a significant (but not critical) amount of business in The United States?

The difference is in fact crucial.

If UBS is a Swiss Company located in Switzerland as it’s primary domicile because that’s where it transacts most of its business, but it happens to do some business here in the US then a revocation of its US banking license (which I have repeatedly argued should happen, including here) would be inconvenient but hardly catastrophic.

But if UBS is in fact a US company – that is, in form, volume and character of the business it does it is US-centric, and continues to be domiciled in Switzerland as a means of dodging enforcement of US law, including that pertaining to customers that are US citizens, then we have a larger problem.

I think we are owed an answer as to which case we’re dealing with, and the simplest way to find out is to revoke UBS’ United States banking charter.

And before the usual cadre of “useful idiots” pipes up and starts attacking me without engaging their brain first, let me be perfectly clear:

The Swiss are free to set any sort of legal standard up for their corporations they wish.  I have no argument with their national sovereignty and in fact kind of like some of their viewpoints.

HOWEVER, this is immaterial to the point at hand, which is that just as they demand we respect their sovereignty and the rule of law with regard to their citizens, we have the right to demand the same of all firms that wish to do business inside the United States.

Therefore, if UBS wishes to have a US Banking License they must be forced to comply in all respects with US law irrespective of where the transaction takes place, and when it comes to accounts held by US Citizens this means they have an absolute obligation to report to the IRS as does every United States domiciled bank.  If they do not like this obligation they must surrender their US Banking License and then are free to deal with US Citizens as they desire anywhere else in the world – but they may not have an office, representatives, or business presence in The United States nor may they enjoy the benefits of US Government Support as is offered to all US-licensed financial firms.

US Banks Face Insider Trading Probe

By Tom Braithwaite in Washington

Neil Barofsky, the special inspector-general overseeing the US government’s financial rescue efforts, is to probe allegations of insider trading among bank executives and their associates.

Eight of the largest banks in the US received between $2bn and $25bn in October 2008 under a programme to prop up the financial system led by Hank Paulson, then Treasury secretary.

Dozens more institutions followed and Mr Barofsky, who examines the troubled asset relief programme, is looking into whether information improperly made its way to trading rooms during a feverish period in which the government and banks were frequently exchanging information.

“We have pending investigations looking into that – typically into insider trading,” he said. “Once upon a time getting Tarp funds actually meant your stock price would go up and we are looking at specific trading around Tarp announcements by insiders or looking at potential tips from insiders.”

Sig-Tarp, the office of the special inspector-general, published its quarterly report to Congress on Sunday, criticising the capital investments in banks as having failed to stimulate lending.

“Part of the problem is, when the Tarp funds were extended . . . although there was this public disclosure that the purpose of these programmes was to increase lending, very little, if anything, was done to encourage or direct lending,” said Mr Barofsky.

The Treasury is celebrating faster than expected Tarp repayments from the financial sector; it now expects relatively small losses, with some elements generating big profits.

While Mr Barofsky acknowledges this, he said there remained substantial problems with the struc-ture of the public-private investment programme, which is designed to encourage investors to buy troubled assets from banks to clean their balance sheets and stimulate lending.

He said there should be walls between fund managers taking part in PPIP, which co-invests government funds with those of the private sector, and managers at the same firm buying and selling similar securities.

An example of suspicious activity at an unnamed firm showed a manager selling a security from a non-PPIP fund and then buying it back at a slightly higher price with a taxpayer-supported PPIP fund minutes later.

“The rules are insufficient,” said Mr Barofsky. He said even if the behaviour, which Sig-Tarp is investigating, was found to be within the rules “it still ­creates this credibility issue, this reputational damage, this appearance of fund managers gaming the system”.

The Treasury said it had identified the suspicious behaviour and brought it to the attention of Sig-Tarp, showing that the system was transparent.

In another example of the sometimes fractious relationship with Treasury, Herb Allison, the Treasury’s head of Tarp, said that Ken Feinberg, the so-called pay tsar, had initiated contact with the New York Federal Reserve to discuss pay at AIG long before Sig-Tarp had made the recommendation in a previous report.

Much of Sig-Tarp’s new report is given over to an examination of the housing market and the multitude of government schemes designed to support lending and help homeowners avoid foreclosure.

“The government has done more than simply support the mortgage market,” the report said. “In many ways it has become the mortgage market with the taxpayer shouldering the risk that had once been borne by the private investor.”

Mr Barofsky added: “All of the things that were broken in the housing market and the different roles that different private players have played, some of what we recognise now . . . actually contributed to the bubble and to the ensuing crisis are really being replicated by government actors.”

His latest report said Tarp was entering a transition as financial aid for banks including Bank of America and Wells Fargo & Co was recouped.

Copyright The Financial Times Limited 2010. You may share using our article tools. Please don’t cut articles from FT.com and redistribute by email or post to the web.

Swiss Warns UBS Bank Could Collapse

Switzerland’s justice minister warned in an interview on Sunday that top bank UBS could collapse if sensitive talks with the United States over a high-profile tax fraud investigation fall through.”The actions of UBS in the United States are very problematic. Not just because they are punishable but also because they threaten all of the bank’s activities,” Eveline Widmer-Schlumpf told Le Matin Dimanche newspaper.”The Swiss economy and the job market would suffer on a major scale if UBS fails as a result of its licence being revoked in the United States,” she said.Switzerland and the United States have negotiated an agreement under which UBS would hand over information on some 4,500 account holders to US tax police.But a Swiss court ruling earlier this month put the deal in doubt.Many in Switzerland, where banking secrecy is a source of pride and a key part of the economy, have accused the government of failing to protect UBS.”We have nothing to blame ourselves for. I don’t think anyone could prove that we acted badly,” Widmer-Schlumpf said in the interview.

Some people are not aware, but FedUpUSA central resides in the great State of Michigan….errr, perhaps not recently so ‘great’ but we’d like to help change that.  FedUp is now going to provide the people of the State of Michigan resources on how to get involved right here at home, locally, and links, resources and information on the candidates running for office, both at the federal level, and the state level.

If you’re a resident of the State of Michigan, and you agree our government in this state is as off-track as our federal government, I encourage you to make our FedUp-Michigan page a regular destination.    A link to FedUp-Michigan is now a tab at the top of all pages on FedUpUSA.  FedUp-Michigan

Game Over for the American Middle Class – Inflation Adjusted Wages up 20 Percent in Last 20 Years While Housing Costs are up 56 Percent and Healthcare Costs are up 155 Percent.

Posted by mybudget360

The struggle for average Americans to keep up is largely becoming an act of will power and force in this current grand recession.  Now you wouldn’t think that there is a definite war raging against the middle class if you simply follow the mainstream media but the facts speak to a more distilled and corporatized method of debt slavery.  Americans are working more hours trying to stay in the same place that they believe would keep them on pace to having the American Dream.  And this dream is merely the ability to afford a home, provide your children with a good education (public or private), and save enough to have a retirement that doesn’t require you to eat cat food after a lifetime of working.  That is at the root of what most average Americans would want after a full working career.

But we are at an inflexion point and the middle class is largely being squeezed out.  A recent study from the Commerce Department shed some light on an issue that we already know.  Over the past 20 years the middle class has been falling behind:

Everything is relative in this world.  Incomes have gone up during this time but the cost of housing, healthcare, and access to education have outpaced income gains in some cases by four to one.  Money is only worth what you can buy with it.  The grand housing bubble of this decade lured many into buying homes that they simply could not afford.  Banks and Wall Street were more than willing to provide access to this dream since they knew if all bets crashed, and they did, that they would call on their connected politicians to bail them out and send the bill to taxpayers for their adventures in finance.  Take a look at the chart above closely.  Housing price changes have wiped out any gains in income.  The relative amount of income needed to buy a home has put many two income households on the brink of bankruptcy.  And the 4 million foreclosure filings in 2009 alone tell us that many Americans are unable to hold onto one cornerstone of the American Dream.

The middle class is absolutely vital to having a sustainable and flourishing economy.  The massive debt machine coming from the big banks has created a new form of debt servitude.  Some would argue that this is a personal responsibility issue and I will be the first to agree with that.  People should live within their means.  But think of the FICO score that has become like a permanent financial report card.  Some employers actually screen for credit scores before hiring applicants.  Want to rent a home because you don’t want to over extend and buy a home?  You better hope that FICO is up to par.  And many insurance companies base their analysis on this score.  So even if you never had a credit card or any debt, you would be in a bad spot because so many people rely on this number.  This is only one example of how people are actually forced to use debt simply to pursue the avenues of the middle class.

In fact, we have many more people simply trying to stay afloat let alone pursuing the middle class ideal.  Over 37 million Americans are now part of the food stamp program, not only is this the highest number ever but also the highest percentage of Americans ever to be on food assistance:

I sometimes read gut wrenching stories from the Great Depression where people would wash and reuse paper towels or have soup for weeks on end just to keep their families fed.  37 million Americans would be one step away from that existence if it weren’t for some basic safety nets.  It is troubling to say the least that this patch is what is keeping this great recession from being a profound depression.  Yet I think the 27 million underemployed Americans are already in that state of mind.  The idea of a middle class life is slowly drifting away as each and every day we realize that our nation is becoming more of a corporatacracy.

The housing nightmare really played on both ends of this middle class dream.  Banks were more than willing to lend trillions of dollars to people that really could not afford the homes they were buying.  This created the biggest housing bubble the world has ever witnessed and the bursting ramifications are being felt throughout the economy.  Yet if you look at the equation, who is really being punished?  Average Americans are being punished as they have their homes foreclosed on.  Yet banks who are in the supposed position of financial experts, have not only garnered trillions in bailouts but are now back to their speculative ways.  This is disturbing because it is highlighting a marked shift and a near game over for the middle class.

Think of the rise of our economy in the 1940s and 1950s.  Many returning GIs had access to affordable education through new programs and grants.  It is the least you can offer to someone defending this country.  Next, it was possible to support a family with one income because we had a strong and sustainable manufacturing base.  Now, we have families with two incomes in the service sector trying to piece things together.  Throw in a child, and that second income evaporates through childcare costs and educational fees.  In other words, just because people have more income their buying power has collapsed.

And this fact is revealed in the data that two-income households are more of an economic necessity:

So of married couples with two children 76 percent have two earners.  The average American is simply working to stay on track or face being thrown off the treadmill.  Jobs are so important to keeping a solid middle class.  This should be obvious but current policy being driven by the corporatacracy is simply focusing on keeping prices inflated for the big ticket items (i.e., housing and healthcare).  At this point in the game, housing values have gone up to points that are clearly unsupportable:

This being the biggest budget item for most households, you would assume that lower prices would be welcomed from the government seeing that many Americans are underemployed and those with jobs have seen stagnant wages.

The middle class dream is at risk.  This is a question of what we want out of our country.  Are we simply obsessed on keeping home values inflated so banking giants could keep gaming accounting rules and claim billion dollar profits?  If we want to prosper in the next decade, there will need to be a radical change to preserve what once was envied by the world.  Otherwise, you can expect banks and their political allies to keep selling away the middle class of America.  On the path we are traveling on the middle class is largely at risk for a big game over in the next decade.

We Are So Screwed

John Mauldin

“Our immersion in the details of crises that have arisen over the past eight centuries and in data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that ‘this time is different.’

“That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy.”

- This Time is Different (Carmen M. Reinhart and Kenneth Rogoff)

When does a potential crisis become an actual crisis, and how and why does it happen? Why did most everyone believe there were no problems in the US (or Japanese or European or British) economies in 2006? Yet now we are mired in a very difficult situation. “The subprime problem will be contained,” said now controversially confirmed Fed Chairman Bernanke, just months before the implosion and significant Fed intervention. I have just returned from Europe, and the discussion often turned to the potential of a crisis in the Eurozone if Greece defaults. Plus, we take a look at the very positive US GDP numbers released this morning. Are we finally back to the Old Normal? There’s just so much to talk about…

The Statistical Recovery Has Arrived

Before we get into the main discussion point, let me briefly comment on today’s GDP numbers, which came in at an amazingly strong 5.7% growth rate. While that is stronger than I thought it would be (I said 4-5%), there are reasons to be cautious before we sound the “all clear” bell.

First, over 60% (3.7%) of the growth came from inventory rebuilding, as opposed to just 0.7% in the third quarter. If you examine the numbers, you find that inventories had dropped below sales, so a buildup was needed. Increasing inventories add to GDP, while, counterintuitively, sales from inventory decrease GDP. Businesses are just adjusting to the New Normal level of sales. I expect further inventory build-up in the next two quarters, although not at this level, and then we level off the latter half of the year.

While rebuilding inventories is a very good thing, that growth will only continue if sales grow. Otherwise inventories will find the level of the New Normal and stop growing. And if you look at consumer spending in the data, you find that it actually declined in the 4th quarter, both annually and from the previous quarter. “Domestic demand” declined from 2.3% in the third quarter to only 1.7% in the fourth quarter. Part of that is clearly the absence of “Cash for Clunkers,” but even so that is not a sign of economic strength.

Second, as my friend David Rosenberg pointed out, imports fell over the 4th quarter. Usually in a heavy inventory-rebuilding cycle, imports rise because a portion of the materials businesses need to build their own products comes from foreign sources. Thus the drop in imports is most unusual. Falling imports, which is a sign of economic retrenching, also increases the statistical GDP number.

Third, I have seen no analysis (yet) on the impact of the stimulus spending, but it was 90% of the growth in the third quarter, or a little less than 2%.

Fourth (and quoting David): “… if you believe the GDP data – remember, there are more revisions to come – then you de facto must be of the view that productivity growth is soaring at over a 6% annual rate. No doubt productivity is rising – just look at the never-ending slate of layoff announcements. But we came off a cycle with no technological advance and no capital deepening, so it is hard to believe that productivity at this time is growing at a pace that is four times the historical norm. Sorry, but we’re not buyers of that view. In the fourth quarter, aggregate private hours worked contracted at a 0.5% annual rate and what we can tell you is that such a decline in labor input has never before, scanning over 50 years of data, coincided with a GDP headline this good.

“Normally, GDP growth is 1.7% when hours worked is this weak, and that is exactly the trend that was depicted this week in the release of the Chicago Fed’s National Activity Index, which was widely ignored. On the flip side, when we have in the past seen GDP growth come in at or near a 5.7% annual rate, what is typical is that hours worked grows at a 3.7% rate. No matter how you slice it, the GDP number today represented not just a rare but an unprecedented event, and as such, we are willing to treat the report with an entire saltshaker – a few grains won’t do.”

Finally, remember that third-quarter GDP was revised downward by over 30%, from 3.5% to just 2.2% only 60 days later. (There is the first release, to be followed by revisions over the next two months.) The first release is based on a lot of estimates, otherwise known as guesswork. The fourth-quarter number is likely to be revised down as well.

Unemployment rose by several hundred thousand jobs in the fourth quarter, and if you look at some surveys, it approached 500,000. That is hardly consistent with a 5.7% growth rate. Further, sales taxes and income-tax receipts are still falling. As I said last year that it would be, this is a Statistical Recovery. When unemployment is rising, it is hard to talk of real recovery. Without the stimulus in the latter half of the year, growth would be much slower.

So should we, as Paul Krugman suggests, spend another trillion in stimulus if it helps growth? No, because, as I have written for a very long time, and will focus on in future weeks, increased deficits and rising debt-to-GDP is a long-term losing proposition. It simply puts off what will be a reckoning that will be even worse, with yet higher debt levels. You cannot borrow your way out of a debt crisis.

This Time Is Different

While I was in Europe, and flying back, I had the great pleasure of reading This Time is Different, by Carmen M. Reinhart and Kenneth Rogoff, on my new Kindle, courtesy of Fred Fern.

I am going to be writing about and quoting from this book for several weeks. It is a very important work, as it gives us the first really comprehensive analysis of financial crises. I highlighted more pages than in any book in recent memory (easy to do on the Kindle, and even easier to find the highlights). Rather than offering up theories on how to deal with the current financial crisis, the authors show us what happened in over 250 historical crises in 66 countries. And they offer some very clear ideas on how this current crisis might play out. Sadly, the lesson is not a happy one. There are no good endings once you start down a deleveraging path. As I have been writing for several years, we now are faced with choosing from among several bad choices, some being worse than others. This Time is Different offers up some ideas as to which are the worst choices.

If you are a serious student of economics, you should read this book. If you want to get a sense of the problems we face, the authors conveniently summarize the situation in chapters 13-16, purposefully allowing people to get the main points without drilling into the mountain of details they provide. Get the book at a 45% discount at Amazon.com.

Buy it with the excellent book I am now reading, Wall Street Revalued, and get free shipping.

A Crisis of Confidence

Let’s lead off with a few quotes from This Time is Different, and then I’ll add some comments. Today I’ll focus on the theme of confidence, which runs throughout the entire book.

“But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked.”

“If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government’s policies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly. Of course, debt instruments are crucial to all economies, ancient and modern, but balancing the risk and opportunities of debt is always a challenge, a challenge policy makers, investors, and ordinary citizens must never forget.”

And this is key. Read it twice (at least!):

“Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence-especially in cases in which large short-term debts need to be rolled over continuously-is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!-confidence collapses, lenders disappear, and a crisis hits.

“Economic theory tells us that it is precisely the fickle nature of confidence, including its dependence on the public’s expectation of future events, that makes it so difficult to predict the timing of debt crises. High debt levels lead, in many mathematical economics models, to “multiple equilibria” in which the debt level might be sustained – or might not be. Economists do not have a terribly good idea of what kinds of events shift confidence and of how to concretely assess confidence vulnerability. What one does see, again and again, in the history of financial crises is that when an accident is waiting to happen, it eventually does. When countries become too deeply indebted, they are headed for trouble. When debt-fueled asset price explosions seem too good to be true, they probably are. But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite.”

How confident was the world in October of 2006? I was writing that there would be a recession, a subprime crisis, and a credit crisis in our future. I was on Larry Kudlow’s show with Nouriel Roubini, and Larry and John Rutledge were giving us a hard time about our so-called “doom and gloom.” If there is going to be a recession you should get out of the stock market, was my call. I was a tad early, as the market proceeded to go up another 20% over the next 8 months.

As Reinhart and Rogoff wrote: “Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, lenders disappear, and a crisis hits.”

Bang is the right word. It is the nature of human beings to assume that the current trend will work out, that things can’t really be that bad. Look at the bond markets only a year and then just a few months before World War I. There was no sign of an impending war. Everyone “knew” that cooler heads would prevail.

We can look back now and see where we made mistakes in the current crisis. We actually believed that this time was different, that we had better financial instruments, smarter regulators, and were so, well, modern. Times were different. We knew how to deal with leverage. Borrowing against your home was a good thing. Housing values would always go up. Etc.

Now, there are bullish voices telling us that things are headed back to normal. Mainstream forecasts for GDP growth this year are quite robust, north of 4% for the year, based on evidence from past recoveries. However, the underlying fundamentals of a banking crisis are far different from those of a typical business-cycle recession, as Reinhart and Rogoff’s work so clearly reveals. It typically takes years to work off excess leverage in a banking crisis, with unemployment often rising for 4 years running. We will look at the evidence in coming weeks.

The point is that complacency almost always ends suddenly. You just don’t slide gradually into a crisis, over years. It happens! All of a sudden there is a trigger event, and it is August of 2008. And the evidence in the book is that things go along fine until there is that crisis of confidence. There is no way to know when it will happen. There is no magic debt level, no magic drop in currencies, no percentage level of fiscal deficits, no single point where we can say “This is it.” It is different in different crises.

One point I found fascinating, and we’ll explore it in later weeks. First, when it comes to the various types of crises with the authors identify, there is very little difference between developed and emerging-market countries, especially as to the fallout. It seems that the developed world has no corner on special wisdom that would allow crises to be avoided, or allow them to be recovered from more quickly. In fact, because of their overconfidence – because they actually feel they have superior systems – developed countries can dig deeper holes for themselves than emerging markets.

Oh, and the Fed should have seen this crisis coming. The authors point to some very clear precursors to debt crises. This bears further review, and we will do so in coming weeks.

Greeks Bearing Gifts

On Monday, the government of Greece offered a “gift” to the markets of 8 billion euros worth of bonds at a rather high 6.25%. The demand was for 25 billion euros, so this offering was rather robust. Today, those same Greek bonds closed on 6.5%, more than offsetting the first year’s coupon. Greek bond yields are up more than 150 basis points in the last month!

Why such a one-week turnaround? Ambrose Evans Pritchard offers up this thought: “Marc Ostwald, from Monument Securities, said the botched bond issue of €8bn (£6.9bn) of Greek debt earlier this week has made matters worse. Many of the investors were ‘hot money’ funds that bought on rumors that China was emerging as a buyer, offering them a chance for quick profit. When the China story was denied by Beijing and Athens, these funds rushed for the exit.”

Greece is running a budget deficit of 12.5%. Under the Maastricht Treaty, they are supposed to keep it at 3%. Their GDP was $374 billion in 2008 (about €240 billion). If they can cut their budget deficit to 10% this year, that means they will need to go into the bond market for another €25 billion or so. But they already have a problem with rising debt. Look at the following graph on the debt of various countries.

When Russia defaulted on its debt and sent the world into crisis in 1998, they had total debt of only €51 billion. Greece now has €254 billion and added another €8 billion this week, and needs to add another €24 billion (or so) later this year. That’s a debt-to-GDP ratio of over 100%, well above the limit of the treaty, which is 60%.

Greece benefitted from being in the Eurozone by getting very low interest rates, up until recently. Being in the Eurozone made investors confident. Now that confidence is eroding daily. And this week’s market action says rates will go higher, without some fiscal discipline. To help my US readers put this in perspective, let’s assume that Greece was the size of the US. To get back to Maastricht Treaty levels, they would need to cut the deficit by 4% of GDP for the next few years. If the US did that, it would mean an equivalent budget cut of $500 billion dollars. Per year. For three years running.

That would guarantee a very deep recession. Just a 10% suggested pay cut has Greek government unions already planning strikes. Nevertheless, the government of Greece recognizes that it simply cannot continue to run such huge deficits. They have developed a plan that aims to narrow the shortfall from 12.7% of output, more than four times the EU limit, to 8.7% this year. That reduction will be achieved even though the economy will contract 0.3%, the plan says. The deficit will shrink to 5.6% next year and 2.8% in 2012.

The market is saying they don’t believe that will happen. For one thing, if the Greek economy goes into recession, the amount collected in taxes will fall, meaning the shortfall will increase. Second, it is not clear that Greek voters will approve such a plan at their next elections. Riots and demonstrations are a popular pastime.

Both French and German ministers made it clear that there would be no bailout of Greece. But here’s the problem. If they ignore the noncompliance, there is no meaning to the treaty. The euro will be called into question. And the other countries with serious fiscal problems will ask why they should cut back if Greece does not. If Greece does not choose deep cutbacks and recession, the markets will keep demanding hikes in interest rates, and eventually Greece will have problems meeting just its interest payments.

Can this go on for some time? The analysis of debt crises in history says yes, but there comes a time when confidence breaks. My friends from GaveKal had this thought:

“What is the next step? Having lived through the Mexican, Thai, Korean and Argentine crises, it is hard not to distinguish a common pattern. In our view, this means that investors need to confront the fact that we are at an important crossroads for Greece, best symbolized by a simple question: ‘If you were a Greek saver with all of your income in a Greek bank, given what is happening to the debt of your sovereign, would you feel comfortable keeping all of your life savings in your savings institution? Or would you start thinking about opening an account in a foreign bank and/or redeeming your currency in cash?’ The answer to this question will likely direct the next phase of the crisis. If we start to see bank runs in Greece, then investors will have to accept that the crisis has run out of control and that we are facing a far more bearish investment environment. However, if the Greek population does not panic and does not liquefy/transfer its savings, then European policy-makers may still have a chance to find a political solution to this growing problem.

“What could a political solution be? The answer here is simple: there is none. So if Europe wants to save Greece from hitting the wall towards which it is now heading, the European commission, the ECB and/or other institutions (IMF?) will have to bend the rules massively. In turn, this will likely lead to a further collapse in the euro. But for us, an important question is whether it could also lead to a serious political backlash. Indeed, at this stage, elected politicians are likely pondering how much appetite there is amongst their electorate for yet another bailout, and for further expansions in government debt levels. The fact that the intervention would occur on behalf of a foreign country probably makes it all the more unpalatable (it’s one thing to save your domestic banking system … but why save Greece?).”

If Greece is bailed out, Portugal and Ireland will ask “Why not us?” And Spain? Italy? If Greece is allowed to flaunt the rules, what does that say about the future of the euro? Will Germany and France insist on compliance or be willing to kick Greece out?

A few months ago, the markets assumed that not only Greece but Portugal, Italy, Spain, and Ireland would have a few years to get their houses in order. This week, the markets shortened their time horizon for Greece.

Even so, we get this quote, which may end up ranking alongside Fisher’s quote in 1929, that the stock market was at a permanently high plateau, or Bernanke’s quote that “The subprime debt problem will be contained.”

“There is no bailout problem,” Monetary Affairs Commissioner Joaquin Almunia said today at the World Economic Forum’s annual meeting in Davos, Switzerland. “Greece will not default. In the euro area, default does not exist.”

The evidence in This Time is Different is that default risk does in fact exist. You cannot keep borrowing past your income, whether as a family or a government, and not eventually go bankrupt.

Are we at an inflection point? Too early to say. It all depends on the willingness of the Greek people to endure what will not be a fun next few years, for the privilege of staying in the Eurozone. And on whether the bond market believes that this time is different and the Greeks will actually get their fiscal house in order.

Oh by the way, did I mention that the history of Greece is not exactly pristine in terms of default? In fact, they have been in default in one way or another for 105 out of the past 200 years. Aristotle, can you spare a dime?

And one last thought. The US is running massive deficits. If we do not get them under control, we will one day, and perhaps quite soon, face our own “Greek moment.” Look at the graph below, and weep.

Obama offering to freeze spending by 17% in US discretionary-spending programs, after he ran them up over 20% in just one year, is laughable. Greece is an object lesson for the world, as Japan soon will be. You cannot cure too much debt with more debt.

Your believing my grandkids will have a better future analyst,

John Mauldin
John@FrontLineThoughts.com

John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore

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The following was translated from the German publication Spiegel:

Ex-Lehman Bankers Getting Billions in Bonuses

The collapse of U.S. investment bank Lehman Brothers sparked the global financial crisis. But now, according to SPIEGEL information, 2,500 employees of the bankrupt company received billions in guaranteed bonuses from their new employer – ironically for the crisis years 2008 and 2009.

2,500 Ex-Lehman employees in Europe have collected guaranteed bonuses for the crisis years 2008 and 2009 amounting to two billion dollars. While the bankruptcy of their bank has caused the world financial crisis, they got on average about 400,000 dollars – per person, according to Spiegel.

On 15 September 2008, the U.S. investment bank Lehman Brothers collapsed – and thus brought a devastating chain reaction. The global financial system was nearing collapse, the world suffered a property loss of at least 15 trillion U.S. dollars.

The bankers were taken over in October 2008 by the Japanese finance house Nomura, and persuaded to stay by guaranteeing them bonuses. Many guarantees only expire in March this year. Most London-based investment bankers are also not affected by the penalty tax by the British Government in the amount of 50 percent.

The guaranteed bonuses would be taxed as fixed income, was given as an explanation. Christian Meissner, the former European head of Lehman and now head of Nomura Europe, also sues the liqudator of his former employer for 17.3 million U.S. dollars which were promised to him in his four years at the U.S. bank but not yet disbursed.

Secret Banking Cabal Emerges From AIG Shadows

Jan. 29 (Bloomberg) — The idea of secret banking cabals that control the country and global economy are a given among conspiracy theorists who stockpile ammo, bottled water and peanut butter. After this week’s congressional hearing into the bailout of American International Group Inc., you have to wonder if those folks are crazy after all.

Wednesday’s hearing described a secretive group deploying billions of dollars to favored banks, operating with little oversight by the public or elected officials.

We’re talking about the Federal Reserve Bank of New York, whose role as the most influential part of the federal-reserve system — apart from the matter of AIG’s bailout — deserves further congressional scrutiny.

The New York Fed is in the hot seat for its decision in November 2008 to buy out, for about $30 billion, insurance contracts AIG sold on toxic debt securities to banks, including Goldman Sachs Group Inc., Merrill Lynch & Co., Societe Generale and Deutsche Bank AG, among others. That decision, critics say, amounted to a back-door bailout for the banks, which received 100 cents on the dollar for contracts that would have been worth far less had AIG been allowed to fail.

That move came a few weeks after the Federal Reserve and Treasury Department propped up AIG in the wake of Lehman Brothers Holdings Inc.’s own mid-September bankruptcy filing.

Saving the System

Treasury Secretary Timothy Geithner was head of the New York Fed at the time of the AIG moves. He maintained during Wednesday’s hearing that the New York bank had to buy the insurance contracts, known as credit default swaps, to keep AIG from failing, which would have threatened the financial system.

The hearing before the House Committee on Oversight and Government Reform also focused on what many in Congress believe was the New York Fed’s subsequent attempt to cover up buyout details and who benefited.

By pursuing this line of inquiry, the hearing revealed some of the inner workings of the New York Fed and the outsized role it plays in banking. This insight is especially valuable given that the New York Fed is a quasi-governmental institution that isn’t subject to citizen intrusions such as freedom of information requests, unlike the Federal Reserve.

This impenetrability comes in handy since the bank is the preferred vehicle for many of the Fed’s bailout programs. It’s as though the New York Fed was a black-ops outfit for the nation’s central bank.

Geithner’s Bosses

The New York Fed is one of 12 Federal Reserve Banks that operate under the supervision of the Federal Reserve’s board of governors, chaired by Ben Bernanke. Member-bank presidents are appointed by nine-member boards, who themselves are appointed largely by other bankers.

As Representative Marcy Kaptur told Geithner at the hearing: “A lot of people think that the president of the New York Fed works for the U.S. government. But in fact you work for the private banks that elected you.”

And yet the New York Fed played an integral role in the government’s bailout of banks, often receiving surprisingly free rein to act as it saw fit.

Consider AIG. Let’s take Geithner at his word that a failure to resolve the insurer’s default swaps would have led to financial Armageddon. Given the stakes, you might think Geithner would have coordinated actions with then-Treasury Secretary Henry Paulson. Yet Paulson testified that he wasn’t in the loop.

“I had no involvement at all, in the payment to the counterparties, no involvement whatsoever,” Paulson said.

Bernanke’s Denials

Fed Chairman Bernanke also wasn’t involved. In a written response to questions from Representative Darrell Issa, Bernanke said he “was not directly involved in the negotiations” with AIG’s counterparty banks.

You have to wonder then who really was in charge of our nation’s financial future if AIG posed as grave a threat as Geithner claimed.

Questions about the New York Fed’s accountability grew after Geithner on Nov. 24, 2008, was named by then-President- elect Barack Obama to be Treasury Secretary. Geither said he recused himself from the bank’s day-to-day activities, even though he never actually signed a formal letter of recusal.

That left issues related to disclosures about the deal in the hands of the bank’s lawyers and staff, rather than a top executive. Those staffers didn’t want details of the swaps purchase to become public.

New York Fed staff and outside lawyers from Davis Polk & Wardell edited AIG communications to investors and intervened with the Securities and Exchange Commission to shield details about the buyout transactions, according to a report by Issa.

That the New York Fed, a quasi-governmental body, was able to push around the SEC, an executive-branch agency, deserves a congressional hearing all by itself.

Later, when it became clear information would be disclosed, New York Fed legal group staffer James Bergin e-mailed colleagues saying: “I have to think this train is probably going to leave the station soon and we need to focus our efforts on explaining the story as best we can. There were too many people involved in the deals — too many counterparties, too many lawyers and advisors, too many people from AIG — to keep a determined Congress from the information.”

Think of the enormity of that statement. A staffer at a body with little public accountability and that exists to serve bankers is lamenting the inability to keep Congress in the dark.

This belies the culture of secrecy obviously pervasive within the New York Fed. Committee Chairman Edolphus Towns noted during the hearing that the bank initially refused to disclose even the names of other banks that benefited from its actions, arguing this information would somehow harm AIG.

‘Penchant for Secrecy’

“In fact, when the information was finally released, under pressure from Congress, nothing happened,” Towns said. “It had absolutely no effect on AIG’s business or financial condition. But it did have an effect on the credibility of the Federal Reserve, and it called into question the Fed’s penchant for secrecy.”

Now, I’m not saying Congress should be meddling in interest-rate decisions, or micro-managing bank regulation. Nor do I think we should all don tin-foil hats and start ranting about the Trilateral Commission.

Yet when unelected and unaccountable agencies pick banking winners while trying to end-run Congress, even as taxpayers are forced to lend, spend and guarantee about $8 trillion to prop up the financial system, our collective blood should boil.

(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)

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To contact the writer of this column: David Reilly at dreilly14@bloomberg.net

Last Updated: January 28, 2010 21:00 EST