Fin/Inv

If president Obama gets his way, still more money, up to $50 billion, will be thrown at the failed Pell Grant system. Pell Grants are based on a means test and the funding comes with no strings attached. The money does not have to be repaid. That alone should tell you the program is rife with fraud. And it is.

Regardless of grades, ability, or likelihood to graduate, students can apply for the money, take it and run, without ever attending one day of class. Many do.

Those who do use the money for education, as apposed to partying and drugs, frequently waste it on useless degrees that leave students deep in debt after graduation, assuming of course the students even graduate.

Obama Wants To Throw More Money Down This Obvious Sinkhole

Let's start off with a review of the most recent proposal as described by the Washington Post in New funding projection could squeeze Obama's education agenda.

Sen. Tom Harkin (D-Iowa), chairman of the Health, Education, Labor and Pensions Committee, said told reporters Thursday that the measure he seeks to enact would channel more than $50 billion into Pell grants. That's up from the House-passed bill's total of $40 billion. In addition, Harkin indicated that the increase in the maximum Pell grant award would be less than the House envisioned. Instead of rising from the current $5,550 to $6,900 over the next decade -- as the House bill projects -- Harkin said the maximum annual award would rise to between $6,300 and $6,500.

Harkin said annual Pell award increases would be tied to inflation, but he omitted mention of a provision in the House bill that would tie the increase to inflation plus one percentage point. Lobbyists say they believe the additional percentage point will be dropped in final negotiations.

Student Debt Zombies

Inquiring minds are reading the New York Times article In Hard Times, Lured Into Trade School and Debt.

One fast-growing American industry has become a conspicuous beneficiary of the recession: for-profit colleges and trade schools.

At institutions that train students for careers in areas like health care, computers and food service, enrollments are soaring as people anxious about weak job prospects borrow aggressively to pay tuition that can exceed $30,000 a year.

“If these programs keep growing, you’re going to wind up with more and more students who are graduating and can’t find meaningful employment,” said Rafael I. Pardo, a professor at Seattle University School of Law and an expert on educational finance. “They can’t generate income needed to pay back their loans, and they’re going to end up in financial distress.”

For-profit trade schools tell people "If you don’t have a college degree, you won’t be able to get a job,” said Amanda Wallace, who worked in the financial aid and admissions offices at the Knoxville, Tenn., branch of ITT Technical Institute, a chain of schools that charge roughly $40,000 for two-year associate degrees in computers and electronics. “They tell them, ‘You’ll be making beaucoup dollars afterward, and you’ll get all your financial aid covered.’”

Ms. Wallace left her job at ITT in 2008 after five years because she was uncomfortable with what she considered deceptive recruiting, which she said masked the likelihood that graduates would earn too little to repay their loans.

As a financial aid officer, Ms. Wallace was supposed to counsel students. But candid talk about job prospects and debt obligations risked the wrath of management, she said.

“If you said anything that went against what the recruiter said, they would threaten to fire you,” Ms. Wallace said. “The representatives would have already conned them into doing it, and you had to just keep your mouth shut.”

The Career Education Corporation, a publicly traded global giant, last year reported revenue of $1.84 billion. Roughly 80 percent came from federal loans and grants, according to BMO Capital Markets, a research and trading firm. That was up from 63 percent in 2007.

The Apollo Group — which owns the for-profit University of Phoenix — derived 86 percent of its revenue from federal student aid last fiscal year, according to BMO. Two years earlier, it was 69 percent.

For-profit schools have proved adept at capturing Pell grants, which are a centerpiece of the Obama administration’s efforts to make higher education more affordable. The administration increased financing for Pell grants by $17 billion for 2009 and 2010 as part of its $787 billion stimulus package.

When Andrew Newburg called the Le Cordon Bleu College of Culinary Arts in Portland, Ore., to seek information, he was feeling pressure to start a new career. It was 2008, and his Florida mortgage business was a casualty of the housing bust. An associate degree in culinary arts from a school in the food-obsessed Pacific Northwest seemed like a portal to a new career.

The tuition was daunting — $41,000 for a 15-month or 21-month program — but he said the admissions recruiter portrayed it as the entrance price to a stable life.

“The recruiter said, ‘The way the economy is, with the recession, you need to have a safe way to be sure you will always have income,’ ” Mr. Newburg said. “ ‘In today’s market, chefs will always have a job, because people will always have to eat.’ ”

According to Mr. Newburg, the recruiter promised the school would help him find a good job, most likely as a line cook, paying as much as $38,000 a year.

Last summer, halfway through his program and already carrying debts of about $10,000, Mr. Newburg was alarmed to see many graduates taking jobs paying as little as $8 an hour washing dishes and busing tables, he said. He dropped out to avoid more debt.

There is much more in the 3 page article worth reading. Give it a look. Also consider this image from the article.



Leah Nash for The New York Times

Susana Holloway of Le Cordon Bleu’s culinary school in Portland, Ore., where a 15- or 21-month program costs $41,000.

Pray tell what are the odds a fancy restaurant hires someone out of one of these programs? 2%? 1%? .25%?

Many students graduating such programs will get a job washing dishes or flipping burgers. No doubt the culinary schools will call that a successful placement.

Pell Grant Controversy

Wikipedia has this to say about the Pell Grant Controversy.

The primary controversy is that a small set of educational institutions comprising 6% of all college students receives roughly 20% of all Federal Pell grant money. University of Phoenix tops this list with Pell Grant revenue of $656.9 million with second and third place held by Everest Colleges at $256.6 million and Kaplan College at $202.1 million for the 2008-2009 educational year[5].

This is combined with accusations of predatory loan practices on students by the highest Pell Grant recipient, University of Phoenix [6]. Additionally, some of the universities that are top recipients of Pell Grants have low completion rates, so students leave with no degree and large indebtedness leading some former students to accuse recruiters of being "duplicitous" [7].

Top recipient University of Phoenix received $3.2 billion in federal moneys of all kinds in 2008, and these federal dollars provided 86% of its revenue (thus, roughly 20% of its revenue came from Pell Grants)[8]. University of Phoenix has, among similar online universities, the lowest graduation rate tabulated by OEDB at 4% compared to the median of 37% and a high of 84% for Champlain College

Time To Kill Pell Grant Program

Rather than throwing hard earned taxpayer dollars at programs that invite fraud and make debt zombies out of students, it's time to kill the program entirely. Instead, Obama wants to expand the fraud, even indexing the fraud to inflation.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Roger Nusbaum is the Chief Investment Officer of Your Source Financial, a Phoenix based financial planning firm. Roger also writes about portfolio construction and management, investment products and economics on the Random Roger blog, is an outside contributor to TheStreet.com as well as providing commentary to numerous other media outlets. He has worked in the financial services industry since 1984. Roger lives in Prescott, AZ with his wife Joellyn and their five dogs and is very actively involved with the local volunteer fire department as a wildland firefighter

~~~

by gmak

Calling the post “The Ides of March” is a bit too obvious, and will probably be used by hundreds of bloggers. I’m a contrarian by nature, so I want to avoid any apocalyptic predictions today.

“As goes January, so goes the year”. “Invest ’til May, then go away”. ”The trend is your friend”. We’ve all heard these quoted at some time or another. Do these hold any water?

I crunched the SPX numbers from 1982 until now to check this out. I used the close from the last trading day of year(-1) to the close of the last trading day of year(0) for the annual returns. I used the last trading day in January to get the January returns (again from the last trading day of the previous year). I used from Sept 30 -> April 30 for the ‘invest until May’, and from April 30 -> Sept 30 for the ‘go away’.   In each case, the myth held true 20 / 26 times (the 27th data point is 2010 which is not complete yet). 

As Goes January…..

Notice in the table below, that January 2010 was a negative month. There are only 9 years out of 27 where this was the case. Half of them didn’t resolve, meaning that the myth works best for January with a positive return. Otherwise, it is a 50/50 proposition at best - which means a coin toss.

Invest ’til May….

When October - April inclusive has a gain, there are 3 / 17 years in which May - September inclusive is a greater gain. Note that there were only 3 years where May - Sept had a loss, when Oct - Apr had a gain. If Oct - Apr has a gain, it is worthwhile holding on, probability -wise.  So far, SPX has about a 100 point gain since the close on Sep. 30, 2009.

When Oct - Apr is a losing period, May - Oct outperforms 4 / 7 times - all of them with gains. So it is safe to say that the loss part of the ‘invest ’til May’ myth is a coin toss as well.

YEAR	As goes January	So goes the Year	26	10	Invest Until May	Then Go Away	26
1982			20				20
1983	3.3%	17.3%	1		36.5%	1.0%	1
1984	-0.9%	1.4%	0		-3.6%	3.8%	0
1985	7.4%	26.3%	1		8.3%	1.3%	1
1986	0.2%	14.6%	1		29.3%	-1.8%	1
1987	13.2%	2.0%	1		24.7%	11.6%	1
1988	4.0%	12.4%	1		-18.8%	4.0%	0
1989	7.1%	27.3%	1		13.9%	12.8%	1
1990	-6.9%	-6.6%	1		-5.3%	-7.5%	1
1991	4.2%	26.3%	1		22.6%	3.3%	1
1992	-2.0%	4.5%	0		7.0%	0.7%	1
1993	0.7%	7.1%	1		5.4%	4.3%	1
1994	3.3%	-1.5%	0		-1.7%	2.6%	0
1995	2.4%	34.1%	1		11.2%	13.5%	0
1996	3.3%	20.3%	1		11.9%	5.1%	1
1997	6.1%	31.0%	1		16.6%	18.2%	0
1998	1.0%	26.7%	1		17.4%	-8.5%	1
1999	4.1%	19.5%	1		31.3%	-3.9%	1
2000	-5.1%	-10.1%	1		13.2%	-1.1%	1
2001	3.5%	-13.0%	0		-13.0%	-16.7%	1
2002	-1.6%	-23.4%	1		3.5%	-24.3%	1
2003	-2.7%	26.4%	0		12.5%	8.6%	1
2004	1.7%	9.0%	1		11.2%	0.7%	1
2005	-2.5%	3.0%	0		3.8%	6.2%	0
2006	2.5%	13.6%	1		6.7%	1.9%	1
2007	1.4%	3.5%	1		11.0%	3.0%	1
2008	-6.1%	-38.5%	1		-9.2%	-15.8%	1
2009	-8.6%	23.5%	0		-25.2%	21.1%	0
2010	-3.7%

 

Is the trend your friend?  My response is: Which trend?

 Monthly shows a move up from October 2009 - off of a lower trend line that seems to begin back in 2005. EUR has closed above the 55 Monthly MA, and above the 61.8% FIB (Not shown but from the high at 1.6038 in July 2009, to the low at 1.2330 in Oct. 2009).
The 10 month MA has crossed above the 21 MA (happened in December) - but they are both sloped down if that really means anything on this scale. OVerall trend = bullish for the EUR.
Monthly EUR:
http://www.uploadgeek.com/share-7AF4_4B9C3AE6.html

On the weekly scale, however, EUR stayed within the channel. The 10 and 21 Week MAs are in a bearish pattern. But TD Pressure is showing a low risk BUY that triggered last week. The FIB situation is  the same for the monthly - here the label says 38.2% but it is the same line as the monthly 62.8%. This could be a possible turn up for EUR on a seekly basis - but a close above the channel is needed to confirm. As well, there is that pesky (red line) TD resistance between the latest bar and the 55 weekly MA. Looking back a ways to Dec 2008 and May 2009, it seems that if the 55 wMA acts as resistance - there is a sell off. If it is pierced and holds that this sets up the move up. Overall - could go either way.
Weekly EUR:
http://www.uploadgeek.com/share-1889_4B9C3CB6.html

 

Daily EUR has closed above the channel (is this some sort of scaling error?). As well, the 10 and 21 DMA have just crossed bullish - which is usually a sign for traders to go bullish. 1.3814 at the 50% FIB stands in the way of a continued move up - could there be a bounce down to re-test the channel top before moving up? Can anyone else see the wide and round J-Lo bottom forming? It’s usually a precursor to a move up.

But, TD pressure does look a little overbought and, unlike SPX, it does not stay up there long; usually 3 - 4 days max (occasionally as much as 8 days - but this is rare). The GS call for EUR = 1.45 is suspect in light of their analysis about a slowing Europe.
Daily EUR:
http://www.uploadgeek.com/share-A55B_4B9C3DCF.html

I found a chart at Jesses American cafe. It is the third one down the page. http://jessescrossroadscafe.blogspot.com/2010/0…

Inspired, I did my own Weekly and daily SPX chart. As you can see, weekly DXY bounced off of the 55 DMA and is still above the support level (dashed yellow line just below) from January. TD Pressure has signaled oversold, and when it crosses above - this can take place during the week - this will be a “low risk BUY” from the DeMark indicators.

Weekly DXY

http://www.uploadgeek.com/share-9CE2_4B9D5427.html

Within that context, I drew the same channel on the daily DXY and you can see that DXY put a pin below, came close to the purple “eyeball” support line. This support line has held up quite well over the last two months. As well, the 55DMA lies below at 79.12 with more support. The 10 and 21 DMA have just crossed bearish. Offsetting this is the TD Pressure that has (like the weekly) gone into oversold and it will only take a move back above the green line to signal a “low risk BUY”. This usually happens within 3 - 4 days max (like the EUR, who knew?).

Daily DXY

http://www.uploadgeek.com/share-4DDE_4B9D53B9.html 

Again, I ask: Which Trend?

Summary:
Possibly a move up Sunday overnight to test the 50% FIB - a little back and forth - testing the top of the channel again, and then on tho the 55 DMA (yellow line) over the rest of the week. If not, then the weekly bar should close back below is channel. Still a few weeks left in the month for it to put in a higher high on its chart. It’s easier to play long here - but looking for the reversal in the short term.
Sound fair or far-fetched?

I keep looking at that FIB at 1.3746. On a 30 min EUR chart, there was a test of this level off of the ramp ffrom overnight on Thursday /Friday. Is this considered solid support - going into a weekend? The drive up afterwards was muted. Does this level need to be retested on the daily chart?

 

The Broken Clock

Lehman Brothers. Ernst and Young. Dick Fuld. Tim Geithner. Prostate tickle in prison orange. Tick. Tock. Tick. Tock.

 

EQUITY

Friday’s SPX bar was a ‘43′. It followed a ‘35′. One has to remember that there are 25 possible bar shapes, so any 2 bar combination should occur 1 / 625 (25 x 25) times, which is only 16 bps (0.16%). My data sample has  7038 data points, more or less, which means that each combination should occur about 11 times. This is not the case, but it may just be due to the fact that the sample since 1982 is not large enough. I’m not going to speculate on this, yet.

Anyhow, the ‘35′ + ‘43′ combination has occured only 6 times - or less than half of what would be expected. In that time, there were 2 x ‘51′  = open near HOD, close near LOD; 2 x ‘15′ = open near LOD, close near HOD; 1 x ‘14′; and 1 x ‘25′. The odds favour a day where the close will be above the open. Note that this does not reflect on where the open will be relative to Friday’s close. Just note that the trend is up still.

To trade intra-day, this suggests going long at the open. There is no better feeling that going long at the open and having Geronimo kick a little while later. heh.

What about the inter-day trade?

I wouldn’t go short here for a longer trade. If you are already short you might want to hedge beyond OPEX. I have no idea what will happen in an OPEX week - but the odds are hgiher of SPX staying above the 55 DMA than they are of it going lower.

SPX has spent a full 10 days above the 55 DMA.  The SPX falls back below the DMA only 4% of the time in the next 4 days. Given that SPX has made it to 10 days, the odds are 4% / 40% =  10% that SPX will go below the 55DMA in the next week. The odds are  90% that SPX will stay above the 5DMA for longer. Please note that this does not necessarily mean the SPX will go up. It could go sideways and the 55DMA could come up to meet it, crossing from below.

Maybe using the two positive slopes (based on the last 10 closes), is getting too ‘cute’.  If only the DMA slope being positive is considered, then there is a 19% chance that the SPX wll go below the 55DMA next week. There is an 80% chance that the SPX will stay above the 55 DMA beyond next week. Given that it has been there for 10 days already, there is a 77% chance that this will not happen for at least 10 trading days (2 more weeks). There is a 58% chance that SPX will not go below the 55DMA for at least another 20 trading days. This is based on data since 1961.

The piece de resistance is that there is a 39% probability that SPX will stay above the 55DMA for more than 40 more trading days. You can make of that what you will. That is a pretty fat tail. Too bad that being ‘above’ doesn’t mean that SPX is necessarily going up that whole time.

Days Above	Frequency
0	0.0%
5	44.2%
10	16.8%
15	7.4%
20	1.6%
30	7.4%
40	5.3%
50	2.1%
More	15.3%

 OVERNIGHT

 

DATA

Empire manufacturing; TIC flows; Industrial production, and Capacity Utilization. These are numbers that might just raise big money’s hair on the back of their necks if they don’t come in as expected. Notice that most of this data is expected to be unchanged. The TIC flows are expected to decline to $47.5 billion from $60.3 billion in December.

GATA's Adrian Douglas has done a tremendous job of combing through dozens of hundred-plus page FOMC transcripts, and has compiled numerous quotes by assorted FOMC-related personnel, including former Chairman Greenspan, which provides yet another piece of evidence, demonstrating the persistence of the Fed's gold price suppression scheme. As Douglas puts it: "My thinking was that if an organization is so inept at covering up that detailed transcripts were retained, then perhaps it is also inept at completely redacting sensitive and incriminating information. What I found is quite astounding and serves as documented evidence by the Federal Reserve itself that it manipulates the gold market." We present the relevant quotes dug up by Douglas, whom we applaud for his effort, together with his very relevant commentary, which once again exposes the Fed's covert gold price suppression intentions.

In the March 21, 1978, FOMC meeting --

http://www.federalreserve.gov/monetarypolicy/files/FOMC19780321meeting.p...

-- the following exchange took place.

* * *

CHAIRMAN MILLER. The Treasury has severe reservations about it. Originally, two weeks ago, they were taking the position that they would not be in favor of it -- that it raised too many problems for them. Since then I think they have become a little more open-minded about it. However, I think the first avenue is apt to be the sale of gold. Sales of gold were under consideration and were deferred partly because of the French elections, which are now over. So I think it's likely that the Treasury will start a program of selling gold, which I personally would favor. There are a lot of advantages in using gold because at least then we don't end up with debt and the currency risks that go with it. So I think that's an avenue that should be pursued. There has been a discussion about the level of gold sales that are possible -- what the market can absorb and that sort of thing. Henry can correct me, but I believe the Treasury feels that they could sell about 300,000 ounces a month.

MR. WALLICH. That would be a very moderate amount -- something like less than 60 million. And bear in mind that unless they can develop a means of selling the gold for foreign currency in a way that doesn't cause holders of dollars to buy that foreign currency in order to buy the gold, it could be completely counterproductive. Then there isn't going to be much of a net effect. There is some because, after all, we are importers of gold, which may reduce the imports of gold and may make the trade balance look a little better. There is some portfolio shift when there is gold in portfolios instead of dollars, so I wouldn't say it's without effect, but there are lots of qualifications on the possible success.

CHAIRMAN MILLER. The nice thing about this problem is that it's surrounded by dilemmas! Everything you do has an adverse effect on something else. Nothing is ideal. I might add that we live in a situation where the market is very realistic, very factual. That's why the possibility that gold would be sold caused the gold price to drop by $5. You don't have to sell gold; you just have to breathe [that you may] one day.

* * *

The last sentence by Chairman William Miller (Fed chairman in 1978 and 1979) telling the FOMC that the gold market can be manipulated by propaganda is very significant. This would certainly make Joseph Goebbels proud. This manipulative deception has been played out time and time again since then. This is why official gold sales are always announced in advance and the announcements are repeated many times, as happened with the International Monetary Fund's gold sales.

At the FOMC meeting of July 9, 1980 --

http://www.federalreserve.gov/monetarypolicy/files/FOMC19800709meeting.p...

-- the following discussion took place.

* * *

MR. BAUGHMAN. Is it considered a political no-no to sell gold in the current environment?

CHAIRMAN VOLCKER. Oh, I don't think so, necessarily. I don't think it's a political problem in the sense that you may be suggesting. It's a question of whether it's very useful or desirable at this stage. [If we sold gold] we'd have to do it alone; I think that's pretty clear. It isn't anything that's ruled out a-priori, but it's a practical matter of whether it's a good idea.

MR. BAUGHMAN. Well, it's between selling assets and borrowing money. That seems to me the significant difference.

VICE CHAIRMAN SOLOMON. The psychology, Ernie, is that [selling gold] seems to be much more effective if it's a component of an overall package of forceful measures than if it is done by itself. In the present climate it would look like a major act of weakness. And that might spur some additional dollar selling unless we did it on an enormously massive scale, not just the levels that we have before. On the other hand, if the situation gets to a point where once again we have to begin thinking carefully of a package, then along with some monetary policy measures it would be appropriate and add to the effectiveness -- this is my own personal feeling -- to do some substantial gold selling. And in that situation I think the Congress would understand that. We'd have less of a political problem also. So I think both factors operate.

CHAIRMAN VOLCKER. I should say, in connection with the political problem, that I don't think there are any great political constraints so far as the thinking in the Administration is concerned. There are politicians who would make a noise that would reflect upon the credibility of the action. If we sell some gold and then immediately get some congressional opposition, the market would say: "Well, they're not going to sell very much because there's too much opposition." And, therefore, it might not be very productive in terms of the impact we'd want to achieve.

MR. BAUGHMAN. There would be some grassroots opposition to it. I can report that, but I don't have any impression. ...

CHAIRMAN VOLCKER. Perhaps I spoke a little misleadingly because that kind of opposition, I think, does reflect on the credibility of the action. It raises questions about whether it could be sustained and what the [total] amount would be and whether it's really an accepted technique or not, even though in some sense I think it's not a political deal for the Administration except in terms of appraising that reaction. I can't quite see the Congress opposing it in a formal sense but there would be a lot of noise by these limited groups. We have to ratify these transactions.

MR. SCHULTZ. So moved.

* * *

What is noteworthy is the comment by Vice Chairman Solomon when he says selling gold "seems to be much more effective if it's a component of an overall package of forceful measures than if it is done by itself. In the present climate it would look like a major act of weakness. And that might spur some additional dollar selling unless we did it on an enormously massive scale, not just the levels that we have before."

This is without a doubt a proposal to undertake gold market manipulation, and what's more it is proposed to be on an "an enormously massive scale." This is not a discussion about selling gold based on a motivation to maximize the profit from such sales. Furthermore, the vice chairman admits to previous gold market intervention when he recommends increased selling of gold that is "not just the levels that we have before."

What is shocking is the apparent cavalier approach to breaking the law. Volcker says, "I should say, in connection with the political problem, that I don't think there are any great political constraints so far as the thinking in the Administration is concerned. There are politicians who would make a noise that would reflect upon the credibility of the action. If we sell some gold and then immediately get some congressional opposition. ..."

Note that the proposal implies that gold sales would occur without the congressional approval required by law.

The "strong dollar policy" was concocted by Treasury Secretary Robert Rubin in 1995. However, the mechanism by which such a policy could be implemented in a supposedly free market was never explained. GATA has long maintained that the policy involved the suppression of the gold price. In December 1994 the following exchange took place at the FOMC meeting --

http://www.federalreserve.gov/monetarypolicy/files/FOMC19941220meeting.p...

* * *

CHAIRMAN GREENSPAN. President Jordan.

MR. JORDAN. I think the main part of our problem right now is inflation psychology. It certainly reflects the lack of a nominal anchor. It suggests that it would be helpful to have a politically supported mandate to attain and maintain a stable value of the dollar. If somehow we could achieve the conditions of a true gold standard -- without gold but the steady purchasing power of money in the minds of people -- over time it would make some of these short-term things that we go through a lot easier to deal with."

* * *

Well, how about that? Achieving the conditions of a true gold standard without gold? Does that sound like a confidence trick? The last sentence of the FOMC minutes above here has been redacted. It would be extremely interesting to know the full extent of the discussion.

In response to a question posed by U.S. Rep. Ron Paul in testimony before Congress in 2005, Fed Chairman Greenspan confirmed that this financial wizardry has actually been implemented:

http://www.lewrockwell.com/paul/paul267.html

* * *

MR. GREENSPAN: So that the question is: Would there be any advantage, at this particular stage, in going back to the gold standard? And the answer is: I don't think so, because we're acting as though we were there. Would it have been a question at least open in 1981, as you put it? And the answer is yes. Remember, the gold price was $800 an ounce. We were dealing with extraordinary imbalances, interest rates were up sharply, the system looked to be highly unstable -- and we needed to do something.

Now, we did something. The United States. ... Paul Volcker, as you may recall, in 1979 came into office and put a very severe clamp on the expansion of credit, and that led to a long sequence of events here, which we are benefiting from up to this date. So I think central banking, I believe, has learned the dangers of fiat money, and I think, as a consequence of that, we've behaved as though there are, indeed, real reserves underneath the system.

* * *

The last sentence is exactly what Mr. Jordan was pondering in the FOMC meeting of December 1994: How to have a gold standard without using gold. Greenspan says the Fed "behaved as though there are, indeed, real reserves underneath the system."

I think it is safe to say there is some financial wizardry that is apparent by implication. One either has real reserves or one doesn't. To behave as if there are when there are not is a confidence trick doomed to fail at some stage.

In the FOMC meeting of Dec 22, 1992, the Fed governors reveled in the fact that accounting errors in gold shipments could improve the U.S. balance of trade numbers --

http://www.federalreserve.gov/monetarypolicy/files/FOMC19921222meeting.p...

* * *

CHAIRMAN GREENSPAN. Did I hear you correctly when you said that the gold exports in October appear to have come from the coffers of the Federal Reserve Bank of New York? Has anyone looked lately?

MR. TRUMAN. Well, I didn't want to tell too many secrets in this temple!

VICE CHAIRMAN CORRIGAN. Obviously, we knew what happened to the gold, but I don't think we knew what it did to exports.

MR. TRUMAN. What happens in the Census data is that the Federal Reserve Bank of New York is treated as a foreign country. [Laughter] And when a real foreign country takes some of the gold out of New York and ships it abroad, it counts first as imports and then as exports. However, the import side is not picked up in the Census data. So there you get the export side of it.

MR. LAWARE. Great accounting!

MR. BOEHNE. Great confidence building!

MR. TRUMAN. That's because you haven't been filling out your import documents!

MR. ANGELL. Let me run this by again. You mean a country owns gold and has it stored in the Federal Reserve Bank of New York and if they ship it out, that's an export?

MR. TRUMAN. And in the balance of payments accounts it also counts as an import, so it washes out.

CHAIRMAN GREENSPAN. The Federal Reserve Bank's basement is a foreign country. When they move it out of the basement into the United States, it's an import. Then, when they ship it out again, it's an export.

MR. ANGELL. That makes sense!

MR. TRUMAN. And sometimes when they sell the gold, it might be sold into the United States, so it should count as an import. It doesn't necessarily always show up as an export.

MR. BOEHNE. That really clarifies it!

MR. KELLEY. Does it have to get out of your vault at all in order to be considered an import and an export?

VICE CHAIRMAN CORRIGAN. Well, I'm not even going to try to answer that. In this particular case I know what happened, so I think. ...

* * *

The most intriguing part of this discussion is the question by Kelley: "Does it have to get out of your vault at all in order to be considered an import and an export?"

While there is no explanation of the thinking behind Kelley's question (it was probably redacted), it is reasonable to extrapolate the inference that "ledger entries" for gold movements could be made to the import or export accounts without any gold having been physically moved.

At the May 18, 1993, FOMC meeting there was much discussion how gold influences public attitudes toward inflation. There were discussions about interfering in the gold market to change the public's expectation of inflation, and such postulated interference was even regarded as amusing by the FOMC --

http://www.federalreserve.gov/monetarypolicy/files/FOMC19930518meeting.p...

* * *

MR. ANGELL. Here's what I think would happen. I don't think we should increase interest rates by 300 basis points, but, if we did, I'm quite certain the price of gold would immediately begin a [sharp], quick [drop]. It would happen so fast you'd just have to go and watch it on the screen. If we made a 100-basis-point increase in the Fed funds rate, the price of gold surely would turn back down unless the situation is worse than I anticipate. If we made a 50-basis-point increase in the Fed funds rate, I don't know what would happen to the price of gold, but I'd sure like to find out! [Laughter]... People can talk about gold's price being due to what the Chinese are buying; that's the silliest nonsense that ever was. The price of gold is largely determined by what people who do not have trust in fiat money system want to use for an escape out of any currency, and they want to gain security through owning gold. Now if annual gold production and consumption amount to 2 percent of the world's stock, a change of 10 percent in the amount produced or consumed is not going to change the price very much. But attitudes about inflation will change it."

* * *

Later in the same meeting Greenspan pursued this line of thinking:

* * *

ALAN GREENSPAN: I have one other issue I'd like to throw on the table. I hesitate to do it, but let me tell you some of the issues that are involved here. If we are dealing with psychology, then the thermometers one uses to measure it have an effect. I was raising the question on the side with Governor Mullins of what would happen if the Treasury sold a little gold in this market. There's an interesting question here because if the gold price broke in that context, the thermometer would not be just a measuring tool. It would basically affect the underlying psychology. Now we don't have the legal right to sell gold but I'm just frankly curious about what people's views are on situations of this nature because something unusual is involved in policy here. We're not just going through the standard policy where the money supply is expanding, the economy is expanding, and the Fed tightens. This is a wholly different thing. Anyway, I'm most curious to get your views in these various respects, so please don't be afraid to throw things out on the table.

* * *

Greenspan proposed that if the gold price could be significantly depressed, then the public's inflation expectations could be radically altered.

In an FOMC meeting in January 1995 Virgil Mattingly, the Fed's general counsel, said the following --

http://www.federalreserve.gov/monetarypolicy/files/FOMC19950201meeting.p...

* * *

MR. MATTINGLY. It's pretty clear that these ESF [Exchange Stabilization Fund] operations are authorized. I don't think there is a legal problem in terms of the authority. The statute is very broadly worded in terms of words like "credit" -- it has covered things like the gold swaps -- and it confers broad authority. Counsel at the White House called the Treasury's general counsel today and asked, "Are you sure?" And the Treasury's general counsel said, "I am sure." Everyone is satisfied that a legal issue is not involved, if that helps.

* * *

This comment suggests that the U.S. gold stock has been mobilized in the market. When GATA urged U.S. Sen. Jim Bunning to pursue this matter with Greenspan, Mattingly responded (http://www.gata.org/node/1181):

"These inquiries focus primarily on a statement attributed to me that appears on Page 69 of the published transcript of the January 31-February 1, 1995, FOMC meeting to the effect that the Exchange Stabilization Fund (ESF) has engaged in 'gold swaps.' Given the passage of time, some six years, I have no clear recollection of exactly what I said that day but I can confirm that I have no knowledge of any 'gold swaps' by either the Federal Reserve or the ESF. I believe that my remarks, which were intended as a general description of the authority possessed by the secretary of the treasury to utilize the ESF, were transcribed inaccurately or otherwise became garbled."

That doesn't pass the smell test. Mattingly's comments "were transcribed inaccurately or otherwise became garbled"? This is the same organization that lied to Congress for 17 years about the existence of any transcripts or recordings of the FOMC meetings. So do we believe him?

Notice the very clever inference -- "I can confirm that I have no knowledge of any 'gold swaps' by either the Federal Reserve or the ESF." He doesn't specify what type of "knowledge" he is talking about. Is it knowledge that any swaps were ever made or is it knowledge of the details of swap arrangements that were made? In any case Mattingly is professing not to know; he is not denying that any swaps have occurred.

The following discussion took place at the July 1991 meeting of the FOMC --

http://www.federalreserve.gov/monetarypolicy/files/FOMC19910703meeting.p...

* * *

ALAN GREENSPAN: Why have commodity prices failed to decline as much as they ordinarily would during recession periods? Now, it also looks as if commodity prices are not spiking upward in a recovery like they ordinarily would. So we have a different picture in commodity prices than I've seen in a recession and, frankly, I'm very puzzled by it. At the same time that commodity prices do not show the extent of the recovery, I think it's somewhat strange that gold prices failed to move down. Given central banks' reduced willingness to own gold, or given what I see as a reluctance in the foreign central banks and others to hold as large gold stocks, given countries in southeast Asia who have changed their attitudes [toward gold], and given the Soviet Union [sales], I don't understand why gold prices do not come down. It suggests to me that there may be some what we call 'crazies' out there who believe that gold is a good [inflation hedge]. And I guess I think that [inflation concern] is in the long bond.

* * *

Greenspan thus labels as "crazies" those investors who want to protect their wealth against the promiscuous money creation of his Federal Reserve. In 1966 Greenspan wrote an essay titled "Gold and Economic Freedom" in which he recognized the unique properties of gold as an inflation hedge --

http://www.321gold.com/fed/greenspan/1966.html

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

"This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."

And clearly once Greenspan had sold his soul to the devil and become a "statist" himself, he joined the antagonists of gold.

The following is a very enlightening discussion at the July 1995 FOMC meeting --

http://www.federalreserve.gov/monetarypolicy/files/FOMC19950706meeting.p...

* * *

CHAIRMAN GREENSPAN. I think I've got it! [Laughter] You are telling me that the SDR [Special Drawing Rights] certificate comes out of the Treasury and we cancel the Treasury obligation and it is wholly an asset swap so that the debt to the public of the U.S. Treasury goes down by that amount. Is that what happens? That solves President Jordan's problem too! [Laughter]

MR. JORDAN. Can I follow up on that? The same thing happened when we changed the price of an ounce of gold from $35 to $38 and then to $42.22. The Treasury got a windfall of about $1 billion to $1.2 billion in both of those so-called devaluations. So an issue on this is: What was the dollar price of SDRs that we monetized? You say I have an asset on my balance sheet and I don't know what the value of it is.

CHAIRMAN GREENSPAN. It's about $42.

MR. TRUMAN. It's $42.22; it's equivalent to the official price of gold.

MR. JORDAN. We do this at the official U.S. Treasury price of gold?

CHAIRMAN GREENSPAN. Do you mean that we can lower the debt to the public by moving the price of gold up to the market price? That could cut the debt back by a not insignificant amount!

MR. JORDAN. I have been trying not to mention that publicly for fear that someone might want to do it.

CHAIRMAN GREENSPAN. It's probably too late; we just mentioned it.

MR. JORDAN. It will become known five years from now!

MR. LINDSEY. Five years from now it will be read in the transcript for this meeting.

MR. BLINDER. By which time it already will have been done.

* * *

This exchange is extremely significant because it recognizes that external debt of the United States eventually will have to be balanced with the amount of gold claimed to be held by the Treasury. Interestingly enough the Fed doesn't want this information to be known, as this would essentially devalue the dollar overnight and give instant hyperinflation. But as Greenspan points out, it would inflate away the debt.

The five-year delay in releasing information to the public is clearly viewed by the Fed as a way to disadvantage the public. When the Fed and Treasury are forced by market conditions to balance the U.S. government's debt with its gold holdings, the dollar will be massively devalued and gold will be multiples of its current price. This would certainly make it advantageous to be one of the "crazies," as Greenspan affectionately calls gold investors.

I think the true crazies will be shown to be those people who have drunk the Kool-Aid to believe that a currency can maintain its purchasing power when the central bank confesses to employing a confidence trick -- that it is "behaving" as if there were real reserves underneath its currency system.

What can be concluded from these insights into the deliberations of the FOMC?

-- On several occasions the Fed discussed targeting gold prices with its policies.

-- The Fed admits that propaganda is effective against gold investors, insofar as just mentioning the possibility of selling gold can drive down the gold price.

-- The Fed at least contemplated interfering in the gold market, and on a massive scale. The Fed admits that the U.S. government has sold gold with the intention of reducing gold's price.

-- The record shows that the Fed opined that the statutes of the Exchange Stabilization Fund have legitimized "the gold swaps." Despite claims that this statement has been inaccurately transcribed or garbled, recent information suggests otherwise. In response to GATA's request to the Fed last year under the Freedom of Information Act for access to Fed documents about gold swaps, Fed Governor Kevin M. Warsh confirmed that the Fed does indeed have gold swap agreements with foreign banks:

http://www.gata.org/node/7819

-- The Fed does not want it to be known that the external debt of the United States could be substantially reduced by revaluing official gold at the market price, lest someone wants to do that. This is an admission that the official U.S. price of gold of $42.22 per ounce is a matter of smoke and mirrors. The ability of the Fed and Treasury to create money is linked to the only liquid collateral they have, gold. The gold price that is required to make the value of U.S. gold equal to the dollars issued is multiples of the current price, and is heavily dependent on how much unencumbered gold the Treasury still holds.

-- The Fed expressed the utility of having the virtues of a gold standard without using gold itself. Greenspan later confirmed that the Fed was behaving as if it was on a gold standard, as if there were "real reserves" underneath the system. This supports GATA's claims that the gold price has been suppressed by an increase in the supply of "paper gold" -- gold that investors believe they have bought and own but is really no more than a certificate saying they own the gold. This is the case with the London Bullion Market Association's unallocated gold accounts, unbacked exchange-trade funds, pool accounts, and gold derivatives.

The demand for real physical gold bullion is surging in the face of an impending daisy-chain of sovereign debt defaults. This threatens to expose the confidence trick -- that much more gold has been sold than exists. I have explained this in a previous essay, "The Tiny Market that is the World's Biggest":

http://www.gata.org/node/8248

The Federal Reserve can "behave" as if there are real reserves under the U.S. dollar, but there are none. A study of the heavily redacted and edited minutes of the Federal Open Market Committee reveal a penchant for targeting and manipulating gold prices, and deceiving Congress and the public.

The words of Alan Greenspan from "Gold and Economic Freedom" could not be more relevant:

"This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."

Like clowns at a rodeo, there are too many academics creating a distraction discussing whether we will have deflation or inflation. We are now in an era of unprecedented deficit spending -- which means that confiscation of wealth will also be unprecedented. One of the most prolific money creators of all time has told us what to do to prevent it: Buy gold. But buy real physical gold, not a gold receivable.

-----

Adrian Douglas is publisher of the Market Force Analysis letter (www.marketforceanalysis.com) and a member of GATA's Board of Directors.

 

By Washington.  Note: I can’t get the videos to embed. Please click here to see videos.

This is an open letter to the economics, finance and banking communities. I don’t have any dog in the fight, other than to figure out and then publicize what is best for the greatest number of people. People I greatly respect advocate for federal-level public banking, state public banks or a return to the gold standard. I am simply attempting to start a high-level debate about what the best option is. I will update this essay with the best responses as I receive them.

How Is Credit Created?

I pointed out in September:

As PhD economist Steve Keen pointed out recently, 2 Nobel-prize winning economists have shown that the assumption that reserves are created from excess deposits is not true:

The model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.

The first economist to establish this was the American Post Keynesian economist Basil Moore, but similar results were found by two of the staunchest neoclassical economists, Nobel Prize winners Kydland and Prescott in a 1990 paper Real Facts and a Monetary Myth.

Looking at the timing of economic variables, they found that credit money was created about 4 periods before government money. However, the “money multiplier” model argues that government money is created first to bolster bank reserves, and then credit money is created afterwards by the process of banks lending out their increased reserves.

Kydland and Prescott observed at the end of their paper that:

Introducing money and credit into growth theory in a way that accounts for the cyclical behavior of monetary as well as real aggregates is an important open problem in economics.

In other words, if the conventional view that excess reserves (stemming either from customer deposits or government infusions of money) lead to increased lending were correct, then Kydland and Prescott would have found that credit is extended by the banks (i.e. loaned out to customers) after the banks received infusions of money from the government. Instead, they found that the extension of credit preceded the receipt of government monies.

Keen explained in an interview Friday that 25 years of research shows that creation of debt by banks precedes creation of government money, and that debt money is created first and precedes creation of credit money.

As Mish has previously noted:

Conventional wisdom regarding the money multiplier is wrong. Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.

This angle of the banking system has actually been discussed for many years by leading experts:

“[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts.”
- 1960s Chicago Federal Reserve Bank booklet entitled “Modern Money Mechanics”

“The process by which banks create money is so simple that the mind is repelled.”
- Economist John Kenneth Galbraith

“[W]hen a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan. The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone. It’s new money, created by the bank for the use of the borrower.”
- Robert B. Anderson, Secretary of the Treasury under Eisenhower, in an interview reported in the August 31, 1959 issue of U.S. News and World Report

“Do private banks issue money today? Yes. Although banks no longer have the right to issue bank notes, they can create money in the form of bank deposits when they lend money to businesses, or buy securities. . . . The important thing to remember is that when banks lend money they don’t necessarily take it from anyone else to lend. Thus they ‘create’ it.”
-Congressman Wright Patman, Money Facts (House Committee on Banking and Currency, 1964)

“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented.”
- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.

“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created — brand new money.”
- Graham Towers, Governor of the Bank of Canada from 1935 to 1955.

I’ve also noted:

In First National Bank v. Daly (often referred to as the “Credit River” case) the court found that the bank created money “out of thin air”:

[The president of the First National Bank of Montgomery] admitted that all of the money or credit which was used as a consideration [for the mortgage loan given to the defendant] was created upon their books, that this was standard banking practice exercised by their bank in combination with the Federal Reserve Bank of Minneaopolis, another private bank, further that he knew of no United States statute or law that gave the Plaintiff [bank] the authority to do this.

The court also held:

The money and credit first came into existence when they [the bank] created it.

(Here’s the case file).

Justice courts are just local courts, and not as powerful or prestigious as state supreme courts, for example. And it was not a judge, but a justice of the peace who made the decision.

But what is important is that the president of the First National Bank of Montgomery apparently admitted that his bank created money by simply making an entry in its book …

Moreover, although it is counter-intuitive, virtually all money is actually created as debt. For example, in a hearing held on September 30, 1941 in the House Committee on Banking and Currency, then-Chairman of the Federal Reserve (Mariner S. Eccles) said:

That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.

And Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta, said:

If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.

This must-see 47 minute video provides details:

So here are the first two questions:

Do you agree that banks create credit by initiating loans, and then obtaining deposits subsequently, to comply with depository requirements? I’m not talking about the coins which governments create (in America, coins represent less than 5% of the total money in circulation).

Do you agree with Eccles and Hemphill that money is debt, in that new credit normally comes into existence when a new loan is issued?

Government Alternative

William Greider is a former Washington Post and Rolling Stone editor, and now writes for the Nation. Greider has written numerous books and articles on the economy over the course of many decades, including one of the leading books on the Federal Reserve, Secrets of the Temple.

In an article in the Nation, Greider argues that the government could solve the economic crisis by taking back the power of money creation from the banks and the Federal reserve:

For the first time in generations, [the Fed is] now threatened with popular rebellion.

During the past year, the Fed has flooded the streets with money–distributing trillions of dollars to banks, financial markets and commercial interests …

Where did the central bank get all the money it is handing out? Basically, the Fed printed it, out of thin air. That is what central banks do. Who told the Fed governors they could do this? Nobody, really–not Congress or the president. The Federal Reserve Board, alone among government agencies, does not submit its budgets to Congress for authorization and appropriation. It raises its own money, sets its own priorities.

Representative Wright Patman, the Texas populist who was a scourge of central bankers, once described the Federal Reserve as “a pretty queer duck.” Congress created the Fed in 1913 with the presumption that it would be “independent” from the rest of government, aloof from regular politics and deliberately shielded from the hot breath of voters or the grasping appetites of private interests–with one powerful exception: the bankers…

Banks are the “shareholders” who ostensibly own the twelve regional Federal Reserve banks…

The Federal Reserve is the black hole of our democracy–the crucial contradiction that keeps the people and their representatives from having any voice in these most important public policies. That’s why the central bankers have always operated in secrecy, avoiding public controversy and inevitable accusations of special deal-making. The current crisis has blown the central bank’s cover…

Altering the central bank would also give Congress an opening to reclaim its primacy in this most important matter. That sounds farfetched to modern sensibilities, and traditionalists will scream that it is a recipe for inflationary disaster. But this is what the Constitution prescribes: “The Congress shall have the power to coin money [and] regulate the value thereof.” It does not grant the president or the treasury secretary this power. Nor does it envision a secretive central bank that interacts murkily with the executive branch…

If Ben Bernanke can create trillions of dollars at will and spread them around the financial system, could government do the same thing to finance important public projects the people want and need? Daring as it sounds, the answer is, Yes, we can.

The central bank’s most mysterious power–to create money with a few computer keystrokes–is dauntingly complicated, and the mechanics are not widely understood. But the essential thing to understand is that this power relies on democratic consent–the people’s trust, their willingness to accept the currency and use it in exchange. This is not entirely voluntary, since the government also requires people to pay their taxes in dollars, not euros or yen. But citizens conferred the power on government through their elected representatives. Newly created money is often called the “pure credit” of the nation. In principle, it exists for the benefit of all];

In this emergency, Bernanke essentially used the Fed’s money-creation power in a way that resembles the “greenbacks” Abraham Lincoln printed to fight the Civil War. Lincoln was faced with rising costs and shrinking revenues (because the Confederate states had left the Union). The president authorized issuance of a novel national currency–the “greenback”–that had no backing in gold reserves and therefore outraged orthodox thinking. But the greenbacks worked. The expanded money supply helped pay for war mobilization and kept the economy booming. In a sense, Lincoln won the war by relying on the “full faith and credit” of the people, much as Bernanke is printing money freely to fight off financial collapse and deflation.

If Congress chooses to take charge of its constitutional duty, it could similarly use greenback currency created by the Federal Reserve as a legitimate channel for financing important public projects–like sorely needed improvements to the nation’s infrastructure. Obviously, this has to be done carefully and responsibly, limited to normal expansion of the money supply and used only for projects that truly benefit the entire nation (lest it lead to inflation). But here is an example of how it would work…

Instead, Congress should create a stand-alone development fund for long-term capital investment projects (this would require the long-sought reform of the federal budget, which makes no distinction between current operating spending and long-term investment). The Fed would continue to create money only as needed by the economy; but instead of injecting this money into the banking system, a portion of it would go directly to the capital investment fund, earmarked by Congress for specific projects of great urgency. The idea of direct financing for infrastructure has been proposed periodically for many years by groups from right and left…

This approach speaks to the contradiction House Speaker Pelosi pointed out when she asked why the Fed has limitless money to spend however it sees fit. Instead of borrowing the money to pay for the new rail system, the government financing would draw on the public’s money-creation process–just as Lincoln did and Bernanke is now doing.

The bankers would howl, for good reason. They profit enormously from the present system and share in the money-creation process. When the Fed injects more reserves into the banking system, it automatically multiplies the banks’ capacity to create money by increasing their lending (and banks, in turn, collect interest on their new loans). The direct-financing approach would not halt the banking industry’s role in allocating new credit, since the newly created money would still wind up in the banks as deposits. But the government would now decide how to allocate new credit to preferred public projects rather than let private banks make all the decisions for us.

Here are my third, fourth and fifth questions:

Do you agree with Greider that the American Constitution and/or the inherent right of sovereign nations gives the government the power and authority to itself create credit?

Do you agree with Greider that such government creation of credit need not be inflationary so long as only as much credit is created as is needed by the economy – in other words, the amount actually needed to buy goods and services?

Several monetary commentators have said that – if credit is created primarily by the government instead of private banks – that it would save the government trillions of dollars in interest. Specifically, they claim that private banks charge interest to the government to fund the government’s debt, but that the government would owe no debt on credit it creates itself.

Is that true?

What Is the Best Public Banking Option?

As I wrote in November:

AFL-CIO president Richard Trumka told Congress last week:

If the Federal Reserve were made a fully public body, it would be an acceptable alternative.

The American Monetary Institute proposes the following alternative:

Incorporate the Federal Reserve System into the U.S. Treasury where all new money would be created by government as money, not interest-bearing debt; and be spent into circulation to promote the general welfare. The monetary system would be monitored to be neither inflationary nor deflationary.

Second, halt the bank’s privilege to create money by ending the fractional reserve system in a gentle and elegant way.

All the past monetized private credit would be converted into U.S. government money. Banks would then act as intermediaries accepting savings deposits and loaning them out to borrowers. They would do what people think they do now. This Act nationalizes the money system, not the banking system.

Bloomberg News columnist Matthew Lynn writes:

The U.K. government needs to start thinking about what it will do with all the banks it now owns. The answer is simple: Hand them to the people…

Instead of selling the stakes it acquired in the financial system to other banks, or listing the shares on the stock market, it could create mutually owned societies. Royal Bank of Scotland Group Plc could be a people’s bank, owned by everyone.That would ensure more diversity, competition and stability, all goals just as worthy as getting back the money Prime Minister Gordon Brown’s government spent on bank rescues…

Sovereign nations such as the U.S. and England have the power to create credit and money (and see this, this and this). Taking the credit-creation power away from the banks and giving it back to the nation would ensure that credit is freed up for people’s use, and the stranglehold over the economy is taken away from the too big to fails.

State Public Banks

Many people argue that – given its actions – people don’t trust the federal government to create money.

Fair enough. Why not let the states do it?

Michael Moore recommends that the American people demand:

Each of the 50 states must create a state-owned public bank like they have in North Dakota. Then congress MUST reinstate all the strict pre-Reagan regulations on all commercial banks, investment firms, insurance companies — and all the other industries that have been savaged by deregulation: Airlines, the food industry, pharmaceutical companies — you name it. If a company’s primary motive to exist is to make a profit, then it needs a set of stringent rules to live by — and the first rule is “Do no harm.” The second rule: The question must always be asked — “Is this for the common good?” (Click here for some info about the state-owned Bank of North Dakota.)

As Moore notes, the state of North Dakota already has such a bank, and – because of that – North Dakota is just about the only state which is not running a huge deficit.

PhD economist and candidate for Florida governor Farid Khavari wants to create a Bank of the State of Florida, to create credit without burdening the state and its citizens with high interest charges by private banks.

See this for details.

Local Public Banks

An alternative to federal or state public banking is local public banks, as proposed by Edward Kellogg and others.

As summarized by Adrian Kuzminski:

During this time of financial and economic crisis, it is worth recalling that credible alternatives to our current financial system exist, if largely unrecognized, and deserve serious consideration…

The now-neglected 19th-century American proto-populist, Edward Kellogg … was a kind of godfather to the later populist movement on monetary issues. Perhaps the most profound of American writers on monetary issues, Kellogg advocated a decentralized but nationally regulated monetary system based on non-usurious, low-interest public loans to individuals. His vision inspired 19th-century century mutualists, greenbackers, populists, and others who sought to restructure the monetary system to redistribute wealth.

In our own day, when usurious credit in the form of private finance capital remains the dominant force in economic life, and is largely taken for granted even by educated people, the alternative Kellogg offers is more important than ever. Indeed, I suggest that Kellogg’s theory of money is the best monetary alternative we have to the baleful system under which we suffer…

Edward Kellogg (1790-1858) was a New York City businessman whose losses in the crash of 1837 led him to examine the business cycle, monetary policy, and debt. In a series of writings, Kellogg developed the idea of … having the government provide very-low-interest loans to the general public. These loans would have a uniform, fixed interest rate, established by law. They would be issued locally through a system of public credit banks he called the Safety Fund. Once issued, these low-interest loan notes would circulate as currency, replacing the privately issued banking notes of his day (which today take the form of Federal Reserve Notes)…

In his day Kellogg seems to have influenced even Abraham Lincoln who, according to historian Mark A. Lause, ” . . . had his own copy of Kellogg’s book, Labor and Capital [sic] advocating the government issuance of paper currency as a just means of redistributing wealth, and he corresponded with the author’s son-in-law.” Kellogg’s public currency was intended to end the monopoly over the discretionary issuance of money at interest, which was held then (and now) by the private banking and investment system…

Kellogg proposed to establish local public credit banks, and we might imagine one in each community. These local public credit banks would be part of the Safety Fund. Instead of money being issued (as it is now) through a privatized and centralized money-management system on a top-down basis, primarily as loans at increasing rates of interest from a central bank to major commercial banks, and then to regional and local banks, and then to the public, money in his system would be issued by local federal banks as loans directly to citizens at nominal interest on the basis of their economic prospects. Once lent out, Kellogg’s public credit notes would flow into circulation, providing the basis for a new currency backed by the assets of individual borrowers…

A centralized national currency would be replaced, in Kellogg’s system, by a locally issued currency. But that currency would everywhere be subject to common national standards, ensuring that each local public credit bank reliably issued equivalent units of currency. A dollar issued by one local public credit bank of the Safety Fund, Kellogg intended, would be worth the same as, and be freely interchangeable with, one issued by any other. The independence of local branches would be guaranteed by the discretionary power reserved to them as a local monopoly actually to loan money; the compatibility of their monies would be ensured under federal law by fixing the value of the dollar by law at 1.1 percent/year – that is, by lending money everywhere to citizens at that rate…

The goal is to establish and preserve economic decentralization. Amounts of money lent in Kellogg’s system would vary considerably from place to place, with some areas needing and creating more currency than others. The solvency of local federal public credit banks would be guaranteed by collateral put up by borrowers, and the money supply would be stabilized by repayment of loans as they came due. The interchangeability of public credit bank notes would ensure a wide circulation for the new money…

To achieve a stable currency, Kellogg insisted that this rate be fixed by law; perhaps today it would take a constitutional amendment.

Michael Hudson (Distinguished Research Professor at the University of Missouri, Kansas City, who has advised the U.S., Canadian, Mexican and Latvian governments as well as the United Nations Institute for Training and Research. He is a former Wall Street economist at Chase Manhattan Bank who also helped establish the world’s first sovereign debt fund) and Congressman Dennis Kucinich both support the federal public banking option:

On the other hand, California considered creation of a state bank modeled after North Dakota’s bank in 1977. And the Massachusetts state Senate is currently considering creation of a state public bank, and other states are currently considering creating their own state banks.

So here is my sixth question:

Do you think a federal, state or local public banking option is best?

What About Gold?

Advocates for a return to the gold standard point out that – when a currency is pegged to a hard asset such as gold – it imposes fiscal discipline. Specifically, the government cannot simply run its “printing press” if its currency has to maintain a set ratio to a hard asset, and this prevents funding of endless wars and other misadventures.

Advocates for public banking, on the other hand, point to the numerous depressions which have occurred during periods when the gold standard was in place.

See these short videos (I don’t necessarily agree with the conspiracy theories alleged in the first video, but only with the general question of whether we can assure that the quantity and quality of gold can be assured):

Here is my seventh and final question:

Is there any way to have a hybrid monetary system which provides the benefits of public banking with the fiscal discipline which something like a gold standard imposes?

By Frank Partnoy, Professor of Law and Finance University of San Diego School of Law and author of Fiasco, Infectious Greed, and The Match King

The buzz on the Lehman bankruptcy examiner’s report has focused on Repo 105, for good reason. That scheme is one powerful example of how the balance sheets of major Wall Street banks are fiction. It also shows why Congress must include real accounting reform in its financial legislation, or risk another collapse. (If you have 8 minutes to kill, here is my recent talk on the off-balance sheet problem, from the Roosevelt Institute financial conference.)

But an even more troubling section of the Lehman report is not Volume 3 on Repo 105. It is Volume 2, on Valuation. The Valuation section is 500 pages of utterly terrifying reading. It shows that, even eighteen months after Lehman’s collapse, no one – not the bankruptcy examiner, not Lehman’s internal valuation experts, not Ernst and Young, and certainly not the regulators – could figure out what many of Lehman’s assets and liabilities were worth. It shows Lehman was too complex to do anything but fail.

The report cites extensive evidence of valuation problems. Check out page 577, where the report concludes that Lehman’s high credit default swap valuations were reasonable because Citigroup’s marks were ONLY 8% lower than Lehman’s. 8%? And since when are Citigroup’s valuations the objective benchmark?

Or page 547, where the report describes how Lehman’s so-called “Product Control Group” acted like Keystone Kops: the group used third-party prices for only 10% of Lehman’s CDO positions, and deferred to the traders’ models, saying “We’re not quants.” Here are two money quotes:

While the function of the Product Control Group was to serve as a check on the
desk marks set by Lehman’s traders, the CDO product controllers were hampered in
two respects. First, the Product Control Group did not appear to have sufficient
resources to price test Lehman’s CDO positions comprehensively. Second, while the
CDO product controllers were able to effectively verify the prices of many positions
using trade data and third‐party prices, they did not have the same level of quantitative sophistication as many of the desk personnel who developed models to price CDOs. (page 547)

Or this one:

However, approximately a quarter of Lehman’s CDO positions were not affirmatively priced by the Product Control Group, but simply noted as ‘OK’ because the desk had already written down the position significantly. (page 548)

My favorite section describes the valuation of Ceago, Lehman’s largest CDO position. My corporate finance students at the University of San Diego School of Law understand that you should use higher discount rates for riskier projects. But the Valuation section of the report found that with respect to Ceago, Lehman used LOWER discount rates for the riskier tranches than for the safer ones:

The discount rates used by Lehman’s Product Controllers were significantly understated. As stated, swap rates were used for the discount rate on the Ceago subordinate tranches. However, the resulting rates (approximately 3% to 4%) were significantly lower than the approximately 9% discount rate used to value the more senior S tranche. It is inappropriate to use a discount rate on a subordinate tranche that is lower than the rate used on a senior tranche. (page 556)

It’s one thing to have product controllers who aren’t “quants”; it’s quite another to have people in crucial risk management roles who don’t understand present value.

When the examiner compared Lehman’s marks on these lower tranches to more reliable valuation estimates, it found that “the prices estimated for the C and D tranches of Ceago securities are approximately one‐thirtieth of the price reported by Lehman. (pages 560-61) One thirtieth? These valuations weren’t even close.

Ultimately, the examiner concluded that these problems related to only a small portion of Lehman’s overall portfolio. But that conclusion was due in part to the fact that the examiner did not have the time or resources to examine many of Lehman’s positions in detail (Lehman had 900,000 derivative positions in 2008, and the examiner did not even try to value Lehman’s numerous corporate debt and equity holdings).

The bankruptcy examiner didn’t see enough to bring lawsuits. But the valuation section of the report raises some hot-button issues for private parties and prosecutors. As the report put it, there are issues that “may warrant further review by parties in interest.”

For example, parties in interest might want to look at the report’s section on Archstone, a publicly traded REIT Lehman acquired in October 2007. Much ink has been spilled criticizing the valuation of Archstone. Here is the Report’s finding (at page 361):

… there is sufficient evidence to support a finding that Lehman’s valuations for its Archstone equity positions were unreasonable beginning as of the end of the first quarter of 2008, and continuing through the end of the third quarter of 2008.

And Archstone is just one of many examples.

The Repo 105 section of the Lehman report shows that Lehman’s balance sheet was fiction. That was bad. The Valuation section shows that Lehman’s approach to valuing assets and liabilities was seriously flawed. That is worse. For a levered trading firm, to not understand your economic position is to sign your own death warrant.

With Geoffrey Batt

This weekend the New York Times has published an interesting observation of gender differences when quanitfying the intangible concept of "overconfidence" as it relates to stock trading. While the article throws a relatively minor wrench at the spoke of "efficient markets", we are following it up with a scientific paper by Wei Xiong and Jialin Yu, discussing the Chinese Warrant Bubble, in which speculative mania gripped the trading of warrants so deep out of the money that they were certifiably worthless, yet trading at an increasing turnover rate, and substantially inflated prices. With numerous unequivocal examples of bubbles in the history of capital markets, starting with Dutch tulip mania (1634-37), progressing through the Mississippi bubble (1719-20) the South Sea bubble (1720), the Internet bubble in the late 1990s, and the housing bubbles of the mid 2000s, it appears that human traders never learn from history as the speculative element overpowers rationality each and every time. The underlying premise: the hope that another greater fool will emerge. And emerge they do, until they don't, and markets collapse bidless. It is certainly easy to draw a parallel between the Chinese Warrant Bubble, and the trading of AIG, C, FNM, FRE and a whole slew of otherwise worthless companies, which on occasion make up over 30% of of the volume of the US stock market, which in turn drives the momentum that pushes the balance of all stocks. Another parallel: the entire US stock market is now one big "greater fool" trap waiting to spring once the greater fools have their fill of gambling fever.

As the authors point out:

In 2005-08, over a dozen put warrants traded in China went so deep out of the money that they were certain to expire worthless. Nonetheless, each warrant was traded nearly three times each day at substantially inflated prices. This bubble is unique, because the underlying stock prices make the zero warrant fundamentals publicly observable. We find evidence supporting the resale option theory of bubbles: investors overpay for a warrant hoping to resell it at an even higher price to a greater fool. Our study confirms key findings of the experimental bubble literature and provides useful implications for market development.

The explanation: overconfident, under-informed "speculators" i.e., the bulk of traders in US stock markets, who get the bulk of their finance education from CNBC, who do no homework, yet hope the a stock will be flippable in one second at a higher price, just like a hose was flippable 4 years ago to some other stupid schmuck. We all know how that one ended. We all know how this one will end too. Furthermore, in China, where natural curbs on shorting exist, it shifts the bias even further toward one of optimism, as the "threat" of going into a shorted trade, makes one overly confident that the next natural trade is a buy. This merely goes tho who how any form of shorting curbs simply tend to exaggerate an upward bias to the market in the short-term, yet one which without fail compensates by a more substantial drop in the medium- and long-term.

Unable to short sell, it is natural for a smart investor to speculate on selling an overvalued warrant at an even higher price to another buyer in the future. Without knowing his own limitation in warrant trading (or in other words, by being overconfident), a less sophisticated investor could also have a similar speculative motive, i.e., he buys a warrant aiming to resell it at a higher price later. In such an environment, warrant prices are determined by investors’ speculative motives instead of the underlying stock prices. Even when a warrant is deep out of the money, investors still trade it as long as its price fluctuates, which may be viewed as profit opportunities by these investors.

The authors then go to debunk the fallacy of the fast/smart money hypothesis, identifying it for what it is: early momentum driven speculators who successfully feed off of other less sophisticated speculators.

A large volume of behavioral finance studies suggests that various behavioral biases can lead inexperienced individual investors to feedback positively to past returns. Does this feedback effect exist in the warrants market? Examining the feedback effect can help us understand the time-series dynamics of the warrants bubble...The presence of positive responses of both warrant returns and turnover changes to past warrant returns again highlights the importance of incorporating investor heterogeneity in understanding the warrants bubble, consistent with the key insight of our earlier analysis.

Yet even if greater fools are sufficient, they are certainly necessary: where did they come from in such volumes as to make a difference?

What explains the lack of investor learning in the Chinese warrants market? It turns out that there was a steady flow of new investors attracted into the Chinese financial markets by the stock market boom. According to a recent report by the CSRC (2008), the total number of individual brokerage accounts in China had increased from 80 million to 140 million from 2005 to 2007. It is conceivable that many of these new investors had been trading warrants. While we do not have access to account-level data, a recent study by Pan, Shi and Song (2008) analyzes all the accounts involved in trading one warrant issued by the BaoGang Cooperation and find that the flow of new investors had a positive impact on the warrant price. The large inflow of inexperienced investors is common during the booming periods of many developed and emerging financial markets. Since most experimental studies focus on a given set of subjects, they tend to miss the important effects of the endogenous inflow of inexperienced investors on bubbles.

And the key caution the authors derive is one that is all too applicable for the US in its current comparable frenzied bubble state:

The Chinese government introduced warrants with the aspiration that they can provide a tool for the Chinese investors to hedge stock price risk in a market environment with many existing restrictions on trading stocks, such as prohibition on short-selling and margin buying. To facilitate this objective, the Chinese government has enacted several rules (the T+0 rule, no stamp tax and registration fee, and wider daily price change limit) to make trading warrants much more convenient than trading stocks. This effort failed to achieve its intended effect. Instead, it led to a spectacular bubble. This outcome might appear surprising. However, it could be explained by a widely documented psychological bias---illusion of control, i.e., people behave as if their personal involvement can influence the outcome of random events (Langer, 1975 and Presson and Benassi, 1996). This bias implies that investors are likely to confuse the control they have---over trading the warrants quickly and cheaply---with the control they lack---over the return the warrants might realize. The frenzied trading and spectacular bubble occurred in the Chinese warrants market thus caution future governments regarding granting too much trading capacity to (possibly inexperienced) investors at an early stage of market development.

With ever-dropping volumes and a shift away from institutional trading, is it precisely the inexperienced marginal traders: the retail and the Ph.D written algo signal models, that determine the price level of the S&P? If so, watch out below when this brand new bubble pops, as bubbles eventually always tend to do.

Full paper.

 

Attachment	Size
Chinese Warrant bubble.pdf	454.04 KB

My general outlook for 2010 is for sluggish and choppy growth. Usually the deeper the recession, the steeper the recovery - however recoveries following economic crisis tend to be sluggish (see: "The Aftermath of Financial Crises", Reinhart and Rogoff, 2009):

An examination of the aftermath of severe financial crises shows deep and lasting effects on asset prices, output and employment. ... Even recessions sparked by financial crises do eventually end, albeit almost invariably accompanied by massive increases in government debt.

Also the two usual engines of recovery, consumer spending and residential investment, both remain constrained as households rebuild their balance sheets (constraining consumption), and serious problems remain in the housing market including significant excess inventory and high levels of distressed properties.

Last November I listed a few possible upside surprises and downside risks to the above forecast. Here is an update on the possible upside surprises:

On consumer spending, I wrote:

Consumer spending. One of the key reasons I think growth will be sluggish in 2010 is because I expect the personal saving rate to increase as households rebuild their balance sheets and reduce their debt burden. But you never know. As San Francisco Fed President Dr. Yellen said yesterday: "Consumers have surprised us in the past with their free-spending ways and it’s not out of the question that they will do so again." Still, it is hard to imagine much of a spending boom with high unemployment (putting pressure on wages), and limited credit (so some people can spend beyond their income).

My expectation has been that the saving rate would rise to around 8% over the next couple of years. The saving rate rose sharply in 2009, however the most recent report from the BEA: Personal Income and Outlays, January 2010 showed the saving rate fell to 3.3% in January.

Click on graph for large image.

This graph shows the saving rate starting in 1959 (using a three month trailing average for smoothing) through the January Personal Income report.

Although I still expect the saving rate to rise, it is possible that it will not rise as far - or as fast - as I expected. That would mean consumption could grow closer to income growth in 2010.

My comments last year on exports:

Exports. Perhaps we are seeing a shift from a U.S. consumption driven world economy, to a more balanced global economy. An increase in consumption in other countries, combined with the weaker dollar should lead to more U.S. exports. And if China revalued that might lead to a boom in U.S. exports. ... Please don't hold your breath waiting for China!

Based on the comments of Chinese Premier Wen last night, "don't hold your breath" was probably good advice (although I do expect China to revalue this year). U.S. exports have increased over the last year, but it appears the growth of exports has slowed.

On Residential Investment:

Residential Investment. Those expecting a "V-shaped" or immaculate recovery - with unemployment falling sharply in 2010 - are expecting single family housing starts to rebound quickly to a rate significantly above 1 million units per year. That won't happen. But it is possible for single family starts to rebound to 700 thousand SAAR, even with the large overhang of existing housing inventory.

This has been as weak as expected ...

And on another stimulus:

With unemployment above 10%, there will be significant political pressure for another stimulus package - especially if the economy starts to slow in the first half of 2010. This next package could be several hundred billion (maybe $500 billion) and could increase GDP growth in 2010 above my forecast.

It now appears the additional stimulus will be in the $100 billion range, mostly for additional unemployment benefits.

The most likely upside surprise appears to be coming from consumer spending and the lack of an increase in the saving rate. I still think the saving rate will continue to rise - although maybe not as fast as I originally expected.

Also - I still think the recovery will be choppy and sluggish. I'll review the downside risks soon ...

Socialism = cutting government spending.

This is an open letter to the economics, finance and banking communities. I don't have any dog in the fight, other than to figure out and then publicize what is best for the greatest number of people. People I greatly respect advocate for federal-level public banking, state public banks or a return to the gold standard. I am simply attempting to start a high-level debate about what the best option is. I will update this essay with the best responses as I receive them.

How Is Credit Created?

I pointed out in September:

As PhD economist Steve Keen pointed out recently, 2 Nobel-prize winning economists have shown that the assumption that reserves are created from excess deposits is not true:

The model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.

The first economist to establish this was the American Post Keynesian economist Basil Moore, but similar results were found by two of the staunchest neoclassical economists, Nobel Prize winners Kydland and Prescott in a 1990 paper Real Facts and a Monetary Myth.

Looking at the timing of economic variables, they found that credit money was created about 4 periods before government money. However, the “money multiplier” model argues that government money is created first to bolster bank reserves, and then credit money is created afterwards by the process of banks lending out their increased reserves.

Kydland and Prescott observed at the end of their paper that:

Introducing money and credit into growth theory in a way that accounts for the cyclical behavior of monetary as well as real aggregates is an important open problem in economics.

In other words, if the conventional view that excess reserves (stemming either from customer deposits or government infusions of money) lead to increased lending were correct, then Kydland and Prescott would have found that credit is extended by the banks (i.e. loaned out to customers) after the banks received infusions of money from the government. Instead, they found that the extension of credit preceded the receipt of government monies.

Keen explained in an interview Friday that 25 years of research shows that creation of debt by banks precedes creation of government money, and that debt money is created first and precedes creation of credit money.

As Mish has previously noted:

Conventional wisdom regarding the money multiplier is wrong. Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.

This angle of the banking system has actually been discussed for many years by leading experts:

“[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts."
- 1960s Chicago Federal Reserve Bank booklet entitled “Modern Money Mechanics”

“The process by which banks create money is so simple that the mind is repelled.”
- Economist John Kenneth Galbraith

"[W]hen a bank makes a loan, it simply adds to the borrower's deposit account in the bank by the amount of the loan. The money is not taken from anyone else's deposit; it was not previously paid in to the bank by anyone. It's new money, created by the bank for the use of the borrower."
- Robert B. Anderson, Secretary of the Treasury under Eisenhower, in an interview reported in the August 31, 1959 issue of U.S. News and World Report

“Do private banks issue money today? Yes. Although banks no longer have the right to issue bank notes, they can create money in the form of bank deposits when they lend money to businesses, or buy securities. . . . The important thing to remember is that when banks lend money they don’t necessarily take it from anyone else to lend. Thus they ‘create’ it.”
-Congressman Wright Patman, Money Facts (House Committee on Banking and Currency, 1964)

"The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented."
- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.

"Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created -- brand new money."
- Graham Towers, Governor of the Bank of Canada from 1935 to 1955.

I've also noted:

In First National Bank v. Daly (often referred to as the "Credit River" case) the court found that the bank created money "out of thin air":

[The president of the First National Bank of Montgomery] admitted that all of the money or credit which was used as a consideration [for the mortgage loan given to the defendant] was created upon their books, that this was standard banking practice exercised by their bank in combination with the Federal Reserve Bank of Minneaopolis, another private bank, further that he knew of no United States statute or law that gave the Plaintiff [bank] the authority to do this.

The court also held:

The money and credit first came into existence when they [the bank] created it.

(Here's the case file).

Justice courts are just local courts, and not as powerful or prestigious as state supreme courts, for example. And it was not a judge, but a justice of the peace who made the decision.

But what is important is that the president of the First National Bank of Montgomery apparently admitted that his bank created money by simply making an entry in its book ...

Moreover, although it is counter-intuitive, virtually all money is actually created as debt. For example, in a hearing held on September 30, 1941 in the House Committee on Banking and Currency, then-Chairman of the Federal Reserve (Mariner S. Eccles) said:

That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.

And Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta, said:

If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.

This must-see 47 minute video provides details:


So here are the first two questions:

Do you agree that banks create credit by initiating loans, and then obtaining deposits subsequently, to comply with depository requirements? I'm not talking about the coins which governments create (in America, coins represent less than 5% of the total money in circulation).

Do you agree with Eccles and Hemphill that money is debt, in that new credit normally comes into existence when a new loan is issued?

Government Alternative

William Greider is a former Washington Post and Rolling Stone editor, and now writes for the Nation. Greider has written numerous books and articles on the economy over the course of many decades, including one of the leading books on the Federal Reserve, Secrets of the Temple.

In an article in the Nation, Greider argues that the government could solve the economic crisis by taking back the power of money creation from the banks and the Federal reserve:

For the first time in generations, [the Fed is] now threatened with popular rebellion.

During the past year, the Fed has flooded the streets with money--distributing trillions of dollars to banks, financial markets and commercial interests ...

Where did the central bank get all the money it is handing out? Basically, the Fed printed it, out of thin air. That is what central banks do. Who told the Fed governors they could do this? Nobody, really--not Congress or the president. The Federal Reserve Board, alone among government agencies, does not submit its budgets to Congress for authorization and appropriation. It raises its own money, sets its own priorities.

Representative Wright Patman, the Texas populist who was a scourge of central bankers, once described the Federal Reserve as "a pretty queer duck." Congress created the Fed in 1913 with the presumption that it would be "independent" from the rest of government, aloof from regular politics and deliberately shielded from the hot breath of voters or the grasping appetites of private interests--with one powerful exception: the bankers...

Banks are the "shareholders" who ostensibly own the twelve regional Federal Reserve banks...

The Federal Reserve is the black hole of our democracy--the crucial contradiction that keeps the people and their representatives from having any voice in these most important public policies. That's why the central bankers have always operated in secrecy, avoiding public controversy and inevitable accusations of special deal-making. The current crisis has blown the central bank's cover...

Altering the central bank would also give Congress an opening to reclaim its primacy in this most important matter. That sounds farfetched to modern sensibilities, and traditionalists will scream that it is a recipe for inflationary disaster. But this is what the Constitution prescribes: "The Congress shall have the power to coin money [and] regulate the value thereof." It does not grant the president or the treasury secretary this power. Nor does it envision a secretive central bank that interacts murkily with the executive branch...

If Ben Bernanke can create trillions of dollars at will and spread them around the financial system, could government do the same thing to finance important public projects the people want and need? Daring as it sounds, the answer is, Yes, we can.

The central bank's most mysterious power--to create money with a few computer keystrokes--is dauntingly complicated, and the mechanics are not widely understood. But the essential thing to understand is that this power relies on democratic consent--the people's trust, their willingness to accept the currency and use it in exchange. This is not entirely voluntary, since the government also requires people to pay their taxes in dollars, not euros or yen. But citizens conferred the power on government through their elected representatives. Newly created money is often called the "pure credit" of the nation. In principle, it exists for the benefit of all];

In this emergency, Bernanke essentially used the Fed's money-creation power in a way that resembles the "greenbacks" Abraham Lincoln printed to fight the Civil War. Lincoln was faced with rising costs and shrinking revenues (because the Confederate states had left the Union). The president authorized issuance of a novel national currency--the "greenback"--that had no backing in gold reserves and therefore outraged orthodox thinking. But the greenbacks worked. The expanded money supply helped pay for war mobilization and kept the economy booming. In a sense, Lincoln won the war by relying on the "full faith and credit" of the people, much as Bernanke is printing money freely to fight off financial collapse and deflation.

If Congress chooses to take charge of its constitutional duty, it could similarly use greenback currency created by the Federal Reserve as a legitimate channel for financing important public projects--like sorely needed improvements to the nation's infrastructure. Obviously, this has to be done carefully and responsibly, limited to normal expansion of the money supply and used only for projects that truly benefit the entire nation (lest it lead to inflation). But here is an example of how it would work...

Instead, Congress should create a stand-alone development fund for long-term capital investment projects (this would require the long-sought reform of the federal budget, which makes no distinction between current operating spending and long-term investment). The Fed would continue to create money only as needed by the economy; but instead of injecting this money into the banking system, a portion of it would go directly to the capital investment fund, earmarked by Congress for specific projects of great urgency. The idea of direct financing for infrastructure has been proposed periodically for many years by groups from right and left...

This approach speaks to the contradiction House Speaker Pelosi pointed out when she asked why the Fed has limitless money to spend however it sees fit. Instead of borrowing the money to pay for the new rail system, the government financing would draw on the public's money-creation process--just as Lincoln did and Bernanke is now doing.

The bankers would howl, for good reason. They profit enormously from the present system and share in the money-creation process. When the Fed injects more reserves into the banking system, it automatically multiplies the banks' capacity to create money by increasing their lending (and banks, in turn, collect interest on their new loans). The direct-financing approach would not halt the banking industry's role in allocating new credit, since the newly created money would still wind up in the banks as deposits. But the government would now decide how to allocate new credit to preferred public projects rather than let private banks make all the decisions for us.

Here are my third, fourth and fifth questions:

Do you agree with Greider that the American Constitution and/or the inherent right of sovereign nations gives the government the power and authority to itself create credit?

Do you agree with Greider that such government creation of credit need not be inflationary so long as only as much credit is created as is needed by the economy - in other words, the amount actually needed to buy goods and services?

Several monetary commentators have said that - if credit is created primarily by the government instead of private banks - that it would save the government trillions of dollars in interest. Specifically, they claim that private banks charge interest to the government to fund the government's debt, but that the government would owe no debt on credit it creates itself.

Is that true?

What Is the Best Public Banking Option?

As I wrote in November:

AFL-CIO president Richard Trumka told Congress last week:

If the Federal Reserve were made a fully public body, it would be an acceptable alternative.

The American Monetary Institute proposes the following alternative:

Incorporate the Federal Reserve System into the U.S. Treasury where all new money would be created by government as money, not interest-bearing debt; and be spent into circulation to promote the general welfare. The monetary system would be monitored to be neither inflationary nor deflationary.

Second, halt the bank’s privilege to create money by ending the fractional reserve system in a gentle and elegant way.

All the past monetized private credit would be converted into U.S. government money. Banks would then act as intermediaries accepting savings deposits and loaning them out to borrowers. They would do what people think they do now. This Act nationalizes the money system, not the banking system.

Bloomberg News columnist Matthew Lynn writes:

The U.K. government needs to start thinking about what it will do with all the banks it now owns. The answer is simple: Hand them to the people...

Instead of selling the stakes it acquired in the financial system to other banks, or listing the shares on the stock market, it could create mutually owned societies. Royal Bank of Scotland Group Plc could be a people’s bank, owned by everyone.That would ensure more diversity, competition and stability, all goals just as worthy as getting back the money Prime Minister Gordon Brown’s government spent on bank rescues...

Sovereign nations such as the U.S. and England have the power to create credit and money (and see this, this and this). Taking the credit-creation power away from the banks and giving it back to the nation would ensure that credit is freed up for people's use, and the stranglehold over the economy is taken away from the too big to fails.

State Public Banks

Many people argue that - given its actions - people don't trust the federal government to create money.

Fair enough. Why not let the states do it?

Michael Moore recommends that the American people demand:

Each of the 50 states must create a state-owned public bank like they have in North Dakota. Then congress MUST reinstate all the strict pre-Reagan regulations on all commercial banks, investment firms, insurance companies -- and all the other industries that have been savaged by deregulation: Airlines, the food industry, pharmaceutical companies -- you name it. If a company's primary motive to exist is to make a profit, then it needs a set of stringent rules to live by -- and the first rule is "Do no harm." The second rule: The question must always be asked -- "Is this for the common good?" (Click here for some info about the state-owned Bank of North Dakota.)

As Moore notes, the state of North Dakota already has such a bank, and - because of that - North Dakota is just about the only state which is not running a huge deficit.

PhD economist and candidate for Florida governor Farid Khavari wants to create a Bank of the State of Florida, to create credit without burdening the state and its citizens with high interest charges by private banks.

See this for details.

Local Public Banks

An alternative to federal or state public banking is local public banks, as proposed by Edward Kellogg and others.

As summarized by Adrian Kuzminski:

During this time of financial and economic crisis, it is worth recalling that credible alternatives to our current financial system exist, if largely unrecognized, and deserve serious consideration...

The now-neglected 19th-century American proto-populist, Edward Kellogg ... was a kind of godfather to the later populist movement on monetary issues. Perhaps the most profound of American writers on monetary issues, Kellogg advocated a decentralized but nationally regulated monetary system based on non-usurious, low-interest public loans to individuals. His vision inspired 19th-century century mutualists, greenbackers, populists, and others who sought to restructure the monetary system to redistribute wealth.

In our own day, when usurious credit in the form of private finance capital remains the dominant force in economic life, and is largely taken for granted even by educated people, the alternative Kellogg offers is more important than ever. Indeed, I suggest that Kellogg's theory of money is the best monetary alternative we have to the baleful system under which we suffer...

Edward Kellogg (1790-1858) was a New York City businessman whose losses in the crash of 1837 led him to examine the business cycle, monetary policy, and debt. In a series of writings, Kellogg developed the idea of ... having the government provide very-low-interest loans to the general public. These loans would have a uniform, fixed interest rate, established by law. They would be issued locally through a system of public credit banks he called the Safety Fund. Once issued, these low-interest loan notes would circulate as currency, replacing the privately issued banking notes of his day (which today take the form of Federal Reserve Notes)...

In his day Kellogg seems to have influenced even Abraham Lincoln who, according to historian Mark A. Lause, " . . . had his own copy of Kellogg's book, Labor and Capital [sic] advocating the government issuance of paper currency as a just means of redistributing wealth, and he corresponded with the author's son-in-law." Kellogg's public currency was intended to end the monopoly over the discretionary issuance of money at interest, which was held then (and now) by the private banking and investment system...

Kellogg proposed to establish local public credit banks, and we might imagine one in each community. These local public credit banks would be part of the Safety Fund. Instead of money being issued (as it is now) through a privatized and centralized money-management system on a top-down basis, primarily as loans at increasing rates of interest from a central bank to major commercial banks, and then to regional and local banks, and then to the public, money in his system would be issued by local federal banks as loans directly to citizens at nominal interest on the basis of their economic prospects. Once lent out, Kellogg's public credit notes would flow into circulation, providing the basis for a new currency backed by the assets of individual borrowers...

A centralized national currency would be replaced, in Kellogg's system, by a locally issued currency. But that currency would everywhere be subject to common national standards, ensuring that each local public credit bank reliably issued equivalent units of currency. A dollar issued by one local public credit bank of the Safety Fund, Kellogg intended, would be worth the same as, and be freely interchangeable with, one issued by any other. The independence of local branches would be guaranteed by the discretionary power reserved to them as a local monopoly actually to loan money; the compatibility of their monies would be ensured under federal law by fixing the value of the dollar by law at 1.1 percent/year – that is, by lending money everywhere to citizens at that rate...

The goal is to establish and preserve economic decentralization. Amounts of money lent in Kellogg's system would vary considerably from place to place, with some areas needing and creating more currency than others. The solvency of local federal public credit banks would be guaranteed by collateral put up by borrowers, and the money supply would be stabilized by repayment of loans as they came due. The interchangeability of public credit bank notes would ensure a wide circulation for the new money...

To achieve a stable currency, Kellogg insisted that this rate be fixed by law; perhaps today it would take a constitutional amendment.

Michael Hudson (Distinguished Research Professor at the University of Missouri, Kansas City, who has advised the U.S., Canadian, Mexican and Latvian governments as well as the United Nations Institute for Training and Research. He is a former Wall Street economist at Chase Manhattan Bank who also helped establish the world’s first sovereign debt fund) and Congressman Dennis Kucinich both support the federal public banking option:

On the other hand, California considered creation of a state bank modeled after North Dakota's bank in 1977. And the Massachusetts state Senate is currently considering creation of a state public bank, and other states are currently considering creating their own state banks.

So here is my sixth question:

Do you think a federal, state or local public banking option is best?

What About Gold?

Advocates for a return to the gold standard point out that - when a currency is pegged to a hard asset such as gold - it imposes fiscal discipline. Specifically, the government cannot simply run its "printing press" if its currency has to maintain a set ratio to a hard asset, and this prevents funding of endless wars and other misadventures.

I largely agree. But advocates for public banking, on the other hand, point to the numerous depressions which have occurred during periods when the gold standard was in place.

See these short videos (I don't necessarily agree with the conspiracy theories alleged in the first video, but only with the general question of whether we can assure that the quantity and quality of gold can be assured):

Here is my seventh and final question:

Is there any way to have a hybrid monetary system which provides the benefits of public banking with the fiscal discipline which something like a gold standard imposes?

Glad I'm not there.

Presenting an update of North American Investment Grade CDS. While Month To Date the credit market has ripped in line with equities, with just CTL and AA marginally wider for the period, Year to Date the vast number of names is still wider than at January 1, or at beast unchanged, demonstrating that credit is certainly not as enthused about the equity market activity over the past two and a half months.

Month To Date:

And Year To Date:

source: Citi

China wants it all.

The Jenner and Block report on Lehman just keeps on giving.

Today I am going to focus on FRBNY's culpability in the apparent Lehman fraud - that is, the role that FRBNY (and thus Tim Geithner) played in keeping an insolvent institution afloat through the use of fraudulent artifices.

We must look first to what the PDCF, or "primary dealer credit facility" was created to be.  The report does this for us:

Under the PDCF, the FRBNY would make collateralized loans to broker‐dealers, such as LBI, and in effect, act as a repo counterparty. Unlike a typical counterparty, though, with the creation of the PDCF, the FRBNY was generally understood by market participants to be the “lender of last resort to the broker‐dealers.”5332 Reflecting the fact that broker‐dealer liquidity had become increasingly dependent on overnight repos to obtain short‐term secured financing,5333 the PDCF was structured as an overnight facility.

Pursuant to the Federal Reserve Act’s requirement that a Federal Reserve Bank lend only on a secured basis, and according to the convention in repo lending, the FRBNY advanced funds against a schedule of collateral. Collateral accepted by the PDCF initially consisted of: Treasuries, government agency securities, mortgage‐backed securities issued or guaranteed by government agencies, and investment grade corporate, municipal, mortgage‐ and asset‐backed securities priced by clearing banks.5334

The FRBNY set the lending rate for PDCF advances equal to the rate charged by the Federal Reserve’s discount window, available to depository institutions.5335 In fact, the PDCF was frequently analogized to the traditional discount window, or viewed as expanding the discount window to securities broker-dealers.

In short, the PDCF was essentially an extension of the overnight repo market set up to deal with a very-specific circumstance - Bear Stearn's near collapse, despite having valid and good, market-recognized marginable collateral that could be posted for overnight repos.

The problem is, as I noted at the time, that broker/dealers used the PDCF not as it was intended and announced but rather as a scheme to post illiquid or even trash collateral that nobody else would take in exchange for liquidity - that is, cash.

Indeed, at the time I said:

These banks could take dogsqueeze, put it in a box and slap a $1 million price tag on it, and given the utter lack of prosecutorial supervision of the law - existing law - they'd get away with it literally forever.

They could then make loans against this "value" and yet what they actually hold is worth zero.

When they ran low on cash they'd then tender that dogcrap to The Fed for a TAF or PDCF loan, and that's ok too - our Congress simply doesn't give a damn as the hundred million dollars in bribes, er, "campaign contributions", insure that blatant violations of The Federal Reserve Act are not only tolerated but cheered whenever Wall Street needs more "slop" for its pigtrough - at your expense.

This was, at the time, an educated guess.  Now we know it was much more - it was fact:

Lehman did indeed create securitizations for the PDCF with a view toward treating the new facility as a “warehouse” for its illiquid leveraged loans. In March 2008, Lehman packaged 66 corporate loans to create the “Freedom CLO.”5347 The transaction consisted of two tranches: a $2.26 billion senior note, priced at par, rated single A, and designed to be PDCF eligible, and an unrated $570 million equity tranche.5348 The loans that Freedom “repackaged” included high‐yield leveraged loans,5349 which Lehman had difficulty moving off its books,5350 and included unsecured loans to Countrywide Financial Corp.5351

Lehman did not intend to market its Freedom CLO, or other similar securitizations, to investors. Rather, Lehman created the CLOs exclusively to pledge to the PDCF.5352 An internal presentation documenting the securitization process for Freedom and similar CLOs named “Spruce” and “Thalia,” noted that the “[r]epackage[d] portfolio of HY [high yield leveraged loans]” constituting the securitizations, “are not meant to be marketed.”5353 Handwriting from an unknown source underlines this sentence and notes at the margin: “No intention to market."

It gets better.  Not only was Lehman aware that it was gaming the system it gamed public disclosure and FRBNY was aware what was going on:

Given that the press has not focused (yet) on the Fed window in relation to the [Freedom] CLO, I’d suggest deleting the reference in the summary below. Press will be in attendance at the shareholder meeting and my concern is that volunteering this information would result in a story.

So we have the company intentionally avoiding public disclosure of "a material event."  Securities laws are supposed to prevent this sort of thing - if they're enforced.

Did FRBNY know of this?  It sure looks that way:

The FRBNY was aware that Lehman viewed the PDCF not only as a liquidity backstop for financing quality assets, but also as a means to finance its illiquid assets.

But wait a second - that's not what the PDCF was intended to be.  So here's a clear statement that FRBNY knew that Lehman (and perhaps others) were in fact gaming the system and yet they did nothing about it.

Who ran FRBNY at the time?  None other than Tim Geithner.

It gets better.

Remember the "tests" of the PDCF from that time?  Those were lies too:

Lehman drew on the PDCF facility sparingly prior to its bankruptcy. Lehman accessed the PDCF seven times in the liquidity stress period that followed the Fed brokered sale of Bear Stearns to JPMorgan.5368 Both internally, and to third parties, Lehman characterized these draws as “tests,”5369 although witnesses from the FRBNY have stated that these were not strictly “tests,” but instances in which Lehman drew upon the facility for liquidity purposes.

And again, FRBNY and Tim Geithner allowed to be promulgated to the market false information about the character of the use of this facility.

Nor does it end there.  FRBNY and Tim Geithner appear to have countenanced and sat silent while Lehman deliberately and intentionally was counting assets that were encumbered in its liquidity numbers!  Specifically:

The FRBNY knew that Lehman included pledged assets in its liquidity pool, but as Lehman’s lender rather than its regulator, the FRBNY took no steps to compel Lehman to disclose the discrepancy between Lehman’s reported liquidity pool figure and the actual, smaller number.

FRBNY, however, is both a regulator and a lender.  In addition the distinction may be immaterial; if you are a party to a violation of the law and do nothing about it, you can be held accountable as an accessory before or after the fact.  In this case these false statements by Lehman appear to be nothing more than a garden-variety fraud, and it certainly appears that Tim Geithner and FRBNY were both fully-aware of what was going on and intentionally said nothing.

The report makes clear that the market was misled, and relied on the misleading statements.  Specifically:

On the basis of Lehman’s reported liquidity pool, specifically its reported size and composition of easy‐to‐monetize assets, market participants formed positive opinions of Lehman’s liquidity profile. Certain influential participants, and rating agencies in particular, cited Lehman’s liquidity pool as the basis for concluding that Lehman’s liquidity position was sound.

...

“The basis for Moody’s assessment of Lehman’s liquidity,” the report continues, “is the strength of their overall funding framework, which includes an ample liquidity cushion of high-quality unencumbered assets."

While private parties may have no obligation to "rat out" misperceptions of the market, it is my position that a government agency or actor, irrespective of what other hats they wear, DOES have such an affirmative obligation.

The SEC has concluded:

Post earnings announcement on September 9[, 2008], Holdings’ liquidity decreased . . . from $41 billion to $25 billion – $16 billion of which was required by clearing banks at the start of the day and approximately $7 billion of which was in liquid securities that became near impossible to monetize immediately in this extremely stressed market environment -primarily because of a loss of repo capacity.

As a result, . . . ”free cash” available intra day was less than $2 billion.

With LBIE facing a projected cash shortage of $4.5 billion on September 15, Lehman had no choice but to place LBIE into administration because of potential director liability. This resulted in a cross‐default of and triggered the filing [of LBHI] on September 15.

In other words, essentially the entire liquidity pool was tied up in security agreements with various firms, and this was the proximate cause of the bankruptcy filing.

The paper makes a clear case that FRBNY was aware of both the encumbrance and Lehman's lack of disclosure of this fact to the investment community and did nothing about it.

Here is the bottom line folks: Tim Geithner, then-head of FRBNY, is responsible as the chief executive for everything that went on there.  Whether he had personal knowledge or not is immaterial, although it is extremely difficult to believe that he would not know about the most-important issue facing the markets in the summer and early fall of 2008.

The record is clear, however, that while the NY Fed knew that (1) Lehman was gaming the PDCF with assets that other banks refused to repo against (in fact Citi called one of them "garbage") and (2) it was encumbering its so-called "liquidity pool" with security agreements and as a consequence there was in fact no liquidity available FRBNY did nothing to alert the SEC or investors of this fact.

This paper appears to set forth several prima-facie cases of violations of Securities Laws, both on a civil and criminal level.

The further question, however, is whether culpability extends to both FRBNY and the banks with which Lehman was doing business with.  The paper also makes a prima-facie case that both FRBNY and these other banks were fully-aware of what Lehman was up to and intentionally looked the other way, deeming it "not their problem."

This, I believe, is false. 

I cannot have constructive or actual knowledge that you have the intention of robbing a bank (breaking the law) and yet drive you to the bank.  If I continue with assisting you in the furtherance of your scheme once I become aware of it I am subject to being charged as an accessory or even as a primary criminal actor in the case.

How is this different?

Further, how is it that we can have a Treasury Secretary who, it appears, had either full or constructive knowledge of the gaming that Lehman was undertaking and yet did nothing about it, leading directly and proximately to the market meltdown in 2008.

Literal trillions of dollars were lost due to this malfeasance and misfeasance, along with millions of jobs.  Yet one of the "watchdog" agencies involved in banking clearing and regulation knew about it, did nothing, and the head of that organization now runs Treasury.

It has been my contention that Geithner was largely responsible for willful blindness in the lead-up to this mess since it began.  We now have a "smoking gun" making a clear and nearly-impossible to refute case.

I call upon prosecutors both at a State and Federal level to look into this for potential prosecution under both civil and criminal Racketeering statutes, including their counterparty banks and FRBNY.

Tim Geithner must be fired by The President.  If he refuses, then following the election in November, when I fully expect that Republicans will re-take both the House and Senate, impeachment proceedings must be brought against President Obama for his willful and intentional refusal to remove the person who this paper makes clear could have put a stop to the collapse for nearly six months and yet failed to do so.

“Dick Fuld is going to be bankrupted and he’s going to spend the rest of his life in court fighting legal battles. There maybe others forced to do the same.”

-Dick Bove of Rochedale Securities. Bove had  all nine volumes of the examiner’s report printed and bound. (Barrons)

>

As it turned out, Lehman Brothers was the firm that deserve to die. The author of the book The Murder of Lehman Brothers asked me to do for a review of it — I politely declined, saying his title was wrong — it wasn’t murder, it was suicide.

Turns out that was more true than I realized.

In addition to tarnishing what little name Fuld had, the tentacles of the Valukas Report are reaching to the NY Fed and Geithner, Ernst & Young, even Linklaters, a law firm in the UK that blessed Repo 105 for the British subsidiary of LEH as kosher.

As you can see by the headlines below, the breadth of Lehman stories is rather substantial. If you want to delve deeper, these are as good a place to start digging:

• Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner’s Report (Jenner & Block)

• Repos Played a Key Role in Lehman’s Demise (WSJ)

• Video: Former 1999 Lehman CFO Brad Hintz on the off-balance-sheet transactions of Lehman Bros (Bloomberg)

• No, JPM and Citi Did Not Cause Lehman’s Collapse. (TBP)

• This just in: short-sellers had nothing to do with the collapse of Lehman Brothers. (Jeff Matthews)

• Financial Crisis May Reach Auditors (WSJ)

• NY Fed Under Geithner Implicated in Lehman Accounting Fraud Allegation (naked capitalism)

• Insider Warned About Lehman Accounting  (WSJ)

• The “Repo 105″ Scam: How Lehman Fooled Everyone (Including Allegedly Dick Fuld) And How Other Banks Are Likely Doing This Right Now (Zero Hedge)

• Why It Doesn’t Matter If Lehman Round-Trip Sales Technically Complied With Accounting Rules  (Business Insider)

• Lehman Failed Its Stress Tests on at Least Three Occasions (Daily Finance)

• Lehman was a poorly-managed bank that operated an irresponsible business model (FT)

• Lehman’s Ghost Haunts California (WSJ)

• In Lehman’s Demise, Some Shades of Enron (Dealbook)

• Linklaters, Ernst & Young face action over Lehman Brothers collapse (Times Online)

• The Devil’s Casino: “Lehman was a culture of lies” (book/video)

• Video: Lehman Brothers, the Next Enron? (MSNBC)

• Findings on Lehman Take Even Experts by Surprise (NYT)

Feel free to throw any other Lehman articles, analysis or commentary worth mentioning into comments.

The top chart shows my proprietary measure of short-term stock market momentum. As a rule, momentum tops ahead of price. While momentum has stayed positive (above 1.0), we're seeing some waning of momentum as SPY (blue line) has marched to new price highs this past week. Given the recent market strength, with new 20-day highs significantly outpacing new lows, I'd look for pullbacks in momentum to under 1.0 as potential buying opportunities.

An even clearer illustration of recent waning momentum can be seen in the proprietary measure of Demand and Supply (bottom chart), which tracks the number of stocks closing above and below the volatility envelopes surrounding their moving averages. Demand tends to top ahead of price; note how we're not only seeing low Demand recently, but Supply actually outpacing Demand as we've moved higher.

Once again, I'd lean toward buying pullbacks in which Supply greatly exceeds Demand. As long as peaks in Supply are occurring at successively higher price lows, I would remain a bull on this market per the recent indicator review. An updated indicator review will follow shortly.
.

Ultimately the biggest loser from the whole Repo 105 scandal may not be the perpetrators, i.e., Fuld, the firm's numerous CFOs, Tim Geithner and Mary Schapiro, but the alleged "fact-checkers" - auditors Ernst & Young. Just like Enron's Star Wars-based off balance sheet accounting gimmicks brought down Arthur Anderson, so "Repo 105" may likely be responsible for the downfall of E&Y. Although while in Enron's case, it was just the accounting that brought the firm down, in Lehman's case the confluence of numerous factors will render each individual one relatively less critical, potentially to the point of irrelevance. And while book cooking was just as big of an issue for Lehman as it was for Enron, the fact that the bank did pretty much every other borderline illegal thing possible, will take away focus from just the Repo 105 fiasco, or just the liquidity misrepresentations, or just the commercial real estate book mismarking, and so forth. So to facilitate a decision on E&Y culpability, we present a candid look at Ernst & Young's Financial Services Office, the company's presentation on Paragraph 10 of IAS 39 overseeing Repo agreements, E&Ys analysis of FAS 140 "Accounting for Financial Transfers and Repurchase Financial Transactions", the Examiner's conclusions on the firm's breach of conduct, the firm's soon to be dwindling banking client base, and last, and most certainly least, a snapshot of E&Y's Lehman co-lead partner, Hillary Hansen, against whose negligent actions, as part of the Lehman E&Y practice, the Examiner concludes "that sufficient evidence exists to support a colorable claim for malpractice."

Follows a presentation of E&Y's Financial Services Office.

In the United States, Ernst & Young LLP is the only public accounting firm with a separate business unit dedicated to the financial services marketplace. Created in 2000, the New York–based Financial Services Office today includes more than 3,300 professionals in more than 30 locations across the US, as well as in Bermuda, the Bahamas and the Cayman  Islands. Key offices throughout the US include Boston, Charlotte, Chicago, Dallas, Los Angeles, McLean, Minneapolis, New York, Philadelphia, San Francisco and Stamford. Our financial services professionals provide high-quality assurance, tax, transaction and advisory services, including operations, risk and technology, to our asset management, banking, capital markets and insurance clients.

In addition, Ernst & Young professionals in our financial services practices worldwide align with key global industry groups, including Ernst & Young’s Global Asset Management Center, Global Banking & Capital Markets Center and Global Insurance Center, which act as hubs for sharing industry-focused knowledge on current and emerging trends and  regulations in order to help our clients address key issues.

The group's key contacts are listed in the attached presentation. Note the name of Bill Schlich, one of the two E&Y people named by the Examiner as responsible for the negligence colorable claim against the firm in the Lehman case.

E&Y was quite aware of the concept of traditional Repos, as can be ascertained by the following company presentation:

 

 

Furthermore, E&Y was certainly quite aware of the nuances of SFAS 140, the accounting board's green light of what would, with Linklaters' blessing shortly, become known as Repo 105. In essence, SFAS 140 is what allowed the accounting of repos as true sales. Some complications, as E&Y itself notes, arising from SFAS, are that "in saome cases it may not be possible for attorneys to provide true sale opinions under U.S. bankruptcy law when the transactions are combined and integrated." The full E&Y SFAS 140-associated education session is presented below.

EY SFAS 140 Repo Alert

A brief tangent here, which goes toward disclosure. Surely the use of SFAS 140 in Lehman's operations should have merited some mention in the firm's public filings, which after all would need E&Y's blessing. Yes and no. As the examiner points out, Lehman did not follow through on full disclosure requirements:

In a few of its financial statements, Lehman stated that “The Company accounts for transfers of financial assets in accordance with SFAS 140” and followed this statement with a summary of SFAS 140’s three criteria for recognizing the transfer of financial assets as sales (LBHI 10?Q, filed July 15, 2002), at p. 8; see also id. at p. 42 (discussing SFAS 140 in the context of securitizations and special purpose entities). In these instances where Lehman made the general disclosure regarding SFAS 140: (1) the SFAS 140 disclosure was listed under “Consolidation Accounting Policies” along with a disclosure regarding Special Purpose Entities or was part of a “Securitization activities” disclosure; (2) Lehman did not state that it treated some repo transactions as sales under SFAS 140; and (3) the financial statement contained other disclosure(s) stating that Lehman treats repo transactions as secured financings (i.e., not as sales) and/or regarding securities owned and pledged as collateral (as described above) (LBHI 10?Q (filed July 15, 2002), at pp. 8, 14; LBHI 10?Q (filed Oct. 15, 2002), at pp. 9?10, 17; LBHI 2002 10?K, at pp. 69, 71, 91; LBHI 10?Q (filed Oct. 15, 2003), at pp. 10?11, 12?13, 20; Lehman Brothers Holdings Inc., Quarterly Report as of Feb. 28, 2007 (Form 10?Q) (filed on Apr. 9, 2007), at pp. 11?12 (“LBHI 10?Q (filed Apr. 9, 2007)”); LBHI 10?Q (filed July 10, 2007), at pp. 11?12; LBHI 10?Q (filed Oct. 10, 2007), at pp. 11?12).

Back to E&Y - where things get really bleak for Ernst & Young is the following disclosure of a whistleblower arising from Lehman's soon to be ashes, and E&Y's treatment of his brand new information.

On May 16, 2008, Matthew Lee, then?Senior Vice President in the Finance Division responsible for Lehman’s Global Balance Sheet and Legal Entity Accounting, sent a letter to certain members of Lehman’s senior management identifying possible violations of Lehman’s Ethics Code related to accounting/balance sheet issues. Lehman involved Ernst & Young in its investigation of the concerns raised in Lee’s May 16, 2008 letter.

Subsequently, less than a month later, on June 12, 2008, Ernst & Young – Schlich and Hillary Hansen – interviewed Lee. Hansen’s notes of the interview reveal that Lee made certain statements to Ernst & Young about Lehman’s Repo 105 practice, including, most notably, the volume of Repo 105 activity that Lehman engaged in at quarter?end (May 31, 2008). Hansen’s notes specifically recount Lee’s allegation that Lehman moved $50 billion of inventory off its balance sheet at quarter?end through Repo 105 transactions and that these assets returned to the balance sheet approximately a week later.

To wit:

Hansen’s notes indicate that Lehman’s “Rates [and] Liquid Markets” businesses engaged in “Repo 105/Repo 108 [to] reduce[] assets by 50B [by] moving off B/S [i.e., balance sheet] in Europe & back in 5 days later.” Hillary Hansen, Ernst & Young, Handwritten Notes (June 12, 2008), at p. 1 [EY?LE?LBHIKEYPERS 5826869]. This is consistent with the Examiner’s conclusions that at quarter?end in second quarter 2008, Lehman reduced its balance sheet by slightly more than $50 billion through Repo 105 transactions.

Amusingly, while yesterday we discussed the interorganizational scapegoating, today we arrive at the intra-version. Bill Schlich, the partner named above, is quick to make thing Hansen's fault.

When interviewed by the Examiner, Schlich did not recall Lee saying anything about Repo 105 transactions during that interview, although he did not dispute the authenticity of Hansen’s notes from the Lee interview. In spite of Hansen’s notes, Schlich maintained that Ernst & Young did not know that Lehman engaged in the following Repo 105 activity during the listed time periods: $49.1 billion at first quarter 2008 (Feb. 29, 2008); and $50.38 billion at second quarter 2008 (May 31, 2008).

Now Hillary Hansen, unwilling to be thrown under the bus without some token defense, also comes out with a scapegoating excuse. Left with little recourse, she blames incompetence.

During the Examiner’s interview of Hansen, Hansen recalled that while Ernst & Young questioned Lee about his May 16, 2008 letter, Lee “rattled off” a list of additional issues and concerns he held, one of which was Lehman’s use of Repo 105 transactions. Ernst & Young had no further conversations with Lee about Repo 105 transactions. Prior to her interview of Lee in June 2008, Hansen had heard the term Repo 105 “thrown around” but she did not know its meaning; according to Hansen, Schlich described Repo 105 transactions to her shortly after they met with Lee.

It is good to know that a head auditor on a top 5 investment bank was unfamiliar with its business practices, and the implications of SFAS 140, even though the firm, as presented above, was edumacating its partners about such things.

We are not sure, however, who Schlich and Hansen will be able to scapegoat this on. Full summary of key events follows:

On June 13, 2008 – the day after Lee informed Ernst & Young of the $50 billion in Repo 105 transactions that Lehman undertook at the end of the second quarter 2008 – Ernst & Young spoke to Lehman’s Audit Committee but did not inform the committee of Lee’s allegation, even though the Chairman of the Audit Committee had clearly stated that he wanted every allegation made by Lee – whether in Lee’s May 16 letter or during the course of the investigation – to be investigated. Ernst & Young met with the Audit Committee on July 8, 2008, to review the second quarter financial  statements and again did not mention Lee’s allegations regarding Repo 105. On July 22, 2008, Ernst & Young was also present when Beth Rudofker, Head of Corporate Audit, gave a presentation to the Audit Committee on the results of the investigation into Lee’s allegations.

 

Ernst & Young did not disclose to the Audit Committee – either during the meetings or in private executive sessions after – that Lee made an allegation related to Repo 105 transactions being used to move assets off Lehman’s balance sheet at quarter-end. Cruikshank told the Examiner that he would have expected to be told about Lee’s Repo 105 allegations. Similarly, Sir Gent told the Examiner that the alleged volume of Lehman’s Repo 105 transactions mandated disclosure to the Audit Committee as well as further investigation...Ernst & Young did not follow?up on either Lee’s allegations regarding Lehman’s Repo 105 activity or Reilly’s claim that he had no knowledge of Lehman’s alleged $50 billion Repo 105 usage figure. Ernst & Young signed a Report of Independent Registered Public Accounting Firm for Lehman’s second quarter 2008 Form 10?Q on July 10, 2008, less than four weeks after Schlich and Hansen interviewed Lee.

Not to beat a dead horse, but E&Y was at fault: as the Examiner points out:

Disclosure of the agreement to repurchase component of Repo 105 transactions was required in the MD&A. Lehman’s repurchase of the securities was a known event that was reasonably likely to occur and would have had a material effect on the company’s financial condition or results of operations. Lehman’s disclosure in the Liquidity and Capital Resources section should have included a discussion of what was known with respect to the timing and/or amounts of the cash flow created by the repayment of the Repo 105 cash borrowing in the first seven to ten days after quarter-end, specifically: (1) the availability of cash as a result of the repayment of the Repo 105 cash borrowing; (2) the ability to borrow more capital because of a reduction in debt rating or deterioration in leverage ratio due to the repayment of the Repo 105 cash borrowing; (3) the effect of the repayment of the Repo 105 cash borrowing on the cost of capital/credit rating; and (4) the economic substance and business purpose of the Repo 105 arrangements.

Indeed, there was a "duty to report":

SEC Rule 12b?20 requires that all filings contain such additional information necessary to make the information contained in the filing not misleading. Moreover, “Once defendants choose to speak about their company, they undertake a duty to ‘speak truthfully and to make such additional disclosures as…necessary to avoid rendering the statements misleading.’”

And here is why the plaintiff bar is really hung over today. The lawsuits are coming:

An investor reviewing Lehman’s 2007 Form 10?K and two 2008 Forms 10?Q would not have been able to discern that Lehman was engaged in Repo 105 transactions. Indeed, Lehman made no disclosures in its Statement of Income, Statement of Financial Condition, Statement of Cash Flows, or MD&A sections (including its section on liquidity) from which an investor could infer that Lehman treated a certain volume of repo transactions as sales under SFAS 140, thereby decreasing its net assets and its net leverage ratio...In addition, even a sophisticated reader of Lehman’s financial statements would not have been able to ascertain from Lehman’s 2007 Form 10?K or its first and second quarter 2008 Forms 10?Q the amount of Lehman’s Repo 105 usage, nor even ascertain the fact that Lehman was engaged in these transactions, by attempting to quantify the amount of liquid securities temporarily removed from the balance sheet, as reported in Lehman’s public financial statements.

We sure hope that Fuld, O'Meara, Callan, Lowitt and all of E&Y are promtly depositing money in their legal representation singking fund:

The Examiner finds that sufficient evidence exists to support the finding of colorable claims against Richard Fuld, Christopher O’Meara, Erin Callan, and Ian Lowitt in connection with their actions in causing or allowing Lehman to file periodic reports that did not disclose Lehman’s use of Repo 105 transactions and against Ernst & Young for its failure to meet professional standards in connection with that lack of disclosure... While there were credible facts and arguments presented by each that may form the basis for a successful defense, the Examiner concluded that these possible defenses do not change the now final conclusion that there is sufficient evidence to support a finding that claims of breach of fiduciary duty exist against Fuld, O’Meara, Callan, and Lowitt and a colorable claim of professional malpractice exists against Ernst & Young.

And focusing again purely on E&Y:

The Examiner concludes that sufficient evidence exists to support colorable claims against Ernst & Young LLP (“Ernst & Young”) for professional malpractice arising from Ernst & Young’s failure to follow professional standards of care with respect to communications with Lehman’s Audit Committee, investigation of a whistleblower claim, and audits and reviews of Lehman’s public filings.

This surely can not be good news to E&Ys current batch of existing banking clients, which are US Bancorp, SunTrust, CapitalOne, Regions Financial, KeyCorp, Comerica, Cullen/Frost Bankers, and Zions Bancorp, among the largest ones. In fact, we anticipate that the termination letters are already in the mail.

Meet Hillary Hansen.

The weakest link in the above presentation is surely E&Y partner, and co-head of the Lehman account, Hillary Hansen. For all of you who would like to get a glimpse of this presumably tireless workhorse which was supposed to be working 24/7 figuring out what the hell was going on with Lehman's books, you may be in for a disappointment. In this Fora TV presentation on the topic of "Women's Networks Help Level the Playing Field" from January, 2009, we get a glimpse into Ms. Hansen's busy lifestyle "I am a woman raising three small children, I commute from far away, I work home two days, usually I am not in on Fridays (laughter), I telecommute and often times I get asked how I fit it all together." Oh yes, Ms. Hansen we are confident you will be getting that question and many others very soon. What we found hilarious is Ms. Hansen's sentiment vis-a-vis her audit client Lehman Brothers. Fast forward to 17:15, where Hansen discloses that "We audit Lehman Brothers, UNFORTUNATELY." Once again prophetic. However in the wrong direction. Something tells us that Lehman's shareholders, despite knowing how great of a woman networker and a terrific partially-stay at home mom M.s Hansen may be, coupled with just how horrendous of an auditor, the lawsuits that are sure to follow will focus on the latter.

Full link of Hansen's brief unspired monologue after the jump.

With all this information, we are confident that (again, with the assumption that we live in some semblance of a sane/ration world), E&Y's Financial Services Office is done (even despite such ironically apropos warnings on the firm's website as "Top six liquidity risk management challenges for global banks "), and quite possibly the entire firm. Integrity is the number one currency for an auditor, and just like Anderson, E&Y's just went out in a puff of green-colored smoke. Then again, with America's population broadly distracted by the healthcare debate, by the phantasmagorical market, and by mass scapegoating campaigns in which nobody seems intent on getting to the bottom of the responsibility chain, we will be very much unsurprised if nothing ends up happening, and the well-greased machine of endless corruption keeps chugging along as per usual.

And here, due to popular demand, is E&Y's Global Code Of Conduct.

Attachment	Size
EY IAS 39 Repos.pdf	644.91 KB
EY SFAS 140 Repo Alert.pdf	132.38 KB
E&Y Contacts.pdf	70.44 KB
EY Code Conduct Global.pdf	484.59 KB

"When the economy's bad, governments pile up these fiscal deficits and they print money to offset the deleveraging of the private sector, he says. They're going to print and print and print. If the economy sours again and especially if deflationary forces take hold, we'll have even more stimulus packages and even more printing. That will bankrupt western governments - not just in the U.S. but everywhere. "

in Yahoo Finance

Marc Faber is an international investor known for his uncanny predictions of the stock market and futures markets around the world. Dr. Doom also trades currencies and commodity futures like Gold and Oil.

"I would rather be lightening up on positions in the next couple of weeks than heavily buying in here"

in Yahoo Finance TECH Ticker

Related ETF`s:SPDR S&P 500 ETF (Public, NYSE:SPY), ProShares UltraShort S&P500 (ETF) (Public, NYSE:SDS)

Marc Faber is an international investor known for his uncanny predictions of the stock market and futures markets around the world. Dr. Doom also trades currencies and commodity futures like Gold and Oil.

Note: Ron Paul has joined me in advocating the repeal of NAFTA. Congratulations to Mr. Paul for renouncing his globalists ways.

But the same cannot be said for Larry Kudlow. In fact, he is every bit as passionate about exporting jobs as he has ever been. If you fast-forward this video to 3:45, you will see the spectacle of Kudlow pounding the table for “global job creation”:

It’s pretty jarring to see such a thing while the US economy has not been able to create jobs for over a decade. Kudlow is clearly mad, but he is also shilling for the powers-that-be and the favela-style economic system that they have planned for the USA.

If you scroll the video back a bit, you will also see the new meme that they are trying to infect us with. It goes like this:

“It’s OK for the USA to have wide-open free trade with low-wage nations because all the factory jobs lost will be compensated for by many new back-office jobs at corporate headquarters in the USA.”

CNBC has been trying to inject this meme into your brain, but I believe it will be strangled in its crib. A good meme requires plausibility, and this one is just plain ridiculous.

If GM moves a plant from Detroit to Guadalajara, how many more office workers do they need to hire at headquarters? They may have to replace some current workers with bilingual workers, and maybe hire a couple of logistics people to work on getting the cars imported back into the USA. But what are the chances that the number of factory workers laid off would be equaled or exceeded by new office workers? ZERO!

Note to CNBC/Kudlow/Evil Overlords: If your new meme is so smart, why isn’t Detroit a paradise? Why are all those factory workers still unemployed? Give it up; you’re not fooling anybody.

I’m sure you have also heard Kudlow shouting about King Dollar, right? There is an “on-shoring” phenomena going on caused by the weak dollar which is forcing American companies to bring jobs back home. That’s making Kudlow apoplectic. Even I was startled when he recently went berserk on Obama for not making more NAFTA-like trade deals. I mean, really, only a crazy person would expect the President to export more jobs, right?

Kudlow is losing it, and that’s a sign that millions of factory jobs just might be coming home soon.

Note to Canada: I don’t see thousands of maquiladoras along your border, so you’re OK in my book.

SPIEGEL-online bringt heute unter der Überschrift „Deutsche Wirtschaft übertrumpft den Rest Europas" (in Anlehnung an einen Artikel im konservativ-neoliberalen britischen Economist) ein besonders gutes Beispiel dümmlicher Medienverdrehung.

Please consider 4 visualizations of Obama's Budget Cuts.

$17 Billion Cuts In Context



Obama Budget Cuts Visualization



Obama's "Unsustainable Course" (And what he's NOT doing something about)

Note: There is no audio in the middle portion of this video.



What Does The Federal Budget Freeze Look Like?



For more on budgetary math behind the freeze please see What Does the Federal Budget Freeze Look Like?

The amount saved from this freeze has been consistently reported as $15 billion in the first year and $250 billion over 10 years. I hate the “we’re saving $250 billion over 10 years” line. It is a piece of crass political rhetoric and I’m disappointed that the administration would use it. If they actually implement a three year freeze on the portion of the budget they’re talking about (which is a big if, but let’s assume the best), why measure the effects in the space of 10 years?

The answer is “To make the freeze look bigger”.

They might as well say that they’re saving a trillion dollars over the next 25 years or a hundred trillion over the next 300 years. It is a data statement designed to trick people.

Second, I hate the “We’re saving all this money by not spending it” line because it is similarly political. If a future politician wants to play this stupid numbers game, all they have to do is “project” that they will spend like a crazy person next year and when the next year comes, they decided to spend like a half crazy person. Then they can claim that they have “saved” all this money because they “reduced” their projected spending.

Keep in mind the hypocrisy on both sides of the aisle. Overall, it looks like both sides are more interested in political gain than in having a frank discussion about the numbers and what they mean. This should surprise no one, but I confess to finding myself somewhat dismayed that the Obama administration, for all their hype about being pro-science and pro-data, has no problem spinning the numbers in a way that decreases clear comprehension in order to increase message potency.

Where Are The Fiscal Conservatives?

When will conservatives in Congress be willing to do something other than play politics? That's what I want to know. There was every opportunity under Bush to do something. Nothing happened.

Entitlements must be reined in, but so must military spending. The US cannot afford to keep troops in 140 nations. We cannot afford to keep fighting wars that do not need to be fought. It's time to declare the war in Iraq won (and leave). It's time to declare the war in Afghanistan won (and leave). The latter war is no more winnable than Vietnam.

We need fiscal conservatism across the board. If Congress is unwilling to raise taxes to pay for a program then the program should be scrapped. We can start by scrapping HUD, and the Department of Education. Then we can scrap the Department of Energy. We can also get rid of all crop subsidies and allow imports of drugs from Canada.

The amazing thing is that Obama says he does not want deficits, Republicans say they do not want deficits, and Democrats say they do not want deficits. So why do we have deficits?

Other than Ron Paul, how many true fiscal conservatives are there? I think it is safe to say we found one in Governor Chris Christie, but where are they in the US Senate? Where are they in the US house? Even the supposedly fiscal conservative Blue Dog Democrats are acting like Obama's lap dog.

We need fiscal conservatives with a backbone of steel, not fiscal conservatives with bones like canned salmon. Worse yet, Obama and his lapdogs have the backbone of over-cooked spaghetti, and even among most of the so-called fiscal conservatives, canned salmon bones are the best we can typically find.

The only solution is a balanced budget amendment because as it sits, neither party is willing to hold the line on spending.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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