Stocks and Precious Metals Charts - Stock Bubble III: The Great Unraveling - Stock Option Expiration Friday

“Realize that narcissists have an addiction disorder. They are strongly addicted to feeling significant. Like any addict they will do whatever it takes to get this feeling often. That is why they are manipulative and fakers. They promise change, but can't deliver if it interferes with their addiction.”

Shannon L. Alder


"As a dog returns to its vomit, so a fool returns to his folly."

Proverbs 26:11


"This is the contempt in which they hold the majority of American people and the political process: the common people are easily led fools, and everyone else who is smart enough to know better has their price.

And they would beggar every middle class voter in the US before they will voluntarily give up one dime of their ill gotten gains."

Simon Johnson, The Quiet Coup, May 2009


"Remember that there will be trying times in the last days.  For people will love only themselves and their money.  They will be boastful and proud, scoffing at God, dishonoring their parents, and ungrateful.  To them nothing is sacred.  They will be unloving and unforgiving; they will slander others and have no self-control. They will be cruel and despise what is good. They will betray their friends, be reckless and proud, and love pleasures of the world more than God. They may talk like they are religious, but they will reject the power that could make them godly.  Shun them."

2 Timothy 3:1-5

Stocks had another ranging day that ended up largely unchanged.

Trumpolini had his long-awaited signing ceremony with a Chinese delegation for the Trade-Lite Deal.  His speech was embarrassingly in character.

Gold and silver finished higher, and the Dollar closed a bit lower.

The stock market is now at bubble levels not seen since the Tech Bubble.

A reckoning with reality is on deck, most likely to arrive later this year. How much later is a very good question.

Protect yourselves, your hearts and minds as well as your money.  For the love of most has already gone cold.

Are we truly in the last days as some think?

As Newman observed, most centuries have thought that their times are the worst.  Pride inflates our view of ourselves in many ways.

No one can truly know when the end is coming, as you may recall.

But it seems as though an end of something, thought to be unassailable, is fast approaching.

And the consequences of this failure of pride, and the reaction its fanatical true believers, may be notable, for many years to come.

Try to not become swept up in the madness, remembering who you are and why you are here.

Have a pleasant evening.

Lessons From the Panic of 1907

I have just finished reading The Panic of 1907: Lessons Learned from the Market's Perfect Storm, written by Robert Bruner and Sean Carr in 2007. It is an extraordinarily well documented, step by step study of one of the worst bank panics and stock market crashes in modern times.  The broad stock market declined 37% from peak to trough in less than 15 months.

Here is an extended quote from the authors' closing remarks.

"Why do markets crash and bank panics occur? Any single case study, such as the one we have presented here, is subject to a range of interpretations, and we encourage the reader to draw one's own conclusions from the foregoing narrative.

Yet we think that the story of the panic and crash of 1907 inspires consideration that major financial crises can be the result of a convergence of certain unique forces - the forces of the market's perfect storm - that cause investors and depositors to act with alarm.

The recounting of the events of 1907 suggests that the storm gathers as follows.

It begins with a highly complex financial system, whose very complexity makes it difficult for anyone to know what might be going wrong; by definition, the multiple parts of the financial system are linked, which means that trouble in one institution, city, or region can travel easily and quickly to others.

Buoyant growth in the economy makes the financials system more fragile, in part due to the demand for capital and in part due to the tendency of some institutions to take on more risk than is prudent.

Leaders in government and the financials sector implement policies that advertently or inadvertently increase the exposure to risk of crisis.

An economic shock hits the financials system. The mood of the market swings from optimism to pessimism, create a self-reinforcing downward spiral. Collective action by leaders can arrest the spiral, though the speed and effectiveness which they act ultimately determines the length and severity of the crisis."

My own reaction to the Panic of 1907 which they document so well is similar, except for a different emphasis on certain factors and a slightly different slant on their development, based on my own extensive readings about other panics and crashes, including a first hand look at the tech bubble collapse of 2001.

First, almost all panics and crashes are preceded by sustained periods of artificial growth, not based on improvements in productivity, but by a false expansion in the money system, aided and abetted by speculators and financiers. Although they do not act in overt cooperation, yet there is an unmistakable collusion of purpose. It suggests that the impulse to benefit in this way is present in a portion of the people at all times, as there are impulses to do many other things for personal benefit without regard to the public good. But at certain times the prohibitions which normally hold this behaviour in check are weakened, sometimes through active interventions against regulation, at other times from a decline in moral conscience.

Seocnd, almost all panics and crashes involves relatively small groups of people who seem to be at the heart of the matter, and are closely interlinked into small cartels of corrupted self-dealing involving the accumulation of enormous personal fortunes. One is struck by the interconnectedness of the primary players in the Panic of 1907 in each others companies, banks, investments, and boards of directors.

In this instance there did not seem to be any significant corruption of the government, which was actually in a progressive mood under Theodore Roosevelt, although he was by now a lame duck. Rather, the central government at this time was weak, and regulation was largely in the hands of the business principals, of which no greater example than J. Pierpont Morgan. They will act to protect their own interests when threatened, but their benevolent reputations are greatly exaggerated.

Lastly, there is always the overextension of credit and excessive leverage. Always. This is how any Ponzi scheme grows.  In every case this is what precedes and precipitates the growth of a crisis and panic - the unreasonable overvaluation and expansion of assets precipitated by a relatively small number of men, interlinked loosely through business associations and personal financial gain.

As in the case of 1907 and its aftermath, a few visible persons are offered up for punishment and destruction, but the largest and most substantial of the predators remain unscathed, often being lionized as saviours who attempted the rescue of the nation from a few bad apples and the public from its own folly.

Although the authors make a great deal of the need to take swift and decisive action to stem the crisis, they miss the point that the place to stop this is before the leverage and excess build to the point where almost anything will set the overextended system into crisis and panic. Even if decisive action is taken, it is the greater public that is invariably harmed by the cure, with a few becoming even more enriched, although the harm be less than if nothing had been done at all. By the time the crisis is underway, you will be making deals of convenience, and at terms with the devil.

It should be stressed that there is no evidence in the correspondence of any of the principals that they desired to cause this Panic of 1907 for their own benefit. And there does not have to be.

If a general atmosphere of looting is fostered by the provocations of a few like-minded individuals, their subsequent actions need no coordination, other than the insufficient response of society to stop them before they gain sufficient momentum from their desires. It is the apathy and weakness of the many that provides the stimulus and the encouragement for their plans.

The authors recount the subsequent meeting of many of the principals at Jekyll Island in 1910, to craft a reform of the banking system to be later known as The Federal Reserve System.

I do not see anything in the system itself that is improper or malignant; it is only in it ability to increase and amplify leverage in secret and without equanimity that makes it a powerful tool for like-minded individuals to seek to defraud the many of their life savings through unscrupulous abuse of anything and everything that comes under their power and control.

If you wish to take the measure of a society, look to how its weakest members are protected from its strongest, and its predators skulking at the fringes.

More concisely, you will receive the results that you incent, the behaviours that you cultivate, the society that you promote, if only by doing nothing and allowing small groups of like-minded individuals to set your greater agenda. We have seen this repeatedly in companies both large and small, in entire industries, and we think in the national economy.

If you wish a hell on earth, do nothing for the benefit of others, for the greater good, or to inhibit those who act solely out of greed, fear, and hate. Soon enough you will have a society that is intensely self-interested, self-concerned, superficial, destructive and self-consuming.

A free and just society is not a prize to be won or a gift that can be bestowed; it is a recurring commitment, and an enduring obligation.

This is a reprise of a blog entry originally published here on 5 July 2008.  It seems remarkably appropriate today.

That such economic disaster is promulgated by official corruption and the general belief that morality and justice are merely quaint notions is nothing new.   If you have not done so you might read A. H. Beasley's description of Rome prior to the rise of the Gracchi brothers, Marius and Sulla, which I included in a recent blog entry here.

Janet Yellen Channels Ronald Reagan: "Deficit's Don't Matter"

"You know, Paul, Reagan proved deficits don't matter."Dick Cheney to Paul O'Neill

The mainstream media is reporting that Fed governor Janet Yellen, a noted dove on inflation as Fed governors go, just told a gathering of bankers in Idaho that "deficits do not cause inflation" and summarily dismissed any concerns in that regard.

So, consulting the source material which is included just below, I am struggling to understand what she is saying, and to believe that she said it with a straight face, and was not just jawboning.

What Janet Yellen seems to be saying is:

First, that deficits do not matter unless they are 'structural' and not temporary. It does not matter how much, for example, we give to the banks. When the crisis is over, the deficits will remain, but will not grow larger, and will be offset by higher taxes, that will come from the improved economy.

Secondly, that developing countries have independent central banks that know how to and are willing to fight inflation, as opposed to the central banks of undeveloped countries where the government impedes their ability to fight inflation and to monetize the debt.

Thirdly, monetary inflation only occurs where excess demand for goods and services is generated. Until that point, unless there is this demand, increased money supply does not generate inflation. We might call this the reverse Laffer, in that it is a Demand side view of inflation that tends to discount the supply side completely.

One would not think that the US had recently seen the collapse of an enormous housing bubble, following the collapse of a large but less enormous stock bubble. Janet brushes this off faster than a stock strategist on CNBC.

Although she received her Ph.D. from Yale in 1971, she surely must have subsequently studied the stagflation of the 1970's in the US, where demand remained relatively stable but a supply shock on the oil side, together with the egregious monetary policy of a pliable Fed that had been accommodating Richard Nixon, finally triggered a rather nasty stagflation that the hairy-knuckled resolve of tall Paul Volcker was finally able to overcome.

Janet Yellen is greatly mistaken, but almost emblematic of the thinking in some circles that can see only the demand side of the equation, which is most common in a layperson relating to their common domestic experience. What is frightening in a way is that she is not some blogger out on the net, or a talking head for the extended infomercial that is financial reporting in the US, but is a Fed governor.

And she is no outlier. Her thinking underpins the basis for Bernanke's strategy of packing the banks with liquidity, monetizing their assets, but maintaining control of that added liquidity by having the ability to attract bank reserves into the Fed where they can be managed through the ability to pay interest on those reserves.

Can the Sorcerer's apprentices keep a steady hand on this latest monster from their laboratory? Every time they try this, something unexpected happen, and we go to the brink, to be rescued by another patch, another new experiment, designed to save us from the last one gone wrong.

Her arrogance toward 'developing countries' is absolutely appalling, and sure to come back to haunt her at some later date. If one looks at the performance of the dollar and its long term purchasing power under the Fed, it appears that Janet is a proud member of the subjective idealist school of behavioural economics. What we do not admit to be real cannot exist, and will not hurt us.

So, we can inflate our way to prosperity, provided that we control the perception of the results of our actions. Jigger the CPI so its no longer valid, suppress long term interest rates by buying the curve selectively and suppressing gold (See Gibson's Paradox by Larry Summers), and coerce the world's central banks through various means to support our monetary inflation step for step. After all, everything is relative. Until it is not.

OMG. Our entire financial system is based on the sufferance and good will of potential adversaries to do what is in our best interests because the fragility of our currency frightens them. And well they might be fearful, when they read this from Ms. Yellen, and see how many true believers in the omnipotence of the Fed take it seriously.


Large deficits don't cause inflation: Fed's Yellen
By Greg Robb
Jul 28, 2009, 1:06 p.m. EST

(MarketWatch - Washington) -- Concern that the massive federal budget deficit will cause inflation is misplaced, said Janet Yellen, the president of the San Francisco Federal Reserve on Tuesday. Deficits don't cause inflation, she said. Instead, the worry is that they might cause interest rates to rise. "Right now, private investment spending is extremely weak, so financing for the large federal deficits is readily available. But once private spending recovers, the competition for funds between the government and private sectors could drive interest rates up," Yellen said in a speech to bankers in Idaho.

Jesse here. The relevant quote from Janet Yellen's speech to the bankers in Idaho is excerpted below from the San Francisco Fed's website.

Let me now address another issue that is garnering attention—inflation. This is a subject rife with contradiction. Almost without exception, my business contacts report downward pressure on wages and prices. At the same time, they tell me they worry that the United States is on the threshold of serious inflation. They see large federal budget deficits today and more looming on the horizon. They also note that the Fed has pumped up bank reserves and expanded its balance sheet to fund its financial support programs. They worry that this may amount to financing deficits with money creation. Surely, they say, these things will eventually have to lead to higher inflation.

I’ll begin with budget deficits. The gap in the federal budget for the current and the next fiscal years are projected to exceed $1 trillion, far larger than anything we’ve ever seen before. But a large part of these current deficits are temporary. A portion stems from the impact of the weak economy on the budget. In a recession, tax collections fall and spending on programs such as unemployment insurance rise automatically. A significant portion is due to the fiscal stimulus that has been put in place over the next few years to address the recession. Antirecessionary fiscal policy, in my view, is entirely appropriate. Since that stimulus is temporary by design, the resulting deficits will shrink as the stimulus phases out. But federal deficits will not disappear completely even when the economy has recovered and the stimulus program has phased out. On the contrary, these ongoing or “structural” deficits are anticipated to stretch indefinitely into the future and to escalate over time in a manner that ultimately is not sustainable. The long-term projected structural budget deficit mainly reflects the impact of an aging population and rapidly rising health-care costs on spending for federal entitlement programs, particularly Medicare and Medicaid.

Economists have known, worried, and warned the public about the damaging consequences of escalating long-term budget deficits in the United States for decades. It’s high time for our country to tackle the problem head-on. But the main concern with these deficits relates to productivity and living standards, and not high inflation. Large budget deficits do not cause high inflation automatically. In fact, since World War II, large deficits have been associated with high inflation only in developing countries. That’s because developing countries often have central banks that are under the sway of the government, which sometimes induces them to print money to finance government spending. The connection isn’t found in countries such as ours with advanced financial systems and independent central banks. Remember that, in the 1980s, the United States ran large deficits just as inflation was coming down. And Japan has had huge deficits through much of the past two decades, yet its problem is persistent deflation—precisely the opposite of inflation. The United States and most other industrialized countries have central banks with long traditions of independence and deep-seated support for keeping politics out of monetary policy. In those countries, the monetary authorities generally have stuck to their inflation objectives, even when governments ran large budget deficits.

In advanced countries, the problem isn’t that large deficits cause inflation. Rather it’s that they raise long-term interest rates, thereby crowding out private investment, which holds back advances in productivity and living standards. Right now, private investment spending is extremely weak, so financing for the large federal deficits is readily available. But once private spending recovers, the competition for funds between the government and private sectors could drive interest rates up. A decline in productivity growth is a serious problem—one we should strive to avoid—but it is not the same as inflation.

So what about the Fed’s unprecedented balance sheet expansion? Our strong steps to avert financial and economic meltdown have caused our assets to more than double, from under $900 billion at the start of the recession to over $2 trillion now. This expansion is largely financed by increases in excess reserves that banks deposit with us.

Now we come to the crux of the issue: Will this expansion of credit and bank reserves create high inflation? My answer is no. And the reason again is because of current economic conditions. Monetary policy fosters inflation when it loosens the stance of policy enough to create excess demand for goods and services. Right now, we have exactly the opposite—an excess supply of goods and services. We need more demand—not less—to offset slack in labor and product markets. We have seen a noticeable slowdown in wage growth and reports of wage cuts have become increasingly prevalent. Businesses are cutting prices to boost sales. As a result, core inflation—a measure that excludes volatile food and energy prices—has drifted below 2 percent, a level that I and most of my colleagues consider consistent with price stability. With unemployment already substantial and likely to rise further, and industrial capacity utilization at record low levels, downward pressure on wages and prices isn’t likely to go away soon. I expect core inflation to remain below 2 percent for several more years.

Of course, the economy will eventually recover and we will need to withdraw monetary accommodation. If we were to fail to do so, we would indeed have higher inflation. The Fed is keenly aware of this. We have the tools to tighten policy when the time is right and we have the will to use them. First, many of our emergency programs are already tapering off as market conditions improve. Second, many of the assets that we have accumulated during the crisis—such as Treasury and mortgage-backed agency securities—have ready markets and can be easily sold. Finally, the Fed can push up the federal funds rate and tighten policy by raising the rate of interest paid to banks on the reserves they deposit with us—authority granted by Congress last year. An increase in the interest rate on reserves will induce banks to lend money to us rather than to other banks, thereby pushing up rates in the interbank market and, by extension, other interest rates throughout the economy. This is an important tool because, even if the economy rebounds nicely, the credit crunch might not be fully behind us and some financial markets might still need Fed support. This tool will enable us to tighten credit conditions even if we maintain a large balance sheet for a time. The experience of central banks in Europe, Japan, and Canada suggests that this approach can be effective.

Full Text of Janet Yellen's Speech to the Idaho Bankers here.

The Banking Bubble Began in 1986, Was Like 'the South Sea Bubble' Says Bank of England Official

In retrospect it should become increasingly clear to most that the Federal Reserve and its associated money center banks were responsible for systematically undermining all regulatory restraint and sound judgement for the sake of their private profits, without regard to the resultant destruction visited upon the public and the larger global economy.

To suggest that the regulatory process should now be concentrated in the hands of the Federal Reserve, still opaque and arrogant, is disgraceful and disqualifies the public officials from service who promote such a travesty of common sense and prudence.

Guardian
Banking system like South Sea bubble, says senior Bank of England official
by Ashley Seager
1 July 2009 13.26 BST

'Banking became the goose laying the golden eggs. There is no period in recent UK financial history which bears comparison,' says executive director for financial stability, Andy Haldane

A senior Bank of England official today compared the banking system over the last 20 years to the South Sea bubble of the early 18th century and said bankers had merely "resorted to the roulette wheel" to keep up with each other.

The Bank's executive director for financial stability, Andy Haldane, said in a speech in Chicago that having been stable over much of the 20th century, returns in the banking system relative to the wider stockmarket shot up after 1986 until 2006.

"Banking became the goose laying the golden eggs. There is no period in recent UK financial history which bears comparison," he said.

He said bankers and policymakers became seduced by the excess returns available: "Banks appeared to have discovered a money machine, albeit one whose workings were sometimes impossible to understand.

"One of the South Sea stocks was memorably 'a company for carrying out an undertaking of great advantage, but nobody to know what it is'. Banking became the 21st-century equivalent."

He said banking returns over the period were magnified by leverage as banks borrowed excessively, he said.

During the golden era, competition simultaneously drove down returns on assets and drove up target returns on equity. Caught in this crossfire, higher leverage became banks' only means of keeping up with the Jones's. Management resorted to the roulette wheel."

He noted that the 80% slump in bank shares since the credit crunch hit meant that returns from the sector were now back in line with their longer-run average (see graphic above). The market capitalisation of global banks has fallen by $3tn (£1.8bn) since the crisis began, he said.

"We should aspire to a financial system where there is greater market and regulatory scrutiny of future such money machines. In achieving this, there is a role for some body – a systemic overseer – which is able to detect incipient bubbles and fads and, as importantly, act to correct them. This role is about removing the punchbowl from future financial sector parties." (We had a group that were responsible for doing this. They were called The Federal Reserve under Alan Greenspan. And Greenspan became the whoremaster of ceremonies for perversion of finance in the bubble economy. - Jesse)

He said that in future there would have to be a greater distinction between management skill, which improves return on assets, and luck, when return on equity can be magnified by leverage.

"Good luck and good management need to be better distinguished. Put differently, returns to investors and managers need to be more accurately risk-adjusted if the right balance between risk and return is to be struck for individual firms and for the financial system as a whole."

A second lesson, he added, was that there would have to be much stricter system-wide limits on leverage, particularly among big banks whose stability is crucial to the whole financial system. (Perhaps some prohibition of the types of activity that banks can engage in like Glass - Steagall? Oh yes, we had that as well and the banks repealed it with the help of the Federal Reserve. Perhaps we should have regulatory reform and place all the oversight responsibility with one group. Like the Federal Reserve? - Jesse)

"For a number of diseases, 20% of the population account for around 80% of the disease spread. The present financial epidemic has broadly mirrored those dynamics," he said, adding that the failure of a core set of large, interconnected institutions such as Fannie Mae, Freddie Mac, Bear Stearns, Lehman Brothers and AIG contributed disproportionately to the spread of financial panic. (In this case there are a few Typhoid Mary's with names like JP Morgan and Goldman Sachs and Morgan Stanley, and they are still hard at work - Jesse)

"Epidemiology provides a second key lesson for financial policymakers – the importance of targeted vaccination of these 'super-spreaders' of financial contagion. Historically, financial regulation has tended not to heed that message." (Vaccination is one approach. Wall Street and the City of London really need a dilation & curretage - Jesse)

He welcomed a recent move by US authorities to bring the trading of credit derivatives, which were at the heart of the crisis, on to exchanges so they could be better understood and controlled. "This is a bold measure and one which deserves international support."

Haldane's speech was part of a growing debate among global policymakers to try to build a better system of regulation and control of the financial system to prevent such crises as the current one from occurring again.