Why the Austrian, Keynesian, Marxist, Monetarist, and Neo-Liberal Economists Are All Wrong

US Personal Income has taken its worst annual decline since 1950.

This is why it is an improbable fantasy to think that the consumer will be able to pull this economy out of recession using the normal 'print and trickle down' approach. In the 1950's the solution was huge public works projects like the Interstate Highway System and of course the Korean War.

Until the median wage improves relative to the cost of living, there will be no recovery. And by cost of living we do not mean the chimerical US Consumer Price Index.

The classic Austrian prescription is to allow prices to decline until the median wage becomes adequate. Given the risk of a deflationary wage-price spiral, which is desired by no one except for the cash rich, the political risks of such an approach are enormous.

On paper it is obvious that a market can 'clear' at a variety of levels, if wages and prices are allowed to move freely. After all, if profits are diminished, income can obviously be diminished by a proportional amount, and nothing has really changed in terms of viable consumption.

The Supply side idealists (cash rich bosses, Austrians, neo-liberal, monetarist, and deflationist theorists) would like to see this happen at a lower level through a deflationary spiral. The Keynesians and neo-classicals wish to see it driven through the Demand side, with higher wages rising to meet the demands of profit in an inflationary expansion. Both believe that market forces alone can achieve this equilibrium. Across both groups runs a sub-category of statism vs. individualism.

Unfortunately both groups are wrong.

Both approaches require an ideal, almost frictionless, objectively rational, and honest economy in order to succeed. The Keynesians have a bit of an edge in this, because it is easier to control inflation than deflation in a fiat regime, and the natural growth of inflation tends to satiate the impulse to greed. They don't care if they can buy more as long as they can say they HAVE more. People tend to be irrational, and there is a percentage of the population that is irrationally greedy and obsessively rapacious. People are not naturally 'good.'

The greatest flaw in the many studies that come from each of the schools to prove their point is the brutal way in which they flatten the reality of the markets and make assumptions to allow their equations and analysis to 'work.' They spend most of their energy showing while the 'other school' is a group of ignorant fools, doomed to ignominious failure, in an atmosphere reminiscent of a university departmental meeting.

This has quietly scandalized those from other scientific disciplines who review the work of many of the leading economists. Benoit Mandelbrot was poking enormous holes in the work of the leading economists long before Nassim Taleb made it more widely known. The ugly truth is that economics is a science in the way that medicine was a profession while it still used leeches to balance a person's vapours. Yes, some are always better than others, and certainly more entertaining, but they all tended to kill their patients.

The most intractable part of the current financial crisis, and the ongoing problem of the US economy is the huge tax which is levied on the American public by its corporations, primarily in the financial and health care sectors, and a political system based on lobbyists and their campaign contributions.

There are hidden taxes and impediments to 'free trade' at every turn. The ugly truth is that capitalism-in-practice hates free markets, always seeking to overturn the rules and impose oligopoly if not outright monopoly through barriers to entry, manipulation of the political process, distortion of regulation, predatory pricing, brute force, and the usual slate of anti-trust practices.

Some of these 'hidden taxes' are the bonuses on Wall Street which require an increasing percentage of the financial 'action.' The credit cards fees and penalties levied by banks to support profits in a contracting economy. The Sales General & Administrative portion of the Income Statements of the pharmaceutical industry which only American consumers seem willing to pay. A health care system which is a monument to overspending, outrageous pricing, and greed.

The notion that "if only government would not regulate markets at all everything would be fine" is a variation of Rousseau's romantic notion of the noble savage which no one believes except those who wish to continue to act like savages, and those who get no closer to the real work of an economy than their textbooks. Economic Darwinism works primarily to the advantage of the sharks. Anyone who believes that 'no regulations' works well has never driven on a modern highway at peak periods.

Yes, a certain portion of the population are adult, and generally good and fair. But there is a percentage of the population that is not. And since the 1980's they have been encouraged by the culture of relativism and greed to 'express themselves' and so they have, with a vengeance.

Discussion rarely proceeds very far because of the dialectical nature of American thought. Both extremes are wrong, but they seem to content to merely bash each other, pointing out their errors, while repeating the same mistakes over and again.

The engineering of the economy has become married to the engineering of the political dialogue by the corporate media and their political parties. "The engineering of consent is the very essence of the democratic process, the freedom to persuade and suggest." Edward L. Bernays 1947

The condition of the American economy is strikingly similar to the Soviet state economy of the last two decades of the 20th century. People are trying to sustain a system "as is" that is based on bad assumptions, unworkable constructions, conflicting objectives, and a flagging empire laced heavily with elitist fraud and corruption. The primary difference is that the US has a bigger gun and its hand is in more people's pockets with the dollar as the world's reserve currency. But the comparison seems to indicate that the economy must indeed fail first, before genuine change can begin, because the familiar ideology and practices must clearly fail before they can recede sufficiently to make room for new ways and reforms.

A new school of Economics will rise out of the ashes of the failure of the American economy as happened after the Great Depression. Let us hope that it is better than what we have today.

In the short term, what does all this mean?

There is NO system that will work without substantial, continuing effort, and continual adaptation and commitment to a certain set of goals that are more about 'ends' than ideological process.

Because our system has been abused for so long, and is so distorted and imbalanced and dominated by a relatively few organizations beholden to a self-serving status quo, reform is not an afterthought, it is the sine qua non.

It means that until the banks are restrained, and the financial system is reformed, and balance is restored, there can be no sustained recovery.

SP Futures Hourly Chart at 10:45 AM

The dynamic on the chart is the short term potential double bottom "W" and the developing intermediate H&S distribution top.

A pullback of 4% with a move to a higher high is supportive of the 'new bull market' scenario and we would expect the media cheerleaders and paid market strategists to hit the pom poms hard if the Street can make this happen.

Volumes are light enough. But we also sense a growing cynicism and distrust of the US financial markets in traders and investors. There is a recognition that the game is rigged, and the 'house' is skimming a larger piece of the daily liquidity thanks to government money and new technology.

This 'skim' may destroy a game while enriching the house, as all seasoned casino operators know. It is not clear to us that the Wall Street crowd can practice this sort of longer term restraint.

The Chief Economists

But do they care?

China Makes Biggest Cut in US Treasury Assets Since 2000

China dumps US Treasuries the most aggressively in a decade. Now THAT's a change you can believe in.

One has to wonder how long the UK, Japan and the US can keep supporting each other's crony capitalist oligopolies.

China Daily
China cuts US Treasury holdings in June
2009-08-18

NEW YORK: China reduced its holdings of US Treasury debt in June by the biggest margin in nearly nine years, according to a US Treasury Department report issued on Monday.

China cut its net holdings by 3.1 percent to $776.4 billion in June from $801.5 billion in May, the report says. This is also the first large-scale reduction of US Treasury debt by China so far this year.

However, its June holdings were still larger than April's $763.5 billion and $767.9 billion in March, according to the statistics of the Treasury Department.

Reuters data show the drop in China's Treasury holdings in June was the biggest percentage reduction since a 4.2 percent cut in October 2000.

On the other hand, Japan, the second-largest holder of US Treasury securities, increased its holdings to $711.8 billion in June from $677.2 billion in May.

The United Kingdom, the third largest holder, also increased its holdings to $214 billion in June from $163.8 billion, a surge of 30.6 percent.

SP Futures Hourly Chart at 1 PM

The US equity markets have bounced back to key resistance on a much great than expected drawdown in oil inventories.

The trade today seems very technical (ie short squeeze by the 100 million dollar men) and lacking in conviction.

Let's see how the markets deal with this and then trade accordingly. Volumes remain light, and may do so until September. However, if anything 'happens' this market may flop as convincingly as Obama's "change" platform.

The Gathering Storm: Stay Defensive

"...market is ahead of reality...worry about things particularly going into Ramadan on the 22nd (of August)...there are things gathering around here (the NYSE) that are kind of esoteric, but we could perhaps see historic trading over the next eight weeks...potentially a very exciting period." Art Cashin, 18 Aug 2009

Larry Summers, Tim Geithner, and Ben Bernanke have managed, once again, to place the economy on the edge of a chasm by pandering to Wall Street, which has a narcissistic short-term obsession with stuffing its pockets at any risk or cost, while the corporate media distracts the public with an outrageous parade of disinformation, delusion, and distraction.

The world markets are entering a period of high risk and volatility. No one knows for certain what will come. Professional traders are preparing for it by managing their risks. We are as well.

The Great American Bank Robbery

If you suspected that fraud, corruption, incompetence, and coverups at the highest levels are at the heart of our current financial crisis, you're right.

"...ideology enabled criminality and political failure led to economic crisis as Wall Street bought Capitol Hill..."

The Great American Bank Robbery
Video - Lecture
By William K. Black

1. Why do we have repeated, intensifying economic crises?
2. What can white collar criminology add to our understanding of what's going wrong?

SP Futures Hourly Chart 9:45 AM with the SP Weekly Chart

So far this is merely a pullback from a consolidation, and a likely distribution top in the making as insiders continue to take profits on their ponzi pump in US equities.

We signalled 'defensive' last week, and that the risk reward in the market was dangerous, and we exited or hedged all longs. Time to Get Defensive

Now we wait to see if this is just a pullback from a consolidation, with a subsequent rally to new highs, or a break in the market slightly ahead of our forecast target. We have been looking for a 3% pullback first, and then a rally to the final high for the year.

The obvious level to watch is the neckline.

Bear in mind that these 100 million dollar men on Wall Street make their pay by taking investors, and the economy, for rides up and down in stocks, commodities, and just about any other market they can push using the leverage of their taxpayer supported funds.



The SP Weekly Chart show that a rally back to 1014 on the cash market represents an approximate 38.2% rally from the bottom. This number is one of the key fibonacci numbers watched by traders. The next stop higher would be 50%.

More Than 150 Publicly Traded US Banks Are In Serious Trouble

This analysis by Bloomberg is based on some fairly modest economic assumptions. Most of the banks in question are state and regional banks that have not enjoyed the largesse of the Fed and Treasury like the free-spending, Wall Street money center banks, who are sharply curbing lending and raising rates on credit cards and other revolving debt aggressively even for customers with excellent credit and no history of non-payment.

As you might suspect, even the worst of the banks with large percentages of non-performing loans all claim to be 'well capitalized' by regulatory standards.

If as indicated more of the smaller banks fail, we will be left with a few, larger, more potentially lethal financial institutions.

The Obama Administration policy decisions, particularly the programs and reserves decision enabled in October 2008, appear to be favoring Wall Street heavily, monetizing debt for the Primary Dealers and the Wall Street market players, while choking off the consumer and the state and regional banks.

Policy decisions have impact, especially when they have the weight of the Federal Reserve, the Treasury, the Congress, and a powerful President behind them. The question becomes are they the right policy decisions? How were they crafted?

Regretfully, most of them were done behind closed doors, with little public discussion or scrutiny, crafted by an army of lobbyists, campaign donors, and crony capitalists galore.


Bloomberg
Toxic Loans Topping 5% May Push 150 Banks to Point of No Return
By Ari Levy

Aug. 14 (Bloomberg) -- More than 150 publicly traded U.S. lenders own nonperforming loans that equal 5 percent or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival.

The number of banks exceeding the threshold more than doubled in the year through June, according to data compiled by Bloomberg, as real estate and credit-card defaults surged. Almost 300 reported 3 percent or more of their loans were nonperforming, a term for commercial and consumer debt that has stopped collecting interest or will no longer be paid in full.

The biggest banks with nonperforming loans of at least 5 percent include Wisconsin’s Marshall & Ilsley Corp. and Georgia’s Synovus Financial Corp., according to Bloomberg data. Among those exceeding 10 percent, the biggest in the 50 U.S. states was Michigan’s Flagstar Bancorp. All said in second- quarter filings they’re “well-capitalized” by regulatory standards, which means they’re considered financially sound.

“At a 3 percent level, I’d be concerned that there’s some underlying issue, and if they’re at 5 percent, chances are regulators have them classified as being in unsafe and unsound condition,” said Walter Mix, former commissioner of the California Department of Financial Institutions, and now a managing director of consulting firm LECG in Los Angeles. He wasn’t commenting on any specific banks.

Missed payments by consumers, builders and small businesses pushed 72 lenders into failure this year, the most since 1992. More collapses may lie ahead as the recession causes increased defaults and swells the confidential U.S. list of “problem banks,” which stood at 305 in the first quarter.

Cash DrainNonperforming loans can eat into a company’s earnings and deplete cash, leaving banks below the minimum capital levels required by regulators.... “This is a fairly widespread issue for the larger community banks and some regional banks across the country,” said Mix of LECG, where William Isaac, former head of the Federal Deposit Insurance Corp., is chairman of the global financial services unit.

Ratios above 5 percent don’t always lead to failures because banks keep capital cushions and set aside reserves to absorb bad loans. Banks with higher ratios of equity to total assets can better withstand such losses, said Jim Barth, a former chief economist at the Office of Thrift Supervision. Marshall & Ilsley and Synovus said they’ve been getting bad loans off their books by selling them...

‘Off the Charts’

“These numbers are off the charts,” said Blake Howells, an analyst at Becker Capital Management in Portland, Oregon, referring to the nonperforming loan levels at companies he follows. Banks are losing the “ability to try and earn their way through the cycle,” said Howells, who previously spent 13 years at Minneapolis-based U.S. Bancorp....

Will the US Consumer Make it a Merry Christmas?

Only if they want to hit those maxed out 24% APR credit cards just one more time.

US Credit Card Trap - Jennifer Barry

The Next Wave of the Financial Crisis Is Coming (And Why)

These excerpts from the most recent TARP Congressional Oversight Panel Report make the risks in the US financial system abundantly clear.

Do you think that the Congress has the will and the ability to act on their recommendation, with the men currently in positions of power on the key Committees? Do you believe that the Obama Administration is capable of reforming itself and effecting genuine change with so many Wall Street denizens forming their policy?

"In order to advance a full recovery in the economy, there must be greater transparency, accountability, and clarity, from both the government and banks, about the scope of the troubled asset problem."

We are persuaded that the government is waiting for the next wave of failures, or some exogenous event of catastrophic proportion, to provide their rationale to take new aggressive action.

But while the financial oligarchy is in control of the men in power, we doubt that these will be the right steps for the majority of Americans, the US economy, and its debt holders.

"There are a thousand hacking at the branches of evil to the one who is striking at the root."
Henry David Thoreau

Congressional Oversight Panel - August 11 Report - The Continued Risk of Troubled Assets

"...But, it is likely that an overwhelming portion of the troubled assets from last October remain on bank balance sheets today.

If the troubled assets held by banks prove to be worth less than their balance sheets currently indicate, the banks may be required to raise more capital. If the losses are severe enough, some financial institutions may be forced to cease operations. This means that the future performance of the economy and the performance of the underlying loans, as well as the method of valuation of the assets, are critical to the continued operation of the banks.

...If the economy worsens, especially if unemployment remains elevated or if the commercial real estate market collapses, then defaults will rise and the troubled assets will continue to deteriorate in value. Banks will incur further losses on their troubled assets. The financial system will remain vulnerable to the crisis conditions that TARP was meant to fix.

...Part of the financial crisis was triggered by uncertainty about the value of banks' loan and securities portfolios. Changing accounting standards helped the banks temporarily by allowing them greater leeway in describing their assets, but it did not change the underlying problem. In order to advance a full recovery in the economy, there must be greater transparency, accountability, and clarity, from both the government and banks, about the scope of the troubled asset problem. Treasury and relevant government agencies should work together to move financial institutions toward sufficient disclosure of the terms and volume of troubled assets on institutions‟ books so that markets can function more effectively. Finally, as noted above, Treasury must keep in mind the particular challenges facing small banks.

This crisis was years in the making, and it won‟t be resolved overnight. But we are now ten months into TARP, and troubled assets remain a substantial danger to the
financial system.

...Nonetheless, financial stability remains at risk if the underlying problem of troubled assets remains unresolved."

The banks must be restrained, and the financial system reformed, and the economy brought back into balance, before there can be any sustained recovery.

Visit msnbc.com for Breaking News, World News, and News about the Economy

Time to Get Defensive

It will not be surpising to see US equities pullback 2 to 3 percent from here, and then push higher to a new rally high near the end of August. This will help to pull in the public money as the insiders continue to sell, distributing their stock and taking their gains.

But from what we are seeing, September and October look to be particularly 'risky' months this year, and now might be a good time to become more defensive in those accounts that are not agile, like 401k's.

What is 'defensive?' Cash is good, and short term government bonds of less than 2 years duration. No need to get fancy if you are an investor.

This is not a prediction or a recommendation. This is what we are doing for ourselves and some friends.

If the market can hold support through November, then we will reconsider.

The Banks Must Be Restrained and the Financial System Reformed...

As Simon Johnson points out in his essay previously cited here, the reform required to support a sustainable recovery will not happen while the financial oligarchs control the government, the media, and the banks. Ken Rogoff reaches the brink of a similar conclusion.

The lengths and ways to which Americans go to avoid their reality grows increasingly surreal. Most economists and thought leaders prefer to lose themselves in non-controversial details, traditional team politics, and of course the spinning of propaganda in support of their patrons or prospective employers in the think tanks, institutes, and corporate enclaves.

In a way who can blame them? I am finding it increasingly difficult to watch financial television these days, because the speakers are so cruelly deformed, devoid of humanity, pale figures washed in the strident din and flickering torches of a concrete stadium hosting a desperate rally as the night closes in.

Truth is becoming such an increasingly scarce commodity in 'the fog of numbers,' so that one might think that a war is fast approaching.

And so it is, that events may unfold as they have done so many times before. As the ancient maps would say as they marked the boundary of the unknown, "Here there be monsters."

In 1940 the American essayist and poet Archibald Macleish wrote a book titled "The Irresponsibles."

Indeed.

Project Syndicate
The Confidence Game
by Kenneth Rogoff

CAMBRIDGE – Next month marks the one year anniversary of the collapse of the venerable American investment bank, Lehman Brothers. The fall of Lehman marked the onset of a global recession and financial crisis the likes of which the world has not seen since the Great Depression of the 1930’s. After one year, trillions of dollars in public monies, and much soul searching in the world’s policy community, have we learned the right lessons? I fear not.

The overwhelming consensus in the policy community is that if only the government had bailed out Lehman, the whole thing would have been a hiccup and not a heart attack. Famous investors and leading policymakers alike have opined that in our ultra-interconnected global economy, a big financial institution like Lehman can never be allowed to fail. No matter how badly it mismanages its business – Lehman essentially transformed itself into a real estate holding company totally dependent on a continuing US housing bubble – the creditors of a big financial institution should always get repaid. Otherwise, confidence in the system will be undermined, and chaos will break loose.

Having reached the epiphany that financial restructuring must be avoided at all costs, the governments of the world have in turn cast a huge safety net over banks (and whole countries in Eastern Europe), woven from taxpayer dollars.

Unfortunately, the conventional post-mortem on Lehman is wishful thinking. It basically says that no matter how huge the housing bubble, how deep a credit hole the United States (and many other countries) had dug, and how convoluted the global financial system, we could have just grown our way out of trouble. Patch up Lehman, move on, keep drafting off of China’s energy, and nothing bad ever need have happened.

The fact is global imbalances in debt and asset prices had been building up to a crescendo for years, and had reached the point where there was no easy way out. The United States was showing all the warning signs of a deep financial crisis long in advance of Lehman, as Carmen Reinhart and I document in our forthcoming book This Time is Different: Eight Centuries of Financial Folly .

Housing prices had doubled in a short period, spurring American consumers to drop any thought of saving money. Policymakers, including the US Federal Reserve, had simply let the 2000s growth party go on for too long. Drunk with profits, the banking and insurance industry had leveraged itself to the sky. Investment banks had transformed their business in ways their managers and boards clearly did not understand. (And willfully so he should add - Jesse)

It was not just Lehman Brothers. The entire financial system was totally unprepared to deal with the inevitable collapse of the housing and credit bubbles. The system had reached a point where it had to be bailed out and restructured. And there is no realistic political or legal scenario where such a bailout could have been executed without some blood on the streets. Hence, the fall of a large bank or investment bank was inevitable as a catalyst to action.

The problem with letting Lehman go under was not the concept but the execution. The government should have moved in aggressively to cushion the workout of Lehman’s complex derivative book, even if this meant creative legal interpretations or pushing through new laws governing the financial system. Admittedly, it is hard to do these things overnight, but there was plenty of warning. The six months prior to Lehman saw a slow freezing up of global credit and incipient recessions in the US and Europe. Yet little was done to prepare. (Why was nothing done? Why is nothing being done even today to prepare for the next wave of defaults one might ask? - Jesse)

So what is the game plan now? There is talk of regulating the financial sector, but governments are afraid to shake confidence. There is recognition that the housing bubble collapse has to be absorbed, but no stomach for acknowledging the years of slow growth in consumption that this will imply.

There is acknowledgement that the US China trade relationship needs to be rebalanced, but little imagination on how to proceed. Deep down, our leaders and policymakers have convinced themselves that for all its flaws, the old system was better than anything we are going to think of, and that simply restoring confidence will fix everything, at least for as long as they remain in office.

The right lesson from Lehman should be that the global financial system needs major changes in regulation and governance. The current safety net approach may work in the short term but will ultimately lead to ballooning and unsustainable government debts, particularly in the US and Europe.

Asia may be willing to sponsor the west for now, but not in perpetuity. Eventually Asia will find alternatives in part by deepening its own debt markets. Within a few years, western governments will have to sharply raise taxes, inflate, partially default, or some combination of all three. As painful as it may seem, it would be far better to start bringing fundamentals in line now. Restoring confidence has been helpful and important. But ultimately we need a system of global financial regulation and governance that merits our faith.

Remember, Remember, the Twelfth of November (1999)

"On November 12, 1999, President Clinton signed the Gramm-Leach-Bliley Act
(GLB) into law. This landmark legislation does much to unravel the influence of
the Glass-Steagall Act on the United States' financial system. Now banks and
other providers of financial services have far greater freedom to compete
against each other. No doubt, the legislation will prompt an altering of the
financial landscape in this country."

John Krainer, Federal Reserve Bank of San Francisco Economic Review,
2000

Federal Reserve August 12 Statement

The following is the Federal Open Market Committee statement following its August policy meeting:

Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out. Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.

Businesses are still cutting back on fixed investment and staffing but are making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability. (So much for the "V" recovery - Jesse)

The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time. (Dream on - Jesse)

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year.

In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

If You Read Nothing Else About the Financial Crisis Read (and Remember) This...

"The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises.

If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time."

The Atlantic
The Quiet Coup
By Simon Johnson
May 2009

...But I must tell you, to IMF officials, all of these crises looked depressingly similar...

...The downward spiral that follows is remarkably steep. Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse. Yesterday’s “public-private partnerships” are relabeled “crony capitalism.” With credit unavailable, economic paralysis ensues, and conditions just get worse and worse. The government is forced to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah. The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions — now hemorrhaging cash — and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.

Squeezing the oligarchs, though, is seldom the strategy of choice among emerging-market governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or—here’s a classic Kremlin bailout technique—the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk—at least until the riots grow too large...

From this confluence of campaign finance, personal connections, and ideology there flowed, in just the past decade, a river of deregulatory policies that is, in hindsight, astonishing:

• insistence on free movement of capital across borders;

• the repeal of Depression-era regulations separating commercial and investment banking;

• a congressional ban on the regulation of credit-default swaps;

• major increases in the amount of leverage allowed to investment banks;

• a light (dare I say invisible?) hand at the Securities and Exchange Commission in its regulatory enforcement;

• an international agreement to allow banks to measure their own riskiness;

• and an intentional failure to update regulations so as to keep up with the tremendous pace of financial innovation.

The mood that accompanied these measures in Washington seemed to swing between nonchalance and outright celebration: finance unleashed, it was thought, would continue to propel the economy to greater heights...

Looking just at the financial crisis (and leaving aside some problems of the larger economy), we face at least two major, interrelated problems. The first is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate. The second is a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support...

At the root of the banks’ problems are the large losses they have undoubtedly taken on their securities and loan portfolios. But they don’t want to recognize the full extent of their losses, because that would likely expose them as insolvent. So they talk down the problem, and ask for handouts that aren’t enough to make them healthy (again, they can’t reveal the size of the handouts that would be necessary for that), but are enough to keep them upright a little longer. This behavior is corrosive: unhealthy banks either don’t lend (hoarding money to shore up reserves) or they make desperate gambles on high-risk loans and investments that could pay off big, but probably won’t pay off at all. In either case, the economy suffers further, and as it does, bank assets themselves continue to deteriorate—creating a highly destructive vicious cycle...

In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts, like the ones we saw in February with Citigroup and AIG. The administration will try to muddle through, and confusion will reign...confusion and chaos were very much in the interests of the powerful—letting them take things, legally and illegally, with impunity. When inflation is high, who can say what a piece of property is really worth? When the credit system is supported by byzantine government arrangements and backroom deals, how do you know that you aren’t being fleeced? (This is where the US is today - Jesse)

The second scenario begins more bleakly, and might end that way too...

Read the complete essay here.

Simon Johnson, a professor at MIT’s Sloan School of Management, was the chief economist at the International Monetary Fund during 2007 and 2008. He blogs about the financial crisis at baselinescenario.com, along with James Kwak, who also contributed to this essay.

NAV Spreads of Certain Precious Metal ETFs and Funds

J P Morgan Chase Caught Speculating with Customer Money

Why the surprise? This is what the Wall Street banks do, even under a 'reform' administration. They use their customer money and public funds, for which they pay a pittance, to wildly speculate in markets, distorting prices and taking enormous risks, in order to pay themselves outrageous bonuses. They buy politicial influence to enable regulatory capture and support their financial schemes. And when their bets go wrong, the public absorbs the losses. This is the model of US gangster banking in the 21st century.

The Obama Administration cannot energize their health care reform because the public demands reform in the financial sector, and quite frankly Obama has lost the 'high ground' of the reformer by his inability to free his administration from the growing taint of scandal.

So it remains for the rest of the world to begin to rein in the outrageous behaviour of the US financial institutions that treat the world's bourses as their private casinos.

For a party that spent eight years on the sidelines, the American Democrats have proven themselves to be particularly inept at doing anything to promote their agenda once presented with a solid majority by the voting public.

The banks must be restrained, and the financial system reformed, before there can be any sustainable recovery.

Daily Mail
Blair bank targeted in £8.5bn FSA probe
By Ben Laurance
10th August 2009

The bank where Tony Blair is an adviser is the target of an unprecedented probe involving billions of pounds of customers' funds, the Daily Mail can disclose.

JP Morgan Chase, whose chief executive Jamie Dimon last year recruited the former prime minister as an adviser, is being investigated by the City's watchdog, the Financial Services Authority for allegedly failing to keep track of £8.5billion of clients' money.

The FSA has called in a top firm of accountants to examine the bank's London activities after evidence emerged that JP Morgan had mixed customers' funds with its own.

Banks are meant to maintain a strict segregation of their own money from that which is held on behalf of clients.

But JP Morgan managers in London discovered last month that client and bank money used for trading futures and options - a way of speculating on movements in currencies, share prices and commodities - had apparently been put into a single pool.

They raised the alarm and notified the FSA. The scale of case is unprecedented, say City insiders. The FSA has penalised small firms in the past for mixing funds owned by clients and the banks themselves.

But this is thought to be the first case involving such a large household name.
JP Morgan Chase faces the threat of an unlimited fine if the watchdog decides enforcement action is necessary.

News of the FSA investigation will come as a huge embarrassment for the bank, which is valued on Wall Street at £100billion.

It is thought that the JP Morgan Chase problem dates back to late 2002. This followed the takeover of JP Morgan by Chase Manhattan two years earlier.

Assets were not segregated to protect clients as FSA rules demand, insiders believe.

When the issue first came to light last month and the FSA was told, the authority called in specialists from leading accountancy firm KPMG to investigate.

The cost of the probe - known as a section 166 review - will be met by the bank.

Sources say that KPMG's team of investigators has been working at JP Morgan Chase's offices on London Wall in the City, combing through records and e-mails and interviewing staff.

Bank employees who were involved in handling client funds in 2002 as well as those still responsible have been questioned. The KPMG team has been asked to find out what checks, if any, were made to ensure that clients' money has been kept safe and segregated.

The accountants have also been asked to calculate if clients lost out because they were not paid any interest they might have been due.

Senior figures at the bank could be reprimanded or even barred from working in the City if the FSA concludes that they were slack in setting up systems for separating customers' funds.

The accountants have been asked to deliver their preliminary findings to the FSA by the end of this month. A final report is due by the end of September. These reports will not be made public - unless the FSA subsequently decides that the bank should be punished.

JP Morgan Chase has been regarded as one of the more robust of the banks to emerge from last year's meltdown in the global financial system. Among the six largest U.S. banks, it is the only one to have stayed consistently in the black since the recession began in 2007.

But it still took £15billion last year under the U.S. government's programme to prop up the financial system. The money has since been repaid.

Last month, the bank reported quarterly earnings of £1.64billion, which was a major factor in spurring the recovery in its shares and in Wall Street prices as a whole.

A report last week showed that last year, the firm paid bonuses of £600,000 ($1m) or more to 1,626 employees. Of those, more than 200 received at least £1.8m. The top four earners received a total of nearly £45million between them.

JP Morgan Chase said: 'We have no comment.'

The FSA said: 'We wouldn't comment on whether we are doing an investigation.'

KPMG also declined to comment.

Gordon Brown's Bottom and the Sale of England's Gold

Unrelated (perhaps not) to the English gold sale is this revelation about the gold reserves of Germany at around 7:25 in the tape .

This is of particular interest because Bundesbank has repeatedly denied the rumoured gold swaps with the the US Exchange Stabilization Fund (ESF) for 1,700 tons of gold, being held at West Point, NY with the designation "custodial gold."

Has the Bundesbank, like the Bank of England, sold (or lent if you will) half of its national gold reserves?

The other side of this rumour is that Bundesbank desperately wishes a 400 ton IMF gold sale to help it recover at least some portion of the 1,700 tonnes of gold which it has lent out to the bullion banks, who subsequently sold it into the market.

Why does it matter? It matters because of the lack of transparency of various Central Banks with regard to the size and timing of their gold sales, and their impact on the markets.

Its never really the initial act that is performed; it is the subsequent cover up and dissembling that brings down careers and governments.

"The most fascinating thing that I learned is that all the gold 'in Germany' is in New York."

Will the US Dollar Falter on an "Iron Cross"?

And in a related question, how absurd is it that AIG posted a 'profit?'