Economics in Disrepute as the Economy Tumbles

The failure of the central bankers and economists to 'manage the economy' is nothing new. One only has to look at the mainstream economic 'forecasts' in 1929 and 1930 to realize that not only is economics not a precise science, but too often economists are nothing more than mouthpieces for vested interests, and dabbling in politics and public policy in the guise of science.

Yes, there are a few notable exceptions. We are speaking of the economics profession. Roger Babson was such an exception in 1929, being dismissed by his establishment peers as gloomy and a crank...until he was proven all too correct.

On September 5th, 1929, he gave a speech saying "Sooner or later a crash is coming, and it may be terrific". Later that day the stock market declined by about 3%. This became known as the "Babson Break". The Crash of 1929 and the Great Depression soon followed.

A new school of economics will likely rise out of the coming financial collapse of the US, as it did in the 1930s. Perhaps this one will be more scientific, less subservient to private business interests and political objectives. This may be a long process, as with the other sciences.

But until that time it is good to realize that much of the discussion of macro-economics is nothing more than public policy and personal philosophy, with a strong dose of financial bias. Economists can prove just about any hypothesis since the data is so abundantly malleable, the relationships so uncertain, the experiments virtually non-replicable in any practical timeframe, the consequences often unintended, and the methods so imprecise and subjective.

For the sake of our country, stop the Fed from increasing its opaque power to regulate and control our economy. They have made a botched job of it, and show no signs of improvement beyond serving the needs of their special interests and the wealthy elite. Our security is in checks and balances, review and transparency, fair discussion and disclosure. The would-be wizards and sorcerer's apprentices of the Fed are none of these.


When the going gets tough, economists go very quiet
They're happy to take the credit in the good times, but the disciples of this false science are hard to find as recession looms
Simon Jenkins
The Guardian
Wednesday July 9, 2008

So the Footsie has tumbled again. Forgive me for asking, but where are the economists? As the nation approaches recession, an entire profession seems to have vanished over the horizon, like conmen stuffed with cash, and thousands left destitute behind. They said recessions were over. They told politicians to leave things to them and all would be fine. Yet they failed to spot the sub-prime housing crash, and now look at the mess. (In the US they have the nerve to demand that the power of regulation be given to them in the person of the Fed - Jesse)

When I studied economics we were told we would be masters of the universe. Ours was not a dismal but a noble science. It had harnessed the verities of maths to those of human behaviour and would go on to conquer politics. Rampant recession would go the way of hyperinflation. Like leprosy and cholera, they were epidemics that modern medicine had rid from our shores.

It did not matter if the economists were welfare Keynesians such as Myrdal, Robinson and Galbraith or free-marketeers such as Marshall, Friedman and the Institute of Economic Affairs. All were "social scientists". They claimed to have cracked the DNA of economic exchange, to have turned the base metal of money into political gold.

We believed them. We believed the Keynesians until we slumped into stagflation. We believed light-regulation capitalists such as Margaret Thatcher and Gordon Brown, that they could convert boom-bust into an upward sloping plane of glory. We believed the Bank of England when it said that, in its hands, inflation was dead and prosperity eternal. Bliss was it in that dawn to be alive - and an economist.

If Britain were now in the grip of bubonic plague, there would be all hell to pay from some profession or other. An "influential" Commons committee would be summoning the chief medical officer and subjecting him to the third degree. Why no national rat strategy? Why no crash inoculation? Why so many planning delays on plague pits?

The espionage pundits were likewise castigated for wrongly leading the nation to war against Iraq, for giving dud professional assessments on fallacious intelligence. (Not here, we've given them a pass. Oops! - Jesse) The architectural profession has taken the rap (very occasionally) for the grotesque failures of public housing in the 1970s. Climate scientists may yet be damned for the costly lunacy of new energy sources, such as wind turbines and biofuels.

Yet economics is a Teflon profession. A quarter of a century ago 364 practitioners wrote a letter denouncing the policies of the then Thatcher government as having "no basis in economic theory". They were wrong in fact and wrong in judgment. Thatcher's policies laid the groundwork for a strategic shift in the underpinning of British prosperity. There was no inquiry, no hearing, no peep of retraction or remorse.

Since then economists have flooded into government; there were roughly a thousand at the last count. What do they all do? Despite reports of demoralisation in the Treasury, that department remains the home base for public sector management through financial aggregates. During the Blair/Brown era it has held government in thrall.

Economic managers have always claimed credit for the success of Brown's Treasury regime. They have espoused quantifiable outputs, targets and delivery indicators. They invented the celebrity consultant and the maxim that only what measures matters. Above all, the economics profession (and its house journal, the Economist) was ecstatic when Brown delegated monetary control to the Bank of England. This was supposed to isolate the economy from political pressure, subcontracting the regulation of interest rates and markets.

Today we are older and wiser. Controlling the agencies of credit has proved beyond the finest professional minds in the game. Where now are the effortless pundits of the Treasury and the Bank? Where now the gilded ones of Moody's and Standard & Poor's, credit raters to the mightiest in the land? They should have stuck to goose entrails.

Alan Greenspan, former chief of the US Federal Reserve Board and a Brown adviser, is unrepentant. He recently declared that "anticipating the next financial malfunction ... has not proved feasible". There is nothing so unseeing as a wronged economist. The Bank of England's apologias over Northern Rock have been protests that regulation is a mess and government indecisive.

When muck hits fan, economists always blame politicians. They would have some justice if they did not take credit when things go right. I was always uncomfortable at the overselling of economics as a science, when it is rather a branch of psychology, a study of the peculiarities of human nature. Its spurious objectivity, manifest in its ridiculous love affair with maths, induced a "Jupiter complex", a conviction that scientific certainty, applied with enough rigour to any problem, triumphs over all.

Economic management is and always will be about politics, about the clash of needs and demands resolved through the constitutional process. The delegation of interest rates to the Bank of England worked when it ran in parallel with politics, but not any more. Now that reflation seems urgent for recovery, the system is biased against common sense, yet no politician dare tell the Bank to cut rates and risk inflation.

The newest craze is "nudge" economics, from the Americans, Richard Thaler and Cass Sunstein. They put the subject firmly among the behavioural sciences - if not the arts. Human actions are too mysterious and unpredictable to be liable to quantification and modelling. They are responsive to what the academic Paul Ormerod called "butterfly economics". Nudge steers, but does not order or plan.

This requires knowledge of the working of markets, incentives, expectations and panics. But converting micro-economics into macro has always been a dangerous game. Much has been made of the success of Spain's dirigiste banking regulators in putting security before runaway profit. But this was a triumph of politics over economics. Greenspan may laconically remark that "we can never have a perfect model of risk", but we can have alertness to risk and we can have caution.

Economics has long traded on being a science when it is not. In this it is like war. For a third of a century since the 1976 IMF crisis it has enjoyed great influence over British policy. Now it has met its Waterloo and a little humility would be in order. Once again economics must be rescued by that true master of all things, politics.

simon.jenkins@guardian.co.uk

Ratings Delusions Part Deux: Fannie and Freddie Rated Aaa but Traded A2

In economics, cognitive dissonance is an uncomfortable feeling of stress caused by holding two contradictory credit ratings or financial assessments simultaneously: one from a corrupt official source and one from your own common sense and some basic math. (SEE also US trade deficit, Non-farm Payroll Report, Consumer Price Index, and Alan Greenspan)

Fannie, Freddie Downgraded by Derivatives Traders Over Capital
By Shannon D. Harrington and Dawn Kopecki

July 9 (Bloomberg) -- Fannie Mae and Freddie Mac, ranked Aaa by the world's largest credit-rating companies, are being treated by derivatives traders as if they are rated five levels lower.

Credit-default swaps tied to $1.45 trillion of debt sold by the two biggest U.S. mortgage finance companies are trading at levels that imply the bonds should be rated A2 by Moody's Investors Service, according to data compiled by the firm's credit strategy group. The price of contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac and to protect against a default doubled in the past two months.

Traders are overlooking the government's tacit guarantee of the debt as credit losses grow and concern rises that the companies don't have enough capital to weather the biggest housing slump since the Great Depression. (The COMPANIES don't have enough capital to cover it, hell, the FED doesn't have enough money to cover that 1.45 trillion debt - Jesse) Even an implied guarantee isn't enough to convince credit investors that there's little risk to owning Fannie Mae and Freddie Mac debt, said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.

''Investors are viewing even an implicit guarantee from the government as potentially troublesome,'' Backshall said. (Investors! What about the taxpayers? Greenie kept saying that there was NO guarantee. - Jesse)

Worries that Fannie Mae and Freddie Mac may need more capital were heightened this week after Lehman Brothers Holdings Inc. released a report saying a new accounting rule may require them to raise $75 billion. Freddie Mac dropped 18 percent June 7 in New York Stock Exchange composite trading and Fannie Mae dropped 16 percent.

The companies' congressional charters provide exemption from state and local corporate income taxes and give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default. Fannie Mae spokesman Brian Faith and Freddie Mac spokesman Michael Cosgrove declined to comment.

Gap Widens

Credit-default swaps tied to Washington-based Fannie Mae's senior debt climbed 39 basis points to 74 basis points since May 1, while contracts on McLean, Virginia-based Freddie Mac's senior debt increased 40 basis points to 75, according to London-based CMA Datavision. A basis point is 0.01 percentage point.

The cost to protect the companies' subordinated debt from default has risen at a faster rate amid concern the government may not honor the subordinated debt, Backshall said. The subordinated debt of both companies is rated Aa2 by Moody's because the owners would be paid after the senior bond investors.

Credit-default swaps tied to Fannie Mae's subordinated debt have jumped 108 basis points to 195 basis points since May 1. Contracts on Freddie Mac's subordinated debt have risen 105 basis points to 193 basis points.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They were conceived to protect bondholders against default and pay the buyer face value in exchange for the underlying securities or the cash equivalent should the company fail to adhere to its debt agreements.

A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

Combined Losses

Fannie Mae and Freddie Mac, which reported combined losses of more than $11 billion, have raised more than $20 billion since December. Merrill Lynch & Co. analyst Kenneth Bruce said in a report yesterday the ''highly levered financial institutions'' will have pretax credit-related losses of $45 billion.

''Fannie and Freddie are going to have to raise more capital and nobody thinks they're going to be able to raise capital when they need to,'' said Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia. ''It's going to be very expensive.'' (When you're a congressman all your problems look like taxpayers. - Jesse)

Recouping Losses

Fannie Mae rose 12 percent and Freddie Mac gained 13 percent yesterday, recouping some losses from a day earlier, after the companies' regulator said they were adequately capitalized and Treasury Secretary Henry Paulson said they can still be a ''constructive force,'' in the economy.

The companies own or guarantee about 46 percent of the $12 trillion U.S. mortgage market. (We are so fucked. - Jesse)

''It concerns me that people sort of extrapolate well beyond what the facts are,'' James Lockhart, the director of the Office of Federal Housing Enterprise Oversight, said in an interview with Bloomberg Television yesterday.

The government is leaning on the companies to help revive the mortgage market. Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger, so-called jumbo mortgages to spur demand for home loans as competitors fled the market. (What do they call that, the 'hair of the dog that bit you?' - Jesse)

Their share of new conforming mortgages, or loans of $417,000 or less, almost doubled to 81 percent in the first quarter, Ofheo said.

The bailout of Bear Stearns Cos. arranged by the Federal Reserve in March shows the government won't allow the companies to fail, Robert Millikan, who manages $5 billion as director of fixed income at BB&T Asset Management in Raleigh, North Carolina.

''We're looking at it from a standpoint of, if the Fed is not going to allow a problem with Bear Stearns, they're certainly not going to allow a problem with Fannie and Freddie,'' Millikan said. ''With all the exposure that banks have to Fannie and Freddie, the ripple effect through the whole financial system would be unbelievable if they were allowed to fail,'' he said. (Dude, the NY Fed couldn't stand up to a default by Fannie and Freddie - Jesse)

To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Dawn Kopecki in Washington at dkopecki@bloomberg.net.

Major US Stock Indices Deflated by Gold: the Cruel Deception

Our hypothesis is that after the tech bubble collapse of 2000-2002 and the economic shock of 911, the Fed began a concerted effort to inflate the currency through an unprecedented period of negative interest rates. The result of this has been a brief return to the 2000 highs in most stocks last year except of course the techs, and a substantial bubble in debt and credit derivatives that threatens to overturn the US banking system.

Here we present a few of the US stock indices as deflated by gold, showing their true performance in 'real value' terms discounting the Fed's monetary inflation. A number of commodities could have been used the same way as deflators of financial assets, among them some of the base metals, silver, and oil.

The Fed can create only paper. Inflation does not create value, it merely masks the rot of economic stagnation, but can do so for several years if the inflation can be concealed artfully. The US has been struggling through a particularly non-productive period for most Americans in terms of real wealth production especially as expressed in the growth of savings, which has been decidedly negative.

In their irresponsible foolishness and greed the Fed and the Bush Administration have managed to transfer more wealth from the many to the few, further impeding any sustained recovery since the health of the economic body has been concetrated in a few parts of questionable productive value.

This is how we coined the term "Potemkin Economy" many years ago. It is a cruel illusion of the Fed, the Treasury, and their associates in misdirection and deception. For that is what this has been, regardless of motives or intentions. It is a disgraceful espisode in our country's history, but this is what happens when one gives themselves over to the rule of fear and greed.


Here is the Dow Industrial Average, deflated by gold. It is also known as the "Dow-Gold Ratio." Long run the ratio tends to return to 2. It seems to be well on its way.



SP 500


Russell 2000

US Stocks Rally on a Decline in OIl Prices and the Fed's Extension of Credit Facilities

Crude Oil prices declined today and the US equity markets rallied hard in the final hours as the shorts were covering and the bulls took the opportunity to buy on a spark of optimism in these deeply short term oversold markets.

Alcoa reports after the bell that it beat Earning Per Share by a penny and also exceeded revenues on estimates that have been greatly lowered. Mohawk Industries warned and was spanked after hours. VMWare is weighing on the tech sector.

We'll have to see if this is just another short covering bounce or something more profound. Follow through to the upside tomorrow to take the SP back into the 1290's is required for a firmer indication of any trend change.



Follow through in the decline of oil prices is necessary. So far its just a correction in an obvious bull market.