Is the Fed Likely to Act If There Is Another Stock Market Bubble?

That title is a bit of a rhetorical question, because I think the stock market bubble has already arrived, and the Fed is pumping the bellows. But let us not allow that detail to impede the progress of our discussion. Let's assume that only the next leg up in this monetary experiment will be breaching the limits of the bubblesphere.

Mark Thoma has 'reblogged' a review of Dean Baker's book False Profits from Brad DeLong Site at his own, The Economist's View.

Brad, the blogging professor from Berkley, takes issue with Dean Baker's book, concluding:

"But let me start by saying how I disagree with the book. I think that its story of the linkages between our current crisis and Federal Reserve policy is significantly overstated. Its argument about how excessively-low interest rates caused the housing bubble is exaggerated. I think that its belief that the Federal Reserve could have taken much more action to curb the housing bubble while is underway is also exaggerated..."

Well, at least he is consistent. In censuring my criticisms of Mr. Greenspan's monetary policy back in 2004 which I made as comments on his blog, Mr. DeLong said that Greenspan "never made a policy decision with which I disagreed." Although I was incredulous, I took him at his word.

Not even Greenspan apparently is willing to say that anymore. Although he is very willing to forget the activist role he took in promoting banking deregulation and the expansion of leverage and derivatives, and the rough treatment measured out to those who dared to disagree with the powerful bureaucrats at the Treasury and the Fed. Reich Levels Broadside at Greenspan, Rubin, Summers and Phony Financial Reform

But the comments to this blog were quite interesting and led me to another review of Dean Baker's book by 'Daniel' over a Crooked Timber.

I found the first comment after Daniel's review to be particularly interesting.

kevincure: 04.03.10 at 6:21 PM

"I was at the Fed in 2006. Everybody at the Fed was aware that there was a housing bubble. The fact that rents and house prices had diverged was known to all of the policymakers I interacted with.

The question was not, is there a bubble, but rather, can monetary policy improve welfare by popping that bubble. The general opinion was no. First, monetary policy is an economy-wide hammer, and housing in only one sector. Second, housing bubbles were prevalent worldwide, and in fact were stronger in many other countries than the US, so it was difficult to imagine that non-extreme changes in policy would affect the bubble. Third, “use policy to clean up the mess after the bubble pops” was, I think, absolutely the right policy in 1987 and 2000, so a model of housing bubbles would have needed to explain what was different this time – even now, lost wealth from housing price declines are not, as far as I know, greater than the wealth decline of the dot-com bubble. That is, the housing bubble in and of itself required no different monetary policy, even with perfect hindsight.

The difference was in the financial markets, where for a variety of reasons (high leverage ratios, principal-agent problems, etc.), the decline in house prices led to what was functionally a bank run. The Fed was not the primary regulator of investment banks in the US, and is one of at least five regulators of local banks (OCC, FDIC, OTS, and state regulators among the others). This isn’t to excuse the Fed – they should have had an office looking at systemic risk! – but merely to point out that very few people saw systemic risk as a major problem in 2006, primarily because of a belief that shareholders and managers were capable of taking better care of their own firms and jobs. This was wrong, but the common criticisms of Baker and Shiller and others about Fed policy and housing bubbles completely abstract away from the real cause of the crisis, which was financial.

In any case, a housing bubble – by itself – would have been straightforward to deal with ex post with policy. That was not the problem."

This is not some outlier comment, but an expression of what is a very mainstream thought among a certain class of American economists, especially those who covet positions of power with the US government.

The 'collateral damage' caused by the dot.com and housing bubbles, all those ruined lives and families, is really not a problem and can be addressed by monetary policy (inflation) after the bubble runs its course. The problem in this last financial crisis is that the housing collapse caused a bank run, and the banks themselves were injured, instead of profiting, in the bubble collapse. Talk about an unintended consequence. Good God, not the Banks! This is a fast being remedied by the enormous subsidies granted by the Fed, and their man Timmy at the Treasury, to set the Banks back up again at the roulette tables, bringing home those eight figure paydays.

If you think the Fed has learned anything, that they are somehow more prudent, more aware of the greater economy and the impact of their behaviour on the American people after this latest financial crisis, you are sadly mistaken. Their hubris is boundless, and they are able to rationalize almost any damage to the republic as a minor glitch in their experiments.

The answer to our initial question about a new stock market bubble is of course is "no." The Fed will allow a stock market bubble to develop, run its course, collapse, empty even more of the savings and retirement funds of mom and pop, and go happily along on its way as long as the banking sector is maintained in the manner to which it has become accustomed.

And if you think this latest financial crisis has stilled the animal spirits of the merry pranksters on Wall Street you are sadly mistaken. The sociopaths will continue to gamble the nation's future, and the propeller heads at the Fed will stand idly by waiting to clean up the mess, only afterwards. But the clean up will be carefully targeted to the FIRE sector, and the public will likely have to fend for itself.

And the Congress would like to make the Fed the overarching regulator and the primary owner of an expanded Consumer Protection Agency? Only afer huge amounts of lobbying contributions to assuage their consciences it must be said. To the Fed, the consumer is only grist for the mill from which the bankers obtain their bones to bake their bread.

Asset bubbles are a form of fraud, in that and mispresentation and deception are employed to circumvent genuine price discovery. And like most Ponzi schemes and financial frauds, they are an effective wealth transfer mechanism from the many to the few. And the few will do quite a bit to create them, and then keep them in place.

Some are critical of people like Robert Reich who 'tell it like it is' although in softer terms than they might desire to have them speak. Let me tell you, the establishment in the US is closing ranks, and is going to try to ostracize and silence anyone who speaks out against the status quo. And the intimidation of critics and witnesses continues.

Here is some knowledge, tempered by actual experience, from William K. Black, an economist and regulator involved in the Savings and Loan Scandal.







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

Reich Levels Broadside at Greenspan, Rubin, and Summers, and Phony Financial Reform

"It is impossible to calculate the moral mischief, if I may so express it, that mental lying has produced in society. When a man has so far corrupted and prostituted the chastity of his mind as to subscribe his professional belief to things he does not believe, he has prepared himself for the commission of every other crime." … Thomas Paine

In 1999 I started wondering what Robert Rubin might have said to Alan Greenspan in a private meeting in 1997 to cause him to reverse his policy bias shortly after his famous "irrational exuberance" speech. Greenspan embraced the monetary easing that led to the tech bubble, and joined the fight against regulation of derivatives, and the repeal of Glass-Steagall, in which the Fed was absolutely instrumental.

PBS Frontline - The Warning: The Roots of the Financial Crisis

This was no accident, in my opinion. This was no misplaced belief in 'the efficient market hypothesis.' This was not the culmination of the neo-liberal fascination with a mythology of human nature that would make Rousseau blush in its unthinking naiveté. And for Greenspan to say now, I am sorry, I guess I was mistaken, is more prevarication from the master dissembler.

There were plenty of enablers to this financial fraud. There always are many more people who do not act out of principle, or inside involvement and knowledge, but out of their own selfish bias and greed or craven fear that compels them to 'go with the flow.'

And there is little better example of this than the many people who are even now turning a willful eye away from the blatant government manipulation of the stock and commodity markets, in particular the silver market. They do not wish to believe it, so they ignore it, and even ridicule it depending on how deeply it affects their personal interests. But the overall body of evidence is compelling enough to provoke further investigation, and the refusal to allow audits and independent investigation starts to become an overwhelming sign of a coverup. I am not saying that it is correct, or that I know something, but I am saying to not investigate it thoroughly and to air all the details, is highly suspicious and not in the interests of the truth. I did not know, for example, that Madoff was conducting a Ponzi scheme, but the indications were all there and a simple investigation and disclosure would have revealed the truth, one way or the other.

"Fiat justitia ruat caelum." Let justice be done though the heaven's fall. This is the principle of English law that says that expediency, that appeals to a false 'national security,' that executive privilege and the secrecy of the powerful interests, are not to deter the light of exposure and the consequences of justice for all. This is the difference between a republic and a dictatorship of the oligarchy.

The military industrial complex came to power in the US on the back of the Red Scare and the smears and fear-mongering perpetrated by the Senator from Wisconsin who 'loved to hear the sound of his own voice, more than the truth,' and his minions in Roy Cohn, and the enablers in the press who were cowed into silence.

There will be smears and distractions, ridicule and old prejudices dug deep will be brought newly forward. False flags and scapegoats. Threats and warnings of collapse will be like bluffs run to encourage the people to hand over their liberty for safety. If you do not think this can happen you have not been paying attention.

The perpetrators of this latest fraud, this unleashing of darkness upon the world, will count on the fear and apathy of the many, and the cynical contempt of the fortunate for the disadvantaged, to make them all the unwitting accomplices in their own inevitable destruction. It has worked for them in the past.

One cannot fight this sort of evil with hatred and violence, or hysteria and intemperate accusations, for these are its creatures and it uses them always to further its ends. The only worthy adversary of the darkness is transparency, openness, justice, and truth based on facts, in the light of reason, with the guidance of the light of the world. We are not sufficient of ourselves to stand against it, and if we knock down the law, the Constitution, to chase it with expediency and private justice, what will protect us when it turns around to devour us?

But we should never be a willing victim, and even worse, a silent bystander or mocking accomplice. This is why were you born here and now, to stand witness to the truth, as you can find it and value it above all else.

It is not easy to find the truth, as it is a journey, a way that never ends. And without a proper guide and companionship, it may be all too easy to grow weary or panic, and lose one's bearings and one's heart. But sometimes it is easier to discover what is not the truth by its acts, its results, the fruit that it produces, and the darkness and secrecy in which it dwells.

And the truth is not with the financial system, and the web of deception and fraud, that has served it. "What is Truth?" he asked. And Pilate turned and washed his hands of it, and condemned himself, forever.

Robert Reich
Greenspan, Summers, and Why the Economy Is So Out of Whack
Sunday, April 4, 2010

"I’m in the “green room” at ABC News, waiting to join a roundtable panel discussion on ABC’s weekly Sunday news program, This Week.

Alan Greenspan is now being interviewed. He says he bore no responsibility for the housing bubble that catapulted the nation into a financial crisis in 2008 because no one could have known about the bubble when he chaired the Fed in the years before it burst. Larry Summers was interviewed just before Greenspan. He said the economy is expanding, that the Administration is doing everything it can to bring jobs back, and that the regulatory reform bills moving on the Hill will prevent another financial crisis.

What?

If any single person is most responsible for the financial crisis, it’s Alan Greenspan. He presided over a Fed that lowered interest rates to zero (adjusted for inflation) but failed to prevent banks from using essentially free money to speculate wildly. You do not have to be a brain surgeon to understand that if money is free, banks will take it and lend it out. And if oversight is inadequate, the banks will lend the money to anyone who can stand up straight and to many who cannot. The result will be a giant subprime lending bubble that will burst.

If any three people are most responsible for the failure of financial regulation, they are Greenspan, Larry Summers, and my former colleague, Bob Rubin. In 1999 they advised Congress to repeal the Glass-Steagall Act, which since 1933 had separated commercial from investment banking. By 1999, Wall Street was salivating over such a repeal because it wanted to create financial supermarkets that could use commercial deposits to place bets in the financial casino. That would yield the Street trillions.

At the same time, Greenspan, Summers, and Rubin also quashed the efforts of the Commodity Futures Trading Corporation to regulate derivatives, when its director began to worry that derivative trading already was getting out of control.

Yet Greenspan continues to take no responsibility for what occurred. In the interview he just completed he avoiding saying anything about the failure of the Fed under his watch to adequately oversee the banks, and the absence of sufficient financial regulation to begin with.

I dislike singling out individuals for blame or praise in a political system as complex as that of the United States but I worry the nation is not on the right economic road, and that these individuals — one of whom advises the President directly and the others who continue to exert substantial influence among policy makers — still don’t get it.

The direction financial reform is taking is not encouraging. Both the bill that emerged from the House and the one emerging from the Senate are filled with loopholes that continue to allow reckless trading of derivatives. Neither bill adequately prevents banks from becoming insolvent because of their reckless trades. Neither limits the size of banks or busts up the big ones. Neither resurrects the Glass-Steagall Act. Neither adequately regulates hedge funds.

More fundamentally, neither bill begins to rectify the basic distortion in the national economy whose rewards and incentives are grotesquely tipped toward Wall Street and financial entrepreneurialism, and away from Main Street and real entrepreneurialism. It was just reported, for example, that America’s top 25 hedge fund managers last year earned an average of $3 billion each. They continue to pay a federal income tax of 15 percent on most of that, by the way, because their lobbying efforts have been so successful.

Meanwhile, the so-called jobs bills emerging from Congress and the White House are puny relative to the challenge of restoring jobs in America. Last Friday’s jobs report, read most positively, showed 112,000 jobs added to the economy in March. But that’s below the number needed simply to keep up with an expanding population. In other words, we’re actually worse off now than we were a month ago. At the same time, the median wage of Americans with jobs keep dropping.

The American economy is seriously out of whack. The two people interviewed this morning don’t seem to understand how far."

Five Weekly Charts: Gold, Silver, US Dollar, US Long Bond, and SP 500

Gold's bull trend is intact, but it is facing formidable resistance at $1150.



Silver is in a bull trend, but the $19 level could be difficult to surmount.



The US dollar index is still in rally mode, but has backed off the key 82 resistance level. The Dollar index is a composite of other currency crosses and the recent strength has been largely due to euro weakness. If stocks retreat the dollar rally will likely continue.



The Long Bond looks range bound, and is hanging on to support.



The SP 500 is a good representation of the US equity markets. It has reached the logical conclusion of what might be termed a bear market bounce based on monetary expansion, similar to other recoveries after significant declines. If the SP 500 breaks down from here, the risk is that it might fall to retest the lows. The market rally is thin and not backed by widespread buying, and certainly not the traditional buy-and-hold investor.

To put it simply, the SP 500 and US equities in general are now 'hitting a high note' and it is a good question to wonder how long they can hold it without some backup from the chorus. The 'chorus' of course is evidence of a structural recovery that is not depending on Fed monetization, official sleight of hand, and accounting gimmickry.



Even with the 'good' employment number, the stark contrast is that the median hourly wage continued to decline. This is not deflation, as the CPI and PPI continue to advance, so much as a reflection that the jobs available are largely temporary and of an inferior quality from which to build a sustainable recovery.



As alway, keep an eye on the VIX which is one of the fear indexes along with some of the key spreads.

The Federal Reserve's Veil of Secrecy And Authority Is Being Taken Down, But Slowly

One of the first things that 'put me off' of Obama was the choice he made of key appointments to his Administration, selecting the two Robert Rubin acolytes Tim Geithner and Larry Summers to his team, marginalizing Paul Volcker, and then making no place for Robert Reich. Although I am sure that, like the rest of us, he puts his pants on one leg at a time, he has shown himself to be a remarkably intelligent and competent member of the Washington political world. I admire him.

Make no mistake, the Fed looks to have been abusing its secrecy and its position, and Bernanke and Geithner are culpable. Reich makes the points as well or better than I could so here is his recent piece on the subject. All the blog's are picking it up.

As I recall, the Fed said they were only acquiring 'investment grade' instruments, which would be taken on its balance sheet in support of the US Dollar, in addition to the usual Treasury Debt. The recent exposures of the holdings of Maiden Lane show these to be more like junk bonds, and certainly not as represented.

The Fed must be audited, and it role as the 'master regulator' and as the place where the Office of Consumer Financial Protection would be located is a farce, a cruel joke. Chris Dodd must either be senile, entirely cynical, or believe the American people to be complete idiots. The only reason I could even imagine for considering it is that the Fed is a 'cost plus' agency, meaning that they are self funding out of the mechanism of creating money, taking all their costs out before they turn over the interest income from the public debt back to Treasury.  This is also a source of their growth and power. The problem that public agencies often have is that the industries that are regulated by them use their donations and lobbyists to curb appropriations for the agencies that regulate them in order to hamper and stifle them.

How can you even think of putting an office of reform and consumer protection in the very institution that was at the epicenter of a historic fraud? And shows itself completely willing to mislead the public, and some even believe perjure itself to the Congress to protect its true owners, the big Banks?

There are more things to come. But the frauds yet to be revealed may very well shake this government to its foundations, and very few blogs and almost none of the mainstream media are yet pursuing those stories of market manipulation, secret dealings, insider trading and official protection of corruption.

From The Fed Is In Hot Water by Robert Reich

"First, only Congress is supposed to risk taxpayer dollars. The Fed is not part of the legislative branch. Its secret deals, announced almost two years after they were done, violate the democratic process, if not the Constitution itself. Thomas Jefferson put a stop to Alexander Hamilton’s idea of a powerful central bank out of fear it would be unaccountable to the public. The Fed has just proven Jefferson’s point.

Second, if the Fed can secretly bail out big banks, the problem of “moral hazard” – bankers taking irresponsible risks because they know they’ll be rescued – is far greater than anyone assumed after Congress and the Bush and Obama administrations bailed out the banks. Big banks will always be too big to fail because they know the Fed will secretly back them up if they get into trouble, even if Congress won’t do it openly.

Third, the announcement throws a monkey wrench into the financial reform bill now on Capitol Hill, which gives the Fed additional authority by, for example, creating a consumer protection bureau inside it. Only yesterday, Sen. Jim DeMint (R-S.C.) blasted the Dodd bill for expanding the Fed’s authority “even as it remains shrouded in secrecy.” (When Jim DeMint and I agree on something you know it has to be close to a universal truth. - Jesse lol)

The Fed has a big problem. It acts in secret. That makes it an odd duck in a democracy. As long as it’s merely setting interest rates, its secrecy and political independence can be justified. But once it departs from that role and begins putting billions of dollars of taxpayer money at risk — choosing winners and losers in the capitalist system — its legitimacy is questionable.

That it chose to reveal the truth about its activities during a week when Congress is out of town, when much of official Washington and the Washington media have gone on vacation, and only after several federal courts have held that the Fed must release documents related to its bailout of Bear Stearns, suggests it would rather remain secret than become transparent.

Much of what Ben Bernanke and Tim Geithner did (when Geithner was at the New York Fed) in 2008 was presumably necessary. But the public has no way of knowing. The public doesn’t even know who else the Fed has bailed out, or what entities it will bail out in the future. All we know is the Fed secretly bailed out Bear Stearns and AIG and thereby subjected taxpayers to risks that remain even today, without informing the public. That’s not a record on which to build public trust."