Let Freedom Wane: The Fed's Role as Regulator and Obama's Failure to Reform

The proposal put forward by the Obama Economic Team to expand the purview of the Federal Reserve as a regulator, perhaps even THE regulator, was always troubling for several reasons.

1. The Fed is in fact not a government institution, but owned by private and corporate banking interests. The failure of self-regulation and regulators who have been 'captured' by the corporations they regulate is one of the great lessons of this crisis.

2. The Fed is notoriously opaque, with the occasional gesture towards transparency, and is often resistant to releasing information to the public in a timely manner, claiming a sort of 'executive privilege.' The Fed is and should remain independent but accountable on review. This precludes them from acting fully and routinely as a government agency responsible to the voters for all of their actions.

3. The Federal Reserve of NY often acts as a member of the 'banking club' with very heavy ties to Wall Street. The objective of financial reform should be to insulate regulators from undue influence by the organizations which they regulate, and more influenced by the law and the public good first and foremost. This is a basic principle of the regulatory process. One cannot successfully regulate their peers when the tough decisions have to be made to uphold justice and expose corruption and conflicts of interest.

This latest incident with Goldman Sachs merely serves to illustrate the too often unilateral decision-making by the Fed in an ad hoc manner, without sufficient explanation.

What the United States needs to reform its financial system is a group of Untouchables who are not on the payroll of Wall Street, or regular participants in the revolving door between government and the industry it regulates. The failure to create this effective reform, and instead gravitate toward ineffective consolidation in one of the key actors in the failure of the system is an error that is as fundamental and basic as one can imagine. It strains credibility that this could merely the result of inexperience.

It was the appointment of Larry Summers that first put us off the Obama 'reform' message. Larry Summers is a holdover from the same team that brought us some of the worst Federal Reserve policy decisions and interference in the regulatory process ever seen.

The Administration needs to convert its vision into action, and stop playing to the Wall Street lobby which created and is still benefiting from this crisis. If that requires replacing the Chief of Staff, Rahm Emmanuel, who is a heavy recipient of Wall Street donations, then so be it.

Whoever is promoting the Fed as uber-regulator within the Obama Administration should be fired, immediately. We hear it is Larry Summers, and this sounds like the politically tone-deaf, impractical, arrogant, and conflicted solution which Larry or Rahm might promote.

Can you imagine what our crisis would have been like if Alan Greenspan had even more power, more control over the markets?

Obama, quite frankly, needs to demonstrate that he is a man of integrity and principled action, vision that is not confined to oratory. He must now demonstrate that he is his own man, and is not owned by powerful special interests that seem to be controlling the American political process in both major parties.

If even a mandate such as Obama received does not energize the Democrats, then the best hope for America is a third party, a Progressive / Libertarian party as was seen at the turn of the 19th century with the rise of Teddy Roosevelt.

Baseline Scenario
A Short Question for Senior Officials of the NY Fed
By Simon Johnson
October 3, 2009

At the height of the financial panic last fall Goldman Sachs became a bank holding company, which enabled it to borrow directly from the Federal Reserve. It also became subject to supervision by the Federal Reserve Board (with the NY Fed on point) – hence the brouhaha over Steven Friedman’s shareholdings.

Goldman is also currently engaged in private equity investments in nonfinancial firms around the world, as seen for example in its recent deal with Geely Automotive Holdings in China. US banks or bank holding companies would not generally be allowed to undertake such transactions - in fact, it is annoyed bankers who have asked me to take this up.

Would someone from the NY Fed kindly explain the precise nature of the waiver that has been granted to Goldman so that it can operate in this fashion? If this is temporary, is it envisaged that Goldman will cease being a bank holding company, or that it will divest itself shortly of activities not usually allowed (and with good reason) by banks? Or will all bank holding companies be allowed to expand on the same basis. (The relevant rules appear to be here in general and here specifically; do tell me what I am missing.)

Increasingly, the issue of “too big to regulate” in the public interest is being brought up – an issue that has historically attracted the interest of the Department of Justice’s Antitrust Division in sectors other than finance. Should Goldman Sachs now be placed in this category?

Given that the Fed has slipped up so many times and in so many ways with regard to regulation over the past decade, and given the current debate on Capitol Hill, now might be a good time to get ahead of this issue.

In addition, there is the obvious carry trade (borrow cheaply; lend at higher rates) developing from cheap Fed dollar funding to the growing speculative frenzy in emerging markets, particularly China. Are we heading for another speculative bubble that will end up damaging US bank balance sheets and all American taxpayers?

Taylored Tales of the Monetary Bards

The title of this blog may appear a bit rude, and it is not intended to be denigrating of this particular paper from the Kansas City Fed linked below, but rather the organizational mindset that uses it to adjust anything more complex than the timing on a 1967 small-block Chevy with a straight face and a clear conscience.

Although a bit wonkish, "Was Monetary Policy Optimal During Past Deflation Scares?" does an exceptionally good job of explaining the Taylor Rule, how it has been derived and is utilized by Central Banks in evaluating and formulating monetary policy, ie., short term interest rate targets. The author gets high marks for clarity of language and a willingness to allude to some of the shortcomings of the method which is remarkable for most Fed research papers.

Financial engineering reminds one of saying we used to have in Bell Labs , when some individual or group was trying to formulate a practical response to a complex problem based on dodgy theories and elaborate field data: "Measure it with a micrometer, mark it with a grease pencil, and cut it with a hatchet."

One suspects that in this case, reducing the complexities of the economy to the output gap, real inflation gap, and the equilibrium nominal interest rate is like trying to arrive at the average depth of the ocean by using a micrometer to take a few ocean depth readings in a hurricane.

Yes each component has additional inputs, that vary widely and are difficult to measure, but to paraphrase, it does not matter if you calculation works, as long as it looks good, and darling doesn't this economy look marvelous.

It would be interesting to see the fun that Benoit Mandelbrot would have dissecting the Taylor Rule equation, derived from an 'optimal period' in US monetary policy. His book The The Misbehaviour of Markets is a must read for anyone who needs to be convinced that much of modern financial engineering and risk models are exercises in mathematical oversimplification and misdirection.

For those that are not so inclined to read this paper, let us just say that the data going in to the equation is subject to wide disagreement, adjustment, and interpretation, and the data coming out has enough spread from lack of modeling robustness to support just about anything, any outcome. Given the 'thinness' of the equation, which as the author refreshingly and freely admits, can choose from widely varying measures of 'core inflation,' while taking no account of asset prices and government industrial policy among other things.

I am sure the Board of Governors would respond that this Taylor Rule is merely one input into the collective decision-making of a group of wise men, who at the end of the day are combining their various perspectives into a judgement as to the optimal course of action, which includes their vast experience and readings of not only tools such as this, but anecdotal data from their various regions.

Too bad that our last Fed Chairman was a dissembling, blithering idiot, a standing joke in his private practice, who could not find the optimal monetary policy with both hands. But he was a masterful politician and bureacrat, surrounded by fellow sycophants, and did know how to serve the banking interests and make himself look credible, at least to outsiders. And in retrospect, this paper asserts that in fact the Committee under Chairman Greenspan did make a mistake in easing too aggressively for too long a period in the early 2000's. (well, duh).

And too bad the Fed has a significant amount of influence and power, so that even academic economists are too cowed by fear and greed to have said much while Sir Alan and His Merry Pranksters blew serial bubbles in support of the new banking economy. Because if Her Majesty the Queen wishes to be truly illuminated, that is why most economists failed to see the Crash coming: you get what you pay for.

Like Elliot Waves, this Federal Reserve process and these tools 'look good' when applied to historic examples, but one wonders who could possible use it to predict anything and take action on that with any level of success. Has the US Fed really had any unqualified successes based on their own initiatives, other than when Volcker took the economy in hand and, applying a sufficient amount of will, personal resolve, and common sense, tamed the pernicious inflation of the 1970's? They appear to have created more problems than they have solved.

So what is the answer? To do nothing and let the markets play themselves out? That is folly as well, because for better or worse markets are highly subject to manipulation from a number of sources, and the distortions caused therein are potentially devastating, when one considers the willingness for example of the Asian states to manipulate their currencies in support of a mercantilist policy of importing jobs as a means of solving domestic social problems. Or the propensity of the Anglo-American establishment to perpetuate gross fraud as a means of ravaging foreign peoples that too trustingly adopted the globalist model of deregulated banking and modern derivative financing.

The answer of course is that only a significant systemic change can take us out of this cycle. It will have to be one that recognizes that globalism is not an a priori good in a world where nations and peoples wish to settle on their own way of life, and solution set to particular problems in ways that suit them.

We are probably nearing the end of a long cycle of economic deregulation and monetary mysticism, in which old barriers and protections and particularities were struck down, often with little or no serious thought to the policy implications and long term social practices. The zenith of this trend is the consideration of the IMF or some such body as the global Central Bank, with a council of global governors setting everything from trade rules to de facto living standards. One way to make the models work and end conflict among the nations is to make everyone a slave.

When the financial and social engineers fail, their natural response is to make excuses and seek more power. If the CPI is proving to be an impediment to our calculations, let's change how we measure it. If the measurement of inflation is now adjusted, but gold keeps signaling inflation, let's manage the price of gold. And if people keep making independent choices that are not consistent with the predictions of our model, let us manage their perception, influence their judgement, override their own experience and the advice of their parents, and persuade them to take on more debt than they can possibly ever repay, and still remain free.

Hopefully this trend will fall apart before the globalists can do any more damage in the real world, but if it does not and we do get a Council of Global Governors, remember that their oracle is likely to be in dodgy, over simplistic equations such as this, which will be used to throw some clothing around what is most likely to be an exercise in influence peddling, elitism, and raw, naked power of the few over the many.

"Those in possession of absolute power can not only prophesy and make their prophecies come true, but they can also lie and make their lies come true."
Eric Hoffer

Was Monetary Policy Optimal During Past Deflation Scares?

Icelandic Police Raid KPMG and Price Waterhouse in Banking Frauds

There is serious fraud and criminal activity permeating the global banking industry. So far, few governments have taken serious action to expose the fraud and begin serious investigations, much less criminal indictments.

So far we have seen the occasional outsiders being thrown off the back of the sleigh for the wolves, but the serious insiders contine on, and in the case of the US, it's business as usual with bonuses back to record levels, and banks chasing trading profits using public monies.

Will some party, some group, rise up in the US to break the grip of the monied interests on government? It appears that it will not be coming from the Obama Administration, which is seriously compromised by conflicts of interest, and the Republicans which are the seed bed of corporate malfeasance and corruption.

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

UK Telegraph
KPMG and PwC Reykjavik offices are raided by Icelandic police
By Rowena Mason
9:30PM BST 01 Oct 2009

Police have raided the offices of KPMG and PricewaterhouseCoopers (PwC) in Reykjavik, seizing documents and computer data as part of an investigation into alleged criminal activity at three collapsed Icelandic banks.

The targets of the raids were the firms' banking clients Kaupthing, Glitnir and Landsbanki, but the move is nevertheless likely to cause embarrassment for the two companies, both among the "big four" accountancy names in the world.

The Reykjavik branches of KPMG and PwC are owned by its partners, common with most accountancy practices, but are also part of the multinational network of firms.

The office of Olafur Thor Hauksson, the Icelandic investigator charged with examining the collapse of the three banks a year ago, confirmed that 22 policemen and six foreign accountants took part in the searches yesterday.

"The purpose of the searches was to look for and secure evidence related to the investigation of several charges which have been investigated by the office," a statement said.

Among the matters being investigated are "violation of laws on accounting and annual reports, violation of laws on financial institutions and securities transactions and violations of laws on public limited companies". PwC Iceland could not be reached for comment.

Sigurdur Jonsson, the chief executive of KPMG Iceland, told The Daily Telegraph that the raids related to some of his clients and that none of his staff had been questioned. He refused to comment further on the investigation.

Mr Jonsson has already become embroiled in controversy after it emerged that KPMG Iceland had been responsible for investigating events leading up to the collapse of Glitnir, despite the fact that his son was chief executive of the bank's largest shareholder. KPMG later resigned from the case.

The UK Serious Fraud Office (SFO) agreed last month to send a team of investigators to Iceland to help "get to the bottom" of whether there were any criminal intentions in the country's collapsed banks, which had extensive links with London.

The Icelandic banks, which had large customer bases in the UK, failed last October, leaving 300,000 British savers unable to access their money and institutions nursing billions in losses. Following the crisis, the Treasury had to pay out £7.5bn to compensate UK savers, although £2.3bn of this will be repaid by Iceland over the next 15 years.

Allegations of fraud, embezzlement and market manipulation have been under investigation in Iceland since February. The SFO has separately been gathering intelligence on the Icelandic banking sector and its UK operations both involving investors and borrowers, which intensified after the leak of Kaupthing's loan book on to the internet last month.

Practical Decision-Making: A Priori versus Empirical Reasoning

"In times of change learners inherit the earth; while the learned find themselves beautifully equipped to deal with a world that no longer exists." Eric Hoffer

A Priori:

from Latin, literally "from the former." Reasoning that starts from accepted first principles or facts requiring no proof or foundation, being a self-evident assumption to the true believer

Empirical:

a. Relying on or derived from observation or experiment: empirical results that supported the hypothesis. b. Verifiable or provable by means of observation or experiment: empirical laws. 2. Guided by practical experience and not theory,

A Priori reasoning is often associated with religion and other belief systems, because it is 'top down' reasoning from a given, accepted fact that is judged to be self-evident and sufficient in itself. So for example, if one believes in an all-powerful and loving God, one can start making logical deductions from that first principle.

Empirical reasoning is often associated with the 'scientific method.' This is reasoning from the "bottom up" based on data, evidence and replicable experimentation and demonstrable relationships. Empirical reasoning can only take one so far, and generally follows the pattern of hypothesis - proof - re-examination - new hypothesis based on new data or insights.

In Economics, it never ceases to amaze how quickly people gravitate towards a priori reasoning once they have become wedded to a belief in an idea, a trading system, a school of thought, or a cult of personality.

If I believe, for example, that deflation is inevitable, no matter what else, then I will selectively choose data to support this view, even if unconsciously, and evaluate all information in the light of deflation as a given outcome, accept that which supports my belief, and rejecting or diminishing in significance the contrary data.

One can make the same case, for example, for those that believe that hyperinflation is an inevitable outcome in the near term. Or those who believe in the infalliblity of a particular trading system such as Elliot Waves, or some favorite indicator.

In less lofty terms, it is what we call a prejudice, although that term has become too specifically associated with racism in the modern world. It is literally a prejudging of situations, and fitting them all into a common pattern no matter what.

Sometimes the lengths to which true believers will go to hold on to their opinions becomes almost funny, if it is not so often accompanied by ad hominem attacks and rather nasty, immature behaviour when the true believer becomes cornered by reality. Or the tragedy of genuine loss when believers are led into folly and the consequences of their errors.

How funny is it, for example, to see a noted pundit keep drawing lines in the sand for the maximum price appreciation of a commodity like gold, and having to change them every year, ignoring past failures and pretending as though they have not been wrong, not daring to acknowledge their failure and attempting to explain it, to at least integrate it into their system in some credible manner.

There is always an alternate count, always the oddly possible but highly improbable excuse or rationale for their own mistaken belief, to avoid admitting that they or their system are imperfect, that they do not know the future with any certainty.

One can believe in something that might eventually become true, but for the wrong reasons. The 'belief' part is accepting the truth before any rational evidence would lead one to accept it logically. It really depends on the odds, and whether they get 'lucky.' People are therefore fooled by chance.

This by the way is the problem I have had with some of the adherents to the Monetarist and Austrian schools of economics, among others gathered in schools. They believe something, and are inclined at times to twist the data to support their predispositions and claims, and reduce objections or alternate views to caricatures that are not correct on close examination by the unbiased mind.

A scientific approach is to assess what is, rather than what we would like things to be, and to draw conclusions carefully from it, calculating probabilities when the evidence does not support a single outcome, and a willingness to accept new data and act on it when it appears, even if it appears contrary to a current working hypothesis.

This does not mean it is wrong to carefully examine evidence that seems to be 'on the tails' of our existing body of knowledge, to see if an adaptation of the hypothesis is all that is required.

Why is this important to us here in this forum?

Because belief is in the realm of the spiritual and the philosophical. Even a statement like "it is self-evident that all men are created equal" is clearly an appeal to a philosophical stance.

Finance, business, trading are not worthy of belief excepting for the ethical implications of behaviour that is contingent on all realms of human endeavor, depending on what one believes.

So, in trading, one should try to avoid becoming a 'true believer' in one idea or person or system. They are all likely to be flawed, and will very often blind the believer to the reality of the situation, so that they can lose impressive amounts of money fruitlessly following a belief that has no validity in their particular case.

In other words, no one knows the future for certain. There are always probabilities involved in every situation, every outcome. Some are more easily discerned than others, but they tend to be in the long and short term trends.

People naturally tend to carve the 'hits' or successful predictions based on their system or belief in marble, and write the 'misses' in sand. They tend to fool themselves as a portion of the belief in what they think must be true. It is a natural, but potentially deadly, behaviour.

In religion, faith alone can lead one to do outlandish things as in the South Seas cargo cults. So there is the thought in the western tradition that one relies on faith and reason together. But of course reason can only take one so far, and then one is faced with what Kierkegaard called 'the leap of faith.'

One might be willing to 'lose money' for the sake of righteousness by refusing to engage in unethical behaviour in their business activity. But foolish is the person who loses money because they have put their faith in human error, in party politics, in groupthink, and profane beliefs.

On an almost daily basis I see otherwise intelligent people making this mistake, and Wall Street takes advantage of it, to the max. I have made this mistake in the past. Overcoming it is one of the great steps towards becoming a successful trading and maintaining a balanced life of the material and the spirit. We render unto Caesar that which is Caesar's, but what is God's is God's.

When the leap of faith is applied to the deployment of a trading account it is too often results in a leap off a cliff. When faith is misplaced in an ideology such as natually efficient, self-regulating markets, or state planned command economies, it can take whole nations into the abyss.

Iceland's Failure: Not All Banana Republics Deal in Bananas

Here is a nice snapshot of an oligarchy at work in a small country. It is a microcosm of the United States. One only has to substitute "major corporations" for power individuals and the parallel becomes more obvious.

It appears to outsiders that in the US, rather than reform or change, rival organizations are in conflict with each other in the US for the spoils of corruption, and alternatively exchange political power to provide the appearance of change, but never relinquishing the primary mission of transferring wealth from the many to their own particular constituents.

The solution in Iceland is for a third party, a progressive party, to rise up and be supported in the elections, despite the stiff opposition from the status quo. Iceland is a small country and its citizens on average reasonably well educated and easily reached. They simply need to get seriously concerned for the future of their children and grandchildren and take control of their country back from the political elite.

It is a much more daunting task for a third party to bring reform to a large country with diverse population, often easily managed into conflict with each other by propaganda from a co-opted mainstream media. Potential leaders often have large egos, and in the States bloggers too often tend to enjoy squabbling with each other over relatively inconsequential things, rather than the primary task at hand. I wonder if it is the same way in Iceland?

UK Telegraph
David Oddsson's ascent to Iceland's editor in chief splits opinion as bloggers gain ground
By Rowena Mason
September 29th, 2009

Plus ca change! And I thought Iceland was moving on from a society where the same elite that caused the financial crash held an iron grip on public life,” groaned one resident of Reykjavik.

The cause of her dismay was the news that David Oddsson, the former prime minister and central bank governor has been appointed editor of the country’s best-respected newspaper.

Only six months ago, shortly after a change in government, he was forced out of the central bank as campaigners lobbied for a new order to help the country recover from the failure of its banking system a year ago.

Mr Oddsson – whose Thatcherite policies led to the privatisation of Iceland’s three big banks in the 1990s – inspires both extreme devotion and antipathy in his home country.

Many blame him for de-regulation of the financial system in the years before the collapse that sparked a domino of corporate bankruptcies, rising unemployment and an investigation into “suspicions of criminal activity” at the failed banks.

Others, including one reader who emailed me this morning, believe the appointment of Mr Oddsson will be a steady force for good behind the many excellent reporters uncovering suspected corruption in Iceland’s financial system.

A couple of Morgunbladid journalists I spoke to were ambivalent – surprised by the choice, but willing to give Mr Oddsson a chance as an editor who must hold those who contributed to the crash responsible.

However this flamboyant politician chooses to sit in his editorial chair, the fact remains that almost a year after the crash Iceland has not yet quite escaped the financial and political powers who have a strong interest in maintaining the status quo and protecting their reputations.

One of the main factors behind Iceland’s financial implosion – an extreme microcosm for the problems in the rest of the world – is the secrecy, interconnection and conflicts of interest in its public life.

That the major shareholders of the banks also owned much of the non-state media undoubtedly helped to perpetuate many myths about Iceland’s economic strength.

Frettabladid, a free newspaper distributed to every home, and Channel 2 television, are both still owned by Jon Asgeir Johannesson – whose companies are strongly linked to Glitnir, one of the collapsed banks, and Baugur, the failed retail giant that owned dozens of British high street shops.

Another television channel, Skjareinn, is backed by the brothers that owned the biggest share of Kaupthing, Iceland’s biggest failed bank.

And Morgunbladid itself was previously owned by Bjorgolfur Gudmundsson, one of a billionaire father and son team behind the third collapsed bank, Landsbanki. It is now in the hands of fishing magnates, who fiercely oppose Iceland’s entry to the European Union out of fear that quotas may be restricted.

One consequence of the links between big business and the media has been that the Icelandic public’s faith in traditional and official sources of news has started to erode, increasing reliance on blogs to provide news services, spread gossip and provide a discussion forum.

This has increasingly irritated some of Iceland’s financiers. Lydur Gudmundsson, one of the two brothers who backed Kaupthing, has publicly blamed bloggers for creating a negative atmosphere and pointing too many fingers.

It’s a sure sign that these new media journalists, empowered by the internet, are digging around in the right back yards.

The Utility of Gold and Silver Over the Past 200 Years

A bit of an oversimplification as one might expect for a short video, but rather effective in making its several of its points. Some interesting data as well.

Warren Buffett has asked "What utility does gold have?"

Since his views are respected and he is unusually successful, it is important to consider this question.

The utility of gold is that it resists the manipulation of the statists, which is why they hate it. It provides a store of wealth that is difficult for the state to confiscate through debasement. Gold and silver have represented the instruments of freedom and safety, a secure store of wealth, for individuals faced with adversity and uncertainty over thousands of years.

For quite some time the various pieces of evidence with regard to the Central Banks and gold have been becoming public. It seems to this reader, based on a careful search and consideration of the facts, that the attempt to control the price of gold and to a lesser extent silver by some of the Banks, led by the Brits and the Yanks, is almost certain as an adjunct in their efforts at financial engineering.

But the Banks are failing. They are failing in particular since the market break of 2000 when the first of the post Asian financial crisis bubbles collapsed. They are being broken, once again, by the physical buying coming in particular from Asia and Europe, where currency risk is a familiar concept. Most American go through their lives never having handled another currency except the dollar, and their education in finance, and even their own history, is sadly lacking. For them, the US dollar is the monetary alpha and the omega, and its decline is incomprehensible.

We are now in the midst of a new financial bubble in world equity markets, and it too will collapse.

This is not to say the future will be straightforward and simple. It will not.

People sometmes worry about government confiscation. Since gold no longer has any official status in the US except as private property, this is a bit of a red herring. True, government can try to seize any of your private property not just gold. It can try to force you to wear a number, or imbed a chip in your head, to buy and sell, it can even try to pack you on a freight train for resettlement in New Mexico. The question is not what the state can try to do, but rather, what you will let them do and how you will respond to it.

At the moment the US dollar remains the linchpin of the Anglo-American financial oligarchy. That is it failing is probably one of the great issues facing world stability today.

Right now the Dollar is the subject of an aggressive carry trade, with traders selling it short to buy other assets. This obviously sets up the potential for another short term dollar squeeze such as we saw last year when the Eurobanks were devastated by the failure of the toxic dollar assets on their balance sheets which had to be paid in full in dollars to their depositors.

A reversal in the dollar and the collapse of carry trade would shake world equity markets to their core as the gamblers are forced to unwind positions. The vampire squid and associates would probably benefit, but many would suffer. In today's environment, that makes the possibility of this happening even more likely in our book.

But then again, sometimes things do go down into a long spiral, and finally are priced at 30 on a Friday, and open up on Monday at 2, or 'no bids.' It happens. But usually it happens in slow motion at first with national currencies. It is much easier to boil a batch of frogs slowly than to wade in and start chopping heads.

Likelihood is a dollar rally at some point if stocks start unwinding. And then things get interesting, and ugly. Not with a bounce, but a 'splat,' with interest rates running to levels that would make your jaw drop.

For a longer view and a warning likely to fall on deaf ears, the more the oligarchs and elitists take the world's people through these cycles, the greater they need to pay attention to one lesson that ripples throughout history: the trick is not only how to make a great fortune through theft and trickery, but how to hold on to it, and very likely your life, when the tide turns and the people have finally had enough.



Gold and Silver Video

Japan: An 'On the Ground View' from 1989 to 2009

A Japanese friend who lives and works outside Tokyo sent this description of life in Japan from 1989 to 2009. He thought it might be of interest to our patrons.

In considering prices, it is a good shorthand to think of 100 yen as $1 US. I thought that this was funny because this is the same shorthand price I used when I was working in Japan in the late 1990's.

My friend's opinions are his own.

In the inflation/deflation debate, I think what most people mean is "their own personal cost of living", in view of income, rather than a macroeconomic concept.

Pay, job availability, and expense accounts were nuts 1990 to 1995. Everyone was partying... all week long... Wednesdays were as busy as Fridays and Saturdays. Fun while it lasted, but was everyone actually better off at the time? I guess just more hungover and with more handbags.

Prices were often exaggerated in the media because, well, normal prices have no entertainment value. Of course you can find $200 a pound Kobe beef in high end stores like Isetan downtown, but who actually buys that? Even during the bubble, almost no one. Beef in a normal supermarket was and is about $5 a pound, very high quality, and might be half off at closing time.
Change 0%.

At the local greengrocer, vegetables, like a bag of three carrots, a head of cabbage, or broccoli, was 100 yen 20 years ago, and is 100 yen now. I would say on the whole, in yen terms, that overall food prices have not changed. A nice large whole mackerel, cleaned and salted and ready for the grill, enough for two people, is 100 yen. Tofu is 50 yen a block, 150 yen for premium kinds. A pot of premium Japanese rice is 100 yen, enough for six servings.

Change 0%.

One of the things I notice when I go to the US is that there is almost always only high fructose corn syrup colored water to drink. In Japan, there is almost none of that. 90% of what is on the shelf, even in a convenience store, is 100% fruit and vegetable juice for about 100 yen a carton/bottle... in other words, the same price as a coke. I think at least some of the health problems in the US are due to simple things like that.

Long distance calls went from about 100 yen a minute to 3 yen per minute via internet telephony using, for example, Yahoo Japan broadband. From around a decade ago, you could just pick up a Yahoo broadband modem while walking through a train station, take it home, plug it into the telephone jack, plug your phone into the modem, and suddenly all your calls were 3 yen a minute all day every day to most countries. I did not know at first about the telephony as I was only interested in the broadband. One day, I realized that I had not gotten a long distance bill in quite some time. I made many calls around the holidays, so was bracing for a $500 bill. Instead, there was a $15 charge on my credit card.

A decade ago, the modem was free, the broadband was 6M, and it was $20 dollars a month with the first 3 months free. Currently, the minimum is 8M for about $20 dollars a month. Skype has unlimited worldwide calling for a flat $10 a month. I think this has saved me about $20,000 over the last decade. NTT is very unhappy. New apartments now often include free broadband via optical fiber or cable at 100M.

Change (for me) -90%.

Transportation prices have not changed much in 20 years. As was the case from 50 years ago, your employer will pay for your bus/train pass to go to work up to $800 per month, and you can use the pass to get off at any station in between. Even if you bought the pass yourself, to commute say 10 miles, the pass would be about $150 per month. AAA says to own and operate a new car in the US costs about $800 a month, $9,000 per year, and even if you drive your car until it dies, I think it still costs about $5,000 per year. Most people do not need a car, or have at most one for outings on the weekend.

Savings from free pass, no need for car, $5,000+ per year.

Trains are much safer than cars, and if the Japanese drove as much as Americans, there would be about 10,000 more fatalities per year. Over the last 20 years, there are 200,000 Japanese wandering around unaware that had they been driving like Americans, they would be dead. And many many more injured. If you want to be an actuary about it, assuming as in the US that a death in a law suit is roughly worth one million dollars, that is a benefit of 200 billion dollars, and untold billions less in hospital care, injury, disability, and misery.

Change 0%

A functioning train system means people actually walk 5 or 10 minutes to go to the station. Exercise automatically included, and another simple thing that could improve health in the US. (Every major city in the US used to have rail systems until General Motors and the oil companies and the tire companies bought them and ripped them out so everyone would be forced to buy cars and municipalities would be forced to buy buses. Rigging the system is far from new.)

Another reason you do not need a car here is that the home delivery system is terrific. You can send a box or suitcase anywhere in Japan within two days for less than $20. They will pick it up at your house, or you can send it from any convenience store, and you can specify the day and hour of delivery. Costco has solved the problem of customers needing a car to shop. Delivery of a box, up to 60 pounds, anywhere in Japan, is $6 (That is not a typo. You could send a 60 pound box from Costco in Hokkaido to Nagasaki in Kyushu, a distance of 1,000 miles, for 6 dollars). I shop for me and my friends, divide up the goods into boxes, and just send the boxes to them.

Costco did not have stores here 20 years ago, so hard to say, but I guess:

Change -60%.

WalMart has come to Japan by partnering with Seiyu. This and the proliferation of 100 yen shops (dollar stores) drove prices way down. Goods might be in some cases of lesser quality, but since the price can be 90% off, fine with me. A hammer to pound in a few nails is 100 yen, whereas before it would have been 2,000 yen for one of unnecessarily high quality. Even things like brand name high end shampoos at drug stores have come down by half or more.

On the whole, I would say the cost of dry goods has come way down.

Change -50 to -90%.

National health care is about $3,000 per person per year. No preexisting conditions are ever excluded. You can go to any doctor you wish. There is usually no waiting, so for routine things, people do not even make appointments.

Change 0%.

Energy efficiency has become a mania. From years ago, when Koizumi said "global warming", what he meant was "The cheap oil is running out! Get the energy efficiency up... now!"

Japan Railways cut energy use in new trains by half.

Compact fluorescents were great, but expensive ($10), from a decade ago, but are about to be superseded by LEDs.

LEDs are marketed showing that although they cost $40, they last for 40,000 hours, and you would have to buy 40 incandescents for that period of time, so at 99 cents per bulb, the price is actually the same. The LEDs use 1/10th the electricity. 2 yen per hour; in the US 1 cent per hour. Over 40,000 hours, an incandescent would use $4,000 in electricity, an LED $400. They clearly make economic sense now, and the transition is starting. They are a little dim, but fine for lights you leave on all the time like on the porch. Performance should improve and price of an LED light bulb should drop to about $10 in a few years.

New air conditioners use as little as 6 yen per hour (electricity is 20 yen per kilowatt-hour), so in the US, at an average of 10 cents per kilowatt-hour, that would be 3 cents per hour to run the air conditioner (they are all reversible heat pumps, so also warm in winter), so about $20 per month. Typical cooling August and September with older units like mine is $50 per month, heating December to March about $50 per month.

Change -50 to -90%.

Water is about $20 per month.

Change 0%.

Rent is $700 and up for 600 square feet, depending mostly on distance from downtown, type of building (wooden or concrete) and distance to the train station.
Change -20%.

Per capital floor space in Tokyo has doubled, mostly due to improved construction techniques that allow tall buildings to be built on deep soil, where it would have been previously cost prohibitive, by simply driving the pilings deeper into the soil. This in turn was made possible by Japanese steel manufacturers figuring out how to make super strong structural steel for the same price as regular steel simply by minimizing the energy it takes to process the steel. As in Manhattan, skyscrapers were concentrated where there were granite outcrops. Not any more. You can build tall buildings anywhere for a reasonable cost, and the Ginza 10 story limit is about to go. This should continue to put a lot of downward pressure on real estate prices and rents.

Change 0% to -50%.

Many of the above prices are in yen, as would be experienced by someone working and living in Japan. From 1989 to the present, very roughly, the yen went from 150 to the dollar to 100 to the dollar, with a lot of ups and downs. Although the yen appreciated, there was generally no inflation, and no increase in pay per hour (although the amount of work went down), so if you have a job, things just seem to be mostly unchanged over the last two decades. Although much reference is made to Japan's "lost decades", had you actually lived here and not read the newspaper or watched TV, you would have had no idea that anything bad was happening. There are still almost no vacant stores. Visitors said "Recession? What recession?" It is not at all like New York in the 70s.

What is confusing if you are looking at Japan from the outside is that while prices in yen have basically not changed for 20 years, because the yen increased by 30 to 50% against most currencies, the nominal price as viewed in dollars, pounds, etc., has gone up. However, there has been inflation outside Japan, so that is confusing. When I see salaries in the US, etc., now, I think, "Huh? They pay that much?" But of course, the prices of goods in those countries have gone up.

Using money as a proxy for goods and services is very confusing. The real question is, assuming one has a reasonable amount of work at reasonable pay per hour, what goods and services and of what quality can you get? On the whole, I would say that that has improved, some of the improvement being inherent in improved technology, building construction, etc., some of the improvement from better distribution and competition among retailers, some from the stronger yen, some from energy efficiency and improvements in public transportation. What we want is food, a place to live, electricity, water, telecommunication, education, and health care. If you have those things, you don't really need much money.

In summary, you could expect to live reasonably, within 20 minutes of downtown Tokyo by train on the following annual budget.

Rent $10,000 (60 square meters, 600 square feet)
Health insurance $3,000
Food $3,000 (if you cook yourself most of the time)
Electricity (heating and cooling included) $1,000
Water $300
Gas $300
Telephone and broadband $700
Transportation $1,000 (free $1,000 employer provided train pass + $1,000 incidental travel by train, taxi, bus; $8 buys pass for unlimited travel for one day on most subways throughout Tokyo)
(Car unnecessary -$5,000 to -$9,000)
National income tax + local income tax = US federal tax rate.
Consumption tax is 5% on all purchases and most restaurant meals.
Average salary is about $50,000.

Cash for Clunkers Will Go Wrong, But Not For the Right Reasons

If I were to design a stimulus plan, Cash for Clunkers might be among them.

The target of the plan was to incent the public to trade in gas guzzling 'clunkers' for more fuel efficient, safer cars. It provided a spark of buying at a time of serious economic recession.

This is a classic case of promoting an economic and societal 'good' while providing a stimulus to spur economic activity. This is precisely the type of program that Big Business and its demimonde of commentators like when they are the primary beneficiary. Let's say, in a program of tax incentives to promote useful capital expenditure spending. And what many of the private individuals who complain about the program like when it benefits them personally, such as the deduction of mortgage interest.

So why is this likely to fail, at least in part?

That is because the Obama Economic Team, under the leadership of Larry Summers, is grasping at stimulus and aids programs like bank capital asset subsidies that as part of a total package might be useful, but as remedies applied to a sick system do not promote a cure, but merely serve to mask the symptoms.

Stimulus and aid programs do not work when they are merely poured into a system that is broken, or worse, broken and corrupt.

And it cannot be reformed by actors who have been and continue to be willing beneficiaries of its flaws, such as the transference of wealth from the many to the few. Congress and the Administration have to take themselves away from the trough and start acting for the greater good of the people whom they represent, rather than the special interests who give them campaign contributions and fat, overpaid jobs when they leave office.

What we are experiencing is a collapsing Ponzi Scheme, as Janet Tavakoli describes so clearly and yet so well in Wall Street's Fraud and Solutions for Systemic Peril.

This is why we say that the banks must be restrained, and the financial system must be reformed, and the economy brought back into balance, before there can be any sustained recovery.

The Fed and Those Money Market Funds Redux

There is quite a bit of speculation on the reasons why the Fed is eyeing the shadow banking system, aka the Money Market Funds, as a target for the reverse repos when they see the need to drain liquidity from the system.

The following chart shows that as the Fed expanded the monetary base, the liqudity was not being accumulated across the financial system proportionately.

There was a quite obvious parabolic increase in excess reserves held at the Fed as one would expect from a balance sheet expansion, for which the Fed is now paying interest.

From the look of the institutional money funds, one might surmise that beginning with the first failures of major banks, there were heavy flows of liquidity into the institutional money market funds from a variety of sources, with less into the retail funds, and very little change in demand deposits at commercial banks. This would have been consistent with a flight to safety in 'cash.'

Why is the Fed eyeing the money market funds? Two reasons perhaps.

First and most simply because, as notorious criminal Willy Sutton once said, that is where the money is. And if it stays there, the Fed must find a way to affect it to drain liquidity while mitigating the effects of their actions on specific institutions and sectors of the financial system.

Secondly, there is a strong possibility that the Fed's initial attempts to drain will not only involve reverse repos, but also an increase in the interest rate which it pays on the excess reserves.

As you know, one of the reasons the Fed wished to pay this interest rate is as a means of putting a 'floor' under short term rates during a period of significant quantitative easing. If the Fed is paying .15 percent on reserves, for example, it is unlikely that short term rates will fall below .15 percent, without regard for the tranches of liquidity it may be adding to shore up the balance sheets of the banks.

Conventional open market operations tend to become sluggish, if not unmanageable, as one approaches zero rates. Therefore Benny 'got a brand new bag.'

Since the Money Market Funds do not place their excess reserves with the Fed, there is an obvious need to somehow tie them into the process, if one intends to manage it gracefully, not tilting the real economy in one direction or the other, as we are sure our Maestro Ben wishes to do.

It was a bit of an eye opener for us to see this comparison of the Funds with the Banks, and the overall expansion of the Base in the period of fiancial crisis.

Granted, wherever the Fed drains there will be at least a temporary 'crowding out' that needs to be managed carefully. Goldilocks and all that.

No doubt the Banks who own the Fed are keenly interesting in making sure that no additional advantage is being given to the Funds in their ability to attract capital, and invest in even short term paper which might prove advanageous in a recovery. The Vampire Squid and its Merry Band of Lame-os do not like competition.

It is also interesting to note the hints being dropped by various Fed heads for the need to draw the regulation of the Funds under their purview, away from the SEC.

And the SEC is contemplating tougher rules on required reserves for the retail and institutional funds, as well as stricter guidelines on what they may hold on their books.

Sometimes the simplest, most straightforward possiblities are the best. And until additional data may prove otherwise, it does not appear that the Fed wishes to 'dump toxic assets' on the Money Market Funds. Rather, it looks to be all about financial engineering, and a desire to attempt to manage the downstream effects more carefully.

Financial engineering is quite possibly a quagmire, and the Fed in fairly deep within it.

The Federal Reserve School of Monetary Witchcraft and Wizardry

Here are some key excerpts from the account by The Institutional Risk Analyst of his trip to "The International Financial Crisis" conference in Chicago. You may read it in its entirety here.

It matches up with our feel from reading on the web, that most economists are going to be painfully slow to change their thinking, particularly in the US, even after this latest financial crisis of historic proportions. It is hard to change when one cannot even admit one's mistakes, and the green shoots of a false Spring bring out new hopes that old ways might still work once again.

The status quo often has a powerful grip on the levers of thought leadership, and a social science like economics is especially vulnerable to peer pigheadedness, even when it is shown to be flat out wrong. The lack of innovation seems even slower now than in the 1970's when the appearance of a virulent stagflation shook up the assumptions of the economic establishment.

One thing which is almost certain is that change will not come from within, but from without. The great opportunity for reform that Obama was presented is passing quickly, probably from the point at which he surrounded himself with highly atrophied economic thinkers, from the atavistic Larry Summers to the clever but highly tailored Ben Bernanke, who is like Alan Greenspan with a real PhD. The Treasury Secretary is not a thinker, but a pair of hands, at best, what T. S. Eliot called 'a willing tool, glad to be of use.'

A new school of economics will rise out of this crisis, and we are more sure now than before that it will not originate in the States, which is seeing an appalling failure in economic thought leadership, in part caused by a dominant Fed, acting in part to stifle innovation as MITI did in Japan.

But the stock market is up, after a brief period of housecleaning last week by the funds and the banks, opening the door to the end of quarter window dressing. So let's ignore our problems once again and keep the printing presses and that wealth transfer mechanism turning. For now.

The US may indeed suffer a lost decade after all.

Institutional Risk Analytics
The Global Carry Trade and the Crimes of Patriots
September 29, 2009

Our trip to Chicago last week to participate in "The International Financial Crisis" conference sponsored by the Federal Reserve Bank of Chicago and the World Bank was instructive in several ways. First and foremost, it confirmed that the US economics profession is still trying to defend the old ways and means in terms of analytical methods for bank safety and soundness.

While there were many calls for "reform" of regulation, we heard nary a suggestion that the mish-mash of quantitative methods that currently comprise the framework for assessing the safety and soundness of banks needs to be set aside and a new approach defined. Indeed, the foreign participants in the two-days of presentations seem to be far more advanced in their thinking about bank safety and soundness than their counterparts from the US.

Andrew Sheng of the China Banking Regulatory Commission, reproached us for thinking that throwing debt at a global problem of insolvency will be successful. We have created the world's largest ever carry trade, Sheng noted, and suggested that the approach of exchanging a bank solvency problem for a sovereign debt problem could effectively replicate the lost decade of Japan on an international scale. He also wondered how any nation will be able to raise interest rates when vast sums of cash (i.e. fiat paper dollars) are ready to immediately pounce on any carry trade opportunities that arise.

Charles Goodhart of the London School of Economics.... reminded the audience that whereas Americans still debate the merits of regulation vs. innovation, in the EU the political class has already decided the robust regulation of banks is a necessary condition for stability. He also dismissed the idea that you can separate the "utility" bank from "the casino," again suggesting that the EU view of regulation of banks is comprehensive and should be emulated by the US....

While the members of our panel suggested various ways to restore balance and even virtue to the regulatory process, we suggested that Washington does not need another oversight agency or more platonic guardians. Rather, we need to address the problem where it truly resides, first with the debt issuance of our profligate government and second with the accommodative monetary policy of our central bank. As one participant noted, there is no longer any distinction between fiscal and monetary policy in the US.

Though there were many insightful and interesting comments made at the two-day conference in the FRB Chicago, the one thing that we heard virtually no one say is that the current financial crisis stems from irresponsible monetary and fiscal policies. Many participants talked about the role of "global capital flows" in fueling the crisis, but none made the basic statement that having printed this money to pay for imports and fund domestic deficit spending, the US was bound to see the dollars eventually come home in the form of a credit bubble.

Since the October 1987 financial crisis, the Federal Reserve System has not denied the Street either liquidity or collateral. The objective goal of policy, it seems, has been to keep the ability of Congress to issue debt intact all the while keeping the casino part of the banking system operating at full steam regardless of the impact on inflation and, more important, investor behavior. Seen in this light, the proliferation of hedge funds and OTC securities is the natural response of investors to inflationary fiscal and monetary policies in Washington, a city where income and the proceeds of borrowing are seen as being equivalent.

Today the amount of debt and fiat money issued by the US government is threatening not only the solvency of private financial institutions and companies, but the stability of the entire global economy. Yet virtually no observers make the connection between the reality of secular inflation in the US and the bad outcomes in the financial markets, and in the global economy, where trade flows continue to shrink. Indeed, if members of Congress ever wanted a reason not to give the Fed more power as a regulator of financial institutions, they should start with an investigation of the Fed's conduct of monetary policy, not bank regulation. Just imagine how the US economy would look several decades from now were the Congress to give the Fed hegemony over bank supervision via the rubric of "systemic risk" even as the central bank continues its reckless policies with respect to monetary policy and its accommodation of US debt issuance.

Systemic risk, it seems, is not the result of bad regulatory policies, but the natural outcome of a system where income from productive economic activities is being increasingly supplemented with debt and inflation. Our political leaders say that such policies are meant to help the American people, but we've heard such empty justifications before. Call the policies of borrow and spend and print the "crimes of patriots," a powerful metaphor used by author Jonathan Kwitny to describe the bad acts of the CIA in the banking world decades ago. Since then, the money game and the role of government in our financial markets has only grown larger.

If the American people want to get the US financial system under control, then the first areas of investigation, we submit, must be fiscal and monetary policies. And if Americans do not soon get control over the habit of borrow and spend practiced by the Congress and facilitated by the Fed, then end result must be a populist backlash against Washington and incumbents in politics and the corporate world. As Congressman Ron Paul (R-TX) writes in his latest book, End the Fed: "Nothing good can come from the Federal Reserve… It's immoral, unconstitutional, impractical, promotes bad economics, and undermines liberty."

Reading for the Weekend

“We are slow to master the great truth that even now Christ is, as it were, walking among us, and by His hand, or eye, or voice, bidding us to follow Him. We do not understand that His call is a thing that takes place now. We think it took place in the Apostles' days, but we do not believe in it; we do not look for it in our own case.

God's presence is not discerned at the time when it is upon us, but afterwards, when we look back upon what is gone and over. The world seems to go on as usual. There is nothing of heaven in the face of society, in the news of the day.

And yet the ever-blessed Spirit of God is there, ten times more glorious, more powerful than when He trod the earth in our flesh.

God beholds you. He calls you by your name. He sees you and understands you as He made you. He knows what is in you, all your peculiar feelings and thoughts, your dispositions and likings, your strengths and your weaknesses. He views you in your day of rejoicing and in your day of sorrow. He sympathizes in your hopes and your temptations. He interests Himself in all your anxieties and remembrances, all the risings and fallings of your spirit.

He encompasses you round and bears you in His arms. He notes your very countenance, whether smiling or in tears. He looks tenderly upon you. He hears your voice, the beating of your heart, and your very breathing. You do not love yourself better than He loves you. You cannot shrink from pain more than He dislikes your bearing it; and if He puts it on you, it is as you would put it on yourself, if you would be wise, for a greater good afterwards.

There is an inward world, which none see but those who belong to it. There is an inward world into which they enter who come to Christ, though to men in general they seem as before. If they drank of Christ's cup it is not with them as in time past. They came for a blessing, and they have found a work.

To their surprise, as time goes on, they find that their lot is changed. They find that in one shape or another adversity happens to them. If they refuse to afflict themselves, God afflicts them.

Why did you taste of His heavenly feast, but that it might work in you—why did you kneel beneath His hand, but that He might leave on you the print of His wounds?

God has created me to do Him some definite service; He has committed some work to me which He has not committed to another. I have my mission -- I may never know it in this life but I shall be told it in the next. I am a link in a chain, a bond of connection between persons. He has not created me for naught.

I shall do good, I shall do His work. I shall be an angel of peace, a preacher of truth in my own place while not intending it if I do but keep His commandments. Therefore I will trust Him.

Whatever I am, I can never be thrown away. If I am in sickness, my sickness may serve Him; in perplexity, my perplexity may serve Him. If I am in sorrow, my sorrow may serve Him. He does nothing in vain. He knows what He is about.

He may take away my friends. He may throw me among strangers. He may make me feel desolate, make my spirits sink, hide my future from me -- still He knows what He is about.

Let us feel what we really are--sinners attempting great things. Let us simply obey God's will, whatever may come. He can turn all things to our eternal good. Easter day is preceded by the forty days of Lent, to show us that they only who sow in tears shall reap in joy.

Contemplate then yourself, not as yourself, but as you are in the Eternal God. Fall down in astonishment at the glories which are around you and in you, poured to and fro in such a wonderful way that you are dissolved into the Kingdom of God.

The more we do, the more shall we trust in Christ; and that surely is no morose doctrine, that leads us to soothe our selfish restlessness, and forget our fears, in the vision of the Incarnate Son of God.

May the Lord support us all the day long, till the shades lengthen, and the evening comes, and the busy world is hushed, and the fever of life is over, and our work is done. Then in His mercy may He give us safe lodging, and a holy rest, and peace at last.”

John Henry Newman

This is a collection of quotatons woven into a whole thought by Le Proprietaire as a young man for a circle of friends.

Do Ben and Tim = Thelma and Louise?

One cannot help but note that Team Obama is trying to derail serious proposals regarding financial reform for Wall Street at the G20 meeting, as we suggested they would.

The concerns raised by US revelations at the G20 today about new intelligence regarding Iran's secret underground nuclear facility have overshadowed financial reform and economic problems, and Gordon Brown's prescription yesterday that the G20 would become the new governing council for the world. It also stepped rather heavily on the House Hearings on HR 1207 "Audit the Fed" bill sponsored by Ron Paul and a good part of the Congress.

Why waste a crisis indeed. Especially when you can cop a two-fer.

Yesterday we put forward a somewhat lengthy piece on the Fed and reverse repos being considered titled Fed Eyes US Money Market Funds.

There is a key quote in there that we would like to highlight today.

The central bank is now considering dealing with money market funds because it does not think the primary dealers have the balance sheet capacity to provide more than about $100 billion... Money market mutual funds have about $2.5 trillion under management..."

Only 100 billion in available capital for a relatively risk free short term investment in the global banking system including the Primary Dealers, does seem a bit tight for a set of such 'well capitalized' banks, especially since they aren't making many commerical loans, preferring to speculate in the commodity and equity markets for daytrading profits.

BNP Paribas Securities Corp., Banc of America Securities LLC, Barclays Capital Inc., Cantor Fitzgerald & Co., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Daiwa Securities America Inc., Deutsche Bank Securities Inc., Goldman, Sachs & Co., HSBC Securities (USA) Inc. , Jefferies & Company, Inc., J. P. Morgan Securities Inc., Mizuho Securities USA, Morgan Stanley & Co. Incorporated, Nomura Securities International, Inc., RBC Capital Markets Corporation, RBS Securities Inc., UBS SecuritiesLLC.

Couple that with the revelation reported some time ago at ZeroHedge and covered here, that the Fed is taking on more than 50 percent of the longer dated Treasuries, and there is only about Ten Billion left on their balance sheet for expansion, and you get the picture of a financial system not cruising into recovery but heading straight at a confrontation with harsh reality.

We have considered the possibility that the Fed is doing this to place exclusively AAA and Treasuries on the balance sheets of the Funds, aka the Shadow Banking System, who are holding some seriously awful garbage. But this does not quite make sense unless those reverse repos are of a very long duration or rolled over automatically for a long period of time. A proper program such as was extended to the banks where the Fed buys the assets outright would be that solution. It made more sense to us that the banking system is still very tight on good capital assets and liquidity.

Here is an update from ZH that is somewhat compelling if one understand the implications. Visualizing the Upcoming Treasury Funding Crisis.

"Summary: foreign purchasers are congregating exclusively around the front end of the Treasury curve, meaning that the primary net purchaser of dated bonds has been the Federal Reserve. As everyone knows by now, the Fed only has $10 billion left out of the $300 billion total allotted for Treasury QE. That should expire next week. ... The time of unravelling may be upon us sooner than most think."

Do Tim and Ben = Thelma and Louise?

As the Eagles sang:

"Take it, to the limit, one more time..."

Federal Reserve Eyes the US Money Market Funds

The Fed is holding a significant amount of assets on its books in the form of Treasuries. For example, the Fed has purchased an enormous amount of US Treasury issuance in the past six months as part of its quantitative easing program, aka monetization. It has also taken on tranches of mortgage debt obligations from the banks, purportedly to improve the banks capitalization profile because of the dodgy nature of the assets.

This has added significant short term liquidity to the system, much of it held by the banks for interest at the Federal Reserve itself.

At some point the Fed will wish to reduce the levels of liquidity in the system. One way to do this is by increasing interest rate targets. It can achieve this, for example, by increasing the amount it pays for reserves.

The traditional way for the Fed to drain liquidity is to conduct what is known as a reverse repurchase agreement, or reverse repo.

In a normal repurchase agreement or repo, the Fed purchases assets held by the banks, normally Treasuries, which obviously increases the 'cash' being held by the bank. A repurchase agreement is by definition for a specific amount of time. At the end of the period the Fed sells the asset back to the bank. The difference in amounts is the 'interest' which changes hands for the transaction.

There is also a type of purchase agreement with no buyback. It is known as a PMO, or Permanent Market Operation. These are used to add liquidity as the name implies, permanently.

A reverse repo is just the opposite. In this case, the Fed sells an asset from its balance sheet to an institution for 'cash' and thereby drains or takes cash liquidity out of the system.

Aren't Treasuries as good as 'cash?' Why does it matter whether a bank is holding Treasuries or cash on its books? Apparently not the case, at least for accounting and regulatory purposes. Remember that the next time someone tells you that banks do not need depositors. Sometimes they do.

Typically the Fed has only done this type of operation with a group of about twenty or so financial institutions known as the Primary Dealers.

According to this news piece, the reason the Fed is looking to the Money Markets is that, just like Willie Sutton, that's where the money is. There, and in the 401k's, and the IRA's.

The central bank is now considering dealing with money market funds because it does not think the primary dealers have the balance sheet capacity to provide more than about $100 billion... Money market mutual funds have about $2.5 trillion under management..."

To digress, please note that somewhat startling statistic. The Fed is going to the money market funds, because they think that the primary dealers among them cannot raise more than $100 billion dollar in liquid capital to take repos from the Fed, without impairing the banking system. If you look it up in the dictionary, try looking under 'fragile' or 'insolvent.'

Back on topic, there has been a longtime animosity between the banks, or at least what used to pass as a bank, and the money market funds. The funds are not covered by FDIC, are not regulated as banks, and typically pay higher rates of interest to depositors than conventional commercial banks. They tend to invest their funds in the commerical paper markets. It was the seizure of the short term paper markets that brought the money market funds to the brink, and a potential run on the funds, as fears grew that they would 'break the buck,' that is, the Net Asset Value of One Dollar for every dollar deposited.

Obviously this entire proposition is a bit puzzling on the surface, and is certain to raise fears of Fed shifting toxic assets from the banking system to the more 'public funds.' It is not a huge concern if these are truly repurchase agreements since the value of the assets will be backed 100 percent by the Fed. We would also assume that the Funds might be able to express some preference for Treasuries, rather than bundles of sludge backed by Joe Subprime Sixpack LLC.

It was also interesting today that in his testimony before the Congress which was widely ignored by the mainstream media, Paul Volcker had some very strong words about what is a bank, and what is not. Money market funds are not banks, and banks have no business using their banking platforms to fund proprietary trading operations that are merely seats at a rather risky virtual casino known as Wall Street.

We admit now as before that we do not fully understand the accounting system of the banking industry, having grown up on the productive side of the economy, but are learning quickly.

One thing we can judge is character, and the character of many of the actors on this stage appear to be less than trustworthy to say the least, especially in the Obama Administration and their cronies on Wall Street. In reviewing the biographies of many of the key players, we were struck by how few of them have ever done anything, built anything, in the productive economy. Its all about FIRE institutions and governments, and revolving doors where one is paid for connections and influence, and following orders.

Increasingly it seems that the Wall Street financial institutions, led by the gang of four, will push their power grip on the nation until something stops them. What that will be, no one can know for sure. The Ponzi scheme they have been running is starting to fall apart. The target bag holders, the Chinese, Japanese, and Europeans seem to be slipping towards the exit. When the music stops, someone may be left with a big pile of worthless paper. It looks to us like the Fed is interviewing candidates.

And this is why we say:

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

Reuters
Fed's exit strategy may use money market funds
Thu Sep 24, 4:02 am ET

LONDON (Reuters) – The U.S. Federal Reserve is studying the idea of borrowing from money market mutual funds as part of eventual steps to withdraw stimulus, the Financial Times reported on Thursday.

The Fed would borrow from the funds via reverse repurchase agreements involving some of the huge portfolio of mortgage-backed securities and U.S. Treasuries that it acquired as it fought the financial crisis, the newspaper reported, without citing any sources.

This would drain liquidity from the financial system, helping to avoid a burst of inflation as the economy recovered.

The FT said Fed officials had in recent days held discussions with market participants on how it might implement such a scheme.

The Fed is considering whether to conduct a pilot scheme, but worries such a test might be seen as a signal that the central bank was about to drain liquidity on a large scale, the newspaper said. In the near term, a big drain remains unlikely, it added.

The central bank held interest rates at close to zero on Wednesday and upgraded its assessment of the U.S. economy, saying growth had returned after a deep recession.

The Fed also said it would slow its purchases of mortgage debt to extend that program's life until the end of March, in a move toward withdrawing the central bank's extraordinary support for the economy and markets during the contraction.

The idea of the Fed using reverse repos to help unwind policy is not new; Fed chairman Ben Bernanke identified them as a potential means of soaking up liquidity in July. But the market had previously expected the repos to be done with primary dealers, including former Wall Street investment banks.

The central bank is now considering dealing with money market funds because it does not think the primary dealers have the balance sheet capacity to provide more than about $100 billion, the Financial Times said.

Money market mutual funds have about $2.5 trillion under management so they could plausibly provide between $400 billion and $500 billion, it said.

The newspaper added that the Fed did not think it would need to drain liquidity all the way to where it was before the crisis, because it was confident it could raise interest rates even with a much larger amount of reserves in the system than existed before the crisis.

Daily Charts for Gold, Silver, Miners and Oil

Gold call options were expiring today, and there was a concentration of options with a strike price of 1000. Let's see if the metals can find a footing or if this correction from a short term overbought condition must continue further.

From UBS:

"October options expiry on Comex will take place at 2000 GMT today, and the greatest nearby open interest for October gold is at the $1000/oz strike... $950 and $1050 strikes also have very large open interest - and that open interest between $950 and $1000 is larger than that between $1000 and $1050. We believe this is a consequence of the recent quick move higher in gold from $950/oz rather than options traders explicitly expressing a preference for the downside. Given the large open interest at the $1000/oz strike, we would not be surprised if gold remains close to this level today, barring a sharp move in EURUSD. To the extent that long October-expiration positioning in the market may have been constraining the range, however, the rolling off of October options should free gold to make larger moves."

More Smoke from the Federal Reserve On Their Opaque Operations in the Markets

Lots of smoke, but not quite a smoking gun, since the Fed representatives can always come back and claim that they were speaking hypothetically, and that the information was being withheld IF it indeed exist.

This highlights the problem of proving something wherein another party has the ability to stonewall and hide their operations. If the Fed was more transparent, then this would not be an issue.

I have been looking into this issue for some time, and have concluded that there is indeed plenty of smokescreens coming out of the Fed on a number of fronts. Some seem legitimate, but many do not. The Fed seems to want its independence, but also a position of power that is integration to the political and administrative policies of the US, more properly the domain of the public representatives.

Perhaps it is more or less innocent, but it does highlight how utterly inappropriate the Fed will be as a choice for a 'super regulator' of the financial system, seeming accountable and forthcoming only when they feel like it.

If this proves to be true, Greenspan is guilty of lying in his testimony to Congress, and most likely Bernanke as well. The Fed would also be implicated in expropriating US assets for its own purposes of rigging public markets far beyond their charter, since gold is hardly a foreign currency these days. They may as well be manipulating the price of oil or corn or wheat to suit their financial engineering. The permission to swap gold which belongs, not to the Fed, but to the American people via the Treasury, can only be granted by Congress.

I have also concluded that the Obama team wishes to broaden the powers of the Fed because this provides additional centralized and opaque power to the federal government. Both the Democrats and Republicans in the US seem to favor this.

As a semi-private organization, owing its allegiance both to the government, but even moreso to its private owners, the Fed should not and cannot be seriously considered for broader powers over more markets. They are hopelessly conflicted in their various agendas and loyalties already.

Business Wire
Federal Reserve Admits Hiding Gold Swap Arrangements, GATA Says
September 23, 2009
09:30 AM EDT

MANCHESTER, Conn.--(BUSINESS WIRE)-- The Federal Reserve System has disclosed to the Gold Anti-Trust Action Committee Inc. that it has gold swap arrangements with foreign banks that it does not want the public to know about.

The disclosure, GATA says, contradicts denials provided by the Fed to GATA in 2001 and suggests that the Fed is indeed very much involved in the surreptitious international central bank manipulation of the gold price particularly and the currency markets generally.

The Fed's disclosure came this week in a letter to GATA's Washington-area lawyer, William J. Olson of Vienna, Virginia denying GATA's administrative appeal of a freedom-of-information request to the Fed for information about gold swaps, transactions in which monetary gold is temporarily exchanged between central banks or between central banks and bullion banks. (See the International Monetary Fund's treatise on gold swaps here.

The letter, dated September 17 and written by Federal Reserve Board member Kevin M. Warsh (here), formerly a member of the President's Working Group on Financial Markets, detailed the Fed's position that the gold swap records sought by GATA are exempt from disclosure under the U.S. Freedom of Information Act.

Warsh wrote in part: "In connection with your appeal, I have confirmed that the information withheld under Exemption 4 consists of confidential commercial or financial information relating to the operations of the Federal Reserve Banks that was obtained within the meaning of Exemption 4. This includes information relating to swap arrangements with foreign banks on behalf of the Federal Reserve System and is not the type of information that is customarily disclosed to the public. This information was properly withheld from you."

When, in 2001, GATA discovered a reference to gold swaps in the minutes of the January 31-February 1, 1995, meeting of the Federal Reserve's Federal Open Market Committee and pressed the Fed, through two U.S. senators, for an explanation, Fed Chairman Alan Greenspan denied that the Fed was involved in gold swaps in any way. Greenspan also produced a memorandum written by the Fed official who had been quoted about gold swaps in the FOMC minutes, FOMC General Counsel J. Virgil Mattingly, in which Mattingly denied making any such comments. (See here.)

The Fed's September 17 letter to GATA confirming that the Fed has gold swap arrangements can be found here.

While the letter, GATA says, is far from the first official admission of central bank scheming to suppress the price of gold (for documentation of some of these admissions, see here and here), it comes at a sensitive time in the currency and gold markets. The U.S. dollar is showing unprecedented weakness, the gold price is showing unprecedented strength, Western European central banks appear to be withdrawing from gold sales and leasing, and the International Monetary Fund is being pressed to take the lead in the gold price suppression scheme by selling gold from its own supposed reserves in the guise of providing financial support for poor nations.

GATA will seek to bring a lawsuit in federal court to appeal the Fed's denial of our freedom-of-information request. While this will require many thousands of dollars, the Fed's admission that it aims to conceal documentation of its gold swap arrangements establishes that such a lawsuit would have a distinct target and not be just a fishing expedition.

In pursuit of such a lawsuit and its general objective of liberating the precious metals markets and making them fair and transparent, GATA again asks for financial support from the public and from all gold and silver mining companies that are not at the mercy of market-manipulating governments and banks. GATA is recognized by the U.S. Internal Revenue Service as a non-profit educational and civil rights organization and contributions to it are federally tax-exempt in the United States....

NAVs of Certain Precious Metal Funds and ETFs

SP Futures Hourly Chart at 3 PM

Market volumes are still thin, and driven heavily by momentum traders and Wall Street wiseguys setting up the small specs, looking into what they holding, and then raising them out of their seats on short term spikes and drops.

Today was likely a bit of a letdown on the Fed news, that is, profit-taking, but the dips *should* continue to get bought once the funds sell off dogs into the monthly and quarter close and start window dressing which will likely begin Friday or Monday.

If any exogenous event occurs this market could drop hard and fast because it is all froth, and little conviction. Third quarter earnings *could* look good by comparison, but we have it in the back of our minds that October may be bloody.

Bernanke is disgraceful in his stewardship of the financial system, although it could be argued that he is doing his part, raising liquidity, but Obama and his crew are failing in their task of reforming the system and helping to direct that liquidity into fruitful efforts, rather than bonuses to their patrons on Wall Street.