Buffett Blames the Banks

Expect to see more broadsides from academics for hire and think tank economists attacking the monetary moralizers and moral hazardists, as the financial situation becomes more dire, and it is put to us that we really have no choice.

A monetary moralizer is anyone who thinks that bailing out the banks with public monies, supplied by the middle and lower classes in inordinate amounts, is not the appropriate thing to do, creating future moral hazard, rewarding incompetency and thievery, et cetera. The neo-Keynesians like to portray those who are concerned with moral hazards as fussy old biddies who let principle get in the way of a really good time with the punchbowl.

Contrast that, however, with the illumination cast by the independently thinking (and independently wealthy), such as the famed Mr. Buffett, who on occasion prefers to like to tell it like it is, as he does at a conference in Toronto, as cited by the UK Telegraph:

Billionaire Warren Buffet has accused major banks of creating their own downfalls. Mr Buffett, known as the "Sage of Omaha" for his investment record, suggested that the banking fraternity has only itself to blame for its recent problems which have seen banks write off more than $130bn (£66.3bn) so far.

"It's sort of a little poetic justice, in that the people that brewed this toxic Kool-Aid found themselves drinking a lot of it in the end," Mr Buffett said, making reference to the American soft drink.

The septuagenarian investor, speaking in Toronto, said that in spite of the meltdown in the sub-prime mortgage market and the impact on the banking system, funds remain available.

"I wouldn't quite call it a credit crunch," he said. "Money is available, and it's really quite cheap because of the lowering of rates that has taken place."

However, he said what had taken place was "a re-pricing of risk," leading to an "unavailability of what I might call 'dumb money', of which there was plenty around a year ago." (his point is that the problem is not liquidity, but a scarce supply of fresh suckers willing to buy into the familiar Ponzi schemes - J)

Mr. Buffett also reiterated his negative views on the subject of the US dollar, saying that over the next five-10 years, the dollar could seriously devalue if the US trade deficit persists.

Now, we don't necessarily believe that the bankers should be punished for what they have done; after all, there is the Ken Lay defence, that destroying the US economy and impoverishing millions was an unintended consequence of simple incompetency, fiduciary abuse, bad management and greed, without malice aforethought.

But we do think it is a bit much even by Wall Street's face-ripping standards to defraud the public, and then to expect the public to foot the bill when the scheme goes awry and money is left on the table, so to speak, or at least a hefty tab remains for someone to pick up.

Lowering interest rates and increasing the money supply is not going to fix this. The problem is not a shortage of funds. The problem is a shortage of suckers willing to buy into these Ponzi schemes, and to buy just about anything from the jokers that sold them damaged good last week. The music is stopping and the bankers don't quite have a seat, and are searching for a fresh supply of dumb money. Hence the grab for public funds from Congress and sovereign wealth funds (SWFs); it doesn't get any dumber than that.

What we recommend is to let the free markets work. Even if we don't allow the banks to fail, thereby impoverishing depositors and the public via the FDIC, the shareholders and owners and top management of these banks need to lose money, and lots of it. What the markets do not accomplish, heavy fines and judgements will have to do. Jail sentences are optional, but recommended for our consideration.

We would also like to see the reinstatement of Glass-Steagall, which the banks spent years and considerable political donations to overturn. A return to a sensible regime of banking regulation and policing, which obviously became a joke during the Greenspan chairmanship and the Clinton and Bush administrations, might be a step in the right direction. The public may wish to do its part by NOT continuing to re-elect these jokers even if they do shed a few crocodile tears.

That will do, for openers.

Free Reserves Go Negative, Blogosphere Goes Bonkers

There has been a recent circumstance where some of the occasionally reading public have noticed that in the bowels of the Fed's publications, in a series affectionately known as the H-Reports, that Non-Borrowed Reserves of the Banks went NEGATIVE last week. Oh my Lord, and heavens to betsy! This is surely a sign of impending insolvency, deflation, and probably the end of Life as we know it (TEOLAWKI).

We've grappled with this for serveral days now, not so much in trying to understand what is happening with the banks, which we think we understand, although there is enough opaqueness, if not outright deception, in the system to make us doubt just about everything, but rather, to try and figure out how to explain this to a group of readers who likely don't know much about central banks, monetary systems, and bank accounting. This is no deficiency on their part, and its probably healthy since we cannot think of a more useless waste of productive effort for those who are not specialist drones in some bureaucratic accounting structure, or a major university.

But since the bankers appear to be going wild, and the economists are either in retreat up in the hills or selling whiskey to the angry villagers on behalf of some political warlord, we seem to be in a position where trying to lend insight into this might be considered a duty. We take this up reluctantly, believe us, because both the goldbugs (said somewhat affectionately) and the deflationists (leave a magazine but please go away) are both holding up their torches and chanting.

So if duty calls, we have decided not to belabor this one, but to just spit it out, provide a reference work for those who have extreme masochistic tendencies, and then run off to do more productive if not enjoyable things like making a living. Keep in mind this is a simplified explanation, will have a lot of technical holes in it, but the major foundations of the argument are pretty sound. We also wrote it at one sitting with no rewrites and precious little spell checking.

Banks are profit seeking, and to shareholders preferably profit maximizing in their behaviour. Put very simply, they have a portfolio of things they 'own' which they wish to use to generate profits. This implies that the must acquire things which is costly, and even the things they already own can cost plenty, as anyone who has ever married a trophy wife must surely know.

When banks put together that portfolio of things that they 'own' they consider the various costs of possessing or acquiring those things, and what they might get in return for doing things with them to generate some income, the net result being often referred to as 'profit.'

Doesn't that sound familiar? Portfolio? As in portfolio theory? Even the investor has often entertained the notion that if they have a portfolio of things, with different returns, risk, and maturities, they might have the ability to tinker with that combination to get the best bang for the buck, so to speak. That's where a little knowledge is dangerous, because the example of the individual goes sour pretty quickly when you start applying it to accounting for banks. But let's go with it a bit.

A bank can have a group of things it 'owns' including cash, Treasuries, loan portfolios, etc. Banks are the ultimate leverage machine. They don't like to hold reserves, because reserves are most often things that are not performing to their multiplying maximum. Very inconvenient and all that. In the UK as we recall, the reserve requirment is zero, but you better not miss it. in the US its some handwavy existential notion that people think of as 10 percent, but with sweeps and so forth its a little virtual. Still it does exist, and the Fed does track it.

Does it matter WHERE the reserves come from? After all they must come from somewhere. Vault cash (ugh no return there) is one example. Banks, contrary to popular belief, hate cash. necessary evil and all that. Pesky stuff.

As you probably know, banks borrow from each other to make reserve requirements (Fed funds rate or effective funds rate if you will) and from the Fed (Discount Rate).

What if the Fed created an extra groovily priced borrowing facility for the banks, that offered 1. privacy 2. ease of use with favorable durations and required collateral 3. a cost that is less than inflation.

Let's repeat number three. The Fed offers the stuff that banks use to make money, capital, and it does it for a cost that is less than inflation. Some might refer to that as 'free money.'

If you put enough of that into the system, what would happen? 1. The effective Fed Funds rate would drop faster than a local hardware store's prospects when the new Walmart gets built, 2. Relatively riskless investment returning even a little better than the super secret discount rate (aka TAF) would plummet in return as too much money chased them. 3. Relatively safe assets would start inflating as the search for return grew more intense.

If you don't believe us take a look at some of the whacky things going on with the yield curve, especially with the two to five year Treasuries since this is where the risk aversion return hungry genie is pointing.

This free money concept sounds great! Why don't they do it all the time? Beats working. Well, the trick is to provide free money without letting on that its free money, at least to the tourists, and especially your creditors who buy and hold your sovereign debt. Its a dollar dropping in value thing.

To do that you have to make people think there is less inflation than there really is. Check. Second thing you have to do is set up an opaque and somewhat exclusive mechanism by which you direct the 'free money.' TAF anyone? Anyone? Bueller?

So what else should a bank do. Acquire more depositors? Sure, and compete with money market funds, and scramble for high cost nickels when the Fed is offering low cost megabucks. Where's the unemployment line Rudy? The money machine is right down the hall in Ben's office.

What we are seeing are a lot of skewing and distorting of the data as the Fed takes extraordinary actions to push liquidity into the system by offering 'free money' to the part of the system where you want to put the juice to make things get moving again, the primary dealer banks. They would still like some non-supply side action in the form of a stimulus to consumers, but the Fed can't do that (yet) and must rely on Congress (where no stimulus goes forward without a hefty chunk for numero uno someway somehow).

This is NOT to say that there are not serious problems in the financial system. This is NOT to say that deflation is impossible (hey fiat cuts both ways and if the Fed raised Fed Funds, margin money and reserve requirments tomorroww to the max we'd probably see something in the ensuing chaos resembling deflation.

However, if and when the real cracks in the system show up, its unlikely to be in one of the H-series documents, as cool and esoteric as they might seem to someone who never looked at them before. They are not secret. They are on the web for God's sake.

The real problems will come like a thief in the night, and most likely with some exogenous shock from a foreign creditor, or an irrational panic like a market crash or a bank run that exposes the weakness hidden in the system. Well hidden until the tide goes out.

We warned you it would be simple, and full of technical holes, but it is sound. If you want the intermediate version read this free book online: Monetary Economics by Jagdish Handa. Its not the best but its fairly readable and the price is right.

As for the real source of the problem? Its not loose money. That's just a prerequisite.

We live in a time when lying is no longer considered dishonorable if you succeed in achieving your objective. It might even be your government sanctioned duty. Heck, you might be admired for it, get a really nice golden parachute, be knighted, or even elected president. And economists are no different, being sullied by their exposure to the marketplace, which is much more richly adorning than a quiet department office and admiring but amazingly similar students.

These are the times in which we live. We are no different than prior civilizations. We just are grading behaviour on a really exceptionally generous curve. No financier, lobbyist, businessman, or corrupt politician left behind.

Quote of the Day from a Favorite Banker

"There will be 3 Fed Heads speaking today... Fed Speak will be all over the place... Yesterday, we had Fed Head Lacker doing the Fed Speak...Lacker believes he sees a "risk of a mild recession." and that more rate cuts are possible, and may be necessary... I say HOGWASH! Quit giving in to the markets, and trying to save a couple of financial institutions that should be strung up and put on public display for their handling of the mortgage bubble...the Fed is out of control... They are laying the groundwork for the next bubble, and it's called inflation!" Chuck Butler, Everbank.com, The Daily Pfennig, Feb. 6, 2008

ISM Reports as Indicators of Recession

This chart shows the ISM Manufacturing and Non-manufacturing Diffusion Indices for Business activity from July 1997 to January 2008. A number below 50 indications contraction, and a number above 50 indicates expansion.

Also on this chart is a gray bar indicating official NBER recessions, and the annual rate of change in Real GDP compounded. Obviously a number below zero (0) is negative growth.

The conclusion is that a dip of both the Non-Mfg and Mfg numbers below 50 are very strong indications that the economy is in recession. In the current situation the Non-Mfg index is screaming recession as of the number given today, which is why the market sold off. However, the Manufacturing number is strangely resilient, especially considering the weak state of manufacturing in the US.

The future revisions of the Manufacturing Index will be watched closely, including any subsequent report such as the upcoming number in February. If the Manufacturing number swings back down below 50 look for most economists to start upping their calls that the economy is in recession.

We believe that we are in recession already with little doubt based on the Jobs and other indicators we have shown in earlier postings. NBER usually makes the official call by the time the recession is over. We think this one might last a little longer that the 2001 recession.

What Happened in the Last Recession and Bear Market?

Like most Americans here in the United States of Amnesia you may have already forgotten, but the last bear market and official recession we had was in the Y2K and stock bubble collapse of 2000-2003. Here is a chart showing a rough but fairly good comparison of the SP 500 action from the market tops, then and now. By popular request, we were asked to show the performance of gold and silver during the entire timeframe spanning the bear market and recession. We have mapped this out, on a percentage basis, in this second chart.
As you can see, gold was a stellar performer as the dollar was devalued to combat the downturn, even though we saw a brief whiff of deflation in M1 during this period, although most probably do not remember the big deflation scare. Silver did a 'sideways chop' throughout, reflecting its own market conditions and slack demand from industrial usages.

We have to note, and will put to you with emphasis, that just because this is how things happened the last time, that does not mean this is how they will happen this time around. Not at all. But its a very positive thing to bother to consider the data when people around you are spinning theories, and pointing to historic examples like Japan in the 1980's and 1990's, which we remember extremely well, being very preoccupied with in-country Japanese business ventures during the latter half of the Japan bust.

We have to admit we were extremely surprised by one thing. A good friend asked us to also take a look at the performance of the miners in this period as represented by the Gold Bugs Index (HUI). Our take on this was that the miners would have been clocked along with the SP500 during this period.

We stand corrected on that assumption, and remind ourselves again, to listen to what others may have to say, hear their arguments, but always, always look at the data.

Don't Worry, the Fed's Got Your Back.....

Oh yeah, you are the Fed's number one priority, for sure.

And after looking at the new Bush budget, you can be sure the Republicans will be looking out for your interests too, ---- as long as you are a major corporation, or an individual in the top 1% of the wealthy in the US.

Right after a flat consumption tax, the most regressive, unjust and insidious tax you can concoct is inflation, and this is exactly what is being created to bail out the banks and their shareholders, and the Wall Street elite.

"The history of the last century shows, as we shall see later, that the advice given to governments by bankers, like the advice they gave to industrialists, was consistently good for bankers, but was often disastrous for governments, businessmen, and the people generally." Carroll Quigley, Professor of History, Georgetown University

"Bush Budget Would Bring Record Deficits
By ANDREW TAYLOR – Feb 4, 2008

WASHINGTON (AP) — The record $3.1 trillion budget proposed by President Bush on Monday would produce eyepopping federal deficits, despite his attempts to impose politically wrenching curbs on Medicare and eliminate scores of popular domestic programs.

The Pentagon would receive a $36 billion, 8 percent boost for the 2009 budget year beginning Oct. 1, even as programs aimed at the poor would be cut back or eliminated. Half of domestic Cabinet departments would see their budgets cut outright..."

Fed's main task: Save the banks, The Christian Science Monitor, Feb. 1, 2008

"In moving with unusual speed to cut interest rates, officials at the Federal Reserve are aiming to prevent a nationwide recession, but they're also doing something more targeted: throwing a lifeline directly to the beleaguered banking industry.

The Fed says that it isn't trying to bail out anyone. Rather, its move is grounded partly in concern that banking troubles could deepen, choking off credit to the whole economy at a precarious time.

The pace of consumer spending stalled in December, according to government data released Thursday. America's businesses are also on edge, with slow job creation causing a rise in unemployment. In response, the central bank is moving to stimulate growth. But it is also trying to forestall a possible bank meltdown that would worsen the situation.

The interest-rate cuts could give financial firms some breathing room to absorb losses tied to home loans.

"This is more about Wall Street than Main Street," says Ken Goldstein, an economist at the Conference Board, a business-sponsored research group in New York. "We've got the monetary strategy we've got because financial markets are nervous..."

Are We In A Recession?

The GDP and CPI graphs using historic measures courtesy of Mr. John Williams' Shadow Government Statistics. Historic means before the Clintons and Bushes perverted them beyond recognition and common sense.

That's a trick question, right? Well, maybe a rhetorical one at best.

More precisely, a nasty little case of stagflation by historic measures.

Jobs!? We don't need no stinking Jobs!!

Ghost of Bubbles Past: Let's Play a Game

All things one has forgotten, scream for help in dreams.
Elias Canetti, Die Provinz der Menschen

Mr. Wall Street Says: Don't worry, the Fed's got your back!

Let's play a game.

This is the alternative to a 'crash' which is a two year grinding bear market. The classic example is 1973-74 but since we did not have good numerical data we decided to use the bear market most recent, 2000-2002, that everyone seems to overlook. The SP took a top to trough haircut of 47%!

Bear Market: And So It Begins....

Plus ça change, plus c'est la même chose.

After sorting out the limits and characteristics of their capital and cash flows, for any trader, any investor, the first and fundamental question should be: am I operating in a bull or a bear market, or one of indeterminate trend, a sideways drift?

For those who do it, the reason for this is obvious. Even a daytrader will notice the change in the complexion of the tape during a bull or bear market in a given stock, index, currency or commodity. Or should we say, any trader who remains in the game for any length of time.

The highest percentage way to make money is to be long in a sustained bull market, and to hold your positions, with minimal changes, adjusting only at periods of obvious relative strength and weakness. Thus do bull markets make geniuses of us all, and therein lies their greatest danger to the self.

In a bear market, short positions tend to 'work' for longer durations than usual, but the rallies are sharp and ferocious, and can wreak havoc on both your account and sympathetic nervous system. In a bull market, short positions work only during the corrections, which are short and sharp, with prolonged perids of generally upward drift. Short side trading is almost never easy, even during bear markets, when nothing really is easy. And when trying to buck the tiger's odds of playing options or the futures, life becomes a triple black diamond adrenaline ride. You might be surprised at how many traders get hooked on the rush of the occasional big profit in brief periods, from styles that are indeed harsh mistresses, both giving and taking small fortunes. We are no different, having done it, all.

So, are we in a bull or bear market, and has anything really changed? The fundamental question, and perhaps the one we so often forget to ask?

The Bonfire of the Vanities

When we speak of new highs and new lows in prices, or the value of most things in commerce, remember that we are speaking in terms of something else. In the case what we discuss here, it generally is the US dollar. And its not your grandfather's dollar, but one which is fully fiat, from the Latin, "let it be done, or it shall be because we say so." Perhaps its nature is better understood when used in the hopefully familiar phrase, fiat lucere, "let there be light."

"Lenin is said to have declared that the best way to destroy the Capitalistic System was to debauch the currency. . . Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million can diagnose." J. Maynard Keynes, Economic Consequences of the Peace, pg. 235

Given fiat money, they shall be as gods perhaps. Except in this case fiat is a vanity, and provides not light by which to see clearly, but rather clouds and distort the true value of things for those who would use it so.

"...wealth gotten by vanity shall be diminished, but wealth gathered by labor shall increase." Prov 13:11-12.

Keep these charts in your mind going forward, because we may see some unexpected twists and turns as we move into this endgame, which of course is nothing really new, at all.

"The real menace of our Republic is the invisible government which like a giant octopus sprawls its slimy legs over our cities, states and nation. At the head is a small group of banking houses... This little coterie...run our government for their own selfish ends. It operates under cover of a self-created screen...seizes...our executive officers...legislative bodies...schools...courts...newspapers and every agency created for the public protection.” John Francis Hylan, NYC Mayor, 1922