A New Year's Resolution on US Financial Markets from the Incoming Administration

These are strong, almost startling words from Bart Chilton, part of Obama's incoming administration, currently on the CFTC.

The message is good and to the point. The illustration of the performance of the regulators over the past ten (not eight) years is remarkable, an indictment of the existing Federal regulatory system as a whole.

Actions will speak louder than words. We will all look forward to seeing what happens in Washington over the next few months, and in particular, what is done by the CFTC and the SEC in reforming US financial markets.

Washington
Time to restore mission of regulators
By Bart Chilton
January 1, 2009

In the building that currently houses the president-elect's transition team, there used to be an imposing bronze plaque with the visage of the Securities and Exchange Commission's redoubtable third chairman, William O. Douglas. It was emblazoned with the inspiring legend, "We are the Investor's Advocate."

For many decades, the SEC enjoyed the reputation of living up to the noble standard of public service. The plaque no longer graces the entryway of the SEC's new quarters, and with the recent revelations of failure to detect and prosecute incidents of egregious securities fraud and abuse, both internally and externally, the agency's reputation has been severely tarnished.

These types of disclosures make us as public servants ask some fundamental questions: Why are we here? The Founding Fathers had the answer: We are employed to protect the common wealth and serve the public good. We are not here to serve amorphous philosophical, economic or ideological concepts such as "financial markets" or "economies."

Our task is to serve the public -- those people in the hinterlands, many of whom have recently lost 30 percent or more of their retirement funds and/or home values and who now face losing their jobs. Our "client," our "constituent," is the American consumer and worker, the businessman or woman who generates and uses the products and services that comprise our "markets" and our "economy." If we fail to protect, first and foremost, these individual Americans, we cannot succeed in assuring the strength of our economy, nor in protecting the integrity of our financial market system.

Do we need to have statutes and regulations in place to ensure reliability of the marketplace? Of course we do, but over the past decade "the marketplace" has been exalted to a position perceived as virtually omnipotent and omniscient, while consumer protections have been generally neglected. The consequence lies scattered around us.

By veering too sharply to the right and letting go of the regulatory reins, we provided neither the market nor the consumer a great service. Rather we harmed both, and have a long hike to escape the resulting global economic meltdown. We must be careful not to over-correct -- not to go so far in the other direction that we stifle innovation and market growth. But it is clearly time for federal financial regulators to re-evaluate our current statutes and regulations, and to put "common sense rules of the road," as the president-elect has suggested, in place to protect consumers and bring our economy back into balance.

The SEC isn't the only federal financial regulator to have failed in serving the public. The Treasury Department appears to have lost its way as well, when a $700 billion bailout package, purportedly written to ensure against unconscionable executive compensation was, within weeks after passage, found to have a loophole allowing such compensation.

Federal banking regulators seem to be off course, permitting casino-like buying and selling of trillions of dollars worth of virtually worthless transactions. When gasoline topped $4 a gallon, the Commodity Futures Trading Commission dropped the ball, unable to oversee speculation's uneconomic role in the U.S. commodities markets.

In decades past, the CFTC has been charged with being too tied to the industry, too closely aligned with the regulated, and overly concerned with protecting "markets" rather than consumers. We've made good progress, and there are very fine people in all of these agencies and departments, but we too can and must do much better.

I have advocated a comprehensive legislative reform of the laws governing over-the-counter trading, and requested that authority over these critically important markets be vested in the Commodity Futures Trading Commission. The CFTC, a small agency in comparison to the SEC, has exclusive jurisdiction over risk-management markets in the United States, and has in recent years carved several significant notches in its enforcement belt.

At any one time, this small agency, with one-tenth the enforcement staff of the SEC, is investigating or prosecuting anywhere between 750 and 1,000 individuals or entities for violations of the Commodity Exchange Act. The agency has, just in the past year, tagged bad actors with more than $630 million in fines and settlements, in actions involving fraud, manipulation and other misconduct. Not a bad record for a small agency operating on a shoestring budget -- and we'd be able to do even more if given the authority.

With the collapse of the economy, the transition of government already under way with the new Obama administration, and the appointment of an excellent new federal financial regulatory team, it will soon be time to implement this new legislation, and similar consumer protection initiatives.

Also, we need to restore the clarity of our own mission in government: that we are here to assure financial opportunity and market fairness to the public. We need to regain the public trust.

With a shared vision of our mission and much needed reforms, our duties and responsibilities will flow clearly. Chief among these duties is a strong and aggressive enforcement arm. Markets must be free from fraud and manipulation for them to operate as they should -- for all Americans. This baseline approach to enforcement protects consumers and allows for open and free markets that are able to grow and innovate.

Investor's Advocate: A good legend, apparently forgotten. All federal financial regulators should use a new door sign: Consumers First. Everything else will follow.

Bart Chilton is a commissioner on the Commodity Futures Trading Commission, a Democrat, and a member of the Obama transition team.

The Last Time the Feds Devalued the Dollar to Save the Banks

The Last Time the Feds Devalued the Dollar to Save the Banks
14 January 2009

We dipped once again into the Federal Reserve Bulletin Publication from June, 1934 to take a closer look at the growth of the monetary base, and found an interesting graphic that shows the accounting for the January 1934 devaluation of the dollar and the subsequent result on Bank Reserves in the Federal Reserve System.

As you will recall, the Gold Act, or more properly Executive Order 6102 of April 5, 1933, required Americans to surrender their gold coinage and certificates to the Federal Reserve Banks by May 1, 1933. There were no prosecutions for non-compliance except one benchmark case which was brought voluntarily by a person who wished to challenge the act in court.

After a substantial portion of the gold was turned in by US citizens and taken from their bank based safe deposit boxes, the government officially devalued the dollar from 20.67 to 35.00 per ounce in the Gold Reserve Act of January 31, 1934.

The proceeds from this devaluation were used to provide a significant boost to the Federal Reserve member bank positions as shown in the first chart below.

The inflation visited on the American people because of this action helped to take the CPI as it was then measured up 1200 basis points from about -8% to +4% by the end of 1933. To somewhat offset the monetary inflation the Fed also contracted the Monetary Base which served the nascent recovery in the real economy rather poorly and is viewed widely as one of a series of policy errors.

Considering that the actions did little for the employment situation this was painful medicine indeed to those who were dependent on wages.



Fortunately at the same time FDR was initiating the New Deal programs which, despite continual opposition from a Republican minority in Congress, managed to provide a small measure of relief for the 20+% public that was suffering from unemployment and wage stagnation.

People ask frequently "Will the government seize gold again?"

While there is no certainty involved in anything if a government begins to overturn the law and seize private property, one has to ask for the context and details first to understand what happened and why, to understand the precedent.

Technically, the government did not engage in a pure seize of private property, since at that time the US was on the gold standard, and much of the gold holdings of US citizens were in the form of gold coinage and certificates.

Governments always make the case that the currency is their property and that the user is merely holding it as a medium of exchange. The foundation of the argument was that the government required to recall its gold to strengthen the backing of the US dollar against the net outflows of gold for international trade. The devaluation helped with this as well, since dollars brought less gold for trade balances.

People also ask, "Why didn't the government just revalue the dollar without trying to recall all the gold from the American public?"

The answer would seem to be that this would have been more just, more equitable recompense for the public. The Treasury could have purchased gold from the public to support its foreign trade needs.

But it would have left much less liquidity for the banks.

One can make a better case that the recall of the gold, with the subsequent revaluation to benefit a small segment of the population in the Banks, was a form of seizure of wealth without due compensation. Hence the lack of active prosecutions.

So, will the government take back gold again to save the banks by devaluing the dollar?

Highly unlikely, because they not only do not need to this, since the dollar is no longer backed by gold, and is a form of secular property except perhaps for gold eagles, but they do not have to, because they are devaluing the dollar already to save the banks.

This time the confiscation of wealth to save the banks is called TARP.

If one thinks about it, US Dollars are being created and provided directly to the banks to boost their free reserves significantly, at a scale comparable and beyond to 1933-34.

The confiscation of wealth is being spread among all holders of US dollars and dollar assets, foreign and domestic, in the more subtle form of monetary inflation.

Granted, the government must be more opaque to mask their actions in order to sustain confidence in the dollar while the devaluation occurs, but this is exactly what is happening, and all that is required to happen in a fiat regime.

There is no need to seize widely held exogenous commodities like gold and oil, but merely dampen any bellwether signals that a significant devaluation of the dollar is once gain being perpetrated on the American people in order to save the banks.

Its fascinating to look carefully at this next chart below.



First, notice the big drop in gold in circulation of 9.8 million ounces, or roughly 36% of the measured inventory at the end of 1932. Think someone was front-running the dollar devaluation? We suspect that the order went out to start pulling in the gold stock to the banks.

The reduction in gold in circulation AFTER the announcement of the Gold Act in April would be about 3.9 million ounces, or roughly 22% of the gold remaining in circulation in March 1933.

Considering that all gold coinage held by banks in the vaults was automatically seized, the voluntary compliance rate is not all that impressive. We are not sure how much of this was being held in overseas hands by non-US entities.

But beyond a doubt, there was a unjust, if not illegal, seizure of wealth by requiring citizen to turn in their gold to the banks, which was then revalued at the beginning of 1934 by 69% from 20.67 to 35 dollars.

It would have been much more equitable to devalue the dollar and to change the basis for dollar/gold first, before requiring private citizens to surrender their holdings. But of course, this would have lessened the liquidity available for direct infusion into the Federal Reserve banks.

Chicago Fed Says Take Interest Rates "Below Zero" and Monetize Debt (to Devalue Dollar)

Quantitative easing to mimic interest rates 'below zero' effectively penalizes the buyers of US bonds and dollar savings by providing a negative rate of return after inflation.

Inflation is desirable if you are a net debtor and you control the value of the method of your payment, ie. cheaper dollars to pay off service your debt.

We have to wonder how well negative real interest rates will support the enormous increase in the supply of Treasury debt that is coming to market this year because of a soaring national debt of about two trillion dollars.

The obvious target buyers are the exporting countries such as OPEC, Japan and China. We also suspect the Fed will start buying the yield curve, quietly and indirectly if not transparently.

Other central banks, such as Europe, will be expected to follow suit and devalue their own currencies through lower rates, to decrease the perceived impact of a dollar devaluation, in a group 'ratcheting down' of the developed nations' currencies.

This will require 'management' of the price of real things like commodities. Fortunately the price for most of them is set in London and New York. Life is tough for an exporting nation when you are riding the dollar reserve currency regime and an industrial policy of 'beggar your people' to support it.

The boundary constraint on the Fed in a purely fiat regime is the value of the US dollar and the Treasury debt. Greenspan's Fed managed to inflate its way out of the tech crash of 2000-2 with bubbles in equities and housing prices, a significant dollar devaluation, but an amazingly resilient bond thanks to official buying by a few foreign central banks.

Alan Greenspan famously stated, in a repudiation of his earlier views while responding to Congressman Ron Paul, that a fiat dollar as the reserve currency is viable because "the Federal Reserve does a good job of essentially mimicking a gold standard and...the Fed does not facilitate government expansion and deficit spending."

We expect to see Bernanke and the Congress test the limits of monetary and Keynesian economic theory again this year, and the acceptance of the US dollar and fiat currencies as a faux gold standard, as being of the utmost integrity and impartiality, immutable and nationless.

We tend to remain skeptical of the outcome however, keeping in mind the words of George Bernard Shaw, "You have a choice between the natural stability of gold and the honesty and intelligence of the members of government. And with all due respect for those gentlemen, I advise you, as long as the capitalist system lasts, vote for gold."

The major challenge for the governments of the world for the remainder of this decade, other than blowing us all to pieces, will be to create a viable alternative to the US dollar as the world's reserve currency and a major vehicle for international trade.

This could be one for the record books.



Reuters
Evans says Fed needs to mimic below-zero rates
By Ros Krasny
Sat Jan 3, 2009 8:18pm EST

SAN FRANCISCO (Reuters) - A grim economic outlook highlights the need for the Federal Reserve to step up quantitative measures to boost growth, with official interest rates already effectively at zero, Charles Evans, president of the Chicago Fed, said on Saturday.

Evans said that based on the outlook for rising unemployment, falling industrial production and a wider output gap, economic models suggest rates should be below zero.

"If it were not constrained by zero, those models would want to push it below zero, but that's not possible," Evans told reporters after a panel at the American Economic Association's meeting in San Francisco.

Quantitative easing, a way to flood the banking system with large amounts of money, "is a way to mimic below-zero rates and provide support to the economy," he said. (They would intend to create a monetary inflation to take the 'real rate' below zero. "Quantitative Easing" is Fedspeak for "printing money." - Jesse)

The process often involves buying up large quantities of assets from banks, such as the Fed's latest programs to buy mortgage-backed securities. (This is known as "monetizing debt." - Jesse)

In December, the Federal Open Market Committee, the Fed's policy-setting body, took the surprising step of lowering the federal funds rate to a range of zero to 0.25 percent. Cash fed funds had been trading below the previous 1 percent target rate for several weeks.

In his remarks, Evans, who is a voting member of the FOMC in 2009, said the Fed's various lending programs should help cushion the impact of the year-old U.S. recession but a large traditional fiscal stimulus plan is also needed, even with the problems it could create over the longer term.

"I believe a big stimulus is appropriate," Evans said. "But it is sobering to be deploying large amounts of taxpayer funds at a time when our fiscal balance sheet is already coming under significant stress."

Without the Fed's programs to help unfreeze credit markets and to-the-bone rate cuts, "the downturn -- and its costs to society -- would be even more severe than what we are currently facing," said Evans.

Since the financial market crisis erupted, the Fed has created several new programs aimed at bypassing the traditional banking system and smashing through the credit-market logjam, including the direct purchase of mortgage-backed securities.

Even so, the U.S. jobless rate appears on pace to exceed 8 percent in 2009, from the most recent reading of 6.7 percent in November, Evans said.

Although the current recession started with the collapse of the U.S. housing market, Evans said many non-financial industries now face the risk of "long-term structural impairment." (It was the Fed's reflationary effort after the Crash of 2000-2 that created the housing bubble. - Jesse)

Evans said fiscal programs to support growth "must be large in order to be effective and to instill badly needed confidence" given the severity of the downturn. (We have an intuition that the Congress will meaningfully explore the concept of 'large' government programs - Jesse)

President-elect Barack Obama has said that signing a major economic stimulus package will be his first priority when he takes office on January 20, with a goal of creating 3 million jobs over two years.

Evans also said the market crisis that erupted in 2007 showed huge holes in financial regulation.

"Significant weaknesses have been revealed in our system of financial regulation. ... These failures call for a reassessment of the roles of market discipline and our regulatory structures," he said