Zero Hedge

On FDIC Failure Friday, one of the odd names to make the list of bank failures was New York’s very own Park Avenue Bank, whose president Charles Antonucci in March of 2009 was trumpeting the bank’s “resilience” by saying “I don’t need TARP money” and as result declined to accept taxpayer bailouts. Certainly with Friday’s failure, Antonucci’s statement seems a little short-sighted. What is more relevant, is that it was just announced that Antonucci, who was the bank’s president from June 2004 to October 2009 has been arrested on bank bribery, embezzlement and fraud charges. Makes you wonder just how safe the “safe” banks are, if only the bailout recipients are doing so-so in the current environment (presumably, without any outright fraud disclosed just yet among the TBTFs).

From BNO Breaking News:

The former President of The Park Avenue Bank in Manhattan, which was
closed by regulators last Friday, has been arrested on fraud charges,
prosecutors said on Monday.

A spokeswoman for the U.S. Attorney’s Office for the Southern
District of New York said Charles Antonucci was arrested on allegations
of self-dealing, bank bribery, embezzlement, and fraud on the New York
State Banking Department, FDIC and TARP.

And some more from Reuters:

A former president of a privately-held New York bank, Park Avenue Bank, was arrested Monday on charges including bank bribery, embezzlement and fraud, a federal prosecutor said.

A source familiar with the case identified the banker as Charles Antonucci, who was president of the bank from June 2004 to October 2009.

On Friday, state regulators closed Park Avenue Bank, which had assets of $520.1 million and deposits of $494.5 million at the end of 2009, according to the Federal Deposit Insurance Corp.

The charges against the former bank president include self-dealing, bank bribery, embezzlement and fraud on the New York state banking department, FDIC and the Troubled Asset Relief Program (TARP), the statement by Manhattan U.S. Attorney Preet Bharara said.

His office said U.S. officials were to disclose more details at a press conference at 1 p.m. (1700 GMT) on Monday.

In November the bank applied for a bailout of less than $12 million under the TARP program but withdrew its application over concerns about restrictions on banks that receive taxpayer money, bank chairman Donald Glascoff said on March 10.

This is truly not surprising: in the corrupt world of Wall Street banking, it appears that rampant criminality has long since become the norm, with selective enforcement here and there to make it seem that perpetrators get punished. The next question: where’s Fuldo.

More articles from Zero Hedge….

Dian L. Chu submits:

According to a gauge derived from data compiled by The American Association of Individual Investors [AAII], bullishness on U.S. stocks is beginning to emerge after the market’s rally in the past year.

The latest AAII Sentiment Survey reading shows optimists outweighed pessimists for the first time since January 2008, three months after the previous bull market ended. (See Chart from Bloomberg)

Read more…. »

Sounds insane. Your stockbroker rings you up with the name of a stock that “you just gotta buy.” Your obvious first question: “What’s it selling at? He tells you it’s about $43 a share. So you do your due diligence and discover the stock is already a big winner, having shot up more than 100% from its 52-week low of $20 a share. Why, you wonder, didn’t he call you when it was $20? What makes such a purchase seem even crazier is that further due diligence reveals the stock sold as low as $3.20 in 2008, meaning it has soared more than 15 fold in about two years.

Since everybody knows stocks don’t go up forever and the rule is you buy low and sell high, not vice-versa, you come to an obvious conclusion: Your broker is out of his mind, the inmates must surely be running the asylum on Wall Street, and, of course, you say nuts to the stock.

In this instance, though, maybe a hearty hello to the stock, rather than a fast, dismissive goodbye, might be a wiser investment strategy. So, at least, is the thinking of Morgan Stanley’s crack banking analyst, Betsy Graseck, who is strongly pitching the stock in question — bank biggie JPMorgan Chase & Co. In effect, she’s recommending purchase of the shares with an “overweight rating” despite their meteoric rise. The intrepid analyst, though, apparently has no trepidations because she figures it has the market muscle to balloon to $59 over the next 12 months, a gain of about 38% from current levels.

Why so gung-ho? For starters, Graseck is convinced we’re in the beginning stages of economic healing with powerful credit improvements coming in the banks. Further, as credit costs fade with credit card losses peaking, she expects per-share earnings to rise as delinquencies accelerate in the first quarter and non-performing loans decline meaningfully in the first half. In fact, Graseck expects JPM to be one of the first banks with materially declining NPLs, partly because of its low exposure to commercial real estate.

On the earnings front, Graseck is forecasting a 17% year-over-year gain in 2010, and over the next three years a whopping 130% increase, driven primarily by declining credit costs. Further, she expects accretion from JPM’s $1.9 billion acquisition of the Washington Mutual bank in September 2008 to boost earnings going forward. Likewise, JPM’s relatively stronger balance sheet should enable it to snare a bigger market share. Yet another plus: The bank could grow international investment banking from its already number one position (roughly 14%-15% of global IB fees).

In specific dollars and cents, the analyst pegs JPM’s per-share earnings at $3.02 this year, versus $2.58 last year, and $4.78 in 2011.

Graseck also takes note of several risks, namely the prospects of larger reserve hikes and higher credit losses than currently anticipated, as well as thinner net interest margins if rates fail to begin to rise in August as Morgan Stanley economists are currently forecasting.

She’s not alone in her risk concerns. JPM’s latest short interest — a bet that its stock price will fall — shows a short position of 25.7 million shares. Among the banking problems cited by one short seller are the prospects of substantially more writeoffs from bad loans, especially in commercial real estate, falling loan demand and the lack of lending. “Many investors,” he says, “seem to believe bank stocks are now money in the bank, but I wouldn’t bank on that because it’s really not clear the ill effects of the recession are almost over.”

Meredith Whitney, one of Wall Street’s leading bank trackers, also has some worries, having recently said she thought bank stocks were vulnerable to a 10%-15% decline.

As far as JPMorgan Chase goes, Graseck is obviously in love to push a stock that has already risen from the basement to the penthouse. She may be right, of course. But while I don’t want to mess around with the affairs of the heart, it’s worth keeping in mind that Wall Street love affairs are notorious for their short lifespan and bitter endings.

What do you think? E-mail me at Dandordan@aol.com

Read more….

The Daily Reckoning

Bacon, Bacon, Bacon…

The bacon reference has been claimed. Marius Gustavson has written a brilliant article on the sovereign debt crisis facing the world. From The Market Oracle:

Smells Like Bacon

“The Greek debt crisis has led many observers to believe a eurozone-wide contagion is in the making, including all of the PIGS – Portugal, Italy, Greece and Spain – and it could spread to the north-western periphery as well. As Ian Bremmer and Nouriel Roubini recently commented in the Wall Street Journal:

“The current crisis in Greece is only the worst example inside the EU. The PIGS … all boast public debt above or headed for 100% of GDP. Though the PIGS acronym was apparently coined by British bankers, Britain, Ireland and Iceland also smell distinctly of bacon.”

Debt distressed nations being called PIGS, countries smelling of bacon, and dubious political spending referred to as pork. What’s next? Maybe Bernanke will bypass money dumping helicopters and grow wings himself – pigs might fly.

The U.S. budget deficit certainly is soaring. It “widened to a record in February as the government boosted spending to help revive the economy.” How spending money that had to be borrowed from someone else can stimulate is a mystery. It just moves money around. How it indebts future generations is not a mystery:

“The figures show the deficit this year will likely surpass the record $1.4 trillion in the fiscal year that ended in September.” The light at the end of the Keynesian tunnel is a runaway steam train loaded with debt obligations.

Wall Street still only sees the light. It has marked its best 12 month performance since the rebound from the Great Depression.

Who done it?

The latest European blame game has begun. After believing the Keynesian free lunch would provide for a cushy future, it seems Europe’s politicians are descending into an even deeper state of denial and delusion. Marius Gustavson at The Market Oracle continues:

“So far the two PIGS most afflicted by the European debt crisis, Greece and Spain, blame mysterious foreign conspirators, rather than home-grown macroeconomic mismanagement.

“Greek Prime Minister George Papandreou expressed the view that the crisis is “an attack on the euro zone by certain other interests, political or financial,” whereas the Spanish government has, reportedly, ordered an investigation into the alleged “collusion” between American investors and the media to hurt the Spanish economy.”

Considering those evil financial institutions hold vast amounts of government debt, as well as facilitate bond markets, the Greeks and Spaniards might want to keep their mouths shut.

Biting the hand that feeds you is a bad idea. This is no less true if that hand is attached to something as unscrupulous as a bank. In fact, it holds even more true.

Amusingly, those unscrupulous banks find themselves in the same fix as Shylock did. If they hold countries accountable for their excesses by requiring higher bond yields, then the bank’s capital base weakens. If they continue to buy bonds, they expose themselves to sovereign risk.

And yes, losing a pound of flesh does compare to losing capital. The real difference is that Shylock could walk away from the debt. Although, with million dollar bonuses, I suppose bankers could walk away quite comfortably. That’s where derivatives like Credit Default Swaps come in. We’ll leave that for another day.

Me, Myself and the Lenders

Sadly, it seems the delusions of politicians have filtered down to the citizens. They now also feel some sort of entitlement to being lent money.

The vast benefits promised by governments and provided by debt markets seemed endless. When it turns out they aren’t, trouble brews. Greece is just the beginning.

“The importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood,” said El-Erian, co-chief investment officer at Pacific Investment Management Co, known as PIMCO.

If Greece is where the world is headed (metaphorically speaking) then things could get interesting.

Bloomberg reports that “Greece’s unions will shut down hospitals, airports and schools today in the country’s second general strike this year to protest Prime Minister George Papandreou’s latest round of budget cuts to curb the European Union’s biggest deficit.”

The Economist, far more insightfully, reports that “Militant pensioners unexpectedly broke through a police cordon blocking the road to Mr Papandreou’s office as he was announcing the new measures.”

Please take a moment to picture that.

Militant pensioners… And it’s not like they have nothing better to do. It’s just that they want to claim what they can while they still can. Marko Papic of Stratfor has forecasted that interest will amount to 6% of GDP for the Greeks by next year. That is past the point of no return, according to Professor Altman, who developed a popular model used to calculate corporate defaults.

His reasoning is that Greece faces structural problems, which are difficult to turn around, even in the long run. Based on this, any bailout will be like a bandaid for a cancer patient. Nobody but two year olds and stock brokers would be comforted. That does leave room for a short term rally. Caveat emptor. Please don’t confuse that with Carpe diem.

One clever solution did pop up in the press. According to two German senior ministers, it would be a good idea for Greece to sell a few of its islands to pay off debt. No kidding, zose German politicians are getting power hungry again.

Meanwhile, the Italians are being themselves as well. “For Greece, the problem is completely over,” said Romano Prodi, a former Italian prime minister. The reason this is newsworthy is that a predictor of the Argentinean debt crisis, Charles Calomiris, has stated that Italy is the next Greece in terms of debt problems – because of political corruption.

Be-ratings Agencies

Those ratings agencies are still at it. Having been beaten and humiliated by the public and the government, they are getting their own back.

The ratings agency Fitch warns of sovereign debt downgrades for the UK if plans for austerity are not outlined. If they are outlined, Fitch will realise the severity of the problem and decide to downgrade anyway.

Karma in action.

So, when will the crisis hit? When does the sovereign debt bubble burst?

After staring into a crystal ball for several moments, the answer strikes as being obvious. The sovereign debt crisis begins when people get rational again. It’s that simple.

Rationality isn’t a terribly difficult thing to get a grasp on. But irrationality is a pain in the neck for an economic forecaster. How long it can last cannot be explained, as it is by nature irrational. So you see the quagmire.

For now, my claim is to be telepathetic, not telepathic, of Mr Market’s intentions.

Tightwire to Nowhere

Regarding forecasts on economic growth, talk has again turned to the letters V U W. V being the rapid recovery that often follows recessions, U being a longer period of anaemic growth, and W being a double dip recession. Nouriel Roubini and his team at RGE have indicated they see an increased risk of the W scenario developing.

That is stating the obvious. Government has gone from being a major player in the economy to being the major player in the economy. If its institutions stuff up, the ability of the free market to correct the mistakes is now severely hampered. The problem is that governments inevitably stuff up.

They can’t even manage their own balance sheet, despite having the power of the law to play with. Now they claim to be gallantly walking a tightwire between inflation and deflation.

The managing director of the International Monetary Fund, Dominic Strauss-Kahn, explained this supposed balancing act policy makers face in their use of fiscal and monetary stimulus:

“If we exit too late … it’s a waste of resources, it’s bad policy, it’s increasing public debt, we should avoid this … But if you exit too early, then the risks are much bigger.”

Michael Pomerleano sees it very differently. Rather than bothering with a balancing act, take a look at where the economy is headed:

“Nationalisation of private debt injects considerable inefficiency into the economic system, inhibiting Schumpeter’s process of Creative Destruction that is essential in a market economy and needed to maintain the private sector.”

But what of the audience watching the spectacle? A V shaped recovery isn’t much different to a U or W if the jobs situation remains awful. One quickly gets the impression they just want to see someone plunge to their death instead of prancing around for applause.

For the “history repeats itself” buffs:

“As historical research conducted by University of Maryland economist Carmen Reinhart and Harvard University economist Kenneth Rogoff shows, financial crises are usually followed by government-debt crises. This starts as private debt is shifted onto the balance sheet of the government, through bailouts and purchases of toxic debt. The government-debt problem is then made worse as the economic downturn leads to an increase in expenditures in the form of unemployment benefits and stimulus spending, coupled with a decrease in tax revenues.”

Here in Australia, the economic outlook could not be more ominous for history fans. According to The Age, the profit outlook for SMEs is the best it has been for 2.5 years.

“Optimism among small and medium size firms about future profits is at its highest level since before the global financial crisis, a survey finds.”

“… before the GFC” are the key words. Just like in 2007, the future is based on optimism. When that turns out to be a load of rubbish, the games will begin again.

Capital Crunch

Enthusiasts of the Austrian School of Economics have mixed feelings for legendary economist Adam Smith. Nevertheless, we don’t like to think of him rolling over in his grave. He must have done so when it was decided that the 20 pound note would bear his face.

You see, Adam Smith was an investor and firm believer in Scottish Free banking. The idea that government should hold a monopoly over issuing currency would not be agreeable to him. Putting his face on a Bank of England note is like having Tony Abbott on abortion ads.

Strangely enough, the UK still has 10 note issuing Banks. People don’t seem interested in the reason. They have bigger things to worry about – like what their government has in store for “its” banks. The Telegraph reports:

“Jonathan Pierce, from Credit Suisse, believes UK banks will have to reduce the size of their balance sheets by as much as £530bn over the next three to four years to meet new regulations.

“According to his analysis, British banks need to issue £420bn-£750bn of long-term wholesale funds. “We don’t think this is plausible and hence we expect balance sheet footings to fall by 6pc-18pc to compensate,” he said.”

In a world that relies on credit to turn, somebody has to get burned if bank balance sheets really do contract that much.

House Prices Uncovered

Based on feedback, it seems property comments are fair game for the Daily Reckoning. So here goes.

That reputable institution, the Reserve Bank of Australia, has not informed us that house prices could rise. It has warned us that house prices could rise. Hmm, so that’s a bad thing now.

It doesn’t have to be. In a free market, an increase in house prices is a signal to builders to build more houses. Once they do, prices normalise again, as supply balances demand.

The idea that house prices can steadily rise relative to incomes is flawed. Why would one generation want to pay more as a percent of their income on housing than another?

More importantly, why would builders not build more homes as prices rise?

The answer is zoning laws, town planning and all regulations remotely similar. Yes, it’s the government again.

If you examine where house prices rise (and then plummet) the most and compare those areas to where prices remain stable relative to income, you will find a remarkable correlation to the intensity of planning and zoning laws.

This was best illustrated in the US. Areas that had the most planning experienced the biggest booms and busts because supply couldn’t adjust to demand. Areas with low planning had little problem and simply built more as demand increased. They haven’t experienced the same subsequent bust either.

Have a great weekend.

Nickolai Hubble.
The Daily Reckoning Week in Review

Similar Posts:

• Pigs Get Slaughtered
• USA Has Fives Times As Much Sovereign Debt As All the PIIGS Put Together
• It’s the Little Economies that Have Trouble
• It All Comes Down to Debt Again for NAB
• The Euro is a Symptom of Centralisation

More articles from The Daily Reckoning….

Zero Hedge

This week in The IRA we feature a
conversation with Bill
King, who along with his wife and business partner Mary works in the
world of
derivatives broadly defined via their Chicago-based firm, M. Ramsey King

Securities. We first started taking with Bill in the 1980s, during the
political wrangle – we won’t call it a battle – over free trade with and

democracy in Mexico. That was about the time of the first
appearance of “Too Big to Fail” for the large banks following the
Mexican peso
meltdown. Un fuerte abrazo a nuestros amigos en Mexico!

But before we go to our feature, a few
comments on current
events. First and foremost we remind one and all about the impending
start
of the FDIC’s rule make effort regarding the reform of bank
securitizations.
Last week, the FDIC approved an extension through September 30, 2010 of
the Safe Harbor Protection for Treatment by the FDIC as
Conservator or
Receiver of Financial Assets Transferred by an Insured Depository
Institution in
Connection With a Securitization or Participation.

We hear that the FDIC rule making
process could start as soon
as next month, but more likely will wait till the FDIC’s board meeting
in May.
We also hear that the President’s Working Group (PWG) on Financial
Services is
preparing a “white paper,” in cooperation with the Federal Reserve Board
and the
Office of the Comptroller, to block the FDIC reform effort. This
campaign, which
apparently was orchestrated by the largest dealer banks, is intended to
derail
the new rules proposed by the FDIC mandating greater transparency and
disclosure
for bank sponsored residential mortgage securitization deals.

The PWG, in case you don’t know, is an
informal group created
in 1988 by President Ronald Reagan that allows the executives of the
biggest
banks to influence public policy in Washington, but without going
through the
trouble of registering as lobbyists or other public disclosure.
Sometimes
referred to the “plunge protection team,” the PWG is part of the
invisible
government of Washington,” an agency which operates within the
government, but
at the behest of private interests.

Barry Ritholtz has a nice summary on
the PWG in his book,
Bailout Nation, and also in his Blog, “The Big Picture.” As Barry
notes,
the PWG is every bit as incompetent as most other people in Washington,
but they
do have one special skill: pushing the banking industry’s agenda in
Washington via informal “guidance” and white papers that are written by
and for
compliant regulators. The PWG essentially acts as a super-lobbying
channel
for the largest banks focused right at regulators. Only “team players”
need apply.

The Federal Reserve Bank of New York
and the OCC in Washington
are reportedly drafting the “guidance” on reform of bank securitizations
and at
the request of the PWG. No clue whether the White House is involved
directly yet
or if this is merely a Tim Geithner operation. These PWG white papers
are
never released to the public even though the Treasury acts as the de

facto public affairs organ for this corporate influence group.

We

called out former Wachovia Bank CEO and Goldman Sachs (GS)
banker Robert Steel on the subject of the PWG last year at the Chicago
Fed’s international banking conference. He was unapologetic and more
than
a little offended, or so he claimed. The PWG acts with impunity in
Washington, in part because the members of Congress understand their
subordinate
role. We hear that Senator John Warner (D-VA) is now competing with
Judd Gregg (R-NH) to be the next “Senator from Wall Street” and
specifically
seems to be angling to join a private equity firm. Gregg’s tastes seem
to
run more along the lines of a large OTC derivative dealer
bank.

The fact that the PWG is in league
with the Fed and Treasury
against the FDIC board is all you need to know about the politics of
reforming
private label mortgage securitization. If Barack Obama were really
interested in
reforming Washington, he would rescind President Reagan’s executive
order and
disband the PWG for good. Allowing the big banks which participate in
the PWG to
lobby financial regulators and members of Congress without any public
disclosure
is a national scandal and makes a mockery of any claim by Barrack Obama
to be
changing the business of Washington.

We noted in our comment last Tuesday
in American
Banker, “Viewpoint: Stop Blocking FDIC Securitization Effort,”

that “the practical policy issue is the losses observed in failed banks
over the
past two years, averaging over 30% of total assets, versus just 11% on
average
in the S&L crisis. The common factor in failed banks with high loss
rates is
unsafe and unsound securitizations practices, thus the FDIC initiative
on
securitization.”

It is very telling to us that the FDIC
is advocating greater
openness and transparency in bank sales of mortgage loans to
securitizations,
but the Fed and OCC are standing with the larger dealer banks that
arguably
caused the financial crisis in complex structured assets. Hopefully
these
federal agencies and the industry groups they seem to be allied with
will
realize that the FDIC’s rule making process holds the potential to
revive
private label mortgage finance and that they can influence the outcome -
but
only if they participate constructively.

One mortgage market veteran who ran
risk for one of the largest
private conduits in the business put the situation succinctly last week:
“You
can argue against the FDIC securitization proposals, looking at them in a

bundle, as perhaps being overkill, but each piece of their proposal,
taken
separately, is pretty compelling. The other bank regulators and industry
groups
could easily negotiate a better, more streamlined deal that would help
the
market if they bothered to push back and participate constructively,
instead of
simply attacking the FDIC.”

To read the rest of our rant on the possibility of zombie bank love between Barclays and Citigroup, and the interview with Bill King, click the link below:

http://us1.institutionalriskanalytics.com/pub/IRAMain.asp

– Chris

More articles from Zero Hedge….

Zero Hedge

By Economic Forecasts & Opinions

According to a gauge derived from data compiled by The American Association of Individual Investors (AAII), bullishness on U.S. stocks is beginning to emerge after the market’s rally in the past year.

The latest AAII Sentiment Survey reading shows optimists outweighed pessimists for the first time since January 2008, three months after the previous bull market ended. (See Chart from Bloomberg)

A Disparity in Sentiment

In contrast to the cheery mood of the markets, the latest readings from consumers and small business owners indicate economic sentiment isn’t improving, despite signs of a factory rebound and less gloom on the labor front.

The National Federation of Independent Business said its optimism index for small business owners fell back in February to its December reading. The IBD/TIPP Economic Optimism Index dropped 3% in March, well below its average of the past year.

Meanwhile, The U.S. consumer sentiment also dipped in early March, according to the University of Michigan Consumer Sentiment Index.

‘Never Seen Anything Like It’

This divergence has got the Wall Street scratching its collective head. In a recent MarketWatch article, Mr. Mark Hulbert cited a Wall Street advisor as saying:

“The disparity between hope on Wall Street and malaise on Main Street continues. I have never seen anything like it.”

In short, the disparity may be deciphered in one word – liquidity – which Wall Street has plenty of from government handouts, while main street remains strapped from the bleak prospects in both the job and housing markets.

Behind The Productivity and Profit Gain

Corporations are now seeing higher profits mainly through cost, inventory, and workforce reductions. It is not a coincidence that the U.S. productivity rose by an outsized 6.9% last quarter, while the cash U.S. corporations have on hand equals about one-tenth of the annualized gross domestic product (GDP) over the past twelve months — near a record high, according to an IHS analysis of Commerce Department data.

This type of “growth” is not real and entirely unsustainable, and at some point, companies won’t be able to get their employees to keep producing more.

For Middle America, the stagnant housing market and the lack of positive job growth are two factors hindering a more robust reading for consumer sentiment. An analysis of these two factors will offer some clues to Wall Street as to what Main Street is concerned about regarding the economy.

Home Not So Sweet Home

In the fourth quarter, national home prices fell 1.1% compared with the third quarter, according to Standard & Poor’s. Meanwhile, nearly one in four of all Americans with a mortgage – more than 11.3 million homeowners – are underwater.

The rising tide of foreclosures, bankruptcies and so-called “strategic defaults” where homeowners just stop paying mortgages on homes worth less than their associated liability, has become a well-recognized phenomenon.

About That Unemployment Rate ….

The picture in the job market does not offer much consolation either. After topping 10% in the last three months of 2009, the unemployment rate in the United States retreated to 9.7% in January, and holding steady – slightly better than expected.

Nevertheless, economists said that an exodus of discouraged workers from the job market has kept the U.S. unemployment rate from climbing above 10%, and the actual unemployment rate is higher than reported by the official numbers.

20% Under-employed

Moreover, what is not in the headlines is that near one in five, or about 30 million Americans are under-employed.

The BLS under-employment rate (U-6) in February – 16.8% seasonally adjusted – was among the highest rates that the Bureau of Labor Statistics (BLS) has recorded since it started tracking the statistic in 1994. A recent Gallup poll puts the figure at almost 20%.

A Decade Low Employment Level

Even more telling is the ADP National Employment Report.  The national employment level is at a decade low as indicated by data from both ADP and BLS ((See Chart from ADP).  Meanwhile, the U.S. Employment to Population Ratio also dipped to the lowest level, at 57.9% in February, not seen since 1984.

The Old Normal = 10 Million New Jobs

Analysts estimate returning to pre-recession employment levels and keeping up with working-age population growth will require the creation of 10 million or more jobs. Under the administration’s own estimate, the economy will create an average of just 95,000 jobs a month this year; that’s far from enough to make much of a difference in the jobless landscape.

…. And Beyond 2015

Generally it takes a 2 percentage point rise in the GDP above a “normal” level (about 2.5%) to drive the jobless rate down each single percentage point. Taking into consideration of the current near 10% unemployment level and the GDP growth generally forecast at a slower pace of 2% to 3%, it could take five or more years for employment to get back to prerecession 2007 levels.

Moody’s Economy.com also expects the unemployment rate to resume rising over the next few months, “peaking near 10.5% in the third quarter, ” while Standard & Poor’s said a return to the pre-recession employment rate is unlikely until 2015 at the earliest.

Housing Not Bottomed Yet

The housing market is yet to revive as many analysts predict a further price drop. The latest pending home sale data, a leading indicator, suggests weakness still in the housing market. According to the National Association of Realtors, the number of contracts to buy previously owned U.S. homes fell 7.6% in January.

In addition, there appear to be a growing backlog of potential foreclosures. As publicized recently in the Time that strapped consumers are paying credit-card bills before mortgages. This change of math stems primarily from falling housing prices, loan-modification programs and restricted credit.

In any case, U.S. households’ net worth in real estate was down by 53.3% from the end of 2006.

Optimism Pinned on Recovery

Right now, it seems the markets are shrugging off the sovereign debt crisis in Europe, and basing their optimism on the expectation of a sustained economic recovery. However, in the U.S., consumer spending still drives about 70% of the GDP growth. And for consumers, job and home equity gloom pretty much means a chock hold on spending, which presents a challenge to the business profit growth in the medium term.

From that perspective, it is probably premature for Bank of America Merrill Lynch to suggest “We suspect confidence will recover as we begin to see a turn in the labor market,” partly based on the surprise retail sales (minus autos) jump of 0.8% in the February blizzard.

Market Exuberance & Correction

Meanwhile, the AAII cautioned that the spread between bullish and bearish sentiment in its index is now at +20 percentage points, more than double the historical average of +9 percentage points.

Historically, similarly wide spreads preceded the mini-corrections of August 2009 and January 2010. In both instances, the spread stayed at similar levels for a period of three weeks before the market topped and pulled back.

“The trouble, in my opinion, with corporate America today, is that everything is thought of in quarters.” ~ Henry Kravis

(Hat Tip: dvolatility, Shane Drozdowski)
Economic Forecasts & Opinions

More articles from Zero Hedge….

Zero Hedge

This is an open letter to the economics, finance and banking communities.
I don’t have any dog in the fight, other than to figure out and then
publicize what is best for the greatest number of people. People I
greatly respect advocate for federal-level public banking, state public
banks or a return to the gold standard. I am simply attempting to start
a high-level debate about what the best option is.

Please see responses posted by economists and others below.  I will update the responses as I receive them.

How Is Credit Created?

I pointed out in September:

As PhD economist Steve Keen pointed out recently, 2 Nobel-prize winning economists have shown that the assumption that reserves are created from excess deposits is not true:

The model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.

 

The first economist to establish this was the American Post Keynesian economist Basil Moore, but similar results were found by two of the staunchest neoclassical economists, Nobel Prize winners Kydland and Prescott in a 1990 paper Real Facts and a Monetary Myth.

 

Looking at the timing of economic variables, they found that credit money was created about 4 periods before government money. However, the “money multiplier” model argues that government money is created first to bolster bank reserves, and then credit money is created afterwards by the process of banks lending out their increased reserves.

 

Kydland and Prescott observed at the end of their paper that:

Introducing money and credit into growth theory in a way that accounts for the cyclical behavior of monetary as well as real aggregates is an important open problem in economics.

In other words, if the conventional view that excess reserves (stemming either from customer deposits or government infusions of money) lead to increased lending were correct, then Kydland and Prescott would have found that credit is extended by the banks (i.e. loaned out to customers) after the banks received infusions of money from the government. Instead, they found that the extension of credit preceded the receipt of government monies.

 

Keen explained in an interview Friday that 25 years of research shows that creation of debt by banks precedes creation of government money, and that debt money is created first and precedes creation of credit money.

 

As Mish has previously noted:

Conventional wisdom regarding the money multiplier is wrong. Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.

This angle of the banking system has actually been discussed for many years by leading experts:

 

“[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts.”
- 1960s Chicago Federal Reserve Bank booklet entitled “Modern Money Mechanics”

 

“The process by which banks create money is so simple that the mind is repelled.”

- Economist John Kenneth Galbraith

 

“[W]hen a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan. The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone. It’s new money, created by the bank for the use of the borrower.”

- Robert B. Anderson, Secretary of the Treasury under Eisenhower, in an interview reported in the August 31, 1959 issue of U.S. News and World Report

 

“Do private banks issue money today? Yes. Although banks no longer have the right to issue bank notes, they can create money in the form of bank deposits when they lend money to businesses, or buy securities. . . . The important thing to remember is that when banks lend money they don’t necessarily take it from anyone else to lend. Thus they ‘create’ it.”

-Congressman Wright Patman, Money Facts (House Committee on Banking and Currency, 1964)

 

“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented.”

- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.

 

“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created — brand new money.”

- Graham Towers, Governor of the Bank of Canada from 1935 to 1955.

I’ve also noted:

In First National Bank v. Daly (often referred to as the “Credit River” case) the court found that the bank created money “out of thin air”:

[The president of the First National Bank of Montgomery] admitted that all of the money or credit which was used as a consideration [for the mortgage loan given to the defendant] was created upon their books, that this was standard banking practice exercised by their bank in combination with the Federal Reserve Bank of Minneaopolis, another private bank, further that he knew of no United States statute or law that gave the Plaintiff [bank] the authority to do this.

The court also held:

The money and credit first came into existence when they [the bank] created it.

(Here’s the case file).

 

Justice courts are just local courts, and not as powerful or prestigious as state supreme courts, for example. And it was not a judge, but a justice of the peace who made the decision.

But what is important is that the president of the First National Bank of Montgomery apparently admitted that his bank created money by simply making an entry in its book …

Moreover, although it is counter-intuitive, virtually all money is actually created as debt. For example, in a hearing held on September 30, 1941 in the House Committee on Banking and Currency, then-Chairman of the Federal Reserve (Mariner S. Eccles) said:

That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.

And Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta, said:

If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.

This must-see 47 minute video provides details:

So here are the first two questions:

Do you agree that banks create credit by initiating loans, and then obtaining deposits subsequently, to comply with depository requirements? I’m not talking about the coins which governments create (in America, coins represent less than 5% of the total money in circulation).

Do you agree with Eccles and Hemphill that money is debt, in that new credit normally comes into existence when a new loan is issued?

Government Alternative

William Greider is a former Washington Post and Rolling Stone editor, and now writes for the Nation. Greider has written numerous books and articles on the economy over the course of many decades, including one of the leading books on the Federal Reserve, Secrets of the Temple.

In an article in the Nation, Greider argues that the government could solve the economic crisis by taking back the power of money creation from the banks and the Federal reserve:

For the first time in generations, [the Fed is] now threatened with popular rebellion.

 

During the past year, the Fed has flooded the streets with money–distributing trillions of dollars to banks, financial markets and commercial interests …

 

Where did the central bank get all the money it is handing out? Basically, the Fed printed it, out of thin air. That is what central banks do. Who told the Fed governors they could do this? Nobody, really–not Congress or the president. The Federal Reserve Board, alone among government agencies, does not submit its budgets to Congress for authorization and appropriation. It raises its own money, sets its own priorities.

 

Representative Wright Patman, the Texas populist who was a scourge of central bankers, once described the Federal Reserve as “a pretty queer duck.” Congress created the Fed in 1913 with the presumption that it would be “independent” from the rest of government, aloof from regular politics and deliberately shielded from the hot breath of voters or the grasping appetites of private interests–with one powerful exception: the bankers…

 

Banks are the “shareholders” who ostensibly own the twelve regional Federal Reserve banks…

 

The Federal Reserve is the black hole of our democracy–the crucial contradiction that keeps the people and their representatives from having any voice in these most important public policies. That’s why the central bankers have always operated in secrecy, avoiding public controversy and inevitable accusations of special deal-making. The current crisis has blown the central bank’s cover…

 

Altering the central bank would also give Congress an opening to reclaim its primacy in this most important matter. That sounds farfetched to modern sensibilities, and traditionalists will scream that it is a recipe for inflationary disaster. But this is what the Constitution prescribes: “The Congress shall have the power to coin money [and] regulate the value thereof.” It does not grant the president or the treasury secretary this power. Nor does it envision a secretive central bank that interacts murkily with the executive branch…

 

If Ben Bernanke can create trillions of dollars at will and spread them around the financial system, could government do the same thing to finance important public projects the people want and need? Daring as it sounds, the answer is, Yes, we can.

 

The central bank’s most mysterious power–to create money with a few computer keystrokes–is dauntingly complicated, and the mechanics are not widely understood. But the essential thing to understand is that this power relies on democratic consent–the people’s trust, their willingness to accept the currency and use it in exchange. This is not entirely voluntary, since the government also requires people to pay their taxes in dollars, not euros or yen. But citizens conferred the power on government through their elected representatives. Newly created money is often called the “pure credit” of the nation. In principle, it exists for the benefit of all];

 

In this emergency, Bernanke essentially used the Fed’s money-creation power in a way that resembles the “greenbacks” Abraham Lincoln printed to fight the Civil War. Lincoln was faced with rising costs and shrinking revenues (because the Confederate states had left the Union). The president authorized issuance of a novel national currency–the “greenback”–that had no backing in gold reserves and therefore outraged orthodox thinking. But the greenbacks worked. The expanded money supply helped pay for war mobilization and kept the economy booming. In a sense, Lincoln won the war by relying on the “full faith and credit” of the people, much as Bernanke is printing money freely to fight off financial collapse and deflation.

 

If Congress chooses to take charge of its constitutional duty, it could similarly use greenback currency created by the Federal Reserve as a legitimate channel for financing important public projects–like sorely needed improvements to the nation’s infrastructure. Obviously, this has to be done carefully and responsibly, limited to normal expansion of the money supply and used only for projects that truly benefit the entire nation (lest it lead to inflation). But here is an example of how it would work…

 

Instead, Congress should create a stand-alone development fund for long-term capital investment projects (this would require the long-sought reform of the federal budget, which makes no distinction between current operating spending and long-term investment). The Fed would continue to create money only as needed by the economy; but instead of injecting this money into the banking system, a portion of it would go directly to the capital investment fund, earmarked by Congress for specific projects of great urgency. The idea of direct financing for infrastructure has been proposed periodically for many years by groups from right and left…

 

This approach speaks to the contradiction House Speaker Pelosi pointed out when she asked why the Fed has limitless money to spend however it sees fit. Instead of borrowing the money to pay for the new rail system, the government financing would draw on the public’s money-creation process–just as Lincoln did and Bernanke is now doing.

 

The bankers would howl, for good reason. They profit enormously from the present system and share in the money-creation process. When the Fed injects more reserves into the banking system, it automatically multiplies the banks’ capacity to create money by increasing their lending (and banks, in turn, collect interest on their new loans). The direct-financing approach would not halt the banking industry’s role in allocating new credit, since the newly created money would still wind up in the banks as deposits. But the government would now decide how to allocate new credit to preferred public projects rather than let private banks make all the decisions for us.

Here are my third, fourth and fifth questions:

Do you agree with Greider that the American Constitution and/or the inherent right of sovereign nations gives the government the power and authority to itself create credit?

Do you agree with Greider that such government creation of credit need not be inflationary so long as only as much credit is created as is needed by the economy – in other words, the amount actually needed to buy goods and services?

Several monetary commentators have said that – if credit is created primarily by the government instead of private banks – that it would save the government trillions of dollars in interest. Specifically, they claim that private banks charge interest to the government to fund the government’s debt, but that the government would owe no debt on credit it creates itself.

Is that true?

What Is the Best Public Banking Option?

As I wrote in November:

AFL-CIO president Richard Trumka told Congress last week:

If the Federal Reserve were made a fully public body, it would be an acceptable alternative.

The American Monetary Institute proposes the following alternative:

Incorporate the Federal Reserve System into the U.S. Treasury where all new money would be created by government as money, not interest-bearing debt; and be spent into circulation to promote the general welfare. The monetary system would be monitored to be neither inflationary nor deflationary.

Second, halt the bank’s privilege to create money by ending the fractional reserve system in a gentle and elegant way.

All the past monetized private credit would be converted into U.S. government money. Banks would then act as intermediaries accepting savings deposits and loaning them out to borrowers. They would do what people think they do now. This Act nationalizes the money system, not the banking system.

Bloomberg News columnist Matthew Lynn writes:

The U.K. government needs to start thinking about what it will do with all the banks it now owns. The answer is simple: Hand them to the people…

Instead of selling the stakes it acquired in the financial system to other banks, or listing the shares on the stock market, it could create mutually owned societies. Royal Bank of Scotland Group Plc could be a people’s bank, owned by everyone.That would ensure more diversity, competition and stability, all goals just as worthy as getting back the money Prime Minister Gordon Brown’s government spent on bank rescues…

Sovereign nations such as the U.S. and England have the power to create credit and money (and see this, this and this). Taking the credit-creation power away from the banks and giving it back to the nation would ensure that credit is freed up for people’s use, and the stranglehold over the economy is taken away from the too big to fails.

State Public Banks

Many people argue that – given its actions – people don’t trust the federal government to create money.

Fair enough. Why not let the states do it?

Michael Moore recommends that the American people demand:

Each of the 50 states must create a state-owned public bank like they have in North Dakota. Then congress MUST reinstate all the strict pre-Reagan regulations on all commercial banks, investment firms, insurance companies — and all the other industries that have been savaged by deregulation: Airlines, the food industry, pharmaceutical companies — you name it. If a company’s primary motive to exist is to make a profit, then it needs a set of stringent rules to live by — and the first rule is “Do no harm.” The second rule: The question must always be asked — “Is this for the common good?” (Click here for some info about the state-owned Bank of North Dakota.)

As Moore notes, the state of North Dakota already has such a bank, and – because of that – North Dakota is just about the only state which is not running a huge deficit.

PhD economist and candidate for Florida governor Farid Khavari wants to create a Bank of the State of Florida, to create credit without burdening the state and its citizens with high interest charges by private banks.

See this for details.

Local Public Banks

An alternative to federal or state public banking is local public banks, as proposed by Edward Kellogg and others.

As summarized by Adrian Kuzminski:

During this time of financial and economic crisis, it is worth recalling that credible alternatives to our current financial system exist, if largely unrecognized, and deserve serious consideration…

The now-neglected 19th-century American proto-populist, Edward Kellogg … was a kind of godfather to the later populist movement on monetary issues. Perhaps the most profound of American writers on monetary issues, Kellogg advocated a decentralized but nationally regulated monetary system based on non-usurious, low-interest public loans to individuals. His vision inspired 19th-century century mutualists, greenbackers, populists, and others who sought to restructure the monetary system to redistribute wealth.

In our own day, when usurious credit in the form of private finance capital remains the dominant force in economic life, and is largely taken for granted even by educated people, the alternative Kellogg offers is more important than ever. Indeed, I suggest that Kellogg’s theory of money is the best monetary alternative we have to the baleful system under which we suffer…

Edward Kellogg (1790-1858) was a New York City businessman whose losses in the crash of 1837 led him to examine the business cycle, monetary policy, and debt. In a series of writings, Kellogg developed the idea of … having the government provide very-low-interest loans to the general public. These loans would have a uniform, fixed interest rate, established by law. They would be issued locally through a system of public credit banks he called the Safety Fund. Once issued, these low-interest loan notes would circulate as currency, replacing the privately issued banking notes of his day (which today take the form of Federal Reserve Notes)…

In his day Kellogg seems to have influenced even Abraham Lincoln who, according to historian Mark A. Lause, ” . . . had his own copy of Kellogg’s book, Labor and Capital [sic] advocating the government issuance of paper currency as a just means of redistributing wealth, and he corresponded with the author’s son-in-law.” Kellogg’s public currency was intended to end the monopoly over the discretionary issuance of money at interest, which was held then (and now) by the private banking and investment system…

Kellogg proposed to establish local public credit banks, and we might imagine one in each community. These local public credit banks would be part of the Safety Fund. Instead of money being issued (as it is now) through a privatized and centralized money-management system on a top-down basis, primarily as loans at increasing rates of interest from a central bank to major commercial banks, and then to regional and local banks, and then to the public, money in his system would be issued by local federal banks as loans directly to citizens at nominal interest on the basis of their economic prospects. Once lent out, Kellogg’s public credit notes would flow into circulation, providing the basis for a new currency backed by the assets of individual borrowers…

A centralized national currency would be replaced, in Kellogg’s system, by a locally issued currency. But that currency would everywhere be subject to common national standards, ensuring that each local public credit bank reliably issued equivalent units of currency. A dollar issued by one local public credit bank of the Safety Fund, Kellogg intended, would be worth the same as, and be freely interchangeable with, one issued by any other. The independence of local branches would be guaranteed by the discretionary power reserved to them as a local monopoly actually to loan money; the compatibility of their monies would be ensured under federal law by fixing the value of the dollar by law at 1.1 percent/year – that is, by lending money everywhere to citizens at that rate…

The goal is to establish and preserve economic decentralization. Amounts of money lent in Kellogg’s system would vary considerably from place to place, with some areas needing and creating more currency than others. The solvency of local federal public credit banks would be guaranteed by collateral put up by borrowers, and the money supply would be stabilized by repayment of loans as they came due. The interchangeability of public credit bank notes would ensure a wide circulation for the new money…

To achieve a stable currency, Kellogg insisted that this rate be fixed by law; perhaps today it would take a constitutional amendment.

Michael Hudson (Distinguished Research Professor at the University of Missouri, Kansas City, who has advised the U.S., Canadian, Mexican and Latvian governments as well as the United Nations Institute for Training and Research. He is a former Wall Street economist at Chase Manhattan Bank who also helped establish the world’s first sovereign debt fund) and Congressman Dennis Kucinich both support the federal public banking option:

On the other hand, California considered creation of a state bank modeled after North Dakota’s bank in 1977. And the Massachusetts state Senate is currently considering creation of a state public bank, and other states are currently considering creating their own state banks.

So here is my sixth question:

Do you think a federal, state or local public banking option is best?

What About Gold?

Advocates for a return to the gold standard point out that – when a currency is pegged to a hard asset such as gold – it imposes fiscal discipline. Specifically, the government cannot simply run its “printing press” if its currency has to maintain a set ratio to a hard asset, and this prevents funding of endless wars and other misadventures.

I largely agree. But advocates for public banking, on the other hand, point to the numerous depressions which have occurred during periods when the gold standard was in place.

See these short videos (I don’t necessarily agree with the conspiracy theories alleged in the first video, but only with the general question of whether we can assure that the quantity and quality of gold can be assured):

Here is my seventh and final question:

Is there any way to have a hybrid monetary system which provides the benefits of public banking with the fiscal discipline which something like a gold standard imposes?

Responses to This Essay

Steve Keen is an Associate
Professor in economics and finance at the University of Western Sydney.
He identifies as post-Keynesian, criticizing both modern neoclassical
economics and (some of) Marxian economics as inconsistent, unscientific
and empirically unsupported. The major influences on Keen’s thinking
about economics include Hyman Minsky, Piero Sraffa and Joseph Alois
Schumpeter. His recent work mostly concentrates on mathematical
modeling and simulation of financial instability. Keen writes at
DebtDeflation.com/blogs

Keen responds:

I
obviously see the need to reform the financial system, but my analysis
of how credit is created (see my “Roving Cavaliers of Credit” post: http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/)
makes me sceptical that any new system will “hold” so long as
financiers can make money by financing asset-price speculation. I
believe the experience of history should tell us that every system
we’ve tried to far has finally succumbed to a debt-financed asset-price
bubble, whose bursting has brought in at best a recession and at worst
a Depression.

 

I have therefore developed proposals to tackle the
root problem from the other side of the ledger: if financiers can
always be expected to exploit the desire of borrowers to speculate on
rising asset prices, then we have to remove that desire in the first
place.

 

The most effective way to do this would be to redesign
assets in a manner that still encouraged individual ownership and
enterprise, but made the prospects of leveraged gains on asset
speculation much less likely.

 

My two proposals are: to modify
shares so that once they are on the secondary market they expire after
a predefined period (say 25 years); and to limit the maximum leverage
that can be secured against a property to some multiple (say 10) of the
property’s annual rental income.

 

Explaining these in more detail:

 

Shares

 

Shares
purchased in an initial public offering or float would last
indefinitely while held by the original purchaser. But once these
shares were sold, they would have a defined life of (say) 25 years.

 

This would have several benefits over our current system:

 

(1)
Purchasers of shares on the secondary market would be forced to do what
the Capital Assets Pricing Model (the delusional neoclassical theory
that dominated academic finance prior to the GFC) pretended they do
now: to value shares on a sensible valuation of expected future
dividend earnings. You would only buy a share under this system if you
expected a reasonably good stream of dividends from it, because in 25
years it would expire; and

 

(2) It would encourage the act of
providing finance to new ventures. At present, the share market does a
very poor job of providing new finance, with over 99% of the
transactions being secondary market sales in search of capital gains.
With my change, the only way to secure an indefinite stream of revenue
from a new venture would be to provide it with some of its initial
capital. This proposal would drastically shift the balance in favour of
raising initial capital, which is the only truly socially beneficial
role of the stock market.

 

Property

 

The great danger with
the current system is that there is a positive feedback loop between
property prices and leverage. An increase in leverage allows a
purchaser to bid a higher price for a property, which encourages other
purchasers to come in with higher leverage again with the intention of
profiting from selling on a rising market. This is the basic mechanism
that led to the Subprime Crisis.

 

If instead there were a maximum
allowed level of leverage based on the income-earning potential of the
property being purchased, then an increase in price would cause a
reduction in leverage: if a purchaser truly wanted a given property and
was willing to pay more than ten times the annual rental income to
secure it, then he/she would necessarily have to use unleveraged funds
to do so, and the increase in price would cause a reduction in leverage.

 

Stability

 

The
real problem with other proposals–such as government-created credit,
etc.–is that without reform to the way we define capital assets, this
money can still be used to speculate on asset prices. This can lead to
asset bubbles, and those who are successful in them will gain money and
the power that comes with it. They will then be in a position to lobby
for the unwinding of the reforms that were enacted during the crisis–as
we have seen in our own lifetimes with the abolition of almost all the
Great Depression era legislation in the leadup to the GFC.

 

This
proposal would limit that prospect by preventing the formation of the
class of Ponzi Financiers in the first instance. This to me is the real
lesson of financial history: every crisis is caused by debt, the debt
is taken on by Ponzi Financiers who then accumulate the economic and
political power to reshape the system to suit themselves, leading to
its inevitable collapse. We have to stop the Ponzis at the source, and
the source is the potential for leveraged gain on asset prices.

More articles from Zero Hedge….

By Karl Denninger, The Market Ticker

This is unbelievable:

The war over mark-to-market accounting is about to get hot, again. In coming weeks, the Financial Accounting Standards Board is likely to propose that banks expand their use of market values for financial assets such as loans, according to people familiar with the matter. That departs from current practices in which banks hold loans at their original cost and create a reserve based on their own view of potential losses. 

Let’s cut the pump-monkey crap and recall for everyone exactly how that “current practice” came to be, shall we?

Back last spring as I have written about more than once, the dishonorable Mr. Kanjorsky, Barney Frank’s stooge, held a hearing in which he basically put a gun to FASB’s head and informed them that they would allow banks to mark their loans to model – or Congress would introduce a law overriding FASB.

FASB objected, but it didn’t matter.  In the end they relented.

This was the catalyst for the huge rally in the stock market.  It was a declaration of legalized accounting fraud from the people who oversee financial accounting matters.

Now, a year later, after Barney Frank comes to realize that it was precisely this “gun up your butt” approach to financial regulation that has made all efforts to modify home loans (including cramdowns) worthless, we see some effort to change things.

Why does it make modifications worthless?  Simple – a second loan behind an underwater first (e.g. a HELOC) is worth zero if the first is underwater and forecloses.  That’s because it is a subordinate lien and is only entitled to be paid (at all) if the first is fully recovered.  In a case where the first is underwater, it won’t be recovered; ergo, the second is worth exactly nothing.

But “mark to fantasy”, otherwise known (by me anyway) as legalized accounting fraud, has these banks carrying the loan on their books at or near 100 cents on the dollar.  That’s because “the loss hasn’t happened yet”, so since they’re entitled to “model” a potential outcome 30 years in the future, they can say “well property prices won’t stay down for that long, so we don’t have to take the loss!”

It’s bogus of course as the odds of someone paying on an underwater loan for a decade are close to zero.  Anything that interrupts the borrower’s cash flow – a loss of job, a medical problem, or simply being tired of taking it in the cornhole month after month while they could buy a house across town for half the price – results in a foreclosure, because the property isn’t worth enough to sell and extinguish the mortgage.

Under mark-to-market rules banks had to price these loans at the current market’s appraisal of their worth.  Thus, as home prices declined and people were more and more underwater the market price would fall toward the zero that would be recovered if the foreclosure happened.  This would in turn make the foreclosure no more damaging to the bank balance sheet than not foreclosing, and thus, the market would tend to clear.

But no!  We can’t have that!  So instead we have this fantasy.  The consequence is banks letting people live in a house that they haven’t made a payment on in a year – and sometimes two.  Nobody cares if the loan is performing or not, because it was probably sold to some poor bastard and the servicer is advancing interest payments anyway!  Moody’s, S&P and Fitch keep downgrading these bonds in a furious fusillade, but nobody cares at the bank, because the bank doesn’t hold that paper – some fool pension fund does.

(What’s left unsaid there, of course, is that said pension fund might be getting their interest payments now, but they sure as hell will not get the principal at maturity – because it doesn’t exist.  What that will do to the pension funds is obvious, but heh, so long as the banks get to lie, it’s all ok that pensioners get screwed, right?)

What the bank holds is the HELOC and they are often the servicer as well.  They have a terrible conflict of interest in this regard because if they foreclose then the HELOC is worth nothing, and they take the full dollar hit right here and now.  If that was to be done across the board with these delinquent loans my analysis shows that many banks Tier 1 common equity levels would be forced below regulatory minimums and in some cases would be destroyed altogether.  The latter would force immediate FDIC seizure.   It is thus cheaper to advance the interest payment to the bondholder and pretend, even though the payments aren’t coming in, praying that somehow the borrower who hasn’t made a payment in a year will suddenly come up with $25,000 to “come current.”  (Yeah, right.)

Let me be absolutely crystal-clear – this is an outright scam promulgated by the same jackassery in The Government (SEC, Treasury and Congress) and The Fed that led to the destruction of Lehman.  Instead of forcing these institutions to take their marks and admit to their losses they were allowed to put forward abjectly false and misleading financial statements.  In the case of Lehman it appears the law was broken.  But in the case of the big banks today Congress got the rules changed by shoving a gun up FASB’s nose so as to make the INTENTIONAL false reporting of asset values a lawful act.

This should have absolutely never, ever happened and those dishonorable knaves in Congress responsible should resign NOW.

These banks should have been taken into receivership by the FDIC and closed.  We would still have the $3 trillion we have blown trying to prop up the economy - well more than enough to pay off the depositors when the assets were liquidated.  Deposits would have been dispersed to strong community banks, lending them further strength and ability to lend to qualified borrowers.  The scam-meisters on Wall Street would have lost their jobs and been closed down, we would have taken a horrific hit in the market but it would now be over and the economy would truly be on the mend.

Instead we lied and pretended, creating a false dawn and a market rally based on nothing more than a scam.  This cannot hold indefinitely, and yet the conditions for a true recovery in those asset prices will not happen for over a decade – if ever.  If we do not stop this insanity cash flow will force the issue eventually and by then The Government will have blown its wad furiously trying to replace 10% of GDP in the private market, as it has for the last two years, and thus be unable to fund the FDIC deficiency.

The simple fact of the matter is that as I have written about for over three years I absolutely believe that if valued on market prices these banks were insolvent then and are today.  Hiding the fact of that insolvency with bogus accounting fictions does nothing to solve the problems that face us and in chokes off lending, prevents markets (especially housing and commercial real estate) from clearing and will absolutely prevent any durable economic recovery from occurring.

Oh yes, it has pumped the stock market to the moon, but the test is not whether the stock market goes to the moon – it is whether the market price reasonably reflects underlying fundamental value, and there the evidence is clear – it does not.

The danger here from continued obfuscation could not be more grave.  We may have already passed the point where the government is capable of funding the deficiency to come in the FDIC accounts, but if we do not stop this crap, it is a certainty that such will occur, exactly as did in Iceland.

More articles from the Market Ticker….

” The video below from the Wall Street Journal gets at the heart of why the bailouts have been so toxic for the economy. Banks, still laden with existing bad loans to small businesses, are unwilling to make new ones. Businesses, unable to receive credit, cannot expand or must downsize. This in turn outs a squeeze on consumers who underpin 70% of economic output.”

Read more….

By Karl Denninger, The Market Ticker

The Jenner and Block report on Lehman just keeps on giving.

Today I am going to focus on FRBNY’s culpability in the apparent Lehman fraud – that is, the role that FRBNY (and thus Tim Geithner) played in keeping an insolvent institution afloat through the use of fraudulent artifices.

We must look first to what the PDCF, or “primary dealer credit facility” was created to be.  The report does this for us:

Under the PDCF, the FRBNY would make collateralized loans to broker‐dealers, such as LBI, and in effect, act as a repo counterparty. Unlike a typical counterparty, though, with the creation of the PDCF, the FRBNY was generally understood by market participants to be the “lender of last resort to the broker‐dealers.”5332 Reflecting the fact that broker‐dealer liquidity had become increasingly dependent on overnight repos to obtain short‐term secured financing,5333 the PDCF was structured as an overnight facility.

Pursuant to the Federal Reserve Act’s requirement that a Federal Reserve Bank lend only on a secured basis, and according to the convention in repo lending, the FRBNY advanced funds against a schedule of collateral. Collateral accepted by the PDCF initially consisted of: Treasuries, government agency securities, mortgage‐backed securities issued or guaranteed by government agencies, and investment grade corporate, municipal, mortgage‐ and asset‐backed securities priced by clearing banks.5334

The FRBNY set the lending rate for PDCF advances equal to the rate charged by the Federal Reserve’s discount window, available to depository institutions.5335 In fact, the PDCF was frequently analogized to the traditional discount window, or viewed as expanding the discount window to securities broker-dealers.

In short, the PDCF was essentially an extension of the overnight repo market set up to deal with a very-specific circumstance – Bear Stearn’s near collapse, despite having valid and good, market-recognized marginable collateral that could be posted for overnight repos.

The problem is, as I noted at the time, that broker/dealers used the PDCF not as it was intended and announced but rather as a scheme to post illiquid or even trash collateral that nobody else would take in exchange for liquidity – that is, cash.

Indeed, at the time I said:

These banks could take dogsqueeze, put it in a box and slap a $1 million price tag on it, and given the utter lack of prosecutorial supervision of the law – existing law – they’d get away with it literally forever.

They could then make loans against this “value” and yet what they actually hold is worth zero.

When they ran low on cash they’d then tender that dogcrap to The Fed for a TAF or PDCF loan, and that’s ok too – our Congress simply doesn’t give a damn as the hundred million dollars in bribes, er, “campaign contributions”, insure that blatant violations of The Federal Reserve Act are not only tolerated but cheered whenever Wall Street needs more “slop” for its pigtrough – at your expense.

This was, at the time, an educated guess.  Now we know it was much more – it was fact:

Lehman did indeed create securitizations for the PDCF with a view toward treating the new facility as a “warehouse” for its illiquid leveraged loans. In March 2008, Lehman packaged 66 corporate loans to create the “Freedom CLO.”5347 The transaction consisted of two tranches: a $2.26 billion senior note, priced at par, rated single A, and designed to be PDCF eligible, and an unrated $570 million equity tranche.5348 The loans that Freedom “repackaged” included high‐yield leveraged loans,5349 which Lehman had difficulty moving off its books,5350 and included unsecured loans to Countrywide Financial Corp.5351

Lehman did not intend to market its Freedom CLO, or other similar securitizations, to investors. Rather, Lehman created the CLOs exclusively to pledge to the PDCF.5352 An internal presentation documenting the securitization process for Freedom and similar CLOs named “Spruce” and “Thalia,” noted that the “[r]epackage[d] portfolio of HY [high yield leveraged loans]” constituting the securitizations, “are not meant to be marketed.”5353 Handwriting from an unknown source underlines this sentence and notes at the margin: “No intention to market.”

It gets better.  Not only was Lehman aware that it was gaming the system it gamed public disclosure and FRBNY was aware what was going on:

Given that the press has not focused (yet) on the Fed window in relation to the [Freedom] CLO, I’d suggest deleting the reference in the summary below. Press will be in attendance at the shareholder meeting and my concern is that volunteering this information would result in a story.

So we have the company intentionally avoiding public disclosure of “a material event.”  Securities laws are supposed to prevent this sort of thing – if they’re enforced.

Did FRBNY know of this?  It sure looks that way:

The FRBNY was aware that Lehman viewed the PDCF not only as a liquidity backstop for financing quality assets, but also as a means to finance its illiquid assets.

But wait a second – that’s not what the PDCF was intended to be.  So here’s a clear statement that FRBNY knew that Lehman (and perhaps others) were in fact gaming the system and yet they did nothing about it.

Who ran FRBNY at the time?  None other than Tim Geithner.

It gets better.

Remember the “tests” of the PDCF from that time?  Those were lies too:

Lehman drew on the PDCF facility sparingly prior to its bankruptcy. Lehman accessed the PDCF seven times in the liquidity stress period that followed the Fed brokered sale of Bear Stearns to JPMorgan.5368 Both internally, and to third parties, Lehman characterized these draws as “tests,”5369 although witnesses from the FRBNY have stated that these were not strictly “tests,” but instances in which Lehman drew upon the facility for liquidity purposes.

And again, FRBNY and Tim Geithner allowed to be promulgated to the market false information about the character of the use of this facility.

Nor does it end there.  FRBNY and Tim Geithner appear to have countenanced and sat silent while Lehman deliberately and intentionally was counting assets that were encumbered in its liquidity numbers!  Specifically:

The FRBNY knew that Lehman included pledged assets in its liquidity pool, but as Lehman’s lender rather than its regulator, the FRBNY took no steps to compel Lehman to disclose the discrepancy between Lehman’s reported liquidity pool figure and the actual, smaller number.

FRBNY, however, is both a regulator and a lender.  In addition the distinction may be immaterial; if you are a party to a violation of the law and do nothing about it, you can be held accountable as an accessory before or after the fact.  In this case these false statements by Lehman appear to be nothing more than a garden-variety fraud, and it certainly appears that Tim Geithner and FRBNY were both fully-aware of what was going on and intentionally said nothing.

The report makes clear that the market was misled, and relied on the misleading statements.  Specifically:

On the basis of Lehman’s reported liquidity pool, specifically its reported size and composition of easy‐to‐monetize assets, market participants formed positive opinions of Lehman’s liquidity profile. Certain influential participants, and rating agencies in particular, cited Lehman’s liquidity pool as the basis for concluding that Lehman’s liquidity position was sound.

…

“The basis for Moody’s assessment of Lehman’s liquidity,” the report continues, “is the strength of their overall funding framework, which includes an ample liquidity cushion of high-quality unencumbered assets.”

While private parties may have no obligation to “rat out” misperceptions of the market, it is my position that a government agency or actor, irrespective of what other hats they wear, DOES have such an affirmative obligation.

The SEC has concluded:

Post earnings announcement on September 9[, 2008], Holdings’ liquidity decreased . . . from $41 billion to $25 billion – $16 billion of which was required by clearing banks at the start of the day and approximately $7 billion of which was in liquid securities that became near impossible to monetize immediately in this extremely stressed market environment -primarily because of a loss of repo capacity.

As a result, . . . ”free cash” available intra day was less than $2 billion.

With LBIE facing a projected cash shortage of $4.5 billion on September 15, Lehman had no choice but to place LBIE into administration because of potential director liability. This resulted in a cross‐default of and triggered the filing [of LBHI] on September 15.

In other words, essentially the entire liquidity pool was tied up in security agreements with various firms, and this was the proximate cause of the bankruptcy filing.

The paper makes a clear case that FRBNY was aware of both the encumbrance and Lehman’s lack of disclosure of this fact to the investment community and did nothing about it.

Here is the bottom line folks: Tim Geithner, then-head of FRBNY, is responsible as the chief executive for everything that went on there.  Whether he had personal knowledge or not is immaterial, although it is extremely difficult to believe that he would not know about the most-important issue facing the markets in the summer and early fall of 2008.

The record is clear, however, that while the NY Fed knew that (1) Lehman was gaming the PDCF with assets that other banks refused to repo against (in fact Citi called one of them “garbage”) and (2) it was encumbering its so-called “liquidity pool” with security agreements and as a consequence there was in fact no liquidity available FRBNY did nothing to alert the SEC or investors of this fact.

This paper appears to set forth several prima-facie cases of violations of Securities Laws, both on a civil and criminal level.

The further question, however, is whether culpability extends to both FRBNY and the banks with which Lehman was doing business with.  The paper also makes a prima-facie case that both FRBNY and these other banks were fully-aware of what Lehman was up to and intentionally looked the other way, deeming it “not their problem.”

This, I believe, is false. 

I cannot have constructive or actual knowledge that you have the intention of robbing a bank (breaking the law) and yet drive you to the bank.  If I continue with assisting you in the furtherance of your scheme once I become aware of it I am subject to being charged as an accessory or even as a primary criminal actor in the case.

How is this different?

Further, how is it that we can have a Treasury Secretary who, it appears, had either full or constructive knowledge of the gaming that Lehman was undertaking and yet did nothing about it, leading directly and proximately to the market meltdown in 2008.

Literal trillions of dollars were lost due to this malfeasance and misfeasance, along with millions of jobs.  Yet one of the “watchdog” agencies involved in banking clearing and regulation knew about it, did nothing, and the head of that organization now runs Treasury.

It has been my contention that Geithner was largely responsible for willful blindness in the lead-up to this mess since it began.  We now have a “smoking gun” making a clear and nearly-impossible to refute case.

I call upon prosecutors both at a State and Federal level to look into this for potential prosecution under both civil and criminal Racketeering statutes, including their counterparty banks and FRBNY.

Tim Geithner must be fired by The President.  If he refuses, then following the election in November, when I fully expect that Republicans will re-take both the House and Senate, impeachment proceedings must be brought against President Obama for his willful and intentional refusal to remove the person who this paper makes clear could have put a stop to the collapse for nearly six months and yet failed to do so.

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