A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Saturday, March 13, 2010

The Demand Side Podcast in for Repair, plus transcirpt of 3.12.10 Idiot of the Week: Fed Groupthink

Podcast down for a few days. The system we use to produce Demand Side, the podcast, is in for repair. Don't look for the podcast until 3.17.10. Sorry for the inconvenience.

That said, we did record one for Friday 3.12.10. Here is the transcript.

366 Crossner Idiot

Today, Idiot of the Week, featuring the group think of the Federal Reserve. We go on at length after a few short notes. First,

from a piece entitled Bill Black’s Top Ten Ways to Crack Down on Corporate Financial Crime. (link online) Ninety-five percent of criminologists study blue collar crime. Five percent study white collar crime. Of the tiny minority who study white collar crime, ninety five percent focus on the individuals who rip off the corporation. We are left with a small handful of criminologists – think Edwin Sutherland, John Braithwaite, Gil Geis – who have studied or are studying – corporate crime. That would be crime by the corporation. Bill Black is one of the most prominent of those living corporate criminologists. His specialty – control fraud. Control fraud is when the CEO of a company uses the corporation as a weapon to commit fraud....

And here by way of Calculated Risk,

From James Sterngold at Bloomberg: ‘On the Edge’ Banks Facing Writedowns After FDIC Loan Auctions (ht jb)

A Federal Deposit Insurance Corp. plan to auction more than $1 billion in assets seized from failed banks next month ... may trigger writedowns that weaken lenders nationwide.
The auctions may have wider repercussions. Of the $50.4 billion in loans seized from failed banks currently held by the FDIC, 63 percent involve participation by other lenders, according to data provided by agency spokesman Greg Hernandez.

“These banks can’t believe that the regulator they pay to protect them is going to sell these loans to someone who can flip them and cause them serious losses,” said Robert Reynolds, a lawyer at Reynolds Reynolds & Duncan LLC in Tuscaloosa, Alabama, ... “Our banks just cannot believe they’re being treated in a way that ultimately hurts the FDIC’s insurance fund, because some of them are right on the edge.”
“We have a number of banks teetering on the edge, and we don’t need this problem,” [John J. Collins, president of Community Bankers of Washington in Lakewood, Washington] said in an interview.

As CR says, "This problem" is many small and regional banks are carrying loans above market value. The FDIC auction will establish market value, and that will probably lead to significant losses for many banks - and more bank failures.

This is not a cause of the banks problems, obviously, it is a cause of their not being on the same life support program as the big banks. Look for this kind of whining to get angrier if some of the bigger not too big banks begin to fall.

Meanwhile, evidence continues to mount that banks have a moratorium on lending to the real economy, particularly smaller businesses, while at the same time they are carrying mortgage loans on their books that are not performing. The homeowners are in their homes not making payments. This is balance sheet paralysis.

Leading us into the Idiot of the Week,

The original taping of today's idiot of the week involved words like numbskulls, meatheads, peabrains, and other such less than polite terms. But we had time to reconsider before air. What was useful in that kind of commentary? True, the Fed's forecasts are worse than useless. True, the monetary policy they have employed so far in the crisis involves mostly making available cheap chips to the financial sector on one end while paying off that sector's bad debts on the other. True, there has been no inclination to review and evaluate these policies in the light of their not working. Rather it is a sign of strength and fortitude and conviction that they persist. "The problem was worse than we thought," and "Forecasting is such an inexact science." "Besides, new data is coming out tomorrow showing how right we were."

But we have decided not to call them names, but to look deeper and find the pith or the patterns. Which we did. Indeed. And indeed, here is the "apparel indicator of policy and practice non-performance."

Rich in alliteration, this theory begins with the empirical observation that the more soberly dressed the banker, the more he is likely to act recklessly, the riskier and less responsible will be his practices. There is confirming evidence in the architecture, where the more auspicious the structure housing a financial institution, the closer to back room loan sharking is the practice within. Bringing this into the economics profession is a short step. We have r-squared nearing one when we seen that the more well-tailored and closer to the Federal Reserve, the less astute and more fly-by-night the practices.

Of course, this is not entirely new ground. It was suggested by the observation of either Keynes or the elder Galbraith, who noted that proximity to money conveys the delusion of competence in economics. This delusion persists in spite of all evidence to the contrary.

If we were to apply Karl Popper's postulate that forecasts and explanations are symmetrical and reversible, we would be compelled to examine our predictions in light of outcomes. Instead, since we -- at the Fed -- know our predictions and theories are substantially correct, we are free to adjust the outcomes. This is how we transition from "There is no problem" in 2007 to "We avoided the Great Depression" in 2009. And how, in Joseph Stiglitz famous anecdote, a senior Fed official can stand in front of Davos and say, "Nobody saw it coming," when facing him in the front row is a line of economists who did see it coming and said so repeatedly.

So let's let that more dispassionate and objective analysis replace our epithets of numbskulls, meatheads, peabrains, and continue with our dignity intact.

Today's idiot of the week is only a representative of the nearly universal error running through the Fed and only the latest in a string of examples we've had up here on Demand Side.

For the first nine-tenths of the Greenspan chairmanship the Fed was the acknowledged seat of probity and wisdom regarding all things economic. They resisted all criticism, pointing to the performance of the economy under their purported direction. If stagnant to the middle class and toxic to the poor, at least the Greenspan economy provided incentives for the wealthy to innovate and kept up the top line number -- GDP -- at respectable levels.

Now, more and more, they are seen as the enablers if not the culprits in the housing bubble and bust and in the collapse of the financial sector.

Rather than review and reassess in the scale needed, Fed officials are now pointing fingers and claiming, as you'll hear in a moment that they saved us from the second Great Depression and their previously high standing is still deserved.

No change in understanding is required. We just need to pour more money down the rat-hole and pretty soon things will float right back up to their former fine condition.

No PhD is required to see that the banking sector's free market experiment was a disaster. No higher math is necessary to see that dilapidated infrastructure, undereducated populations, misapplied capital and massive unemployment are not the result of the high cost of government, but of Market Fundamentalists and predatory capitalists corrupting government, failing to deliver on their promises, and delivering instead a non-functioning real economy being preyed upon by the very financial sector that delivered it.

The main branch office of the give away the store form of governance is at the Federal Reserve.

Particularly difficult for the monetary policy nabobs at the Fed is that their preferred explanation of the Depression as that the Fed of that time got it wrong. That narrative then goes on to explain that Milton Friedman then analyzed the situation and corrected monetary policy and now the Fed operates in an enlightened manner. As Ben Bernanke once said to Anna Schwartz, Friedman's wife and collaborator, "He was right, we got it wrong. We understand now and we won't do it again."

The more correct narrative and the likely historical verdict is that Friedman and the Fed and the Monetarists went exactly the wrong way, preferring to blow up a series of asset bubbles for the benefit of the financial sector rather than operate a vanilla system and let real economy investment and production take the lead.

It must be particularly galling to Bernanke that his magnum opus, the hypothesis that saving the banking institutions will save the economy ushered in the Great Stagnation. I remind you Bernanke's is only a hypothesis. It served him well in terms of getting a good job, but it is more than likely that it will put him ahead of even Alan Greenspan on the numbskulls list.

Still, how much more are we the fools who sit and listen even after the evidence is in, impressed, no doubt, by the fine quality of the suits they wear.

But here, finally, representing the Fed on this edition of the idiot of the week, Randall Crossner, who left the Fed's board in January 2009, and is now a professor at ... the University of Chicago.


This is the reference to the trillion dollar plus purchase of mortgage backed securities, likely the worst of the MBS's. Bernanke and crew decided buying these CDOs would give them market value, aiding the banks and others who were carrying them, and stimulating the housing market and hence the collapse of household balance sheets. There WAS a sharp hiccup in the down-slope of housing at about minus 30, but at is over. Now the decline has resumed. The Fed has more than a trillion dollars of probably illegally purchased securities to unwind. How indeed?


Well, yes, the short-term facilities were basically rolled over into the MBS purchase program. No trillion dollars disappeared from the Fed's balance sheet. It has just been traded.


Before Mr. Crossner runs this sentence into an area where it doesn't connect, let's notice the panic. "Save the economy." Look out the window. Is the economy saved? But the banking institutions who brought us the mess still have zombie life.


And just as I had mentioned before, the Fed's balance sheet did not shrink, but instead moved into more risk with the same money -- to the benefit of the sellers of junk mortgage securities. We need to look at Crossner's "timing" as a variation of "We kicked the can down the road, Now What do we do?"


This is garbage economics. Short-term focus is code for tax breaks. Tax breaks didn't work as stimulus. People saved them. "The whole point?" The point was to get the economy going. This did not happen to the extent it needs to precisely because the stimulus was modest and short term. Ushered in by Timely Targeted and Temporary Larry Summers.

Meanwhile the Fed's monetary stimulus has done nothing - zero - nada - for the real economy. They may point with pride to the facades of the big banks, bigger than ever, but these institutions are serving no financial purpose. And they will continue to simply bleed the real private economy (not unlike Big Pharma and Insurance continue to bleed the health care economy) as long as the Fed keeps them upright. These guys are the problem, not any emblem of success.


Greece, as the victim or vehicle for derivatives and the object of speculative attack, is connected in a way far different than Mr. Crossner suggests. As to the chickens coming home to roost, the huge debt of governments is not on the scale of or of the economy-crushing character of the private debt, which is the Fed's malfeasance and nonfeasance coming home to roost.


And that research with its attendant hypotheses pointed to not bailing out the big banks -- which were as complicit in the crash of the 1930s as they are today -- that research did not -- and still does not -- admit the asset price deflation as being rooted in the tremendous private debt.

"We had to act or have a Great Depression" is a kind of black-white, numbskull ... oops ... absence of critical thinking that epitomizes the Fed. Never on the radar were policy prescriptions like winding down the insolvent and profligate banks, reducing them in size rather than propping them up. Now it's "If we can only dump these garbage MBS's, we will have done our job."

The U.S. has no viable banking sector today, in the sense of one doing the job of a financial sector. This condition is not the preferable alternative to the Great Depression. It is the unnecessary by-product of the remedy.


This sound to me like:

1. We were panicking
2. We were out of our depth
3. We were isolated
4. We needed to flood the system with liquidity because that's what Cap'n Greenspan did.
5. Let's not talk about the cheap money, the predation of private households and businesses. Just remember, we saved the civilized world because, well, we did something

Randall Crossner, the Federal Reserve Groupthink, idiot of the week!

1 comment:

  1. I hope you get the podcast up and running soon. I am definitely missing it! Over the past year, I have learned so much from you and I really appreciate the content and the manner in which you deliver it.

    Keep up the good work and I look forward to your return!

    A loyal listener.