Knowing Who Your Friends Are …

A friend will help you move.

Unknown photographer ‘Al Capone and associates’

A really good friend will help you move a body.

A new article from John Hussman, PhD:

Finally, the Federal Reserve has expanded the U.S. monetary base by more than 150% since the beginning of the recession. That is not a typo. The monetary base has soared from $800 billion to over $2 trillion. Much of this has been accomplished through outright purchases of mortgage-backed securities (not repurchases) and an equivalent creation of base money. Unless these securities can be sold back out into private hands for the same value that was paid to acquire them, the Fed will have effectively forced the U.S. government to make its implicit guarantee of these agency securities explicit, without the authorization of Congress. To the extent that the underlying mortgages default, the U.S. government will be forced to issue additional Treasuries to retire the mortgage backed securities now held by the Fed. Alternatively, if the U.S. does not explicitly bail out Fannie Mae and Freddie Mac to the full extent, the Fed will have created money, with no recourse, and without the equivalent backing of assets or securities on its books. In short, the Fed is now engaging in unlegislated, back-door fiscal policy.

I’m sitting here at the table beating my fist going, “Why, why … why? Why do you think they are doing this?”

I can’t believe Hussman can write this down and still dance around the obvious conclusion; the Fed is running a racket. What is the end point of the Fed’s ad hoc fiscal policy? If a policy cannot be conceived as a success at the beginning, why would it be implemented? The GSE- agencies that traded trash for cash are bankrupt, the banks that have also traded their trash for cash are either effectively bankrupt or will be as they are not making good loans. The Fed knows this as they have armies of bank examiners. The insolvent banks are receiving free money from the central bank with no strings attached! What sort of monetary (or fiscal) policy is this?

Bernanke under pressure from the Senate admits that he was wrong to not recognize the property bubble. How can he not know that the securities his organization receives from property lenders can only return to par if property prices return to bubble levels? He knows and makes the trades anyway!

What Bernanke really knows is who is friends are.

A lot of other finance observers call Bernanke and the Fed onto the carpet for monetary mis- steps: Mike Shedlock’s Fed Uncertainty Principle, Karl Denninger, as well as most of the other writers who share this space. Where I claim a distinction is this:

The observation on their part that the Fed expects the economy to return to normal at some point with a high level of energy- fueled growth. My observation is the Fed and much of finance are smart like me, they expect no such thing!

The game is over and they are taking the balls home. All of them. It’s every man for himself and devil take the hindmost.

To believe otherwise, that there is potential business growth in the future, finance would act otherwise. Banks would be aggressively marking down their own bad loans, purging their balance sheets and competitively asking the public to critique their banking functions. The aim would be to restore confidence and gain a competitive edge against other banks. Yet NO BANK is doing this; they are engaged in paper speculations, holding loans off the books until they can be sold to the Federal Reserve for cash or traded for Treasuries whereupon these are sold for cash. They wink and nod at the FDIC. They are operate like banks did in the early 1930’s, speculating on gold or other derivatives as a substitute for ordinary business until the end.

The difference was widespread uncompensated failure of banks in the Depression; free no- strings- attached funds for the banks in the present!

What Mr. Hussman refers to as compromising depositors and taxpayers to benefit bondholders. He’s too careful to come right out and say the Fed is running a money laundering operation.

We have a situation where the Federal Reserve engages in a widespread international campaign to devalue the dollar, to make it cheap and generate revulsion overseas – 75% of US currency holdings are overseas – and to call it home where it can be swapped for worthless securities.

Where the Fed’s primary dealers pump up equities markets to facilitate the laundering of worthless stocks such as AIG and C  into cash. Where the Fed buys Treasuries directly to turn the government debt market into a cash fountain. Where the Fed swaps dollars overseas to unknown proxies under unknown terms to benefit unknown parties. Where these and other practices could never be consistent with prudent monetary practices as the consequences have repeatedly led to default and money panics … yet the Fed does just these things!

By its actions the Fed and its closed circle of cronies has made a bet against the finance future of this country. Having made the bet – that the finance casino has run its course – the insiders are cashing out. The manner of their cashing out suggests they have no intention of coming back.

No intention of coming back! Hello!

At the practical level, cash and ‘power money’ is fleeing the economy. The outcome of the money laundry added to the general deflationary shrinkage of lending multipliers and the tailing off of fiscal stimulus is effective monetary tightening. Interest rates are on the razor’s edge. Less public borrowing and high fuel costs are pushing on them. Money costs overseas are also rising. Japan pushes to devalue the Yen … the circle closes on the short- dollar trade.

If Bernanke is not re- confirmed, the Fed money racket will likely collapse. Any replacement will be more of a dollar bull. The Senate vote in January becomes very important.

The consequences of a Bernanke exit will mark the end of current ‘mystery markets’ where trading action defies sense and sensibility. Interest rates will rise whether the Fed acquiesces or not. Stocks will decline along with the other ‘laundry’ trades. There will be more business failures and earnings will reflect the current, fuel constrained growth prospects. Gravity – and thermodynamics – will assert itself.

Hussman does come out and predicts an equities correction. He’s being cautious and speaks ‘fund manager- ese’; he’s also realistic. Our markets are now crime scenes. All that is needed is the yellow tape.

4 thoughts on “Knowing Who Your Friends Are …

  1. Blue Peter

    A very chilling post, Steve.

    To take the other side, though, can this be accounted for by cock-up rather than conspiracy? To quote that former head of Citi (?), "when the music plays, you gotta dance." If central banks are throwing zero interest money at you, why not make hay now and worry about cleaning your books up later? I bet that making hay now is more profitable in the short-term for the individuals involved (and damn the banks and shareholders), and the medium- long-term can be looked after by someone else.

    And to take the central bankers' perspective, what else could they do. Lehman was thrown under / got caught under the wheels and that almost took down everything. Better to extend and pretend and hope that something turns up.

    Though again, my understanding of the plot of the film '2012' is: big, inevitable disaster coming (in 2012…sounds about right), but there is a way to safety if you're rich enough. Perhaps that is a true mirror for our times?

    Peter

  2. Steve From Virginia

    I don't think there are simple errors because there have been other banking crises before and relief to banks and other finance businesses has always carried stringent conditions. Soundness has always been a pre- requisite.

    The Fed doesn't expect to be repaid. It's repurchase efforts are minuscule. I just cannot conceive of a 'mistake' that allows the Fed to lend on a non- recourse basis over a sustained period of time. The Fed has rules, they are supposed to lend against Treasuries or 'triple- A rated commercial instruments' as collateral. Certainly in emergencies, lesser collateral has been accepted but the emergency is over and prior lending has required repayment.

    The Fed refuses to divulge what collateral it has accepted, what makes up its reserves, who its overseas swap counterparties are and in what amounts, how much it has 'lent' as 'capital in fact' to its major clients. Nobody knows how much stock or private bond issue the Fed is buying (through its proxies). The Fed has something to hide.

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