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Why This Harvard Economist Is Pulling All His Money From Bank Of America | Zero Hedge

Why This Harvard Economist Is Pulling All His Money From Bank Of America | Zero Hedge.

A classicial economist… and Harvard professor… preaching to the world that one’s money is not safe in the US banking system due to Ben Bernanke’s actions? And putting his withdrawal slip where his mouth is and pulling $1 million out of Bank America? Say it isn’t so…

From Terry Burnham, former Harvard economics professor, author of “Mean Genes” and “Mean Markets and Lizard Brains,” provocative poster on this page and long-time critic of the Federal Reserve, argues that the Fed’s efforts to strengthen America’s banks have perversely weakened them. First posted in PBS.

Is your money safe at the bank? An economist says ‘no’ and withdraws his

Last week I had over $1,000,000 in a checking account at Bank of America. Next week, I will have $10,000.

 

Why am I getting in line to take my money out of Bank of America? Because of Ben Bernanke and Janet Yellen, who officially begins her term as chairwoman on Feb. 1.

Before I explain, let me disclose that I have been a stopped clock of criticism of the Federal Reserve for half a decade. That’s because I believe that when the Fed intervenes in markets, it has two effects — both negative. First, it decreases overall wealth by distorting markets and causing bad investment decisions. Second, the members of the Fed become reverse Robin Hoods as they take from the poor (and unsophisticated) investors and give to the rich (and politically connected). These effects have been noticed; a Gallup poll taken in the last few days reports that only the richest Americans support the Fed. (See the table.)

Gallup poll

Why do I risk starting a run on Bank of America by withdrawing my money and presuming that many fellow depositors will read this and rush to withdraw too? Because they pay me zero interest. Thus, even an infinitesimal chance Bank of America will not repay me in full, whenever I ask, switches the cost-benefit conclusion from stay to flee.

Let me explain: Currently, I receive zero dollars in interest on my $1,000,000. The reason I had the money in Bank of America was to keep it safe. However, the potential cost to keeping my money in Bank of America is that the bank may be unwilling or unable to return my money.

They will not be able to return my money if:

  • Many other depositors like you get in line before me. Banks today promise everyone that they can have their money back instantaneously, but the bank does not actually have enough money to pay everyone at once because they have lent most of it out to other people — 90 percent or more. Thus, banks are always at risk for runs where the depositors at the front of the line get their money back, but the depositors at the back of the line do not. Consider this image from a fully insured U.S. bank, IndyMac in California, just five years ago.
  • Some of the investments of Bank of America go bust. Because Bank of America has loaned out the vast majority of depositors’ money, if even a small percentage of its loans go bust, the firm is at risk for bankruptcy. Leverage, combined with some bad investments, caused the failure of Lehman Brothers in 2008 and would have caused the failure of Bank of America, AIG, Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Stearns, and many more institutions in 2008 had the government not bailed them out.

In recent days, the chances for trouble at Bank of America have become more salient because of woes in the emerging markets, particularly Argentina, Turkey, Russia and China. The emerging market fears caused the Dow Jones Industrial Average to lose more than 500 points over the last week.

Returning to my money now entrusted to Bank of America, market turmoil reminded me that this particular trustee is simply not safe. Or not safe enough, given the fact that safety is the reason I put the money there at all. The market turmoil could threaten “BofA” with bankruptcy today as it did in 2008, and as banks have experienced again and again over time.

If the chance that Bank of America will not return my money is, say, a mere 1 percent, then the expected cost to me is 1 percent of my million, or $10,000. That far exceeds the interest I receive, which, I hardly need remind depositors out there, is a cool $0. Even a 0.1 percent chance of loss has an expected cost to me of $1,000. Bank of America pays me the zero interest rate because the Federal Reserve has set interest rates to zero. Thus my incentive to leave at the first whiff of instability.

Surely, you say, the federal government is going to keep its promises, at least on insured deposits. Yes, the Federal Government (via the FDIC) insures deposits in most institutions up to $250,000. But there is a problem with this insurance. The FDIC currently has far less money in its fund than it has insured deposits: as of Sept. 1, about $41 billion in reserve against $6 trillion in insured deposits. (There are over $9 trillion on deposit at U.S. banks, by the way, so more than $3 trillion in deposits is completely uninsured.)

It’s true, of course, that when the FDIC fund risks running dry, as it did in 2009, it can go back to other parts of the federal government for help. I expect those other parts will make the utmost efforts to oblige. But consider the possibility that they may be in crisis at the very same time, for the very same reasons, or that it might take some time to get approval. Remember that Congress voted against the TARP bailout in 2008 before it relented and finally voted for the bailout.

Thus, even insured depositors risk loss and/or delay in recovering their funds. In most time periods, these risks are balanced against the reward of getting interest. Not so long ago, Bank of America would have paid me $1,000 a week in interest on my million dollars. If I were getting $1,000 a week, I might bear the risks of delay and default. However, today I am receiving $0.

So my cash is leaving Bank of America.

But if Bank of America is not safe, you must be wondering, where can you and I put our money? No path is without risk, but here are a few options.

  1. Keep some cash at home, though admittedly this runs the risk of loss or setting yourself up as a target for criminals.
  2. Put some cash in a safety box. There is an urban myth that this is illegal; my understanding is that cash in a safety box is legal. However, I can imagine scenarios where capital controls are placed on safety deposit box withdrawals. And suppose the bank is shut down and you can’t get to the box?
  3. Pay your debts. You don’t need to be Suze Orman to know that you need liquidity, so do not use all your cash to pay debts. However, you can use some surplus, should you have any.
  4. Prepay your taxes and some other obligations. Subject to the same caveat about liquidity, pay ahead. Make sure you only pay safe entities. Your local government is not going away, even in a depression, so, for example, you can prepay property taxes. (I would check with a tax accountant on the implications, however.)
  5. Find a safer bank. Some local, smaller banks are much safer than the “too-big-to-fail banks.” After its mistake of letting Lehman fail, the government has learned that it must try to save giant institutions. However, the government may not be able to save all failing institutions immediately and simultaneously in a crisis. Thus, depositors in big banks face delays and defaults in the event of a true crisis. (It is important to find the right small bank; I believe all big banks are fragile, while some small banks are robust.)

Someone should start a bank (or maybe someone has) that charges (rather than pays) interest and does not make loans. Such a bank would be a good example of how Fed actions create unintended outcomes that defeat their goals. The Fed wants to stimulate lending, but an anti-lending bank could be quite successful. I would be a customer.

(Interestingly, there was a famous anti-lending bank and it was also a “BofA” — the Bank of Amsterdam, founded in 1609. The Dutch BofA charged customers for safe-keeping, did not make loans and did not allow depositors to get their money out immediately. Adam Smith discusses this BofA favorably in his “Wealth of Nations,” published in 1776. Unfortunately — and unbeknownst to Smith — the Bank of Amsterdam had starting secretly making risky loans to ventures in the East Indies and other areas, just like any other bank. When these risky ventures failed, so did the BofA.)

My point is that the Federal Reserve’s actions have myriad, unanticipated, negative consequences. Over the last week, we saw the impact on the emerging markets. The Fed had created $3 trillion of new money in the last five-plus years — three times more than in its entire prior history. A big chunk of that $3 trillion found its way, via private investors and institutions, into risky, emerging markets.

Now that the Fed is reducing (“tapering”) its new money creation (now down to $65 billion a month, or $780 billion a year, as of Wednesday’s announcement), investments are flowing out of risky areas. Some of these countries are facing absolute crises, with Argentina’s currency plummeting by more than 20 percent in under one month. That means investments in Argentina are worth 20 percent less in dollar terms than they were a month ago, even if they held their price in Pesos.

The Fed did not plan to impoverish investors by inducing them to buy overpriced Argentinian investments, of course, but that is one of the costly consequences of its actions. If you lost money in emerging markets over the last week, at one level, it is your responsibility. However, it is not crazy for you to blame the Fed for creating volatile prices that made investing more difficult.

Similarly, if you bought gold at the peak of almost $2,000 per ounce, you have lost one-third of your money; you share the blame for your golden losses with Alan Greenspan, Ben Bernanke and Janet Yellen. They removed the opportunities for safe investments and forced those with liquid assets to scramble for what safety they thought they could find. Furthermore, the uncertainty caused by the Fed has caused many assets to swing wildly in value, creating winners and losers.

The Fed played a role in the recent emerging markets turmoil. Next week, they will cause another crisis somewhere else. Eventually, the absurd effort to create wealth through monetary policy will unravel in the U.S. as it has every other time it has been tried from Weimar Germany to Robert Mugabe’s Zimbabwe.

Even after the Fed created the housing problems, we would have been better of with a small 2009 depression rather than the larger depression that lies ahead. See my Making Sen$e posts “The Stockholm Syndrome and Printing Money” and “Ben Bernanke as Easter Bunny: Why the Fed Can’t Prevent the Coming Crash” for the details of my argument.

Ever since Alan Greenspan intervened to save the stock market on Oct. 20, 1987, the Fed has sought to cushion every financial blow by adding liquidity. The trouble with trying to make the world safe for stupidity is that it creates fragility.

Bank of America and other big banks are fragile — and vulnerable to bank runs — because the Fed has set interest rates to zero. If a run gathers momentum, the government will take steps to stem it. But I am convinced they have limited ammunition and unlimited problems.

What is the solution? For you, save yourself and your family. For the system, revamp the Federal Reserve. The simplest first step would be to end the dual mandate of price stability and full employment. Price stability is enough. I favor rules over intervention. We don’t need a maestro conducting monetary policy; we need a system that promotes stability and allows people (not printing presses) to make us richer.

FOMC Ignores EM Crisis, Tapers Another $10 Billion | Zero Hedge

FOMC Ignores EM Crisis, Tapers Another $10 Billion | Zero Hedge.

Consensus that the Fed would extend its $10bn taper from December with a further $10 bn taper today (reducing the monthly flow to a ‘mere’ $65 billion per month – $30bn MBS, $35bn TSY) was spot on. We suspect the view, despite the clear interconnectedness of markets (and flows), of the FOMC is that “it’s not our problem, mate” when it comes to EM turmoil.

  • *FED TAPERS BOND BUYING TO $65 BLN MONTHLY PACE FROM $75 BLN
  • *FED SAYS LABOR MARKET `MIXED,’ `SHOWED FURTHER IMPROVEMENT’

Of course, “communication” was heavy with forward guidance on lower for longer stressed. We’ll see if the market buys the dichotomy of hawkish real tapering and dovish promises…remember “tapering is not tightening.”

Pre-FOMC: S&P Futs 1775, Gold $1267, 10Y 2.71%, 2Y 35.5bps, USDJPY 102, EM FX 85.67, WTI $97.35, IG 72bps, HY $106.35

Perhaps this chart from Saxo Capital Markets ( @saxomarkets ) sums up the world best for now…

Full redline below…

How U.S. Fed chair Janet Yellen could affect Canadians – Business – CBC News

How U.S. Fed chair Janet Yellen could affect Canadians – Business – CBC News.

Janet Yellen is succeeding Ben Bernanke as the chair of the U.S. Federal Reserve.Janet Yellen is succeeding Ben Bernanke as the chair of the U.S. Federal Reserve. (Jason Reed/Reuters)

Photo of Don Pittis

Don Pittis
The Business Unit

Don Pittis has been a Fuller Brush man, a forest fire fighter and an Arctic ranger before discovering journalism. He was principal business reporter for Radio Television Hong Kong before the handover to China and has produced and reported for CBC and BBC News. He is currently senior producer at CBC’s business unit.

Janet Yellen, soon to be the new head of the world’s most powerful central bank, sure seems like a nice person. In some circles, being nice is an insult. Some Americans say Canadians are too nice – we even thank our bank machines, goes the joke. But despite all that, JanetYellen does seem nice.

Not that the outgoing chair of the U.S. Federal Reserve, Ben Bernanke, is a bad man. And surely the one before that, Alan Greenspan, meant well when he kept cutting interest rates to keep the stock and property boom alive – long past the moment when, most now agree, they should have been allowed to take a rest.

But Janet Yellen – soft-spoken, seemingly concerned about America’s disenfranchised as much as she is about stock market growth – exudes character. With Yellen assuming the role of Fed chair on Feb. 1, the question is, what does the character of a central banker mean for the economic future of the U.S., the world… and Canada?

For all the supposed clout of the U.S. central bank, the chair of the Fed does not have the power of a dictator. In a rare foray into central bank humour, comedian Rick Mercer reminds us that the levers of that power are subtle.

There is no question that Yellen is smart. That will count in her job of swinging the 19 members of the committee that makes interest rate decisions toward consensus. But it will also be helped by the feeling that she is motivated by the best intentions for the entire U.S.

Central bankers a product of their time

It may be that each of the recent central bankers was perfectly suited to their times. Greenspan, who trained at the knee of Ayn Rand, presided during the era of Greed Is Good, when everyone in the world was supposed to be fighting to get to the top of the heap.

When the house of cards suddenly collapsed, it was the turn of Ben Bernanke, a man who has made a career studying the economic mistakes that turned a 1929 market collapse into the Great Depression. He wanted to prevent the same thing from happening again, at all costs.

Now, we are in a different era. It appears that Bernanke’s strategy managed to avert a disruptive economic collapse. But one of the results of the Fed’s emergency measures was to give a giant handout to the people who Greenspan had allowed to climb to the top of the heap, creating a class divide not seen since before the Great Depression.

Like almost everyone else in the upper echelons of U.S. government, Yellen is elite, with elite friends. As she said in a revealing interview in the early 2000s with fellow University of California, Berkeley economist Kenneth Train, when she voted in favour of interest rate hikes in the 1990s, she says she felt pressure in social circles.

“Higher interest rates are things that people really don’t like,” she told Train. “I would go to parties and meet people [and people would say,] ‘I’m losing money because you’re raising interest rates and what you’re doing is harming me.'”

She goes on to say that while it drove home her personal responsibility for making rate decisions, she had to put the interests of the wider economy before those of her friends.

An easing of quantitative easing?

Yellen’s job now could have even more of an impact on her well-off friends. As I have said before, the distorting effect of Bernanke’s quantitative easing (or QE) – buying bonds to stimulate the economy when interest rates could go no lower – has been great for the stock market. But there are growing doubts that the extra injection of cash is making it into the hands of the poorer Americans who need it most.

Yellen knows she will have to cut QE eventually. But it is a scary process. You may argue whether or not QE really worked. But if buying bonds stimulated the economy, then ending the buying of bonds will definitely de-stimulate it. As with plans to halt fiscal spending in 2010,stopping a strong stimulant is effectively indistinguishable from taking a strong depressant.

As the Fed said in recently released minutes, even if reducing QE does not have a huge, direct impact on Main Street, it might cause an “unintended tightening of financial conditions if a reduction in the pace of asset purchases was misinterpreted as signaling that the Committee was likely to withdraw policy accommodation more quickly than had been anticipated.”

That’s Fed-speak for bond and mortgage markets taking fright, sending interest rates shooting up. It’s not just hypothetical. It happened once last year, just because people thought policy would change. And that wouldn’t just be bad for Americans. World bond and mortgage rates are set in the U.S., and the Canadian housing market might be severely hurt by such a shock.

If you believe, as I do, that QE is hurting a majority of Americans and Canadians, and maybe doing long-term damage to the entire society by increasing the disparity of rich and poor, Yellen has a balancing act ahead of her. Her feat must be to reduce QE as quickly as possible without scaring the markets into thinking she is doing it too quickly.

Thankfully, Yellen is appropriately humble.

“Macroeconomics, I think it’s a very useful set of tools for thinking about the economy,” she said in her interview with Train. “But in terms of our ability to know the future and forecast where things are going, that’s a very difficult thing to do. There are a lot of imponderables.”

If Yellen succeeds, it will not be a feat of strength. It will be a feat of wisdom. It will be a feat of experience. And it will depend on being nice. Nice as a Canadian. With luck, Yellen, like Greenspan and Bernanke, will be the right person for her time. The world needs a little nice.

Tracking “Bubble Finance” Risks in a Single Chart | CYNICONOMICS

Tracking “Bubble Finance” Risks in a Single Chart | CYNICONOMICS.

In his 712-page tour de force, The Great Deformation, David Stockman dissects America’s descent into the present era of “bubble finance.” He describes the housing bubble’s early stages as follows:

The American savings deficit was transparent after the turn of the century, but the Fed flat-out didn’t care. … Greenspan and his monetary central planners had a glib answer: do not be troubled, they admonished, the Chinese have volunteered to handle America’s savings function on an outsourced basis.

So instead of addressing the growing deformations of the American economy after the dot-com crash, the Fed chose to repeat the same failed trick; that is, it once again cranked up the printing presses with the intent of driving down interest rates and thereby reviving speculative carry trades in stocks and other risk assets.

Needless to say, it succeeded wildly in this wrong-headed game plan: by pushing interest rates down to the lunatic 1 percent level during 2003-2004, the Fed sent a powerful message to Wall Street that the Greenspan Put was alive and well, and that the carry trades now offered the plumpest spreads in modern history. Under the Fed’s renewed exercise in bubble finance, asset prices could be expected to rumble upward, whereas overnight funding costs would remain at rock bottom.

That is exactly what happened and the equity bubble was quickly reborn. After hitting bottom at about 840 in February 2003, the S&P 500 took off like a rocket in response to virtually free (1 percent) money available to fund leveraged speculation. One year later the index was up 36 percent, and from there it continued to steadily rise in response to reported GDP and profit growth, albeit “growth” that would eventually be revealed as largely an artifact of the housing and consumer credit boom which flowed from the very same money-printing policies which were reflating the equity markets.

In hindsight, it’s hard to refute Stockman’s perspective on the Fed’s role in the housing bubble. But that won’t stop some from trying, and especially the many academic economists beholden to the Fed. Research papers have stealthily danced around the Fed’s culpability for our crappy economy, as we discussed here.

More importantly, if Stockman is right about bubble finance, there’s more mayhem to come. Consider that denying failure and persisting with the same strategy are two sides of the same coin. Just as investors avoid the pain of admitting mistakes by holding onto losing positions, Fed officials who claim to have done little wrong are also more committed than ever to propping up asset markets with cheap money.

For those concerned about another policy failure, a key question is:  “As of today, where do we stand with respect to bubbles and bubble finance?”

We’ll compare two indicators that may help with an answer:

 

  1. Stock valuation indicator: To eliminate the problem that price-to-earnings (P/E) multiples tend to skyrocket when earnings shrink in a recession, we use price-to-peak-earnings (P/PE). This is the S&P 500 (SPY) index divided by the highest earnings result from any prior 12 month period. (See here for further discussion.)
  2. Monetary policy indicator: We use the difference between Fed policy rates (the discount rate until 1954 and fed funds rate thereafter) and inflation, averaged over the prior two years. By taking a two-year average, we capture lags in the economic effects of rate changes (commonly estimated at up to 24 months), while also smoothing out anomalies.

Here’s the data:

visualizing stock valuation 1

The chart shows that it wasn’t until the Fed’s battle with the Internet bust – described above by Stockman – that policy rates were first lowered below inflation at the same time that stocks were “fully valued” (which we defined as a P/PE above 17). The Fed had never before allowed the policy/valuation mix to drift into the chart’s bolded, upper-left quadrant.

Today, we’re well into our second experiment with that quadrant, which is a precarious place to be. It doesn’t take much analysis to see that strong policy stimulus despite an elevated price multiple is a recipe for bubbles.

In other words, the chart suggests another reason to expect the next bear market to be severe, as we discussed in “P/E Multiples, Deleveraging and the Big Experiment: Sizing Up the Next Bear Market” and again in “Bubble or Not, U.S. Stocks Are Priced to Deliver Dismal Long-Term Returns .”

Worse still, we haven’t even contemplated the Fed’s preoccupations as we head into Janet Yellen’s reign. The next time you puzzle over the transparency of the forward guidance or the timing of the taper or the transparency of the guidance for the timing of the taper (you get the idea), we suggest coming back to the data above.

In the bigger picture, interest rates alone are enough to show that we’re back in the danger zone.

Bonus chart

While the policy/valuation mix reached the chart’s bolded quadrant for the first time in 2003, you may wonder about close calls. Eliminating the bubble finance era, we find two:

visualizing stock valuation 2

The first occurred in late 1958 and 1959, and Fed Chairman William McChesney Martin met the challenge with aggressive increases in both interest rates and stock market margin requirements. Stockman discussed these policies in The Great Deformation, stressing that Martin responded to financial excess only four months after the end of a recession. Martin’s actions helped to slow lending growth while preventing asset bubbles.

The second close call occurred in 1972, when Fed Chairman Arthur Burns held the discount rate steady at a five-year low of 4.5%. Alongside President Nixon’s blunders, Burns’ dovish approach soon spawned double-digit inflation, a painful recession and a severe bear market.

Overall, four past chairmen faced a policy/valuation mix that was either headed toward or inside the bolded “danger zone” in our charts. Martin tightened preemptively and escaped unscathed. Burns and Greenspan will forever be seen to have lost the plot. The history books aren’t yet written for Ben Bernanke, but we don’t like his chances.

“Two Roads Diverged” – Wall Street’s Doubts Summarized As “The Liquidity Tide Recedes” | Zero Hedge

“Two Roads Diverged” – Wall Street’s Doubts Summarized As “The Liquidity Tide Recedes” | Zero Hedge.

From Russ Certo, head of rates at Brean Capital

Two Roads Diverged

As we know, it has been a suspect week with a variety of earnings misses.  Although I have been constructive on risk asset markets generally, equities anecdotally, as figured year end push for alpha desires could let it run into year end.  New year and ball game can change quickly.  Just wondering if a larger rotation is in order.

There is an overall considerable theme of what you may find when a liquidity tide recedes as most major crises or risk pullbacks have been precipitated by either combination of tighter monetary or fiscal policy.  Some with a considerable lag like a year after Greenspan departed from Fed helm, or many other examples.  I’m not suggesting NOW is a time for a compression in risk but am aware of the possibility, especially when Fed Chairs take victory laps, Bernanke this week.  Symbolic if nothing more.       Cover of TIME magazine?

I happen to think that 2014 is a VERY different year than 2013 from a variety of viewpoints.  First, there appears to be a dispersion of opinion about markets, valuations, policy frameworks and more. This is a healthy departure from YEARS of artificiality.  Artificiality in valuations, artificiality in market and policy mechanics and essentially artificiality in EVERY financial, and real, relationship on the planet based on central bank(s) balance sheet expansion and other measures intended to be a stop-gap resolution to  tightening financial conditions, adverse expectations of economic activity, and the great rollover….of both financial and non-financial debt financing.       Boy, what a week in the IG issuance space with over $100 billion month to date, maybe $35 billion on the week.        Debt rollover on steroids.

Beneath the veneer of market aesthetics, I already see fundamental (and technical) relevance.  This could be construed as an optimist pursuit or reality that markets are incrementally transcending reliance and/or dependence on the wings of central bank policy prerogatives.  The market bird is trying to fly on its own with inklings of a return to FUNDAMENTAL analysis.  A good thing, conceptually, and gradualist development of passing the valuation baton back to market runners.  A likely major pillar objective of policy despite more than a few critics worried about seemingly dormant lurking imbalances created by immeasurable policy and monetary and fundamentally skewed risk asset relationships globally.

This exercise of summarization of ebb and flow and comings and goings of markets and policy naturally funnels a discussion to what stature of central bank policy currently or accurately exists?  Current events.  What is the accurate stage of policy?

I actually think this is a more delicate nuance than I perceive viewed in overall market sentiment. Granted, we have taken a major step for mankind, which is the topical engagement of some level of scope or reduction of liquidity provisioning,” not tightening.”  Tip of the iceberg communique with markets to INTRODUCE the concept of stepping off the gas but not hitting the break.  Reeks of fragility to me but narrative headed in right direction to stop medicating the patient, the global economy.

Some markets have logically responded in kind.  The highest beta markets as either beneficiaries or vulnerable to monetary policy changes, the emerging markets, have reflected at least the optics of change with policy.  More auditory than optics in hearing a PROSPECTIVE change in garbled Fedspeak.  The high flyer currencies which capture the nominal flighty hot money flows globally affirmed the Fed message.

In literally the simplest of terms, the G7 industrialized, not peripheral; interest rate complex has simply moved the needle in form of +110 basis point higher moves in nominal sovereign interest rates.  And there are a bevy of other expressions which played nicely and rightly conformed to the messages coming out of the central bank sandbox.  But there are ALSO notable dichotomies, which send a different or even the opposite message.

I perceive a deviation in perception of message as some markets or market participants appear to be betting on taper or a return to normalcy in global growth or U.S. growth outcomes???  OR no taper, or conversely QE4 or whatever.  Sovereign spreads have moved materially tighter vs. industrial and supposed risk free rates (Tsys, Gilts, Bunds) both last year and in the first three weeks of 2014. Something a new leg of QE would represent, not a taper.   A different year!!!

There have been VERY reliable risk asset market beta correlations over the last 5 years and sovereign or peripheral spreads have been AS volatile and correlated as any asset class.  These things trade like dancing with a rattle-snake.  Greece, Spain, France etc.  They can bite you with fangs.  They have been meaningfully more correlated to high yield spreads and yields and to central bank balance sheet expansion as nearly any asset class.  So, the infusion of central bank liquidity into markets has seen “relief” rallies in peripherals and one would think the converse would be true as well.  The valuations have represented the flavor and direction of risk on/risk off or liquidity on/liquidity off reliably for many months/years.

But I THOUGHT markets were deliberating tapering views and expressions as validated by some good soldier markets BUT that is not necessarily what the rally in riskiest of sovereign “credits” is suggesting.  The complex seems to be decoupling with Fed balance sheet correlation and message.  Some are OVER 100 standard deviations from the mean!  They are rich and could/should be sold.     Especially if one was to follow the obvious correlation with the direction of central bank as stated.

But look to other arena’s like TIPS breakevens which also have been correlated with liquidity and risk on/off and central bank balance sheet expansion.  Correlated to NASDAQ, HY, peripherals and the like.   BUT this complex COUNTERS what peripherals are doing.  They haven’t shown up to the punch bowl party yet.  Not invited.      This is a departure of markets that have largely and generally been in synch from a liquidity and performance correlation view.

Like gold and silver which got tattooed vis a vis down 35%+ performance last year MOSTLY, but not exclusively, due to perceptions of winds of central bank change.  BUT even within a contrary, the fact that rallies in Spain, France, Greece, and Italy reflect more of central bank easing notions, the opposite of taper.  In essence, the complex has gone batty uber-appreciation this year.  Sure, many eyeball the Launchpad physical metals marginal stabilization no longer falling on a knife but the miner bonds and the mining stocks are string like bull with significant appreciation.  This decidedly isn’t the stuff of taper which had the bond daddy’s romancing notions of 3% 10yr breaks, 40 basis point Green Eurodollar sell-offs,  emerging market rinse, and upticks in volatility amongst other things.

Equity bourses appear to be changing hands between investors with oscillating rotations which mark the first prospective 3 week consecutive sell-off in a while.  New year.  This is taper light.       Somewhere in between and further blurs the correlation metrics.

So, which is it?  Are we tapering or not and why are merely a few global asset classed pointed out here, why are they deviating or arguably pricing in different central bank prospects or scenarios or outcomes?

I’m not afraid but I am intrigued as to the fact that there may some strong opinions within markets and I perceive a widely received comfortability with taper or tightening notions, negative leanings on interest rate forecasts, a complacency of Fed call if you will.  And all of these hingings occur without intimate knowledge of the most critical variable of all, what Janet Yellen thinks? She has been awfully quiet as of late and there are many foregone conclusions or assumptions in market psyche without having heard a peep from the new MAESTRO.

Moreover, looking in the REAR view mirror within a week where multiple (two) Fed Governor proclamations, communicated and implicated notions which arguably would be considered radical in ANY other policy period of a hundred years.  How to conduct “monetary policy at a ZERO lower bound (Williams) ” and “doing something as surprising and drastic as cutting interest on excess reserves BELOW zero (Kocherlakota).”

This doesn’t sound like no stinking taper?  A tale of two markets.  To be or not to be.  To taper or not to taper.  Two roads diverged and I took the one less traveled by, and that has made all the difference.  Robert Frost.

Which is it? Different markets pricing different things.  Right or wrong, the market always has a message; listen critically.

Russ

Activist Post: The Hows and Whys of Gold Price Manipulation

Activist Post: The Hows and Whys of Gold Price Manipulation.

Paul Craig Roberts and Dave Kranzler
Activist Post

The deregulation of the financial system during the Clinton and George W. Bush regimes had the predictable result: financial concentration and reckless behavior. A handful of banks grew so large that financial authorities declared them “too big to fail.” Removed from market discipline, the banks became wards of the government requiring massive creation of new money by the Federal Reserve in order to support through the policy of Quantitative Easing the prices of financial instruments on the banks’ balance sheets and in order to finance at low interest rates trillion dollar federal budget deficits associated with the long recession caused by the financial crisis.

The Fed’s policy of monetizing one trillion dollars of bonds annually put pressure on the US dollar, the value of which declined in terms of gold. When gold hit $1,900 per ounce in 2011, the Federal Reserve realized that $2,000 per ounce could have a psychological impact that would spread into the dollar’s exchange rate with other currencies, resulting in a run on the dollar as both foreign and domestic holders sold dollars to avoid the fall in value. Once this realization hit, the manipulation of the gold price moved beyond central bank leasing of gold to bullion dealers in order to create an artificial market supply to absorb demand that otherwise would have pushed gold prices higher.

The manipulation consists of the Fed using bullion banks as its agents to sell naked gold shorts in the New York Comex futures market. Short selling drives down the gold price, triggers stop-loss orders and margin calls, and scares participants out of the gold trusts. The bullion banks purchase the deserted shares and present them to the trusts for redemption in bullion. The bullion can then be sold in the London physical gold market, where the sales both ratify the lower price that short-selling achieved on the Comex floor and provide a supply of bullion to meet Asian demands for physical gold as opposed to paper claims on gold.

The evidence of gold price manipulation is clear. In this article we present evidence and describe the process. We conclude that ability to manipulate the gold price is disappearing as physical gold moves from New York and London to Asia, leaving the West with paper claims to gold that greatly exceed the available supply.

The primary venue of the Fed’s manipulation activity is the New York Comex exchange, where the world trades gold futures. Each gold futures contract represents one gold 100 ounce bar. The Comex is referred to as a paper gold exchange because of the use of these futures contracts. Although several large global banks are trading members of the Comex, JP Morgan, HSBC and Bank Nova Scotia conduct the majority of the trading volume. Trading of gold (and silver) futures occurs in an auction-style market on the floor of the Comex daily from 8:20 a.m. to 1:30 p.m. New York time. Comex futures trading also occurs on what is known as Globex. Globex is a computerized trading system used for derivatives, currency and futures contracts. It operates continuously except on weekends. Anyone anywhere in the world with access to a computer-based futures trading platform has access to the Globex system.

In addition to the Comex, the Fed also engages in manipulating the price of gold on the far bigger–in terms of total dollar value of trading–London gold market. This market is called the LBMA (London Bullion Marketing Association) market. It is comprised of several large banks who are LMBA market makers known as “bullion banks” (Barclays, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorganChase, Merrill Lynch/Bank of America, Mitsui, Societe Generale, Bank of Nova Scotia and UBS). Whereas the Comex is a “paper gold” exchange, the LBMA is the nexus of global physical gold trading and has been for centuries. When large buyers like Central Banks, big investment funds or wealthy private investors want to buy or sell a large amount of physical gold, they do this on the LBMA market.

The Fed’s gold manipulation operation involves exerting forceful downward pressure on the price of gold by selling a massive amount of Comex gold futures, which are dropped like bombs either on the Comex floor during NY trading hours or via the Globex system. A recent example of this occurred on Monday, January 6, 2014. After rallying over $15 in the Asian and European markets, the price of gold suddenly plunged $35 at 10:14 a.m. In a space of less than 60 seconds, more than 12,000 contracts traded – equal to more than 10% of the day’s entire volume during the 23 hour trading period in which which gold futures trade. There was no apparent news or market event that would have triggered the sudden massive increase in Comex futures selling which caused the sudden steep drop in the price of gold. At the same time, no other securities market (other than silver) experienced any unusual price or volume movement. 12,000 contracts represents 1.2 million ounces of gold, an amount that exceeds by a factor of three the total amount of gold in Comex vaults that could be delivered to the buyers of these contracts.

This manipulation by the Fed involves the short-selling of uncovered Comex gold futures. “Uncovered” means that these are contracts that are sold without any underlying physical gold to deliver if the buyer on the other side decides to ask for delivery. This is also known as “naked short selling.” The execution of the manipulative trading is conducted through one of the major gold futures trading banks, such as JPMorganChase, HSBC, and Bank of Nova Scotia. These banks do the actual selling on behalf of the Fed. The manner in which the Fed dumps a large quantity of futures contracts into the market differs from the way in which a bona fide trader looking to sell a big position would operate. The latter would try to work off his position carefully over an extended period of time with the goal of trying to disguise his selling and to disturb the price as little as possible in order to maximize profits or minimize losses. In contrast, the Fed‘s sales telegraph the intent to drive the price lower with no regard for preserving profits or fear or incurring losses, because the goal is to inflict as much damage as possible on the price and intimidate potential buyers.

The Fed also actively manipulates gold via the Globex system. The Globex market is punctuated with periods of “quiet” time in which the trade volume is very low. It is during these periods that the Fed has its agent banks bombard the market with massive quantities of gold futures over a very brief period of time for the purpose of driving the price lower. The banks know that there are very few buyers around during these time periods to absorb the selling. This drives the price lower than if the selling operation occurred when the market is more active.

A primary example of this type of intervention occurred on December 18, 2013, immediately after the FOMC announced its decision to reduce bond purchases by $10 billion monthly beginning in January 2014. With the rest of the trading world closed, including the actual Comex floor trading, a massive amount of Comex gold futures were sold on the Globex computer trading system during one of its least active periods. This selling pushed the price of gold down $23 dollars in the space of two hours. The next wave of futures selling occurred in the overnight period starting at 2:30 a.m. NY time on December 19th. This time of day is one of the least active trading periods during any 23 hour trading day (there’s one hour when gold futures stop trading altogether). Over 4900 gold contracts representing 14.5 tonnes of gold were dumped into the Globex system in a 2-minute period from 2:40-2:41 a.m, resulting in a $24 decline in the price of gold. This wasn’t the end of the selling. Shortly after the Comex floor opened later that morning, another 1,654 contracts were sold followed shortly after by another 2,295 contracts. This represented another 12.2 tonnes of gold. Then at 10:00 a.m. EST, another 2,530 contracts were unloaded on the market followed by an additional 3,482 contracts just six minutes later. These sales represented another 18.7 tonnes of gold.

All together, in 6 minutes during an eight hour period, a total amount of 37.6 tonnes (a “tonne” is a metric ton–about 10% more weight than a US ”ton”) of gold future contracts were sold. The contracts sold during these 6 minutes accounted for 10% of the total volume during that 23 hours period of time. Four-tenths of one percent of the trading day accounted for 10% of the total volume. The gold represented by the futures contracts that were sold during these 6 minutes was a multiple of the amount of physical gold available to Comex for delivery.

The purpose of driving the price of gold down was to prevent the announced reduction in bond purchases (the so-called tapering) from sending the dollar, stock and bond markets down. The markets understand that the liquidity that Quantitative Easing provides is the reason for the high bond and stock prices and understand also that the gains from the rising stock market discourage gold purchases. Previously when the Fed had mentioned that it might reduce bond purchases, the stock market fell and bonds sold off. To neutralize the market scare, the Fed manipulated both gold and stock markets. (See Pam Martens for explanation of the manipulation of the stock market:http://wallstreetonparade.com/2013/12/why-didn’t-the-stock-market-sell-off-on-the-fed’s-taper-announcement/ )

While the manipulation of the gold market has been occurring since the start of the bull market in gold in late 2000, this pattern of rampant manipulative short-selling of futures contracts has been occurring on a more intense basis over the last 2 years, during gold’s price decline from a high of $1900 in September 2011. The attack on gold’s price typically will occur during one of several key points in time during the 23 hour Globex trading period. The most common is right at the open of Comex gold futures trading, which is 8:20 a.m. New York time. To set the tone of trading, the price of gold is usually knocked down when the Comex opens. Here are the other most common times when gold futures are sold during illiquid Globex system time periods:

– 6:00 p.m NY time weekdays, when the Globex system re-opens after closing for an hour;
– 6:00 p.m. Sunday evening NY time when Globex opens for the week;
– 2:30 a.m. NY time, when Shanghai Gold Exchange closes
– 4:00 a.m. NY time, just after the morning gold “fix” on the London gold market (LBMA);
– 2:00 p.m. NY time any day but especially on Friday, after the Comex floor trading has closed – it’s an illiquid Globex-only session and the rest of the world is still closed.

In addition to selling futures contracts on the Comex exchange in order to drive the price of gold lower, the Fed and its agent bullion banks also intermittently sell large quantities of physical gold in London’s LBMA gold market. The process of buying and selling actual physical gold is more cumbersome and complicated than trading futures contracts. When a large supply of physical gold hits the London market all at once, it forces the market a lot lower than an equivalent amount of futures contracts would. As the availability of large amounts of physical gold is limited, these “physical gold drops” are used carefully and selectively and at times when the intended effect on the market will be most effective.

The primary purpose for short-selling futures contracts on Comex is to protect the dollar’s value from the growing supply of dollars created by the Fed’s policy of Quantitative Easing. The Fed’s use of gold leasing to supply gold to the market in order to reduce the rate of rise in the gold price has drained the Fed’s gold holdings and is creating a shortage in physical gold. Historically most big buyers would leave their gold for safe-keeping in the vaults of the Fed, Bank of England or private bullion banks rather than incur the cost of moving gold to local depositories. However, large purchasers of gold, such as China, now require actual delivery of the gold they buy.

Demands for gold delivery have forced the use of extraordinary and apparently illegal tactics in order to obtain physical gold to settle futures contracts that demand delivery and to be able to deliver bullion purchased on the London market (LBMA). Gold for delivery is obtained from opaque Central Bank gold leasing transactions, from “borrowing” client gold held by the bullion banks like JP Morgan in their LBMA custodial vaults, and by looting the gold trusts, such as GLD, of their gold holdings by purchasing large blocks of shares and redeeming the shares for gold.

Central Bank gold leasing occurs when Central Banks take physical gold they hold in custody and lease it to bullion banks. The banks sell the gold on the London physical gold market. The gold leasing transaction makes available physical gold that can be delivered to buyers in quantities that would not be available at existing prices. The use of gold leasing to manipulate the price of gold became a prevalent practice in the 1990s. While Central Banks admit to engaging in gold lease transactions, they do not admit to its purpose, which is to moderate rises in the price of gold, although Fed Chairman Alan Greenspan did admit during Congressional testimony on derivatives in 1998 that “Central banks stand ready to lease gold in increasing quantities should the price rise.”

Another method of obtaining bullion for sale or delivery is known as “rehypothecation.” Rehypothecation occurs when a bank or brokerage firm “borrows” client assets being held in custody by banks. Technically, bank/brokerage firm clients sign an agreement when they open an account in which the assets in the account might be pledged for loans, like margin loans. But the banks then take pledged assets and use them for their own purpose rather than the client’s. This is rehypothecation. Although Central Banks fully disclose the practice of leasing gold, banks/brokers do not publicly disclose the details of their rehypothecation activities.

Over the course of the 13-year gold bull market, gold leasing and rehypothecation operations have largely depleted most of the gold in the vaults of the Federal Reserve, Bank of England, European Central Bank and private bullion banks such as JPMorganChase. The depletion of vault gold became a problem when Venezuela was the first country to repatriate all of its gold being held by foreign Central Banks, primarily the Fed and the BOE. Venezuela’s request was provoked by rumors circulating the market that gold was being leased and hypothecated in increasing quantities. About a year later, Germany made a similar request. The Fed refused to honor Germany’s request and, instead, negotiated a seven year timeline in which it would ship back 300 of Germany’s 1500 tonnes. This made it apparent that the Fed did not have the gold it was supposed to be holding for Germany.

Why does the Fed need seven years in which to return 20 percent of Germany’s gold? The answer is that the Fed does not have the gold in its vault to deliver. In 2011 it took four months to return Venezuela’s 160 tonnes of gold. Obviously, the gold was not readily at hand and had to be borrowed, perhaps from unsuspecting private owners who mistakenly believe that their gold is held in trust.

Western central banks have pushed fractional gold reserve banking to the point that they haven’t enough reserves to cover withdrawals. Fractional reserve banking originated when medieval goldsmiths learned that owners of gold stored in their vault seldom withdrew the gold. Instead, those who had gold on deposit circulated paper claims to gold. This allowed goldsmiths to lend gold that they did not have by issuing paper receipts. This is what the Fed has done. The Fed has created paper claims to gold that does not exist in physical form and sold these claims in mass quantities in order to drive down the gold price. The paper claims to gold are a large multiple of the amount of actual gold available for delivery. The Royal Bank of India reports that the ratio of paper claims to gold exceed the amount of gold available for delivery by 93:1.

Fractional reserve systems break down when too many depositors or holders of paper claims present them for delivery. Breakdown is occurring in the Fed’s fractional bullion operation. In the last few years the Asian markets–specifically and especially the Chinese–are demanding actual physical delivery of the bullion they buy. This has created a sense of urgency among the Fed, Treasury and the bullion banks to utilize any means possible to flush out as many weak holders of gold as possible with orchestrated price declines in order to acquire physical gold that can be delivered to Asian buyers.

The $650 decline in the price of gold since it hit $1900 in September 2011 is the result of a manipulative effort designed both to protect the dollar from Quantitative Easing and to free up enough gold to satisfy Asian demands for delivery of gold purchases.

Around the time of the substantial drop in gold’s price in April, 2013, the Bank of England’s public records showed a 1300 tonne decline in the amount of gold being held in the BOE bullion vaults. This is a fact that has not been denied or reasonably explained by BOE officials despite several published inquiries. This is gold that was being held in custody but not owned by the Bank of England. The truth is that the 1300 tonnes is gold that was required to satisfy delivery demands from the large Asian buyers. It is one thing for the Fed or BOE to sell, lease or rehypothecate gold out of their vault that is being safe-kept knowing the entitled owner likely won’t ask for it anytime soon, but it is another thing altogether to default on a gold delivery to Asians demanding delivery.

Default on delivery of purchased gold would terminate the Federal Reserve’s ability to manipulate the gold price. The entire world would realize that the demand for gold greatly exceeds the supply, and the price of gold would explode upwards. The Federal Reserve would lose control and would have to abandon Quantitative Easing. Otherwise, the exchange value of the US dollar would collapse, bringing to an end US financial hegemony over the world.

Last April, the major takedown in the gold price began with Goldman Sachs issuing a “technical analysis” report with an $850 price target (gold was around $1650 at that time). Goldman Sachs also broadcast to every major brokerage firm and hedge fund in New York that gold was going to drop hard in price and urged brokers to get their clients out of all physical gold holdings and/or shares in physical gold trusts like GLD or CEF. GLD and CEF are trusts that purchase physical gold/silver bullion and issue shares that represent claims on the bullion holdings. The shares are marketed as investments in gold, but represent claims that can only be redeemed in very large blocks of shares, such as 100,000, and perhaps only by bullion banks. GLD is the largest gold ETF (exchange traded firm), but not the only one. The purpose of Goldman Sachs’ announcement was to spur gold sales that would magnify the price effect of the short-selling of futures contracts. Heavy selling of futures contracts drove down the gold price and forced sales of GLD and other ETF shares, which were bought up by the bullion banks and redeemed for gold.

At the beginning of 2013, GLD held 1350 tonnes of gold. By April 12th, when the heavy intervention operation began, GLD held 1,154 tonnes. After the series of successive raids in April, the removal of gold from GLD accelerated and currently there are 793 tonnes left in the trust. In a little more than one year, more than 41% of the gold bars held by GLD were removed – most of that after the mid-April intervention operation.

In addition, the Bank of England made its gold available for purchase by the bullion banks in order to add to the ability to deliver gold to Asian purchasers.

The financial media, which is used to discredit gold as a safe haven from the printing of fiat currencies, claims that the decline in GLD’s physical gold is an indication that the public is rejecting gold as an investment. In fact, the manipulation of the gold price downward is being done systematically in order to coerce holders of GLD to unload their shares. This enables the bullion banks to accumulate the amount of shares required to redeem gold from the GLD Trust and ship that gold to Asia in order to meet the enormous delivery demands. For example, in the event described above on January 6th, 14% of GLD’s total volume for the day traded in a 1-minute period starting at 10:14 a.m. The total volume on the day for GLD was almost 35% higher than the average trading volume in GLD over the previous ten trading days.

Before 2013, the amount of gold in the GLD vault was one of the largest stockpiles of gold in the world. The swift decline in GLD’s gold inventory is the most glaring indicator of the growing shortage of physical gold supply that can be delivered to the Asian market and other large physical gold buyers. The more the price of gold is driven down in the Western paper gold market, the higher the demand for physical bullion in Asian markets. In addition, several smaller physical gold ETFs have experienced substantial gold withdrawals. Including the more than 100 tonnes of gold that has disappeared from the Comex vaults in the last year, well over 1,000 tonnes of gold has been removed from the various ETFs and bank custodial vaults in the last year. Furthermore, there is no telling how much gold that is kept in bullion bank private vaults on behalf of wealthy investors has been rehypothecated. All of this gold was removed in order to avoid defaulting on delivery demands being imposed by Asian commercial, investment and sovereign gold buyers.

The Federal Reserve seems to be trapped. The Fed is creating approximately 1,000 billion new US dollars annually in order to support the prices of debt related derivatives on the books of the few banks that have been declared to be “to big to fail” and in order to finance the large federal budget deficit that is now too large to be financed by the recycling of Chinese and OPEC trade surpluses into US Treasury debt. The problem with Quantitative Easing is that the annual creation of an enormous supply of new dollars is raising questions among American and foreign holders of vast amounts of US dollar-denominated financial instruments. They see their dollar holdings being diluted by the creation of new dollars that are not the result of an increase in wealth or GDP and for which there is no demand.

Quantitative Easing is a threat to the dollar’s exchange value. The Federal Reserve, fearful that the falling value of the dollar in terms of gold would spread into the currency markets and depreciate the dollar, decided to employ more extreme methods of gold price manipulation.

When gold hit $1,900, the Federal Reserve panicked. The manipulation of the gold price became more intense. It became more imperative to drive down the price, but the lower price resulted in higher Asian demand for which scant supplies of gold were available to meet.

Having created more paper gold claims than there is gold to satisfy, the Fed has used its dependent bullion banks to loot the gold exchange traded funds (ETFs) of gold in order to avoid default on Asian deliveries. Default would collapse the fractional bullion system that allows the Fed to drive down the gold price and protect the dollar from QE.

What we are witnessing is our central bank pulling out all stops on integrity and lawfulness in order to serve a small handful of banks that financial deregulation allowed to become “too big to fail” at the expense of our economy and our currency. When the Fed runs out of gold to borrow, to rehypothecate, and to loot from ETFs, the Fed will have to abandon QE or the US dollar will collapse and with it Washington’s power to exercise hegemony over the world.

Dave Kranzler traded high yield bonds for Bankers Trust for a decade. As a co-founder and principal of Golden Returns Capital LLC, he manages the Precious Metals Opportunity Fund.

This article first appeared at Paul Craig Roberts’ new website Institute For Political Economy.  Paul Craig Roberts was Assistant Secretary of the Treasury for Economic Policy and associate editor of the Wall Street Journal. He was columnist for Business Week, Scripps Howard News Service, and Creators Syndicate. He has had many university appointments. His Internet columns have attracted a worldwide following.

Bernanke reflects on ‘trying to avoid going off the bridge’ – Business – CBC News

Bernanke reflects on ‘trying to avoid going off the bridge’ – Business – CBC News.

Ben S. Bernanke likened the financial crisis to a car crash in his final public comments as head of the Federal Reserve Thursday.Ben S. Bernanke likened the financial crisis to a car crash in his final public comments as head of the Federal Reserve Thursday. (Bloomberg)

In his final public appearance as chairman of the Federal Reserve, Ben Bernanke took a moment to reflect on the 2008 financial crisis and compared it to surviving a bad car crash.

During an interview Thursday at the Brookings Institution, Bernanke recalled some “very intense periods” during the crisis, similar to trying to keep a car from going over a bridge after a collision.

The government had just taken over mortgage giants Fannie Mae and Freddie Mac. Lehman Brothers had collapsed. He recalled some sleepless nights working with others to try and contain the damage.

“If you’re in a car wreck or something, you’re mostly involved in trying to avoid going off the bridge. And then, later on, you say, ‘Oh my God!”‘ Bernanke said.

Term ends January 31

Bernanke will leave the Fed on Jan. 31 after eight years as chairman. His successor, Janet Yellen, will take over on Feb. 1.

In his appearance, Bernanke defended the Fed’s efforts during the crisis, which included massive purchases of Treasury bonds to push long-term interest rates lower and forward guidance to investors about how long the Fed plans to keep short-term interest rates near zero.

Critics have warned that those efforts pose great risks for higher inflation or future financial market turmoil.

But Bernanke says there has not been a problem with inflation, which is still running well below the Fed’s 2 per cent target.

Should inflation start to be a problem as the economy starts growing at faster rates, the Fed “has all the tools we need to manage interest rates” to keep inflation from getting out of hand, he said.

“Inflation is just not really a significant risk” from the bond purchases, Bernanke said.

Bernanke said the central bank was aware of potential threats to financial market stability from its massive bond holdings and is monitoring markets very closely to spot any signs of trouble. He said this threat was the one “we have spent the most time thinking about and trying to make sure that we can address” should the need arise.

But he said any concerns about financial stability did not outweigh the need to keep providing support to the economy.

The Fed announced last month that it would slightly reduce the size of its bond purchases in January from $85 billion per month down to $75 billion. And it said it would likely make further reductions at upcoming meetings, if the economy keeps improving.

The Greatest Myth Propagated About The FED: Central Bank Independence (Part 1) | New Economic Perspectives

The Greatest Myth Propagated About The FED: Central Bank Independence (Part 1) | New Economic Perspectives.

By L. Randall Wray

It has been commonplace to speak of central bank independence—as if it were both a reality and a necessity. Discussions of the Fed invariably refer to legislated independence and often to the famous 1951 Accord that apparently settled the matter. [1] While everyone recognizes the Congressionally-imposed dual mandate, the Fed has substantial discretion in its interpretation of the vague call for high employment and low inflation. For a long time economists presumed those goals to be in conflict but in recent years Chairman Greenspan seemed to have successfully argued that pursuit of low inflation rather automatically supports sustainable growth with maximum feasible employment.

In any event, nothing is more sacrosanct than the supposed independence of the central bank from the treasury, with the economics profession as well as policymakers ready to defend the prohibition of central bank “financing” of budget deficits. As in many developed nations, this prohibition was written into US law from the founding of the Fed in 1913. In practice, the prohibition is easy to evade, as we found during WWII in the US when budget deficits ran up to a quarter of GDP. If a central bank stands ready to buy government bonds in the secondary market to peg an interest rate, then private banks will buy bonds in the new issue market and sell them to the central bank at a virtually guaranteed price. Since central bank purchases of bonds supply the reserves needed by banks to buy bonds, a virtuous circle is created so that the treasury faces no financing constraint. That is what the 1951 Accord was supposedly all about—ending the cheap source of US Treasury finance.

Since the Global Financial Crisis hit in 2007 these matters have come to the fore in both the US and the European Monetary Union. In the US, discussion of “printing money” to finance burgeoning deficits was somewhat muted, in part because the Fed purportedly undertook Quantitative Easing to push banks to lend—not to provide the Treasury with cheap funding. But the impact has been the same as WWII-era finances: very low interest rates on government debt even as a large portion of the debt ended up on the books of the Fed, while bank reserves have grown to historic levels (the Fed also purchased and lent against private debt, adding to excess reserves). While hyperinflationists have been pointing to the fact that the Fed is essentially “printing money” (actually reserves) to finance the budget deficits, most other observers have endorsed the Fed’s notion that QE might allow it to “push on a string” by spurring private banks to lend—which is thought to be desirable and certainly better than “financing” budget deficits to allow government spending to grow the economy. Growth through fiscal austerity is the new motto as the Fed accumulates ever more federal government debt and suspect mortgage-backed securities.

The other case is in the EMU where the European Central Bank had long been presumed to be prohibited from buying debt of the member governments. By design, these governments were supposed to be disciplined by markets, to keep their deficits and debt within Maastricht criteria. Needless to say, things have not turned out quite as planned. The ECB’s balance sheet has blown up just as the Fed’s did—and there is no end in sight in Euroland even as the Fed has begun to taper. It would not be hyperbole to predict that the ECB will end up owning (or at least standing behind) most EMU government debt as it continues to expand its backstop.

It is, then, perhaps a good time to reexamine the thinking behind central bank independence. There are several related issues.

First, can a central bank really be independent? In what sense? Political? Operational? Policy formation?

Second, should a central bank be independent? In a democracy should monetary policy—purportedly as important as or even more important than fiscal policy—be unaccountable? Why?

Finally, what are the potential problems faced if a central bank is not independent? Inflation? Insolvency?

While this two part piece will focus on the US and the Fed, the analysis is relevant to general discussions about central bank independence. We will limit our analysis to the questions surrounding what we mean by central bank independence. We leave to other analyses the questions surrounding the wisdom of granting independence to the Fed, democratic accountability, and potential problems. We will argue here that the Fed is independent only in a very narrow sense. We have argued elsewhere that the Fed’s crisis response during the global financial crisis does raise serious issues of transparency and accountability—issues that have not been resolved with the Dodd-Frank legislation.[2] Finally, it will become apparent that we do not believe that lack of central bank independence raises significant problems with inflation or insolvency of the sovereign government.

For the US case we will draw on an excellent study of the evolution of governance of the Fed by Bernard Shull, one of the foremost authorities of the history of the Fed.[3] As we will see, the dominant argument for independence throughout the Fed’s history has been that monetary policy should be set to promote the national interest. This requires that it should be free of political influence coming from Congress. Further, it was gradually accepted that even though the Federal Open Market Committee includes participation by regional Federal Reserve banks, the members of the FOMC are to put the national interest first. Shull shows that while governance issues remain unresolved, Congress has asserted its oversight rights, especially after economic or financial crises.

I’ll also include summaries of the arguments of two insiders—one from the Treasury and the other from the Fed—that also conclude that the case of the Fed’s independence is frequently overstated. The former Treasury official argues that at least within the Treasury there is no presumption that the Fed is operationally independent. The Fed official authored a comprehensive statement on the Fed’s independence, arguing that the Fed is a creature of Congress. More recently, Chairman Bernanke has said that “of course we’ll do whatever Congress tells us to do”:  if the Congress is not satisfied with the Fed’s actions, the Congress can always tell the Fed to behave differently.[4]

In the aftermath of the GFC, Congress has attempted to exert greater control with its Dodd-Frank legislation. The Fed handled most of the US policy response to the Great Recession (or, GFC). As we have documented, most of the rescue was behind closed doors and intended to remain secret. (See Felkerson 2012; and Wray 2012)[5]  Much of it at least stretched the law and perhaps went beyond the now famous section 13(3) that had been invoked for “unusual and exigent” circumstances for the first time since the Great Depression. Congress has demanded greater transparency and has tightened restrictions on the Fed’s future crisis response. Paradoxically, Dodd-Frank also increased the Fed’s authority and responsibility. However, in some sense this is “deja-vu” because Congressional reaction to the Fed’s poor response to the onset of the Great Depression was similarly paradoxical as Congress simultaneously asserted more control over the Fed while broadening the scope of the Fed’s mission.

INDEPENDENT OF WHAT?

Most references to central bank independence are little more than vague hand-waves. In the US, the Fed is a “creature of Congress”, established by the Federal Reserve Act of 1913, which has been modified a number of times. Elected officials play a role in selecting top Fed officials. And while the Fed is nominally owned by share-holding banks, and while the Fed’s budget is separate, profits above 6% on equity are returned to Treasury. Congress also has asserted its authority to mandate that the Fed release detailed information on its operations and budget—and there seems to be nothing but Congressional timidity to stop it from demanding more control over the Fed (indeed, Dodd-Frank sanctions many of the actions taken by the Fed during the GFC, now requiring prior approval by the President, the Treasury Secretary, and/or Congress for various interventions). Further, as we will see, the Fed’s operations are necessarily closely coordinated with the Treasury’s; the Fed, after all, functions as the Treasury’s bank. Finally, as everyone knows, Congress has provided a dual mandate to guide Fed policy although one could easily interpret Congressional will as consisting of four (at least some of which are related) mandates: high employment, low inflation, acceptable growth, and financial stability.

Above I have argued that the Fed is a creature of Congress. MacLaury has put the relationship this way:

Ultimately the [Federal Reserve] System is accountable to congress, not the executive branch, even though Reserve Board members and the chairman are president-appointed. The authority and delegated policy powers are subject to review by the congress not the president, the Treasury Department, nor by banks or other interests. (p. 4)

While many supporters and critics alike have stressed the Fed’s nominal ownership by member banks as evidence that it is somehow independent of government, the Fed’s Bruce MacLaury interprets the independence as follows[6]:

First, let’s be clear on what independence does not mean. It does not mean decisions and actions made without accountability. By law and by established procedures, the System is clearly accountable to congress—not only for its monetary policy actions, but also for its regulatory responsibilities and for services to banks and to the public. Nor does independence mean that monetary policy actions should be free from public discussion and criticism—by members of congress, by professional economists in and out of government, by financial, business, and community leaders, and by informed citizens. Nor does it mean that the Fed is independent of the government. Although closely interfaced with commercial banking, the Fed is clearly a public institution, functioning within a discipline of responsibility to the “public interest.” It has a degree of independence within the government—which is quite different from being independent of government. Thus, the Federal Reserve System is more appropriately thought of as being “insulated” from, rather than independent of, political—government and banking—special interest pressures. Through their 14-year terms and staggered appointments, for example, members of the Board of Governors are insulated from being dependent on or beholden to the current administration or party in power. In this and in other ways, then, the monetary process is insulated—but not isolated—from these influences. In a functional sense, the insulated structure enables monetary policy makers to look beyond short-term pressures and political expedients whenever the long-term goals of sustainable growth and stable prices may require “unpopular” policy actions. Monetary judgments must be able to weigh as objectively as possible the merit of short-term expedients against long-term consequences—in the on-going public interest.

We can take that as our starting point: the Fed is part of government–a public institution–but is insulated from day-to-day politics and other types of special interest pressures. Let’s explore this independence in more detail, beginning with an historical perspective.

Fed Governance: Historical Perspective

Shull[7] (2014) offers a detailed history of the evolution of Fed governance. He notes that the Fed is an independent government agency like the Federal Trade Commission, the National Labor Relations Board, and the Securities and Exchange Commission. Each of these has substantial discretion in implementing laws through rules and regulations and in formulating policies. Most independent agencies have an Inspector General and are subject to Congressional oversight. The Fed is somewhat unusual in that it is self-financing and in that there is a widely held belief that if its formulation of monetary policy were not independent, the policy outcome would be worse. In other words, good monetary policy supposedly depends on independence (from Congress and the Administration).Thus, the Fed’s monetary policy is not subject to audit by the General Accountability Office—and courts have refused to hear suits that accuse the Fed of policy mistakes. In recent decades, the Administration has been reluctant even to criticize the Fed’s monetary policy. However, as we will see, that has not always been the case.

The movement to create a central bank strengthened after the Panic of 1907. Rival plans were put forward, which ranged from a bank-supported plan which would create a privately-owned central bank (like the Bank of England), to a proposal to house the US central bank within the Treasury. The Glass-Owen bill split the difference, with private ownership and a decentralized system, but with the Treasury Secretary and the Comptroller of the Currency sitting on the Board. The decentralized system was supposed to ensure “fair representation of the financial, industrial and commercial interests and geographic divisions of the country,” (quoted in Shull p. 4). The Board was to be “a distinctly nonpartisan organization and was to be wholly divorced from politics.” (ibid p. 5) According to Paul Warburg, governance was to be maintained by a “system of checks and counter-checks— a paralyzing system which gives powers with one hand and takes them away with the other.” (ibid) In other words, the idea was that by ensuring broad representation of interests, the Fed would be stymied by a “clash of interests” that would reduce the damage it might do; as Shull puts it, “The checks and balances thus constituted a form of internal governance.” (ibid p. 5) That of course sounds somewhat familiar as a typically American approach to governance.

When WWI came along, however, the Fed turned its attention to supporting the Treasury’s debt issue. In the inflationary period at the end of the war, the regional Feds raised discount rates sharply (up to 85%) and a deep retraction followed that led to deflation of farm prices. Congress revisited the governance issue as some critics wanted to force the Fed to seek Congressional approval in advance of future rate hikes. One of the Board members, Adolph Miller, understood the implication:

“The American people will never stand contraction if they know it can be helped. Least of all will they stand contraction if they think it is contraction at the instance, or with the consent of an institution like the Federal Reserve System….The Reserve System cannot ‘make’ the business situation but it can do an immense deal to make its extremes less pronounced and violent….Discount policy…should always address itself to the phase of the business cycle through which the country happens to be passing.” (quoted in Shull, p. 7)

As Shull argues, the governance by paralyzing checks and balances conflicted with the need to cooperate to use monetary policy to stabilize the economy. Congress tightened the reins on the Fed but also centralized decision-making at the Board in Washington. The GAO began to audit the Board and there were a number of Commissions and Committees that investigated new guidelines to control the Fed. However, the 1927 Pepper-McFadden Act replaced the Fed’s original 20 year charter with an indefinite charter, and a Congressional report at the time declared that the Fed had demonstrated its usefulness. In the end, Congressional anger dissipated and not much was done to constrain the Fed’s discretion.

Governance issues again came to the forefront during the Great Depression, with serious consideration given to government ownership of the Fed, to be housed in the Treasury. President Roosevelt (who seemed to have supported such a move) as well as many in Congress were concerned that the Fed was not sufficiently attune to the national interest. Title II of the Banking Act of 1935 was a compromise that preserved private ownership but moved to ensure the Board would be more responsive, focusing on the national interest. (Shull, p. 10)  As power was further centralized in Washington, the “checks-and-balances” approach to governance continued to fade.

As in WWI, WWII saw the Fed cooperating with Treasury, in the national interest to keep rates on national debt low. That ended in the famous Accord of 1951, restoring “independence” of the Fed to formulate monetary policy. However, policy was still to be undertaken in the national interest, with the Fed keeping rates very low until the mid 1960s; the Fed mainly operated in short-term Treasury bills so as to have minimum effects on other financial markets. Monetary policy remained on the backburner until the inflation-recession cycle of the early 1970s. In 1975, Congress decided to exert greater control, in House Resolution 113.

In the Federal Reserve Reform Act of 1977, the Senate insisted on the requirement that it confirm the President’s appointment of the Fed’s chairman and vice-chairman. In addition Congress required that Class B Reserve bank directors had to be “elected to represent the public”. (Shull p. 12) The 1978 Humphrey-Hawkins full Employment and Balanced Growth Act clarified the Fed’s mandates and required semi-annual reports to both the Senate and the House. Later, after Chairman Greenspan got caught in “white lies” provided to Chairman Gonzalez, the Fed was required to release its transcripts of FOMC meetings (albeit with a five year lag).[8] The Fed also voluntarily agreed to measures designed to increase transparency (including announcing its explicit interest rate target).

The final big changes to governance occurred after the GFC, when Dodd-Frank tightened limits on what the Fed can do in response to a crisis. This was a surprising turn of events, as Chairman Greenspan had become the darling of Congress and the media and his replacement, Chairman Bernanke, had declared the era of the New Moderation in which central bankers could do nothing wrong. However, in the aftermath of the crisis, many elected representatives as well as the media and the population at large blamed the Fed for the crisis and for bungling a response that made the downturn worse than it should have been. As we’ve argued elsewhere, even many of those directly involved agreed that the Fed’s crisis response “stunk” and that it should never be repeated.[9] The Dodd-Frank legislation was designed in part to ensure it would not happen again.

However, yet again, Congress actually extended Fed responsibility, to include authority over large, systemically important non-bank financial institutions. Still, the Act restricted application of Section 13(3) in future crises, and for some actions required approval from the Treasury. It also mandated increased transparency (including a review by the GAO of all the Fed’s emergency assistance after the GFC). Congress also created the Financial Stability Oversight Council that is chaired by the Treasury Secretary and includes heads of agencies involved in overlooking the financial sector—including the Fed. In that manner it diluted the Fed’s power somewhat. Exactly what difference all this will make for the response in the next crisis cannot be foreseen in advance.

Next time, in Part 2, we look at the Fed’s supposed independence from our elected representatives. We’ll see that that is a fabricated myth.

 


[1] Thorvald Moe examines the role of Marriner Eccles and the discussions and events that led up to the 1951 Accord. Eccles was a dominant figure in the transformation of the Fed from the relatively weak and decentralized institution that had been created in 1913 to the modern central bank we know now. Moe makes a strong case that the vision of Eccles was instrumental in that evolution; as we will see, modern theories of central banks, however, deviate sharply from the Eccles vision in quite illuminating ways. See: Thorvald Grung Moe “Marriner S. Eccles and the 1951 Treasury – Federal Reserve Accord: Lessons for Central Bank Independence” Working Paper No. 747, Levy Economics Institute of Bard College January 2013.

[2] See two annual reports of research conducted with the support of Ford Foundation Grant no. 1110-­‐0184, administered by the University of Missouri–Kansas City. See: L. Randall Wray, 2012. “Improving Governance of the Government Safety Net in Financial Crises,” Research Project Report, April 9.http://www.levyinstitute.org/pubs/rpr_04_12_wray.pdf; and L. Randall Wray, 2013. “The Lender of Last Resort: A Critical Analysis of the Federal Reserve’s Unprecedented Intervention after 2007”, Research Project Report, April http://www.levyinstitute.org/publications/?docid=1739.

[3] Bernard Shull, who made a great presentation at the annual ASSA meetings in Philadelphia. His paper, “Financial crisis resolution and Federal Reserve governance: economic thought and political realities”, Jan 4 2014, is forthcoming as Levy Institute Working Paper.

[4] See his statement here: http://www.youtube.com/watch?v=a7XV3vS1hAM.

[5] See James A. Felkerson, 2012 “A Detailed Look at the Fed’s Crisis Response by Funding Facility and Recipient.” Public Policy Brief No. 123. Annandale-on-Hudson, NY: Levy Economics Institute of Bard College.http://www.levyinstitute.org/pubs/ppb_123.pdf; and L. Randall Wray, 2012. “Improving Governance of the Government Safety Net in Financial Crises,” Research Project Report, April 9.http://www.levyinstitute.org/pubs/rpr_04_12_wray.pdf.

[6] See Bruce K. MacLaury; “Perspectives on Federal Reserve Independence – A Changing Structure for Changing Times”;  Published January 1, 1977, The Federal Reserve Bank of Minneapolis, Annual Report 1976, http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=690, which examines Fed independence with respect to Congress, the Executive branch (including the Treasury), member banks, and within itself (ie, for example relations between the Board of Governors in Washington and the District banks). I will use several quotes from this comprehensive survey.

[7] Bernard Shull, “Financial crisis resolution and Federal Reserve governance: economic thought and political realities”, Jan 4 2014, forthcoming as Levy Institute Working Paper.

[8] See L. Randall Wray, “The Fed and the New Monetary Consensus: The Case for Rate Hikes, Part Two”, Public Policy Brief No. 80, December 2004, p. 14 for a discussion of this episode.

[9] See Wray 2013, the second report of this Ford Foundation-funded project, cited above.

Gonzalo Lira: The Fed Is Playing Global Pump-and-Dump

Gonzalo Lira: The Fed Is Playing Global Pump-and-Dump.

The Fed Is Playing Global Pump-and-Dump

People often criticize me for objecting to the Federal Reserve’s Quantitative Easing (QE) and Zero Interest-Rate Policy (ZIRP) on the grounds that they are setting the stage for hyperinflation and a dollar collapse. Since neither has arrived—yet—people mock me, often pretty badly: “Hey Lira! How’s that 2% ‘hyperinflation’ working out for ya!

“The left side reminds me of Dow Jones.”
“Hmm! There does seem to be
a family resemblance . . .”

Funny-funny hardy-har-har.

.!..

But even if you don’t buy that QE and ZIRP will lead to a dollar collapse, you do have to admit that these Fed policies have severely brainwashed investors.

Why ‘brainwashed’? Because today, due to the Fed’s policies, stock prices are booming—we’re about to crack 16,500 on the Dow Jones, NASDAQ is well on its way to 4,200, and the S&P is close to 1,850—all record highs.

What’s wrong with record highs? What’s wrong with booming stock prices? Absolutely nothing—unless you look at the two-year charts and realize that these three indices are not reflecting a robust, booming economy. Rather, they have had unrelenting climbs that have been openly—and exclusively—caused by QE and ZIRP.

Which has brainwashed investors into dismissing value. Today,all investors are momentum-chasing pump-and-dumpers who are not worrying about fundamentals, or worrying about the long-term health and well-being of a company.

All they have been brainwashed into caring about is the rise in a stock’s price.

Which is pretty funny, if you think about it: These investors might shun penny-stocks, they might buy and sell stocks by way of “respectable” brokerage houses—but these investors are behavingexactly like the suckers taken for a ride by sketchy boiler rooms operating out of north Jersey.

And we all know how those poor saps usually end up: Broke, holding on to worthless stock certificates not worth the paper they’re printed on.

Why is this happening? Easy, because of the Fed’s QE and ZIRP have so flattened the yield curve across Treasuries and the rest of the bond markets, that anything yielding better than 5%—in anyasset class, not just bonds—quickly gets priced up.

They call Treasuries the “benchmark” for a reason: As the (supposedly) safest asset class, they set the yield curve for allassets in all classes—not just in other bonds, but in equities and real estate as well. If Treasury yields are minimal, then a “normal” yield in a riskier asset class will also be minimal.

Look at the following chart:

Click to enlarge.

These are the Top 20 Dow Jones stock as measured by expected stock dividend yields for 2014. The mean of these Top 20 is 3.16%, the average 3.28%.

Now, these are the bluest of the blue-chips—repeat, the Top 20 as measures by yield. If you get dividends of 3.28% on these blue-chip stocks, and pay an income tax rate of say 35% combined State and Federal, you’re looking at a yield of 2.13%.

That’s yearly. That’s less than inflation.

So why are the yields on these oh-so-blue-chips so low? Because of QE and ZIRP’s unrelenting asset price inflation. That’s why you have companies like twitter—which does not have any income to speak of—with a market valuation of $38 billion or whatever.

Since nothing yields a healthy 6% or better, the only thing investors care about today is whether the price of the asset they “invest in” will rise within the year—so that they can sell it at a profit.

That’s not investing—that’s speculating.

By the way, unrelenting asset price inflation was the whole point of the Federal Reserve’s policies. Yeah, I know I went overboard with the combined bold-italics-underlined thing, but I just wanted to emphasize that point, and one other:

The Federal Reserve is the boiler room operation that has pumped up the equities market by way of QE and ZIRP. You are investing in a pump-and-dump scam. And like in all such scams, you will lose. 

Clear enough for ya?

Crazy as this may sound, when you look at those measely yields for the Top 20 performer, you realize that investors for the time being are acting rationally: Since yields are minimal—in fact negative, after you factor in income tax and inflation—it pays investors to speculate, rather than to properly invest. Not only are the Fed’s policies goosing the equities markets, the tax code privileges speculators as well, by way of a capital gains tax rate which is lower than the income tax rate. You pay less taxes if you speculate than if you invest responsibly. (!)

Thus both the Federal Reserve and the IRS are encouragingspeculation. That’s how investors have become brainwashed: They think that this low-yield, high-asset price inflation, low-capital gains tax environment is the way things ought to be.

But even though the Fed is deliberately, openly goosing the market, no different from a Jersey boiler room operation, nobody’s complaining—or even realizing it—because at this time, investors are making money with this Global Pump-and-Dump.

It ought to be beautiful, right? Everybody making money, all happy in the world. Only problem is, these pump-and-dum scams always end. When do they end? When people stop believing in the hype. When people realize that the global economy is in the toilet, companies are not booming but barely getting by, and there’s nothing on the horizon which will restart the economy. When people—and not a lot of people, mind you, just a tipping point estimated at about 10%—realize that this game that the Fed is playing with QE and ZIRP is a game of musical chairs.

That’s when the Fed’s Global Pump-and-Dump Scam will blow up.

You don’t think as I do that QE and ZIRP will lead to hyperinflation and dollar collapse? Fine, that’s cool—but admit that these Fed policies are skewing the market: They are turning investors into speculators—scratch that, brainwashing them intogamblers.

And it will all end in tears—these schemes usually do. I for one am keeping an ear on this game of musical chairs, trying to anticipate when the music will stop.

oftwominds-Charles Hugh Smith: Janet Yellen, the Nation’s New Chief Slumlord

oftwominds-Charles Hugh Smith: Janet Yellen, the Nation’s New Chief Slumlord.

Janet Yellen’s role as the nation’s slumlord is masked by her apparent distance from the Fed’s money spigot and the resulting institutional ownership of the nation’s rental housing stock.

Please welcome the nation’s new chief slumlord, Janet Yellen. The previous top slumlord, Ben Bernanke, has retired from the position of Chief Slumlord (i.e. chair of the Federal Reserve) to the accolades of those who benefited from his extraordinary transfer of wealth from the many to the few.

Why is the chairperson of the Fed the nation’s top slumlord? Allow me to explain.We only need to understand two facts to understand the Fed’s role as Slumlord.

1. Rental housing has long been a decentralized, locally owned industry. Over 90% of rental properties under 50 units have historically been owned by individuals or couples: the nation’s landlords have historically been Mom and Pop, middle-class folks who saved capital and used those savings to buy a single-family home or small apartment building (duplex, triplex, four-plex) as an investment that they own and manage.

Very few amass a huge portfolio of properties, as few have the income or assets (i.e. the collateral) to leverage the purchase of dozens of rental properties.

Buildings up to four units qualify for conventional mortgages; small rental properties are not considered commercial properties like strip malls or large apartment complexes.

This diverse, local ownership provided a wide spectrum of residential rentals. The wider the variety of rentals and owners, the greater the diversity of prices, locales and requirements. This is the essence of free enterprise: sellers (landlords) and buyers (renters) agree to price and conditions in a dynamic, open and adaptive marketplace.

2. No Mom and Pop real estate investor can compete with financial institutions who can borrow unlimited sums of money from the Federal Reserve at near-zero rates of interest.

Let’s start by asking what happens to the price of real estate when mortgages fall from 8% interest to 4%: prices basically double, because buyers can “afford” to pay more at low rates of interest.

When conventional mortgage rates are 8%, a rental that costs $200,000 requires a 30% down payment in cash (because the buyers are not owner-occupants) or $60,000. The simple interest on a $140,000 mortgage is about $11,200 annually. (Let’s use simple annual interest for simplicity’s sake.)

At 4%, the price can double to $400,000, with a 30% down of $120,000 and a mortgage of $280,000, and the mortgage accrues the same $11,200 in annual interest.

Declining interest rates push real estate prices higher.

At first glance, this doubling in price doesn’t seem to affect the cost of ownership. But that is deceptive; consider how many households can scrape up $120,000 in cash compared to the number who can scrape up $60,000. The higher the price, the bigger the down payment required. The higher the down payment, the fewer the number of households who can accumulate that much cash.

To households that live paycheck-to-paycheck, both sums are out of reach. But a significant number of middle class households could accumulate $60,000: such a sum could come from a family house that was sold and divided amongst the offspring, for example, or a Solo 401K that allows the retirement fund to own real estate, or from saving $5,000 a year for 12 years.

The Federal Reserve’s Zero Interest Rate Policy (ZIRP) was designed to push real estate prices higher. The Fed’s public justification was “the wealth effect”: the idea was that as the family home increased in value, homeowners would begin to borrow and spend more money due to their increased home equity.

The second Fed goal was to increase home sales by lowering mortgage rates, theoretically enabling more marginal buyers to buy a home. But since prices rise as mortgage rates drop, this goal is mooted unless marginal buyers are also given a free ride on down payments and qualifying income, i.e. offered near-zero down payments and no-document mortgage qualification processes.

But zero interest rates and unlimited liquidity don’t just push real estate prices higher–they give institutions with access to the Fed’s nearly-free money an unbeatable advantage over Mom and Pop real estate investors.

Imagine being able to borrow $400,000 at 1% with zero collateral. You can now buy the rental property for cash, and pay only $4,000 in simple annual interest. And you didn’t have to put up a dollar of actual collateral to buy the property.

Consider the huge advantages you now have over the competing Mom and Pop bidders. Sellers typically prefer cash offers, so your cash offer (of Fed money) is more attractive than Mom and Pop’s loan-based bid.

If the price jumps to $500,000, Mom and Pop are blown out of the water: they don’t have the additional $30,000 cash required as collateral.

Thanks to the Fed, you don’t need any collateral. You can borrow $500,000 as easily as $400,000, and the increase in annual interest is trivial: a mere $1,000.

Now consider the operating costs: you have a $7,000 annual advantage because you have access to the Fed’s nearly-free money. Mom and Pop have to pay $11,200 in simple annual interest, while you pay only $4,000. A property that is break-even to Mom and Pop reaps you a $7,000 annual profit, just because you can borrow money from the Fed for next to nothing.

Now multiply the $400,000 and the $7,000 by 1,000. Now you can buy $400,000,000 of rental properties and skim $7,000,000 in annual profits, just from the advantage of having access to the Fed’s quantitative easing (QE) nearly-free money.

Any advantages you can accrue from economies of scale from owning tens of thousands of rental properties are also yours to keep, courtesy of the Fed.

Now you understand why Janet Yellen is the nation’s new top slumlord. Her policies of unlimited liquidity, QE and zero interest rates directly enable financial Elites to beat out Mom and Pop rental housing investors and buy tens of thousands of rental properties at will.

Access to free money and near-zero interest rates gives institutional buyers a built-in advantage over Mom and Pop rental property owners: no collateral and free profits from super-low rates available to those closest to the Fed’s QE money spigot.

Institutional ownership turns the rental housing stock into a Fed-enabled financial monoculture. Individual Mom and Pop owners may not require a credit check, or they might not raise the rents very often; the odds that you will be treated as a human being are higher because the scale of the operation is small and local.

To Fed-enabled Institutional landlords, you are an income stream to be skimmed.You will be processed and managed remotely, and variations are not allowed, as they mess up the profit machine.

Fed-enabled Institutional landlords may or may not hire competent, responsive managerial firms to manage their thousands of properties: from the point of view of Fed-enabled Institutional landlords, the lower the costs, the larger the profits. One way to lower costs is to not respond to tenant complaints or requests for service. Another is to hire the lowest-cost (and likely understaffed) management firm.

Janet Yellen’s role as the nation’s slumlord is masked by her apparent distance from the Fed’s money spigot and the resulting institutional ownership of the nation’s rental housing stock. But guess what, Chairperson Yellen: we’re not fooled. Your phony facade of “progressivism” doesn’t mask your real role as the nation’s top slumlord.

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