Greece Secures a Bailout

Greece finalized its bailout from the Eurozone.

Euro-region ministers agreed to a 110 billion-euro ($146 billion) rescue package for Greece to prevent a default and stop the worst crisis in the currency’s 11-year history from spreading through the rest of the bloc.

The first payment will be made before Greece’s next bond redemption on May 19, said Jean-Claude Juncker after chairing a meeting of euro-region finance ministers in Brussels yesterday. The 16-nation bloc will pay 80 billion euros at a rate of around 5 percent and the International Monetary Fund contributes the rest. Greece agreed to budget measures worth 13 percent of gross domestic product.

They say the crisis is over in the Euro's currency but that's only until the next time Greece or another nation winds up in this situation again. That's when not if.

Greenspan: More Oversight of Banks

Now he tells us. Alan Greenspan famously gave millions of novice home owners the green light to jump into adjustable loan mortgages is now advising more oversight over banks.

After more than six decades as a skeptic of big government, the former Federal Reserve chairman, now 84, is gingerly suggesting that perhaps regulators should help rein in giant financial institutions by requiring them to hold more capital.

Mr. Greenspan, once celebrated as the “maestro” of economic policy, has seen his reputation dim after failing to avert the credit bubble that nearly brought down the financial system. Now, in a 48-page paper that is by turns analytical and apologetic, he is calling for a degree of greater banking regulation in several areas.

Greenspan argues for higher reserves, a return of Glass Steagall, and he wants a requirement that banks hold bonds that automatically convert to equity when their equity falls below the required level.

Under capitalization is one of the untold stories of the financial crisis. Banks were not only taking massive risk but they were highly leveraged in that risk. A return to Glass Steagall is something I have endorsed as well. The third idea is most interesting since it's not been proposed anywhere I've seen. It's a way to make banks more accountable for their risk and it would reduce moral hazards.

Greenspan continued to insist that his own low interest rate policy didn't get the ball rolling on the crisis.

Fed Keeps Rates the Same

The Federal Reserve has kept the Fed Funds Rate at zero today.

The Federal Reserve repeats its pledge to hold interest rates at record lows to foster the economic recovery and ease high unemployment.

But its decision draws one dissent. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, for the second meeting in a row opposes keeping the yearlong
pledge.

We're into the third year of the Fed Funds Rate being at this obscenely low level. We'll see the implications if and when the economy recovers.

Fed Raises Discount Rate

Is this the beginning of the Fed's turnaround and tightening?

The Federal Reserve on Thursday raised its discount rate to 0.75% from 0.5%, an effort to return its lending facilities to more normalized levels.

The Fed said the move, along with other recent modifications to its credit programs, does not signal a change in its outlook for the economy or for monetary policy, and the more important fed funds rate remains in its range of 0% to 0.25%.

The Discount Rate is what the Federal Reserve charges banks to borrow in order to meet reserve requirements.

The Fed chairman, Ben Bernanke, was very careful to use mild language in describing the future stance. The Fed Funds Rate was held at 0-.25%. So, it's still unclear if this is small augmentation or if it is the beginning of more serious.

The equity markets will be of great interest over the next few weeks. When Alan Greenspan raised rates suddenly, that popped the internet bubble. This was also a mild surprise and futures are already down on the news. So, it will be interesting to see what sort of a reaction equities will have.

The Fed in Reverse?

Fed Chairman Ben Bernanke has signaled what he will do to make sure that his loose money policy won't create hyper inflation.

The Federal Reserve could begin pulling back its unprecedented stimulus for the U.S. economy by first removing some cash from the financial system and then raising interest rates, Fed Chairman Ben Bernanke said Wednesday.

The U.S. central bank has pumped more than $1 trillion into the economy after it
slashed benchmark rates to near zero to combat the worst financial crisis since the Great Depression.

While the economy has grown for the past two quarters, unemployment is at a lofty 9.7 percent. In his most detailed description to date of how the Fed aims to dismantle the extensive emergency support facilities it put in place during the crisis, Bernanke made clear the Fed's thinking on its exit strategy had advanced even though the time for tightening monetary policy was still some ways away.

So, what Bernanke will do is largely reverse everything he's done over the last couple years. Right now, the Fed Funds Rate is at zero. He will raise that though he hasn't indicated how high.
Beyond that, he'll sell back most, if not all, of the bonds that he's bought over the last couple years.

This will of course increase interest rates significantly. Tightening the money supply will also stunt economic growth. What most people aren't talking about is what this constant yo yo monetary policy does to long term economic growth. Bernanke spent 2007-2008 furiously lowering rates. He spent the next year furiously increasing the money supply. Now, in 2011, he'll just as furiously do the opposite. Greenspan did something similar in 1999-2003 in which he furiously raised and then lowered rates. This sort of schizophrenic interest policy stunts long term growth, encourages bubbles, and creates chaos and confusion. Monetary policy is a powerful thing but used too liberally it can cause disaster.

The Coming Small Business Bubble?

The situation seems eerily familiar. Our economy is weak. Money is cheap, and loan standards are then loosening.

President Barack Obama is asking Congress to extend the provisions that helped revive U.S. Small Business Administration lending this year.

The economic stimulus bill provided the SBA with $375 million to increase the loan
guarantee on the agency’s flagship 7(a) business loans to 90 percent, and to reduce or eliminate fees on 7(a) loans and 504 loans, which primarily finance real estate. The higher guarantee brought more than 1,000 lenders back to the SBA’s loan programs, and the lower fees made the loans more affordable to borrowers.

Thanks to these enhancements, SBA lending hit a record high in November.

That was the set up for the real estate boom, bubble, and bust. Our economy was weak. The Fed made money cheap. Banks began to extend mortgage terms to levels never seen before.

What do we have now? Our economy is weak. The Fed Funds Rate is zero and now President Obama has designed a plan so that small businesses will get loans at loan to values and sizes never seen before.

I have been forecasting the creation of a bubble in the economy since Bernanke lowered the Fed Funds Rate to zero. That's no especially astute analysis. Cheap money creates an artificial stimulus to spend and invest. Banks had a lot of cheap money in 2002-2003. They needed a place to put it and they found one in sub prime.

The same is true now only now the administration is determined to make as much of the final place small business loans. That's a set up for a small business loan bubble.

The Politics of Bernanke's Renomination

If you've read this site some, you know I have no use for the Federal Reserve. I also believe that Ben Bernanke is wilfully repeating the mistakes of his predecessor, Alan Greenspan. Still, I am watching most of the opposition, from both sides, to the renomination of Bernanke and almost all is political in nature.

The folks are ticked off. They are looking for someone to blame and the Fed Chairman is an easy target. It's also the wrong target. The Federal Reserve itself has plenty of blame, in my opinion, for the current financial crisis. Furthermore, I believe that the Bernanke's current loose money policy will have a devastating effect on our economy down the road.

What most politicians are trying to do is blame Bernanke for the current crisis. That's, of course, nonsense. Bernanke took over at the end of 2006. By then, the wheels were already long in motion for our current crisis and nothing was going to stop it. It's clear, however, that most in Congress haven't the faintest clue what the role of the Fed is and what Bernanke has done in his office. Here's what Boxer said.

In a statement Friday morning, Senator Barbara Boxer, Democrat of California, came out against Mr. Bernanke, who was named to his post during the Bush administration. She said she had “a lot of respect” for him and praised him for preventing the economic crisis from getting even worse. “However, it is time for a change,” she said. “It is time for Main Street to have a champion at the Fed.”

“Our next Federal Reserve chairman must represent a clean break from the failed policies of the past,” Ms. Boxer said.

I'd ask Senator Boxer two questions. First, what Fed Chairman represented the interests of Main Street and second, how can we have a Fed Chairman that has a clean break with the past. The Federal Reserve is the bankers' bank. By nature, he represents the interests of the banks. Ordinary citizens can't get a loan at the Fed's window. Only banks can. How would a Fed Chairman represent the interests of Main Street as Fed Chairman? Given that this crisis touched all parts of our financial world, how exactly would we get someone with a clean break from the past. To do that, we'd need to get a Fed Chairman entirely void of financial experience over the last ten years.

Both Jeff Sessions and Jon Cornyn have put some of the blame for the current crisis on the shoulders of Bernanke, and here's how Oregon Senator Jeff Merkey characterized the scenario.

Oregon Sen. Jeff Merkley said Friday he would vote against granting a second term to Federal Reserve Chairman Ben Bernanke, concluding that Bernanke was partly to blame for the nation's deep recession and that he is ill-equipped to lead a recovery.

In explaining his decision in a floor speech, Merkley credited Bernanke for the major role he played in keeping the nation from tumbling into a depression.


That is not enough to justify another four-year term, Merkley said, suggesting that that Bernanke was too close to bankers and Wall Street financiers. Merkley, who serves on the Senate Banking Committee, also opposed Bernanke's nomination for a second term when the question came before the committee.

Let's try and put this into perspective. What Fed policies caused the crisis? Wasn't it the loose monetary policies that caused interest rates to be kept far too low far too long? This is what Merkey blames Bernanke for even though it was Greenspan's leadership that had these policies. What policies is Merkey crediting Bernake for in lessening the current crisis? Isn't it the same loose money policies that have caused interest rates to be even lower for an even longer period?

Senator Merkey is blaming Bernanke for the policies of Alan Greenspan. Worse than that, he's then congratulating Bernanke for instituting the same policies. This is the level of political thought on the Federal Reserve out of Congress.

In 2002-2003, these same Senators were congratulating Alan Greenspan for saving the same country from the brink for the exact same policies. Now, years later they are blaming the same Fed for the policies of the past. At the same time, they are congratulating the same Fed for those very same policies in the present.

The Mysterious Profit of the Fed

Looks like one bank in particular had a good year in 2009.

The Federal Reserve made a record profit of $46.1 billion last year, reflecting money made off its extraordinary efforts to rescue the country from the worst economic and financial crisis since the 1930s, the central bank announced Tuesday.

The windfall gets turned over to the Treasury Department.

It marks the biggest profit on record dating back to 1914 when the Fed was created. The previous record profit -- of $34.6 billion -- was registered in 2007. In 2008, the Fed reported a profit of $31.7 billion.

The Fed says the bigger profit was primarily due to increased income from the securities it held last year.

Now, if we follow the money here, it leads to an interesting place. The Fed made a whole lot of money this year because the debt securities it owned from previous years increased in value. How did they increase? Remember, at the end of 2008, the Fed promised, and delivered, to buy trillions of dollars worth Fannie/Freddie and U.S. Treasury bonds. By doing so, it lowered interest rates in a dramatic way and it increased the value on all debt securities dramatically. (if you have a treasury bond paying 5% and current bonds only pay 4% yours is that much more valuable) So, the Fed's own market manipulation contributed in a large way to its own profitability.

Keep in mind that the Fed has the power to create money out of whole cloth. That's what it did and used that money to buy trillions worth of bonds at artificially low levels. That's the real story. Of course, the Fed is now sitting on trillions worth of bonds at artificially low rates. At some point, they will need to take a lot of this money out of circulation and sell these bonds back into the market. We can expect those years to hit the Fed as hard as their manipulation helped this year.

The Fed Won't Rule Out Repeating History

Fed Chairman Ben Bernanke says that stricter regulations would have prevented the current crisis. He downplayed the Fed, and his predecessor's involvement, and then threw a financial shot across the bow.

Bernanke said, however, in a speech to the American Economic Association, that policy makers can no longer eliminate rate increases from their arsenal to prevent future crises.

"If adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplemental tool for addressing those risks,'' he said.

Bernanke conceded that efforts by the Fed and other regulators beginning in 2005 came too late or were insufficient to slow the housing bubble.

That's nice. The last time the Fed raised rates to stop a bubble was in 1999-2000. That certainly did pop the asset bubble in the internet and technology sectors. That also lead directly to the recession of 2001-2003. Then, the Fed lowered rates furiously leading directly to the bubble that's caused the current crisis.

Now, the Fed has lowered rates so low that they can't go any lower. They're now telling people that future bubbles will be popped by the Fed itself. Of course, last I checked, popping bubbles wasn't in the job description of the Fed chairman. At least this one is being honest. When Greenspan popped the internet bubble, he claimed he was raising rates to head of inflation, which was of course non existent at the time.

Rogers V Roubini

As I, along with most of the financial media, have reported, Nouriel Roubini, the famed economist who predicted our current crisis, has predicted the mother of all asset bubbles. By this, he believes that investors are using the cheap dollar to invest in assets. These investments are being driven not by fundamentals but by the weak dollar and so this is creating a bubble. One of the assets that Roubini has targeted for a bubble is gold. Now, another famed investor has taken issue with that. Jim Rogers, no slouch himself, believes that Roubini doesn't know what he's talking about.

I am most perplexed about this alleged bubble which is out there.

Rogers told Wall Street Cheat Sheet.Rogers has been bullish on gold and other commodities for the long term, often arguing that the weakening U.S. dollar will make commodities a better investment, pushing gold toward $2,000 an ounce, hundreds of dollars higher than where it is now.

Roubini, on the other hand, says investors are borrowing dollars to buy emerging market stocks and commodities, which is inflating the value of those assets.

Now, the beauty of debates like this is that while all sides have mammoth intellect they are ultimately worthless. Only time will tell whether or not there is a bubble. Both men will emerge wealthier whether they're right or not.

Roubini has earned a lifetime's worth of a reputation for predicting this crisis. He could get everything wrong moving forward and still make millions speaking and teaching. Rogers has already made his money.

For me, I'm perplexed by two things. This isn't the first criticism of Roubini's theory. Most simply dismiss Roubini's theory without giving much explanation for why. It's true that we may still be years away from the bubble popping. There's plenty of money to be made until then, presumably. Roubini's theory is based on a simple logic. Our fiscal and monetary policy is weakening our currency. Investors are using that weak currency to invest in assets they otherwise would not. That is forming a bubble. That's the theory.

We'll see if he's right but so far no one has challenged the theory. For my money, I don't know if Roubini himself is right but I do know that our policies are forming a bubble somewhere.

Bernanke Named Time Person of the Year

Ben Bernanke has been named Time Person of the Year.

Federal Reserve Chairman Ben Bernanke, who helped steer the nation through the worst economic crisis since the Great Depression, was named TIME Person of the Year 2009 on Tuesday, eclipsing finalists who included President Barack Obama and House Speaker Nancy Pelosi.

“He didn’t just reshape U.S. monetary policy; he led an effort to save the world economy,” Time’s Michael Grunwald writes in the cover story, which will be on newsstands Friday.

Asked by Time in a Dec. 8 interview if bankers make too much money, Bernanke replied: “I think that bankers ought to recognize that the government and the taxpayer saved the financial system from utter collapse last year. And in recognizing that, I would think that bankers ought to look in the mirror and decide that perhaps there should be some more restraint in how much they pay themselves, given what the government and the taxpayer did to protect the system.”

Bernanke certainly has transformed monetary policy. He has taken it to new levels, however, whether that's a good thing or something dangerous is still a matter of debate. Did Bernanke keep the U.S. economy from going into a tail spin? He probably at least contributed. How did he do this though? He lowered the Fed Funds Rate to zero and created more than two trillion dollars worth of new money? Is that bold and courageous or reckless? That's a question that remains.

There was a time that Alan Greenspan was seen as an oracle. He was similarly seen as saving the U.S. economy in 2001-2002. He's now viewed by many as the villain that created the current crisis. The same may wind up being seen of Bernanke.

It's important to note that what Bernanke did was neither bold nor innovative. Anyone can lower rates until they can't go any lower. Anyone can create trillions of dollars in new money. That's not bold or innovative. What would be bold and innovative would be to keep the economy from collapse without doing these things. This sort of monetary policy has all sorts of unintended consequences that haven't materialized yet. So, today's man of the year can be tomorrow's villain very quickly.

UPDATE:

Speaking of Bernanke,the Fed minutes just came out. The rates remain unchanged. The language says that the economy remains weak. The Fed Funds Rate is now at zero for just over a year. The Fed just called inflation "subdued".

Bernanke Pleads for More Fed Power

Fed Chairman Ben Bernanke took his case for expanded Fed power to the people with an Op Ed.

The chairman of the Federal Reserve is concerned that congressional efforts at financial reform could weaken the central bank's ability to handle future crises and may politicize monetary policy.

Fed Chairman Ben S. Bernanke made the comments in an Op-Ed piece to appear in Sunday's Washington Post, five days before the Senate Banking committee holds a hearing on his nomination for a second term. His current four-year term expires Jan. 31.

Bernanke wrote the nation is challenged to design a financial oversight system that will "embody the lessons of the past two years and provide a robust framework for preventing future crises and the economic damage they cause."

It's now a standard M.O. for the Fed, and/or its backers, to scream "politicizing monetary policy" whenever anyone dares to question it, it's power, or worse tries to lessen its power. It's become the monetary policy version of the race card. That's what they did when confronted with the Ron Paul challenge of auditing the Fed.

The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions. A perceived loss of monetary policy independence could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability. We will continue to work with the Congress to provide the information it needs to oversee our activities effectively, yet in a way that does not compromise monetary policy independence.

This is becoming a mantra for the Fed. Any time, anyone challenges it on anything, they are "politicizing monetary policy". No one really understands monetary policy and so they surely don't want to be accused of "politicizing" it. What some, like me for instance, call scrutiny and checks on near absolute power, the fed calls "politicizing monetary policy".

I say beware of anyone that makes political cliches. Trotting out the race cad is a political cliche and so too is the cliche of "politicizing monetary policy".

The Asset Bubble is Forming

The latest piece in the rapidly forming asset bubble is now in place. Short term treasury bills are now below zero.

For the first time in seven decades, Treasury bills are paying no interest while stocks continue to appreciate -- a divergence in U.S. financial markets that might be perilous if Federal Reserve Chairman Ben S. Bernanke didn’t know all about 1938.

That’s when the Standard & Poor’s 500 Index climbed 25 percent even as bill rates tumbled to 0.05 percent from 0.45 percent. As 1939 began, stocks began a three-year, 34 percent decline after the Fed increased borrowing costs prematurely to stymie inflation that never materialized.

In my mind, the difference between inflation and a bubble is this. During periods of inflation, all prices go up. During a bubble, the prices of one area goes up extraordinarily. Often the forces that set each in motion are the same. It's only a matter of how those forces spread through the economy.

Right now, equities are zooming at the exact same time that short term bonds couldn't be trading any better. Keep in mind, if you were to buy a three month T Bill, you would get near a negative rate. That means you'd get less money back then when you started. Yet, investors are buying them in bunches.

Such anomoles are almost always a sign that there's trouble ahead. Throughout 2006, we had what's called an inverted yield curve. By that, short term rates were higher than long term rates. That caused ARM's to go out of style since they were worse than the regular fixed mortgages. (in other words an adjustable rate mortgage actually had higher rates than fixed rates, meaning there was no reason to get them) That was a sign of upcoming recession. That's exactly what happened.

Now, we have nearly zero yields on very short term rates and a massive yield spread. The yield spread is the difference between the two year U.S. Treasury bond and the ten year U.S. Treasury bond. That's been bouncing but it's often, over the last six months, between 2.50%-2.70%. That's near a record of 2.75% set in June. This is a sign of upcoming inflation.

We're alread seeing signs of upcoming inflation. The Dow is skyrocketing. Gold is skyocketing. Oil is zooming up. Even emerging market assets are zooming up. All of it is coming at the expense of a weak dollar. The weak dollar is entirely caused by both irresponsible fiscal policies and loose monetary policies, which are financing the irresponsibility. With massive debt, and a massive creation of new dollars, both those have combined to weaken the dollar.

Inflation is defined as too many dollars chasing too few assets. I define a bubble as assets being enticed into an industry by outside forces rather than fundamentals. So, if the weak dollar is forcing investors into equities, commodities, and emerging markets, then what we have is a bubble forming. In fact, there isn't necessarily a long term correlation between a weak dollar and strong equities. That's because in the long term equities trade based on fundamentals not the strength or weakness of the dollar. Now, people are rushing to get dollars cheaply and take advantage of that weakness. By that, we have a bubble forming.

People aren't buying because the fundamentals in the market are strong. We have 10% unemployment, record foreclosures, record deficits. Those aren't necessarily fundamentals for strong growth. People are buying because they can get the dollar cheap.

That won't last forever. At some point, the Fed will have to reverse itself. It will have to contract the money supply. That will strengthen the dollar. All those that rushed in to get their assets cheaply will rush out to cash out of the strong dollar. That's how bubbles that form burst. That's what we have.

It's happening again because the Fed, again, has caused the next crisis by fixing the current one. The Fed saw the internet bubble forming so it popped it by increasing rates. That lead directly to the recession. So, it lowered rates, TOO MUCH. That lead directly to the housing bubble. Now, it's lowered rates again to expand growth. This is leading to the next bubble.

Perpetual Zero Rates?

The President of the Fed in St. Louis is hinting that the Fed Funds rate will be at zero until early 2012.

Federal Reserve Bank of St. Louis President James Bullard said past experience suggests policy makers may not start to raise rates until early 2012, while facing a “too low for too long” argument that may “weigh heavily” on the central bank.

“If you look at the last two recessions, in each case the FOMC waited two and a half to three years before we started our tightening campaign,” Bullard said today in a speech in St. Louis. “If we took that as a benchmark, that would put us in the first half of 2012.”

That would mean that this Fed Funds Rate would be at zero for more than four years. To put that into perspective, Alan Greenspan kept the same Fed Funds rate at .75% about a year and a half, and many, like me, believe that loose money policy lead directly to the current mortgage crisis.

We're already facing an unprecedented loose money policy. We're already facing continued zero Fed Funds rate for the indefinite future. Now, that future might not end until 2012.

Giving banks the ability to borrow for nothing leads to all sorts of consequences, namely having those same banks take risks they normally wouldn't. That's good if you want to stimulate the economy but it can also lead to over stimulation. That can lead to inflation and bubbles.

It's clear the Fed doesn't think we're anywhere near a recovery. It also believes that monetary and not fiscal policy will lead us into a recovery. Yet, it also could be a sign of recklessness and desperartion. This sort of monetary stimulus is unheard of. Before Greenspan dropped the fed funds rate below 1%, that was unheard of. Now, Bernanke has not only dropped it to zero but will keep it there at least two and half years and maybe as many as four years.

It doesn't take all that much financial knowledge to know that such looseness in monetary policy leads directly to a new crisis. All such policy requires some semblance of balance. The problem by the Federal Reserve is that its been so aggressive that for each problem solved it created a new problem Greenspan popped the bubble and that caused the recession. Then, Greenspan dropped rates below 1% to get us out of the recession. Now, Bernanke is trying to get us out of this crisis with even more extreme monetary policy.

At some point, some other folks might point out that the Fed is the problem not the solution.

The Jobs Summit

There's a time honored political tradition. Whenever politicians have no answer to a problem, they hold a summit, a roundtable, or a create a committee to study the situation. This president appears no different.

President Obama's announcement Thursday of a December jobs summit aimed at synching job growth with massive government spending has provoked cynicism among critics who believe the president is more interested in burnishing his reputation than tackling rising unemployment.

"I think the purpose of the summit is basically just public relations, is to try and convince people that the administration is doing a good job," Harvard economist Jeff Miron said.

Obama's announcement came with unemployment at a 26-year high of 10.2 percent despite the president's repeated touting of all the administration's efforts to create jobs.

The president realizes that the job outlook may be his biggest achilles heal come November of next year. The stimulus has done nothing to create jobs, and the Democrats have spent the rest of the legislation session on health care reform.



So, if unemployment rates stay near where they are now, the ones that will really be in pain next November will be the Democratic politicians facing re election. There's really only a few ways for governments to create an environment for job creation. I say to create an environment because, despite what some politicians will tell you, government can't create jobs. They can only create an enviroment for job creation.



The first is tax cuts especially to job creators: capital gains tax cuts, the top marginal rate, and corporate tax rate cuts. The second is expansive monetary policy. The third is regulatory reform. That of course means less regulation. That's it. He needs no jobs summit. This is really not all that difficult to understand.



Government spending doesn't create an environment for job creation. A massive health care bill doesn't create an environment for job creation, and neither does an energy tax. The president needs no jobs summit but rather a total and complete policy adjustment.

Fed Creating Another Bubble

So says famed economic analyst, Nouriel Roubini,

The Federal Reserve is running the risk of creating another bubble, and needs an exit strategy from its credit easing policy, says former Clinton White House economist Nouriel Roubini.

The sharp increase in the stock market and commodities, and narrowing of credit spreads since March, are partly due to a wall of global liquidity chasing assets and already causing asset inflation, Roubini writes in The Wall Street Journal.

Now, it's important to point out that Nouriel Roubini is nicknamed Dr. Doom because he's much more apt to take a negative position than a positive one. He's also now famous because he's one of the few economists that called the bubble and collapse of the housing market while others were chasing money.

I bring this up only because Roubini is echoing things I said months ago.

Back in 2002, the Fed Chairman Alan Greenspan lowered the Federal Funds Rate to .75%. The Federal Funds Rate is the rate at which banks borrow from each other. At the time, we were still recovering economically from the internet bubble popping. The pop of the internet bubble eventually cost three trillion Dollars in paper lost. The bubble burst was topped by the economic devastation of 9/11. About one million jobs were lost in October, November, and December of 2001. Then, this was followed by the revelations of accounting malfeasance at Enron et al. I bring this context because when Greenspan lowered the Federal Funds Rate this low so called experts justified it as an appropriate response to extreme economic weakening.

...

Now, new Fed Chairman Ben Bernanke has lowered the Fed Funds Rate to 1%, just .25% higher than Greenspan lowered it to. The reason no one is crying bloody murder is once again so called experts believe that Ben Bernanke is responding with aggressive action to an unprecedented economic weakness. The reason this is happening is that most people don't blame Alan Greenspan for even starting the mortgage crisis.

Bernanke is repeating very recent Fed history and he's repeating it even more aggressively. I had a very simple explanation. Bernanke, as Greenspan before him, is creating loose money. (that is money that's too easy to borrow) Once money is too easily available, it's borrowed and spent to accomodate the relative ease with which its gotten and not because there's necessarily a good place to put it. This, in my opinion, is a common trigger for bubbles. Roubini is far more technical but both of us believe that current Fed policy is creating the next bubble.

Some Thoughts on the Fed Minutes

The Fed released its minutes a few hours ago. These are the most predictable minutes that I can remember. To no one's surprise the Fed kept the Fed Funds Rate at its current levels. Also to no one's surprise, the Fed analyzed the current state of the economy as bottoming out and steadying.

Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

If you are looking at a graph of an economic cycle, we are at the bottom and, according to the Fed, at the beginning of the upswing.

The most important question going forward is just how quickly will we recover. Will we see unemployment below five percent in the next year or year and half? Or, is it more likely that growth and unemployment will stagnate and the economy will grow slowly and keep unemployment fairly high for years?

The Federal Reserve outlook seems to be closer to the second scenario than the first. The markets initially reacted positively. At one point the Dow pushed above 9900 and the Dow was up nearly one percent. Yet, in the last hour and a half the Dow lost everything and another 81 points. Meanwhile, the ten year U.S. Treasury bond pushed down to 3.41% after being as high as 3.49% during the day. This may have something to do with the outlook of the Fed of upcoming inflation.

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

Often the initial reaction to Fed minutes is indicative of little long term and so I would caution anyone with reading too much into any of this.

Finally, the Federal Reserve said it would " continue to employ a wide range of tools to promote economic recovery and to preserve price stability". The Fed continues.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

So, while I wouldn't expect the sort of loose money policy that we saw over the last twelve months, we should expect loose monetary policy for the indefinite future.

The Federal Reserve as Pay Czar?

It's hard to fathom that the Federal Reserve might soon get even more power than they already have but an idea being floated now will do just that.

Policies that set the pay for tens of thousands of bank employees nationwide would require approval from the Federal Reserve as part of a far-reaching proposal to rein in risk-taking at financial institutions.

The Fed's plan would, for the first time, inject government regulators deep into compensation decisions traditionally reserved for the banks' corporate boards and executives.

Under the proposal, the Fed could reject any compensation policies it believes encourage bank employees -- from chief executives, to traders, to loan officers -- to take too much risk.

Bureaucrats wouldn't set the pay of individuals, but would review and, if necessary, amend each bank's salary and bonus policies to make sure they don't create harmful incentives.

There are very few things more dangerous than the power that is being consolidated into the hands of the Federal Reserve. Right now, here are the proposals being floated that would ultimately give even more power to the Federal Reserve. First, the Federal Reserve may soon have regulatory power over all financial services companies rather than simply banks. The president wants to give the Federal Reserve the power to be a "systemic risk regulator". Now, they may also have power to regulate executive pay among banks. This is above and beyond its ability to create money, manipulate interest rates, and buying and selling trillions of dollars worth of securities.

It's hard to put into words how bad an idea this latest proposal is. One of the most important jobs of policy making is to manage the power of any given entity. It's vital that no entity become too powerful. Too much power always leads to all sorts of bad problems. At this point, simply creating money and manipulating interest rates gives the Federal Reserve too much power. As such, policy makers should be working on ways to limit its power. Instead, policy makers are showering the Federal Reserve with even more power. That's just a recipe for disaster.

The Federal Reserve and Conflict of Interest

The Federal Reserve is among the most misunderstood organizations in our societies. For instance, most don't even know that it's privately owned. The folks that own the Fed are bankers themselves. In fact, it's the main names in the banking and financial services system: Goldman Sachs, Chasen, Wells Fargo, etc. The share of the Fed that each bank has is determined by the individual size of the bank. In other words, the larger the bank, the larger its share in ownership in the Fed. Then, each year each bank gets a dividend paid out from the Fed based on its share of the Federal Reserve ownership.

The Federal Reserve system is made up of twelve governors, and each is a political appointee. The Federal Reserve has two specific responsibilities: control the money supply and regulate the banking system.

Now, let's think about that for a minute. If the Fed is owned by the major players of the Federal Reserve, isn't there a natural conflict of interest in it regulating the banks. Isn't that what you'd call the fox guarding hen house.

Then, there's the Fed's ability to control the money supply. The Fed does this by buying and selling securities. Overwhelmingly, the Federal Reserve buys and sells U.S. Treasury bonds. In fact, the Federal Reserve has its preferred bond traders. It goes to these traders when it wants to buy and sell U.S. Treasury bonds.

There's no evidence that the Fed tips off its owners when its about to buy or sell a lot of U.S. Treasury bonds overtly. Yet, banks like Chase, Goldman, etc. are tipped off either way. They have traders on the floor. Heck, for all we know, it's their traders that are the ones that the Fed goes to. In any case, Chase, Goldman et al know the Fed is making major purchase or sales long before the average person. Overt or not, that's not a free market but a rigged system. The banks that own the Fed know before everyone else when they make a move. If the average person got their hands on this information, that would be insider trading. In the case of Goldman, Chase, etc. it's the way business is done.

Now, while the Fed usually only trades in U.S. Treasury bonds, knowing what the Fed is doing provides a massive advantage over the average investor. Worst of all, the Fed has this power because the initial act that created it, the Federal Reserve Act of 1913. That act moved the power to create money from the Congress, where it was in the Constitution, and moved it to the Federal Reserve. Since an audit has never been done of the Federal Reserve, we, the citizens, don't know just how much money its created since its own creation in 1913. It's a totally non transparent process. We don't however know if its owners know just how much money its created.

So, the banking system that the Federal Reserve is supposed to regulate is likely in a position to know more than the public at large. The conflicts, in effect, are numerous.

Auditing the Fed Is Economic Suicide?

That's the view from this particular blog.

The free market understands that auditing the fed is a very dangerous line to cross. If crossed, U.S. inflation will likely skyrocket over the next decade to unseen levels. U.S. economy tanks. Bond investors lose money as interest rates rise. Stock investors earn negative real return as equity risk premium rises and aggregate PE ratio tank. The US Dollar erodes due to higher domestic inflation relative to foreign inflation. Gold and commodity prices rise.

The thesis of this blog is that if Congress knows what is in the books of the Fed, they can then use that information to put pressure on the Fed Chairman to influence their decisions going forward.



This is the mantra that comes from all those that are against the a full audit of the Fed. In fact, the Fed Chairman, Ben Bernanke, has said the same thing himself.

The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions. A perceived loss of monetary policy independence could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability. We will continue to work with the Congress to provide the information it needs to oversee our activities effectively, yet in a way that does not compromise monetary policy independence.

It's not totally clear just how a full audit would give Congress the license to influence policy. For one, most Congress people wouldn't have the first clue what will be in the audit anyway. The thinking, I assume, goes that if Congress knows what the Fed is holding onto as far as financial instruments, cash and liabilities, that they can use this knowledge to put pressure on the Fed to influence policy.



The explanation goes that the Fed needs total independence and any influence could politicize monetary policy. Let's think about this for a minute. The Fed is required to go to Capitol Hill regularly to testify. The Fed Chairman is selected by the President and confirmed by Congress. No one that claims that an audit would threaten the Fed's independence claim that all of these political interventions now threaten the Fed's independence.



I am not discounting that the only thing worse than the Fed Chairman running the Fed is Congress. I am not discounting the idea of unintended consequences. Yet, the Federal Reserve now trades trillions of dollars of a plethora of sophisticated assets. They do this in markets, with other central banks, and with other banks in the U.S. We, the people that it's supposed to serve, don't know exactly what they are holding on to. Can this be?



So, the argument against a full Fed audit is that someone could see a scenario under which this audit could then be used by Congress people would influence Fed policy. So, we're all supposed to dismiss the very real fear that our own central bank can make decisions worth trillions of dollars without having the public know exactly what they are doing because someone has a scenario under which the solution would lead to its politicization.



Now, it's important to point out that this particular blog is one I haven't heard of. I only found it after a scan of the much more popular blog, Little Green Footballs. Charles Johnson, the proprietor of LGF, has a thing against Ron Paul, the person most responsible for legislation calling for auditing of the Fed. As such, in the view of Johnson, anything that Paul champions must be loopy. It is in fact Johnson that linked to this blog as some sort of authority. Now, I doubt that Johnson could explain how auditing the Fed would lead to its politicization. In fact, I doubt that Johnson could explain much of anything on Fed policy. It's an area he's better to simply stay away from. Yet, he can't resist because it's an opportunity to attack Paul. So Johnson, without having a clue about the authority and expertise of the site in question, puts it out there as a site of expertise.

If you think auditing the Fed might not be a bad idea, I suggest you read this: Auditing the Fed Is Economic Suicide.

As such, Johnson engages in little more than propaganda. It's just one of many unfortunate examples of the internet being the wild, wild west. Lot's of people actually trust Johnson's words as an authority, and they might even conclude that this blog is also an authority. That piece in which he purports to act as an authority on monetary policy does them no favors.