True Gross Domestic Product – Q1 2009

April 29, 2009 · Posted in General Economics · Comment

Click on image to enlarge.

The True GDP has paused its decline and risen to 13.9 billion gold ounces in Q1 of 2009, a 6% increase from 1 year ago.

Tags: true gross domestic product

Home Prices – February 2009

April 29, 2009 · Posted in General Economics · Comment

Click on image to enlarge.

Composite home prices have fallen by 19% from last year.

Top 3 annual delines:

1. Phoenix, AZ – 35%
2. Las Vegas, NV – 32%
3. San Francisco, CA – 31%

Top 3 monthly declines:

1. Cleveland, OH – 4.99%
2. Phoenix, AV – 4.46%
3. Detroit, MI – 3.82%

Noteworthy: Declines in Cleveland and Detroit are picking up steam.

Tags: case shiller, february 2009, home prices

IMF Seeking a $500 Billion Bailout

April 28, 2009 · Posted in General Economics · Comment

As it is running out of money, IMF head says it will sell bonds to raise funds:

The International Monetary Fund will sell bonds as a way to raise funds to lend to struggling nations, the head of the organization said Saturday, in a victory for developing countries.

(…)

Treasury Secretary Timothy Geithner on Saturday urged world finance officials to pony up more funds to meet the $500 billion goal. Progress towards that target “must be an important outcome of these meetings,” he said.

President Barack Obama is seeking congressional approval for up to $100 billion, matching commitments for the same amount made by Japan and the European Union. Canada and Switzerland have pledged $10 billion and Norway about $4.5 billion. But the full $500 billion hasn’t yet been raised.

(…)

The additional funds reflect the growing importance of the IMF in dealing with the global downturn, the worst the world economy has experienced in six decades. Just a year ago, the 185-member organization was seen as increasingly irrelevant as many developing country economies boomed.

(…)

The IMF “needs a more representative, responsive and accountable governance structure,” he said. “This is essential to strengthening the IMF’s legitimacy.”

Make no mistake. What the poor nations of the world need is the exact opposite. The IMF should be abolished, plain and simple. What has it done to fight world poverty since its inception in 1944? Has it not caused way more havoc than anything else throughout history? We don’t need a national central bank, and we most definitely don’t need a world central bank.

Obviously there is a concerted move toward a more and more powerful IMF. I wrote about this recently in Talks About Global Currency Gain Traction:

If you look at the description of SDRs (http://en.wikipedia.org/wiki/Special_Drawing_Rights), they already possess a lot of the features that the European Currency Unit had in Europe as a prelude to the Euro.

I expect that if there is to be a concerted move toward a world currency, it will coincide with more and more talk about SDRs in the news and in the government propaganda all around the world.

Naturally, talk about the supposed importance of the IMF is increasing along with global currency proposals.

This is the first time ever the IMF is selling bonds. There is a striking parallel between this and what Fed recently did. Please Consider Update on Treasury’s Supplementary Financing Account:

Thus the Fed resorted to the Supplementary Financing Program, a 3rd, nontraditional, way of obtaining financing. The precise characterization of this move has to be nothing but this: That the Treasury borrowed very short term money on the open market, thus withdrawing it, and then invested this money in the Fed, similar to someone investing in stocks of a business.

Again:

A global currency would aggravate all the disastrous effects of national central banking enormously. There can’t be any doubt that the idea is nontheless becoming more and more palatable to world leaders. No matter how distant its potential fruition, individuals worldwide need to make sure these harmful aspirations are nibbed in the bud and reject the idea unconditionally.

What we need is the exact opposite. The global monetary system needs to become less centralized so as to increase and enhance regulation. We do need more regulation, not more government decrees, monopolies, and power that lead to less regulation. A global central bank would be just that. There simply is no better regulation of the global money and credit markets than Gold’s Honest Discipline. The history of money has shown us this time and again.

Tags: global currency, imf, sdr

Confidence in US Banks at New Low

April 25, 2009 · Posted in General Economics · 1 Comment

Amid stress tests and seemingly positive “news” Americans’ Confidence in Banks Hits New Low:

As the Treasury and banking regulators prepare to provide a description of their banking “stress” tests on Friday and the results on May 4, the percentage of Americans saying they have a “great deal” or “quite a lot” of confidence in U.S. banks has fallen to 18% — down 14 percentage points from a June 2008 Gallup Poll and 23 points from a June 2007 poll.

I think whoever proclaims that we might have hit some magic bottom or that we are out of the woods is utterly mistaken. We have certainly seen an all to familiar bear market rally, and banks have made their earnings look appealing. But fundamentals haven’t changed. Consumer credit is just beginning to unravel. Commercial real estate is about to implode:

Since late 2007, a total of 47 banks and savings institutions have failed, of which a dozen or so had unusually high commercial-mortgage exposure. Foresight Analytics in Oakland, Calif., estimates the U.S. banking sector could suffer as much as $250 billion in commercial real-estate losses in this downturn. The research firm projects that more than 700 banks could fail as a result of their exposure to commercial real estate.

Bank failures will likely be rampant. So long as the business cycle correction is being slowed down, the economy is likely to continue down the path it has been on for the past 2 years.

Tags: banks, confidence

Saving the X Industry

April 24, 2009 · Posted in Interventionism · Comments Off

Henry Hazlitts Economics in One Lesson is timeless, clear, and simple. When it was written in 1946 its lessons were as true as they are today. Unfortunately most journalists, economists, and politicians have not learned from it and still resort to the same tired arguments that have been refuted long ago. Please consider Chapter 14, “Saving the X Industry”. Feel free to substitute “Auto” or “Banking” for the “X”:

The lobbies of Congress are crowded with representatives of the X industry. The X industry is sick. The X industry is dying. It must be saved. It can be saved only by a tariff, by higher prices, or by a subsidy. If it is allowed to die, workers will be thrown on the streets. Their landlords, grocers, butchers, clothing stores and local motion picture theaters will lose business, and depression will spread in ever-widening circles. But if the X industry, by prompt action of Congress, is saved—ah then! it will buy equipment from other industries; more men will be employed; they will give more business to the butchers, bakers and neon-light makers, and then it is prosperity that will spread in ever-widening circles.

It is obvious that this is merely a generalized form of the case we have just been considering. There the X industry was agriculture. But there are an endless number of X industries. Two of the most notable examples in recent years have been the coal and silver industries. To “save silver” Congress did immense harm. One of the arguments for the rescue plan was that it would help “the East.” One of its actual results was to cause deflation in China, which had been on a silver basis, and to force China off that basis. The United States Treasury was compelled to acquire, at ridiculous prices far above the market level, hoards of unnecessary silver, and to store it in vaults. The essential political aims of the “silver Senators” could have been as well achieved, at a fraction of the harm and cost, by the payment of a frank subsidy to the mine owners or to their workers; but Congress and the country would never have approved a naked steal of this sort unaccompanied by the ideological flimflam regarding “silver’s essential role in the national currency.”

To save the coal industry Congress passed the Guffey Act, under which the owners of coal mines were not only permitted, but compelled, to conspire together not to sell below certain minimum prices fixed by the government. Though Congress had started out to fix the price of coal, the government soon found itself (because of different sizes, thousands of mines, and shipments to thousands of different destinations by rail, truck, ship and barge) fixing 350,000 separate prices for coal! One effect of this attempt to keep coal prices above the competitive market level was to accelerate the tendency toward the substitution by consumers of other sources of power or heat—such as oil, natural gas and hydroelectric energy.

But our aim here is not to trace all the results that followed historically from efforts to save particular industries, but to trace a few of the chief results that must necessarily follow from efforts to save an industry.

It may be argued that a given industry must be created or preserved for military reasons. It may be argued that a given industry is being ruined by taxes or wage rates disproportionate to those of other industries; or that, if a public utility, it is being forced to operate at rates or charges to the public that do not permit an adequate profit margin. Such arguments may or may not be justified in a particular case. We are not concerned with them here. We are concerned only with a single argument for saving the X industry—that if it is allowed to shrink in size or perish through the forces of free competition (always, by spokesmen for the industry, designated in such cases as a laissez-faire, anarchic, cutthroat, dog-eat-dog, law-of-the-jungle competition) it will pull down the general economy with it, and that if it is artificially kept alive it will help everybody else.

What we are talking about here is nothing else but a generalized case of the argument put forward for “parity” prices for farm products or for tariff protection for any number of X industries. The argument against artificially higher prices applies, of course, not only to farm products but to any other product, just as the reasons we have found for opposing tariff protection for one industry apply to any other.

But there are always any number of schemes for saving X industries. There are two main types of such proposals in addition to those we have already considered, and we shall take a brief glance at them. One is to contend that the X industry is already “overcrowded,” and to try to prevent other firms or workers from getting into it. The other is to argue that the X industry needs to be supported by a direct subsidy from the government.

Now if the X industry is really overcrowded as compared with other industries it will not need any coercive legislation to keep out new capital or new workers. New capital does not rush into industries that are obviously dying. Investors do not eagerly seek the industries that present the highest risks of loss combined with the lowest returns. Nor do workers, when they have any better alternative, go into industries where the wages are lowest and the prospects for steady employment least promising.

If new capital and new labor are forcibly kept out of the X industry, however, either by monopolies, cartels, union policy or legislation, it deprives this capital and labor of liberty of choice. It forces investors to place their money where the returns seem less promising to them than in the X industry. It forces workers into industries with even lower wages and prospects than they could find in the allegedly sick X industry. It means, in short, that both capital and labor are less efficiently employed than they would be if they were permitted to make their own free choices. It means, therefore, a lowering of production which must reflect itself in a lower average living standard.

That lower living standard will be brought about either by lower average money wages than would otherwise prevail or by higher average living costs, or by a combination of both. (The exact result would depend upon the accompanying monetary policy.) By these restrictive policies wages and capital returns might indeed be kept higher than otherwise within the X industry itself; but wages and capital returns in other industries would be forced down lower than otherwise. The X industry would benefit only at the expense of the A, B and C industries.

Similar results would follow any attempt to save the X industry by a direct subsidy out of the public till. This would be nothing more than a transfer of wealth or income to the X industry. The taxpayers would lose precisely as much as the people in the X industry gained. The great advantage of a subsidy, indeed, from the standpoint of the public, is that it makes this fact so clear. There is far less opportunity for the intellectual obfuscation that accompanies arguments for tariffs, minimum-price fixing or monopolistic exclusion.

It is obvious in the case of a subsidy that the taxpayers must lose precisely as much as the X industry gains. It should be equally clear that, as a consequence, other industries must lose what the X industry gains. They must pay part of the taxes that are used to support the X industry. And consumers, because they are taxed to support the X industry, will have that much less income left with which to buy other things. The result must be that other industries on the average must be smaller than otherwise in order that the X industry may be larger.

But the result of this subsidy is not merely that there has been a transfer of wealth or income, or that other industries have shrunk in the aggregate as much as the X industry has expanded. The result is also (and this is where the net loss comes in to the nation considered as a unit) that capital and labor are driven out of industries in which they are more efficiently employed to be diverted to an industry in which they are less efficiently employed. Less wealth is created. The average standard of living is lowered compared with what it would have been.

These results are virtually inherent, in fact, in the very arguments put forward to subsidize the X industry. The X industry is shrinking or dying by the contention of its friends. Why, it may be asked, should it be kept alive by artificial respiration? The idea that an expanding economy implies that all industries must be simultaneously expanding is a profound error. In order that new industries may grow fast enough it is necessary that some old industries should be allowed to shrink or die. They must do this in order to release the necessary capital and labor for the new industries. If we had tried to keep the horse-and-buggy trade artificially alive we should have slowed down the growth of the automobile industry and all the trades dependent on it. We should have lowered the production of wealth and retarded economic and scientific progress.

We do the same thing, however, when we try to prevent any industry from dying in order to protect the labor already trained or the capital already invested in it. Paradoxical as it may seem to some, it is just as necessary to the health of a dynamic economy that dying industries be allowed to die as that growing industries be allowed to grow. The first process is essential to the second. It is as foolish to try to preserve obsolescent industries as to try to preserve obsolescent methods of production: this is often in fact, merely two ways of describing the same thing. Improved methods of production must constantly supplant obsolete methods, if both, old needs and new wants are to be filled by better commodities and better means.

Tags: bailouts, corporate bailouts, economics in one lesson, henry hazlitt

The Dollar Crisis in its Final Chapter

April 23, 2009 · Posted in Monetary Economics · Comment

A prescient outlook from Chapter 20 of Richard Duncan’s The Dollar Crisis:

Chapter 20: Bernankeism

Anticipating the Policy Response to Global Deflation

“Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
Fed Governor Ben Bernanke, 2002

The Fed would already be faced with its worst nightmare, deflation in the United States, had the price of oil not risen above US$50 a barrel following the U.S. invasion of Iraq. Globalization is exerting tremendous downward pressure on the U.S. cost structure that can only intensify in the years ahead as service sector jobs follow manufacturing jobs offshore. A correction in the U.S. current account deficit will cause the floor to drop out from under global prices and threaten the world with a 1930s-style deflationary depression. The following paragraphs will consider how policymakers in the United States are likely to respond to that event.

America’s free trade policy, which it has pursued for decades, is obviously flawed. Free trade between countries with enormous wage rate differentials, and within an international monetary system entirely lacking in any mechanism to prevent large-scale, persistent trade imbalances, is untenable. However, U.S. policymakers are afflicted by the collective hypnosis of conventional wisdom which has taught them that free trade is good and must always be good under any and all circumstances. It is anyone’s guess as to how much longer those in charge of economic policy in the U.S. will cling on to this strange idea.

Meanwhile, it is almost certain that they will respond to the approaching crisis by applying the two great economic policy tools of the last century: Keynesianism and monetarism. The abuse of those tools will prolong and exacerbate the death throes of the dollar standard.

The first recourse will be to employ more fiscal stimuli. With prices falling and in light of the extraordinary amount of paper that has been created in recent years, interest rates will be very low and there will be little difficulty in paying interest on a much larger amount of government debt. It would not be surprising to see the U.S. budget deficit surpass US$1 trillion by 2007 or 2008 if the U.S. current account has come down significantly by that time.

If, at that point, the U.S. current account deficit has been reduced, foreign central banks would not have a sufficient inflow of dollars to finance such a large deterioration in the U.S. budget deficit, even assuming that Fannie Mae and Freddie Mac have ceased issuing any new, competing, debt of their own.

The Fed, however, as Governor Bernanke explained, has already put considerable thought into how to deal with such a contingency and stands ready, in Bernanke’s opinion, to support “a broad-based tax cut” through “a program of open-market purchases to alleviate any tendency for interest rates to rise.”

How long could such “cooperation between the monetary and fiscal authorities” underpin the global economy? For quite a number of years, most probably. Economic cycles play themselves out over very long periods of time. Moreover, U.S. policymakers will use every last tool at their disposal to prevent, or at least delay, a global depression. An economic system underpinned by large-scale fiscal stimulus financed by central bank monetization of government debt could hardly be described as capitalism (perhaps the term “Bernankeism” would be appropriate) but, with any luck, it could stave off disaster for a considerable length of time.

Nevertheless, despite the best efforts of policymakers to keep the dollar standard alive and to stave off the depression that would most probably follow its collapse, ultimately, one of the following scenarios is likely to overwhelm even Bernankeism:

1. A protectionist backlash against free trade, resulting in a trade war similar to that which occurred during the Great Depression.

2. A U.S. asset price bubble (as interest rates fall toward zero) that drives property prices so high they can’t be financed even at very low interest rates. This is similar to what occurred in Japan at the end of the l980s.

3. A meltdown of the under-regulated US$200 trillion derivatives market. (Two hundred trillion U.S. dollars is roughly six times global GDP.)

4. A loss of nerve on the part of policymakers that deters them from undertaking ever more unorthodox economic policies, resulting in a “deer in the headlights” kind of policy freeze.

5. A decline in interest rates to 0%, or very near 0%, as in Japan at present.

Any one of the first four scenarios could undermine the dollar standard, but the final scenario, where interest rates fall very near 0%, would certainly deal it a fatal blow. From that point, the only option left to stimulate aggregate demand would be to drop paper money from helicopters. That too would fail, however, for who would accept paper dropped from helicopters in exchange for real goods and services? Hyperinflation would quickly set in. Economic transactions would then be conducted through barter rather than via the medium of a debased script. Eventually, a gold standard would re-emerge.

Exactly how these events will unfold is impossible to forecast; nevertheless, the eventual outcome is within sight. The dollar standard is inherently flawed and increasingly unstable. Its demise is imminent. The only question is, will it be death by fire — hyperinflation — or death by ice — deflation? Fortunes will be made and lost, depending on the answer to that question.

Right now it seems like the answer is death by ice – deflation…if by deflation the author is not referring to pure monetary deflation, but rather to a money & credit deflation (or wealth deflation as I would prefer to call it) as per Mish’s model. On the correctness of his predictions on trade and budget deficits, please consider Trade Deficit Continues to Decline and President Obama’s Budget.

Tags: deflation, richard duncan, the dollar crisis

Geithnerish Translated into English

April 21, 2009 · Posted in General Economics · Comment

In case people are still trying to make sense of Tim Geithner’s statements, here an attempt to provide some help – another day of superficial answers to superficial questions:

Most U.S. banks have enough capital to keep lending but a pile of bad debts is fostering doubts about their health and slowing a recovery, U.S. Treasury Secretary Timothy Geithner said on Tuesday.

English: “The most relevant banks have absolutely no capital left but we will try to help them obscure their true numbers for as long as we can. By ‘most’ banks I am referring to the banks by number, not by relevance. This way I can make you all think that the banking industry is ‘mostly’ fine.”

Testifying before the Congressional Oversight Panel, which monitors the Treasury’s efforts to bail out troubled banks, he said toxic assets were “congesting” the U.S. financial system and hindering efforts to get credit flowing normally.

“Uncertainty about the value of legacy assets is constraining the ability of financial institutions to raise private capital,” Geithner said, adding that he hoped a public-private investment program will improve the ability to put a price on troubled mortgage and other assets.

English: “I ‘hope’ that no one will figure out that these toxic assets are worth nothing and I am confident that we will somehow be able to bail out their owners by making the taxpayer guarantee 97% of all assets acquired in the PPIP.”

Earlier, the special inspector general for the government’s bailout effort said the toxic-asset plan offered opportunities for fraud and abuse and warned it should be bolstered by tough conflict-of-interest rules.

English: The toxic asset plan WILL be abused and fraud will be rampant. We intend to act surprised once we find out.

Neil Barofsky also said subsidies for the public-private partnerships to buy assets could expose taxpayers to higher losses without matching increases in the potential for profit. He called for tough screening of investors as well as forced disclosure of ownership stakes and any dealings by the funds.

English: The taxpayer is cooked. He will lose billions, once again.

The government has injected hundreds of billions of dollars into banks to help them weather the damage from bad mortgage loans and is running stress tests on 19 of the largest banks to see whether they are prepared to deal with a further downturn.

English: The banks are getting a free ride. We intend to do everything to shield them from the real stress test, the market, no matter how much it will cost the taxpayer.

In a letter to panel chairman Elizabeth Warren, Geithner said the Treasury still has about $134.5 billion available out of an originally approved $700 billion for bolstering banks’ capital and said he wouldn’t need to ask Congress for more.

English: Geithner will ask Congress for more. Either the Treasury will do it directly, or the underfunded FDIC will collapse under the obligations of Geithner’s Public Private Investment Program and ask Congress for more funding.

STOCKS GET A LIFT
“Currently, the vast majority of banks have more capital than they need to be considered well capitalized by their regulators,” Geithner said, a comment that gave stocks a lift in morning trading.

English: “Currently, by market standards the banks absolutely don’t have sufficient capital left. But we don’t care what the market says, we let the “regulators” decide. In doing so, we minimize true regulation but maintain the appearance of it.”

But he conceded there were persistent worries about the health of the banking system and said that was impeding a broader economic recovery.

“Concerns about economic conditions — combined with the destabilizing impact of distressed ‘legacy assets’ — have created an environment under which uncertainty about the health of individual banks has sharply reduced lending across the financial system,” he said.

If the stress tests — parts of which are expected to be made public next month — show some banks need to raise more capital, then they will have options for doing so.

“Those banks that need more capital will have an opportunity to raise that capital from private sources or request capital from the Treasury in the form of convertible preferred stock,” Geithner said.

English: “No matter how lousy the banks, no matter how useless, they will get money from the taxpayer, even if private investors don’t want to touch them with a 10 foot pole.”

Some of the biggest banks have said they want to quickly repay money that they received under the government’s Troubled Asset Relief Program, or TARP, in part to avoid constraints on pay set out as a condition for getting the money.

GLAD TO TAKE MONEY

Geithner said if regulators certify that a bank would be sound without government help, the Treasury would gladly take the money back.

“It helps to underscore the basic point that the institutions of our financial system are in very different circumstances,” Geithner said.

But he hedged on whether he thought it would be good for the banking system if some banks returned the TARP money early, and he specified that regulators, not he, would decide whether to take bailout money back.

English: “Banks are in a Tarp Trap. We’ll let them out at our whim. I prefer to alleviate myself of any responsibility by shifting it to the regulators, whoever they may be.”

“My basic obligation and our responsibility is to make sure that system as a whole … has the ability to provide the credit that recovery requires,” Geithner said, “So we need to make a careful judgment about what policies are going to best promote that objective.”

English: “My basic responsibility is to do everything I can to force lending again, no matter how destructive credit has been to our economy, no matter how broke we are, and no matter how sick and tired of debt individuals are.”

Some analysts question whether letting some banks return the TARP money would add to investors’ and borrowers’ doubts about dealing with banks that still need government help, potentially making them more vulnerable to failure.

In response to questions, Geithner said it will be important for people to see what stress tests on major banks show, though he did not shed any further light on how extensive the publicly issued comments on banks’ health will be.

Transparency is vital, he said, adding “Without that, they are going to live with a deeper cloud of uncertainty over their financial health than they need to.”

English: “Transparency is terrible. With it, we would remove the cloud of uncertainty that currently covers up the truth about how this fractional reserve banking system and its credit expansion has brought about our demise.”

Geithner said the scope of the current crisis is unprecedented, so the government has no guide to follow in its efforts to ease the situation. But he insisted there were some signs of progress.

“Indicators on interbank lending, corporate issuance and credit spreads generally suggest improvements in confidence in the stability of the system and some thawing in credit markets,” he said.

English: “I have absolutely no clue what is going on. I will cover it up with platitutes since none of you seem to have a problem with it.”

Tags: ppip, tarp, tim geithner

Money vs. Credit

April 19, 2009 · Posted in Monetary Economics · 5 Comments

Mish defines inflation and deflation as an increase/decrease of money and credit, respectively. He brings this issue up a lot in his posts, for example:

The logical outcome of the above discussion is that a proper definition of inflation or deflation must be built on the foundation of a sound definition of money supply that distinguishes between money itself and credit. The definition should also ensure that the horse and the cart are in their proper places.

The problem that I have with his explanations is that nowhere I have seen him make a clear and precise definition of what he means by money vs. credit.

The two don’t preclude each other. Money is the commonly accepted medium of exchange. Credit is the exchange of present goods against future goods. A money credit transaction it the exchange of present money against future money. Virtually all credit transactions are money credit transactions.

If new money is created via credit expansion, the money is injected by a central bank or fractional reserve banks via the purchase of a newly issued credit instrument, a claim to future money. Credit increases, just as money increases on the recipients bank account. When the money is repaid, money disappears from the recipient’s bank account, the credit instrument disappears from the bank’s balance sheet and the money supply, ceteris paribus, falls, just as credit falls.

If one catches the appearance of this newly created money and the disappearance thereof on individuals’ or businesses‘ bank accounts, the money supply is perfectly accounted for. The true money supply accomplishes just that. Thus it would suffice to say inflation/deflation is an increase/decrease in the true money supply, respectively.

Thus I am not sure what Mish is referring to when he talks about money vs. credit and so far I have not really found a sufficient answer in his posts. Nor have I received any satisfactory answers from him directly that addressed my concerns outlined above. What he could be talking about is maybe base money injected by the Fed vs. fractional reserve money created on top of the base money. If this is the case then he should refer to it in those terms to avoid confusion. If it is not, then I am still confused.

Any suggestions are appreciated.

Update: I have now dealt with this issue in my post Inflation & Deflation Revisited which clarifies the questions above.

Tags: mish, money vs credit, true money supply

A Stress Test Called “The Market”

April 18, 2009 · Posted in General Economics · Comment

In a usual display of incompetence Bank Regulators Clash Over U.S. Stress-Tests Endgame:

The disarray highlights what threatens to be a lose-lose situation for Treasury Secretary Timothy Geithner: If all the banks pass, the tests’ credibility will be questioned, and if some banks get failing grades and are forced to accept more government capital and oversight, they may be punished by investors and customers.

“There are plenty of ways to go wrong here,” said Wayne Abernathy, executive vice president of the American Bankers Association in Washington. “It might have sounded good at the time, but now looking back, it has far more risk than benefit.”

Hey Mr. Geithner, why make it so hard on yourself? What are you trying to accomplish? You say you want to find out which banks are sound enough to weather the storm. There is a pretty interesting concept to find out. It’s called the “market“. You know, that place where producers go to sell goods and services to consumers. You heard about that, right? I am saying “heard” because you obviously haven’t experienced it in your life as government bureaucrat and bank executive.

It’s that place where entrepreneurs exchange their consumer goods and services against money offered by consumers. It’s also the place where entrepreneurs obtain the resources to produce those goods. When they obtain these scarce resources they withdraw them from other uses. Then follows the stress test: If the goods produced are more demanded by consumers than the previous occupation of these resources, they make an entrepreneurial profit. If they are not they incur a loss. If they incur a loss they have to change what they are doing and listen to the consumers, or they need to release the resources they are squandering and make them available to entrepreneurs who know what the consumers are asking.

But this thing called market presupposes voluntary choice on the part of the consumers and entrepreneurs. Nobody can force them to buy or sell something. It is the concepts of liberty, peace, happiness, and prosperity in action.

When, due to the interventions of a government backed central bank, the majority of people in society is withdrawn from productive sectors and employed in an industry whose main objective is to make loans day in day out, the market will send a signal at one point. Some banks will report losses. This means they have failed the stress test. They need to adjust their operations or release their resources. Some banks will remain profitable. Those banks have passed the stress test.

If you keep using tax money or newly created fiat money in order to bail the failed banks out, you are doing the opposite of a stress test. You are giving their executives what is commonly referred to as a free ride. It’s really pretty harmful. Because they will be inclined to keep doing what they have been doing. They will make the majority of the people poorer and poorer.

It’s very simple, this neat little thing called market. You should try it out sometime, unless you want to be remembered as the worst Secretary Treasury this country has ever seen.

Tags: market, stress test, tim geithner

The Fed Bought MBS Starting in 2000

April 18, 2009 · Posted in Monetary Economics · Comment

The following is rather commonplace to people who understand the financial crisis. I just felt it necessary to refresh people’s memories since for some reason no one in the mainstream seems to point this out.

Even though the US housing bubble was a symptom of a much bigger problem of general credit expansion, it obviously began to expand by an accelerated and unusual pace in or around the year 2000.

What caused this? It was of course due to the fact that the Federal Reserve Bank decided in August 1999 to add Mortgage Backed securities to its portfolio:

The broader range of collateral approved by the Committee for repurchase transactions included mainly pass–through mortgage securities of GNMA, FHLMC, and FNMA, STRIP securities of the U.S. Treasury, and “stripped” securities of other federal government agencies.

John Paul Koning has this chart on the mises.org site:

Should it be a surprise to anyone, then, that what ensued was a period of reckless speculation in and issuance of these types of securities and their derivatives?

So what should we do to avoid such a disaster in future? The solution is simple. Audit the fed, expose its disastrous policies, and get rid of it once and for all.

Tags: audit the fed, federal reserve bank, mortgage backed securities