Bernanke Bids for Soros' Danish Covered Bonds; Obama to Make Toast

The big news today was not of the twist type, but of another dance number (or slumber) between Bernanke and Obama. As expected, the Fed will be swapping some of its shorter maturity Treasury securities for longer ones into mid-2012, but it will also start purchasing mortgage backed securities again after an eighteen month hiatus.

Since the announcement of so-called QE-Lite (which preceded QE2), the Fed has kept its balance sheet from shrinking by buying Treasury securities with the proceeds from the maturing Agency and Agency MBS bonds it bought during QE1. No longer. The Fed will now purchase more MBS with this money. The question is: why?

With 30 year rates hovering around 4%, hasn't everyone who qualifies for a refinance already done so? And, that's the point. There are millions of homeowners who don't qualify for a refi because of a low credit score, lost job or simply being underwater on their home. To be useful, low mortgage rates need a fiscal side program to get around these hurdles. As Bruce Krasting pointed out several weeks ago, the FHFA, which regulates Fannie and Freddie, is already moving in this direction:

The second thing of note is that late Friday afternoon a was letter released by the FHFA. There was a very significant softening of the language regarding the terms for refinancing:

FHFA is also considering the barriers to refinancing mortgages that would otherwise be HARP eligible but for having a current LTV above 125 percent.

Our objective is to provide borrowers in high-LTV loans who have a history of making on-time mortgage payments with an opportunity to refinance, resulting in reduced credit risk to the Enterprises and added stability to housing.

Bingo! The current ReFi restrictions that require a borrower be no more than 25% underwater and have a 780 FICO are about to be waived.

Krasting continues with more evidence:

The final bit of data comes from the CBO. They did an analysis of what the implications are of big refinancing might be. I contacted the CBO on this and they were very clear that the work they did on this topic was not a report on a specific proposal, but rather a generic review.

It is probably correct that any plan that the administration comes up with will vary in scope from the review by CBO. It is also correct that this review has been done in anticipation of a specific proposal. Therefore the review and the conclusions are worth noting. The key assumptions used in the analysis:

(1) Eligibility includes existing loans guaranteed by Fannie Mae, Freddie Mac, or FHA.

(2) A borrower must be current on an existing mortgage and must not have been more than 30 days late on any mortgage payments during the prior year, but there are no limits on the borrower’s current income or on the loan-to-value ratio of the new loan.

(3) The new loan has a fixed rate of interest, at the prevailing market rate, and a term of 30 years.

The CBO has concluded that there are $4.3 trillion of mortgages that broadly meet the above requirements. These mortgages have been converted to Agency MBS. The report looks at what were to happen if 10% in that universe were restructured. The following chart looks at the results.

We can only speculate about the exact details of the program, but conveniently, George Soros has one out of the can. From the Absalon Project website:

Absalon Project (Absalon) will market the Danish Mortgage Solution on a worldwide basis. Absalon is an extension of a partnership between affiliates of VP SECURITIES A/S and Soros Fund Management that was established back in 2005 with the purpose to implement the Danish Mortgage Model in Mexico. This project was successfully carried through with the creation of a mortgage servicing company in Mexico named HiTo that issued the first loans based on the Danish Mortgage Model just before Christmas 2007. Since then HiTo has introduced more loan types to the Mexican market and is issuing loans on a weekly basis, using the solution provided by Absalon.

The Danish way of financing housing through mortgage loans has proven its efficiency and reliability for more than 200 years. It has survived a few crises in its lifetime and also during the current crisis starting in 2008 the Danish Mortgage Model has proven its robustness to the benefit of the borrowers, the investors and the Danish Mortgage Credit Institutions themselves. The project in Mexico has attracted a world wide attention. Combined with the problems that have occurred since the subprime crisis started in the US the Danish Model has gained a lot of interest from all around the world.

Absalon Project was created to capitalize on the experiences from the project in Mexico to offer a solution based on the Danish Mortgage Model to customers on a worldwide basis. The offerings range from initial financial analysis of the possible benefits of introducing the model, over the creation of a Business Plan and Marketing Plan to the delivery of software, services and assistance in setting up the business procedures and the integration of the IT systems.

The US-tailored proposal was released September 1, 2011 and got a nod from RC Whalen, who wrote at ZeroHedge (emphasis ours):

Below is the intro for an important paper by Alan Boyce, Glenn Hubbard, and Chris Mayer, which lays out the finances of the mortgage market in great detail and argues for refinancing of all GSE-covered loans. For home owners, this proposal offers hope to obtain the refinance which is their lawful option but is being denied by the large bank/GSE mortgage cartel.

For investors in RMBS, this proposal is a disaster, a massive pre-payment on vintage RMBS and the loss of tens of billions in net interest margin for the financial system. This paper hopes to shift $70 billion per year from bond investors to consumers and thereby help the economy. The US banking system made $28 billion last quarter. Got your attention now?

-- Chris

Streamlined Refinancings for up to 30 Million Borrowers

By Alan Boyce, Glenn Hubbard, and Chris Mayer

Executive Summary

Frictions in the mortgage market have restricted the ability of tens of millions of borrowers from refinancing their mortgages, hampering monetary policy, slowing the economic recovery, and leading to excessive numbers of foreclosures. We propose a streamlined refinancing program that may benefit up to 30 million borrowers with government-backed mortgages, leading to possible savings of $70 billion per year in lower mortgage payments. Below we describe the current barriers to refinancings, how our plan would overcome these barriers, and why this plan is in the interest of taxpayers, the GSEs, and other mortgage service providers. We also discuss possible critiques and implementation issues and how such issues can be addressed.

1) The problem

a) As of June 2011, more than 75% of GSE3 borrowers with a 30-year fixed-rate mortgage (FRM) have a rate of 5% or more, despite the fact that market-determined mortgage rates have been at or below 5.0% for nearly every month in the past two years and are currently around 4.25%.4 Under normal credit conditions we might have expected three times this many eligible mortgages to have been prepaid, as happened during the last refinancing wave from 2002 to 2003.5 This suggests tens of millions of borrowers have not taken advantage of a seemingly attractive refinancing proposition.

b) We believe that inefficiencies in the origination and servicing process, combined with GSE surcharges (so-called loan level pricing adjustments and adverse market delivery charges), falling home values, and conservative appraisals have made refinancing nearly impossible for most Americans.

c) In addition to blunting refinancing, these mortgage-market frictions are slowing the economic recovery by limiting the benefits of low interest rates for household spending. Unable to refinance their mortgages the way corporations have been able to refinance their debt, consumers are left with weak balance sheets and mortgage payments often above of the cost of renting, contributing to excessive delinquencies and foreclosures. These constraints on refinancing have a disproportionate impact on middle-class borrowers with origination balances under $200,000 and poorer credit and whose employment opportunities have been hit especially hard by the recession.

2) The Offer

a) Every homeowner with a GSE mortgage can refinance his or her mortgage with a new mortgage at a current fixed rate of 4% or less, with the rate subject to change up or down with the price of Agency pass-through Mortgage-Backed Securities (MBS). For borrowers with an FHA or VA mortgage, rates would be higher, but these borrowers should be included in any large-scale refinancing program.

b) The homeowner must be current on his or her mortgage or become so for at least three months.

c) NO other qualification or application is required, other than intention to accept the new rate (that is, no appraisal, no income verification, no tax returns, etc.).

Read the rest of the paper at link below:

http://absalonproject.com/wp-content/uploads/2011/09/BHM-V11-final.pdf

After the jump, the proposal continues (emphasis ours):

d) Minimal paperwork, other than what is needed legally to refinance in homeowner’s jurisdiction. The Bureau of Consumer Financial Protection may provide a one-page substitute for TILA, RESPA, and HMDA filings to further reduce paperwork and costs.

e) Homeowners can choose between a 15- or 30-year amortization schedules for newly issued mortgages.

f) Homeowners may only refinance existing first-lien mortgage debt and cannot cash out or roll multiple mortgages into the new mortgages.

g) GSEs would be required to issue new MBS in large, highly standardized, transparent, and homogeneous pools, as current Ginnie Mae II Jumbo securities are now issued.

h) Existing servicers would be relieved of their liability for past “Reps and Warranties” violations as long as the mortgage is current today and is at least a year old.

i) Existing second-lien holders would be asked to resubordinate to the newly refinanced first mortgage.8

j) Existing mortgage insurance contracts should be rolled to the new first mortgage.9

k) New title insurance policies must be done in a streamlined process and at low cost, likely a few hundred dollars at most.10

The whole paper is worth a read, and did anyone catch (h) above? That would tidy up some lingering problems, wouldn't it. [In fact, we might be tempted to wonder why New York Attorney General Eric Schneiderman, who's not nearly as anti-Wall Street as his "E.S." predecessor, is so aggressively blocking the BAC and Bank of NY Mellon settlement. We're sure it has nothing to do with campaign contributions from the amateur tennis circuit...but that's a thought for another day).]

In contrast to the CBO plan, Absalon envisions re-papering the entire MBS-eligible US mortgage universe--not just those that cannot refinance now. But, there's another striking feature that contradicts the CBO analysis. Remember part (a) of the deal:

a) Every homeowner with a GSE mortgage can refinance his or her mortgage with anew mortgage at a current fixed rate of 4% or less, with the rate subject to change up or down with the price of Agency pass-through Mortgage-Backed Securities (MBS). For borrowers with an FHA or VA mortgage, rates would be higher, but these borrowers should be included in any large-scale refinancing program.

These are not 15 or 30 year fixed rates envisioned by the CBO, but the equivalent of adjustable rate mortgages. Though not as common as fixed-rate in the Danish system, these floating-rate bonds are prevalent and are fixed to CIBOR two or four times annually.

If you think interest rates are going to stay low forever, great. If you think they might be materially higher sometime in the next three decades, then it might not be so wise to trade in your 5.5% 30 year fixed. Regardless, today Bernanke has pledged to keep mortgage rates low long enough to jump start whatever Obama's new mortgage program is, Absalon or not, and to buy the new MBS bonds with the lower coupon.

The Fed's Next Step: Thoughts on Operation Twist 2 and the Fed's Third Mandate (yes, there are really 3)

Now that Chairman Bernanke has inasmuch admitted he has no clue what's going on, but is ready to pull yet another rabbit out of his beard at the next FOMC meeting, it's time to address his monetary manipulation options and just why the most likely one might be illegal. While some might doubt the imminence of the next round of easing, according to the minutes of the last FOMC meeting, released only yesterday, there was a secret meeting by videoconference on August 1 to discuss the debt ceiling and the "possibility" of a ratings downgrade of US debt (which would occur just four days later). The last (and only, according to our search) videoconference was conducted October 15, 2010, just prior to the FOMC meeting that would announce QE2.

Curiously, Bernanke made scant mention of his "tools" Friday at Jackson Hole, perhaps not wanting to tip off the broader bond market on which Treasurys to load-up (though we're sure Larry Meyer is advising his clients). However, his options are basically twofold and come down to targeting either interest rates or the Fed's own balance sheet size.

Really, the Fed has been doing both, as it has continuously targeted the shortest end of the curve in the overnight Federal Funds market at 0-0.25% since late 2008, while its QE1 and QE2 operations aimed at increasing its balance sheet by a total of $2.35 trillion. Arguably, the latter helped facilitate the former. And, in the last FOMC statement, the Fed committed to keeping an exceptionally low Federal Funds rate into mid-2013. This means that even if the market starts demanding higher short term interest rates in the next two years, the Fed has pledged it will step in and flood the markets with liquidity via open market operations (likely temporary repos) to keep rates low. Think about that.

Correct or not, many perceive this massive digital money printing as causing the recent and growing price inflation at the pump and Piggly Wiggly. Recent civil unrest in MENA and (gasp) Londontown are serving as wake up calls. The public, when it perceives itself sufficiently aggrieved, will turn on its government on a shiny, FDR dime. Bernanke knows he needs something different to give himself plausible cover. See here for a variety of possibilities set forth by Goldman.

Today, we'll focus on interest rate targeting further out on the yield curve (so-called Operation Twist 2, or OT2), and why it looks increasingly likely. First hypothesized by David Rosenberg and discussed in detail at ZeroHedge, OT2 would be a quasi repeat of the Kennedy-era Fed operation, whereby it committed to purchasing enough Treasurys at the longer term yields to effectively cap them, in order to strengthen the US Dollar and prevent gold outflows, while simultaneously not putting pressure on short term rates. It was initially judged a moderate success, as indeed the yield curve flattened. While gold convertibility itself is now itself a barbarous relic, the concept of long term interest rate targeting has been revived as an alternative to balance sheet targeting.

The question is what maturity the Fed would target. If, as Rosenberg originally suggested, it is in the longest maturities (10 to 30 years), then we could indeed see higher stock market prices. As TradeWithDave reasoned (prior to Jackson Hole and the last FOMC meeting):

Here’s Dave’s gut instinct. This is a temporary attempt to strengthen the dollar artificially cooling inflation while attempting to coax cash off of corporate balance sheets into mid-term investments by inverting the yield curve and motivating banks to lend to businesses again due to attractive low, long-term rates. What will it actually do? Dave thinks it’s like “cash for clunkers”, but it’s really more just “cash for candy.” It will create the need for increased liquidity and more paper money and it will increase the near-term velocity of cash actually creating a currency shortage.

It will be like a sugar high. Like dropping a Mentos into a bottle of Coke. Wow! Then you’re left with a flat soda and sticky mess. Is anyone foolish enough to sink long-term or even mid-term (say a 7 year term loan for a business) investments when you have such an unstable environment? No. So, what will happen is an increase in liquidations (further drop in real estate prices) in an effort to lock-in short term returns.

In other words, companies will sell the ranch and use the money to chase the higher near-term returns which will allow them to pay stellar dividends which will rocket their stock price all while they destroy their (and our) long-term prospects… but who cares because they’ll make their numbers for the quarter while no one else is, which means they will not only survive, but prosper and further consolidate their leadership positions in the UPS/Fedex, Verizon/AT&T, Apple/Android, Coke/Pepsi duopolistic fantasy of a free market. If the sugar fix was legitimate investment and the dollar was fundamentally strong, then it would destroy the stock prices, spoiling our dinner and the intended wealth effect and we can’t have that now can we.

Since then, we have learned the Fed will target short term rates for two more years (which presumably could include a couple of modest Fed Funds rate hikes up to 0.75%). Accordingly, this might ultimately weigh on the US Dollar. If indeed the Fed ends up targeting longer term yields as well, we might end up with a yield curve that looks something akin to a handlebar mustache. In this scenario, the chase for yield would indeed be in the belly of the curve.

What the Fed might have all along planned is for a two prong interest rate targeting of both ends of the yield curve spectrum, with each leg to be implemented at successive FOMC meetings, sandwiching Jackson Hole for maximal PR value.

Another possibility, raised by Bill Gross of Pimco, is that the Fed will target the 2 to 3 yr maturities. Other than restarting the mortgage option-arm market, we're curious to know what this might accomplish, as the Fed would cede control of the long end. However, we do present it below as a possibility, which is a very rough sketch (we're not bond market wizards):

Why OT2 will not come from QE-Lite

The Fed continues to maintain its balance sheet size by buying Treasury securities as the Agency and Agency MBS securities it also owns mature or are paid off (so-called QE Lite). People pay down mortgages, the servicers pay Fannie and Freddie, who in turn pay the MBS holders, which includes the Fed (holding just under $1 trillion in MBS now). Accordingly, the Fed is still buying Treasurys at about $15 billion per month (down from over $100 billion per month during QE2).

It has been suggested that the Fed could simply target longer maturities with this $15 billion fire power, or actually reshuffle its portfolio to extend its duration. Our view is this puts the Fed in a very precarious position, because once it guides expectations that it will extend duration, the bond market might awaken and demand a full commitment for yield targeting. As many have noted, the Fed cannot target long term rates and its balance sheet size simultaneously. It must be willing to purchase every single bond at a given maturity range.

The legal problem

The oft-cited "dual mandate" of the Federal Reserve for maximum employment and stable prices was enacted in 1977 when Congress modified the Fed's mandate. Curiously, stable prices is always interpreted by the Fed to mean 2% annual inflation dollar devaluation. However, there is actually a third mandate for "moderate long-term interest rates". It's right there in the Federal Reserve Act:

Section 2A. Monetary Policy Objectives

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

Exactly why the third mandate fell down the memory hole is revealed in the footnote of a speech given by none other than Bernanke himself (emphasis ours):

The Employment Act of 1946 established the objectives of "maximum employment, production, and purchasing power" for all federal agencies, whereas the 1977 amendment to the Federal Reserve Act gave the Federal Reserve the specific mandate of promoting "maximum employment, stable prices, and moderate long-term interest rates." Price stability requires that the central bank not attempt to drive employment above its sustainable level, and so in practice the Federal Reserve has interpreted its mandate to include maximum sustainable employment. The goal of moderate long-term interest rates is frequently dropped from statements of the Federal Reserve's mandate not because the goal is unimportant, but because moderate long-term interest rates are generally the byproduct of price stability.

Yet, what if exceptionally low long-term interest rates are the by-product of intentional distortions created by Federal Reserve interest rate targeting? Wouldn't this be an intentional and explicit violation of the Fed's statutory mandate of "moderate" long term interest rates?

What constitutes "moderate" is not explicitly defined, but long term rates are already at historically low levels, and it would be difficult to characterize any further targeted lowering as "moderate". While the 2-3 year range might be considered "middle term", the Fed's most likely option, the 10-30 year, is definitely long term.

All it would take is one Federal lawsuit and a sympathetic judge to serve a temporary restraining order on Brian Sack at the New York Fed to bring the digital money printing wheels to a grinding halt.

Now think about that.

End of Intermediate Term MIDAS TopFinder in Gold Suggests Moody's Downgrade Now Priced In

Today, we're taking a break from rummaging through the Fed's website to present a bit of voodoo technical analysis, which we usually reserve for our daytrading forum, but will post here, as it might be of some interest to those keeping track of the barbarous relic's recent surge.

For background* on the MIDAS TopFinder(TF)/BottomFinder (BF) tool, see our post at ZeroHedge from October 15, 2010, and the follow up by Andrew Coles here (coincidentally posted on July 5, the low from which the current TF was launched, and when he noted a rally was indeed possible as TF support from the weekly time frame had held).

The termination of the current TopFinder concurrent with the ominous bearish engulfing candlestick today likely signals an end to the current epoch of panic-to-quality induced by the Moody's downgrade of US debt. This would mean long term Treasury yields have likely troughed as well, at least for the short term [and, yes, they indeed plunged much lower than we had anticipated just prior to the Moody's news].

As Paul Levine wrote in 1997:

What I’ve just described here may be confusing to those who are new to using TopFinders, since people are usually expecting one indicator that will clearly identify the top. It’s important to understand what a TopFinder does and does not do. It does identify an accelerated uptrend that is all “of a kind”, with price behaving in the same way all the way to its end. The end of a TopFinder does identify the end of this kind of price behavior and the beginning of a consolidation even if it’s only a brief consolidation. And the end of the TopFinder does identify the place beyond which price behavior will be distinctly different. However, in spite of the catchy phrase “Top Finder”, it does not necessarily “find the top”. After the consolidation, price may resume going up, albeit with a different pattern than before the end.

So, the end of the TopFinder on the daily chart does not preclude yet another disaster from setting the markets ablaze, but it does suggest the Moody's downgrade is now priced in. Indeed, on the weekly time frame (reproduced to conform to Coles' July presentation), we might see a retracement to its rising TF (currently $1686), with a subsequent price rally to new highs above $2000. At 95% completion and incrementing 1% per week, that would coincide with mid-September.

Finally, on the secular/decadal time frame, as Coles wrote in July:

It may not have escaped the noticed of some readers that the secular degree trend (10 to 25 years) in gold from the 2001 bottom also appears to be accelerating. Indeed, as in Chart 7, we have the same setup for a TF (red), since S1 (green) displaced immediately from the trend when it was launched from the March 2001 bottom. This enormous secular-degree TF is 56.9% done, suggesting – on an extrapolation of a price/time reading from the cumulative volume prediction – that we could see another decade of rising gold prices.

Conclusion: sell your bullion? No! But, be wary of leveraged long gold exposure here.

*The recent Bloomberg Press publication by Coles and Hawkins, MIDAS Technical Analysis, has become the definitive reference book on Paul Levine's work, incorporating a number of innovations, including some of our work.

More on how the GAO's phony Fed audit failed to disclose some dirty secrets about BlackRock and JP Morgan

We recently revealed that the Government "Accountability" Office (GAO) audit of the Fed's emergency practices during the financial panic (which caused so much consternation even in watered down form) was a complete whitewash. In its review of the Fed's outsourcing practices, it failed to mention the most damaging and suspicious sole-source (no bid) contract awarded to BlackRock, which was for handling the New York Fed's toxic Bear Stearns portfolio, otherwise known as Maiden Lane. This contract would generate $108,000,000 in fees and was one of the largest awarded during the bailout period, but it might also have saved JP Morgan $1.1 billion in losses from its Bear Stearns acquisition.

A key finding from the GAO report related to the noncompetitive award of contracts to third parties, particularly by the New York Fed:

The Reserve Banks, primarily FRBNY, awarded 103 contracts worth $659.4 million from 2008 through 2010 to help carry out their emergency lending activities. A few contracts accounted for most of the spending on vendor services. The Reserve Banks relied more on vendors more extensively for programs that provided assistance to single institutions than for broad-based programs. Most of the contracts, including 8 of the 10 highest-value contracts, were awarded noncompetitively due to exigent circumstances as permitted under FRBNY’s acquisition policies.

The report also stated there was a total of three sole-source contracts awarded, and the GAO went out of its way to highlight the reason for two of them:

For example, FRBNY noncompetitively selected BlackRock as the investment manager for Maiden Lanes II and III because BlackRock had already evaluated the underlying assets pursuant to an engagement with AIG prior to the extension of credit by FRBNY.

Yet, amazingly (or not so), the GAO failed to disclose that BlackRock had no similar experience with the Bear Stearns portfolio (the original Maiden Lane). According to [now] Vice President Sarah Dahlgren of the New York Fed, there was no "clear reason" for BlackRock to be awarded the management rights on a noncompetitive basis. We know this because of internal emails, which were subpoenaed by Congress pursuant to its investigation of the Fed's bailout of AIG:

To Sarah Dahlgren/NY/FRS@FRS

Re: Sole Source

Spent some time with him [Tom Baxter, Jr., FRBNY GC] tonight. (He doesn't understand ML3, and I can't begin explain it either -- so don't needle him! -- and I am going to have [Paul] Whynott [FRBNY VP] spend some time with him tomorrow, BTW, you might touch base with Joyce [Hansen, FRBNY Deputy GC] about her reaction to Sunday's briefing; I think she had some concerns about how ML3 was presented to Geithner, which she expressed to Paul.) [Geithner] knew that Stephanie [Heller, FRBNY Asst. GC] was handling the Blackrock contract -- he didn't express any concerns -- and I explained that, in contrast to MLI, we had a clear reason to sole source it this time (that they had already modeled, etc.). So, although I have no worries, yes, probably worth reviewing it with him [Geithner] before taking it to Tom."

As to the New York Fed's guidelines on third party contracts, the GAO notes:

FRBNY awarded contracts in accordance with its acquisition policy, which applied to all services associated with the emergency programs and single-institution assistance. FRBNY is a private corporation created by statute and is not subject to the FAR. Instead, FRBNY developed its own acquisition policy, called Operating Bulletin 10.

According to the New York Fed's Operating Bulletin 10, sole-source contracts require approval at the highest levels (emphasis ours):

4.3 Exceptions to Competitive Acquisitions

A. Procedures other than competitive solicitations or small purchase procedures may be used in the following circumstances. The Contract Representative should draft a memorandum with sufficient supporting documentation to justify the use of the exception to acquisition procedures, and obtain the approval of a senior officer (Vice President or higher). The approving senior officer must have the appropriate level of signing authority, pursuant to Operating Bulletin No. 2, for the expected dollar expenditure. A copy of both the approval memorandum and senior officer approval should be placed in the acquisition file of the Contract Representative area and forwarded to the Procurement Division as the central repository for contract information. Contracts in excess of $500,000 that are not competitively bid must be approved by the Bank’s Board of Directors pursuant to Operating Bulletin No. 2.

1. Sole Source. The property or services are available from only one responsible supplier and no other type of property or services will satisfy the Bank’s needs.

Commentary

(1) A sole-source acquisition involves no competition and should be utilized only when justified and necessary to serve Bank needs. A sole-source award should generally be made only where no other source of supply is available.

In short, the approval of the $108 million BlackRock contract had to be approved by both a senior officer at the New York Fed and its Board of Directors due to the size of the contract. And just who comprised the board at the time?

STEPHEN FRIEDMAN, Chair and Federal Reserve Agent

Chairman

Stone Point Capital, LLC, Greenwich, Conn.

DENIS M. HUGHES, Deputy Chair

President

New York State AFL-CIO, New York, N.Y.

JAMES DIMON

Chairman and Chief Executive Officer

JPMorgan Chase & Co., New York, N.Y.

JEFFREY R. IMMELT

Chairman and Chief Executive Officer

General Electric Company, Fairfield, Conn.

CHARLES V. WAIT

President, Chief Executive Officer, and Chairman

The Adirondack Trust Company, Saratoga Springs, N.Y.

RICHARD L. CARRIÓN

Chairman, President, and Chief Executive Officer

Popular, Inc., San Juan, P.R.

INDRA K. NOOYI

Chairman and Chief Executive Officer

PepsiCo, Inc., Purchase, N.Y.

VACANCY 2010 B

LEE C. BOLLINGER

President

Columbia University, New York, N.Y.

Notably, ex-Goldman Sachs Chairman, Stephen Friedman, would later resign in disgrace after it was learned that he was loading up on shares of his former employer (Goldman) as it was receiving overt and covert bailouts from the very same New York Fed through the various emergency lending facilities.

And while the contract amount of $108 million might seem like peanuts in light of the billions being thrown around at the time, BlackRock might have served another function by becoming investment manager for Maiden Lane. As we wrote in June, 2010, BlackRock ended up heavily trading the MBS portion of ML, which had been sold to the public as a vehicle to simply unwind Bear Stearn's toxic assets. So much so, that MBS trading profits papered over the substantial losses in the RMBS and loan sections of the portfolio. While the New York Fed had loaned ML approximately $28.8 billion to purchase the portfolio, JP Morgan ponied up a cool $1.1 billion of its own, and was last in line to be paid if there were losses.

Also, BlackRock was also one of the managers of the NY Fed's separate $1.25 trillion MBS purchase program as part of QE1. Contrary to the lie on the NY Fed's webpage (that the MBS auctions were conducted via competitive bidding), the NY Fed's own purchasing manager, Brian Sack, admitted in a paper that, "the MBS purchases were arranged with primary dealer counterparties directly, [and] there was no auction mechanism to provide a measure of market supply."

Putting it all together, it looks like Jamie Dimon signed off on hiring BlackRock for no justifiable reason to trade the very Maiden Lane portfolio that could have caused his bank, JP Morgan, to lose up to $1.1 billion. And, it was entirely possible that BlackRock saved the portfolio by trading the MBS portion of ML with the New York Fed directly as QE1 was underway.

Unfortunately, the GAO's work product is not subject to public request, but it can be compelled to be released by Congress. The next time Congress decides to subpoena the Fed, or Bloomberg decides to file a FOIA, they might request the acquisition file for the BlackRock Maiden Lane contract containing the officer approval and justification notes, as well as the minutes of the director meeting with Friedman, Dimon, Immelt et al.

If one guy with nothing more than a laptop and an internet connection could find all this, we are left to wonder what other elephants the GAO ignored during its field trip to 33 Liberty Street.

Is the ECB starting to massively print money again?

Earlier today at EPJ Central, Robert Wenzel warned that the Eurozone economy is on the edge of a major downturn (emphasis ours):

A tight money policy by the European Central Bank is causing the eurozone to go into an "unexpected" recession.

In Germany, the second-quarter gross domestic product growth number of a mere 0.1%, was significantly lower than the 0.5% Keynesian economists had been predicting. German GDP expanded 1.3% in the first quarter.

And the Markit/BME purchasing managers’ index for the German manufacturing sector fell 2.6 points in July to 52 points, its lowest level since October 2009.

There was zero growth registered by France in the second quarter and the euro area’s overall GDP rose only 0.2% in the second quarter from the preceding three months, after growing 0.8% in the first quarter, Eurostat said Tuesday. Growth in Spain and Italy was 0.2% and 0.3%, respectively.

A non-money growth policy is the best policy, however, this policy, following a period of money printing results in the downturn of the boom-bust cycle as the economy adjusts to a non-money manipulated economy. Central banks rarely allow this correction to play out and return to money printing. Keep an eye on the ECB if it returns to money printing, we may very well be near the first near-global price inflation, as the U.S. money supply is already in near super-growth mode.

That last paragraph is indeed interesting, as only today, the ECB published its consolidated financial statement of the Eurosystem for the week ending August 12, 2011. The statement reflects the first round of new bond purchases (€22.0 billion) since early January, 2011 via the ECB's Securities Market Programme (SMP) . But it also shows that, contrary to the previous bond purchases, which were sterilized with concurrent liquidity withdrawals, last week there was a massive ramp in liquidity providing activities. Here's the asset side of the balance sheet:

We can see the €22.0 billion in bonds under line 7.1, "Securities held for monetary policy purposes", which is where the 2010 bond purchases were reflected week by week.

Here is the liabilities side:

In the previous bond purchasing period, there would be a concurrent increase in line 2.3, "Fixed-term deposits", which are akin to short term non-negotiable bills the ECB would issue to banks to soak up liquidity [reductions in refinancing operations would account for the balance of sterilization]. Last week's increase in fixed-term deposits? Zero. Instead, there was a €54.6 billion reduction in the regular deposit facility at line 2.2.

Going back to the asset side for a minute, we also see there was a €57.8 billion increase in line 5.2 "Longer-term refinancing operations" (LTROs), which is also liquidity providing. This combined €112.4 billion went into line 2.1 on the liabilities side, "Current accounts (covering the minimum reserve system", which increased €127.0 billion over the week. To be fair, there was a large drop in the prior week in this line of $48.5 billion, and it is historically subject to large fluctuations from time to time. However, Current accounts is now at one of highest amounts on record, as is the weekly change.

One final table, which lists the ECB's open market operations and demonstrates where most of the increase in Item 5.2 LTROs on the asset side of the balance sheet came from:

The highlighted LTRO liquidity providing operation is the fourth longest maturity on record at 203 days, the longest since December, 2009. Apparently, the ECB was spooked enough when it announced the operation on August 4, 2011, that it knew it would need to provide a cool €50 billion to banks for a guaranteed six months.

Going back to the balance sheet, what's interesting about the Current accounts line is it apparently contains both required reserves and any excess reserves. Contrary to the US Federal Reserve, the ECB does not pay interest on excess reserves (it does pay interest on required reserves), so banks typically keep excess reserves very low and put any excess money in the deposit facilities to earn interest.

One possible conclusion is that we are seeing very short term time preference by the Euro banks, where they are voluntarily foregoing all interest on excess reserves in return for immediate access to the zero maturity funds, if need be. It is also remotely possible that these are in fact required reserves, which have been increased due to regulatory change.

One week does not make a trend, but it is undeniable thatthere are some very large chairs being rearranged on the Eurosystem's deck, and the ad hoc day-to-day changes in monetary policy are setting the stage for a potential meltdown either from the previous epoch of liquidity contraction, or a new epoch of monetary inflation.

Big Banks and Brokers to Treasury: Too Much Short Term Debt Means Rollover Risk is Real

From Bloomberg yesterday (bolding and brackets ours):

The committee of bond dealers and investors that advises the U.S. Treasury said the dollar’s status as the world’s reserve currency“appears to be slipping” in quarterly feedback presented to the government.

The Treasury Borrowing Advisory Committee, which includes representatives from firms ranging from Goldman Sachs Group Inc. to Pacific Investment Management Co. [not to mention JP Morgan Chase], said the outperformance of haven currencies and those from emerging nations has aided in the debasement of the dollar’s reserve status, according to comments included in discussion charts presented ahead of the quarterly refunding. The Treasury published the documents today.

“The idea of a reserve currency is that it is built on strength, not typically that it is ‘best among poor choices’,” page 35 of the presentation made by one committee member said. “The fact that there are not currently viable alternatives to the U.S. dollar is a hollow victory and perhaps portends a deteriorating fate.”

Indeed, and here is the full slide from page 35 (click for larger image):

The presentation continues with a look at the mix of maturities of OECD nations:

The exposure that the US has on the short end of the curve (less than five years) is a key concern of these well-connected financial insiders. Highlighted is that any comparison with the mid-1940's is not apt because the US had a much greater percentage of its debt in longer maturities at that time.

While GDP is bogus, it's still a closely watched statistic, and the TBAC is noting the alarming trend in debt maturing as a percentage of GDP.

Another chart that projects interest expense differentials. Note the worst case scenario covered is a relatively mild (in our view) 500 bp (5.00%) "shock" increase in rates in five years.

And the somber conclusion that, for once, includes a statement of "it's different this time" with which we agree.

Conclusion

• The benefits of extension do not come for free. Historical analysis suggests that shorter term funding has at many times been both cheaper and the volatility volatility costs costs have have not not been been high high

• Recent cycles of rising rates have not lasted long enough for maturity extension to pay off

• It is possible, however, that “this time is different” because
  
  o Nominal rates are much closer to the zero bound than previous periods
  
  o Deficits are are very very high high historically historically and and rising rising interest interest expense expense less less acceptable acceptable
  
  o Concentrated foreign ownership creates less reliable demand
  
  o The benefits of funding attributable to being the reserve currency may be fading

• While this this presentation presentation has has focused focused exclusively exclusively on average average maturity maturity, a topic topic for future study is the impact of the distribution of maturities on total interest expense

The full presentation in PDF format may be found here.

Are T-Bonds a Sale Here?

On February 9, we timely asked "Is the 3 Decade Bond Bull Market Officially Over, or Will the Central Planners Succeed in Kicking the Can?"

To which we responded, "While we're long term bond bears, the 30 year yield shooting north of 5% is too great a risk for the central planners to not exercise the few powerful cards they still hold."

And posted the following chart:

Though the catalysts would be a MENA meltdown, then Tsunami fallout, followed by a PIGGS rout, indeed, February 9 was the high of the rally in yields. Today the 30 Year hit the downside target, albeit two weeks late according to our crude cycle analysis:

While we might see a capitulation dip to 3.60% or thereabouts in the coming days, we suspect the intermediate term trend will soon turn upwards. The question then becomes when (not whether) the three decade secular bear trend in yields (bull trend in bonds) officially ends with a definitive break of the highlighted downward trend channel. It might be as soon as the end of 2011.

GAO Audit of Federal Reserve No Bid Contracts Fails to Finger Geithner, Baxter, Dimon, Immelt and Friedman in Suspicious BlackRock Contract

Remember the Audit the Fed bill that was supposed to bring the financial system to its knees if Congress dared pass it? Remember the toothless, watered down version that finally made it into Dodd-Frank and at the time was itself controversial?

Pursuant to direction under Dodd-Frank, the Government Accountability Office today released a 266 page report detailing its findings after a review of the numerous emergency programs instituted by the Federal Reserve from 2008 to 2010. Among the many findings was that the bulk of over half billion dollars in service contracts were awarded without bid. While the report is a step in the right direction, its failure to mention the most suspicious contract (about which we know only because of Congressionally subpoenaed email records of the New York Fed), suggests the review was either facile or compromised. In other words, we cannot rely on even the simplest of half measures when it comes to providing Fed accountability.

Here is what the GAO wrote (all bolding and brackets are ours, throughout this post):

Reserve Banks Awarded Largest Contracts Noncompetitvely and Would Benefit From Additional Guidance on Seeking Competition

Although FRBNY awarded contracts both competitively and

noncompetitively for the emergency programs, the highest-value

contracts were awarded noncompetitively due to exigent circumstances.

FRBNY awarded almost two-thirds of its contracts noncompetitively,

which accounted for 79 percent of all vendor compensation (see fig. 4).

Eight of the 10 largest contracts were awarded noncompetitively. The

largest noncompetitive contract was valued at more than $108.4 million,

while the largest competitive contract was valued at $26.6 million.

Click image to enlarge.

Explaining the process by which FRBNY awarded contracts:

FRBNY awarded contracts in accordance with its acquisition policy, which

applied to all services associated with the emergency programs and

single-institution assistance. FRBNY is a private corporation created by

statute and is not subject to the FAR. Instead, FRBNY developed its own

acquisition policy, called Operating Bulletin 10.

Operating Bulletin 10 states that business areas may use noncompetitive

processes in special circumstances, such as when a service is available

from only one vendor or in exigent circumstances. FRBNY cited exigent

circumstances for the majority of the noncompetitive contract awards.78

Footnote 78 reads:

78 Of the noncompetitive contracts we reviewed, FRBNY awarded only three under the sole-source exception, when a service was available from only one vendor.

This fact will be key later on. Delving into the GAO's findings:

A guiding principle of the FAR, which applies to all executive agencies,

not to the Reserve Banks, is to ensure that agencies are able to deliver

the best value product or service in a timely manner while fulfilling

agencies’ policy objectives. Similarly, Operating Bulletin 10 provides a

framework for acquiring goods and services at the most favorable terms.

However, while the FAR requires certain activities for noncompetitive

awards and identifies specific steps to take, Operating Bulletin 10 does

not. Without similar guidance, FRBNY could be missing opportunities to enhance competition and provide the best value service in

noncompetitive awards. Examples of activities required or restricted by

the FAR include the following:

Soliciting multiple bids. The FAR requires contracting officers to solicit

as many offers as is practicable in the absence of full and open

competition.79 FRBNY officials stated that in noncompetitive

circumstances business areas are encouraged to collect a reasonable

number of competitive quotations and noted that, in at least some

cases, staff members contacted multiple vendors before awarding

contracts noncompetitively. However, FRBNY did not contact multiple

vendors before awarding some of the largest noncompetitive

emergency program and assistance contracts.80

Restrictions on contract duration and scope. Operating Bulletin 10

does not place any limits or restrictions on the duration of a

noncompetitive contract, nor does it require subsequent competition.

In contrast, the FAR generally limits the duration of contracts awarded

under “exigent circumstances” to the time necessary to meet the

unusual and compelling requirements and award a new contract using

competitive procedures, and such contracts may generally not exceed

1 year.81 FRBNY’s longest and most expensive contracts were

awarded noncompetitively and lasted more than 2 years and, in some

cases, could potentially last as long as 10 years.82 Some of these

contracts included distinct services that, while related, were needed at

different times and with different degrees of urgency. FRBNY officials

said that in some cases they think there would be limited benefits to

opening noncompetitive contracts to competition. FRBNY held

subsequent competitions for competitively awarded Agency MBS

program and TALF contracts when the terms of the programs

changed.

Justifying noncompetitive procedures. Operating Bulletin 10 requires

business areas to draft a memorandum that includes sufficient

documentation to justify the noncompetitive acquisition. However,

Operating Bulletin 10 does not provide guidance on what information

should be included in the memorandum. FRBNY justification

memoranda typically included background information on the

emergency program, vendor scope of work, vendor selection factors,

and an explanation of the special circumstances necessitating

noncompetitive awards. The memoranda did not typically identify

efforts made to promote competition, which the FAR requires.

Regarding Vendor Selection Criteria, the GAO makes a curious statement in the next paragraph:

FRBNY considered a number of factors when selecting vendors for both

competitive and noncompetitive contract awards, including a vendor’s

knowledge and expertise and ability to meet program requirements.

FRBNY also considered a vendor’s previous working relationship with

FRBNY or program participants as part of the selection criteria for

competitively and noncompetitively awarded contracts. FRBNY selected

vendors that had previous working relationships with FRBNY and the

program recipients so that it could leverage that familiarity to shorten the

vendor’s learning curve or ramp-up time. For example, FRBNY

noncompetitively selected BlackRock as the investment manager for

Maiden Lanes II and III because BlackRock had already evaluated the

underlying assets pursuant to an engagement with AIG prior to the

extension of credit by FRBNY.

These would constitute two of the three sole-source contracts mentioned in footnote 78, above. The appendixes disclose that BlackRock earned $24.1 million and $50.0 million for serving as the investment manager of Maiden Lane II and III, respectively.

BlackRock was also the investment manager for the original Maiden Lane portfolio that took on the toxic Bear Stearns assets. For serving as investment manager, it was paid $107.6 million in fees.

Recall that there are two bases upon which a no-bid contracts would be awarded: exigency or sole source, whereby there are no practical alternatives to a single service provider. The GAO report does not say on what basis the BlackRock Maiden Lane no-bid contract was awarded, but given the roughly three month window between the mid-March announcement of the new facility and the commencement of management by BlackRock in late June, it would be difficult to claim exigency. Also note the contract was not dated until September 9, 2008, several months later.

Thanks to the aforementioned subpoenaed emails of the NY Fed, we do in fact know that the BlackRock Maiden was sole-sourced. As we wrote in January, 2011:

[W]e'd like to know why BlackRock management of Maiden Lane I was sole sourced without a "clear reason", as is implied by the below email to FRBNY [then] Senior VP, Sarah Dahlgren, which we excerpt from the below document presented to Congress, with emphasis and brackets ours:

To Sarah Dahlgren/NY/FRS@FRS

Re: Sole Source

Spent some time with him [Tom Baxter, Jr., FRBNY GC] tonight. (He doesn't understand ML3, and I can't begin explain it either -- so don't needle him! -- and I am going to have [Paul] Whynott [FRBNY VP] spend some time with him tomorrow, BTW, you might touch base with Joyce [Hansen, FRBNY Deputy GC] about her reaction to Sunday's briefing; I think she had some concerns about how ML3 was presented to Geithner, which she expressed to Paul.) [Geithner] knew that Stephanie [Heller?, FRBNY Asst. GC] was handling the Blackrock contract -- he didn't express any concerns -- and I explained that, in contrast to MLI, we had a clear reason to sole source it this time (that they had already modeled, etc.). So, although I have no worries, yes, probably worth reviewing it with him [Geithner] before taking it to Tom."

It appears there was quite some consternation at the highest levels at the NY Fed about this contract award, yet no mention in the GAO report.

In follow up posts, we will document the full email chain from which the above was excerpted, explore just exactly how the NY Fed's Acquisition Policy (Operating Bulletin Number 10) implicates some of the country's top bankers in this no-bid contract scandal, discuss the GAO's findings of failure in conflicts of interest disclosure, and the GAO's own failure to follow its Congressional mandate under Dodd-Frank.

Krugman Gets it Right With Gold

Everyone seems to be making fun of Paul Krugman, who's out on the NY Times oped page today, suggesting the run-up in gold might be due to Goldline's advertising on Glenn Beck show. Both Bob Wenzel and Bob Murphy have added their two cents.

Krugman concludes:

Market prices almost always tell you something useful. But sometimes what they tell you is that there’s a marketing scam in progress.

I'm afraid I have to side with Krugman on this one as I think he's on to something. In fact, should demand ever falter for the Treasury's notes and bills, I suggest the Fed simply purchase airtime on its behalf on the Glenn Beck show.

Call it QE Beck, a truly patriotic marketing scam.

Sorry MMTers, the Economy Doesn't Exist and GDP is Bogus

The other day, a practitioner of Modern Monetary Theory (MMT), Robert Koerner, called for a sythesis between MMT and Austrian Economics. Robert Wenzel, at EPJ Central, provided an Austrian rebuttal here, which provoked an interesting discussion in the comments. Unfortunately, this appears to be part of a trend, in which the bogus constructs of MMT are passed off as somehow part of Austrian economics, which they are most definitely not. This post will demonstrate that MMT is simply a justification for the broken and irreparable status quo, but with a novel face.

Friend of EPJ, Robert Murphy, provides some background and criticism of its foundations, here*. To say that so-called MMTers come to some rather unconventional conclusions is understated, and something from which they do not run. For instance, Murphy writes, "if the federal government runs a budget surplus, then by simple accounting the private sector can't save."

However, at its heart, MMT appears to be based on accounting identities derived from national income accounting methods, which are themselves based upon imperfect abstractions. These are the same familiar equations [sadly] taught in nearly every economic intro course:

GDP = C + I + G + (X — M)

and

GDP = C + S + T

Austrian economist, Frank Shostack, tears apart GDP and its foundations here (emphasis mine):

To gain insight into the state of an economy, most people rely on a statistic called Gross Domestic Product (GDP). The GDP framework looks at the value of final goods and services produced during a particular time interval, usually a quarter or a year. This statistic is constructed in accordance with the view that what drives an economy is not the production of wealth but rather its consumption. What matters here is demand for final goods and services. Since consumer outlays are the largest part of overall demand, it is commonly held that consumer demand sets in motion economic growth.

By focusing exclusively on final goods and services, the GDP framework lapses into a world of fantasy wherein goods emerge because of people's desires. This is in total disregard to the facts of reality (that is, the issue of whether such desires can be accommodated). All that matters in this view is the demand for goods, which in turn will give rise almost immediately to their supply. Because the supply of goods is taken for granted, this framework completely ignores the whole issue of the various stages of production that precede the emergence of the final good.

In the real world, it is not enough to have demand for goods: one must have the means to accommodate people's desires. Means—i.e., various intermediate goods that are required in the production of final goods—are not readily available; they have to be produced. Thus, in order to manufacture a car, there is a need for coal that will be employed in the production of steel, which in turn will be employed to manufacture an array of tools. These in turn are used to produce other tools and machinery and so on, until we reach the final stage of the production of a car. The harmonious interaction of the various stages of production results in the final product.

The GDP framework gives the impression that it is not the activities of individuals that produce goods and services, but something else outside these activities called the "economy." However, at no stage does the so-called "economy" have a life of its own independent of individuals. The so-called economy is a metaphor—it doesn't exist.

By lumping the values of final goods and services together, government statisticians concretize the fiction of an economy by means of the GDP statistic. By regarding the economy as something that exists in the real world, mainstream economists reach a bizarre conclusion that what is good for individuals might not be good for the economy, and vice versa. Since the economy cannot have a life of its own without individuals, obviously what is good for individuals cannot be bad for the economy.

The GDP framework cannot tell us whether final goods and services that were produced during a particular period of time are a reflection of real wealth expansion, or a reflection of capital consumption.

For instance, if a government embarks on the building of a pyramid, which adds absolutely nothing to the well-being of individuals, the GDP framework will regard this as economic growth. In reality, however, the building of the pyramid will divert real funding from wealth-generating activities, thereby stifling the production of wealth.

Because the GDP framework completely disregards the intermediate stages of production, it can be of little help in the assessment of boom-bust cycles. It is little wonder then that mainstream economists are forced to conclude that recessions are a response to a sudden fall in consumer spending. Consequently, it is quite logical within the GDP framework to advocate loose monetary policies to revive the "economy."

The whole idea of GDP gives the impression that there is such a thing as the national output. In the real world, however, wealth is produced by someone and belongs to somebody. In other words, goods and services are not produced in totality and supervised by one supreme leader. This in turn means that the entire concept of GDP is devoid of any basis in reality. It is an empty concept.

Quoting the Austrian masters on the fallacy of national accounting:

According to Mises the whole idea that one can establish the value of the national output is somewhat far-fetched:

The attempt to determine in money the wealth of a nation or the whole mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimension of the pyramid of Cheops.

Furthermore,

If a business calculation values a supply of potatoes at $100, the idea is that it will be possible to sell it or replace it against this sum. If a whole entrepreneurial unit is estimated at $1,000,000 it means that one expects to sell it for this amount the businessman can convert his property into money, but a nation cannot.

In addition to all these issues, there are serious problems regarding the calculation of the GDP statistic. To calculate a total, several things must be added together. To add things together, they must have some unit in common. It is not possible to add refrigerators to cars and shirts to obtain the total of final goods. Since the total real output cannot be meaningfully defined, obviously it cannot be quantified.

To solve this problem, economists employ total monetary expenditure on goods which they divide by an average price of those goods. There is, however, a serious problem with this. What is price? It is the rate of exchange between goods established in a transaction between two individuals at a particular place and a particular point in time. The price, or the rate of exchange of one good in terms of another, is the amount of the other good divided by the amount of the first. In the money economy, price will be the amount of money divided by the amount of the first good.

Suppose two transactions were conducted. In the first transaction, one TV set is exchanged for $1,000. In the second transaction, one shirt is exchanged for $40. The price or the rate of exchange in the first transaction is $1000/1TV set. The price in the second transaction is $40/1shirt. In order to calculate the average price, we must add these two ratios and divide them by 2. However, $1000/1TV set cannot be added to $40/1shirt, implying that it is not possible to establish an average price.

It is interesting to note that in commodity markets, prices are quoted as Dollars/barrel of oil, Dollars/ounce of gold, Dollars/tonne of copper, etc. Obviously, it wouldn't make much sense to establish an average of these prices. On this Rothbard wrote, "Thus, any concept of average price level involves adding or multiplying quantities of completely different units of goods, such as butter, hats, sugar, etc., and is therefore meaningless and illegitimate."

More on the fallacy of average price level, and getting to the heart of the matter (that GDP is simply a tool of coercion for the ruling class):

The employment of various sophisticated methods to calculate the average price level cannot bypass the essential issue that it is not possible to establish an average price of various goods and services. Accordingly, various price indices that government statisticians compute are simply arbitrary numbers. If price deflators are meaningless, however, so is the real GDP statistic.

So what are we to make out of the periodical pronouncements that the economy, as depicted by real GDP, grew by a particular percentage? All we can say is that this percentage has nothing to do with real economic growth and that it most likely mirrors the pace of monetary pumping.

As a rule, the more money created by the central bank and the banking sector, the larger the monetary spending will be. This in turn means that the rate of growth of what is labeled as the real economy will closely mirror rises in money supply.

So it is no wonder that in the GDP framework, the central bank can cause real economic growth, and most economists who slavishly follow this framework believe that this is so. Much so-called economic research produces "scientific support" for popular views that, by means of monetary pumping, the central bank can grow the economy. It is overlooked by all these studies that no other conclusion can be reached once it is realized that GDP is a close relative of the money stock.

One is tempted to ask, why it is necessary to know the growth of the so-called "economy"? What purpose can this type of information serve? In a free unhampered economy, this type of information would be of little use to entrepreneurs. The only indicator that any entrepreneur relies upon is profit and loss. How can the information that the so-called "economy" grew by 4 percent in a particular period help an entrepreneur make profit?

What an entrepreneur requires is not general information but rather specific information regarding the demand for his specific product, or products. The entrepreneur himself has to establish his own network of information concerning a particular venture.

Things are quite different, however, when the government and the central bank tamper with businesses. Under these conditions, no businessman can ignore the GDP statistic since the government and the central bank react to this statistic by means of fiscal and monetary policies. Likewise, participants in financial markets closely follow the GDP statistic in order to assess the likely responses of the central bank.

The entire army of economists is busy guessing whether the central bank will lower, or raise, interest rates. Moreover, to provide a rationale for all this, a new form of economics labeled macroeconomics was invented. Needless to say, this type of economics doesn’t deal with the real world but rather with a nonexistent entity called the economy.

By means of the GDP framework, government and central bank officials generate the impression that they can navigate the economy. According to this myth, the "economy" is expected to follow the growth path outlined by omniscient officials. Thus whenever the rate of growth slips to below the outlined growth path, officials are expected to give the "economy" a suitable push. Conversely, whenever the "economy" is growing too fast, the officials are expected to step in to cool off the "economy's" rate of growth.

The powerful conclusion:

If the effect of these policies were confined only to the GDP statistic then the whole exercise would be harmless. However, these policies tamper with activities of wealth producers and thereby undermine people's well-being. To take a particular instance, by acting to make the nonexistent entity the "economy" more efficient, U.S. government officials are busy destroying a major wealth generator—Microsoft. Likewise, by means of monetary pumping and interest rate manipulations, the Federal Reserve doesn't help generate more prosperity, but rather sets in motion a "stronger GDP" and the consequent menace of the boom-bust cycle—i.e., economic impoverishment.

We can thus conclude that the GDP framework is an empty abstraction devoid of any link to the real world. Notwithstanding this, the GDP framework is in big demand by governments and central bank officials since it provides justification for their interference with businesses. It also provides an illusory frame of reference to assess the performance of government officials.

Bob Roddis writes in the comments in Wenzel's post about MMT's intellectual heritage:

Never forget that MMT godfather Abba Ptachya Lerner’s magnum opus was “The Economics of Control”:

Chapter l. INTRODUCTION. THE CONTROLLED ECONOMY

The fundamental aim of socialism is not the abolition of private property but the extension of democracy. This is obscured by dogmas of the right and of the left. The benefits of both the capitalist economy and the collectivist economy can be reaped in the controlled economy.

And again, in a subsequent comment:

More things I have dug up on MMT…

1. Abba Lerner was a longtime economic Stalinist. He writes in the preface to “The Economics of Control” that he was long resistant to the any “free market” analysis but finally he thanks Joan Robinson for getting him to overcome his prejudices against “Mr. Keynes great advancement in economic understanding”. Great. A Stalinist tempered with some Keynesianism. That’ll work, right? This is their starting point and helps explain how they can be so joyous when they explain “The government is not revenue constrained!!! [how cool is that??]”

2. In 1980, two years before he died, Abba Lerner (1903-1982) was dabbling in the following price control system based upon this article by David Colander, a co-author of a 1980 book with Lerner:

Lerner found the implications of sellers’ inflation so important that, beginning in the 1960s, he changed his research program to center on finding cures for sellers’ inflation. Initially he toyed with various administrative wage and price control policies, but he found those lacking and soon gave them up. He replaced them, first, with a tax based incomes policy and ultimately, a market based[??!!!] incomes policy in which property rights in prices are set and individuals have to buy the right to change prices from others who change their price in the opposite direction. It was this idea that formed the basis of our market [???!!!!] anti inflation (MAP) book. (Lerner and Colander 1980) Under MAP, rights in value added prices would be tradable so that any firm wanting to change its nominal price would have to make a trade with another firm that wanted to change its nominal price in the opposite direction. Thus, by law, the average price level would be constant but relative prices would be free to change [@page 12]

http://tinyurl.com/4rfk3jk

So, we now know enough about MMT to know that Abba Lerner wrote a book in 1980 proposing a ghastly and barbaric Rube Goldberg system where one would be precluded from raising (setting) one’s one prices without trading the right to do so with somebody else under penalty of statist law. But I thought the MMTers could cure inflation just by changing the tax code. Hmmm.

And it was Keynes, himself, in collaboration with a few other economists and statisticians at the beginning of World War II, who invented the national accounting constructs that would give rise to GNP and GDP. All for the purpose of justifying a protracted, expensive war. Writes Judo Cuyvers in the Economic Journal:

The elaboration of national economic accounts and detailed national income estimates is generally considered to be a direct result of Keynes's emphasis on the main macroeconomic determinants of employment and aggregate demand.

Scholars have repeatedly stressed Keynes's impact in the course of the first few years of the Second World War, or have pointed to Colin Clark's pioneering calculations during the 1930s. However, as we shall show in the following pages, it was at the very beginning of the Second World War, not in 1937 nor in 1941, that British national income accounting entered a critical phase. Determined to convince the authorities and public opinion of the necessity of financing the war effort properly, Keynes immediately set himself the task of elaborating a proposal based on statistical evidence. It was during the period between Octboer-November 1939 and February 1940, when Keynes was working on his December 1939 article in this JOURNAL and subsequently on his pamphlet How to Pay for the War, in close statistical collaboration with Erwin Rothbarth, that the first double-entry national accounts were developed and the still very crude accounting and estimation procedures became essential steps in economic policy making.

In true Ministry of Truth fashion, decades of Keynesian and related indoctrination continues to facilitate and propagate the lie that the banking system is somehow not regulated enough--too free market. As Tom Woods recently wrote:

She likewise thinks the banking system is pretty close to a free market – after all, hasn’t she seen news reports about bank "deregulation"? To the contrary, the banking system is perhaps the least free-market sector of the entire economy. The whole system is overseen by the government-created Federal Reserve System, which presides over a system-wide cartel. It involves monopolistic legal tender laws, a monopoly of the note issue, artificial disabilities on other media of exchange apart from the depreciating dollar, and various forms of bailout guarantees. For a sense of what a free market in banking would actually look like, read Murray N. Rothbard’s The Mystery of Banking.

Even if we ignore MMT's dubious historical origins and assume beneficent intent, it's important that Austrian economics not be conflated with MMT and the work of its practitioners, such as Wray, Mosler*, Aureback, Mitchell, Fullwiler. Why make the distinction? As governments and economies fail around the world, there is and will be increasing demand for alternatives. MMT ensures the status quo ante. It's simply another system for central planning and price fixing. And prices matter, as I wrote last November:

Though it's possible we will eventually transition to a new Ponzi (which is in the works), the case for optimism can be made that a better informed public with no prospects for a future bailout will rebuild a system in which prices are given the respect they deserve.

* EPJ Regular, Taylor Conant, produced a series of critiques of Warren Mosler's book called "Seven Deadly Frauds of Economic Policy", which itself is based upon MMT.

Ex-Goldmanite NY Fed President, Bill Dudley, Looks to Join the Council on Foreign Relations

From his daily schedule released by the New York Federal Reserve only an hour ago, we learn that Bill "Let them eat iPads" Dudley conducted a meeting for 30 minutes in his private office at the Fed regarding one "CFR Application" on February 15, 2011.

Click for larger image.

According to the official CFR roster, he's not yet a member:

Though he has spoken before the CFR on a previous occasion, presumably the delay in membership will be rectified now that the final QE2 commissions gift has been doled out to the primary dealers.

Unlike previously released schedules, we find Mr. Dudley refrained from meeting with the top banksters. No breakfast with Jamie Dimon (though there were some meetings with other JPMers) and, curiously, not one meeting with a Goldman Sacks exec. It's increasingly looking like Lloyd should have flown through the fog to that meeting with Obama, after all.