I know its late Friday and I’m sorry for the rant but a headline across the tape forced my hand. From a speech on June 25th to the BIS that the Fed officially released today, Fed Vice Chairman Kohn said that “the root cause of our problems was the underpricing of risk as the financial sector interacted with nonfinancial sectors” and that “leverage was a symptom rather than a cause of the underlying crisis.” He has a Ph.D and I don’t but I want to correct him that easy money policy under Greenspan that had the fed funds rate at 1% for way too long was the root cause of the crisis and the underpricing of risk was just another symptom. With rates artificially low, meeting required rates of return got more difficult. Whether one is a pension fund, an insurance company, mutual fund, hedge fund, etc… in order to get higher returns in this kind of environment, one had to take on more risk and leverage in order to goose returns. The result of course was a massive misallocation of capital and an underpricing of risk and we all know the chapters that followed. It’s amazing that with all of us having the same sets of facts we come to different conclusions but the Fed refuses to take any responsibility for what occurred.

Category: MacroNotes

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

14 Responses to “Fed Vice Chairman Kohn/It still is someone else’s fault”

  1. Andy T says:

    The lower Fed Funds rate does not explain the amount of debt/credit that was created during the greatest credit bubble of all time. The neoclassical views on monetary theory were unable to predict that kind of credit expansion the world witnessed. There are other factors at work. The fact is banks, aka “The Roving Cavaliers of Credit,” extended credit at an unprecedented rate because they made a lot of money doing so, and their activities went unchecked by any regulators. I blame the Fed mostly for failing to understand the fact that they lost control over the monetary supply long ago. I think it’s important for you to read this essay by Steve Keen. It’s powerful stuff and it may change your views on inflation v. deflation. It did for me…

    http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/

  2. fresno dan says:

    Thanks Andy T for that link. I have read that before but had no one to discuss it with. It strikes me that there is something there – I find it difficult to believe that the “saving glut” makes any sense. Sure, people in China may save a lot of their income, but the yuan is purposefully undervalued, and even if people in China save 50% (people act as if 50% of the income of the US pays for Chinese imports – its only a small fraction of that) of their paltry incomes, its not much money. (a billion Chinese save 100$ a year, which seems reasonable if its true that income is somewhere around 500$ a year for most Chinese). Of course, my numbers may be way off – I would appreciate it if anybody can set me straight on how much money the Chinese actually invest. Anyway, 100 billion is a lot, but it certainly doesn’t explain the TRILLIONS in liability. Therefore I agree with the article – banks, by leverage, created vast amounts of credit:

    However, in the real world, they do control the creation of credit. Given their proclivity to lend as much as is possible, the only real constraint on bank lending is the public’s willingness to go into debt. In the model economy shown here, that willingness directly relates to the perceived possibilities for profitable investment—and since these are limited, so also is the uptake of debt.

  3. patient renter says:

    - Easy money
    - Underpricing risk

    Which came first?

  4. David Merkel says:

    Being a Ph. D. Economist in the neoclassical school is a liability here, not an asset, because it is not capable of connecting the dots between monetary policy and financial markets.

  5. Simon says:

    @Steve Barry

    In case you haven’t discovered Steve Keen there is a good chance he is your soul mate. Follow AT’s link for further info.

  6. MrUnexpectedly says:

    “…meeting required rates of return got more difficult.”

    Wow, I wish I could hope you were joking. “Required” by whom? And isn’t that the DEFINITION of risk? Hitting some rate of return when you know deep down you really oughta maybe shouldn’t kinda sorta, so DON’T BECAUSE THAT’S RISKY?

    This crisis gets laid at the feet of many different institutions and values, but the first to defend a collapse in favor of Meeting Self-Imposed Requirements of Rates of Anything So As To Procure Greater “Success”–oh no, I’m sorry, it’s actually as pathetically petty as “higher returns”–can be first to the guillotine without the slightest hesitation, in my book.

    Greed blows. Greenspan failed to see it. Apparently, so did you. Pot, kettle, piacere.

  7. BG says:

    Well….You sure as hell can’t prosecute anybody if nobody did anything wrong.

    It seems so ironic to me that we have this (penny-annie/chicken feed) COPS show on TV (You know the little diddy…”Whatcha gonna do when they come for You…Watcha gonna do….?”)

    In the case of the financial elite, (even though it clearly isn’t chick feed) they ain’t coming…don’t worry about it.

    We, commoners have lost control of this Country and I don’t see us ever getting it back. We live in a society of pathological liers with no conscious who from birth were never held accountable for anything.

    A financial system with no discipline, no accountability, no ethics and no enforcement gets you just about where we currently find ourselves.

    You know back there when we learned that BODs were back-dating options to increase the bonuses of the CEOs….do you really need to know anything else about these individuals? At least, they’re consistent. They’ve been cheats from the very beginning.

  8. Winston Munn says:

    It seems for many of our centers of great learning that arrogance has replaced the quest for truth and understanding. When a serious academic discovers that his model does not reflect the actions of the real world, he determines now that it is the real world that must be wrong.

    No one in a position of authority is willing to stand up and say, “Our economic model is flawed.” Now instead they say that “China is saving too much.”

    Still running deeply through the economy is the concept that bolstering the top earners will propel the economy to greatness. Reagan introduced these ideas and both Democrats and Republicans have continued to advance the concept.

    But the fallacy in the concept responds to simple reason.

    The common sense flaw in the theory is that when you give tax advantages to people like Henry Ford or Andrew Carnagie, you end up with better automobile plants and more efficient steel plants, higher wages, and greater GDP.

    But when you give that same tax advantage to people like Henry Paulson or “Tan Man” Mazilo you end up with Andy Warhol paintings selling at auction for 3 times their value, higher sales for Ferrari, more spending on lobbying Washington, and a destitute middle class bailing out the leak in the ship of state with borrowed money.

    Our great learned Fed leaders look at this conundrum and determine that the banking world was right and everyone else was wrong; fix the banks and you fix the world; after all, everyone knows that bankers and banking are the center of the universe, and everything revolves around them. We learned this lesson in 1919 with the creation of the Federal Reserve system and we’ve hardly had a hiccup since.

    Copernicus….or was it Gallileo?….thanks for introducing this orbital reasoning. Goldman-Sachs is the sun, Citigroup, Bank of America, and the rest are planets….

  9. Andy T says:

    Well stated Winston Munn!

  10. Winston Munn says:

    Andy T,

    Thanks. That was also a nice link you provided, although I am unclear if even that author quite grasped in totality what has occurred. His identification of the deflationary forces is quite accurate, but I am unsure if he realizes why quantitative easing cannot keep pace with credit (monetary) destruction. It is far more than a problem with fractional reserve banking (which in truth is not a problem at all if regulated correctly). The problems stemmed from the unregulated Shadow Banking Industry.

    Consider a home mortgage for $100,000 that created $100,000 of new money under fractional reserve lending. This is a zero sum game of asset/liability/cash. The seller received the cash, the bank holds the asset (the loan) and the buyer holds the liability (the debt). But what happens when you take that same loan, package it with 10 other $100,000 loans and call that package a security? For simplicity, let’s say this new $1,000,000 MBS was sold to Lehman Brothers – still a net wash – bank loses its loan asset but gains cash, while LB loses a cash asset and replaces it with an MBS asset – still no increased lending. But now it gets weird.

    LB now dangles this $1,000,000 worth of loan assets as a collateral carrot to see if any rabbits want to nibble – sure enough, because of its AAA rating and the ease of credit it is simple for LB to get lots of loans from non-traditional lenders, private money looking for yield. LB manages to leverage (borrow) 30 times the amount of MBS, $30,000,000. They take the $30,000,000 and repeat the process.
    This is the effect of the Shadow Banking System.

    What just happened? In essence, $30,000,000 of new cash was created from the original $1,000,0000. This was fractional reserve lending on steroids, with no regulation, no commissioner to fine you and make you sit out 50 games.

    And then the bubble popped, the collateral that supported the loans became worthless, and all that borrowed money had to be re-payed. But Humpty Dumpty had taken a great fall – and no one was willing to make a PIK loan to all the king’s horses and all the king’s men. And when it couldn’t be repaid, it was real money loaned by private lenders that disappeared.

    The only difference between now and then is that the Fed has been able to organize a more orderly destruction of debt and pass on the losses to the U.S. Treasury (meaning us). The Fed was not then and is not now in control of this situation – all they are doing is acting to facilitate a liquid proceeding by acting as bidder, buyer, and crooked auctioneer.

  11. Brad says:

    When I listen to the Fed through Mr. Bernanke and or read the transcript of Vice Chairman Kohn’s speech and also, listen to Secretary of Treasury officers like Mr. Geithner, talk about the commodities market, they omit to talk about the:

    “CONFLICT of INTEREST”

    Wherein large banks, have access to data and aggregate data on clients, they hold loans for, some based in commodities industries: For example companies who distribute gas or Oil to end users or refiners (they have cost of business, employees, payroll expenses, health care, taxes and insurance, etc), companies growing crops like corn,wheat, or operate to produce milk and other dairy products, even copper miners or copper-pipe manufacturing companies. …Many may have loans with large banks.

    It is unconscionable for banks to dip in and out of commodities markets to compete against companies they hold loans for, and drive up key costs of doing business like oil/gas needed to transport goods to grocer, or fertilizer to grow crops etc.

    Theoretically, if a basic cost of doing business can be driving up 40 percent or 100 percent in a 3 to 6 month time frame, large banks stand to profit by that activity, as customers who have loans in those industries, will be driven into their arms, because they need another loan to cover cost increases that are so sudden, as to be unexpected cost increases (erratic market). There are all kinds of problems and systemic risk to small businesses and intermediate sized businesses, who depend more on fair value and fair markets, than they depend on whether large banks can bid up the paper cost, by buying the paper and selling it back and forth between other large banks (who are using the small and medium sized company’s down payment, and money taken from deposit base) driving up cost so they can write more loans.

    There is another side: they can in theory sell suddenly, driving costs down in a 3 month period so that a small businesses trying to sell their crop, do not get the best price and their business (which the large bank has the loan for) becomes distressed. Their family becomes distressed, and soon the large banks are predators again. Dont look now, they are preying on vulnerability created by price spikes they also “predict” and foment.

    Meanwhile no one is protecting the small business or the family of the small business owner. The small business defaults, because they could not sell above their costs. The small business had to take out a loan in the prior six months, to deal with increase costs (which were suddenly run up because large banks were bidding the paper in a frenzy).

    No one wants to admit that large banks keep detail data or aggregate numbers on key assets, or loan records where they know just how much money a small or medium size firm has to make payroll … but by driving up cost of oil by a certain percent, the lending industry, knows, it does directly effect other costs of doing businesses in America.

    No one wants to acknowledge that large banks would pool information and act in a predatory or seasonal practice, to distress a certain number of businesses in an industry or roll assets from driving up cost in one industry to driving up costs effecting another.

    Many a Nebraska billionaire got rich on this information not being widely distributed.

    It does create a systemic risk to small businesses, as well as a conflict of interests for large banks with a large deposit base of client cash, from which to draw money from.

    Everyone wants to believe large banks are responsible, but some of us know, when they get desperate, they are just as bad as a dishonest card shark. They will double deal to their preferred clients, they will pull a card from under the deck and turn cards for some to see but not all. The game usually goes to the highest bidder and small/medium sized businesses do not have a chance. They usually get run like antelope for several miles before the rest of the pack are waiting to either continue the run, or drive them to the ground and devour them.

    When large bank executives like at Goldman Sachs, JPMorgan and Morgan Stanley, get desperate, they will quickly abandon fair play; good intentions and concern for common Americans goes out the window. They will gang up and they will become predators; again.

    The Federal Reserve agents and the last two Treasury Officers, are altogether, silent about this predatory practice.

  12. Brad says:

    When I listen to the Fed through Mr. Bernanke and or read the transcript of Vice Chairman Kohn’s speech and also, listen to Secretary of Treasury officers like Mr. Geithner, talk about the commodities market, they omit to talk about the:

    “CONFLICT of INTEREST”

    Wherein large banks, have access to data and aggregate data on clients, they hold loans for, some based in commodities industries: For example companies who distribute gas or Oil to end users or refiners (they have cost of business, employees, payroll expenses, health care, taxes and insurance, etc), companies growing crops like corn,wheat, or operate to produce milk and other dairy products, even copper miners or copper-pipe manufacturing companies. …Many may have loans with large banks.

    It is unconscionable for banks to dip in and out of commodities markets to compete against companies they hold loans for, and drive up key costs of doing business like oil/gas needed to transport goods to grocer, or fertilizer to grow crops etc.

    Theoretically, if a basic cost of doing business can be driving up 40 percent or 100 percent in a 3 to 6 month time frame, large banks stand to profit by that activity, as customers who have loans in those industries, will be driven into their arms, because they need another loan to cover cost increases that are so sudden, as to be unexpected cost increases (erratic market). There are all kinds of problems and systemic risk to small businesses and intermediate sized businesses, who depend more on fair value and fair markets, than they depend on whether large banks can bid up the paper cost, by buying the paper and selling it back and forth between other large banks (who are using the small and medium sized company’s down payment, and money taken from deposit base) driving up cost so they can write more loans.

    There is another side: they can in theory sell suddenly, driving costs down in a 3 month period so that a small businesses trying to sell their crop, do not get the best price and their business (which the large bank has the loan for) becomes distressed. Their family becomes distressed, and soon the large banks are predators again. Dont look now, they are preying on vulnerability created by price spikes they also “predict” and foment.

  13. Simon says:

    @ Brad

    Very interesting comment Brad. I have had a nagging feeling some sort of process like you have described could happen. I think you are way too easy on the banks. When a bank is allowed to trade in equities and commodities there is nothing stopping them taking actions that could put companies out of business or at least seriously reduce the value of its shares. Then of course there is nothing stopping their traders buying those assets at a big discount.

    It has become completely clear that giving big banks access to unlimited taxpayer money is an excellent recipe for economic disaster.

  14. Andy T says:

    brad. Funny you mention the interaction between banksters trading in equities and commodities. Back when commodities were on a never ending tear I used to think it was some hedge fund driving the price higher in order to pump the oil and gas stocks; afterall, the commodity market is very small compared to equity of the oil and gas companies. I though maybe there was some big genius out their engaging in one massive leverage play between commodities and equities.

    I never thought of it the other way around where someone could use the commodity market to harm certain companies/industries.

    All that said, what became clearer to me the last few years was the great commodity bubbles of 2006-2008 were mostly fueled by large endowments/pension funds that were sold the bill of goods by large investment banks that commodities were a “great new asset class providing diversification from equities and fixed income.” What bullshit! Commodities as an asset class…..HA. I can tell you most commodity traders though this was very humorous until it became dangerous (see $147 crude). Michael Masters testimony in front of Congress was SPOT on last year. It should be required for anyone who wants to really understand what happened with oil last year….