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Attacking Central Bank Independence
By DAVID R. KOTOK AND JOSEPH R. MASON
Originally published in Barron’s May 21, 2011
Republished by permission

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Political tension and economic crisis have combined to threaten the independence of the Federal Reserve, and that in turn threatens sound monetary policy.

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America’s central bank faces the greatest risk to its independence since the end of World War II.

Quantitative Easing 2, the Federal Reserve policy of holding interest rates down by purchasing Treasury securities with newly created money, is much more than a dramatically expansionary monetary policy.

It also should be seen as a response to increasing political pressure from Congress, exhibited through recent appointment scuffles, the assignment of new regulatory responsibilities under last year’s Dodd-Frank law and increased scrutiny through a series of congressional oversight hearings.

POLITICAL ANALYSTS HAVE LONG been concerned with a president’s ability to stack the Supreme Court. But the Federal Reserve seemed protected by the 14-year staggered terms of its seven governors. That protection was eroded during the second Bush administration, when former Sen. Christopher Dodd, D-Conn., used his chairmanship of the Finance Committee to hold up the confirmation of two Bush appointees.

Throughout the financial crisis, the Federal Reserve Board was short two governors because Dodd refused to hold a hearing and send the nominations to the Senate floor for confirmation. As a result, the minimum quorum of five governors, rather than a full seven, made emergency decisions during the worst financial period in modern times.

Tim Foley for Barron’s

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The only records of the board members’ stands on invoking various emergency powers are their final votes. Because the Fed operated under a unanimity rule rather than a super-majority rule during this stretch, Fed-watchers have no way to determine whether there were internal dissents on such matters as the Bear Stearns merger, the purchase of troubled banks’ debt and the failure to merge Lehman Brothers into another institution.

With President Obama’s 2010 nomination of Peter Diamond, there was hope that the board of governors would have a full complement of seven for the first time in many years. But that has turned out not to be the case: Politics continues to hold up the appointment process. In the aftermath of the financial crisis, the Fed still operates without a full complement of governors, and it is becoming unlikely that it will have one. But this is only one of the developments that threaten the Fed’s independence.

THE ROLE OF THE BOARD in pragmatic politics was expanded under the banking-reform provisions of the new Dodd-Frank law. That legislation required the Federal Reserve to fund as-yet-unspecified activities of the new Consumer Financial Protection Agency, even though the Fed has no oversight power over that agency.

In using the central bank as its own off-balance-sheet funding conduit, supporters of Dodd-Frank circumvented the traditional appropriations process. This is likely to worsen as fiscal conditions tighten.

The third threat to the Fed’s independence is unfolding in the new Congress. Representative Ron Paul (R-Texas) is chairman of the House panel that oversees the Fed’s activities. Paul is a Fed critic and detractor. He has announced that he plans to “audit” the central bank’s policy-making.

As chairman, Paul, who is running for president, can subpoena records and compel testimony. And he can introduce legislation that alters the Fed’s composition, activities and reporting requirements. He might even try to eliminate the central bank and replace it with some other monetary authority, including a return to the gold standard.

Many things are possible.

SO, EROSION OF THE FED’S independence continues. So does intense scrutiny of the central bank as it demonstrates its financial muscle with new policy initiatives like QE2.

Federal Reserve Chairman Ben Bernanke has indicated that inflation is too low and that the risk of deflation is perceived to be high. Having acknowledged that the Fed hasn’t fulfilled either of its two mandates — to seek full employment and stable prices — Bernanke and the central bank are exposed to additional congressional meddling.

Many in Congress have already said that they would rewrite the Federal Reserve Act and institute change if they could get the votes needed to do so.

As long as unemployment remains high and the likelihood of rapid and robust economic improvement is remote, Bernanke can expect that continued pressure will come from Congress.

The problem is that the congressional capture of the central bank is more than just a political or even regulatory curiosity.

Central-bank independence helps maintain consistent economic growth. It also restrains inflation and holds down the cost of debt.

In a speech delivered at Princeton University in 2009, then Fed Vice Chairman Donald Kohn noted that “experiences studied over a range of countries and periods of history tell us that central banks need a degree of insulation from short-term political pressures if they are to consistently foster the achievement of [the] medium-term macroeconomic objectives of price stability and high employment.”

NO CENTRAL BANK lacking such insulation can long avoid sacrificing long-term objectives for short-term political expediency. In countries that have experienced such regimes, to regain economic growth the central bank’s independence and reputation had to be re-established at great cost.

Despite recent monetary-policy pressures, the Federal Reserve Bank doesn’t need to be fixed by Congress. Instead, Congress needs to focus on fixing its own fiscal and growth policies.

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DAVID R. KOTOK is chairman and chief investment officer of Cumberland Advisors, in Vineland, N.J. JOSEPH R. MASON is a professor of banking at Louisiana State University.

Photographer Stephane Vetter combined six exposures to capture not only two green auroral rings, but also their reflections off Iceland’s largest glacial lake. He took his photographs during a visit to the lake, Jökulsárlón.

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click for bigger photo

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Source:
Green sky at night
Spectacular image of the Northern Lights that captures two auroral rings and their reflections in a lake
LEE MORAN
Daily Mail on 21st May 2011 
http://www.dailymail.co.uk/sciencetech/article-1387993/Image-Northern-Lights-captures-auroral-rings-reflections-lake.html?ITO=1490

The weight of inflationary concerns, interest rate hikes and possibility of economic slowdowns has Asian stock markets still under pressure. Overnight, the Shanghai index fell to a 4 month low and the Kospi, ASX, Nikkei and Sensex indices all dropped to 2 month lows. In Europe, Junker, the head of the European Finance Ministers, said a decision on Greece may come as early as next week. The Irish 10 yr is rising to a fresh high but Spanish yields, importantly, are lower. German consumer confidence fell to a 6 month low coming in a touch below expectations. In the US, the MBA said refi’s rose .9% to a 5 month high as mortgage rates remained very subdued coincident with the rally in US Treasuries and purchases were up 1.5% to a level slightly above the one yr average. The gauge of market sentiment, the II data, has the most amount of bulls expecting a correction (that they want to buy) since Feb ’10 while outright Bears remained subdued. Bulls 43 v 45.6, Bears 19.4 v 19.6, Correction 37.6 v 34.8

April Durable Goods were weaker than expected both headline and ex transports BUT March was revised higher, so taken together the data wasn’t much different from expectations. Non Defense Capital Goods ex Aircraft fell 2.6% vs the forecast of a drop of 2.1% but March was revised to a gain of 5.4% from 3.7% initially. Orders ex transports fell 1.5% vs an expected rise of .5% but March was revised up to a gain of 2.5% from the 1st report of up 1.3%. Another thing to note, because inventories rose by .9% as shipments fell by 1%, the inventory to shipments ratio rose to 1.80 from 1.76, the highest since Jan ’09. It is very possible though that the rise in inventories was a prudent response to the Japanese disaster and concerns with supply disruptions. Bottom line, the revisions to March did compensate for the April fall in orders and proves how volatile this data set is month to month. Thus, I’m not confident to make any firm conclusion with today’s April figure. With respect to manufacturing, the most important figure we await is next week’s ISM because of the moderating May regional manufacturing surveys we’ve seen thus far.

“You need a massive prosecutorial effort. I don’t see evidence that it’s happening. If we were talking baseball, it would be at the AAA level.”

-Solomon Wisenberg, former federal prosecutor.

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During George W. Bush’s reign of error, the Justice Department looked the other way at all manner of fraud, but most especially Securities fraud on Wall Street. During his presidency, it plummeted 87%.  Other forms of fraud prosecutions also fell. My working assumption was this was specific to W and his unique brand of incompetency.

As it turns out, that was the wrong assessment. After two years in office, President Barrack Obama is no better when it comes to “corporate, securities and bank fraud” than his hapless predecessor:

“Prosecutions of three categories of crime that could be linked to the causes of the crisis — corporate, securities and bank fraud — declined last fiscal year [2010] by 39 percent from 2003, the period after the accounting scandals at Enron Corp. and WorldCom Inc., Justice Department records show.”

Which raises the question: Why has the USAG dropped the ball ?

Some of it involves staffing — after 9/11, many FBI agents were reassigned to anti-terror work. But that should be under a different budget, and if this was a priority, the head of the Justice department should be clamoring for more fraud investigators and those who have forensic skills.

But 9/11 is a lame excuse for a dearth of successful fraud prosecutions a decade later.

I see three big bottlenecks for Fraud prosecutions:

1) Failure to attack the problem as a systemic issue: If it were up to me, I would be using RICO statutes to attack origination fraud and foreclosure fraud.

2) Conflict of interests: Uncle Sam still has huge stakes in banks and insurers. That reduces the incentives to find wrongdoing (thereby hurting your taxpayer funded portfolio)

3) Lobbying/Campaign donations from financials: Congress remains a wholly owned subsidiary of Wall Street. Despite rules prohibiting it, there has been increased pressure on DOJ to not bring actions by Congress-critters.

Thus,we have seen little motion from DOJ against the banksters.

I continue to hold the position that the best hope for obtaining any form of post-crisis Justice will come from the State AGs . . .

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Previously:
Security Fraud Prosecutions Down 87% Since 2000 (December 25th, 2008)

Source:
Prosecutors Faulted on Failure to Charge ‘Bandits’ in U.S. Market Collapse
Justin Blum
Bloomberg, May 23, 2011
http://www.bloomberg.com/news/2011-05-23/prosecutors-faulted-on-failing-to-catch-credit-crunch-bandits-.html

Macro E.U. — D.O.A.
By John Mauldin
May 23, 2011

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I am attending the Global Interdependence Center’s latest conference here in Philadelphia, writing you from the Admiral’s Club on my way to Boston. The chatter last night at dinner and between sessions was focused on the risks in Europe. I did an interview with Aaron Task on Yahoo’s Daily Ticker, where I noted that European leaders are starting to use the word contained when they talk about Greece. Shades of Bernanke and subprime. This too will not be contained.

And that brings us to this week’s Outside the Box. Greg Weldon has graciously allowed me to use his latest missive on Europe’s woes. A teaser:

“The EU, like the US, suffers from what we might call the ‘Cyrenaic Syndrome’, a dynamic linked to the ancient Greek philosophers Aristippus and Hegesias of Cyrene, who, in 3rd and 4th Centuries BC, hypothesized that the goal of life was the avoidance of pain and suffering. Addicts accomplish this thru substance abuse. The EU is trying to accomplish this thru pure denial, and an outright refusal to accept that austerity, like sobriety, is the ONLY way to actually deal with the problems it faces.”

Greg is my favorite slicer and dicer of data. And he (as a registered CTA) has real skin in the game, as he runs money; so his work is not just some guy drawing lines on charts. He has to draw real-world conclusions, for real-world trades. For those who have NOT had a free trial of Weldon’s three research publications, visit www.Weldononline.com and sign up for a free trial.

And for the record, the euro will not fall out of bed until I have exchanged my last dollar in the third week of June. But what’s a little exchange-rate issue when you are talking Tuscany? I can’t complain too much. Have a great week.

Your wondering if Bernanke will ever say the word contained again analyst,

John Mauldin, Editor
Outside the Box

JohnMauldin@2000wave.com

Macro E.U. — D.O.A.

By Greg Weldon

Today’s Money Monitor theme can be pitched two ways …

… D.O.A. = Dead on Arrival …

… or … D.O.A. = Debt Offenders Anonymous

Either way, the title applies to our examination of the still-intensifying EU debt-deficit debacle. We are tempted to say that the Eurocurrency is currently being rushed to the hospital, and that it is likely to be pronounced ‘D.O.A.’, or dead-on-arrival …

… but we think the more ‘appropriate’ analogy is to look at the EU as if it were a prime candidate to join a twelve-step self-help program called D.O.A., or ‘debt-offenders-anonymous’.

The first step would be ‘acceptance’.

However, the EU is not yet capable of this, as it remains ‘in denial’.

As EU debt markets come under renewed pressure amid a broadening in the scope of downgrades to sovereign credit ratings, and ratings outlooks, we note commentary from the Union’s Economic and Monetary Affairs Commissioner Olli Rehn …

… “We have contained the crisis to the three countries now in the EU-IMF programs. It is not correct to speak of a crisis of the euro or monetary union.”

DENIAL, case closed.

EU officialdom, via their denial, continues to be an ‘enabler’.

Of course, a symptom almost always attached to an ‘addict’, is lying … by the addict, AND by the co-dependent enabler.

Thus we find it MOST interesting to observe last week’s startling admission from the head of the EU Finance Ministers, Luxembourg’s Jean-Claude Juncker, who stated that he “LIED’ to the press and the public, regarding a secret meeting of top EU officialdom, held to discuss the Greek situation …

… “It was done in the interest of the people who use the euro as their common currency. The denial immediately prevented further speculation in the markets. Speculation about an exit by Greece from the euro-zone had to be avoided at all costs, in the interest of the euro-zone.”

Denials and lies — this has become the EU’s arsenal.

The reality is … the EU is unwilling to accept the fact that it has become addicted to debt and deficits, and that their fiscal life has become ‘unmanageable’. The EU must first admit to themselves, and to the markets, the exact nature of their wrong-doing.

Without acceptance, the EU cannot reach the point where they can make a conscious decision to turn over their ‘will’ to a ‘higher power’, which in this case would be ‘fiscal austerity’, and a restructuring of debt that will allow the situation to become ‘manageable’.

Without acceptance, the EU cannot even think about ‘making amends’.

The EU (along with the US) is in desperate NEED of a ‘spiritual awakening’.

The problem is one linked to our instinctive nature as human beings …

… a thing called … the desire to avoid pain, at any cost.

The EU, like the US, suffers from what we might call the ‘Cyrenaic Syndrome’, a dynamic linked to the ancient Greek philosophers Aristippus and Hegesias of Cyrene, who, in 3rd and 4th Centuries BC, hypothesized that the goal of life was the avoidance of pain and suffering. Addicts accomplish this thru substance abuse. The EU is trying to accomplish this thru pure denial, and an outright refusal to accept that austerity, like sobriety, is the ONLY way to actually deal with the problems it faces.

The EU is still … FAR … from ‘hitting bottom’.

For SURE … the debt-deficit crisis is NOT “contained”, as Olli Rehn would have us believe. We have been pounding the table for years, screaming that the problems facing Greece, Ireland, and Portugal, will look like CHILD’S PLAY, when the situation in Belgium, Spain, and Italy, begins to take center stage. This is NOW HAPPENING, on the back of today’s outlook downgrade placed on Belgium and Italy, in synch with intensified anxiety linked to Spain following weekend elections in which the ruling Socialist party got mauled.

At the heart of the issue in Spain, and Greece, is rising unemployment. Indeed data released last week in Greece revealed a jump to yet another new high in the Unemployment Rate, as seen in the chart. The Unemployment Rate jumped to 15.9% in February (data lagged by one-month), up from 15.1% in January, and up from 12.1% in Feb-2010. Worse yet, the Number of Unemployed has now spiked higher by +30.1% versus last February, and is up by a mind-numbing +99.9% versus February of 2008.

We also shine the spotlight on data released by the Greek National Statistics Service two weeks ago revealing that Industrial Production contracted by (-) 8.0% year-over-year during the month of March, plummeting deeper into negative territory versus the decline of (-) 4.8% yr-yr posted in February …

… LED by a double-digit decline in the year-year rate of Manufacturing Output, which plunged by (-) 10.3% during March, sliding from a (-) 6.8% yr-yr contraction in February, and the (-) 4.5% yr-yr decline seen in January. Evidence the chart on display below, which speaks for itself.

Further, we note today’s report on the Greek Budget, revealing that DESPITE austerity measures undertaken as part of the EU-IMF directed program, the Deficit WORSENED during the month of April. Indeed, the government reported a deficit of (-) EUR 7.246 billion in the four-month YTD 2011, an ‘increase’ of +13.7% versus the same period 2010.

Worse yet … Revenue FELL, while Spending ROSE … with Revenue falling by (-) 9.1% in the YTD-yr-yr, and Spending rising by +3.6%.

Problematic for SURE … as a rise of +14.4% in Outlays linked directly to Interest Payments on the debt, which accounted for a MIND-BLOWING 52.7% of the TOTAL DEFICIT in the year-to-date, pegged at (-) 3.819 billion EUR.

Unfortunately, Greek bond yields continue to SOAR, reaching a new ALL-TIME HIGH TODAY, as evidenced in the chart below, wherein the 2-Year Bond yield now exceeds 25%.

Turning to Spain, we note that the ruling Socialist Party got crushed in regional elections, falling victim to promises made by the People’s Party that they will move to restructure the electoral process, and squash planned cuts to social spending programs.

Perhaps more troubling is the fact that the United Left Party, formerly the Spanish Communist Party, saw a significant rise in support from a disenchanted populous, in line with massive protests among the youth in the country last week, who reject thoughts of … austerity.

Read the rest of this entry »

“LDL” is my new favorite acronym.

Call it Wall Street prosecution arcana:  To avoid putting into email any damaging info — especially about insider trading — some of the recent expert networks thought they might avoid prosecutions by using the acronym “LDL.” It is strewn throughout their emails, and informs the reciever that they are getting close to sensitive information that should best be discussed without a paper trail. Hence, LDL — “Let’s Discuss Live.”

It is the Wall Street equivalent of the teenage POS — “Parents Over Shoulder” — only in this case, it was more accurate to say “Prosecutors Over Shoulder” !

Dealbook used this example on April 28, 2010:

“Even at a disadvantage, not all clients were easy to convince. Goldman e-mails show how the bank backed up its sales team as they sought to unload bets they thought might one day go sour.

In one exchange, a Goldman employee refers to a mortgage investment as “as a way to distribute junk that nobody was dumb enough to take first time around.” The response of Jonathon Egol, a colleague of Mr. Tourre’s who designed some of the mortgage trades, was “LDL,” or “let’s discuss live,” effectively moving the discussion off record.”

How is it possible that in 2010, otherwise intelligent people still fail to understand that they are creating a permanent email trail? Did they actually think no one would know what that meant? The next time I hear anyone say “Goldman Sachs is the smartest shop on the street,” in my mind I will be hearing “He’s the smartest kid on the short bus.”

All I can say is thank goodness for stupidity. It makes prosecution so much easier!

Bloomberg: Hedge-fund manager Jim Chanos said investors concerned that U.S. technology stocks such as LinkedIn Corp. are overvalued should turn their attention to China.

Chanos, the president and founder of Kynikos Associates LP, said his “dramatic” bet against Chinese real estate may not be sufficient. While LinkedIn, the first social-media company to go public in the U.S., traded as high as 31 times sales last week, overvaluation is more widespread in China, he said.

Bloomberg, May 24, 2011

Some interesting links for your reading pleasure:

• Lessons from a difficult year of trading (Peter Brandt)
• Forefront:  The Inflation Issue (Cleveland Fed)
• Prosecutors Faulted on Failure to Charge ‘Bandits’ in U.S. Market Collapse (Bloomberg)
• Hedge-fund secrets to beat the market  (Marketwatch)
• Oil stock buybacks stoke tax debate (Chron)
• Terry Smith doesn’t like ETFs (FT.com)
• How our debt happened (Washington Post)
• The Elephant in the Green Room (NY Mag)
• How to De-Crapify Your Home: A Start-to-Finish Guide (Lifehacker)
• “We Are Crossing the Boundary Between Knowledge and Belief” (The European)

What are you reading?

Bob R writes: “Your item yesterday reminded me of Larry Lessig’s March, 2007 TED.com talk, “Larry Lessig on laws that choke creativity”.

Larry Lessig, the Net’s most celebrated lawyer, cites John Philip Sousa, celestial copyrights and the “ASCAP cartel” in his argument for reviving our creative culture.