Weekend Watching

Interesting facts from Max Keiser. While sometimes presented in a bit extreme way, he remains factually accurate. Maybe he has what most of us lost at some point, i.e. the capability to be outraged when viewing atrocities and come out acting when we see crimes being committed.

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The Legality of the Federal Reserve System

The U.S. Constitution states in Article I, Section 1:

All legislative powers herein granted shall be vested in a Congress of the United States, which shall consist of a Senate and House of Representatives.

So how come the Federal Reserve (Fed), FDIC SEC, etc can make rules by way of regulations as well as adjudicate disputes?

The following document presents a critical review of the legal basis of the Federal Reserve System.

Bank Supervision and Disclosure

On Bloomberg, we read the following:

Former U.S. bank regulators warned that lenders and supervisors may share less information with each other in day-to-day dealings after lawmakers released dozens of confidential Federal Reserve e-mails.

“The regulatory process could be chilled or stifled because of a reluctance to speak candidly,” said Robert Clarke, a former comptroller of the currency and now a senior partner at Bracewell & Giuliani LLP in Houston. At a minimum, supervisors may communicate less via e-mail, said Oliver Ireland, an ex-Fed attorney now at Morrison & Foerster LLP in Washington.

No, I disagree. This coming from a former comptroller of the currency shows exactly where the problem with regulators was and still is.
According to these remarks we have to assume that supervision of financial institutions works on a ‘would-you-mind-sharing-information-with-us’ basis. If the banks say, uhm, yes we’d mind, regulators would just answer with ‘ok, have a nice day then’ and forget about it. The current mess comes as no surprise, then.

The requirements can be written into law making it a legal requirement for a financial institution to deliver any information requested by the regulator. Since these requirements will be the same for everyone, there really is no competetive disadvantage to disclosing the information.

Notwithstanding the fact, that important stuff is mostly not discussed in e-mails anyway, regulators are required as a matter of law to keep a paper trail for their decision processes and the decissions they made. And, if I am not mistaken, so are financial institutions, because of Sarbanes-Oxley.

It seems what they are telling us is that they can’t bank if they have to follow any law. Then it would be time to close them down.
You want to bank, you comply with regulations we give you. Period.

The results are in banks are doing fine-NOT!

The U.S. Treasury has published the results of the so called “stress test” of the 19 major banks. Surprise, surprise the picture is all positive. See the list at the Washington Post and at Zero Hedge.

So the banks are save, what now? Well, contrary to what they want to make us believe, banks maz not be as save as they now appear to be. The results of these so-called stress tests are unreliable for several reasons.

The stress tests were not thorough and relied mainly on the banks view of their own assets quality. As mentioned in the Feds press release

More than 150 examiners, supervisors and economists from the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation participated in this supervisory process. Starting from two economic scenarios–a consensus estimate of private-sector forecasters and an economic situation more severe than is generally anticipated–they developed a range of loss estimates and conducted an in-depth review of the banks’ lending portfolios, investment portfolios and trading-related exposures, and revenue opportunities. In doing so, they examined bank data and loss projections, compared loss projections across firms, and developed independent benchmarks against which to evaluate the banks’ estimates. From this analysis, supervisors determined the capital buffer needed to ensure that the firms would remain appropriately capitalized at the end of 2010 if the economy proves weaker than expected.

What the Fed is telling us here is that it has “more than” 150 – probably 151, or do they not even know how many people worked on this? – examiners, supervisors etc worked on it. This is not many considering that they had to stress test the 19 largest banks. Thankfully, they could rely on the banks data and just rubber stamp the results the banks required.  As pointed out by Barry Ritholz

the Consensus estimates, professional forecasters and blue chip surveys have all been awful — terribly wrong — during this entire fiasco.

Why then should anyone assume that they are right this time?

That the results were not scientific but negotiated is fully clear from an article in the Washington Post writes

The banks were intent on sending a message that they were strong enough to weather the economic storm and didn’t need additional capital infusions from the government that could all but nationalize their franchises.

I fail to see the value of a test in which you can not only define the contents of the tests, the weight of the questions being answered and negotiate the result.

Paul Krugman in his New York Times op-ed of today writes that

As a result, the odds are that the financial system won’t function normally until the crucial players get much stronger financially than they are now. Yet the Obama administration has decided not to do anything dramatic to recapitalize the banks.

I am wondering, if the taxpayer will be liable if the banks tank again. After all, the government has given an investment advice. If someone follows that, loses money and it turns out the government whitewashed the banks, this could be expensive.

Where inflation comes from

Continuation of my previous post ‘Why do we invest’

There are several different theories as to the causes of inflation, for an overview see here.
I have a much simpler view of inflation and it does involve the FED, or any central bank able to print money for that matter. It goes like this.

Start with a clean slate. At the beginning there is nothing except people who want to do business with each other. They think that it would be cool to have some token to exchange their products and services among each other and that it would be much simpler if everyone were relying on the same token instead of everyone producing its own. They call this token ‘money’ or ‘currency’ and found a bank (central bank) whose task it is to print enough money so that there is no shortage of it and everyone has access to it when he needs it.
So the central bank prints some currency and stocks it in its vault. Since you need, say 100$ to do business, how do you get access to it? It requires you to have an account with the central bank into which you have to pledge some of your wealth (note: you can’t put currency in there, as at this point because you don’t have any yet), also called collateral. The central bank then ‘loans’ you this 100$. Obviously, a loan comes with an attached interest rate. In other words, you loan 100$ from the central bank and will have to give it 102.5 back (assuming a 2.5% rate per annum). Where does the additional currency come from, after all, only 100$ were printed so far which you have loaned? Well, you need to ‘take it away’ from someone else by doing business with him for at least 102.5$. And for this not to be an exercise in futility you need to make a profit yourself, so you will charge this someone 105.0 (assuming you are not greedy and are satisfied with 2.5%). Now, your business partner has to come up with at least 105$. He has loaned his 100 from the central bank as well – where else can printed money come from at this stage – and needs to give 102.5 back as you do. If he pays you 105 for your services or products and wants to make a profit for himself as well. He is now forced to do business with another some at 107.5 to be able to pay his bills and still make a profit.
The original 100$ put in circulation by the central bank have now become 107.5$. Those 7.5 $ must be printed as well or would have to be printed if everything had to be paid back. This is unlikely to be the case and here reserve requirements of fractional reserve banking come in. You cannot lend-out the full 100$ you loaned from the central bank, but only a fraction of it. See the drawing at the end of this post.
If you think this sounds like a Pyramid scheme, then you are not alone. This system will break down as soon as no new players that can be used as currency source enter into the game. Whether it is a Ponzi depends entirely on the definition of when you judge a return (or interest rate) to be unusual high.
The above makes it clear that inflation is artificially induced by the central bank and aggravated by the fact that everyone that deals with the currency, i.e. the banks, needs to make a profit in the process. In other words, inflation is a built in component of the banking system which is entirely artificial and could be avoided completely if a alternative to the way money is managed were found.