Blog Archives

David Stockman: We’ve Been Lied To, Robbed, And Misled

And we’re still at risk of it happening all over again

by Adam Taggart
Saturday, March 30, 2013, 12:42 PM

Then, when the Fed’s fire hoses started spraying an elephant soup of liquidity injections in every direction and its balance sheet grew by $1.3 trillion in just thirteen weeks compared to $850 billion during its first ninety-four years, I became convinced that the Fed was flying by the seat of its pants, making it up as it went along. It was evident that its aim was to stop the hissy fit on Wall Street and that the thread of a Great Depression 2.0 was just a cover story for a panicked spree of money printing that exceeded any other episode in recorded human history.

David Stockman, The Great Deformation

David Stockman, former director of the OMB under President Reagan, former US Representative, and veteran financier is an insider’s insider. Few people understand the ways in which both Washington DC and Wall Street work and intersect better than he does.

In his upcoming book, The Great Deformation: The Corruption of Capitalism in America, Stockman lays out how we have devolved from a free market economy into a managed one that operates for the benefit of a privileged few. And when trouble arises, these few are bailed out at the expense of the public good.

By manipulating the price of money through sustained and historically low interest rates, Greenspan and Bernanke created an era of asset mis-pricing that inevitably would need to correct.  And when market forces attempted to do so in 2008, Paulson et al hoodwinked the world into believing the repercussions would be so calamitous for all that the institutions responsible for the bad actions that instigated the problem needed to be rescued — in full — at all costs.

Of course, history shows that our markets and economy would have been better off had the system been allowed to correct. Most of the “too big to fail” institutions would have survived or been broken into smaller, more resilient, entities. For those that would have failed, smaller, more responsible banks would have stepped up to replace them – as happens as part of the natural course of a free market system:

Essentially there was a cleansing run on the wholesale funding market in the canyons of Wall Street going on. It would have worked its will, just like JP Morgan allowed it to happen in 1907 when we did not have the Fed getting in the way. Because they stopped it in its tracks after the AIG bailout and then all the alphabet soup of different lines that the Fed threw out, and then the enactment of TARP, the last two investment banks standing were rescued, Goldman and Morgan [Stanley], and they should not have been. As a result of being rescued and having the cleansing liquidation of rotten balance sheets stopped, within a few weeks and certainly months they were back to the same old games, such that Goldman Sachs got $10 billion dollars for the fiscal year that started three months later after that check went out, which was October 2008. For the fiscal 2009 year, Goldman Sachs generated what I call a $29 billion surplus – $13 billion of net income after tax, and on top of that $16 billion of salaries and bonuses, 95% of it which was bonuses.

Therefore, the idea that they were on death’s door does not stack up. Even if they had been, it would not make any difference to the health of the financial system. These firms are supposed to come and go, and if people make really bad bets, if they have a trillion dollar balance sheet with six, seven, eight hundred billion dollars worth of hot-money short-term funding, then they ought to take their just reward, because it would create lessons, it would create discipline. So all the new firms that would have been formed out of the remnants of Goldman Sachs where everybody lost their stock values – which for most of these partners is tens of millions, hundreds of millions – when they formed a new firm, I doubt whether they would have gone back to the old game. What happened was the Fed stopped everything in its tracks, kept Goldman Sachs intact, the reckless Goldman Sachs and the reckless Morgan Stanley, everyone quickly recovered their stock value and the game continues. This is one of the evils that comes from this kind of deep intervention in the capital and money markets.

Stockman’s anger at the unnecessary and unfair capital transfer from taxpayer to TBTF bank is matched only by his concern that, even with those bailouts, the banking system is still unacceptably vulnerable to a repeat of the same crime:

The banks quickly worked out their solvency issues because the Fed basically took it out of the hides of Main Street savers and depositors throughout America. When the Fed panicked, it basically destroyed the free-market interest rate – you cannot have capitalism, you cannot have healthy financial markets without an interest rate, which is the price of money, the price of capital that can freely measure and reflect risk and true economic prospects.

Well, once you basically unplug the pricing mechanism of a capital market and make it entirely an administered rate by the Fed, you are going to cause all kinds of deformations as I call them, or mal-investments as some of the Austrians used to call them, that basically pollutes and corrupts the system. Look at the deposit rate right now, it is 50 basis points, maybe 40, for six months. As a result of that, probably $400-500 billion a year is being transferred as a fiscal maneuver by the Fed from savers to the banks. They are collecting the spread, they’ve then booked the profits, they’ve rebuilt their book net worth, and they paid back the TARP basically out of what was thieved from the savers of America.

Now they go down and pound the table and whine and pout like JP Morgan and the rest of them, you have to let us do stock buy backs, you have to let us pay out dividends so we can ramp our stock and collect our stock option winnings. It is outrageous that the authorities, after the so-called “near death experience” of 2008 and this massive fiscal safety net and monetary safety net was put out there, is allowing them to pay dividends and to go into the market and buy back their stock. They should be under house arrest in a sense that every dime they are making from this artificial yield group being delivered by the Fed out of the hides of savers should be put on their balance sheet to build up retained earnings, to build up a cushion. I do not care whether it is fifteen or twenty or twenty-five percent common equity and retained earnings-to-assets or not, that is what we should be doing if we are going to protect the system from another raid by these people the next time we get a meltdown, which can happen at any time.

You can see why I talk about corruption, why crony capitalism is so bad. I mean, the Basel capital standards, they are a joke. We are just allowing the banks to go back into the same old game they were playing before. Everybody said the banks in late 2007 were the greatest thing since sliced bread. The market cap of the ten largest banks in America, including from Bear Stearns all the way to Citibank and JP Morgan and Goldman and so forth, was $1.25 trillion. That was up thirty times from where the predecessors of those institutions had been. Only in 1987, when Greenspan took over and began the era of bubble finance – slowly at first then rapidly, eventually, to have the market cap grow thirty times – and then on the eve of the great meltdown see the $1.25 trillion to market cap disappear, vanish, vaporize in panic in September 2008. Only a few months later, $1 trillion of that market cap disappeared in to the abyss and panic, and Bear Stearns is going down, and all the rest.

This tells you the system is dramatically unstable. In a healthy financial system and a free capital market, if I can put it that way, you are not going to have stuff going from nowhere to @1.2 trillion and then back to a trillion practically at the drop of a hat. That is instability; that is a case of a medicated market that is essentially very dangerous and is one of the many adverse consequences and deformations that result from the central-bank dominated, corrupt monetary system that has slowly built up ever since Nixon closed the gold window, but really as I say in my book, going back to 1933 in April when Roosevelt took all the private gold. So we are in a big dead-end trap, and they are digging deeper every time you get a new maneuver.


Is JPM “The Burning LOH”?

May 11, 2012

“The target is marked by the burning LOH.”

When I was an reconnaissance helicopter pilot in the Army many years ago, that was a popular saying that was passed down by the more experienced pilots, some of whom had flown during the Vietnam War.  It was meant to convey our own frailty, and the foolishness of being too eager about finding the enemy’s location.

LOH back then stood for Light Observation Helicopter, either a Hughes OH-6 Cayuse or a Bell OH-58.  It was pronounced as “loach”.  They were 4-seat commercial helicopters that were bought by the Army and adapted for use in scouting for enemy forces.  A pilot had little more than his eyes and his wits as weapons, and the .040″ aluminum skin and Plexiglas windows were not much protection from enemy fire.  The idea was to fly low, using the terrain for cover and concealment, and try to find the enemy so that fighter planes or attack helicopters could be called in to deliver ordinance on the enemy’s position.

But given the fact that enemy soldiers are usually not stupid, and don’t want to be spotted, often the first indication that a pilot had located the enemy’s position was that he was taking fire from the enemy.  A lot of them got shot down.  So then another helicopter crew would step in to radio the fast movers and guide them into the target.  The fighter pilots would acknowledge that call, and the existence of enemy fire in the area, and then ask:

“Roger, how is the target marked?”  The question was about the possible use of colored smoke, landmarks, or other features that can be seen while zooming in at 500 MPH.

And the answer would be, “The target is marked by the burning LOH.”

There is a corollary to this in the financial markets.  Quite often at the end of a big price move, we learn about a big institution blowing up because they did not think that the trade would go so far against them.  The 2006 case of Amaranth Advisors would be a classic example, with its bankruptcy in late 2006 marking the bottom for natural gas prices ahead of the big commodity bubble in 2008.  There were several portfolios that blew up at the top of that bubble.

In this week’s chart, I have labeled several notable news events that served as markers of important turns for T-Bond prices.  Back in 1994, Orange County, California went bankrupt because its treasurer, Robert Citron, had overextended his bets the wrong way in the bond market.  That bankruptcy marked the bottom for the big price decline.  Orange County was the burning LOH.

In late 1998, the money management firm Long Term Capital Management (LTCM) famously made huge bets on T-Bonds that were based on the limits of how far price moves had historically gone in the past.  And the market taught them a lesson about how trends can persist longer than one can stay solvent.  The Federal Reserve had to intervene, lining up several major banks to help take apart LTCM’s positions and keep it from cascading into a bigger problem.  LTCM’s collapse was the burning LOH for that up move.

More recently, the collapses of Bear Stearns, Lehman Brothers, and MF Global each coincided with peaks in bond prices.  Each was the burning LOH for its particular moment in history.

So now this week, we find out that J.P. Morgan Chase (NYSE:JPM) has suffered a $2 billion loss on financial derivative bets that went bad.  And this news comes as T-Bond prices are once again getting back up to the price levels seen at last year’s MF Global collapse.  The implication is that the news of JPM’s big loss is serving as the “burning LOH” of this current time frame, and the news arrives just as the stock market is about at the end of the corrective period suggested by both our eurodollar COT leading indication and the Presidential Cycle Pattern.  Subscribers to our twice monthly newsletter and our Daily Edition have been watching the current stock market correction unfold pretty much right on schedule relative to those models, and now we have a portfolio blowup to help mark the beginning of the end of that corrective process.

Tom McClellan
Editor, The McClellan Market Report

%d bloggers like this: