December, Friday 09, 2011

DOW +186 = 12,184
SPX +20 = 1255
NAS +50 = 2646
10 YR YLD +.08 = 2.05%
OIL +1.47 = 99.80
GOLD +5.50 = 1712.30
SILV +.57 = 32.33
PLAT + 20.00 = 1519.00

The European Union has come up with an economic treaty for 26 Euro nations. The UK did not sign on. The new treaty replaces the old treaty. The new treaty is supposed to require stricter fiscal and financial discipline in future budgets. The New Euro will pump hundreds of billions into the IMF and the Euro Stabilization Mechanism, and the ECB, and there will be more printing of money. And I am more convinced it is straight out of the Federal Reserve Playbook, with subtitles.

So let’s review the playbook.

I talked about this yesterday, but it deserves a little more attention today: the Government Accounting Office conducted an audit of the Federal Reserve, the first independent audit of the Fed in its 99-year history. The audit dealt with emergency measures conducted by the Fed and it was NOT a complete audit of all Fed functions, but the GAO produced a 251-page report. If you want a link to the report, then drop me an email and I’ll send you the link. http://www.gao.gov/new.items/d11696.pdf

The report documents that Wall Street Bailouts by the Fed dwarf the $700 billion TARP, and everything else you’ve heard about.

Page 131 - The total lending for the Fed's "broad-based emergency programs" was $16,115,000,000,000. That's right, more than $16 trillion. The four largest recipients, Citigroup, Morgan Stanley, Merrill Lynch and Bank of America, received more than a trillion dollars each. The 5th largest recipient was Barclays PLC. The 8th was the Royal Bank of Scotland Group, PLC. The 9th was Deutsche Bank AG. The 10th was UBS AG. These four institutions each got between a quarter of a trillion and a trillion dollars. None of them is an American bank.

Pages 133 & 137 - Some of these "broad-based emergency program" loans were long-term, and some were short-term. But the "term-adjusted borrowing" was equivalent to a total of $1,139,000,000,000 for more than one year. That's more than $1 trillion out the door. Lending for these programs in fact peaked at more than $1 trillion.

Pages 135 & 196 - Sixty percent of the $738 billion "Commercial Paper Funding Facility" went to the subsidiaries of foreign banks. 36% of the $71 billion Term Asset-Backed Securities Loan Facility also went to subsidiaries of foreign banks.

Page 205 - Separate and apart from these "broad-based emergency program" loans were another $10,057,000,000,000 in "currency swaps." In the "currency swaps," the Fed handed dollars to foreign central banks, no strings attached, to fund bailouts in other countries. The Fed's only "collateral" was a corresponding amount of foreign currency, which never left the Fed's books (even to be deposited to earn interest), plus a promise to repay. But the Fed agreed to give back the foreign currency at the original exchange rate, even if the foreign currency appreciated in value during the period of the swap. These currency swaps and the "broad-based emergency program" loans, together, totaled more than $26 trillion. That's almost $100,000 for every man, woman, and child in America. That's an amount equal to more than seven years of federal spending -- on the military, Social Security, Medicare, Medicaid, interest on the debt, and everything else. And around twice American's total GNP.

Page 201 - Here again, these "swaps" were of varying length, but on Dec. 4, 2008, there were $588,000,000,000 outstanding. That's almost $2,000 for every American. All sent to foreign countries. That's more than twenty times as much as our foreign aid budget.

Page 129 - In October 2008, the Fed gave $60,000,000,000 to the Swiss National Bank with the specific understanding that the money would be used to bail out UBS, a Swiss bank. Not an American bank. A Swiss bank.

Pages 3 & 4 - In addition to the "broad-based programs," and in addition to the "currency swaps," there have been hundreds of billions of dollars in Fed loans called "assistance to individual institutions." This has included Bear Stearns, AIG, Citigroup, Bank of America, and "some primary dealers." The Fed decided unilaterally who received this "assistance," and who didn't.

Pages 101 & 173 - You may have heard somewhere that these were riskless transactions, where the Fed always had enough collateral to avoid losses. Not true. The "Maiden Lane I" bailout fund was in the hole for almost two years.

Page 4 - You also may have heard somewhere that all this money was paid back. Not true. The GAO lists five Fed bailout programs that still have amounts outstanding, including $909,000,000,000 (just under a trillion dollars) for the Fed's Agency Mortgage-Backed Securities Purchase Program alone. That's almost $3,000 for every American.

Page 126 - In contemporaneous documents, the Fed apparently did not even take a stab at explaining why it helped some banks (like Goldman Sachs and Morgan Stanley) and not others. After the fact, the Fed referred vaguely to "strains in the financial markets," "transitional credit," and the Fed's all-time favorite rationale for everything it does, "increasing liquidity."

81 different places in the GAO report - The Fed applied nothing even resembling a consistent policy toward valuing the assets that it acquired. Sometimes it asked its counterparty to take a "haircut" (discount), sometimes it didn't.

Page 2 - As massive as these enumerated Fed bailouts were, there were yet more. The GAO did not even endeavor to analyze the Fed's discount window lending, or its single-tranche term repurchase agreements.

Pages 13 & 14 - And the Fed wasn't the only one bailing out Wall Street, of course. On top of what the Fed did, there was the $700,000,000,000 TARP program authorized by Congress. The Federal Deposit Insurance Corp. (FDIC) also provided a federal guarantee for $600,000,000,000 in bonds issued by Wall Street.

For the first 96 years of the Fed's existence, the Fed's primary market activities were to buy or sell U.S. Treasury bonds (to change the money supply), and to lend at the "discount window." Neither of these activities permitted the Fed to play favorites. But the programs that the GAO audited are fundamentally different. They allowed the Fed to choose winners and losers.

So what does all this mean? Here are some short observations:

(1) In the case of TARP, at least The People's representatives got a vote. In the case of the Fed's bailouts, which were roughly 20 times as substantial, there was never any vote. Un-elected functionaries, with all sorts of ties to Wall Street, handed out trillions of dollars to Wall Street. That's not how a democracy should function, or even can function.

(2) The notion that this was all without risk, just because the Fed can keep printing money, is both laughable and cryable (if that were a word). Leaving aside the example of Germany's hyperinflation in 1923, we have the more recent examples of Iceland (75% of GNP gone when the central bank took over three failed banks) and Ireland (100% of GNP gone when the central bank tried to rescue property firms).

(3) In the same way that American troops cannot act as police officers for the world, our central bank cannot act as piggy bank for the world. If the European Central Bank wants to bail out UBS, fine. But there is no reason why our money should be involved in that.

(4) For the Fed to pick and choose among aid recipients, and then pick and choose who takes a "haircut" and who doesn't, is both corporate welfare and socialism. The Fed is a central bank, not a barber shop.

(5) The main, if not the sole, qualification for getting help from the Fed was to have lost huge amounts of money. The Fed bailouts rewarded failure, and penalized success.The Fed helped the losers to squander and destroy even more capital.

(6) During all the time that the Fed was stuffing money into the pockets of failed banks, many Americans couldn't borrow a dime for a home, a car, or anything else. If the Fed had extended $26 trillion in credit to the American people instead of Wall Street, would there be 24 million Americans today who can't find a full-time job?

Yes, this did happen. Yes, it can happen again.

There is another study that was recently published, its titled“$29,000,000,000,000: A Detailed Look at the Fed’s Bail-out by Funding Facility and Recipient” by James Felkerson. The study looks at the lending, guarantees, facilities and spending of the Federal Reserve.

This past week, Fed head Ben Bernanke said the figure was more like $1.5 trillion but he offered nothing to support his claim.

Over the past few days we have been hearing the terms hypothecation and re-hypothecation tossed about to explain the liquidity problems in Europe and to explain how the MF Global funds might have disappeared. Hypothecation is just a fancy word to say that an asset has been pledged. It’s the very basis of central banking. Central banking worked on the principle of fractional reserves, an old trick learned by goldsmiths and money changers. The money changers would often hold gold or other metals as deposits, for a fee, and issue receipts or paper notes. The notes were accepted for many commercial transactions. The money changers and goldsmiths quickly discovered they could make loans based upon deposits held, and the loans were made in the form of paper notes. They figured they could issue more paper notes than the actual gold deposits held in reserve, because it was unlikely that all depositors would demand their gold at the same time. They issued notes based upon gold reserves even though there wasn’t enough gold to fully back the notes; this process involved a pledge or in other words hypothecation; they were creating money out of thin air or in other words counterfeiting. And the same thing is going on right now. The banks are pledging money that is not theirs to pledge, then they create money out of thin air based upon the pledge, then they re-pledge, or re-hypothecate that money. They are not even relying on a central bank to create money out of thin air, they are pledging and creating money on their own. The banksters have usurped the ability to create money.

There has always been a huge problem with fractional reserve banking. Here it is: a bank takes in $10 dollars in deposits and they pledge $100 dollars in paper notes. That’s fine as long as only two or three people a day try to redeem their paper notes. Then it is called a run on the bank. It is happening right now in Europe – the modern version is called a credit freeze or liquidity crisis.

The problem is that the banksters have been writing pledges on assets they do not own – such as the customer accounts of MF Global – and there are not enough assets to cover all the pledges. The end game is inevitable; throughout history, it always ends the same – there will be a run on the banks.

Money is a measure of things that are sold – it is a store of value. But money, in and of itself, does not create the fruits of economic activity. Money is not itself a commodity that can be sold.

And all the summits and all the treaties are just extending the inevitable. Sand castle meet Tsunami.

Hello Sinclair,

Excellent show! Quick question: I have been trying to figure out this whole inflation/deflation argument in regards to the future debt unwinding in the U.S. 

My question is, as some Keynesian's say, will price inflation not occur in a deflationary environment? (OK, that was a strangely worded question. Here is the answer: the economy is not static. In a deflationary environment there will be massive efforts to re-flate the economy. You will likely end up with a push/pull of inflationary and deflation)

Also, I hear that the big banks have large cash reserves parked at the Fed, and U.S. corporations hold large cash reserves as well. Will this money make it out into the larger economy? And if so, will this cause high inflation, or just replace collapsing debt? (Banks hold excess reserves of about $1.7 trillion. Corporations are sitting on more than $2 trillion in cash. At some point, that money stops sitting on the sidelines. Keep in mind that a deflationary depression is resolved by devaluation of the currency, so by the time the money comes off the sideline – it might be worth less.)

I am a long time listener and love your show.  What is he album/artist/song of the song you play at the start of your show - it is the swing jazz piece with nice piano - I know a lot of the music you play but not that one.  You are the best!  Thanks!  Dale

The last several months have seen more action in the overnight futures market than at any point in history.  It is very difficult for a retail investor to participate in the stock market when most of the action (price movements) occur in this manner, which translates to major gap ups and downs at the market open. Could you please describe this market, the players and why this is happening?  Thanks!

Hi, I've been in this loan modification nightmare for almost 4 years now with BOA. I bought my home in 1982 I was 22, I'm 52 now. I had never been late, or missed a payment until I was instructed to by my lawyer in order to get any kind of help. If you would like to hear the whole story how I got into this mess in the first place, and how BOA has lost my paperwork twice, then trying to put the blame on me! I met someone that actually work's in BOA's modification department. She went through my loan, and when she was finished, "she couldn't believe how bad they messed it up and were trying to cover it up to save their job's!". They have made the last 4 years a living hell! My health, my job, and my way of looking at things is suffering because of their total lack of knowledge, structure, organization, whatever you want to call it. They truly robbed my family and I out of any kinda of vacation, going out to dinner, or to the movies, anything that was not a necessity, we went without for the last 4 years! That's not living! Sorry for unloading on you, I'm just about at the end of my rope... I will try anything to get this thing straightened out. I guess we need to see if they can produce my note???

                                                    Thank You for your time,

(If anybody knows a way to get BofA to act responsibly, I would love to hear it.)

Sinclair,
 Dumb question, but I always thought the market was basically a zero-sum game.  For every trade there is a winner and a loser on each end of the trade.  That being the case how are these many gap-up/gap-down openings accounted for?  (Of which there seems to have been an increasing amount) Who wins/loses?  Or are they only on-sided trades with only a winner (gap-up) or loser (gap-down)?  I'm assuming the futures market and options market have nothing relevant to explain these gaps.  Maybe I'm wrong?

If the market was at X value and tomorrow it gapped up (whatever amount) the new value is X+.  But there were no losers.  So am I correct to think that that is instant equity creation?  There were no losers?  Just increased overall value...poof?  Same as gap-downs?  There is no one on the opposite side of those trade gaps?

I get it when there are buyers and sellers taking the trades.  But gaps confuse me as to where that instant value (or devalue) is to equate to a zero-sum game...?  Or is it really not a zero-sum game?

Thanks, I don't know who the hell else to ask and I can't find any adequate information although I have spent ample time googling around but coming up empty.

Your stumped and enthusiastic listener,

(Don’t get tripped up over-thinking gaps. The price changes from one trade to the next. It doesn’t matter if the next trade takes place in one second or in 17 hours; it doesn’t matter if the price change from one trade to the next is one penny or one dollar or ten dollars. IT’S JUST THE NEXT TRADE.

Is it all a zero sum game? Over a long enough period – yes.)