Archive from July, 2010
23 Jul
2010
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Helicopter Pilots Wanted!

The expounders of the Keynesian paradigm are nothing if not consistent.  Is there a danger of deflation?  Then open the money spigots some more, and raise that price level!

In his article “What Can the Fed Still Do?,” Keynesian Bruce Bartlett explains that banks are sitting on over $1 trillion of excess reserves.  This money was, as they say, “injected” by the Fed during the financial crisis.  Economically, this makes is no different than counterfeiting, but I digress.

A little primer: For almost 2 years now, very smart people have been fretting about the rise in the price level, which is popularly called “inflation” (though historically the term inflation referred to the cause of rising prices, i.e. currency debauchment by governments).  For the most part inflationary measures, such as the CPI, have reported very modest inflation, about 1%-2% annually.  More information on the CPI can be found here.  The reason why this general price rise has not materialized is because banks are not yet lending all that freshly printed cash.  Thus, as credit collapses and the total volume of fiduciary media (money and money equivalents) declines, you get a decline in the price level, what’s popularly referred to as deflation.

Bartlett, in attributing the fear to lend on deflation, then suggests we end the policy of paying banks interest on money held on deposit with the central bank.  Correctly, he points out that this (albeit small) interest income from the government provides for a disincentive to lend.  That’s fair enough, although I’d argue that banks aren’t lending primarily because of excessive and unnecessary political uncertainty introduced by Obama and Congress.  Banks are also likely terrified of future inflation as they do start to lend.  This fear ironically contributes to the present deflationary conditions.

His quibbling about ending the interest on deposits aside, it’s hard to describe just how exactly wrong Bartlett is.  If a classical economist were brought back from the dead to read Bartlett’s piece, he’d think it satire.  Deflation is natural and normal following the burst of an inflationary bubble (i.e., the necessary result of credit expansion).

A few point here: First, what’s wrong with falling prices anyway?  And second, Bartlett should recognize that once banks DO start to lend, the alleged bogeyman of deflation will be replaced by the horror of potentially crippling inflation (again, I am using these terms in their popular sense, referring to price levels).  Remember, a mere $2 billion in excess reserves supported the 2008 bubble height of $6 trillion.  Presently, we have over 500x that amount.  (See this excellent article by Pepperdine economist George Reisman here for more.)

Only a thinker like Bartlett (i.e., a Keynesian) could write “…the zero-bound problem is a very severe constraint on monetary policy” and not be joking.  Seriously, what Bartlett means by that little statement is that the Fed must be creative when attempting to deal with the seemingly inconvenient fact of life that negative interest rates don’t exist and never will.  Think about it: only a statist intellectual has the gumption to suggest that the one lending money should be paying the interest on the loan.  Wouldn’t that be a different world?

(I should note here that interest rates and money creation are not directly related in the way Bartlett’s article implies.  However, it is characteristic of our Federal Reserve system – and other central banks – that new money is injected via the banks, with the stated purpose of lowering interested rates.)

This is the illogic of Keyensianism brought to its logical end.  Milton Friedman famously said that one way around this “constraint” was to drop money from helicopters.  How much longer until Obama starts hiring the pilots?

13 Jul
2010
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Gibbs: November could be rough

Yesterday, White House Spokesman Robert Gibbs caused a stir when he suggested that Democrats could lose the House this November election season.  Said Gibbs:

I think there’s no doubt there are enough seats in play that could cause Republicans to gain control. There’s no doubt about that.

Did Gibbs gaffe??  Some Democrats think so.  According to this Politico story, party supporters are angry:

But Democratic strategists are privately grumbling that the White House press secretary gift-wrapped a bludgeon and handed it to the GOP.

“It was the dumbest thing in the world to do,” one major Democratic money-bundler told POLITICO. “Barack Obama doesn’t understand this [election] is a referendum on his agenda.”

Many have theorized that Gibbs was merely managing expectations (a phrase I find offensive from a literary perspective, for the record), and that by lowering the bar Democrats can spin a loss into a kind of win.

For my 2 cents, I think Gibbs doesn’t really know what his role in the world is, and found himself a hapless Press Secretary to a terrible President, contributing his poor brand of propaganda to a nation that is experiencing a groundless economic recovery and quickly losing international allies.

To sum up: an honest statement from a very confused man.

10 Jul
2010
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Historic Events in Financial Regulation

Historic Events in Financial Regulation

By Ronnie Guidone & Michael Armeno
ronnie.guidone@mssb.com ; michael.d.armeno@mssb.com

1929 – Uniform Sale of Securities Act
In the wake of the Crash of 1929, this act was intended to unify the varying securities practices amongst states. This Act was adopted in only five states and was abandoned shortly thereafter.

1932 – Senate Probes the Street
The eight year bull market that signified the roaring 20’s powered by massive speculation and market manipulation has come to a disastrous end. By the summer of 1932, NYSE listed equities have lost 83% of their value. Ferdinand Pecora, the Senate Banking Committee’s counsel and future SEC commissioner, spearheaded what became to be known as the “Pecora Hearings.” The Pecora Hearings aimed to determine the role Wall St. practices played in causing the crash of 1929 and what could be done to prevent a similar situation in the future.

1933 – Securities Act of 1933
The Securities Act of 1933 was the first federal law to regulate new issues in the marketplace. The Act is highlighted by the requirements of securities issuers to file registrations statements with the FTC and provide investors with a prospectus. The aim of this act was to help insure that fraudulent securities did not make it to market and the public was provided with the appropriate information required to make an informed investment decision regarding the new issue. If the FTC determined a security to not meet requirements, this Act has empowered them to prevent the sale of the security. Wall St. took exception the Securities Act of 1933 and refused to bring new issues to market.

1933 – Glass-Steagall Act
This Act prohibited commercial banks from participating in investment banking activities and collaborating with full-service brokerage firms.

1933 – FDIC Created
The Federal Deposit Insurance Corporation was established to insure deposits against bank failure in order to maintain the public’s confidence in the country’s financial system.

1933 – Securities Act of 1934
This Act called for the formation of the SEC. The Act required that stock exchanges register, gave the SEC the ability to approve the rules of stock exchanges and prohibited the manipulative trading practices that were rampant in the marketplace during this era.

1938 – Maloney Act
This Act amended the 1934 Act and led to the birth of the NASD in 1940.

1940 – Investment Company Act and Investment Advisers Act
Investment companies experienced massive growth towards the end of the 1920’s in an unregulated environment which played witness to serious self-dealing and various other abuses. This act required that the investment companies, their advisors, managers, and directors, register with the SEC and enacted regulation which thwarted many of their improper practices.

1956 – Uniform Securities Act
The purpose of this Act was to protect investors without inhibiting the ability of the states and businesses to raise capital. This Act is most known for allowing a security which is already registered under federal securities law to be exempt from further requirements.

1970 – Securities Investor Protection Act
The Act established what is known as the Securities Investor Protection Corporation, also known as the SIPC. The SIPC provides insurance to the customers of broker dealers in the event of a brokerage firm failure.

1975 – MSRB
Congress created the Municipal Securities Rulemaking Board to establish proper practice in terms of the issuance and trading of Municipal Securities.

1981 – CRD
The NASAA and the NASD joint forced to create the Central Registration Depository which allows stated and federal regulators to share information about broker-dealers with the public. The practical application of CRD is the creation of the ability of investors to run a check on a broker before investing and to prevent fraudulent brokers from fleeing one jurisdiction to become registered in another.

1983 – Insider Trading Sanctions Act
This Act empowered the SEC to seek damages as much as three times the amount of profits or losses avoided as a result of trading on nonpublic information.

1987 – October Market Break
The 22.6% drop in the market on October 19 led to the creation of a Presidential Task Force on Market Mechanisms which concluded that this crash was a result of mechanical and structural issues in which lack of inter-market communication and regulation played a significant role.

1988 – ITSFEA
The Insider Trading and Securities Fraud Enforcement Act was passed in response to the high profile insider trading cases against Michael Milken, Dennis Levine, and Ivan Boesky to name a few. The act called for harsher insider trading penalties as well as a private right of action for those trading with anyone violating these securities laws.

1990 – Market Reform Act
This Act, a response to the crash of 1987, empowered the SEC to take action in emergency market situations to restore a fair and orderly marketplace.

1998 – Fed Rescues LTCM
Long Term Capital Management was among the most successful hedge funds of this era and posted annual returns in the 30% range. The strategies LTCM employed were primarily based on highly leveraged derivative transactions with Wall Street’s investment banks playing counterparty. In the spring of 1998, instability in the currency markets cause LTCM to hover on the brink of bankruptcy. The Wall Street firms which were counterparties to LTCM’s derivative contracts would have suffered a serious liquidity crisis should LTCM default. As a result, the Federal Reserve Bank assembled a team of leading investment banks, LTCM’s clearing banks, and major LTCM counterparties to infuse LTCM with capital in fear that the bankruptcy would destabilize the U.S. economy.

1999 – Congress Repeals Glass-Steagall Act
The Gramm-Leach Bliley Act removed the prohibition of banks owning broker-dealers or engaging in security activities thus essentially repealing the Glass-Steagall Act.

2000 – Regulation FD
This regulation requires issuers to simultaneously disclose any information to the public that they are making available to analysts and large investors in an effort to help keep the individual investor from being at a disadvantage.

2000 – Dot-com Bubble
March 10, 2000 marked the peak of the NASDAQ index at 5,132, a level it has yet to approach since 2000. Many internet-related IPO’s with little history of earnings would dramatically increase in value in an unsubstantiated fashion.

2001 – Enron
After growing its assets to the tune of $65 billion from 1996 to 2000, Enron announced that they would be restating their earnings from 1997 to 2000. Enron restated earnings because they had moved assets off of their balance sheet to a variety of entities owned partly by Enron executives. This illegal brand of off balance sheet financing gave the impression that certain Enron transactions were hedged which enabled the concealment of significant losses. Enron, of course, was not hedged as the counterparties to these transactions were Enron related entities. The Enron executives that participated in these partnerships profited handsomely. This was a classic example of the failure of checks and balances within a corporation including the board of directors, Arthur Andersen, and its host of attorneys.

2002 – Sarbanes-Oxley Act
Enron was the beginning of many high-profile cases of corporate scandal. WorldCom, Global Crossing, Adelphia and Tyco were cases of similar magnitude. Congress responded to these scandals with Sarbanes Oxley in 2002. SOX spawned the PCAOB (Public Company Accounting Oversight Board which has the authority to create a process for registration of public accountants, auditing standards, inspections, and disciplinary hearings. In addition, SOX prevented an accounting firm from providing a host of additional services to a public company that they simultaneously provided the audit work for.

2007- FINRA
FINRA was formed by the merger of the NASD and the member regulation, enforcement and arbitration functions of the NYSE.

2008 – Bear Stearns Collapse and a Global Financial Crisis
In March of 2008, the Federal Reserve, utilizing its capacity as an emergency lender, intervened to facilitate the purchase of a failing Bear Stearns to JP Morgan Chase. The Fed also temporarily opened its discount window.

By September, the U.S. government began taking emergency action to nationalize financial institutions overwhelmed by distressed assets. The financial landscape of the country would never be the same. Fannie Mae and Freddie Mac were taken over by the Federal Government. Merrill Lynch was sold to Bank of America. Lehman Brothers filed Chapter 11. Goldman Sachs and Morgan Stanley were transformed into bank holding companies. The largest bank failure in U.S. history unfolded as Washington Mutual Bank failed.

Congress responded to the financial devastation with TARP (Toxic Asset Relief Program), which allowed the U.S. treasury to buy poorly performing mortgage backed securities from overexposed institutions. Despite the rescue plan, many capital markets worldwide suffered record declines.

2008 – Bernie Madoff
Bernard Madoff confessed to running the biggest Ponzi scheme in the history of the U.S. and federal regulators faced severe scrutiny for not recognizing the fraud.

2010 – Flash Crash and Individual Stock Circuit Breakers
On May 6, 2010, the Dow Jones experienced an intraday plunge of 998 points before quickly rebounding to the tune of 400 points. This became known as the “Flash Crash.” The Flash Crash spawned the institution of individual stock circuit breakers throughout the marketplace. It is important to realize that on the floor of the NYSE these circuit breakers were already in existence.

3 Jul
2010
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Rick Lazio Speaks to the NYYRC

Rick Lazio Speaks to the NYYRC

Rick Lazio (lazio.com), New York gubernatorial candidate, spoke to the NYYRC on June 17th, 2010.

Rick Lazio from NYYRC on Vimeo.