By Winton Bates, on January 29th, 2010
John Stuart Mill assisted in the triumph of the idea of progress in the 19th Century but he also had concerns about the future that still seem relevant today. Richard Reeves comments: ‘Mill was not a knee-jerk critic of what Ruskin dismissed as the “steam whistle society”, but nor was he a blind advocate of industrialization for its own sake. As an avid botanist and walker, he was acutely sensitive to what would today be called environmental concerns’ (‘John Stuart Mill, Victorian Firebrand’: 233).
I will focus here on the views on progress and, in particular, concerns about public opinion that Mill put forward in ‘Civilisation’, published in 1836, when he was about 30 years old.
Mill identified three characteristics of civilisation:
• the development of commerce, manufactures and agriculture;
• people acting together for common purposes in large organisations; and
• peace being maintained within society through arrangements for protecting the person and property of members.
He suggests: ‘Wherever there has arisen sufficient knowledge of the arts of life, and sufficient security of property and person, to render the progressive increase of wealth and population possible, the community becomes and continues progressive in all the elements which we have just enumerated’.
Mill goes on to argue that the most remarkable consequence of advancing civilization is ‘that power passes more and more from individuals, and small knots of individuals, to masses: that the importance of the masses becomes constantly greater, that of individuals less’. He gives several reasons: economic growth results in the growth of a middle class and the dispersion of knowledge; the development of habits of cooperation and discipline in large organizations enable development of associations of different kinds, including benefit societies and trades unions; and improved communications through newspapers that enable people to learn that others feel as they feel.
Mill argued that political reform would follow inevitably: ‘The triumph of democracy, or, in other words, of the government of public opinion, does not depend upon the opinion of any individual or set of individuals that it ought to triumph, but upon the natural laws of the progress of wealth, upon the diffusion of reading, and the increase of the facilities of human intercourse’.
Mill’s concern about the growth in power of public opinion was that the individual would become lost in the crowd; although the individual depends more and more on opinion (reputation) he is apt to depend less and less upon the well-grounded opinions of those who know him. Mill suggested that with the growth in power of public opinion ‘arts for attracting public attention formed a necessary part of the qualifications even of the deserving’. His main concern was that ‘growing insignificance of the individual in the mass’ … ‘corrupts the very foundation on the improvement of public opinion itself; it corrupts public teaching; it weakens the influence of the more cultivated few over the many’.
One for the remedies that Mill proposed was ‘national institutions of education, and forms of polity, calculated to invigorate the individual character. Mill then proceeded to castigate the English universities for acting as though the object of education was to inculcate the teacher’s own opinions in order to produce disciples rather than thinkers or inquirers. Mill wrote: ‘The very corner-stone of an education intended to form great minds, must be the recognition of the principle, that the object is to call forth the greatest possible quantity of intellectual power, and to inspire the intensest love of truth: and this without a particle of regard to the results to which the exercise of that power may lead, even though it should conduct the pupil to opinions diametrically opposite to those of his teachers’.
Massive changes have occurred in university education over the last 174 years, some of which correspond to Mill’s suggestions. Does this mean that Mill’s views on university education are now of only historical relevance? Do our universities now inspire the intensest love of truth? Are these standards of truth-seeking now reflected in the mass media and politics?
Unfortunately, there seem to be many people in universities these days who would regard Mill’s aim of inspiring the intensest love of truth as a philosophically suspect idea that is inconsistent with the modern purpose of universities in training technicians and inculcating them with politically correct views.
By Thomas Knapp, on January 29th, 2010
… then he’s not serious about freezing or cutting spending.
Glenn Greenwald elaborates on just how friggin’ big and bloated the US “defense” budget is over at Salon. My shorter version:
The US spends almost as much as the rest of the world combined on “defense.” It spends six times as much as the next-largest “defense” spender (China), and 29 times as much as the six top “rogue states” (Cuba, Iran, Libya, North Korea, Sudan and Syria) combined.
And let’s be truthful here: US “defense” spending is mostly just a gigantic corporate welfare program — a way of redistributing wealth from the taxpayer to the politicians’ corporate cronies (and if a few hundred thousand people have to die every few years to keep the gravy train running, no problem as long as most of those people are evil, swarthy furriners). The actual national defense requirements of the US come to a small fraction of the amount spent under that label. Politicians and corporate welfare queens like the label because they can call anyone who objects to spending under it “unpatriotic.”
If Obama was serious about a discretionary spending “freeze,” he’d include the Department of Defense in that freeze. If he was serious about balancing the budget, he wouldn’t stop there, either. He’d propose a 25% cut to DoD over the three-year “freeze” period, and ask for a much larger cut over a longer time period.
So, now we know Obama isn’t serious.
By Trace Mayer, on January 28th, 2010
The Great Credit Contraction grinds on as the system continues evaporating. People are realizing the true nature of the worldwide fiat currency and fractional reserve banking system that is built on a fraudulent premise and has become a Ponzi scam of epic proportions, the largest in the history of the world. Capital, both real and fictions, has begun burrowing down the liquidity pyramid while the upper layers evaporate. Recent developments in the one month United States Treasuries appear to portend another round of credit crisis. 
 THE TREASURY BUBBLE
A year ago I discussed how the Treasury bubble was the largest of all and explained both how and why it would burst. I prognosticated:
However, as more capital piles into them it drives rates lower and lower. Eventually Treasury Bill rates reach 0% or even go negative. This presents a problem.
Why hold a Treasury Bill with a bank, broker, custodian bank or the Federal Reserve itself when you could take possession of physical Federal Reserve Notes?
Taking possession eliminates at least two types of risks. First, is any potential counter-party risk with whoever is holding the Treasury Bill for you. Second, ‘political risk’ which is a much larger threat. …
As the yields on Treasury Bills approach 0% they have the return of cash but do not have the benefits of cash as they may be impregnated with counter-party risk or have decreased liquidity. In other words, Treasury Bills and cash have the same benefit profile but not the same safety and liquidity profile. This analysis also applies to demand deposits with the bank such as checking accounts or CDs. All the downside but none of the upside.
Predictably the Treasury bubble burst. Poof!
PILING INTO ONE MONTH TREASURIES
The one month Treasury has recently traded with negative rates. This portends another round of the credit crisis which could very easily have its catalyst in either another sovereign debt downgrade of either Japan or Portugal or in Austria with banks owning a large amounts of primarily mortgage assets denominated in foreign currency in primarily Slovakia but also the Czech Republic, Hungary and Croatia.
The last few weeks shows just how close the rates are towards 0%. Of course, real interest rates are already negative. But a weak FRN$ would help meet Obama’s goal to double exports which would not be helped by his proposed discretionary spending freeze.
MONEY MARKET FUNDS
One tool many investors use as a proxy for their cash are money market funds. Many view these as like-cash vehicles just like many viewed auction-rate securities as like-cash vehicles for 25 years. On 18 September 2009 I explained that I closed my Paypal money market fund because money market funds had lost government backing. On 27 January 2010 Nasdaq.com reported:
The U.S. Securities and Exchange Commission approved by a 4-1 vote Wednesday rules designed to shore up the resiliency of money- market mutual funds, with general support from the industry, although fund representatives are uncomfortable with a few points. …
The rules also would permit a money-market fund’s board of directors to suspend redemptions if the fund is about to “break the buck” by having a net asset value fall below $1 per share. Currently the board must request an order from the SEC to suspend redemptions.
“The halting of redemptions will stem the motivation for runs. It also will eliminate the need for a failing fund to sell securities into a potentially de- stabilized market and further drive down prices,” Schapiro said.
For those with too much time on their hands who want to see what the proposed rule looked like I would direct you to page 32,714 of the 8 July 2009 Federal Register under proposed rule 22(e)-3. I find the discretion of the Director of the Division of Investment Management in this instance to be particularly egregious.
Treasuries are below money market funds in the liquidity pyramid because there is more safety and liquidity. If a money market fund has redemptions suspended then that asset is not very liquid and will likely find their value evaporate. This is precisely what happened with auction-rate securities and in some cases overnight investors went from thinking they held a like-cash instrument to finding themselves holding 40 year student loans that received no payments for several years.
WHERE IS REAL SAFETY AND LIQUIDITY
On May 20, 1999 Alan Greenspan testified before Congress, “And gold is always accepted and is the ultimate means of payment and is perceived to be an element of stability in the currency and in the ultimate value of the currency and that historically has always been the reason why governments hold gold.”
During the 1990’s Mr. Rubin had devised the gold leasing scheme with the intent being elucidated by Dr. Greenspan’s testimony in 1998, “Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.”
Because of massive governmental intervention for decades through either patent activities such as legal tender laws, the tax code, etc. or latent activities such as surreptitious leasing of gold into the market the result is a massively suppressed gold price.
The tremendous amount of evidence accumulated by the Gold Anti-Trust Action Committee ought to be examined by any serious investor or money manager. As Mr. Robert Landis, a graduate of Princeton University, Harvard Law School and member of the New York Bar, asserted years ago, “Any rational person who continues to dispute the existence of the rig after exposure to the evidence is either in denial or is complicit.”
Nevertheless it is very difficult to assess an accurate value of gold, silver or platinum in this era and for a specific time period where almost all financial professionals are infected with the financial insanity virus, the system is riddled with chronic fingers of instability and it somehow muddles along like a terrifically abused zombie. There is already a one world currency, gold, and it poses a mortal threat to fiat currency.
CONCLUSION
As the next round of the credit crisis plays out it may be worse than the earlier iterations. All of the interventions have not addressed the root causes and are actually textbook responses for someone who would want to intentionally exacerbate the greater depression.
As Ludwig von Mises predicted decades ago in chapter 20 of Human Action, ‘The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. … But then finally the masses wake up. … A breakdown occurs. The crack-up boom appears.’
New credit creation is nearly non-existant, banks are hoarding reserves so they can win the Friday bank failure lottery and the velocity of currency has slowed to glacial speeds. Because gold and the FRN$ abut in the liquidity pyramid they tend to have an inverse correlation. Buying gold and other tangible assets, I particularly like the extremely rare and useful platinum, is the only place to go for safety from the specter of the FRN$ evaporating through hyperinflation because of all the quantitative easing.
After all, with a gold coin in hand, or with a reputable third party like the company GoldMoney, I can remain solvent longer than the market can remain irrational. Gold is not an investment but real cash because it is ‘risk-free’ and an instrument for wealth preservation not wealth generation. Far into the future and long after these money market funds are frozen, retirement accounts are nationalized to buy FRN$s that are evaporated into nothing via hyperinflation the gold or platinum coin will still have value because they are tangible assets that are not subject to counter-party risk.
DISCLOSURE: Long physical gold, silver and platinum with no interest TLT, the problematic SLV or GLD ETFs or the platinum ETFs.
By Eldon Mast, on January 28th, 2010
So far this week, we’ve continued a string of good news following last week’s focus on banking reform. More specifically reports on consumer confidence and the housing market confirm the worst of the recession’s detriments are now behind us.
First in December, existing home prices firmed significantly — up a sizable 4.9% on the median to $178,300 and up 6.4% on the average to $225,400. The National Association of Realtors attributed the gains to a higher proportion of repeat buyers during the month.
The report on new home sales also confirmed the December trend indicating a firming in those prices as well. Their median month on month price rose 5.2% to $231,000 while the average rose 7.6% to $290,600. The year-on-year rate for the average price is now actually up 10.5%.
The conference board’s consumer confidence index edged forward in January to 55.9 vs. December’s 53.6 in continued welcome news. The assessment of the present situation improved noticeably, up nearly 5 points to 25.0. The present situation added another 7 tenths to 76.5 and is inching closer to the important 80 milestone. A reading of 80 or better for the expectations index is widely considered to be a signal of economic health.
The assessment of the present jobs market has now improved for three straight months. Those saying jobs are hard to get fell again to 47.4% vs. 48.1% in December and 49.2% in November.
And on Wednesday, markets cheered as Fed policy makers kept the funds and discount rates unchanged at very low levels. Their summary assessment is that the economy is strengthening, labor market declines are abating, and household spending is expanding at a moderate rate.
By Thersites, on January 28th, 2010
Government cannot fix America’s problems. Only innovative, responsible individuals acting according to their own free will can help cure what ails us. If government could solve all our problems, then government might as well centrally plan society, but as we have seen in every instance in which this has been tried, the sole result has been poverty and mass genocide.
Of course it is naive to think that this President cares about solving our problems. The man’s sole concern is power, obtained by “fundamentally transforming the United States of America.”
By Thersites, on January 27th, 2010
Zero Hedge (with help from the Huffington Post) has been all over the biggest fraud perpetrated by the government in economic history. While trying to avoid some of the minutiae of the transactions that took place, below are some of the highly poignant issues to come out of HuffPo’s (shockingly!) and Zero Hedge’s excellent muckraking. My commentary is in blue.
On CDOs
AIG did not understand what it was doing; it relied on the rating agencies.
But if Goldman was so smart, how could AIG be so dumb? There’s a short answer and a long answer. The short answer is three little letters: AAA. The long answer gets to the same result; it just takes a longer while to get there.
According to Michael Lewis’s reporting in Vanity Fair, the guys at AIGFP were clueless:
Toward the end of 2005, Cassano [the head of AIGFP] promoted Al Frost, then went looking for someone to replace him as the ambassador to Wall Street’s subprime-mortgage-bond desks. As a smart quant who understood abstruse securities, Gene Park was a likely candidate. That’s when Park decided to examine more closely the loans that A.I.G. F.P. had insured. He suspected Joe Cassano didn’t understand what he had done, but even so Park was shocked by the magnitude of the misunderstanding: these piles of consumer loans were now 95 percent U.S. subprime mortgages. Park then conducted a little survey, asking the people around A.I.G. F.P. most directly involved in insuring them how much subprime was in them. He asked Gary Gorton, a Yale professor who had helped build the model Cassano used to price the credit-default swaps. Gorton guessed that the piles were no more than 10 percent subprime. He asked a risk analyst in London, who guessed 20 percent. He asked Al Frost, who had no clue, but then, his job was to sell, not to trade. “None of them knew,” says one trader. Which sounds, in retrospect, incredible. But an entire financial system was premised on their not knowing–and paying them for their talent! [Emphasis added.]
It seems less shocking if you understand how these CDOs were put together and sold. Take a few minutes and glance over the prospectus for Davis Square Funding VI, one of the dozens of CDOs structured by Goldman before the risk was laid off on AIG. You could spend all day studying the document, but you will never be able to answer the question, “What am I buying?” The document doesn’t tell you. That’s the point. It’s evident in every aspect of this document and the offering circulars for most of the other CDOs. The business purpose, the essence of the deal, can be summarized in one word: obfuscation.
Goldman argued that these CDOs were put together to meet market demand, but demand for what? These subprime CDOs were not financing anything (the underlying mortgages and mortgage securities had already been financed), nor were they promoting liquidity in the marketplace (they couldn’t be traded because nobody knew what was in them).
So just to recap, AIG was trading garbage assets. As we know, the proliferation of subprime mortgages would have never occurred without artificially low interest rates, the CRA, Fannie and Freddie subsidization and the other political forces like ACORN pushing banks to make loans to uncreditworthy borrowers. The end result? A large quantity of mortgages of very low quality, which were clumped together and sold buy banks like Goldman Sachs in CDOs, and of which CDS (basically insurance policies) were sold on to hedge the risk of the CDOs. Without the garbage mortgages enabled by government intervention, you would have never had the massive increase in the mortage-backed security market and the CDS contracts that were written on the CDOs.
The other element of course of this problem attributable to government is the Washington DC-stamped, cartelized ratings agencies, who created moral hazard in markets by taking the onus off of investors to evaluate the underlying mortgages backing things like the toxic CDOs. This isn’t to place the blame solely on S&P, Fitch and the like notwithstanding their errors in rating the securities (which of course can be held partially attributable to the inherent conflict of interest between the investment banks and the ratings agencies themselves), as the buyers of CDOs should have invested more responsibly. But nevertheless, one can see the government role herein. Incidentally, I would suggest against buying any product whose prospectus looks like this one of a CDO structured by Goldman. On Moral Hazard
Was AIG really too big to fail? Maybe if you worked for Goldman.
The party line, expressed in Too Big To Fail and elsewhere, is that an AIG bankruptcy posed a greater systemic risk than a Lehman bankruptcy, because AIG was so much bigger. But that analysis is highly superficial and very misleading. AIG itself was a holding company, which guaranteed the debt of its unregulated financial subsidiary, AIGFP. The lion’s share of AIG’s revenues and profits, and about 80% of its consolidated assets, were concentrated among its different insurance company subsidiaries. Those insurance companies were solvent. They did not pose any systemic risk. In fact, it’s quite likely that they would have continued to operate outside of bankruptcy.
The only subsidiary with major problems was AIGFP, whose financial obligations were guaranteed by the parent. But AIGFP was only about one-third the size of Lehman. It’s almost impossible to see how AIGFP ever posed a systemic risk, unless everyone’s intention to provide a backdoor bailout to the banks. Put another way, it seems that the only reason that the government needed to step in for AIG was to provide a backdoor bailout to its banks.
This pretty much speaks for itself. The free marketeers among us would argue that there is no such thing as TBTF – that many of these banks would not have grown to the size they did, nor taken on the risks they did without massive government intervention in the banking sector to begin with, but nevertheless that Lehman fell and the financial system didn’t die (even if credit markets froze which is what should have happened in response to the collapse of a major financial institution) is fairly good evidence that AIG’s collapse of solely one of its subsidiaries likely would not have destroyed the financial system. Granted, AIG had many institutional problems, and AIGFP was merely one of them. Next, the drama picks up:
Goldman’s scheme to create a liquidity crisis at AIG, in order to manipulate the government into paying CDO counterparties 100 cents on the dollar
Because of laws that emasculated regulatory oversight, Goldman’s trading positions in credit derivatives with AIG had escaped the scrutiny of the Fed until September 11 or 12, 2008, when AIG told the New York Fed that it would soon run out of cash. The CDOs did not trigger a liquidity crisis at AIG, at least, not directly. Rather, it was the imminent cash drain from anticipated downgrades, from AA- to A-, which would trigger $30 billion in new collateral postings on AIGFP’s trading positions. In addition, someone at the company had screwed up. They had invested billions in cash collateral, intended for someone else, in highly rated mortgage securities, for which there was suddenly no liquid market. So AIG needed to come up with the cash right away.
Simultaneously, of course, Lehman Brothers was imploring the government for support, and Paulson’s position, at least on September 12, 2008, was that the Federal government would provide no support of any kind to bail out a private company like Lehman or AIG. Private bankers must come up with a private solution on their own.
On September 15, 2008, the same morning that Lehman’s bankruptcy sent shockwaves, Geithner had convened a meeting with JPMorgan Chase and Goldman to work on an emergency bridge financing for AIG. Why include Goldman? Traditionally, the bank with the largest credit exposure to distressed borrower helps arrange the debt restructuring. Geithner opened the meeting, and left soon thereafter, leaving Paulson’s deputy, Dan Jester, in charge. Jester was a former Goldman banker whom Paulson had plucked in July 2008 to work on matters that concerned Paulson.
September 15, 2008: Paulson’s deputy sabotages efforts to negotiate a private bank deal.
Sorkin describes the opening of the Monday morning meeting:
“Look, we’d like to see if it’s possible to find a private-sector solution,” Geithner said addressing the group. “What do we need to do to make this happen?
This strikes me as incredibly interesting. That the government initially wanted to look for a private-sector solution is a good thing. Yet as the title to this section shows, and as we will soon discover, it seems as if Goldman wanted to intentionally cause a crisis so it could be bailed out for its positions with AIG. In some ways, this seems reminiscent of the Panic of 1907, where some have argued that JP Morgan intentionally tried to sink the market in order to continue building the case for the development of a central bank to cartelize the major Wall Street Banks and provide them with a backstop in the event of a banking crisis. Granted, now we already have a central bank, but that Goldman might intentionally create a liquidity crisis in order to be bailed out and made whole on its AIG exposure, while further strengthening its position as THE dominant financial institution with an implicit taxpayer backing is certainly within the realm of possibility.
For the next ten minutes the meeting turned into a cacophony of competing voices as the banks tossed out their suggestions: Can we get the rating agencies to hold off on the downgrade? Can we get other state regulators of AIG’s insurance subsidiaries to allow the firm to use those assets as collateral?
Geithner soon got up to leave, saying, “I’ll leave you with Dan,” and pointed to Jester, who was Hank Paulson’s eyes and ears on the ground. “I want a status report as soon as you come up with a plan.”
On the Conflict of Interest and Intimidation
A critical point here is that Pauslon’s deputy, not Geithner, sat at the table to lead government negotiations.
Job 1 was to persuade the rating agencies to forestall their anticipated downgrades, which would have burned up billions because of increased calls to post collateral. This task was assigned to the government’s representative, Dan Jester.
“He was as useless as tits on a bull.” [AIG CEO] Bill Willumstad, normally a calm man, was in an uncharacteristic rage as he railed about Dan Jester of Treasury, while telling Jamie Gamble[a lawyer at Simpson Thatcher] and Michael Wiseman [a lawyer at Sullivan & Cromwell] about his and Jester’s call to Moody’s to try to persuade them to hold off on downgrading AIG.
Willlumstad had hoped that Jester, using the authority of the government and his powers of persuasion as a former banker, would have been able to finesse the task easily.
Willumstad explained that the original plan “was that the Fed was going to try to intimidate these guys to buy us some time.” Instead, when Jester finally got on the phone, “he didn’t want to tell them.” Clearly uncomfortable with playing the heavy, Willumstad told them that Jester could only bring himself to say, “We’re all here, and, you know, we got a big team of people working and we need an extra day or two.”
If Jester spoke to Moody’s the way Willumstad said he did, then there is no doubt in my mind that Jester intended to sabotage the deal. No other explanation is plausible. The importance of the phone call was not unlike that of a death row lawyer seeking a last minute stay of execution. Jester had been the Deputy CFO at Goldman. It would have been his job to deal with the rating agencies regularly. There is no way that he would not have known what to say. All he would need to say is that since AIG’s last meeting with Moody’s, the situation is evolving in a way so Treasury and the Federal Reserve are feeling increasingly confident that the deal being hammered out will significantly ameliorate the company’s liquidity issues. Everyone knows that the rating agencies do not like to abruptly pull the trigger when a situation is still evolving. Everyone also knows that the rating agencies are acutely aware of their chicken/egg role they play in determining a firm’s liquidity situation. (A company has access to the capital markets because of its rating, but its rating reflects its access to the capital markets.) Also, as Janet Tavakoli once mentioned, investment banks train their analysts about how to place pressure on the rating agencies. Finally, it would not have been indelicate to allude to the agencies’ no-so-clean hands in building up the AAA pyramid scheme known as AIGP’s CDO portfolio.
Here we see the evidence that a former Goldmanite, Jester, it seems did little to persuade the ratings agencies to buy AIG time so that a private sector solution could be put in place to deal with the problems between AIG and its counterparties. There are a few important things to note. One is the conflict of interest that had to exist between Paulson and Jester dealing with AIG whose biggest counterparty was Goldman, second that the Fed according to AIG CEO Willumstad was trying to INTIMIDATE the ratings agencies (funny I didn’t see that responsibility in the Constitution) and third that Paulson and Geithner were not in the room at this time. Could this be because they wanted to be able to recuse themselves of any malfeasance in the event of a trial down the road?
September 16, 2008: Paulson installs a CEO at AIG who will favor Goldman.
And a few minutes after Goldman, JPMorgan Chase and the government tried to figure out what was next, at 9:40 a.m., September 16, Goldman CEO Lloyd Blankfein placed a call to Hank Paulson, which Paulson took, even though such communication was illegal. According to Sorkin’s sources, they discussed Lehman and not AIG. Just at the moment when the government was deciding whether to step in and save AIG, Blankfein never mentioned that an AIG collapse could have easily wiped out $15 billion in Goldman’s equity and caused everyone to scrutinize the dodgy CDOs underwritten during Paulson’s tenure. Do you think they just forgot?
As it happened, a few minutes after Paulson got done speaking with Blankfein, Geithner briefed Paulson about a tentative proposal for the government to extend AIG an $85 billion facility. The conversation with Geithner ended at 10:30 a.m.
Sorkin’s sources fabricated a tall tale about what took place afterward:
However resistant Hank Paulson had been to the idea of a bailout, after getting off the phone with Geithner, who had walked him through the latest plan, he could see where the markets were headed and that it scared him. Foreign governments had already been calling Treasury to express their anxiety about AIG’s failing.
Jim Wilkinson [Paulson's deputy, formerly of the White House Communications office] asked incredulously,” are you really going to rescue an insurance company?”
Paulson just stared at him as if to say only a madman would stand by and do nothing.
Ken Wilson, his special advisor, raised an issue they had yet to consider. “Hank, how the hell can we put $85 billion into this entity without new management?”– a euphemism for how the government could fund this amount of money without firing the current CEO and installing its own. Without a new CEO, it would seem as if the government was backing the same inept management that had created this mess.
“You’re right. You’ve got to find me a CEO. Drop every other thing you are doing,” Paulson told him. “Get me a CEO.”
Their choice: Ed Liddy, the former CEO of Allstate and Goldman board member.
Whoever bore the blame for creating the mess at AIG, it’s extraordinarily reckless, during the middle of a crisis, to immediately install a CEO with no prior experience at the company, which is a huge sprawling conglomerate. That’s especially true when that new CEO has a conflict of interest the size of the Grand Canyon.
Sorkin also makes clear that it was Jester, not Geithner, who took control in structuring AIG’s bailout facility. Before Geithner gets on a conference call with Bernanke:
Jester and [Paulson's assistant Jeremiah] Norton were poring over all the terms. They had just learned that Ed Liddy had tentatively accepted the job of AIG’s CEO and was planning to fly to New York from Chicago that night. To draft a rescue deal on such short notice, the government needed help, preferably from someone who already understood AIG and its extraordinary circumstances. Jester knew just the man: Marshall Huebner, the co-head of insolvency and restructuring at David Polk & Wardell who was already working on AIG for JP Morgan and who happened to be just downstairs.
Months later, Paulson’s spokesman told The New York Times that, “Federal Reserve officials, not Mr. Paulson, played the lead role in shaping and financing the A.I.G. bailout.”
Again, the conflict of interest here is breathless. A former GS board member who would obviously act amenably to GS was put in charge, it seems as a puppet leader of AIG. The fact that the Fed again was maneuvering this whole program shows the significant amount of power they held over the entire financial system, and their panicked actions with massive amounts of taxpayer money are if nothing else incredibly irresponsible if not downright scary. Below, the WSJ outlines the whole bamboozle:
Gaming the System
Further, as Zero Hedge had discovered earlier, none of this intervention at all in AIG may have been necessary as GS was willing to tear up its CDS contracts with AIG:
In tonight’s Heard On The Street section, the WSJ notes:
As everybody knows, AIG got a huge government bailout in September 2008 to help make payments on derivatives contracts with banks, including Goldman. Yet in the previous month, Goldman approached AIG about “tearing up” its contracts, according to a November 2008 analysis by BlackRock, then an adviser to the New York Fed. So was Goldman prepared to offer AIG a haircut in the month before its rescue? A legitimate question, given that Goldman refused to accept such a cut when the New York Fed raised the idea after it bailed out AIG.
The implications of this discovery are huge as they essentially destroy all the arguments presented by the FRBNY about an inability to extract concession out of Goldman (which being the largest AIG CDO counterparty, was the critical negotiating factor). It also casts doubt on the veracity of any arguments presented in Congress by Goldman representatives discussing the potential to take a haircut on their AIG exposure. What this means in plain English is that, in the month before the Fed entered the scene, GOLDMAN SACHS ITSELF OFFERED TO TEAR DOWN THE CDS ON AIG’S CDO PORTFOLIO (we don’t use caps lock lightly). This is basically a smoking gun on the moral hazard issue perpetrated by the FRBNY when it got involved, and indicates that through their involvement, Tim Geithner, Sarah Dahlgren or whoever, not only did not save US taxpayers’ money, but in fact ended up costing money, when they funded the marginal difference between par (the make whole price given to all AIG counterparties after AIG was told to back off in its negotiations) and whatever discount would have been applicable to the contract tear down that had been proposed by Goldman a mere month earlier. This, more so than anything presented up to now, is the true scandal behind the New York Fed’s involvement.
If this November BlackRock report indeed exists, and if Goldman did in fact offer to tear down contracts, this is an act of near criminal implications and heads at the FRBNY must roll immediately.
Today, Zero Hedge released the November BlackRock report. The report indeed verifies the aforementioned theory:
In layman’s terms, what all this means, is that Goldman would have indeed been willing to accept tear downs due to the excess buffer (positive haircut) arrangement the firm had in place with AIG. Indeed, the firm had downside protection all the way down to at least 12% below fair value as determined by all other AIG counterparties (granted, in such an extremely illiquid market as CDOs nobody knew what price these securities would print at, especially if trades were done in the size discussed). Furthermore, according to BlackRock, Goldman was wise enough to offload the actual CDOs to clients, and was exposed merely through “back-to-back swaps on most of the positions.” This means that Goldman only was exposed purely to counterparty risk on AIG’s behalf – should AIG default, Goldman would become the client-facing entity guaranteeing “pass through” sold CDS.
Yet one wonders just how many billions of dollars Goldman had in margin variation between collateral posted to it via AIG, and how the amount of money it had paid to buyers of CDS sold by Goldman. We are certain that since no Goldman client had the same negotiating power as Goldman did with AIG, Goldman likely had a positive balance in the hundreds of millions if not billions simply on the collateral variance.
As page 10 indicates, whereas all counteparties had requested collateral at a price for the underlying CDOs of 49, Goldman was extremely aggressive, demanding collateral for a price-equivalent of 37. The latter compares to a BlackRock model price for Goldman of 44, meaning that even the Fed’s advisor in good faith could not recommend such a generous treatment of Goldman in the context of all its other counterparties. Were Goldman to receive the same collateral as everyone else, it would be due 8.1 billion: $1 billion less than the 10/24 collateral request.
Now keep in mind, that of the top 5 counterparties, SocGen, GS, Deutsche Bank, Merrill and Calyon, only Goldman had subsequently sold off its entire CDO book: once again implying that unlike the other 4 firms, who at least held the exposure on their own balance sheet, and thus one can say deserved to receive some insurance, Goldman had bought then sold its entire portfolio, in essence making Goldman nothing than an AIG conduit, which was fully hedged and, as noted above, only had counterparty risk, yet which had the benefit of up to $1 billion in excess cash on its books due to day-to-day marking of its CDS exposure and its advantage collateral arrangement.
Futhermore, as Goldman owned CDS on AIG itself (as a counterparty hedge), Goldman had absolutely no risk in its relationship with AIG whatsoever!!! Of course, It is critical to remember that Goldman not only received par between the collateral previously posted to it, and actual cash from Maiden Lane III, it also made billions by selling actual AIG CDS (which as we claimed previously was done while in possession of material non-public information). Amusingly, while Goldman bought all of its CDO protection from AIG exclusively, it definitely used a very broad seller base when it loaded up on the actual AIG protection. Therefore, Goldman’s only, ONLY risk, was that of a complete systemic collapse and the repudiation of all contracts, CDS and otherwise. Which is why Goldman’s various agents did everything they could to prevent that from happening, up to and including loading the Federal Reserve with trillions of toxic debt in the upcoming 12 months.
Note that the link in the last stanza detailing how GS may have acted on non-public information to make a significant profit on its AIG CDS is simply breathtaking in its corruptness. But further, that the system was gamed by the banks, again at the expense of the taxpayer is despicable and heads should roll for it.
The French Connection
FURTHER, as was noted in the Huffington Post piece, as of November 6, 2008:
29% of the remaining CDO exposure belonged to two French banks, whose regulator advised Geithner that it was illegal for them to settle at less than par. Challenging another country’s bank regulator would have opened up a whole can of worms at a point when the risk of global financial panic was very real.
In light of this revelation, Zero Hedge did some digging and the BlackRock document revealed that the French bank Soc Gen “has pledged much of the (CDO) portfolio to the Fed discount window for future liquidity.” As Zero Hedge puts quite well:
Aside from the fact that in October 2008 France-based Soc Gen was not a Primary Dealer (it only just applied for this position a few weeks ago), one needs to turn to page 5 of the presentation to realize that Soc Gen’s portfolio had a value of 49 cents on the dollar. What this implies is that in October of last year (and ostensibly prior) Soc Gen, a foreign, non Primary Dealer, had access to the Federal Reserve’s Discount Window, where it had pledged securities that had a value of 49 cents on the dollar, and for which the Fed would have taken arguably no haircut, thereby funding the French firm at par for securities that were worth less than half, and which the taxpayer was on the hook for. Indeed, these securities may well have been completely worthless: lower on page 3 we read:
Soc Gen and AIG are currently in dispute over existing events of default and credit events under transaction [ineligible] for 2 deals, totaling $650 million of notional exposure.
We would not be at all surprised if the defaulted securities were part of the crap that had been given to Tim Geithner, at the time head of the New York Federal Reserve. And what Soc Gen was doing by pledging reference assets to the Fed, we are certain that all the other counterparties (those which unlike Goldman still held on to the securities) were doing as well.
The fact that the Fed was willing to risk taxpayer capital with such reckless abandon, first in the form of accepting literally worthless reference securities from Soc Gen (as documented by BlackRock), and subsequently by bailing out Goldman at well over par (remember the money the firm made on its actual AIG counterparty-risk) protection, would have been sufficient to terminate Geithner’s career in any self-respecting banana republic. Too bad America is no longer even that.
To recap, we have government intervention causing imprudent financial innovation and speculation, moral hazard, major conflicts of interest, Fed intimidation, the banking cartel gaming the system, a variety of potentially illegal actions and the corrupt bailout (of US AND FRENCH(!?) institutions) itself being hoisted on the back of the taxpayer. This is all truly damning evidence that the actions taken by our government during the financial meltdown were not only incredibly destructive to any semblance of capitalism, potentially illegal but also horribly detrimental to the American people. Bernanke, Geithner, Paulson and any of the other architects of these corrupt bargains need to face the music. Let the fireworks begin!
By Claus Vistesen, on January 27th, 2010
Sometimes no news is more telling than one might initially think and although it was hardly earth shattering for the market that the BOJ chose yesterday to keep its main benchmark rate sitting at 0.1% it does highlight the extraordinary difficulties Japan currently face in terms of sparking its economy back into some kind of forward momentum.
(quote Bloomberg)
The Bank of Japan held interest rates near zero and said it remains committed to fighting deflation as gains in the yen risk stunting the recovery from the country’s worst postwar recession. “I hope that price declines will be overcome as soon as possible,” Governor Masaaki Shirakawa told reporters in Tokyo after his board kept the overnight lending rate at 0.1 percent. “It will take time before we can see prices rising to favorable levels,” he said, adding that the central bank will maintain an “extremely accommodative financial environment.”
Japan’s credit rating outlook was lowered by Standard and Poor’s today, highlighting concern that the world’s biggest public debt will lead to higher borrowing costs in a country already facing falling prices and a strengthening yen. Finance Minister Naoto Kan said today that the BOJ can do more to battle deflation, and people with knowledge of the matter have said it may consider expanding an emergency loan program or increasing purchases of government bonds. “It’s highly probable the central bank will come under pressure to ease policy further as the economy loses steam,” said Teizo Taya, a former central bank board member and now adviser to the Daiwa Institute of Research in Tokyo. “The bank will likely consider expanding the lending facility, while it will try to avoid increasing bond buying as much as possible.”
The statement by the governor Shirakawa really tells it all and one can only second his hope that price declines will soon hit the shores of Japan. Yet, this seems more and more unlikely which is also why the BOJ seems to be moving straight back into full out QE mode at the same time as its peers are set to try, albeit with great difficulty, to restore some kind of normal monetary conditions over the course of 2010.
The BOJ consequently seems to be silently conceding that it will have to cooperate tightly with the MOF in trying to bring some kind of momentum back to Japanese soil. In this concrete case it will mean keeping open the taps to create a bid for the steady flow of Japanese government bonds.
(click on graphs for better viewing)
The core-of-core index has now fallen since January 2008 with the total accumulated decline in the core nominal price level of 6.8%. Now, I don’t need, I think, to spell out what this implies for debt and growth dynamics in Japan which just seem to perennially stuck at the moment.
The problem for Japan is really that it is fighting a losing battle on two fronts. Firstly, and quite as most observers would expect Japan is having great difficulty in terms of building up domestic demand (see graph here). Secondly however and much worse; conventional wisdom would have that as the risky assets began to fly back in March 2009 and as the global economy showed the first tepid signs of emerging from the death bed so should the JPY weaken and Japan ride, through the carry trade effect, the global upturn on exports. Yet, this has not been the story so far and while Japan indeed is exporting a lot to service the runaway train China, the new found reluctance of the JPY to react to global risk sentiment is preoccupying.
Measured against the Euro and using the period 2004 to 2009 (more or less) as the base average value the JPY is now 10% and 17% stronger against the Euro and the Buck respectively.
Finally, to add injury to insult S&P moved in Monday with a nudge as it threathened to downgrade Japan’s sovereign debt rating less it gets its fiscal book on the mend. As a mitigating factor S&P mentions Japan’s strong net external position which acts as an important dam towards the rising flood of public sector debt. Yet, unless Japan succedes in pushing the JPY down on a sustainble basis against its main competitors this dam will break sooner rather than later. Needless to say that if the BOJ decides to abide completely from the implied domestic pressure to continue funding deficit spending, S&Ps hands will be effectively forced. One thing is for sure as Societe Generale’s chief Japan economist Takuji Okubo is quoted by Bloomberg;
“The market should be braced for the BOJ keeping its current rate unchanged for a very, very long time”.
Indeed, and thus as the big talking point in the rest of the world remain fixed on exit strategies and the need (and peril) of fiscal consolidation Japan continues to be stuck in the mire. My own personal feeling is that it might very well be the BOJ leading the pack of global central banks rather than the other way around, but for now the fact that there is no news from Japan is exactly what makes it news.
By Thomas Knapp, on January 26th, 2010
Ilana Mercer concisely and elegantly makes a point that I’ve been harping on among big-L Libertarians for some time.
“Targeted tax credits” aren’t “incremental moves toward liberty,” they’re just social engineering — shifting the tax burden from those who spend their money the way bureaucrats decide they should spend it, and onto those who spend their money however they damn well please.
By Dan McLaughlin, on January 26th, 2010
Robert Shiller wrote a recent New York Times editorial, suggesting that the United States Government sell shares of the gross domestic product (GDP), similar to how corporations sell stocks. Mr. Shiller is obviously a very smart person. He is an economics professor at Yale University and authored various books on finance and the economy. He should know what he is talking about. So let’s look a little closer at his proposal.
People buy stocks of corporations because they have an underlying value. Yes, there are real assets that the paper certificate represents, but the fundamental value to an investor is the cash flow that is ultimately expected. In essence, a business sells shares in the present value of its anticipated future profits. The investor believes that the future dividends and capital appreciation will pay back the investment with an additional return. That is a very rational expectation. Those companies that perform well enough to have excess cash flow can reward the investors with dividends, or with capital growth and higher future earning potential if the money is plowed back into the business. Investors pay more for stocks of profitable ventures.
It is an obvious fact, one that is the foundation for investment in stocks, that the company owns productive assets and processes. It also owns all of the profits that those assets and processes earn. Because it owns them, it can also sell them to others. The business sells the right to future profits and cash flow in exchange for cash in the present.
Gross domestic product is a very different animal. It is a crude and rather arbitrary gauge of the productivity of all of the people in an economy. It is a measure of your wages, your business income, and your investment income added to that of everyone else. The assumption is that the higher the GDP, the more productive the population.
Mr. Shiller’s proposition is that, just as businesses sell shares of their earning potential, the government should sell shares of the GDP. They could issue what he calls “trills”, or trillionths of the GDP of the entire economy. The logic is that, if significant trill markets could be developed, it would be a vast new source of revenue for governments. Investors, like you, or like the government of China, would be able to count on a return from future economic growth, which would, presumably, mitigate the risk of investing in increasingly risky government debt alone.
There is one itsy-bitsy problem with your proposition, Mr. Shiller. The government doesn’t own GDP. It doesn’t own my salary, my business income or my investment returns, nor does it own anyone else’s. By selling a portion of GDP that it doesn’t own, it is stealing that productivity from the people. It is assuming that people are slaves of the state. It is nothing more than another clever stealth tax so that irresponsible politicians can spend more money buying votes and power.
Mr. Shiller, are you being dishonest, trying to scam the people of this country and any other country brazen enough consider it, or do you really not know what GDP is? Whether it is lying or incompetence, the result is the same. You are not telling the truth.
That is nothing new. Shiller is one of the large and growing breed of influential economists who don’t let truth or economic laws get in the way of shilling for politicians and big government. His 2009 book, “Animal Spirits”, was written in conjunction with George Akerlof, another smart, influential and arrogant economics professor, who’s idea of practical economics is to think of a problem in the world and then decide what he and government should do to fix it. The underlying assumption in the book is that economic cycles are caused by a mysterious psychological manifestation called “animal spirits.” According to them, it is the government’s job to direct those unruly spirits so they don’t get out of hand. Seeing that they have been actively directing those spirits for decades, we can see just how well that works out.
There really are generally accepted economic laws that even Shiller and Akerlof must recognize. True economics has helped to understand cause and effect relationships in societies. It is extremely unfortunate for the people of the world that the profession has been taken over by a bunch of scam artists. It is a black mark on the economics community that this proposal is treated with anything other than scorn and ridicule.
By Trace Mayer, on January 26th, 2010
The great monetary scientist Isaac Newton, who served as England’s Master of the Mint for 24 years, also did some ancillary work in physics. The laws of Newtonian physics are known by nearly everyone and are often used by analogy to apply logical reasoning in other fields. In this case, a few of these laws are particularly applicable in discussing the impending state of the economy in 2010 based on the massive momentum of 2009. 
LAWS OF MOTION
Stated in layman’s terms the three great Newtonian laws of motion are:
1. A body persists in a state of uniform motion or of rest unless acted upon by an external force.
2. Force equals mass times acceleration” or “F = ma.
3. To every action there is an equal and opposite reaction.
In regards to human action a body seems to stay at rest rather than work unless acted upon by some type of force. The force can be either internal such as hunger, the desire for self-actualization or anywhere in between on the Maslow hierarchy of needs or external such as a saber-tooth tiger, boss or customer. To sustain life the human body must consume fuel.
Capital is the means of production and the difference between production and consumption flows into or out of the store of capital. Out of this dynamic human society has attempted to efficiently allocate capital to produce more and this has resulted in institutions, large and small, where individuals work in the attempt to produce in order to meet their needs and wants. Of course, the great fiction of government is that everyone can live off someone else’s production.
MASSIVE FAILING INSTITUTIONS
The chains of habit are too weak to be felt until they are too strong to be broken. The mass of the economy times its speed in the Information Age has resulted in a tremendous force. But this mass has largely been built from the atomic level upon something which is inherently unstable and undefinable leading to chronic fingers of instability. What Is A Dollar?
The problem is debt and because psychology is changing, The Great Credit Contraction has begun and the rate at which the mass of the economy is evaporating is truly scary. While many attribute the ongoing financial crisis to the subprime mortgage mess, which is surely a contributing factor, the problem is much more systemic than a few defaulted mortgages.
UNEMPLOYMENT
But now the second wave of Option ARMs are getting ready to reset at the same time the Federal Housing Administration is requiring higher down payments. But where are these renters going to find a job when over 6.1M people have been unemployed for 27 weeks or more?
 And what about all the discouraged workers who are not included in the labor force because they have ceased looking for non-existant jobs? The Detroit News reported:
Despite an official unemployment rate of 27 percent, the real jobs problem in Detroit may be affecting half of the working-age population, thousands of whom either can’t find a job or are working fewer hours than they want …
Mayor Dave Bing recently raised eyebrows when he said what many already suspected: that the city’s official unemployment rate was as believable as Santa Claus. In Washington for a jobs forum earlier this month, he estimated it was “closer to 50 percent.”
With so many unemployed almost all of the States, with California being the poster child, are under severe financial pressure. For example, 40 state unemployment insurance funds are either broke or moving in that direction. While there are people starving in the chaos of Haiti about 37M Americans are now on welfare state food stamp programs, the rate of acceleration is expanding at about 20,000 per day and 1.4M Americans filed for personal bankruptcy in 2009. And this is a rosy situation considering the FRN$ is still the world’s reserve currency!
RETIREMENT CHAOS
The Baby Boomer generation has driven trends their entire lives because of their mass and acceleration. From Gerber baby food to the housing booms and busts caused by costumed government officials gallivanting in genocide which caused serious aberrations in demographics and are now getting increasingly explosive politically as the 2016 election will see 78M Baby Boomers pitted against 112M Millennials.
Social Security and Medicare are out of control kudzu that are strangling the economy. Additionally, virtually all pension funds in the United States are massively underfunded with epic games being played with the discount rate. As Forbes reported:
The GAO study found that states’ cumulative unfunded liabilities were $405 billion, while Novy-Marx and Rauh figure $3.2 trillion is a more accurate number.
All those tax eating costumed government officials are going to be extremely happy when they realize their retirements evaporated. But with unemployment benefits draining the capital of the economy like vampires while the productive members of society are punished via increased taxation and regulation the entrepreneur has either learned how to vanish or been turned to stone by the local Gorgons.
The result has been massive declines in State and local tax revenues. Even Federal corporate income tax receipts were down 55% for the fiscal year ended 30 September 2009.
KICK THE CAN
So like a classic Ponzi scam the answer has been to attempt to bailout the State and local governments via Federal resources.
For example, a chief bailout recipient Citigroup is accepting California IOUs indefinitely at face value; a surreptitious Federal bailout of California in a preemptive attempt to keep them from seceding monetarily by taking the next step of unconstitutionally decreeing the IOUs legal tender for all debts public and private. The Euro faces the same type of structural issues.
But if the States unconstitutionally decree FRN$ legal tender then why not their own little colored coupons? With 13% of US GDP a $30B deficit California should have nothing to worry about with a mere $30B+ cash-flow issue. After all, the California Dollar could have a bear on it; the Florida Dollar an alligator, the Texas Dollar a long-horned bull and the New York Dollar a vampire squid. They would be such fitting symbols!
And so the adjusted monetary base has exploded.
The FRN$ is destined to evaporate and the increase in debt is only hastening the rate.
 CONCLUSION
Despite propagandist cheerleaders on television the economy is in horrible condition. The Obama administration’s attempt to alter the speed and direction of the economy is textbook action for intentionally exacerbating the greater depression. Like in the recently released movie Daybreakers soon the starving vampire squids of Wall Street, Washington DC, State and local governments will run out of their productive human livestock and only a few understand their true predicament. They think they can ’save or create 3M jobs’. Seriously?
No one knows how this ginormous mess will play out. But the massive momentum of 2009 has largely shaped the direction for 2010. While the FRN$ may rise in the short term it is an extremely risky play because of how fast hyperinflation could strike the FRN$.
Of course, among the chief uses of silver and reasons to buy gold, platinum and lead are to keep you and your property safe from the costumed vampire tax eaters who will likely spring Obama’s retirement trap by nationalizing retirement accounts and forcing purchases of US debt to bolster Treasuries.
Using force or intimidation against innocent people or their legitimately acquired property is unfair, immoral and unsustainable. The current state of the economy and where it is headed is merely the result of cause and effect from economic law. George Mason, the father of the Bill of Rights, observed this principle hundreds of years ago in his writings contained on page 966 of The Papers Of George Mason:
As nations cannot be rewarded or punished in the next world, so they must be in this. By an inevitable chain of causes and effects, Providence punishes national sins by national calamities.
Please, leave your thoughts on how you think 2010 will play out.
DISCLOSURE: Long physical gold, silver and platinum with no interest the problematic SLV or GLD ETFs, the platinum ETFs or Treasuries.
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