Here comes Hank!

Hank Paulson today trots out his blueprint for revamping the regulation of the financial sector.  Highlights:  “SEC?  I’m sorry, I don’t know what you’re referring to.  We have no SEC here.”  The Fed gets promoted.  The FedGov is going to become a lot more agnostic about “bank” vs “investment bank” vs “hedge fund.”  This is going to be tricky, a lot of organizations that have never ever dreamed of being regulated by the FedGov are going to find a man in a cheap ill-fitting suit with a plastic briefcase rooting around in their underwear.

But, Hank’s proposals are DOA.  Nothing will happen that requires legislation until the new president is sworn in.

Obama’s Cooper Union Speech

Barack Obama delivered a speech earlier this week at Manhattan’s Cooper Union on the economy. Here’s how I boil it down to its essentials:

  1. the government has a duty to regulate the economy, regulation plays a healthy role in the economy
  2. lobbyists have hijacked recent changes in regulation of the financial sector, to our detriment
  3. here’s my long list of ways I am going to loot the treasury to give things to people I favor
  4. Nonetheless, I believe in PAYGO (*snicker*)
  5. Here are six principles which I believe should guide a revamping of regulation of the financial sector

Ok, so Enrico agrees with #1.  He might not have agreed with it in his exuberant Randian youth, but he has become more cynical, perhaps wiser, and sees that, if we are going to have nation states, the nation states are inevitably going to meddle in the markets, and whining about it and pretending it doesn’t happen is totally pointless.

Enrico can totally go along with #2.

I cast a highly jaundiced eye on #3.  Shit, we’re already completely broke, we don’t need to give away more stuff.

#4:  Give me a break.   I will give Obama a bit of pass on this one by not calling him a lying sack of shit, because I am going to construe that this is like the Treasury secretary (no matter what party, no matter who he is) saying he believes in a strong dollar.  PAYGO would be a good start, for sure, but we need to do A LITTLE BIT MORE THAN THAT and there is absolutely no way to reconcile #3 with #4.

On #5, I think these are pretty good principles.  If the Fed is going to lend money to the ibanks, it should certainly get the opportunity to regulate them.   As I recall, one of the big arguments for repealing Glass-Steagal was that the eurobanks were going to kick the asses of our banks if we didn’t repeal.  At the time, I thought that was the correct view, but we should have completely revamped the regulatory structure then.  Ah, well, live and learn!

I don’t think I am smart enough to come up with a regulatory regime that would have moderated the toxic derivatives syndrome.  I won’t claim it is impossible, since I would be making that claim only because I don’t personally know how to do it, but I will say, with some confidence, that the legislation will always lag behind the financial engineers.  Writing a law which bans the specific excesses that killed Bear Stearns is mostly pointless.

But, I am enthusiastic about a redo on the regs.  Certainly we can do better.

I really think, and I will advance this argument in some detail in the soon-to-be-posted “The Printing Press Part II,” that the repeal of Glass-Steagal, without corresponding regulatory enhancements, leads in a direct path to the housing bubble, to the desperate marketing of interest-only adjustable rate mortages, to the subprime lending debacle, to the wildly poisonous growth in the money supply, and to the collapse of the dollar.

Unfortunately, the American President cannot really make a significant impact on this problem now.  We need the central bankers to rein in the growth in the money supply, to give us the nasty medicine, to force the great  unwinding, to allow the inflated assets to be marked down and to allow the market to find a clearing price for all the stranded securities and assets.   Commanding the tide not to come in just makes you look foolish.

Obama’s speech is predictable in some negative ways, and reflects thoughtfulness in others.  I give it 6 out of 1o rotten tomatoes.

The Printing Press Part I

Enrico has probably been guilty of the excessive use of colorful language about the Fed’s printing press.

Of course, the Fed does not literally print currency. Only the US Treasury can do that.

As all conspiracy theorists know, the Fed is actually a private organization.

Well, the conspiracy theorists are full of crap. The Federal Reserve Bank is a government agency, authorized by an act of Congress, whose operation is controlled by federal law. The Fed typically makes a hell of a profit in its operations, but, before you grab your pitchfork and descend on the nearest convenient Greek Revival edifice, let me reassure you, the Fed turns all its profits over to the Treasury.

The conspiracy theorists base their claim that the Fed is a private organization on the fact that the banks own stock in it. This stock ownership is a vestigal remnant of the arrangement whereby banks are required to pony up capital to the Fed as part of reserve requirements imposed by law, delegated to the Fed. The stock ownership has nothing to do with actual ownership, much less control, of the Fed.

The Fed’s mission is to manipulate the money supply to maximize employment while keeping inflation under control. Its mission has nothing whatsoever to do with protecting the dollar, pumping up the dollar, or anything in the realm of dollar exchange rates vs other currencies.

“Money supply” is a little bit of a slippery concept. In the jargon, there are four categories of money. The first, called M0, is literally currency and coins. The second, called M1, is M0 plus balances in checking accounts. M2 is M1 plus savings accounts. M3 is M2 plus everything else, basically all dollar-denominated relatively liquid money instruments. This category includes things like eurodollar deposits, which are dollar-denominated accounts in European banks, accumulated by companies trading with the US, and repurchase agreements, which are kind of like money market funds for huge banks.

The Fed has two main tools for manipulating the money supply: the discount rate, and open market action.

The discount rate is the interest rate at which banks are permitted to borrow from the Fed. Banks borrow from the Fed to get the money they lend to their customers, and to meet their reserve requirements. Banks are required to actually have in their possession 10% of the demand deposits their customers have deposited with them. In other words, banks are permitted to lend out 90% of the money deposited with them as demand deposits. The reserve requirement for time deposits is zero–banks are permitted to lend 100% of their time deposits.

The spread between the discount rate and the prevailing rate charged to customers on loans is the basic gross profit margin for banks. So, right now, the discount rate is 2.5%, and let’s say the prevailing loan rate is somewhere around 5.25%, which happens to be the current prime rate. So, the bank’s basic gross profit margin in 2.75%. Small, you might say, but lordy lordy, do they ever make it up on volume!

So, what on earth does the discount rate have to do with the money supply? The answer: the real action in money creation is through the banks lending money. Bank lending is highly stimulated by a bigger spread between the discount rate and the prevailing market rate for loans. Let’s look at how bank loans create money.

Let’s say the Skank of America borrows $10k from the Fed at the discount window. Then the Skank of America lends $9k to the learned counselor. The learned counselor buys a car for $9k from Tilman Fertitta, yet another porsche in panties for the LC, and Tilman, who is a bit strapped for cash at the moment, deposits the $9k in a local branch of JP Mogen David. JP Mogen David lends $8.1k to Dr. Virus, who buys a shiny new theremin with the loan, from Paddy O’Reilly. Paddy O’Reilly deposits the $8.1k in DiscHoover Bank. DiscHoover Bank loans $7.3k to Enrico, to buy a BeerAVan, a mobile beer brewery built on the platform of a pink Winnebago.

So, the original $10k from the Fed’s discount window has now been used to buy $24.4k worth of goods. The daisy chain of bank loans and deposits has created $14.4k of new money out of thin air.

Open Market action is when the Fed buys or sells treasury securities from its member banks. If the Fed buys treasury securities, the selling bank gets more reserves, in payment for the securities, and therefore can lend more money, amping up the money supply through the mechanism described above. If the Fed sells treasury securities from its member banks, the buying bank has less reserves, reducing its ability to lend money.

Now here is the part of this that I know is going to be hard to believe: when the Fed buys treasury securities from a member bank, it makes an electronic CREDIT entry increasing the selling bank’s reserve balance by the appropriate amount. THERE IS NO CORRESPONDING DEBIT ENTRY ANYWHERE! Do you have the chills? The Fed just created money out of absolutely nothing.

The same principle holds when the Fed sells securities. The selling bank gets its reserve balanced DEBITED by the appropriate amount, and there is no corresponding CREDIT entry anywhere. The Fed just burned some money.

I know this is very hard to swallow. Read it for yourself, on page 7 of this document.

So, the Fed doesn’t need an actual printing press. The eventual recipient of the invented money is perfectly free to go to any bank and demand paper currency, and the US Treasury makes sure all the time that there is plenty of paper for all comers.

Look for a few more editions of this post, dealing with the late lamented Glass-Steagal Act, and the Fed’s recent actions regarding mortgage-backed securities, and the implications of this for the money supply, oh, and I guess I’d best pay homage to the quantity theory of money (everyone say “amen”).

Carville says one or both of the Clintons is Jesus Christ

Clinton Gargoyle-in-Chief James Carville says that one or both of the Clinton is/are Jesus Christ.

I think Carville better return to his second career playing Gollum in LOTR movies. He is not helping his diabolical master and mistress with this commentary.

A few years, Carville was hired to record some radio spots for a company selling some kind of GPS service or device. I wrote the company and told them that I inferred that they were unable to get Jeffrey Dahmer to front for their product, and so they had hired the next best person. I told them that the impression I got of their company was that the company was profoundly evil, and would disregard laws, morality, ethics, common decency and even the unspoken compact between men not to get unnecessarily close to one another at a wall of urinals.

They wrote me back and thanked me for my input.


Jimmy Cramer is an entertainer, not a financial advisor. He is getting a lot of ribbing about this clip above, but I have to come to Jimmy’s defense a little bit in this specific case.

In this clip, he is NOT saying that holders of Bear’s common stock are going to be fine, he is saying that Bear’s CUSTOMERS, particularly its RETAIL customers are going to be fine. He is saying that there is no reason to flock to Bear’s door to withdraw your funds.

Of course, he was right about that. So lay off him. There’s plenty of other reasons to ridicule him.

My fellow Ephs, take note of EphBabe Erin Burnett coming on at the end this clip to report the summary execution of Bear.

I don’t know if anyone has already pitched this, but I hereby make a public offer to Jimmy Cramer’s peeps to develop a concept and write some scripts for a kid’s animated TV show, targeted notionally at Nick, based on Jimmy’s manic CNBC persona. My twelve old son is apt to remark “SellSellSellSellSellSell!” I won’t disclose the whole concept here, but Jimmy, have your people call my people and let’s take a meeting.

Global Cooling

Here’s an article from an Australian newspaper, which lays out the uncontroversial fact that, since 1998, global average temperatures have decreased.

As I have argued previously, it is pretty obvious from the scientific data that the sun’s activity, within its normal range of variation, is a far more significant factor in the temperature of the earth than atmospheric concentrations of CO2. I really cannot imagine any rational person contradicting this statement.

Global warming enthusiasts argue that the earth’s recent cooling cycle is a product of other countervailing natural forces, and that, were it not for the massive quantities of CO2 mankind is dumping into the atmosphere, the earth right now would be cooler than it is, presumably by about one degree fahrenheit, or so.

It seems to me that this response reinforces the argument I make, that other forces, some known, others possibly unknown or poorly understood, are bigger factors in the earth’s temperature than CO2 levels in the atmosphere.

The mechanism by which CO2 contributes to warming is limited to a certain spectrum of reflected infrared radiation. We have long since passed the point of CO2 concentrations where there is no more reflected infrared radiation in the specific spectrum to be additionally trapped. This is a partial explanation for that fact, although CO2 levels have continued to climb rather dramatically since 1998, temperatures have not continued to climb. I suspect that this is a MINOR part of the explanation, however, given the fact that CO2 has to compete with a giant (what an inadequate term!) burning sphere of hydrogen for its influence over our climate.

Despite the fact that CO2 doesn’t pose the specific threat of sending us into a catastrophic warming cycle, there are quite sufficient other reasons for putting a stop to the massive emissions of CO2 into the atmosphere. For one, and this would really be quite sufficient by itself, the oceans absorb CO2 from the atmosphere. As they absorb more and more CO2, the oceans become more acidic. This is not a good thing for our current complement of ocean life, and there is a very real potential for this to be highly disruptive to the global foodchain.

For two, and this one is also quite sufficient all by itself, we in the United States are hocking our wealth and our future, and compromising our security, by buying hydrocarbons from our enemies. The dollar would probably not be plummetting as it is were it not for our addiction to foreign oil. We’ve got to cut this out.

Genetic Engineering to make fuel

Craig Venter gave a talk recently at the TED conference on his work on digitally engineering life. He’s working on engineering an organism which converts CO2 into an ethanol-like fuel.

Venter is a genius. He’s the man behind Celera and Human Genome Sciences. Back in the 90s, there was a huge government-backed program to map the human genome. The official government position was that this a difficult, expensive project, and that it would probably take a decade or so to complete, all the while consuming the efforts of thousands of scientists. Venter believed that the project could be done much more rapidly and less expensively, using whole genome shotgun sequencing, a riskier approach involving blasting the human DNA into tiny bits and attacking the analysis on a massively parallel basis. The government program said his approach was bullshit, and there was a falling out. Venter went off on his own, raised capital, and completed the analysis in about 2 years and at a fraction of the cost of the government program.

The science Venter describes is astounding, powerful beyond my imagination. Making fuel will certainly turn out to be the least interesting application.

But making fuel for humanity is a very significant scale challenge. The scale of production needed to produce meaningful quantities of fuel is hard to conceive. The world produces (and essentially consumes) about 80 million barrels of oil per day. On an annual basis, this is enough oil to cover the state of Massachussetts 1.5 feet deep in crude oil.

The corn ethanol program is insane, nearly criminal. Making ethanol uses more energy than is contained in the ethanol. The only reason there is ethanol being made from corn is that the government subsidizes it to a scandalous level.

Not all ethanol is bad in this way. Brazil derives more than half of its fuel for transport from ethanol, but the ethanol is produced from other feedstocks, in a process which is energy profitable. But it is virtually impossible for even the most efficient, most feedstock-versatile ethanol fermentation process to ever make a significant dent in the world’s demand for liquid fuels. We just cannot afford to dedicate the arable land we have to making fuel at the scale the world needs.

I think Venter’s science may still be 10 years away from a place where it can be used to make fuels at commercial scale. But there are other companies exploring similar, though not as amibitious, genetic engineering approaches which have the potential to hugely increase the efficiency of the conversion of feedstocks into fuels. LS9 and Amyris are two of the most promising, well-funded companies, both based in Silicon Valley.

This is an area well worth watching. We are on the verge of a revolution in genetic engineering that will surpass the industrial revolution in its impact on humanity.

Barry Bonds for Fed Chief: the RTC on ‘roids

Well, here’s a sensible idea, or at least, it’s sensible in comparison to the gasoline-on-bonfire discount rate cuts Bernanke has trotted out so far.

I heard Jimmy Rogers say on Bloomberg the other day that, pretty soon, Helicopter Ben is going to be flying around the country collecting car payments, picking up mortgage checks, getting rent checks.  I think Jimmy could say that the sun’s going to rise tomorrow, and the way he says it would make you dismiss him as a paranoid maniac.  But here it is.

Where we are now, the central banks have to get these adulterated alleged securities off the banks’ balance sheets.  This is a no brainer.  It will be expensive, but the alternative is complete and unmitigated disaster.