The Trump rally has stocks at all-time
highs. The VIX (which reflects the volatility of the
S&P 500) is at 10-year lows. The headline unemployment rate is 4.8%.
Everything must be A-OK in the U.S of A.
Head Keynesian Janet Yellen, the Fed’s
Chair, may be sleeping soundly, as she and her Ph.D. monetary mandarins
continue to gin up a robust wealth effect. At 70 years old, described by
Danielle DiMartino Booth as “Bernanke in lipstick and a skirt,” Yellen is far
from retired, pulling down $201,700 per year to push the buttons and pull the
chains of monetary policy.
The
typical retiree, however, not so ably employed as Ms. Yellen and not wanting to
play in Wall Street’s big casino to provide sustenance in their golden years,
are suffering under the Federal Reserve’s financial repression.
Ms.
DiMartino Booth provides us the book we’ve been waiting for: a view from inside
America’s central bank which doesn’t paint the Ph.D. army as heroic for the
simple skill of money creation. “An insider’s unflinching exposé of the toxic
culture within the Federal Reserve,” says Amazon where all 17 reviews so far
are 5 stars.
Yes,
the author has written a dandy book chronicling her jump from Wall Street to
financial columnist and then her career serving at the Dallas Federal Reserve
under governor Richard Fischer. DiMartino Booth is not a Ph.D. and neither is
Fischer, so those two relied on actual market data to determine what the
economy was doing as the housing market boomed then busted. What a concept.
However, in a Ph.D. la-la land she was either criticized or ignored for
using actual data that wasn’t seasonally adjusted or manipulated in some other way
to make the real economist’s benzentine formulas work out.
The Ph.D.’s looked down their pointy noses
at Fischer and DiMartino Booth, at the same time both were well respected on
the Street for their good sense. Meanwhile, as the market melted down
Greenspan, Bernanke and Yellen did their best Sergeant Schultz impression, “I
see nothing!”
Yellen
would eventually admit, “I did not see and did not appreciate what the risks
were with securitization, the credit rating agencies, the shadow banking
system, the SIVs–I didn’t see any of that coming until it happened.”
Yellen was so blind to what was happening that,
as DiMartino Booth relates, the San Francisco Fed, led by Ms. Yellen, was
offering loans to Indymac in 2008 as the huge thrift was circling the drain.
Even the Office of Thrift Supervision (OTS), not known as the toughest of
regulators, had downgraded the California institution.
Besides Fed head and Ph.D. bashing, which
the author excels at, the most important chapter in Fed Up is Chapter 11 entitled “Slapped in
the Face by the Invisible Hand.” This is when Zoltan Pozsar appears. Pozsar is
an another non-PhD who authored a paper “The Rise and Fall of the Shadow Banking System.”
As DiMartino Booth explains, it was
the shadow banking system that caused the ‘08 meltdown. PIMCO’s Paul McCulley
actually coined the phrase describing, “the whole alphabet soup of levered up
non-bank investment conduits, vehicles, and structures.”
All this off-balance sheet (OBS)
maneuvering was driven by the 1988 Basel I Accord. Basel, I required
banks to de-lever, so, assets and liabilities needed to be hidden. “Financial
firms began to employ entities called structured investment vehicles (SIV) and
conduits to hold these assets OBS,” writes DiMartino Booth. As the housing
market boomed, mortgages of increasingly dubious quality were the assets these
instruments contained.
Nobody
at the Fed, and very few anywhere else understood shadow banking. Simple
fractionalized banking, as explained by Murray Rothbard in The Mystery of Banking is hard
enough. Shadow banking adds to the complexity exponentially.
All of these OBS were levered from 15 to 1,
or in some cases to infinity. The need for more products was met with
enterprising investment bankers creating a massive supply of synthetic
CDOs. This alphabet soap was connected to the repo system (overnight
loans to and from banks and large corporations), the grease that allows the
cogs in the banking system machine to operate.
Of course, for those who have read or
watched “The Big Short” the way to bet “don’t pass” at this huge craps game was
with credit default swaps.
In the dark room that was (and is) the
shadow banking system there is no information. Assets are pledged multiple
times (or to use fancy words: hypothecated and re-hypothecated). The author’s
example of Barney making a loan and Aunt Mabel’s car is elegant and brilliant.
So how big and complex is the shadow
banking system? “Zoltan sent me a huge four-by-three-foot laminated color copy
of his [shadow banking] diagram in a tube,” DiMartino Booth writes. “Even at
that size, which took up half my office wall at the Fed, it was hard to read
the tiny fonts on various pieces of the puzzle.”
Chapter 11, by itself, is worth the price
of the book and should be read multiple times to understand what happened in
2008. So Dodd-Frank probably cleaned up all this mess, right? Not
hardly. The Economist reports, “The Financial
Stability Board, an international watchdog estimates that globally, the
informal lending sector serviced assets worth $80 trillion in 2014 up from $26
trillion more than a decade earlier.” So the next crash will be that much
larger.
With a title like Fed Up the reader might think DiMartino
Booth wants to throw in with Ron Paul and his book End the Fed. Sadly, no. Our heroine
was bothered by protesting retirees outside her window and thought “Damn Ron
Paul” and his book, she writes. “America is not a banana republic. It needs a
strong and independent central bank.”
Well, with all due respect Ms. DiMartino
Booth, the evidence is in your book. A government with a central bank expanding
its balance sheet by five and a half times and refusing to shrink it,
perverting capital markets with zero to near zero interest rates for nearly a
decade, and enabling the national debt to soar to $20 trillion, is, in fact, a
banana republic.
Doug French [send him mail] writes from Las Vegas and is
the author of three books; Early Speculative Bubbles and Increases in the
Supply of Money, The Failure of Common Knowledge, and Walk Away: The Rise and
Fall of the Home-Ownership Myth. He is the former president of the Ludwig von
Mises Institute in Auburn, Alabama.
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