Wall Street's Bailout Hustle

Matt Taibbi

Goldman Sachs and other big banks aren't just pocketing the trillions we gave them to rescue the economy - they're re-creating the conditions for another crash

On January 21st, Lloyd Blankfein left a peculiar voicemail message on the work phones of his employees at Goldman Sachs. Fast becoming America's pre-eminent Marvel Comics supervillain, the CEO used the call to deploy his secret weapon: a pair of giant, nuclear-powered testicles. In his message, Blankfein addressed his plan to pay out gigantic year-end bonuses amid widespread controversy over Goldman's role in precipitating the global financial crisis.

The bank had already set aside a tidy $16.2 billion for salaries and bonuses - meaning that Goldman employees were each set to take home an average of $498,246, a number roughly commensurate with what they received during the bubble years. Still, the troops were worried: There were rumors that Dr. Ballsachs, bowing to political pressure, might be forced to scale the number back. After all, the country was broke, 14.8 million Americans were stranded on the unemployment line, and Barack Obama and the Democrats were trying to recover the populist high ground after their bitch-whipping in Massachusetts by calling for a "bailout tax" on banks. Maybe this wasn't the right time for Goldman to be throwing its annual Roman bonus orgy.

Not to worry, Blankfein reassured employees. "In a year that proved to have no shortage of story lines," he said, "I believe very strongly that performance is the ultimate narrative."

Translation: We made a shitload of money last year because we're so amazing at our jobs, so fuck all those people who want us to reduce our bonuses.

Goldman wasn't alone. The nation's six largest banks - all committed to this balls-out, I drink your milkshake! strategy of flagrantly gorging themselves as America goes hungry - set aside a whopping $140 billion for executive compensation last year, a sum only slightly less than the $164 billion they paid themselves in the pre-crash year of 2007. In a gesture of self-sacrifice, Blankfein himself took a humiliatingly low bonus of $9 million, less than the 2009 pay of elephantine New York Knicks washout Eddy Curry. But in reality, not much had changed. "What is the state of our moral being when Lloyd Blankfein taking a $9 million bonus is viewed as this great act of contrition, when every penny of it was a direct transfer from the taxpayer?" asks Eliot Spitzer, who tried to hold Wall Street accountable during his own ill-fated stint as governor of New York.

Beyond a few such bleats of outrage, however, the huge payout was met, by and large, with a collective sigh of resignation. Because beneath America's populist veneer, on a more subtle strata of the national psyche, there remains a strong temptation to not really give a shit. The rich, after all, have always made way too much money; what's the difference if some fat cat in New York pockets $20 million instead of $10 million?

The only reason such apathy exists, however, is because there's still a widespread misunderstanding of how exactly Wall Street "earns" its money, with emphasis on the quotation marks around "earns." The question everyone should be asking, as one bailout recipient after another posts massive profits - Goldman reported $13.4 billion in profits last year, after paying out that $16.2 billion in bonuses and compensation - is this: In an economy as horrible as ours, with every factory town between New York and Los Angeles looking like those hollowed-out ghost ships we see on History Channel documentaries like Shipwrecks of the Great Lakes, where in the hell did Wall Street's eye-popping profits come from, exactly? Did Goldman go from bailout city to $13.4 billion in the black because, as Blankfein suggests, its "performance" was just that awesome? A year and a half after they were minutes away from bankruptcy, how are these assholes not only back on their feet again, but hauling in bonuses at the same rate they were during the bubble?

The answer to that question is basically twofold: They raped the taxpayer, and they raped their clients.

The bottom line is that banks like Goldman have learned absolutely nothing from the global economic meltdown. In fact, they're back conniving and playing speculative long shots in force - only this time with the full financial support of the U.S. government. In the process, they're rapidly re-creating the conditions for another crash, with the same actors once again playing the same crazy games of financial chicken with the same toxic assets as before.

That's why this bonus business isn't merely a matter of getting upset about whether or not Lloyd Blankfein buys himself one tropical island or two on his next birthday. The reality is that the post-bailout era in which Goldman thrived has turned out to be a chaotic frenzy of high-stakes con-artistry, with taxpayers and clients bilked out of billions using a dizzying array of old-school hustles that, but for their ponderous complexity, would have fit well in slick grifter movies like The Sting and Matchstick Men. There's even a term in con-man lingo for what some of the banks are doing right now, with all their cosmetic gestures of scaling back bonuses and giving to charities. In the grifter world, calming down a mark so he doesn't call the cops is known as the "Cool Off."

To appreciate how all of these (sometimes brilliant) schemes work is to understand the difference between earning money and taking scores, and to realize that the profits these banks are posting don't so much represent national growth and recovery, but something closer to the losses one would report after a theft or a car crash. Many Americans instinctively understand this to be true - but, much like when your wife does it with your 300-pound plumber in the kids' playroom, knowing it and actually watching the whole scene from start to finish are two very different things. In that spirit, a brief history of the best 18 months of grifting this country has ever seen:

CON #1 The Swoop and Squat

By now, most people who have followed the financial crisis know that the bailout of AIG was actually a bailout of AIG's "counterparties" - the big banks like Goldman to whom the insurance giant owed billions when it went belly up.

What is less understood is that the bailout of AIG counter-parties like Goldman and Société Générale, a French bank, actually began before the collapse of AIG, before the Federal Reserve paid them so much as a dollar. Nor is it understood that these counterparties actually accelerated the wreck of AIG in what was, ironically, something very like the old insurance scam known as "Swoop and Squat," in which a target car is trapped between two perpetrator vehicles and wrecked, with the mark in the game being the target's insurance company - in this case, the government.

This may sound far-fetched, but the financial crisis of 2008 was very much caused by a perverse series of legal incentives that often made failed investments worth more than thriving ones. Our economy was like a town where everyone has juicy insurance policies on their neighbors' cars and houses. In such a town, the driving will be suspiciously bad, and there will be a lot of fires.

AIG was the ultimate example of this dynamic. At the height of the housing boom, Goldman was selling billions in bundled mortgage-backed securities - often toxic crap of the no-money-down, no-identification-needed variety of home loan - to various institutional suckers like pensions and insurance companies, who frequently thought they were buying investment-grade instruments. At the same time, in a glaring example of the perverse incentives that existed and still exist, Goldman was also betting against those same sorts of securities - a practice that one government investigator compared to "selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars."

Goldman often "insured" some of this garbage with AIG, using a virtually unregulated form of pseudo-insurance called credit-default swaps. Thanks in large part to deregulation pushed by Bob Rubin, former chairman of Goldman, and Treasury secretary under Bill Clinton, AIG wasn't required to actually have the capital to pay off the deals. As a result, banks like Goldman bought more than $440 billion worth of this bogus insurance from AIG, a huge blind bet that the taxpayer ended up having to eat.

Thus, when the housing bubble went crazy, Goldman made money coming and going. They made money selling the crap mortgages, and they made money by collecting on the bogus insurance from AIG when the crap mortgages flopped.

Still, the trick for Goldman was: how to collect the insurance money. As AIG headed into a tailspin that fateful summer of 2008, it looked like the beleaguered firm wasn't going to have the money to pay off the bogus insurance. So Goldman and other banks began demanding that AIG provide them with cash collateral. In the 15 months leading up to the collapse of AIG, Goldman received $5.9 billion in collateral. Société Générale, a bank holding lots of mortgage-backed crap originally underwritten by Goldman, received $5.5 billion. These collateral demands squeezing AIG from two sides were the "Swoop and Squat" that ultimately crashed the firm. "It put the company into a liquidity crisis," says Eric Dinallo, who was intimately involved in the AIG bailout as head of the New York State Insurance Department

It was a brilliant move. When a company like AIG is about to die, it isn't supposed to hand over big hunks of assets to a single creditor like Goldman; it's supposed to equitably distribute whatever assets it has left among all its creditors. Had AIG gone bankrupt, Goldman would have likely lost much of the $5.9 billion that it pocketed as collateral. "Any bankruptcy court that saw those collateral payments would have declined that transaction as a fraudulent conveyance," says Barry Ritholtz, the author of Bailout Nation. Instead, Goldman and the other counterparties got their money out in advance - putting a torch to what was left of AIG. Fans of the movie Goodfellas will recall Henry Hill and Tommy DeVito taking the same approach to the Bamboo Lounge nightclub they'd been gouging. Roll the Ray Liotta narration: "Finally, when there's nothing left, when you can't borrow another buck . . . you bust the joint out. You light a match."

And why not? After all, according to the terms of the bailout deal struck when AIG was taken over by the state in September 2008, Goldman was paid 100 cents on the dollar on an additional $12.9 billion it was owed by AIG - again, money it almost certainly would not have seen a fraction of had AIG proceeded to a normal bankruptcy. Along with the collateral it pocketed, that's $19 billion in pure cash that Goldman would not have "earned" without massive state intervention. How's that $13.4 billion in 2009 profits looking now? And that doesn't even include the direct bailouts of Goldman Sachs and other big banks, which began in earnest after the collapse of AIG.

CON #2 The Dollar Store

In the usual "DollarStore" or "Big Store" scam - popularized in movies like The Sting - a huge cast of con artists is hired to create a whole fake environment into which the unsuspecting mark walks and gets robbed over and over again. A warehouse is converted into a makeshift casino or off-track betting parlor, the fool walks in with money, leaves without it.

The two key elements to the Dollar Store scam are the whiz-bang theatrical redecorating job and the fact that everyone is in on it except the mark. In this case, a pair of investment banks were dressed up to look like commercial banks overnight, and it was the taxpayer who walked in and lost his shirt, confused by the appearance of what looked like real Federal Reserve officials minding the store.

Less than a week after the AIG bailout, Goldman and another investment bank, Morgan Stanley, applied for, and received, federal permission to become bank holding companies - a move that would make them eligible for much greater federal support. The stock prices of both firms were cratering, and there was talk that either or both might go the way of Lehman Brothers, another once-mighty investment bank that just a week earlier had disappeared from the face of the earth under the weight of its toxic assets. By law, a five-day waiting period was required for such a conversion - but the two banks got them overnight, with final approval actually coming only five days after the AIG bailout.

Why did they need those federal bank charters? This question is the key to understanding the entire bailout era - because this Dollar Store scam was the big one. Institutions that were, in reality, high-risk gambling houses were allowed to masquerade as conservative commercial banks. As a result of this new designation, they were given access to a virtually endless tap of "free money" by unsuspecting taxpayers. The $10 billion that Goldman received under the better-known TARP bailout was chump change in comparison to the smorgasbord of direct and indirect aid it qualified for as a commercial bank.

When Goldman Sachs and Morgan Stanley got their federal bank charters, they joined Bank of America, Citigroup, J.P. Morgan Chase and the other banking titans who could go to the Fed and borrow massive amounts of money at interest rates that, thanks to the aggressive rate-cutting policies of Fed chief Ben Bernanke during the crisis, soon sank to zero percent. The ability to go to the Fed and borrow big at next to no interest was what saved Goldman, Morgan Stanley and other banks from death in the fall of 2008. "They had no other way to raise capital at that moment, meaning they were on the brink of insolvency," says Nomi Prins, a former managing director at Goldman Sachs. "The Fed was the only shot."

In fact, the Fed became not just a source of emergency borrowing that enabled Goldman and Morgan Stanley to stave off disaster - it became a source of long-term guaranteed income. Borrowing at zero percent interest, banks like Goldman now had virtually infinite ways to make money. In one of the most common maneuvers, they simply took the money they borrowed from the government at zero percent and lent it back to the government by buying Treasury bills that paid interest of three or four percent. It was basically a license to print money - no different than attaching an ATM to the side of the Federal Reserve.

"You're borrowing at zero, putting it out there at two or three percent, with hundreds of billions of dollars - man, you can make a lot of money that way," says the manager of one prominent hedge fund. "It's free money." Which goes a long way to explaining Goldman's enormous profits last year. But all that free money was amplified by another scam:

CON #3 The Pig in the Poke

At one point or another, pretty much everyone who takes drugs has been burned by this one, also known as the "Rocks in the Box" scam or, in its more elaborate variations, the "Jamaican Switch." Someone sells you what looks like an eightball of coke in a baggie, you get home and, you dumbass, it's baby powder.

The scam's name comes from the Middle Ages, when some fool would be sold a bound and gagged pig that he would see being put into a bag; he'd miss the switch, then get home and find a tied-up cat in there instead. Hence the expression "Don't let the cat out of the bag."

The "Pig in the Poke" scam is another key to the entire bailout era. After the crash of the housing bubble - the largest asset bubble in history - the economy was suddenly flooded with securities backed by failing or near-failing home loans. In the cleanup phase after that bubble burst, the whole game was to get taxpayers, clients and shareholders to buy these worthless cats, but at pig prices.

One of the first times we saw the scam appear was in September 2008, right around the time that AIG was imploding. That was when the Fed changed some of its collateral rules, meaning banks that could once borrow only against sound collateral, like Treasury bills or AAA-rated corporate bonds, could now borrow against pretty much anything - including some of the mortgage-backed sewage that got us into this mess in the first place. In other words, banks that once had to show a real pig to borrow from the Fed could now show up with a cat and get pig money. "All of a sudden, banks were allowed to post absolute shit to the Fed's balance sheet," says the manager of the prominent hedge fund.

The Fed spelled it out on September 14th, 2008, when it changed the collateral rules for one of its first bailout facilities - the Primary Dealer Credit Facility, or PDCF. The Fed's own write-up described the changes: "With the Fed's action, all the kinds of collateral then in use . . . including non-investment-grade securities and equities . . . became eligible for pledge in the PDCF."

Translation: We now accept cats.

The Pig in the Poke also came into play in April of last year, when Congress pushed a little-known agency called the Financial Accounting Standards Board, or FASB, to change the so-called "mark-to-market" accounting rules. Until this rule change, banks had to assign a real-market price to all of their assets. If they had a balance sheet full of securities they had bought at $3 that were now only worth $1, they had to figure their year-end accounting using that $1 value. In other words, if you were the dope who bought a cat instead of a pig, you couldn't invite your shareholders to a slate of pork dinners come year-end accounting time.

But last April, FASB changed all that. From now on, it announced, banks could avoid reporting losses on some of their crappy cat investments simply by declaring that they would "more likely than not" hold on to them until they recovered their pig value. In short, the banks didn't even have to actually hold on to the toxic shit they owned - they just had to sort of promise to hold on to it.

That's why the "profit" numbers of a lot of these banks are really a joke. In many cases, we have absolutely no idea how many cats are in their proverbial bag. What they call "profits" might really be profits, only minus undeclared millions or billions in losses.

"They're hiding all this stuff from their shareholders," says Ritholtz, who was disgusted that the banks lobbied for the rule changes. "Now, suddenly banks that were happy to mark to market on the way up don't have to mark to market on the way down."

CON #4 The Rumanian Box

One of the great innovations of Victor Lustig, the legendary Depression-era con man who wrote the famous "Ten Commandments for Con Men," was a thing called the "Rumanian Box." This was a little machine that a mark would put a blank piece of paper into, only to see real currency come out the other side. The brilliant Lustig sold this Rumanian Box over and over again for vast sums - but he's been outdone by the modern barons of Wall Street, who managed to get themselves a real Rumanian Box.

How they accomplished this is a story that by itself highlights the challenge of placing this era in any kind of historical context of known financial crime. What the banks did was something that was never - and never could have been - thought of before. They took so much money from the government, and then did so little with it, that the state was forced to start printing new cash to throw at them. Even the great Lustig in his wildest, horniest dreams could never have dreamed up this one.

The setup: By early 2009, the banks had already replenished themselves with billions if not trillions in bailout money. It wasn't just the $700 billion in TARP cash, the free money provided by the Fed, and the untold losses obscured by accounting tricks. Another new rule allowed banks to collect interest on the cash they were required by law to keep in reserve accounts at the Fed - meaning the state was now compensating the banks simply for guaranteeing their own solvency. And a new federal operation called the Temporary Liquidity Guarantee Program let insolvent and near-insolvent banks dispense with their deservedly ruined credit profiles and borrow on a clean slate, with FDIC backing. Goldman borrowed $29 billion on the government's good name, J.P. Morgan Chase $38 billion, and Bank of America $44 billion. "TLGP," says Prins, the former Goldman manager, "was a big one."

Collectively, all this largesse was worth trillions. The idea behind the flood of money, from the government's standpoint, was to spark a national recovery: We refill the banks' balance sheets, and they, in turn, start to lend money again, recharging the economy and producing jobs. "The banks were fast approaching insolvency," says Rep. Paul Kanjorski, a vocal critic of Wall Street who nevertheless defends the initial decision to bail out the banks. "It was vitally important that we recapitalize these institutions."

But here's the thing. Despite all these trillions in government rescues, despite the Fed slashing interest rates down to nothing and showering the banks with mountains of guarantees, Goldman and its friends had still not jump-started lending again by the first quarter of 2009. That's where those nuclear-powered balls of Lloyd Blankfein came into play, as Goldman and other banks basically threatened to pick up their bailout billions and go home if the government didn't fork over more cash - a lot more. "Even if the Fed could make interest rates negative, that wouldn't necessarily help," warned Goldman's chief domestic economist, Jan Hatzius. "We're in a deep recession mainly because the private sector, for a variety of reasons, has decided to save a lot more."

Translation: You can lower interest rates all you want, but we're still not fucking lending the bailout money to anyone in this economy. Until the government agreed to hand over even more goodies, the banks opted to join the rest of the "private sector" and "save" the taxpayer aid they had received - in the form of bonuses and compensation.

The ploy worked. In March of last year, the Fed sharply expanded a radical new program called quantitative easing, which effectively operated as a real-live Rumanian Box. The government put stacks of paper in one side, and out came $1.2 trillion "real" dollars.

The government used some of that freshly printed money to prop itself up by purchasing Treasury bonds - a desperation move, since Washington's demand for cash was so great post-Clusterfuck '08 that even the Chinese couldn't buy U.S. debt fast enough to keep America afloat. But the Fed used most of the new cash to buy mortgage-backed securities in an effort to spur home lending - instantly creating a massive market for major banks.

And what did the banks do with the proceeds? Among other things, they bought Treasury bonds, essentially lending the money back to the government, at interest. The money that came out of the magic Rumanian Box went from the government back to the government, with Wall Street stepping into the circle just long enough to get paid. And once quantitative easing ends, as it is scheduled to do in March, the flow of money for home loans will once again grind to a halt. The Mortgage Bankers Association expects the number of new residential mortgages to plunge by 40 percent this year.

Con #5 The Big Mitt

All of that Rumanian box paper was made even more valuable by running it through the next stage of the grift. Michael Masters, one of the country's leading experts on commodities trading, compares this part of the scam to the poker game in the Bill Murray comedy Stripes. "It's like that scene where John Candy leans over to the guy who's new at poker and says, 'Let me see your cards,' then starts giving him advice," Masters says. "He looks at the hand, and the guy has bad cards, and he's like, 'Bluff me, come on! If it were me, I'd bet everything!' That's what it's like. It's like they're looking at your cards as they give you advice."

In more ways than one can count, the economy in the bailout era turned into a "Big Mitt," the con man's name for a rigged poker game. Everybody was indeed looking at everyone else's cards, in many cases with state sanction. Only taxpayers and clients were left out of the loop.

At the same time the Fed and the Treasury were making massive, earthshaking moves like quantitative easing and TARP, they were also consulting regularly with private advisory boards that include every major player on Wall Street. The Treasury Borrowing Advisory Committee has a J.P. Morgan executive as its chairman and a Goldman executive as its vice chairman, while the board advising the Fed includes bankers from Capital One and Bank of New York Mellon. That means that, in addition to getting great gobs of free money, the banks were also getting clear signals about when they were getting that money, making it possible to position themselves to make the appropriate investments.

One of the best examples of the banks blatantly gambling, and winning, on government moves was the Public-Private Investment Program, or PPIP. In this bizarre scheme cooked up by goofball-geek Treasury Secretary Tim Geithner, the government loaned money to hedge funds and other private investors to buy up the absolutely most toxic horseshit on the market - the same kind of high-risk, high-yield mortgages that were most responsible for triggering the financial chain reaction in the fall of 2008. These satanic deals were the basic currency of the bubble: Jobless dope fiends bought houses with no money down, and the big banks wrapped those mortgages into securities and then sold them off to pensions and other suckers as investment-grade deals. The whole point of the PPIP was to get private investors to relieve the banks of these dangerous assets before they hurt any more innocent bystanders.

But what did the banks do instead, once they got wind of the PPIP? They started buying that worthless crap again, presumably to sell back to the government at inflated prices! In the third quarter of last year, Goldman, Morgan Stanley, Citigroup and Bank of America combined to add $3.36 billion of exactly this horseshit to their balance sheets.

This brazen decision to gouge the taxpayer startled even hardened market observers. According to Michael Schlachter of the investment firm Wilshire Associates, it was "absolutely ridiculous" that the banks that were supposed to be reducing their exposure to these volatile instruments were instead loading up on them in order to make a quick buck. "Some of them created this mess," he said, "and they are making a killing undoing it."

Con #6 The Wire

Here's the thing about our current economy. When Goldman and Morgan Stanley transformed overnight from investment banks into commercial banks, we were told this would mean a new era of "significantly tighter regulations and much closer supervision by bank examiners," as The New York Times put it the very next day. In reality, however, the conversion of Goldman and Morgan Stanley simply completed the dangerous concentration of power and wealth that began in 1999, when Congress repealed the Glass-Steagall Act - the Depression-era law that had prevented the merger of insurance firms, commercial banks and investment houses. Wall Street and the government became one giant dope house, where a few major players share valuable information between conflicted departments the way junkies share needles.

One of the most common practices is a thing called front-running, which is really no different from the old "Wire" con, another scam popularized in The Sting. But instead of intercepting a telegraph wire in order to bet on racetrack results ahead of the crowd, what Wall Street does is make bets ahead of valuable information they obtain in the course of everyday business.

Say you're working for the commodities desk of a big investment bank, and a major client - a pension fund, perhaps - calls you up and asks you to buy a billion dollars of oil futures for them. Once you place that huge order, the price of those futures is almost guaranteed to go up. If the guy in charge of asset management a few desks down from you somehow finds out about that, he can make a fortune for the bank by betting ahead of that client of yours. The deal would be instantaneous and undetectable, and it would offer huge profits. Your own client would lose money, of course - he'd end up paying a higher price for the oil futures he ordered, because you would have driven up the price. But that doesn't keep banks from screwing their own customers in this very way.

The scam is so blatant that Goldman Sachs actually warns its clients that something along these lines might happen to them. In the disclosure section at the back of a research paper the bank issued on January 15th, Goldman advises clients to buy some dubious high-yield bonds while admitting that the bank itself may bet against those same shitty bonds. "Our salespeople, traders and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research," the disclosure reads. "Our asset-management area, our proprietary-trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research."

Banks like Goldman admit this stuff openly, despite the fact that there are securities laws that require banks to engage in "fair dealing with customers" and prohibit analysts from issuing opinions that are at odds with what they really think. And yet here they are, saying flat-out that they may be issuing an opinion at odds with what they really think.

To help them screw their own clients, the major investment banks employ high-speed computer programs that can glimpse orders from investors before the deals are processed and then make trades on behalf of the banks at speeds of fractions of a second. None of them will admit it, but everybody knows what this computerized trading - known as "flash trading" - really is. "Flash trading is nothing more than computerized front-running," says the prominent hedge-fund manager. The SEC voted to ban flash trading in September, but five months later it has yet to issue a regulation to put a stop to the practice.

Over the summer, Goldman suffered an embarrassment on that score when one of its employees, a Russian named Sergey Aleynikov, allegedly stole the bank's computerized trading code. In a court proceeding after Aleynikov's arrest, Assistant U.S. Attorney Joseph Facciponti reported that "the bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways."

Six months after a federal prosecutor admitted in open court that the Goldman trading program could be used to unfairly manipulate markets, the bank released its annual numbers. Among the notable details was the fact that a staggering 76 percent of its revenue came from trading, both for its clients and for its own account. "That is much, much higher than any other bank," says Prins, the former Goldman managing director. "If I were a client and I saw that they were making this much money from trading, I would question how badly I was getting screwed."

Why big institutional investors like pension funds continually come to Wall Street to get raped is the million-dollar question that many experienced observers puzzle over. Goldman's own explanation for this phenomenon is comedy of the highest order. In testimony before a government panel in January, Blankfein was confronted about his firm's practice of betting against the same sorts of investments it sells to clients. His response: "These are the professional investors who want this exposure."

In other words, our clients are big boys, so screw 'em if they're dumb enough to take the sucker bets I'm offering.

Con #7 The Reload

Not many con men are good enough or brazen enough to con the same victim twice in a row, but the few who try have a name for this excellent sport: reloading. The usual way to reload on a repeat victim (called an "addict" in grifter parlance) is to rope him into trying to get back the money he just lost. This is exactly what started to happen late last year.

It's important to remember that the housing bubble itself was a classic confidence game - the Ponzi scheme. The Ponzi scheme is any scam in which old investors must be continually paid off with money from new investors to keep up what appear to be high rates of investment return. Residential housing was never as valuable as it seemed during the bubble; the soaring home values were instead a reflection of a continual upward rush of new investors in mortgage-backed securities, a rush that finally collapsed in 2008.

But by the end of 2009, the unimaginable was happening: The bubble was re-inflating. A bailout policy that was designed to help us get out from under the bursting of the largest asset bubble in history inadvertently produced exactly the opposite result, as all that government-fueled capital suddenly began flowing into the most dangerous and destructive investments all over again. Wall Street was going for the reload.

A lot of this was the government's own fault, of course. By slashing interest rates to zero and flooding the market with money, the Fed was replicating the historic mistake that Alan Greenspan had made not once, but twice, before the tech bubble in the early 1990s and before the housing bubble in the early 2000s. By making sure that traditionally safe investments like CDs and savings accounts earned basically nothing, thanks to rock-bottom interest rates, investors were forced to go elsewhere to search for moneymaking opportunities.

Now we're in the same situation all over again, only far worse. Wall Street is flooded with government money, and interest rates that are not just low but flat are pushing investors to seek out more "creative" opportunities. (It's "Greenspan times 10," jokes one hedge-fund trader.) Some of that money could be put to use on Main Street, of course, backing the efforts of investment-worthy entrepreneurs. But that's not what our modern Wall Street is built to do. "They don't seem to want to lend to small and medium-sized business," says Rep. Brad Sherman, who serves on the House Financial Services Committee. "What they want to invest in is marketable securities. And the definition of small and medium-sized businesses, for the most part, is that they don't have marketable securities. They have bank loans."

In other words, unless you're dealing with the stock of a major, publicly traded company, or a giant pile of home mortgages, or the bonds of a large corporation, or a foreign currency, or oil futures, or some country's debt, or anything else that can be rapidly traded back and forth in huge numbers, factory-style, by big banks, you're not really on Wall Street's radar.

So with small business out of the picture, and the safe stuff not worth looking at thanks to the Fed's low interest rates, where did Wall Street go? Right back into the shit that got us here.

One trader, who asked not to be identified, recounts a story of what happened with his hedge fund this past fall. His firm wanted to short - that is, bet against - all the crap toxic bonds that were suddenly in vogue again. The fund's analysts had examined the fundamentals of these instruments and concluded that they were absolutely not good investments.

So they took a short position. One month passed, and they lost money. Another month passed - same thing. Finally, the trader just shrugged and decided to change course and buy.

"I said, 'Fuck it, let's make some money,'" he recalls. "I absolutely did not believe in the fundamentals of any of this stuff. However, I can get on the bandwagon, just so long as I know when to jump out of the car before it goes off the damn cliff!"

This is the very definition of bubble economics - betting on crowd behavior instead of on fundamentals. It's old investors betting on the arrival of new ones, with the value of the underlying thing itself being irrelevant. And this behavior is being driven, no surprise, by the biggest firms on Wall Street.

The research report published by Goldman Sachs on January 15th underlines this sort of thinking. Goldman issued a strong recommendation to buy exactly the sort of high-yield toxic crap our hedge-fund guy was, by then, driving rapidly toward the cliff. "Summarizing our views," the bank wrote, "we expect robust flows . . . to dominate fundamentals." In other words: This stuff is crap, but everyone's buying it in an awfully robust way, so you should too. Just like tech stocks in 1999, and mortgage-backed securities in 2006.

To sum up, this is what Lloyd Blankfein meant by "performance": Take massive sums of money from the government, sit on it until the government starts printing trillions of dollars in a desperate attempt to restart the economy, buy even more toxic assets to sell back to the government at inflated prices - and then, when all else fails, start driving us all toward the cliff again with a frank and open endorsement of bubble economics. I mean, shit - who wouldn't deserve billions in bonuses for doing all that?

Con artists have a word for the inability of their victims to accept that they've been scammed. They call it the "True Believer Syndrome." That's sort of where we are, in a state of nagging disbelief about the real problem on Wall Street. It isn't so much that we have inadequate rules or incompetent regulators, although both of these things are certainly true. The real problem is that it doesn't matter what regulations are in place if the people running the economy are rip-off artists. The system assumes a certain minimum level of ethical behavior and civic instinct over and above what is spelled out by the regulations. If those ethics are absent - well, this thing isn't going to work, no matter what we do. Sure, mugging old ladies is against the law, but it's also easy. To prevent it, we depend, for the most part, not on cops but on people making the conscious decision not to do it.

That's why the biggest gift the bankers got in the bailout was not fiscal but psychological. "The most valuable part of the bailout," says Rep. Sherman, "was the implicit guarantee that they're Too Big to Fail." Instead of liquidating and prosecuting the insolvent institutions that took us all down with them in a giant Ponzi scheme, we have showered them with money and guarantees and all sorts of other enabling gestures. And what should really freak everyone out is the fact that Wall Street immediately started skimming off its own rescue money. If the bailouts validated anew the crooked psychology of the bubble, the recent profit and bonus numbers show that the same psychology is back, thriving, and looking for new disasters to create. "It's evidence," says Rep. Kanjorski, "that they still don't get it."

More to the point, the fact that we haven't done much of anything to change the rules and behavior of Wall Street shows that we still don't get it. Instituting a bailout policy that stressed recapitalizing bad banks was like the addict coming back to the con man to get his lost money back. Ask yourself how well that ever works out. And then get ready for the reload.

www.rollingstone.com

Civilization's Wrecking Crew

J. R. Nyquist

Joseph Schumpeter once explained that many Marxists and Keynesians never read a line of Marx or Keynes. According to Thomas Sowell, "They have gotten their ideas second- or third-hand from the intelligentsia." One might say that Marxism and Keynesianism bear a resemblance to disease. If Bubonic plague is carried by flea-infested rats, Marxism and Keynesianism are carried by intellectuals. In the first instance, we are dealing with dangerous bacteria; in the second instance, we are dealing with dangerous ideas.

It was Richard Weaver who wrote Ideas Have Consequences, warning that bad ideas were unsafe at any speed; especially those that rejected universal truth and/or universal morality. Such a rejection, he explained, encouraged men to become morally ambivalent materialists or anarchists. Without universal principles, hierarchy and noble aspiration could not be defended. Order would be undermined and all mankind would sink into hellish egalitarianism. The interior world of man would be shattered. What would come in its place? A system based on "suspicion, hostility, and lack of trust and loyalty."

In a recent book titled Intellectuals and Society, Thomas Sowell offers a detailed examination of those who carry today's ideological equivalent of the Black Death. He defines the term "intellectual" as referring to those teachers and writers who chiefly deal in ideas, and are paid - by the media or the state - for batting ideas around. By focusing on intellectuals who are paid for intellectualizing, he is able to make a series of observations about their ideological tendencies, their lack of accountability, and their tendency to live outside the "real world." It is not their fault that intellectuals are what they are, and not all of them are plague carrying vermin. It is one of those sociological tragedies that intellectuals act as if "their special kind of knowledge of generalities can and should substitute for, and override, the mundane specific knowledge of others." The intellectuals, as a class, tend to reject the first-hand knowledge of non-intellectuals as "prejudice" or "stereotypes." Abstract formulas, adopted by the intelligentsia as dogma, are advanced as some kind of superior wisdom and used to undergird insane government policies that fly in the face of common sense. How else, indeed, has our Republic arrived at its present state?

Once established, the intellectual class continues to feed politicians and bureaucrats with ideas that point toward one solution: big government, interventionism, wealth redistribution, and other egalitarian absurdities. The country is pushed, inch by inch, toward an unnamed catastrophe. Who will name it? Who will stop the pushing? The intellectuals are feeding at the public trough, and they are entrenched. It seems that the rest of society is helpless to stop them.

To decry their push for "judicial activism" avails us nothing. If you stop them in the Supreme Court they will infect popular opinion and a new Congress will be elected. If they don't elect Congress, they will elect a president. If they cannot act politically, they will take over the universities and bring out a generation of politically correct drones. Here we are not dealing with a particular set of abuses that can be fixed with appeals to democracy, Christianity, or legal reform. Here we are dealing with thousands of writers and professors who have, through some mysterious process, arisen from the lower depths, from the inner hell of a confused though fashionable relativism. The welfare state is their brainchild, and economic calamity is also theirs.

It is worth repeating the following point: The intellectual, as defined by Sowell, is someone who works with ideas for a living. He is generally a teacher or writer. As society is currently organized, teachers and writers are judged by their peers according to "purely internal criteria" that leaves them "sealed off from feedback from the external world of reality and remain circular in their methods of validation." What is accepted, under such circumstances, is in accordance with the existing groupthink of the hour. Intellectual consensus is the end-all and be-all. The empirical validity of an idea is not fully checked. It incubates within the intelligentsia and, according to Sowell, bleeds through to the external world. "The ideas of Lenin, Hitler, and Mao had enormous - often lethal - impact ... however little validity those ideas had in themselves or in the eyes of others beyond the circle of like-minded followers and subordinate power-wielders."

This statement may appear incredible, but it is true. Many casual readers will pass this by, undervaluing its significance. It has been assumed, all too often, that everyone must accept an idea before it can become powerful or affect our lives. But political outcomes are determined by minorities who may or may not be in touch with reality. History tells of regimes, and elites, whose ideas were insane.

In the first line of his book, Sowell warns his reader: "Intellect is not wisdom." Only the good are wise, and goodness is rare. "Wisdom is the rarest quality of all," wrote Sowell - "the ability to combine intellect, knowledge, experience, and judgment in a way to produce coherent understanding." He also wrote that wisdom requires self-discipline and self-limitation. Totalitarian ideologies, embraced by leading intellectuals, are self-indulgent and self-expansive. The temptation to power, and ego-aggrandizement, may be hard to resist.

The success of an intellectual idea is not determined by an objective, external test. Success is determined by whether intellectuals find an idea "interesting, original, persuasive, elegant, or ingenious." In other words, a specific class of persons, paid to write or teach or think about such ideas, decide among themselves what is "interesting," and therefore they decide what has legs. If intellectuals have been corrupted by the prospect of power, the prospect of government money, or an envious attitude toward the rich, one might expect the gradual emergence of an irresistible totalitarian tendency.

The demand for intellectuals and intellectual ideas is self-created, self-sustaining, and self-replicating. "The general public contributes to the income of intellectuals in a variety of ways involuntarily as taxpayers who support schools, colleges, and various other institutions and programs subsidizing intellectual and artistic endeavors." In other words, the people who are wrecking our civilization are paid by the rest of us to do their work. We have nurtured them, raised them up, and fostered their conceits with our own cash contributions. In other words, we have paid for our own destruction up front.

Copyright © 2010 Jeffrey R. Nyquist

Jeffrey R. Nyquist Email

www.jrnyquist.com

Investing in Gold is a Move Toward Real Wealth

Bill Bonner

Oil edged up towards $80 a barrel yesterday. And the latest numbers for producer prices showed more inflation than was expected.

Meanwhile, jobless claims were up. And the Dow rose 86 points...

What do investors see that we don't? A mirage...the shimmering of hot money...money that comes from the feds. And they can't believe it's not real.

But that's the problem. No one can tell the difference between real money and the counterfeit stuff. Nor can they tell the difference between real prosperity and the phony variety. And who can really know whether the feds are doing some good...or just up to their usual tricks?

Oh my...it's Friday...and we're too tired to dig very deeply into these issues. We're going to keep it simple...even superficial...

Yesterday, gold rose $4. Is it too expensive...or too late... to buy in now?

What we're looking at is a huge, systemic failure. Instead of 'keeping it real,' the financial system has been so phonied up that you can't tell what's what.

And then, when prices move...you have to figure out what's really moving. Is the world spinning? Or just you?

We've been following the gold market for years. Gold has gone up about 300% over the last 10 years. But what does that mean? Does it mean gold has gone up? Or that the dollar has gone down?

We raise the question because we're wondering how to keep score... Richard Russell suggests that you should keep score in ounces of gold, not in dollars. He's right. Gold is not a perfect way of measuring wealth...it's just the best way.

Over the long pull of history, gold is more reliable a measure of wealth than just about anything else. Whether you had 100 ounces of gold at the time of Caesar or 100 ounces at the time of Charlemagne...or 100 ounces during the Jimmy Carter years – you were well off.

Note that we said gold is a 'measure of wealth' not means to wealth. Gold is inert. Lifeless. Incorruptible. But inherently shiftless. It never gets out of bed in the morning. It has never earned a penny in its entire life.

Gold won't make you rich. It toils not; neither does it spin. Since it doesn't hustle, it won't increase your wealth. That's why, in the Bible, the slave who kept his master's wealth safe in gold got beaten. Gold won't earn a profit. It won't pay you a salary or give you a company car. All it will do is help keep you from getting poor. We've never heard of a man who had 100 ounces of gold who was poor. On the other hand, we've read about millions of people with stacks of paper money who couldn't afford a cup of coffee. In our wallet, for example, is a 10 Trillion Dollar bill from Zimbabwe. A dear reader gave it to us. You could have a stack of those a foot high. You still wouldn't be able to buy a latte at Starbucks. On the other hand, imagine you had a stack of Krugerrands or maple leafs. Well, you still couldn't buy a cup of coffee at Starbucks. Because the dumb clerk wouldn't know what it was. And if he did take the gold coin in exchange for coffee, he'd probably rush over to the mall where some sharp dealer offered to take it off his hands in exchange for PAPER MONEY!

You see, the average person has no idea what real money is. One dollar bill looks the same as another to him. And gold? He's probably never seen gold, unless it was wrapped around his finger.

Gold is real money. At least, it's as real as money ever gets. Gold represents wealth. It can be exchanged for wealth. And since the above-ground supply of gold grows about as fast as the economy itself, gold tends to hold its value over centuries. Today, gold is worth about the same as it was worth 2000 years ago.

But you've heard us make that point before, haven't you? Well, the point we're making today is different. If gold holds its value, more or less, year after year...how can you expect to make any real profit by holding gold? Won't it hold its value in the future too?

Yes, dear reader, it probably will. As inflation increases, you'll watch your gold shoot up in price...along with other prices!

BUT...gold is subject to manias and bubbles...just like everything else. Though, it can be expected to hold its value in the long run, in the short run, it could become very over-valued. Why? Because the paper money system is doomed. It is doomed because we can't tell the difference between a real dollar...and a phony one. And it is doomed because the people in charge of dollars find it more convenient to introduce new counterfeit dollars than to strictly control the quantity and quality of the US currency.

Little by little, average people will come to see gold as a way to protect themselves. Then, suddenly, they will begin talking about gold. Cab drivers will have opinions about which gold coins are the best one to own. Hairstylists will want to convert their savings into gold rings and bracelets. Investors will talk about how much they made by trading in and out of mining stocks.

Gold will soar. Gold's bubble will have finally arrived. Then, it will be time to sell.

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning.

dailyreckoning.com

Central Banks Are On the Defensive

Gary North

All over the Western world, central banks are under pressure from their governments to inflate. Governments are not satisfied with short-term interest rates at historic lows, such as a federal funds rate of 0% to 0.25% in the United States. Politicians want rapid economic growth, and they are convinced that this is possible after a major recession only with more fiat money. In short, they have accurately understood the message of their college-level textbooks. This is what textbooks have been saying for over 50 years. This is the new, improved Keynesianism. Keynes focused on the need for large government deficits and increased government spending, not monetary inflation. The new Keynesianism wants large government deficits and lots of fiat money.

These twin pillars of neo-Keynesian policy are not working anywhere in the West. They are working for now in China, which has become the world's bubble economy, but not in the popped-bubble economies of the West.

The Bank of Japan

On February 18, Bloomberg ran a story on a statement by the governor of the Bank of Japan, who warned against government interference. The government is running a large budget deficit. It is pressuring the Bank of Japan to inflate. The Bank has refused.

Interest rates are low today because commercial bankers still refuse to lend. This has been Japan's problem for two decades. Investors still buy the Treasury securities of their governments. The central banks initially pushed rates down through monetary inflation (more reserve money to supply the commercial banks), but today, rates are low because lenders are frightened of the private sector, and the private sector is afraid of more debt. The central banks are not inflating, yet short-term government debt rates are extremely low. The economic boom is nowhere to be seen. The recovery is slow.

Traditional Keynesian textbooks say that to keep short-term rates this low, there must be rapid monetary inflation. But these rates are low today without monetary inflation. This fact conflicts with textbook Keynesianism. The policy-makers are in disarray, both in the government and the central banks.

We can see this in a Bloomberg report on Japan.

Feb. 18 (Bloomberg) – Bank of Japan Governor Masaaki Shirakawa countered government pressure by suggesting it should develop a plan to contain the world's largest public debt.

"It's important to gain trust of financial markets by showing a path for fiscal consolidation," Shirakawa said in Tokyo today after his policy board kept interest rates at 0.1 percent and refrained from expanding monetary easing steps.

As Hans Sennholz used to say, "Wait a minute!" If the Bank of Japan "kept interest rates at 0.1%," how did it do this?

The governor is protesting government pressure to inflate. The official textbook explanation for the boom-producing effects of monetary inflation is that this policy will lower interest rates. But the bank rate has been one-tenth of one percent. Japan's central bank did not "keep" the rate this low this week, or last week, or last year, or last decade. It has done approximately nothing for 15 years, yet the rate stayed this low.

The Bank of Japan has barely inflated the money supply since 1994. M2 has rarely increased above 3% per annum. As a result, there has been little price deflation in Japan since 1994. Consumer prices fell slightly in a few years: about 1%. In other years, consumer prices rose a little. You can see the chart for yourself.

So, the story of Japan's long-term price deflation is a complete myth. I have discussed this before.

The Bank of Japan is not keeping the rate low. The free market is. Lenders want safety. They will pay for this: low interest rates on government debt. The rate on 10-year Japanese bonds is 1.3%. With consumer prices falling at a rate of 2% per annum – the first time they have fallen this much – 1.3% is a real rate of return of a little over 3%. Not much.

Private borrowers want safety, too – by not taking on more debt. So, rates stay low.

The Bank of Japan can of course expand its purchases of government debt. But why should it do this? The government can sell its debt at low rates. What will more fiat money do for the government's ability to sell its debt? Nothing.

The Bloomberg story goes on to say that the governor insisted that the central bank needs independence from the government. This is the cry of central bankers at all times, in all places.

Have you ever read of the senior tenured bureaucrat in any government-protected, semi-private monopoly agency recommending that the nation's Congress or Parliament take over the operations of his agency, because government protection has made the agency unresponsive to the public good? The next time will be the first.

In his strongest warning yet on the country's growing debt burden, Shirakawa said governments need to "respect" that monetary policy isn't aimed at funding fiscal spending. His remarks came after Finance Minister Naoto Kan earlier this week stepped up heat on the central bank to fight deflation by saying Japan needs an inflation target of at least 1 percent. . . .

"Monetary policy isn't aimed at fiscal funding," Shirakawa said at the news briefing. "It's aimed at achieving sustainable growth under stable prices. It's important that governments respect this stance and markets have faith in it."

He is not alone in his protest against government interference.

"Accountability is Autonomy"

On February 17, the President of the Federal Reserve Bank of Philadelphia gave a speech to the Philadelphia chapter of the World Affairs Council. Whenever an official gives a speech to a WAC chapter, we can be sure that the official regards this as an important speech.

The media do not talk about the World Affairs Council. There may be an occasional report about a speech at a WAC chapter, but there will be nothing said about the WAC: what it is, who belongs, and what influence it possesses.

The WAC has an important social function. It is the single most important membership organization for the nation's senior elite Establishment to communicate the latest perspective to the nation's elite.

According to the brief entry on Wikipedia, the WAC has 535,000 members in 89 separate councils in 39 states. There are 175 million adults in the United States. This means the WAC's membership is a little over three-tenths of one percent of the adult population. I call this an elite.

The WAC was founded in 1918, three years before the Council on Foreign Relations was founded. Like the CFR, the WAC officially is concerned with international affairs. Also like the CFR, the WAC deals with domestic issues as well.

The President of the Philadelphia FED, Charles Plosser, titled his speech, "The Federal Reserve System: Balancing Independence and Accountability." This sounds boring. For those who understand the function of the Federal Reserve and its influence, the speech is not boring to read.

The target of the first half of the speech was Ron Paul. It was a warning against Ron Paul's bill in the House of Representatives that would authorize the Government Accountability Office to audit the FED. The House's leadership has kept the bill from coming to the floor for a vote, despite the fact that a majority of the membership has officially supported it, and despite the fact that a majority of the House Financial Services Committee voted for it, 43 to 26, in November 2009.

The FED has consistently opposed this bill. The official explanation is that this would in some way constitute interference with the FED's policy-making. This argument has never been clear. The fact that the General Accountability Office will verify the numbers in no way constitutes interference with FED policy, unless FED policy has been carried on under false numbers.

Nobody at the FED will say what is really at stake: an independent audit of the government's gold holdings, which are officially held for the government by the FED for safekeeping. If the gold is gone, or if there are legal claims against it by foreign central banks as a result of FED swaps, this would constitute fraud on a massive scale.

The real power in the FED has always been the Federal Reserve Bank of New York. In all textbook accounts of the years leading up to the Great Depression, the focus is on Benjamin Strong, the President of the New York FED. He set policy, not the Board of Governors.

The bulk of the world's gold holdings are stored in the vault of the New York FED. This includes most of the deliverable gold (99.9% fine) owned by the FED as trustee of the U.S. government's gold. The gold at Ft. Knox (probably coin melt, 90% fine) constitutes a second holding area, said to be 20% of the nation's gold. No one knows. It has not been audited since the early 1950's, not even by the private accounting firms that audit the FED on an annual rotation basis.

The FED demands secrecy. It proclaims that it pursues transparency, but it does not on any issue of substance.

Bloomberg News in November 2008 sued the Board of Governors under the Freedom of Information Act to find out which institutions received how much money in the October 2008 bailouts. The Board of Governors refused to comply on this legal basis: this would expose trade secrets of the recipient banks.

Even though a district Federal judge in August 2009 ruled that the New York FED must turn over these records, the FED refused to comply. She gave the FED five days to comply. It did nothing for six months.

Anyone who thinks that the Federal courts have operational authority over the Federal Reserve System is ignorant of the last century of American history.

The Board of Governors appealed the ruling on January 11, 2010. A ruling will not come down for months. A recent summary of this bizarre story appeared in the New York Times. In a rare form of candor, the writer added this observation, deep down in the bowels of his article:

The Federal Reserve has wrapped itself in secrecy since the turn of the 20th century, when a select group of financiers met at the private Jekyll Island Club off the eastern coast of Georgia and, forgoing last names to preserve their anonymity among the staff, drafted legislation to create a central bank. Its secrecy, of course, persists today, with Ben S. Bernanke, the Federal Reserve chairman, refusing to tell even Congress which banks received government money under the bailout.

"Secrecy is Transparency "

Mr. Plosser gave the usual reasons for opposing the audit.

So, our uniquely American form of a central bank strikes a balance between centralization and decentralization; between the public and private sectors; and among Washington, Wall Street, and Main Street. The result is a central bank that achieves a delicate balance: it permits policymakers a good deal of independence when conducting monetary policy but in return requires transparency and accountability to the American people.

Why does setting monetary policy require this degree of secrecy? Officially, the FED is rather vague on the answer. It is all about accountability, the FED says. You see, transparency and accountability to the American people require secrecy, so that Congress is kept in the dark. You understand this, don't you?

The elite at the World Affairs Council did not bat an eye. "Of course, of course." There was no response comparable to a town hall meeting in a Congressman's district over the bailouts. There were no catcalls. There was polite acceptance.

From the point of view of economic analysis – the pursuit of self-interest – secrecy by the FED is required because the FED is the administrator of a cartel of government-protected commercial banks. The government has created barriers to entry, thus creating the cartel. Bankers do not want the government to police the cartel. They want their own agency to do this. They nominate the Presidents of the 12 Federal Reserve Banks. The big banks want to milk the cartel for all they can. They got the bailout money, and in their view, that ended any legitimate interest Congress may have in pursuing the matter. So, Mr. Plosser said this:

Another frequently mentioned proposal under consideration would politicize the governance of the 12 Reserve Banks by making the chairs of the boards of directors, or the Reserve Bank presidents, political appointees. Other legislators have suggested eliminating the votes of Reserve Bank presidents on the Federal Open Market Committee.

As I hope I've explained, such changes would weaken the regional and decentralized structure of the Federal Reserve System and lead to a more centralized and political institution and less effective policy. Were regional Reserve Bank presidents or chairs to become political appointees, they might be more attuned to the political process in Washington that selected them, rather than having a public interest in the broad economic health of the nation and the Reserve Districts in which they reside. Politicizing these important positions might also discourage some talented, public-spirited individuals to serve as part of our nation's central bank.

The hearts of World Affairs Council members must have swelled with pride. "Yes, yes, we understand. Far be it from us to discourage some talented, public-spirited individuals to serve as part of our nation's central bank."

The message was clear: we must keep politics out of the most powerful cartel in the country. No audit! No control over who gets to be President of a regional FED bank!

Central bank independence means that the central bank can make monetary policy decisions without fear of direct political interference. It does not mean that the central bank is not accountable for its policies.

Allow me to summarize:

  1. Autonomy is accountability.
  2. Secrecy is transparency.

George Orwell saw it coming. Newspeak is alive and well inside the FED.

CONCLUSION

For the first time since 1914, the Federal Reserve System is under serious attack. The attackers are not members of the World Affairs Council. The attackers are from the hinterlands. The bailouts angered them in October 2008. The bailouts confirmed Ron Paul's warnings in his Presidential campaign. The Web has made it possible for the troops to get mobilized.

The FED has never had to deal with anything like this. It does not know how to respond. Mr. Plosser's speech is an indication of just how little the FED understands public relations. A minority of critics have seen through the Wizard of Oz's smoke and mirrors. The Web has given these people access to information that could be concealed before.

The genie will not go back into the bottle. Opposition to the FED will spread, no matter how many speeches that high-level FED officials deliver to local chapters of the World Affairs Council.

February 20, 2010

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2010 Gary North

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