Wednesday, August 31, 2011

Harvard Deconstructed: The Taming of the Zoo

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

The Atlantic magazine has illustrated the unsustainable growth of student debt in the chart below. In David Indiviglio's August, 18, 2011, article, "Student Loans Have Grown 511% Since 1999," the author notes: "Obviously the number of students didn't grow by 511%. So why are education loans growing so rapidly? One reason could be availability. The government's backing lets credit to students flow very freely.... [U]niversities are raising tuition aggressively since students are willing to pay more through those loans."

Indiviglio concentrates his attention on the future problem for the students, though that is secondary, except, of course, to the students in hock and out-of-luck lenders. Colleges and universities in the United States are a short sale. Great Courses are a long. The latter is the model to ponder.

The number of colleges will plummet. This is due to the loss of nerve, confidence, substance, direction, integrity - will that do? - of teaching in America. Just look at that chart: what a picture of insatiable greediness and self-indulgence among the colleges. No thought to the unbearable debt deposited on their students.

Angelo Mozilo, the grand poobah of subprime mortgages, is correctly vilified for coaxing financial naives into debtors' prison, but the same tactics by the education establishment goes unremarked. In another Atlantic article,
"The Debt Crisis at American Colleges," authors Andrew Hacker and Claudia Dreifus write: "[C]olleges have embraced a host of extraneous activities - from obscure sports to overseas centers - and tacked most or all of their tabs onto students' bills. Unlike businesses, which cut losing operations, colleges simply hike their tuitions." Will former Harvard Professor Elizabeth Warren's ill-defined federal agency, watchdog over slatternly marketing hoaxes by financial institutions, apply the same standards to deceptive, college sales practices?

A century ago, John Jay Chapman, Harvard alum, was a pain-in-the-neck to Harvard College President
Charles William Eliot. He tried to sack the president. In 1909, Chapman wrote that his college had diluted its resolve to teach the truth: "The men who control Harvard to-day are business men, running a large department store.... Devising new means of expansion, new cash registers and credit systems - systems for increasing their capital and the volume of trade....The wonderful ability of the American business man for organization is now at work consolidating the Harvard graduates into a corps which seems to have the same sort of enthusiasm about itself as a base-ball team.... (This is excerpted from "The Hundred Year Bubble," a dissertation originally published in the January 2010 issue of the Gloom, Boom & Doom Report on America's unwillingness to set limits over the past century, and the parallel inflation of money, self-improvement, self-delusion, and self-gratification.)

Chapman's alarm may be difficult to understand today, but he had the advantage of living during a sharp break in the then-nearly-300-year history of Harvard College: before and after it took the low road.
Eliot was an early exemplar of the "New Education" thesis that sought a "universal utility" in American education. This inflation of mission and of human potential, captured in Eliot's substitution of vocabulary for thought, is collapsing.

Others also rued the dangerous downgrading of the American mind at the universities. In 1908, Albert Straus, then partner at the investment firm of J.W. Seligman and Company, told a Columbia University audience: "[W]e are slaves to our phrases; what begins by being a metaphor ends by dominating our thinking...[W]e often reason about these matters as though the pictures that our words call up were real." And Straus never saw MTV.

Colleges today have set many missions for themselves, not many of which are in the interests of their students. They disguise their reluctance to teach with slogans and images: "empowering students to achieve professional and personal success in dynamic careers and in a diverse global society by providing a comprehensive and supportive educational experience, fostering academic integrity, and encouraging lifelong learning." (Berkeley College, Boston) Only by carrying the imprimatur of a college, or of a government bureaucracy (really, one in the same, they are slaves to each other), does the public accept such a pile of flotsam as making sense. (Yes: Bernanke and his fellow imposters.)

A globally-known investor wrote to me after "Scarlett O'Hara's Risk-Free Rate" that Harvard is finished and will be insolvent. The collapse of America's colleges, and of the primary- and secondary-school farm systems, will probably be a good thing overall, difficult as it will be to understand during the unfolding: It may clear out the zoo.

In the July 2011 edition of the Gloom, Boom & Doom Report, Marc Faber quoted a study from the Goldwater Institute that found between "1993 and 2007, the number of full-time administrators per 100 students at America's leading universities grew by 39 percent, while the number of employees engaged in teaching, research, or service only grew by 18 percent."

In the Summer 2011 edition of City Journal, Heather MacDonald writes: "This past academic year, for example, a Bowdoin College student interested in American history courses could have taken 'Black Women in Atlantic New Orleans,' 'Women in American History, 1600-1900,' or 'Lawn Boy Meets Valley Girl: Gender in the Suburbs,' but if he wanted to take a course in American political history, the colonial and revolutionary periods, or the Civil War, he would have been out of luck."

Noteworthy is the larger topic Mac Donald discusses in "Great Courses, Great Profits." A company called Great Courses is making gobs of money selling recorded lectures by college professors who teach "Plato, Aristotle, Cicero, Paul, Erasmus, Galileo, Bacon, Descartes, Hobbes, Spinoza, Dante, Chaucer, Spenser, Shakespeare, Cervantes, Milton, Pope, Swift, Goethe, and others..." This may not be materially different from the lectures John Jay Chapman attended in the 1870s. Those who pay Great Courses receive no degree, no padding to their resume, no Delta House invitations, no country-club dormitory suite, no indulgent, grief-counseling administrators, and no future business network.

Macdonald goes on to write that college faculties wring their hands because the curriculum has been "problemetized." There is some resistance to such courses as "Queering the Alamo."

"My dear James," wrote Chapman in 1907 to his friend, Harvard professor William James (The Varieties of Religious Experience), "Eliot has boomed and boomed - till we think it's the proper way to go on. He must, or lose foothold. Well, why not a man who does not boom? Is boom the best thing in life? Is it all boom? Is there now and to be nothing ever but boom, boom, boom? Is there not something that operates without money - not anywhere?"

The Spring 2011 edition of The Trinity Reporter, alumni magazine of Trinity College (Connecticut), includes a full-page pitch to alums under the picture of a 2004 graduate (name withheld, to spare his family further publicity for this embarrassing incident) screaming like Janis Joplin and tearing his white shirt, blue blazer, and blue-and-gold school tie off to reveal a muscle-bound chest covered with a gray "Trinity" gym shirt. "Blue and Gold Is In Your Blood," shrieks the copy: "Let's keep that competitive spirit alive and show our rivals why Trinity College is among the Top Ten schools in alumni giving participation in the country."

There is really no need to comment on the consummation of Chapman's foresight. The fulfillment of Chapman's letter to Dear James has regressed to the least common denominator.

What might we gain from Sherman's march through the academy? A taming of the zoo. Twenty years ago the author and critic Harold Bloom (The Western Canon, 1994) was interviewed by the Paris Review. Quoting Bloom: "I watch MTV endlessly." This enemy of "The School of Resentment" - feminist literary critics, new historicists, poststructuralists, deconstructionists, semioticians, laconists, and poetry slamists - saw MTV as the real vision of what this country desires: "no matter how many [performers] are on the screen, not one of them feels free except in total self-exaltation." Time to short March Madness?

Saturday, August 20, 2011

Scarlett O'Hara's Risk-Free Rate

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

The death of the long-established risk-to-reward asset categories was the subject of "It's Over." From lowest to highest: cash, bonds, and stocks, are the pecking order of institutional investment policies. Pension plans and endowments that have wandered into warehouses and gas-pipeline management often retain the outline as a mental diagram. The assets with the highest assumed risk (using statistical measurements) are expected to produce the highest return. The genesis for this construction is the Capital Asset Pricing Model (CAPM), a deeply flawed academic theory.

"It's Over" struck a nerve with readers who have suffered from its domination of asset management over the past three decades. Some gave speeches denouncing it, some forsook advancement, and many endured business-school indoctrination in bewilderment.

The CAPM is not worth further examination (other than the necessity to understand the structure of the institutional mind). However, there is one train of thought that should be considered by the average investor: the incapacity of the model to consider discontinuities. There is no room to "be prepared for the next time the world turns over." That happens every generation or three, and it is happening today.

Quoting from "It's Over":

"There is also the much larger problem of constructing an asset pecking order with rigged asset returns and yields. The market rate for Treasury bills is not zero. The coming dislocation that institutional and retail investors face is, to most if not all, incomprehensible. Consider the reconstruction of Scarlet O'Hara's Capital Asset Pricing Model after 1860. She discovered what can happen to chimerical fortunes built on the backs of government-fixed, zero-percent, risk-free rates."

Each morning the news in the U.S. and Europe veers closer to the closing scene of George Bernard Shaw's Heartbreak House. Recent market turbulence indicates recognition, but the disappearing euro and dollar are treated in the media as a distant political argument among economists, the most destructive group of cross-border planners imaginable. The Federal Reserve, U.S. Treasury Department, European Union, and European Central Bank are acting in unison - that is, in their own short-term interests. Doing so, the independence and viability of personal assets, pension plans, municipalities, colleges, and museums - you can add to this list - are at stake.

The debt-ceiling debate in the U.S. was the most pointless waste of air since Elizabeth Taylor divorced her twelfth husband. First, the debt-ceiling question is not the same as the question of whether the federal government will make good on bond payments, but the two became hopelessly intermingled.

Separating the two: A country that spends one dollar for every 59 cents in tax receipts cannot freeze its level of spending. As a practical matter, cash-matching of inflows to outflows was not possible with over 45 million Americans receiving food stamps, consumers having drawn down savings by $149 billion between September 2010, and April 2011 (during a period when inflation-adjusted spending fell), when 64% of the population is unable to put $1,000 together in an emergency (The National Foundation for Credit Counseling, August 12, 2011, Chicago Tribune), and with a military currently deployed in over 100 different countries. QED.

Second, the federal government did not waver from its commitment to meet bond payment obligations. This was not clear from listening to the media, or the U.S. Treasury Secretary, who bears the duty to defend the nation's credit, integrity of the dollar, and integrity of his office.

Standard & Poor's implicitly downgraded the U.S. Treasury Secretary along with the nation's credit. On July 10, 2011, Treasury Secretary Tim Geithner settled the bond-payment question on Meet the Press: "Let me make this clear: The U.S. is not going to default. We are a country that pays its bills. We're going to meet our obligations." He contradicted himself on July 27, 2011, as stated in The King Report: "[B]y August 2, [2011], Treasury Secretary Tim Geithner says the government will run out of money to pay all its bills, including obligations to bondholders. "On July 28, 2011, Bloomberg reported: "The U.S. Treasury will give priority to making interest payments to holders of government bonds when due if lawmakers fail to reach an agreement to raise the debt ceiling, according to an administration official." This was the case all along.

The double-talk was issued by a Treasury Secretary who did not pay his taxes until a Senate committee requested that he do so (the Internal Revenue Service reports to Geithner) and who acknowledges: "I never had a real job," (April 2010).

Europe is even more distraught. This is a real, current crisis. The Eurocrats will do anything to prevent a dismantling of the euro; yet, it is coming to an end, or, about to be reduced in scope. The unelected authorities may be able to delay the inevitable, but that will require an enormous amount of money printing. Estimates of €1 trillion to save the Italian and Spanish banking systems are common, but, no one knows the side effects beforehand. Estimates of write-offs and losses over the past few years (Citigroup, Fannie Mae) have generally come up short.

French President Nicholas Sarkozy's statement on August 16, 2011, that the size of the current bailout fund (EFSF) is large enough (€440 billion) is not credible. It is not clear if €440 billion is large enough to prevent Greece and Portugal from rupturing. It is possible that the August 16 meeting between Sarkozy and German Chancellor Angela Merkel ended with an agreement that it is time to cut bait. (They also dismissed "Eurobond" monetization, but euro-salvation initiatives never quite die.) They may have decided expansion of the money-printing adventure will drag France and Germany into the abyss.

Whether or not this is the case, European markets will be chaotic in the months ahead (as they will in the U.S.), with a good chance capital controls will be instituted to prevent Europeans from moving their money elsewhere: an example of a rare occurrence that has not been anticipated by the usual investment strategy. Swiss franc and gold movements show where the more alert European money is moving. Gold has risen from $1,500 on July 5, 2011, to over $1,800 on August 18, 2011. The consequences to U.S. banks, in such an intertwined financial world, are being discounted in the market.

Should an Iron Curtain of capital controls surround Europe, U.S. authorities may issue some gobbledygook nonsense of how Europe's unfortunate decision forced the United States' hand. Doing do, captive financial assets, with limited avenues of dispersal, will drift into 10-year Geithners and the common stocks of National Champions selected by the United Auto Workers and the chairman of the President's Council on Jobs and Competitiveness, General Electric Chairman Jeffrey Immelt.

Now, the star of the show:

To Scarlett O'Hara, her family's plantation in Georgia (Tara) was as risk-free as it comes. Probably to Mr. O'Hara, too, who did not contemplate hard times. When Scarlett wanted to chase other long-term assets (Ashley Wilkes), she told her father "plantations don't amount to anything." Mr. O'Hara fumed: "Land is the only thing in the world that amounts to anything, for 'tis the only thing in the world that lasts, and don't you be forgetting it!" This sounds like an old Fannie Mae ad, not to confuse the honor of Mr. O'Hara and Jim Johnston.

Scarlett's father favored the Capital Asset Pricing Model of the day (100% plantation weighting; risk-free, perpetual, cotton-backed dividends) as did the other, local, wealth-management offices. The plantation owners could not wait to beat those Yankees. (Lincoln and Hamlin, not Jeter and Rivera.) Defeat did not cross their minds. The book value of Tara and Twelve Oaks (Ashley Wilkes' family plantation) was chiseled in stone, just as the historical stock-market and bond-market returns stamped in indelible ink by Jeremy Siegel, Rex Sinquefield and Roger Ibbotson, are as immutable to asset allocation today as they will be gone with the wind tomorrow.

Rhett Butler was what might be considered a contrarian thinker. It is approaching a truism today that a contrarian thinker does not mean much more than common sense. That is, once every generation or two, the world blows up. So it was with Butler, who told the war-whooping plantation owners: "I have seen many things that you have not seen. The thousands of immigrants who would be glad to fight for the Yankees for food and a few dollars, the factories, the foundries, the shipyards, the iron and coal mines - all the things we have not got. Why all we have is cotton and slaves and arrogance. They'd lick us in a month." His comments were not appreciated, and why would they listen to this disreputable financier (which he was), lounging as they were at Twelve Oaks: "the beautiful white-columned house that crowned the hill like a Greek temple."

The South marched off to war and Rhett Butler bought cotton. Scarlett did not approve. She told Rhett he was "vile and a mercenary."

Butler disagreed: "Mercenary? No, I'm farsighted. Though perhaps that is merely a synonym for mercenary. At least, people who were not as farsighted as I will call it that. Any loyal Confederate who had a thousand dollars in cash in 1861 could have done what I did, but how few were mercenary enough to take advantage of the opportunities! [To deflect hostility after preventing money from leaving the European Union (and from the U.S, later), the euro authorities will blame the mercenary Europeans who are buying Swiss francs and gold. Such an accusation always goes down well with loyal, though not far-sighted, citizens when they suffer relative impoverishment at the hands of the authorities. - FJS] As, for instance, right after Fort Sumter fell and before the blockade was established [that prevented leakage from the Confederate financial system - FJS], I bought up several thousand bales of cotton at dirt-cheap prices and ran them to England. [Butler shipped his assets offshore - FJS] They are still there in warehouses in Liverpool. I've never sold them. I'm holding them until the English mills have to have cotton and will give any price. I wouldn't be surprised if I got a dollar a pound."

Scarlett's reply sounds typical, though far more original, than that of a Wall Street airhead on CNBC: "You'll get a dollar a pound when elephants roost in trees."

On the 220-year-chart of cotton prices in the 2010 CRB Yearbook it looks as though cotton rose from around 10 cents a bushel in 1860 to $1.05 a bushel a couple of years later.

Scarlett, clinging to her ERISA-sanctioned policy, which was therefore legally risk-free, retorted: "[I] don't need your advice. Do you think Pa is a pauper? He's got all the money I'll ever need..." This could be an occasion to discuss the topical question of what is money? (see:"Do you think Ben Bernanke is J.P. Morgan?", but Butler, (or Margaret Mitchell), is an expert in the field.

Rhett, with a better historical sense than Scarlett, (even while she, herself, unschooled, would have been shocked at the narrow-minded, ahistorical theories of modern economists), replied: "I imagine the French aristocrats thought practically the same thing until the very moment when they climbed into the tumbrels."

Meanwhile, back at Tara, Mr. O'Hara had stuck with the plantation owner's CAPM: "The South had always lived by selling cotton and buying the things it did not produce, but now it could neither sell nor buy [because of the union blockade of southern ports - FJS]. Gerald O'Hara had three years' crops of cotton stored under the shed near the gin house at Tara, but little good it did him. In Liverpool it would bring one hundred and fifty thousand dollars, but there was no hope of getting it to Liverpool. Gerald had changed from a wealthy man to a man who was wondering how he would feed his family and his negroes through the winter." When it rains it pours: "With the new fall of currency, prices soared again. Beef, pork, and butter cost thirty-five dollars a pound, flour fourteen hundred dollars a barrel....[W]arm clothing, when it was obtainable had risen to such prohibitive prices that Atlanta ladies were lining their old dresses with rags and reinforcing them with newspapers to keep out the wind."

Butler knew what he wanted in a girl and he made sure he got it - a woman who knew how to make money during bad times: "I'm going to be a rich man when this war is over, Scarlett....I told you once before that there were two times for making big money, one in the upbuilding of a country and the other in its destruction. Slow money on the upbuilding, fast money in the crack-up. Remember my words." There were probably similar reminders when investment banks paid credit-rating agencies for AAA ratings on CDOs.

Rhett's concept of money was so old that it's new: "I've made money enough, and it's in English banks and in gold. None of this worthless paper for me." The Confederacy had been reduced to paper money, not necessarily a road to ruin but given Rhett's belief: "the Confederacy is doomed....It had to go and it's going now," he took the only course of action a man with common sense would follow.

Rhett's far-sightedness was not well received: "It simply made everyone furious that an old speculator who always said nasty things about the Confederacy should have so much money when we were all so poor." If the Powers That Were had paid attention to the "nasty things" Rhett Butler willingly shared with anyone who would listen in 1860, he would have remained a shady, wealthy, but unimportant figure.

On the battlefield, writing to his wife (Melanie), Ashley Wilkes expressed contempt for the leaders whom he had trusted: "I see too clearly that we have been betrayed, betrayed by our arrogant Southern selves, believing that King Cotton could save the world. Betrayed too, by words and catch-phrases, prejudices and hatreds coming from the mouths of those highly placed, those men whom we respected and revered - 'King Cotton, Slavery, States' Rights, Damn Yankees.'" Ashley had trusted the Confederacy's Committee to Save the World (see February 15, 1999 cover of Time magazine )

Rhett's sermons were not in vein. Parlor discussions at Tara praised Southern advances but Scarlett listened in contempt. "They haven't any idea what is really happening to themselves or to the South. They still think, in spite of everything, that nothing really dreadful can happen to any of them because they are who they are - O'Hara's, Wilkeses, Hamiltons. [Or: Harvard, Princeton, the Fed. Or: pension plans, endowments, family offices. Or: stocks-for-the-long-run, Too-Big-to-Fail banks, Treasuries, money-market funds. - FJS] Oh, They're all fools! They'll never realize! They'll go right on thinking and living as they always have and nothing will change them....They don't change to meet changed conditions because they think it'll all be over soon."

Scarlett was witness to the fall: "The charred remains of [Twelve Oaks] had crowned the hill in white-columned dignity. The deep pit which had been the cellar, the blackened field-stone foundations and two mighty foundations marked the sight...Ashley had married his bride here but his son and son's son would never bring brides to this house....The House was dead."

This will be the lament of unfortunate trusts and endowments that mistakenly believed they have apportioned their assets for perpetuity.

Tara may have met the same fate but Scarlett had spirit - and was ruthless, inexhaustible, and refused defeat. Nevertheless, she needed aid and solicited her TARP: Rhett Butler. During her same train-of-thought quoted above ("Oh, they're all fools!"), Scarlett concluded: "They think God is going to work a miracle for their benefit. But He won't. The only miracle that's going to be worked around here is the one I'm going to work on Rhett Butler."

Rhett was not forthcoming: "I couldn't give [you money] if I wanted to. I haven't a cent on me. Not a dollar in Atlanta. I have some money, but not here. And I'm not saying where it is or how much. But if I tried to draw a draft on it, the Yankees would be on me like a duck on a June bug..."

From a zero-percent, risk-free rate, money could not be had at any price.

Much later in the book, Rhett explains in textbook fashion his refusal to participate in Scarlett's miracle. Only a sampling is included here. It springs to mind that the author wrote a long story while concealing a coded tract on how to preserve financial independence, legally or illegally, during a time when the government has exceeded its legal authority: "If I'd drawn a draft they could have traced it somehow and I doubt if you'd have gotten a cent. My only hope lay in doing nothing. I knew the money was pretty safe, for if worse came to worse...I could have named every Yankee patriot who sold me bullets and machinery during the war. Then there would have been a stink because some of them are high up in Washington now."

On that score, Rhett tells Scarlett how he secured his release from a post-War federal prison: "I employed a delicate system of blackmail on a friend in Washington who is quite high in the counsels of the Federal government. A splendid fellow - one of the staunch Union patriots from whom I used to buy muskets and hoop skirts for the confederacy.... [H]e hastened to use his influence, and so I was released. Influence is everything, Scarlett. Remember that when you get arrested. Influence is everything, and guilt and innocence merely an academic question."

And so it goes.

Margaret Mitchell, author of Gone with the Wind, was very much surprised that her book was even publishable. She wrote to a reviewer at the time [1936]: "I wrote the book nearly 10 years ago.... It seemed, to be quite frank, pretty lousy and I never submitted it to any agent or publisher.... I wrote the book when the Great American Boom was at its height and the high tide of the Jazz Age was with us. Everyone I knew had a car, a radio, an electric ice box and a baby that they were buying on time (everybody except me!). Heaven knows I didn't foresee the Depression.... I was writing about an upheaval I'd heard about when I was a small child. For I spent Sunday afternoons [hearing about men and women who survived the War and Reconstruction].... I heard them talk about friends who came through it all and friends who went under.... And all during my childhood, I'd been told to be prepared for the next time the world turned over.... So I suppose that explains why I wrote a book about hard times when the country was enjoying its biggest boom."

Sunday, August 14, 2011

It's Over

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

Standard & Poor's downgrade of the United States Treasury Department is a harbinger of changing times. The institutional mind has been trained to operate within the framework of the Capital Asset Pricing Model (CAPM). The CAPM is a formula, designed by professors, that assigns assets to distinct and simple categories. It filled a need when the investment management industry drew in the masses. Not, in this case, the mass of investors, but the mass of so-called investment professionals, that include consultants to pension plans, endowments, and foundations. Most of the well-compensated consultants have little understanding of investing, so substitute vocabulary for thought. The same is true of the professors who hand each other Nobel Prizes and collect seven-figure consulting fees for pontificating.

In the October 2002, issue of Marc Faber's Gloom, Boom and Doom Report, I wrote an essay about the Capital Asset Pricing Model and its companions (e.g., efficient markets), that doused the homogenized investment industry which had contributed to the then-current consequence (in October 2002) of a runaway housing mania. Quoting from that 9,000-word dirge: "Indexing is an obvious conclusion to efficient markets. Since companies do not matter, the asset class is all. Indexes are also practical. We all have some idea of what's going on today when we hear that the Dow is down 200 points. From that rudimentary average have been added the Standard & Poor's 500, the Russell 1000, 2000, and 3000. Dozens of offspring met the demand for ever more microscopically defined asset classes that fill the mauve, turquoise, and magenta slices of the consultants' pie charts."

The CAPM includes a "risk-free rate of return." The risk-free asset is, in its simple form, a United States Treasury bill, which has more recently been noted for its "return-free risk." Both in theory and in fact, Standard & Poor's downgrade of the United States from AAA to AA+ is another death rattle for the CAPM. (The downgrade itself has little real meaning, aside from its influence on minds.) This action foreshadows the declassification of assets according to such dreary concoctions as "mid-cap growth," comparative asset benchmarks, and the hierarchy of asset classes that equate higher return with higher risk (e.g., cash, bonds, stocks).

There is also the much larger problem of constructing an asset pecking order with rigged asset returns and yields. The market rate for Treasury bills is not zero. The coming dislocation that institutional and retail investors face is, to most if not all, incomprehensible. Consider the reconstruction of Scarlet O'Hara's Capital Asset Pricing Model after 1860. She discovered what can happen to chimerical fortunes built on the backs of government-fixed, zero-percent, risk-free rates.

The authorized hierarchy is a reason that Treasury yields fell after Timothy Geithner was downgraded on August 5, 2011. Europeans peering over the precipice owe professors and the (so-called) investment professionals - in reality, they are all a bunch of bureaucrats - a kick in the behind for their simplifications. European banks are not required to allocate tier 1 capital against government bonds since sovereign debt is risk-free. So, they bought like there was no tomorrow. Tomorrow has arrived and European banks are furiously ridding themselves of Greek, Portuguese, Italian, French - and anything else that isn't German - sovereign bonds (so, risk-free!!!) that have left them on (or over) the brink of insolvency.

The classification game is finished. In these waning hours of western civilization, gold is safer than government bonds. It also has much higher return possibilities than the unlimited supply of 0.001%, 10-year Geithners - take that, CAPM! Many institutions will sink, including governments. Sovereignty is not what it used to be. Some of the universities where highly decorated professors teach will cease to exist. This is a deleveraging world. It does not conform to the categories. Periodic bursts of insight, such as market behavior of the past two weeks, are preceded by months of mental hibernation.

Looking at that October 2002 diatribe in the Gloom, Boom and Doom Report, probably for the first time since I wrote it, brings to mind all the frauds - central, commercial, and investment bankers, in particular - who claim: "We never saw it coming." The two most recent Federal Reserve Chairmen, Greenspan and Bernanke, have most adamantly insisted, during sworn testimony, that not only did they not see "it" coming, but also, that nobody - yes, nobody - could have seen the credit bubble before it burst.

There were many readers of the October, 2002 issue of the Gloom, Boom, and Doom Report who had already identified the housing bubble. Telephone calls and emails came from all points of the compass. They saw it coming in Hong Kong, London and Madrid, but not at the Fed. Quoting myself from the 2002 essay (this is inevitably an instance of self-promotion, but, inseparable from another attempt to expose these mental and moral midgets):

"Most people who have seen the Internet bubble inflate and burst, who have seen the Nasdaq bubble inflate and burst, do not recognize, even though similar characteristics and atmosphere surround them, that the U.S. real estate market is a credit bubble (of which the stock market bubble was a sibling) and it is living on borrowed time."

"America is broke. We could really stop right here. For an investor, a helpful rule-of-thumb is to own real money (cash, gold, a company trading at its cash value) and squeeze debt-dependent conglomerations until they gag and choke."

I wrote several pages about the then - October, 2002 - obvious housing and credit bubble. Following is one paragraph:

"There never has been a time, since World War II, when homeowners have held less equity in their residences than they do today (about 55%). Is 'homeowner' a dated description? There is an incredibly well tuned mechanism at work here. The savings rate of individuals fell to zero a couple of years back. The ready reason was the stock market -- who needed to save? That money lost, the Average Joe tapped his home equity line. This is unfortunate; a chance to regain his financial solvency is lost. As Nicholas Retsinas of the Center of Housing Studies at Harvard noted, "With real-estate prices up, you would think that Americans would be rolling in home equity. But as fast as they lay hands on it, they are borrowing it out." Not only is this a source of credit, but also the interest rate structure is so low and the borrowing terms so aggressively profligate (loans of 120% of appraised value are hot, Fannie Mae and Wells Fargo have restrained themselves at 107%, interest-only loans for the first 15 years are a big hit) and so flagrantly unscrupulous (the Philadelphia Inquirer reported of brokers tracking down more aggressive appraisers) that the village idiot is living a very princely existence. (Need it be said that buying on infinite margin, house prices have risen according to a structure that might be called the home carry-trade?)"

I was already trying to expose the most destructive American who has ever lived. An effort, I might add, that was a waste of time:

"Greenspan is still talking about the New Era producing miraculous leaps in the timeliness of information, yet he couldn't tell there was a bubble when the Nasdaq traded at a 400:1 price-to-earnings multiple."

"'What Greenspan says is what the market does.' That eight-word proposition that so many believed was all they cared to know. Now, a growing number have second thoughts. This may have been what prompted him to deliver what has become known as his "Jackson Hole Speech" on August 30 [2002]. He claims there is no way he could have seen a bubble coming, seen it when it was here, or done anything about it even if it cuddled up beside him and offered to buy lunch. He claims he couldn't have known about a bubble since that knowledge is available 'only in history books and musty archives.' What are we to make of that? Maybe, bred in a republic, he is confused about his [then recent] British knighthood and thinks it requires him to play the role of court jester. Why hasn't some politician grilled him, at least to evaluate his mental faculties?
Maybe they fear the precarious financial state of the union is positively correlated to our confidence in the head of the Fed. To rant now may cause real capitulation and a liquidation of over leveraged and non-performing assets. (Compared to a shoe factory, a new 6,000-square-foot house is not all that productive. It is an asset that fills up previously empty air.)"

Even in 2002, the Most Destructive American - who still appears on the Sunday-morning talk shows, still enjoys periodic love-ins with Maria on CNBC (subsidiary network to NBC, where Greenspan's wife pulls strings), continues to write tripe in the Financial Times, has read (so-called) academic papers (thus validating his importance) at the Brookings Institute and Counsel of Foreign Relations - was working hand-in-hand with the housing industry:

"In other words, chaotic lending and borrowing reigns, although few see it as such. We have it on the authority of David Seiders, Chief Economist of the National Association of Home Builders, whose stentorian late-July blast comforted the wary: 'The time has come to put this issue to rest. The nations [sic] home builders have said it, the [r]ealtors have said it, and Alan Greenspan has said it once again, in no uncertain terms: there is no such thing as a current or impending house price bubble.'" It is an odd feeling to correct my grammar nine years later. Why didn't you catch that, Andrea? (Andrea was my top-notch assistant who proofread countless tirades against empty suits and on behalf of gold. If you are looking for someone with such talents, please let me know. )

The following two extracts are a warning of how faith-based investors continue to think today:

"[Greenspan] sought... adulation like the celebrities who grace the covers of People magazine. He filled the role of fashion model to perfection. He was known for what he was rather than what he did. He was the man who forever moaned incantations to the New Era and New Economy, and he drew legions of followers, agape as we were to this new technology, of which we did not understand the actual importance, but he unfailingly did."

"[Greenspan] met a willing audience, one that was quite content to believe his testimony even though his speeches were nearly impossible to understand, even by the most astute Fed watchers. He speaks in hieroglyphic abstractions. Common sense should have told his legions of admirers to act prudently, but that was not the mood of times. As Samuel Johnson reflected, 'In time some particular train of ideas fixes the attention, all other intellectual gratifications are rejected, the mind, in weariness or leisure, recurs constantly to the favorite conception, and feasts on the luscious falsehood whenever she is offended with the bitterness of the truth.'"

Tuesday, August 2, 2011

"Do you think Ben Bernanke is J.P. Morgan?"

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

On July 13, 2011, Federal Reserve Chairman Ben S. Bernanke was questioned by members of the U.S. House Financial Services Subcommittee on Domestic Monetary Policy.

Chairman (of the Committee) Ron Paul asked: "Do you think gold is money?"

Chairman (of the Federal Reserve Board) Ben Bernanke responded: "No.... Well, it's an asset."

Chairman Bernanke went on to equate holding gold to owning Treasury bills. In his mind's eye, Bernanke could see the Federal Reserve's balance sheet on which gold and Treasury securities line up in the asset column. He could not have offered Congressman Paul a more sincere answer. But, this is the same man who told 60 Minutes: "I've never been on Wall Street." And, the same man who told a 2006 conference that money no longer played a role in monetary policy, to which the (then) vice president of the European Central Bank walked to the podium and called the statement "pointedly foolish."

Congressman Paul asked Chairman Bernanke, well then, why don't central banks hold diamonds. Bernanke responded: "Tradition."

Tradition appeared before the Pujo Committee in 1912: J.P. Morgan. (To be clear, this is J.P. Morgan - the man - who operated J.P. Morgan - the bank - until his death in 1913, and who midwifed General Electric, Westinghouse, U.S. Steel, the Natural History Museum, the Metropolitan Museum of Art, the Pierpont Morgan Library and had relieved Europe of its Raphaels, Van Dycks, and Gutenberg bibles.) Appointed by the House Committee on Banking and Currency, Congressman Arsene Pujo's inquiry was in temper with the times. The Panic of 1907 had sparked wider interest in bestowing authority over the banking system to a government appointed body. This movement would culminate in the Federal Reserve Act in 1913.

The committee's lead attorney, Samuel Untermeyer, questioned the star witness, J.P. Morgan.

Explaining to Untermeyer the difference between credit and money, the man who prevented a United States Treasury default in 1895 and saved the banking system from collapse in 1907 replied: "Money is gold, and nothing else."

Three words. Six words, counting the qualifying phrase that nailed shut the coffin to the qualifications and equivocations that relieve bureaucratic economists from accountability and expanded their incapacity over the past 40 years to make either a helpful or interesting statement.

Morgan had nothing else to say since he had precisely and comprehensibly answered the question.

A 2002 study by the International Monetary Fund concluded: "[T]he aggregate price level in the United Kingdom and the United States was virtually the same in 1700 as in 1900." During the century after J.P. Morgan died, the Federal Reserve, somehow authorized to replace gold with Federal Reserve Notes, has destroyed 98% of the dollar's value. This was progress.

The Panic of 1907 was resolved by J.P. Morgan, the apex of which was the Knickerbocker Trust failure in consonance with bank runs, calls from country banks on their correspondent New York banks, call rates on the stock exchange rising above 100%, and European selling of American stocks, the proceeds exchanged for gold in New York vaults, which was then loaded on ships sailing for Europe.

By now an old man, suffering from the flu, sneezing, coughing, cigar surgically attached to his lips, Morgan assembled a high command around his library desk at Madison Avenue and 36th Street. For approximately six days and nights the group decided which banks (and trust companies) "were hopelessly overextended and should be allowed to fail, and which were essentially healthy and could be saved." (Jean Strouse, Morgan: American Financier.) The U.S. Treasury had advanced $31 million to stem the panic, but that was the extent of government involvement. If Morgan miscalculated, Jacob Schiff predicted, it would "make all previous panics look like child's play."

Morgan told solvent bankers how much they must contribute to shore the weak banks. Occasionally, a financier balked. One banker told Morgan his reserves had fallen below the legal limit. Morgan fumed: "You ought to be ashamed of yourself to be anywhere near your legal reserve. What is your reserve for at a time like this except to use it?"

Morgan's actions were Olympian, autocratic, undemocratic, and he repelled progressive economists, who knew what was best for Americans. Irving Fisher, a celebrity economist at Yale, wrote in 1907: "The world consists of two classes-the educated and the ignorant-and it is essential for progress that the former should be allowed to dominate the latter." This impulse was considered democratic. Chairman Bernanke, former head coach to Princeton University's economics inductees, is successor to this lineage, as certain of its truth as was Fisher.

The colloquy between Ron Paul and Ben Bernanke elicited the best macro, market-timing advice since March, 1933, when Leon Trotsky made the blue-ribbon call of the 20th century. The revolutionary, murderer, author, and future ice-pick recipient told international investors to (effectively) short the British Empire, the pound sterling's time had passed, and to go long the dollar and the American empire. If FDR was listening, even he must have shook his head in disbelief.

On July 13, 2011 Chairman Bernanke explained: "The reason people hold gold is protection against tail risk, really, really, bad outcomes. To the extent that the last few years have made people more worried about the potential of a major crisis, then they hold gold as a protection," said the greatest tail risk to the West since Genghis Khan.