Poor Ben’s – New (First?) Recession
Technical Indicator Index web site, we’d never have known, much less understood. Mr. McHugh was previously a founder and executive of a bank in Delaware and he ought to and does know about what follows. He’s convinced us that Poor Ben is committed to starting a recession.
The last tool, the fourth tool is a behind the scenes operation not generally known, if at all, to the general public. It goes by the name of: The Federal Reserve Bank Examiner. The Fed Chairman sends bank examiners into banks about once a year. They make a decision as to whether or not the active loans the banks have made are good or bad. How do they know? Well, it depends on the result that the Fed Chairman wants, seeks, demands.
In other words the rules aren’t written in stone, and they can change on whim or intention of the Fed Chairman. If the Fed wants more money in the system, they’ll generally pass on the quality of the loans outstanding, meaning that the examiner will certify that it looks like the loans are good and will be repaid on a timely basis. If it’s all good like that, then the banks will not have to reserve so much cash (from deposits) for potential losses, so they’re actually empowered to make more loans.
Thus more money is pumped into the economy, which is “liquidity” in the system. This is actually Inflation – increasing the money supply. This excessive liquidity always, every time throughout history causes not only daily expenses, but, asset prices to increase. Remember, due to “fractional reserves,” for every $1.00 deposit, the bank can loan $10.00, creating debt, which they carry on their balance sheet as assets. Viola – money out of thin air. Those that receive the new loans, sure as heck get “money,” though in fact – it’s debt.
All parties thereto are happy; and, the Bank Examiner may actually smile when he leaves, really leaves, after four or five days hanging around your bank, and digging into all your paperwork. Business people, particularly local commercial property developers will be well aware when the green light is on. The bankers actively solicit their business, take them on outings, talk to them about the fact that this is the time to expand, we’ve got your back and it’s all good like that.
On the Other Hand
Consequently, the Chairman’s seemingly innocuous comment above, “Neither bankers nor their supervisors should become complacent….” Is extremely significant to our story. Because now comes the “roughing up.” Bank Supervisors will be dropping in on these local banks. After they arrive, they’ll be given a private room with a door that locks, a table, and a coffee pot. And they’ll request the records, the actual records on file from entities that the bank has loaned money to. All the records, which they’ll pour over (perhaps in the Bank President’s mind), endlessly. And, there is little to no smiling at the beginning or end of the day. A curt nod, maybe more, but not much. These people are showing the Bank President that they are very very serious.
There is no smile, no comments, maybe a request for more documents. Soon a meeting will be called and the Bank President may be confronted by the Examiner, and, most likely, a supervisor to raise the ante, to let the banker know that things have changed. Sunny skies have receded. What may have been considered perfectly good loans last year (Mr. Greenspan’s tenure) are suddenly declared “unsatisfactory.” Well after several months of back and forthing, some bank personnel may be fired, and the bank may begin pushing their previous “best friend” commercial developers to sell the properties, pay back the loans and just forget about it for awhile. Until conditions become favorable, once again.
In the past, this process was controlled much more than less by the Business Cycle. Today, that has been altered to some extent by the amount of money flowing around the global economy that the Central Bank cannot control completely like in the old days when their thumb on the local bankers was end-all and be-all. However, that moreover applies to the major banks, and in the matter of the smaller banks, local and regional, the Fed controls, absolutely.
At any rate, the local bank comes under extreme pressure, the Board of Directors is reminded that there might be criminal charges filed, extreme sanctions, and they’d best get with the program to call in loans, and stop making new ones. This is beginning behind the scenes, is not in the papers, except for mentions that a developer fell down, and lost his funding, and his shirt along with it. The Bank President may or may not keep his job and stock options. And, lesser folk, like the head loan officer will walk the plank without complaining at all. He’ll get another job, because the entire industry will know what is happening.
While this is going forward, the economy begins slowing because those easy money commercial real estate loans are gone, not facilitating new opportunities, and some loans are actually being recalled, even if only a bit of slow pay. But the door is shut for new loans, and darn it, that’s how the banks make more and more money, by making new loans. So the retrenchment begins, on the way to Recession, and the Fed hopes it can stop it there.
Quiet – Keepin’ it Quiet
It’s a very serious and tough game being played out, and none of the parties in the know are going to say a single word to the press. Only to their lawyers, and the lawyers are definitely involved. Call it – beyond risk management – call it Damage Control. How can they be so cruel to these banker boys? They’d been so “accommodative,” as has been said about the Fed for so very very long. Well, they’re worried about an extremely imbalanced, some call it a bizarre economy with unprecedented conditions we’ll discuss below. This is very serious business.
Chairman Bernanke stated, “The rapid growth in commercial real estate exposures relative to capital and assets raises the possibility that risk-management practices in community banks may not have kept pace with growing concentrations and may be due for upgrades” Now if you aren’t a banker, and hadn’t read what’s above, you wouldn’t likely understand how serious such comments really are. But, you get it now! If not, read again, and prepare to list and sell your residential property, and lock-down your portfolio, because a hard winter storm is much more likely to occur, and sooner now, sooner. Again, this was barely reported in the press.
But, it means that Dr. Bernanke is now on the job. Firmly, and out comes the steel glove. More than that, he’s bringing a “soft” wrecking ball with him. When he swings it, he can only hope he swings it just hard enough and in just the right places. Very very difficult if not impossible. Why? Greenspan should have begun credit tightening process at least one year ago. But, heck, he wanted to go out January 31, 2006 with the DOW market above $11 thousand, and a “stated” rosy economy. So he could get a great book deal advance? He pulled $8.5 Million, and he won’t have to give the money back. Now we’ll pay, many with their homes and disrupted families; and, Greenspan, the Great Charlatan, rather, the Maestro, rather, the Retired Courtesan, will play.
Remember one thing: Inflation. More money, creation of more money and credit is Inflation of the money supply. More money and credit then leads to higher prices for things. Like your house. That’s why housing prices have gone up 50% in alleged value in the last five years. Now you may exercise regularly, read good books, eat right, and sure, your kids are above average. But, that is not what caused the increase in your home values. What you’ve read directly above is a large part of it. And, what follows is the rest of the piece.
It Isn’t Good Now
In fact it’s treacherous. But, you knew that if you’re still with us here. The Feds have wanted the money supply to grow and they’ve allowed the banks to be very very aggressive, and, in particular they’ve been making these extremely risky Adjustable Rate Mortgages. But, not just for residential property. They’ve been aggressively making commercial real estate and business loans. Well, we’re all looking for an opportunity, and when your banker starts courting you, and encouraging you to make that business expansion, invest in more equipment, build the building, then you should realize the Fed wants to continue to grow the money supply, put more liquidity into the system. Banks compete with each other, and even some Regional Banks are publicly traded companies, and all of them, even the smaller ones have investors, share holders, and everyone wants to make more money.
Moral Hazard
Naturally, the Fed encourages this, which leads inexorably, every time, to a thing called “Moral Hazard.” The major banks have learned that if the Fed is helping them push out, and the Fed knows that the loans are getting a bit more risky, then well everything will be OK, because the Bigga Banks are too big too fail. They’re all so intertwined and such, with money being traded back and forth between them on a daily basis, that if one biggie failed, it could bring down the system. Too big too fail.
So, as you can imagine, when the Fed gives the green light they’re off to the races, and the worthiness of the loans they make become secondary to an awakening of “animal spirits.” The lust for more profits. Add in real competition between the banks, and they begin to lower there credit standards to make the deal, any profitable looking deal. In housing, the lenders compromise the appraisers. Through subtle manipulation they make it clear that the house “must” hit the numbers, be worth on paper, the number to make the deal go through. Finally, here, the banks, the lenders, keep few or none of those mortgages. They immediately sell them upstream into the Secondard Market. They are purchased by Fannie Mae or Freddie Mac, or are outright bundeled up in packages and sold through Wall Street as Mortgage and Asset Backed Securities (MBS and ABS).
It’s All Over Now Baby Blue
Contrarian analysts such as our selves, have been saying, some for years, that the Credit Bubble, which begat the Mortgage Bubble, which begat the Housing Bubble has to come to an ignominious end. Perhaps real tragedy. At least a controlled and consciously induced Minor Recession, or a slightly run away Major Recession, or, if it goes completely out of control, World Wide calamity, another Great Depression. The money and credit supply, the debt numbers today are worse than what existed prior to the Crash of 1929, which brought on the Great Depression.
Sure, this is all gloom and doom scenario stuff. But, once you understand it in your mind, you might, just might be able to overcome the emotional element that drives investment by non-professionals. In particular here, we are talking directly to residential investors. Forget about: “You gotta be in it, to win it.” Realize you already did. You won it if you’ve held residential investment property for the last five years. Sometimes “You gotta get out of it, to win it.” That time has arrived.
But – There’s More … To It
As we’ve mentioned in past articles the Fed will stop publishing the M3 data at the end of March. Meaning, that we won’t have a true, and accurate fix on the amount of money and credit the Fed is creating, the total amount of money in the system. With the M3 number available (has it’s been since 1913) close-watching analysts can determine how much money and credit is being dumped into the system. It guides investment decisions. If foreign holders of dollar assets are able to understand the amount of money being created out of thin air, and if it’s a large amount, they become very wary of buying, and worse, holding our Treasury, Corporate and Mortgage Securities and Bonds, our Debt.
The more money created from nothing, in fact, will devalue the dollar, lowering the balance sheet worth of the dollar; and, consequently, they’ll at minimum demand higher interest rates to compensate. Well, that would blow up the Housing Bubble. So, how is the Good Doctor Ben going to keep them in the dark, while pumping to avoid a total collapse? He stops reporting M3. Remember, he must bring on a Recession, but, wants to avoid – worse.
As discussed, there are basically two ways for the money supply, the dollar money supply to grow. Bank lending and credit expansion creates more spending, but, critically, those funds are placed in the bank as deposits before they’re spent. Remember, this is based on bank deposits and the fractional reserve process. For every dollar on deposit, the bank can loan ten dollars. Thus blowing up the money supply. That is a known component. The problem for the Fed, is that they really can’t control where that money is going, to who it’s being lent, and for what purposes. As you can imagine, it’s going to create jobs through business expansion. But, the Fed wants – needs – to control where it’s going as part of it’s Master Plan.
Consequently, rather than allow money to be created through the fractional reserve bank lending process, which they can’t control, they’re just going to print the money, create it out of thin air. While some appropriately call that counterfeiting, we’ll let them say that, and we’ll just call it what it also is: Fiat Money. Not based on anything, but, the desire to create more money by “printing” it in the back room. The Fed will therefore, buy things directly, and/or lend money to entities (not the commercial banks) that will put it to use the way the Fed wants. He (the Fed) who pays (or loans to) the piper (markets), calls the tune. Always. And, Thank You Very Much. Sir.
So, now you understand, with M3 no longer printed, it will be more difficult to determine how much money they’re printing and where it’s going. Where might it go? Well, many argue that the Fed through various entities props up the stock market to this day, and last week, and very likely tomorrow, because tomorrow, based on above, is going to be very bad indeed. In other words the Fed, without direct accountably through accurate M3 reporting, can buy share of stock directly, prop the markets, and never report it publicly. Those in the know, on the team, in the game at the highest levels, who figure it out, will remain silent. And, those marginal, but often very professional bearish analysts, who figure it out and try to go public with the information are marginalized, limited to the Internet to get out the news. Better than nothing.
Alternatively, they can loan to financial entities (can you say: Wall Street Financial Firms) that will buy stock, really on behalf of, and you can bet, at the direction of the Fed. Like General Motors? Keep them afloat, fool the naive investors. (And, all this is done basically off the Fed’s books, which we don’t get to see anyway.) Don’t get to see? That’s right. Remember, the Fed is a Specially Chartered National Corporation whose shares of stock are privately held by Major Banking Institutions. There is no bottom-line balance sheet made public, to the public or Congress. And, we’re willing to bet five cents that the Treasury Department doesn’t see the real data either. Those two wash their dirty laundry in the same hidden back waters. “Partners in Crime” as the saying goes.
What else might the Fed buy to prop the economy and avoid an institutional, or Systemic Monetary System Failure. Like what stock? Well how about like Fannie Mae or Freddie Mac stock shares. If the need to prop them up becomes even more dire in a raising interest rate environment, which causes more of Fannie (lil’ sister) and Freddie (lil’ brother) “guaranteed” loans to fail; and, if, heaven forbid. If those two errant brother and sister ever accurately report their actual accounting numbers over the past few years, heads would role, jail may loom for some, and the stock share price would plummet. Can’t have that.
Why Hide the Money – Again
Simply put, if you had a situation where you could determine that bank lending is slowing down, and, M3 was increasing, you’d realize instantly that the Fed was creating money and credit, because the banking system was not. So, there you have it. They’re going to have to bite the bullet, but, let’s hope they catch it in their teeth the first time, and that fast approaching bullet doesn’t make a huge exit hole out the back of the Collective Head. Which rhymes with Fed, and we really have a need to make a corny joke about right Now.
The Political Economy
In November we have a thing called an Election. A very critical election. With the President’s polls running so low, he’s discovering many Republican pols are running away from him like mad. Too bad. They’ll attempt to distance themselves from a failed War; moreover, they’ll likely pile on regarding the economy. The Democrats are so ineffective that the Republicans may have to lead that charge to keep their seats in November.
So, the Chairman Ben can play it hard, or not. If he plays it hard, and the Congress swings to the Democrats, you can bet way more than five cents that he’ll be gone before the Presidential election in November 2008. They will find a way to blame him for everything and force his resignation. He knows this. Imagine trying to sleep. Economically, or monetarily speaking, he must have a recession by maintaining a firm position.
Finally, someone must take away the punch bowl, all the free money and credit. He’ll be forced to raise interest rates some what. What’s his back door plan? While he’ll do his level best (as we’ve gone on ad absurdum) to simultaneously and covertly add more money through the back door to stop housing from flat out tanking, he probably will scare the homeowner (who inadvertently contributes 70% to GDP) enough to stop consuming. That’s not good in an election year.
At any rate, unless interest rates go up, the dollar tanks. With these extremely negative scenarios playing out, what’s a nice guy like Benjamin Bernanke to do to – well you know – keep his job. That can always be rationalized by saying to one’s self. We’ll I’ll play along. I have to Go Along to Get Along. Then I can fix it, balance it out later. Great Good Luck – Poor Ben. How many home foreclosures did you consciously set up today?
