How a Central Bank Really Shapes the Economy
Among the many evils flowing from the serial bubble machine ensconced in the Eccles Building is the stupendous boom and bust cycles that it unleashes among so-called “risk assets”.
This is not the free market at work in the slightest. Under a regime of honest interest rates and two-way price discovery (that is, absent the central bank put) there never would have been the legion of dotcom billionaires of the first Greenspan Bubble, nor the multi-billionaires who won the Big Short prize when the Fed’s housing bubble collapsed in 2007-2008. And the tens of millions of retail investors who got lured into these get rich manias would not have parted with nearly so much of their accumulated savings, either.
When the central banks turn the money markets and the capital markets into carry-trade driven casinos in this manner, the result is inherently a massive, dead-weight loss to economic output and national wealth. That’s because capital and other economic resources are drastically misallocated to pointless secondary market speculation and pure economic waste. For example, there are now upwards of a trillion dollars of assets managed by so-called “funds-of-funds”.
The latter skim off several percentage points of profit on top of the 20% that the underlying hedge funds extract on their winnings in the central bank casino. Yet they provide no free market based economic value added whatsoever — except to deliver to their wealthy clients the equivalent of race track tips regarding which hedge funds are likely to win, place or show during the coming weeks or quarters.
Mr. Levin’s astonishing win did not result from inventing something unique…like Bill Gate’s desktop software.
And so, living high on the hog from these unearned rents, the operators and owners of funds-of-funds—pure artifacts of financialization— consume the services of swank resorts, office chefs and chartered Gulf Streams that would not be demanded on the free market. There could never be enough profit in honest two-way markets in “risk assets” to absorb the cantilevered fee layering that exists in the Wall Street casino today.
By contrast, in a real free market the principal features of the Fed’s serial bubble machine would be precluded in the first place. The gambling windfalls which result from short-run speculation in risk assets funded primarily with ZERO-COGS—cheap, short- term repo and wholesale funding — would not exist because there would be no pegged money markets offering the economic absurdity of free money for seven years running. Likewise, the abject plundering of the slow-footed home-gamers who get lured into these speculative ramps would also not exist because chronic “pump and dump” schemes could not survive in honest two-way markets.
Yet absent the inherent checks and balances of the free market these central bank enabled casinos do not simply boom-and-bust randomly—they do so chronically and predictably. With the ever increasing confidence levels developed over the bubble cycles since the early 1990s, an entrenched class of permanent, professional speculators has learned to front-run the maneuvers of our monetary politburo almost perfectly.
Accordingly, they do not hesitate to ride the bubble on the way up until they see the lights go off in the Eccles Building, nor plunge back into the post-crash carnage at cents on the dollar when the Fed re-opens the sluice gates, as it did in the winter of 2008-2009. So what has emerged is a permanent moveable feast of speculation where the same so-called “risk assets” are strip-mined over and over as these massive and artificial central bank financial bubbles wax, wane and wax again.
Exhibit number one at the moment might be the $119 million annual paycheck that 30-year old Jimmy Levin earned recently trading “structured credit” at Ochs-Ziff Capital Management. During the year in question his winnings apparently exceeded by 25% the combined $94 million that was hauled down by the CEOs of the largest 6 banks in the US—that is to say, the well-coddled crony capitalists who run JPM, BAC, GS, MS, C and WFC.
But when you strip away the euphemisms, it becomes clear that young Mr. Levin’s astonishing win did not result from inventing something unique, useful and permanent like Bill Gate’s desktop software. No, the entire windfall resulted from the utterly transient trading fact of being audacious and lucky enough to be standing around in the vicinity of a Fed enabled “third dip” on toxic sub-prime securities.
During 2012 Levin’s 14-person team of speculators apparently made a $2.0 billion profit on a short-term bet on about $7.5 billion of busted loans and bonds— mainly the smoking remnants of subprime CDOs and private labor MBS. As head of the trading group, Levin’s share was apparently the aforesaid $119 million, and this swell outcome was truly a gigs-to-riches story.
It seems that only a few years back Jimmy had excelled at teaching the son of the joint’s founder, Daniel Och’s, how to water-ski at summer camp. Levin then got himself a “computer science” degree at Harvard, an intern job at stepping-stone firm and eventually a gig at Ochs-Ziff Capital Management— where soon the sub-prime triple-dip presented itself. And then, lickety-split, Levin landed among the top 0.0001% of wealth holders in what is surely no longer Horatio Alger’s America.
Here’s the point. In an honest free market there would not be a Ochs-Ziff Capital Management with $40 billion of casino chips. There would not be tens of billions of busted financial assets laying around the streets of Wall Street for Fed front-runners to scoop up when the timing was propitious.
Likewise, in an honest two-way market, no one in their right mind would bet $7.5 billion on financial drek using high leverage and minimal hedges. And no 30-year old would be given leave to close his eyes and bet the ranch, as apparently Levin did, based on merely the “housing recovery” word clouds being emitted by the monetary politburo and its echo-boxes in the financial press.
In short, free market capitalism is not about something for nothing.
Once upon a time no honest capitalist tycoon would… demand that taxpayers fund his polo ponies…
The central bank casino that gave rise to the Levin fortune has also rendered an even more noxious offspring: namely, a culture of entitlement among the casino gamblers that fuels insensible crony capitalist plunder throughout the land. So today comes forward one Vincent Viola, founder of the HFT firm, Virtue Financial, demanding a $100 million ransom from the hapless taxpayers of Florida — a burned-over economic province that might as well be labeled ground zero of the Fed’s serial bubble machine.
It seems that only a few months ago, Viola purchased the Florida Panthers hockey team for $750 million — notwithstanding the fact that it appears to be losing about $25 million annually. Needless to say, during the 5-years he was building Virtue Financial, Mr. “Viola” — who is blessed with the happenstance of a truly resonant family name — did not have much experience losing money. According to his IPO filings, Virtue Financial was profitable on 1,277 days out of 1,278 days it has operated in its current firm.
That’s a win rate of 0.9992175.
Only in Bubbles Ben’s casino!
The point is simple. Once upon a time no honest capitalist tycoon would have had the gall to demand that taxpayers fund his polo ponies and players. So add the noxious culture of entitlement and political corruption to the list of ills that our monetary central planners have created.
People like Vincent Viola should make true believers in liberty and free enterprise downright ill!
The worst thing is that the Vince Viola story is just par for the course.
Try this nightmare of plunder that came out of the crony capitalist bailout of GM: the fast money boys reaped billions from the busted securities of a bankrupt auto supplier based on outright blackmail of the White House. From The Great Deformation: The Corruption of Capitalism In America, pp 662-665:
Delphi was comprised of the former parts divisions—radiators, axles, lighting, interiors—that had been spun out of GM in the late 1990s by investment bankers claiming it would make GM look more “focused” and “manageable.” In truth, Delphi was a dumping ground for $10 billion of GM’s debt, pension, and health-care obligations, as well as dozens of hopelessly unprofitable UAW plants and billions more of hidden liabilities such as parts warranties.
Not surprisingly, Delphi hit the wall early, entering Chapter 11 in the fall of 2005. That this spin-off company was intended all along to be a financial beast of burden for GM is evident in its reported financials for its prior six years of existence as an independent company. During that period its sales totaled $165 billion, mostly to GM, but it recorded a $6 billion cumulative net loss and generated negative operating free cash flow. Indeed, saddled with $60 per hour UAW labor costs against non-union competition at $15 per hour, it was kept alive only by an intra-industry Ponzi scheme: Delphi floated bad trade credit to GM and GM massively overpaid Delphi for parts.
Needless to say, Delphi was an economic train wreck that had no prospect of honest rehabilitation, but under pressure from GM and the UAW it remained mired in bankruptcy court for the next four years. In the interim it continued to float billions of GM’s payables on the strength of its DIP facility, yet was ultimately able to emerge from Chapter 11 only because the White House auto task force saw fit to pump billions of taxpayer money into its corpse as part of the GM bailout.
The first-order effect of this terrible abuse of state power, of course, was a few more $60 per hour UAW jobs in Saginaw, Michigan, and a few less $15 per hour non-union jobs in Tennessee and Alabama. But the real evil of the bailout lay in its rebuke to free market discipline and the powerful message conveyed by the White House fixers that failure in the market-place no longer mattered. Even complete zombies like Delphi could be spared, so long as crony capitalism was alive and well in Washington.
The self-evident fact is that Delphi should have been liquidated, with its few viable operations auctioned off and its dozens of uncompetitive and obsolete UAW plants shuttered. The billions of trade credit it had foolishly extended to GM should have been written off, not paid in full by the taxpayers (with GM bailout funds). Yet this capricious assault on the free market was only one of the evils that came from the auto bailouts.
After Delphi was unnecessarily resuscitated with what turned out to be $13 billion of taxpayer money, including $5 billion from TARP and $6 billion from the Pension Benefit Guaranty Corp.’s takeover of Delphi’s busted pensions, an even more obnoxious turn of events unfolded. A marauding band of hedge fund speculators were able to scalp an astounding $4 billion profit from a company that under the rules of the free market and bankruptcy law would never have seen the light of day after its original Chapter 11 filing.
Indeed, just one of the investors, a so-called vulture fund named Elliot Capital, appears to have realized a 4,400 percent gain, or $1.3 billion, on its Delphi investment, which was taken public in an IPO in the fall of 2011.
The particulars of this case, in fact, reek with the stench of crony capitalism. They powerfully illuminate how the Fed’s boom and bust cycling of the financial markets wantonly showers ill-gotten wealth on the 1 percent. According to the SEC filings, Elliot Capital picked up its Delphi position for $0.67 per share in the midst of the auto industry collapse and while both GM and Delphi were still in Chapter 11. It had the good fortune to sell stock to the public two years later at $22 per share.
Perforce, what the filings do not disclose is that in the interim Elliot Capital and its confederates had gained control of the Delphi bankruptcy by buying up the so-called fulcrum securities for cents on the dollar. They then threatened to paralyze GM by not shipping certain irreplaceable precision-engineered parts like steering gears, where GM technically owned the tooling but it was physically hostage in Delphi plants.
Needless to say, in a regular way bankruptcy a judge would have come down on the Elliot Gang like a ton of bricks for contempt; a tough judge might have even figuratively put them in shackles. But under the ad hoc rules of crony capitalism, the law counts for little and political hardball is the modus operandi. This meant that the hedge funds were literally able to strongarm the Obama White House into providing the $13 billion bailout to the Delphi estate. Even auto czar Steve Rattner, who was himself busily fleecing the taxpayers, described the hedge fund position as an “extortion demand by the Barbary pirates.”
Winnings of the Elliot Gang are an obscene lesson in how crony capitalism and Fed money printing perverts the free market. Without the $13 billion fiscal transfer Delphi would never have emerged from bankruptcy; and without the flood of liquidity from the Eccles Building there would have been no frothy market on which to unload the Delphi IPO.
As it happened, however, the other vultures in the Elliot Gang had a good feed, too. In particular a credit-oriented hedge fund and spin-off from Goldman Sachs called Silver Point gained a $900 million profit from the deal, and this was not an atypical result: it was one of the most adroit speculators in the busted loans and bonds of overleveraged train wrecks miraculously brought back to life by the Fed’s flood of fresh money.
Another huge winner was John Paulson’s fund. This time its big short was against the American taxpayer and the gain was a reputed $2.6 billion. But the most egregious windfall was the $400 million gain racked up by Third Point Capital. This hedge fund is run by one Daniel Loeb who had been an Obama supporter in 2008, but had since noisily denounced the president for unfairly picking on the 1 percent.
Given the history here this might have put an uninformed observer in mind of biting the hand that feeds you. Except Loeb didn’t stop with his supercilious but widely circulated critique of Obama’s purported “class war.” Instead, he held fund-raisers for Romney and contributed $500,000 to the GOP campaign.
In so doing, Loeb helped clarify why crony capitalism is so noxious and pervasive. It turned out that another winner from the Elliot Gang’s 40X return on the carcass of Delphi was an allegedly passionate opponent of the GM bailout; that is, the author of a famously penned New York Times op-ed called “Let Detroit Go Bankrupt.”
The ease with which the vultures made their billions from this crony capitalist raid on the US treasury is evident in Mitt Romney’s $15 million of Delphi winnings. Based on the timing of this saga, it appears they were obtained while Romney was on the chicken dinner circuit honing his anti-Big Government rhetoric for the upcoming presidential campaign. Call it the Detroit Job.
It goes without saying that with friends like these the free market does not need any enemies. More importantly, under the financial repression and Wall Street–coddling policies of the Fed there is no free market left. Instead, it has been supplanted by a continuous and destructive cycle of boom and bust emanating from the monetary depredations of the state’s central banking branch.
In the process of inflating stocks, leverage, and speculation to absurd heights, the Fed finally loses control, transforming the financial markets into economic killing fields. Yet in its panicked reflation maneuvers, it then fosters a vulture capitalist harvest of such magnitude as to be unthinkable on the free market. This is the absurd end game of Greenspan’s wealth effects monetary policy and specious claim that bubbles can’t be seen, but only left to burst. This is how recovery for the 1 percent happens.
Ed. Note: When you peel back the curtain on the current system of crony capitalism, it becomes abundantly clear what corrupt and insane system it really is. It’s a system that rewards insiders and punishes the vast majority of investors without good political connections. And it doesn’t show any sign of stopping. But there is a way around it. A way for average investors to stay one step ahead of the insiders, and turn the whole damn system on its head. Sign up for the FREE Daily Reckoning email edition, right here, to learn more.
For more great essays and insight, please visit David Stockman’s Contra Corner.