The God's Next Big Laugh

Alan Greenspan, the world’s best-known civil servant since Pontius Pilate, wrote in the Financial Times this week. In the interest of saving readers’ time, we reduce his half-page circumlocution on today’s financial crisis to 4 simple words: it wasn’t his fault. Bill Bonner explores…


Hear that noise?

That’s the sound of the gods laughing They’re laughing at Northern Rock, Bear Stearns, and all the angels, archangels, seraphim and cherubim of the whole financial industry. The geniuses thought they had put an ankle bracelet on uncertainty. They believed that with their new tools they could model risk, quantify it, and control it. Now, they’re going broke…and the gods are tumbling off their chairs.

But listen up, because the biggest laughs are still ahead.

Alan Greenspan, the world’s best-known civil servant since Pontius Pilate, wrote in the Financial Times this week. In the interest of saving readers’ time, we reduce his half-page circumlocution on today’s financial crisis to 4 simple words: it wasn’t his fault. An unexpected and unpredictable force had taken over in the financial markets, he explained…a kind of ‘dark matter’ that caused everyone to act a little funny. According to Mr. Greenspan the source of the proximate problem is the homebuilding industry. For some reason, (he decided not to mention what), it overbuilt. The crisis will end, he continued, “when home prices stabilize and with them the value of equity in homes supporting troubled mortgage securities.”

Mr. Greenspan further explained that “trust” in the system was “badly shaken”… “when BNP Paribas revealed large unanticipated losses on U.S. subprime securities. Risk management systems – and the models at their core – were supposed to guard against outsized losses. How did we go so wrong?”

He followed this rhetorical question with what was essentially an elaborate feint, designed to send the hounds barking up the wrong tree. Risk management systems, he says, “do not fully capture what I believe has been, to date, only a peripheral addendum to business cycle and financial modeling – the innate human responses that result in swings between euphoria and fear that repeat themselves generation after generation with little evidence of a learning curve.” The former Fed chief has a point. The public is subject to mood swings. It is just a shame he dodged credit for his own contribution to the euphoria of ‘2002-’07.

Looking back at the long history of the market’s manic-depressive episodes, it is difficult to find an instance in which extreme mood swing was not exaggerated by something in the water. Neither the Mississippi Bubble nor the South Sea Bubble would have happened had not John Law invented the first central bank – the Banque Generale – in 1716. Americans wouldn’t have been so bumptious in ’29 had it not been for Fed chairman Benjamin Strong’s little ‘coup de whiskey’ intended to help out his friend Montagu Norman at the Bank of England. The Japanese wouldn’t have goosed their stock market up to 39,000 (currently near 12,000) had it not been for the exceptionally low interest rates following the Plaza Accords in September 1985; rates were cut four times the following year – sending Japanese property and equities soaring. And Americans never would have gone on a residential property binge had the prime rate not been kept exceptionally low for an exceptionally long period under the leadership of the very same person writing in the Financial Times this week: Alan Greenspan.

Centrally-planned prices send the wrong signals and cause people to miscalculate. And no price causes as many miscalculations as the price of credit – controlled at the short end by central bankers. Of course, anyone can make a mistake. But to make the kind of mess we’re seeing in the capital markets now, you need a theory. Of course, central bankers had one.

The foundation for modern central banking theory was laid down in the very year Alan Greenspan was born – 1926. That was when one of the first “neoclassical” economists, Professor Irving Fisher, published “A Statistical Relationship between Unemployment and Price Changes,” arguing that a little inflation was a good thing, since it seemed to stimulate employment.

Then, “in the 1970s,” writes Nobel Prize winner Edmund Phelps in the Wall Street Journal, “a new school of neo-neoclassical economists proposed that the market economy, though noisy, was basically predictable. All the risks in the economy, it was claimed, are driven by purely random shocks – like coin throws – subject to known probabilities…”

By 2001, the Fed opened a new museum in Chicago. Visitors were invited to look at the economy as though it were a science project. They were confronted with a problem and asked what would be the appropriate response – lower rates or raise them? Then, they were given the correct answer.

Today, America’s central bank applies a “rule based monetary policy” – supposedly founded on the ‘scientific’ discoveries of Irving Fisher and his heirs. What’s the rule? Balance out inflation against unemployment. When inflation threatens, raise rates. When the economy is menaced by unemployment, cut them. And always, like a dishonest butcher, make sure your thumb lingers on the inflation side.

Professor Fisher lived long enough to see the gods laughing at him. Just days before the stock market crash of ’29 he wrote, “stock prices have reached what look like a permanently high plateau.” Then, when the crash came he said that the “market was only shaking out the lunatic fringe,” and claimed that prices would soon go much higher. A few months later, Fisher had lost his fortune and his reputation, but still told investors that recovery was just around the corner.

So far, Alan Greenspan has only gotten a few chuckles, as he attempts to explain where he was and what he was doing when the world’s biggest bubble took shape. But the more he explains, the more people understand: that the ‘science’ of central banking is nothing more than claptrap, and Mr. Greenspan is a scalawag.


Bill Bonner
The Daily Reckoning

March 21, 2008 — London, England

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now.

“And in green underwood and cover
Blossom by blossom the spring begins…”
– Algernon Charles Swinburne

Yesterday brought much conflicting, confusing news.

The Dow rose 262…bouncing back from Wednesday’s drop. Oil held just over $100. Gold dropped hard…and came to rest at $920. And the dollar rose strongly against the euro. Now, you can buy a euro for only $1.54.

What to make of all this?

“Central banks pour on the cash,” is the central headline in today’s International Herald Tribune. The European Central Bank is getting in the act – with a $15 billion infusion of cash. The Bank of England came in with $10 billion.

When central banks put in extra cash it sounds vaguely inflationary. In fact, it is a sign of just the opposite – at least at first. Banks in the euro-zone have reacted to the crisis just like those in Britain and America – they’ve become reluctant to part with money. The interest rate on three-month loans has risen to 4.67% as “system crisis shows no sign of ending.”

It shows no sign of ending because it’s impossible to say where the end of the losses will be…even when you’re looking right at them.

Gretchen Morgensen in the New York Times:

“As of last Nov. 30, Bear Stearns had on its books approximately $46 billion of mortgages, mortgage-backed and asset-backed securities. Jettisoning such a portfolio onto a mortgage market that is not operative would, it is plain to see, be a disaster.

“But who knows what those mortgages are really worth? According to Bear Stearns’ annual report, $29 billion of them were valued using computer models ‘derived from’ or ‘supported by’ some kind of observable market data. The value of the remaining $17 billion is an estimate based on ‘internally developed models or methodologies utilizing significant inputs that are generally less readily observable.’

“In other words, your guess is as good as mine.”

Our guess is that there are more surprises to come. But this is the first day of spring, so we’re determined to look at things in a positive way…even if we have to stand on our head.

Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) have been authorized to buy up more mortgages. The Fed has made available another $200 billion. Rates have been cut to barely half the rate of consumer price inflation.

The banks are trying to avoid a “liquidity crisis,” something that happens when there’s no money or credit readily available. But liquidity is not the real problem; the real problem is solvency.

There’s plenty of money around. But it’s scared money…fearful money…timid money. It’s now rushing to cover – into short-term Treasury bills. So much money has gone into 3-mo. T-bills that the yield has fallen to only half of one percent. And so much money has sought the additional safety of TIPS – indexed against inflation – that the yield has actually gone negative.

The TIPS are favored by investors who want the certainty of the full faith and credit of the U.S. government…but who are also certain that they can’t put too much faith in the U.S. government’s money. The TIPS are not merely IOUs from the government, but IOUs with handcuffs.

It is a bit like a second marriage – to the same person. ‘Yes,” say the feds, in the pre-nup redux, ‘we admit that we’ve cheated on you…but we promise not to do it again.” (As a measure of how much hankey pank has been going on, a silver dollar – once worth a dollar – now has silver content alone worth $15.20.)

And so, the TIPS are to be adjusted to the rate of consumer price inflation. If this worked as well in practice as it does in theory, an investor could put money confidently into TIPs, knowing that he was protected not only against the risk of default, but the risk of inflation too.

But there’s a catch. The same people who issue the IOUs also figure out how much inflation has gone up. ‘No, we won’t cheat again,’ say the Feds, ‘and just to make sure…we promise to tell you if we do.’

Conveniently, for them, they also changed the way they calculated changes in consumer price inflation. Previously, if the price of say, butter, rose 10 cents a pound, they figured the cost of living had risen accordingly. Now, if the price of butter goes up 10 cents, they figure you will switch to margarine, which is 20 cents a pound cheaper. Hey, fella – your cost of living just went down!

*** Yesterday’s big news was the downturn in commodities and gold. We’ve been waiting for it…it now seems to have arrived.

The softs are going down – not surprising, considering all the wheat and corn that is being planted.

The hards are going down too – also not surprising considering how much they’ve run up…and what will happen to demand as the credit crisis evolves into an economic crisis.

Ah…that’s the point, isn’t it, dear reader? At the debut of the housing bubble, we argued that speculation in housing would evolve from a purely financial matter into an economic one. That is, people would gradually change their spending and saving habits as they believed they were getting rich. The economy itself – not just the financial markets – would be affected. That is just what happened. Girls went wild. Boys too. And soon, the whole economy was giddy.

Now, there are those who believe that the credit crisis – which is the debut of the deflation phase of the bubble – will be merely a financial phenomenon, with little impact on the real economy. It that were true, the damage would be limited to a few banks and investment firms…and a fringe of lunatic homebuyers. The great mass of consumers, and the lumpeninvestoriat, on the other hand, should be spared.

But it is obvious – to us at least – that the same delusions of wealth that led people to overdo it on the upside will surely lead them to overdo it coming down the other side.

That is what we are beginning to see – not just in U.S. retail spending…but in the world’s commodity markets too.

Yesterday, commodities continued their meltdown. In dollar terms, they were almost all down. As mentioned above, the dollar rose against the euro and just about everything else – save stocks and bonds.

Unemployment rose.

In the United States, according to a Bloomberg report, California leads the nation – in defaults, falling house prices, and a slumping economy.

And the automakers report that they have given up expecting a rebound in sales in the second half of the year.

*** Mothers all want their children to grow up to be a success. But we’re beginning to wonder about the whole plan.

The thought was planted when we reflected on America’s candidates for president. You could scarcely ask more for your child than that he grow up to occupy America’s highest office, right? And yet, looking at the current post-holder, and those who would take his place, we wonder: why bother? The problem with politics is that it forces a man to offer empty phrases, make empty promises, and make empty gestures. In the current campaign, for example, the word “change,” is cast about as though it were coins to a mob. They scramble for them and come up empty handed. Years of this kind of posturing take its toll on the politicians themselves. (We happen to know this for a fact – though a very well-guarded state secret: when autopsies were done on a random selection of dead congressmen, they opened up the crania and found there was nothing there. “How did these men function with no brains,” asked the astonished doctors. But for those of us who have been following politics, the answer was obvious.)

A politician – especially one who is running for the highest office – can’t afford to think; he hasn’t got time. He has to appear everywhere…make empty speeches, with feeling, of course…and shape his palaver until it is smooth enough to go down the gullet of the marginal voter. In private, the politicians we’ve met have mostly been likable people – we had a particular fondness for Senator Harry Byrd…a real gentleman of the old school, and of course our friend Ron Paul – but most of them are ruined by the trade…hollowed out…and made useless for honest work or genuine conversation.

We’ve been reading up on the history of Rome – trying to prepare for the decline and fall of the U.S. Empire.

During the hundreds of years of Roman hegemony, from the early Republic to the Late Empire, the singular mark of success of all Romans was success on the battlefield. Rome had a military machine that no rival could match. And much of its power came from the ideas and attitudes of the Romans themselves…and later, other citizens of the empire. They believed that a military career was not only the route to success – it was success itself.

The ideal – and most successful – Romans, from Scipio Africanus to Julian the Apostate, attached themselves to the legion in their late teens…and stayed with it practically for the rest of their lives, moving in an out of military service along with other government roles – senator, consul, governor, and so forth.

While in Rome, a man on the make might rest and over-eat, but the best military leaders shared the hard life of their soldiers while on campaign.

“He marched always on foot in the middle of his men,” Dion says of Trajan. “He attended to the organization and disposition of his troops all the while he was campaigning, directing them with one order, then with another, fording all the rivers and streams right along with them.”

The good Roman general lived the same tough life as his men. Trajan was said to eat the same food, and sleep on the same hard beds, as his men. He marched with them…and fought with them.

In the early days of the Republic, generals were expected to fight hand to hand with the enemy. Many were killed, of course. But that was just a part of the job…a part of what it meant to be a successful Roman. Later, the generals began to think they could serve better back from the front lines, where they could direct the battles in a safer, more rational manner.

Often, the best generals – or even the worst, for that matter – spent the greater part of their lives in camp. Caesar spent seven years fighting the Gauls…like Trajan, living most of the while in not much greater luxury than the average soldier. When he was killed, on the Ides of March, he was planning yet another campaign against the Dacians.

And almost all of the greatest generals of Rome ended badly. Publius Scipio died at age 55, for no apparent reason. Scipio Africanus, who defeated the Carthaginians, withdrew bitterly from Rome after being accused of stealing money from the government. He barely made it past 50.

Fabuis and Marcellus, who had successfully defended Rome against Hannibal (it was a close call), both died in an ambush.

Poor Germanicus was probably poisoned by the father who adopted him, Tiberus, at age 36. His wife and 2 oldest children were then executed. (His great rival Arminius, who had destroyed three Roman legions in the Teutoberg Forest, was murdered in the same year.)

Domitius Corbulo defeated the Parthians and settled the Armenian question. For his trouble, Nero let him commit suicide.

Titus Vespasianus captured Jerusalem after the Jewish uprising of 70AD. He died at 40.

And Caracalla went behind a bush to do his business – while on campaign, of course – and one of his own soldiers stabbed him to death.

Success? Give us failure.

The Daily Reckoning