Sprott: Is It All Just A Ponzi Scheme?

Well respected investor Eric Sprott's recent client newsletter opines that the Federal Reserve system might just be one big ponzi scheme...

The problem is that nobody knows who is buying a huge chunk of US Treasuries - which are categorized under "Other Investors".

This is a must read and a reason why at a minimum the Fed needs to be audited.

Scott Dauenhauer CFP, MSFP, AIF

Goldman Profits Twice on Mortgage Sales

Here are the basics:

Goldman creates a mortgage back security or CDO and sells it to you - knowing that it is a worthless piece of junk because they had to convince (and probably pay off) their friends at the rating agency in order to get it a decent rating. Goldman knows its junk and just a matter of time before this junk explodes - thus they help create securities that allow them to profit when this junk does explode (or implode.....you choose).

So Goldman makes money selling junk, then makes leveraged bets to short the junk it just sold you and makes a mint when the junk goes bad......does this sound like a healthy financial system?

Scott Dauenhauer CFP, MSFP, AIF

"All of this has happened before, and it will all happen again."

Do you recognize this line? If so you may be a fellow "Battlestar Galactica" fan. I won't give away any secrets of the hit series but the oft used phrase feels applicable to the financial crisis that engulfed the world last year and is perhaps awaiting its second (or perhaps third) movement.

The parallels to our financial system with the themes of Battlestar Galactica are frightening, a constant evolution of finance that eventually destroys itself and then rebuilds just to destroy itself again....can the cycle be broken?

Last year the parody website and newspaper, The Onion posted a parody piece titled "Recession-Plagued Nation Demands New Bubble To Invest In" (link above). While all good humor requires some truth, this piece is actually prophetic. Our Federal Reserve system has set us on a cycle that won't be broken unless someone stands up and says "enough". The fix is not easy (which is why we haven't fixed our problems, we've covered them up) and will hurt, but severe pain that is short-term is preferable to pain that is chronic and never ending.

All of this has happened before, it will happen again.

Scott Dauenhauer CFP, MSFP, AIF

Bi-Partisan Agreement on Taxpayer Funded Foreign Travel

If this story requires a log-in, I can e-mail you a new link that will work.

At least Democrats and Republicans can agree on one thing, the taxpayers shouldn't fund travel and shindigs for private companies.....but they should fund them for congress. The above linked article goes into some detail about recent trips take by both parties to lush locals (with spouses and on military jets). The costs for these trips have skyrocketed in recent years. While some trips appear legit, others are clearly taxpayer funded pleasure trips disguised as official business.

Do we really need more proof that our spending is out of control? It's not healthcare that is going to bankrupt this nation, its a profligate congress.

Scott Dauenhauer CFP, MSFP, AIF

Ben's Bastardization of Bagehot

"[T]o avert panic, central banks should lend early and freely (ie without limit), to solvent firms, against good collateral, and at 'high rates.'"

These are the words of Walter Bagehot, a Brit famous for his work and writings about economics and specifically about "Lenders of last resort" or Central Banks.

Bagehot has five basic dictums to avert a panic:

Lend Early
Lend Freely (without limit)
Lend to Solvent Firms
Lend against Good Collateral
Lend at High Rates

Bagehot is often referred to by central bankers when bailing out financial institutions and he has been quoted by Bernanke in the past, it is clear that Bernanke (Federal Reserve Chairman) has been influenced by Bagehot.

The question really becomes, is Ben Bernanke following the Bagehot dictums or bastardizing them?

I vote for the latter, though my vote doesn't matter, the evidence is clear the latter is the course taken.

Did the Fed lend early?

No, in fact it didn't understand the true nature of what was happening on Wall Street (though keep in mind the Fed was set up to work with banks, not necessarily investment banks - but that line was crossed when Glass-Steagall was repealed and the Fed should have been prepared)

Did the Fed Lend Freely?

Not really, not until it was too late (they helped Bear, but not Lehman). This one they get a free pass as they should not have lent to Bear or Lehman give the next few dictums

Lend to Solvent Firms?

Now this is the funny thing, it seems the Federal Reserve and Treasury are doing the exact opposite of the Bagehot Dictums, they are lending the most to the most insolvent firms (Citi, Bear, AIG, Fannie, Freddie). This is the key to all the other dictums, my belief is that Bagehot felt that insolvent firms should be allowed to fail, allowing them to continue created moral hazard and rewarded the profligate at the expense of the parsimonious (a bit strong, but both P words!). The big mistake made was the free lending of funds to firms that are now and will be in the future insolvent.

Lend against Good Collateral?

I think the evidence shows that the collateral lent against was not good, in fact our own government called it Toxic.

Lend at high rates?

There is some disagreement about why Bagehot created this dictum - was it to avoid moral hazard or to simply keep the solvent, liquid firms from borrowing needlessly. Regardless, it works both ways and avoids moral hazard while keeping solvent firms with cash away from borrowing. The Fed and Treasury fail on this point. Warren Buffet lent at much better terms to Goldman Sachs than did the Treasury. Banks can now borrow from the Fed at effectively a zero percent rate - which they do and then engage in a carry trade.

Ben Bernanke's Fed and Paulson/Geithner's Treasury have used Bagehot's dictums as an excuse for their bailout's, but in doing so have bastardized them.

Effectively the Fed's action have turned what would have been a Great Recession into a Depression and potentially into another Great Depression, far from avoiding a Depression, Bernanke, Geithner and Paulson have served one up for us.

Don't mistake me to be saying that the markets are going to crash, though that possibility exists. My point is that while a recovery could be underway and may in fact happen (perhaps even greater than we all think), it will in fact be another in a long series of faux rallies, perhaps the third in a trilogy that began with the Tech bubble and crash, then continued with the Housing bubble and crash. What will this third (and hopefully last) bubble bring? When will it end? What will be its affects? These are all questions without good answers (though many are trying).

It feels ironic to me that Paul Volcker is once again the voice of reason and sanity and yet he seems to be ignored in favor of Bernanke, Geithner, Dodd and Frank. Will it be the irony of ironies that the window dressing (Volcker) is in fact the one person in this administration that people should be listening too? I'm not saying we should rename Volcker to the Fed, but certainly getting rid of Geithner and replacing Bernanke would be wise moves.

Scott Dauenhauer CFP, MSFP, AIF

WAPO: Mortgage agency's growth gives fuel to risky lenders

Unbelievable. That is the only word to describe this article about how poorly Ginnie Mae has been run. The corruption that is taking place in broad daylight in front of these people is scary and yet it is allowed to continue in order to reflate housing. I hope this story brings about the change needed, otherwise we the taxpayer are going to be shelling out in more ways than one.

Scott Dauenhauer CFP, MSFP, AIF

Humor Break: Colbert Takes On The Fed

If you don't fall out of your seat laughing after this......well, you're probably not a finance geek like myself - but this if funny stuff!

The Colbert Report	Mon - Thurs 11:30pm / 10:30c
Fed's Dead
www.colbertnation.com
Colbert Report Full Episodes Political Humor U.S. Speedskating

On Federal Reserve Independence

It is no secret that Thomas Jefferson was against a central bank, in fact the following quote seems rather prophetic:

The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution. I am an Enemy to all banks discounting bills or notes for anything but Coin. If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered.

The debate today however is not a Jefferson versus Hamilton (should we or shouldn't we have a central bank), but whether or not the Federal Reserve should be Independent of the federal government. There is much debate about the independence of the Federal Reserve, many don't believe it is Independent, or do and want it more accountable. The fact of the matter is that the Federal Reserve is a branch of government, though it is controlled by bankers and is perhaps the most powerful branch of our behemoth government.

In David Wessel's book, "In Fed We Trust" there are a few things that I learned that shocked me, but now make sense given what has transpired over the past few years:

"From the beginning, the regional Fed banks were organized not as government agencies, but as private companies in which local banks own shares, a remnant of a time when central banks raised capital privately as well as publicly. Under the 1913 law (to create the Fed), each bank has nine directors, the majority chosen by the banks in the district. Three are bankers. Three are nonbankers picked by the local banks. Three are chosen by the Fed board in Washington to represent the public."

Interestingly enough the "nonbanker" chosen for the New York Federal Reserve was none other than Stephen Friedman, a former Goldman Sachs CEO and then member of the Goldman board of directors (now disgraced and no longer a member of the NY Fed after it was discovered he was buying stock in Goldman Sachs while he was making decisions about its future).

It was these people who hire the head of the New York Federal Reserve branch (the most powerful branch), it was these people (the so-called bankers and non-bankers....who were really just insiders and bankers) that hired Timothy Geithner. Its a pretty nice deal when you can essentially hire your own regulator.

Its beginning to make sense why the Federal Reserve was so asleep at the switch, they were never supposed to be awake, it was set up that way (maybe not originally, but that is how it turned out).

In Wessel's book he makes clear that Bernanke and even Geithner did not understand the complex securities being traded and sold by wall street and the banks - which is a complete dereliction of duty, which should be punishable by job loss. Instead Geithner and Bernanke kept their jobs and Geithner was promoted (this must be one of the jobs "saved").

My point is that the Federal Reserve is NOT independent, it is highly controlled and it is designed to work in favor of Wall Street and the bankers, not main street and the citizens. Whether or not the Federal Reserve is independent of congress and the President is a moot point, they are not independent of those who control congress and the President.

Fed Independence is a myth and the current debate is a waste of time, the real question is not how much power the congress should have over the Fed, the real question is how much control Wall Street should have over the citizens of the United States.

Scott Dauenhauer CFP, MSFP, AIF

Confronting the Inflation Boogeyman

Hearing a lot about Gold lately? Comparison of America to Zimbabwe? Is America a Banana Republic? Hyperinflation has become the buzzword, but is it real and is it a possibility?

The answer is not easy, evidence suggests we are not heading toward hyperinflation, defined as a 50% inflation....per month! However, given the events of the past decade one cannot rule anything out.

I wouldn't bet on a hyperinflation, but I do believe inflation will be an issue in the intermediate to longer term.

Don't discount the possibility of a short-term recovery fueled by speculation, low interest rates, massive government spending and misplaced euphoria (sound familiar?). While 2010 could bring with it the complete disintegration of the banking system, it could also bring the sense of relief, that prosperity is back and things are okay again. Don't be lulled, be on the defensive - but part of the point of the linked too article is to be careful of going overboard in your defense.

Scott Dauenhauer CFP, MSFP, AIF

Prins: Enron Accounting for US Banks

Nomi Prins writes about what I've been saying now for months, big banks are rigging their books....Enron style. A few snipets from this former Goldman Sachs Managing Director:

After two weeks sifting through over one thousand pages of SEC filings for the largest banks, I have the same concerns. While Washington ponders what to do, or not do, about reforming Wall Street, the nation’s biggest banks, plumped up on government capital and risk-infused trading profits, have been moving stuff around their balance sheets like a multi-billion dollar musical chairs game.

I was trying to answer the simple question that you'd think regulators should want to know: how much of each bank’s revenue is derived from trading (taking risk) vs. other businesses? And how can you compare it across the industry—so you can contain all that systemic risk? Only, there's no uniformity across books. And, given the complexity of these mega-merged firms, those questions aren’t easy to answer.

With taxpayers now on the hook, we need an objective, consistent evaluation of bank balance sheets complete with probing questions about trading and speculative revenues, allowing for comparisons across the banking industry. This lack of transparency leaves room to misrepresent risk and trading revenue.

The long-term solution is bringing back Glass-Steagall. Being big doesn’t just risk bringing down a financial system—it means you can also more easily hide things. Remember the lesson from the Enron saga: when things look too good to be true, they usually are.

Nomi Prins is author of It Takes a Pillage: Behind the Bonuses, Bailouts, and Backroom Deals from Washington to Wall Street (Wiley, September, 2009). Before becoming a journalist, she worked on Wall Street as a managing director at Goldman Sachs, and running the international analytics group at Bear Stearns in London.

Scott Dauenhauer CFP, MSFP, AIF

Ferguson: An Empire at Risk

Rising interest rates and deflation? This is a scenario Nial Ferguson has put forth in this Newsweek article that explores the consequences of a rising national deficit. The article is long, but good.

Scott Dauenhauer CFP, MSFP, AIF

Farrell: Obama's 'predictably irrational' economic policies

14 reasons Obama's love of Wall Street will trigger the Great Depression 2

This is not the column I expected to see from Paul Farrell, it is based on a newsletter I posted last month by GMO's Jeremy Grantham and it is spot on.

The reiteration by Farrell that Geithner and Bernanke should lose their jobs is perhaps the best points, though their are many others. Lest you think this article is an Obama tirade by an angry right winger....it is not, Farrell supported Obama and he lambast's the Bush administration's handling of the crisis as well.

Scott Dauenhauer CFP, MSFP, AIF