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An amusing commentary on the August mortgage lending fiascoes. May even be something to it....

THE ULTIMATE “SUCCESS THROUGH FAILURE” MANUAL

I have just written a success manual. Actually, it’s a book
on the world’s oldest, best, yet least implemented success
manual. I posted it on-line this week. It’s free — a bonus for
my readers.

You can be a success, just not at zero price. The price is
high. The manual’s price isn’t. It’s in the public domain. But
the cost of implementation is personally much higher than most
people are willing to pay.

http://www.garynorth.com/proverbs.pdf

It’s a lot easier to sell a success manual than a failure
manual. To sell a manual based on a record of personal failure,
you must first gain the reputation of being highly successful.
That isn’t easy. But, as I shall show, it’s doable.

Begin with a slogan: “Nothing succeeds like failure.” You
must believe this with all your heart.

Next, you need a verifiable track record of failure: a
career-long series of failures which nevertheless gains you the
reputation for being an extraordinary success. You need to be
like the pointy-haired manager in “Dilbert.” He survives, no
matter how much havoc he creates.

The Federal Reserve System surely qualifies. I can see the
headline in a full-page ad.

Wake up the financial idiot inside you! How
you can cash in big-time on your own
failures.

Then there are the bullet teasers.

World’s leading experts reveal:

You’ve heard the phrase, “a license to print
money.” How to get one.

How to plant your very own tree that everyone
says money doesn’t grow on.

How to get the reputation of being a
brilliant rescue specialist when you actually
caused the disasters, some of them
catastrophic.

How to get all the money you want and then
decide how much to pay the government at the
end of the year.

How to silence your most dangerous potential
critics by hiring them or else by buying them
off with money that costs you nothing.

How to get your few unbought critics labeled
by the media as conspiracy nuts.

How to bamboozle Congress in full public view
at least four times a year, decade after
decade.

IS THIS A JOKE?

When you read the ad, you think, “This is some kind of
joke.” Indeed, it is: a practical joke — the most successful
practical joke in modern history. It’s highly practical for
central bankers. The joke’s on us!

The Bank of England pioneered this failure-guaranteed system
in 1694. It was a privately owned bank that had the right to
issue currency and buy the government’s debt. As its powers were
expanded by Parliament over the years, its notes became legal
tender. Creditors had to accept them in payment of debts.

It was only at the end of the 19th century that central
banking became universal. It took until December 22 (House) and
23 (Senate), 1913, when most of Congress had gone home for the
Christmas holidays, for the Federal Reserve System to be enacted
into law. President Wilson signed the bill that same day. All
the Democrats voted for it. The Democrats had traditionally
opposed central banking. Republicans tended to oppose it, they
who had always favored central banking.

William Jennings Bryan, who had been the Populist opponent
of Eastern bankers and banking, was President Wilson’s agent for
getting the Federal Reserve Act passed. As Secretary of State,
he lobbied Congressmen to vote for the bill. Years later, he
said this had been his greatest mistake. Too late.

It is always too late.

All it took was a name change. It is called the Federal
Reserve System. The work “bank” is nowhere to be seen. It has
12 regional banks, so as to confuse the rubes. The New York FED
was for decades the main decision-maker, not the Board of
Governors. The New York FED is the only permanent regional bank
with membership on the Federal Open Market Committee, which
decides to buy or sell debt.

My point is simple: all it took was a name change and the
creation of insignificant regional reserve banks to gull the
rubes in 1913. Today, no one cares.

This is the central fact: no one cares.

Economists of all views (except the Austrian School, and
even some of them do) accept the idea of central banking.
Economists are employed by the hundreds by the system. The
freshman college economics textbooks are all favorable. So are
all the upper division textbooks on money and banking.

There is no other agency of government that has universal
acceptance, yet all but the Board of Governors are not part of
the government, as their websites’ addresses indicate. They are
all “org.”

The FED is the most powerful privately owned monopoly in the
United States and therefore the world. Yet anyone who points
this out as a negative factor is dismissed as a crackpot or a
conspiracy theorist or both.

No other organization in the United States is equally immune
from criticism in the Establishment media.

When you find any idea or organization that is immune from
criticism from the major institutions, you are inside the temple.
This was the title of William Greider’s book on the FED, “Secrets
of the Temple: How the Federal Reserve Runs the Country” (1987),
which was unwilling to call for its abolition.

In a 1988 review in “The Washington Monthly,” a liberal
magazine, the author made the point: nobody cares any more.

Ironically, the Federal Reserve had its philosophical
roots in the populist uprisings of the late 1800s, when
farmers and small businessmen rose up against the power
of the big banks. But the bankers managed to frame the
new institution in a way that gave them effective
control. Reforms made in the 1930s diluted the power of
the banks over the Fed but left intact an unusual,
hybrid government institution with little direct
accountability to the public. The president appointed
Fed governors, but they held 14-year terms that assured
their independence. The chairman held only a four-year
term, but that term was set so that one president could
saddle his successor with an uncongenial central
banker.

The unusual arrangement went unnoticed by most people.
As Greider points out, the “money question” was the
subject of great debate during most of the nineteenth
century, when William Jennings Bryan stirred thousands
with his famous “cross of gold” speech, calling for an
abandonment of the gold standard. But in the twentieth
century, the Fed succeeded in convincing the public
that monetary policy was an arcane undertaking that
need not concern the average American. Never mind that
the Fed had the power to bankrupt thousands of small
businesses, to erode a lifetime’s savings, or to throw
millions of people out of their jobs.

http://findarticles.com/p/articles/mi_m1316/is_n12_v19/ai_6306539/print

Maybe the most accurate book title on the FED is this: “The
Federal Reserve: An Intentional Mystery.” It was published over
two decades ago by Praeger, an Establishment publisher.

The plan worked. No one cares.

FED-MADE DISASTERS

The basic disaster is this: ever since 1914, the dollar has
lost 95% of its purchasing power, according to government
statistics. (Inflation Calculator, Bureau of Labor Statistics:
www.bls.gov).

The secondary disasters have been the recessions, above all,
the great depression of the 1930’s, which was a consequence of
the FED’s monetary policies in the 1920’s. The best book on this
is Murray Rothbard’s “America’s Great Depression” (1963). It’s
free here:

http://mises.org/rothbard/agd.pdf

Each time, the FED has escaped blame. The only exception
was Milton Friedman’s attack on the FED for its policies in the
1930’s (”A Monetary History of the United States,” 1963), which
he argued could have been solved with more FED-money creation.
He did not blame the FED for the fiat-money funded boom of the
1920’s.

The FED is praised when the economy booms. The bubbles are
an unfortunate side effect. What is a side effect? An effect we
don’t like.

The FED is criticized when it fails to intervene with more
fiat money in any liquidity crisis brought on by the FED’s slower
rate of money creation in the post-bubble period. The critics
say that the FED must take action to lower interest rates. The
FED always does.

Then the praise resumes. Price inflation accelerates. Debt
accelerates. Bubbles reappear. All this is blamed on
speculators.

The FED has the reputation of being the man on the white
horse: the rescuer of last resort.

Here is the program: (1) Create a problem. (2) Solve the
problem. (3) Get praise for having solved the problem. (4) Make
sure the solution leads to the next problem. Repeat forever.

A LICENSE TO PRINT MONEY

Actually, it’s much better than this. It’s a license to
print digital money — so much digital money that nobody except
illegal immigrants use printed money. They send it to relatives
back home. So, there can never be a run on the bans. Any money
withdrawn from one bank winds up in another bank. Digital money
can’t go in your pocket. Nobody who speaks English and who has a
bank account uses paper money to make most of his transactions.

This has been the fulfillment of bankers’ dreams for five
centuries: no more bank runs by the public. No more lines in
front of banks.

The problem today is all those hedge fund managers and
mortgage brokers, who packaged mortgages and other collateralized
debt obligations (CDO’s), and who are now facing default by the
borrowers. There is no guaranteed market for these new,
creative, and untested forms of debt.

In mid-August, 2007, the markets for billions of dollars
worth of these supposedly marketable securities simply
disappeared at anything like a retail price. Henry Liu comments.

In a financial crisis, there may simple not be enough
credit-worthy borrowers at any interest rate level and
the number of sellers stay stubbornly larger than the
number of buyers because sellers need to sell precisely
because they do not have credit worthiness to borrow
even at low interest rates and buyers stay on the
sideline waiting for even lower prices.

This is the problem facing the FED and other central
bankers. The outfits that have run up the debts to the banks are
no longer credit-worthy. They now face bankruptcy. They cannot
unload their assets at anything like book value. The commercial
banks lent hundreds of billions of dollars to them, and in a
panic meltdown, these assets fall in value. The FED can pump in
money, but in a panic, banks will buy T-bills, not the assets
that are threatened.

This is why the FED has announced that it will accept
subprime mortgages as collateral. But this still means mass
inflation if it has to buy all of them. The FED must create
monetary base money to buy this junk, and then commercial banks
expand their loans to take advantage of the FED’s increased
reserves. They will not loan to struggling hedge funds and
similar sinking ships.

When the Fed adds liquidity directly into the banking
system through the discount window, it injects
high-power money into banks by making interest rate for
overnight interbank banks loans within its set target.
The theory is that banks will in turn be able to make
loans at interest rates deemed appropriate by the Fed,
thus relaying the added liquidity to the market in
multiple amounts because of the mathematics of partial
reserve.

This will inflate the economy. It will not provide solvency
for highly leveraged hedge funds.

With deregulated global financial markets, central bank
capacity for adding liquidity to the banking system is
constrained by its need to protect the exchange value
of its currency. For the US, which depends on foreign
central banks to fund its twin deficits, any drastic
fall of the dollar will itself create a liquidity
crisis from foreign central banks shifting out of
dollar in their foreign exchange reserves.

If the dollar falls in relation to other currencies, the
Treasury will have to raise interest rates to attract replacement
money. That money may come from newly liquified American banks,
but that does no good for the liquidity squeeze of the private
capital markets. Here is what the FED is facing:

The current challenge is one of returning an abnormal
economy of excess liquidity to an economy of normal
liquidity without extinguishing the flame of liquidity
entirely. The period of stress will be the time it will
take to work off the excess liquidity, to turn the
liquidity boom back to a fundamental boom. It is not
possible to preserve abnormal market prices of assets
driven up by a liquidity boom if normal liquidity is to
be restored. All the soothing talk about the
fundamentals of the economy being strong
notwithstanding the debt bubble is insulting to the
thinking mind.

Bernanke’s FED tried from February, 2006 to mid-August,
2007, to move the economy from excess liquidity to “normal”
liquidity. But that is what the FED has tried to do ever since
1920. It never sticks to the program because of the resulting
liquidity crisis and recession.

Will the stock market hold up, once it is clear that the
FED’s money is insufficient to re-liquify credit-unworthy
borrowers? Will the economy remain positive? Liu does not think
so.

This is a debt economy fed by a liquidity boom. When
the liquidity boom turns to bust, all the strong
fundamental indicators such as corporate earnings will
wilt from a debt crisis. Asset value cannot be held up
by simply adding excess liquidity forever without
creating hyper inflation. Also, some liquidity
problems, such as those caused by a loss of market
confidence, cannot be solved by merely injecting money
into the financial system which in fact will only add
to the problem. Restoring market confidence requires a
rational restructuring of the economy to absorb excess
liquidity.

So, having solved the age-old problem of bank runs by
depositors, the commercial bankers are now facing massive default
by their borrowers. If it’s not one thing, it’s another.

The stock market faces a problem. So does the corporate
bond market. “When debts are not repaid, financial value is
destroyed which will be expressed in falling asset prices. This
loss of value will need to be reckoned in the economy.”

The FED loaned $2 billion to the four largest U.S. banks on
August 22. This was through the discount “window.” Why lend to
banks? Why not lend directly to faltering hedge funds? Liu has
an explanation.

However, the Fed’s actions reflected a shift of the
focus of concern from hedge funds towards banks who
loaned the hedge funds money to trade with leverage.
Banks are also exposed to the problem of having
committed credit lines to financial institutions with
subprime exposure, such as mortgage lenders or
specialist investment vehicles. Banks have also
arranged loans to risky firms such as buy-out groups,
which they had planned to sell into a debt market that
had evaporated overnight. An estimated $300 billion of
unsold loans are sitting on bank balance sheets,
gobbling up funds pushing up reserve requirements.

http://henryckliu.com/page137.html

If he is correct about $300 billion of unsold loans, then
the FED faces a true disaster.

I think Bernanke’s attempt to wring liquidity out of the
system was successful. The FED is now running like mad to
reverse this policy.

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CONCLUSION

The FED keeps intervening to make things better, and the
result seems to be systemic vulnerability. This is the fate of
government intervention generally. It produces the opposite of
what the planners promised.

If nothing succeeds like failure, then the FED may soon be
able to add a spectacular chapter to its success manual.

Gary North
REALITY CHECK
Issue 680
August 31, 2007