The Stock Market and the End of the Bernanke Put – Part I

Since the 1980s, speculation in U.S. financial markets has been supported by first the Greenspan “Put” and then the Bernanke “Put.”  These puts – informal promises by the Federal Reserve Bank to protect the value of stocks and bonds and prevent destructive crashes, will come to an end if the Fed stops buying housing bonds and allows interest rates to rise this fall.

The wealthiest 1% of Americans, who own about 33% of the total value of stocks and bonds on Wall Street, are upset about the amount of risk they face without the Fed pouring money into the economy.

PART I  To understand why the stock market jumps up and down depending on what Ben Bernanke says, you have to understand the Greenspan “Put.”  In the 1970s, the post-WWII golden age of American prosperity came to an end.  The combination of staggering oil price increases, fierce competition from foreign imports, and resistance to wage cutbacks by unionized workers led to “Stagflation” – an unhappy world of slow growth and high inflation.

Profits for non-financial corporations were squeezed by these trends; in the late 1970s the rate alternated between 2% and 4%, less than half the profit rate of the 1950s and one third of the profit rate of the mid-1960s. 

In response to intense competition from modern factories in Germany, France, and Japan, U.S. industrial firms began what Barry Bluestone and Bennett Harrison wrote about in their ground-breaking book The De-Industrialization of America.  In a process that now seems commonplace to us, many companies closed old, unionized factories in the northeast and mid-west, moving them first to the south and then overseas.

Other manufacturing firms were purchased, their assets sold for cash, and the shell of the company then allowed to go bankrupt.  The blockbuster movie Wall Street captures the ruthless scramble to turn factories into cash in the 1980s.

With investment in tangible production assets becoming more risky and less profitable, American banks and investors began turning to financial speculation as a way to maximize their returns.  The newly elected Reagan administration was eager to help, persuading Congress to loosen regulatory restrictions on the savings and loan industry and stocking the government with regulators who looked the other way when new financial instruments like “junk bonds” appeared on Wall Street.

The explosive growth in these new financial products was fueled by a rapid and costly defense build-up which led to federal deficits of 6.1% of GDP in 1983, 5.2% in 1985 and 5.1% in 1986 – the largest peace-time deficits in U.S. history.  These deficits led to wild speculative excesses on Wall Street, vividly captured in Tom Wolfe’s novel Bonfire of the Vanities.

Alan Greenspan, formerly Chairman of Gerald Ford’s Council of Economic Advisors, was appointed chairman of the Federal Reserve in August of 1987, at a time when the roaring stock market had soared 44% in just one year.  Then, on October 19, 1987, a day after the Hong Kong the stock market collapsed, Wall Street stumbled into full financial panic, losing 22.5% of its value in a single day.  Greenspan immediately stepped in, providing large loans to banks and lowering interest rates.  He announced that the Fed “affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”

Greenspan, over the course of five terms as Fed chairman, would demonstrate again and again that the Federal Reserve was ready to pump money into the economy any time the financial markets got into trouble.  This guarantee of support became known as the Greenspan “Put.”  In the world of finance, a “put” is a contract that gives its owner the right to sell a stock or bond at a certain price regardless of whether the market is falling – essentially a guarantee against severe losses.

With the Greenspan “Put,” banks and investment companies could take more risks.  In response, they began inventing the world of derivatives, hedge funds, sub-prime mortgages, and securitization of loans that proved so unstable in 2000 and 2008. 

Next week in Part II, I will look at two examples of the Greenspan “Put” and then show how Bernanke has done even more than Greenspan.

Postscript: Front page headline in the Wall Street Journal on Friday the 11th, the day after I put up this post: “Stocks Surge to Fresh Highs: Skittish Investors Gain Courage From Fed Chief’s Reassurance on Easy-Money Policy.”

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Time for a National Voting Rights Law

The Supreme Court is right, voting rights are threatened throughout the country and national standards are needed for any election involving federal lawmakers.  Voting rights abuses in Ohio, Pennsylvania, Florida and other states reveal widespread attempts to deprive people of the vote.

Voting rights are too important to leave to the whim of state and local governments.

Most commentaries about the Supreme Court’s decision to strike down part of the Voting Rights Act of 1965 focus on its impact in the southern states most directly affected by its provisions.  This tendency will be accelerated by the way Texas, in keeping with their cowboy reputation, is rushing ahead to implement a discriminatory voter ID law that will affect thousands of poor people in that state.  (Mississippi is doing the same thing.)

This, of course, is rank discrimination and must not be allowed to succeed.  The NAACP estimates that one-quarter of African-Americans and 16% of Latinos of voting age do not have a government-issued photo ID.

However, we need to keep in mind that there were widespread attempt to limit access to voting in a number of states during the 2012 election season.  In Florida, Republican officials attempted to shorten the popular early voting period, making it harder for people to chose to vote on the weekend and avoid the burdensome task of waiting in line for many hours on Election Day.  Reportedly, the Republicans were disturbed when they discovered that more than four million people voted before election day in that swing state.

In Ohio, Republican officials tried to get rid of the rules instituted in 2008 that allowed people to vote early by absentee ballot and to vote on the Saturday and Sunday before the traditional Tuesday election day.  When they saw that the new rules encouraged minority and working class voters to show up, their earlier enthusiasm for the reform disappeared.

“It just so happened that this was the first time that early voting had been used in large numbers to mobilize African American and Latino voters,” said Wendy Weiser, who directs the Democracy Program at the Brennan Center for Justice at New York University School of Law.”

In Pennsylvania, the Republican legislature passed a strict Voter ID law.  However, the state Supreme Court ruled that the state did not do an adequate job of providing voters with an opportunity to acquire state-issued IDs and prevented the law from going into effect in 2012.  The ID law is operational this year and inspiring protests even as I write this posting.

Thus, voting restrictions are not monopolized by backwoods legislatures in Dixie, but are a national issue that requires national solutions.  The President should step forward and propose a national election law that would require fair standards in every election where a federal office is part of the ballot.

Why should Pennsylvania be allowed to require voter IDs and Texas be prohibited?  Voting in every state is a right, not a privilege, and citizens should be encouraged to participate in the political life of the country, not be excluded by discriminatory laws.

NSA Surveillance is an Ineffective Invasion of Privacy

General Keith Alexander, head of the National Security Agency, told the House Intelligence Committee on June 18th that American surveillance had helped prevent “more than 50 terrorist events” since 9/11 including 10 “homeland-based threats.”  However, when Deputy Director Sean Joyce of the FBI told the committee about two of the cases, the first was of a Kansas City man who contacted an extremist in Yeman who was already being watched by U.S. agencies, and the second was a man from San Diego who wanted to send money to a terrorist group in Somalia who was identified through the use of the NSA database. 

 In other words, two of the ten “homeland-based threats” were really the results of surveillance of known terrorist groups overseas, rather than plots by people in the U.S. who were not already being watched.  The article goes on:

 “In a rare note of skepticism, Representative Adam B. Schiff, a California Democrat, pressed Alexander about why the FBI could not use subpoenas to get the necessary domestic phone logs surrounding a suspicious number without the government’s obtaining logs of everyone’s calls. Alexander said he was open to discussion, but added, “The concern is speed in a crisis.”

 Note that the speed in a crisis excuse here is a re-run of the Bush administration’s justification for the use of torture – the bomb is ticking so we need to use water-boarding.  However, the police work necessary to prevent terror plots seldom involves the kind of Jack Bauer “24” style drama.  Even the cases cited by Deputy Director Joyce were initial conversations, not bomb ticking crisis.

 Big Data vs. Real Police Work

 In short, anti-terrorism work is police work, it is detective work, it is connecting evidence and figuring things out work.  NSA is unable to publically disclose even one case where big data was the principle means by which the agency deterred a real terrorist plot in the United States.  If there was such a case, it would be easy for General Alexander to release general details – for example, three men from Ohio were arrested for suspicious activities – without compromising agency methods.

 In fact, I believe the scale of the NSA data program (there are numerous stories about thousands of employees and billions of dollars spent on software and giant computer facilities) makes it less effective right now at tracking people who are possible terrorists.  That is, having billions of pieces of data and millions of people on watch lists, with more added daily, results in a process too vast to be used by people – the use of intuition and flashes of insight which are important in detective work is removed. 

We in Boston are especially sensitive to this issue.  The oldest Boston Marathon bomber, targeted for NSA and the FBI by his native Russian government, was not monitored closely enough to prevent his lethal attack.  Even more stunning are the hostile Twitter posts of his younger brother.  Why were these not flagged?  As least part of the answer is the agencies were busy siphoning up billions of pieces of data instead of carefully examining the ones that really mattered.  The fascination with technology is pushing aside more tradition and more effective methods of police work.

Now is the Time for Limits

The nature and scale of this surveillance program will only grow larger if we don’t create limits and safeguards while we are in this moment of national debate.  Already, there are more than 1,000 government security agencies and over 1,000 private companies invested in surveillance and data management.  More than one million people in these agencies and companies have top-secret security clearances.  As James Carroll pointed out:

“Such massive bureaucracy, staffed by un-named millions but commanded by no one, generates an impersonal dynamic of its own…Moral responsibility is diffuse.  Such a massive institution gathers its own momentum, and neither laws nor the Constitution nor oath-bound authorities may be able to channel it or stop it.”

Remember, this is only a point in time; the expansion of the power to watch you and track your movements is an on-going process.  If nothing is done now, I believe the next phase will be a greatly expanded use of surveillance drones, justified as fighting crime.

 We suffered grievously when we pushed aside fighting terrorism with police work in favor of using military power to invade and crush our enemies.  Let’s not make another terrible error by using computer technology to invade and crush our freedoms.

Big Data is Watching You

NSA surveillance methods can spin webs of guilt-by-association around any American who uses a telephone or the Internet. The end result will be unreasonable invasions of privacy and a big chill on political dissent.

Are you willing to give up your relationships with anyone who doesn’t toe the line?

I was watching the President’s press conference about NSA spying last week in the locker room of my local gym. The guy next to me was adamant that there is no problem. “They aren’t listening to your phone calls,” he insisted. I would not be surprised if this is a common reaction to the new revelations – I don’t talk about terrorism or subversion on the phone or the Internet, so I am free from suspicion.

As I thought about his words while finishing my shower, the flaw in his logic suddenly dawned on me. This kind of spying, using computers to track tremendous amounts of data, relies on the logic of guilt by association. There is no personal connection, no delving into the essence of who you are, no evaluation of you and your motives. This is “watching the tar baby” surveillance. The NSA collects the names and phone numbers and email addresses of tar babies and then records whoever gets touched by them.

The tar babies are anyone the NSA and its fellow spy agencies have decided are possible suspects. Here are a number of people whose names are almost certainly on their lists – Muslims who live in the U.S., people who participated in the Occupy Movement in any way, people who have friends or contacts in countries that are deemed influenced by terrorists, and people who participated in Tea Party rallies. There must be more because there are approximately one million people on Department of Homeland Security watch lists. And the lists are getting bigger. Wired.com revealed last year that NSA is building a $2 billion facility in Utah with enormous computers able to manipulate and track “yottabytes” (10 to the 24th bytes) of data from telephones and the Internet.

What is NSA looking for? First, it wants to identify people like you who might have contacts with one or more of the people on the watch list. Then, you go on the list, too, and the agency computers bring all of your digital information – phone numbers, number of times called, length of call, email destinations, Google searches, etc. – together in your file. The computers then go over your data to see if there are any suspicious patterns. If not, they keep collecting data and adding it to your file until your actions or contacts change, or future political leaders decide something should be done with or to people on the watch list.

Sadly, while all of this might be a bad idea, it is perfectly legal. In 2008, the U.S. Congress, including then Senator Obama, amended the Foreign Intelligence Surveillance Act to give the executive branch powers to conduct surveillance without an individual warrant. The Supreme Court, in several 5 – 4 decisions has refused to review the revised law.

Thus, my fellow exercise adherent is not immune from being swept into the NSA big data net and now faces a choice – just like the rest of us. Either carefully monitor everyone you communicate with and rapidly cut ties with anyone you suspect might be placed on the NSA watch list, or reject the creeping surveillance state that, in the name of security, is threatening our age-old civil liberties.

Don’t Buy at the Top of the Stock Market

The Stock Market is reaching the end of a long rise in values, so heed the yellow caution signs. There are many indications that when the downturn comes, investors who brought their money late to the party will end up taking a financial bath.

It is not time to run, but it is time to put your cash in a safe place.

Our modern Stock Market is not deeply tied to the fate of the real economy; with hedge funds, e-trading, derivatives, and “shorting,” the markets have plenty of things to do with their cash without worrying about messy things like investing, manufacturing, and selling. However, there is one thing that gets everyone’s attention – the candy machine known as QE 3, the U.S. Federal Reserve program that injects $85 billion into the financial markets every month, providing cheap money for banks to use as they please.

The key is to remember that the third round of Quantitative Easing since 2010 (thus QE 3) does not consist of the Fed buying government bonds, which would facilitate deficit spending and stimulate the entire economy. Instead, QE 3 consists of the Fed buying housing bonds from banks and other bundlers of mortgage bonds, thus giving money to these financial firms to spend on stock market purchases, commodity speculation, and maybe a few bank loans. It is the trickle-down theory in a financial management disguise. Give money to the rich and let them do things that will get the economy moving.

In practice QE 3 has two results: (a) mortgage rates are very low, so if you have a good, steady job you can get a cheap mortgage and, (b) financial firms have a lot of money to invest in stocks. Thus, the stock market has steadily risen during QE 3.

So, when Fed Chairman Ben Bernanke told a Congressional Committee on May 22 that the Fed might decide to reduce the number of housing bonds it purchases at one of the “next few meetings” the stock market trembled. Then, the minutes of the April Fed meeting were released later that afternoon and people discovered that “a number” of officials wanted to begin reducing the program in June. Investors panicked. The Dow lost more than 80 points in two hours and other indexes fell, too. With wild rumors about the Fed’s intentions still flying about, the Dow lost 138 points on Wednesday the 29th and 240 points on Friday, May 31st.

These events essentially confirm what many people suspected; the vigorous rise in the stock market since last fall is primarily a function of the Federal Reserves’ stimulation policy. It must be, because the real world economy is in decline:

The Eurozone, the world’s largest economic unit, is trapped in its 7th consecutive quarter of declining growth;
China’s growth is slowing to less than 7% a year (the smallest rate since 1990);
Cuts in federal spending will reduce U.S. economic growth in the second part of the year; and
The gradually falling U.S. unemployment rate is largely a product of 6.5 million people leaving the workforce.

In this environment, stocks will continue to rise only as long as the Federal Reserve keeps pumping $85 billion dollars into the financial markets each month. A major cut-back in that subsidy is likely to lead to a drop of 10% to 20% in stock prices. That means that if you put money in the market when the Dow is at 15,200 and it rises to 15,500 and falls 20%, then it goes back to 13,000 or less and you lose a good chunk of your investment. Wait and buy at the next market bottom, when you see Washington and the Fed stimulating the real economy.

The Center of Gravity in Afghanistan

Official U.S. military strategy highlights the idea proposed by Clausewitz that a nation should focus its efforts against an enemy’s “center of gravity,” the Schwerpunkt. Unfortunately, in Afghanistan, the focus has always been too narrowly drawn toward military matters when the real weakness was always the inept and corrupt Afghan government.

This explains why the U.S. has won every battle and still lost the war in that far away country.

Whenever the U.S. loses a guerrilla war – first Vietnam and then Iraq – there is an intellectual debate over the nature of “The American Way of War” and whether it is a model that leads to success in wars against popularly based armed forces. Critics like Antulio Echevarria II, a retired officer and Director of Research at the U.S. Army War College, say that there is an “American way of battle” – hit the enemy fiercely with overwhelming firepower – and not an American way of war because our military victories have not translated into strategic successes.

Dr. Echevarria says that “The new American way of war appears to have misidentified the center of gravity in each of these campaigns [Afghanistan and Iraq], placing more emphasis on destroying enemy forces than securing population centers and critical infrastructure and maintaining order.” Here we can return to Clausewitz and the marvelous trinity. For Clausewitz, war is a wrestling match – a dynamic contest that features multiple points of contact and develops over time. In this situation, the center of gravity “is created by the interaction between the wrestlers and changes as they alter their relationship.”

To be more concrete, in any guerrilla war, where the U.S. is intervening to defend a local government from a rival political organization, the center of gravity, the dynamic point of interaction between the U.S. and the guerrilla army, is the native government . In Afghanistan (and in Iraq and Vietnam) the U.S. military focused on killing members of the guerrilla army while the government it was protecting was alienating and exploiting the population – driving them into the arms of the rebellion.

There are no written accounts of the Afghan government under the leadership of President Hamid Karzai that do not include the words incompetent and corrupt. For example, in the fall of 2010 there was a run on the Kabul Bank when the bank’s chairman, Sherkhan Farnood acknowledged to NBC that the bank had invested $160 million of the bank’s $1.3 billion in assets into luxury villas and two residential towers in Dubai. The villas were located in Palm Jumeirah, a man-made island that juts out into the Persian Gulf in the shape of a giant palm tree – you must see it. During the interview Farnood confirmed that the homes were acquired in his name and were used by the bank’s major shareholders, included President Karzai’s brother and the brother of Vice President Muhammed Fahim. When he was asked why the homes were purchased in his name, Farnood replied… “it was easier” to do it that way.

Every other matter of governance in the country is done in the same spirit. With little popular support, Karzai has been dependent since the beginning on local warlords – who control key economic assets and heavily armed militias – in every part of the country. Unconcerned about local governance once the war was “over” and the Taliban was defeated; the Bush administration propped up our shaky ally, allowing the enemy to regroup and begin a classic guerrilla war. Obama’s surge in 2009 did nothing to change the Afghan government and his escalation of the war merely slowed the Taliban’s rising influence.

The First Mistake in Afghanistan

Clausewitz studied the guerrilla war waged in Spain against Napoleon and decided that resistance by an aroused population could prove decisive in war, even if the national army was defeated. The Bush Administration failed to prepare for a long war in Afghanistan because it did not understand how the native population would react to an American occupation.

Seeking an easy victory in Afghanistan, Bush and Cheney did not consider the consequences of fighting an enemy who possessed the will to fight a protracted war.

Humiliated by Napoleon’s defeat of the Prussian army at Jena in 1806, Carl von Clausewitz watched with fascination as guerrilla soldiers in Spain harassed and frustrated thousands of French soldiers. His patriotic passions then boiled over in the spring of 1812, when Napoleon intimidated Prussian King Frederick Wilhelm into sending a corps of Prussian troops to participate in the Emperor’s invasion of Russia. Clausewitz resigned his commission in the Prussian army and became an officer in the Czar Alexander’s army.

Before leaving he wrote Bekenntnisdenkschrift, roughly meaning “statement of belief.” In it he declared that Napoleon meant to occupy the German nation and the King and his court were fools to cooperate with the country’s real enemy. He then laid out an alternative plan of resistance based on the Prussian army breaking up into small units combined with a general arming of the patriotic citizenry. Clausewitz and the State. In Russia, he had a front row view of Napoleon’s disastrous campaign. Russian generals avoided decisive battles, drew the Emperor deep into an armed, hostile countryside, and then successfully counter-attacked.

Later, Clausewitz wrote in his seminal work On War “As we shall show, defense is a stronger form of fighting than attack.” Clausewitz in the 21st Century. In the modern era, when whole nations are mobilized to go to war, no attacker can achieve a decisive victory with “a single, short blow…Even when great strength has been expended on the first decision and the balance has been badly upset, equilibrium can be restored… The defeated state often considers the outcome merely as a transitory evil, for which a remedy may still be found in political conditions at some later date.”

The Bush Administration made the mistake of viewing the Taliban as merely a government and believed that the loss of formal ruling powers would lead to a break-up after their military defeat in late 2001. However, the Taliban is really a movement, the principal representative of the Pashtun people.

A quick look at a map shows that their tribal area includes about one-third of Afghanistan, the southeastern region, and a similar size area in Pakistan’s southwestern region. It is estimated that there are about 50 million Pashtuns in all. The Afghan Pashtuns are the most populous ethnic group in their country while Pakistani Pashtuns are a distinct minority in theirs. The tribe has lived in this region since around 1,000 BCE; that is, long before Rome was founded or the golden age in Greece. To act as if this organization would simply disappear after a military defeat was the height of folly.