Repo 105

Branded a Villain, Lehman’s Dick Fuld Chases Redemption

Wall Street veteran, pilloried over bank’s collapse, has said his firm didn’t have to die. A new book agrees. – Wall Street Journal (September 6, 2018)

Every time Dick Fuld’s publicists succeed in getting a “redemption story” published in the Wall Street Journal or New York Times, I’m going to write an Epsilon Theory brief about Repo 105, the fraudulent scheme that Lehman Brothers ran for years to hide its deteriorating financial condition from investors and regulators alike.

Here’s what makes the world go round: you can borrow more money than you have in liquid assets.

That’s what a mortgage or an auto loan or a college loan is. You don’t have enough cash to buy that house or car or college tuition all at once, so the bank gives you the cash to make the purchase. But by the same token, banks are by necessity lending out more cash than they actually have deposited with them. This is both the gasoline and the oil for the modern economic engine, and if you and I didn’t go into debt and the banks didn’t lend more than they have in deposits, the engine would seize up and our entire economy would come to a screeching halt. This is, in fact, what causes Depressions.

But in exactly the same way that you or I might be in trouble if we borrowed a lot more money than we have stashed away in a bank account somewhere, a bank might be in trouble if it lends out a lot more money than its underlying customer deposits or invested capital or otherwise loan-supporting reserves warrant. And in exactly the same way that the banks review our financial records before giving us a loan to make sure we’re not borrowing too much money for the bank’s standards, so does the government review a bank’s financial records to make sure they’re not lending too much money for the government’s standards. And by government standards I mean laws.

Repo 105 was a multiyear scheme by Lehman to defraud the government and its own investors by falsifying the actual amount of loans it had on the books, making Lehman look safer than it actually was.

It worked like this. A few days before the end of the calendar quarter, Lehman would “sell” billions of dollars worth of loans to another bank. I put “sell” in quotation marks, because Lehman ALSO had an agreement with these other banks to buy the loans back a few days after the quarter ended for the same price as they were sold, plus enough money to cover whatever the going interest rate was on that cash for the few days it was in Lehman’s hands. This is what’s called a repurchase agreement, or repo, hence the name Repo 105 (the 105 refers to the 5% overcollateralization that counterparty banks required to lend the cash to Lehman even for a few days – theyknew Lehman was in trouble). Since financial reporting happens at the end of the quarter, Lehman’s books would look like they had more cash and fewer loans than they actually did.

Surely, you say, no law firm would bless this blatant attempt to cook the books? And I say, don’t call me Shirley. I say, well … no US law firm would bless this, so naturally Lehman found a UK firm, Linklaters, to say that this was, in fact, technically a “true sale”. Even then, to pull this off Lehman had to run Repo 105 through their offshore subsidiaries, not through their US-chartered entities. It was really expensive for Lehman to run Repo 105. But also entirely necessary, or else the entire house of cards that WAS Lehman would have collapsed well before September, 2008.

What about Lehman’s auditors, you ask, surely no auditor would go along with this scheme? Again … Shirley. Again, Lehman found that Ernst & Young would indeed sign off on the program, in exchange, of course, for a sharp increase in fees. The state of New York filed civil fraud charges against Ernst & Young over Repo 105 in December, 2010. I believe they paid a (small) fine.

Dick Fuld claims that he knew nothing about the Repo 105 program. The only possible answer to this, and here I’ll apologize in advance for my language, but it’s really the best possible word – bullshit. Did I mention that Repo 105 was a really expensive program to run? Did I mention that Dick Fuld’s nickname was The Gorilla, that he was infamous for controlling everyone and everything at Lehman? Did I mention that Repo 105 was concealing existential risk for Lehman?

If you or I did what Lehman did with Repo 105, we would be charged and convicted of bank fraud. Happens all the time. It’s pretty much what Paul Manafort just got convicted on. This is a crime. It is not a minor crime. It’s an absolute slam-dunk case for any prosecutor in any jurisdiction in the country. And yet, with the exception of the civil fraud charges brought against Ernst & Young, no other charges – civil or criminal – were ever filed by the SEC or the Justice Department in connection with Repo 105. 

When was I radicalized?

When Dick Fuld walked away scot-free from the wreckage of Lehman after getting half a billion dollars in cash comp and stock sales during his tenure.

Never forget.

Bankrupt Philadelphia Plunders Its Property-Owners For Cash

Like a lot of major cities in the United States, Philadelphia is in pretty rough financial condition.

One of the city’s biggest problems is its woefully underfunded public pension, which has a multi-billion dollar funding gap.

In 2001, Philadelphia’s pension fund was still in decent shape with a funding level of 77%, meaning that it had sufficient assets to meet 77% of its long-term obligations.

By 2017 the funding level had dropped to less than 50%.

Part of this is just blatant mismanagement; while most of the market soared in 2016, for example, Philadelphia’s pension fund lost about $150 million on its investments, roughly 3.17% of its capital.

It’s interesting that, along the way, the city has actually tried to fix the problem. Between 2001 and 2017, the amount of money that the city contributed to the pension fund actually increased by 230%.

Yet despite increasing contributions to the fund, the fund’s solvency level keeps shrinking.

Mayor Jim Kenny summed up the grim situation in his budget address last year:

The City’s annual pension contribution has grown by over 230 percent since fiscal year 2001. . . These increasing pension costs have caused us to cut important public services while the pension fund’s health has grown weaker. In fact, our pension fund has actually dropped from 77 percent funded to less than 50 percent funded during the same time our contributions were so rapidly increasing.

So, desperate for revenue, the local government has been relying on an old tactic to get their hands on every spare penny they can.

The city of Philadelphia owns the local gas company – Philadelphia Gas Works (PGW). It’s essentially a local government monopoly.

And over the last few years, PGW developed an automated system to comb its billing records, find delinquent accounts, and file a lien on those properties.

If you’re not familiar with real estate law, a ‘lien’ is a formally-registered security interest in which your property serves as collateral for a debt.

When you borrow money from the bank to buy a home, for example, the bank registers a lien over your home for the value of the mortgage.

The lien prevents you from selling the home until you satisfy the debt. It also means that if you don’t pay the debt, the lienholder (the bank, or the gas company) can seize the property.

In PGW’s case, the gas company is filing liens over people’s properties due to unpaid gas bills for as little as $300.

There is essentially zero due process here.

It’s not like the gas company has to go in front a jury and prove that there’s an unsatisfied debt.

They just have their automated system file some papers, and, poof, the lien is registered.

So someone could have their home encumbered for a $300 late bill that ended up being an administrative error.

More importantly, it’s curious why the gas company is filing a lien against the property… because it’s entirely possible that the delinquent customer isn’t even the property owner.

Let’s say you’re a landlord and renting out your investment property to a tenant… and the tenant doesn’t pay his gas bill: PGW will put a lien on your property, even though it’s not your bill.

Even worse, you wouldn’t even know about it, because PGW would be sending the late notices to the tenant… not to you.

At that point it turns into a total bureaucratic nightmare.

If you’re lucky enough to even find out about it, you call PGW to try and get the lien removed.

But (according to court documents), PGW tells angry landlords that they have no control over the lien process, and tell people to file a complaint with the Pennsylvania Public Utility Commission.

But then the Pennsylvania Public Utility Commission tells you that they have no jurisdiction over liens in Philadelphia, and that you should talk to the utility company.

Classic government bureaucracy. You just get bounced around between various departments and nothing ever gets resolved from a problem that you didn’t even create.

Well, a bunch of landlords finally had enough of this nonsense, so they got together and sued the city in federal court.

It seemed like a slam dunk case. Why should property owners be held liable for the actions of their tenants?

If tenants don’t pay for their own gas, the tenants should be held responsible… not the property owners.

Common sense, right?

Wrong. The landlords lost the case.

Two weeks ago the US District Court for the Eastern District of Pennsylvania ruled that the City of Philadelphia was well within its rights to hold property owners responsible… and to file a lien on the property without even notifying the owner to begin with.

This is a pretty strong reminder of how low governments will sink when they become financially desperate.

CO2 Emissions Hit 67-Year Low, As Rest-Of-World Rises

We suspect you won’t hear too much about this from the liberal mainstream media, or the environmental movement, or even Al Gore – but, according to the  latest energy report from The Energy Information Administration (EIA)under President Trump, per-capita carbon dioxide emissions are now the lowest they’ve been in nearly seven decades.

Even more interesting is the fact that US carbon emissions dropped while emissions from energy consumption for the rest of the world increased by 1.6%, after little or no growth for the three years from 2014 to 2016.

The U.S. emitted 15.6 metric tons of CO2 per person in 1950. After rising for decades, it’s declined in recent years to 15.8 metric tons per person in 2017, the lowest measured levels in 67 years.

And as The Daily Caller reports, in the last year, U.S. emissions fell more than 0.5% while European emissions rose 2.5% (and Chinese emissions rose 1.6% along with Hong Kong’s 7.0% surge), according to BP world energy data – an ironic turn of events given Europe’s shaming of Trump for leaving the Paris climate accord.

One Bank’s Striking Admission: The Fringe Is Now In Charge Because Of Central Banks

Whereas several years ago, forecasting that central banks would unleash wars, bloodshed and social conflict was considered so preposterous, it was relegated to the domain of fringe, tinfoil hat blogs, it has gradually been “normalized” as even the mainstream realized just how clueless the world’s central planning elite truly are, and this scandalous topic has since migrated to the permitted list of items for discussion by respected, establishment institutions including banks and wealth managers, such as the UK’s Clarmond Wealth.

Last October, in a market comment note by Clarmond’s Chris Andrew and Mustafa Zaidi, the duo warned, in no uncertain terms, that “central banks are currently furnishing the excess credit that, in the past, has been followed by an orgy of blood.”

In today’s note, instead of looking at the inevitable militant outcome of failed central bank policies, they instead take on the connection between monetary policy and the rise of the “fringe” in politics, buoyed by a resentful electorate, which unable to partake in the “rise in asset prices, be they in equities, fixed income, or real estate” and where the “continued stagnation in income has only highlighted the disparity between income and asset growth”, meant that the “resentment has simmered in the electorates of the developed world.

The cost of these policies, like in Takahashi’s time, is being paid years after the event. QE and deficit spending has brought unexpected and unsavoury guests to the political dinner table, invited there by the angry electorates. In 2012 we did not know who they would be in 2012, now we do and the guest list is nearly complete.

This list of actors spawned by central bank actions include those on the edge of acceptability: “the kind of characters who have provided diversionary entertainment for decades. These are now the main guests, sitting on both the Left and Right sides of our table: Trump & Bernie, Jacob & Jeremy, the Europeans leaders of AfD, Podemos & LegaNord.”

These couplings are the costs of QE’s best intentions. These new guests bring with them their outlandish ideas to our desperate mainstream, that is struggling to find a vision of the future.

In short, “the fringe is now in charge because the centre is bankrupt of ideas.

Below we repost the full Clarmond note which just a few short years ago would have prompted scandalous outrage across the “very serious people’s” world of finance, and now is more or less considered common knowledge as to how “this” all ends, and hardly generates any reaction.

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The Best Of Intentions (link)

Dear Mustafa,

In preparing for my annual pilgrimage to the wifi-free valleys of the Cevennes National Park in France I have been reviewing our old pieces to remind me on what we were thinking in the past. One piece written in November 2012 jumped out at me, we called it ’Resurrecting Reflation’.

In it we introduced Takahashi Korekiyo, finance minister of 1930s Japan. He combined massive Quantitative Easing with deficit spending to propel Japan out of its slump. The result…the equity markets tripled, employment soared, and inflation decreased. Sadly for Korekiyo he paid for this easy money with his life. The loose money went into the military and when he tried to turn this tap off the group of army thugs visited him and cut him to pieces.

In 2012 it was only Ben Bernanke who was engaging in serious QE and we suggested that we should not be surprised to experience a similar outcome. Well Draghi, Kuroda and Carney soon joined the party and what a ride we have had.

We have enjoyed a significant rise in asset prices, be they in equities, fixed income, or real estate. However, this has coincided with continued stagnation in income – and this rise in asset prices has only highlighted the disparity between income and asset growth. So resentment has simmered in the electorates of the developed world.

The cost of these policies, like in Takahashi’s time, is being paid years after the event. QE and deficit spending has brought unexpected and unsavoury guests to the political dinner table, invited there by the angry electorates. In 2012 we did not know who they would be in 2012, now we do and the guest list is nearly complete.

Our guest include those on the edge of acceptability; the kind of characters who have provided diversionary entertainment for decades. These are now the main guests, sitting on both the Left and Right sides of our table: Trump & Bernie, Jacob & Jeremy, the Europeans leaders of AfD, Podemos & LegaNord. These couplings are the costs of QE’s best intentions. These new guests bring with them their outlandish ideas to our desperate mainstream, that is struggling to find a vision of the future. The fringe is now in charge because the centre is bankrupt of ideas.

If we fast-forward another 5 years from now I only see this guest list expanding, all the while the central bankers silently attempt to skulk away. In the past both parties eventually collided, with the new guests prevailing.

Nassim Taleb Slams “These Virtue-Signaling Open-Borders Imbeciles” In 3 Short Tweets

As liberals across America continue to attempt to one-up one another with the volume of virtue they can signal, specifically on the question of ‘open borders’ – especially since ‘jenny from the bronx’ victory over the weekend, none other than Nassim Nicholas Taleb unleashed a trite 3-tweet summary of how farcical this argument is…

What intellectuals don’t get about MIGRATION is the ethical notion of SYMMETRY:

1) OPEN BORDERS work if and only if the number of pple who want to go from EU/US to Africa/LatinAmer equals Africans/Latin Amer who want to move to EU/US

2) Controlled immigration is based on the symmetry that someone brings in at least as much as he/she gets out. And the ethics of the immigrant is to defend the system as payback, not mess it up.

Uncontrolled immigration has all the attributes of invasions.

3) As a Christian Lebanese, saw the nightmare of uncontrolled immigration of Palestinians which caused the the civil war & as a part-time resident of N. Lebanon, I am seeing the effect of Syrian migration on the place.

So I despise these virtue-signaling open-borders imbeciles.

Silver Rule in #SkinInTheGame

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“Words Fail Me. It’s Insanity”: Inside Tesla’s “Preposterous” Model 3 Production Tent

Bears and bulls alike following Tesla’s gripping nailbiter of a story – the company has until the end of the month to pump out 5,000 Model 3 sedans a week – both agree on one thing: the output of the company’s new “tent” structure which Musk erected recently to produce Model 3 vehicles is going to decide whether or not the company hits its production goal that it has touted over the last couple of months.

Photo Credits: Bloomberg

The tent was erected in just a matter of weeks, and came online in early June, to help the company produce more vehicles at a time when they are under the microscope. Until recently, we didn’t know the details as to when it was erected, what the timing looked like and what it is expected to produce. However, a Bloomberg article out today helped shed some light on the details of what is arguably the most important – if archaic – structure that Tesla has built yet.

Not surprisingly, opinions extend the whole gamut, with some manufacturing experts claiming the tent is “basically nuts”:

Elon Musk has six days to make good on his pledge that Tesla Inc. will be pumping out 5,000 Model 3 sedans a week by the end of the month. If he succeeds, it may be thanks to the curious structure outside the company’s factory. It’s a tent the size of two football fields that Musk calls “pretty sweet” and that manufacturing experts deride as, basically, nuts.

Inside the tent in Fremont, California, is an assembly line Musk hastily pulled together for the Model 3. That’s the electric car that is supposed to vault Tesla from niche player for the wealthy to high-volume automaker, bringing a more affordable electric vehicle to the masses.

Analysts at Bernstein are equally unimpressed. Here is a quote from Max Warburton who benchmarked auto assembly plants before his job as a financial analyst:  “Words fail me. It’s insanity,” said Max Warburton, who benchmarked auto-assembly plants around the world before becoming a financial analyst.

Ironically, Musk’s “Hail Mary” is the polar opposite of Tesla’s own vision for its future of state of the art robotics, hermetically sealed manufacturing facilities and millisecond efficiency.

To be sure, the tent is also a far cry from the automation that investors were promised during the early days of Tesla. The company‘s goal, which once was to have a state of the art factory producing vehicles, has now been reduced to a literal tent using manual labor and spare parts to put together cars. Worse, nobody seems to even know whether or not the line is up and running. Welcome to the future?

Musk announced it on Twitter on June 16, saying the company had put together an “entire new general assembly line” in three weeks with spare parts; the building permit was issued on June 13, though the company could have started working on aspects of the project before that.

Whether this new line is fully operational is unclear. Company officials declined to comment. The Tesla-obsessed users of Twitter and other internet forums have posted photos and videos and comments either praising or ridiculing the parking-lot big top. Apparently in response to the intense interest, the tent has recently been surrounded by very large trucks, which obstruct the view.

Predictably, the tent is being called a “hail mary” move by analysts, after the company finally admitted that its vision for automation and assembly – pitched as the “most sophisticated in the world” as recently as February 2018 -was  simply “not working”:

What gives manufacturing experts pause about Tesla’s tent is that it was pitched to shelter an assembly line cobbled together with scraps lying around the brick-and-mortar plant. It smacks of a Hail Mary move after months of stopping and starting production to make on-the-fly fixes to automated equipment, which Musk himself has said was a mistake.

The existing line isn’t functional, it can’t build cars as planned and there isn’t room to get people into work stations to replace the non-functioning robots,” Warburton said in an email. “So here we have it—build cars manually in the parking lot.”

As Bloomberg notes, an April admission that he erred by putting too many robots in Tesla’s plants was a humbling moment for Musk. The chief executive officer had boasted in the past that his company would build an “alien dreadnought,” sci-fi bro code for a factory so advanced and robotic, it would be incomprehensible to primitive earthlings.

During a February earnings call, Musk told analysts that Tesla had an automated-parts conveyance system that was “probably the most sophisticated in the world.” But by the spring, it had been ripped out of the factory.

“We had this crazy, complex network of conveyor belts,” Musk told CBS This Morning in April. “And it was not working, so we got rid of that whole thing.”

Analyst Dave Sullivan, who previously used to supervise Ford factories and now works at AutoPacific, chimed in: “To say that it’s more efficient to build this with scrap pieces laying around means that either somebody made really bad decisions with the parts in the plant inside, or there are a lot of other problems yet to be discovered with Tesla’s efficiency.”

The article concludes with what may be the most suitable epitaph for Tesla should Musk disappoint in a few days when he reports Q2 production figures.

“It’s preposterous,” Bernstein’s Warburton said.

“I don’t think anyone’s seen anything like this outside of the military trying to service vehicles in a war zone. I pity any customer taking delivery of one of these cars. The quality will be shocking.”

Preposterous or not, the clock is ticking on Tesla.

The company has just days before it has to update investors on the current state of production and how the business is running. If the tent is any indication, expect many to voice their disappointments out in the open…

Another Confesses The Impossible, We Might Not Have Known What Were Doing

When you go around claiming that central bankers don’t know the first thing about money, people tend to think you are crazy. It’s not really their (people’s) fault. Not only have we been conditioned to believe in a technocracy of sorts, it is raw human nature to immediately suspect such a radically contrarian view.

It would be one thing to say, well, central banks screwed up and were behind, making a few big mistakes along the way and we had the pay the price for it. Even that would be hard for some to really accept. But to make the indictment that they really don’t know what they are doing even on the most fundamental level just cuts way too deeply against convention. Your natural instinct is to believe there is no way that could possibly be true.

The Maestro, after all.

Yet, if you actually take the time to listen to what they say, and have said in the past, they do admit as much. It’s never summarized in that fashion, of course, and any potentially negative implications are downplayed or dismissed.

Since the Great Inflation monetary policy has been quite intentionally stripped of money. Banks evolved and there was really no easy way to define money beyond a certain point (in the sixties), so Economists just gave up trying. This is no small thing, but in Economics it is treated trivially.

Around the same time, Positive Economics, or econometrics, came into its own. It was widely accepted as one possible answer to a lot of academic problems. Rather than being forced to study incessantly the dizzying complexity of any economic system, econometrics offered a short cut. Define a few big correlations and that was all that was required.

But first, Economists had to solve markets. Before the seventies, most mainstream econometric models tried incorporating an “adaptive” expectations regime. This assumes that economic agents, including those operating in any financial markets, are always backward looking, forming their expectations from only past conditions and data.

Not only was it a theoretical problem, it was also a mathematical one leading to incomplete regressions and equations riddled with infinities. John Muth began the trend toward “rational” expectations, a journey ultimately completed by Robert Lucas (and Thomas Sergeant). The singularities disappeared from the math and efficient markets were born. No need to try and understand how markets form expectations and prices, Economists will just assume they use all available data and work themselves out efficiently to the best forward-looking position.

Once you’ve made such assumptions, what use to further study markets and therefore credit-based money? The modern central bank model was complete in its stunningly arrogant simplicity. It need only push around a single money rate and from there it actually expected to control the marginal variations for the entire economy. It didn’t know how or why, it just expected from that single input predictable outcomes would result.

What these neo-Keynesian DSGE models “knew” about money and finance was nothing other than simple maturity transformation: the central bank lowers (or raises) the money rate, that steepens (flattens) the asset yield curve as desired, making it more (less) profitable for depository institutions to make additional loans, therefore banks stimulate (retard) additional economic projects.

But what if the biggest source of credit doesn’t originate from depository institutions? And what if these other financial agents use very different sources of “money” and funding? Greenspan worried about the “proliferation of products” banks were substituting for traditional money, little did he know it was a proliferation of a proliferation.

In public, these questions appear to be all but forbidden. No Federal Reserve official has ever been made to answer them. In private, as noted so many times before, they did particularly Alan Greenspan who fretted about such grand ignorance, but for the rest of us we are supposed to be content with this shockingly incomplete basis for a purported technocratic enterprise of still some great esteem.

Mario Draghi, for example, says in 2018 there is no evidence that European inflation after years of QE is about to breakout, but he believes it will anyway because of QE and so his belief is written as truth at the direct expense of years upon years of contrary evidence.

As I’ve also written, what is so disheartening about these small economic upswings like the one we are experiencing now is that they all but erase the public’s curiosity about these big questions and more importantly the urgency to try to get someone to answer them. In 2015 and early 2016, in particular, the trend was very much in the right direction. Policymakers were openly nervous and uncertain; it was palpable at times. Everyone could see that “something” was missing, and that something was a big deal.

Now? Nobody cares (again) – at least until the next one.

FRBNY President Bill Dudley is retiring. In addition to holding the most important post at the most important branch, before that he was the head of the Open Market Desk during the most consequential nineteen months in modern economic history. There is a reason why I quote him most for the crisis period, the same reason he, like Bernanke, is already starting to try and reshape his legacy.

The revision to history, at least for Dudley, began Friday as an internal interview posted at FRBNY’s Liberty Street Economics blog. He begins by absurdly claiming Economists are truth seekers:

So economists may be a little bit more open-minded to the facts—not to say that lawyers aren’t, but a lawyer’s job is to do something, to advocate a position, to protect a positon [SIC]. So they’re starting with a very strong a priori view. I think economists start with a priori views, in the form of a hypothesis, but if the evidence is inconsistent then they start to change the theory and hypothesis, as opposed to arguing that the evidence is obviously not applicable.

You don’t get four QE’s if this was in any way true. You just don’t; one was enough of an experiment. Two maybe to test a different variable, but after what happened in 2011 the whole paradigm of bank reserves would have been tossed into the East River if these were anything like faithful scientific principles.

Dudley follows that up with some examples, casting himself in the role of the scientist though careful to construct his new narrative so that his evolving position is never anchored to any big, historic events in the recent past where such evolution might have instead proved beneficial. All you are supposed to know is the he is learning, not pay attention to when or how it might be way, way too late.

Historically macroeconomists imagined that changes in federal funds were transmitted directly from the Fed to the macroeconomy. But in my mind, the linkage between the federal funds rate and financial conditions is quite variable. So if you just focus on the federal funds rate, you’re going to, at times, make pretty bad forecasts about what’s actually going to happen in the real economy.

This is where the Fed’s push toward limited transparency is going to, ironically, haunt them for decades. He can claim what he does above, but it’s all there in the transcripts directly contradicting him. As head of the Open Market Desk, he truly believed, as the global monetary system came crashing down around him, that big cuts in the federal funds rate would make everything better. They all did because they just assumed it (maturity transformation) worked that way.

In addition to the above, Dudley makes another stunning admission because, again, he is retiring and transparently wants to start rehabilitating his reputation.

One of the challenges going into the financial crisis, for example, if you look at the big DSGE model—dynamic stochastic general equilibrium model—it didn’t include a finance sector. So the whole experience of what actually happened during the global financial crisis—the collapse of the financial system and that taking down the real economy—wasn’t an actual possibility within the major macro models that some economists were using to forecast the economy.

The problem with trying to claim “it’s the models fault” is, again, the transcripts. Starting with the association of “some economists were using”, we are supposed to believe that he isn’t included in that group. He most certainly was.

The FOMC followed the Greenbook and other modeled assessments as their forecasting gospel. It’s why as late as July and August 2008 they were still thinking that through their own skill in handling the crisis to that point, largely Bear Stearns, the US economy might even manage to steer clear of any recession – even though one had already begun the prior December (unbeknownst to rational expectations theory) and by that summer had already experienced the first rumblings of collapse.

The real issue is why Bill Dudley is talking about all this now rather than in, say, 2011. In January of that year, FRBSF researchers published a paper totally exposing the economic illiteracy this doctrine of shortcuts demands.

What you see above taken from that paper is exactly what policymakers expected to happen vs. what did happen that they thought was impossible (almost all the red lines in all the modeled runs were more than six standard deviations from projections). Bill Dudley, on the verge of retirement, admits to you now a decade later what could only have been helpful more than eleven years ago. They really don’t know what they are doing. They never have.

FRBNY’s outgoing president unintentionally highlights both of our major problems, each relating to Economics as an ideology rather than scientific pursuit. First is this rule of principled ignorance. In econometrics, the math is all that matters when instead there are very real circumstances where we might wish to understand why the math might not matter at all. Substituting statistical competence and comprehensiveness for on-the-ground understanding of, you know, an economy is a potentially fatal blindness. It sure was starting on August 9, 2007.

The second gets back to the first of Dudley’s quotes above. Economists never deviate from their models. These statistical constructions are treated like they are their children. They start with a hypothesis constructed from them and stick with it no matter what as if the models themselves can never, ever be wrong. Economists are irretrievably devoted to the math, or the economy that “should be.” These models made the biggest of all big mistakes and still they persist as if they are in any way useful.

Yet, it still sounds preposterous to most people when you write or speak about how there is no money in monetary policy and how Economists don’t know the first thing about the economy. It is important to pay attention to when they actually admit it and to broadcast the confession as far and as wide as possible especially during another limited upswing before one lost decade turns to a second and what then might happen as more of the impossible.

Italians Angry After ECB Admits It Slashed Purchases Of Italian Debt During Latest Crisis

Italians Angry After ECB Admits It Slashed Purchases Of Italian Debt During Latest Crisis

 Heading into the second half of May, just as the political turbulence in Italy was rising as investors took fright at 5-Star’s attempts to form a coalition government with the anti-immigrant League party, and what was initially a trickle of selling in Italian BTPs became a full-blown liquidation panic, some Italians wondered if the Mario Draghi wasn’t using a page from the Silvio Berlusconi playbook and allowing Italian bonds to tumble without ECB intervention, simply to “pressure” the domestic political process against the formation of a populist, Euroskeptic cabinet, something European Budget Commissioner, Guenther Oettinger scandalously suggested last week when he said that “the negative development of the markets will lead Italians not to vote much longer for the populists.”


Indeed, as we noted last week, several politicians suggested at the end of May that the ECB was exacerbating the sharp market moves: “It would be useful to know how much debt the Bank of Italy and the ECB have bought compared to the norm? Have purchases gone down?” tweeted Carla Ruocco, a Five Star MP, at the peak of the market turmoil last week.


Impennata dello #Spread: sarebbe interessante conoscere quanti #BTP #BCE e #Bankitalia hanno acquistato questa settimana rispetto al solito. Non saranno mica scesi? Qualcuno ci leva il dubbio?!

— Carla Ruocco (@carlaruocco1) May 29, 2018

Elsewhere, Laura Castelli, another Five Star parliamentarian close to leader Luigi Di Maio said in an interview with Huffington Post that “the ECB and Italian banks have slowed up if not suspended their buying of BTP [Italian government bonds] . . . which is adding to pressure on spreads”. She also argued that “quantitative easing is being weakened at exactly the moment when we need it strengthened to secure the stability of the EU.”

As it turns out, skeptical Italians was proven right because as the ECB revealed when it disclosed its PSPP bond purchases for the month of May when “lo spread” between the yield on Italian and German government bonds blew out to its highest level for five years – leading some of the country’s politicians to hit out at perceived “bullying” from the bond markets – the central bank sharply scaled back the proportion of Italian purchases relative to all other bonds purchased under QE in the month of May, which according to the FT is an “admission that could fuel suspicions of the new Eurosceptic Italian government that the central bank is seeking to punish it.”

As shown below, in total less than 15% of ECB’s net May purchases were of Italian debt, the lowest proportional allocation to Italy since the bond-buying program began in March 2015.

And with relative Italian purchases tumbling, some other nation must have seen its bond purchases jump. It will come as no surprise to anyone, that someone was Germany, which as the chart below shows, saw its net ECB purchases of bonds as a % of total soar to the highest since the program began.

Of course, any hint the ECB is intervening in markets to push for a specific political outcome, even though it did precisely that in November 2011 when a crash in Italian bonds led to the ouster of then-PM Sylvio Berlusconi, would lead to a huge European scandal in which the “apolitical” central bank is seen as intervening in domestic politics, and the bank came out prepared with a statement “explaining” precisely why Italian purchases tumbled, and to deny  Castelli’s allegations that the ECB’s QE was being weakened “at exactly the moment when we need it strengthened to secure the stability of the EU” just to punish Italian voters who picked a populist government.

This is what the ECB said:

“Several countries including France, Austria, and Belgium saw their share in net purchases go down in May, not just Italy. This is the result of greed and communicated rules on the timing of re-investments.”

Yes, but no other nation saw its share drop as much as Italy; a plunge which certainly exacerbated the low liquidity liquidation that sent “lo spread” above 300bps.

Furthermore, as the ECB’s spokesman tried to explain, there was a high volume of German bond redemptions in April which could not all be reinvested in the market during that period, so “some of these re-investments were spread also to May to ensure a smooth implementation.”

Confused? The ECB just blamed the plunge in relative Italian bond purchases, and the surge in German, on a calendar quirk. The ECB continued:  “In absolute terms, the amount of net purchases for Italy in May (EUR 3.6 bln) was higher than, for example, in March (EUR 3.4 bn) and January (EUR 3.4 bn). Gross purchases for Italy were actually higher in May than in April (around 32% higher).”

Indeed, but again on a relative basis, they plunged, and that’s all that traders in Europe – where nations pretend to be at least relatively equal – cared about.

Incidentally, as we reported last week, the ECB said that it was watching political events in Italy but was unlikely to intervene by buying debt. Well, it clearly did intervene by purchasing debt… of Germany, much to Bill Gross’ chagrin, as the relative outperformance of Bunds over US Treasurys led to the biggest one day loss for Bill Gross’ unconstrained fund.

Finally, in light of the ECB’s sudden drop off in Italian bond purchases in May, it is hardly surprising that as we reported on May 31, the Italian Ministry of Finance announced it had unexpectedly repurchased €500 million in 2 Year BTPs…

urprising market watchers.

And while the Italian bond crash has been put on hold for now, the far bigger question remains: what happens to this artificially supported bond market, in which politicians scream bloody murder when the ECB tapers its purchases even modestly, when the ECB fully ends its QE and stops monetizing public debt as it is widely expected to do on January 1, 2019?

* * *

Following the news that the ECB had purchased fewer Italian bonds in May, the FTSE MIB slumped to session lows, with Italian banks following suit as Italians are given a stark reminder just how precarious the price of every single asset in the country is without the continued support of the ECB.

Needless to say, Italian politicians were not happy: Claudio Borghi, the League’s top economic adviser, said it was “no surprise” to discover the ECB had been buying more German bonds. “Since Draghi promised to do ‘whatever it takes’ the biggest players in the Italian bonds market has been the ECB and they fix the price,” he told the FT,  adding that  “it is necessary to clarify the storytelling about Italian debt.It is not general markets’ that have the greatest influence on the price but the ECB is by far the biggest factor.”

Borghi, is of course, correct – we first discussed this last December in “Italian Bonds Slide As Market Realizes ECB Has Been The Only Buyer“, but the obvious next question is: so what? Yes, Italian bonds are massively mispriced and they will plunge if and when the ECB stops supporting the market, in effect holding Italy hostage. As for the biggest question, it is what if anything, Rome has up its sleeve to avoid such a fate when Draghi’s QE finally ends.


Inspector General Finds FBI, DOJ Broke Law In Clinton Email Probe, Refers To Criminal Prosecutor

Inspector General Finds FBI, DOJ Broke Law In Clinton Email Probe, Refers To Criminal Prosecutor

As we reported earlier Thursday, a long-awaited report by the Department of Justice’s internal watchdog into the Hillary Clinton email investigation has moved into its final phase, as the DOJ notified multiple subjects mentioned in the document that they can privately review it by week’s end, and will have a “few days” to craft any response to criticism contained within the report, according to the Wall Street Journal.

Those invited to review the report were told they would have to sign nondisclosure agreements in order to read it, people familiar with the matter said. They are expected to have a few days to craft a response to any criticism in the report, which will then be incorporated in the final version to be released in coming weeks. –WSJ

Now, journalist Paul Sperry reports that “IG Horowitz has found “reasonable grounds” for believing there has been a violation of federal criminal law in the FBI/DOJ’s handling of the Clinton investigation/s and has referred his findings of potential criminal misconduct to Huber for possible criminal prosecution.”

Sperry also noted on Twitter that the FBI and DOJ had been targeting former National Security Advisor Mike Flynn before his December 2016 phone call with Russian Ambassador Sergey Kislyak, stemming from photos of Flynn at a December 2015 Moscow event with Vladimir Putin (and Jill Stein).

Who is Huber?

As we reported in March, Attorney General Jeff Sessions appointed John Huber – Utah’s top federal prosecutor, to be paired with IG Horowitz to investigate the multitude of accusations of FBI misconduct surrounding the 2016 U.S. presidential election. The announcement came one day after Inspector General Michael Horowitz confirmed that he will also be investigating allegations of FBI FISA abuse.

While Huber’s appointment fell short of the second special counsel demanded by Congressional investigators and concerned citizens alike, his appointment and subsequent pairing with Horowitz is notable – as many have pointed out that the Inspector General is significantly limited in his abilities to investigate. Rep. Bob Goodlatte (R-VA) noted in March “the IG’s office does not have authority to compel witness interviews, including from past employees, so its investigation will be limited in scope in comparison to a Special Counsel investigation,”

Sessions’ pairing of Horowitz with Huber keeps the investigation under the DOJ’s roof and out of the hands of an independent investigator.


Who is Horowitz?

In January, we profiled Michael Horowitz based on thorough research assembled by independent investigators. For those who think the upcoming OIG report is just going to be “all part of the show” – take pause; there’s a good chance this is an actual happening, so you may want to read up on the man whose year-long investigation may lead to criminal charges against those involved.

In short – Horowitz went to war with the Obama Administration to restore the OIG’s powers – and didn’t get them back until Trump took office.

Horowitz was appointed head of the Office of the Inspector General (OIG) in April, 2012 – after the Obama administration hobbled the OIG’s investigative powers in 2011 during the “Fast and Furious” scandal. The changes forced the various Inspectors General for all government agencies to request information while conducting investigations, as opposed to the authority to demand it. This allowed Holder (and other agency heads) to bog down OIG requests in bureaucratic red tape, and in some cases, deny them outright.

What did Horowitz do? As one twitter commentators puts it, he went to war

In March of 2015, Horowitz’s office prepared a report for Congress  titled Open and Unimplemented IG Recommendations. It laid the Obama Admin bare before Congress – illustrating among other things how the administration was wasting tens-of-billions of dollars by ignoring the recommendations made by the OIG.

After several attempts by Congress to restore the OIG’s investigative powers, Rep. Jason Chaffetz successfully introduced H.R.6450 – the Inspector General Empowerment Act of 2016 – signed by a defeated lame duck President Obama into law on December 16th, 2016cementing an alliance between Horowitz and both houses of Congress. 

1) Due to the Inspector General Empowerment Act of 2016, the OIG has access to all of the information that the target agency possesses. This not only includes their internal documentation and data, but also that which the agency externally collected and documented.

TrumpSoldier (@DaveNYviii) January 3, 2018

See here for a complete overview of the OIG’s new and restored powers. And while the public won’t get to see classified details of the OIG report, Mr. Horowitz is also big on public disclosure:

Horowitz’s efforts to roll back Eric Holder’s restrictions on the OIG sealed the working relationship between Congress and the Inspector General’s ofice, and they most certainly appear to be on the same page. Moreover, FBI Director Christopher Wray seems to be on the same page as well. Click here and keep scrolling for that and more insight into what’s going on behind the scenes.

Here’s a preview:


Which brings us back to the OIG report expected by Congress a week from Monday.

On January 12 of last year, Inspector Horowitz announced an OIG investigation based on “requests from numerous Chairmen and Ranking Members of Congressional oversight committees, various organizations (such as Judicial Watch?), and members of the public.”

The initial focus ranged from the FBI’s handling of the Clinton email investigation, to whether or not Deputy FBI Director Andrew McCabe should have been recused from the investigation (ostensibly over $700,000 his wife’s campaign took from Clinton crony Terry McAuliffe around the time of the email investigation), to potential collusion with the Clinton campaign and the timing of various FOIA releases.

Courtesy @DaveNYviii

On July 27, 2017 the House Judiciary Committee called on the DOJ to appoint a Special Counsel, detailing their concerns in 14 questions pertaining to “actions taken by previously public figures like Attorney General Loretta Lynch, FBI Director James Comey, and former Secretary of State Hillary Clinton.” 

The questions range from Loretta Lynch directing Mr. Comey to mislead the American people on the nature of the Clinton investigation, Secretary Clinton’s mishandling of classified information and the (mis)handling of her email investigation by the FBI, the DOJ’s failure to empanel a grand jury to investigate Clinton, and questions about the Clinton Foundation, Uranium One, and whether the FBI relied on the “Trump-Russia” dossier created by Fusion GPS. 

On September 26, 2017, The House Judiciary Committee repeated their call to the DOJ for a special counsel, pointing out that former FBI Director James Comey lied to Congress when he said that he decided not to recommend criminal charges against Hillary Clintonuntil after she was interviewed, when in fact Comey had drafted her exoneration before said interview.

And now, the OIG report can tie all of this together – as it will solidify requests by Congressional committees, while also satisfying a legal requirement for the Department of Justice to impartially appoint a Special Counsel.

As illustrated below by TrumpSoldier, the report will go from the Office of the Inspector General to both investigative committees of Congress, along with Attorney General Jeff Sessions, and is expected within weeks.

DOJ Flowchart, Courtesy TrumpSoldier (@DaveNYviii)

Once Congress has reviewed the OIG report, the House and Senate Judiciary Committees will use it to supplement their investigations, which will result in hearings with the end goal of requesting or demanding a Special Counsel investigation. The DOJ can appoint a Special Counsel at any point, or wait for Congress to demand one. If a request for a Special Counsel is ignored, Congress can pass legislation to force an the appointment.

And while the DOJ could act on the OIG report and investigate / prosecute themselves without a Special Counsel, it is highly unlikely that Congress would stand for that given the subjects of the investigation.

After the report’s completion, the DOJ will weigh in on it. Their comments are key. As TrumpSoldier points out in his analysis, the DOJ can take various actions regarding “Policy, personnel, procedures, and re-opening of investigations. In short, just about everything (Immunity agreements can also be rescinded).

Meanwhile, recent events appear to correspond with bullet points in both the original OIG investigation letter and the 7/27/2017 letter forwarded to the Inspector General: 

With the wheels set in motion last week seemingly align with Congressional requests and the OIG mandate, and the upcoming OIG report likely to serve as a foundational opinion, the DOJ will finally be empowered to move forward with an impartially appointed Special Counsel.