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The Bank of England has imposed a permanent news blackout on its £50bn-plus plan to ease the credit crunch.

Ferocious and unprecedented secrecy means taxpayers will never know the names of the banks that have been supported through the special liquidity scheme, which was unveiled by Bank Governor Mervyn King last week.

Requests under the Freedom of Information Act are to be denied. Details will be kept secret even after 30 years – the period after which all but the most sensitive state documents are released.

Any Bank of England employee leaking the names of institutions involved will face court action for breach of contract.

Even a figure for the overall amount advanced will not be published until October. Meanwhile the Bank is expected to issue at least £50bn of Treasury bills to banks in exchange for their mortgages – entirely in secret.

This hypersensitive official stance is thought to be a response to the events of last year when a huge stigma was attached to any lender suspected of going to the Bank for cash help.

The scheme is intended to steady the markets, but it is feared that reports of banks making widespread use of the facility could trigger further instability.

Barclays and HBoS have both confirmed they will use the Bank of England scheme. ‘We welcome the Bank facility and we will participate in it,’ confirmed Andy Hornby, chief executive of HBoS.

Other banks declined to comment, but it is expected that this week all of the leading banks, with the exception of Lloyds TSB, will tender some of their mortgages to the Bank of England.

HBoS confirmed last week it had packaged up £9bn of mortgages ready either for securitisation – in effect, selling them on in the wholesale financial markets – or to be offered to the Bank in return for Treasury bills.

The scheme, drawn up by King and approved by Chancellor Alistair Darling, aims to improve banks’ liquidity by temporarily swapping bundles of mortgages and credit card debt for Treasury bills, which are short-dated Government debt that matures within nine months.

The scheme will run for three years so these bills will be replaced by new ones when required.

Under the plan, bills will be exchanged only for securities rated triple-A – the highest possible grade of security – by at least two of the three big ratings agencies, Fitch, Moody’s and Standard & Poor’s.

It would not normally be considered acceptable for big companies to arrange billions of pounds of financial support without telling their shareholders.

But one source close to major institutional investors said: ‘I can see why there may be a case for secrecy.

‘It may be the lesser of two evils.’

The £50bn or more of Treasury bills involved will dwarf the £17.6bn currently in issue, but the authorities are adamant this will not destabilise the Government debt market.

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via

… In Washington, nuclear experts were puzzled by the timing and quality of the evidence released by the Bush administration. Democrats suggested hardliners around Dick Cheney, the vice-president, had forced the issue to try to wreck the talks with Kim.

However, there is a more persuasive argument. Analysts in Seoul see the American disclosures as a sly way to keep the negotiations alive. Kim had refused to make a “full declaration” of his nuclear programme by a December 31 deadline; now, in effect, the CIA has done it for him. “The revelation was a highly orchestrated one,” commented The Korea Herald, adding that it “enabled” Pyongyang to “make its declaration without losing face”.

One indication is that Christopher Hill, the US State Department negotiator, flew to Singapore for an unusual session with his North Korean counterparts shortly before the United States went public. “There must have been some sort of secret agreement or deal,” said Taewoo Kim, of the Korea Institute for Defence Analyses in Seoul.

Last year Hill persuaded the White House that the talks offered a realistic chance to accomplish a peace treaty formally ending the 1950-3 Korean war, in which more than 50,000 Americans died. His critics, such as John Bolton, the former United Nations ambassador, say North Korea has a long recidivist history of selling missiles and unconventional weapons to unstable Middle Eastern regimes such as Syria, Iran and Libya.

Whatever the truth, even by the standards of North Korean politics the atomic intrigue half a world away – with its multinational cast of spies, scientists, diplomats and airmen – makes an exotic story.

The alliance between the two clan dictatorships in Damascus and Pyongyang is more than 35 years old. In another tunnel, this one under Mount Myohang, the North Koreans have kept as a museum piece the Kalashnikov assault rifle and pistols sent as gifts from President Hafez al-Assad of Syria to Kim Il-sung in the early years of their friendship.

Today North Korea and Syria are ruled by the sons of their 20th-century dictators – Bashar al-Assad succeeded his father in 2000 and Kim Jong-il took over in 1994. They inherited a hatred of America and a fondness for authoritarian family rule.

Syria possesses the biggest missile arsenal and the largest stockpile of chemical weapons in the Middle East, built up over the past two decades with arms bought from North Korea.

North Korea, which detonated a nuclear device in October 2006, has become pivotal to Syria’s plans to enhance and upgrade its weapons.

Syria’s liquid-fuelled Scud-C missiles depend on “essential foreign aid and assistance, primarily from North Korean entities”, said the CIA in a report to the US Congress in 2004.

Diplomats based in Pyongyang have said they now believe reports that about a dozen Syrian technicians were killed in an explosion and train crash at Ryongchon, North Korea, on April 22, 2004. North Korea blamed a technical mishap, but there were rumours of an assassination attempt on Kim, whose special train had passed through the station en route to China some hours earlier.

No independently verified cause of the disaster was made known. However, teams of military personnel wearing protective suits were seen removing debris from the section of the train in which the Syrians were travelling, according to a detailed report quoting military sources which appeared on May 7, 2004, in the Sankei Shimbun, a Japanese newspaper.

The technicians were said to be from Syria’s Centre D’Etudes et de Recherche Scientifique, a body known to be engaged in military technology.

Their bodies were flown home by a Syrian military cargo aircraft which was spotted on May 1, 2004 at Pyongyang. There was speculation among military attachés that the Syrians were transporting unconventional weapons, the paper said at the time. Diplomats said the Sankei Shimbun report was now believed to be accurate.

Last year Jane’s Defence Weekly reported that dozens of Iranian engineers and Syrians were killed on July 23 attempting to load a chemical warhead containing the nerve gases VX and sarin onto a Scud missile at a plant in Syria.

The Scuds and warheads are of North Korean design and possibly manufacture. Some analysts think North Korean scientists were helping the Syrians to attach air-burst chemical warheads to the missiles.

Syria possesses more than 100 Scud-C and ScudD missiles which it bought from North Korea in the past 15 years. In the 1990s it added cluster warheads to the Scud-Cs that experts believe are intended for chemical weapons.

Like North Korea, Syria has an extensive chemical weapons programme including sarin, VX and mustard gas, according to researchers at the Center for Nonproliferation Studies at the Monterey Institute in California.

The Scud-C is strategically worrying to Israel because Syria has deployed it with one launcher for every two missiles. The normal ratio is one to 10. The conclusion: Syria’s missiles are set up for a devastating first strike.

Since 2004 there have been a series of leaks designed to suggest that Syria has renewed its interest in atomic weapons, a claim denied by Damascus.

In December 2006 the Kuwaiti newspaper, Al-Siyasa, quoted European intelligence sources in Brussels as saying that Syria was engaged in an advanced nuclear programme in its northeastern Hasakah province.

It also quoted British security sources as identifying the man heading the programme as Major Maher Assad, brother of the president and commander of the Republican Guard.

Early last year foreign diplomats had noticed an increase in political and military visits between Syria and North Korea. They received reports of Syrian passengers on flights from Beijing to Pyongyang, almost the only air route into the country. They also spotted Middle Eastern businessmen using trains between North Korea and the industrial cities of northeast China.

Then there were clues in the official media. On August 14 Rim Kyongman, the North Korean minister of foreign trade, was in Syria to sign a protocol on “cooperation in trade and science and technology”. His delegation held the fifth meeting of a “joint economic committee” with its Syrian counterpart. No details were disclosed.

Initially, the conclusion of diplomats was that the deal involved North Korean ballistic missiles, maintenance for the existing Syrian arsenal and engineering expertise for building silos and bunkers against air attack. Now it is known that Israeli intelligence interpreted the meeting as the last piece in a nuclear jigsaw; a conclusion that Israel shared with President George W Bush.

For years the United States and Israel saw North Korean weapons sales to the Middle East as purely a source of revenue – apart from seafood, minerals and timber, North Korea is impoverished and has little else to sell. The nuclear threat in Syria was also believed to be dormant, as Damascus appeared to rely on a chemical first-strike as an unconventional deterrent.

In a period of detente, the United States and its allies concurred when China sold a 30kw nuclear reactor to Syria in 1998 under international controls.

Then, in 2003, American intelligence officials believe that Syria recruited Iraqi scientists who had fled after the fall of Saddam Hussein. Like other countries in the region, Syria renewed its pursuit of nuclear research.

The calculus changed for good after North Korea tested a nuclear bomb in 2006 and admitted to a plutonium stockpile sufficient for 10 more.

The danger to Israel is multiplied by the triangular relationship between North Korea, Syria and Iran. Syria has served as a conduit for the transport to Iran of an estimated £50m of missile components and technology sent by sea from North Korea to the Syrian port of Tartous, diplomats said.

They say Damascus and Tehran have set up a £125m joint venture to build missiles in Syria with North Korean and Chinese technical help. North Korean military engineers have worked on hardened silos and tunnels for the project near the cities of Hama and Aleppo.

Israel also noted reports from Pyongyang that Syrian and Iranian observers were present at missile test firings by the North Korean military last summer and were given valuable experimental data. Israeli sources said last week that Iran was informed “in every detail” about the nuclear reactor and had sent technicians to the site.

Such was the background against which Israel took its decision to strike. Two signals from the North Koreans in the aftermath showed that the bombs hit home.

On September 10, four days after the raid, Kim sent a personal message of congratulations to Assad on the Syrian dictator’s 42nd birthday.

“The excellent friendly and cooperative relations between the two countries are steadily growing stronger even under the complicated international situation,” Kim said.

The next day, in a message that went largely unnoticed, the North Koreans condemned the Israeli action as “illegal” and “a very dangerous provocation”.

Just days later a top Syrian official, Saeed Elias Daoud, director of the ruling Syrian Arab Ba’ath party, boarded a Russian-made vintage jet belonging to the North Korean airline, Air Koryo, for the short flight from Beijing.

Daoud brought counsel and sympathy from Assad, whose father Hafez was famed as a strategic gambler with a talent for brinkmanship.

Now Kim is waiting to see if his own gamble has paid off.

Additional reporting: Sarah Baxter in Washington

Interesting ….

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April 25, 2008 1511 GMT
At least one shot has been fired at an Iranian vessel from a ship contracted by the U.S Military Sealift Command, Reuters reported April 25, citing a U.S. military official. No other details were immediately available.
Additionally, Debkafile (yes yes, I know) reports that Hamas’s number two has been killed in Damascus by a hit and run. The Saudis seem to be the ones with the most ins into Syria, in which case this would show them doing their fair share of the heavy lifting.
These “confrontations,” by the way, happen a lot. What’s revealing is which ones get played up, and why.

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the monolines (Ambac and MBIA — remember them?) are going to be the next “crisis” … again. (h/t Alea)

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Libor

… via Bloomberg:

Banks That Misquote Money-Market Rates to Be Banned (Update1)

By Ben Livesey

April 16 (Bloomberg) — The British Bankers’ Association said it will ban any member deliberately misquoting lending rates at daily money-market operations amid concern that some contributors are providing misleading quotes.

The global credit squeeze has raised concern lenders have been manipulating the so-called fixing process to prevent their borrowing costs from escalating, the Bank for International Settlements said in March. Participants have complained to the BBA, the Wall Street Journal said today, citing a person familiar with the matter. The BBA holds its annual board meeting today.

“It’s very important to us that we preserve the integrity of the figures,” said Lesley McLeod, a BBA spokeswoman in London. “It’s something we have been looking at. If we find that people have been putting in figures which don’t reflect accurately their financial figures, the ultimate sanction is to throw them out of the pond.”

The BBA asks 16 member banks every morning to say how much it would cost them to borrow from each other for 15 different periods in currencies including dollars, euros and pounds. It then calculates averages, known as the London interbank offered rates, or Libor, which are used as benchmarks for companies, lenders and investment banks around the world.

The BBA represents lenders such as HSBC Holdings Plc, Europe’s largest bank by market value, Royal Bank of Scotland Group Plc and Barclays Plc.

`Credibility Weakened’

“Libor will survive, although its credibility is severely weakened,” Paul Calello, Credit Suisse Group’s head of investment banking, said in a speech at the International Swaps and Derivatives Association annual conference in Vienna today. “Continuing to base an enormous amount of derivative contracts on an index with credibility problems is a serious issue we must address.”

Money-market rates began surging last year as the fallout from the U.S. housing slump left banks wary of lending to all but the safest borrowers. The three-month dollar rate was at 2.73 percent today, the highest since April 3, according to BBA data. That’s 48 basis points more than the Federal Reserve’s target rate for overnight lending between banks, compared with an average of 11 basis points in the first half of last year.

Liquidity concerns, the cost of wholesale market borrowing and Libor rates will be discussed at today’s annual board meeting, McLeod said. The BBA holds a review of its daily money market operations every year, concluding in June.

`Calls Coming Down’

Eurodollar futures contracts, which are based on traders’ expectations for three-month dollar Libor, rose today amid concern that rates may increase at tomorrow’s fixings as banks exercise more care when giving quotes, said Ian Lyngen, an interest-rate strategist at RBS Greenwich Capital in Greenwich, Connecticut. The implied yield on the contract expiring in June climbed 13 basis points to 2.69 percent.

“The risk is that there are calls coming down from the highest level of the 16 different banks associated with the Libor process saying this better not be us and if it is, it better not be us tomorrow,” said Lyngen. “Some people have estimated that there is up to 30 basis points of inaccuracy in Libor rates. We might find out tomorrow what it really was.”

Money markets would benefit from increased transparency and “trimming,” or the discarding of extreme rates quoted by participating banks, the Basel, Switzerland-based BIS said in a study released in March with its quarterly report. The system still worked as it was meant to do when rates started rising last year, it said.

“The design worked as intended to moderate the influence of strategic behavior and changing perceptions of credit quality,” researchers Jacob Gyntelberg and Philip Wooldridge wrote. The divergence of rates quoted for different currencies “reflected dislocation in the underlying interbank markets more than shortcomings in the design of the fixing mechanisms.”

This will be fixed soon one way or another. Any bank that gets kicked out of the BBA for fudging its Libor rates will very quickly become the next Bear Stearns.

And the USD will be further besmirched.

Note that gold has rallied >2% in the last two days. We’re headed for $1150.

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Today marks the first mass explosion in an Iranian metropolitan area in over a year:

At least eight people have been killed and more than 50 wounded in an explosion in the southern Iranian city of Shiraz, Iranian media reports say.

The blast occurred in a mosque in the city either during or after evening prayers, the reports said.

Iran’s Fars news agency was quoted as saying that the explosion was caused by a bomb. It said at least three of the wounded were seriously hurt.

There was no immediate claim of responsibility for the blast

Fars said the death toll was expected to climb.

Where have we seen this before?

(AP) Police and insurgents clashed after a bombing in southeastern Iran late Friday near the site where an explosion killed 11 members of the elite Revolutionary Guards this week, Iranian news agencies reported. “Minutes ago, the sound of a bomb explosion was heard in one of Zahedan’s streets,” the state-run news agency IRNA said, without giving more details. The semiofficial Fars news agency said clashes broke out between Iranian police and armed insurgents after the explosion.

Fars quoted the governor of Zahedan, Hasan Ali Nouri, as saying the blast was a “sound bomb explosion”_ a device that creates a loud boom but that usually does not cause casualties.

Nouri said there was gunfire heard but that it was late at night and that police had cordoned off the area.

On Wednesday, a car bomb blew up a bus carrying Revolutionary Guards, killing 11, in Zahedan, capital of Sistan-Baluchestan province, which sits on the border with Pakistan.

A Sunni Muslim militant group called Jundallah, or God’s Brigade, which has been blamed for past attacks on Iranian troops, has claimed responsibility for the Wednesday bombing.

Iran has accused the United States of backing militants to destabilize the country. Tensions between Tehran and Washington are growing over allegations of Iranian involvement in attacks on U.S. troops in Iraq, and over Iran’s nuclear activities.

Fars said the Friday explosion was at a school in Zahedan.

“The insurgents began shooting at people after the explosion. Clashes are continuing between police and the armed insurgents. Police have cordoned off the area,” the Fars agency said.

IRNA quoted an unnamed “responsible official” late Friday as saying that one of those arrested on charges of involvement in Wednesday’s bombing, identified as Nasrollah Shanbe Zehi, has confessed that the attacks were part of alleged U.S. plans to provoke ethnic and religious violence in Iran.

The confessions by Zehi helped police detain an unspecified number of Jundallah members and confiscate weapons and documents from the group in a raid Thursday in Zahedan, IRNA also said.

A majority of Iran’s population are Shiite Muslims but minority Sunnis live in southeastern Iran.

Friday’s blast came just hours after the funeral of the 11 Revolutionary Guardsmen in the capital.

Iran’s state-run television showed footage of Zahedan residents marching in the streets with the coffins of the killed Guardsmen. The crowd chanted, “death to hypocrites,” in a reference to the insurgents.

The blasts are a sharp flare-up of violence, but the remote southeast corner of Iran, near Pakistan and Afghanistan, has long been plagued by lawlessness. The area is a key crossing point for opium from Afghanistan and often sees clashes between police and drug gangs.

Jundallah, which is believed by some to have links to al-Qaida, has waged a low-level insurgency in the area and is led by Abdulmalak Rigi, a member of Iran’s ethnic Baluchi minority, a community that is Sunni Muslim and also can be found in Pakistan and Afghanistan. Rigi has said his group is fighting for the rights of impoverished Sunnis under Iran’s Shiite government.

Fars said that Rigi appeared on a station run by an opposition group known as the People’s Mujahedeen, which is based in Iraq, minutes before Friday’s explosion. The People’s Mujahedeen has long sought to overthrow the Iranian government by force.

Iranian officials have often raised concerns that Washington could incite members of Iran’s many ethnic and religious minorities against the Shiite-led government in Tehran.

Iran has faced several ethnic and religious insurgencies that have carried out occasionally deadly attacks in recent years _ though none have amounted to a serious threat to the government.

In December, Jundallah claimed responsibility for kidnapping seven Iranian soldiers in the Zahedan region, threatening to kll them unless group members were freed from Iranian prisons. The seven were released a month later, apparently after negotiations through tribal mediators.

In March 2006, gunmen dressed as security forces killed 21 people on a highway outside Zahedan in an attack authorities blamed on “rebels,” though Jundallah was never specifically named.

=====================

US funds terror groups to sow chaos in Iran

By William Lowther in Washington DC and Colin Freeman, Sunday Telegraph

Last Updated: 12:30am GMT 25/02/2007

America is secretly funding militant ethnic separatist groups in Iran in an attempt to pile pressure on the Islamic regime to give up its nuclear programme.

In a move that reflects Washington’s growing concern with the failure of diplomatic initiatives, CIA officials are understood to be helping opposition militias among the numerous ethnic minority groups clustered in Iran’s border regions.

The operations are controversial because they involve dealing with movements that resort to terrorist methods in pursuit of their grievances against the Iranian regime.

In the past year there has been a wave of unrest in ethnic minority border areas of Iran, with bombing and assassination campaigns against soldiers and government officials.

Such incidents have been carried out by the Kurds in the west, the Azeris in the north-west, the Ahwazi Arabs in the south-west, and the Baluchis in the south-east. Non-Persians make up nearly 40 per cent of Iran’s 69 million population, with around 16 million Azeris, seven million Kurds, five million Ahwazis and one million Baluchis. Most Baluchis live over the border in Pakistan. …

What else was going on in Iraq/Iran in February of 2007?

Iran rejects claims of equipping Iraqi Shiite extremists

Updated 2/12/2007 10:54 AM ET

BAGHDAD — Iranian officials today rejected claims they were arming Shiite extremists in Iraq with armor-piercing roadside bombs, a day after the U.S. military said those bombs have killed 170 American and coalition troops in Iraq.

LATEST: Dozens killed in Baghdad blasts on anniversary of Shiite mosque attack

U.S. military officials, who declined requests to be identified, said Sunday that shipments of weapons and ammunition to Iraq’s Shiite militias were being directed at the highest levels of the Iranian government.

Iran on Monday rejected the accusations. “Such accusations cannot be relied upon or be presented as evidence. The United States has a long history in fabricating evidence. Such charges are unacceptable,” Foreign Ministry spokesman Mohammad Ali Hosseini told reporters.

In a briefing, U.S. officials showed reporters part of a device they described as a sophisticated roadside bomb, along with mortar shells and rocket-propelled grenades they said were made in Iran. Later, one of the officials, an intelligence analyst, said it would be impossible to find a “smoking gun” conclusively proving Iranian government involvement.

FROM THE U.S. MILITARY: Pictures, descriptions of Iranian support to insurgents (PDF)

Sunday’s briefing by the three military officials was the most detailed attempt to show that Iran supports militants in Iraq. It followed similar remarks Friday by U.S. Defense Secretary Robert Gates.

Gates said serial numbers and markings found on explosives provide “pretty good” evidence that Iran is supplying either weapons or expertise to extremists in Iraq.

U.S. and coalition forces have not captured any Iranian agents in possession of the armor-piercing roadside bombs. The U.S. officials at the briefing said Iraqis are usually used to transport the explosives from Iran.

The Mahdi Army militia is among the Shiite extremist groups that have obtained the powerful bombs. The Mahdi Army is aligned with anti-American cleric Muqtada al-Sadr, whose political organization is part of Prime Minister Nouri al-Maliki’s government. …

February 2007 also marked the beginning of a secular shift upwards in oil prices, from a 2004-06 average of about $58/barrel, to a peak of $86 per barrel (using December 2007 dollars) by November of 2007, when the publication of the National Intelligence Estimate blunted what the oil market perceived was an inexorable march to US-Iranian war.

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Didn’t see this gem anywhere in US business media. What an Orwellian “surprise” that is.

The Greenspan Fed: a tragedy of errors

Mr Greenspan’s apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to convince.

  1. The Greenspan Fed (August 1987 – January 2006) did indeed contribute, through excessively lax monetary policy, to the US housing boom that has now turned to bust.
  2. The Greenspan-Bernanke put is real. It is an example of an inappropriate monetary policy response to a stock market decline.
  3. The Greenspan Fed focused erroneously on core inflation, rather than using all available brain cells to predict underlying headline inflation in the medium term.
  4. The Greenspan Fed failed to appreciate the downside of the rapid securitisation during the first half of this decade and acted exclusively as a cheerleader for its undoubted virtues.
  5. The Greenspan Fed displayed a naive faith in the self-regulating and self-policing properties of financial markets and private financial institutions.
  6. The Greenspan Fed, by enabling the rescue of Long Term Capital Management in 1998, acted as a moral hazard incubator.
  7. The failure of the Greenspan Fed to press, before or after LTCM, for a special insolvency resolution regime with prompt corrective action features for all highly leveraged private financial institutions that were likely to be deemed too big and too systemically important to fail, demonstrates either bad judgement or regulatory capture.
  8. During his years as Chairman of the Federal Reserve Board, Mr. Greenspan’s statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding guided his actions as monetary policy maker and financial regulator. Mr Greenspan’s theories have been comprehensively refuted by the financial crises of 1997/98 and 2007/08.

Below, I shall elaborate on these eight bullet points, although some of them will be amalgamated and some will come up more than once.

1. The Greenspan Fed’s excessively accommodating monetary policy during 2003 – 2006

Mr Greenspan is correct that a major global decline in risk-free real interest rates was an important factor in the housing booms that occurred in a couple of dozen countries between, say, 2002 and the end of 2006. The Fed, indeed central banks in general, had little to do with this. The extremely high saving propensities of the rapidly growing economies in the Far East and of the Gulf states were a key contributor, as was the extreme conservatism, until recently, of the portfolio allocation policies of the current account surplus countries of the Far East and the Middle East.

But the fact that on top of these very low risk-free long-term real rates, credit spreads became extraordinary low, had something to do with the liquidity glut created by the Fed, the Bank of Japan and, to a slightly lesser extent, the ECB. The Fed kept the Federal Funds rate target too low for too long after 2003. Because of the unique role played by the US dollar in the global financial system, the US dollar liquidity shower not only soaked the US economy, but also many others. First those who kept a formal or informal peg vis-a-vis the US dollar. Then those whose monetary authorities, without pursuing a dollar peg, kept a wary eye on the exchange rate with dollar, and ultimately most central banks in the globally integrated financial system.

2. The Greenspan-Bernanke put: an example of cognitive state capture by vested interests

[…]

Nevertheless, looking at the available data as a historian, and constructing plausible counterfactuals as a laboratory economist, it seems pretty self-evident to me that the Fed under both Greenspan and Bernanke has responded more vigorously with rate cuts to sharp falls in stock prices than can be rationalised with the causal effects of stock prices on household spending and private investment or with the predictive content of unexpected changes in stock prices.

To me, the LTCM and January 2008 episodes suggest that the Fed has been co-opted by Wall Street – that the Fed has effectively internalised the objectives, concerns, world view and fears of the financial community. This socialisation into a partial and often highly distorted perception reality is unhealthy and dangerous.

It can be called cognitive state capture, because it is not achieved by special interests buying, blackmailing or bribing their way towards control of the legislature, the executive, the legislature or some important regulator, but through those in charge of the relevant state entity internalising, as if by osmosis, the objectives, interests and perception of reality of the vested interest.

3. The Greenspan’s Fed unfortunate focus on core inflation

… core inflation in the US has persistently under-predicted headline inflation and headline inflation has been above the Fed’s comfort zone for most of the past six years (see Buiter1, Buiter2 and Buiter3).

This is just technical incompetence compounded by institutional inertia and unwillingness to correct a mistaken intellectual framework, even when it obviously no longer makes sense to stick with it. Even now, the Fed has not been completely rid of this bug.

4. The Greenspan Fed’s failure to appreciate the downside of securitisation

[omitted for sake of brevity]

5. The Greenspan Fed as moral hazard incubator
In 1998, the Federal Reserve System played an important role in orchestrating the private sector bail-out of Long Term Capital Management (LTCM), a hedge fund brought down by hubris, incompetence and bad luck. Although no Fed money, and indeed no public money of any kind, was committed in the rescue, the Federal Reserve System, through the Federal Reserve Bank of New York and its President, William J. McDonough, played a key role in brokering the deal, by offering its good offices and using its not inconsiderable powers of persuasion to achieve agreement among its 14 major creditor banks (ironically, Bear Stearns refused to participate in the rescue). The reputation of the Fed therefore was put at risk.

The reason given by the Fed for its orchestration of this bailout was the fear that, in a final desperate attempt to forestall insolvency, a fire-sale by LTCM of its assets would cause a chain reaction. This rushed liquidation of LTCM’s securities to cover its maturing debt obligations would lead to a precipitous drop in the prices of similar securities, which would expose other companies, unable to meet margin calls, to liquidate their own assets. Such positive feedback could create a vicious cycle and a systemic crisis.

This is the same vicious cycle leading to systemic risk story that was trotted out by Timothy F. Geithner, the current President of the New York Fed, to rationalise the bail out of Bear Stearns.

Notable features of the LTCM bailout were (1) that the existing shareholders retained a 10 percent holding, valued at about $400million, and (2) that the existing management of LTCM would retain their jobs for the time being, and with it the opportunity to earn management fees. A rival (rejected) offer by a group consisting of Berkshire Hathaway, Goldman Sachs and American International Group, would have had the shareholders lose everything except for a $250 mln takeover payment and would have had the existing management fired.

One reason given for allowing the existing shareholders to retain a significant share and for keeping the existing managers on board was that only these existing shareholders-managers could comprehend, work out and unwind the immensely complex structures on LTCM’s balance sheet. These were the same people, including two academic finance wizards, Myron Scholes and Robert C. Merton, joint winners in 1997 of the Nobel Memorial Prize in Economics, whose ignorance and hubris got LTCM into trouble in the first place.

Any handful of ABD graduate students from a top business school or financial economics programme could have unravelled the mysteries of the LTCM balance sheet in a couple of afternoons. The bail-out of LTCM smacks of crony capitalism of the worst kind. The involvement of the Fed smacks of regulatory capture.

The nature of the bail-out of LTCM meant that there was never any serious effort subsequently to address the potential conflicts of interest arising from simultaneously financing hedge funds, investing in them, and making money executing trades for them, as many investment banks did with Long-Term Capital. Things were even worse because, apart from the inherent potential conflict of interest that is present whenever a party is both a shareholder in and a creditor to a business, the bailout created a serious corporate governance problem because executives of one of the financial institutions that funded the bailout had themselves invested $22 mln in LTCM on their personal accounts. Using shareholder resources for a bail-out of a company to which you have personal exposure is unethical, even where it is legal.

For the Fed to have been involved in this shoddy bailout was a major mistake that soiled its reputation. If the Fed becomes involved (as an ‘enabler’ and/or by putting its financial resources at risk) in the rescue of a highly leveraged private financial institution, be it a hedge fund, an investment bank or a commercial bank, that private institution should immediately be subject to a special resolution regime, including the appointment of a special public administrator. That is, what is needed is an arrangement for all highly leveraged private financial institutions ddeemed too big and too systemically important to fail, akin to the treatment of (insured) commercial bank insolvencies under the Federal Deposit Insurance Act.

Under the rules established by the FDIC Improvement Act of 1991, a legally closed bank’s charter is revoked and the bank is turned over to the FDIC which serves as receiver or conservator. Typically, the old top management are fired and shareholder control rights are terminated. The shareholders do, however, keep a claim on any residual value that remains after all creditors and depositors have been paid off. [2]

From a longer-run perspective, the LTCM bail-out can be seen as a key enabler of the 2008 bailout of the investment bank Bear Stearns, another type of highly leveraged financial institution deemed too big to fail by the Fed. In the case of Bear Stearns too, shareholders were left with something ‘up front’ (two dollars per share initially, subsequently revised to ten dollars per share) and the old management is still in situ. In addition, in the Bear Stearns case, Fed money is directly at risk – the Fed is funding the senior $29 bn of a $30 bn off-balance sheet facility created to warehouse Bear Stearns’ most toxic assets.

If the” too big and too systemically important to fail” argument for bailing out large deposit-taking commercial banks is now also applied to other highly leveraged private financial institutions, including but not limited to, investment banks and hedge funds, then a similar special resolution regime, including prompt corrective action provisions must be in place if rampant moral hazard is not to be encouraged. The Greenspan Fed failed to make the case for or press for such reforms, even after the LTCM debacle. They bear a heavy responsibility for the moral hazard created in 1998 and in 2008, and for the future financial crises that will be encouraged and exacerbated by these failures.

Conclusion

During his years as Chairman of the Federal Reserve Board, Alan Greenspan’s statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding also guided his actions as monetary policy maker and financial regulator.

Mr Greenspan consistently saw but half the picture when it came to what makes competitive market capitalism work. He recognised the central roles of greed, self-interest and competition. He failed to appreciate the complementary roles of non-strategic/non-opportunistic forms of altruism, solidarity and cooperation. Both competition and cooperation must be monitored and regulated, lest they become predation and collusion respectively.

Chairman Greenspan emphasized self-regulation, spontaneous order and the disciplining effect of reputation. He failed to appreciate the essential role external or third-party (i.e. state) enforcement of laws, rules and regulations. He did not understand the weakness of reputational concerns as an enforcement or self-discipline mechanism ensuring good behaviour, when credible commitment is limited at best in a world with short horizons and easy exits.

He failed to appreciate the essential role external/third-party (i.e. state) enforcement of laws, rules and regulations, and the indispensability of collective action when faced with the threat of the breakdown of trust and confidence.

Alan Greenspan’s period as Chairman of the Board of Governors of the Federal Reserve System represents to me the nadir of central banking in advanced economic-financial systems during modern times. While monetary policy was only mildly incompetent, the regulatory failures were horrendous. The US and the world economy will pay the price for Mr Greenspan’s misjudgements and errors for years, perhaps decades, to come.

By overselling, at home and all over the world, the virtues of American-style transactions-based financial capitalism and light-touch regulation, Mr. Greenspan has done more to harm the cause of decentralised, competitive market-based financial systems based on private ownership, than even Charles Ponzi.

The spectacular failures, first in 1997/98 and then in 2007/08, of the global tests of Mr Greenspan’s theory that global financial markets do not require global regulators and that even national regulators should use only the lightest of touches, did more to discredit financial globalisation and competitive market systems based on private ownership generally than any event since the 1930s.

I am not as enthusiastic about Buiter as I used to be. While Buiter has brought his stature to bear against Greenspan-Bernanke “monetarism” very effectively, his “market maker of last resort” drumbeat does not seem any different from what Bernanke is actually doing. The market in question (structured finance) crashed because a very large percentage of it was discovered to be worthless. No new market should have been made by the Fed.

However, this column, besides making valuable points with extra venom, brings at least one new idea to bear: the idea of “cognitive regulatory capture” in the United States. This goes to the heart of why the dollar has suffered so badly relative to other currencies. The American regulatory apparatus is perceived to be in thrall to Wall Street, not because of any concrete or provable corruption or favors, but rather because the regulators allow themselves to be intellectually browbeaten into inflationistic action during every crisis.

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