Fed Head Departure and Why Stress Tests Are a Sham

Top Ten Reasons This Bear is Wrong About the Markets
A while back I opined that I thought the Dow could run to 10,000 and the S&P to 1000 by late June/early July. I figured reality could be suspended long enough that a move up could happen. While that call may seem right as we continue the march north, the time span and elements of the current rally are faster and more vicious to the upside than I had imagined. I also never saw the banks leading the way higher with rippers of 20% plus almost daily.

So why was I wrong? In Letterman like fashion, allow me to present the Top Ten Reasons This Bear Was Wrong:
10. I have no idea what I am talking about - probably the best reason
9. I did not appreciate the ability for many to pretend they cannot read or think
8. I did not take into account how many others would follow those from #9 into a buying spree
7. I figured the Congress would be a no go for any more banking money, but I failed to see just how crafty the Fed/Treasury/FDIC were going to be about taking money without asking
6. I had no appreciation for the market manipulation possible by Goldman Sachs (GS) and others (GS made money on an astounding 87% of their trades as of late, according Zero Hedge)
5. I never thought that people would buy into being told "everything is fine" by an incompetent government
4. I fully expected public anger over bonuses and bailouts to last more than 5 minutes; I had hoped for a full half an hour
3. I figured to save any credibility the Fed would have to stop taking garbage onto their balance sheet at such a high rate, but they just pushed the pedal through the floorboard instead
2. I figured nobody would want to talk stocks after getting clipped for a 50% down hit; instead everyone is all giddy about the 30% rally.....
1. After said 30% rally nobody remembers they are still 40% down because simple math is not taught in America anymore and thus they have no idea they look dumb talking about how "well" their stocks are doing

That is my list. Add your own in the comments section.

Bad Timing For Bernanke
If there is one person out there with worse timing than yours truly it has to be Ben Bernanke. One day after giving a speech where he outlined how the Fed needs more power to oversee operations of banks to "ensure stability" we get this gem:

New York Fed Chairman Stephen Friedman resigns
WASHINGTON – Stephen Friedman, chairman of the Federal Reserve Bank of New York's board of directors, has resigned effective immediately, the bank announced Thursday.
Friedman was the subject of a recent Wall Street Journal story that raised questions about his ties to Goldman Sachs Group Inc.
"Although I've have been in compliance with the rules, my public service ... on the Reserve Bank Board is being mischaracterized as improper," Friedman said in his resignation letter. "The Federal Reserve System has important work to do and does not need this distraction."
Goldman Sachs late last year received quick Fed approval to become a bank holding company. During that time, Friedman sat on Goldman Sachs' board and had a large holding in the company, a violation of Fed policy, the Journal reported.
But the New York Fed's executive vice president and general counsel Thomas Baxter on Thursday said Friedman's purchases of Goldman Sachs stock in December 2008 and January 2009 "did not violate any Federal Reserve statute, rule or policy."

Spare me the whole "did not violate rules" junk. A sitting NY Fed head was aggressively buying GS stock in December 2008-January 2009 right before a monster rally in financials and you expect me to believe you had no idea what was about to come? Whatever. The burden of proof would be on those at the Fed to prove both that GS was not engaging in futures gouging to pump stocks and that if they were the Fed heads had no idea they were. Go ahead and try.

Beyond that, the Fed cannot both be in bed with the banks and be regulating them. While I hate "independent panels" that oversee such things because they are made up of US Congressional members that are not impartial at all, it seems any real regulator would have to be a complete outsider. May I recommend my top four panel members of any regulatory committee:
-Michael Shedlock
-Karl Denninger
-Calculated Risk
-Yves Smith

I know, but one can dream.

Solvency, Solvency Everywhere But a Sea of Money Awaits
As you may have heard, the previously leaked "stress test" results were published in their entirety Thursday. I will not recount all the particulars, the more technical and spreadsheet talented writers in the blogroll do a much better job than I can on that.

Tim Geithner has made the rounds saying that the banking sector is very sound and they are all very solvent, save the itsy bitsy bit of capital some banks need to raise. The first trick is about "when" they must raise that capital.

But Economic Disconnect, surely you are aware that the banks have 30 days to raise the cash, right?

Oh no my apprentice, you must read the really small print with these guys. I want you to think Chrysler and GM. Now understand that:
-The banks must submit a PLAN to raise the capital through private markets in 30 days BUT....
-The actual capital raise must be done by November 9th 2009!

Trust me, by November 9th no one will remember this tidbit so it may as well be November 9th 2050 or any year. They are consistent; submit a plan then wait for that to collapse.

The next item I wanted to highlight was an interview given by Tim Geithner (TG) in an interview with Charlie Rose (CR), picked out by Zero Hedge. Revealing section is right here:

In the interview above, please fast forward to 17:49 for this key exchange.
CR:You will set the standard as to how much capital they need and they will tell you how much capital, or you will help them define how much capital they have.

TG: That's right.

CR: ...and therefore there's a shortfall, in some cases, in some cases there will be none.

TG: There will be a shortfall in some cases, but again, this is not a solvency thing. There's very significant cushions in these institutions, today, and all Americans should be confident that these institutions are going to be viable institutions going forward. This is designed to make sure that the economy will be able to benefit from larger lending capacity going forward, in the event we were to face greater uncertainty again about a deeper recession. So it's like insurance... against... precautionary insurance against the risk of a deeper recession. That'll help make recovery more likely, because then banks won't have to keep behaving against the possibility that they have to protect themselves against things getting worse. So that's the dynamic this'll help us with.

So there you have it in plain English. The stress tests were worthless because the Fed/Treasury are ready to put any and all resources behind the banks so that they can act as if they have no fear of losses. We are certainly at that point!

Now you may call me crazy. You may call me a bit on the fringe. I do not care what you call me, as long as you call me.

To show that I am not way off the rocker here, consider these headlines with the above interview in mind:

Obama budget keeps $250 billion placeholder for banks
So if the banks have so much money that they are well off, why are $250 Billion dollars stashed in a budget to stay away from another TARP like vote in Congress? If, like Mr. Geithner and company say, all the banks have plenty of cushion, why keep $250 Billion in the wings for them? Makes you wonder.

Next up, the total corruption of the FDIC:
Senate approves broad bipartisan housing bill - "Bill would allow FDIC to temporarily borrow $500 billion for deposit insurance fund."

Another classic. The FDIC, who assures us our money is as safe as gold (well maybe not that safe!) needs access to $500 Billion. Mrs. Bair must be getting tired of all the Friday night bank closures. While we here at Economic Disconnect are off rock blogging Friday night, the FDIC is closing banks and assuming losses at alarming levels.

On the side, that $500 Billion is for the PPIP program and whatever other funding scam the banks will need to weather their total solvency period unharmed.

Take away point: The stress tests are, and were always a sham meant to give false confidence. As I am very long false confidence (FLSCONFDNC) I appreciate the effort. Actions speak louder than press releases though, and if the banks were all set there would not be another almost 1 Trillion dollars waiting in the wings for them. Unless we want to "supersize" their solvency.

Long Bond Problems?
This could be a one off event, or a start of things to come. Should the Chinese grow a brain and figure that US treasuries are a pile of junk, this might just start occurring more often: (Hat tip Alea blog)

30-year Treasury Bond Collapses
Horrific auction results sent the long bond down more than 2 points, last yielding 4.27, [the] highest since november.
This will be a monthly event, fasten your seat belts. Odds on a fail some time this year.

As an aside, should the Fed succeed in forcing savers into speculation, expect the long bond to rise in yield quickly, which will complicate keeping mortgage rates low. You know what they say about juggling too many bowling pins and torches....well, if you do, write it in the comments but I am sure it is not good.

Comments

[Roger Knights:]

"Stephen Friedman, chairman of the Federal Reserve Bank of New York's board of directors, has resigned effective immediately, ..."

Do not pass GO. Do not collect $200.

May 08 08:10 AM

[GeminiAtlas:]

You get burned or get knocked unconscious, but probably both.
Anyways, about the "everything is fine" # 5 on the list. Yeah, I'm not buying it either. I think that's what they say to the cattle in the slaughterhouse "come this way, little cow, everything will be fine, don't you worry" just before it is NOT fine.

May 08 08:29 AM

[dcb:]

You have effectively outlined why the second amendment gives us the right to carry arms. it isn't to protect our homes. it is so we would never allow a government to take over that doesn't represent our interests. this is what is happening.

May 08 08:44 AM

[dcb:]

my reading says the guy bought stock and then got permission later. so, because he got the OK after the fact that doesn't violate the rules. (what a joke) What should happen is that he gets busted for insider trading, looses the gains, and hopefully gets convicted. But we are never going to see our government go after a goldman guy because they run the government.


On May 08 08:10 AM Roger Knights wrote:

> "Stephen Friedman, chairman of the Federal Reserve Bank of New York's
> board of directors, has resigned effective immediately, ..."
>
> Do not pass GO. Do not collect $200.

May 08 08:48 AM

[Economic Di...:]

Re Stephen Friedman;
Another point I wanted to make about the former NY FED head is that whether or not the "rules" say he can or cannot buy GS stock he is complete fool to have been buying stock actively while deeply enmeshed in the banking bailout process. On shear incompetence he should have been fired alone.
Jobs number was "great" this morning as "only" 500k plus jobs were lost. The birth/death model today added over 200k lobs versus 100k last month. Prior two months revised WAY larger job losses as well.

May 08 09:25 AM

[EXCBS:]

Is the long bond liquid enough to reflect the real state of expected long run inflation based on current policies? My understanding from fixed income traders is the free float is small...

May 08 10:05 AM

[bagman432:]

Be patient and the truth will be revealed. The economy is in the early stages of what will be a massive collapse. The government can lie enough to keep the markets moving up for only so long. Eventually it's game over. For now, the market is for the longs. Soon enough the shorts will laugh last.

May 08 10:46 AM

[realist len:]

I couldn't agree more, I love the way you spelled out all the stupidity going on and the wishfull thinking. I think the next shoe or shoes will fall soon, especially commercial real estate, credit cards, and housing declines. I'm waiting for the producers and powers that be on CNBC to decide when to change the tone. We are up 30% from the march lows so when the air comes out of this BEAR RALLY we will see where it all ends.

May 08 11:35 AM

[Jason Rines...:]

It is not incompetence. It was the common knowledge of Washington, NYC banking leadership that the citizenship could do nothing about it. The system has always been rigged, but now it is a casino where the roulette wheel lands on black every time. Those are the insiders of course.

In this environment, you must follow the moves of Washington very closely to see where Washington is legislating into it's own pocket to make money so you don't pick the red chip. That by the way is a hallmark of Fascism. We'll see soon enough if the bully that stole the kids lunch money decides to beat the victim up to silence him.




On May 08 09:25 AM Economic Disconnect wrote:

> Re Stephen Friedman;
> Another point I wanted to make about the former NY FED head is that
> whether or not the "rules" say he can or cannot buy GS stock he is
> complete fool to have been buying stock actively while deeply enmeshed
> in the banking bailout process. On shear incompetence he should
> have been fired alone.
> Jobs number was "great" this morning as "only" 500k plus jobs were
> lost. The birth/death model today added over 200k lobs versus 100k
> last month. Prior two months revised WAY larger job losses as well.
>

May 08 12:18 PM

[Economic Di...:]

Great comments all, thanks for reading!

May 08 01:33 PM

[DonFurio:]

I don't mind the discussion, but just realize that most people in this country want the market to go up. Yea, stocks can drop like a free-fall where there is a large amount of fear, but besides that the shorts have to really pick their spots because they can get busted pretty easily, especially in the low dollar stocks. I still think the best way to play the market is to put in a range of money each month, but averaging down does work, at least it's worked for me. There will always be conspiracy theories, but you have to ask yourself (based on whatever your risk tolerance & time frame is), do I see this stock up or down in 1 year, 3 years, etc. While S&P 1500 may seem unrealistic in 2 years, maybe we have a shot at S&P1200. If you averaged down properly and picked your shots, you maybe able to get your average cost down to that.

Also, it has brought me great joy to have seen the amount of short busting that has happened over the last few weeks. It may not continue forever, but hopefully it discourages the shorts from piling in if we have a correction soon, in the mean time, I will continue to average down. It is horrible news for the bears that the financials rallied when the leaks came out the amount of capital they needed to raise why manageable, and the companies were able to raise capital at prices far higher than then were a few months ago.

May 08 03:25 PM

[user396040:]

The truth is that noone really knows what will happen because we have never had this combination of bad debt/overleveraging and extremely accomodative Federal Reserve monetary policy. However,I think that looking three to five years out it is very, very hard to believe that buying Treasuries at this prices will produce better performance than buying a careful selection of strong, dividend-paying stocks(e.g., PG, JNJ, MSFT, XOM, MCD, KO, T).

May 08 05:39 PM

[henarl:]

The three branches of government used to be the Presidency, the Congress, and the Supreme Court. Now it is the Treasury, the Federal Reserve Bank, and Goldman Sachs. I guess we need a new Constitution - the old one doesn't seem to be working any longer.

May 09 11:51 AM

[Northstar10000:]

You are buying GS stock now when they are selling into the rally.
Nice timing and of course smart thinking.

May 09 01:44 PM

[Phil Trupp:]

There's plenty of bearishness left in the market. No one would argue against the persistence of bears and the shorts. But the market isn't always linear, which is what this article assumes. Think in three dimensions, possibly even four. So much more is involved beyond market dynamics. To assume hard and fast positions in a fluid, multi-dimensional economy is a mistake.

May 09 06:38 PM

[PainfullyAware:]

We do not need a "New Constitution" - We Need To ENFORCE THE OLD ONE.

Amendment Ten is being brought out currently by many states and the Idea of Constitutional Limits OF The Federal Government is being relearned. Contrary To The Weak Minded - This Does Not Necessarily Mean Secession.

Those In Power Will Sacrifice All To Stay In Power.

Anyone Advocating A Return Toward Constitutional Governance IS An Ally.

This Will Get Much Worse Before It Gets Better.

The Trouble With Conspiracies Is That Some Are Actually Not Purely Theoretical. Remember - The World Was "Flat" For A Very Long Time Before Reality Was Vindicated. Just Because "Most Believe" Does Not Make It Necessarily True.

henarl - Unfortunately, I must concur with your satire on the "New" branches of governance.



On May 09 11:51 AM henarl wrote:

> The three branches of government used to be the Presidency, the Congress,
> and the Supreme Court. Now it is the Treasury, the Federal Reserve
> Bank, and Goldman Sachs. I guess we need a new Constitution - the
> old one doesn't seem to be working any longer.

May 09 08:05 PM

[H. T. Love:]

9. I did not appreciate the ability for many to pretend they cannot read or think

Your error here is the use of the word "pretend". Otherwise, a great piece.

HardToLove

May 10 07:23 AM

[Economic Di...:]

Hard to love;
"Your error here is the use of the word "pretend". "
That one had me laughing, veryt funny!

May 10 12:29 PM