STAFF NEWS & ANALYSIS
Fed Makes Monitoring Bank Capital Foremost Concern
By Staff News & Analysis - November 21, 2009

Federal Reserve officials are stepping up scrutiny of the biggest U.S. banks to ensure the lenders can withstand a reversal of soaring global-asset prices, according to people with knowledge of the matter. Supervisors are examining whether banks such as JPMorgan Chase & Co., Morgan Stanley and Goldman Sachs Group Inc. have enough capital for the risks they take, how much they know about the strength of their counterparties and whether risk managers have authority to influence bank practices and policies. Lawmakers led by Senator Christopher Dodd have criticized the Fed for failing to prevent a decline in lending standards that contributed to the credit crisis. The central bank's monitoring takes on renewed urgency as Chairman Ben S. Bernanke's pledge to keep the benchmark interest rate near zero for "an extended period" is helping to fuel a surge in assets. The MSCI AC World stock index is up 71 percent since hitting a recession low on March 9. Gold reached an all-time high of $1,145.50 an ounce. – Bloomberg

Dominant Social Theme: The Fed is on the job?

Free-Market Analysis: Well, here is an interesting conundrum. The wise men at the Federal Reserve, having thrown trillions into the larger marketplace, now worry that banks won't have the wherewithal, capital-wise, to withstand another asset-bubble blow up. The Fed's top brains are all-but-telling-us that they expect foul weather ahead, and in fact they are not alone. The same gloomy predictions are being made in Europe by some of the euro-zone's top banks.

But our question, dear reader, is why do possessors of so much gray matter expect another asset bubble? Is it the neural synapses firing all at once that make them gloomy? Actually, we don't think it's physiological. We think it has to do with past practice. The Fed has printed so much money along with its brethren that another such implosion is almost all but assured.

Do you want to go through another 2008? We don't. And yet this is the world we live in, then, when a group of energetic but fairly mature individuals (we won't call them old this time), most of them men, have the ability to print as many paper tickets as they want in the name of an "independent" monetary policy. And having printed all that money, they then begin to worry about THAT, and send their dozens or hundreds of surrogates into the field to make sure that the banks to which they are lending are going to be able to survive the next bust.

Pretty silly, huh? The Fed, in our humble opinion, has given up denying what is obvious to everyone in this Internet day-and-age – that it is proximate cause of money mischief, and that its policies are so destructive that they threaten to sink even the largest and best capitalized firms. Here's some more from the article:

"The Fed staff has to be under a massive amount of pressure," said Vincent Reinhart, a former director of the Fed's Division of Monetary Affairs and now a resident scholar at the American Enterprise Institute in Washington. "They must have a sense of zero tolerance for failure."

Banks might not like "leverage ratios or capital requirements, but they can be effective and protect against the really bad behavior," he said.

Such controls are critical to economic recovery because they can help ensure that large banks aren't hurt by swings in the capital markets. Banks are still clamping down on credit to consumers and businesses, even though gross domestic product expanded at a 3.5 percent annual pace in the third quarter after a yearlong contraction….

"My constituents, they're not just anxious, they are mad," Representative Michael Burgess, a Republican from Ft. Worth, Texas, told Treasury Secretary Timothy Geithner at a hearing of the Joint Economic Committee yesterday.

Under the TARP's capital-purchase program, the Treasury injected about $205 billion into more than 600 financial institutions of all sizes as of Nov. 13, according to department figures.

John Mack, chief executive officer of Morgan Stanley, said banks' behavior justified a Fed crackdown.

"We cannot control ourselves," he said yesterday at a panel discussion hosted by Bloomberg News and Vanity Fair at Bloomberg LP'S headquarters in New York. "You have to step in and control the Street."

The Fed is already under pressure from Dodd, chairman of the Senate Banking Committee, who proposed legislation Nov. 10 to strip the central bank of its supervisory authority. The Connecticut Democrat's move strikes at the core of efforts by Bernanke, 55, and Governor Daniel Tarullo, 57, to overhaul Fed supervision and increase monitoring of risks to the financial system.

Tarullo, President Barack Obama's first appointee to the central bank, is making greater use of so-called horizontal reviews that compare several banks' exposures and practices.

He is also drawing more on the Fed's staff of 220 Ph.D. economists to help identify risks. The Fed is now more likely to pull in the economists to run scenarios on what would happen to bank profits if global markets plunged, especially if the central bank's exams turn up concentrations of risk throughout the financial system. …

The central bank has been Morgan Stanley's primary regulator since September 2008, when it became a bank-holding company to gain access to Fed funding after Lehman Brothers Holdings Inc. collapsed. "We have probably 15 to 20 Fed regulators in our building 24 hours a day," Mack said. "They test our models. They question everything we do. I've never been regulated like that before. It's a different environment. Someone said to me, ‘What do you think of it?' I love it."

You see what the green-eyed devil (envy) can do to you? Take care, dear reader! Let this be an OBJECT lesson to you. John Mack has been VERY jealous of his counterpart Lloyd Blankfein ever since Lloyd said recently that Goldman Sachs was doing the Good Lord's work. John Mack has obviously had sleepless nights tossing and turning and trying to think of something to say that would take the spotlight off Blankfein and put it back where be believes it rightly belongs – on him and Morgan Stanley.

And boy did he do it, in our opinion. Not once but twice.

1. "WE CANNOT CONTROL OURSELVES," Mack said yesterday at a panel discussion hosted by Bloomberg News and Vanity Fair at Bloomberg LP'S headquarters in New York. "You have to step in and control the Street."

2. "WE HAVE PROBABLY 15 TO 20 FED REGULATORS IN OUR BUILDING 24 HOURS A DAY," Mack said. "They test our models. They question everything we do. I've never been regulated like that before. It's a different environment. Someone said to me, ‘WHAT DO YOU THINK OF IT?' I LOVE IT."

Say what? …

In fact, these are some of the most absurd statements we have read since … Blankfein's. Is Mack a kind of corporate victim of the Stockholm syndrome (when the captive comes to admire and even love his captors)? We were brought up to think that the CEO was in charge of his or her company and business. If the CEO could not "control" the business it would seem to us that he or she should step down.

And we're not so sure we "get" the idea that Mack is grateful that Morgan Stanley is being swarmed, apparently, by a virtual SWAT team of federal regulators. This is his idea of doing good business? Of retaining the flexibility to make quick business decisions? Of providing shareholders with the dominant leadership that will put them in the black?

Some other questions that come to mind … Are the agents armed? Are they operating under a policy that allows them to "taze" rogue bankers? Would Mack be even more grateful if the US army itself interceded? How about the Marines? They could storm the Morgan Stanley trading room.

We … we … hell, we're running out of words. There are virtually no adjectives to describe the bizarre nature of these statements (though we have to admit the Bloomberg reporters don't seem to find them so bizarre). We knew that Wall Street would mount a PR campaign to combat the backlash of 2008. But its heaviest hitters are proving no better at it than the Fed, in our humble opinion. (And across the Pond in Britain, they're just as bad, or even worse.)

This abortive PR effort by Wall Street's top money men to somehow reposition their businesses in such a way that the average Mom and Pop will stop being mad at them – well, it's yielding quotes that should last for the ages. Blankfein compares himself (or those around him) to the angels and Mack blurts out that he is not in charge of his business and that he loves it when his corporate headquarters is being swarmed by police.

No … these are not your father's corporate execs. In fact we don't know what they are. Are they governmental bureaucrats masquerading as bold visionaries? Are they agents of the federal meritocracy who have just found themselves out of their depth? Are they imposters who have been spirited in by reptilian aliens to take the places of the real individuals?

You decide. Here's a final excerpt from the article:

Continuing the [American} zero-rate policy may lead emerging economies "to overheat and experience financial turmoil," Bank of Japan Governor Masaaki Shirakawa said in Tokyo Nov. 16. The MSCI Asia Pacific index is up 66 percent since the March 9 low, and Asian countries from Singapore to South Korea are trying to rein in surging property prices.

Asian policy makers, including officials from India, South Korea and Indonesia, are studying capital controls to limit "hot money" inflows that may stoke asset bubbles and force their currencies to appreciate. Indonesia's central bank is "seriously" studying a limit on inflows to short-term bills, Senior Deputy Governor Darmin Nasution said Nov. 19. Taiwan last week banned international investors from placing funds in time deposits.

The U.S. shouldn't adjust monetary policy to account for rising Asian assets, Federal Reserve Bank of St. Louis President James Bullard said Nov. 18. "If there are problems in real- estate markets in Asia, it is not very practical to say you should raise interest rates in the U.S.," he said.

U.S. investors are concerned, too. They would have to be "joking or smoking — something" to think the Fed would raise rates with 15 million people out of work, Gross wrote in his note. Pimco had $940.4 billion in assets under management as of Sept. 30, according to its Web site.

So, this is the dirty little secret that the Fed doesn't want too widely disseminated! The Fed, dear readers, is in a box. Barack Obama may own the economic crisis now, but the Fed owns the policy. If jobless rates do not go down, the Fed itself will come in for criticism. No more pointing fingers at Wall Street. If jobs become more plentiful but the economy overheats, the Fed will be criticized for that as well. And while Ben Bernanke seems cool and collected about the whole thing, we can't imagine he wants to undergo further weeks and months of grilling about Fed monetary strategies.

Anyway, the riddle within the secret has to do with the Fed's expectation that jobs are probably NOT going to return, or not anytime soon. This is VERY bad from the Fed's point of view (PR-wise anyway) because now the Fed looks as if it has dumped trillions into the market to avert the ruin of friends and colleagues but has done nothing for the larger economy. There is the appearance of crony capitalism here, and you know what – sometimes appearances aren't all that deceiving. That's exactly what it was, wasn't it? Only it is inconvenient to have to justify it.

The Fed (and other central banks) have some ‘splainin to do. In the past (pre-Internet) it was a lot easier to have one's cake (an economic downturn that further consolidated central banking power) and to eat it, too (gobble up more regulatory territory by blaming the private sector for economic woes.) But it doesn't work that way anymore. Too many people have noticed the wizard behind the curtain.

After Thoughts

We don't know what the Fed is going to do next. But if another asset bubble bursts, they can point all they want to their cadres of field agents and their endless stress tests and it likely won't matter a bit. The Fed itself, the irresponsible and unjustifiable price-fixing mechanism at the heart of American monetary policy, will be held accountable. Of course, we have a modest solution. If the Fed does not want this fate, however, its top honchos should declare that they wish the West to return to a private gold and silver market standard of the kind that served the world well for thousands of years. This would remove them from the line of fire. And it would be an excellent PR move. We stand ready to assist. Unlike Alan Greenspan, we do not charge a million dollars an hour.

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