His hopeful yet empty words caused me to reflect on the progress of government intervention through this crisis so far. And I can come to only one conclusion;

I’m praying that they’re devious.

That their measures are intended to fail. That they’ve got some secret plot…a conspiracy going on. Otherwise it means our leaders – political and economic – are just plain obtuse – complete with dunce caps.

Because there’s no other way to explain the abysmal failure of rhetoric and ‘policy’ over the course of the last year. It’s either deliberate or just thanks to incompetence. And with a darkening future ahead of us, we can only hope that it isn’t the latter.

So I’m done holding it in. I’ve been watching this farce play out for months and it’s time to let loose the broadside on these fools…smashing their misconceptions, half-truths and lies of omission to little bits.

Enough with the talk…it’s time for the fireworks.

The Free Market Didn’t Fail; The Regulations Did

Truthfully, every time I hear some politician talk about how this is an example of the failure of free markets, I want to whack the guy on the head with a rubber mallet.

There’s a fine line between free markets and the deregulation that’s allegedly intended to create a ‘free-er’ market…and that’s a distinction most fail to notice.

And in the last few decades we haven’t had anything even closely resembling a free market. Instead, we’ve had a 21st century banking system that’s governed by a gutted 1940s regulatory structure.

I’m talking about some of more dangerous “free market reforms” of the Clinton/Bush era. The repeal of the Glass Steagall Act – which kept the banking system functional from the Great Depression through the end of the 20th century – and the 2004 decision to lift leverage limitations on American banks.

Were these regulations removed with the intention of creating a free-er marketplace? In my humble opinion; absolutely not.

These were crucial safety nets for our highly-regulated economic system that got in the way of bankers’ profits. Removing them wasn’t a free market initiative, and it didn’t create a free market. It just made the whole situation far more dangerous.

If anything, the massive amounts of lobbyist money that made this deregulation possible prove – beyond a shadow of a doubt – that the U.S. government is too compromised to properly manage the economy.

Meanwhile, the government-mandated ratings agencies continued to stamp their seal of approval on questionable mortgage-backed securities. And the SEC continued to let Madoff and Stanford go about their business, long after they were warned of Madoff’s shenanigans.

You’re probably starting to see that it wasn’t the free market that created today’s problems, but the false sense of security brought on by “strict” government regulations.

So yeah, let’s go ahead and build a bigger safety blanket. One that costs more, makes the market even less efficient, and ultimately proves to be as dodgy and inconsistent as the existing regulatory system. Now that’s genius.

Taking it a step further; the size and scope of this crisis could be pinned directly on the Federal Reserve. That’s right; Greenspan’s ‘liquidity experiment’ and years of rock-bottom interest rates were the lungs blowing up the bubble. But that’s a different story altogether.

Moving on to Lie # 2…

A Novel Idea for Politicians: Quit Lying and Make up Your Mind

This is a big one.

Asking a politician to tell the truth or actually make up his mind…well that’s like asking a teenager to drive 20 miles under the speed limit. It’s just not going to happen.

Generally, that’s because telling the truth is bad for a politician’s business. No problem there…I can respect that. But what about when it’s actually a good thing for the country?

Take right now for instance. The markets are running scared. They’re beaten down and oversold, waiting for a single ray of hope or even just some consistency. What do they get instead?

They get bald-faced lies like the most recent joint statement from the Treasury, FDIC, OTS, OCC and the Fed…one that macroeconomist Mike Shedlock calls “a Purposeful Joint Lie.” A document so filled with puffery and damage control that it could make Ben Bernanke blush.

They get a government that fails to warn them that one of the people’s newest acquisitions – AIG – is set to declare the single largest loss in corporate history. They get a President who tells the press that years of trillion dollar deficits are on the way…only to backpedal a few weeks later and promise deficits half that size by the end of his first term.

Hey government; I’ve got a novel idea. How ’bout you pick a story, and stick to it?

Want another shining example? Look no further than “illiquid assets.” Know why they’re illiquid? Because the government won’t pick a value and stick to it.

The “illiquid assets” aren’t worth face value, and they’d fetch maybe a third of their value in the secondary market (for sake of argument). But ever since Paulson’s “Master Liquidity Enhancement Conduit” (MLEC) in the summer of 2007, the government’s been waffling back and forth with half-hearted promises to pay 75% of face value…perhaps more…perhaps less. They just haven’t made up their minds.

So instead of having the market’s clearing mechanism do its magic, working out deals and determining a fair market value for these securities – so that we can all move on with the lengthy road to recovery – we’ve got the government in there gummin’ up the works.

Faced with the decision of either shaking the rotten apples out of the tree or forcing taxpayers to pay for those rotten apples, they’ve chosen indecision. And the market’s not happy about that.

Paving the Road to Great Depression II

Remember, sequels are always bigger, more violent and less entertaining than the original. Oh, and they also have a knack for rehashing the worst parts of the original.

But seriously folks, let’s set the stage before I’m dismissed as a ‘fearmonger’ by people that don’t know all the facts. It surprises me that so much of the news media has reverted to questioning whether this is even the biggest slump since the Great Depression. Have they been reading the same news I have?

Both George Soros and Nassim Taleb have gone on record as saying that we’re facing a bigger slump than the Great Depression. In a little-known interview regarding his interest rate policy, Greenspan warned that this event could make the Great Depression, “look like a Sunday Picnic.” And at least nominally speaking, you can safely say that this is the biggest asset price bubble in the history of human civilization. So yes, it can be a little unnerving.

And yes; a full-blown Depression is in the range of possible outcomes.

Especially if bumbling politicians and the Fed keep themselves firmly lodged between the economy and a recovery. Just look at 1990s Japan or 1929 America. In both cases, authorities got involved and mucked up the works. Unlike the barely-remembered 1920-21 slump, a deep recession that quickly corrected itself thanks to non-intervention.

Not that they couldn’t be helping if they wanted to. They’d just have to make up their minds, quit pandering to their “sponsors” or just plain get out of the way. But that’s not likely any time soon.

(To learn how you can cut through this mess yourself, read Chairman John Pugsley’s full Lies Report)

Source: The U.S. Government: Devious or Just Plain Stupid…

This dismantling of the so-called “New Federalism” will be readily apparent again this week as the federal government is once again at the forefront of the most-closely watched  crisis-fighting initiatives at hand: With Congress pushing forward on an $827 billion stimulus plan and the Treasury Department planning to unveil its new banking bailout blueprint on Tuesday, economists and other experts say the federal government is taking its biggest role in the economy in a generation.

States that once pushed away from the federal government as part of the New Federalism are now essentially begging it for financial support, banks and Big Business that once viewed near-total deregulation as Corporate America’s Holy Grail are now seeking federal financial aid and new regulatory protections (and in many cases are becoming actual business partners with the government), and individuals are asking for tax relief.

Alan Viard, a Bush administration economist now at the American Enterprise Institute, may well epitomize this reversal of thought: He’s one of the economists who initially rejected the need for a fiscal stimulus, stating that the right size for a government spending bill was “probably zero,” believing that federal interest rate cuts and existing unemployment benefits would be enough to do the trick. But he now sees the package as necessary.

“Things have gotten so bad so quickly,” Viard told The Washington Post. “We have now lost 3.6 million jobs, a stunning loss. But what’s more horrifying is that half that loss has occurred in the last three months. This is a severe recession.”

The exact shape and size of the package matters less than the timing, and any delay will be very damaging, economists say.

“Most of the things in the package, the big dollar amounts, are things that are pretty quick stimulus and need to be done,” Alice Rivlin, who was former president Bill Clinton’s budget director and a critic of aspects of the proposed stimulus, told The Post. “Is it a perfect package? Of course not. But we’re past that. Let’s just do it.”

Signs of the Stimulus

The U.S. Senate late Friday reached agreement on the estimated $827 billion stimulus bill, setting the stage for what’s expected to be some tough negotiations with the House of Representatives over tens of billions of dollars in aid to states and local governments, tax provisions, and programs focusing on education, health and renewable energy.

Congress is pushing hard to complete the legislation this week. But that figures to be a challenge. The House bill was passed without any Republican support, while the Senate version passed Friday night between Democrats and three moderate Republicans.

During a rare floor session on Saturday, Republican opponents continued to criticize the entire stimulus proposal – even though they clearly don’t have the votes to stop it. The bill is expected to be passed in the next few days.

The price tag for the Senate plan is only slightly more than the $820 billion measure adopted by the House late last month. Both plans seek to resuscitate the U.S. economy with similar one-two punch strategies:

• Fast-acting tax cuts designed to jump-start consumer and business spending.
• And longer-term – albeit slower-acting – spending on public works programs and other projects that are projected to create more than 3 million jobs.

Despite these seemingly similar philosophies, the two plans rely on approaches that are very different. The higher-priced House bill emphasizes help to states and municipalities that would otherwise be facing major cuts in services and layoffs of public employees, while the Senate slashed $40 billion of that kind of funding from its version of the bill.

The Senate plan focuses more on tax cuts, lowers a proposed increase in food stamps and provides health-care subsidies for the unemployed that are much less generous than the House version. The Senate plan also creates $30 billion in tax incentives to encourage Americans to buy homes and cars within the next year.

House Speaker Nancy Pelosi, D-Calif., said the emerging Senate cuts to the stimulus program “very damaging” and that she was “very much opposed to them.” But after the Senate reached a deal, Pelosi expressed resolve to complete the legislation in the days ahead.

U.S. President Barack Obama has made the economic recovery effort the centerpiece of his agenda since even before he officially took office. But President Obama now intends to get much more involved, and much more aggressive: He will conduct a “town-hall-style” meeting in Indiana today (Monday), followed by a formal “prime time” White House news conference – the first of his term – tonight.

The president will then pitch the plan again in Florida tomorrow (Tuesday) and again in Virginia on Wednesday.

Senate Majority Leader Harry Reid, D-Nev., said final passage of the Senate bill is expected Thursday, after which congressional leaders say they will hurry to get the House and Senate versions into conference with the hope that a passed bill can be sent to the White House by the end of week, the San Francisco Chronicle reported.

Banking Plan Overhaul Unveiling Tomorrow (Tuesday)

Busy new U.S. Treasury Secretary Timothy F. Geithner last week promised that the Obama administration would unveil its new blueprint for rescuing the U.S. banking system today. Over the weekend, however, the administration said the rollout would be delayed until Tuesday, so that the focus could remain on passage of the stimulus package, Bloomberg News reported.

But that doesn’t mean the banking bailout plan isn’t key.

According to a recent analysis, the Obama administration has a multi-pronged strategy for quelling the financial crisis, including:

• A program to insure banks against extreme losses on mortgages and other loans.
• A new round of investments in banks.
• Help for homeowners facing possible foreclosure.
• The broadening of a U.S. Federal Reserve program to ramp up lending.
• The Treasury Department could also look at purchasing toxic assets from banks – possibly with the aid of private-sector financing.

This would represent an overhaul of the $700 billion Troubled Assets Relief Program (TARP) initiated by the Bush administration. As the name implies, TARP was initially concerned with buying troubled assets – but it quickly evolved into a direct-government investment into the banks.

This new Obama plan reflects Geithner’s personally held view of how governments should respond to financial crises. Geithner believes all available financial tools should be used – and used aggressively. Any such effort would include direct efforts to deal with the financial sector’s massive losses, since that would help renew public confidence in the financial system.

Too small a government response during a crisis poses more risk than too much response, he said during his confirmation hearing.

Many of the details of what Geithner will announce remained in flux, although the broad outlines were becoming clear, published reports state. But one thing is certain: Even the ideas that are continuations of the initiatives started by former Treasury Secretary Henry M. “Hank” Paulson Jr. will have a unique Geithner twist.

One example: The government will almost certainly continue to invest in banks. But past investments consisted of a form of “preferred stock” that granted the federal government no say in how the bank was run, or how the money would be used.

As a Money Morning investigation revealed, that lack of control allowed banks to use taxpayer-provided TARP money as financing for buyouts. And then the banks refused to detail how they spent the money – and why not? They weren’t required to.

Under the new plan, there will still likely be new government investments in banks. But Geithner will likely call for those new investments to be convertible into common stock after some fixed period of time, perhaps seven years. If the banks are unable to raise private capital in that span, government control would escalate.

Banks receiving money also will probably have to report to the government and to the public, and the government is likely to insist that the new capital be used to expand lending.

Geithner has also been looking for a way to bring back the original TARP concept, which Congress passed on Oct. 3. Paulson pitched the plan to Congress as a program to buy troubled assets off of banks’ books, then shifted the plan and opted to invest directly into the banks instead.

Paulson’s chief worry – and the reason that he changed direction – was that asset purchases would involve too many technical complications, meaning it would take too long to enact. And that delay could be costly to a system where banks were teetering on the precipice of failure.

After struggling with those same issues, Geithner and his team appear to have settled on an approach that amounts to financial triage, meant to give investors confidence that banks will not encounter vast new losses so that they are willing to invest private money, The Post reported.

In addition to buying bad assets, the Fed and Treasury in the next few weeks are expected to expand a program that should jump-start lending outside the banking system. In November, the agencies launched a program – the “Term Asset-Backed Securities Loan Facility” – that would devote $200 billion for credit card, auto, student and small-business loans.

That program will be extended to include residential real-estate mortgages and into the commercial real estate sector. Geithner may also announce an initiative that would inject government money into companies known as mono-line insurers. These firms are key players for states and municipalities when it comes time for those state and local government bodies to borrow money. With the implosion of the housing bubble, and the subsequent implosion of the commercial real estate business, mortgage-related losses by the insurers have made it harder for states to issue the municipal bonds that would help them ride out the recession without aggressive tax increases or budget cuts.

Geithner is likely to roll out a plan, worth $50 billion to $100 billion, to encourage the modification of mortgages for homeowners who would otherwise likely face foreclosure. It could be based loosely on a strategy for foreclosure relief engineered by Federal Deposit Insurance Corp. (FDIC) Chairman Sheila C. Bair, when the FDIC took control of the failed bank IndyMac Bancorp Inc. (IDMCQ) last year.

Market Matters

On the corporate front, United Parcel Service Inc. (UPS) posted a profit (though revenue declined) and then announced new cost-cutting measures.  Motorola Inc. (MOT), The Walt Disney Co. (DIS), Time Warner Inc. (TWX), and Costco Wholesale Corp. (COST) reported disappointing results.  Visa Inc’s (V) earnings jumped by 35%, though management warned of tougher times ahead.

Bailout plan recipients have tried to cut back excessive spending (and the associated bad PR) as Goldman Sachs Group Inc. (GS) (Miami) and Well Fargo & Co. (WFC) (Las Vegas) canceled huge boondoggles. Bank of America Corp. (BAC) is selling off corporate jets, and Citigroup Inc. (C) may be attempting to get out of the $400 million marketing deal with the New York Mets.

C-SPAN must be enjoying stellar ratings as investors seem obsessed with the inner-workings of Congress and their debates on the stimulus and bailout.  The markets disregarded much of the dire earnings and economic data (terrible unemployment report…see below) and focused on the newfound optimism that politicos can work together to get the country moving in the right direction.

Economically Speaking

Just how long until a stimulus package starts creating jobs?  That answer can’t come soon enough for the almost 600,000 people who moved to the unemployment line in January, the most devastating month for job losses since 1974.  The unemployment rate climbed to 7.6%, forcing many economists to (upwardly) revise their projections for the rest of the year (and beyond).

Since the recession “officially” began in December 2007, the country has lost more than 3.6 million jobs, with most of the losses coming in the past three months.  The rest of the data released during the week did little to contradict the lousy unemployment picture.  Factory orders fell for the fifth straight month and the ISM index revealed that purchasing managers still look for contraction in the manufacturing sector. Though the services sector showed a slight rebound in its ISM survey, the index reported a fourth consecutive month of declining activity.  Residential construction spending experienced its worst annual decline ever recorded (since 1993), though optimists are hopeful that a stimulus package that focuses on infrastructure growth will prompt a renewal in non-residential building.

With the Fed stuck looking for creative ways to get involved (now that the benchmark Federal Fund rate stands at about 0%), its international counterparts took action (or inaction) of their own. The Bank of England (BOE) cuts its primary lending rate to a record low 1.0%, while the European Central Bank chose to leave its rate unchanged (for now) at 2.0%.

Weekly Economic Calendar

Source: As Stimulus-Package Debate Continues in Congress, New-Look Bank Bailout Plan is Set to Debut This Week

It also forces us to ask some tough questions – questions for which there may be no simple answers. Key among them:

• Where are we?
• How did we get here?
• How do we get home?

There are innumerable opinions as to how we got where we are – not to mention about who and what caused the housing bubble, the credit crisis, the insolvency of banks, the implosion of markets and the slippery slope to potential reprise of the Great Depression. All the opinions and bad directions aside, we would not have crashed if we had not thrown away the regulatory map that had been designed to guide us.

In 1980, stirring winds of change began buffeting the regulatory edifice that for decades had protected us from unsound banking practices. Ultimately, the safe harbors of pragmatic and prudent regulation, born of the Great Depression, were swept away. And deregulation unleashed unmitigated greed.

In the ensuing rush for profits – under the bigger-is-better banner – the unfettered and unchecked growth of illusive financial instruments and excessive leverage spawned an unprecedented concentration of systemic risk. The result has been a global financial catastrophe of truly biblical proportions.

Death by Derivatives

It used to be that new financial products were only allowed to come to market after a thorough examination by several different regulators who each weighed in on how the product might affect the portion of the market that they supervised. While that was a cumbersome process, it served to keep dangerous products off the shelves of institutional and retail investors.

In the brave, new deregulated world of today, however, the story is very different. Indeed, it’s frightening to conclude that toxic products with nuclear potential were manufactured and stockpiled in every neighborhood in America.

The specific products – structured collateralized mortgage obligations (CMOs) and credit default swaps (CDS) – are “derivative” products that stand out as being particularly egregious. There were no regulations against creating newfangled, incendiary residential and commercial mortgage products that, only on their surface, looked like other tried-and-true securitized mortgage products. Imagine your kids being given real guns and told they were just like the toys they were used to, only better.

As for credit default swaps, only in a deregulated world could a “product” of such massive destructive power be allowed to proliferate into a $60 trillion market, impact virtually any company it targets for destruction and not be subject to even a single rule or regulation. In the absence of any regulation, credit default swaps have become a financial plague. If you need proof, just look at what happened with insurer American International Group Inc. (AIG).

Even in an appropriately regulated marketplace, sound products are subject to changing market conditions. In a properly regulated product market, regulated ratings agencies would provide transparent, researched and documented analyses of the products they rate, and would also adjust their ratings in a timely manner to reflect changing conditions. One of the reasons we are here in this mess is that the debt-rating agencies were not regulated.

That’s right: No one was watching the watchers.

You Can’t Rate What You Can’t See

Incongruously and deceptively, ratings agencies are paid handsomely by the issuers of the products they rate, who would like high ratings on their products so they can sell more of them, more easily, and for greater profits.

Ratings are vital to ascertaining the risk and reward relative to the market price of products. Ratings agencies and the existing business model they work under must be changed and strenuously regulated.

“Buyer beware” might be acceptable advice when shopping in a regulated financial supermarket. But, in the current deregulated market, it is a prescription for suicide. And without proper regulation, dangerous products stamped “rating agency approved” proliferated.

That was bad enough.

But these toxic products were then distributed by co-conspirators in the age-old game of “heads I win, tails you lose.” The existing, self-serving, self-policing regulatory regime that oversees financial professionals is a very unfunny joke.

Regulations with repercussions must replace the thin veil that covers and covers-up the criminal and stupid individuals and firms that prey on retail customers and unsuspecting institutional clients alike. The financial-services industry is about products and professionals. Without better oversight of the individuals and the companies involved, there will be no confidence in the integrity of the financial system.

As far as regulating other intermediaries at such non-bank institutions as mortgage originators, they need to come under a united umbrella and be regulated, not separately, but under a comprehensive apparatus.

Of the multiple failures of inadequate regulation, one in particular is responsible for the coalescing of destructive forces that imploded the world as we knew it: There is no mechanism to monitor and dilute the inordinate concentration of risk that leverage and greed conspired to allay in a gross gambit for profitability.

The build up of systemic risk was largely a byproduct of deregulation, or non-existent regulation. Banks merged with investment banks and stand-alone investment banks borrowed more and more to compete with commercial bank subsidiaries that had access to massive depositor capital. Meanwhile, giant hedge funds were borrowing from banks and investment banks to leverage returns, all in a machismo-fueled competitive frenzy to out-earn each other.

They all ended up in the same small sandbox holding the same lottery tickets for a dance with the school prom queen. When everyone realized that the queen had already been spoken for, their mass exodus to cash in their lottery tickets created the great de-leveraging and the sell-off that swept through all the world’s markets. Where were the regulators?

The Crisis of Confidence

There are, no doubt, free-market disciples who will argue that regulation actually created the problems we are facing. While the theory makes for good debate, the reality is that greed is a part of human nature, which can’t be regulated away.

The truth is that our system of regulatory protections has been hollowed out while we watched. And what’s left is inadequate. In order to fix a banking crisis – which is what we’re faced with now – the very first task, and the most important step of all, is to restore confidence. Or create it anew.

Without appropriate, transparent and dynamic regulation, there will be no recovery. The world has changed and the financial system must change with it. Only a new, comprehensive, transparent and protective regulatory apparatus can save future investors from again experiencing the financial horrors of the past.

The time for change is now.

Source: Only Tighter Regulation Will Stem this Crisis of Confidence

Editor’s Note: This is the second installment of a three-part examination of deregulation, and how it helped spawn the U.S. credit crisis. In Monday’s capstone installment, Gilani will outline a plan for rebuilding the nation’s regulatory safety net.

If you haven’t figured it out, I’m talking about green investing. And as gas prices rocket higher and higher, green technology will become even more widespread.

In the past two weeks, I have written about the subject. I’ve discussed that for the most part, the economics of becoming green don’t make sense. But thanks to higher gas prices, green energy is becoming more and more commonplace.

For example, the Financial Times estimates that by 2030, plug-in cars will make up 50% of all cars sold. According to the World Watch Institute, starting in 2010, China will spend over $236 billion each year on green investments.

That’s huge. But that’s not all…

In a recent Harper’s Magazine article, it was pointed out that to have a bubble you need three things:

1. Government incentives or deregulation
2. An irrational belief that drives the masses to buy
3. A sector which can spawn new ways to make money nearly instantly

Now think about it. The Internet bubble saw all three things.

The government decided not to collect taxes from online purchases. They also helped speed up adoption of broadband and granted various tax credits to companies that would deal in technology (Silicon Valley anyone?). So obviously, the government helped.

Second, most people believed the Internet was the future. They thought that it would be so huge that life itself would depend on it (they weren’t wrong, just early). Remember the Y2K bug scare? That was part of America’s obsession with technology.

To make matters worse, everyone thought that buying an Internet stock was a sure bet. Companies were spawning every day and they all thought they had a great idea. But the problem was that they were only ideas. I saw my best friend’s father make over $140,000 – and then lose almost all of it as the bubble burst.

Now let’s look at the real estate bubble.

Under Greenspan, financial regulation was a joke. He believed in a free market and so thought that any government regulation would result in more harm than good. Add in the super-low interest rates we had and you’ll see that banks had the green light to grow undeterred.

Mix all of this in with the belief most people had that real estate never goes down, and you’ve got yet another bubble recipe brewing. Heck, people who had never bought real estate were buying and flipping houses and speculative vacant lots in a matter of months.

Finally, when mortgage demand started drying up, banks started issuing subprime, interest only, and no-doc loans. Then they would pull mortgages off their balance sheet, wrap them up in a nifty little investment vehicle, and sell them to hedge funds, banks, and investors looking for the supposedly safer mortgage backed returns. These banks were essentially creating these investment vehicles out of thin air.

As you can see, the real estate market also fits the profile of a bubble.

So how about the green market?

Well, the government recently incentivized production of ethanol, biofuel, and solar technology. If a Democrat gets into office, these incentives should grow. Congress even pushed up the Corporate Average Fuel Economy (CAFÉ) guidelines for the first time since 1975. And the idea of carbon credits is beginning to gain traction in Congress.

So the government is helping fuel the creation of cleaner energy. Step one is complete.

What about step two?

If I talk to any of my friends and tell them I love the things oil does to the earth, they’ll slap me (yes, I know oil is bad for the earth). If I told them that I didn’t recycle, they’d yell at me (yes, I recycle). My friends are already convinced that the green movement is the way to go.

If you type in the word ‘green’ in Google, you’ll see thousands of new websites that all talk about how great it is to be green.

Look at corporate trends, and you see more commercials with companies talking about going green. Wal-Mart, IBM, Intel, Google, and even ExxonMobil is getting into the act. The idea of going green is spreading like wildfire. And it will only increase as gas prices move higher.

This week’s news told us that good times are over. “For the time being, at least,” said the Governor of the Bank of England, “the ‘nice’ decade is behind us.”

Of course, just because an economist or a central banker says something, it doesn’t make it so. And when a central banker who is also an economist says something, it should be treated with the skepticism of an airline schedule.

“I am obviously biased, but I find it sad to conclude that the role of serious economists in financial institutions is very limited today,” said Han de Jong, Chief Economist at ABN Amro Bank to the Financial Times on February 21, 2008. ” We are little more than clowns, whose purpose is to entertain clients….”

Mr. de Jong is too modest. Economists are essential to the financial industry. They distract the customers while the boys on the sales desks pick their pockets.

We say that not in contempt but admiration; the role of the financial industry – like the contemporary art market or like Las Vegas – is to separate the punters from their money. Economists help them get the job done.

This they did in the last two decades with a variety of gaudy theories. It didn’t seem to matter that the theories were contradictory and absurd. On the one hand, prices were said to move randomly – permitting them to ‘model’ risk and sell extravagant securities. On the other hand, private equity experts and fund managers pretended to know which way the ‘random’ movements would go; they claimed to be able to produce “alpha” – above market returns – on a such a regular basis they could charge “2 and 20″ for it.

But while economists are usually wrong about things, the burden of the present essay is that Mr. King is right this time.

Last week, we argued that ‘alpha’ was a mountebank. The financial industry doesn’t often add much value, we pointed out. Instead, fair winds and convenient tides are what usually get investors’ little barks where they want them to go. Most of the results investors get depend upon setting sail at the right hour, from the right place, in other words, not in having a Wall Street hotshot at the tiller. Put an alpha-seeking whiz-kid out in a storm and he’ll sink along with everyone else.

In the 20-year period ’83 to ’03, for example, the price of oil barely moved. Sheep could graze peacefully in the Mideast, confident of being undisturbed. Now, everywhere they go, someone’s setting up an oil rig. The latest figures show oil exploration up 400% since 2000.

Almost a whole generation of investors got nothing from that greasy sector. Then, all of a sudden, in the following 5 years the roughnecks suddenly had money in their pockets and the wind at their backs.

Likewise, in America, you could have held residential housing for 100 years – from 1896 to 1996. You would have gotten nothing for your trouble but leaky roofs and cracked paint; prices rose only as much as consumer prices. Then, the next ten years, a tide of easy credit rushed into the residential real estate market; prices rose 70% in real terms.

Behind both these booms is a story too long to tell here. But the moral of it is simple enough. The average investor makes far more by accident than by fund manager. And here we venture a guess: of all the times and places in which a US investor might hope to get a decent return on his money, this is not one of them.

But the beauty of capitalism is that people get what they’ve got coming – not matter what they think. NICE is an acronym for “non-inflationary consistent expansion,” according to Mr. King. It is his way of describing what other economists called the “great moderation,” a period so agreeable that they gave themselves credit for it. Macro economists believed they had finally mastered the art of central banking – so perfectly manipulating the credit cycle as to produce growth without causing the consumer price inflation that typically accompanies it.

If economic wizards were really responsible for the Great Moderation, it would be reasonable to think they could keep it going. Alas, they can no more sustain it than they can claim credit for it. What really happened, over the last 25 years, was a unique series of events and trends that now seem to have run their course. Labor rates fell as millions of new workers entered the modern economy. Now, even in China and India, salaries are rising fast. Logistical expenses declined as computers and just-in-time inventory systems were put in place; now inventories (and associated costs) are rising again. Outsourcing, globalization, deregulation, capitalization, securitization – all these trends helped keep prices down; now, all seem to have played themselves out, gone into reverse, or backfired.

Finally, the cost of money has fallen for the last 27 years. Sometimes it fell naturally. Sometimes it fell unnaturally, even grotesquely – such as when Alan Greenspan lent the Fed’s money at below the inflation rate for more than a year. Normally, cheaper money creates boom-like conditions. But normally, it comes at a cost: consumer prices soon begin to rise. As the economy “heats up,” the domino of labor costs falls over; workers are in demand so they ask for more money. Then, that domino knocks over consumer price stability; prices rise. Then, a whole line of dominos topples over. Bond investors run for cover, for example, forcing up interest rates. Then, the economy “cools down,” as the cost of money increases.

That was what was so nice about the ‘nice’ years. The dominos wouldn’t budge. Thanks to so many things working so hard to keep prices down, the normal process of self-correction broke down. As demand for labor increased, new, cheaper workers were found overseas. And even though the supply of dollars increased twice as fast as GDP, the domino with the CPI on it stayed right where it was.

Alas, those happy days are over. The Great Moderation is finished. This week, oil rose over $130 a barrel. T. Boone Pickens said it would hit $150 this year. And America’s core producer price index registered its biggest increase in 17 years.

Of course, the real level of consumer price inflation is probably far higher than the official numbers. The raw data suggest price increases closer to 10% per year than the 4% the US Department of Labor confesses. But the economists have their ways of making the numbers say whatever they want. In March, for example, the consumer price index was “seasonally adjusted” from 0.9% down to 0.3%. In April, wouldn’t you know it, another seasonal adjustment took the number from 0.6% down to 0.2%. We don’t know what the real number should be; no one does. But Mervyn King is right; the season has changed.

Source: Not So NICE Anymore