In defense of free market fundamentalism

Jun 10, 2011 16:32 UTC

“Extremism in the defense of liberty is no vice. And moderation in the pursuit of justice is no virtue.”

–Senator Barry Goldwater (R-AZ)

There is a great deal of debate in the media about the economy and whether the “recovery”, which supposedly occurred in the US in 2010, is faltering. While the macro economic statistics, which fascinate many economists, show that there was indeed some increase in financial flows through in the US economy, it remains debatable whether any real economic benefit trickled down to the lowest common denominator, namely people.

The growing political unease in the country over economic policy and job creation is starting to become downright nasty. For the first time since the 1970s, Americans face the prospect of a low or no growth economy and this is not an outcome that is at all welcome. The swing from the irrational exuberance of the past two decades to something more closely akin to “normal” is shocking for the public. The latest evidence of pressure for fiscal cuts is shown in the proposal this week by Democratic New York Governor Andrew Cuomo to limit public pensions.

Reading various online threads, it never ceases to amaze me that advocates of what we will call a more liberal or progressive line of economic thinking inevitably embrace the corporate state for solutions. We need to buy every American a copy of George Orwell’s Animal Farm, a book you need to read a couple of times during your life. Orwell was a long time supporter of the socialist Labor Party in the UK , but he was also a fierce libertarian who saw the authoritarian side of socialism so beautifully told in Animal Farm.

The individualist or free market tendency in economics, on the other hand, is ridiculed by supposedly liberal economists and others as the choice of greedy people who are really sociopaths or worse. Free market fundamentalism, to paraphrase environmental activist Vandana Shiva, is at the root of the economic woes of the earth. She writes in her book War on the Earth:

The predatory practices of corporations are increasingly turning our fragile garden into a junkyard. Citizens are told by their political masters and the corporados who pay them that there is no alternative. That’s true if one’s only concern is profits. That approach is fast turning our planet into a toxic waste dump.

What is fascinating about Shiva is that even as she attacks the excesses of big business, much of her work and also her background as a physician and scientist is very similar to that of the great libertarian economic thinkers such as Ludwig von Mises, F.A. Hayek and Frederick Bastiat. Shiva’s focus on empowering individuals to think and to act in a free fashion as actors in a larger civil society to achieve collective needs is very much in line with von Mises, not to mention the classical liberal view of America’s founders who embraced diversity and equality of opportunity for all as the basic rule of civil society.

The rapid commercialization of American society since WWI and the rise of the corporation as the dominant model in the global political economy raises many challenges for those who struggle to protect individual liberties. First and foremost its is necessary is to understand the distinction between true individual choice as economic actors and people being swept along by a consensus about economic policy that is molded by the public relations apparatus of government and large corporate enterprises.

Geoffrey West, in a conversation published by Edge, “Why Cities Keep Growing, Corporations and People Always Die, and Life Gets Faster,” illustrates the dilemma facing society. Large organizations, which seem to promise stability and security, often are actually dying and thus unable to promote wealth creation and employment. Noting the quality of great cities as economic entities which promote and encourage individual diversity, West raises basic questions about whether industrial consolidation and the rise of global corporations is really good for society — that is, individuals in aggregate — in terms of long-term economic growth.

Von Mises argues in his classic 1945 book, Human Action, that it was the development of economic thinking generally, not merely the free market variety, which made the period from the industrial revolution onward so powerful in terms of expansion of benefits for all people. Von Mises wrote:

People fall prey to the fallacy that the improvement of the methods of production was contemporaneous with with the laissez faire only by accident. Deluded by Marxian myths, they consider modern industrialism an outcome of the operation of mysterious ‘productive forces’ … Hence the abolition of capitalism and the substitution of socialist totalitarianism for a market economy and free enterprise would not impair the further progress of technology.

So when author and professor Nassim Taleb is reported to say that all CEOs and economists are basically “sociopaths,” a person with a lack of conscience and extreme antisocial attitudes and behavior, what does he mean? My interpretation is that Taleb accurately notes that most CEOs of large enterprises are value destroyers in the sense described by West, while individuals and smaller enterprises tend to be far more productive in terms of creating value for society and employment for people.

Large corporations tend to avoid risk and over time try to control markets and even governments to protect their interests. While the vast majority of business people, who run smaller enterprises, are honest and support a civil society (and generate the majority of jobs), the captains of the largest corporations often take actions antithetical to a democratic society and their shareholders.

Far from being an achievement of the era of laissez faire economics, the rise of the large corporation is a throwback to the period of monarchism and tyranny before the industrial revolution. In The Modern Corporation and Private Property by Adolf Berle and Gardiner Means, published in 1932, the authors warn:

The property owner who invests in a modern corporation so far surrenders his wealth to those in control of the corporation that he has exchanged the position of independent owner for one in which he may become merely recipient of the wages of capital … [Such owners] have surrendered the right that the corporation should be operated in their sole interest.

Likewise, the wonderful reference to economists as sociopaths conjures images of the dominance of the statist mindset among the dismal profession. The notion that national economies can be managed from the macro level and that human action, as opposed to market perception, is not significant are entirely authoritarian perspectives. Yet this type of thinking is precisely what passes for mainstream economic thought in the academic world and in important institutions such as the Federal Reserve System. The Fed likes the idea of large banks because they serve as conduits for make-believe macro economic policy, not because large banks are good for the economy or its inhabitants.

Just as large, mature organization tend to lose the ability to innovate and thus destroy shareholder value, the economic thinking which celebrates big government and cartels in finance and industry is slowly killing the private sector in America and diminishing the rights of individuals. In the difficult debate over economic restructuring and renewal which must occur in the US over the next several years, we ought to begin with an assessment of elemental principles. Americans need to leave aside labels like left and right, and start asking basic questions about what mixture of policies will best enhance the economic and political lives of individuals.

Once we understand that many of the problems we face today as communities of individuals called nations come about due to concentrations of power in large governmental and corporate enterprises, and the corruption of these structures, then people on all sides of the supposed political debate are going to discover new common ground.

Focusing on individual economic and political rights is no vice, as Barry Goldwater famously declared. Rather, a new focus on individual rights and responsibilities in an economic and social sense is the start of a long overdue discussion about the American political economy. If we inform our discussion with the focus on individual liberties that was the point of departure for our nation’s founders, we will be successful.



Another Good article, and thank you, Chris.

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Why Congress should vote no on raising the debt ceiling

Apr 13, 2011 14:38 UTC

By Christopher Whalen
The opinions expressed are his own.

“A spectre is haunting Europe — the spectre of communism. All the powers of old Europe have entered into a holy alliance to exorcise this spectre: Pope and Tsar, Metternich and Guizot, French Radicals and German police-spies.”

–Karl Marx – Friedrich Engels
The Communist Manifesto

There is a specter haunting the industrial nations, too — the specter of debt default and deflation. All of the powers of the post-WWII regime of neo-Keynesian economic management have entered into a holy alliance to exorcise this specter: Fed Chairman Bernanke, European Central Bank Head Jean-Claude Trichet, Democrats in the American Congress and the German centrist tendency under Angela Merkel.

All of these champions of the status quo ante are, ironically enough, serving as agents for the bond holders of the largest US and EU banks, the clients of PIMCO, Black Rock and even my friend David Kotok at Cumberland Advisors. These agents of the global creditor class are betting on the likes of Bernanke, Trichet and Merkel to collect their debts for them like so many China gunboats — and thereby plunge hundreds of millions of people into penury for decades to come.

It is no small irony that the interests of the banks and bond holders in the US are being protected by a Democrat from Chicago named Barack Obama. Far from being a leftist, Obama is a global technocrat who turned out to be the most perfectly compliant stooge for the interests of the large banks and institutional investors. With Timothy Geithner at Treasury and former JPMorgan banker William Daley at the White House, the only decision Obama needs to make every day is what shirt to wear.

On Capitol Hill, however, the long slumbering Republicans are starting to discover the political power of fiscal sobriety. In the negotiations with the White House over the budget for fiscal 2011, House Speaker John Boehner (R-OH) managed to win some significant concessions from the White House on spending issues — even if entitlements and military spending were off the table this time around. The next and more important fight comes over the question of raising the US debt ceiling. Once again, President Obama is not even in the game.

Secretary Geithner and his boss, JP Morgan Chase CEO Jaime Dimon, have made clear their distaste for a fight over extending the debt ceiling, in part because a debt default by the US would end the pretense of “too big to fail.” If Washington is willing to contemplate a default by the US Treasury, who cares about the fortress balance sheet of JP Morgan and other US zombie banks? But for a number of reasons, democratically elected governments from Lisbon to Dublin to Washington need to begin the process of financial restructuring whether the banks like it or not. And all of the political servants of the banksters are doing their best to avoid debt write downs.

In Ireland, for example, the new government of Fine Gael leader Enda Kenny is in a struggle with Trichet and his vile contemporaries at the ECB. The Euro central bank is essentially trying to keep together an under-funded bailout of the continent’s corporate and bank debts at the expense of public taxpayers. So muted is the political discourse in Western Europe that people are barely protesting — at least not yet. But offering Ireland the choice of default or decades of deflation and unemployment to repay its foreign obligations at par is untenable and risks comparisons with the German war reparations after WWI.

The Kenny government should reject the self-serving advice of the German-dominated ECB as well as the technocrats inside Ireland’s finance ministry, and tell Angela Merkel and French President Nicholas Sarkozy to try harder. Specifically, if the ECB and the core nations of the EU are not willing to offer Ireland more generous terms to bail out the private debts of EU banks, then the Kenny government should take the example of the people of Iceland and tell the technocrats in Brussels an emphatic “no” to bailing in the Irish bank debt at public expense.

Frankly, if you weigh the trade off between the immediate cash flow benefit to Ireland of walking away from its foreign debt and being cut off from the global capital markets, as Trichet has threatened to Kenny, a default seems the obvious choice. And with Portugal and other “peripheral” states of the EU tottering, the Kenny government has more leverage than it knows. Putting a gun to the head of Trichet right about now and daring him to blink might prove a very satisfying experience for any Irish officials with the guts to play the hand God has dealt to them.

In Washington as well, some Republicans are starting to appreciate that saying no to more debt and devaluation a la the Paul Krugman school of economic mismanagement is good politics. It is wrong to call Krugman and his ilk “Keynesians.” Lord Keynes was neither an apologist for debt or inflation, nor was he a free trader. He valued strong national industry and financial markets that were only supplemented by global capital and trade flows. What would Keynes tell Ireland today?

For the same reasons that the Kenny government needs to impose haircuts on Ireland’s creditors, the US Congress needs to vote no on the debt ceiling increase as part of a larger shift in thinking on debt and spending in Congress. Just as the people of Iceland have done the right thing by saying no to repaying corporate debts of UK and Dutch banks (all of which are now nationalized naturally), Americans need to take a page from the history books and begin the actual process of default on all manner of debt and entitlements obligations.

The only way we can force our citizens and also our trading partners to talk about the economic issues that are driving America’s growing mountain of debt is to stop adding to the pile. The role of the dollar as the primary means of exchange for global commerce and finance are the twin evils at the heart of the US fiscal disease. The role of the dollar as the world’s “reserve currency” is likewise a terrible millstone around the necks of American workers.

Saying “no” on raising the debt ceiling is the way for deficit hawks in Congress in both parties to seize the fiscal agenda and start a long overdue conversation about America’s place in the world. As I wrote in my book, Inflated: How Money and Debt Built the American Dream, this discussion must include an end to the dollar as the primary global means of exchange. When the dollar ceases to be the global currency, then the Fed can no longer monetize deficits with impunity as today.

One way of forcing this adjustment process is to start imposing losses on holders of dollar debt. Painful as it will be, helping the world to readjust the level of debt in the industrial nations back to realistic levels and rebalance the global currency markets into a peer-to-peer framework is a necessary process if America is ever to achieve a sustainable economic model. The only question is when and where will emerge the political leadership to do the right thing and begin to actively restructure debts.

Barack Obama has already failed that test of leadership by studiously avoiding any response to the US real estate meltdown, but new leaders in many heavily indebted nations will face the same issues — chronic levels of debt that will only grow heavier as and when global interest rates rise. If the ECB manages to bully Prime Minister Kenny in Ireland, do they really expect a more malleable regime after the next election?

The looming threat of debt is why we should expect to see a majority of Republicans and perhaps more than a few Democrats in Congress seek to block any increase in the US debt ceiling unless the measure includes a balanced budget amendment to the US Constitution.

My view is that Congress should vote down any debt ceiling measure unless President Obama agrees to sign the balanced budget amendment. Even if Secretary Geithner has to run the US government on cash, like the good people of Iceland and Ireland today, it will be a good thing for America’s political debate to default — at least for a few weeks. Then people will know that the once unthinkable is very possible.


I find it disappointing that Reuters would publish such a trite and hypocritical commentary on such an important issue. The suggestion that the government should switch in mid-course to a cash budget is utterly absurd for one. For another, the ideological bias of the author’s opinions demonstrates profound ignorance of the intricacies of central banking. The interrelation of inflation, interest rates, exchange rates, liquidity, and economic growth are far too complex to be dismissed as a conspiracy.

But above all, the idea that Americans will have to work like slaves to pay off the national debt to angry Chinese is both comical and utterly fictitious. The worst case scenario in the far future if we were to amass unrepayable amounts of debt is no worse than the author is proposing as the solution in the present day – default. So why default today when we can default tomorrow? This makes no sense.

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Will 2011 mark the return of market risk, and the IMF?

Dec 15, 2010 18:11 UTC

This week in The Institutional Risk Analyst, “Will Devaluation and Default be the Themes for 2011?,” we feature a comment on the likelihood that sovereign defaults and devaluation will be the themes of 2010 in both Europe and the EU.

Despite the best efforts by the Federal Open Market Committee to provide liquidity to the entire world, the retreat of the bond market over the past few weeks proves that even Ben Bernanke cannot keep the bond market at bay forever. As I said at the meeting of Professional Risk Managers International Association in New York last night, risk professionals need to question the data and metrics they see on the computer screens more than ever before.

October was arguably the best month in the global bond markets in recent memory; we can call the first week in that month was the peak. A good bit of money was taken off the table by savvy investors who realized that the markets have just barely regained the levels seen a year before. But for those investors who now cling to the side of the proverbial capsized sailboat, the past month and more has seen bond prices move down in what one veteran hedge fund manager calls the worst month he’s ever seen.

Take a look at the chart for the iShares S&P National AMT-Free Muni Bd (MUB), which illustrates the climb of the municipal bond market in the U.S. buoyed by the subsidized “Buy America” bond program and the Fed’s quantitative easing, or “QE”, program to keep interest rates artificially low. The chart shows very directly how these markets were supported by the Fed during the most aggressive phases of the emergency liquidity operation, but now these same markets are reverting to the mean.

In an earlier post on — “Bernanke conundrum is Obama’s problem” — I looked at the way in which the Fed was understating the degree of risk in the global markets via QE. Essentially, the U.S. central bank is not only forcing down interest rates, but also visible measures of risk, such as the VIX, that are widely used to price and manage market risk. With the market for U.S. Treasury bonds moving nearly a point in yield, and spreads on junk and muni bonds moving at several times this rate, funds and financial institutions have been hit hard. As David Kotok of Cumberland Advisers said to me earlier this week, the impact of the sudden, sharp movement in U.S. interest rates has been “global.”

As Martin Wolf suggested in the Financial Times yesterday, the Fed is probably not unhappy with the move in rates since it marks a normalization of the Treasury yield curve after two years of heavy manipulation. The trouble is that the duration of the bond market, including several trillion dollars worth of mortgage backed securities, has been increasing by leaps and bounds over the past several years. Thus the volatility of the overall market has increased, amplifying market risk for investors many fold.

For many banks and fixed income investors in dollar assets, the relatively sudden move in U.S. interest rates has wiped out the gains of October and then some, showing that whatever the good intentions of Fed policy makers, the U.S. central bank is now a major source of market volatility. Banks, ETFs and REITs have all been hit with sharp movements in the market value of bonds, causing many to scramble to meet margin calls.

With the QE effort seemingly tailing off at just the time when credit concerns are mounting regarding states in the EU and the U.S., the upcoming year could be a time of rising volatility in the markets. But this increase in the visible market risk is also coming at a time when credit concerns are growing.

One senior U.S. official told me this week that the International Monetary Fund may eventually be called upon to manage a combination of debt haircuts and fiscal reforms for states like Ireland, Spain and Portugal, but that the U.S. states may be in the same boat. “Think of IMF-style conditionality for U.S. states like California, Illinois and New York, imposed by Washington at the behest of its foreign creditors,” the veteran financial observer predicted.

As we wrote this week in The IRA: “One of the things about a free society is that when a problem grows to a certain size, the political force behind the good of the many becomes irresistible and the good of the few or the one can often be overlooked.

As new political tendencies join governments in Ireland and the U.S. in January 2011, we look for macro economic and financial factors to start driving events that will be very unpleasant in some ways for creditors and consumers. Just remember that sovereign states like Ireland, California and New York don’t file bankruptcy, they merely default a la Iceland and Argentina. Or to quote blogger James Pethokoukis’s headline, “Secret GOP plan: Push states to declare bankruptcy and smash unions.”

In a new period of instability, Obama becomes Hoover

Oct 7, 2010 14:50 UTC

Yesterday I participated in a “Living in the post-bubble world: What’s next?” event with Nouriel Roubini. The key take-away from the discussion is that the U.S. and global economies are headed into a new period of instability and competitive currency devaluations.

The primary driver of this breakdown in the international consensus around free trade and global markets is the overt policy by the Fed to use quantitative easing or “QE” to devalue the dollar. The final comments by John Makin illustrate this point very nicely.

Now the Fed claims that further QE, which will include the purchase of hundreds of billions in debt issued by the Treasury, will help stimulate the U.S. economy and reverse the secular deflation that is depressing real estate valuations, employment and business investment. But the trouble is that QE is having little positive impact on American households. Without refinancing, there is no reflation of balance sheets or consumer spending.

As I noted in an earlier comment, “Bernanke conundrum is Obama’s problem,” the Fed’s attempts to help American households is being blocked by the largest banks. We wrote about the issue again this week in The Institutional Risk Analyst, “Refinancing, Not Foreclosures, is the Issue.”

While the Fed has been attempting to refloat these same banks — and their bond holders — on a sea of cheap money, the central bank is ignoring the larger, structural problems in the real estate sector. Forget mere valuations losses on ABS and derivatives on same. The real surprise heading for Washington and Wall Street is when everyone realizes that the big risk facing the U.S. economy is not from the foreclosure crisis, but from the actions of the “Big Five” financial monopolies — Fannie Mae, Freddie Mac, Bank of America, Wells Fargo and JP MorganChase – to prevent tens of millions of American homeowners from refinancing performing mortgages.

In public, the Fed is keeping a brave face on its policy moves, but in private current and former Fed officials acknowledge that there is little that the central bank can do to reverse the deflation that seems to be accelerating. There is a 40% probability of a double-dip recession, Nouriel Roubini said during the discussion.

I would argue that such metaphors miss the many differences in the present economic collapse compared with previous “recessions.” Indeed, as Tom Zimmerman of UBS noted very astutely, by easing interest rates in 2001-2002, the Fed avoided a recession then, so now we are going through double the adjustment process.

What is to be done? For starters, American policy makers need to acknowledge that the real intent of the Fed’s resumption of QE is not to stimulate directly domestic economic activity, but instead to drive down the value of the dollar — an adjustment that is long overdue. The monetary ease already injected into the U.S. economy justifies a significant drop in the value of the greenback, an adjustment that America’s creditors and trading partners have long resisted. A cheaper dollar means less export revenue for China and the other mercantilist nations of Asia and a de facto default for America’s foreign creditors.

Second, in concert with QE, the Fed needs to dust off the bully pulpit and start to publicly discuss why the largest U.S. banks are unable or unwilling to refinance the more than 30 million households which have relatively high-cost mortgages. As I have noted previously, the large banks and the housing GSEs, Fannie Mae and Freddie Mac, are using fees and other subterfuges to block refinancing for millions of Americans. This renders Fed interest rate policy largely ineffective.

It also is time for Chairman Bernanke and other Fed governors to publicly own up to the surreptitious transfer of hundreds of billions of dollars per year from American savers to the largest banks, a cowardly strategy that is allowing the Obama Administration and Congress to avoid making tough decisions about restructuring the U.S. financial system. The spectacle of Treasury Secretary Tim Geithner publicly accounting for repayment of TARP while the largest U.S. banks sink into insolvency is a national scandal.

As the Fed starts to get ahead of the curve in terms of the continuing crisis in the banking sector, the economists inside the central bank should start to ponder a new policy approach: QE to devalue the dollar and modestly higher interest rates to restore balance between the continuing needs of the banking industry and American savers.

Retired Americans, working families and corporate treasurers are all being taxed via QE and zero interest rates to subsidize the largest banks. It is time for Fed Chairman Bernanke to reassert the independence of the U.S. central bank and demand that Congress and the Treasury start to do their jobs. If we need to restructure the largest banks, then we should make the cost explicit and conduct the process publicly for all Americans to see.

As I told the AEI audience, the avalanche of mortgage defaults now hitting Bank of America, Wells Fargo and other large lenders could force these banks to seek new government bailouts in 2011, an outcome that will expose the Obama Administration’s incompetence for all to see.

For the economy, the slow process of muddling along championed by Secretary Geithner will ensure that Barack Obama becomes the Herbert Hoover of the Democratic Party. From the Crash of 1929 until the end of his term in 1932, President Hoover repeatedly predicted the end of the crisis. The rest is history.


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Bernanke conundrum is Obama’s problem

Sep 9, 2010 16:56 UTC

In the wake of Institutional Risk Analytics’ comment last week about the lack of ideas inside the Obama Administration for resolving the economic mess, President Obama suggested new tax credit and infrastructure spending. Neither of these ideas is likely to become real, however, since the Republicans are expecting to take control of at least one house of the Congress in two month’s time.

Over at the Federal Reserve Board, a different kind of policy gridlock persists. The Federal Open Market Committee thinks low interest rates are helping the economy, but the opposite is the case. The monetary policy mechanism that provided liquidity to households when the Fed lowered the cost of credit is broken. Both the central bank and the White House need to recognize this fact and act to address it with effective policy.

Offit Capital Advisors noted in an August 1, 2010 commentary entitled “The Invisible Tax” that the zero rate policies by the Fed are draining hundreds of billions of dollars in income each year from the U.S. economy. Offit estimates that $350 billion per year is being foregone by investors in state and federal obligations and transferred to the government due to Fed low rate policy. The income foregone by individual and corporate savers and transferred to the banks is something closer to $600 billion annually or nearly $1 trillion in total.

When theses subsidies from low interest rates are added to the huge mortgage banking profits being taken by the top four banks from Fannie Mae and Freddie Mac, the largest U.S. banks are literally draining a large portion of the income from the American economy. The fact that these large banks and GSEs are refusing to refinance many residential mortgages in order to preserve their profit margins only adds insult to injury, a political fact that will be made clear at the polls in November.

The chart below, which is inspired by a chart used by David Zervos at Jeffries & Co in a research note on this same topic, illustrates the problem. MTGEFNCL is the yield of the par 30-year FNMA mortgage backed security. USMIRATE is the effective rate for all outstanding mortgages in the US from the Bureau of Economic Analysis. In days gone by, you could add 50 bp to the FNMA yield to get the zero point mortgage rate to homeowners, but not today with banks adding points to the effective cost of mortgages. The Fed target rate is the federal funds rate.


Note how the progression of Fed interest rate cuts from the 1980s to today resulted in a significant reduction in average mortgage borrowing costs for households. This is the case until 2008, when mortgage rates implied by the bond market fell significantly but households were not able to refinance.

What is preventing a refinancing wave today? Fees charged by Fannie Mae and Freddie Mac (Loan Level Pricing Adjustments and Adverse Market Development Fees) and a mortgage origination industry that is highly concentrated in the big four banks, who are working for 4-5 points on new origination loans. Those frictions, which can add up to 7 to 10% of the face value of the loan, raise mortgage rates to borrowers by hundreds of basis points. Banks and the housing GSEs, however, saw significant benefits in declines in funding costs thanks to low Fed rates.

The banks, of course, do not exist in a vacuum. As JPM and the other money center’s desperately fight to survive, they are actually making conditions worse in the real economy, for consumers and business alike. As this reality comes more sharply into focus and the forward growth prospects for the U.S. economy are revised lower, the final blow to consumer confidence will come in the form of higher interest rates by the Fed.

Now into year three of the Fed’s quantitative easing, with visible duration on all first mortgages is already 2x 2005-2006 levels, the party is over for the largest zombie banks. And federal regulators cannot claim that they were not warned. The table below is from a presentation by Alan Boyce, CEO of Absalon, given at an FDIC-sponsored mortgage conference organized by Professional Risk Managers International Association in 2009 and shows the changes in the duration of the US mortgage system:




% ARMs


Market Size

Total OAD



5.0 est





5.0 est











































Source: Absalon

Notice in the table that the option-adjusted duration (OAD) of the mortgage sectors has roughly doubled during the period of Fed zero rate policy – this due to the steepness of the yield curve, a flight from adjustable rate mortgages to fixed rate loans, and high interest rate volatility. As the central bank is slowly forced to allow rates to rise in order to restore income to savers (or perhaps defend the dollar), the OAD for all manner of U.S. securities will explode. This interest rate trap illustrates the key policy error made by the Fed under Alan Greenspan and with the complicity of Ben Bernanke.

“From September 2003 to September 2006, the Federal Reserve Board (“FRB”) directly reduced the total mortgage market OAD by doing three things: they flattened the yield curve, they talked down options volatility and they encouraged homeowners to take out ARMs,” notes Boyce. “This sucked out a huge amount of OAD from the mortgage system despite increasing the outstanding amount of mortgages by $3 trillion. If the FRB had not driven down the OAD, we would never have made all those loans. The change in OAD was $3.6 trillion dollar duration years. To put it in perspective, the Chinese bought $600 billion of Treasuries and Agencies during that time period, with an aggregate duration of $1.2 trillion. The latter is 1/3 the “weight” of the former but is well understood and is the commonly accepted explanation of the Greenspan Conundrum.”

There are many things that need to be done in order to correct the immediate and structural problems in the U.S. economy. But one of the top priorities for President Obama and Chairman Bernanke is to press the banks and the GSEs to immediately accelerate efforts to refinance performing loans in their portfolios to lower rate mortgages now, before interest rates begin to move.

We cannot undo the decisions made by the Fed in past years, but we can recognize at long last that there is no free lunch. The low rates policies of 2002-2006 created a distortion in the financial markets, a shift we are still struggling to deal with a decade later. The first step to fixing the problem is to lighten the load on households now so that today’s homeowner is not tomorrow’s loan default event.


Capitalism. So passe

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