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Is Europe at the Tipping Point? Sol Sanders & Bill Alpert on Keynes, Keynesianism -- and Keynesianitis
April 20, 2011

Is Europe at the Tipping Point? Sanders & Alpert on Keynes, Keynesianism -- and Keynesianitis

The selfish, they're all standing in line
Faithing and hoping to buy themselves time
Me, I figure as each breath goes by
I only own my mind

The North is to South what the clock is to time
There's east and there's west and there's everywhere life
I know I was born and I know that I'll die
The in between is mine
I am mine

And the feeling, it gets left behind
All the innocence lost at one time
Significant, behind the eyes
There's no need to hide
We're safe tonight

"I Am Mine"
Eddie Vedder
Pearl Jam (2002)

In this issue of The Institutional Risk Analyst, we feature a comment on John Maynard Keynes by Sol Sanders and William Alpert. With the world preparing for the final collapse of the post-WWII, post-Bretton Woods economic order, we thought it might be useful to look at what Keynes actually said as opposed to what Paul Krugman or Larry Summers, for example, think today.

The reason that we depart from our usual optimism is the situation in Europe. Forget the threat of a ratings downgrade of the US by S&P, votes in Washington on debt ceilings or our part-time POTUS, the final collapse of the southern states of Europe is accelerating. Most of the banks in the EU are insolvent and the states supposedly backing them cannot access the global markets. The collapse of the EU bank bailout effort could be the next catalyst for global contagion.

Now there is a fascinating school of thought that says the Germans are merely encouraging the debt defaults of Greece, Portugal and Ireland in order to engineer a devaluation of the euro. David Zervos of Jefferies & Co. in a wonderful comment entitled "Schaeuble ringing the Greek restructuring bell," concludes that:

"Regular readers of these commentaries will remember our correlation theory on anti-peripheral German rhetoric and the level of the Euro. Here we go again! Just as the Euro pushes 1.45, the Greeks go under the bus. The Germans have always needed the periphery in EMU - trouble in the south keeps the Euro from being a DEM. And of course the DEM has history of destroying the German mercantilist business model. That's why the Euro was created in the first place....but I digress."

Our friend David Kotok of Cumberland Advisors, recently back from a triumphant tour of Sicily and the Eastern Mediterranean, likewise opines on the dicey global liquidity situation in global markets, even if the liquidity in Sicily is always abundant. His latest comment, "Scylla and Charybdis The FDIC and the Federal Reserve," describes well our chief worry bead, namely that effective credit remains tight even despite QE:

"The Fed is completing its program of asset purchases, called by many "QE2. As this program reaches its completion this summer, many participants expect the Fed to call it quits on additional purchases. The current market expectation is that the Fed will then go into a mode of preserving the then-existing size of its balance sheet. As maturities occur or paydowns take place in the mortgage-related portfolio, the Fed will replace those maturities and paydowns with purchases of treasuries. Essentially, the Fed will go into a holding pattern and await "incoming data. Meanwhile, the Federal Deposit Insurance Corporation (FDIC) has just introduced a new factor. We have written about it in the past. Since April 1, the FDIC now costs a bank an additional insurance premium between and ten and forty-five basis points as a fee on its assets. That is a payment the bank must make any American bank to the FDIC. In making monetary policy decisions, the Fed did not have to contend with this cost prior to April 1. Now the FDIC has interfered in a way that adds a cost to the banking system at the very time the Fed is engaged in easing. The mechanics of the FDIC fee act as a form of a tightening. We estimate that the impact is the nearly the same as if the Fed were to have raised interest rates about 15 basis points. By some "guess"timates, the FDIC has taken back all the easing provided by all of QE2."

Of note, IRA has received a number of comments on our new FDIC assessment base calculator feature in The IRA Bank Monitor. To David's point, the change in the assessment base for some of the largest banks is quite significant -- but the overall amount of money raised is about the same as under the current revised FDIC premium framework put in place during the depths of the crisis. The difference is the distribution of the premium levy, which now falls more heavily on the largest banks.

The table below shows the before and after on the FDIC assessment base, as well as the public data CAMELS (Capital, Assets, Management, Earnings, Liquidity, and Sensitivity to Market Risk) ratings created by IRA and available to users of the professional version of The IRA Bank Monitor as well as our institutional ratings customers. Many banks bury their deposit insurance in the cost of revenue, so you need to go through the fine print to find this little gem in EDGAR filings.

Large Bank FDIC Assessment Base (2010-2011)

2010 Base

2011 Base

$ Change

% Change

CAMELS

JPMorganChase

670,052,983

1,679,014,484

1,008,961,501

150.6%

2.1

Citigroup

335,530,975

1,187,852,666

852,321,691

254.0%

2.5

Wells Fargo & Co.

786,162,921

1,059,033,902

272,870,981

34.7%

1.7

Bank of America

943,235,523

1,591,686,428

648,450,905

68.7%

2.1

US Bancorp

177,504,855

285,845,014

108,340,159

61.0%

1.6

PNC Financial

182,160,160

246,704,119

64,543,959

35.4%

1.5

CapitalOne Financial

121,604,715

184,212,383

62,607,668

51.5%

2.0

Bank of New York Mellon

76,785,471

185,149,926

108,364,455

141.1%

2.2

SunTrust Banks

122,483,706

149,389,591

26,905,885

22.0%

2.0

State Street Corp

23,007,287

145,041,359

122,034,072

530.4%

2.0

Source: FDIC/The IRA Bank Monitor. Figures in $000. 2010 Assessment base from RIS.

The fact that we can generate public CAMELS factors for all FDIC insured banks allows us to bin the members of the population of banks into ratings buckets aligned with the new FDIC deposit insurance assessment rule. If you run a brokered funds desk or service, you need to speak to us about risk management and compliance in the brave new world of Dodd-Frank living wills. Please refer questions about the CAMELS methodology or our service bundles, which include the FDIC assessment model functionality, to our CEO Dennis Santiago at our offices in Torrance, CA, during regular business hours.

Meanwhile, we heard a ground level report on the situation in the EU banking sector from a member of the global mortgage servicing study group, a Berlin-Los Angeles axis of enlightenment seeking to help people understand the supposed crisis. In particular, we point your attention to the appearance of all manner of price indices and overt subsidies in the EU, from bank funding to labor rates, as a means of forestalling the seemingly inevitable economic collapse of the peripheral states of Western Europe.

Our colleague Achim Duebel reports from the midst of the fray about how the benefits of structured notes and other derivative securities are making the EU banking crisis become an even more profound disaster:

"In Ireland banks are hemorrhaging via index tracker portfolios vastly underperforming cost of funds, so ECB is basically funding the indexed portfolio. And while capital market indexing is destroying the Irish system and the Euro, our Eurozone macroeconomists are going after wage indexation in Belgium and Luxemburg. It is a madhouse. We are having surreal meetings with EU banks, which are highly reluctant to change their policies as Eurozone governments and ECB are keeping them on lifeline forever. Nobody finds anything peculiar here in that Irish borrowers pay half of German and 40% of US interest rates. Welcome to the new permanent transfer world."

Trouble is, with the end of QE looming and the Republicans digging in their heels on the US debt ceiling, there is no political room for the Fed to make additional loans to the EU. As we've noted before, the ECB cannot even repay the swaps lines with the Fed or at least roll them into commercial funding. All this makes us think that perhaps dollar funding is not nearly so plentiful as policy makers and market shakers would have us believe. Will spreads explode when QE ends and the dealer community is forced to support all Treasury issuance? We hear from one well placed official that this is precisely what will happen, but does anyone in Treasury or the White House understand that the ice is cracking?

In that vein, let's go to our feature on the legacy of Lord Keynes, a favorite topic of The IRA. We continue to believe that the US must make some fundamental changes in the role of the dollar in the global economy, even if it means shaking the very foundations of our political system and making investors wait a few days to get paid. See the latest comments of IRA co-founder Chris Whalen on Reuters.com.

William T. Alpert is Associate Professor of Economics University of Connecticut is co-founding managing partner of FIDES, Philanthropic Management and Advisory Services, LLC. He is formally, Senior Program Officer of the William H. Donner Foundation, he publishes in labor economics. Sol Sanders is a veteran journalist and writer who contributes to The Washington Times.

Keynes, Keynesianism -- and Keynesianitis

By William T Alpert and Sol W Sanders

Few would dispute the claim that John Maynard Milord Keynes was a genius.

He was one of a long line of British writers on the political economy, who revolutionized the sport. He was brilliant if sometimes torturous in seeking to explain the riddle of human economic life. Like his British [mainly Scots] forbears, and like their offspring on the Continent who continued the tradition after it had died in Britain, he was a savant of political, repeat, political economy. For they understood as successive generations of practitioners of "the dismal science" often have not, that it is not a science. They also knew that those who use statistics and, may the Lord help us, the new digital revolution, to build their "constructs", not only to examine but to predict human behavior, will usually fail. Keynes, certainly, understood the "political" part of political economy well before James Buchanan received his Nobel Prize in public choice theory for its "discovery."

Torturous? Well, at least more than a bit Machiavellian. He rather quickly left his Cambridge colleagues behind, including a homosexual lifestyle, when he ventured into the world. He had minimum truck with the leaders of the chattering classes of his time, the inbred Bloomsbury Set, and even less with the Fabian Society. The latter, of course, thought they had found the ultimate formula for a several hundred years search in utopian, Christian, anarcho, syndicalist, Marxian and other European socialisms. But unhappily, they were completely derailed by the Soviet heresy. For example, H.G. Wells would write a pamphlet not only endorsing but calling Stalin "beloved" on the eve of the Moscow Trials.

Torturous, too, if you are a layman and have tried to struggle through his General Theory of Employment, Interest and Money, generally acknowledged as his magnum opus or through an incredible array of writing -- some of it surprisingly good. See for example his The Economic Consequences of the Peace, in which he predicts the disastrous outcome of the Treaty of Versailles.

Machiavellian? Keynes not only put his stamp on the academic world and excelled in the vicious infighting of government bureaucracy but he made a fortune gambling in commodities. A fund he set up for his Cambridge alma mater despite taking a massive hit during the Stock Market Crash of 1929, produced an average increase of 13.2% compared with the general market in the United Kingdom declining by an average 0.5% per annum until 1945.

His contempt for many if not most of his bureaucratic contemporaries was monumental. After the Bretton Woods agreements were signed, the attempt to reset the world's economies after World War II over which he presided, he snidely told one of his gophers: "The clerks have got it wrong again. The Bank [International Bank for Reconstruction and Development, latterly to be called The World Bank] should have been called 'fund', and the Fund [International Monetary Fund] should have been called 'bank'."

In his own way, Keynes could be called the father of Europe's post-World War II miraculous reconstruction. This time his proposal that modest reparations should be sought, that all the powers should unite in rebuilding and with American credits under the Marshall Plan was accepted. They had been rejected when as a young rising star in the British Treasury he had proposed them as early as 1915 and at the Versailles Conference. But Keynes, alas, was not by any means always right!

"The day is not far off", he wrote, "when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems/the problems of life and of human relations, of creation and behavior and religion."

In 2010 we are still waiting.

His reputation, however, has become omnipresent - - spreading even to his self-acknowledged opponents. In 1999, Pres. Richard M. Nixon, having thrown his own primitive economic prejudices to the winds and instituted disastrous wage and price controls, said, "We are all Keynesians now". But however politically wily domestically or brilliant at international strategy, it's unlikely that Nixon knew much about what Keynes had in fact argued.

Things haven't changed. A Greek chorus of the kind of economists who believe econometric models can predict social and political events is once again invoking the Old Boy's name to bless profligacy.

It is true that Keynes was an interventionist, that he believed government had a role and should employ it, to curb and limit the business cycles which have dominated modern economic life since The Industrial Revolution began with the advent of capitalism -- and perhaps before. But Keynes set strict limits on how governments might borrow and toss capital into the machinery to get it up and going again.

Keynes did believe in something he called "socialized investment", that is public funds/borrowing that had to be made for the general good beyond the normal functioning of the capitalist system. And, if not lick the business cycle, to at least ameliorate it.

He wanted to set up separate budgets -- for current accounts and for longer term capital projects which might require government assistance if not sponsorship. That's something, by the way, that most corporations do today but which the Congress, which so far hasn't produced this year's budget. has never undertaken for one of the largest commercial enterprises in the world, the U.S. government.

But he neither believed in general funding of an amorphous public debt through public borrowing and spending, nor of using the tax tables to work out solutions to social problems.

For a man who could twist the English language until it screamed for mercy, he actually made this point very clearly:

The more socialised we become, the more important it is to associate as closely as possible the cost of particular services with the sources out of which they are provided even when a grant-in-aid is also required from general taxes. This is the only way by which to preserve sound accounting, to measure efficiency, to maintain economy and to keep the public properly aware of what things cost. [CW, vol. XXVII,p p. 224-225] As early as 1931 [although it was hardly early for the British who already had endured a painful decade of restoration of the pound to its pre-war status,], Keynes, in a radio address, said:

"[At] the present time, all Governments have large deficits. For government, borrowing of one kind or another is nature's remedy... for preventing business loses from being, in so severe a slump as the present one, so great as to bring production altogether to a standstill. It is much better in every way that the borrowing should be for the purpose of financing capital works, if these works are of any use at all than for the purpose of paying doles [or veterans' bonuses]. But, so long as the slump lasts on the present scale, this is the only effective choice for the one purpose or the other [or a diminished Sinking Fund, which has the same effect] is practically inevitable For this is the case, fortunately perhaps, where the weakness of human nature will, we can be sure, come to the rescue of human wrong-headedness."

"... My own policy for the Budget, so long as the slump lasts, would be to suspend the Sinking Fund, to continue to borrow for the Unemployment-Fund, and to impose a Revenue Tariff. [Author's note: Few recognize that his The General Theory was written with the assumption of an economy closed to foreign trade - - unlike our own today, but that is the subject for another time.] To get us out of the slump we must look to quite other expedients. When the slump is over, when the demands of private enterprise for new capital have recovered to normal and employment is good and the yield of taxation is increasing, then is the time to restore the Sinking fund and to look critically at the less productive state enterprises." [Essays in Persuasion, Norton 1963, pp. 161 and 162]

Perhaps even more to the point:

"I should aim at having a surplus on the ordinary Budget, . . . thus gradually replacing dead-weight debt by productive or semi-productive debt. . . . I should not aim at attempting to compensate cyclical fluctuations by means of the ordinary Budget." The collected writings of John Maynard Keynes, 1971 by Macmillan, St. Martin's Press, for the Royal Economic Society in [London], [New York] vol. 27 pp 277 - 278.

Maybe Keynes wouldn't have been a Tea Party-er. But there is little doubt that his mind and heart would not have been with the Dodd-Frank-Geithner spend-until-we- recover crowd who have taken his name in vain. Pres. Barack Hussein Obama's stalwarts may think they know what they are doing, throwing "stimulus" about - - mostly in the form of supporting and expanding government through national and regional public sector employment. But their claim that it is all following the philosophy of one of the last of the great political economists [rather than today's econometricians pretending they are] is false.

His ghost must be screaming about the downs at Tilton in Sussex where his ashes were scattered in 1946.

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