Best of the Week
Most Popular
1. US Housing Market House Prices Bull Market Trend Current State - Nadeem_Walayat
2.Gold and Silver End of Week Technical, CoT and Fundamental Status - Gary_Tanashian
3.Stock Market Dow Trend Forecast - April Update - Nadeem_Walayat
4.When Will the Stock Market’s Rally Stop? - Troy_Bombardia
5.Russia and China Intend to Drain the West of Its Gold - MoneyMetals
6.BAIDU (BIDU) - Top 10 Artificial Intelligence Stocks Investing To Profit from AI Mega-trend - Nadeem_Walayat
7.Stop Feeding the Chinese Empire - ‘Belt and Road’ Trojan Horse - Richard_Mills
8.Stock Market US China Trade War Panic! Trend Forecast May 2019 Update - Nadeem_Walayat
9.US China Trade Impasse Threatens US Lithium, Rare Earth Imports - Richard_Mills
10.How to Invest in AI Stocks to Profit from the Machine Intelligence Mega-trend - Nadeem_Walayat
Last 7 days
Facebook's Libra Crypto currency vs Bitcoin: Five Key Differences - 19th June 19
Fed May Trigger Wild Swing In Stock Index and Precious Metals - 19th June 19
How Long Do Land Rover Discovery Sport Brake Pads Last? - 19th June 19
Gold Golden 'Moment of Truth' Is Upon Us: $1,400-Plus or Not? - 18th June 19
Exceptional Times for Gold Warrant Special Attention - 18th June 19
The Stock Market Has Gone Nowhere and Volume is Low. What’s Next - 18th June 19
Silver Long-Term Trend Analysis - 18th June 19
IBM - Watson Deep Learning - AI Stocks Investing - Video - 18th June 19
Investors are Confident, Bullish and Buying Stocks, but… - 18th June 19
Gold and Silver Reversals – Impossible Not to Notice - 18th June 19
S&P 500 Stuck at 2,900, Still No Clear Direction - 17th June 19
Is Boris set to be the next Conservation leader? - 17th June 19
Clock’s Ticking on Your Chance to Profit from the Yield Curve Inversion - 17th June 19
Stock Market Rally Faltering? - 17th June 19
Johnson Vs Gove Tory Leadership Contest Grudge Match Betfair Betting - 17th June 19
Nasdaq Stock Index Prediction System Is Telling Us A Very Different Story - 17th June 19
King Dollar Rides Higher Creating Pressures On Foreign Economies - 17th June 19
Land Rover Discovery Sport Tailgate Not Working Problems Fix (70) - 17th June 19
Stock Market Outlook: is the S&P today just like 2007 or 2016? - 17th June 19
US China War - Thucydides Trap and gold - 16th June 19
Gold Stocks Bull Upleg Mounting - 16th June 19
Gold Price Seasonal Trend Analysis - Video - 16th June 19
Fethiye Market Fruit, Veg, Spices and Turkish Delight Tourist Shopping - 16th June 19
US Dollar Gold Trend Analysis - 15th June 19
Gold Stocks “Launch” is in Line With Fundamentals - 15th June 19
The Rise of Silver and Major Economic Decline - 15th June 19
Fire Insurance Claims: What Are the Things a Fire Claim Adjuster Does? - 15th June 19
How To Find A Trustworthy Casino? - 15th June 19
Boris Johnson Vs Michael Gove Tory Leadership Grudge Match - Video - 14th June 19
Gold and Silver, Precious Metals: T-Minus 3 Seconds To Liftoff! - 14th June 19
Silver Investing Trend Analysis - Video - 14th June 19
The American Dream Is Alive and Well - in China - 14th June 19
Keeping the Online Gaming Industry in Line - 14th June 19
How Acquisitions Affect Global Stocks - 14th June 19
Please Don’t Buy the Dip in Nvidia or Other Chip Stocks - 14th June 19
A Big Thing in Investor Education is Explainer Videos - 14th June 19
IRAN - The Next American War - 13th June 19
Boris Johnson Vs Michael Gove Tory Leadership Grudge Match Contest - 13th June 19
Top Best VPN Services You Can Choose For Your iPhone - 13th June 19
Tory Leadership Contest Betting Markets Forecast - Betfair - 13th June 19
US Stock Market Setting Up A Pennant Formation - 13th June 19
Which Stocks Will Lead The Cannabis Rebound? - 13th June 19
The Privatization of US Indo-Pacific Vision - Project 2049, Armitage, Budget Ploys and Taiwan Nexus - 12th June 19
Gold Price Breaks to the Upside - 12th June 19
Top Publicly Traded Casino Company Stocks for 2019 - 12th June 19
Silver Investing Trend Analysis - 12th June 19
Why Blue-Chip Dividend Stocks Aren’t as Safe as You Think - 12th June 19
Technical Analysis Shows Aug/Sept Stock Market Top Pattern Should Form - 12th June 19
FTSE 100: A Top European Index - 12th June 19
Gold Surprise! - 11th June 19
How Forex Indicators are Getting Even More Attention in the Market? - 11th June 19
Stock Market Storm Clouds on the Horizon - 11th June 19
Is Your Financial Security Based On A Double Aberration? - 11th June 19
What If Stocks Are Wrong About Interest Rate Cuts? - 11th June 19
US House Prices Yield Curve, Debt, QE4EVER! - 11th June 19
Natural Gas Moves Into Basing Zone - 11th June 19
U.S. Dollar Stall is Good for Commodities - 11th June 19
Fed Running Out of Time and Conventional Weapons - 11th June 19
Trade Wars Propelling Stock Markets to New Highs - 11th June 19
Best Travel Bags for Summer Holidays 2019, Back Sling packs, water proof, money belt, tactical - 11th June 19

Market Oracle FREE Newsletter

Gold Price Trend Forecast Summer 2019

From the Greenspan Put to the Kohn Put: Our Brilliant Central Bankers

Politics / Central Banks Mar 08, 2010 - 10:24 AM GMT

By: Fred_Sheehan

Politics

Best Financial Markets Analysis ArticleFederal Reserve Vice Chairman Donald Kohn announced his retirement on March 1, 2010. In his obligatory lament, Federal Reserve Chairman Ben S. Bernanke was half right: "The Federal Reserve and the country owe a tremendous debt of gratitude to Don Kohn." What is good for the Fed is generally not good for the country. The influence of Donald Kohn supports this view.


A rarity, Kohn rose through the ranks of the Federal Reserve System. After 32 years of grunt work, he was named a Federal Reserve governor in 2002 and assigned the vice chairmanship in 2006. He participated in Federal Reserve Open Market Committee (FOMC) meetings long before his governorship. He had been a staff economist (Director of Monetary Affairs) and Secretary at FOMC meetings.

Donald Kohn will be smothered in praise from now until his June retirement. The media will quote celebrity economists who will deify the celebrity vice chairman. Alan Greenspan was "the greatest central banker who ever lived," according to former Federal Reserve Vice Chairman Alan Blinder at a 2005 conference. These farewell hosannas are necessarily vague and meaningless, as was the March 6, 2010, appraisal of Kohn in the Economist: "Mr. Kohn is widely considered one of the most experienced and thoughtful central bankers in the world." Given the worldwide failure of central bankers, this may well be true, so a critique of Kohn's brilliance is necessarily specific.

October 15, 1998: Fanning the Greenspan Put

The FOMC held a conference call on October 15, 1998. This remains the most infamous FOMC discussion on record. It was held shortly after Wall Street paid over $3 billion to bail out Long-Term Capital Management (LTCM), a hedge fund. The Nasdaq Composite Index fell 20% from mid-July to mid-October. It had boomed for the past three-and-one-half years (a 160% return), but the Fed decided a hiatus would not do.

In the wake of the conference call, the Fed announced a surprise rate cut at 3:14 p.m. The bond market had already closed for the day, stock-option contracts expired the next day, and investors panicked. A frenzy of buying pushed the S&P 500 futures up 5% in five minutes. The Nasdaq Composite rose from 1,540 on October 14, 1998 to 4,069 on December 31, 1999.

Donald Kohn's contribution, as Secretary of the FOMC, was to announce at the meeting's conclusion: "We are not constrained by the practice followed after regularly scheduled FOMC meetings where the release time is set for 2:15 p.m. We will try to move through the process of preparing the press release as rapidly as possible."

It was after this surprise rate cut that the "Greenspan Put" came into common use. A put option is bought by investors to limit losses when the market falls. Now, instead of buying protection, the Greenspan Put inspired such confidence that speculators replicated the borrowing and leveraging of LTCM. Kohn's faux pas, if that is what it was, served the interests of the Fed but not those of the American people. Around $5 trillion was lost by investors after the Greenspan Stock-Market Put failed in 2000.

Joining the Inflation Targeting Team

The Fed's deflation team was beefed up on August 5, 2002. Both Ben Bernanke and Donald Kohn were appointed as Fed governors, and to the FOMC. Bernanke had devoted his adulthood to inflationary economics. His book, which he wrote with three other economists, Inflation Targeting: Lessons from the International Experience made clear that an economy should always be inflating.

At Bernanke's first FOMC meeting (August 13, 2002), it was the other newcomer, Donald Kohn who sounded as if he was reading from Bernanke's book: "I don't see a zero real rate as a natural bound for monetary policy." He not only was unconcerned about real rates below zero, Kohn stated the opposite case: [I]nflation is already as low as I would like to see it go." He intimated that real rates were already below zero (when inflation exceeds the borrowing rate), and stated a desire for even lower real rates.

This was an about face. At the May 2002, Donald Kohn, speaking as a staff economist, had warned the committee it would soon need to address a fed funds rate hike from "its currently unsustainably low level." He also told the FOMC the fed funds rate "will have to be tightened at some point to forestall increasing inflationary pressures."

Donald Kohn has been an asset inflator since his coming out party at the August 2002 meeting. Although (the current) Chairman Bernanke has led the charge against deflation at all costs, Donald Kohn has been a loyal sidekick.

The FOMC had started cutting the fed funds rate in 2001 and did so until 2003, when it stopped at 1.0%. There are few precedents to a 1.0% borrowing rate. When we sift through the wreckage in future years, the zero-percent school will deserve a healthy portion of the blame.

"[H]ouseholds Have Bought More and Larger Houses and Cars, Have Taken on More Debt..."

Ignorance will not be an excuse. Donald Kohn knew what he was doing. After the Greenspan Stock-Market Put had failed, the FOMC instituted the Greenspan Home-Equity, Cash-Out Put. On April 1, 2004, Kohn spoke at Widener College in Chester, Pennsylvania. He opened by reminding his audience of the gratitude it owed the Federal Reserve: "Starting in January of 2001, the Federal Reserve moved to counter [the weak economy] by lowering the funds rate.... This prompt and aggressive action undoubtedly served to limit the decline in economic activity, and, in fact, the recent recession was one of the mildest on record." Attendees among the cohort that had lost the $5 trillion may not have appreciated this P.R. stunt.

Kohn acknowledged there were dissenters to the Fed's current 1.0% fed funds rate: "[S]ome observers have been calling for the Federal Reserve to begin the tightening process sooner rather than later." They were concerned "that the Federal Reserve, by keeping the funds rate so low and signaling that it is likely to stay low for a while, is sowing the seeds for different kinds of future problems. In particular, these critics worry that a continued environment of low interest rates is giving rise to economic imbalances - excessive indebtedness, and elevated prices of houses, equities, and bonds - that in the longer run will come back to haunt us."

Since the financial meltdown, the Fed has recited from its handbook: "No one saw it coming." The credit crash in 2007 had been widely anticipated and in all its severity. The question was not "if," but "when." The media quotes the Fed without correction, and so, Ben Bernanke was recently awarded another term as chairman.

Kohn dismissed concerns before the Pennsylvania college audience: "[H]ouseholds have bought more and larger houses and cars, have taken on more debt, and generally have spent more than would have been the case if interest rates had been higher.... [T]hese developments... are by-and-large the intended and logical consequences of the Federal Reserve's efforts to reduce economic slack through low interest rates."

Should there be credit "adjustments", Kohn assured his audience: "Commercial banks remain highly profitable and well capitalized...." They were only well capitalized as long as they remained highly profitable.

Of course, Kohn praised the Fed's regulatory vigilance: "Banking supervisors at the Federal Reserve, for example, in the course of the ongoing examination process, have been paying close attention to the sorts of vulnerabilities we have reviewed and have been discussing these risks with the commercial banks they oversee."

Regulation: "It's a Very Hard Sell to the Banks."

On March 4, 2008, Vice Chairman Kohn testified before the Senate Banking Committee about the "Condition of the U.S. Banking System." He made an honest admission: "I don't know that we fully appreciated all the risks out there." He also made a self-serving claim: "I'm not sure anybody did, to be perfectly honest."

Kohn was among the slow minded. In October 2007, Kohn had predicted that once "we get through the near-term weakness caused by the extra downleg from the housing contraction and any spillover from tighter credit conditions, I am looking for moderate growth with high levels of employment."

At the March 2008 hearing, Kohn acknowledged that banks had not priced certain risks appropriately, but "It's a very hard sell to the banks." Senator Richard Shelby, a member of the committee, was not amused: "It's a hard sell to the banks, yes, but you are the supervisor of all the bank holding companies, and you are also the central bank.... So you have not just a little bit of power, but a lot of power." Shelby asked Kohn if the Fed "was afraid of the banks they regulate." Kohn responded in the negative. If this was true, a classroom of rookie bank tellers would have done - and would do - a better job supervising the banks.

Donald Kohn was talking through his hat on September 9, 2009. Again, selling the virtues of the Fed, he claimed the Fed's myriad bailouts (not his description) over the past year had followed the "precepts derived from the work of Walter Bagehot [author of Lombard Street, a central-banking blueprint from Queen Victoria's time.] Those precepts hold that central banks can and should ameliorate financial crises by providing ample credit to a wide set of borrowers, as long as the borrowers are solvent, the loans are provided against good collateral, and a penalty rate is charged." [Italics added]

Bagehot's precepts were stated correctly but Fed practices contradicted the Victorian author. Kohn betrayed a complete ignorance of what the Fed was doing. Kohn and Company had provided loans against collateral that was so damaged it was necessary for the Fed to buy it from the banks and hide it from the public on its own books. We still do not know what the Fed bought and this is probably the main reason the central bank is resisting an audit. As for charging a "penalty rate," the Fed has charged a negative real rate of interest (below the rate of inflation). A double-digit interest rate would meet Bagehot's requirement.

The Kohn Put: Inducing "Savers to Diversify into Riskier Assets"

This past fall, the Kohn Put was announced. Maybe because he was speaking to the choir - at a Federal Reserve conference - he explicitly stated the Fed's grand plan. "[R]ecently the improvement, in risk appetites and financial conditions, in part responding to actions by the Federal Reserve and other authorities, has been a critical factor in allowing the economy to begin to move higher after a very deep recession.... Low market interest rates should continue to induce savers to diversify into riskier assets, which would contribute to a further reversal in the flight to liquidity and safety that has characterized the past few years."

In other words, the Federal Reserve is attempting to rescue itself as it did in 1998 and in 2002. Afraid the LTCM failure would cause financial institutions to freeze, the October 15 Greenspan Put inflated confidence and the stock market. In 2002, Federal Reserve governors, in speech after speech, terrorized Americans into believing it had to lift prices or the United States would suffer another Great Depression. This was the rationale for the 1% fed funds rate, the means by which the Fed inflated another asset bubble, the mortgage market, to compensate for its earlier mistake. And now, with the housing market and economy in despair, Kohn has announced the Fed's zero percent interest-rate policy will induce savers into the stock market and the already inflated municipal and federal government bond markets.

Presidential adviser Larry Summers and Secretary of the Treasury Tim Geithner are leading the search for Donald Kohn's replacement. We can be sure this pair of insiders will identify a candidate who will serve the Federal Reserve first and the American people last.

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, November 2009).

See his blog at www.aucontrarian.com

© 2010 Copyright Frederick Sheehan - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules