Sunday, February 22, 2015

Hollow Horses: Janet's Apollonian Curse

"I'm afraid of Greeks even those bearing gifts."

Laocoön in Virgil's Aeneid, Book II

Before she was raped and murdered, King Priam's daughter Cassandra was allegedly seduced by Apollo with the proposition that in exchange for sex she would receive the capacity to prophesy.  Through some twist of chastity, Apollo got upset with her spurning of his affections and cursed her with the fate of being right but never believed.  So, when she advised the Trojans that the large wooden horse was actually the agency of their downfall, they neglected her warnings and the rest is history.  Her miserable life ended as the assassinated concubine of King Agamemnon of Mycenae.  How's that for a tough dose of reality!

There's more than enough Greek tragedy to go around this week and everybody's got a little case of the Siege of Troy going on.  The Germans and the French are sick and tired of promises of Aegean austerity being met with populist protests which lead to Greek political accommodation.  The IMF is frustrated and doesn't see a path forward that doesn't include massive political and social upheaval.  And let's face it: this is not a great time to incite the oppressed classes in any country into revolt.  Before long, you could have all kinds of things going wrong and there are already enough things off the rails.  

If you try to trace what's gone on in Greece since the run up to the Athens Olympic Games in 2004 (you really don't want to pull back the curtain on that if you want to live in blissful ignorance of what's happening in the Middle East right now), you'll note that there have been over €300 billion pumped into Greek economic support packages none of which have a reasonable expectation of being repaid.  In a recent article, Princeton University's Professor of History and International Affairs Harold James attempted to unpack the populist message in Greece reminding creditor-in-chief Germany that it still owes Greece an unpaid debt from the end of World War I.   "When democracy" [the pro-labor stance that says that Greek pensions should be untouched and that austerity is too austere] "is used to justify shifting a country's burden onto its neighbors, integration becomes impossible - and both democracy and the international order may be jeopardized.  Just as financial contagion can spread market uncertainties through neighboring economies, so, too, can political contagion spread the adoption of a zero-sum mentality."

Whew!  I'm so thankful that I'm living in America where we don't have any of these… I'm sorry, what is that?  Federal Reserve Chair Janet Yellen is about to address Congress on Tuesday to discuss U.S. interest rates.  Oh, no worries, unemployment is down, oil prices are low which should boost consumer spending.  Right?  Nothing to see here - back to the EU paroxysm… right?

Well, kind of… almost… not quite. 

As I sought to untangle the bailouts and refinancings of the Greeks, I thought I'd check in on the lovely U.S. of A. and see how we're doing with our post-2008 financial house.  For that, I pulled up the February 19, 2015 H.4.1. - a document that I find deeply informative and more Greek tragedy than I'd like.  It's always mind bending to see that in a country where we have about $1.3 trillion in circulation, the Fed holds $1.7 trillion in mortgages, $2.5 trillion in Treasury securities and other assets totally about $4.5 trillion in reserve funds.  Over the past week, it picked up another $14 billion in mortgage-backed securities just to beef up a health economy!  Well done.  But footnote 17 - you know the one - at the bottom of the footnote section where you never actually go to read is that pesky little line item "liability for interest on Federal Reserve notes due to the U.S. Treasury" which currently sits at $65.4 billion. 

Four years ago, through a technical accounting gimmick, the Federal Reserve created a mechanism whereby it could never show a capital loss.  Let's examine this more closely.  The Federal Reserve is required to send its profits to the U.S. Treasury and, given their amazing investments in things like AIG's Maiden Lane, Mortgage Back Securities and the like - this amount should be sizable.  As long as interest rates stay anemically low, the Fed's ability to earn income in excess of interest paid on bank reserves is totally cool.  However, if the Fed ever had to sell assets - like mortgages and other securities - at a loss, it would lose money, right?  Not so fast!  Now, if the Fed loses money on saleable assets, it reports it as a negative interest due to the U.S. Treasury.  In other words, if the Fed loses money, such losses will be offset against future remittances to the Treasury thereby making the Fed incapable of having a negative capital position.  And clearly, smart people who are watching our economic interests care, right?  The ultimate anti-Cassandra clarity award goes to Bank of America's Ralph Axel who stated that: "We will not make too much of a fuss over this accounting change, but the overall theme of reduced government credibility is strengthened by it."  Wow!  The theme of reduced credibility is strengthened…. beware of bank executives and their beguiling Fed double speak. 

So here's a puzzle.  If Yellen signals a rise in interest rates, it's going to effectively devalue the "assets" held on its own balance sheet (which it bought during a period where Quantitative Easing mandated buying assets others didn't want).  But that's cool, right?  Because she'll be able to pick up the benefit of a negative interest on obligations due the Treasury and so she'll actually suffer no loss.  However, if the Fed doesn't suffer a loss, doesn't someone have to pick up the tab?  Ummm…

Greece, the U.S., and the E.U. all have the same problem.  During the end of the siege from 2008-2011, some clever soldiers got together and left a horse outside the city gates.  It had the name Quantitative Easing hung around its neck.  And, failing to heed the voices of the Cassandras who said that if we take the horse into our debauched celebration of economic recovery, bad things might come out and stab us in our sleep, we drug the colossal gift into our balance sheets.  And now, realizing that the horse was loaded with our undoing, we've decided to shift attention on the Greeks and their incapacity to be fiscally responsible in hopes that no one ever reads the footnotes in our financial statement.  Because if they did, they'd see that our problems are an order of magnitude bigger and, as Harold James put it, "both democracy and the international order may be jeopardized".


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Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave