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Editor’s Note

This article describes the destruction power to the economy when crony business marry the Federal Reserve. This relationship is so cozy it will take a powerful political effort to undo it.

Confessions of a Quantitative Easer

The Wall Street Journal - November 11, 2013 by Andrew Juszar

We went on a bond-buying spree that was supposed to help Main Street. Instead, it was a feast for Wall Street.

I can only say: I'm sorry, America. As a former Federal Reserve official, I was responsible for executing the centerpiece program of the Fed's first plunge into the bond-buying experiment known as quantitative easing. The central bank continues to spin QE as a tool for helping Main Street. But I've come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time.

Five years ago this month, on Black Friday, the Fed launched an unprecedented shopping spree. By that point in the financial crisis, Congress had already passed legislation, the Troubled Asset Relief Program, to halt the U.S. banking system's free fall. Beyond Wall Street, though, the economic pain was still soaring. In the last three months of 2008 alone, almost two million Americans would lose their jobs.

The Fed said it wanted to help—through a new program of massive bond purchases. There were secondary goals, but Chairman Ben Bernanke made clear that the Fed's central motivation was to "affect credit conditions for households and businesses": to drive down the cost of credit so that more Americans hurting from the tanking economy could use it to weather the downturn. For this reason, he originally called the initiative "credit easing."

My part of the story began a few months later. Having been at the Fed for seven years, until early 2008, I was working on Wall Street in spring 2009 when I got an unexpected phone call. Would I come back to work on the Fed's trading floor? The job: managing what was at the heart of QE's bond-buying spree—a wild attempt to buy $1.25 trillion in mortgage bonds in 12 months. Incredibly, the Fed was calling to ask if I wanted to quarterback the largest economic stimulus in U.S. history.

This was a dream job, but I hesitated. And it wasn't just nervousness about taking on such responsibility. I had left the Fed out of frustration, having witnessed the institution deferring more and more to Wall Street. Independence is at the heart of any central bank's credibility, and I had come to believe that the Fed's independence was eroding. Senior Fed officials, though, were publicly acknowledging mistakes and several of those officials emphasized to me how committed they were to a major Wall Street revamp. I could also see that they desperately needed reinforcements. I took a leap of faith.

In its almost 100-year history, the Fed had never bought one mortgage bond. Now my program was buying so many each day through active, unscripted trading that we constantly risked driving bond prices too high and crashing global confidence in key financial markets. We were working feverishly to preserve the impression that the Fed knew what it was doing.

It wasn't long before my old doubts resurfaced. Despite the Fed's rhetoric, my program wasn't helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn't getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.

From the trenches, several other Fed managers also began voicing the concern that QE wasn't working as planned. Our warnings fell on deaf ears. In the past, Fed leaders—even if they ultimately erred—would have worried obsessively about the costs versus the benefits of any major initiative. Now the only obsession seemed to be with the newest survey of financial-market expectations or the latest in-person feedback from Wall Street's leading bankers and hedge-fund managers. Sorry, U.S. taxpayer.

Trading for the first round of QE ended on March 31, 2010. The final results confirmed that, while there had been only trivial relief for Main Street, the U.S. central bank's bond purchases had been an absolute coup for Wall Street. The banks hadn't just benefited from the lower cost of making loans. They'd also enjoyed huge capital gains on the rising values of their securities holdings and fat commissions from brokering most of the Fed's QE transactions. Wall Street had experienced its most profitable year ever in 2009, and 2010 was starting off in much the same way.

You'd think the Fed would have finally stopped to question the wisdom of QE. Think again. Only a few months later—after a 14% drop in the U.S. stock market and renewed weakening in the banking sector—the Fed announced a new round of bond buying: QE2. Germany's finance minister, Wolfgang Schäuble, immediately called the decision "clueless."

That was when I realized the Fed had lost any remaining ability to think independently from Wall Street. Demoralized, I returned to the private sector.

Where are we today? The Fed keeps buying roughly $85 billion in bonds a month, chronically delaying so much as a minor QE taper. Over five years, its bond purchases have come to more than $4 trillion. Amazingly, in a supposedly free-market nation, QE has become the largest financial-markets intervention by any government in world history.

And the impact? Even by the Fed's sunniest calculations, aggressive QE over five years has generated only a few percentage points of U.S. growth. By contrast, experts outside the Fed, such as Mohammed El Erian at the Pimco investment firm, suggest that the Fed may have created and spent over $4 trillion for a total return of as little as 0.25% of GDP (i.e., a mere $40 billion bump in U.S. economic output). Both of those estimates indicate that QE isn't really working.

Unless you're Wall Street. Having racked up hundreds of billions of dollars in opaque Fed subsidies, U.S. banks have seen their collective stock price triple since March 2009. The biggest ones have only become more of a cartel: 0.2% of them now control more than 70% of the U.S. bank assets.

As for the rest of America, good luck. Because QE was relentlessly pumping money into the financial markets during the past five years, it killed the urgency for Washington to confront a real crisis: that of a structurally unsound U.S. economy. Yes, those financial markets have rallied spectacularly, breathing much-needed life back into 401(k)s, but for how long? Experts like Larry Fink at the BlackRock investment firm are suggesting that conditions are again "bubble-like." Meanwhile, the country remains overly dependent on Wall Street to drive economic growth.

Even when acknowledging QE's shortcomings, Chairman Bernanke argues that some action by the Fed is better than none (a position that his likely successor, Fed Vice Chairwoman Janet Yellen, also embraces). The implication is that the Fed is dutifully compensating for the rest of Washington's dysfunction. But the Fed is at the center of that dysfunction. Case in point: It has allowed QE to become Wall Street's new "too big to fail" policy.

Mr. Huszar, a senior fellow at Rutgers Business School, is a former Morgan Stanley managing director. In 2009-10, he managed the Federal Reserve's $1.25 trillion agency mortgage-backed security purchase program.

Editor’s Note

This is straight out of Atlas Shrugged. It could not be a better example. Greenberg would be wise to re-read Hank Rearden courtroom speech

WSJ August 20, 2013 by Seth Lipskreet

Bernanke Destroys AIG Shareholder Wealth for Revenge?

Sometime in the next few weeks—if Judge Thomas Wheeler of the U.S. Court of Federal Claims gets his way—Federal Reserve Chairman Ben Bernanke will be forced to testify under oath about the Fed's 2008 bailout of the insurance giant American International Group, better known as AIG.

The U.S. government has been fighting this deposition tooth and nail, warning of financial calamity if Mr. Bernanke is distracted from his duties at the central bank. But Judge Wheeler ruled last month that Mr. Bernanke could not duck his responsibility in a case involving enormous claims for damages. "The court cannot fathom having to decide this multibillion-dollar claim without the testimony of such a key government decision-maker," the judge wrote.

The deposition could still be halted by an appeals court. If it does take place it would be unprecedented for a sitting Fed chairman. Such a deposition would be unlikely to be open to the public. But it could lead eventually to the public gaining a glimpse of what might be called Mr. Bernanke's own moral hazard.

A moral hazard arises when someone takes a risk because the costs will be felt by someone else. It is exactly the kind of hazard Mr. Bernanke faced when, in a fit of anger that he acknowledged publicly only later, he engineered the AIG bailout—and takeover of the company—in September 2008.

Now Starr International is in court, on behalf of itself and other owners of AIG stock, with a $55 billion claim against the United States. Starr was the largest shareholder in AIG when the insurer ran into a liquidity crisis that triggered the bailout. Starr is headed by Maurice "Hank" Greenberg, who built AIG before he came under attack by the then-New York state attorney general, Eliot Spitzer, for accounting irregularities, and stepped aside. The new management took most of the gambles at the heart of AIG's collapse.

Starr contends that the bailout wiped out shareholder equity in a way that amounted to a government "taking" that is unconstitutional absent the due process and just compensation guaranteed by the Fifth Amendment. Starr filed suit in 2011. As the case was later summarized by Judge Wheeler, Starr alleged that rather than providing liquidity support like the government did to "comparable financial institutions" such as Citigroup and the Hartford Financial Services Group, the government "exploited AIG's vulnerable financial position by becoming a controlling lender and controlling shareholder of AIG."

The government's motive, as the judge summarized Starr's argument, was to use AIG and its assets to provide a "backdoor bailout" of such other financial institutions as Deutsche Bank, Goldman Sachs, Merrill Lynch, J.P. Morgan and UBS. In pursuit of that end, Starr alleges, the government seized AIG's property, including 562,868,096 shares of its common stock.

Starr alleges that when the Fed made its loan to AIG in 2008, it took 79.9% of its stock and put it in what Starr characterizes as a "sham Trust"—a sham because it existed solely as a vehicle to get around the Fed's lack of authority under the law to own stock in private companies.

Starr also makes an issue of the Fed's denial of a shareholder vote on the dilution of AIG shareholders in 2009. The company initiated a reverse stock split to accommodate the government's demand for 80% of the company's stock. In other words, did the Fed use a forbidden ownership in a private corporation to achieve a public-policy goal of making the Fed's constituents, the banks, whole?

"The basic terms of these transactions amounted to an attempt to 'steal the business,' " Starr claims, quoting what it says a banker hired to represent the interests of the New York Federal Reserve Bank remarked at the time of the bailout.

The government disputes this, arguing in a court filing that to the extent AIG "exchanged any property" with the New York Fed, "it agreed to do so for consideration" and was rescued from the consequences of its own actions. "That exchange was not a taking."

Government officials, though, were plenty nervous about what they were doing. The Treasury secretary at the time, Henry Paulson, has written of a meeting with Mr. Bernanke and a group of congressional leaders in September 2008. Mr. Paulson reports that then-Sen. Christopher Dodd (D., Conn.) twice asked "how the Fed had the authority to lend to an insurance company and seize control of it."

According to Mr. Paulson, Mr. Bernanke explained that the Federal Reserve Act "allowed the central bank to take such actions under 'unusual and exigent circumstances.'" Eventually, in Mr. Paulson's account, Sen. Harry Reid (D., Nev.) announced: "You've heard what people have to say. I want to be absolutely clear that Congress has not given you formal approval to take action. This is your responsibility and your decision."

The meeting was so tense, according to Mr. Paulson's account, that the Treasury secretary at one point ducked behind a pillar in the Capitol and went into dry heaves. The following year, when Mr. Bernanke was being questioned by the Senate, he confessed in reference to AIG's behavior and the need for a bailout, "If there's a single episode in this entire 18 months that has made me more angry, I can't think of one, than AIG."

Could it have been an anger management issue that explains the Fed running past redlines in the statute and the Constitution? Mr. Greenberg, in his own book, "The AIG Story," insists that the statute did not authorize the Fed to seize control of private property. He argues that the constitutionality of any such provision would be doubtful.

On top of which, Starr argues, the seizure of AIG's equity was part of punitive measures imposed on no other recipient of a government bailout. Mr. Bernanke himself has said that the Fed imposed significant costs and constraints on AIG's owners in order to mitigate concerns that the bailout of AIG would "exacerbate moral hazard" and "encourage inappropriate risk taking."

No wonder Judge Wheeler seems bound and determined that Mr. Bernanke becomes the first Fed governor to sit for a deposition. The only question is why do it in private?

There's a lot the public deserves to know, starting with the question of whether Mr. Bernanke, who normally seems unflappable, got so angry at AIG that he lost his own sense of the very moral hazard he was claiming to be acting to prevent.

Mr. Lipsky is editor of The New York Sun.

Editor’s Note

The Fed is destroying our wealth and we are doing nothing to stop them. Printing money (quantitative easing) helps only the government fund the welfare state and heavy borrowers like most on Wall Street. We don’t believe Wall Streeters are inherently evil, but they are smart enough to out Fed the Fed.

We should call for the dissolution of the Fed to everyone who will listen.

Wall Street Journal - August 15, 2013 by David C. Patterson

The Games the Fed Plays With Your Investments

Federal Reserve Chairman Ben Bernanke is playing games with your investments. The Fed's quantitative-easing program and near-zero interest rate policy is explicitly aimed at (among other things) raising asset prices to create a "wealth effect" that will bring about more confidence and spending, which will support the economy and, in turn, the market.

The Fed's game isn't that easy to win, however. Since everyone knows what the Fed is doing, its actions are highly anticipated and "discounted" by the market, to the extent that when they actually occur they may have no effect on prices at all. Worse, they may have the opposite of the intended effect. This can happen if an "accommodative" move is judged to be a tad less so than was expected, sending the market down rather than up.

The Fed, of course, must take this possibility into account, since its whole wealth-effect strategy depends on market reaction. It may therefore have to make the move a little more accommodative, lest it disappoint.

But the market understands this also, and may have anticipated this second-order adjustment, a possibility that the Fed in turn must assess in deciding whether to make it. Mind you, "the market" isn't one person, but a very large number of different actors, each trying to anticipate how all the others will behave.

The process can at some point turn powerfully negative, if the monetary stimulus stops, or is expected to stop, or becomes ineffective—which it will if it is expected to become ineffective, because it is only effective based on what the market expects.

If your head is spinning by now, join the club. The conditions are those of a classic "game" in the language of game theorists. The job of that profession (which includes several Nobel Prize winners) is to predict and if possible handicap the possible outcomes of such games. You don't have to be much of a theorist to see that the number and volatility of outcomes increases geometrically with each new player, especially one as powerful and manipulative as the Fed.

And you don't need a theory at all to notice that the market has been regularly moving in the "wrong" direction: Bad news is good news, and vice versa, because it isn't the news itself that matters, but how the Fed will react to it—or, more accurately, how the market thinks it will react.

Price and value have a weak relationship at best on Wall Street, and the Fed seems intent on bringing about a complete divorce, by manipulating and generally inflating price, and by simultaneously undermining value.

Value, to make any sense for investment assets, must make some reference to why we hold the assets. Generally speaking, it isn't for the ability to convert them to cash, in bulk and on short notice, but to generate a cash flow, or income stream, that continues reliably over some lengthy if not indefinite period and preserves its purchasing power. Value for this purpose would be the size of such a cash flow that the assets can support.

The Fed's aggressive suppression of interest rates, while raising the price of bonds, has correspondingly destroyed their value. A 10-year Treasury bought today at a 2% yield would pay 1.2% net of tax (current top federal rate only), for an annual loss of .8% against the 2% rate of inflation that the Fed is aiming for. The loss would be greater against the higher rate that the Fed says it may tolerate, and greater still against the rate that many investors think they are really facing in their expenses.

Stocks have a better record of supporting lifestyles over long periods, but that ability also depends on their price level at the starting point. You might think that a draw of, say, 3% from a diversified equity portfolio would produce a cash flow that sustained its purchasing power over time. Yet looking at all 10- or 15-year, quarter-to-quarter periods since the start of the S&P index in 1926, this was true only about 60% of the time. Unless it is justified by real profit growth, higher price just means lower sustainable draw.

Higher prices logically mean lower value (more money having to be paid for the same thing), but they tend to correct themselves for just that reason: Wanting better value, people stop paying the higher price.

The rules are different in the game the Fed is playing. If the price of investment assets is going up, not because of improved economic conditions—creditworthiness of debtors, profitability of companies, real demand for commodities—but rather because the Fed has decreed that they shall go up, the natural, corrective effect is subverted, at least for as long as the Fed has credibility. In this respect there is no difference between prices on the stock market and in other markets: Engineered inflation is self-feeding rather than self-correcting, until it isn't. We saw this play out to disastrous effect in the housing market as low mortgage rates pushed home prices ever higher until they collapsed in 2007-08.

All in all, judging the value of your investment portfolio is a lot more work these days than opening your account statement. The more people do that work, of course, the less stimulated they will feel about spending, and the more futile will be Fed policy and it’s supposed "wealth effect."

Meanwhile, painful as it is to hold cash, it might pay to keep some handy as the game plays out. The Fed is a powerful but uncertain player. When it steps away, the turmoil may be more painful still, but will set the stage for a return of true value determined by market forces.

Mr. Patterson is chairman and CEO of Brandywine Trust Group LLC.

Editor’s Note:

I wonder how Hockett can work both sides of the street and no one in law enforcement makes a sound. Over the years there has been a very cozy (read mutually financially beneficial) relationship between some big Wall Street firms and the Fed and other regulators. (Read up on how many Goldman Sachs executives worked at Treasury or the Fed before and after their career on Wall Street).

If any real business (not crony business) tried to pull this off, the FBI, SEC, IRS and host of others would be on your doorstep almost immediately.

So I ask...when are you going to shrug and fight back?

Wall Street Journal - June 12, 2013

The Fed’s Eminent Mistake

The Federal Reserve has spent trillions of dollars trying to revive U.S. housing prices, and at long last a recovery is underway. So it's more than a little surprising that amid this progress the New York Fed would suddenly lend its intellectual imprimatur to a dubious proposal for government to use eminent domain to seize underwater mortgages.

Yet there it was Monday on the New York Fed website: "Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt," a research paper by Cornell law professor Robert Hockett. The title is certainly arresting since it promises an economics free lunch.

Mr. Hockett notes with alarm in the paper that home prices "still linger close to 30 percent below peak levels," and he avers that government must act to keep pushing prices back up. His solution?

He wants politicians to identify mortgages worth more than the homes, seize them via the power of eminent domain out of private trusts, refinance them with government help, repackage them into new securities, and sell those securities to new investors. He muses that the money to buy the mortgages could come from the feds (read: taxpayers) or "private investors" or both.

This might please underwater borrowers who would immediately pay less for their loan, and the politicians would take credit for the windfall. But the not-so-free lunch would be financed by the original mortgage investors, who would suffer losses without recourse. There's also the little issue of higher interest rates for future borrowers as lenders price in this new political uncertainty into mortgage contracts.

Eminent domain is supposed to be used for public purposes, with adequate compensation to the private parties whose assets are seized. But in this case government would seize private assets—with uncertain compensation—for someone else's private gain.

We couldn't help but notice that Mr. Hockett's idea closely resembles the eminent-domain pitch made by Mortgage Resolution Partners, a private investment firm out of San Francisco. MRP could be a big winner in such a scheme as the repackager of the seized mortgages into new securities in return for a fee. The firm has pitched the idea to the likes of Chicago and San Bernardino County, without success.

And wouldn't you know, Mr. Hockett turns out to have been on the payroll of none other than Mortgage Resolution Partners. After we made a query, MRP Chairman Steven Gluckstern explained in an email Tuesday that MRP paid Mr. Hockett "a nominal, one-time honorarium" to help the company "with some legal analysis based on his previous published work in related areas."

One problem: The Fed didn't disclose Mr. Hockett's ties to MRP when it posted his research paper. We called the New York Fed on Monday asking about Mr. Hockett and MRP, and only several hours later did the bank get around to disclosing the connection on its website.

New York Fed spokeswoman Andrea Priest emailed us that Mr. Hockett had been an "unpaid visiting scholar" at the bank from 2011 to 2012, adding that the bank has also published work critical of his ideas. She declined to explain on the record who brought Mr. Hockett to the Fed or the reason for the initial failure to disclose his ties to MRP.

For his part, Mr. Hockett explained the oversight to us Tuesday by noting that "I guess because I told everybody about that this past summer, that I had been paid in early 2012." He added that "I've been unassociated with MRP particularly in a pecuniary way ever since then, and of course that's all over the press and television and radio interviews last summer. I suppose it just doesn't occur to me anymore."

Perhaps the Fed was out of this media loop, and in any case our point isn't to play conflict-of-interest gotcha. The real problem is that the Fed would lend its credibility to a scheme for governments to seize private mortgages for someone else's private gain. The central bank used to be known for sensible regulators, not as the venue for every crackpot notion to favor some investors over others.

The Fed has already bent too far to boost housing more than other parts of the economy with its trillion-dollar purchases of mortgage securities. This is credit allocation, but at least those purchases are plausibly related to the central bank's monetary policy mandate.

The Fed goes well beyond that mandate when it starts advertising proposals to urge politicians to seize private mortgage assets. Mr. Hockett's research paper follows New York Fed President William Dudley's 2012 decision to join the lobbying of Fannie Mae regulator Edward DeMarco to allow principal writedowns on Fannie loans. Mr. Dudley was echoing pleas by the Obama Treasury—a highly inappropriate foray into politicized housing regulation by a supposedly independent central banker.

Housing prices are recovering—in some places at a rate that suggests speculation more than economic fundamentals. Mr. Dudley and his fellow Fed Governors ought to be focusing now on how to exit from their extraordinary interventions without further distorting the market or undermining the larger economy. They've already meddled far too much in the housing market.

Editor’s Note

George Orwell in his famous book 1984 used the obscuring of words to hide truths. When the FED calls printing money out of out thin air “quantitative easing” or now “portfolio balancing” it is committing a far more serious immoral act than hiding the truth. Orwell wrote fiction but the FED is stealing your wealth and my wealth by debasing our currency and eroding our savings.

No matter how many PhD economists support the FED actions it is impossible to create wealth by printing money.

As a note to WSJ editors and conservative writers the phrase “increasing the balance sheet (of the Fed)" should never be used without an explanation of what is really happening. Accounting 101 teaches you cannot increase anyone’s balance sheet in and by itself. In the real world balance sheets are comprised of assets, liabilities and equity and they must balance to zero. What is usually meant by the phrase is increasing one’s equity. That can be done only by earnings or new outside investment. So how does the FED increase its balance sheet? It doesn’t and the WSJ and economic writers know they don’t.

Wall Street Journal - May 10, 2013 By Martin Feldstein

The Federal Reserve's Policy Dead End

The Federal Reserve recently announced that it will increase or decrease the size of its monthly bond-buying program in response to changing economic conditions. This amounts to a policy of fine-tuning its quantitative-easing program, a puzzling strategy since the evidence suggests that the program has done little to raise economic growth while saddling the Fed with an enormous balance sheet.

Quantitative easing, or what the Fed prefers to call long-term asset purchases, is supposed to stimulate the economy by increasing share prices, leading to higher household wealth and therefore to increased consumer spending. Fed Chairman Ben Bernanke has described this as the "portfolio-balance" effect of the Fed's purchase of long-term government securities instead of the traditional open-market operations that were restricted to buying and selling short-term government obligations.

Here's how it is supposed to work. When the Fed buys long-term government bonds and mortgage-backed securities, private investors are no longer able to buy those long-term assets. Investors who want long-term securities therefore have to buy equities. That drives up the price of equities, leading to more consumer spending.

But despite the Fed's current purchases of $85 billion a month and an accumulation of more than $2 trillion of long-term assets, the economy is limping along with per capita gross domestic product rising at less than 1% a year. Although it is impossible to know what would happen without the central bank's asset purchases, the data imply that very little increase in GDP can be attributed to the so-called portfolio-balance effect of the Fed's actions.

Even if all of the rise in the value of household equities since quantitative easing began could be attributed to the Fed policy, the implied increase in consumer spending would be quite small. According to the Federal Reserve's Flow of Funds data, the total value of household stocks and mutual funds rose by $3.6 trillion between the end of 2009 and the end of 2012. Since past experience implies that each dollar of increased wealth raises consumer spending by about four cents, the $3.6 trillion rise in the value of equities would raise the level of consumer spending by about $144 billion over three years, equivalent to an annual increase of $48 billion or 0.3% of nominal GDP.

This 0.3% overstates the potential contribution of quantitative easing to the annual growth of GDP, since some of the increase in the value of household equities resulted from new saving and the resulting portfolio investment rather than from the rise in share prices. More important, the rise in equity prices also reflected a general increase in earnings per share and an increase in investor confidence after 2009 that the economy would not slide back into recession.

Earnings per share of the Standard & Poor's 500 stocks rose 50% in 2010 and a further 9% in 2011, driving the increase in share prices. The S&P price-earnings ratio actually fell to 17 at the start of 2013 from 21 at the start of 2010, showing the importance of increased earnings rather than an increased demand for equities.

In short, it isn't at all clear that the Fed's long-term asset purchases have raised equity values as the portfolio balance theory predicted. Even if it did account for the entire rise in equity values, the increase in household equity wealth would have only a relatively small effect on consumer spending and GDP growth.

There is one further puzzle about the quantitative-easing program. The Fed's purchase of Treasury bonds and other long-term securities has not been nearly as large as the increase in the government debt during the same period. The Fed's balance sheet has grown by less than $2.5 trillion since the summer of 2007, while the federal debt has grown by more than twice that amount just since the beginning of 2009. As a result, the public has had to absorb more than $2 trillion of net government debt during the past three years. At best, the Fed's long-term asset purchases reduced the extent to which the federal deficits crowded out equity purchases.

The Federal Reserve has rationalized its use of long-term asset purchases and its explicit guidance about future values of short-term interest rates by noting that conventional monetary policy—lowering the federal-funds rate—is not possible now that the fed-funds rate is very close to zero. With a dual mandate that includes growth as well as price stability, the Federal Open Market Committee apparently feels a compulsion to do something. Unfortunately, the evidence suggests that it hasn't worked.

Mr. Bernanke has emphasized that the use of unconventional monetary policy requires a cost-benefit analysis that compares the gains that quantitative easing can achieve with the risks of asset-price bubbles, future inflation, and the other potential effects of a rapidly growing Fed balance sheet. I think the risks are now clear and the benefits are doubtful. The time has come for the Fed to recognize that it cannot stimulate growth and that a stronger recovery must depend on fiscal actions and tax reform by the White House and Congress.

Mr. Feldstein, chairman of the Council of Economic Advisers under President Ronald Reagan, is a professor at Harvard and a member of the Journal's board of contributors.

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Editor’s Note

Buy stocks and farm land, but be careful and watch for the crash!

Wall Street Journal - February 6, 2013 by George Melloan

The Fed's Asset-Inflation Machine

Stock-market winners should remember what happened to those who cashed in gains for more debt before 2008.

In a 1996 speech to the American Enterprise Institute, Federal Reserve Chairman Alan Greenspan famously warned about the dangers when "irrational exuberance" fueled asset inflation. By that he meant that rising values of stocks and real estate might reflect only a cheapened dollar, not an increase in their real worth. Since he was the man in charge of the dollar, his remark caused quite a stir.

We've learned a lot about asset inflation since that speech, but maybe not enough. The nearly 2,000-point rise in the Dow Jones Industrial Average since last June no doubt at least partly reflects asset inflation, since there has been very little in the economic or political outlook to justify it.

Midwest farmland prices were rising at a 13% annual rate last fall even after a summer of crippling drought. How could drought-stricken farms be gaining value so rapidly, other than through inflation generated by cheap credit? House prices also are climbing again in many areas, much as they were during the asset inflation of the 2000s. Those are the same houses that were on the down escalator not long ago. Call it "asset reflation."

Asset inflation often produces something called "wealth illusion," the belief that pricier asset holdings necessarily make one permanently richer. Illusions are dangerous. Eventually, painful reality intervenes.

We've been down this road before. Mr. Greenspan was cautioning himself as well as Wall Street in his AEI speech when he said, "we should not underestimate, or become complacent about the complexity of interactions of asset markets and the economy." After nearly a decade on the job, he knew the uncertainties of managing a fiat currency. He also knew that tightening the money spigots in boom times required the courage to face the political outrage that invariably results.

Seven years later, Mr. Greenspan would fail to heed his own warning. Urged on by his soon-to-be successor, Ben Bernanke, Mr. Greenspan would hold interest rates down too long, setting off a mid-2000s credit binge that sent assets soaring, home prices in particular. Congress developed a blasé attitude toward huge budget deficits, simply because Fed policy made them easy to finance. State and local governments overleveraged themselves. This was "irrational exuberance" indeed.

When the Fed finally tightened credit, the bubble burst, with a resulting stock-market crash, a vast wave of home foreclosures, public-sector pension funds in distress, and many state and municipal governments technically bankrupt. As Mr. Greenspan had feared, a crash in asset values did profound damage to the real economy. We are still living with it.

At least Chairman Greenspan understood the risks. It is not clear that Chairman Bernanke is aware that he has now set the Fed's asset-inflation machine on automatic pilot by promising near-zero interest rates well out into the future. The longer the policy continues, the greater the difficulty in climbing down from the debt mountain it is creating, particularly the rapidly rising national debt.

President Obama and Mr. Bernanke worsened the effects of the 2008 crash by adopting the same Keynesian antirecession measures—fiscal and monetary "stimulus"—that had failed before, most dramatically in the 1970s. Stanford economist and former Treasury official John Taylor recently argued persuasively on these pages that "stimulus" measures had retarded rather than speeded recovery.

Mr. Bernanke will have great difficulty letting go of the near-zero interest rate policy without severe consequences for both the Fed and the economy. The Fed's own economists recently warned that the Fed itself could lose as much as $100 billion on its vast portfolio when bond prices finally fall from their artificially elevated levels. Meanwhile, higher interest rates will cause the cost of financing government debt to skyrocket.

The Fed policy of quantitative easing is designed to rebuild the asset inflation edifice that collapsed in 2008. German banker and economist Kurt Richebächer provided some of the earliest warnings of the dangers. In his April 2005 newsletter, he wrote that "there is always one and the same cause of [asset inflation], and that is credit creation in excess of current saving leading to demand growth in excess of output."

Richebächer added that "a credit expansion in the United States of close to $10 trillion—in relation to nominal GDP growth of barely $2 trillion over the last four years since 2000—definitely represents more than the usual dose of inflationary credit excess. This is really hyperinflation in terms of credit creation." Richebächer died a year before the debacle of 2008. The crash that surprised so many bright people wouldn't have surprised him at all.

The rising Dow is of course good news for savers, who have been forced into equities to try to find a decent return on investment. Thanks to Fed policy, "safe" 10-year Treasury bonds yield a near-zero or negative return, depending on whether you measure price inflation at the official rate or at higher private estimates.

Winners on stocks or land holdings should happily accept their gains as the best to be expected in a very unsettled financial environment. But they should also remember the 2000s, when so many people thought their newfound riches were real and cashed them in for yet more debt, such as home-equity loans.

They later had a rude awakening. The "wealth illusion" of asset inflation is seductive, which is why central banks in charge of a fiat currency and subject to no external disciplines so often drift in that direction. Politicians smile in satisfaction and powerful Washington lobbies cry for more.

But an economy built on an illusion is hardly a sound structure. We may be doomed to learn that lesson once again before long.

Mr. Melloan, a former columnist and deputy editor of the Journal editorial page, is the author of "The Great Money Binge: Spending Our Way to Socialism" (Simon & Schuster, 2009).

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Wall Street Journal – January 16, 2013 by Paul Moreno

Gold, Greenbacks and Inflation—A History and a Warning

The Federal Reserve, which celebrates its 100th anniversary this year, is tasked by Congress with managing the money supply so as to preserve price stability while maximizing employment. But with the central bank having increased the money supply by 25% since the financial crash of 2008—while the federal government has borrowed $5 trillion—can inflation be far off?

It won't be the first time. Inflation has often been popular, especially in democracies, since it benefits debtors, who are always more numerous than creditors. Inflation allows debtors to repay in money that is less valuable than the money they borrowed. This was the case after America's Revolutionary War, when economically distressed debtors demanded that state governments ease their burdens. State after state enacted paper-money laws, so that debts contracted in scarce gold and silver could be repaid with infinitely expandable paper.

This sort of inflation was one of the principal reasons for the adoption of the Constitution, which forbids the states to "make anything but gold or silver coin legal tender in payment of debts." In the Federalist Papers, James Madison referred to state paper-money laws as the sort of "improper or wicked project” that the new Constitution would prevent. Chief Justice John Marshall later recalled, in the 1819 Dartmouth College v. Woodward decision, that such laws had “weakened the confidence of man in man and embarrassed all transactions between individuals by dispensing with a faithful performance of engagements."

The adoption of an anti-inflationary Constitution was a remarkable example of democratic self-restraint, and it worked wonderfully to control inflation for the next century and a quarter.

The only significant inflation came with the Civil War, via $500 million in paper "greenbacks"—the Constitution being silent on Congress's power to issue paper money. Rather than an act to relieve private debtors, the Civil War inflation was a way to pay the government's bills, a kind of de facto taxation. Still, private debtors—those who borrowed in gold before the war and could pay back their debts in depreciated greenbacks—were happy, and there were calls for still more inflation after the war.

Those calls led to the "Greenback Party," which enjoyed some success at the state level and sent some 20 members to Congress. But the government showed remarkable discipline in resisting such demands, and the greenback was as good as gold by 1879. Nevertheless, the inflationary experience led lenders to insert “gold clauses" in contracts specifying repayment in gold coin (provisions that were effective until Congress canceled them in 1934, a move upheld by the Supreme Court the following year).

The ending of the Civil War-era inflation, plus the massive increases in productivity in the largely free market of the following decades, led to a modest deflation—which meant that as prices gently declined, the real value of wages increased. Still, special interests such as southern and western farmers with mortgages pushed incessantly for an increase in the money supply. The high point came in the election of 1896, the famous "battle of the standards," when the gold-standard Republicans won a decisive victory over the silver-inflation Democrats.

The era of stable or declining prices came to an end in the 20th century. Inflation began innocently, with gold discoveries in Alaska, South Africa and Australia that increased the money supply in the only way possible under a gold standard. But the great engine of inflation was the enactment of the Federal Reserve System in 1913, and a dangerous delegation of monetary power to an unelected bureaucracy. From 1800 to 1913, prices rose 176%; since then they have risen 448%.

The Fed got to work right away, helping to keep the government's borrowing costs low during World War I. It increased the money supply by 75%, and consumer prices doubled from 1914 to 1920. The central bank became the best illustration of the adage that "in politics, nothing succeeds like failure." As Milton Friedman and Anna Schwartz showed in their "Monetary History of the United States," the Fed mismanaged the postwar reconversion, kept interest rates lower and prices higher than they should have been in the 1920s, and aggravated the Great Depression by keeping rates too low before the crash and raising them after it. Yet the Fed was rewarded with greater power, especially by the Banking Act of 1935.

The bank continued to facilitate low-interest Treasury borrowing in World War II and the Korean War. But during that latter conflict it finally bridled against Treasury demands to keep borrowing rates artificially low. In 1951 it negotiated a landmark "accord" with the White House reasserting its "independence."

Yet inflationary pressures built up again in the late 1960s thanks to the Fed’s accommodation of deficit spending on Lyndon Johnson's Great Society programs and the Vietnam War. That, plus the abandonment of the gold standard and the collapse of the Bretton Woods system of fixed exchange rates, led to the infamous "stagflation" of the 1970s. The Fed eventually tamed inflation under the chairmanship of Paul Volcker in the early 1980s, though prices still have more than doubled since then.

Now the inflationary potential of deficit financing has grown enormously over the first Obama term. The lesson of American history is that it is difficult enough for the government to resist popular demands for inflation to relieve private debts. When the government itself is the country's chief debtor, resistance is all but impossible.

Mr. Moreno, a professor of history at Hillsdale College, is the author of "The American State from the Civil War to the New Deal," forthcoming from Cambridge University Press.

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Wall Street Journal by Cox and Archer- January 2013

Why $16 Trillion Only Hints at the True U.S. Debt

Hiding the government's liabilities from the public makes it seem that we can tax our way out of mounting deficits. We can't.

A decade and a half ago, both of us served on President Clinton's Bipartisan Commission on Entitlement and Tax Reform, the forerunner to President Obama's recent National Commission on Fiscal Responsibility and Reform. In 1994 we predicted that, unless something was done to control runaway entitlement spending, Medicare and Social Security would eventually go bankrupt or confront severe benefit cuts.

Eighteen years later, nothing has been done. Why? The usual reason is that entitlement reform is the third rail of American politics. That explanation presupposes voter demand for entitlements at any cost, even if it means bankrupting the nation.

A better explanation is that the full extent of the problem has remained hidden from policy makers and the public because of less than transparent government financial statements. How else could responsible officials claim that Medicare and Social Security have the resources they need to fulfill their commitments for years to come?

As Washington wrestles with the roughly $600 billion "fiscal cliff" and the 2013 budget, the far greater fiscal challenge of the U.S. government's unfunded pension and health-care liabilities remains offstage. The truly important figures would appear on the federal balance sheet—if the government prepared an accurate one.

But it hasn't. For years, the government has gotten by without having to produce the kind of financial statements that are required of most significant for-profit and nonprofit enterprises. The U.S. Treasury "balance sheet" does list liabilities such as Treasury debt issued to the public, federal employee pensions, and post-retirement health benefits. But it does not include the unfunded liabilities of Medicare, Social Security and other outsized and very real obligations.

As a result, fiscal policy discussions generally focus on current-year budget deficits, the accumulated national debt, and the relationships between these two items and gross domestic product. We most often hear about the alarming $15.96 trillion national debt (more than 100% of GDP), and the 2012 budget deficit of $1.1 trillion (6.97% of GDP). As dangerous as those numbers are, they do not begin to tell the story of the federal government's true liabilities.

The actual liabilities of the federal government—including Social Security, Medicare, and federal employees' future retirement benefits—already exceed $86.8 trillion, or 550% of GDP. For the year ending Dec. 31, 2011, the annual accrued expense of Medicare and Social Security was $7 trillion. Nothing like that figure is used in calculating the deficit. In reality, the reported budget deficit is less than one-fifth of the more accurate figure.

Why haven't Americans heard about the titanic $86.8 trillion liability from these programs? One reason: The actual figures do not appear in black and white on any balance sheet. But it is possible to discover them. Included in the annual Medicare Trustees' report are separate actuarial estimates of the unfunded liability for Medicare Part A (the hospital portion), Part B (medical insurance) and Part D (prescription drug coverage).

As of the most recent Trustees' report in April, the net present value of the unfunded liability of Medicare was $42.8 trillion. The comparable balance sheet liability for Social Security is $20.5 trillion.

Were American policy makers to have the benefit of transparent financial statements prepared the way public companies must report their pension liabilities, they would see clearly the magnitude of the future borrowing that these liabilities imply. Borrowing on this scale could eclipse the capacity of global capital markets—and bankrupt not only the programs themselves but the entire federal government.

These real-world impacts will be felt when currently unfunded liabilities need to be paid. In theory, the Medicare and Social Security trust funds have at least some money to pay a portion of the bills that are coming due. In actuality, the cupboard is bare: 100% of the payroll taxes for these programs were spent in the same year they were collected.

In exchange for the payroll taxes that aren't paid out in benefits to current retirees in any given year, the trust funds got nonmarketable Treasury debt. Now, as the baby boomers' promised benefits swamp the payroll-tax collections from today's workers, the government has to swap the trust funds' nonmarketable securities for marketable Treasury debt. The Treasury will then have to sell not only this debt, but far more, in order to pay the benefits as they come due.

When combined with funding the general cash deficits, these multitrillion-dollar Treasury operations will dominate the capital markets in the years ahead, particularly given China's de-emphasis of new investment in U.S. Treasurys in favor of increasing foreign direct investment, and Japan's and Europe's own sovereign-debt challenges.

When the accrued expenses of the government's entitlement programs are counted, it becomes clear that to collect enough tax revenue just to avoid going deeper into debt would require over $8 trillion in tax collections annually. That is the total of the average annual accrued liabilities of just the two largest entitlement programs, plus the annual cash deficit.

Nothing like that $8 trillion amount is available for the IRS to target. According to the most recent tax data, all individuals filing tax returns in America and earning more than $66,193 per year have a total adjusted gross income of $5.1 trillion. In 2006, when corporate taxable income peaked before the recession, all corporations in the U.S. had total income for tax purposes of $1.6 trillion. That comes to $6.7 trillion available to tax from these individuals and corporations under existing tax laws.

In short, if the government confiscated the entire adjusted gross income of these American taxpayers, plus all of the corporate taxable income in the year before the recession, it wouldn't be nearly enough to fund the over $8 trillion per year in the growth of U.S. liabilities. Some public officials and pundits claim we can dig our way out through tax increases on upper-income earners, or even all taxpayers. In reality, that would amount to bailing out the Pacific Ocean with a teaspoon. Only by addressing these unsustainable spending commitments can the nation's debt and deficit problems be solved.

Neither the public nor policy makers will be able to fully understand and deal with these issues unless the government publishes financial statements that present the government's largest financial liabilities in accordance with well-established norms in the private sector. When the new Congress convenes in January, making the numbers clear—and establishing policies that finally address them before it is too late—should be a top order of business.

Mr. Cox, a former chairman of the House Republican Policy Committee and the Securities and Exchange Commission, is president of Bingham Consulting LLC. Mr. Archer, a former chairman of the House Ways & Means Committee, is a senior policy adviser at PricewaterhouseCoopers LLP.

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