That dreaded phrase: ''The system is fundamentally sound''

[EJ]

That dreaded phrase: ''The system is fundamentally sound''

Just over two years ago we issued this advisory to our readers:

Turbulence in markets unnerves Bank and Fed officials
June 13, 2006 (Times Online)

Concern is growing over the present instability of financial markets among senior officials at the Bank of England and the US Federal Reserve.

The Bank of England’s Governor meanwhile sounded a warning last night that markets and the global economy may be set for a period of greater turbulence triggered by rising interest rates around the world.

AntiSpin: "Period of turbulence" is not the signal to run for serious cover. When central banks seek to assure us that "the system is fundamentally sound" that means that the system is most certainly not sound, and that the wheels are about to come off. Watch for phrase "the system is fundamentally sound."

Protesting too much is a time honored tradition of US Treasury secretaries in such periods, and the phrase "fundamentally sound" comes up on each occasion when, after a year or so of debt deflation and systemic breakdown, the system becomes most certainly fundamentally unsound.

"Traders, talking over the Morgan meeting, failed to remember any previous occasion on which a stock market conference had been called while a trading session was still in progress. They did recall, however, that in 1907, with call money at 125%. Secretary of the Treasury Cortelyou conferred with J. P. Morgan, put $25,000,000 of Government funds into Manhattan banks, halted the Panic. They remembered too the Northern Pacific crash of 1901. when, after Northern Pacific stock had gone overnight from $150 to $1,000 a share, the House of Morgan, representing the late great James J. Hill and the House of Kuhn, Loeb, representing the late great Edward H. Harriman, compromised at $150 a share, saved from ruin many a short. Then there was the U. S.-England war scare of 1895 when, with money at 80%, J. P. Morgan offered money at 6%, averted a threatened crash. Thus bankers have for a long time recognized their responsibilities as panic-preventers, and when the glass house of speculation has cracked and splintered, it has most often been the strong House of Morgan that has assumed the responsibility of fame and brought order out of confusion." - Bankers v. Panic, TIME Magazine, Nov. 4, 1929

Tonight, reading the century old script, Treasury Secretary Henry Paulson asserts:

Paulson braces public for months of tough times
Sunday July 20, 2008 (AP)

Treasury chief braces people for months of tough times ahead, says US banking system is sound

Treasury Secretary Henry Paulson sought to reassure an anxious public Sunday that the banking system is sound, while also bracing people for more troubled times ahead.

"I think it's going to be months that we're working our way through this period -- clearly months," he said.

Paulson said the number of troubled banks will increase as they struggle to cope with big losses on bad mortgages. The government this month took over IndyMac after a run led it to become the largest regulated thrift to fail.

"Of course the list is going to grow longer given the stresses we have in the marketplace, given the housing correction. But again, it's a safe banking system, a sound banking system. Our regulators are on top of it. This is a very manageable situation," he said in broadcast interviews.

Paulson used appearances on the Sunday talk shows to tell people that deposits up to $100,000 are fully insured. He said no one has lost a single penny on an insured deposit in the 75 years that the Federal Deposit Insurance Corporation has operated.

"We're going through a challenging time with our economy. This is a tough time. The three big issues we're facing right now are, first, the housing correction which is at the heart of the slowdown; secondly, turmoil of the capital markets; and thirdly, the high oil prices, which are going to prolong the slowdown," he said.

"But remember, our economy has got very strong long-term fundamentals, solid fundamentals. And you know, your policy-makers here, regulators, we're being very vigilant."

Banker's reputations suffer for bad calls, and I suspect Hank's will as well.

"Al Wiggin has never been known as a hard banker like President William Chapman Potter of Guaranty Trust Co., but he saw to it that his bank was ready for the 1929 stockmarket crash. Last week, in acknowledging Mr. Wiggin's letter, the executive committee revealed that in October 1929, Chase had less than $1,000,000 in brokers' loans. In the week of the panic, while frightened outside lenders were scrambling to call their Stock Exchange loans, Chase expanded its loans $373,000,000. It was National City Bank's Charles Edwin Mitchell, a rampant bull, who became the popular scapegoat of the Crash with his insistence that conditions were fundamentally sound." - Wigging Out, TIME Magazine, Jan 2, 1933

Ultimately, politics decides the outcome.

Tireman Harvey Firestone: "Business is good all over the country. But is it going to keep on? Are we fundamentally sound? I don't know. I can't subscribe to some of the principles being put into effect."

Banker Claude Ashbrook of Miami declared that President Roosevelt's promise to keep the U. S. out of the war was worthless, "like all his other promises."

Frank Bornn, Brooklyn distiller, predicted that "unless the Government does something drastic about it," bootleggers would force legitimate liquor concerns to the wall. "Just another example of how the Roosevelt Administration has fallen down on the job," said Mr. Bornn.

President George A. Hughes of Chicago's Edison General Electric Appliance Co., which just electrified the White House kitchen, reported business 100% better, denied that the New Deal was in any way responsible, predicted a Roosevelt defeat in the 1936 campaign.

Republican George H. Moses, onetime New Hampshire Senator, tartly remarked that the country was "going to hell in a hack," that the "sons of the wild jackass are multiplying like jack-rabbits," that "this country cannot continue to exist half Roosevelt, half Frankfurter." - Millionaires' Talk, TIME Magazine, Oct. 14, 1935

Of our more modern banks we are not assured that they are any better than previous over-leveraged and poorly structured systems.

...ex-Fed Chairman Paul Volcker had this to say: "Simply stated, the bright new financial system, for all its talented participants, for all its rich rewards, has failed the test of the marketplace," Volcker said during a speech Tuesday to the Economic Club of New York. "What has plainly been at risk is a disorderly unraveling of the mutual trust among respected market participants upon which any strong and efficient financial system must rest." San Francisco Chronicle, April 13, 2008

The system is fundamentally unsound. Today, as ever before, sons of wild jackasses are coming out to offer scripted reassurances. They are multiplying like jack-rabbits. If you are counting on them to save the day and prevent both the loss of your money, and of its purchasing power, I recommend you put aside at least a few month's cash just in case they prove to be as incompetent and full of shit as in previous instances.

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[GRG55]

That dreaded phrase: ''The system is fundamentally sound''

Well at least they've stopped blathering on about how everything is "contained" and "well anchored". Gentle Ben actually used the word "crisis" this week. That's progress...:rolleyes:

[Chief Tomahawk]

I just covered my shorts last week. Oil was finally coming down & letting go of it's stranglehold of the stock market/U.S. economy.

Now Hank, our 3rd Treasury Secteray in fours years or so, says "all is well." Uh huh. Why were the two previous Treasury secretaries let go? They ran around for the longest time saying "we believe in a strong dollar." Wait, Hank's been reading from the script too. Oh sh*t!

I sense a day coming up where Jim Cramer goes through every emotion in one appearance, and the clip of it gets 1,000,000 views on You Tube within one day. Then we'll know that all is indeed NOT well....

Do those circa 1950 backyard bombshelters protect from financial crises?

Oh what the hell: bring back Disco!

[krakknisse]

If you are counting on them to save the day and prevent both the loss of your money, and of its purchasing power, I recommend you put aside at least a few month's cash just in case they prove to be as incompetent and full of shit as in previous instances.

Over in this thread on "RBS issues global stock and credit crash alert" a month ago on I wrote:

When is the time to withdraw actual paper cash from your friendly neighbourhood bank? I'm sort of waiting for EJ to put "CRASH - GO GET YOUR CASH" in 72-point letters on the ITulip front page.

Thanks, EJ! When a level headed guy such as you speaks, it is time to listen. "ITulip: The Fear & Greed Anti-serum (TM)". May I invite you to speculate, pontificate, predict or otherwise enlighten your trans-Atlantic friends as to when the proverbial financial fecal matter will hit the impeller over here? Does your call only hold for US banks?

[MLM]

Thanks for helping connect the dots a little Eric. My first take on Paulson's TV appearances this weekend was that they were simply to help sell the Fanny/Freddy bailout that's apparently starting to take shape in Congress.

But if I add the "no short" list to this latest data point, and ponder a bit, I come to a different conclusion.

They are busy circling the wagons because the major shitstorm is about to make landfall.

[Chris Coles]

The video on your front page shows a man unable to clearly enunciate and with his voice stuttering. I find that VERY scary. But turn to your video above and notice that they have gone back and, presumably at his request, faded his voice when he tells us how many banks were going bust during the savings and loan crisis.

He does make one admission that at least gives us an idea that he has at last the courage to admit to what is wrong. No, not about housing, but about leverage, he admits leverage is an issue.

About 20 times too late and at least 10 years too late, but at least someone has brought that issue to the front of his mind.

Perhaps at last he is reading iTulip?

[Chris Coles]

This turned up today in The Times London and, if you go look you will see that it seems I got the chance to make a comment too. But most noteworthy is this from the text:

Despite spending months consulting with mortgage industry experts, including banks, building societies and other specialist lenders, Sir James is expected to tell the Chancellor that “no clear consensus” has emerged on how best to tackle the problems in the wholesale funding markets.

http://www.timesonline.co.uk/tol/mon...MC-Bltn=PLZCA9

July 21, 2008

'Gold standard' plan for mortgage securities

Siobhan Kennedy

Plans to introduce a “gold standard” for mortgage securities are to be considered this week. The Treasury will look at the proposals as part of an interim report to be submitted to Alistair Darling tomorrow.

[krakknisse]

Am I the only one finding it very ironic that they use the phrase "gold standard" metaphorically in these times?

[nathanhulick]

Am I the only one finding it very ironic that they use the phrase "gold standard" metaphorically in these times?

I thought that was pretty funny as well. Of course, without having even read how it works, I can surmise that their "gold standard" involves absolutely no gold whatsoever.

[oddlots]

If you think the "gold standard" line was ironic what about this blindingly obvious irony:

"... the Federal Reserve said Fannie and Freddie could get financing at its discount window, a privilege previously available only to banks. The absurdity of this situation was highlighted by the way the discount window works. The Fed does not just accept any old assets as collateral; it wants assets that are “safe”. As well as Treasury bonds, it is willing to accept paper issued by “government-sponsored enterprises” (GSEs). But the two most prominent GSEs are Fannie Mae and Freddie Mac. In theory, therefore, the two companies could issue their own debt and exchange it for loans from the government—the equivalent of having access to the printing press..."


From the Economist via Ritholtz...


http://www.economist.com/finance/dis...ry_id=11751139

[Mega]

"I recommend you put aside at least a few month's cash just in case they prove to be as incompetent and full of shit as in previous instances."


Rather Strong stuff Eric....."Full of Shit" !

Are you saying:-

"Mega, go to bank & get out a months worth of cash & stash"?

Mike

[jtabeb]

"I recommend you put aside at least a few month's cash just in case they prove to be as incompetent and full of shit as in previous instances."


Rather Strong stuff Eric....."Full of Shit" !

Are you saying:-

"Mega, go to bank & get out a months worth of cash & stash"?

Mike

Mike, speak english dude.

[sn1p3r]

I did just that when IndyMac failed...no use in having an emergency fund that you can't get to....

BTW they had a slight moment of panic and I only took out 7k...my teller had to vouch for me being a "regular" otherwise I think I probably would have had to fill out paperwork :mad:

Crazy Times!

[*T*]

Mike, speak english dude.

I have exactly the same question as Mega, not sure what wasn't clear about his question but here it is again:

When you say have a few months of cash on hand, do you mean literally wads of notes under the mattress or do you mean cash deposit in a bank...

That much cash is a lot to have lying around.

[Mega]

You know, am a fool..........a nobhead...left school with very little.....but as far back as 2003 i smelt trouble, by 2005 i was banging my head on the wall............"Why don't they see it!?"

I am NOT willing to believe that the Brightest & best of American goverment/Fed/Banking DID NOT SEE THIS COMING!

The Dogs in the streets KNEW !

The phase "Looting" keeps coming into my head!
Mike

[LargoWinch]

Or maybe they planned this all along to obtain more power? More of the world's assets?

Maybe "your best friend" will save us?

http://static.technorati.com/asset/i...afa64ef2e6.jpg
ahhh that sweet, comforting smile...

[ASH]

If you are counting on them to save the day and prevent both the loss of your money, and of its purchasing power, I recommend you put aside at least a few month's cash just in case they prove to be as incompetent and full of shit as in previous instances.

I apologize for a "me too" post...

When a level headed guy such as you speaks, it is time to listen.

... but, seriously?

I mean, this is pretty close to an Alas, Babylon message for banking. Given EJ's credibility, I cannot but take this seriously.

Ironically, this is also exactly what Bank runs, inflation, and other desperate memes in the Internet age is about. By following EJ's advice, does that mean I am part of the leading edge of a run on the banks? (Better by far than being on the trailing edge, I guess.)

[EJ]

I apologize for a "me too" post...



... but, seriously?

I mean, this is pretty close to an Alas, Babylon message for banking. Given EJ's credibility, I cannot but take this seriously.

Ironically, this is also exactly what Bank runs, inflation, and other desperate memes in the Internet age is about. By following EJ's advice, does that mean I am part of the leading edge of a run on the banks? (Better by far than being on the trailing edge, I guess.)

I am not suggesting that anyone here run to the bank, withdraw all of their money and bury it in the back yard. I am asking readers to consider the pattern of behavior of the leadership and institutions of our financial system and ask, "Do I trust them?" And of not, "What shall I do?"

Anyone who has ever been in the position to hire and manage others knows that patterns of behavior are what matter in assessing the likely future behavior a person. The same holds true for institutions, especially those dominated by an individual as the Fed was under Alan Greenspan; even the Bernanke Fed with its group think is probably primarily directed by an individual, but not Bernanke.

Uneducated and ill informed men and women make bad decisions all the time. But brilliant, well educated, and well intentioned individuals can get together and, under circumstances of ideology born of political and economy convenience, make catastrophically bad decisions, too. Then, after the consequences of their catastrophic errors emerge, they come up with creative explanations for their group error and market the hell out of it.

I reach back a mere two years in this piece for the antecedent of this warning, but have been a student of these leaders and these institutions for a decade, and of scholars who have been students of theirs far longer than I. If you have been here for only two years, but especially if you have been here for the full ten – and bless you – I ask you to ask yourself, given the record, the pattern of behavior of understating risks – to the housing market, to the economy, to the dollar, to the financial system, to the banking system – only to be proven by the passage of time to consistently misunderstand or perhaps misrepresent the situation, why believe what they say? And if you do not believe them, then who and what should you believe, and what should you do?

Let me say this:

It is easy to give leaders too much credit.

It is easier to expect a benign outcome than a tragic one.

It is easier to hope that nothing unseemly will occur.

We are all quite busy, flat out paying the economic rent as it turns out, with no time to worry about whether the mechanics of the economy and financial system are doing their jobs.

I am telling you that there is precious little evidence that they have, and for the most mundane of reasons: they are paid not to. Not in the sense of a bribe but in the fact of executing on a set of collective false beliefs that fed on itself.

Things may in the end work out, but not due to the intelligence of leaders or the power of great institutions. The institutions are dysfunctional, the leaders confused but paddling very hard – the phrase Paulson used is "we're being very vigilant." But make no mistake, if things work out it will be due primarily to luck.

All I am asking you to do is not count on their luck.

What you do is a judgment call that depends on your circumstances. Most of you are already sufficiently skeptical of authorities that you are not still waiting around for someone to tell you, as we did in 2001, that the dollar is going to fall and the purchasing power of your hard earned income is going to be cut in half.

What is new here is that I am starting to suspect that with this pronouncement by Paulson that the crisis is about to enter a new phase, and that a prudent person acts on the facts before them, established by an enduring pattern of behavior, reinforced by historical precedent, and to me that means taking measures to ensure that those we love are not endangered by the mistakes of anyone betraying the public trust.

[sn1p3r]

I have exactly the same question as Mega, not sure what wasn't clear about his question but here it is again:

When you say have a few months of cash on hand, do you mean literally wads of notes under the mattress or do you mean cash deposit in a bank...

That much cash is a lot to have lying around.

...put it in the safe next to your physical gold

[ASH]

I am not suggesting that anyone here run to the bank, withdraw all of their money and bury it in the back yard. I am asking readers to consider the pattern of behavior of the leadership and institutions of our financial system and ask, "Do I trust them?" And if not, "What shall I do?"

Thank you, EJ, for the calibration. It turns out that you meant exactly what I took you to mean. However, I felt the subjective impact of what you said on this topic more strongly than other of your risk management warnings, because it concerns risk in an area I haven't previously encountered. I just barely remember the S&L failures of the late 80's (I was 12 in 1987), and for some reason risk in this area is harder to get my mind around than risk associated with mispriced assets -- even when the two are linked! In that sense, my post "Seriously?" amounts to a written word doubletake.

Withdrawing a few months' worth of cash is indeed different than closing out one's account (for some people, at least). Other than the threat of theft, there's no particular downside to taking such a limited precaution, and it's less likely to cause the banking institution a problem than if one closed their account. Nevertheless, it does occur to me that if enough people take even this limited step, others will observe, and there is the potential for a panic to develop. This is not a criticism of your advice, but rather a regurgitation of iTulip's recent observations. And that said, as with any other panic, it's better to be early than late.