We need a Minsky at the Fed or Treasury

Great Depressions Are So Methodical

Address to the Spring Dinner Meeting of the Committee for Monetary Research and Education (CMRE) www.cmre.org

May 14, 2009
BOB HOYE
�

One of the features of a great boom is the excitement of shared convictions about eternal prosperity. One of the features of the consequent contraction is bewilderment about how suddenly the bust arrived. Beyond those directly hit, the establishment becomes perplexed by the loss of liquidity and wonders where the money went.

With the 1980s crash in oil and property deals, a hearing run by offended politicians asked a particularly aggressive Oklahoma banker about "just where did the money go?". And as the Wall Street Journal faithfully reported "We spent it on wine, women and song � the rest we just pissed away."

As flippant as this may be, it is accurate and could be suitable in any example in any century. Fortunately, for consistency in any century, there is the classic definition of inflation that it is an "inordinate expansion of credit". In the 1930s, Keynes in a number of letters to the Fed twisted this around to mean that inflation was simply rising prices that had very little to do with central bank manipulations.

Fortunately, Keynes is not around to provide official confusion to the description that deflation is an inordinate contraction in credit. Relentless credit deflation started in 2007, and this implacable force has been part of every long depression.

Clearly, the title of this address puts me firmly in the bear camp. Just as clearly, the possibility of another great depression is highly controversial, particularly when such magnificent efforts are being made to restore the prosperity of a financial mania, which have always been ephemeral.

Perhaps my credentials should be reviewed. Everything I needed to know about the markets I learned on the old and notorious Vancouver Stock Exchange. For example, in a world of extravagant claims from big government, big academe and big Wall Street the old definition of a promotion is useful: "In the beginning the promoter has the vision and the public has the money. At the end of the promotion the public has the vision and the promoter has the money."

In 2006 to 2007 the public had the vision that policymakers could depreciate the dollar forever and were positioned accordingly. And for a moment the promoters looked brilliant as everyone thought they were wealthy. Moreover, as with any promotion the bigger it is � the bigger the crash.

There are two failures going on. The most obvious is in the financial markets and the other is in interventionist economics. The latter failure is in theory as well as in practice, and can be described as the greatest intellectual failure since the Vatican insisted that the solar system revolved around the earth, more particularly, Rome. Too many still believe that the financial world revolves around the Federal Open Market Committee.

Last year's disaster fit the pattern of the 1929 fall crash with remarkable fidelity. Such a crash was obvious and as the train wreck in the credit markets continued through the summer of 2008 the Fed continued its recklessness. But with some marketing skills, the objective of "stimulus" changed from keeping the boom going to the absurd notion that bailing out one insolvency, Bear Stearns, would revive the boom. As usual with a bubble, it was not just one bank that had been imprudent � most had been.

The establishment missing this recurring event was bad enough but there is another clanger and that is the hopeless notion of a national economy. Even in ancient times, Cicero knew that the prosperity of Rome was vulnerable to the credit conditions in the Middle East. In this regard, Mother Nature has again been providing some harsh lessons, and history suggests she and Mister Margin will ultimately be successful in teaching markets 101 to many policymakers.

In the meantime, coming out of the classic fall crash orthodox investments such as commodities, stocks and bonds were expected to rebound out until April-May. Until this hooked up, the typical GDP forecast was tentative in looking for the recovery to begin "by mid-2010�, but our "model" needed forecasts of the recovery starting much sooner. Then, thanks to the "Green Shoots" that began to appear with the rebound in March, confidence was gradually restored in high places such that the miracle of recovery would happen sooner. The higher the stock market gets the more popular this idea becomes.

And this gets us to another lesson from the old Vancouver Stock Exchange. "So long as the price is going up � the public can believe the most absurd story." This has been the best explanation of why Wall Street, the supposed bastion of capitalism, focused on every utterance from central planners in a central bank. Then when the price breaks, the vision disappears along with liquidity.

The next phase of the contraction has been expected to start after mid-year.

For most participants, post-bubble bear markets have been sudden and severe. The 1929 example ran for three years and the post 1873 example lasted for five years. The latter has been the best guide for our recent mania and its bust, but this will be expanded in a few minutes as it is worth reviewing the excuses offered by many in not anticipating that short-dated interest rates as well as gold would plunge in a classic fall crash. This was the pattern with the 1929 and 1873 crashes and knowledge of such a plunge in short rates should have ended conventional wisdom that a Fed rate cut would have prevented crashes from 1929 to 2008.

The quickest sign of a gold bug forecast going wrong is "Conspiracy!". With their latest disappointment Wall Street strategists described it as a "Black Swan" event, and therefore unpredictable. That has been a cheap out as each transition from boom to bust has been methodical. Others called it a "Minsky Moment". Minsky accurately described the mechanism of a crash, but being a Keynesian he also wrote that "apt intervention" could keep the economy on a successful path.

Actually, financial conditions reached the perfect "Keynesian Moment". As we all know, Keynes said "If you save five shillings you put a man out of work for a day." As part of the greatest mania in history the savings rate plunged to zero � Keynesian perfection had finally been accomplished. Many in the street, but only a few economists, knew this was dangerous. Econometric modelers, who still believe in the powers of regression equations, have long had their out, which has been "Exogenous", and in one memorable paper of 1983 there was "Super-Exogenity". This arrived in May 2007 when the yield curve reversed from inverted to steepening. Our research expected it to occur around June. By July of that fateful year, there was enough deterioration to conclude that "This is the biggest train wreck in financial history". It is not over.

Although crashes are grisly events, they share a common response from the establishment. No matter how shocking, bloody, expensive, ruinous or just plain shattering a crash is � within a week, there is no one in the street who didn't see it coming. As ironical as this is, there is a critical link from the stock market to the economy.

On the usual business cycle, the peak in stock speculation typically leads the peak in the economy by about a year. On the previous example, stocks set their high in March 2000, and the NBER set the start of that recession in March 2001. Using their determination this has been the case for most cycles back to 1854. But, at the conclusion of each great bubble in financial and tangible assets things change from normal. The failure in the financial markets and the economy beginning in 2007 have been virtually simultaneous.

As we all know, in 1929 the Dow made its high in September and the recession started in August. In 1873 the bear started in September, and the recession in October. This time around, the stock market high was in October 2007 and this recession started in December of 2007. Close enough to fit the post-bubble model, with implications that financial history is now in the early stages of another Great Depression.

This melancholy event is being confirmed by the behaviour of politicians and policymakers. After swanning around claiming credit for the boom politicians panic and then find scapegoats. Remember the "Goldilocks" celebration of perfect management of interest rates, money supply and the economy. Well, all five great bubbles from the first in 1720 to the infamous 1929 have been accompanied by such boasting, followed by what can best be described as frenzies of recriminatory regulation. If the political path continues � protectionism � will follow.

One of the worst such examples was called, in real time, the Tariff of Abominations. But, this is enough of dismal events and it is time to turn to irony for amusement and enlightenment. The clash between the establishment and financial history is rich with irony. Beyond that, financial history, itself, should be considered as an impartial "due diligence" on every grand scheme promoted during a financial mania by the private sector as well as by policymakers. Let's use a good old fashioned term � policymakers have been financial adventurers.

One of the richest ironies occurred with the 1873 mania and its collapse. With typical strains developing in the credit markets during a speculative summer, the leading New York newspaper editorialized:

�but while the Secretary of the Treasury plays the role of banker for the entire United States it is difficult to conceive of any condition of circumstances which he cannot control. Power has been centralized in him to an extent not enjoyed by the Governor of the Bank of England. He can issue the paper representatives of gold, and count it as much as the yellow metal itself. [He has] a greater influence than is possessed by all the banking institutions of New York.�

In so many words, because the treasury secretary was outstanding and had the benefit of unlimited issue of a fiat currency � nothing could go wrong. But it did; the initial bear market lasted for five years and the initial recession ran a year longer. The pattern of severe recessions and poor recoveries continued such that in 1884 leading economists began to call it "The Great Depression", that endured from the 1873 bubble until 1895.

An index of farm land value in England fell almost every year from 1873 to 1895. Of course, academic economists were fascinated and for a couple of decades wondered how such a dislocation could have happened, or even worse, discussed how it could have been prevented. Ironically, this debate continued until as late as 1939 when another Great Depression was belatedly discovered.

Naturally the long depression was blamed upon the old and unstable Treasury System, and at the height of the "Roaring Twenties" John Moody summed it up with:

"The Federal Reserve Law has demonstrated its thorough practicality, and thus secured the general confidence of the business interests. The breeder of financial panics, the National Banking Law, which had been a menace to American progress for two decades, has now been replaced by a modern scientific system which embodies an elastic currency and an orderly control of money markets."

The probability of a depression has been discussed in the media. It seems that both sides have yet to provide adequate research, with the establishment's response limited to a classic non sequitur. "This is nothing like the Great Depression, where we had 25% unemployment". That was just the most recent example and sound research would compare unemployment numbers from the first year after the crash. In 1930 the number was around 8%, and in noting that there could be some difference in methodology today's number is an 8 percenter.

Will it get to 25 percent? This remains to be seen, but unemployment in the private sector will be the worst since the last great depression.

By way of a wrap we will take it from the top. In late 2007, Gregory Mankiw, boasted that the US had a "dream team" of economists as advisors, and as with all claims at the top of six previous bubbles "Nothing could go wrong". And even if things went only a little wrong there were the "safety nets" that Krugman claimed would prevent serious deterioration. Our view on Keynesian safety nets has always been that in a bust they would be about as useless as a hardhat in a crowbar storm.

In the post-1929 bust policymakers were realistic enough to know that the boom caused the bust. The SEC was established to prevent another hazardous 1929 mania. Also, one of the promoters of the SEC boasted that the SEC would put a "Cop at the corner of Wall and Broad Streets". Without much doubt the SEC has failed to live up to its billing. The discovery of malfeasance always accompanies the discovery of malinvestment.

Of course, the other act passed to prevent another 1929 mania was Glass-Steagal, which separated commercial banking from the evils of Wall Street. This was taken off the books in 1999 as too many banks were participating in the high-tech frenzy.

Has this happened before? I'm glad I asked the question. With the financial violence of the South Sea Company in 1720, the House of Commons passed the "Anti-Bubble" Act, which was taken off the books in 1771 � just in time for the full expression of the 1772 bubble. As with the climax of the 1720 bubble the Great Depression ran for some twenty years. This was also the case for the bubbles that blew out in 1825, 1873, and 1929.

This ominous sequence of financial excess and consequent disaster brings us to 2007, which will soon have the connotation of "1929", as the world experiences the sixth Great Depression. Quite likely, the only offsetting event could be the collapse of interventionist policymaking, that would eventually be seen as a blessing.

The title of this address, "Great Depressions Are So Methodical" is intended to be ironical, but some may be startled by the audacity of the statement. Actually it is the conclusion that anyone would make after a thorough review of market history. The real audacity is in the claims of charismatic economists that their personal revelations can provide one continuous throb of happy motoring. As Hayek said � Keynes, as a young scholar, was absolutely ignorant of financial or economic history. Only someone who was ineffably ignorant of financial history would claim that it can arbitrarily be altered.

The next Oscar in audacity goes to Paul Samuelson, who, in the 1960s, boasted that the business recession had been eliminated. Right!

Another such example was recently provided by Gregory Mankiw when he condemned the �old� Fed with "When you look at the mistakes of the 1920s and 1930s, they were clearly amateurish." Any impartial review of market history would conclude that the "Roaring Twenties" and the contraction was the way financial history works, after all it was the fifth such example. It is worth recalling that at the height of the 1929 mania John Moody had condemned the old Treasury System while reciting that the new Fed was the perfect instrument of policy.

Mankiw then bragged "It is hard to imagine that happening again � we understand the business cycle better".

The Harvard professor topped this late in 2007 with: "The truth is that Fed governors, together with their crack staff of Ph.D economists, are as close to an economic dream team as we are ever likely to see."

Now it is time to get into the way Great Depressions have worked. All six have started with soaring prices for tangible and financial assets that, typically, run against an inverted yield curve for some 12 to 16 months.

Then when the curve reverses to steepening it is the most critical indicator that the credit contraction is starting. This time around, the sixteen-month count ran to June 2007 and the curve reversed by the end of May. Our presentations in that fateful month stated that the greatest train wreck in the history of credit had begun. Deterioration through July prompted the advice that most bank stocks were a nice "widows and orphans" short.

Beyond the raw power of speculation, one of the key features is each mania has been accompanied by a remarkable decline in real long interest rates, sometimes to zero, and sometimes to minus. In our case the decline was to around minus 1.5% in January and the increase so far has been 5 percentage points. In five previous examples, the typical increase has been twelve percentage points, which has been Mother Nature's way of correcting untempered expansion of credit. And - in our times, untempered policymaking.

Lower-grade corporate bonds, have already suffered an increase of some 25 percentage points, which suggests that the 12 point potential for treasuries is possible.

There is another important distinction. At the peak of a great bubble, the stock market peaks virtually with the business cycle. In 1873, the stock market blew out in September and the recession started in that October. As noted above, a fiat currency with the potential of unlimited issue was not proof against yet another Great Depression. In 1929 stocks peaked in September and the economy peaked in August. This time around stocks set their high in October, 2007 and according to the NBER, the recession started in that December.

Since 1937 the average length of recession has been ten months, with six in the order of 8 months. This one has run for 17 months, which breaks a long-standing pattern. Following 1873, the initial recession lasted 65 months, and following 1929, it ran for 43 months. NBER data starts in 1854 and these were the longest recessions, with no others in this league. This one has the potential of being a long one.

This is a lot of history, but what is happening in the markets right now? Well, then the Green Shoots have finally encompassed chairman Bernanke. On May 5, Bernanke observed that the "broad rally in equity prices" is indicating that "economic activity will pick up later in the year."

At the height of a similar rebound to April-May of 1930, Barron's wrote:

�It is thus apparent that the public preference for stock is not only as marked as ever, but also the will to speculate is still a speculative factor not to be overlooked. The prompt return of huge speculation and the liberal manner in which current earnings are again being discounted indicate that it will be difficult to quench the fires of stock-market enthusiasm for long.�

Prompted by an animated stock rally, the Harvard Economic Society, but with more gravitas, concluded that it "augured" a recovery by late in the year. As we all know this did not last and what we should understand is that it is the dynamics of a crash that sets up the exciting rebound. Not policymakers.

Let's look at a classic fall crash, which we expected. The pattern is interesting. The 1929 crash amounted to 48%. The decline to the low in November 2008 was 47%, and within this the hit to October 27 amounted to 42%. In 1929 the initial plunge amounted to 40% to October 29.

The rebound was to November 4, in both examples, with 2008 gaining 17% and 1929 gaining 12%. The final slump into each November was 22% and 23%. Is it important to identify it as 1929 or 2008?

Our "historical" model expected the crash and the rebound, as well as the nature of the establishment's utterances. Another usual event is a frenzy of recriminatory regulation � all supposedly new, but delivered without knowing that their counterparts over the centuries have made the same futile gestures.

Ironically, today's excitement in the markets and convictions in policymaking circles are important steps on the path to a great depression. As disconcerting as this may be, it is worth reviewing another clich� of policymaking, which is the notion that lowering administered rates will restore the momentum of a boom. Massive declines in short rates, such as Treasury Bills have only occurred in a post-bubble crash. In 1873 the senior bank rate plunged from 9% to 2.5%, as the stock market crashed. In the 1929 example the fed discount rate plunged from 6% to 1.5%, as the stock market crashed.

This is getting a little heavy. Not so long ago, but in another world, financially speaking, when an economist would change a forecast on GDP from 3 % to 3.25% it was only done to display a sense of humor. Now policy wonks seriously debate whether the Fed target rate should be zero or a quarter of one percent (that�s 0% to 0.25%). It is patently absurd to debate what the rate should be or whether it would have any effect on financial history.

It won't, because we are in a world of financial violence that is not random, and not due to the Fed not making the perfectly-timed rate cut. Instead it is due to a natural accumulation of private speculation, as well as a chronic experiment in policy by financial adventurers � to accurately use a Victorian term.

There are some early terms to describe the sudden loss of liquidity that marks the end of a bubble. In the 1561 crash Gresham wrote the �Credit cannot be obtained � even on double collateral.�.

Another term goes back to the 1600s when Amsterdam was the commercial and financial center of the world. The Dutch described the good times as associated with "easy" credit and the consequence as "diseased" credit. I'm sure that all in this room would agree with the accuracy of the latter description. Diseased credit.

What can be done about it? Nothing � since the 1500s the literature is complete with many comments that someone, or some agency can set interest rates � either high or low depending upon the personal concerns of the writer.

Misselden in the 1618 to 1622 crash earnestly believed that throwing credit at a credit contraction would make it go away. Despite all this history, Keynes and his disciples cannot be accused of plagiarism.

What's next?

Virtually, all of the "good stuff" likely to be revived into May is being accomplished. This includes investments such as commodities, junk-bonds and stocks, as well as positive statements from the establishment. Both technical and sentiment measures on the stock market are at "tilt" levels.

Because it is up at the right time, the conclusion is that the down will come in on time as well. This would be the next step on the path towards another Great Depression.

Of course, there is no guarantee that events will continue on the path. But, then there is no guarantee that it won't. Best to consider the odds.
oh look The OTS was involved...

no kidding. or somebody that actually read his books (same with keynes).

"we are in a world of financial violence that is not random."

I think Willliam Black & Hyman Minsky would've gotten along.

Riversider, check out the video I posted of the Fed's inspector general testifying. Scary, scary stuff.

abooutready nice post on the inspector general... she is a complete waste of my tax $

Riversider, check out the video I posted of the Fed's inspector general testifying. Scary, scary stuff.

A.R. I've seen the video. I have a different take. I think she was stalling. This guy is scary. Just a big bully. He demanded AIG publicly release on TV the names of every AIGFP employee on air.

1) Grayson proposes dumb legislation

http://www.youtube.com/watch?v=ITq19ezj_Xg&eurl=http%3A%2F%2Fbucknakedpolitics.typepad.com%2Fbuck_naked_politics%2F2009%2F04%2Falan-grayson-versus-foxs-neil-cavuto.html&feature=player_embedded

2)Contrast his style with Mary Schapiro who brings industry executives to a roundtable to gather information
http://www.youtube.com/watch?v=-CAKrhdz0nA

riversider, there are numerous possibilities for her performance. none of them reassure me. and i like someone to pound the pulpit. just another style of playing the game, and Grayson and Schapiro hold very different positions.

A.R. scares me when politicians play to the camera. Somehow I doubt he knows what a credit default swap is.

Jim Bunning did it better.
http://www.youtube.com/watch?v=faerjvrtFJI

& especially....( 9:30 second start point) and finsishes in the next one
http://www.youtube.com/watch?v=igjwVosdXb4&feature=related
http://www.youtube.com/watch?v=oq15p4mW7UA&feature=related

ttp://latimesblogs.latimes.com/laland/images/2008/04/08/iyhs97nc.jpg

i get your point, but courttv and all that. and sometimes i find it effective (particularly when it is consistent with my agenda, of course!!). that was a joke, btw.

Whose head hurts?
My head hurts.
Don't know how much more I can take.
If your a 'dark' person these are glorious times. (dark as in mood and attitude not as in skin color)
If your the eternal optomist but, realistic these are harsh brain times.
MY BRAIN HURTS!
My plan is simple, make lots of money, enjoy my family, live large but, within my means.
This is screwing with my plan.
Makes my head hurt.
Scoring an amazing property at tiny price would sure cheer me up!
Yeah tiny prices!!!

riversider, that Fox interview is absurd. Grayson is exactly correct. Almost every bill is vague, and goes to the relevant department for interpretation and codification. standards are always set by the relevant department.

and i happen to agree with him. that if they are eating at my table i get to decide what's being served for dinner.

"One of the problems with Guys like Geithner & Summers & Greenspan is they really don't address why we have repeated bubbles & manias..."

They want bubbles because they make people rich.

Alpine, i disagree. too sinister. People like Rubin, Greenspan , Summers, etc believe too much in free market and formulas. Rubin made his money at Goldman that way, and probably helped lose it at Citicorp that way. I think there is a sense that we've had way too many crises in the last 20 years, so maybe some minor things will change, but Geithner & Summers are too close to the banks to take decisive action and the banks spend too much money on Frank & Dodd. I couldn't help notice that they shot down a provision to have CFTC regulate swaps in favor of the banker's preferred regulator, the Fed. I think deep down Summers believes markets work. William Black argues that the science of criminology should be brought in. But I do think and maybe we agree here, that the Fed has done nothing to manage systemic over-leverage in our system(i.e. Margin requirements, lending standards,etc)

About read.. Disagree
I found the following here.
http://www.cga.ct.gov/lco/Docs/Drafting_Manual_Public.pdf

The Contents of a Bill, or, How To Draft
Every statute should state who has to do what, who may do what or who is prohibited
from doing what. It should state it clearly and in plain language.
There are three main errors that people frequently make in drafting legislation: 1) they
try to make it sound legal; 2) they know the subject matter so well that what’s clear to
them is not necessarily clear to the rest of the world; or 3) the bill is drafted by a group
that was more concerned about coming to a consensus and finding language everyone in
the group could agree on than they were with finding clear language and a well organized
structure.
The most important aspect of good drafting is thinking the bill through. Will it be clear
to a reader who isn’t an expert in the field? What are the ramifications? For example, if a
law says “All citizens shall have the right to free medical care in times of national or state
emergencies” does that mean the state is required to provide free medical service? that
private medical personnel are required to provide service but the state will reimburse
them? If the medical provider declines, is there a penalty?

Also found this
http://74.125.47.132/search?q=cache:twXqzuzqVjwJ:www.opc.gov.au/calc/docs/Article_QLDPC_draftinginstructions_2001.rtf+drafting+effective+legislation&cd=19&hl=en&ct=clnk&gl=us

Complete, accurate and comprehensive 36. Effective drafting instructions are complete, accurate and comprehensive. It is important they state—
• what has to be done
• why it has to be done
• by what time it has to be done.
Effective drafting instructions include proposals that have been worked out. In some cases, time constraints may mean drafting will have to start while some aspects are still being worked out. If this happens, effective instructions would clearly identify matters still undergoing consideration or subject to change.

Also found this on Wykpedia
Legal principle

In the common law system, vagueness is a possible legal defence against by-laws and other regulations. The legal principle is that delegated power cannot be used more broadly than the delegator intended. Therefore, a regulation may not be so vague as to regulate areas beyond what the law allows. Any such regulation would be "void for vagueness" and unenforceable. This principle is sometimes used to strike down municipal by-laws that forbid "explicit" or "objectionable" contents from being sold in a certain city; courts often find such expressions to be too vague, giving municipal inspectors discretion beyond what the law allows. See Vagueness doctrine.

and here
http://supreme.justia.com/constitution/amendment-14/54-void-for-vagueness-doctrine.html
Clarity in Criminal Statutes: The Void-for-Vagueness Doctrine

Clarity in Criminal Statutes: The Void-for-Vagueness Doctrine.—Criminal statutes which lack sufficient definiteness or specificity are commonly held "void for vagueness."983 Such legislation "may run afoul of the Due Process Clause because it fails to give adequate guidance to those who would be law-abiding, to advise defendants of the nature of the offense with which they are charged, or to guide courts in trying those who are accused."984 'Men of common intelligence cannot be required to guess at the meaning of [an] enactment.'985

While Neil Cavuto was clearly playing to the camera, like Alan Grayson does, I agree with the premise. Vague legislation is BAD legislation. Why not a law that says its illegal to drive too fast? Clearly a bad ideak, but a law against excessive pay? I don't agree with you.

Riversider, the reality is that much of what gets into the CFR hardly resembles the initial bill. In some cases it is good to spell out certain terms, in other cases it is not. In some instances vagueness is a political move, which is a good one if you concur with the intent of the legislation and realize it is the only way one can pass the bill, and bad otherwise. The regulation is formatted by the department, to say that a congressional bill's vagueness leads to vague regulation is disingenuous. A law that says it is illegal to drive to fast will then be sent to the DOT with a requirement for speed laws by a certain date. The DOT will study the issue and promulgate the new rules. Often those rules aren't satisfactory, and Congress will have to revisit it. But that's the system. If Congress had to sit down and decide what speeds were appropriate within 3 miles of cities of more than 20,000 people, what within 100 yards of schools, etc. and you get the picture, nothing would ever get fucking done. Not much gets done as is. It is far from a perfect system, and gives the departments way too much leeway, but it is the system.

Criminal statutes are an entirely different beast.

Thank God I have too much money to even notice the recession.

The current TARP legislation jumps out. Nobody knows what they agreed to nor can they say the law isn't being upheld. Recent example.. Banks want to repay TARP. Some believe the money goes back to tax payer, others say it can be recycled. I agree that vague laws might be easier to pass. Vague laws probably have one benefit, they keep the judiciary busy.

Haven't the Madison Avenue boutiques become a tad bit depressing, though? Where's the frivolity, the shared enjoyment of overconsumption? Seems kind of lonely, not having as many to gloat with.

riversider, you have no clue how hard it is to get standing to sue the government. vague laws do not necessarily become vague regulations. that's something different. i used to work for the Department of Justice. you'd be stunned at how often the departments effectively gut legislation, particularly when the party in power in congress is not the same as the one in the white house.

it's a sucky system. it is only as good as the employees of the department. geithner doesn't even have half of his employees, and Paulson was lying to Congress when he got the bill passed.

A.R.
Sounds like bureaucrats do the best they can. We should expect more from our legislatures.

i don't think so. i think we could use more from them all. although congress getting around to confirming the bureaucrats might be a start.

Agree with AR re: drafting, passing & interpreting legislation. Agree w/ Riverside re: ambiguities of repaying TARP.
Question, guys: I want to buy gold. How should I go about doing that? Thanks

Problem with gold is it's non interest bearing. Stocks in gold mining companies do not correlate perfectly but do offer a leveraged play. Coins have huge spreads. Personally I like the gold idea. I play it through conservative big cap gold stocks, but could see a good argument in favor of investing via certificates. Can't see putting more than 10% of one's assets into this, and you should keep your mind open to other metals and commodities.

"I play it through conservative big cap gold stocks, but could see a good argument in favor of investing via certificates. "

Riverside: Could you please elaborate? What are "big cap gold stocks" & what are "certificates"? I'm not a financially oriented person.

You're posting great videos, thanks. Geez, these fed guys, I could kill 'em!!

US: Vague Law and Hard Lobbying Add Up to Billions for Big Oil

by Edmund L. Andrews, The New York Times
March 27th, 2006

It was after midnight and every lawmaker in the committee room wanted to go home, but there was still time to sweeten a deal encouraging oil and gas companies to drill in the Gulf of Mexico.

"There is no cost," declared Representative Joe L. Barton, a Texas Republican who was presiding over Congressional negotiations on the sprawling energy bill last July. An obscure provision on new drilling incentives was "so noncontroversial," he added, that senior House and Senate negotiators had not even discussed it.

Mr. Barton's claim had a long history. For more than a decade, lawmakers and administration officials, both Republicans and Democrats, have promised there would be no cost to taxpayers for a program allowing companies to avoid paying the government royalties on oil and gas produced in publicly owned waters in the Gulf.

But last month, the Bush administration confirmed that it expected the government to waive about $7 billion in royalties over the next five years, even though the industry incentive was expressly conceived of for times when energy prices were low. And that number could quadruple to more than $28 billion if a lawsuit filed last week challenging one of the program's remaining restrictions proves successful.

"The big lie about this whole program is that it doesn't cost anything," said Representative Edward J. Markey, a Massachusetts Democrat who tried to block its expansion last July. "Taxpayers are being asked to provide huge subsidies to oil companies to produce oil — it's like subsidizing a fish to swim."

How did a supposedly cost-free incentive become a multibillion-dollar break to an industry making record profits?

The answer is a familiar Washington story of special-interest politics at work: the people who pay the closest attention and make the fewest mistakes are those with the most profit at stake.

It is an account of legislators who passed a law riddled with ambiguities; of crucial errors by midlevel bureaucrats under President Bill Clinton; of $2 billion in inducements from the Bush administration, which was intent on promoting energy production; and of Republican lawmakers who wanted to do even more. At each turn, through shrewd lobbying and litigation, oil and gas companies ended up with bigger incentives than before.

Until last month, hardy anyone noticed — or even knew — the real costs. They were obscured in part by the long gap between the time incentives are offered and when new offshore wells start producing. But lawmakers shrouded the costs with rosy projections. And administration officials consistently declined to tally up the money they were forfeiting.

Most industry executives say that the royalty relief spurred drilling and exploration when prices were relatively low. But the industry is divided about whether it is appropriate to continue the incentives with prices at current levels. Michael Coney, a lawyer for Shell Oil, said, "Under the current environment, we don't need royalty relief."

The program's original architect said he was surprised by what had happened. "The one thing I can tell you is that this is not what we intended," said J. Bennett Johnston, a former Democratic senator from Louisiana who had pushed for the original incentives that Congress passed in 1995.

Mr. Johnston conceded that he was confused by his own law. "I got out the language a few days ago," he said in a recent interview. "I had it out just long enough to know that it's got a lot of very obscure language."

A Subsidy of Disputed Need

Things looked bleak for oil and gas companies in 1995, especially for those along the Gulf Coast.

Energy prices had been so low for so long that investment had dried up. With crude oil selling for about $16 a barrel, scores of wildcatters and small exploration companies had gone out of business. Few companies had any stomach for drilling in water thousands of feet deep, and industry leaders like Exxon and Royal Dutch Shell were increasingly focused on opportunities abroad.

"At the time, the Gulf of Mexico was like the Dead Sea," recalled John Northington, then an Energy Department policy adviser and now an industry lobbyist.

Senator Johnston, convinced that the Gulf's vast reservoirs and Louisiana's oil-based economy were being neglected, had argued for years that Congress should offer incentives for deep-water drilling and exploration.

"Failure to invest in the Gulf of Mexico is a lost opportunity for the U.S.," Mr. Johnston pleaded in a letter to other lawmakers. "Those dollars will not move into other domestic development, they will move to Asia, South America, the Middle East or the former Soviet Union."

Working closely with industry executives, he wrote legislation that would allow a company drilling in deep water to escape the standard 12 percent royalty on up to 87.5 million barrels of oil or its equivalent in natural gas. The coastal waters are mostly owned by the federal government, which leases tens of millions of acres in exchange for upfront fees and a share of sales, or royalties.

Mr. Johnston and other supporters argued that the incentives would actually generate money for the government by increasing production and prompting companies to bid higher prices for new leases.

"The provision will result in a minimum net benefit to the Treasury of $200 million by the year 2000," Mr. Johnston declared in November 1995, denouncing what he called "outrageous allegations" that the plan was a giveaway.

He won support from oil-state Democrats, Republicans and the Clinton administration. Hazel O'Leary, the energy secretary at the time, said the assistance would reduce American dependence on foreign oil and "enhance national security."

Representative Robert Livingston of Louisiana, then a rising Republican leader, declared that the inducements would "create thousands of jobs" and "reduce the deficit."

Many budget experts agree that the rosy estimates were misleading. The reason, they say, is that it often takes seven years before a new offshore field begins producing. As a result, almost all the costs of royalty relief would occur outside of Congress's five-year budget timeframe.

Opponents protested that the cost estimates were wrong, that the incentives amounted to corporate welfare and that companies did not need government incentives to invest.

"They are going to the Gulf of Mexico because that's where the oil is," said Representative George Miller, Democrat of California, during a House debate. "What we do here is not going to change that. We are just going to decide whether or not we are going to give away the taxpayers' dollars to a lot of oil companies that do not need it."

Industry executives and lobbyists fanned out across Capitol Hill to shore up support for the program, visiting 150 lawmakers in October 1995. The effort succeeded. A month later, Congress passed Mr. Johnston's bill.

A Missing Escape Clause

To hear lawmakers today, they never intended to waive royalties when energy prices were high.

The 1995 law, according to Republicans and Democrats alike, was supposed to include an escape clause: in any year when average spot prices for oil or gas climbed above certain threshold levels, companies would pay full royalties instead.

"Royalty relief is an effective tool for two things: keeping investment in America during times of super-low prices, and spurring American energy production when massive capital and technological risks would otherwise preclude it," said Representative Richard W. Pombo, Republican of California and chairman of the House Resources Committee. "Absent those criteria, I do not believe any relief should be granted."

But in what administration officials said appeared to have been a mistake, Clinton administration managers omitted the crucial escape clause in all offshore leases signed in 1998 and 1999.

At the time, with oil prices still below $20 a barrel, the mistake seemed harmless. But energy prices have been above the cutoff points since 2002, and Interior Department officials estimate that about one-sixth of production in the Gulf of Mexico is still exempt from royalties.

Walter Cruickshank, a senior official in both the Clinton and Bush administrations, told lawmakers last month that officials writing the lease contracts thought the price thresholds were spelled out in the new regulations, which were completed in 1998. But officials writing the regulations left those details out, preferring to set the precise rules at each new lease sale.

"It seems to have been a massive screw-up," said Mr. Northington, who was then in the Energy Department. No one noticed the error for two years, and no one informed Congress about it until last month.

Five years later, the costs of that lapse were compounded. A group of oil companies, led by Shell, defeated the Bush administration in court. The decision more than doubled the amount of oil and gas that companies could produce without paying royalties.

The case began as a relatively obscure dispute. Shell paid $3.8 million in 1997 for a Gulf lease and soon drilled a successful well. But the Interior Department denied the company royalty relief, saying that Shell had drilled into an older field already producing oil and gas. The decision hinged on undersea geography and the court's interpretation of language in the 1995 law.

A typical field, or geological reservoir, often encompasses two or three separately leased tracts of ocean floor. Interior Department officials insisted that the maximum amount of royalty-free oil and gas was based on each field. Shell and its partners argued that limit applied only to each lease.

Perhaps shrewdly, the oil companies sued the Bush administration in Louisiana, where federal courts previously had sided with the industry in spats with the government.

The fight was not even close. In January 2003, a federal district judge declared that the Interior Department's rules violated the 1995 law. If the department "disagrees with Congress's policy choices," Judge James T. Trimble Jr. wrote, "then such arguments are best addressed to Congress."

What might have been a $2 billion mistake in the Clinton administration suddenly ballooned into a $5 billion headache under Mr. Bush.

But even as the Bush administration was losing in court, it was offering new incentives for the energy industry.

Mr. Bush placed a top priority on expanding oil and gas production as soon as he took office in 2001. Vice President Dick Cheney's task force on energy, warning of a deepening shortfall in domestic energy production, urged the government to "explore opportunities for royalty reduction" and to open areas like the Arctic National Wildlife Refuge to drilling.

Gale A. Norton, who stepped down this month as interior secretary, moved quickly to speed up approvals of new drilling permits. Starting in 2001, she offered royalty incentives to shallow-water producers who drilled more than 15,000 feet below the sea bottom.

In January 2004, Ms. Norton made the incentives far more generous by raising the threshold prices. Her decision meant that deep-gas drillers were able to escape royalties in 2005, when prices spiked to record levels, and would probably escape them this year as well.

She also offered to sweeten less-generous contracts the drillers had signed before the regulation was approved.

"These incentives will help ensure we have a reliable supply of natural gas in the future," Ms. Norton proclaimed, predicting that American consumers would save "an estimated $570 million a year" in lower fuel prices.

Ms. Norton's decision was influenced by the industry. The Interior Department had originally proposed a cut-off price for royalty exemptions of $5 per million British thermal units, or B.T.U.'s, of gas. But the Independent Petroleum Association of America, which represents smaller producers, argued that the new incentive would have little value because natural gas prices were already above $5. Ms. Norton set the threshold at $9.34.

Based on administration assumptions about future production and prices, that change could cost the government about $1.9 billion in lost royalties.

"There is no cost rationale," said Shirley J. Neff, an economist at Columbia University and Senator Johnston's top legislative aide in drafting the 1995 royalty law. "It is astounding to me that the administration would so blatantly cave in to the industry's demands."

Incentives Keep Growing

Last April, President Bush himself expressed skepticism about giving new incentives to oil and gas drillers. "With oil at $50 a barrel," Mr. Bush remarked, "I don't think energy companies need taxpayer-funded incentives to explore."

But on Aug. 8, Mr. Bush signed a sweeping energy bill that contained $2.6 billion in new tax breaks for oil and gas drillers and a modest expansion of the 10-year-old "royalty relief" program. For the most part, the law locked in incentives that the Interior Department was already offering for another five years. But it included some embellishments, like an extra break on royalties for companies drilling in the deepest waters.

Lee Fuller, vice president of the Independent Petroleum Association of America, said smaller companies wanted to prevent future administrations from cutting back on incentives. "Having a clear, stable royalty policy was of value to independent producers," he said.

And energy companies, whose executives had long contributed campaign funds to Republican candidates, pushed to block any amendments aimed at diluting the benefits.

The push to lock in the royalty inducements came primarily from House Republicans. The only real opposition came from a handful of House Democrats, in a showdown about 1 a.m. on July 25, according to a transcript of the session.

"It is indefensible to be keeping these companies on the government dole when oil and gas prices are so high," charged Representative Markey of Massachusetts, who proposed to strip the royalty provisions. "We might as well be giving tax breaks to Donald Trump and Warren Buffett."

Mr. Barton, the Texas Republican, brushed aside the objections. He reassured lawmakers that the new provisions would not cost taxpayers anything.

When Mr. Markey proposed a more modest change — having Congress prohibit incentives if crude oil prices rose above $40 a barrel — Republicans quickly voted him down again.

"The only reason they waited until after midnight to bring up these issues is that they couldn't stand up in the light of day," Mr. Markey said in a recent interview. "They all expected me to give up because it was so late and I didn't have the votes. But if nothing else, I wanted to get these things on the record."

A Royalty-Free Future?

It is still not clear how much impact the reduced royalties had in encouraging deep-water drilling. While activity in the Gulf has increased since 1995, prices for oil and gas have more than quadrupled over the same period, providing a powerful motivation, experts say.

"It's hard to make a case for royalty relief, especially at these high prices," said Jack Overstreet, owner of an independent oil exploration company in Texas. "But the oil industry is like the farm lobby and will have its hand out at every opportunity."

The size of the subsidies will soar far higher if oil companies win their newest court battle.

In a lawsuit filed March 17, Kerr-McGee Exploration and Production argued that Congress never authorized the government to set price cut-offs for incentives on leases awarded from 1996 through 2000. If the company wins, the Interior Department recently estimated, about three-quarters of oil and gas produced in the Gulf of Mexico will be royalty-free for the next five years.

Mr. Markey and other Democrats recently introduced legislation that would pressure companies to pay full royalties when energy prices are high, regardless of what their leases allow.

But Republican lawmakers and the Bush administration have signaled their opposition.

"These are binding contracts that the government signed with companies," Ms. Norton recently remarked. "I don't think we can change them just because we don't like them."

One more, if you please, Riverside:

If I put no more than 10% in gold, what happens when the $ is devaluated? I'm thinking I should take all my cash & convert it into something other than the USD, but what? Martian shekels? no place to run/hide?

Thank you for your help.

Newmont mining & Barrick Gold would be the obvious candidates for large cap. No idea if they will make you any money.

Most experts suggest no more than 10% in gold. Rather than take my word for it take a look at the historic vols. Gold can easily move a great deal up or down in a given year.

“"The one thing I can tell you is that this is not what we intended,"

“Mr. Johnston conceded that he was confused by his own law. "I got out the language a few days ago," he said in a recent interview. "I had it out just long enough to know that it's got a lot of very obscure language."

“But officials writing the regulations left those details out, preferring to set the precise rules at each new lease sale.
"It seems to have been a massive screw-up," said Mr. Northington, who was then in the Energy Department. No one noticed the error for two years, and no one informed Congress about it until last month.”

Riverside, I bet this type of sloppiness & manipulation occurs more than we realize. It's sickening.

Thanks, Riverside for the gold info.

Riverside, I bet this type of sloppiness & manipulation occurs more than we realize. It's sickening.

I agree about the sickening part. Our elected representatives should spend more time understanding the legislation they are sponsoring and voting on and less time posing for the camera.

Riversider, I agree. But once again it is simplistic to blame it on only the elected representatives. I can't tell you how many enacted laws morphed into something totally different in the regulatory process. The Clean Water Act come immediately to mind, but hundeds of others do as well. "But officials writing the regulations left those details out." The Bushies were particularly good at leaving those details out when it so suited them. Congressional intent is subverted regularly, which you may think is good if you don't agree with the particular congressional intent, or bad if you do or if you have any respect for the notion of separation of powers.