Dodgy Market and Dodgy Federal Reserve Chairman Candidate!


Is that sound we hear the sabres of war rattling, or the knocking together of wood as a bunch of Pinocchios gather in front of the media to justify their coming attack on Syria?

Both! Truth, as the saying goes, is the first casualty of war. These days, it’s the first casualty of a politician opening his or her mouth in the morning. Here’s the latest nose grower from UK Prime Minister David Cameron, courtesy of Bloomberg:

"This is not about wars in the Middle East; this is not even about the Syrian conflict,” Cameron said in televised remarks. “It’s about the use of chemical weapons and making sure as a world we deter their use"‘.

The three old imperialist cronies, the US, UK and France, are apparently getting together to organise a military strike. But don’t worry, it has nothing to do with Syria or the Middle East.

France has had a special interest in the region ever since Godfrey de Boullion led the first crusade to the ‘promised land’ around 1096. When the Ottoman Empire crumbled after the First World War Britain started carving the place up, and then the US got involved when the oil began to flow.

Ever since, these three Western powers have been moving pieces around the Middle Eastern chessboard. We’re not sure how good the moves have been though. And it’s hard to win a long strategic game when you’re running out of money.

Reuters reported recently that:

‘Treasury Secretary Jack Lew pressed Congress on Monday to allow the government to borrow more money, saying that it could default on its obligations if lawmakers do not act by mid-October.

"Congress should act as soon as possible to protect America’s good credit by extending normal borrowing authority well before any risk of default becomes imminent," Lew said in a letter to congressional leaders’.

What better way to get Congress to open the purse strings once again than by starting a war! Or is that too cynical?

It pays to be cynical these days. To be a cynic is to be a realist. And the reality is that governments will do anything to get their hands on more cash if they need to.

Whatever the reality, markets don’t like it. The Dow Jones was down 170 points overnight. Gold rallied strongly into resistance around the US$1,420 area, before pulling back a bit.

But has the weakness really got anything to do with the looming war that is not about Syria or the Middle East? Or is it just an excuse to sell overvalued stocks that may not have the benefit of a Federal Reserve tailwind anymore?

We’ve been telling our subscribers for months that a major correction is coming. Gowdie Family Wealth editor Vern Gowdie has been telling anyone who’ll listen to get into cash and ride out the storm.

War isn’t a reason why Vern is expecting trouble and nor is it a reason for our concerns.

We just know the market is overvalued, propped up by liquidity rather than fundamentals, and is, in general, a farce.

In these environments, all it needs is an excuse to hit the sell button and turn the mood from bullish to bearish. War is one excuse…a new Federal Reserve Chairman is another.

According to CNBC, we’ll soon hear who the new Federal Reserve boss is.

‘A source from Team Obama told CNBC that Larry Summers will likely be named chairman of the Federal Reserve in a few weeks though he is “still being vetted”; so it might take a little longer.’

If Summers does get the job, it will be a triumph of PR over substance. Over the last few months we have been told relentlessly how ‘brilliant’ Summers is.

He was one of Harvard University’s youngest tenured professors at the age of 28; he left to become Chief Economist of the World Bank in the early 1990s before joining the Clinton Administration and taking over from Robert Rubin as Secretary of the Treasury.

He returned to Harvard as President from 2001 to 2006, before resigning under ignominious circumstances. In 2009, President Obama appointed Summers as a Director of the National Economic Council, where he became a key advisor to the President. He left in December 2010, returning to Harvard and the pursuit of private business interests, which among other things included consulting to large US investment banks.

What is often left out or glossed over in the ‘Summers for the Federal Reserve chief’ PR drive is the major role he played in losing the Harvard Endowment fund huge amounts of money in the global financial crisis.

During his Harvard Presidency, Summers made two big calls that ultimately cost the prestigious university billions of dollars. He argued that Harvard should manage its cash account more aggressively, in line with its long term endowment fund strategy. (The cash fund was for everyday operational expenses).

The head of Harvard’s endowment, legendary fund manager Jack Meyer and his successor Mohamed El-Erian, warned against the move but Summers ignored them.

As a result, 80% of the operating cash fund (only slightly lower than Summers’ recommended 100%) turned into a relatively illiquid, long term investment fund. That is, the cash fund was no longer ‘cash’.

Then in 2004, he hedged US$2.4 billion in Harvard’s future borrowing costs by entering into interest rate swap agreements with some of America’s largest investment banks. The idea was to protect the university from rising interest rates. They didn’t plan to issue bonds until 2008 and beyond, but Summers wanted to lock in the low interest rates that prevailed in 2004.

The swaps weren’t a new innovation for Harvard. What was new, and practically unprecedented, was the long duration of the agreements.

Swaps provide protection against rising interest rates but they lose value if rates fall. As it turned out, the US housing market collapse and subsequent financial crisis saw interest rates in the US fall — a lot. This meant Harvard’s interest rates swaps were quickly losing value, and their investment banking counterparties demanded cash collateral to offset these losses.

But Harvard was short of ‘cash’. Thanks to Larry Summers, it was nearly all invested in the endowment fund, an illiquid, long term vehicle whose value was plummeting due to the escalating credit crisis.

The Harvard board panicked. Instead of riding the storm, they just wanted out of the swaps. They issued bonds (ironically at a relatively high rate of interest) to raise enough cash so they could terminate the swap agreement – at the worst possible time. That is, when the cost of doing so was greatest.

According to data available from Bloomberg, Harvard paid their investment bank counterparties around US$600 million to exit most of the swaps immediately, and agreed to pay another US$425 million over 30 to 40 years to exit the remainder.

On top of all this, Harvard’s general operating ‘cash’ account reported a US$1.8 billion loss in the 12 months to 30 June 2009.

Larry Summers may not have been around when the proverbial hit the fan, but his fateful decisions from years earlier cost the University plenty.

And this guy is set to get his hands on the world’s biggest monetary lever. No wonder the market is selling off.


Greg Canavan+
for The Daily Reckoning Australia

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From the Archives…

Richard Fisher’s ‘Super Easy’ Fed
23-08-2013 – Nick Hubble

US Stocks and the Timeless Wisdom of Izzy Stone
22-08-2013 – Chris Mayer

Bankers Profit at the Expense of the Broader Community
21-08-2013 – Vern Gowdie

A Bond Market Tantrum

20-08-2013 – Nick Hubble

Australia’s Economy: Complex, Fragile or Centralised?
19-08-2013 – Nick Hubble

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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5 Comments on "Dodgy Market and Dodgy Federal Reserve Chairman Candidate!"

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3 years 2 months ago

Two suppliers have recently informed me me their prices are going up. One by 15% and one by 20%.

Syrian girls viewpoint

Interesting how people are turning to Russia and China for salvation now. I will reserve judgement. The old world order is old.

slewie the pi-rat
slewie the pi-rat
3 years 1 month ago
Summers is still being vetted? [CNBC] i think this reflects the need to choreograph the dance/show through the “consent” process in the Congress. ~he may not have paid off DiFi’s hubby yet? ~he may want to taper MBS QE-buying before Treasuries? ~he is not a woman? ~the Harvard peeps on the CFR want to kill him? of course, the real questions and psycho-dynamic analyses may revolve around loyalty: will he be loyal to TPTB and the US chapter of the NWO control-cabal? or, could he be “turned” and become loyal to some other entity? the Constitution, perhaps? or Yale? beyond… Read more »
3 years 1 month ago
No, your not a cynic Greg, its how you see it, much like the rest I bet. We have our own ‘Bernanke’ here in the old country, one Mark Carnage former bankster out of golden sachs and Bank of Canada it seems we are now ‘going forward’ and everything is going to be sugar and spice, the only one ‘going forward’ is himself and his poor missus whom cannot find a decent shack in London under £75,000 per month, paid for by the ‘bleeding’ taxpayer. As you say, Cameron & co are banging the war drums, whilst people are being… Read more »
3 years 1 month ago
Firstly, Summers is a “Rubinite”. Summers was Rubin’s protege and the pair of them did the derivatives thing to conjure liquidity for Clinton. Rubin preceded Summers at Harvard. The “Rubinites” are a network. Mainly a boys network but Summers also pulled up “Presidential central power activist” Kagan for the Supreme Court. Who beat old money Ms Clinton and banksters Romney hands down for campaign contribution raisings? That would be Obumma. 2012 election campaign funds sailed past $2 billion in aggregate funding. Where did Harvard University come in at for Obumma funding? No. 5 Obumma’s biggest bundlers by profession? Lawyers. Ties?… Read more »
3 years 1 month ago

It’s scary when so-called progressives start to get it …

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