July | 2012 | JMGshortcuts

One, two, three strikes you’re out. The chairman, CEO and COO of Barclay’s all resigned in the wake of the bank’s manipulation of the London inter bank offered rate, or Libor. The bank agreed to pay a penalty of about $450 million.

The Libor rate is essentially how much interest banks pay to borrow money on a short-term basis from other financial firms, a process overseen by the British Bankers’ Association, an industry trade group.

Libor, a global benchmark based on a gentlemen’s agreement among major financial institutions, is a reference point for a whole range of securities, loans, mortgages and derivatives sold around the world. According to The Wall Street Journal, the total value of these financial products is as much as $800 trillion, which dwarfs the global gross domestic product of nearly $70 trillion. Libor’ s corruption means consumers, corporations and governments have been paying the wrong interest rate.

Government officials on both sides of the Atlantic are now investigating how many other big banks joined in attempts to manipulate this important interest rate for their own gain. The alleged behavior is similar to falsifying your net worth and salary on a loan application to secure a lower interest rate.

The number of banks participating in rigging the Libor ranges from 16 to 20. Their alleged behavior is reminiscent of the organized crime cartel put in place during the 1930s by managerial genius Charles “Lucky” Luciano (no one called him “Lucky” to his face) and his partners.

This cartel was based on ideas originally developed by advanced management thinkers like New York gambling impresario Arnold Rothstein and Chicago gang leader Johnny Terrio.

They believed the market for traditional criminal gang activities was so large and profitable that there was “room for everybody.” Wasteful competition between rival gangs was unnecessary, foolish and got in the way of maximizing profits.

The cartel was popularly known as the Mafia (which incorrectly implies that it was exclusively Italian). Its activities were based on the “Lansky Principle.”

Meyer Lansky grew up with Luciano on Manhattan’s Lower East Side and helped create the organized crime syndicate. His simple principle, which came from observing gambling rackets as a kid, was that the best way to make money gambling is to run the game yourself.

Isn’t that what the big banks allegedly did in conspiring to fix the Libor rate? We have a large number of firms (families) that roughly coexist within an environment of”mutual cooperation” and share broad common goals. Just like members of an organized crime cartel, these financial institutions understood how to manage a portfolio of various businesses to maximize their overall value.

Regulators are now dealing with the fallout from the alleged conspiracy. It turns out that the Federal Reserve Bank of New York learned about the rate rigging in the summer of 2007. The regulatory pursuit of this conspiracy was, to say the least, not put on the fast track.

This rate manipulation follows multibillion-dollar trading losses at JP Morgan Chase, the Facebook initial public offering debacle and the collapse of the Peregrine Financial Group just months after the failure of MF Global.

Now politicians and the Justice Department are tripping over themselves in hot pursuit of criminal wrongdoing in manipulating Libor. When it comes to pursuing the financial mafia, let’s hope they have more success this time.

Anyone with a library card knows that there have been very few recent prosecutions oflarge U.S. financial institutions and their senior executives. These days, this crowd is the untouchables.

Assuming they are successful, we should forget the tobacco settlement-sized fines, the handcuffs and multimillion-dollar settlements that represent a minuscule percentage of firm profits. The worst punishment you can inflict on these white-collar criminals is not a long prison term.

No, force them instead to spend the rest of their lives living on not more than say $75,000 a year. Too bad we don’t punish school teachers that way. But to crooked CEOs, that’s poverty. And with the multimillion-dollar lifestyles they’ve become accustomed to, it would be the worst punishment of all.

originally published: July 28, 2012

As the prolific and insightful author anonymous once said: “The two things you don’t want to see being made are legislation and sausage.” The latest evidence for this same observation is how the federal government manages and calculates the Consumer Price Index.

Looking at how the CPI is calculated shows how inflation is underestimated and denies Social Security recipients full cost of living adjustments, eroding the real value of their Social Security income.

For the uninitiated, the standard CPI is the benchmark measure of inflation calculated monthly by the U.S. Department of Labor’s Bureau of Labor Statistics. Widely used and closely watched, the federal government uses it for multiple purposes. For example, the CPI is the standard means for adjusting Social Security benefits paid monthly to about 56 million Americans. The goal of this cost-of-living adjustment, first paid in 1975, is to prevent a decline in the purchasing power of retirees’ benefits.

However, 35-plus years later, elders and Social Security recipients are being hammered by how government measures inflation. Here’s how.

Let’s consider the inflation rate, a key driver of the CPl. If the federal government mistakenly underestimates the rate of inflation as part of the standard CPI, Social Security recipients receive a smaller earned benefit check than they need to stay even. From Quincy to Carlsbad, Calif., understating inflation means a substantial reduction in retiree’s standard of living. For the feds, understating inflation makes real GDP growth appear higher and makes budget deficits seem smaller.

For starters, in the turbulent decade ofthe 1970s the concept of”core inflation” was invented by the feds by subtracting food and energy in calculating CPl.

The feds argued for this changed definition of inflation because oil and food prices -two large components of the average family’s budget- were rising too rapidly, outpacing the rest of the economy.

Does it still make sense to exclude these two categories? Certainly, food and energy have been going up for quite some time. And fundamental global demand for food and fuel, in particular, have changed dramatically: surely these impact inflation on a consistent basis? Fortunately for our seniors, the core CPI is not used to set Social Security payments.

Then a few vintages ago in the mid-1990s, more changes were made in the standard CPI methodology that understates inflation. Experts argued that when consumers could no longer afford the rising price of a specific product, they would purchase a cheaper substitute. If steak, for example becomes too expensive, the consumer would switch to hamburger. Brand names give way to generics. And so on. So the CPI would reflect hamburger price for consumer meat purchases, not steak. Does this change in methodology reflect price changes? But wait- as with the Ginsu knife- there’s more! The CPI was also adjusted for “quality effects”. So if a car costs 10 percent more, but it is 10 percent higher in quality, then presto there is no inflation to report. Same if a basic computer is 10 percent faster: a 10 percent increase in the price is not really inflation. Higher prices for gasoline subject to the government mandated use of ethanol are also left out because we get a “quality” improvement from breathing cleaner air.

We could go on but you all catch what the joke is now. When you consider how the CPI is managed and calculated, it raises the basic question never to be mentioned in mixed company: Is it a measure of inflation or is it pure propaganda? To be totally kosher, a combination of Fed policy of keeping interest rates low through the end of 2014 and the likelihood that the CPI understates inflation punishes our seniors. Many of whom are already living close to the ground; chasing certificates of deposit and other safe investment yielding less than 1 percent while their standard of living declines. Indeed, these interest rates are below the rates of inflation. Not only is their income lower but the effects of inflation have eroded their buying power.

Our economy is not just moving slowly, it seems as if it’s trying to grow with the emergency brake on. Perhaps it is time to correct the CPI calculation to give our Social Security recipients what they need for essential items such as food, shelter, clothing, transportation, and medical care. Of course, trying to explain this to our political class in Washington is like trying to explain psychology to someone who has never met a human being.

originally published: July 7, 2012