Published by WallStreetWeather.net
“We nonetheless think someone should say that, as a matter of accountability for the financial crisis and looking at the hard monetary choices to come, the country needs a new Fed chief.” – “The Bernanke Record,” Wall Street Journal lead editorial December 3, 2009
On the day of the Senate Banking Committee hearing to confirm Ben Bernanke to a second term, The Wall Street Journal has reached the same conclusion that I’ve been blogging about for over two years: Ben Bernanke is not fit to be Fed Chairman. But I’ll go one step beyond the Journal and say that the entire Board of Governors and the regional bank presidents should be removed for enabling Bernanke to continue to carry out Greenspan’s bubbles.
WSJ: “The real problem is Mr. Bernanke’s record before the panic, with its troubling implications for a second four years. Mr. Bernanke was the intellectual architect of the decision to keep monetary policy exceptionally easy for far too long as the economy grew rapidly from 2003-2005.”
Bernanke joined the Board of Governors in 2002, encouraging Greenspan to keep interest rates low even as the housing and credit bubbles were spinning out of control. As the Journal points out in yesterday’s front page story (“Fed Debates New Role: Bubble Fighter”), the Princeton professor first attracted the central bank’s attention when he delivered a presentation at the Fed’s 1999 Jackson Hole gathering where he warned the Fed against trying to prick asset price bubbles.
WSJ: “This, too, might be forgivable if Mr. Bernanke had made any attempt in recent months to acknowledge the Fed’s role in the mania. Mr. Bernanke and Vice Chairman Don Kohn have formed an intellectual moat around the Fed, blaming the credit bubble on the ‘global savings glut’ that they themselves helped to create.”
From Bernanke to the regional bank presidents, no member of the Federal Reserve has admitted that mistakes were made. Instead Bernanke and the Fed have defended their actions by trying to trigger people’s fear-based emotions into believing that the Fed’s actions saved the financial system from a catastrophe greater than the Great Depression, refusing to admit that their policies enabled the crisis in the first place!
Bernanke strongly disagrees with legislation that would remove the Fed’s power to supervise banks and regulate consumer finance, yet refuses to admit that the combination of overly accommodative monetary policy and lax supervision created a super spiked punchbowl that has left the nation with a huge hangover that will take several years to wear off.
The Fed claims its ability to effectively carry out monetary policy will be affected if Congress removes its authority to supervise banks, claiming it will no longer have access to the “economic color” provided by the banks. But there is nothing in the financial legislation that would hinder the Fed’s ability to communicate with banks or anyone else it chooses to receive “color” about market conditions.
In “Asset Inflation: The Missing Indicator In Economic And Monetary Policy,” I described how easy it is to determine when rising asset prices are driven by inflation rather than real increased net worth. Asset price bubbles require collateral to grow. The reason why the housing bubble became the biggest bubble that caused the greatest financial crisis since the Great Depression is that real estate can be purchased with 95% leverage vs. 50% for stocks. And once one lender was willing to stretch the rules regarding who would qualify for a mortgage, who do you think realtors would steer buyers too? As more lenders stretched the rules, all had to follow or be exluded by the markets for being too cautious.
No matter what the asset class, leverage creates what the above cited WSJ “Bubbles” article calls “a self-feeding loop” where increased leverage creates increased collateral values which in turn again increases the ability to leverage more.
Real estate became the most dangerous bubble of all because no one believed that real estate prices could ever decrease in value on a nationwide basis. The Fed was dead against increasing margin requirements on securities. Beyond the Fed, no one in government wanted any kind of restrictions placed on real estate purchases.
WSJ: “The hard part, the time when central bankers earn their fame, is when they have to take the money away. We see little in the chairman’s policy history or guideposts to suggest he will be willing to endure the criticism that will come with tightening money amid a lackluster recovery.”
It has been 30 years since a Fed Chairman had the guts to go against the grain and raise interest rates in spite of the highest rate of unemployment since the Great Depression. Paul Volcker chose to ignore the Fed’s dual mandate to do what was politically unpopular and painful in the short term in order to create long term economic growth.
In an interview with CNBC’s Maria Bartiromo (Part I and Part II) yesterday, St. Louis Fed president James Bullard* said that the Fed has debated about how to react to asset price bubbles for the last 15 years. “The question is what to do? Quashing a bubble in the middle of good times is not a very popular thing to do.”
The Fed resists any attempt by Congress to alter its purpose and scope, claiming it would be a threat to a “strong and independent Federal Reserve,” yet here we have an entire Federal Reserve System that enables an environment to allow bubbles to form in the first place, but lacks the courage to carry out its duties because its members put their own personal interests first! Then when the economy suffers a train wreck, the Fed rescues Wall St. at Main St.’s expense because as the banks’ chief regulator, their loyalty is to stabilize the banking system.
The Fed is not really independent since the President nominates and the Senate approves the Chairman and the Board of Governors while private bankers choose the six of the nine directors that comprise each of the 12 regional Fed banks. The Fed’s independence is entirely up to the Chairman and its members desire to do what it best for the health of the entire economy. From a monetary policy perspective this would mean keeping interest rates on a steady course, balancing the interests of borrowers and savers. Asset price bubbles are born when investors become frustrated by the abysmally low rate of return received on safe instruments such as FDIC-insured bank certificates of deposits.
WSJ: “Mr. Bernanke is assuring the world that, this time, he knows how and when to start removing this stimulus.”
The Fed knows zero rates and excess liquidity has spawned another asset price bubble in equities, commodities (especially gold), Treasuries, and has caused the desecration of the dollar. Yet the Fed continues to fuel the hot air balloon by telegraphing that “interest rates will remain low for a considerable period of time.”
Never has the Fed injected so much liquidity into an economy running record debt levels. Bernanke believes he knows when to begin the Fed’s exit strategies, but Bernanke’s well known obsession with the Great Depression will make him reluctant to tighten until every economic indicator is solidly green.
The unfortunate irony here is that the Fed’s actions will delay the green light from being steadily solid anytime soon because the economy will take a few steps backward first when Bernanke’s bubble bursts.
*Bullard be a voting member of the FOMC in 2010.