SHOULD BERNANKE BE REAPPOINTED?
There has been a lot of chatter lately about the impending reappointment of Ben Bernanke. There is little doubt in my mind that he will be reappointed (much to my dismay). I was a harsh critic of Bernanke when he was first appointed. Why would we select a man with no actual market experience, to run the most important arm of the U.S. economy? Would you select a General of the U.S. Army who has never fought in a battle or shot a weapon? Bernanke is a lifelong academic and theorist, but as a banker he has zero hours of experience. In my opinion, he was entirely unqualified for the position from the beginning. But I digress….
A number of pundits, politicians and economists have already come out supporting his reappointment. Even Nouriel Roubini, one of his harshest critics, is impressed with the job Bernanke has done. The message is fairly universal: he saved the U.S. from the next Great Depression. In my opinion, this is horribly flawed logic.
My primary problem with the Federal Reserve and Bernanke is the reactive approach to the economy. How can the most important facet of a proactive market be so reactive? The last 25 years of Fed policy and the endless boom/bust cycle is excellent evidence of this flawed philosophy in action. As regular readers know, I am no fan of electing academics into positions of such importance. Academics by nature, subscribe to the scientific method. You wait for the evidence to present itself before taking action. That’s all well and good if you’re running a science experiment, but unfortunately, the market isn’t an experiment. The market is a forward looking complex system. Like an investor, if you wait to act when the event actually occurs you’re likely too late. Fed policy is no different. If you wait for inflation to present itself the odds are that you’re already behind the curve. Bernanke is the most classic example of an academic who subscribes to this methodology. The last 25 years have been an endless cycle of scientific method at work. The Fed waits for the evidence to present itself, then after it presents itself the Fed is forced to overreact because they are behind the curve. It’s like a pendulum that gets pushed too far in one direction and comes slicing back at you with equal force. The results of this approach speak for themselves.
Not only was Bernanke an open advocate of all of Alan Greenspan’s policies (which arguably caused the crisis), but he predicted this impending crisis worse than just about any economist on the planet. Below are a few of Bernanke’s classic quotes regarding the state of the economy and the housing market in the years leading up to the crisis. Not only did he see no chance of a recession, but he also said there was no chance that housing prices would even decline:
“Well, unquestionably housing prices are up quite a bit; I think it’s important to note that fundamentals are also very strong. We’ve got a growing economy, jobs, incomes. We’ve got very low mortgage rates. We’ve got demographics supporting housing growth. We’ve got restricted supply in some places. So it’s certainly understandable that prices would go up some. I don’t know whether prices are exactly where they should be, but I think it’s fair to say that much of what’s happened is supported by the strength of the economy.”
- January 2005
“We’ve never had a decline in house prices on a nation-wide basis. So what I think is more likely is that house prices will slow, maybe stabilize: might slow consumption spending a bit. I don’t think it’s going to drive the economy too far from its full employment path, though.”
- July 2005
“We expect moderate growth going forward. We believe that if the housing sector begins to stabilize, and if some of the inventory corrections still going on in manufacturing begin to be completed, that there’s a reasonable possibility that we’ll see some strengthening in the economy sometime during the middle of the new year.
Our assessment is that there’s not much indication at this point that subprime mortgage issues have spread into the broader mortgage market, which still seems to be healthy. And the lending side of that still seems to be healthy.”
- Feb 2007
The global economy continues to be strong, supported by solid economic growth abroad. U.S. exports should expand further in coming quarters. Overall, the U.S. economy seems likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008, to a rate close to the economy’s underlying trend.
July 2007
Don’t get me wrong. I don’t expect a Fed Chairman to be able to predict recessions, but I do expect a Fed Chairman to have some sort of risk management tools in place at all times. Much like a good portfolio manager, a good Fed Chairman has to at least consider the potential risks confronting the market. Bernanke was like the portfolio manager who went into 2008 entirely invested in equities. He had no risk management tools in place just in case something unforeseen occurred. And it’s not as if there were no red flags waving in 2006 or 2007….
Not only were Bernanke’s actions leading up to the crisis entirely off base and incorrect, but his actions during the crisis actually made things worse. Bernanke is largely credited with saving the global economy from falling off a cliff when in fact the economy did fall off a cliff. Let’s not forget that the market did indeed crash. Global equity markets were sliced in half and still remain 30%, 40% or 50% off their highs. Unemployment is at 10% in the U.S. Two years into the recession we are still losing 400K+ jobs per month and experiencing half a million jobless claims every week. This is the worst economic downturn in the last 80 years and investors are playing it off like we averted crisis. Ask the 10% of unemployed American’s how the averted crisis feels. It’s all well and good that the banks are reporting profits again and the stock market is 45% off its lows, but make no mistake – the blue collar working American is still very much in pain.
Granted, you could make the argument that things could be worse, but couldn’t they also be much better? Many believe we were staring at an impending Depression. I think that’s hogwash. I have long maintained that a second Depression was never on the table so the comparisons are off based to begin with. Not only are there substantial safeguards that protect us from another Depression (such as the FDIC), but most importantly, the U.S. economy is a very different economy than it was in the 30’s. We are no longer a fast growing economy with poor regulations and little to no infrastructure. We are quite the opposite now. This doesn’t mean we aren’t at risk of prolonged and difficult economic periods, but the deepness of the contraction in the 30’s isn’t applicable to today’s U.S. economy.
I would argue instead, that this recession and downturn could have been substantially less destructive had Ben been a bit more prescient and proactive in his policy measures (and yes, I wrote on more than one occasion in 2006 and 2007 that Bernanke should be cutting rates and using a bit more risk management in his policy approach). The boiling point in Bernanke’s chain of poor decisions came when he decided to let Lehman Brothers fail. After bailing out every firm that was about to fail, Bernanke somehow came to the conclusions that Lehman should fail. It was stunning. It was a total diversion from his previous policy. I can only imagine how he came to this decision. My money is on the fact that he got strong armed by Hank Paulson, the former CEO of Goldman Sachs, who strongly believed it was a good idea to let Lehman fail, but save AIG during the same weekend. Curiously, both actions benefited Goldman enormously. Unfortunately, the decision, which ultimately falls on Bernanke’s shoulders, led to a near meltdown of the system. Had Bernanke not decided to let Lehman fail, there is a good chance that the market would not have crashed late last year.
Most importantly though, I believe it is still too early to judge Bernanke. As Anna Schwartz, Milton Friedman’s right hand woman says, Bernanke is fighting the “last war”. Unfortunately for Bernanke, his battles have only just begun. Schwartz notes in a recent Newsweek article, that Bernanke’s policies have been deeply flawed:
“I don’t believe we would have had a Fed balance sheet currently that has doubled, or tripled, in such a short period of time without any kind of Fed acknowledgment that it was creating a problem for itself [with] inflation already baked into the economy.” In clear, strong tones marked by her New York accent, Schwartz said: “Everybody’s talking about what kind of exit strategy does the Fed have, given that its balance sheet has exploded. It’s something [Fed chair Ben Bernanke] doesn’t discuss. It’s as if he isn’t willing to acknowledge that it is a problem.”
My guess is that Bernanke will go down in history in much the same way that Greenspan has. If you recall the 90’s it was widely believed that Greenspan was the greatest central banker that ever walked the Earth. Oh how the tables have turned. My guess is we will look back in 10 years and notice that the Fed failed to thread the needle. We will either experience continuing deflation that leads to years of below trend growth and a mostly sideways stock market or we will experience an inflationary environment that rivals the 70’s and creates bubbles in many undesirable places. Anyone that thinks Bernanke can best Greenspan’s history of creating boom/bust cycles when he is using the exact same methodology is likely bordering on delusion.
To me Bernanke has been like the Fireman who sleeps through the fire alarms, shows up late, sprays gasoline all over the fires making it substantially worse and then claims to have saved the day when he finally puts the fire out after half of your house has already burned down. Or in other words, the Fed Chairman who completely fails to predict the crisis, implements zero risk management tools in advance, nearly drives the economy off the cliff and then takes credit for not destroying the entire economy. Unfortunately for him, his biggest mistakes and “lifesaving” recoveries are likely in the years ahead of him. And unfortunately for the rest of us, we are the ones who are most likely to suffer for his “brilliance” because Lord knows the bankers won’t….
Who would you like to see the President nominate as a replacement? As for bankers/traders with market experience, Rubin and Paulson were both flawed. I believe Bernacke’s background, both historical and as the man in the hot seat for the last 2 years, is a solid match for the position so long as his staff can balance the lack of market experience. And they can.
I’m not a big fan of the man, but when I hear Summers mentioned as a replacement I cringe. Maybe we can do better, but given the lack of bench strength I expect we would fair far worse.
The article: Ben “Systemic Risk” Bernanke proves that Bernanke knowingly maintained a strict monetary policy long after he knew of the sub prime problem as he knew it would cause of the “Depression”.
It shows that he probably engineered it on purpose!
If you want to sleep tonight, Don’t Read It!
“In contradiction to the prevalent view of the time, that money and monetary policy played at most a purely passive role in the Depression, Friedman and Schwartz argued that “the [economic] contraction is in fact a tragic testimonial to the importance of monetary forces” (Friedman and Schwartz, 1963, p. 300).
…..
The slowdown in economic activity, together with high interest rates, was in all likelihood the most important source of the stock market crash that followed in October.
In other words, the market crash, rather than being the cause of the Depression, as popular legend has it, was in fact largely the result of an economic slowdown and the inappropriate monetary policies that preceded it.
Of course, the stock market crash only worsened the economic situation, hurting consumer and business confidence and contributing to a still deeper downturn in 1930.”
Governor Ben S. Bernanke
Money, Gold, and the Great Depression.
At the H. Parker Willis Lecture in Economic Policy, Washington and Lee University,
Lexington, Virginia.
March 2nd, 2004
You can read also: Preparing for the Crash, The Age of Turbulence Update: 27/07/09., which tries to accomplish Greenspan Mission Impossible:
“That is mission impossible. Indeed, the international financial community has made numerous efforts in recent years to establish such oversight, but none prevented or ameliorated the crisis that began last summer.
Much as we might wish otherwise, policy makers cannot reliably anticipate financial or economic shocks or the consequences of economic imbalances.
Financial crises are characterised by discontinuous breaks in market pricing the timing of which by definition must be unanticipated – if people see them coming, then the markets arbitrage them away.
…
The clear evidence of underpricing of risk did not prod private sector risk management to tighten the reins.
In retrospect, it appears that the most market-savvy managers, although conscious that they were taking extraordinary risks, succumbed to the concern that unless they continued to “get up and dance”, as ex-Citigroup CEO Chuck Prince memorably put it, they would irretrievably lose market share.
Instead, they gambled that they could keep adding to their risky positions and still sell them out before the deluge. Most were wrong.“
Alan Greenspan
The Age of Turbulence: Adventures in a New World [Economic Order?].
The Age of Turbulence: Plea for a New World Economic Order. explains the nature and causes of economic depressions and proposes a plausible alternative solution.
I think we need to audit the Federal Reserve before we can determine if Bernanke should be reappointed. Look, I don’t want Congress have control over the Federal Reserve, but I don’t think it should be operating in secret. To me an audit does not equal a loss independence. Anyway, we won’t know what the taxpayer is on the hook for, until we do an audit.
How can the most important facet of a proactive market be so reactive?
You’re looking for the wrong place for proactivity. The bubble was ultimately fed by excessive leverage, and whatever regulatory authority that may have fixed that lies with the Congress and, to some extent, the executive branch.
Even if the Fed had raised interest rates, that would have not even come close to fixing the excess leverage problem. If anything, it would have been worse, as rate increases would have simply motivated banks and loan brokers to convert 30-year fixed-rate borrowers into ARM and interest-only customers, because of their lower payments. If you want to fix the leverage problem, then the only solution is to curtail, regulate and/or ban those types of loans in the first place.
Bernanke certainly **said** a lot of erroneous stuff, presumably for the sake of PR (this was never just a subprime crisis, for example), but he **acted** appropriately once confronted with a crisis.
We should have gone further than we did (by nationalizing the banks). But we didn’t and we won’t, so we may as well focus on what is likely to happen, rather than on what should happen. Anything that should happen will have to come from Congress, and they’re too busy fighting over turf and hurtling ideological BS to actually do something that might be productive.
Would you select a General of the U.S. Army who has never fought in a battle or shot a weapon?
Eisenhower commanded the ETO during WWII having never been in combat prior to that. (He spent WWI at training camps in the US.) We’d be hard pressed to find anyone with experiencing battling depressions, and anyone who did would have to be recruited from abroad, such as those who dealt with the crashes in Sweden and Finland during the early 90’s. Just sayin’…
MBA,
The carry trade and low interest rate environment made the high leverage products profitable. The only reason all the MBS products were so lucrative was because they were based on low rates. They appeared like low risk instruments because housing had never declined, but we all know the results of that. The leverage and interest rates go hand in hand.
The only reason all the MBS products were so lucrative was because they were based on low rates.
I’m sorry, but that isn’t accurate. The return comes from the spread, and the spreads were actually quite low by historical standards. (If you want to see a high spread credit market, look now.) They were making money through volume, more so than from margin.
This was ultimately a volume business, and the volume came from the loan market’s willingness to buy high LTV products. Had the market rejected high leverage and high income/debt ratios, the market would have been far smaller than it was. But expanding the tolerance of what was defined as an acceptable loan, there was plenty of interest in securitized debt.
Bankers don’t turn bank branches into coffeehouses when rates go up during a boom period, they just change their product mix to accommodate the high rates. The Aussies had a housing bubble with retail interest rates in the 8-9% range precisely because the market is almost entirely dominated by pure ARM’s. The price of money matters far less than the ability to get approved for the loan, and we obviously had very easy credit due to reduced standards, independent of the rates.
Sign & comment on the Abolish the Federal Reserve Petition to show your displeasure at the real estate and financial meltdown caused to a large degree by easy money policies of Greenspan and the Fed. http://www.petitiononline.com/fed/petition.html
MBA, the only reason the MBS were even a product was due to the booming housing market. The booming housing market was due in large part to the availability of credit and inexpensive mortgages. They wouldn’t have been able to push the volume if the underlying rates had been substantially higher because the demand for mortgages wouldn’t have been there to begin with. It’s pretty cut and dry in my opinion.
The leverage in MBS was a direct result of the combination of poor regulation and low interest rates. All of those ARM loans were made possible by the Fed.
Also, your data in Australia is wrong. Real rates were cut in half in the period leading up to the housing bubble in Australia. Data is from the RBA:
http://i417.photobucket.com/albums/pp252/pragcap/Aussie.png
To imply that the reduction in real rates had no impact on home prices is just flat out wrong. That’s essentially saying that the cost of mortgage doesn’t matter to the buyer.
Real rates were cut in half in the period leading up to the housing bubble in Australia.
That misses the context of the issue here, namely that they managed to have a housing bubble, even in a high-rate, low-inflation environment. The anti-Bernanke crowd seems to believe that bubbles are not possible with higher rates, but they certainly are — their price increases were quite similar to the US, even though the cost of a typical retail mortgage has generally been above 7%. http://www.aph.gov.au/library/pubs/bn/2007-08/homeloan-1.jpg
The Aussies deal with this higher rate environment by generally avoiding fixed-rate, long-term loans, because fixed rate debt comes at a premium. ARMs are the norm, and there are a variety of loan products that are meant to reduce the monthly payment.
That’s essentially saying that the cost of mortgage doesn’t matter to the buyer.
You’re focusing on the wrong cost. It isn’t the interest rate that drives the transaction, it’s the required monthly payment. And there are plenty of ways to reduce that payment simply by using an alternative loan product.
Combine that with easier credit, and you have the mortgage problem. The market was able to substantially reduce loan payments by using variable rate and interest-only loans, expand the qualified pool by increasing debt-income ratios, and made it easier to put deals together by using high LTV’s to effectively eliminate the need to save for a down payment, and you end up with a hot market.
Just look at today’s market. Money is quite cheap, yet there is no bubble. Banks have increased underwriting standards, and the bubble disappears, even with cheaper money. The cost of money means little when nobody can borrow it.
The Aussies weren’t in a high interest rate low inflation environment. Their central bank doesn’t account for property increases in their CPI data. Just take a look at the wage chart I put up. How can you claim they were in a low inflation environment when wages were soaring and land and commodity prices were ripping higher? Australia actually proves my point abut poor central banking better than the U.S. does. Their bankers were totally oblivious to the bubbles growing around them.
You’re implying that the interest rate isn’t a vital component of a mortgage. That is entirely wrong.
As for money flows in the economy and the current low rate environment – it takes years for low interest rates and cheap money to provide the economy with liquidity. It works with a lag. It always has. You can’t just cut rates and expect the economy to boom tomorrow. Just look at the money multiplier. The money isn’t getting off the bank balance sheets because there is no borrowing right now. The case was quite different in 2003 when they cut rates and lending exploded over the following 4 years.
You’re implying that the interest rate isn’t a vital component of a mortgage.
It isn’t that important when the lender can shift the borrower into a different loan type that results in the same or lower monthly payment, irrespective of the interest rate. It’s the monthly payment that matters most, not so much the percentage figure attached to it. That’s how the Aussies and many other countries manage to cope with much more expensive money — they slice up the repayment obligation in whatever ways necessary so that they may successfully back into the rate and achieve the loan volumes that they want.
Interest rates would be quite relevant if all mortgages were all fixed-rate loans with a specific pre-ordained maturity period, because the payments would naturally increase in all cases. But we have used plenty of financial engineering to get around that problem quite nicely. Every car salesman and mortgage broker would understand this implicitly.
The fixation on interest rates is wrong headed. The Fed can play with rates a bit, but retail long-term rates are ultimately determined by the market. Just work a spreadsheet for a bit, and see what happens when you replace a fixed-rate product with a cheaper variable rate one, or when you extend or eliminate amortization.
This phenomenon should be the primary driver for banning alternative loan products — if you did, the Fed really would have some degree control over retail mortgage markets. But with creativity at work, they really don’t have much control at all. With lending markets in their present form, this is a legislative issue, not so much a central bank issue.
I guess we’ll just have to agree to disagree. The evidence correlating Fed policy and booms and busts and interest rates is quite compelling. You’re essentially arguing that the low interest rate environment of 2003-2005 had nothing to do with Fed policy. I don’t think the evidence adds up to back your argument.
You’re essentially arguing that the low interest rate environment of 2003-2005 had nothing to do with Fed policy.
No, I’m pointing out that low rates do not, by themselves, create bubbles. It’s obviously false – just look at today’s environment for one example of an environment in which cheap money is not feeding a bubble, or Australia as an example of a market in which money wasn’t particularly cheap yet a bubble was formed, regardless.
Real estate bubbles are fed by easy credit, and creative financing makes credit easier to get, by definition. The bubble drivers were ultimately a legislative failure, and there is little or nothing that the Fed could have done about those. If you want to eliminate bubbles, then place the target on the creativity that allows lenders to circumvent the impact of rates in the first place.
You know what TPC, I give BB a lot more leeway than Paulson. Paulson knows what the hell he is doing and that he was simply frigging stealing.
When is the populace going to wake up?? Is it that easy to enslave a population??? Apparently so. For what. GS, a piece of shit company that pays out more than 50% of company profits in bonuses??
What if GE did that????
Hang the felons!!! Seriously, the American people need to wake up.
But I digress. BB is ok in my book, just not the best.
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