Friday, August 22, 2008

Ben The Blind

In a truly remarkable speech at the Federal Reserve Bank of Kansas City's Annual Economic Symposium at Jackson Hole, Wyoming, Fed Chairman Ben Bernanke demonstrated cluelessness across the spectrum of his remarks.

Let start at the top. Bernanke says:

The Federal Reserve's response to this crisis has consisted of three key elements. First, we eased monetary policy substantially, particularly after indications of economic weakness proliferated around the turn of the year. In easing rapidly and proactively, we sought to offset, at least in part, the tightening of credit conditions associated with the crisis and thus to mitigate the effects on the broader economy. By cushioning the first-round economic impact of the financial stress, we hoped also to minimize the risks of a so-called adverse feedback loop in which economic weakness exacerbates financial stress, which, in turn, further damages economic prospects.
Although the Fed has cut interest rates, this is not easing monetary policy. Easing monetary policy occurs when, well, money growth policy is eased. In the last three months, money supply growth, far from being eased, has collapsed. From double digit money supply growth earlier this year, the money growth over the past three months has grown at a remarkably slow 2.5% annualized rate.

For Bernanke to say monetary policy has eased he seemingly must not be aware that money supply growth has slowed to a trickle, that the Fed has sterilized the bailouts it has conducted by selling or loaning out Treasury securities, and that in the face of the current financial crisis the real interest appears to have collapsed which is behind the fact that, despite Fed interest rate cuts, money supply has not grown.

Bernanke also speaks on the Bear Stearns collapse:

The collapse of Bear Stearns was triggered by a run of its creditors and customers, analogous to the run of depositors on a commercial bank. This run was surprising, however, in that Bear Stearns's borrowings were largely secured--that is, its lenders held collateral to ensure repayment even if the company itself failed. However, the liquidity of markets in mid-March was so severe that creditors lost confidence that they could recoup their loans by selling the collateral. Many short-term lenders declined to renew their loans, driving Bear to the brink of default.
Clearly, something else was going on with Bear Stearns, given the fact that, as Bernanke points out, Bear's securities were collateralized. Either Ben isn't capable of drawing the conclusion from these facts that the Bear collapse appears to have been orchestrated, most likely by Treasury Secretary Paulson. Or he was in on the game and is now just blowing smoke, or he has chosen to stick his head in the sand on this one.

Bernanke also tells us that there is consideration as to whether the Fed should supervise the entire financial system:

Going forward, a critical question for regulators and supervisors is what their appropriate "field of vision" should be. Under our current system of safety-and-soundness regulation, supervisors often focus on the financial conditions of individual institutions in isolation. An alternative approach, which has been called systemwide or macroprudential oversight, would broaden the mandate of regulators and supervisors to encompass consideration of potential systemic risks and weaknesses as well.

At least informally, financial regulation and supervision in the United States already include some macroprudential elements. As one illustration, many of the supervisory guidances issued by federal bank regulators have been motivated, at least in part, by concerns that a particular industry trend posed risks to the stability of the banking system as a whole, not just to individual institutions. For example, following lengthy comment periods, in 2006, the federal banking supervisors issued formal guidance on underwriting and managing the risks of nontraditional mortgages, such as interest-only and negative amortization mortgages, as well as guidance warning banks against excessive concentrations in commercial real estate lending. These guidances likely would not have been issued if the federal regulators had viewed the issues they addressed as being isolated to a few banks. The regulators were concerned not only about individual banks but also about the systemic risks associated with excessive industry-wide concentrations (of commercial real estate or nontraditional mortgages) or an industry-wide pattern of certain practices (for example, in underwriting exotic mortgages). Note that, in warning against excessive concentrations or common exposures across the banking system, regulators need not make a judgment about whether a particular asset class is mispriced--although rapid changes in asset prices or risk premiums may increase the level of concern. Rather, their task is to determine the risks imposed on the system as a whole if common exposures significantly increase the correlation of returns across institutions.

Of course, Bernanke may tout some supervisory guidance in 2006, but the fact of the matter is that in 2004, New York Federal Reserve economists Jonathan McCarthy and Richard W. Peach wrote a paper, Is There A Bubble in The Housing Market Now? Their answer was decidedly, "No". The Fed is not God, the solution to the financial crisis is not more supervision, it should be less supervision. The more alternatives and creative routes people take, the less likely that we will see the huge macro-collapses of the current day where regulators funnel all players in the same direction.

In conclusion, from all possible angles Bernanke is missing key points. His monetary policy is driving the economy toward a huge economic crisis, which in itself would not be a bad thing, if the economy would be allowed to adjust from the crisis period in a laissez faire manner and wipe out previous malinvestments. However, Bernanke and other government operators are apt to step in with new regulations that will cause things to go from very bad to even worse.

This is all simply very alarming.

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