Thursday, December 17, 2009

Will Bernanke Never Learn?

The report from the Federal Reserve yesterday was positive. The headline in the Wall Street Journal was typical: “Fed More Upbeat, but Keeps Lid on Rates.” In other Federal Reserve news we hear that the Fed is going to phase out the special facilities set up during the financial crisis.

So, what else is new? (

Our fearless leader, Time’s Person of the Year, POTY, Chairman Benjamin Shalom Bernanke, was an avid supporter of Alan Greenspan and low, low interest rates earlier this decade, rates that spurred on the credit bubble in housing and elsewhere. In 2007, Chairman Bernanke was late in identifying the fact that the economy was slowing and that there was a looming financial crisis on the horizon. Then, Time’s POTY seemingly panicked after the bailout of AIG in September 2008 and this resulted in the rushed passage of TARP. (

Once it was finally accepted that there was a financial crisis, POTY saw to it that just about everything that could be thrown against the wall, was...thrown against the wall. In this he has been deemed a savior. The balance sheet of the Fed ballooned from about $900 billion to roughly $2.1 trillion.

Now, POTY is seeing that the target rate of interest for the conduct of monetary policy can hardly be differentiated from zero and this target has been maintained since December 16, 2008.

WOW! The Fed’s zero target rate of interest was one year old YESTERDAY!

Excess reserves in the banking system have gone from about $2 billion to over $1.1 trillion!

And, what is the result?

Big banks are eating this up! There are two articles in the morning papers that attest to this. See the column by John Gapper in the Financial Times, “How America let banks off the lease”: Gapper writes, “As the FT reported on Wednesday, banks and hedge funds have made huge profits in distressed debt trading in the past year, aided by the Federal Reserve keeping short-term interest rates low. Meanwhile, the banks that turned out to be too big to be allowed to fail are bigger than ever.”

Next, the op-ed piece in the Wall Street Journal by Gerald P. O’Driscoll, Jr., “Obama vs. the Banks”: O’Driscoll states “that banks can raise short-term money at very low interest rates and buy safe, 10-year Treasury bonds at around 3.5%. The Bernanke Fed has promised to maintain its policy for ‘for an extended period.’ That translates into an extended opportunity for banks to engage in this interest-rate arbitrage.” He then asks, “Why would a banker take on traditional loans, which even in good times come with some risk of loss?” Seems like I have been arguing this point for at least six months now in assorted blog posts.

But, of even more importance is the attitude of the bankers toward financial innovation.

There is no better environment for financial innovation than the one that we are now experiencing. I would argue very strongly that financial innovation is taking place right now even though we may not see all the different forms the innovation is taking. And, the current round of financial innovation is coming at the expense of regular borrowing and lending. And, the financial innovation is benefitting the large, financially savvy financial institutions and not the small- and medium-sized organizations that don’t have the resources, or, the inclination, or, the freedom, since they still have plenty of questionable assets to deal with. Hail, Wall Street! See you later Main Street!

For the past fifty years or so, the government of the United States has basically followed an expansionary economic policy that has provided a safety-net to the financial system, and established an inflationary bias within the economy. There is no better environment for financial innovation than this!

The banks, the financial system, the non-financial system, and governments have innovated like mad during this time period.

The current federal government is just continuing to underwrite this practice at the present time.

POTY and the current administration are just exacerbating the situation they are so heavily criticizing.

And, as Gapper states, "the banks that turned out to be too big to be allowed to fail are bigger now than ever."

POTY and the current administration may win, politically, in the short run because the big bankers seem to have a deaf ear: See

In the longer run, the victory may go to another side. Paul Volcker seems to be taking the other side of the argument. See the article by Simon Johnson in The New Republic: “Is History on Paul Volcker’s Side?”

The bottom line, however, is that Benjamin Shalom Bernanke doesn’t seem to get it…once again! Time after time, the Fed Chairman has seemed to miss the mark. Because of this record, one, I think, can seriously ask the question: “Why should we expect Bernanke to be correct this time?”

In nominating the Chairman for another term, President Obama seems to believe that Bernanke will be correct this time. More than anything else the president has done, even sending more troops into Afghanistan, his bet on the re-appointment of Chairman Bernanke may determine how his presidency is perceived by future historians. A lot is riding on Chairman Bernanke.

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