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? (http://seekingalpha.com/article/178117-federal-reserve-exit-watch-part-5)

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. (http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)

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”: http://www.ft.com/cms/s/0/0ad195f8-ea7a-11de-a9f5-00144feab49a.html. 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”: http://online.wsj.com/article/SB20001424052748704398304574597910616856696.html#mod=todays_us_opinion. 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 http://seekingalpha.com/article/178269-defining-the-banking-situation-as-a-political-issue.

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?” http://www.tnr.com/blog/the-plank/history-paul-volckers-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.

The Bernanke Re-Appointment

At first I was not going to comment on the re-appointment of Ben Bernanke to the position of Chairman of the Board of Governors of the Federal Reserve System. I thought I had had my say. See my post “Exit Strategy: An Argument Against Bernanke's Reappointment” of July 27, 2009. Guess this was not to be. Since this post was re-posted on several sites yesterday and people have asked me to comment on the news, I decided to provide a current comment on the situation.

There are seemingly two reasons given for the re-appointment of Ben Bernanke to another term as the Chairman of the Board of Governors. The first is that he was calm throughout the crisis. The second is that his appointment, since he is a “known”, will calm the financial markets.

Calm is “good”! I have just been writing about it: see Banking Sector Stays Quiet on August 10 and The Deleveraging Continues: What This Means on August 24. It is good that the financial markets are calm and everyone is on vacation this last week in August: a great time to make a very important appointment.

But, is “calm” what we need. The financial markets do get over changes in leadership. For example, we change Presidents and the markets get over the change! In fact, changing leadership in a time of calm is the best time to change leadership!

And, what does it mean that Bernanke was “calm” during the financial crisis. Why do I keep remembering management team after management team taking their banks public during the Savings and Loan crisis that kept telling us: “Yes, we got the bank into this mess but we learned our lesson. Now, all you have to do is give us another $100 million in new capital and we will change our ways!” And, that was the last the investors saw of their $100 million. But, these managements were calm as their institutions crumbled.

Bernanke was one of the leaders that got us into this mess. He got us through the crisis? I have over my desk the cartoon from the Financial Times showing Bernanke in front of the Federal Reserve building with two revolvers in his hands shooting off lots and lots of currency. The title of the cartoon: “A Fistful of Dollars”. He is not known as “Helicopter Ben” for nothing.

His policy for the crisis: throw as much money into the market as possible. It is way better to have too much money out there than to not have enough. A good, coherent, concise policy!

And, he did this very calmly!

Or did he? See my post of November 16, 2008: The Bailout Plan: Did Bernanke Panic?

My final concern over this re-appointment is my disappointment with President Obama. I had hopes that he would bring a whole new quality of leadership to Washington, D. C. He has been President for over six months now and I must say that hope has not been fulfilled.