Even veteran Fed watchers were caught off-guard by Chairman
Bernanke's performance before the Senate Banking Committee last Thursday.
Bernanke was expected to make routine comments on the state of the economy but,
instead, delivered a 45-minute sermon detailing the afflictions of the
foundering financial system. The Senate chamber was stone-silent throughout.
The gravity of the situation is finally beginning to sink in.
For the most part, the pedantic Bernanke looked uneasy;
alternately biting his lower lip or staring ahead blankly like a man who just
watched his poodle get run over by a Mack truck. As it turns out, Bernanke has
plenty to worry about, too. Consumer confidence has dropped to levels not seen
since the 1970s recession, real estate has gone off a cliff, credit brushfires
are breaking out everywhere, and the stock market continues to gyrate
erratically. No wonder the Fed chief looked more like a deckhand on the
Lusitania than the monetary czar of the most powerful country on earth.
Bernanke's prepared remarks were delivered with the
solemnity of a priest performing Vespers. But he was clear, unlike his
predecessor, Greenspan, who loved speaking abstrusely.
As you know, financial markets in the United States and in a number of other
industrialized countries have been under considerable strain since late last
summer. Heightened investor concerns about the credit quality of mortgages,
especially subprime mortgages with adjustable interest rates, triggered the
financial turmoil. However, other factors, including a broader retrenchment in
the willingness of investors to bear risk, difficulties in valuing complex or
illiquid financial products, uncertainties about the exposures of major
financial institutions to credit losses, and concerns about the weaker outlook
for the economy, have also roiled the financial markets in recent months."
Yes, of course. The banks are ailing from their subprime
investments while Europe is sinking fast from $500 billion in unsalable
asset-backed garbage. The whole system is clogged with crappy paper and
deteriorating collateral. Now there are problems popping up in auction rate
sales and the normally safe municipal bonds. The whole financial Tower of Babel
is cracking at the foundation.
Money center banks and other large financial institutions have come under
significant pressure to take onto their own balance sheets the assets of some
of the off-balance-sheet investment vehicles that they had sponsored. Bank
balance sheets have swollen further as a consequence of the sharp reduction in
investor willingness to buy securitized credits, which has forced banks to retain
a substantially higher share of previously committed and new loans in their own
portfolios. Banks have also reported large losses, reflecting marked declines
in the market prices of mortgages and other assets that they hold. Recently,
deterioration in the financial condition of some bond insurers has led some
commercial and investment banks to take further markdowns and has added to
strains in the financial markets.
Bernanke sounds more like a New Testament prophet reading
passages from the Book of Revelation than a central banker. But what he says is
true. even without the hair shirt. The humongous losses at the investment banks
have forced them to go trolling for capital in Asia and the Middle East just to
stay afloat. And, when they succeed, they're forced to pay excessively high
rates of interest. The true cost of capital is skyrocketing. That's why the
banks are protecting their liquidity and cutting back on new loans. Most of the
banks have also tightened lending standards which are slowing down the issuance
of credit and threatens to push the economy into a deep recession. When banks
cramp-up, the overall economy shrinks. It's just that simple, no credit, no
growth. Credit is the lubricant that keeps the capitalist locomotive
chugging-along. When it dwindles, the system screeches to a halt.
"DOWNSIDE RISKS TO GROWTH HAVE INCREASED"
In part as the result of the developments in financial markets, the outlook for
the economy has worsened in recent months, and the downside risks to growth
have increased. To date, the largest economic effects of the financial turmoil
appear to have been on the housing market, which, as you know, has deteriorated
significantly over the past two years or so. The virtual shutdown of the
subprime mortgage market and a widening of spreads on jumbo mortgage loans have
further reduced the demand for housing, while foreclosures are adding to the
already-elevated inventory of unsold homes. Further cuts in homebuilding and in
related activities are likely. . . . Conditions in the labor market have also
softened. Payroll employment, after increasing about 95,000 per month on
average in the fourth quarter, declined by an estimated 17,000 jobs in January.
Employment in the construction and manufacturing sectors has continued to fall,
while the pace of job gains in the services industries has slowed. The softer
labor market, together with factors including higher energy prices, lower
equity prices, and declining home values, seem likely to weigh on consumer
spending in the near term.
So, let's summarize. The banks are battered by their massive
subprime liabilities. Housing is in the tank. Manufacturing is down. Food and
energy are up. Unemployment is rising. And consumer spending has shriveled to
the size of an acorn. All that's missing is a trumpet blast and the arrival of
the Four Horseman. How is it that Bernanke's economic post-mortem never made
its way into the major media? Is there some reason the real state of the
economy is being concealed from 'we the people'?
On the inflation front, a key development over the past year has been the steep
run-up in the price of oil. Last year, food prices also increased exceptionally
rapidly by recent standards, and the foreign exchange value of the dollar weakened
. . . (If) inflation expectations to become unmoored or for the Fed's
inflation-fighting credibility to be eroded could greatly complicate the task
of sustaining price stability and reduce the central bank's policy flexibility
to counter shortfalls in growth in the future.
Right. So, if the Fed's rate-cutting strategy doesn't work
and the economic troubles persist (and prices continue to go through the roof)
then we're S.O.L. (sh** out of luck) because the Fed has no more arrows in its
quiver. It's rate cuts or death. Great. So, we can expect Bernanke to hack away
at rates until they're down to 1 percent or lower (duplicating the downturn in
Japan) hoping that the economy shows some sign of life before it takes two full
wheelbarrows of greenbacks to buy a quart of milk and a few seed-potatoes.
Sounds like a plan!
We don't blame Bernanke. He's been remarkably
straightforward from the very beginning and deserves credit. He's simply left
with the thankless task of mopping up the ocean of red ink left behind by
Greenspan. It's not his fault. He should be applauded for dispelling the
decades-long illusion that a nation can borrow its way to prosperity or that
chronic indebtedness is the same as real wealth. It's not; and the bill has
finally come due.
Of course, now that the low-interest speculative orgy is
over; there's bound to be a painful unwind of hyper-inflated assets, falling
home prices, tumbling stock markets, increased unemployment, and a generalized
credit-contraction throughout the real economy. Ouch. Who said it was going to
At present, my baseline outlook involves a period of sluggish growth, followed
by a somewhat stronger pace of growth starting later this year as the effects
of monetary and fiscal stimulus begin to be felt . . . It is important to
recognize that downside risks to growth remain, including the possibilities
that the housing market or the labor market may deteriorate to an extent beyond
that currently anticipated, or that credit conditions may tighten substantially
(Editor's translation) "Discount everything I've said
here today if the economy blows up -- as I fully expect it will -- from decades
of regulatory neglect and the myriad multi-trillion dollar Ponzi schemes which
have put the entire financial system at risk of a major heart attack."
Bernanke's candor is admirable, but it is little relief for
the people who will have to soldier on through the hard times ahead. Perhaps,
next time he could spare us all the lengthy oratory and just forward a brief
cablegram to Congress saying something like this:
"We are deeply sorry, but we have totally fu**ed up
your economy with our monetary hanky-panky. You are all in very deep Doo-doo.
Prepare for the worst.
"Our sincerest regrets,
Whitney lives in Washington state. He can be reached at email@example.com.