Five Things You Need to Know: Bernanke Hits One Out of the Park
Looking ahead to the other side of the "point of recognition," Bernanke lays the foundation for re-thinking the Fed's dual mandate.
Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
And now for a completely unexpected point of view. Yesterday's speech by Federal Reserve Chairman Ben Bernanke may have been one of the greatest speeches ever delivered by a Federal Reserve Chairman.
Let me be clear, I am no fan of the Federal Reserve. I believe the very institution itself is a mistake. But reality, intrusive as it is, has put us here at a time where, like it or not, the Federal Reserve's actions influence financial markets and thus help shape the psychology and belief systems of the participants in those markets.
Bernanke's speech yesterday was a rigorous departure from anything former Federal Reserve Chairman Alan Greenspan ever crafted, and that is probably why it was so very good. What was absent was the Greenspan-esque obfuscation and sophistry - the public speaking technique the former Fed Chairman perfected so well and, with any justice at all will, for which he will one day be vilified, rather than praised as "The Maestro."
Instead, there was an honest assessment of the problems facing the economy, and a clear declaration of the Bernanke-led Federal Reserve's macroeconomic goals and objectives placed squarely within the context of what this Fed believes is its dual mandate of promoting maximum sustainable employment and price stability.
We can debate that dual mandate for weeks and months, even years, but we will be doing so even as it functions as the guidepost for this Federal Reserve's macroeconomic policy, so until we are ready as a country to actually do something about changing it, let's leave it to economic academia and look at seven sentences from Bernanke's speech that have the potential to make it a classic.
1. The Flawed Premise
"Although poor underwriting and, in some cases, fraud and abusive practices contributed to the high rates of delinquency that we are now seeing in the subprime ARM market, the more fundamental reason for the sharp deterioration in credit quality was the flawed premise on which much subprime ARM lending was based: that house prices would continue to rise rapidly."
Who, ultimately, is responsible for the creation of that flawed premise upon which not just subprime ARM lending was responsible, but all lending? Why, the very policies of the Federal Reserve, of course, which actually forced this lending into the hands of unwitting borrowers through artificially low interest rates.
Wait, don't borrowers have some responsibility in this matter? Not in this system they don't. See, we can't have it both ways. We can't decry the irresponsibility of the subprime borrower while at the same fostering a system that, at the same time, asymmetrically rewards ill-timed speculation and risk-taking based on the magnitude of the bets being laid down.
Note what Bernanke did not say. He did not say, the premise that asset (house) prices would continue to rise is flawed. He said the premise that "house prices would continue to rise rapidly is flawed." Given the Fed's dual macroeconomic mandate, and the policy response that has been outlined, the rise of asset prices is a given. The rate of that rise is the only thing in question.
2. Unintended Consequences
"One of the many unfortunate consequences of these events, which may be with us for some time, is on the availability of credit for nonprime borrowers."
How would Greenspan say this? One wonders. In a nutshell, this means the asymmetrical rewards for speculation and risk-taking will increase in their skew. The gaming table is now closed for all but the high rollers.
3. The Official End of "Containment"
"Although subprime borrowers and the investors who hold these mortgages are the parties most directly affected by the collapse of this market, the consequences have been felt much more broadly."
One suspects Greenspan might have chosen to carry the mantle of containment permanently. Here, Bernanke admits the spillover, and consequently diffuses it.
4. The Credit Crunch, Defined
"[O]n balance, these developments have prompted banks to become protective of their liquidity and balance sheet capacity and thus to become less willing to provide funding to other market participants, including other banks."
This is the definition of a decrease in time preferences and ensuing credit crunch. Re-igniting an increase in time preferences is a necessary step in the continuation of the game of ever-rising asset prices.
5. The Credit Crunch Hits Consumers
"We also see considerable evidence that banks have become more restrictive in their lending to firms and households."
6. Without Credit Expansion, Growth Must Slow
"More-expensive and less-available credit seems likely to impose a measure of financial restraint on economic growth."
I'm not sure a Federal Reserve Chairman has ever put forth this premise with such clarity. This is what the Federal Reserve does, like it or not. It makes credit available in what it hopes are manageable doses. In academia much debate centers on whether this is possible. It's never before been possible in the history of the world, but because our experiment is playing out in real time we at least feel like we don't know for sure how it's going to end; at times, an inconvenient illusion.
7. The Point of Recognition
"[A]ny tendency of 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."
A "point of recognition" moment is what the Fed fears most. At that moment - the recognition that credit expansion has met an irresistible wall of credit revulsion - the Federal Reserve will have exhausted its arsenal of "traditional" policy tools.
In a sense, the speech is an interesting gambit by this Federal Reserve Chairman. Instead of obfuscation and sophistry, he's instead chosen to outline very clearly what is happening and what the policy responses will be. Perhaps, arguably, he had no choice. But the departure from the days of Greenspan is stark.
On a deeper level, the admission - and that's what it is, an admission - that there are things out there that could "reduce the central bank's policy flexibility" might be the one concept even the most intractable Fed abolitionists can thank Bernanke for introducing. Looking ahead to the other side of the "point of recognition," it actually lays the foundation for re-thinking the Fed's dual mandate. When that time comes, let's hope we have the courage to choose correctly.
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