Five Things You Need to Know: Bernanke's Jackson Hole Gets Deeper
Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:
It was a full year ago while speaking at the Kansas City Fed's annual symposium in Jackson Hole, WY, that Fed Chairman Ben Bernanke explicitly outlined The Bernanke Put. But reading news stories previewing Bernanke's upcoming Jackson Hole speech, it seems few really listened to last year's version. "A year after speech, Bernanke may have to eat his words," says USA Today. No he won't. Let's review.
1. What Did Bernanke Say Last Year?
Speaking at the last year's symposium in Jackson Hole, Bernanke sought to reassure financial markets that The Bernanke Put remains firmly in place and that the Fed stands ready to limit damage to consumer spending and economic growth from a deepening housing recession.
The full text of last year's speech here.
2. What Was the Primary Concern Last Year?
Remember all that stuff about subprime mortgage issues being "well contained"? Well, that was wrong. and Bernanke admitted it.
"The financial turbulence we have seen had its immediate origins in the problems in the subprime mortgage market, but the effects have been felt in the broader mortgage market and in financial markets more generally, with potential consequences for the performance of the overall economy," Bernanke said.
What happens when risk aversion grows? The velocity of money slows. In other words, the key engine of our economic growth begins to sputter.
"More generally, investors may have become less willing to assume risk," Bernanke noted.
Of course, the role of the Federal Reserve as it is seen from within, is to push risk assumption without letting it get too carried away.
"Some increase in the premiums that investors require to take risk is probably a healthy development on the whole, as these premiums have been exceptionally low for some time," Bernanke acknowledged. "However, in this episode, the shift in risk attitudes has interacted with heightened concerns about credit risks and uncertainty about how to evaluate those risks to create significant market stress."
In other words, risk aversion at this time last year had spilled over into credit markets generally, threatening the whole ball of wax.
3. The Bernanke Put Clarified
In last year's speech, we learned quite a bit more about The Bernanke Put. Let's take a brief step back, what is the Bernanke Put?
Back in May, 2007 (Only One Thing You Need to Know: The Bernanke Put), in prepared remarks before a conference on bank structure at the Chicago Fed, my take is Chairman Bernanke essentially absolved the Fed of playing any role whatsoever in the subprime loan debacle, declared the subprime problem "isolated" from "responsible lending" and then waved around a gigantic put option just to let everyone know that, regardless, the Fed will step in and clean up whatever mess is left over. CONTINUED...
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So, the Bernanke Put involves obligating me to pay for Angelo Mozilo's insurance. And he drove like a maniac because he knew he had near-comprehensive insurance.
Lovely. Where do I go to apply for membership in the club where I can bill the taxpayers to insure my behavior? Isn't my income stream and spending a critical part of the velocity of money?
*Checks bank statements*
Well, maybe not critical....
what happens to all that "money" that was "created?"
With asset deflation in full swing and engine of the American economy (consumers) on the sidelines, harldy anyone in the right mind would extend themselves credit. Yet the Fed would still pump it in.
Is it akin to "if a tree falls in the woods...does it make a noise?" or is it more like "a constantly rising tide floods everything?"
Either the money will simply dry up as we wait and do nothing or the crazy guys who do use tons of credit and leverage (like hedge funds and commodity futures traders, for instance) will have at their disposal an unprecedented opportunity to trade commodity prices into the stratosphere, including gold and oil.
Wouldn't that be the worst possible scenario: the little guy waits, as his assets deflate terribly, while highly-leveraged opportunists send the price of milk and eggs through the roof?
The 1.4 trillion total losses are spread out globally which is not a lot except for the fact that many other countries are in the same boat perhaps worse. The unfortunate part of this mess is that all the banks had a total float on their shares and stock holders will take the brunt of the loss. If at all possible we should try to insure that the worst examples of these banks should be left to burn. That is in the works as the banks that got strapped with the last of the mortgages which is the worst is the stuff that is not seasoned enough not to default. Here we sit fighting two wars in the name of righteousness and we get destroyed from within due to inept bankers, greed and a political administration that was so busy trying to destroy each other that they destroyed us. What can you say other then (BASTurds)
JPM
one of my fav's:
"...It's about discussing the most probable outcome...."
thanks!
The USD can not strengthen as credit "expands" per the scenario Kevin describes here. USD supply will always outpace the demand for USD (to repay debt) by a wide margin. If USD demand somehow becomes greater than USD supply, then the scenario Kevin describes here simply doesn't exist. Furthermore, the effects of globalization (massive USD reserves currently held abroad) will also impact the USD negatively, but this part of the unwind is unprecedented and thus absent from all models/theories.
As conditions worsen, investors (first) and even regular people (last) will abandon fiat currencies in favor of commodities... yet another reason that USD demand will be overwhelmed by supply. People will be far more likely to trade/barter with firewood & cigarettes than trust a currency that expands infinitely.
The comments by O. Tymoshenko above are quite accurate... excess credit will be leveraged by those in position to do so, and those people will buy/hoard commodities.
Olex, As someone that questions the assumptions of the deflationistas, the scenario you mention is exactly what I (and I presume the rest of the inflation hawks) fear. If the money/credit is presented, someone will use it! Hedge funds, pension funds, desperate banks-they all go double or nothing in one last alpha lunge at survival. I view the current commodity correction as one big rotation trade and the money that was there 2 months ago will surely find its way back.
It's unusual, however, in this day and age to see people behave in this pattern. Many years ago, when information was much harder to come by, and people lived and learned based on the urban myths fed to each other by word of mouth, deflationary behavior was far more prevalent and thus less addressable through policy.
Today, it's highly unlikely that a deflationary spiral could set in, and not just because of the Fed intervening. There are many people who, as soon as the first signals of deflation appear, will take advantage of any and all opportunities available.
As I tend to stipulate whenever I comment in these forums, I never say "NEVER". Certainly anything is possible. But there are a few ways to view things, and where you stand is always dependent upon where you sit.
A friend of mine who still rents his apartment is dying for hyperinflation, because his apartment is rent controlled. Obviously there's a ludicrous angle here, but it's worth mentioning because he would likely "benefit". On the other hand, deflation and vastly lower interest rates are intriguing to me because, while the value of my home would fall, I could refinance and cut my payments dramatically. Luckily, I have tons of equity in it...a 50% drop in value would be enough to make my mortgage equivalent to house value. This seems entirely unlikely. Even if it did happen, I still own a rental property that is fully paid off, so things aren't horrendous.
I look at the price of homes today and I realize one thing - comparing to 1962, when it cost 3X the average annual income to purchase a median priced house - the ratio is not that far out of whack today. Perhaps a 20-25% fall in housing prices would put things back into alignment. And we've seen 17% of that already. Markets tend to overshoot, though, so we probably will hit 30% before things are "bottomed out" for the average guy.
The best part of the above article, in my view, isn't the analysis. It's the interesting pattern definition - how we remember non-linear events in a linear fashion. How true that is. I rarely look at things in a linear fashion. Ever since I became interested in Chaos and Complexity Theory in the early 90's, I've tried to remove linear progressions from my analysis. It's impossible to do it completely, but what it does mean is that your business models have to be crafted to account for a variety of scenarios. Picking the ones that are "most probable" allows you to limit the number of iterations and make the most likely scenarios apparent.
It's an unfortunate fact of life that so many people do think along linear lines. It oversimplifies every process, and leads people to make ridiculous mistakes. The additional politicization of financial markets that is occurring during this period of time will only make things worse, not better, because politics is very linear. And politicians make lousy economists and businessmen.
Sub prime loans are a symptom of the problem, not the problem itself.
It is like a pyamid scheme. As long as there were more buyers home builders could sell more houses, appliance makers could sell more appliances, carpet and paint manufactureres could sell more carpet and paint etc. etc.
No one really cared if the buyers could continue to make their payments because the party was about to end without new players in what was to become an even more absurd game.
Credit got confused with cash and the result was over two decades of the illusion of prosperity built on debt. Actually, accelerating debt.
Let's say housing drops 50% to what everyone would accept as 'reasonably' priced how does that fix the problems of the balance of trade deficit, consumer debt, the baby boomers becoming dependent on society or peak oil?
Human nature is such that instead of acknowledging the end of the party and making the apporopriate sacrifices we will do everything in our power to 'fix' (aka avoid) the problems and thereby guarantee that the problems become much worse.
Everyone knows (on some rational level) that the solution to most of our problems involves raising interest rates to promote savings and strengthen the dollar, adding substantial taxes to gas to promote fuel efficient vehicles and alternative energy, limiting costly law suits and medical procedures covered by insurance and setting the social safety nets at a much lower level.
Knowing the correct course of action and actually taking it are two very different things however.
Like Kevin's article, I see a lot of the better financial media trying to help the hapless investor understand the gravity of our current economic situation. Without much success, in my view. The problem is the lack of explaining cause and effect. While it is intellectually elegant to point out the non-linearity of such connections, that simply to my mind is a rationalization for not having an idea to express about what comes next.
In addition, it seems like economist commentary is either hopelessly ambiguous or apocalyptic. Ok, but the latter is not likely to happen, or if it is we should be recommending that everyone have a mormon food cache and a bomb shelter with plenty of ammo.
Maybe it's my untrained mind that is the problem. All I see is the near demise of the credit markets. "De-leveraging" is the trendy euphemism. There's a lot of bad debt. As bond premiums rise, industry operating on too much leverage will fail. Prices of real estate and other assets that depend on high leverage will fall. The more leverage, the greater the fall in price. The big question is of course how much.
The scuttlebutt now predicts a floor for real estate prices defined by "affordability". I submit that affordability has no predictive value because we cannot hold wages steady as whole industries fail.
In my view, the best we can do is recognize trends and take investment positions based on where we believe those trends continue and when they seem exhausted. Right now, I am appalled that many financial writers, buoyed by the fall in oil yesterday, are calling an end to commodity inflation. Similarly, based on the overwhelming evidence of further credit deterioration, I find it insane that some folks want to shop for bargains among financials.
I don't know what the government should do. Save our credit system from collapse, surely, but beyond that I trust that those officials are doing what they can without emperiling our government's financial safety. What I do know, I think, is that the safe bet is keep some cash, stay out of or short the financials, and keep a position in oil and other deleveraged industries.
