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Five Things You Need to Know: The Bernanke Doctrine


It's neither bold nor new, and hasn't actually altered anything about how central banks operate.


Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Bernanke Like a Military Commander Applying Overwhelming Force...

Look, we didn't just make that headline up. It comes directly from a quite flattering New York Times story that made the front page of that newspaper yesterday:

"Like a military commander applying overwhelming force, he took steps then and over the next two months that some at the central bank are now calling the Bernanke Doctrine."

The Bernanke Doctrine? What, exactly, is this so-called "Bernanke Doctrine"? Well, in May of last year we described the "Bernanke Doctrine," though we referred to it by the decidedly less catchy name: The Bernanke Put.

The "Bernanke Put" was based on a May 17 speech Bernanke delivered called, appropriately enough, "The Subrpime Mortgage Market."

The May 17 2007 speech is a fascinating read, especially In light of the Times article, which defines the "Bernanke Doctrine" as "the overpowering use of monetary policies and lending" to handle economic crises. Clearly, last year at this time the Fed Chairman had a much different doctrine.

"Having emerged more than two decades ago, subprime mortgage lending began to expand in earnest in the mid-1990s, the expansion spurred in large part by innovations that reduced the costs for lenders of assessing and pricing risks," Bernanke said a little more than a year ago. "In addition, lenders developed new techniques for using [credit scoring] to determine underwriting standards, set interest rates, and manage their risks," he added.

Well, it may have appeared that way to the Fed chairman a year ago, but we now know (actually, we knew then) that there wasn't exactly a whole lot of "managing risk" going on. There appears not to have been any risk manging going on.

Bernanke concluded in his speech last year that, "[W]e believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."

But, in the event that belief was wrong, and it was, his secondary conclusion in the speech was this: "Markets can overshoot, but, ultimately, market forces also work to rein in excesses. For some, the self-correcting pullback may seem too late and too severe. But I believe that, in the long run, markets are better than regulators at allocating credit."

Apparently, the long run has changed. Today, we have an ongoing alphabet soup of Bernanke Fed actions specifically designed to circumvent market pricing of devalued assets. Today, we have a Fed that single-handedly engineered the JP Morgan (JPM) "takeover" of Bear Stearns (BSC). In short, today we have the exact opposite of what Bernanke publicly advocated as the right medicine for allocating credit and reining in excesses.

What may be worse is that the "Bernanke Doctrine," described in reverential terms by the Times as "bold steps," and by fellow central bankers as "alter[ing] the framework for how central banks operate in a crisis, is neither bold nor new, and hasn't actually altered anything about how central banks operate.

Every step taken by the Fed over the past nine months has a precise analog and origin in 1930s banking policy. Every one. Meanwhile, even as today's central bankers sit around patting themselves on the back for "averting the crisis," it's actually continuing. We're reminded of something we once read, a quote many years ago, in the Times actually, about the Great Depression: "Just when we thought it was over, it was really only beginning."

2. Quarterly Banking Profile Paints Grim, Deteriorating Picture

This morning the Federal Deposit Insurance Corporation (FDIC) released the Quarterly Banking Profile, a quarterly publication that provides a summary of financial results for all FDIC-insured institutions.

It was, as one might have expected, grim. The picture it painted was one of consumer stress and how it is impacting the ability of banks to turn a profit. Think about it, why did banks make so many subprime and Alt-A loans that continue to impair their balance sheets? Because they were hugely profitable. Now, with the game changing, profits are increasingly tough to squeeze out of consumers and businesses.

Below are some highlights from the report.

  • The average margin at community banks -- institutions with less than $1 billion in total assets -- fell to 3.70% , the lowest level since fourth quarter 1988.
  • Why the margin pressure? Community banks' funding costs did not reprice downward as rapidly as larger institutions' when short-term interest rates declined.
  • Retail deposits typically reprice more slowly and their rates generally have a higher floor than other short-term liabilities.
  • Insured institutions charged-off $19.6 billion (net) during the first quarter, an increase of 139.1% year-over-year.
  • Noncurrent loans (those 90 days or more past due) rose 23%
  • Dividends were slashed, almost half (48%) paid lower dividends, and 666 paid no dividend.
  • Total assets increased by 2.6% even as loan growth slowed; a hallmark of tightening credit conditions.
  • Retail deposit growth strengthened; people are beginning to save more.
  • Estimated insured deposits (including U.S. branches of foreign banks) increased by 3.3% during the first quarter of 2008.
  • This was the largest one-quarter increase in insured deposits since quarterly reporting was adopted in 1991.

3. Sears Surprises? Surprises Whom?

Sears's (SHLD) this morning came in with a first-quarter loss of $56 million, or 43 cents a share. Sales declined 5.8% to $11.1 billion, both of those trailing analysts' estimates. While many media reports characterized the loss as a "surprise," we were left wondering how in the world anyone could have expected anything better from Sears.

About one-third of the retailer's sales are from home goods and appliances, two of the weakest consumer spending categories behind the ongoing real estate bubble unwind. Moreover, Sears last year was determined to put it's "economy will improve" stake in the ground by actually increasing inventories in anticipation of a better sales.

Sales declines have moderated since May 3, the company noted, but was quick to note that the moderation was due to increased promotional activity and markdowns. Margins declined 90 basis points to 27.3%.

4. Costco Sees Inflation/Deflation Battle First-Hand

Costco (COST) this morning reported third quarter profit rose 32% to $295.1 million, or 67 cents a share. Comparable sales for the fiscal quarter were up 6%, but gas prices were up 20% for the quarter year-over-year, so back out gas prices and comp sales were 4%.

What was interesting about Costco, however, was what the company noted it is seeing in terms of inflation and deflation. Similar to comments made last week by BJ's Wholesale Club (BJ), Costco noted seeing inflation in food items and staples, while seeing deflation in more discretionary categories, such as electronics.

Three important notes from the conference call that deserve mentioning as they've been ignored in the mainstream media reports on the company's results:

1) As you could see from the impact of gasoline prices and sales, with prices up 20% year-over-year for the quarter and accounting for 10% of sales, this is an important segment for COST. However, while they benefited from pretty strong margins from gasoline in Q4, they are less certain they'll see those same margins going forward.

2) Costco, unlike many retailers, has been ahead of the curve in what they call their "margin initiatives," efforts to show strong improvements in margins. Going forward, with most of those initiatives having been completed, Costco said "it's going to be hard for us to quantify how much more we can do."

3) The company is beginning to see some inflationary pressures from vendors. This has been partially offset by deflation in other categories, but the company said it may see some impact in 2009.

5. Heinz Results Driven by Pass-Through Ability

Speaking of passing though increased materials costs, Heinz (HNZ) this morning reported net income climbed 7.2% to $194.1 million, or 61 cents a share. The results were driven to a degree by foreign exchange, but the story there is higher prices being passed through to customers.

While Heinz was able to raise prices 3.3% during the fiscal year, commodities prices increased 8% in Fiscal 2008, so you can see the difference was made up by productivity, cost cutting and currency gains.

The company is predicting 8% commodities inflation again for the next two years, which is something we very much disagree with. In fact, that's the thesis: commodities inflation over the next two years comes in, allowing companies like Heinz to benefit as the pass-through costs remain in place.

One thing to keep in mind about Heinz, they are seeing the bulk of their strength in sales of healthy eat-at-home foods and emerging markets. The company saw 14% growth in Heinz-branded products, 26% in Weight Watchers and their Smart Ones brand, and 25% growth in emerging markets.

Finally, a note about signs of demand destruction. Heinz took pricing of 1.7% in their U.S. Foodservice group, but sales volume decreased 1.1% due to soft restaurant business.

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