demandside

Bernanke has bet the house, we hope his theory is right.  But it likely is not.

oday, Idiot of the week, Ben Bernanke.

Audio from his speech to the Economic Club of New York last week.

Bernanke looks not so much like Baffled Ben as I have called him, but more like Pall Bearer Ben in the CSPAN video.

BERNANKE

Enough.  I probably let that go on too long, but it is fascinating how Bernanke’s dry Fedspeak cannot conceal the increasing momentum of the financial unraveling.

“Now has the tools.”

I have the recurring image of a bridge that has collapsed.  With all the derivatives, credit default swaps, hedge fund schemes, and the rest, 30-to-1 leverage was just not enough.  The bridge collapsed under the weight of bad securities and bad practices predicated on a housing bubble.  The enormous leverage ratios are coming back down on them in a multiplied seismic event.

To say this is a crisis of confidence is something like saying we should cross the bridge even though it has collapsed.  Papering over the current mess or throwing up a few struts against its weakest members is like putting plaster over the cracks.  It is not very convincing.

Confidence has been lost and continues to be lost because these institutions are opaque with regard to their real financial positions.  They don’t trust themselves is what the interbank lending rate is telling us.  Why should we trust them?

It is not a crisis of confidence, it is a crisis of structural damage that needs to be repaired, or rather a market that needs to be restructured to a more sound design.  The current scheme of government props and combining failing banks with larger banks is a practice of lashing a crumbling column to its neighbor and saying that makes things stronger.

What we need is a bridge of many support columns spaced to share part of the load.  What we are getting is a span supported by a few huge pillars of uncertain strength.

And this does not even address the shadow banking system.  AIG was an insurance company that wrote gargantuan sums of credit default swaps, unsupported insurance on financial events that have now come to pass.  There is a dark forest of unregulated hedge funds and private equity funds which will unwind with perhaps devastating consequence.  They are not yet mentioned by the Fed and Treasury.

As for the so-called novel aspects of the crisis, the complexity of the financial instruments and the speed of light that connects the world.  These are the problem only insofar as the complexity and the speed involve opaque instruments and unregulated markets.

Bernanke and Demand Side have two different views of acting quickly.

The Fed Chairman claims that he acted quickly, although somewhat later he mentions that he waited until all other options were exhausted before condoning direct government intervention.

The acting quickly part is his so-called “classic tenets of central banking” practice of injecting liquidity and cutting interest rates.  This is classic only for the past twenty years, when Maestro Magoo, Alan Greenspan, used a river of cheap money to wash away every negative economic event.  Prior to Greenspan, Volcker ignored the S&L’s (and actually contributed to their downfall) when he restricted the money supply to combat inflation.  Both are monetarist solutions, and neither solves anything, but only kicks the can down the road.

The Volcker experiment created enormous unemployment on the front end and the S&L debacle on the back end.  The current Greenspan/Bernanke sequence of monetary expansions has — as attested to by George Soros and many others — led directly to a sequence of financial bubbles.  Ever bigger bubbles which are now collapsing.

The word “classic” in Mr. Bernanke’s speech, should be corrected to “modern.”  Prior to Volcker, Greenspan and Bernanke, the Fed was relatively subdued.  And we must notice that prior to these three the trend growth of the economy was twice what it has been since.

In the very distant past, the enormous stresses of transition from war to peace under Harry Truman, which included inflation pressures greater than any we have seen since, was accomplished with no — zero — monetary tools.  Monetary policy was closely held by the administration and closely linked with fiscal policy until the Treasury Accord of 1951, which extracted sovereign control of monetary policy for the unelected Fed.

We will say that Bernanke acted quickly, but quickly in doing the wrong thing.  It was obvious from the beginning that banks had been crippled by their own hand and that the system needed to be recapitalized.  You will remember Paulson waving in the sovereign wealth funds in the fall of 2007.  Demand Side wondered at the time why the US sovereign wealth fund didn’t move in.

And Bernanke is admitting here that his riding to the rescue did not rescue anything.  But he is not deterred.  Fannie and Freddie, Lehman, AIG, TARP, etc., etc.  Perhaps his best line of the evening from Bernanke is the “we will not stand down” line.

RECAP 30

Bernanke’s academic and professional reputation lie with the theory that saving the banks will save the economy.  Many politicians during the recent rush to TARP were impressed that this man was a great expert on the Depression.  That was a naive attitude, because it did not understand that Bernanke’s theory has not been tested, and it is far different than the remedies applied by those on the ground during the Depression.

During the first 100 days, FDR and his brain trust required bad banks to close, all banks to be subject to regulation and transparency, and only then the good banks were recapitalized.  And then, and even then, the economy did not recover simply because banks returned to solvency and started lending again — the Paulson/Bernanke line — but recovered only after the Roosevelt Administration applied fiscal recovery programs for jobs, public works, and ultimately because of the fiscal shock of the Second World War.

So we do not share Mr. Bernanke’s confidence that,

RECAP 130-147 Hoisted from Comments: Kaleburg: Grasping Reality with Both Hands: The Semi-Daily Journal Economist Brad DeLong: Re: “There is a serious misconception among many macroeconomists that this is a replay of the events that triggered the Great Depression. We don’t have a liquidity crisis, we have a trust crisis brought on by an overabundance of inscrutable financial instruments.”

If you actually look at the Great Depression, it started with a liquidity crisis [in the fall of 1929], but [that soon came to an end, and] through the 1930s there was more than twice as much money sitting around in T-bills getting 0.8% as there was money running up real estate and stock prices in the 1920s. While the main fear in the 1930s was that the weak recovery would collapse, there was a real fear that this money might fund a new bubble from which recovery might be unimaginable. We are still in late 1929. Secretary Mellon, in his annual fiscal statement, was quite optimistic despite the 15% drop in housing starts. He didn’t have the advantage of hindsight either.

I’m with the dead parrot theory. Preserving zombie banks is a waste of money. If the problem is credit, the government should provide credit, not prop up obsolete credit organizations.

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