Federal Reserve Chairman Ben Bernanke has been nominated for a second term, and is facing a confirmation hearing in the Senate today. Below are the key parts of his prepared testimony, and my reaction to it.
“Over the past two years, our nation, indeed the world, has endured the most severe financial crisis since the Great Depression, a crisis which in turn triggered a sharp contraction in global economic activity. Today, most indicators suggest that financial markets are stabilizing and that the economy is emerging from the recession.
“Yet our task is far from complete. Far too many Americans are without jobs, and unemployment could remain high for some time even if, as we anticipate, moderate economic growth continues. The Federal Reserve remains committed to its mission to help restore prosperity and to stimulate job creation while preserving price stability. If I am confirmed, I will work to the utmost of my abilities in the pursuit of those objectives.”
I agree with the thrust of what he said there. Clearly, financial markets are in much better shape than they were a year ago, and that does not just mean the level of the Dow or the S&P. Credit market conditions, as measured by things like the rate that banks charge each other for short-term loans, and by bond spreads, are almost completely back to normal. That is not the sort of thing that gets a lot of media attention, but it is vitally important to the overall economy.
Just a year ago we had banks turning down letters of credit, which is a more effective way of stopping world trading ships than any fleet of submarines could ever hope to be. However, the damage caused by the freeze-up in the credit markets a year ago to the real economy was severe and has not been repaired as of yet — and it will be a long time before it is.
“As severe as the effects of the crisis have been, however, the outcome could have been markedly worse without the strong actions taken by Congress, the Treasury Department, the Federal Reserve, the Federal Deposit Insurance Corporation and other authorities both here and abroad. For our part, the Federal Reserve cut interest rates early and aggressively, reducing our target for the federal funds rate to nearly zero.
“We played a central role in efforts to quell the financial turmoil, for example, through our joint efforts with other agencies and foreign authorities to avert a collapse of the global banking system last fall; by ensuring financial institutions adequate access to short-term funding when private funding sources dried up; and through our leadership of the comprehensive assessment of large U.S. banks conducted this past spring, an exercise that significantly increased public confidence in the banking system.”
“Early and aggressively” is a relative term. I have no quibble with the term “aggressively,” but he could have moved earlier. Zero really is as aggressive as is mathematically possible when it comes to rates.
He does sort of gloss over where the Fed was in its role as a banking supervisor when all the crappy loans were being made. Granted, Bernanke was not in the driver’s seat at the Fed when the loans were being made, but he was in the car. He generally shared the anti-regulatory zealotry of Alan Greenspan.
However, once the crisis hit, I give him high marks for helping stabilize the situation. Now that the storm has passed, people are starting to forget just how close we came to the abyss, and the Fed’s actions were a very big part of avoiding it. Of course, those actions were not cost-free, but relative to the alternative, they were well worth it.
“We also created targeted lending programs that have helped to restart the flow of credit in a number of critical markets, including the commercial paper market and the market for securities backed by loans to households and small businesses. Indeed, we estimate that one of the targeted programs — the Term Asset-Backed Securities Loan Facility–has thus far helped finance 3.3 million loans to households (excluding credit card accounts), more than 100 million credit card accounts, 480,000 loans to small businesses, and 100,000 loans to larger businesses. And our purchases of longer-term securities have provided support to private credit markets and helped to reduce longer-term interest rates, such as mortgage rates.”
Yes, but what happens when it comes time to unwind those programs, or will they be permanent? Normally all central bank lending should be effectively riskless, and clearly the mortgage-backed paper that the Fed has been gobbling up ($1.25 Trillion worth) is far from risk-free. While this violates one of the central tenets of central banking, extraordinary times call for extraordinary measures. The Fed truly was the lender of last resort.
“Taken together, the Federal Reserve’s actions have contributed substantially to the significant improvement in financial conditions and to what now appear to be the beginnings of a turnaround in both the U.S. and foreign economies. Having acted promptly and forcefully to confront the financial crisis and its economic consequences, we are also keenly aware that, to ensure longer-term economic stability, we must be prepared to withdraw the extraordinary policy support in a smooth and timely way as markets and the economy recover. We are confident that we have the necessary tools to do so.”
Yes, technically the tools are in place to do it, but it will be painful when they get used. Eventually, all that excess liquidity will have to be withdrawn from the system, or we could have a very big inflation problem — but that is down the road a very long distance. Right now there is no real inflation pressure outside of commodities. Deflation is still probably the bigger threat, but I doubt that Bernanke will allow that to happen. If it starts to creep in, he will become more aggressive on the quantitative easing front.
The Fed has a dual mandate of providing price stability, and to foster the conditions for full employment. Right now, they need to focus squarely on the full employment front and not worry about inflation. The market clearly is not worried about inflation. Heck, right now people are willing to lock up their money for 30 YEARS for a return of just 4.32%, which is far below the historical norm for the long bond. Think of it this way: 30 years ago, Jimmy Carter was in the White House.
“However, as is always the case, even when the monetary policy tools employed are conventional, determining the appropriate time and pace for the withdrawal of stimulus will require careful analysis and judgment. My colleagues on the Federal Open Market Committee and I are committed to implementing our exit strategy in a manner that both supports job creation and fosters continued price stability.”
It would be a HUGE mistake to do so too soon.
“A financial crisis of the severity we have experienced must prompt financial institutions and regulators alike to undertake unsparing self-assessments of their past performance. At the Federal Reserve, we have been actively engaged in identifying and implementing improvements in our regulation and supervision of financial firms.”
Horses long gone over the horizon, barn door now closing. Well, better late than never.
“In the realm of consumer protection, during the past three years, we have comprehensively overhauled regulations aimed at ensuring fair treatment of mortgage borrowers and credit card users, among numerous other initiatives.”
These are not new problems, just ones that the Fed had refused to pay attention to for decades. Consumer protection was probably the least sexy and most neglected area of Fed bank supervision. Only under enormous political pressure — and the threat of those duties being completely stripped from the Fed — did they show even the slightest amount of concern about abusive practices by the banks towards consumers. Then again, the previous Chairman of the Fed, saw such moves as being totally unnecessary, that the magic of the market would cure any abuse there ever was, literally up to and including outright fraud.
The Fed is simply the wrong place to have consumer protection regulation; it needs to be under an actual federal government institution, not under a private entity owned and controlled by the banks it regulates. The Fed should focus on monetary policy, the safety and soundness of individual banks, and the overall stability of the financial system.
“To promote safety and soundness, we continue to work with other domestic and foreign supervisors to require stronger capital, liquidity, and risk management at banking organizations, while also taking steps to ensure that compensation packages do not provide incentives for excessive risk-taking and an undue focus on short-term results. Drawing on our experience in leading the recent comprehensive assessment of 19 of the largest U.S. banks, we are expanding and improving our cross-firm, or horizontal, reviews of large institutions, which will afford us greater insight into industry practices and possible emerging risks.”
The stress tests proved to be a brilliant move in restoring confidence to the banking system, and particularly to the huge and very troubled mega-firms like Citibank (C) and KeyCorp (KEY). While the baseline scenario used in the tests was a farce, the more adverse scenario did prove to be a relatively accurate forecast of the path of the economy, and it showed that the big systemically important banks could survive it — provided they were able to raise more private capital, and the stress tests played a role in allowing them to do so.
I would like to see the stress tests simply become a regular annual part of the bank examination problem, rather than a one-time extraordinary thing. It sounds like they are moving partially in that direction with his talk of horizontal reviews.
“To complement on-site supervisory reviews, we are also creating an enhanced quantitative surveillance program that will make use of the skills not only of supervisors, but also of economists, specialists in financial markets, and other experts within the Federal Reserve. We are requiring large firms to provide supervisors with more detailed and timely information on risk positions, operating performance, and other key indicators, and we are strengthening consolidated supervision to better capture the firmwide risks faced by complex organizations.
“In sum, heeding the lessons of the crisis, we are committed to taking a more proactive and comprehensive approach to oversight to ensure that emerging problems are identified early and met with prompt and effective supervisory responses.”
Good idea, but hardly a hard one to just now come up with. Why didn’t it get implemented sooner…like, say, 1913 when the Fed was founded?
“We also have renewed and strengthened our longstanding commitment to transparency and accountability. In the making of monetary policy, the Federal Reserve is highly transparent, providing detailed minutes three weeks after each policy meeting, quarterly economic projections, regular testimonies to the Congress, and much other information. Our financial statements are public and audited by an outside accounting firm, we publish our balance sheet weekly, and we provide extensive information through monthly reports and on our website on all the temporary lending facilities developed during the crisis, including the collateral that we take.
“Further, our financial activities are subject to review by an independent inspector general. And the Congress, through the Government Accountability Office, can and does audit all parts of operations, except for monetary policy and related areas explicitly exempted by a 1978 provision passed by the Congress. The Congress created that exemption to protect monetary policy from short-term political pressures and thereby to support our ability to effectively pursue our mandated objectives of maximum employment and price stability.”
True, relative to the near total-opaqueness of the Greenspan Fed, the Bernanke Fed has been as transparent as crystal. Bernanke actually talks in a way that any reasonably well-educated person can understand him, while Greenspan was the absolute master of talking but never really answering any question posed to him. While I applaud this trend, I would love to see still more transparency.
Being able to audit everything but monetary operations is a bit like an accounting firm being able to audit everything at Ford (F) except its auto operations. Monetary operations are the absolute core of what the Fed does. I understand the point about political pressure. However, the Ron Paul bill, which Bernanke was clearly referring to, allows for a six-month delay in releasing the audits. I could see a reasonable case for extending that delay to, say, a year, but not one for continuing the exemption from audit.
“In navigating through the crisis, the Federal Reserve has been greatly aided by the regional structure established by the Congress when it created the Federal Reserve in 1913. The more than 270 business people, bankers, nonprofit executives, academics, and community, agricultural, and labor leaders who serve on the boards of the 12 Reserve Banks and their 24 Branches provide valuable insights into current economic and financial conditions that statistics cannot. Thus, the structure of the Federal Reserve ensures that our policymaking is informed not just by a Washington perspective, or a Wall Street perspective, but also a Main Street perspective.”
But mostly a Wall Street perspective, particularly at the NY Fed, which is the most important of the regional banks. Bernanke is being a bit disingenuous here, suggesting that labor leaders or farmers have as much influence on the Fed as, say, Goldman Sachs (GS). Clearly, that is not the case.
“If confirmed, I look forward to working closely with this Committee and the Congress to achieve fundamental reform of our system of financial regulation and stronger, more effective supervision. It would be a tragedy if, after all the hardships that Americans have endured during the past two years, our nation failed to take the steps necessary to prevent a recurrence of a crisis of the magnitude we have recently confronted. And, as we move forward, we must take care that the Federal Reserve remains effective and independent, with the capacity to foster financial stability and to support a return to prosperity and economic opportunity in a context of price stability.”
Overall, if I were sitting in the Senate, I would vote to give him a second term. While he got off to a slow start, once he got moving he moved decisively and literally saved the world as we know it.
Were some mistakes made? Of course there were. However, it is now clear that the TARP program was a huge success, and the taxpayers might even make a small profit off of it. My biggest problem is that we should have made huge profits from it given the risk we were taking.
But those negotiations were mostly done at Treasury, not at the Fed. Hank Paulson simply refused to negotiate reasonable terms on behalf of the taxpayers, and in the process gave away tens of billions to his old buddies. However, the program did its job, and prevented the total collapse of the U.S. and world economy. The news today the Bank of America (BAC) will payback the $45 billion it took in TARP funds is a big positive. That will help take some of the pressure off the budget deficit, and is a good sign of stability in the financial system.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market-beating Zacks Strategic Investor service.
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