Monday, January 25, 2010

A hairy reed or a thin one?

Harry Reid is one of the Senators taking aim at Fed Chair Bernanke. His tepid endorsement and implied support in return for a more helpful Fed is repugnant.

The senators angry at the Fed for not printing more money simply don't get it. The Fed has expanded bank reserves at a very rapid pace. But it is banks that turn reserves into money by lending it. Their loans are redeposited by recipients into bank accounts where the funds are relent again. The process repeats in what is known as the multiplier effect.

The Fed does not create money. The Fed creates reserves which are the raw material for money supply. Interest rate policy is used to assist banks and the public in the expansion or retardation of loan growth and money growth. In this episode, the Fed has done all it can. Short of becoming like China, a bank that tells its banks to whom to lend, the Fed has done all it can. Those that castigate the Fed for not doing enough to grow the money supply are wrong and confused.

In the economic text books it is noted that when it is time to stimulate the economy the Fed's policies are hampered. Its attempts to stimulate are like pushing on a string. That is the problem, not Bernanke or that he has not done his job correctly or prudently. Oddly, those who want him do more are trying to lynch him for his role in in his activist stance under the previous Fed chairman. There is no ideological consistency to this criticism - it's all for political theater.

The view that Bernanke is damaged goods because he served under Greenspan misses the point that it was Greenspan who was the Chairman. No one ever accused Greenspan of sharing too much power. This never ending blaming of Bernanke for advocating low interest rates in the last cycle misses the point too. Low rates did not destabilize the economy. They stabilized it. With good lending practices the damage from low rates would have been minimal. The economy was not undone by 'too much lending' but by lending of a very poor quality and by too much leveraged lending.

It was Congress and it's pushing to extend home ownership- regardless of prudence that was at fault to a large extent. Banks engineered derivatives that were poorly constructed and not understood. that was their own error. A whole industry was set up to remain in denial and to defend the status quo of home loan production.

The SEC was in charge of securities regulation, not the Fed. The Fed's mandate was narrower than the SEC's. Yet the Fed did uncover mortgage irregularities and Greenspan stopped it from pursing those findings. How is that Bernanke's fault?

Perhaps the most amazing thing through all of this is that Greenspan seems to remain as a respected former Chairman despite his key role in all that went wrong while some in Congress have decided to go after Bernanke! The House Financial Services Committee and Senate Banking Committee were in the thick of making wrong policies especially regarding the missions of Fannie Mae and Freddie Mac. Yet these are the committees that have conducted the witch hunt. Read the WSJ Journal Op Ed then re-read this. The WSJ has it all wrong. The Witch hunters have it all wrong.

Bernanke is and was the right man for the job. There is little to blame him for. His innovation and consistency in sticking to the Fed's mission saved the economy. We should seek out those who attack the Fed and explore their ulterior motives. that would be the most productive tact at this point - after reappointing Bernanke, of course.

Wednesday, January 13, 2010

Financial Crisis Inquiry Committee

First of all I recommend looking at the picture in the WSJ of the four CEOs with their hands up taking an oath to be truthful. Is this the most board, lackadaisical set of oath postures you have ever seen? If you were taking an oath to tell the truth would you want to look a bit shaper and crisper and seem a little less board than say Lloyd Blankfein? Lloyd looks like he thinks he is operating a hand puppet. B of A's Moynihan looks like he has the stop sign on. Morgan Stanley's Mack seems to be waving as you would to some youngsters, arm bent, less than shoulder high. Only Dimon seems to be somewhat serious in his posture for the oath.

See link below for picture

I think body language matters

Blankfein was careful in this responses never to commit to anything. That sort of caution is a bit too cagey for me. I thought you were supposed to go to these sorts of hearings prepared.

Blankfein also was repeating the phrase about the 100 year s storm and being prepared for it. He cautioned about setting the whole financial system to be prepared for such an unlikely event.

It's an interesting tact on his part but it's wrong and the analogy is wrong too. It was a 100 years' flood not an uncontrollable, rogue, storm. Moreover, the financial firms were operating the sluice way and doing so in such a fashion that they mismanaged the dam's flood waters and wound up having to let the flood gates open full bore, imperiling everyone. This was no exogenous event. This was an event in which market participants laid their own ground work and they could have seen it coming if they had been paying attention instead of telling everyone that everything was fine. Fine it was not. Blank they were; fine it wasn't.

Jamie Dimon said that in their various stress tests or scenarios he did not consider that house prices might fall.


Now Alan Greenspan set the stage for such idiocy by saying that house prices never had fallen on a national basis in the US. As a 'stylized fact' Greenspan was right. But he was also so far off the true mark. It's a bit like saying Jack the Ripper was a nice guy because he never shot anyone. So he stabbed and sliced them? He didn't shoot anyone.

When Greenspan first made his now infamous statement on house prices I was immediately incensed. What and idiot I thought. Since the 1960s there have been several recessions and some of them deep (notably 1973 and then 1980 and 1981). But house prices had not fallen. Still the reason for that seemed quite clear to me: inflation. Inflation cooked in those recessions and real house prices did fall on a national level. Greenspan has glommed onto the WRONG statistic. I wrote several papers pointing that out. But he had the bully pulpit and most of Wall Street was a like a bobble head doll on his dashboard nodding even when the Great One hit a speed bump. No one was critical of G- Span and being critical of him did not get you much attention - far from it.

Nonetheless I wrote that we have seen real house price declines (house prices that rose more slowly than inflation). I extrapolated from this and argued that with inflation now low that meant we were more at risk than ever to a nationwide decline in NOMINAL house prices. No one listened.

This was simple economics but no one seemed to see it. It makes me wonder just how the street used economists. This cross-industry-wide mistake on house prices suggests that economists either were not used, were bullied, or were incredibly stupid in applying and thinking about what was going on in housing. It is hard for me to see how you could have been an economist specializing in that data and not catching on to that simple point about prices declining let alone carrying that train of thought to a broader and deeper conclusion based upon the ongoing lending recklessness. But apparently nobody did. That is Mr Dimon's version.

Dimon's assertion that house price declines were not even considered suggests strongly that no serious thinking about any negative consequences was in train: stressless-stress tests.

On balance the testimonies of these CEOs was not very reassuring. Moreover, they hardly come off looking like the smartest guys in the room as you might have expected of Corporate Titans paid the way these guys have been.