Where have I heard this before?
"Bernanke Said to Minimize Asset-Bubble Concern at Meeting." This little headline lit up Bloomberg.com over the weekend.
Apparently, Federal Reserve Chairman Ben Bernanke made statements along this line to a meeting of dealers and investors during February. The meeting was with the Treasury Borrowing Advisory Committee.
Not surprising. Earlier in the 2000s it seems as if the Federal Reserve leadership at that time, Fed Chairman Alan Greenspan and Fed Board member Ben Bernanke, ignored what was going on in the housing bubble and elsewhere, as they kept interest rates quite low in order to avoid a severe recession.
The effective Federal Funds rate was kept around 1.00 percent from July 2003 through June 2004.
Concern over a housing bubble ... or, any kind of bubble ... was minimized by the Fed's leadership throughout this time period.
And, how fast were housing prices increasing during this time?
According to the article in Bloomberg, "The Fed Chairman brushed off the risks of asset bubbles in response to a presentation on the subject from the group, one person said. Among concerns raised, according to this person, were rising farmland prices and the growth of mortgage real estate investment trusts. Falling yield on speculative-grade bonds also were mentioned as a potential concern, two people said."
This report, to me, rings true.
Bernanke seems to have a "tin ear" when it comes to reading the financial markets. If there has been one thing Chairman Bernanke has been consistent on during his time at the Fed, both as a Board Member and as the Chairman, it is this.
Remember, Bernanke was even saying the August 2007 financial disturbance that he was most concerned about the economy overheating and inflation getting out of control.
I quote from the excellent book, "The Quants" - "At the start of August 2007, the nation was treated to the typical mid-summer news lull…But beneath the calm surface, a cataclysm was building like magma bubbling to the surface of a volcano. All the leverage, all the trillions in derivatives and hedge funds, the carry-trade cocktails and other quant esoterica, were about to explode." (Page 209) (See my review of the book "The Quants" in "Model Misbehavior.")
So, just before the financial problems began, Bernanke was for a tighter monetary policy. After the financial problems began, Bernanke took a completely different stance: (See "The Bailout Plan: Did Bernanke Panic?)
I do not get my forecasts for the state of the economy and for the financial markets from Mr. Bernanke.
And, the dissent to Mr. Bernanke has surfaced during the month. Jeremy Stein, a member of the Board of Governors, has pointed to some areas in the financial market when continued watching is needed. For example in a speech on February 7 titled "Overheating in Credit Markets" Mr. Stein called attention to the corporate bond market. He states, "We are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit."
Note that Stein, in this speech, also called attention to the action in mortgage real estate investment trusts.
Furthermore, Ester George, president of the Federal Reserve Bank of Kansas City, in a January 10 speech, pointed to fact that the prices of assets such as bonds, agricultural land, and high-yield and leveraged loans were at historically high levels.
The point is that our leader of the Fed, Mr. Bernanke, has an awful record when it comes to understanding financial markets and especially understanding asset bubbles.
Plus, Mr. Bernanke doesn't seem to be in the least bit worried about what is going on in the government bond markets. He just pushes to keep quantitative easing going on…and on…and on.
No mention is made of the fact that international investors are still putting billions of dollars into the financial havens they believe have the least amount of risk ... German bunds and United States Treasury issues. These flows into low risk governments have once again driven down the yields on ten-year issues from highs reached just a week ago or so.
The real evidence of this, to me, is that fact that the yields on US Government inflation-adjusted bonds (TIPS) remain substantially below zero. Ten-year TIPS closed around a negative 58 basis points on Friday.
The fact that so much international money has flowed into Treasury bonds impacts that whole yield structure. It is interesting to me that the spread between the nominal ten-year Treasury issue and the ten-year TIPS yield is around 260 basis points. One can call this spread the markets' expectation of future inflation. That is, the market expects over the next ten years that inflation in the United States will be somewhere around 2.60 percent.
The interesting thing is that when money seems to be going out of the United States bond market the negative yield on TIPS seems to become less negative and the nominal yield becomes greater. However, the difference between the two still stays around 2.60 percentage points.
Of course, having all this money flowing into the United States keeps the borrowing costs to the United States government down and it reduces the amount of United States Treasury issues that the Federal Reserve has to buy for its quantitative easing program.
When these international monies really begin to flow the other way, then it is going to be a much different story for the Treasury Department and the Federal Reserve. (See "A Coming "Rout" in US Government Debt.") But, that will be another story.
The basic problem is that I have very little confidence in the Chairman of the Board of Governors of the Federal Reserve System when it comes to understanding what is going on in the economy and what is going on in the financial markets. Given this low degree of confidence in the leader of the Fed, how can I have any confidence that Fed will be able to do the right thing when it comes to un-winding and removing all the liquidity it has forced into the banking system?
Bernanke missed the bubble in housing prices, he missed the financial collapse, he seemed to "panic" at the time of the Lehman Brothers collapse, and he continues to seem to be out-of-touch with the tenor of the financial markets and the wave of funds flowing into the shadow banking system. What is there to be confident about?