Bernanke Speaks, Stocks Fall

Federal Reserve Chairman Ben Bernanke testified before the House Budget Committee Wednesday calling for fiscal balance and voiced the need to limit debt issuance, presenting a less than rosy picture, including a projected $1.8 Trillion federal budget deficit and rising Treasury interest rates over concerns about the deficit. He said the Fed has limits and will not monetize the debt. Stocks did not respond well.

MARKET ACTIONS YESTERDAY

Here is how US stocks, non-US developed market stocks and emerging market stocks acted yesterday:

Here is how US bonds, non-US developed market bonds and emerging market bonds acted yesterday:

Here is how different types of US bonds acted yesterday:

SELECTED BERNANKE TESTIMONY

On Fiscal Management:

Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance.

He pointed out that before the crisis, the US federal debt was about 40% of GDP, and that by 2011 it’s likely to be about 70%. He said, “These developments would leave the debt-to-GDP ratio at its highest level since the early 1950s, the years following the massive debt buildup during World War II."

… unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth.

On Retiree Entitlements:

Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the Baby Boom generation and continued increases in medical costs.

[He pointed out that SS and Medicare funds could be depleted in a few years]

On Taxation:

In the end, the fundamental decision that the Congress, the Administration, and the American people must confront is how large a share of the nation’s economic resources to devote to federal government programs, including entitlement programs … Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient enough to achieve an appropriate balance of spending and revenues in the long run …

On Mortgages and Lending:

My impression is that most (mortgage rates) reset on shorter-term interest rates, like the LIBOR rate, which is very very low right now, or the Treasury bill rate. Since the Federal Reserve brought interest rates down to such a low level in the last year, concerns about resets in the mortgage market have considerably been reduced.

[We read that statement as; if rates rise for whatever reason, such as inflation, falling Dollar, lower bids from China or others, mortgage rates will rise and a new wave of foreclosures and bank asset troubles will wash over the US]

Financial markets and financial institutions remain under stress … and low asset prices and tight credit conditions continue to restrain economic activity.

On The Economy:

Even after a recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further … We expect that the recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, and the unemployment rate is likely to rise for a time, even after economic growth resumes.

We think these are still very difficult times, warranting cautious risk taking.

Disclosure: we one one or more of each of the securities mentioned in one or more managed accounts.

Comments

[Moon Kil Woong:]

Why doesn't Bernake quit talking and do something about inflation. While he jawbones about the US spending too much he pumps trillions of loose money into the market in zirp rates, debt guarantees, and by blowing his own balance sheet to the gearing levels of a 2007 bankrupt brokerage firm.

It could be argued, he is more responsible for the fleeing of investors out of bonds, the rise of long term treasury yields, and rising inflation concerns than Congress or the Treasury.

So in conclusion, Bernake should speak to himself about unsustainable actions, because what he is doing is anything but unsustainable or prudent.

Jun 04 07:25 AM

[Tony Petroski:]

Bernanke: "Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient enough to achieve an appropriate balance of spending and revenues in the long run …"

It's crucial to distinguish between tax rates and tax revenue.

Starbucks doesn't turn their company around by "raising revenue" in the form of $10-per-cup coffee. Neither does the U.S. Government maximize tax revenue by raising rates at the already confiscatory levels.

Jun 04 10:05 AM

[swaps:]

I agree that taxes should be low and government overhead should be even lower.
But what can you do but raise taxes now that the free market terrorists have destroyed the economic system and the free market officials in control shoveled huge amounts borrowed from the Fed and to be paid back to the Fed, with interest?

Jun 04 10:43 AM

[dcb:]

this may sound silly, but banks and the market do not care about defecit in the short term. the more money spent, wasted, etc the more the market will actually go up.

Make the dollar a worthy currency, hold the printing presses, create stability instead of short term boom and bust and the market will punish you.

My theory is that you will know a policy is effective it it drops the market. Just an idea, but I'd love some feedback. I can argue the point with examples. It's a joke, but it isn't.

Jun 04 12:34 PM

[Buckoux:]

The Fed Chair, that is the position itself, has taken on a cartoon fiction-like quality since Volcker. Chairman's Greenspan and Bernanke are now not persons, but "characters". Why would any prudent person trust their future to "characters"? They are like two clueless doctors. One doc amputates the wrong leg, the other doc, brought in to save the patient, amputates a perfectly good arm instead of the diseased leg. The patient may survive with more surgery, but will be severely handicapped. Meanwhile, these "surgeon's" are celebrated by those who they continue to harm. Physician, heal.............Oh, never mind!

Jun 04 12:44 PM

[Dana H.:]

The statement "free market officials in control" betrays the ignorance of those who blame the financial crisis on the free market.

In a genuinely free market, no one is "in control". There is no Fed, no Fannie, no Freddie, no TARP, and no Community Reinvestment Act. If you want to see how an economy can thrive in the absence of all these, read the first part of the following Seeking Alpha post: seekingalpha.com/artic...

Jun 05 02:19 PM