Bernanke's Wealth Effect Or A Credit Bubble?

by: John M. Mason


Bernanke wanted to create a wealth effect.

America's wealth is at the highest level ever.

Maybe this increase is not exactly what Mr. Bernanke counted on.

Former Chairman of the Board of Governors of the Federal Reserve System, Ben Bernanke argued that the way to speed up economic growth was to create a consumer "wealth effect" and this would drive consumption spending, which would lead to business investment, and so on and so forth.

The support of this argument came from his academic research, among other things.

Well, in the first instance, Mr. Bernanke was very successful in his tenure as Chairman of the Fed. We read in the Wall Street Journal, "U.S. Household Net Worth Hits Record High."

"Americans' wealth hit the highest level ever last year…reflecting a surge in the value of stocks and homes that has boosted the most affluent U. S. households."

Mr. Bernanke was a success, after all!

Well, at least it appears so.

But, there are rumblings on the sidelines. For example, Andrew Smithers writes in the Financial Times, "Households have been persistent sellers of shares…"

On the other hand, Smithers continues, "companies have been major buyers and have issued a lot of debt to help finance these purchases and, as the Fed have been buying other forms of debt, the sellers have been eager buyers of company debt."

"When the Fed buys assets the sellers have money and, unless they wish to increase their cash holdings, they will attempt to spend the money on other assets. Unless there is a rise in liquidity preference, which is when investors want to hold more cash, this will push up asset prices."

Included in this piece by Smithers is a chart that graphs the rise of the S&P 500 stock index and the Monetary Base, the financial variable that is most closely impacted by the Fed's purchases of securities. There appears to be an almost uncanny, one-to-one correlation between the rise in the stock index and the rise in the Monetary Base.

The New York Times reported that, "One private equity chief went so far as to publicly thank Ben S. Bernanke, the Federal Reserve chairman until last month, whose program of extraordinary economic stimulus has helped push stocks higher, feeding the private equity machine.

"Thank you, Ben Bernanke. I saw him last Thursday, and I thanked him," Mr. Schwarzman of Blackstone said during a conference in December.

And, what about the rise in house prices. Well, this doesn't seem to be exactly a result of middle class exuberance. In fact, it seems as if some of the big players in the housing area are hedge funds, private equity groups, real estate firms, and wealthy individuals. Here are just two of my recent posts on this issue: "More Evidence of How the Wealthy are Getting Wealthier" and "Restructuring the Housing Industry: Deals Galore."

But, this is not all. Credit seems to be flowing out to the entire world. Tracy Alloway writes in the Financial Times, "Can nothing stop the runaway capital market train. It seems not, after the US delivered record corporate bond sales this week..." and this despite all the world turmoil going on during this time.

Alloway has also, recently, written about the strength in other, unusual, credit market developments, like the "Race to Joint Rally in Subprime US Car Loans" and "Non-bank Lending Steps Out of the Shadows."

There is lots of evidence that the Fed's quantitative easing has been a boon to those financial institutions that work in the "shadows".

And, it seems as if this kind of economy has been building for a long time. For example, people do change their behavior patterns over time in the face of, say, unchanging governmental policy. A classic example of this is seen in the response of the economist Milton Friedman to the argument that there was a tradeoff in the economy between inflation and unemployment. Those in favor of using government stimulus to lower the unemployment rate stated that it would be an acceptable tradeoff to create a little inflation if the policy of stimulus could lower the unemployment rate. The assumption built into this tradeoff is that the tradeoff would never change.

Friedman argued that after a while, people would change their expectations about inflation, and that the tradeoff would only work if the government accepted a higher rate of inflation for the same reduction in unemployment. Friedman concluded that to continue to achieve the same lower rate of unemployment, the government would have to create rising levels of inflation.

I believe that we have seen the reality of this kind of behavior over the past fifty years, only that it has exhibited itself in a slightly different way. As, for example, the Federal Reserve has pumped more and more funds into the financial system, fewer and fewer of these funds flowed into the production of goods and services and more and more of them went directly into financial transactions. Thus, we could see asset prices rise, like the price of stocks and the price of homes, without the creation of much more economic growth.

In the current environment, we are seeing a large portion of the Fed's newly created funds are flowing into the financial circuit and not going into "real" economic activity. Thus, Mr. Bernanke has gotten his increases in "wealth" in the economy, but there has been very little spillover into greater economic growth. Credit is growing… but, the economy is not.

Ms. Alloway, in the first of her articles mentioned, writes "Although continuing acceleration of the stock market has made all the headlines in recent months, it is the credit market that has been experiencing the biggest boom since the US Federal Reserve began its unconventional monetary policies in 2009. While $132 billion has flowed into global equity funds in the past five years, a staggering $1.2 trillion has poured into global bond funds, according to net figures from Goldman Sachs."

She continues, "Sales of corporate debt and leveraged loans have boomed in recent years. Issuance figures are through the roof and some hallmarks of pre-financial crisis lending practices have returned. The amount of borrowing used to fund the leveraged buyouts undertaken by big private equity firms is creeping back to levels last seen in 2007, for instance."

But, it is not the banks that are the culprits. The banks are not playing that game. The big ones are trying to thrive on "trading". Ms. Alloway writes, "In terms of credit, the best-endowed Wall Street players are now at places like Pimco and Apollo."

Mr. Bernanke helped to create a whole new world of credit. In the process, he has gotten a rise in America's wealth to where it is the "highest level ever." Yet, I am not sure that the result he has achieved is quite what he was looking for.

The title of Ms. Alloway's article is, "Banks are a Proxy for Credit Bubble Fears."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.