Bernanke Reappointment: Irrational Exuberance?

by: Ray

The markets and economists are thrilled with the reappointment of Ben, but is this just another case of irrational exuberance? I think so. His policies are too similar to Greenspan and he made some very horrible mistakes which will eventually cost us. However, I will concede he did do some things right and because of this I think you can make a case for or against Ben being our Fed Chariman. However, the one thing that bothered me about Obama’s speech yesterday was his consistent reference to an independent Fed, more on that later.

What Ben did wrong

Starting in 2003 Ben had been a strong supporter of cheap money and endorsed Greenspan’s policies, which earned Ben the nickname Helicopter Ben. There is no way anyone who takes a rational look at the policies of the Federal Reserve in the early 2000’s can say no one could have foreseen the problems we have today. Time and again loose money policy has created bubbles, this is no surprise, and this last bubble was the bubble of all bubbles which the Fed is completely responsible for.

The Fed has also become more of a market appeaser than the organization that is supposed to manage our money supply. What I mean is that the Fed adjusts interest rates based on what the market wants, versus what it should actually do. The economy and the markets are totally different and have to be managed differently. Going back to the 1990’s the Fed has been increasing liquidity and doing everything it could to increase credit to everyone, whether they deserved it or not. The Fed cannot create credit, but it can make money so cheap that banks can afford credit losses and that is exactly what happened until cheap credit made its way to mortgages.

A perfect example of how the Fed is more accommodating to the markets than the real economy is when the Fed started raising interest rates in the 2003 area; companies like Ford (NYSE:F) came out crying. The Ford CEO said interest rates need to be lower so they can sell more cars at zero interest rates. What happened? Rates leveled out for a time when they should have been much higher. In fact, one can argue that the Fed raises and lowers rates at the wrong time frequently. There are countless other examples, but clearly the Fed is more interested in keeping securitized loans going instead of the old fashioned types of loans that actually stay on the books of banks.

In 2007 Ben said that sub-prime is contained and that there is no problem with the mortgage market, Cramer said the same thing in July of 2007, just practicing full disclosure. However, in August of 2007 the Fed knew there was a problem and started putting hundreds of billions into the overnight market. Either he lied to us or he just felt as though adding liquidity at that level was just a good thing. Regardless, August of 07 Ben should have been adding special liquidity features then, but he waited. In fact, he continued to lie to the American public about the real problems we faced. They knew then the problems that we had, I knew then, but Ben either ignored them or thought he knew better. Perhaps it was a political move to show how good the Federal Reserve is for the economy when they fixed the very problem they caused.

Now we have a $2 trillion dollar Fed balance sheet, expected to grow to $4 trillion, and the Fed is now playing all sorts of games. For example, they moved many of the troubled securities from private banks to, essentially, the government’s balance sheet. We also see some more strange events, like a nice ‘other contract’ section to their balance sheet which, presumably, is some sort of derivative product they have taken on. The question is, if these are derivatives what happens to our country if they blow up?

Finally, we have the monetization of debt that the Fed had started with its quantitative easing program. Monetization of debt is the worst thing a country can do and is a signal that they do not believe others will buy their debt so they buy it themselves. This will eventually create inflation, but in the meantime it destroys the country’s currency, look at the DXY for an example of this. The Fed has also started playing games here as well with having primary dealers sell them new issue treasuries from the last few auctions we had. This artificially boosts demand and keeps the market happy, but, again, is terrible for the currency and a sign that other countries are considering cutting us off.

A case for Ben

He came in and created several innovative programs to fix the mess that they caused. There is no doubt that TALF and other programs have helped improve the economy. I cannot take that away from Ben, but would we have even needed to be saved if the Fed had acted responsibly over the last 20 years? I think you know the answer to that question. However, the Fed did step up with these innovative programs and zero interest rates, but this is likely to create more problems in the future.

Frankly, other than the innovative programs he started there really is no case for him to have a job. There is one exception to that statement. With Ben we know what we are getting and he might be able to know when to stop the programs he started. If we got a Larry Summers, (thank God we didn’t), we would have no idea what his policies would be. The unknown is a major problem which is why, in my opinion, Obama is keeping Ben. Since Obama is already moving drastically away from traditional policies, if he threw another unknown into the mix he could have a major issue if things blew up. Ben was a safe option for Obama. The reappointment comes on the heels of the notion that the Obama administration still has no clue how bad things were, or are, in the economy and that they cannot do math correctly with the projected deficit error that they made earlier in the year.

What I think

I think Ben should have been fired and the Fed needs to be rolled into the Treasury department, it is really that simple. Keep all of the governors the Fed has, but if they are a government organization then they would actually be held accountable for their actions. That, of course, would never happen, but I like to think that it could. The Fed has outlived its usefulness and has caused all of the booms and busts we have ever had, why do you think we had the Great Depression in the 1930’s and not in 1907?

Frankly, we will never really know what the Federal Reserve is up to because they do not show anyone their books. The ‘other contract’ column for example, what is it and what risk does the Fed hold on its balance sheet? We don’t know because they do not and will not open their books. When asked who received TARP funds the Fed refused to divulge who got what because it would ‘jeopardize the firs reputation’ or some nonsense like that, that is about to change as the Fed lost the FOIA lawsuit Bloomberg filed.

The point is we know very little about this very privately owned organization that controls our money. Rolling up the Fed under the Treasury Department makes perfect sense because we will know everything that is being done and banks will have the lender of last resort. This is the 21st century and we are still under the 20th century monetary policies which is absurd.

As a nation we can no longer continue creating credit bubbles and have a monetary policy that has caused the dollar to lose 95% of its value since 1971. I am not saying a gold standard or anything like that, but how about a monetary policy that does not cost us any interest to print any money? The problems with the Fed will continue and, perhaps, get worse if Obama gets his way and grants this private organization more control over the financial system. Why would you give a failed organization more power? I guess this is what we get when we elect lawyers to represent us.