A New Viewpoint on Bernanke

by: Jeff Miller

With so much written about Fed Chairman Ben Bernanke, you might doubt that there is anything fresh to say. Wrong!

Not only is there a new way to think about Bernanke, it will probably help your investment results.

One of the most costly mistakes that traders or investors could make over the last two years is the "Bernanke Blunder." This mistake includes everyone who has left money on the table -- or even worse, lost through shorting the market -- because of their opinions about the Fed Chair.

There are many reasons why people might choose to dislike Bernanke:

  1. He was appointed by a Republican, so Democrats might object.
  2. He was reappointed by a Democrat, so Republicans can object.
  3. He is an academic, so everyone who thinks he is smarter, wiser, or has more street sense than the Chairman of the Princeton Economics deepartment can show his superiority. You know about inflation, and he obviously does not!
  4. He has Keynesian roots, from his research and books. Those with a different economic philosophy can pound away with "hair of the dog" homilies -- no data required.
  5. He is the head of a central bank. Anyone who disagrees with the concept of central banking can choose Bernanke as the personification of this evil.

But the biggest Bernanke criticism, by far, is one of competence. Many question his economic knowledge and leadership. There is a single widely-cited moment that critics use -- the "containment statement."

Let us turn to Colin Barr, one of our featured, authoritative sources. Writing three months ago, he noted Bernanke's five-year anniversary (Has it really been that long?) in Bernanke's biggest blunders. Here is blunder #1:

March 2007: Saying subprime was contained. Bernanke will never live down his remark to Congress that "the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained." The damage to Bernanke's reputation, by contrast, has turned out to be almost unlimited.

This is an accurate assessment or the impact, and Colin also acknowledges that it is a tough job. Let's take a closer look at the "containment remark."

The Word Cloud Test

After Wednesday's press conference, several bloggers used the "word cloud" approach to illustrate both what was emphasized and what was missing. Here is a good example:

[Click all to enlarge]

Bernanke Presser Cloud
Bernanke critics urge you to look for the words "jobs" or "dollar."

How about the word cloud from the 2007 Congressional testimony?

Wordle: Bernanke

You can look hard to find "contained," but we do see "subprime." So what did Bernanke say that generated so big an image for subprime and nothing for contained?

Here are some of the quotes that no one ever cites:

Developments in subprime mortgage markets raise some additional questions about the housing sector. Delinquency rates on variable-interest-rate loans to subprime borrowers, which account for a bit less than 10 percent of all mortgages outstanding, have climbed sharply in recent months.


As a result of this deterioration in loan performance, investors have increased their scrutiny of the credit quality of securitized mortgages, and lenders in turn are evidently tightening the terms and standards applied in the subprime mortgage market.

And finally:

This forecast is subject to a number of risks. To the downside, the correction in the housing market could turn out to be more severe than we currently expect, perhaps exacerbated by problems in the subprime sector. Moreover, we could yet see greater spillover from the weakness in housing to employment and consumer spending than has occurred thus far.

The testimony was incorrect in the specific forecast, but it was not the conclusion of a clueless bozo, totally unaware of the subprime threat.

Why Was "Containment" So Wrong?

In evaluating the "containment" forecast, there is another very important factor to consider. Bernanke (and nearly everyone else using actual data) looked at the overall size of the subprime market and made a forecast. Little did he (or others) know that Goldman Sachs (NYSE:GS) alone had created over $73 billion in synthetic subprime instruments. Most of those who claim to have been right on housing forecasts did not write about any of this at the time.

It was only later, when we got the hearings for the FCIC, that we saw the size of the problem. I covered this in my review of Michael Lewis's excellent book, The Big Short. I recommend my review to show how so many made this mistake, and the book to get the color. Even the heroes who were shorting the market had no idea that the side bets were so much larger than the original subprime market.

Investment Conclusion

Market participants are much harder on Bernanke than mainstream sources. You are free, of course, to draw your own conclusions. When investing, however, it is probably wise to remember that Bernanke is making the decisions. He has been quite clear about his intentions, reaffirmed and slightly clarified on Wednesday.