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Bernanke Refrains From Using The “R” Word
Comment 4/4/2008
BERNANKE REFRAINS
FROM USING THE “R” WORD
Federal Reserve Chairman Ben Bernanke has been very
busy this past week, giving testimony before the Joint Economic
Committee of Congress and before the U.S. Senate Committee on Banking,
Housing and Urban Affairs. The Chairman discussed the effectiveness of
recent actions by the Federal Reserve to stabilize financial markets and
gave a status report on current economic and financial conditions.
Bernanke held up well before both Congressional bodies, particularly
when grilled by the joint Congressional Committee which seemed
especially interested in the Fed’s role in saving Bear Stearns from
almost certain bankruptcy. It characterized the action as a “moral
hazard.”
BERNANKE ADMITS A “RECESSION” IS POSSIBLE
This is the first time
the Fed Chairman has admitted that the U.S. could “slip into a
recession” this year, noting that the turmoil in the housing and credit
markets are limiting any near-term economic recovery. However, Bernanke
offered a ray of hope, saying that he expects the economy to “rebound
slowly” in the second half of the year as the effects of lower interest
rates (an initiative which began in earnest in the last quarter of 2007)
and as checks from the stimulus legislation are placed in the hands of
consumers who will more than likely spend them immediately. Bernanke
defended the Fed’s actions, stating that it has continued to ease
monetary policy to forestall a recession. (Many economists believe the
U.S. is already in the throws of a recession, notwithstanding the
National Bureau of Economic Research’s reticence to officially declare a
recession.)
BERNANKE’S COMMENTS DASH HOPES THAT A BOTTOM
IS AT HAND
Our expectation is that
the economy will remain weak for the entire year, perhaps even extending
into the first two quarters of 2009 as housing (a major store of wealth
when compared to stocks and bonds) is unlikely to experience a
“V-shaped” recovery. Moreover, stocks may seem expensive with the
release of first quarter earnings. They have not fallen as much as
earnings, which is the reason P/E’s have held up. Until the market
absorbs weaker corporate earnings stocks will be vulnerable to downward
pressures. Thus it is difficult for us to embrace the market gains and
horizontal movements posted in recent weeks. It is not the eagerly
awaited “bottom” yet.
CONGRESS PRESSURES BERNANKE FOR ANSWERS
Certain committee
members pressed Bernanke hard, asking why the benefits of interest rates
cuts and the stimulus package had not yet produced any noticeable
benefits. The Fed hopes that these actions, together with the steps
taken to foster market liquidity, will promote growth and mitigate the
risks to economic activity. The Fed reduced the federal funds rate by a
total of 125 basis points in January and by an additional 75 basis
points in March, leaving the current Federal Funds rate at 2 ¼ %, 3
percentage points below its level last summer. The Fed does not appear
to be averse to lowering again when it meets at the end of April.
Currently, there is a strong consensus that rates would be reduced by
25 basis-points, to 2%, with a minority of economists forecasting a 50
basis-point cut. We anticipate that the Fed will move more slowly at
this stage and think a 25 basis-point cut is most likely (with the
caveat that there are no further jolts to the economy between now and
the April 29th - 30th meeting).
BERNANKE’S ECONOMIC OUTLOOK
The Fed chairman reiterated his view that in order
to alleviate the current economic slowdown and the financial havoc
brought on by the housing mess, the Board has substantially eased
monetary policy and taken strong actions to increase market liquidity.
This has included shoring-up market confidence by preventing Bear
Stearns from slipping into bankruptcy. Bernanke asserted that recent
Fed actions appear to have helped stabilize the situation somewhat.
Still, he said, the financial markets remain under considerable stress,
acknowledging that the economy is “going through a very difficult
period.” Bernanke appeared confident that the Fed has responded
constructively to support the economy as well as to promote long-term
growth.
Congress pressured Bernanke for simple solutions to
the current economic woes. For example, twice he was asked to offer
three actions Congress could take now to help boost the economy.
Bernanke skillfully dodged the question (as if the answer were so
simple).
THE GREAT MORAL
HAZARD
Senators were particularly interested in
understanding the factors leading to the precedent-setting nature of the
Fed’s intervention in the “private sector” and whether or not he
anticipated intervention in other cases. Bernanke assured congress that
its actions to bail out Bear Stearns were necessary to stabilize the
entire financial market by providing badly needed liquidity to such an
important member of the financial system. He said that “given the
current exceptional pressure on the global economy and financial system,
the damage caused by a default by Bear Stearns could have been severe
and extremely difficult to contain.” Congress has referred to the Fed’s
action as possibly creating a “moral hazard,” a phrase which we feel
will become the next market buzz word as Congress dissects the Bear
Stearns / J.P. Morgan Chase transaction.
A BLUEPRINT FOR
CHANGE
The Fed chairman was quizzed about the wisdom of
the agency serving as “the lender of last resort” for a type of
financial institution not specifically envisioned by its 1913 charter.
The congressional review came only days after Treasury Secretary Henry
Paulson proposed giving broad new powers to the Federal Reserve to
combat the type of severe credit crisis currently overshadowing the
financial markets. We feel there is little chance that Paulson’s
proposal or any other sweeping legislative changes in the Federal
Reserve’s powers or major structural changes in the financial markets
are politically feasible under this administration. That will fall
squarely in the lap of the new president and congress. Highlights of the
plan:
§
The plan would eliminate the Office of Thrift Supervision and the
Commodity Futures Trading Commission, merging their functions into other
agencies. The Paulson plan calls for the eventual creation of three
regulatory agencies, including expanding the role of the Federal Reserve
to act as a “market stability regulator” by broadening its powers to
cover the capital requirements of brokerage firms.
§
Next, the plan would create a “prudent financial regulator” for
the nation’s banks, thrifts and credit unions in place of the five
agencies currently performing that task.
§
Finally, the third new agency would regulate business conduct and
consumer protection, assuming several of the functions presently held by
the Securities and Exchange Commission.
Democrats were quick to criticize Paulson’s plan,
arguing that the provisions wouldn’t do enough to resolve problems in
mortgage lending and the sale of complex financial products that have
contributed to the current market turmoil. Although House Financial
Services Committee Chairman Barney Frank (Democrat, Massachusetts) is
crafting his own regulatory restructuring plan, he welcomed Paulson’s
proposal as a “constructive step” in the right direction. Among his
criticisms, Frank noted that the Treasury Secretary’s proposal wouldn’t
give the Federal Reserve the regulatory authority required to provide
the broader market stabilization envisioned.
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