Having been unceremoniously dismissed and relegated to the role of “Lame Duck Chairman”[i], Ben Bernanke maintained his dignity and sense of pride in the work of the institution that is now more important than any American President. It is clear that, as a man of principle, he intends to go out on his own terms. His first legacy speech was made at the 49th Annual Conference on Bank Structure and Competition sponsored by the Federal Reserve Bank of Chicago, entitled Monitoring the Financial System[ii]. This speech gave further insight into how the Fed is going to use its expanded balance sheet going forward (Terminal Velocity “Minds and Hands on the Joystick”[iii]). We observed that:
“In Bernanke’s latest signal, the expanded balance sheet will be used as an anchor for macroprudential stability; in addition to being the monetary base for economic growth.”
The second in his own abridged legacy version was made to the Princeton Class of 2013[iv] (Terminal Velocity “Normalization?”[v]). In this speech, he addressed the young demographic who are inheriting a broken economy that he was unable to fix. Bernanke’s career may now be over however he has been quick to opine that the Fed’s work is not done.
His third and latest speech picks up where he left off in Chicago. Bernanke provides a concise historiography of the Fed and its progress on the quest to find enlightenment. After what has been called the “Great Moderation”, in honour of the Titan Paul Volcker who cured the monetary excesses of his predecessors, Bernanke adds his own chapter in Fed historiography which he calls “The Financial Crisis, the Great Recession, and Today”[vi]. The title implies that he has had three discrete episodes to deal with on his watch, rather than the general headline events of the previous epochs. By implication therefore, his job must have been more difficult than that of his historic peers. The cryptic use of the word “Today” also implies that the third discrete event has just arrived. Alas! Bernanke will be gone “Tomorrow” leaving this event unaddressed by him in practice….. but not in words.
In his own words:
“Today, the Federal Reserve sees its responsibilities for the maintenance of financial stability as coequal with its responsibilities for the management of monetary policy, and we have made substantial institutional changes in recognition of this change in goals. In a sense, we have come full circle, back to the original goal of the Federal Reserve of preventing financial panics”.
Bernanke has confirmed the original signal from Terminal Velocity (10) – “Minds and Hands on the Joystick”. This confirmation has been endorsed by the Fed, the OCC and the FDIC; who have now all voted for the strict application of Basel III, which will double capital leverage ratios on the systemically important banks.
Winston Churchill said that –
“History will be kind to me, for I intend to write it”.
Bernanke is doing his best, but one feels that he will be remembered for “Yesterday’s QE” rather than “Today’s macroprudential stability”. His attempt to merge QE with macroprudential stability is intuitive and holistic; and is probably correct. Unfortunately, as we have seen with the spike in interest rates after he said that he was unhappy with speculators reaching for yield, binary trading animals still see his holistic fusion of disciplines as discrete entities. QE is Risk On and macroprudential is Risk Off. Until the markets get it, the volatility and risk of a rise in interest rates triggering a market collapse and a recession remains the most clear and present danger. Bernanke will then be consigned to the same dubious posterity awarded to Alan Greenspan, as the other man who created bubbles.
Mindful of their own impotence and legend, when they first voted for ‘No Bailout’ only to be coerced into voting ‘Yes’ when the markets then collapsed, lawmakers are jumping onto the macroprudential bandwagon. Having failed, since 2009, to create a fiscal and legal platform for a sustained economic recovery they are now trying their hand at preventing the next crash. Clearly they are worried that their failure from crash-to-date will trigger another crisis; so they are quickly exonerating themselves ex-ante by passing bills that will make them appear to have been prudent and wise when the sell-off comes. Senators McCain and Warren, wish to bring back Glass-Steagall; to try and “out-Volcker” Paul Volcker and hence the Fed itself.
One can see that, when the next sell-off comes, the finger-pointing and blaming will have some strong regulatory precedents. Reputations will be ruined and fortunes will be lost. The next crash is a certainty; that has been made real by the zeal of the policy makers and regulators to evince muscular signs of macroprudential rectitude. In their rush, to tighten capital adequacy standards, they have forced banks and dealers to lighten the inventory of assets that they carry. Holding assets for any period of time has become capital intensive and expensive. Capital investment has also been made capital intensive and expensive. Banks have thus cut back lending and dealers have cut back securities inventories.
There is thus no lending in primary capital markets and no liquidity in secondary capital markets. Since the two are connected, the weakness in the former translates into the greater weakness and volatility of the latter. To cover up this lack of the essential conditions for economic activity and liquid capital markets the Fed has had to expand its QE programme indefinitely. To encourage capital investment, the Fed has had to engineer a rise in long term interest rates to create an attractive reward stimulus for lenders. Unfortunately, this rise in long term interest rates has been negatively amplified by the lack of liquidity that the new capital adequacy rules have enforced. The policy makers and the regulators have therefore shot themselves in the feet. What they have failed to understand is the market and economic context in which they are acting. The current infatuation with communication policy and guidance is nothing more than an attempt to cover the void of essential conditions for economic activity and capital markets liquidity with words; now that it has become clear that more QE is creating the mother of all bubbles. But as we have observed markets are now saying “Don’t Tell Me, Show Me”.
Policy makers and regulators have assumed that they are making new rules for capital markets that have no legacy assets and mark to market issues. What they see as a Blue Ocean of opportunity is in fact a Red Ocean of losses created by less onerous prior rules. Rather than deal with the Red Ocean, they have opted to create a new Blue Ocean; in which none of the existing swimmers can swim. Like the other cherished absurdities and assumptions, such as Rational Economic Behaviour and the Efficient Markets Hypothesis, the new capital rules have been created by fiat and applied to a system which cannot apply them in practice. The banking system in the Developed Markets is by and large insolvent; and in desperate need of capital to prop up existing asset portfolios. Doubling capital ratios at this point in the economic cycle is as risky as enforcing fiscal consolidation on the public sectors of these same countries. In effect fiscal austerity hits the public sector and Basel III hits the private sector. The combination of the two effectively kills the only two drivers of economic activity. More QE just creates asset price inflation to levels beyond those that initially worried Bernanke when he spoke in Chicago. The only solution then is inflation, to erode the value of the public debt and create the incomes in the private sector to service the private debt. Overzealous policy makers and regulators have therefore guaranteed the next growth crisis and the inflation crisis that will ensue. Mark Twain observed that history rhymes rather than repeats. It would seem that he did not live long enough to see the cycle of repetition.