Friday, January 9, 2009

Remove Bernanke Now Before Its Too Late

The foolishness of Bernanke:
Bernanke has been exposed as a fool who does not understand the economy,and he needs to be removed from his post, to prevent him from continuing to damage the economy any further with his false ideas:

Bernanke follows old route
In his 2000 article of faith, Bernanke was openly endorsing the "Greenspan put", the monetary stance from late 1980s on during which, whenever the economy slowed, the Fed would come to its rescue by radically lowering the Fed funds rate target even to the point of negative real yields as measured against inflation, and kept it there until a new boom bubble was solidly formed. The Greenspan put repeatedly pumped liquidity into the market to avert the price correction consequences of speculative excesses that caused the 1987 crash, then the geo-economic consequences of the First Gulf War in 1991, then the contagion effects from the Mexican peso crisis of 1994, then the Asian financial crisis of 1997 and the Russian default that caused the collapse of Long-Term Capital Management in 1998, then the phantom Y2K digital threat, then the bursting of the Internet bubble in 2000 and then the market panic from the 2001 9/11 terrorist attacks to launch the subprime housing bubble that burst in July 2007.

Accordingly, Bernanke was complacently confident that another application of the Greenspan put could again handle the housing bubble burst in July 2007. He appeared to have no inkling that the economy had been drawn closer each time since 1978 into a perfect storm of structured finance run amok.

On May 17, 2007, three months before the credit crisis broke out, Bernanke said in a speech on the subprime mortgage market at the Federal Reserve Bank of Chicago's 43rd Annual Conference on Bank Structure and Competition:
... given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of home equity, and growth in jobs and incomes should help keep the financial obligations of most households manageable.
The top US central banker did not see what Greenspan later called "the crisis of a century" coming at him at full speed to hit him in the face in four weeks. Even on August 31, 2007, six weeks after the credit crisis broke out in mid July, Bernake still spoke with surprising calm confidence in a speech on "Housing, Housing Finance, and Monetary Policy", delivered at the Federal
Reserve Bank of Kansas City's Annual Economic Symposium at Jackson Hole, Wyoming:
Importantly, the easing of some traditional institutional and regulatory frictions seems to have reduced the sensitivity of residential construction to monetary policy, so that housing is no longer so central to monetary transmission as it was. In particular, in the absence of Reg Q ceilings on deposit rates and with a much-reduced role for deposits as a source of housing finance, the availability of mortgage credit today is generally less
dependent on conditions in short-term money markets, where the central bank operates most directly.

Most estimates suggest that, because of the reduced sensitivity of housing to short-term interest rates, the response of the economy to a given change in the federal funds rate is modestly smaller and more balanced across sectors than in the past. These results are embodied in the Federal Reserve's large econometric model of the economy, which implies that only about 14% of the overall response of output to monetary policy is now attributable to movements in residential investment, in contrast to the model's estimate of 25% or so under what I have called the New Deal system.

The econometric findings seem consistent with the reduced synchronization of the housing cycle and the business cycle during the present decade. In all but one recession during the period from 1960 to 1999, declines in residential investment accounted for at least 40% of the decline in overall real GDP, and the sole exception - the 1970 recession - was preceded by a substantial decline in housing activity before the official start of the downturn.

In contrast, residential investment boosted overall real GDP growth during the 2001 recession. More recently, the sharp slowdown in housing has been accompanied, at least thus far, by relatively good performance in other sectors. That said, the current episode demonstrates that pronounced housing cycles are not a thing of the past.

My discussion so far has focused primarily on the role of variations in housing finance and residential construction in monetary transmission. But, of course, housing may have indirect effects on economic activity, most notably by influencing consumer spending. With regard to household consumption, perhaps the most significant effect of recent developments in mortgage finance is that home equity, which was once a highly illiquid asset, has become instead quite liquid, the result of the development of home equity lines of credit and the relatively low cost of cash-out refinancing.

Economic theory suggests that the greater liquidity of home equity should allow households to better smooth consumption over time. This smoothing in turn should reduce the dependence of their spending on current income, which, by limiting the power of conventional multiplier effects, should tend to increase macroeconomic stability and reduce the effects of a given change in the short-term interest rate. These inferences are supported by some empirical evidence.
Bernanke was still twiddling his theoretical thumb in the comfort of his institutional bunker while the whole financial world was falling under a credit fire storm. With the awesome data collection capability at his disposal, the Fed chairman's radar apparently totally missed the possibility of systemic collapse of the non-bank credit market on structured finance from chain-reaction effects of rising subprime mortgage default.

To be fair, Bernanke was in good company among establishment experts of equally unjustified complacency. Brookings Policy Brief Series #164 dated October 2007, three months after the credit crisis imploded, used as headline - "Credit Crisis: The Sky is not Falling". The brief by Anthony Downs, who describes himself on his website as the "World's Leading Authority" on real estate and urban affairs, asserts that " … the facts hardly indicate a credit crisis. As of mid-2007, data show that prices of existing homes are not collapsing. Despite large declines in new home production and existing home sales, home prices are only slightly falling overall but are still rising in many markets. Default rates are rising on subprime mortgages, but these mortgages - which offer loans to borrowers with poor credit at higher interest rates - form a relatively small part of all mortgage originations. About 87 percent of residential mortgages are not subprime loans, according to the Mortgage Bankers Association's delinquency studies. Subprime delinquency rates will most likely rise more in 2008 as mortgages are reset to higher levels as interest-only periods end or adjustable rates are driven upward. Unless the US economy dips dramatically, however, the vast majority of subprime mortgages will be paid. And, because there is no basic shortage of money, investors still have a tremendous amount of financial capital they must put to work somewhere."

However, while this complacent view was widely held in the financial establishment, not everybody was drinking the Cool-Aid. Instead of "tremendous amount of financial capital", the entire financial sector was seriously undercapitalized as distressed debts added up losses. Warnings had been publicly aired months before the credit crisis imploded in July 2007 by a few lonely voices that the subprime mortgage bubble would burst and its effect would spread globally, granted that such warnings had been summarily dismissed by the establishment media. (See Why the sub-prime mortgage bust will spread, Asia Times Online, March 17, 2007.)

Bernanke exposed
By December 2008, 18 months after the credit crisis broke out in July 2007, events have conclusively proved that Bernanke's faith in the magic of the Greenspan put had been misplaced. Decades of misapplication of Friedmanesque monetarism had driven the doctrine into theoretical bankruptcy. Monetarist measures not only fail to revive an economy caught in a global debt tsunami; there is also clear evidence that the liquidity cure devised by Greenspan has eventually run out of ammunition after the serial bubbles got bigger each time to paper over the previous one. The Greenspan put does not work for a stalled economy facing a liquidity trap of absolute preference for cash. It only adds more water to a raging flood of debt to threaten even the shrinking remaining high ground.

The flaw in his faith in self-regulating monetarism that Greenspan openly confessed before Congress apparently did not get through to Bernanke, who continues to apply the Greenspan put. Bernanke's futile monetary moves to save wayward financial institutions have managed only to increase the immunity of the deeply wounded economy against any Keynesian fiscal cure attempted by the next occupant of the White House and his economic team.

Bernanke made the same mistake of obstinate denial in the early phases of the economic meltdown from a debt crisis even after his acceptance eight years earlier of Friedman's counterfactual conclusion that the Fed in 1930 failed to act in time to respond effectively to the oncoming disaster with bold monetary countermeasures. Again, the world missed another opportunity to test if preemptive Keynesian fiscal cures would work.

More fundamentally, president Herbert Clark Hoover (1929–1933) should have applied Keynesian demand management through fiscal spending to maintain full employment immediately after the 1929 crash, if not before, rather than a timely monetary cure as proposed by Friedman in hindsight. No recovery from speculative excess can be expected without a policy-induced rise in employment and wage income to catch up with an asset price bubble. It was true in 1929; and it is true today.

Unfortunately, the rescue approach by the George W Bush administration led by Treasury Secretary Henry Paulson and the Bernanke Fed has been focused on saving distressed financial institutions by providing taxpayers' money to restructuring bad debts and de-leveraging overblown balance sheets. This approach inevitably pushes already stagnant wage income further down, with more layoffs and ruthless renegotiation of already draconian labor contracts, to cut operating cost. All this does is to reinforce the downward market spiral by transferring financial pain to innocent workers while not helping the economy with a needed revival of consumer demand.

Trillions of dollars of good taxpayer money are being thrown after bad debts concocted by unprincipled financiers into a crisis black hole. This money will have to be repaid in coming years by taxpayers while supply-siders are clamoring for tax cuts for corporations, on capital gains and for high-income earners. This means the future tax bill to pay for the Greenspan put will be borne by low- and middle-income wage earners. Thus far in this financial crisis, the Bernanke Fed has sown the seeds not for a quick recovery but for a decade or more of stagflation for the US and the global economy.

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