The Chairman's Testimonies: Listen to What He Really Said
Well the markets are down so far today on yet another testimony induced swing, just as yesterday they swung upwards (which made the 4th day in a row for a "Tale of Two Fantasies" to triumph experience and analysis, but that's another topic). Actually the Chairman was stunningly clear and, in our interpretation, entirely conistent with our assessments which we want to re-draw your attention to. Particularly since data and events have been bearing us out and are likely to continue to do so. Below the line you'll find an excerpt from a WSJ econblog post summarizing his testimony yesterday which is well done. You'll also find a selection of CNBC vidclips showing not only the testimony but the questioner,which is often even more interesting. That's all below the break.
The WSJ summary focues on the economic information while much of the testimony, while covering that ground, really focuses on the credit mess, the regulatory breakdowns and the institutional failures in the Finance Industry and regulatory communities. If you haven't the time to listen too all of these at least listen to the opening one with Rep. Barney Frank. Among other things you'll hear and intelligent and informed man who displays a good understanding of the problems and causes and is already thinking about how to approach them. Most of the other Congressment display similar smarts. Which should be encouraging as should their convergece on similar diagnosis.
But let's set the context and review the bidding a bit - almost all of which is consistent with both Bernanke's testimony and the questions. Let's put it another way - all the things we've been talking about here for weeks and months ared dead on what the most responsible parties see. Yet none of this is being reflected in broader understandings, particularly on the Street. As Barry Ritholz put it...surprise, surprise, WTF do you mean surprise !
1. The economy is slowing though the Fed hopes for an uptick later in the year their l.t. outlook is for below trend growth thru 2010 ! They recognize all the weakness and risks to the downside as well as growing inflationary problems. Those problems will be reduced as the economy slows and it's a tradeoff they are accepting.
- Housing continues to worsen and the outlook is NOT clear. IOHO we've got a long way to go as we've previously mentioned.
- Credit markets are badly damaged and the contagion is NOT contained.
2. The primary reason for the breakdown in the credit markets is that the people creating the loans (the originators) passed them onto to others instead of keeping them. The others (the distributors) in their turn re-packaged the loans into various synthethic investments which where very...very highly leveraged and passed on to more links in a chain of re-packages and distributors.
- The Origin-Distribution model DID provide more access to capital to a wider range of users BUT did not disperse, share or reduce risks. In fact it seems to have increased them thru a viscious feedback cycle of perverse incentives in the finance industry and regulatory failures to adopt fast enough to these new instruments.
- Because the chain of financial actors created a situation where the reward was based on maximizing the flow of deals (originations) instead of the solvency and soundness of the origination they made their money by lowering standards of prudent business practice to nearly nothing at every link in the chain.
- These deficiencies need to be addressed with major regulatory overhauls because the Finance industry has proven the reverse of reliably self-governing. In fact, we would argue that, in fact, they enshrined s.t., narrow interest thinking as an idol and made demonstrably bad strategic decisions that will haunt the players, the markets and the economy for a long time.
- These institutional breakdowns in the Finance industry have been recurring regularly for amost a decade in one major screwup after the other and demonstrate poor strategy, bad business practice, major leadership failures and terrible corporate governance in the sense of sound management systems and practices.
Analysis of Major Themes in Bernanke’s Testimony Here is a look at Federal Reserve Chairman Ben Bernanke’s statements in today’s congressional testimony on major economic themes, followed by commentary from economists.
· Monetary Policy
Bernanke: A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures. In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects. Monetary policy works with a lag. Therefore, our policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast. Although the FOMC participants’ economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.
Comment: The takeaway message is that further easing is probable, and there was nothing in the tone of this testimony to shake market expectations from the 50bp cut in the Fed funds target (to 2.50%) that is expected on March 18. Essentially, the FOMC’s strategy is to “cut and hope”, trusting that lower short term interest rates will help the economy regain its footing, and that incipient inflation pressure will prove to be short-lived. While not a perfect strategy, it is probably the only viable course at the moment, and it is one that is already well-discounted by financial markets. –Joshua Shapiro, MFR Inc.
· Inflation
Bernanke: Consumer price inflation has increased since our previous report, in substantial part because of the steep run-up in the price of oil… The higher recent readings likely reflected some pass-through of energy costs to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices… The projections recently submitted by FOMC participants indicate that overall PCE inflation was expected to moderate significantly in 2008, to between 2.1% and 2.4% (the central tendency of the projections). A key assumption underlying those projections was that energy and food prices would begin to flatten out, as was implied by quotes on futures markets… Further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month.
Comment: The [Fed’s] 2010 central tendency forecasts for inflation seem to show a de facto inflation target. This helps to explain why the Fed seems less concerned about the near term inflation outlook, about which they have little control, and more concerned about the medium-term outlook which shows a modest deterioration in their “target” inflation rate since October. –Drew Matus, Lehman Brothers
· Housing
Bernanke: The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and closely related industries.
Comment: Global Insight is projecting that the downside risks to growth mentioned by Bernanke will become more apparent as the first quarter progresses… The huge drag to growth from negative dynamics in the housing market, which recently have showed no signs of abating, will become more apparent in upcoming reports on real growth. These indicators point in the direction of a “mild recession” in the first half of 2008. –Brian Bethune, Global Insight
· Risks
Bernanke: The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further.
Comment: Although the words stagflation and recession appear nowhere in Bernanke’s testimony, the discussion of downside risks to the growth outlook and upside risks to a higher inflation outlook have both a stagflationary and potentially recessionary feel about them. –Bear Stearns
CNBC Vidclip Selections
Bernanke on Economic Growth
Bernanke on Risk Rep. Spencer Bachus, R-Ala., asks Fed Chairman Ben Bernanke about the price of risk.
Bernanke on Mortgage Regulation Rep. Tom Price, R-Ga., asks Fed Chairman Ben Bernanke about the lack of regulation in the mortgage market.