scenes of Robin Williams’ movie, Patch
Adams, were quite good. Two of them remind me of Bernanke’s
present assignment. One was Adams’ attempt to cheer up a morose
dying patient. His strategy was to dress as an angel and come up
with phrases synonymous with death. The dying man finally enters
into the spirit of the challenge. Basically, it was “go out with
a smile.” (Doesn’t sound funny? I guess you had to be there.)
the scene in a ward full of pre-teen cancer patients. Williams grabs
some available implements and turns them into a clown’s wardrobe.
He cuts a red rubber syringe and sticks it onto his nose. He grabs
a pair of bedpans and uses them as shoes.
I think of Ben Bernanke, I think of a guy with a bright red nose
and bedpan shoes. But I merge the two scenes. He is trying to get
us to laugh by coming up with clever euphemisms for financial death.
To this image, I add a beard.
Think of a
combined circus act: a tightrope walker who is a clown. He dons
a pair of bedpan shoes and steps out onto the rope.
He uses a
safety net. But he uses it in a peculiar way. It isn’t under him;
it’s over his shoulder.
This is Bernanke’s
assignment. He is the man in charge of the economy’s safety net.
It isn’t much of a net. It is the legal authority to create money.
This money is then used to buy mostly U.S. Treasury debt. To this
has been added collateral held by commercial banks.
This may not
seem like much of a net. Basically, it’s a license to print money.
How does that provide safety for the tightrope walker himself?
a very special performer. He must provide a sense of command. He
must persuade the rest of us that he is the preserver of the safety
net. That net is supposed to protect all the rest of us in our death-defying
walks across the high wire. But it’s not attached to anything except
the equivalent of a printing press. Bernanke holds that device in
has two long bars, each extending out from one side. It’s a kind
of balance pole. At the end of each bar is a sign. One says “deflationary
depression.” The other says “inflationary crack-up boom.”
At the center
of the two bars is the mini-printing press. It’s voice-activated.
A whisper gets it going. It then spews out money toward the “crack-up
boom” side of the bar whenever it looks as though the economy is
tilting toward deflationary depression. Then, when the bar tilts
too far toward “crack-up boom,” he whispers to stop printing money.
He then leans toward the deflationary depression side.
All the while,
he keeps up a line of patter. When it looks as though he and the
economy will topple off the tightrope toward recession or even depression,
he starts talking up liquidity. He’s got it down pat.
Federal Reserve also took a number of supplemental actions, such
as cutting the fee charged for lending Treasury securities. The
purpose of the discount window actions was to assure depositories
of the ready availability of a backstop source of liquidity. Even
if banks find that borrowing from the discount window is not immediately
necessary, the knowledge that liquidity is available should help
alleviate concerns about funding that might otherwise constrain
depositories from extending credit or making markets. The Federal
Reserve stands ready to take additional actions as needed to provide
liquidity and promote the orderly functioning of markets. (Aug.
At the height
of the recent financial turmoil, the Federal Reserve took a number
of steps to help markets return to more orderly functioning. The
Fed increased liquidity in short-term money markets in early August
through larger-than-normal open market operations. And on August
17, the Federal Reserve Board cut the discount rate — the
rate at which it lends directly to banks — 50 basis points,
or 1/2 percentage point, and subsequently took several additional
measures. These efforts to provide liquidity appear to have been
helpful on the whole, but the functioning of a number of important
markets remained impaired. (Nov.
it looks as though the economy might be facing rising prices and
the instability associated with rising prices, he starts his famous
fundamentally, experience suggests that high and persistent inflation
undermines public confidence in the economy and in the management
of economic policy generally, with potentially adverse effects on
risk-taking, investment, and other productive activities that are
sensitive to the public’s assessments of the prospects for future
economic stability. In the long term, low inflation promotes growth,
efficiency, and stability — which, all else being equal, support
maximum sustainable employment, the other leg of the mandate given
to the Federal Reserve by the Congress. (July
if inflation were to move higher for an extended period and that
increase became embedded in longer-term inflation expectations,
the re-establishment of price stability would become more difficult
and costly to achieve. With the level of resource utilization
relatively high and with a sustained moderation in inflation pressures
yet to be convincingly demonstrated, the FOMC has consistently
stated that upside risks to inflation are its predominant policy
The thing that
catches my attention is the dating of these routines. The first
two, designed to take our minds off the threat of depression, were
both given after mid-August, 2007, that is, after the subprime mortgage
crisis first raised its ugly head. The second two, designed to take
our minds off the threat of rising prices, were delivered prior
means anything, the balance bar was leaning toward anti-inflation
before August. Then, in late July, he shifted the balance bar’s
weight by leaning toward anti-depression. He turned on the money
machine in a rather loud whisper.
But then he
whispered it back off in mid-August through mid-September. Then
back on. Then off. On-off, on-off: it’s
a sight to behold!
There he is,
high above the ground, with a bright red nose, a beard, and a pair
of shiny bedpan shoes. He is out there in front of us. We dutifully
listen to his words of encouragement. We watch him lean left, then
lean right, all the time insisting that the net will save us, probably,
all things considered, but not to trust in moral hazard, where the
net saves any group’s investments. It will save all our investments,
more or less, give or take 20% — 30% at the worst.
But he’s carrying
the net. It’s supposed to be down there under us, isn’t it? But
it isn’t. It’s over his shoulder.
I keep looking
at his shoes. Just one slip. . . .
the vast increase in the size of the leveraged futures markets called
derivatives, now in the range of $11 trillion in contracted liabilities
and $500 trillion in dollar amounts or their currency equivalent
traded annually, the world’s central banks’ task has become highly
complex. The size of the derivatives market is vastly beyond the
assets of any central bank. The Federal Reserve, which is the largest
central bank, has
about $1.2 trillion in its portfolio, mostly in the form of U.S.
are all the other debt liabilities, worldwide, especially real estate
debt. The participants — creditors and borrowers — have
trustingly operated on the assumption that over a hundred legally
independent central banks somehow manage the upkeep of a single
safety net for the interdependent world economy.
assumes that committees of salaried bureaucrats can handle the unforeseen
outworkings of hundreds of millions of private transactions in regulated
and unregulated capital markets. These committees can do this while
walking the other tightrope, which links central banks’ assertion
of independence from government control and incumbent politicians
who don’t want an economic downturn on their watch, but above all
in election years.
If we wanted
to make this analogy accurate, a central banker has one foot on
the depression/crack-up boom tightrope and the other foot on the
independence/incumbent politicians tightrope. The ropes don’t always
of modern capital markets grows greater every day, yet the central
banks’ tools of evaluation, let alone control, remain basically
stagnant. Franklin Sanders has summarized these tools: “inflation
and blarney.” Sometimes the blarney is incoherent: Greenspan’s Fedspeak.
Sometimes it is footnoted: Bernanke’s speeches. But it remains blarney.
It is patter from a very high wire without an independent safety
We need a
safety net. We used to have one. It was called the international
gold standard. It was a gold coin standard. It controlled central
banks and their governments. How? By putting commercial banks at
the mercy of holders of IOUs to gold coins. The same system governed
the issue of government IOUs: bonds. Some of these IOU holders were
other central banks. Most were little people who held legally redeemable
paper money rather than gold coins.
All this ended
in the late summer of 1914, when commercial banks ceased redeeming
IOUs for gold coins, central banks confiscated the gold in commercial
banks’ accounts, and governments passed laws legalizing both steps.
The justification for this confiscation was World War I. With respect
to the confiscation of gold in the United States in 1933, it was
the Great Depression. It was upheld by the Supreme Court by a vote
of 5 to 4.
of events placed the world’s central bankers on their individual
yet interconnected tightropes.
They all have
tightrope has begun to swing back and forth more violently. The
winds of financial change are blowing more wildly. The ability of
central bankers to walk the line has been reduced.
in August, the subprime mortgage crisis revealed itself in America’s
capital markets. Millions of borrowers — home owners —
had signed loan agreements that allowed creditors to hike their
interest rates. The creditors were in fact borrowers. The initial
issuers of mortgages were no longer long-term holders of the mortgages.
They sold the contracts to pools of investors within days of the
signing of the papers.
So, to keep
the process going full blast, the creditors decided to become borrowers.
They borrowed money short-term in order to issue more mortgages.
The mortgages were of two varieties: long term and short term. Long-term
mortgages were issued to reliable borrowers who were expected to
remain in their homes and making monthly payments for decades. Short-term
mortgages were issued to home buyers who did not have credit ratings
to obtain long-term mortgages. The lenders assumed these people
would remain in their homes even after rates climbed to match rates
in short-term credit markets. This assumption blew up in August.
At that point,
the money for leverage — short-term loans to long-term lenders
— dried up. The mortgage lenders had been going out of business
since December, 2006. Now the
bankruptcy rate increased, as large lenders went belly-up.
the local mortgage markets without large pools of short-term loans
disguised as long-term loans. This reduces liquidity locally. Home
sellers cannot find buyers at pre-August prices. But they refuse
to admit that this lack of liquidity will force them to lower their
asking prices. The inventory of unsold homes rises. Sellers are
holding on when they can.
2008, millions of them will no longer be able to hold out any longer.
A recession will force their hands. They will have to move, either
leaving homes vacant or forcing them to rent their homes to strangers.
At that point, the decline in housing prices will accelerate.
that everyone’s home equity will shrink. For recent buyers (2005
or later), it may disappear. It may even go negative: more money
owed than the homes are worth after commissions and discounts.
own their homes free and clear, this does not affect them immediately
unless it’s time to sell. If they move out — to a retirement
facility, for example — they can rent their homes to strangers
if they want to retain ownership. The same applies to people who
have been building equity for a decade. But equity builds rapidly
only after about half the mortgage period is over. Most Americans
move every five years. So, equity as a percentage of home prices
is usually reduced because sellers buy larger, more expensive homes.
Then they borrow against this equity.
This is another
way of saying “increased leverage.” This is the nightmare of central
banking. The more leverage there is, the more wildly the tightrope
swings in the wind.
world has imitated central banking: increased leverage. There is
no industry more wealthy with less equity than central banking.
The equity is in the form of a government-granted monopoly: the
legal right to say how fast commercial bankers can create fiat money.
bankers can inflate. They usually limit this inflation to the purchase
of very short-term assets: promises to repay. This, plus blarney,
is all they have to keep the economy from toppling into either recession
When you think
“central banker,” think “bedpan shoes.”
more equity you have, the stronger your safety net. The Federal
Reserve can buy equity by issuing more fiat money. When it does,
the nominal equity of the economy increases. The actual equity shrinks.
Equity is more and more defined as IOUs: promises to pay.
your future on promises to pay.