Bernanke's State of the Economy Speech: u2018You Are All Dead Ducks'

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Even veteran
Fed-watchers were caught off-guard by Chairman Bernanke’s performance
before the Senate Banking Committee on Thursday. Bernanke was expected
to make routine comments on the state of the economy but, instead,
delivered a 45-minute sermon detailing the afflictions of the foundering
financial system. The Senate chamber was stone-silent throughout.
The gravity of the situation is finally beginning to sink in.

For the most
part, the pedantic Bernanke looked uneasy; alternately biting his
lower lip or staring ahead blankly like a man who just watched his
poodle get run over by a Mack truck. As it turns out, Bernanke has
plenty to worry about, too. Consumer confidence has dropped to levels
not seen since the 1970s recession, real estate has gone off a cliff,
credit-brushfires are breaking out everywhere, and the stock market
continues to gyrate erratically. No wonder the Fed-chief looked
more like a deck-hand on the Lusitania than the monetary-czar of
the most powerful country on earth.

prepared remarks were delivered with the solemnity of a priest performing
Vespers. But he was clear, unlike his predecessor, Greenspan, who
loved speaking in hieroglyphics.


As you know,
financial markets in the United States and in a number of other
industrialized countries have been under considerable strain since
late last summer. Heightened investor concerns about the credit
quality of mortgages, especially subprime mortgages with adjustable
interest rates, triggered the financial turmoil. However, other
factors, including a broader retrenchment in the willingness of
investors to bear risk, difficulties in valuing complex or illiquid
financial products, uncertainties about the exposures of major
financial institutions to credit losses, and concerns about the
weaker outlook for the economy, have also roiled the financial
markets in recent months."

Yes, of course.
The banks are ailing from their subprime investments while Europe
is sinking fast from $500 billion in unsellable asset-backed garbage.
The whole system is clogged with crappy paper and deteriorating
collateral. Now there are problems popping up in auction rate sales
and the normally-safe municipal bonds. The whole financial Tower
of Babel is cracking at the foundation.

Bernanke continues:

Money center
banks and other large financial institutions have come under significant
pressure to take onto their own balance sheets the assets of some
of the off-balance-sheet investment vehicles that they had sponsored.
Bank balance sheets have swollen further as a consequence of the
sharp reduction in investor willingness to buy securitized credits,
which has forced banks to retain a substantially higher share
of previously committed and new loans in their own portfolios.
Banks have also reported large losses, reflecting marked declines
in the market prices of mortgages and other assets that they hold.
Recently, deterioration in the financial condition of some bond
insurers has led some commercial and investment banks to take
further markdowns and has added to strains in the financial markets.

Bernanke sounds
more like an Old Testament prophet reading passages from the Book
of Revelations than a Central Banker. But what he says is true;
even without the hair-shirt. The humongous losses at the investment
banks have forced them to go trolling for capital in Asia and the
Middle East just to stay afloat. And, when they succeed, they’re
forced to pay excessively high rates of interest. The true cost
of capital is skyrocketing. That’s why the banks are protecting
their liquidity and cutting back on new loans. Most of the banks
have also tightened lending standards which is slowing down the
issuance of credit and threatens to push the economy into a deep
recession. When banks cramp-up, the overall economy shrinks. It’s
just that simple, no credit, no growth. Credit is the lubricant
that keeps the capitalist locomotive chugging-along. When it dwindles,
the system screeches to a halt.


Bernanke again:

In part as
the result of the developments in financial markets, the outlook
for the economy has worsened in recent months, and the downside
risks to growth have increased. To date, the largest economic
effects of the financial turmoil appear to have been on the housing
market, which, as you know, has deteriorated significantly over
the past two years or so. The virtual shutdown of the subprime
market and a widening of spreads on jumbo mortgage
loans have further reduced the demand for housing, while foreclosures
are adding to the already-elevated inventory of unsold homes.
Further cuts in homebuilding and in related activities are likely….
Conditions in the labor market have also softened. Payroll employment,
after increasing about 95,000 per month on average in the fourth
quarter, declined by an estimated 17,000 jobs in January. Employment
in the construction and manufacturing sectors has continued to
fall, while the pace of job gains in the services industries has
slowed. The softer labor market, together with factors including
higher energy prices, lower equity prices, and declining home
values, seem likely to weigh on consumer spending in the near

So, let’s
summarize. The banks are battered by their massive subprime liabilities.
Housing is in the tank. Manufacturing is down. Food and energy are
up. Unemployment is rising. And consumer spending has shriveled
to the size of an acorn. All that’s missing is a trumpet blast and
the arrival of the Four Horseman. How is it that Bernanke’s economic
post-mortem never made its way into the major media? Is there some
reason the real state of the economy is being concealed from ‘we
the people’?

Bernanke continues:

On the inflation
front, a key development over the past year has been the steep
run-up in the price of oil. Last year, food prices also increased
exceptionally rapidly by recent standards, and the foreign exchange
value of the dollar weakened…. (If) inflation expectations to
become unmoored or for the Fed’s inflation-fighting credibility
to be eroded could greatly complicate the task of sustaining price
stability and reduce the central bank’s policy flexibility to
counter shortfalls in growth in the future.

Right. So,
if the Fed’s rate-cutting strategy doesn’t work and the economic
troubles persist (and prices continue to go through the roof) then
we’re S.O.L. (sh** out of luck) because the Fed has no more arrows
in its quiver. It’s rate cuts or death. Great. So, we can expect
Bernanke to hack away at rates until they’re down to 1% or lower
(duplicating the downturn in Japan) hoping that the economy shows
some sign of life before it takes two full wheelbarrows of greenbacks
to buy a quart of milk and a few seed-potatoes.

Sounds like
a plan!

We don’t blame
Bernanke. He’s been remarkably straightforward from the very beginning
and deserves credit. He’s simply left with the thankless task of
mopping up the ocean of red ink left behind by Greenspan. It’s not
his fault. He should be applauded for dispelling the decades-long
illusion that a nation can borrow its way to prosperity or that
chronic indebtedness is the same as real wealth. It’s not; and the
bill has finally come due.

Of course,
now that the low-interest speculative orgy is over; there’s bound
to be a painful unwind of hyper-inflated assets, falling home prices,
tumbling stock markets, increased unemployment, and a generalized
credit-contraction throughout the real economy. Ouch. Who said it
was going to be easy?


At present,
my baseline outlook involves a period of sluggish growth, followed
by a somewhat stronger pace of growth starting later this year
as the effects of monetary and fiscal stimulus begin to be felt….
It is important to recognize that downside risks to growth remain,
including the possibilities that the housing market or the labor
market may deteriorate to an extent beyond that currently anticipated,
or that credit conditions may tighten substantially further.

translation) “Discount everything I’ve said here today if the economy
blows up — as I fully-expect it will — from decades of regulatory
neglect and the myriad multi-trillion dollar Ponzi-schemes which
have put the entire financial system at risk of a major heart attack."

candor is admirable, but it is little relief for the people who
will have to soldier-on through the hard times ahead. Perhaps, next
time he could spare us all the lengthy oratory and just forward
a brief cablegram to Congress saying something like this:

“We are deeply
sorry, but we have totally fu**ed up your economy with our monetary
hanky-panky. You are all in very deep Doo-doo. Prepare for the worst.”

Our sincerest
The Fed

19, 2008

Mike Whitney
[send him mail] lives
in Washington state.

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