At the Economics Club of New York, Fed chairman Benjamin Bernanke, gave a nuanced speech about the economy (meaning he showed as few cards as possible without pulling a Greenspan of hiding behind tortured sentence structures). But nevertheless a few revealing statements were made.
Federal Reserve Chairman Ben S. Bernanke said the housing slump will be a “significant drag” on U.S. growth into next year, though evidence of a broader impact on spending is limited….
“The ultimate implications of financial developments for the cost and availability of credit, and thus for the broader economy, remain uncertain,” Bernanke said today. “It remains too early to assess the extent to which household and business spending will be affected” by the housing recession.
Translation: we are still reading the tea leaves and will do so up to the October 30-31 meeting.
Although the headline, “Bernanke Spots Relief in Markets” put the best possible spin on things, the Wall Street Journal concurred on both the negative view of housing and the refusal to give a signal about rate cuts:
Federal Reserve Chairman Ben Bernanke …. offered no clear signal on whether officials are inclined to cut rates again at their next policy meeting in two weeks…..
Mr. Bernanke also said the housing sector is expected to deteriorate further and is likely to be a “significant drag” on economic growth through early 2008. But he added that strong income growth has so far propped up consumer spending even in the face of signs — which he called “quite tentative” — of a cooling labor market.
Although these assessments that mix discouraging news with the reasons for optimism are probably a PR necessity in nervous times like these, Dean Baker has pointed to a independent cause for concern: the Fed has had a propensity to be surprised on the downside:
It is cute when children are surprised. Their eyes light up as they discover new information about how the world works. The same sense of surprise is less endearing when it applies to central bankers. Yet,
that seems to be the fashion these days….
It is disconcerting to hear that the weakness is the housing market is greater “than had previously been expected” will be “more prolonged than had seemed likely” or would persist longer “than previously anticipated.”
The members of the Federal Reserve Board are supposed to be knowledgeable about the economy and therefore should not be continually surprised by events. The fact that they have been repeatedly surprised by the weakness in the housing market raises serious questions about their competence. The Fed’s repeated expressions of surprise warrant attention in the media, which they have not yet received.
We noted in July that the Fed had estimated total subprime losses at $50 to $100 billion, when the vast majority of experts tat that time were pegging them in the $100 to $200 billion range. If Bernanke’s Fed has a prediliction for conservative, meaning inertial, estimates, we may have a rough ride on our hands.
It was also interesting to observe that some of Bernanke’s remarks were picked up only selectively. CNN Money focused on Bernanke’s warning to Wall Street:
Federal Reserve Chairman Ben Bernanke said the central bank’s rate cut in September has shown signs of success, but cautioned that lenders and investors must bear responsibility for financial decisions that caused the subprime mortgage meltdown.
“Although the Federal Reserve can seek to provide a more stable economic background that will benefit both investors and non-investors, the truth is that it can hardly insulate investors from risk, even if it wished to do so,” Bernanke said, adding that “over the past few months…those who made bad investment decisions lost money.”
After the Bank of England’s governor Mervyn King, who really believed that those who profit from risk bearing need to be willing to take their lumps, was forced to go against his pronunciations and bail out failing UK building society Northern Rock, it’s not clear than anyone takes this sort of thing seriously.
And at least in the quick gander I did through some of the stories on the speech, some important remarks weren’t recounted in the press (see here for full text of the speech). For instance, Bernanke gives the first acknowledgement I have seen by a US regulator in this cycle that banks might come under strain:
As the strains in financial markets intensified, many of the largest banks became concerned about the possibility that they might face large draws on their liquidity and difficult-to-forecast expansions of their balance sheets. They recognized that they might have to provide backup funding to programs that were no longer able to issue ABCP. Moreover, in the absence of an active syndication market for the leveraged loans they had committed to underwrite and without a well-functioning securitization market for the nonconforming mortgages they had issued, many large banks might be forced to hold those assets on their books rather than sell them to investors as planned. In these circumstances of heightened volatility and diminished market functioning, banks also became more concerned about the possible risk exposures of their counterparties and other potential contingent liabilities.
These concerns prompted banks to become protective of their liquidity and balance sheet capacity and thus to become markedly less willing to provide funding to others, including other banks. As a result, both overnight and term interbank funding markets came under considerable pressure. Interbank lending rates rose notably, and the liquidity in these markets diminished. A number of the U.S. ABCP programs that had difficulty rolling over paper were sponsored by or had backup funding arrangements with European banks. As a result, some of these banks faced potentially large needs for dollar funding, and their efforts to manage their liquidity likely contributed to the pressures in global money and foreign exchange swap markets.
Is it a concidence that this statement comes on the heels of the leaks about the SIV rescue plan?
But the best tidbit came from Bloomberg:
In response to a question by Henry Kaufman, the former Salomon Brothers Inc. economist who now runs a New York firm bearing his name, Bernanke said investment firms “need to be as transparent as possible” about how they value their assets.
“This current financial stress is not likely to disappear overnight; partly it is an information problem,” Bernanke said. “It is going to take a while for investors to appropriately value these assets.”
Kaufman asked Bernanke what market and economic information he would need for more effective policy making.
“I would like to know what those damn things are worth,” Bernanke joked, referring to the products that investors have shunned in the credit rout. “This episode has revealed a weakness in structured credit products,” namely the difficulty in coming up with valuations in periods of stress.