At the Stamp Lecture, London School of Economics, London, England, Bernanke Urges ‘Strong Measures’ to Stabilize Banks
Federal Reserve Chairman Ben S. Bernanke warned that a fiscal stimulus won’t be enough to spur an economic recovery and that the government may need to buy or guarantee banks’ tainted assets to revive growth.
“Fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system,” Bernanke said in a speech today at the London School of Economics. “More capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets.”
My Translation: “Banks are in much worse shape than we have admitted previously. More taxpayer money is needed to prop up these failing banks.”
The Fed chairman recommended three approaches on troubled assets. Public purchases of the bad assets are one possibility, as was originally planned under U.S. Treasury Secretary Henry Paulson’s Troubled Asset Relief Program, or TARP.
The government could also agree to absorb, in exchange for warrants or a fee, part of the losses on a specified portfolio of troubled assets, he said. Regulators used that method recently with their bailout of Citigroup Inc.
Another measure “would be to set up and capitalize so- called bad banks, which would purchase assets from financial institutions in exchange for cash and equity in the bad banks,” he said.
My Translation: “Nothing is working yet, including the massive bailout of Citigroup. Here are three more ideas for Congress for still more taxpayer money”.
Speaking separately today, Fed Vice Chairman Donald Kohn urged using the second half of the $700 billion TARP to reduce foreclosures, help revive credit markets and continue direct aid to banks.
“Although a number of efforts are under way to address the problem of preventable foreclosures, more needs to be done,” Kohn said in testimony prepared for a House Financial Services Committee hearing.
My Translation: Kohn wants to do something different than Bernanke requiring still more taxpayer money.
The Fed chairman said the favorable treatment that financial institutions are receiving from the government is “unavoidable” because the economy needs credit to grow. Still, aid should be accompanied by stronger supervision and regulation, he said.
My Translation: “Loose Credit got us into this mess, so loose credit will get us out of it. What’s not to understand about that?”
“Financial firms of any type whose failure would pose a systemic risk must accept especially close regulatory scrutiny of their risk-taking,” he said. “It is unacceptable that large firms that the government is now compelled to support to preserve financial stability were among the greatest risk-takers during the boom period.”
Bernanke reiterated his call for a regulatory procedure for resolving a large, failing nonbank institution. The absence of such a process hampered policy makers during the failures of Bear Stearns Cos. and Lehman Brothers Holdings Inc. last year.
My Translation: “Congress needs to recognize ‘We’re All Banks Now‘ and pass appropriate legislation that would allow any institution, financial or otherwise, to be placed under control of the Fed.”
The Crisis and the Policy Response
Here are still more translations straight from Bernanke’s Speech.
The Crisis and the Policy Response
For almost a year and a half the global financial system has been under extraordinary stress–stress that has now decisively spilled over to the global economy more broadly.
Although the subprime debacle triggered the crisis, the developments in the U.S. mortgage market were only one aspect of a much larger and more encompassing credit boom whose impact transcended the mortgage market to affect many other forms of credit. Aspects of this broader credit boom included widespread declines in underwriting standards, breakdowns in lending oversight by investors and rating agencies, increased reliance on complex and opaque credit instruments that proved fragile under stress, and unusually low compensation for risk-taking.
My Translation: “We did not not see any of this coming. If we could not see it coming, no one could. We see it now. Besides, as Greenspan has pointed out on many occasions, it is always better to clean up a mess than prevent a mess.”
The global economy will recover, but the timing and strength of the recovery are highly uncertain. Government policy responses around the world will be critical determinants of the speed and vigor of the recovery.
My Translation: “The global economy is not going to recover anytime soon. If our actions fail, please blame the ECB, China, and Japan for not spending enough. We intend to spend whatever it takes.”
The Committee’s aggressive monetary easing was not without risks. During the early phase of rate reductions, some observers expressed concern that these policy actions would stoke inflation. These concerns intensified as inflation reached high levels in mid-2008, mostly reflecting a surge in the prices of oil and other commodities.
However, the Committee also maintained the view that the rapid rise in commodity prices in 2008 primarily reflected sharply increased demand for raw materials in emerging market economies, in combination with constraints on the supply of these materials, rather than general inflationary pressures.
As you know, commodity prices peaked during the summer and, rather than leveling out, have actually fallen dramatically with the weakening in global economic activity. As a consequence, overall inflation has already declined significantly and appears likely to moderate further.
My Translation: “The Fed has a policy of asymmetrical thinking. This is on purpose. We ignore asset bubbles on the way up and loosen up further when the asset bubbles break. “
Beyond the Federal Funds Rate: The Fed’s Policy Toolkit
Although the federal funds rate is now close to zero, the Federal Reserve retains a number of policy tools that can be deployed against the crisis.
One important tool is policy communication. Even if the overnight rate is close to zero, the Committee should be able to influence longer-term interest rates by informing the public’s expectations about the future course of monetary policy.
My Translation: “This is our E.F. Hutton Policy. When Bernanke talks, people listen.”
To illustrate, in its statement after its December meeting, the Committee expressed the view that economic conditions are likely to warrant an unusually low federal funds rate for some time.2 To the extent that such statements cause the public to lengthen the horizon over which they expect short-term rates to be held at very low levels, they will exert downward pressure on longer-term rates, stimulating aggregate demand. It is important, however, that statements of this sort be expressed in conditional fashion–that is, that they link policy expectations to the evolving economic outlook. If the public were to perceive a statement about future policy to be unconditional, then long-term rates might fail to respond in the desired fashion should the economic outlook change materially.
My Comment: Huh? Bernanke thinks the public is going to perceive this and that it will influence the market?
Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve is effectively printing money, an action that will ultimately be inflationary. The Fed’s lending activities have indeed resulted in a large increase in the excess reserves held by banks. Bank reserves, together with currency, make up the narrowest definition of money, the monetary base; as you would expect, this measure of money has risen significantly as the Fed’s balance sheet has expanded. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates, such as M1 and M2, have been much lower than that of the monetary base. At this point, with global economic activity weak and commodity prices at low levels, we see little risk of inflation in the near term; indeed, we expect inflation to continue to moderate.
My Translation: “We are trying to pump like mad but those damn banks just aren’t lending. We will keep pumping more until they do.”
The management of the Federal Reserve’s balance sheet and the conduct of monetary policy in the future will be made easier by the recent congressional action to give the Fed the authority to pay interest on bank reserves. In principle, the interest rate the Fed pays on bank reserves should set a floor on the overnight interest rate, as banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed. In practice, the federal funds rate has fallen somewhat below the interest rate on reserves in recent months, reflecting the very high volume of excess reserves, the inexperience of banks with the new regime, and other factors. However, as excess reserves decline, financial conditions normalize, and banks adapt to the new regime, we expect the interest rate paid on reserves to become an effective instrument for controlling the federal funds rate.
My Translation: “Paying interest on reserves sure did not work like we thought it would. In fact, nothing is working like we thought it would. The Maestro taught us that it’s always possible to blow a bigger bubble. However, I am perplexed why these actions are not working. You do know I’m a student of the Great Depression, don’t you?”
50 Ways To Beat Deflation
Bernanke left the London School of Economics and was heard singing his favorite song “50 Ways To Beat Deflation“.
Mike “Mish” Shedlock
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