The Macroprudential Bernanke ~ Steve Blitz Morning Notes
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Tuesday, July 21, 2009

The Macroprudential Bernanke

Today's testimony sounded a lot like the Captain of the Titanic taking credit for the rescue after driving the ship into an iceberg. He also wants to assure everyone of safe passage going forward because he is using the same navigation techniques only now the guys in the engine room are under his direct command.

We heard today a predictable collection of words to satisfy the required report to Congress -- the Fed saved the day, the Fed needs broader supervisory/regulatory powers to prevent the day from needing to be saved again, caveats regarding the tepid outlook, inflation and the budget, and then he tosses the obligatory bone to Congress regarding transparency and oversight. His op-ed piece in the WSJ calmed the market's concerns about the great unwind to come -- it is self-liquidating.

In his words --

To some extent, our policy measures will unwind automatically as the economy recovers and financial strains ease, because most of our extraordinary liquidity facilities are priced at a premium over normal interest rate spreads. Indeed, total Federal Reserve credit extended to banks and other market participants has declined from roughly $1.5 trillion at the end of 2008 to less than $600 billion, reflecting the improvement in financial conditions that has already occurred. In addition, bank reserves held at the Fed will decline as the longer-term assets that we own mature or are prepaid. Nevertheless, should economic conditions warrant a tightening of monetary policy before this process of unwinding is complete, we have a number of tools that will enable us to raise market interest rates as needed.

Meaning all is well until he deems it isn't. Since he missed that mark by a wide margin the last time, what are the guideposts this time? Considering that he is still beating the "CPI is inflation" drum, he will make the same mistake again.

. . maintaining the confidence of the public and financial markets requires that policymakers begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and continued increases in the costs of Medicare and Medicaid. Addressing the country's fiscal problems will require difficult choices, but postponing those choices will only make them more difficult.

If the budget is fixed it would be better. Remember, however, that the trade deficit as a percentage of GDP expanded in the 1990s because of corporate borrowing --the budget deficit was moving towards surplus. In the current decade it was households borrowing to buy houses. In both cases, the management of monetary policy supported the unsustainable growth in leverage. Slippage in market confidence came from the financial sector's meltdown made possible by the gross mismanagement of monetary policy and the Fed's failure of regulatory oversight.

The Federal Reserve has taken and will continue to take important steps to strengthen supervision, improve the resiliency of the financial system, and to increase the macroprudential orientation of our oversight. For example, we are expanding our use of horizontal reviews of financial firms to provide a more comprehensive understanding of practices and risks in the financial system.

"Macroprudential." "Horizontal reviews." This reads as if it was written by some management consultant from McKinsey or Bain or someplace like that. And like most consultant-speak it is meant to sound as if the speaker is smarter with more insight than the consultee. It would be better if we heard directly what precepts will be guiding Chairman Bernanke's oversight through the next cycle assuming his faith in the marketplace and its democratization of risk has been shaken -- or perhaps it hasn't.

The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy.
And what exactly were the benefits of having an independently omnipotent FOMC focused on CPI inflation while ignoring the explosion in credit creation and then underestimating what would happen once credit began to implode.

A perceived loss of monetary policy independence could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability.
Letting Congress run monetary policy is not a good idea, but the Fed has not brought us a stable, balanced economy. Quite the contrary. And the banality of Bernanke's testimony belies any sense that there has been a seismic change in how monetary policy should be executed.

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