bank run blog

Speaking to members of Congress today, Federal Reserve Board Chairman Ben S. Bernanke delivered a message of cautious optimism about the US economy, saying that modest growth may be possible later this year. The Associated Press reports :

“Federal Reserve Chairman Ben Bernanke told Congress Tuesday the economy should start growing again later this year, his most optimistic assessment of the country’s financial health since the recession struck with force last year.”

Bernanke sees reasons for renewed hope that the economy may be on the rebound :

“’We continue to expect economic activity to bottom out, then to turn up later this year,’ he told lawmakers. ‘We expect that the recovery will only gradually gain momentum.’

Recent data suggest the recession may be loosening its grip on the country, Bernanke said.

‘The pace of contraction may be slowing,’ he said. It was similar to an observation the Fed made last week in deciding not to take any additional steps to shore up the economy.”

If the tenor of Bernanke’s economic prognosis sounds familiar, it’s only because you’re paying attention. Here’s what the Fed chairman told an audience of distinguished academics and policymakers at the International Monetary Conference in Barcelona in June, 2008 :

“We may see somewhat better economic conditions during the second half of 2008, reflecting the effects of monetary and fiscal stimulus, reduced drag from residential construction, further progress in the repair of financial and credit markets, and still solid demand from abroad. This baseline forecast is consistent with our recently released projections, which also see growth picking up further in 2009.”

Today’s guardedly upbeat remarks were made in Congressional testimony before the Joint Economic Committee. Bernanke told the same committee in March, 2007 :

“Growth in consumer spending should continue to support the economic expansion in coming quarters. In addition, fiscal policy at both the federal and the state and local levels should impart a small stimulus to economic activity this year.”

Bernanke’s forecast for 2007 concluded :

“Overall, the economy appears likely to continue to expand at a moderate pace over coming quarters. As the inventory of unsold new homes is worked off, the drag from residential investment should wane. Consumer spending appears solid, and business investment seems likely to post moderate gains.”

Keenly sensing a “cooling” of the US housing market in 2006, USA Today reported that Bernanke was expecting a “soft landing” :

“The housing market, after flying high for five years, has lost altitude but appears headed for a safe landing, Federal Reserve Chairman Ben Bernanke said Thursday.

‘It seems pretty clear now that the U.S. housing market is cooling,’ Bernanke said in a question-and-answer session following a speech he delivered on banking in Chicago.

He noted that home sales and construction are slowing.

‘Our assessment at this point … is that this looks to be a very orderly and moderate kind of cooling,’ Bernanke said.”

A former professor of economics at Princeton, with degrees from Harvard and MIT, it is certain that Bernanke is one of the best and brightest of his generation. The question is, at what?

Associated Press : Bernanke: Economy should grow again later in 2009

Federal Reserve Board : Remarks by Chairman Ben S. Bernanke at the International Monetary Conference, Barcelona, Spain (via satellite), June 3, 2008

Federal Reserve Board : Prepared Testimony of Chairman Ben S. Bernanke Before the Joint Economic Committee, U.S. Congress, March 28, 2007

USA Today : Bernanke: Housing market is headed for a soft landing (May 18, 2006)

It appears from testimony being leaked by New York Attorney General Andrew Cuomo’s office that former Treasury Secretary Henry Paulson told Bank of America CEO Ken Lewis that he would be fired if he did not go through with the Merrill Lynch deal after Lewis discovered huge losses at the once-esteemed investment bank. Lewis also alleges that he was instructed by federal regulators to remain silent about the deal.

In an irony that anyone following the three-year (and counting) financial fiasco can appreciate, the New York Times reports that it looks like Bernanke told Lewis to keep quiet, while Paulson told him to play dumb :

“The head of Bank of America changed his mind about trying to pull out of its deal to buy Merrill Lynch after Henry M. Paulson Jr., the Treasury secretary at the time, suggested that the bank’s management and board could be removed if that happened, Attorney General Andrew M. Cuomo of New York said in a letter to Congress made public on Thursday.

Kenneth D. Lewis, the bank’s chief executive, also testified in that he was told by Mr. Paulson to keep quiet about the deal’s new developments, even after it was clear that the bank was going to absorb much bigger-than-expected losses in buying Merrill, according to a transcript that Mr. Cuomo released Thursday.

In his letter, Mr. Cuomo said his investigation into the Bank of America-Merrill merger had raised questions about the government’s financial bailout program, ‘as well as about corporate governance and disclosure practices at Bank of America.’”

The Wall Street Journal notes that the release of this testimony will only fuel criticism of the government’s secretive handling of the crisis :

“Mr. Lewis’s statements highlight a lack of public disclosure that has accompanied the financial crisis since its inception. The crisis has roots in the fact that Wall Street banks didn’t adequately disclose the true prices of the toxic mortgage-related assets they held. The government has also been criticized for offering limited disclosure of the details or rationale of some of its bailout strategies, from the forced sale of Bear Stearns Cos., to the $173 billion injection into American International Group Inc.”

New York Times : Treasury Pushed BofA to Close Merrill Deal, Cuomo Says

Wall Street Journal : Lewis Testifies U.S. Urged Silence on Deal

The minutes from the most recent Fed meetings, released yesterday, reveal more negativity and urgency than is usually found in these dry documents. Analysts seemed split over whether the minutes confirm the resolve of the Fed to deal with the banking crisis or the depth of that crisis, as the markets drifted on Wednesday afternoon. The BBC reports :

“Notes from the last meeting of US Federal Reserve policy makers show just how downbeat they had become on the state of the US economy.

It was this pessimism that led them to agree to spend more than $1tn (£680bn) to revive its fortunes.

‘Most participants viewed the downside risks as predominating in the near term,’ the minutes said.

But the committee did expect a recovery to start in 2009, despite unemployment rising sharply into next year.

Projections for economic activity in 2009 and 2010 were also revised down.”

BBC News : Fed minutes reveal gloomy outlook

Federal Reserve Board : Minutes of the Federal Open Market Committee March 17-18, 2009

Emergency measures are announced so routinely these days, and often radically revised a short time later, that it is difficult to keep up with details of all the tinkering. Today the Fed, which is not by any measure a transparent agency, postponed the expiration of an array of liquidity programs designed to benefit banks. According to the Associated Press :

“The Federal Reserve has extended the life of key programs aimed at busting through credit clogs and restoring stability to financial markets.

The Fed said Tuesday that the programs, originally slated to last through Jan. 30, will be extended through April 30. The Fed said it was taking the action ‘in light of continuing strains in financial markets.’

The Fed’s emergency lending facility, which investment firms can tap for a ready source of cash, is covered by the decision. This category was recently broadened to include any loans that were made to the U.S. and London-based broker-dealer subsidiaries of Goldman Sachs, Morgan Stanley and Merrill Lynch.

A program that lets financial institutions temporarily swap risky investments, such as shunned mortgage-backed securities, for super-safe Treasury securities also is covered.

Another Fed program being extended makes loans to money market mutual funds — via banks — to help the funds, which have been under pressure as skittish investors demand withdrawals.”

In a story that somehow seems related, the New York Times is reporting Bailout Monitor Sees Lack of a Coherent Plan :

“The head of a new Congressional panel set up to monitor the gigantic federal bailout says the government still does not seem to have a coherent strategy for easing the financial crisis, despite the billions it has already spent in that effort.

Elizabeth Warren, the chairwoman of the oversight panel, said in an interview Monday that the government instead seemed to be lurching from one tactic to the next without clarifying how each step fits into an overall plan.”

Associated Press : Fed extends key credit programs through April 30

New York Times : Bailout Monitor Sees Lack of a Coherent Plan

The underlying fundamentals of the US economy are deflationary, and have been for some years. It has taken a while for the country to bumble through predictable phases of denial, bailouts, and finally denial of bailouts, but timid discussion of deflation has begun to surface in the mainstream media. From this morning’s Washington Post :

“With the stock market crumbling and the economy shrinking, a whiff of deflation is in the air.

Oil prices yesterday slid below $50 a barrel to the lowest level since May 2005; stores are advertising sales on the eve of what should be peak holiday shopping season; and worldwide demand for items as varied as steel, petrochemicals and clothing plunged in October.

This week’s news of a drop in consumer prices may sound on the surface like a good deal for financially strapped U.S. households. But economists warn that sustained deflation — a period of falling overall prices — would deepen the nation’s economic troubles. Such a period would make it harder for people to repay debts and would prompt consumers to delay purchases in anticipation of lower prices and harder times.”

Federal Reserve Board Chairman Ben Bernanke has scoffed at the prospect that the US economy could enter a deflationary depression, hinting in numerous speeches and public statements that his Fed would risk hyperinflation through aggressive intervention rather than succumb to deflation, which he apparently views as the ultimate failure for a central banker.

But with a Japanesque ZIRP (Zero Interest Rate Policy) on the immediate horizon, what more can Bernanke do to avoid the word “deflation” making it into his epitaph? Have the Fed pay interest on money it lends to banks? Don’t laugh; the Fed is already stealthily floating this concept. Reuters reports :

“Deflation would be very damaging to the United States economy and with nominal interest rates already very low, quantitative easing may be needed to keep it at bay, a top Federal Reserve official said on Thursday.

‘At least over the near term, any additional influence through interest rate reductions will be limited and the focus of monetary policy may turn to quantity measures,’ St Louis Federal Reserve President James Bullard told a regional economic conference.

Quantitative easing recalls the massive liquidity injections made by the Bank of Japan during the 1990s to re-inflate growth once official interest rates reached zero.

Some economists believe the Fed will cut rates to zero over the next three months, together with actions to boost the money supply, as the U.S. central bank takes aggressive steps to prevent the world’s biggest economy from Japanese-style deflation and lost decade of growth.”

Washington Post : Falling Prices Raise a New Fear: Deflation

Reuters : Fed’s Bullard: U.S. deflation an issue Fed must face