Ben Bernanke Runs Out of Options

Originally published on The Agonist

The US economy is on the road to recovery, right? That’s what all the economists and financial analysts say. Unemployment has dropped down to 8.3%, unemployment claims are now at a level last seen in 2008 before the economy fell off a cliff, almost all the TBTF banks have just passed the recent Fed stress tests and are now allowed to use their excess capital to pay dividends and buy back their stocks, inflation is tame if you go by official government statistics (especially core inflation that the Fed loves to look at because it removes the effects of food and oil price increases), and finally all major economic indicators are flashing green lights.

So why is Ben Bernanke saying that zero interest rates and his endless stream of quantitative easing programs are still essential? You would think the Fed would grab at any opportunity to pare back its balance sheet and restore interest rates to a more normal level. Several Fed officials have asked that same question. When Ben Bernanke was giving his speech yesterday in defense of his policies, Philadelphia Fed President Charles Plosser was giving an entirely different speech arguing that central banks should not have unlimited authority to expand their balance sheets, because all that does is enable their governments to rack up larger deficits. Another Fed President, Richard Fisher of Dallas, has said QE3 is unnecessary and is simply not going to happen, no matter what Wall Street wants.

Who is correct here – Ben Bernanke, or his critics who sit around the Fed board table and are now very public with their complaints about his approach to monetary policy? It’s a reminder of how far we have come from the dark days of 2008 when the Fed first began its program of flooding the global economy with dollars. Back then the Fed Board of Governors and Open Market Committee members were unanimous in support of this program, at least publicly. The only complaints one could find about the Fed were to be found on the blogosphere, which was not taken seriously by anybody in Washington, and the only politician speaking against the Fed was the lone wolf Congressman, Ron Paul.

My how the world has changed. Ben Bernanke wants to embark on QE3 despite all the signs of economic recovery, but he can’t easily do so because he doesn’t have unanimity around the board table, and his critics are opening questioning his leadership. The financial press has caught on to the fact that the only beneficiary of easy money is the stock market, which jumped nearly 2% yesterday on the news that Bernanke has no intention of even slightly lowering the flood gates. Reporters from the main stream media such as Bloomberg and Reuters are openly referring to the “Bernanke Bubble”, and a bubble it certainly is, especially in tech stocks.

The NASDAQ, which hasn’t had a meaningful correction since October, is behaving like it was 1999, at the height of the bubble. Only this time, the bubble is focused on a single stock – Apple – which is now rising exponentially (from $500 to $600 in one month). Apple is now larger in market capitalization than all retail stores in the United States combined, and it has such an enormous weighting on the stock indexes that were it to be included in the Dow Jones index, it would add 1,000 points overnight to the DJI. Apple is also masking the fact that technology stocks are not doing well in general, and that companies like Dell, Micron, Microsoft, and Hewlett Packard are struggling to keep up their margins and revenue.

There are other bubbles out there, but they are not likely to be noticed by Ben Bernanke because the Fed excludes food and energy costs from its inflation outlook. This allows for “core inflation” perceptions to be perpetually “well-grounded”, meaning consumers and businesses supposedly aren’t concerned about inflation or doing anything to protect themselves from price increases. But business is certainly noticing an inflationary problem. General Mills, the maker of cereals and other food products, recently stated that increases in wholesale food prices in 2011 averaged 10%-11% . This is certainly well beyond the 2% rate of inflation that Ben Bernanke said was the Fed target for inflation, beyond which it would begin to do something (like tightening monetary policy). In fact, even the core inflation rate beloved by the Fed is growing in excess of this 2% target, which is another reason why Fed critics on the board are questioning what Bernanke is doing.

In the US, yet another bubble waiting to pop is with the student loan program. Loans for higher education have now approached the $1 trillion level, and are larger than all credit card debt outstanding. The problem is the default rate on these loans, which officially last year according to the Department of Education had jumped to 8.8%. Unofficially, most education officials say that over 20% of borrowers are late on their payments, assuring that the default rate is bound to go much higher. There is a particular concentration of defaults with students who attend for-profit colleges, which have been a growth business in this depression, and which get 80% of their income from these government-guaranteed student loans. Some of these colleges are reporting default rates in excess of 75% . The average college student graduates with $25,000 in debt – Ben Bernanke admitted last month that his own son has a $400,000 debt from attending medical school. The entire student loan program poses at least two huge problems: hundreds of billions of dollars of defaults are going to have to be paid by the taxpayers, and 20-year-olds are now entering the work force with huge debts, so they will have no credit capacity to buy a home. This guarantees that the housing market is going to limp along in a deep trough for at least the next ten years.

Then there is the oil price bubble. Recent academic research indicates that oil over $100/bbl is the result primarily of speculation by hedge funds and banks using Exchange Traded Funds as their financial tool of choice. Of course, the money used for all this speculation comes directly from Ben Bernanke, but also from Mario Draghi, the president of the European Central Bank. He has the same problem as Bernanke; some of his colleagues on the ECB board are publicly sniping at him, saying any more quantitative easing from the central bank is going to have to wait until it is clear that the money is going to be used for productive purposes, and not for equity and commodity speculation.

Ben Bernanke can afford to ignore energy inflation, because even though the price of gasoline at the US is now near record levels of $5/gallon, Americans have a lot of ways to reduce gasoline consumption, and that is exactly what they are doing – driving less is one example. Not so with the Europeans. Gasoline prices in France, for example have reached $10/gallon, and the pain is quite real for the average driver, who does not motor around in a lumbering American SUV and has already slimmed down to a fuel-saving auto. No wonder the ECB board wants to figure out whether the damage from quantitative easing is too much to bear.

There is another problem with the price of oil. Not all of the increase is speculatively driven. Besides the risk of supply interruptions should Israel attack Iran, there is the very real supply shock caused by the Japanese tsunami of 2011. Japan now has only one of its 54 nuclear reactors on line; the rest are under inspection with no indication from the government as to when they will be returned to service. In fact, the government is under intense pressure to shut the industry down entirely, as Germany did. Japan has lost a third of its energy capacity, and has been forced to buy oil on the open market as a replacement. This is at least as big a shock to the oil market as the Libyan crisis of a year ago.

It used to be that Japan could finance such a sudden burden because of the enormous revenues generated by its trade surplus, not to mention the mountainous pile of savings Japanese consumers had created. Neither of these benefits exists anymore. Japanese domestic savings have been slowly cashed in over two decades of economic depression, as consumers have been forced to use up their long term retirement kitty to keep up their standard of living (and in many cases, just to buy food and pay for energy). As to the trade surplus, that has evaporated under relentless pressure from China, which has devastated the Japanese high-value export industry just as readily as it has forced US manufacturers to shut down.

This is why veteran market observers fear the next black swan event for the global economy could come from Japan. It wouldn’t be a black swan event really, since many people understand the dire situation Japan faces, and since the real black swan event was the tsunami and Fukushima disaster of a year ago. There is no denying, however, that as Japan has now run out of domestic savings and in the past quarter swung to a trade deficit (it’s been nearly seventy years since anyone has been able to utter the three words “Japanese trade deficit”), its reliance on the generosity of outsiders willing to buy its government bonds is more crucial than ever. An enormous pile of such bonds already exists; the Japanese government deficit is easily 200% of its GDP, compared to the US ratio of 100% deficit to GDP. For the past two decades of depression, Japan has been able to cover its interest costs on this deficit by using a zero interest rate policy, and here is the tricky part: Japan simply cannot afford even a modest increase in interest rates. Its debt burden is too large; its domestic tax revenue has been crushed by the depression; its trade surplus has vanished, and its consumer savings pool is gone as well.

If the international bond market gets even slightly finicky about buying Japanese government bonds, and pushes long term bond rates to 3.0% or higher, Japan will have a very difficult time meeting its interest obligations. A default or restructuring becomes a serious possibility – and if you think the global banking system had problems coping with its Greek debt portfolios, wait until you see the size of their Japanese bond portfolios, which does not even count loans to Japanese corporations and trade finance relationships which would be badly hurt by a government default.

The global masters of the universe are no doubt talking quietly among themselves about how to keep the Japanese situation below the radar of the press and the public, and avoid a market panic. Every effort will be made to publicly minimize the problem, and present Japan as the economic powerhouse it always has been, as if the country has not gone through 20 years of economic depression and deflation.

Nor will Ben Bernanke ever admit that for the past five years he has been following the same path Japan has been on for twenty. Zero interest rates have given US politicians the perfect environment in which to issue enormous amounts of government debt. Barack Obama has been no different than any Japanese prime minister: he has taken advantage of what appears to be free debt at every opportunity, and the US Congress has happily abetted this splurge in borrowing, to the point that the government deficit has ballooned from $10 trillion to $15 trillion in just four years.

The US economy has a way to go before it reaches the parlous situation facing Japan, but in truth such a crisis could reach American shores faster than many think possible. What we learned from Japan is that a major economic power was seriously crippled by a black swan event. Japan was able to cope with and recover from the Kobe earthquake of 1995, but the Sendai earthquake last year hit a nation that was far more vulnerable.

What will be the black swan event for the US? A stock market crash is a significant possibility, given the Bernanke Bubble that now exists, and the fact that humans no longer trade stocks – machines do. At least three-quarters of all trading is done by Wall Street and hedge fund robots, and we have seen time and again mysterious price collapses in stocks and indexes that are driven by programming errors. Perhaps the growing student loan problem will be the last straw for a bond market increasingly disinclined to load up on more and more US debt. Nature may have a say as well, especially if the bizarre weather patterns that are becoming the norm devastate America’s farm belt. Then there is always the possibility of military overreach, or shall we say some military fiasco that finally forces the country to realize it can no longer support the rapacious appetite of the military-industrial-Congressional complex (to use Eisenhower’s original phrase).

The point is, the US is very much like Japan – it is far less able to cope with surprises than ten years ago. It has squandered its national wealth, its reserve currency status, its AAA credit rating, and the perception that it is militarily indomitable. It is rapidly becoming just one of many nations in a multipolar world filled with weakened friends in Europe and Japan, and emboldened competitors in China and Russia.

Whether Ben Bernanke finds himself worrying about such possibilities in the wee, dark hours of the morning is hard to say. We are not even sure he appreciates the liquidity trap he is in – his inability to raise rates, or let off the gas pedal of the monetary machine he is operating, without devastating the global economy and destroying the United States economy. All we know is that he is acting as if he understands the central banker’s hell that he is inhabiting. The US has reached the point where incremental amounts of government debt do nothing to create economic growth, and where the next dose of quantitative easing will have far less economic benefit than the previous doses, other than to keep a drug-addicted stock market from collapsing. Yet all Ben Bernanke can do is keep feeding the beast with “liquidity”, knowing that no one and nothing can survive on a liquid diet forever. And always, always, lurking around the corner, is the potential for a surprise.



8.3% unemployment rate is anything but normal, oil

I didn't get Bernanke was pushing for QE3, although it could be construed that way. See Wall Street Selective attention problem. I got he was talking about how labor markets are anything but normal and a huge drag on the overall economy at the moment. In the above link I ask are workers being used as a pawn to justify more quantitative easing...when we know QE doesn't do anything for workers, labor, jobs, hiring per say.

Just to sound CT for a moment, have you noticed politicians start to get serious about curtailing oil speculation and magically the price goes back down and politicians stop talking about oil speculation so nothing happens?

Yes, oil is correlated to demand, i.e. recessions but still, I find the latest projections oil will drop by $1.50 by next winter so "don't worry about it" message most interesting.

Numerian, have you read anything correlating MBSes to actual physical residential real estate activity?

There is a feeble attempt to revive the MBS market

The Fed and the TBTF banks have been able to issue asset-backed securities for some classes, such as credit cards. In an interest-rate starved market, some investors have been querying what the yield might be on new issues of mortgage-backed securities. I don't see, though, how the industry is going to get around overall investor reluctance to participate in a market that was so obviously flawed legally and structurally, against the interest of the investors. It's hard to see banks, for example, putting in the effort to register thousands of mortgages with county recorders of deeds every time one of these securities is resold in a secondary market. The banks barely have enough staff, and certainly very few experts, to review the existing backlog of distressed securities.

What does seem to be happening, though, is vulture funds are scouting out some of these distressed securities in the hopes of buying them cheaply. After all, in most of these securities the bulk of the mortgages are still performing and generating some yield. This is part of the reason the Fed was able to report the miraculous "income" of $77 billion the last quarter - it was declaring the cash flow from its vast MBS pool as income payable to the Treasury.

I do recall seeing about a month or so ago a private deal between the Fed and one of the banks - maybe it was Goldman Sachs - to buy some of the Maiden Lane properties. The deal was not shopped around exactly, though the Fed insisted it received a fair market price for the assets. That was funny - it is supposedly the inability of the banks to discover any fair market prices in the first place that has allowed them to suspend mark to market for their mortgage backed securities portfolios.

magic money

I covered some of this in the magic money article. Yup Goldman Sachs, Barclays, and Credit Suisse want to buy up old AIG MBSes held at the NYFed.

There is some "claim" running around that buying up MBSes, (I'm not sure about issuing new, your analysis makes a hell of a lot of sense to me), will somehow revitalize construction, residential real estate.

I'm thinking that's 100% BS there is no correlation between MBS values/yield and new construction.

But this latest round of QE3 rumors (WSJ) will be the Fed buying up more MBSes and that's the latest claim.

I suspect all of this is just lobbyist generated lies and muck to keep their MBS derivatives going.

I was wondering if anyone has gone into deep research to find any correlation between buying up these toxic assets, derivatives and the real world economy, i.e. production, construction, hiring and so on. Beyond spurious conclusions, I'm betting there isn't any, but getting to the classes of MBSes and their values/yield over time, then running some correlations seems to be the needed analysis.

No correlation, but maybe a perverse kind of evidence

The point is well made that empirical evidence of any correlation linking new construction activity to MBS values/yield almost certainly doesn't exist. That's just barking up the wrong tree.

On the other hand, when Numerian points to 'vulture funds', there is maybe a perverse kind of evidence there. The 'vulture funds' get into the picture by way of the 'interest-starved' environment and other influences, such as those pointed out by Frank T, in comment titled 'Lenders of Last Resort' (at the 'Magic Money' article) about how liquidity is stalled by insistence of banks on fees and interest charges. Now Numerian fills in more details in comment above 'There is a feeble attempt to revive the MBS market'. From Numerian's comment --

The Fed and the TBTF banks have been able to issue asset-backed securities for some classes, such as credit cards. In an interest-rate starved market, some investors have been querying what the yield might be on new issues of mortgage-backed securities. I don't see, though, how the industry is going to get around overall investor reluctance to participate in a market that was so obviously flawed legally and structurally, against the interest of the investors. It's hard to see banks, for example, putting in the effort to register thousands of mortgages with county recorders of deeds every time one of these securities is resold in a secondary market. The banks barely have enough staff, and certainly very few experts, to review the existing backlog of distressed securities.

What does seem to be happening, though, is vulture funds are scouting out some of these distressed securities in the hopes of buying them cheaply.

This is a terrible thing to say, but if vulture funds are looking for MBSes to buy on the cheap, seeing opportunities created by inefficiencies of banks .... is that like a positive sign that residential values have, after all, bottomed out? blush

Cheap shots targeting poor Ben?

It's astounding that there are currently only four commissioners (members of the Board of Governors)  -- Bernanke, Yellen, Tarullo, Raskin. Three (of seven) seats are vacant and will remain so at least until 2013. Undoubtedly, the political point of this is that whereas the FOMC would otherwise consist of 12 members, it currently consists of 9. The result is 5-4 control, where the 5 are appointed by shareholders (banks) and the public members (from the Board of Governors) form a minority. (It appears to be an objective of the Republican Party to assure that bank-appointed members dominate the FOMC.) Thus, the Fed is not unlike the SCOTUS these days.

Why all the talk about Bernanke as though he has ever been any kind of king of the Fed in the way that the Chairs of old -- Greenspan, for example -- were? Bernanke is like Obama: what he has had going for him is that his opponents don't have a clue any more than he does, and they can't agree among themselves on much of anything.

Is this situation ever discussed in mainstream media or even in the financial news media -- even on the boring Sunday afternoon shows? I doubt it. As far as John Q. Public is concerned, FED = BERNANKE.

Of course, what is obvious to every thinking person is that something more is needed than Fed policy or Fed action -- changes much more fundamental in the way of monetary/financial/economic/tax policies of the USA. Until many more Americans get to the point of recognizing the need for fundamental reform legislation, the spotlight on Bernanke is really counter-productive -- a distraction. Ron Paul and his talk about ending the Fed -- that's just the tip of an iceberg. The iceberg is the global banking scam and the increasingly contradictory realities of the WTO world-system. Meanwhile, the Titanic drives on through the waves!

He's no Greenspan

And certainly no Volcker. Both of these chairmen kept an iron grip on the board and the FOMC. Most votes were unanimous and it would have been considered traitorous for a majority to vote against the Chairman. They were also powerful public figures and certainly represented the face of the Federal Reserve to the public. The institution throughout their time held a mystique, and the Fed Chairman was often described in the press as the second most powerful man in the US behind the President.

Bernanke has a much harder public relations task in this depression. Since he has chosen policy actions that stretch the mandate and traditional authority of the Fed - he has even encroached on Congressional prerogatives by lending vast amounts of money as if he were the Treasury - he is on the defensive in front of Congress and within his own board. Unprecedented actions by the Fed evoke unprecedented criticisms as well. On the other hand, Congress can't complain if the Fed is buying up over 50% of the debt they have issued, allowing them to issue more.

That's why Bernanke has gone on his public relations offensive, also unprecedented. Like the Pope or the Queen of England, the Fed Chairman needs to be somewhat aloof if the mystique is going to continue. You don't want the public to get too familiar with the institution, and the Fed certainly doesn't want too much light shown on their operations. The Atlantic monthly article that describes Bernanke as The Hero who saved the global financial system is just the sort of publicity he wants. It washes away all the anxiety over his decisions, some of which may have been technically a violation of the Fed charter.

The problem is that a significant number of analysts, specialists and various experts on the Fed aren't buying the hagiography. We already went through that with Bob Woodward's book on Greenspan, The Maestro, and people just aren't going to be fooled once again. The Fed has more power than ever before, but wants the same old lack of accountability for its actions. Bernanke has never owned up to Greenspan's failures in blowing bubbles (of course Bernanke is doing the same thing himself), and he has never admitted that the Fed was a failure in its regulatory oversight role. For that matter - it still is. It's deliberately ignoring the disaster brewing with student loans, the terrible credit standards being used in the auto loan business, and the hidden losses on bank balance sheets (with HELOCs for example). It's as if the Fed has no sense as to how credit risk in a bank should be managed and controlled. No one has learned anything from the 00's failures.

This is certainly odd coming from an institution that now has much more regulatory powers under Dodd-Frank than ever before. It was the big winner in the reallocation of regulatory authorities among the Fed, OCC, CFTC, SEC, etc. What Bernanke should be doing is addressing the problems caused by TBTF banks. That would require the Fed to reorient its policy and deliberations to focus almost entirely on the economy and the welfare of ordinary people,.recognizing that the TBTF banks are a detriment to the economy, and not the drivers of the economy as they are today. The Fed should even voluntarily give up its oversight duties to some competent third party not captive of the finance industry (in other words, not the OCC). The TBTF banks need to be broken up into regional players, with investment banking activities stripped away as we had under Glass-Steagall. Volcker's right in that respect - if the TBTF banks want to speculate (and this includes Goldman and Morgan which are still structured as investment/brokerage firms despite their bank status) - then such speculation should be done in entities with no access to the Fed and no ability to count on the taxpayers to bail them out. That is the only way discipline is going to return to the trading world. Then the Fed can go back to being stewards for the economy, and not first and foremost for the banking system.


You hit the nail on the head on what the Fed should be doing. I imagine breaking up TBTF, reinstating Glass-Steagall would have more effect on jobs, hires than anything. If banks were taken off of their "free money", which they just sit on, forced to put it back in the domestic economy.

Fantastic summary of the status of Ben (who I think is miles above Greenspan).

black swans

While Japan's tsunami qualifies as a black swan, economic crises in general are more like white swans. They come swimming gracefully along with remarkable regularity, with only the severity and precise timing a smidgen unpredictable. In other words, crisis isn't a bug, it's a feature.

Swans, apples and oranges

Good point from 'pelham' that the current Great Recession, for example, shouldn't be compared to the 2011 tsunami and Fukushima Daiishi events -- but 'pelham' begs several questions. Namely, the great question of economic cycles, the question of sustainability of the WTO 'final solution' of the human problem, the question of resource depletion coupled with unsustainable population growth.

Japan has had a 'white swan' long-term economic crisis (or decline) for two decades now, and within that decline Japan has experienced a Black Swan. I don't think that Numerian missed the distinction between predictable and Black Swan crises -- rather was asking how USA might do if we happen to experience some Black Swan event such as climate-related crop failure, perhaps in the middle of an approaching or continuing 'White Swan' economic decline (related to weakening of the USD).

IMO, comparisons of Japan and USA are fraught with problems, beginning with enormous cultural differences. The economies of both nations have been impacted by China's export successes in the context of the rise of global neo-merantilism, but in very different ways. Japan pioneered neo-mercantilist policy, preparing the way for China, whereas USA ... well ... what can we say? USA is pioneering the political economics of national dissolution by any other name?