Bernanke A Man For All Seasons

Well, sincere congratulations to Ben Bernanke.

We think he did a fine job, within his powers and without giving the shop away, of holding a growing panic in check, at least for a time, and time is important!

According to news reports of our Fed Chairman’s talk this morning in Wyoming, we feel that Bernanke was on the money.

Apparently, it was well received, at least initially, in the bond and stock markets, who gained the impression, at least, that action will be taken to avoid the present liquidity crunch morphing into a solvency crisis.

Furthermore, it appears that it has met with approval from both bears and bulls alike.

So, Ben Bernanke appears to have been deserving of praise, in playing for valuable time.

So what did he say?

He made five key points.

First and most importantly, all American tax payers and believers in free enterprise may be pleased that Bernanke does not intend to bail out irresponsible borrowers or lenders.

Second, Bernanke has been accused of being overly cautious and of looking through the rear view mirror. He undertook to look at "timely" indicators and to lend weight to contact with "real" market practitioners.

This is good, as waiting for confirmation from lagging indicators can make the Fed too late in taking timely corrective action.

Third, at long last the Fed Chairman has publicly accepted the contagion effect of the subprime problem, as we have long warned. We understand that, in his position, he did not want to trigger a panic, by alerting people to the problem in advance.

However, even his latest public acceptance of the reality is a positive. It gives the hard pressed consumer the impression that, at long last, our government appears to be living in the same "real" world as the rest of us.

Fourth, Bernanke assured us that the Fed will act if necessary.

Importantly, this gave the impression that action will be taken to avoid a deepening economic and financial crisis.

Our only problem with this vital statement of good intent is, what can the Fed do?

We feel the Fed can do two main things. It can make more liquidity available and reduce the cost of money.

But we do not see how the Fed can force the banks to lend, to thus alleviate the growing solvency crisis, or raise the confidence of consumers enough to avoid a recession, or worse.

Finally, Bernanke was honest enough to admit that he was not certain as to the specific measures the Fed would be called upon to take.

As we see it, our economic problem is potentially very severe. It risks leading to a depression. We think our leaders now see this spectacle at long last and are beginning to focus their attention.

So far, our President, in his new Mortgage Initiative, has mouthed a few words and promised to take some "political" measures.

We feel the President was political brand building. As described, his initiative will have little effect upon the root problems of the subprime market, its repercussions on the credit markets and our economy in general.

The key problems that we see facing the Fed are: an economy heading for recession; a dangerously weak dollar and a liquidity crisis that risks morphing into a massive solvency crisis, involving otherwise healthy companies and individual consumers, pointing towards a deep recession at best.

This calls more money to be made available in terms of lending, not just in liquidity and cheaper money.

But how can the Fed encourage or even force the banking system to lend?

It is like a person going to buy a supply of bottled water at a store and suddenly hearing on their car radio that toxic waste has been found in some bottled water. They will not buy the water, despite assurances, from the store manager that it is ok and discount offers. Even if the shopper’s spouse promises more money, by telephone, the shopper will still not buy bottled water. In fact, they will turn back to government tap water (Treasuries?), despite the fact the taste (yield) is relatively unattractive.

The same is happening in today’s credit markets. There is toxic waste (sub-prime), often unseen, but possibly embedded in the credit risk. No one wants to touch it, regardless of price or of the cost of money.

Despite this, we hear growing cries for a Fed rate cut and not just from bears.

We hear increasing cries from bulls. The same Wall Street and related "cheerleader" bulls who tell us repeatedly how cheap stock look, how strong the economy is and that the sub-prime is a minor problem are now almost screaming for a rate cut.

We find it hard to credit this "mismatch". If the economy is so healthy and stocks are so cheap and attractive, why the crying need for a rate cut?

Nevertheless, the financial markets and economists are crying out for a rate cut.

As we said yesterday, we feel that, on balance, politics will win out and that, by September 18^th, the Fed will face extreme political pressure to cut rates, as evidence of recession grows.

The problem, is that if the Fed does cut its target rate, so what?

How will a rate cut help the crucial and looming insolvency crisis?

A rate cut may boost market confidence, but would it encourage lending.

Indeed, as lending rates fall closer to short-term Treasury yields, lending could become less, not more attractive to the banks!

Bernanke gave us a confidence building speech while cleverly playing for time. It was indeed a speech for all seasons.

Unfortunately, we feel we are heading for an economic and financial winter. But, the required Fed action, even if it proves to be to hold rates to protect our dollar, is still to come.

We see the Fed’s action on September 18th as proving more than usually crucial.