Christopher Pang
Feds Chairman Bernanke pretending to look smug
It is unwarranted to give so much attention to a clueless central banker in my opinion but he is after all the most powerful man on earth. Therefore the focus of this article shall be on his recent interview on “60 Minutes”.
On why he has to save Wall Street:
There is absolutely no need to save a financial institution in distress based on Bernanke’s analogy. There is a list of questions to be answered after listening to his analogy.
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Why would anyone have a wooden house if you know your neighbour is a smoker who smokes in bed?
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Why would anyone build your house so close to his house such that your house will catch fire?
If it happened that you built your house before him and he moved in thereafter, then what you should do is to mitigate your risk by installing a fire alarm on your own house or buy fire insurance or even installing a fire sprinkler system or fire proof your house. It is therefore ludicrous to use such an analogy. If you did not manage your risk exposure with the following actions, your house deserved to be burnt to ashes.
Clearly this is his explanation of why he had to save a reckless smoker(AIG, Citigroup) to save the town (Main Street). In fact what happened was that some folks in this town(Goldman, Deutche, Société Générale, Barclays, Merrill Lynch) sold fire insurance on this reckless smoker’s house because the premiums were high. Now that the reckless smoker’s house caught fire, these folks started to panic at their potential loss if the house does collapse. They would not only lose their own houses built so closely to the smoker’s house but including whatever insurance payouts which they have underwritten. With a vested interest, is it any wonder why these financial institutions would be pressurizing the Treasury and Federal Reserve to save this reckless smoker?
On whether letting Lehman failed was a mistake:
The markets did take care of Lehman. They deserved to fail for overleveraging, taking on more risk than what they should or rather what the markets would have allowed them to by cooking the books with Repo 105 and Repo 108. As balance sheets are only recorded at a point in time, Lehman could easily deceive investors with a sale towards end of the quarter with a repurchase agreement to buy back at the start of next quarter. This went on for more than 5 years with Ernst and Young as their auditor, recently being sued. The auditors argued that it was within the accounting rules to do this. An auditor has to maintain a healthy level of professional skepticism and judge if this type of transactions done repeatedly makes any business sense. Does it make any business sense to sell low and buy back higher towards the end of every quarter? Has the judgment of the audit partner been impaired by the higher audit fee each year he/she got away with it?
The markets would have “taken care” of the other investment banks if Bernanke did not intervene. Markets are always self correcting. People make mistakes, they get punished. People do the right things, they get rewarded. Now what we are seeing is people make mistakes, they avoid punishment, and they get a bailout. That is crony capitalism. There would be other financial institutions that might fail because they lent money to Lehman or Goldman or any of the overly leveraged financial firms that would have failed. That is part of the process of weeding out the bad institutions. Like weeds, if not taken out from time to time, they will spread all over the garden and destroy every flower and plant.
In the interview, Bernanke was asked, “Do you anticipate a scenario in which you would commit to more than $600 billion?” Bernanke’s answer was startling.
This suggests his initial exit strategy for QE 1 was all empty talk and there is a higher possibility of QE 3, 4, 5 than a exit strategy. Firstly if the Fed stops accepting problematic assets as collateral on their balance sheets for the loans they lend to the financial institutions, these financial institutions would be back to the time of post Lehman collapse in 2008. If these assets were back onto the banks’ balance sheets, and housing prices do not go back to levels in 2007-2008, it is extremely likely we will see the banking sector facing huge losses on these mortgages. The change to mark to market accounting has given these bankers some hope of delaying the inevitable losses on their books. These banks are now relying on the central bank to inflate the money supply, keep the low interest rates and attempt to push housing prices back up to previous highs again.
Unfortunately the fear among the baby boomers facing retirement in another 10 years is too high. They reached a point of realization that they do not have enough savings and can no longer rely on the “American Dream” of home ownership to bring them to financial freedom. The next bubble, a currency bubble, will finally see the end of the Federal Reserve and the banks that helped create it.
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Photo courtesy of Chris Whalen
