The public dialogue that FED policymakers hold with themsleves bears increasing resemblance to a dialogue among the deaf, the dumb, and the blind. These officials have been dead wrong about the crucial economic and monetary issues since the accession of Bernanke -- the strength of the economy, the likelihood of strong economic growth continuing, the growing threat of inflation, the insignificance and easy containability of the sub-prime crisis, the need for higher interest rates (then, stable rates, now, slightly lower rates). The FED has seen no need to increase liquidity in the financial system and has declined to increase the inflation-adjusted monetary base by more than a pittance. The FED has been dead wrong about the real estate bear market -- their initial response was: what bear market? Then the market was "cooling." Now it is having a "correction." What will they term it tomorrow, we wonder, as they seek to remain BEHIND THE CURVE BY A HEARTY MARGIN?
We were assured by the media during the period when the FED made its 2 final rate HIKES that the new Chairman, Dr. Bernanke, was unhappy with them but felt he could not oppose them. He was "building credibility," we were told. Alas, we were all too credulous, it would seem.
Since the onset of the subprime crisis, all the Bernanke FED has done is roll back the last 2 totally inappropriate rate hikes and cut by an additional 50 basis points. This in repsonse to a sub-prime crisis which, despite FED assurances that it was "contained", now threatens the banking system, the municipal bond market, muni bond insurers, money market funds, the European banking system, and has now blossomed into a full scale credit contraction and real estate bear market unlike any we have seen since the 1930s.
Even among the FED's natural constituencies -- Wall Street and the economics profession in particular -- there is a sharply rising discontinuity. On the one hand, Wall Street firms and world class economists are warning daily, in ever-more dire terms, of the growing risk of a serious recession. The Bernanke FED, on the other, is chirping merrily about solid growth in the second half, no recession, and the "insurance" it has supposedly taken out against recession with a grand total of 1-point rate cut.
Bernanke and Co. talk about a housing "correction" (Is this what they would have called the 1929-1932 equity bear market, when stocks dropped 90%, we wonder?). The Bernanke FED has conjoined wisful thinking, daydreaming, denial, inept analysis, and computer models which do not work into a dangerous melange, in our view. The latest rate cut -- 25 basis points, analogous to applying a band aid to arterial bleeding -- was accompanied by warnings of INFLATION RISK. Subsequent to a 7-year QUADRUPLING of oil prices, and the explosion of commodity prices across the board, the PCE-Core has risen a grand total of 2% over the past 12 months. Since inflation is the most LAGGING of indicators, and since the FED's restrictive monetary policy is already manifesting its deflationary consequences in the housing sector, with sectoral damage about to ramify, this obsessive prattling about inflation is remarkable. The only even roughly analogous situation we can recall is that of the FED in 1929 and 1930.
FED policy can be measured by its success or failure. The FED has told us since the subprime crisis erupted last summer that its principal objective was to restore stability to the credit market. Let us review what has happened between then and now:
(1)The commercial paper market continues to contract, reducing significantly lendable bank capital and worsening the credit contraction;
(2)The American and European banking systems are desperately short of cash, as evidenced by huge emergency injections by the FED and the European Central Bank (ECB), eerily similar to what we saw at the very START of the crisis in August;
(3)The SIVs have gone from being in trouble to facing imminent insolvency; their "rescue" by their affiliated banks has crippled the lending capability of the banking system seriously and threatens a much intensified credit crunch, with contractionary and deflationary implications which are increasingly clear;
(4)The municipal bond market has dropped sharply and lost liquidity in response to the rising risk of failure of the bond insurers, who were ostensibly in good shape in August when the FED began its "rescue operation" (God help you if you are on a ship which gets into trouble and the ship has a Bernanke-like captain);
(5)The mortgage-backed market is paralyzed by illiquidity and plunging valuations;
(6)The bear market in residential real estate is intensifying at dizzying speed here, and has now spread to Britain, Spain, and Ireland;
(7)Stock prices are LOWER than they were BEFORE 3 FED rate cuts;
(8)The high yield bond market is deeper in the tank than it was in August.
This is progress? This is success? We find it necessary to quote the famous Greek general, Pyrrhus, who remarked after a victorious battle:
"One more such victory and I am lost."
