March 17, 2008

I confess to almighty Bernanke

Posted in Banks · 18 comments ·

The Federal Reserve’s decision to give a $200 billion loan to the US banking system does not signify the end of the credit crisis.

When the awkward pre-business meeting chit-chat between strangers is dominated by the identity of a call girl, you know you have a huge story. Last week in New York, St Patrick, Barack Obama and the plunging dollar were all pushed out of the headlines by Eliot Spitzer.

Every taxi and dinner table conversation was humming with speculation about the New York governor’s antics with a call girl. The typically unflappable New Yorkers seem shocked, which in a city of vice – where everything is available and everyone has their price – is quite something.

The price of the dollar, the volatile stock markets and the reaction to the Federal Reserve’s most recent mega-bailout of the banking system with a $200 billion loan, lagged – even in Wall Street – a distant second to the governor, the Mayflower Hotel, ‘client 9’ and Kirsten, the call girl.

However, one thing is immutable in the US, and that is St Patrick’s Day. If any of us Irish, born in Ireland, want to see the potential power of the diaspora, come to New York for St Patrick’s weekend.

Tomorrow the city is ours and, despite all the small-minded chatter in Dublin about the cost of politicians’ visits to the diaspora, anyone with half a commercial brain can see that, in an era of ‘soft power’, the Irish network, contacts and financial muscle around the world is an invaluable economic asset for the motherland.

Now that it is finally dawning on people that the slowdown in the economy is severe and might be prolonged, an Irish plan B is necessary.

The demographic echo of our emigrant past, the millions of ‘hyphenated’ Irish are our best resource who are willing to be tapped as the biggest potential sales force the country has. For us at home, it is only a matter of having the vision to see them as a resource.

Like all new ideas, plan B – the notion of re-energising the diaspora – will become more logical in the context of a crisis. Last week, both at home and abroad, the extent of the financial crisis and the redundancy of the old ‘buy now, pay later’ model of growth was being exposed. So too were the limitations of the rather Catholic approach to financial responsibility that the Federal Reserve has decided to follow.

An interesting way and, in the context of St Patrick’s Day, an appropriate way to look at recent financial history in the US is to think of confession. Corporate America is behaving like a sinner, and Ben Bernanke – the head of the Federal Reserve — is behaving like a parish priest in the confessional.

For years, the US banking sector was being warned that overspending and over-borrowing was the path to financial delinquency. Yet the banks in the US and more egregiously, in Ireland, ignored the warning. Those who spoke out were referred to, bizarrely, as unpatriotic.

All this has changed and now the errant banks are acknowledging their sins. In the US, rather than the puritanical ‘repent or be damned’ approach, Wall Street is adopting the more Catholic ‘bless me Father for I have sinned’ tack. Bernanke – like a good priest – responded to these acts of contrition with the monetary equivalent of three Our Fathers and a Hail Mary and granted absolution, most recently last week in the form of a $200 billion bailout.

Unfortunately, as this was the fifth time the sinners had gone to confession since August, the pardoning power of the priest is being questioned. No one believes that the financial crisis is over. Nor do people accept the word of the priest anymore. We have reached ‘bailout fatigue’.

The last time we witnessed anything like bailout fatigue from the financial markets was in July 1998,when the International Monetary Fund (IMF) issued a $10 billion loan to Russia to assist the delinquent Yeltsin government, as a result of an economic crisis that had been building for months.

Gullible market players took this loan as a sign that the corner had been turned. They contended that such intervention could only stabilise things.

In contrast, I got a call that morning from an old market hand who had seen it all before and who told me: ‘‘sell everything, this is your last chance’’. He was on the money -Russia defaulted three weeks later. There was an eerily similar reaction in world financial markets to the Fed’s $200 billion bailout.

The Fed, worried that this credit crunch was not easing, pledged to inject money into the system to try and bring down interest rates. Normally, such a sign of official muscle would be enough to steady nerves, but these are not normal times. The opposite occurred.

Investors regard the Fed’s intervention as either a sign of panic or a sign that the balance sheets of banks were much ropier than even the most pessimistic bear had imagined. As a result – after an initial rise in prices – the intervention prompted a sell-off, confirming the suspicion that we are not out of the woods yet, by any means. This was emphasised on Friday when emergency funding had to be provided for Bear Stearns, the big Wall Street bank. The news sent the US stock markets tumbling again.

As we noted a few months back, the catchphrase in the banking world is now ‘‘guilty until proven innocent’’. This was the cause of Bear Stearns’s problems: it couldn’t raise funds because investors were hearing rumours that it was in difficulty.

Everyone knows that there is more horrible sub-prime and other derivative related crud on the balance sheets of some large banks, but because the banks have been evasive, no one knows for sure where the toxic stuff is. So the essential lubricant of the financial system – liquidity – has dried up, because trust has evaporated. You lend to people you trust and, if you don’t trust them any more, you demand a higher risk premium for the pleasure of lending them cash.

This ephemeral quality – trust – is what the central banks are trying to resuscitate. The financial markets arena has become a large game of pass the parcel. No bank wants to be the one that lends to the other bank with the huge sub-prime losses. The banks are desperately trying to pretend that they trust each other, while at the same time minimising the potential risk of any inter-bank loan, by trying to lay off that risk to someone else.

When everyone was confident, there were lots of banks happy to ensure that the system of loans, repackaged loans and syndicated loans worked well. But now the chain has broken, and the central banks are finding that trust is an expensive and elusive commodity.

Even Father Bernanke – the most benign, forgiving priest on the block – has lost his powers. There is a real sense this St Patrick’s weekend in New York that the financial markets, like Spitzer, are beyond redemption.

  1. AndrewGMooney

    Father Bernanke is not investing the markets with either ‘bailout liquidity’ or an absolution that will restore trust.

    He is investing more ‘moral hazard’ into the scenario, more ‘Socialism For The Uber-Rich’. Rescuing institutions that applaud the ‘free market’ and abhor government interference and ‘red-tape’ about boring fundamentals such as solvency:
    Yet suddenly become fervent supporters of it, regaining their faith in managed markets, as and when their dubious orgy of leveraged greed comes to an end.

    They’re ‘too big to fail.’ They’ll be rescued by taxpayers money. As always. Bernanke will debauch the dollar, and inflate another hyper-leveraged bubble:

    Unless and until the Market is allowed to re-set according to fundamentals, not bubble fantasies.
    It doesn’t matter whether is US, UK or Eire: You can’t just endlessly inflate on eternally optimistic assumptions of economic growth which aren’t backed up by ‘reality’.

    I was asked yesterday how house prices could possibly fall in the UK. Easy. Lenders impose 5%/10% deposit -FRB London that equals: £12.5/£25k. It’s happening now with several top banks.
    How many prospective buyers have that? How can distressed sellers sell when no one can get the credit to fund the purchase. So, prices fall despite massive demand.

    In Ireland, it’s less complicated. Massive oversupply, Just like Orlando and other states.

    The market has to be allowed to correct itself to regenerate or it isn’t ‘capitalism’. Is it?

  2. VincentH

    Why the hell will the Fed not buy the paper at 50% off the face. It will be a hell of a lot cheaper in the long run. And will have the effect of both removing from the banks book paper they do not believe and protecting those in the homes and their equity. When the arse has fallen there is not a lot of point patching the wallet pocket.

  3. Here in the American Heartland, Mt. Horeb, Wisconsin, some of us are watching the new television mini-series produced by Home Box Office, of HBO, on the life of 1776 patriot John Adams, the second President of this Republic It is back to the future time. As some folks around here now ask, “When do the next ‘tea parties’ start?” I share this as an example of a growng anger over abuse in this country. Our forefathers knew what to do.

  4. Rob

    While not a socialist by any means it does seem to me that capitalists are running for cover at the moment. I agree wholeheartedly with the other commentator that the market must correct itself. The basic tenet of capitalism has always been that the market must reign free, i.e. no subventions. Now we have the scenario where some banks got greedy, took excessive risks and now look to central govt to bail them out, ridiculous. In my view it will just prolong the agony, the junkie gets a hit for another day without addressing the fundamental addiction. Where are the free marketeers now?

  5. John Q. Public

    Paul Rux Phd. Correct me if I’m wrong but did John Adams not borrow a huge amount of money from Holland to fund a revolution or something? We don’t need that today surely. I’m no historian but I’d like to hear your opinion on this.

  6. AndrewGMooney

    DMcW says: ‘the financial markets, like Spitzer, are beyond redemption.’

    Bless you my son! But no-one is beyond redemption, no matter how egregious their failings. However, to return to the One True Faith:
    The recitation of Sin must be sincere and – commitment to future abstention from further sinning must be equally sincere.

    Hence the severity of this penance: Say ‘The Recession‘ for how ever many Quarters of Economic Output as is required to cleanse your soul.
    It doesn’t matter whether that ‘One True Faith’ is Capitalism or Catholicism:
    For a ‘belief system’ to function it has to have coherence and credibility. If it creates too much ‘cognitive dissonance’ amongst the Faithful:
    They will flee to another temple, perhaps even to bizarre cults such as ‘The Temple of State Planning and Socialism‘.

    Whether it be clerical child abuse or corporate balance sheet fiddling:
    ‘Blind Faith’ is destroyed by too much exposure to arrogant Hypocrisy. And ‘Trust’ can only be restored by virtuous behaviour. Whether in the Sacristy, The Market Place – or The Covenant of Marriage.

    If anyone sees Spitzer ascending the steps of St Patrick’s Cathedral: Judge not lest ye be judged! Am I the one to cast the first stone? *rollseyes*

    As for Father Bernanke:

    Will he just be moved on to another ‘parish ‘quietly – without full disclosure of his errant behaviour to date?

    There can be no doubt he’ll return to ‘past form’ if he’s allowed a position of power and influence from which to seduce the vulnerable with his deviant Financial Gospel. He must be removed form any further possibility of polluting The One True Faith that is American Capitalism.

    My children! Let us all learn from this humbling lesson and return.
    To the One True Faith of :
    Sound Money.
    Free Markets.
    And The Rule Of Law.

    If that means Merchant Bankers sleeping on the streets of London and New York: So be it. Lots of other have done so in the past and do so tonight.
    Why should their claim to ‘public assistance from taxpayer funds’ be any more important than others who ‘cannot cope’ with the consequences of their ‘life-style choices’? In this case: Arrogant Greed.

    Anyway: It will be ‘character-building’ for them. LOL!

    Father Mooney.

  7. Stephen Kenny

    What the markets need is time, and a clear head, to enable the ludicrous position that they’ve put themselves in, to unwind in an orderly fashion. That must be Bernanke’s goal.
    Sure, there’ll be blood, a gnashing of teeth, and general sackcloth and ashes, but it will be very considerably worse if it is produced by accelerating cascade of spectacular fire sales, than if it is produced by a trading plan of accepting that losses will be made, and trading to minimise those losses.
    People say that Bernanke has studied past market crashes. If he can get the banks onside (sort of “listen friend, you know you’re dead meat, just go out with a degree of calm, relatively selfless, decorum, and we’ll guarantee your pension”) he has an opportunity to make himself a global hero. He can’t be blamed for the delirious boom (Greenspan is still desperately pointing in every direction except at himself), so…… well, it’s interesting.

  8. Sean

    The one key for Fr Bernanke is what happens when the interest rate cute pot is empty and there is no where else to turn. Fending of the inevitable is a dangerous game. Praise should be given and guidance should come from the bishops in the ECB who have not panicked and are prepared to take the pain now rather than give absolution like their friend across the water. Maybe a new power is emerging and maybe its about time.

  9. MK

    Hi again David,

    I think its more a case not of ‘father’ Bernanke dishing out ‘hail marys and our fathers’ as ‘puishment’ but more a case of ‘okay, so you stole the poor box money, well, tut, tut, oh, and now you have no money left after you’ve spent it all on sweets, okay then, here is another tenner, off you go’.

    The Fed is ‘allowing’ the US financial system to correct, but Bernanke, who helpfully is an expert on the 1929-32 crises, is along with his committee managing this one closely with very timely and strong interventions. Yes, it will create ‘moral hazards’, and US taxpayers will be taking the risk (ie: not JP Morgan Chase in the Bear Stearns bailout), and solutions will not be perfect, but at leas they are not sticking their heads in the sand. They will have seen how Japan went after the 1980′s and interestes rates there are still 0.5% or so and they have not yet recovered.

    Where it all ends in the US is anyone’s guess, and how it will affect this country is also open, but this is a big ‘storm’ and a ‘swell’ that as been building unbeknown to most of us since 2003 and earlier.

    Like watching a damn burtsing, have we seen the fullness of the flow or are thse just the first few drops over the edge. We will all be more knowledgeable this time next year!

    A belated Happy Paddy’s Day,


  10. shtove

    Can’t agree with the liquidity crisis analysis. It’s about insolvency, and any business that’s insolvent soon gets its overdraft balance called in. That’s what happened to NRK and Bear Stearns, and could happen to other, even bigger, players. Not so much absence of trust, as presence of sweaty fear. The Fed doesn’t dispose of much power in those circumstances.

    And all this with no end in sight of the US housing collapse, and the European housing collapse just beginning. As they say on all the best blogs: got popcorn?

  11. Garry

    We are in much the same position as the states, events seem to be following about a year behind on the housing market but we have an ECB that wont be too concerned about a little local difficulty in Ireland. The high moral ground wont be ours for much longer our bubble was every bit as manic as the US, I mean a million for a f****ing flat in Drumcondra!

    I would love to know what the conversations are between the Fed and the ECB, they have to be coming under real pressure at this stage to cut rates in solidarity with the US. Right now, there are 2 very predictable responses to todays interest rate cut, the euro will rise again against the dollar and the price of oil will go up.

    Whats the ECB’s game, do they really believe its in Europes best interest to see the states being brought to their knees without helping them, do they think the problems are so bad that europe cant help out, or any help at this stage will be counterproductive? WTF is going on?
    its being spun as the wise old ECB governers calmly steering us through the worst crisis in decades but are we giving them too much credit, they probably havent a rashers what to do, and are just falling back to the classic EU pose…. do nothing, keep quiet and hopefully someone else will step in and do the dirty work. Well to my uneducated eye, the US look like they could do with some help.

    I havent a clue whats going on but I hope our central bankers are earning their salaries these days.

  12. Stephen Kenny

    It’s interesting watching it. All these recent books about crowds and crises. Ever watched a herd of wilderbeast suddenly turn? well, nor have I, but I have that feeling when watching our financial markets: The short sighted one at the front, looks up through sweat filled eyes, and mistakes a storm cloud for a cliff, and promptly performs a sharp left. The 100,000 or so following bum-watchers promptly follow suit.
    What Bernanke seems to be trying to do is to stop them all watching bums, and slow to a walk. They must know that there’ll be no bonuses this year, that most of them will be considering a complete career change next year (what a lot of consultants, freelance journalists, and trainee teachers we’ll have next year), or earlier, whatever happens. Why run? Stop, think, and act in the best interests of the group. The CEOs must know this, if I hadn’t recently read ‘Smartest Guys in the Room’, I’d say that guys that smart just can’t make this mistake.
    And surely, please tell me that every crunch head in the west is working overtime to get some credible valuations of the looming derivatives ‘questions’…..

  13. Dan Hayes

    Gentlemen: it’s starting to get really, really interesting.

  14. Ed

    I talked to someone in the US yesterday that bought a new house at half last year’s asking price of 800,000 – is it fire sale or just reality?

  15. Rob

    Not sure if anything would be helped by the ECB jumping to the rescue, i.e. not sure that it can anyway and also why add more petrol to the fire? It looks as if the credit crunch in the States will have to work its way, however painfully, out of the system. However after ten plus years of growth, surely a drop was predicted at some stage? The bankers on big salaries knew what they were getting into, not sure that they would be ideal candidates as trainee teachers either! Red Ken may not need to penalise Ferrari’s after all…….

  16. Jonathan

    The free market, low regulation, financial system is a joke. The whole point of a free market is that the price of things, economic activity, inflation and all the rest, should in theory come to represent the fundamentals of an economy without the interference of an inept government creating instabilities. Instead of an inept government or governments we have inept bankers/financiers, and, worse again, inept international bankers/financiers creating pan-national screw ups. It is my contention that national governments had abdicated fiscal responsibility to the international bankers and financiers who, with their massive holdings and freedom to move money where ever they wished, have had a greater opportunity to create instability than at any other time in modern history.
    Fr. Bernake (god bless him ;-)) and the rest of the worlds central bankers need to get together put in place checks and balances to limit the amount of rope given to these institutions.
    On the topic of the subprime market and indeed any market, the link between equity and further investment in the same asset class should be forcefully decoupled. I.e. just because you have 100k equity on paper doesn’t mean that you are good for a 100k loan to buy more of the same asset and repeat the trick ad infinitum. Same principle applies to stocks as well as property.

  17. Rob Grease Monkey

    Newtons theory- what goes up must come down? If i was to draw a bar graph representing the last ten years we would have run out of space on the page in 2003. I think we are about to come back into orbit captain……….

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