- How Would He Know? by John P. Hussman, Ph.D.
Ben Bernanke, Federal Reserve Chairman
On Friday, investors took great cheer in an optimistic statement by Ben Bernanke suggesting good prospects for economic growth ahead. We might be inclined to place a sliver of credibility in Chairman Bernanke's assessment if not for the fact that the quote above wasn't from last week at all, but rather, hails back to November 8, 2007, just before the recent recession began. You might recall that the S&P 500 was pushing 1500 at the time. The implosion of the global credit markets was still just a slight rumble.
As it happens, that was also the week our recession warning composite shifted clearly into negative territory, prompting the weekly comment Expecting A Recession, where I wrote On Saturday, the consensus of economists surveyed by Blue Chip Economic Indicators indicated expectations that growth will be sluggish into next year, but that there will be no recession. Unfortunately, the economic consensus has never accurately anticipated a recession. For my part, the outlook has changed. I expect that a U.S. economic recession is immediately ahead. That was followed the next week with Critical Point, which opened with a saying of Rudiger Dornbusch: The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.
A good economist thoughtfully recognizes general equilibrium resources moved to one place must be taken from somewhere else. Securities or monetary liabilities, once issued, must be held by someone in the economy until they are retired (the failure to recognize this is the basis for the cash on the sidelines fallacy). Instead, Bernanke's economic research is a minefield of partial equilibrium analysis. Helicopter Ben is a lot like John Maynard Keynes, who wrote in his General Theory If the Treasury were to fill old bottles with banknotes, bury them at suitable depths, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again, there need be no more unemployment.
Solving economic problems, to our Fed Chairman, is as easy as throwing money out of helicopters. Not surprisingly, throwing money out of helicopters has been the basic core of his strategy during this crisis. This does not involve complex thought about debt restructuring, moral hazard, incentives, equitable distribution of resources, or other factors. All it requires is the three second tape playing in Bernanke's head - "We let the banks fail in the Great Depression, and look what happened." And then the tape repeats. Never mind that the cause of the upheaval was not the failure of banks per se, but the disorganized Lehman-style failure of banks. The tape isn't long enough to encompass such nuances.
Ben Bernanke (like Tim Geithner and his predecessor Hank Paulson), shows no hesitation in diverting the real resources of the American public to defend and compensate the bondholders of mismanaged financial companies who made reckless loans and who should have (and equally important, could have) been expected to write down principal or swap debt for equity as an alternative to receivership. This is not decisiveness. It is timidity and poor stewardship. Worse, the underlying problems are not healed - only band-aided temporarily by a flood of public money.
Unfortunately, the resources used in the recent bailout were not just free money tossed out of a helicopter. Only a partial-equilibrium economist thinks that way. No, this was an allocation of trillions of dollars of real resources that could be spent improving access of poor families to health care, finding cures for life-changing diseases, providing better education, and reversing the crowding-out of productive private investment. A public servant willing to act this carelessly with the resources entrusted to him, and so strongly in defense of fellow bankers, frankly does not deserve the job. Most likely, we will face the same credit issues a few quarters from now, given that the lull in the adjustable-rate reset schedule is near its end. We continue to expect a fresh acceleration of credit losses as we enter 2010. It would be best if we faced these challenges with more thoughtful leadership.
Meanwhile, Harvard economist Martin Feldstein (who was the likely alternative for Fed Chairman when Bernanke was appointed) noted last week I think we'll see a positive number in the third quarter, but what will it be driven by? Fiscal stimulus, Cash for Clunkers, and some inventory building. But the question is what happens next in the fourth quarter and into next year and I think there's a real danger of a double dip. Elsewhere, Alan Greenspan concurred, saying We're OK for the next six months. We are getting a recovery& but the process doesn't have legs to it.
A second part of Friday's enthusiasm, of course, was the sharp jump in the rate at which lenders are realizing losses on failing mortgages. That, as it happens, is what was behind the sharp jump in the rate of existing home sales. As John Mauldin recently pointed out, a June survey of 1500 real-estate agents by Mortgage Finance found that only 36% of all existing home sales involved non-distressed properties, and of those, only 31% were described as unforced or optional, the remainder being sales prompted by personal financial difficulty such as unemployment or changes in family circumstances, but without a delinquent or foreclosed mortgage. As John wrote, Think about that for a minute. Two-thirds of home sales are either foreclosures or banks taking a loss on the mortgage. And only a third of the remaining one-third roughly 10% of overall sales comes from something we could call a normal selling process.
Rest easy though. Bernanke sees a recovery.
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