Bubble headed Fed got it wrong

Thanks to all those DU readers who both spotted and appreciated yesterday's piece by yours truly in The Nation - on the very day that Ben Bernanke's nomination for a second term in office was eventually passed by Senate, after a period of very publicly humiliation for the Fed Chairman, whose nomination actually received the highest ever number of opposition votes, carrying the vote by 70-30.  For those who missed the article, I've reproduced it below -

When the tumult of last year finally ended we entered 2010 with a real sense of regret and foreboding. Regret for the opportunities missed last year and foreboding for what may lie ahead. While 2009 was what football commentators might have called ‘a game of two halves’, i.e. sharp falls from January to March in most asset prices that, in many cases, recovered thereafter and led to widespread relief across investment markets, we see the year as an opportunity missed to really change the global economic infrastructure.

Real reform of the financial system is a daunting task at any time let alone during the severe economic dislocation of the last two years and the temptation may well be to not rock the boat. However, repeating the policy mistakes that caused the credit crunch is a far more damaging long term scenario. By fundamental measures, the global economy finished 2009 in worse shape than it started it, with IMF stats indicating GDP contraction. Systemic risks still face the global economy as concerns remain over the long-term health of the world’s major banks. Whilst the fractional reserve banking system requires all banks to use significant leverage, the credit crunch was largely due to excessive levels of financial sector leverage. UBS was reported, at one stage, to be 82X levered – i.e. a fall in the bank’s total asset values of just 1.25% would have been enough to tip it into insolvency. A smaller fall would have been enough to impair its ability to continue borrowing. Similar illiquidity paralysed debt markets when Lehman Brothers collapsed in 2008.
 
This year banks and policymakers may again be forced to confront the same two difficult choices that had faced them during 2008 and 2009 – either paying down debt or boosting asset prices to levels that made banks and the entire financial system solvent once again. Despite the change in US Presidents at the beginning of last year, they have so far continued to pursue the latter option, although talk of freezing discretionary budget expenditure is an encouraging sign and there are signs that Pres. Obama is finally starting to show that he is his own man and won't be hamstrung any longer by inept, partial advisors. Debt reduction wouldn’t have been easy – a more severe recession would have brought even higher unemployment and widespread hardship but sometimes tough choices need to be made. The Japanese are still paying the price twenty years later. Replacing burst bubbles with new ones defers the day of reckoning but ultimately makes the pain far worse, as we all discovered in the aftermath of The Greenspan Put. Difficult lessons have not been learned and instead of choosing to take pain now, central bankers still prefer to put off all the difficult decisions in the hope that the problems will go away. 
 

A growing realization of this may well have shaped the shenanigans surrounding the Senate’s recent delayed reconfirmation of Ben Bernanke for a second term of office. Notwithstanding successful reappointment, momentum seems to be building on Republican Senator Jim Bunning’s comments to The Federal Reserve Chairman at last year’s Senate Committee re-appointment hearing:
 
“You put the printing presses into overdrive to hand out cheap money to your masters on Wall Street which they used to rake in record profits while ordinary Americans and small businesses can’t even get loans for their everyday needs”.
 
Award-winning fund manager, Jeremy Charlesworth of the Moonraker Commodities Fund, highlighted the inherent risk of this tactic:

“Little of the bailout money given to banks seems to have been passed on to businesses or consumers and it might have gone to the proprietary desks of the banks to punt the markets…Clearly, someone has been buying, and given that it hasn’t been ordinary investors and the institutions that does just leave the banks. If they could sell these investments into a rising market then they would be in a better position to repay their debts. But there will be a problem if the public and institutions do not join the rally and the banks have to sell equities into a vacuum.”

Banks were in real danger of collapsing in 2008 and were kept in business by taxpayer bailouts. In 2009 they seem to have used these funds to resume their previous speculative tendencies. Maybe this is why Senator Bunning described Bernanke as “the definition of a moral hazard”.