The Worst of All Policies
By Adrian Ash
August 30, 2007
To lend a great deal, and yet
not give the public confidence is the worst of all policies...
"HISTORY PROVES that a smart central bank
can protect the economy and the financial sector from the
nastier side effects of a stock market collapse," wrote Ben
Bernanke in Foreign Policy magazine, way back in
October 2000.
Dr.Bernanke was merely a Fed governor at the time,
rather than chief pooh-bah at the world's biggest central bank.
But with the S&P500 index already 7.5% off its top of 24th
March that year – way up there at 1552 – he was clearly
planning for the main event of his professional career:
Saving the United States from a second Great
Depression.
Now the S&P index has just repeated that very
same move, only in triple-quick time. The S&P hit an
intra-day peak of 1556 on 16th July this year; on Tuesday 28th
August it ended the day at 1432, down by 7.5% once again.
This pullback took little more than a month. And
this time around, Ben Bernanke is wearing the long trousers. So
what's to fear?
The economic outcomes of a stock-market crash, as
the Princeton professor wrote in that article – A Crash
Course for Central Bankers – "depend less on the
severity of the crash itself than on the response of economic
policymakers, particularly central bankers."
Indeed, "without policy blunders by the
Federal Reserve, there is little reason to believe that the 1929
crash would have been followed by more than a moderate dip in US
economic activity."
To prove his point, Bernanke pointed to the more
recent deflationary slump suffered by Japan. "In some
crucial aspects," he wrote, "Japan in the 1990s was a
slow-motion replay of the US experience 60 years earlier. After
effectively precipitating the crash in stock and real estate
prices through sharp increases in interest rates (in much the
same way that the Fed triggered the crash of 1929), the Bank of
Japan seemed in no hurry to ease monetary policy and did not cut
rates significantly until 1994."
No one, of course, could accuse Ben Bernanke of
precipitating the current crash in US real estate or stock
market prices – not with "sharp increases" in the
cost of money at any rate! The 17 baby-steps he took from 1% up
to 5.25%, however, might still cast him as the villain when the
history books come to be written.
After all, it's so much easier to point the finger
of blame at distant figures in history once the crisis has long
since blown over. Bernanke's career as a Depression-era
commentator after the fact just goes to prove it.
"Much like US officials during the 1930s,
Japanese policymakers were unconscionably slow in tackling the
severe banking crisis that impaired the economy’s ability to
function normally," he tutted in Foreign Policy
magazine in October 2000. "[But] central bankers got it
right in the United States in 1987."
Oh really? It's worth reading what Ben Bernanke
believes – or certainly said he believed – of Alan
Greenspan's response to the stock-market crash of two decades
ago. It's worth comparing his actions in this financial panic to
date with Alan Greenspan's decisions of two decades ago, too.
"[The Fed in late '87] avoided deflationary
pressures as well as serious trouble in the banking system. In
the days immediately following the October 19th crash, Federal
Reserve Chairman Alan Greenspan – in office a mere two months
– focused his efforts on maintaining financial
stability."
Bravo Alan! Give that man a knighthood!
"For instance, he persuaded banks to extend
credit to struggling brokerage houses, thus ensuring that the
stock exchanges and futures markets would continue operating
normally. (US banks, which unlike their Japanese counterparts do
not own stock, were never in any serious danger from the crash.)
Subsequently, the Fed’s attention shifted from financial to
macroeconomic stability, with the central bank cutting interest
rates to offset any deflationary effects of declining stock
prices."
Encore! Encore! But just how did Greenspan do it?
Short on detail and long on plaudits, Bernanke's
short history of the Great 1987 Getaway simply says the markets
were "reassured by policymakers’ determination to protect
the economy...Economic growth resumed with barely a blip."
Never mind that US banks are now stuffed full of
securitized mortgage debt – albeit through the
off-balance-sheet conduit of "special investment
vehicles". (So too are banks in Japan, France, Britain,
Germany, and Australia.) Because even if the banks are "in
serious danger" from the house-price deflation bankrupting
hedge funds across the world, all that's required is a strong
central banker, standing ready to reassure the markets that
nothing will harm them. Not on his watch, no siree!
"The Federal Reserve, consistent with its
responsibilities as the nation's central bank, affirmed today
its readiness to serve as a source of liquidity to support the
economic and financial system."
One sentence, one message – and a shockingly
clear statement of purpose from Alan "the Confuser"
Greenspan. Made on the morning of Tuesday, 20th October 1987,
the statement was quickly followed by Fed bond-trading that cut
three-month Treasury yields from 6.75% to barely 5% in just 24
hours. Then came nearly two weeks of large and highly visible
injections of liquidity.
You might have thought Ben Bernanke would simply
replay this gambit. He claims to have studied it in depth, after
all, alongside every other major central-bank action of the 20th
century.
But no. Dr.Ben first approved large shots of cash.
Then he pushed the overnight lending rate in New York below the
Fed's target. Only then did he make a statement – and that
same day he slashed the "discount" rate, which offers
short-term loans no longer made at a discount any way, confusing
both CNBC and Wall Street's finest alike.
Instead of affirming the Fed's readiness,
Bernanke's statement said the Fed was "monitoring the
situation". Less reassuring still, the Fed's crisis
response in 2007 including this carefully crafted piece of
prose:
"[The Committee] is prepared to act as needed
to mitigate the adverse effects on the economy arising from the
disruptions in financial markets."
Finally, nearly four weeks into the crisis,
Bernanke released a letter he'd sent to a Democratic Senator in
New York, vowing to "act as needed". The Nasdaq and
S&P rallied 2% on the news, late as it was and still lacking
a formal stamp from the Fed itself. Such weak-willed responses
and half-promises are being much-used outside Washington, too.
"Can we deprive ourselves of the weapon of interest rates
in the face of a crisis such as we are experiencing at the
moment?" asked Nicholas Sarkozy, president of France, on
Friday. Jean-Claude Trichet, head of the European Central Bank,
responding this week by saying his policy team "is never
pre-committed" to any interest-rate decision.
With it yet? Nothing is decided. The ECB might not
raise rates. Or it might. Nobody yet knows, not even the ECB
executives. Put another way, "I am confident that
confidence will return," as Gertrude Tumpel-Gugerell, an
executive member of the European Central Bank, said to Reuters
while attending a conference in the Austrian Alps today.
Perhaps she wore a straight face; maybe the phrase
just doesn't bare translation. But having confidence that
confidence will return – as if by magic – leaves
Ms.Tumpel-Gugerell and her colleagues right in the frame if they
do choose to raise interest rates next week...and Europe's
current stock market turmoil is seen to tip the Eurozone economy
into a slump.
Hence the action, taken straight from the Bernanke
Playbook, at the European Central Bank so far this summer. The
ECB had already seen money supply growth surge to a
quarter-century high in July. Its M3 measure of the Eurozone
money supply rose by 11.7% from a year earlier last month,
compared with 10.9% growth in June. An auction of short-term
money on Wednesday this week saw Europe's biggest banks bid for
nearly 2.4 times as much cash as was on offer.
As it was, the ECB offered a record sum of 90-day
money at today's sale...nearly $70 billion's worth.
"Either shut the Bank at once, and say it will
not lend more than it commonly lends, or lend freely, boldly,
and so that the public may feel you mean to go on lending,"
urged Walter Bagehot in the Victorian investment classic, Lombard
Street.
"To lend a great deal," he advised the
world's central banks, "and yet not give the public
confidence that you will lend sufficiently and effectually, is
the worst of all policies."