WSJ: The Bernanke Market

http://online.wsj.com/article/SB124762005061042587.html

I remember once buying the stock of a small company and I couldn't believe my luck. Every time my fund bought more shares the stock would go up. So we bought even more and the stock kept climbing. When we finally built our full position and stopped buying the stock started dropping, ending up at a price below where we started buying it. We were the market.

Just about every policy move to right the U.S. economy after the subprime sinking of the banking system has been a bust. We saved Bear Stearns. We let Lehman Brothers go. We forced Merrill Lynch, Wachovia and Washington Mutual into the hands of others. We took control of Fannie and Freddie and AIG and even own a few car companies, pumping them with high-test transfusions. None of this really helped.

We have a zero interest-rate policy. We guaranteed bank debt. We set up the Troubled Asset Relief Program (TARP) to buy toxic mortgage assets off bank balance sheets. But when banks refused to sell at fire sale prices, we just gave them the money instead. Dumb move. So we set up the Public-Private Investment Program to get private investors to buy these same toxic assets with government leverage, and still there are few sellers. Meanwhile, the $1 trillion federal deficit is crowding out private investment and the porky $787 billion stimulus hasn't translated into growth.

At the end of the day, only one thing has worked -- flooding the market with dollars. By buying U.S. Treasuries and mortgages to increase the monetary base by $1 trillion, Fed Chairman Ben Bernanke didn't put money directly into the stock market but he didn't have to. With nowhere else to go, except maybe commodities, inflows into the stock market have been on a tear. Stock and bond funds saw net inflows of close to $150 billion since January. The dollars he cranked out didn't go into the hard economy, but instead into tradable assets. In other words, Ben Bernanke has been the market.

The good news is that Mr. Bernanke got the major banks, except for Citigroup, recapitalized and with public money. June retail sales rose 0.6%. Housing starts jumped 17% month to month in May and will likely be flat for June. Second quarter GDP may be slightly up. And he was successful in spreading a "green shoots" psychology throughout the media. But the real question is, now what? Government interventions are only meant to light a fire under the real economy and unleash what John Maynard Keynes called our "animal spirits." But government dollars can't sustain growth.

The dollars he cranked out didn't go into the hard economy, but instead into tradable assets. In other words, Ben Bernanke has been the market.

Like it or not, the stock market is bigger than the Federal Reserve and the U.S. Treasury. The stock market anticipates only future profits and prosperity, not government-funded starter fluid. You can only fool it for so long. Unless there are real corporate profits from sustainable economic growth, the stock market is not going to play along. It's the ultimate Enforcer.

In mid-May, Mr. Bernanke's outlook seemed to change. Maybe he didn't approve of the sharp housing rebound -- like we need more houses! Maybe he saw inflation in commodity prices -- oil popping to $72 from $35. Or, more likely, he finally realized that he was the market and took his foot off the money accelerator, as evidenced in the contracting monetary base (see nearby chart). Sure enough, things rolled over -- the market dropped 7.5% from its peak, oil prices dropped almost 17%, and even gold has lost some of its luster. But in July, the Fed started buying again and the market rallied.

Can the U.S. economy stand on its own two feet without Mr. Bernanke's magic dollar dust? Eventually, but apparently not yet. Unemployment stubbornly hit 9.5% in June, according to the Bureau of Labor Statistics. Housing prices are still dropping, albeit at a slower pace, and foreclosures are still rampant.

But I think what really bothers the market is that the structural problems that got us into trouble in the first place still exist. We took the easy way out and, with the help of Treasury Secretary Tim Geithner's loose "stress tests," swept banking problems under the carpet. We waved off mark-to-market accounting and juiced bank stock prices to help them recapitalize, but all those toxic mortgage assets on bank balance sheets are still there as anchors on lending. All the pump priming and stock market flows didn't get rid of them.

Hats off to Mr. Bernanke for getting the worst behind us. He'll be pressured politically to keep pumping out dollars, but he should resist the urge. The stock market will ignore his dollars if it doesn't believe they'll turn into real profits. Green jobs and government health-care clerks do not make a productive, sustainable economy. That can only come from innovative companies with access to growth capital. The stock market won't turn bullish until it sees that type of economy.

Again, when it's clear that you are the market you have to stop buying and begin tackling the hard stuff. By not restructuring banks, by not getting bad loans off bank balance sheets, by not standing up to the massive increases in government debt crowding out private capital, the Fed and Treasury are holding back real economic growth.

Comments

[Harry]

Thank you for a very interesting article. How can the average investor track the money supply level you have in your graph?

[geekmba360]

This is a brilliant article. I have forwarded this article to as many friends as I could.

Job Creation is absolutely critical for economic recovery, and we haven't seen any real sign of job recovery/creation.

Looking at how Golden made their huge profits last quarter -- they're from trading and underwriting (which essentially help other banks to raise money.) This is not real economic value creation. We're going back to where we came from.

Bernanke might have prevented another Great Depression, but his effort might very well severely prolonged this economic turn. I'm afraid that it'll take us a very long time to get ourselves out of this deep hole.

[Joseph]

Great article. It clearly describes the market activity and the false economy we are still engaging in. Our economy has been so seriously damaged by exactly this type of behavior, that I can't see us returning to a sound economic base for a very long time, perhaps even a decade. We don't even engage in the real important conversations on the solutions. We are willing to be lead like lambs by false promises and monetary manipulations, which lull us into inactivity. We need to re-energize and bring back our true industrial base. This means brick and mortar facilities manufacturing real products. We need to re-focus our education to provide us with the skilled laborers whom we have lost to this bubble economy. Enough lawyers, financiers analysts, economists, accountants... blah! blah! blah! Where are our engineers? Scientists? Inventors! The most important money spent would be in providing quality education to all for free. I would rather see 1 Trillion spent on this then a dime given to the thieves that got us in this mess in the first place. Not until we address these deep issues will be be able to get out of this one. I am sure those who have their hands in the pie will fight to keep it there, regardless if it destroys us.
As far as I am concerned we are in a depression. I manage commercial property on both coasts and none of my tenants can pay their rent. These are mom and pop operations that supported families. It isn't in one sector it is across the board.
I even helped re-fi a loan for a client. This is a client who is paying a note for 15yrs at approximately $7,500.00 per month I was extending the the loan to a 30yr term which would essentially take the payment down by more then 50% per month. This clients credit rating is 800. I started this process from last November, had him turned down once and then re-applied in January again we still haven't closed if he can pay $7,500.00 per month he sure can pay half of that. So much for the TARP money trickling down to help the economy. The TARP monies are being sucked up by the banks to shore up their operations. These banks will still fail and it will be because we are throwing our money exactly where it was blown in the first place.

[Ted Kavadas]

I found this article interesting, and it is well-written.

I don't concur, however, with the line, "Hats off to Mr. Bernanke for getting the worst behind us." I don't believe the worst is behind us.

[John]

Nice article as usual.

If the Fed had a clue, we wouldn't continue going from bubble to collapse to bubble. They never stop overstimulating. They fail to acknowledge that 1% interest rates, held there for too long, helped fuel an epic real estate bubble after the liquidity-fueled stock market bubble. To 'solve' the problem, they have now promised to keep rates at 0% for a long, long time - reiterated by Geithner the day after this article appeared. In the meantime, the stock market is screaming of too much liquidity, having rocketed 40% in 3 months and their heads remain in the sand.

Nothing like another debt induced bubble to make everything better again. Good job guys.

[Chad Harris]

Always enjoyed your writing Andy. Can't fight the chart either. I have been slammed and did not notice the new book. Just ordered from Amazon from the site. I am in health care and find all kinds of entrepreneurial activity going on in the most unexpected places.

I think the market actually believes that this new health care, Stimulus 1,2 and 3... debt will reverse the recession and thinks the treasury is smart enough to monetize the paper back into some Chinese central banker’s mattress. 7-10 year time frame, we all have a front rail position right next to Leonardo and Winslet for an economic iceberg the world has never seen.

Short term, what I am seeing in health care is some green shoots of a cash market forming that does not involve insurance or medicare. Imagine the market forces that drove lasik from 3k per eye and crappy to $300 per eye and good. An un-reimbursement market for higher level procedures.

With all the greenbacks floating I think a new market will be built funding a cash health care system that basically finances all sorts of procedures and acts like a reverse insurance market. You buy now, but pay later. GE Capital sold Care Credit to Amex about a year ago which is more retail but now the insurance train has ran its last lap, they have a massive amount of cash to deploy elsewhere. We are working on some small things but have you heard of anything big cooking? Look forward to the new read. Thx Chad

[Dr. Kenneth Noisewater]

http://research.stlouisfed.org/fred2/series/BASE

May be what you're looking for?

(and historical:)
http://alfred.stlouisfed.org/graph/?chart_type=bar&s_1=1&s[1][id]=BASE&s[1][vintage_date]=2009-07-23&s[1][line_color]=%230000FF&s_2=1&s[2][id]=BASE&s[2][vintage_date]=2009-07-30&s[2][line_color]=%23FF0000&s[1][range]=Max&s[2][range]=Max

[Glenn Atias]

This article at least exposes what Bernanke is doing, but in a soft-soap way. Let's just call it what it is - a Generational Ponzi Scheme. Bernanke is shell-gaming money from future generations into the markets in order to induce green-shoot-gasms from the media.

This is not only a dishonest way to deal with this crisis, it is a downright shameful way to deal with it, and will get us burned so badly when it all bursts again, we may not be able to get out. Bernake is actually committing take-to-the-streets crimes against the American people. An irresponsible man who will go down in history as a dangerous ponzi-schemer, not a leader.

[JDT0429]

This is a great article and perfectly captures all of the nuances of the current situation. I have always thought, throughout this whole mess, "fix the banks, help them to liquidate the toxic mortgages from their balance sheets in as economically effective manner as possible, get them back to healthy operations and everything else in our economy will take care of itself." I, like many Americans, feel somewhat helpless as I watch Obama's $787B porkulus package not move the needle in any positive sense and hear that an additional pork package may be on the way. All the while, Bernanke infuses less capital in a more intelligent and effective manner and makes a bigger impact.

Our national debt frightens me, regardless of how valuable our intellectual properties are if you borrow money you will be paying it back someday. When are we going to wake up and realize that if we want our economy to get back on its feet we need to have our government begin to behave like every one of us have in our households. They need to cut spending commensurate with the drop in revenue, create a surplus instead of adding to the deficit and our national debt, and let smart people (like Ben Bernanke) put smart dollars in smart places that will get the markets and the economy going again. And when I say smart people I include most Americans in that statement as I believe they would do a better job of spending their money in a beneficial way than the goverment would.

[OliverDarcy]

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