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Ben Bernanke and Henry Paulson - What They Needed to Say

Stock-Markets / Credit Crisis 2008 Feb 18, 2008 - 12:04 PM GMT

By: Andy_Sutton

Stock-Markets Best Financial Markets Analysis ArticleThis week, we saw in mild fashion what can happen when at least one part of society begins to have doubts about another's ability to do its job. We saw Ben Bernanke and Henry Paulson on Capitol Hill this week offering testimony to Congress about the various messes we are involved in as a nation, including, but not limited to: the credit mess, the housing mess, the economic situation, the stimulus package and the list goes on.

What Ben said… “As you know, financial markets in the United States and in a number of other industrialized countries have been under considerable strain since late last summer. Heightened investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates, triggered the financial turmoil. However, other factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial institutions to credit losses, and concerns about the weaker outlook for the economy, have also roiled the financial markets in recent months.”

What needed to be said...

“As you should know by now, it was impractical to expect the recent boom in housing to last forever. We told you back in 2001 that lower interest rates were only a band-aid and that you were going to have to find some way to put people to work producing real products that we could export overseas to pay off our trade bills. We also told the bankers to be careful about giving away loans to strawberry pickers making $7.50 an hour for homes costing $500,000. But they figured that since they could just offload the stuff onto the securities market that it wasn't a big deal. Besides, the risk was spread out....dispersed as they like to say. Well, in the past 6 months, this whole thing has turned into a giant boomerang and now threatens not only the banking system, but the entire economy as well.”

What Ben said… “Although the baseline outlook envisions an improving picture, it is important to recognize that downside risks to growth remain, including the possibilities that the housing market or the labor market may deteriorate to an extent beyond that currently anticipated, or that credit conditions may tighten substantially further. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.”

What needed to be said…

“At this point, the FOMC has absolutely no idea what is going on here. Our models don't account for the rationality that has been seen in recent weeks. Consumers are actually seriously considering taking their tax rebates and saving them or worse yet, paying off existing debts. This will not stimulate anything and we'll be forced to do it again. Maybe we'll have to print up a bunch of gift cards to the top 50 retailers and make them pick one. Now I know in a few months I'm going to have to come back here and tell you that your little stimulus package didn't work, so I might as well tell you now. I guess you'd better start working on the next one because we can only drop interest rates so far or else we're going to have to start paying people to borrow.”

To be fair, we must include some of what Treasury Secretary Henry Paulson had to say as well…

What Hank said…“The U.S. economy is fundamentally strong, diverse and resilient, yet after years of unsustainable home price appreciation, our economy is undergoing a significant and necessary housing correction. The housing correction, high energy prices and capital market turmoil are weighing on current economic growth. I believe that our economy will continue to grow, although its pace in coming quarters will be slower than what we have seen in recent years.”

What needed to be said…

“Our economy, after years of unsustainable debt growth, fleeting production, and excess consumption is nearing a tipping point. We are seeing a much-needed correction in housing, but other corrections are needed. We need to as a country and as individuals clean up our balance sheets. Government spending must be cut immediately and the printing presses must stop running 24-7 to make up for our fiscal shortfalls. Only after we clean up the excesses of the past decade will healthy economic growth return.”

This is utterly frightening. Mr. Paulson believes that everything that has happened is the fault of an overblown housing market. It's the debt, Hank. The housing bubble was only the trigger for this mess. It could have just as easily been an overleveraged stock market. With the bursting of the housing bubble though, the effects are much bigger simply because we are talking about a lot more money and many more people being affected. When you run a consumption-based economy, the only way you have any ‘growth' is to get people to buy even more stuff this quarter than they did during the last. When you add the double-whammy of financing a good portion of your consumption with debt, you get to the point where it is impossible to take on any more debt. Are we there yet? I have a feeling if we aren't, then we're pretty close.

Even more frightening was the Treasury Secretary's response to a question about the ongoing crisis: “It's one thing to identify a problem, it is another to know exactly what to do about it”. So we are left to make a subjective judgment. Do they really know what is going on or are they taking it day by day? If they do know what is going on, it must be a whole lot worse than we think, otherwise it would stand to reason that they'd tell us. This goes WAY beyond the stock market. They know they can control that. This goes to the very core of the banking and monetary system. It goes right to the actual faith and confidence that people have in the banking system and the value of our money. As I've emphasized time and time again, it is ONLY confidence that supports our monetary system. Otherwise, monopoly money would suffice to make purchases. Ostensibly, there is no other difference between the two.

The next area of concern is going to be credit card companies and the banks heavily involved in credit cards and other types of consumer debt. They have been raising rates even as their customers have been defaulting at higher and higher levels. It will only be a matter of time before the amount of defaults overwhelms the reserves set aside to deal with them. This will be the next domino. The government will then have to rush in and print even more money to keep the system liquid. Monoline bond insurers AMBAC and MBIA (among others) are already in trouble and will need to be bailed out. What is puzzling is why it hasn't been done already.

There is going to be an unprecedented amount of money printing over the near term to deal with all of these messes. It is clear that no institution of any real size or significance will be allowed to fail. That money will go somewhere unless somehow it can be trapped in the banking system. However, since banks only make money when they make loans, I am not confident that the money will remain trapped for long. It will hit the streets in the form of higher prices for pretty much everything. Meanwhile, due to the erosion of confidence, we will likely see continued weakness in asset prices coupled with rising consumer prices; a double whammy for Main Street. We are entering a vicious cycle; increasing prices beget increased borrowing, which will fuel even further increases in prices and so on. While the free market has desperately tried to cleanse the system by destroying some of this cancerous money and credit growth, the printing press will ultimately win and the American saver will ultimately lose.

There are ways to mitigate the effects of these realities; our newsletter The Centsible Investor selects opportunities that are able to help offset the effects of the inflation being created and brings them to you each month. We are currently running a President's Day special: $39/year or $69 for two years. Visit for more information.

By Andy Sutton

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. His firm, Sutton & Associates, LLC currently provides financial planning services to a growing book of clients using a conservative approach aimed at accumulating high quality, income producing assets while providing protection against a falling dollar. For more information visit

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