Best of the Week
Most Popular
1. US Housing Market House Prices Bull Market Trend Current State - Nadeem_Walayat
2.Gold and Silver End of Week Technical, CoT and Fundamental Status - Gary_Tanashian
3.Stock Market Dow Trend Forecast - April Update - Nadeem_Walayat
4.When Will the Stock Market’s Rally Stop? - Troy_Bombardia
5.Russia and China Intend to Drain the West of Its Gold - MoneyMetals
6.BAIDU (BIDU) - Top 10 Artificial Intelligence Stocks Investing To Profit from AI Mega-trend - Nadeem_Walayat
7.Stop Feeding the Chinese Empire - ‘Belt and Road’ Trojan Horse - Richard_Mills
8.Stock Market US China Trade War Panic! Trend Forecast May 2019 Update - Nadeem_Walayat
9.US China Trade Impasse Threatens US Lithium, Rare Earth Imports - Richard_Mills
10.How to Invest in AI Stocks to Profit from the Machine Intelligence Mega-trend - Nadeem_Walayat
Last 7 days
Brexit Party and Lib-Dems Pull Further Away from Labour and Tories in Latest Opinion Polls - 22nd May 19
The Deep State vs Donald Trump - US vs Them Part 2 - 21st May 19
Deep State & Financial Powers Worry about Alternative Currencies - 21st May 19
Gold’s Exciting Boredom - 21st May 19
Trade War Fears Again, Will Stocks Resume the Downtrend? - 21st May 19
Buffett Mistake Costs Him $4.3 Billion This Year—Here’s What Every Investor Can Learn from It - 21st May 19
Dow Stock Market Trend Forecast 2019 May Update - Video - 20th May 19
A Brief History of Financial Entropy - 20th May 19
Gold, MMT, Fiat Money Inflation In France - 20th May 19
WAR - Us versus Them Narrative - 20th May 19
US - Iran War Safe-haven Reasons to Own Gold - 20th May 19
How long does Google have to reference a website? - 20th May 19
Tory Leadership Contest - Will Michael Gove Stab Boris Johnson in the Back Again? - 19th May 19
Stock Market Counter-trend Rally - 19th May 19
Will Stock Market “Sell in May, Go Away” Lead to a Correction… or a Crash? - 19th May 19
US vs. Global Stocks Sector Rotation – What Next? Part 1 - 19th May 19
BrExit Party EarthQuake Could Win it 150 MP's at Next UK General Election! - 18th May 19
Dow Stock Market Trend Forecast 2019 May Update - 18th May 19
US Economy to Die a Traditional Death… Inflation Is Going to Move Higher - 18th May 19
Trump’s Trade War Is Good for These 3 Dividend Stocks - 18th May 19
GDX Gold Mining Stocks Fundamentals Update - 17th May 19
Stock Markets Rally Hard – Is The Volatility Move Over? - 17th May 19
The Use of Technical Analysis for Forex Traders - 17th May 19
Brexit Party Set to Storm EU Parliament Elections - Seats Forecast - 17th May 19
Is the Trade War a Catalyst for Gold? - 17th May 19
This Is a Recession Indicator No One Is Talking About—and It’s Flashing Red - 17th May 19
War! Good or Bad for Stocks? - 17th May 19
How Many Seats Will Brexit Party Win - EU Parliament Elections Forecast 2019 - 16th May 19
It’s Not Technology but the Fed That Is Taking Away Jobs - 16th May 19
Learn to Protect your Forex Trading Capital - 16th May 19
Gold Ratio Charts Offer The Keys to the Bull Market - 16th May 19
Is Someone Secretly Smashing the Stock Market at Night? - 16th May 19

Market Oracle FREE Newsletter

U.S. House Prices Analysis and Trend Forecast 2019 to 2021

The Bernanke Bluff on US Interest Rates

Interest-Rates / US Interest Rates Apr 30, 2007 - 12:18 PM GMT

By: Paul_Petillo

Interest-Rates Ben Bernanke, the Federal Reserve chairman seems to be holding his ground when it comes to short-term interest rates – at least in the short-term. His recent testimony before the Congressional Joint Economic Committee offered no additional insight into how the chairman thinks. His testimony before legislators offered no hint as to what he would do with rates in light of some troubling economic news.


Investors have become like so many oysters of late, left to filter the economic waters passing by in search of some morsel of insight into why the news is good then bad and then good again. 

With risks increasing on “both sides of the outlook”, Mr. Bernanke's open-ended belief was reiterated with the veiled suggestion that rates could go higher or remain the same or be lower by year's end. Once billed as the clear speaking Fed chief, he instead left anyone watching the Fed scratching their collective heads.

Economists believe that the mortgage meltdown in the sub-prime sector will have a lingering effect over the growth of the economy. While the actual effect may be more psychological than real, the threat of any slowdown by default spreading throughout the rest of the economy is quite low. Currently, the numbers of foreclosures have risen but recent reports suggest that only 15% of the sub-prime marketplace will be affected.

Even though that number is small, banks have begun to tighten with the net result of fewer riskier mortgages. That may perceived as a plus for one side of Bernanke's economic outlook. 

His focus, although is not on the mortgage market. The sub-prime fallout has little to do with Fed policy or the regulation of short-term interest rates. If Mr. Bernanke were concerned with the slow unfolding of this segment of the lending market, he didn't show it. This seemed to worry Congress.

Instead, he came close to asking for additional regulatory power over institutions that did not fall under his scope of banking power. Reigning in the high-risk lenders, many of whom were financially backed by the very banks that Mr. Bernanke currently regulates may very well have offset the problem. He believes that the mortgage markets will self-correct and although the damage that done was regrettable, any knee jerk reaction, namely additional legislation might do more harm than good. 

Inflation numbers still worry the Fed chief. That has brought many investors and economists to the conclusion that rates will not be cut anytime soon. Perhaps rates are the least of Mr. Bernanke's concerns.

His rather sanguine view of the economy aside, what seems to concern the Fed chief is business. A cursory glance at the health of businesses based on economic reports is often deceiving and likely subject to revisions or rebounds. As one report suggests strength, still another portrays an overall slowdown with disastrous downside possibilities. He admits to being puzzled. This is merely a bluff.

Bernanke understands that Congress grasps the basic business model. Keep companies strong and jobs are created. First-time weekly jobless claims actually been falling of late, which is generally perceived as both economically and politically good. 

Closer inspection of those reports only adds additional confusion to the economic outlook. Businesses are hiring, yet an increase in capital spending hasn't followed this worker-based growth.

The extra weight of these workers is having a negative effect on productivity. Once considered a necessary element of growth, productivity measures have fallen below pre-1997 levels. So more than inflation is on the other side of the “outlook”.

Historically, Mr. Bernanke has been vocal about the relationship between inflation and productivity/wages/growth momentum. He has pointed out that has his predecessors seen that correlation in the ‘70's, much of that decades problems with inflation could have been averted. Seeking to avoid that sort of reoccurrence on his watch, Bernanke has kept his cards close.

Yet, well within the scope of the Fed's regulatory jurisdiction, a growing problem has fully matured. A new record was set during the 1 st quarter of this year in the leveraged lending market. These markets exist for business borrowing when the usual channels require too much in the way of disclosure. If that sounds suspiciously like the mortgage markets version of “no-doc loans”, it is.

Under normal circumstances, these types of loans require assets to be affixed as collateral. Increasingly, banks have waived those requirements. 

The borrowers, often-private equity, use the money to finance leveraged buyouts. These high-risk loans come with “covenant holidays” a grace period that allows the borrowers to erase bad quarters from the books. 

Bernanke's banks have written poorly secured loans to less-than-creditworthy borrowers and then repackaged them with the lenders better credit rating affixed. Acting as sort of middleman and in theory, spreading the risk, banks have become sub-prime lenders. Mr. Bernanke seems to have turned a blind eye on this outwardly benign risk.

CLO's or collateral loan obligations have been around for over twenty years. Banks bundle them and sell them to investors. These financial products are sold with a generally wink-wink understanding that purchased individually the underlying loans would carry a low-grade credit rating. By standing behind them, at least in reputation, the overall credit rating on these otherwise sub-par loans improves. That improvement and a slightly higher return against similarly rated investments, up to 2%, makes them more attractive.

These unwary investors tend to be in the market for the AAA rated bonds. Among the unsuspecting customers are pensions, insurance companies and the most conservative investor of all, the ultra wealthy. Much of the underlying junk debt is involved in the current wave of leveraged buyout, an activity that many of these investors would normally scorn.

Is Mr. Bernanke bluffing when he tells Congress that corporate profits should remain healthy? Possibly. If CLO's are any indication of how his own banking system calculates business health, Mr. Bernanke's economy may be on very shaky ground. Perhaps there is much more than inflation and slowing productivity on the “other side of the outlook”.

By Paul Petillo
Managing Editor
http://bluecollardollar.com

Paul Petillo is the Managing Editor of the http://bluecollardollar.com and the author of several books on personal finance including "Building Wealth in a Paycheck-to-Paycheck World" (McGraw-Hill 2004) and "Investing for the Utterly Confused (McGraw-Hill 2007). He can be reached for comment via: editor@bluecollardollar.com


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Tex
02 May 07, 18:34

Somethings got to give. The falling dollar means higher inflation which 'should' mean higher interest rates and hence stagflation.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules