Thoughts on the 60 Minutes Bernanke Interview

From my bond-trading friend, who prefers to remain anonymous…

* Ben Bernanke was interviewed on 60 minutes last night. Supposedly, this was the first time in 20 years which a Federal Reserve Chairman was interviewed on TV. He was on TV to bring home the point that he (and the Fed) are doing everything needed to right the faltering economy. As I take apart the details about what was asked and what wasn’t, this appears to be an orchestrated effort to bolster public confidence in the administration’s efforts to remedy the current problems. Even this morning, the Squawk Box crew on CNBC, notably Joe Kiernan, who usually likes to take shots at famous guests, was like a lamb. At first, I seemed to feel that Ben did a good job, but on further review, thank goodness for instant replay, I am concluding that many important questions were not asked. Here is my biased summary:

On the surface, Ben came off well, and 60 minutes made him seem personable, and in touch with the current problems. I would say the interview was a success from that perspective. 

Ben declared that the economy would stop bottoming by the end of this year, and that we have averted a depression. Ben was given the credentials as being an expert on the depression of the 1930s. According to Ben, there were two things which the Fed (or the government) did wrong in the 1930s, which helped to exacerbate the problems. First off, the Fed let the money supply contract, which helped push the economy downhill. Secondly, Bernanke said that the Fed (or the Hoover administration) let the banks fail. The 60 minute interviewer did not challenge Ben on what the Fed’s powers are to allow them to rescue banks. This point was glossed over, and the inference was that the Fed was currently rescuing banks.

The reality here is two-fold: First, the power to save banks really exists with the FDIC and the Treasury (via TARP). The FDIC was created in 1933, after thousands of banks had already failed. Nonetheless, the effects, and loss of wealth from thousands of banks going bust, did have adverse consequences in the 1930s.

During the current crisis, the Fed gets an assist for saving banks, and financial institutions. However, some of their tactics have been border-line, in terms of what the Fed’s authorities allow. The Fed is only supposed to make collateralized loans to financial institutions. However, it is quite questionable what the value of the collateral, which the Fed received from Bear Stearns, and from AIG, is. The 60 minutes interview did not challenge Bernanke on the viability of the collateral of both of these rescues, which both occurred prior to TARP being passed. My point here is that at the time, the Fed made questionable loans, while there was no other power, who could have saved Bear Stearns and AIG. (Since then, TARP has given the Treasury department authority to spend money to save financial institutions). 

To their credit, the Fed has made about $1 trillion of additional credit available to financial institutions over the last 6 months, most of which is correctly collateralized. I would imagine that given the plethora of downgrades to many MBS securities over the past year, I wonder how many assets have been kicked out of Fed lending programs?

When 60 minutes questioned Bernanke about why he let Lehman go bankrupt, he said it was not possible to rescue Lehman, given the Fed’s powers. Unfortunately, the 60 minutes interview did not challenge Bernanke on the difference between rescuing Bear Stearns, or AIG, and letting Lehman go. Personally, I question whether the Fed is owning up to the true under-collateralization of their loans to AIG and Bear Stearns, as part of the Maiden Lane LLC, enterprises. Each week, the Fed reports a supposed value of these enterprises, with the current loans to Bear Stearns, being reported as $2 billion under-collateralized. What I am saying is that the Fed is still playing the charade that their Bear Stearns and AIG loans are correctly collateralized, while the same slight of hand could not be applied to Lehman. And while we are at it, I wonder what a BWIC (Bid Wanted in Comp) would prove the value of this collateral to be?

During the interview, Bernanke did own up to printing money. While this might be a necessary evil, to keep “things” from falling apart further, my guess is that this will ultimately sow the seeds of future problems.

Another interesting item came up when Bernanke was asked what the risks are. He stated that the primary risk is whether we have the political will to solve this problem. He did not elaborate, but to me this is a very loaded comment. As I see the problem, here is the conundrum we have yet to encounter:

1>    The Fed has added $1 trillion of money into the financial system, created out of thin air, since last September, and will add another $600 billion through June, via the purchase of MBS and Agency debentures. With the TALF program likely to start, that is another potential $1 trillion of money creation which has yet to come on stream.

2>    Obama will run a budget deficit of $1.7 trillion this year, and $1.2 trillion in 2010. The treasury will go out and borrow this money, which in turn will place massive demands on the markets for capital.

3>    The Fed will have no choice but to print some more money, and buy the treasury debt which no one else wants. The alternative will be a massive increase in treasury rates, and a crowding out of the private sector, which right now is challenged to buy non-agency mortgage backed securities with yields in the teens.

4>    The aggressive increase in money, likely to be in the $2-3 trillion range, will ultimately result in inflation. At this point, the Fed will have a choice between reigning in inflation, or sinking the economy – big time. This is likely to occur in 2010.

And this is where we come back to Bernanke’s question: Will we have the political will to solve the problems which will confront us. From where I sit, we have stabilized the patient, but the problems have not gone away. And the real question of our political will, has yet to be tested. (I realize I am twisting Bernanke’s comments to fit my view as to what the future problems are likely to be).

Behind the glow of the Fed’s easy money policy, I expect the financial markets, including stocks, to stabilize and improve over the next few months, and quite possibly, the next 6-7 months. This will be a massive head fake, which will ultimately end badly.

…Let’s hope Bernanke and the folks at Treasury know what they are doing.