Ben Bernanke's speech at Jackson Hole, to me, was a yawner. The fellow who promotes transparency said absolutely nothing about the exit strategy he began to discuss in the Monetary Policy Report. Instead he gives Reflections on a Year of Crisis, the climax of which is a prediction that the turnaround of the economy will be slow:

Overall, the policy actions implemented in recent months have helped stabilize a number of key financial markets, both in the United States and abroad. Short-term funding markets are functioning more normally, corporate bond issuance has been strong, and activity in some previously moribund securitization markets has picked up. Stock prices have partially recovered, and U.S. mortgage rates have declined markedly since last fall. Critically, fears of financial collapse have receded substantially. After contracting sharply over the past year, economic activity appears to be leveling out, both in the United States and abroad, and the prospects for a return to growth in the near term appear good. Notwithstanding this noteworthy progress, critical challenges remain: Strains persist in many financial markets across the globe, financial institutions face significant additional losses, and many businesses and households continue to experience considerable difficulty gaining access to credit. Because of these and other factors, the economic recovery is likely to be relatively slow at first, with unemployment declining only gradually from high levels.

Up to the last two sentences it sounded like he was popping a cork. Arnold Kling is even more critical than I am. The role of Bernanke in the decisions on Bear, Lehman, and Merrill Lynch are not uniform, but Kling notes that Bernanke portrays the latter two as part of a grand strategy.

There [sic] word "panic" appears 14 times during the speech. The phrase "house prices" appears just twice, and the phrase "mortgage defaults" appears just once.

Clearly, Bernanke was listening to the CEO's of the big financial institutions who were telling him that they would have been fine if their short-term lenders had stuck by them. As far as the big bankers were concerned, this was an immaculate panic, in which their actual bad investments were not the problem. It was just that too many people lost confidence.

If this story is true, then whoever invested in banks and "toxic assets" last year should end up with a huge profit. The taxpayers should be raking in tens of billions, if not hundreds of billions, in windfall gains over the next few years, as the Fed and the Treasury cash in on the investments they made while everyone else was in panic.

But the market seemed to like it, with the Dow shooting up 1.5% in the first 90 minutes of trading. So the question to market participants is, what did you learn from this that you didn't know before? Is the U-shaped recovery a signal that the Fed will keep interest rates down long? What does that mean for inflation (gold is up $13 as I type this)? Why would Bernanke not reflect on the housing market where foreclosures continue to climb?

And before you pop a cork even on banks (what with the government deciding it doesn't need the last $250 billion of TARP), what about the 77 FDIC-closed institutions so far this year? Floyd Norris writes:

Although the losses on current failures stem mostly from construction loans, it is possible that commercial real estate will be the next big problem area. Losses in that area were growing at the Temecula bank, although its portfolio was relatively small.

During the credit boom, loans on those properties became easier and easier to get, on more and more liberal terms. Unlike residential mortgages, commercial real estate loans typically must be refinanced every few years. With rents and values down in many areas, that will not be possible for a lot of buildings, and some owners are just walking away from their buildings.

Two years ago, when the subprime mortgage problems began to surface, Washington took great comfort from solid balance sheets, which regulators thought meant the banks could easily weather the problem.

Last year, we learned that the regulators, like the bankers, did not comprehend the risks of some of the exotic instruments dreamed up by financial engineers. This year we are learning that the regulators, like the bankers, also failed to understand the risks of the generous loans that the banks were making in the middle of this decade.

I was on KNSI this morning, extending into Hot Talk when the Ox called in sick. Co-host Mike Landy asked me whether we have the right team in place to run whatever exit strategy we have. "We have smart people in the top places," I answered, "but these same people were there three years ago." I would like to see more learning and less cheering.

Labels: economics, Federal Reserve, money