On the one hand, it’s a relief that the stock markets in the US stabilized today, although the Dow recovering only a bit more than 1/10 of its prior day tumble is hardly a rousing vote of confidence. On the other hand, we have to scratch our heads as to how even this wee bit of recovery was achieved.
Perhaps Lazlo Birinyi was right, and we would have had a rebound regardless. But the Nikkei and the European averages were down a second day, and it seems just as likely that we would have had another down day, but likely an only modestly down day, as the worldwide panic was ebbing.
So that it a longwinded way of saying that I believe that Bernanke’s and Greenspan’s remarks had more than a little to do with the stock market recovery today. And I have a problem with that.
Simply put, before Greenspan, Fed chairmen didn’t give a rat’s ass about how the stock market fared. And by its charter, the Fed has no role in the equity markets. The objectives of the Federal Reserve System are to “furnish an elastic currency, to afford a means of rediscounting commercial paper,” and “to furnish a more effective supervision of banking in the United States. As Palgrave’s Dictionary of Money and Finance puts it, “in short, the Fed was to execute monetary policy, act as a lender of last resort, and regulate and supervise banking.”
But Greenspan became keenly interested in the stock market. He put the valuable and scare resource of bright young Fed economists on studying the formation of stock prices, rather than, issues related to the Fed’s charter, such as, the proliferation of various forms of near money and how that affected the Fed’s role as steward of money supply. And his oracular pronouncements came to have great sway over the equity markets, in large measure because market participants believed (correctly, in my mind) that the Fed cared about the health, and perhaps even the performance of the stock markets.
And today’s events would seem to confirm that belief. By a bit of good fortune (if your fortunes happen to be tied to the stock market), Bernanke was scheduled to speak before the House Budget Committee, which gave him a ready platform to dispense reassurance (I don’t know how with a straight face he can forecast a strengthening economy for the second half of the year. If that isn’t pandering to the markets, I don’t know what is). And Greenspan similarly retreated somewhat from his prediction earlier this week, now saying recession was “possible,” not “probable”.
A mere 3% correction is not worth the Fed saying anything. A market move of that magnitude posses no threat to the security of the banking system. Even if we has had another bad day today, a 6-7% downdraft similarly poses no threat to the banking system. The crash of 1987, a far more dramatic decline (25%) did get a bit scary the week after because the Japanese started repatriating capital and stopped buying Treasuries. Some words were apparently said in high places and Japanese banks resumed their Treasury purchases (I was in Japan at the time, and heard this directly from people involved with the Ministry of Finance). That, and orchestrating the bailout of LTCM, which threatened the financial system, is an appropriate use of the Fed’s authority. Acting as a CNBC talking head is not.
Another reason to be less than happy with Bernanke’s testimony is that it represents a transfer of wealth away from middle class Americans to savvy financial players, who pretty much by definition are affluent. Palgrave points out that the reason the early corporate central banks, such as the Bank of the United States, were dissolved was that having wealthy individuals in charge of the federal government’s banking activities was inherently anti-democratic. It further notes, “….there has been a lively element of American politico-economic thinking that any central bank is likely to attend to the interests of the rich and powerful, which – depending on one’s own politics – might or might not coincide with the public interest.”
Dean Baker in his Beat the Press comment, “Should Bernanke Be Stabilizing Financial Markets?” sees Bernanke’s pronouncements today as a sop, perhaps untended, to the smart money crowd:
In his testimony before Congressional today, Ben Bernanke reportedly made an effort to sooth uneasy financial markets. For this he was widely applauded by the business press. But is it the Fed’s job to be soothing financial markets?
Let’s throw out a purely hypothetical scenario. Imagine that the bad news on new home sales, mortgage applications, durable goods orders, and productivity actually translates into an economy that is about go into a recession.
Now let’s suppose that the market has two types of investors. The first type are the high rollers. They move in and out of financial assets on a moment’s notice. Let’s call them “hedge funds.” The second type are naïve investors. They put money into the stock market at regular intervals and let it sit. We’ll call them middle class 401(k) investors.
Okay, now in our hypothetical scenario, because the economy is genuinely facing serious problems, the market is likely to be heading downward in the months ahead. Our hedge fund investors will likely begin to recognize this fact and dump their stock. On the other hand, our middle class 401(k) investors are likely to keep putting new money into the market.
Suppose that Mr. Bernanke recognized that the economy is facing trouble and told Congress that the future looks bleak. The markets would presumably crash, because both the hedge funds and the middle class 401(k) investors would dump their stock. Everyone takes a hit, but the pain would be shared between the hedge funds and the middle class 401(k) investors.
Now, let’s suppose that Mr. Bernanke recognizes bad times ahead, but thinks that it is best to try to calm the financial markets, so he tells Congress that the economy is just fine. While this could be sufficient to assuage the middle class 401(k) investors, the assurances may not be sufficient to calm the hedge fund investors. Suppose they offload their stock over the next few weeks.
In this case, Bernanke’s soothing words would have the effect of keeping the market high while the hedge fund investors offloaded their holdings. The big losers would end up being the middle class 401(k) investors who keep buying into a sinking market.
In this purely hypothetical scenario, it would not be good for Bernanke to soothe financial markets, unless the goal is to redistribute wealth from middle class 401(k) investors to hedge funds. While this scenario may bear no relationship to the actual situation, it is not always true that the Fed should be trying to stabilize financial markets. The press could ask some questions along these lines, instead of just assuming that stable financial markets are always good.
