Bernanke's Complete and Utter Failure

It has been about six months since Federal Reserve Chairman Ben Bernanke panicked and issued a surprise rate cut. Ostensibly, it was positioned as an attempt to ward off recession by injecting liquidity into the market. If that had been the extent of his command-and-control meddling, we might've been out of the woods by now. Sadly, it wasn't, and we're not.

Instead, we've been treated to some of the most incompetent monetary policy ever to come out of that hundred-square-mile hunk of swampland known as Washington, D.C. It'd be amusing to watch from afar, if it weren't so painful to live through.

Comrade Bernanke's central planning blunders
At the core of the current catastrophe is Bernanke's asinine assumption that simply throwing money at a problem is a way to solve it. Unfortunately, the (nearly) free money he throws about is about the costliest capital on the planet. The true cost isn't measured by the interest rate he arbitrarily chooses to charge, but on the effects his actions have on the private sector.

First and foremost, Bernanke's bailouts socialize risk while privatizing profit. It started with that sweetheart deal that JPMorgan Chase (NYSE: JPM  ) got by picking up Bear Stearns' assets while shafting taxpayers with $29 billion of its liabilities. It continued with the insanity by opening its "Primary Dealer Credit Facility." Essentially, with that window, we taxpayers have been forced into making margin loans to brokers like Goldman Sachs (NYSE: GS  ) , Morgan Stanley (NYSE: MS  ) , and Lehman Brothers (NYSE: LEH  ) .

Now, just a few months after they begged to be allowed to take on the extra risk of higher loan limits, Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) are also failing. Go figure. So Bailout Ben once again opens your wallet and hands out your hard-earned cash through that special window available to the politically connected few. This time, though, the money is going to the mortgage giants whose "conservative" lending standards were supposed to have made them immune to the subprime mortgage meltdown.

Hmmm. Could it possibly be that all that cheap federal cash Bernanke keeps handing out is crowding out private investment, thus exacerbating the credit crunch? Who in their right mind, after all, is going to stick their neck out to loan money for anything, when the government is only charging 2.25% to essentially failing companies? Not a single person with a brain and two wooden nickels to rub together, that's who.

That's the second problem with Bernanke's interventions. Rather than helping restore liquidity to the market, the Fed's too-cheap interventions are actively keeping private money out. No wonder Bernanke "had" to extend both the duration and the list of companies eligible for his emergency window of essentially free cash. Of course, any Fool should have seen that coming when the window first opened.

The consequences of socialized lending
Without private liquidity, the ability to borrow for business expansion is at a standstill for any company not a member of Bernanke's politically privileged elite club. That translates to job losses, a weaker economy, and a far longer period of time until we hit rock bottom and can start to rebuild.

And unfortunately, by handing out cash at rates well below rational levels, that economic stagnation comes with the additional pain of inflation. Or, to revive the 1970s term: stagflation. Since Bernanke's first destructive salvo on that cold January day, here are some shocking stats about the further deterioration of the economy:

 

Gold

Oil

U.S. Dollar Index

S&P 500

7/15/2008

$986.00

$138.74

71.69

1212.91

1/22/2008

$875.00

$89.86

77.061

1310.5

Change

12.69%

54.40%

(6.97%)

(7.45%)

In a nutshell, the cost of living has become phenomenally more expensive in the past six months, thanks to far-too-cheap lending. To make matters worse, our capacity to pay for it has evaporated, too, thanks to the falling greenback and stock prices. If that's what "help" looks like from the central bank, I'd hate to see what hurt looks like.

What's next if we don't change course?
Already weak automaker General Motors (NYSE: GM  ) is perhaps the canary in the coal mine of the further destruction to come. Its aggressive self-cannibalization, cutting back of benefits, closing of manufacturing plants, and early employee separations show the downside of Bernanke's stagflationary interventions. GM was in trouble to begin with, though, and already largely expected to drive toward oblivion. The longer these insane monetary policies are allowed to be kept in place, the higher the likelihood that even stronger companies will succumb.

Capitalism isn't quite dead yet, but the more heavy-handed "help" Bernanke gives it, the worse off it gets. Instead of granting new powers to this utterly destructive agency, Congress should reign in the Federal Reserve before the Fed's meddling brings us the next Great Depression.

JPMorgan Chase is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Chuck Saletta wants to know who's willing to loan him billions of dollars at 2.25%. He promises to do his best to put the cash to good use. At the time of publication, Chuck owned shares of General Motors, though he's really not sure why. The Fool's disclosure policy made Chuck confess to that poor investment, which should tell you just how strict it is.


Read/Post Comments (18) | Recommend This Article (60)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 17, 2008, at 3:56 PM, Calculated4Risks wrote:

    You think you're smarter than Bernanke? No!

  • Report this Comment On July 17, 2008, at 3:56 PM, VincitOmnia wrote:

    What would happen to Fannie Mae and Freddie Mac if the Federal Reserve hadn't intervened with taxpayers' money?

  • Report this Comment On July 17, 2008, at 4:12 PM, dcholtx wrote:

    Yes loaning to the rich at low rates is foolish (though not Motley Foolish). Your really addressing the problem of stagflation (commodity prices rising without corresponding rises in wages.) This stems from 3 financial actions of the US government, unrestricted money supply, deficit spending (largely the Iraq War), and reduced tax revenues (yes money held for years offshore did raise the total amount of tax revenue when the reduce tax rates enticed the wealthy to return their profits to the US, but not in proportion to the cost of these profits.) So other than making the rich richer and the poor poorer, anything else new in US policy over the last 8-28 years?

  • Report this Comment On July 17, 2008, at 4:16 PM, Calculated4Risks wrote:

    Everything is going according to the plan of Washington insiders. This is the way Washington financed the wars, by borrowing the hands of the free market to transfer wealth. Bernanke knows that the housing speculation will be end badly. He along with the Washington insiders just was too happy to see as long as it would chug, so the economy will not feel pain of the war expenses. Now it comes the time to pay. How? that's the beauty of all: By allowing the worst of the apples to be disposed. Yeh, the former owner's of CFC, IndyMac, FNM, FRE, paid, or are paying the bill. People owned these stocks are just as stupid as the people taking out PAP loan and paid minimum. They deserved to loss some money to pay for the war.

    Now Bernanke is moving to the second phase of the plan: Talk up commodity inflation while keeping the wage inflation under tag. Guess who else, after food and energy, has pricing power today. The apartment owners. In the face of the commodity inflation, the apartment owners will start to jack up rent. This way Bernanke will engineer a stabilization, if not mildly recovery of the housing market. Everyone's going to loss some in this round of wealth transfer but the biggest loser will be those deadbeat that walked away from their mortgage simply because there was negative equity in their houses. By doing that, they ruined their credit, and for the next 10 years, they'll see their rental bill to double.

  • Report this Comment On July 17, 2008, at 4:17 PM, joeyee1 wrote:

    Chuck, your arguments are idiotic. We things went along as you suggested, we'd be in a depression. So let everything fail, let the recession become a depression ... then what ?

  • Report this Comment On July 17, 2008, at 4:36 PM, LoliaChristine wrote:

    Darling, the entire premise of your article is flawed. Private money has not at all been stifled by the Fed window. In fact, the window has only been improved the market for private money.

    First, corporates generally do not want to use the Fed Window, because it suggests that they are not able to gain private financing and therefore are fragile. Therefore, no matter what the interest rate offered by private lenders, a corporate lender will always choose a private lender, assuming the rate is one the Company can afford with its projected cash flow. Therefore, the interest rate competition that you have mentioned in your article does not exist.

    Second, private money investors do not decide whether or not to invest their money based on the interest rates offered by other investors (i.e. the Fed). Private money investors decide whether they will invest based on (i) how much funds they have and (ii) the risk / return reward. Therefore, if they have the funds, they will indeed offer a rate that they feel is appropriate for the risk of the Company. The question, however, is whether the Company can afford that rate.

    Further to that point, a private investor will find comfort in the fact that a Corporate that they are considering lending money to has access to additional funds in the case of emergency. Naturally, if I have just lent my capital to a ABC bank, and then tomorrow ABC bank looses a quarter of its capital due to a bad investment, I would be comforted by the fact that ABC bank can borrow the additional funds it needs to stay solvent from the Fed. If that was not the case, ABC bank would either have to come back to me for more money (which I wouldn’t like) or would go bankrupt (which I really wouldn’t like). Therefore, the Fed window helps to reduce the risk of the finance firms it supports, and therefore will make the private money investor more likely to invest.

    Finally, there are some firms that Ben just cannot go bust --- Freddie and Fannie --- not an option. If those two went bust, the entire residential real estate market would disappear – not collapse, but actually disappear. Meaning, for a very long time, the only way you could buy a new home would be if you could pay for it all in cash. I could go into how this alone could easily cause another great depression, but my time is too precious.

  • Report this Comment On July 18, 2008, at 2:10 PM, dustdevil11 wrote:

    The metaphor "Bailing out" is apt in this situation. As in the question, "What if the passengers on the Titanic had been more adept at "bailing out?'" The answer would rightly seem to be that the Titanic (i.e. US economy) would still have sunk, but the passengers while furiously bailing would still have drowned. They just would have been more distracted by the bailing out activity and wouldn't be able to have paid as much attention to the Real Dilemma. Ben, more buckets, please.

  • Report this Comment On July 18, 2008, at 7:43 PM, robertf36009 wrote:

    As Lolia correctly pointed out the premise of the article is indeed flawed. Fannie and freddie were created by tax payer money.which is why they are called government sponsors entities (GSE). Their stock price decline was largely a psychological response by investors. Good for me I bought in at $10 bad for those who were buying at $50+ per share. Since Fanny and Freddie are not actually banks they can not be exposed to a run as happened to Indy Mac and they are capitalized differently. Even if 1% of their loans defaulted tomorrow a very remote possibility,, they are adequately capitalized. with $65 billion in cash.

  • Report this Comment On July 21, 2008, at 10:44 AM, jesaws wrote:

    Once Fannie and Freddie have been stabilized, which philosophically I am against, but practically favor, I think the system needs to be reinvented. Someone suggested setting up 12 separate mortgage financing agencies mirroring the 12 federal reserve districts. Each would function independently and a downturn in the northeast wouldn't impact the southwest. Whatever else we do, we need to learn from this financial crisis like we did after the Depression. Keep in mind that the system they put in place following the 1930's economic crisis, functioned pretty well for nearly 3/4 of a century.

  • Report this Comment On July 21, 2008, at 7:31 PM, dslocum wrote:

    Let's see, in 1971 Congress convinced us it needed to bail out Lockheed, to the tune of $250 million...so, it could later devour Martin-Marietta, becoming Lockheed-Martin. During the 1980's the banks & savings and loans were next in line for a hand-out (excuse me) bailout - the names Continental and Bank of America come to mind. They weren't just bailed out, they were downright taken over by the government. Not to be outdone, along comes Clinton in 1995 and bails out Mexico, with $50 billion in loans to shore up the tanking Peso. Now, here we are in the 2000s and what do we see? Ah yes; this time, we're going to bail out an entire industry: Banks, mortgage brokers, "investors" even "GSEs"; all because some greedy bankers and brokers out for a quick buck, and some gullible home buyers or dishonest speculators are now stuck with mortgages they can't afford and can't get out from under. In the military, we used to have a word for this sort of government screw job - BOHICA. Well, Mr. and Mrs. Taxpayer: Get ready, 'cause it's definitely BOHICA time. In fact, as the late Yogi Berra would say, "It's de'ja vu, all over, again."

  • Report this Comment On July 21, 2008, at 8:13 PM, jollyman50 wrote:

    WOW, after all of these comments I feel that one should awake to what is truly the objective of what we as investors should keep in mind, and that is when the government steps in for whatever reason that (they, he, she, we) reason is for the good, it will obviously cost money to (they, he, she, we, U.S.) Why should that change if we as the government will not step up and say enough is enough.

  • Report this Comment On July 21, 2008, at 9:56 PM, krazycanuck wrote:

    One thing this article mentions only implicity is the economic concept of "moral hazard". The de facto guarantees, by the government, and/or its agents (including the Fed, possibly under government direction) to corporations, and the bailing out the shareholders at taxpayers' expense, sends out a loud signal, that essentially says "it's okay to take bad risks; if you fail the taxpayers will pay, but if you succeed the shareholders will be rewarded", or "heads we win, tails the taxpayers lose". This moral hazard dissuades due diligence, as it reduces their risk. How do taxpayers benefit if these big risks succeed? Not much. Of course, the "essentially free" money comes from somewhere; either your taxes are going up, or the price of goods and services (in dollar terms) is. The funds are either coming from you, the taxpayer, or they're coming from the printing press and diluting existing dollars' purchasing power, since the more of a good that exists, the less its value!

  • Report this Comment On July 22, 2008, at 2:49 PM, evilteddy wrote:

    Chuck, your careless -- particularly around how Fed lending impacts private lending -- and wholly sensationalistic analysis demonstrates that the market does not always act rationally or make good choices: If it did, we'd be reading much better material from people who actually had a better grasp of fundamental economics.

  • Report this Comment On July 22, 2008, at 6:16 PM, s2rikanth wrote:

    Chuck, While I appreciate your sentiment about socialized lending, I don't think we are yet appreciating how close we have come a complete failure of the banking system. By being a trust provider in times of panic, the fed has played a very important role. I am quite sure more broker-dealers like Lehman would have fallen by now without the discount window. Fannie and Freddie also might have been at great risk. Let's be thankful about what we may have avoided, thanks to Fed!

  • Report this Comment On July 22, 2008, at 7:25 PM, chriswood1533 wrote:

    Rather than addressing the flawed economic logic embodied by the article and every comment above, I will try and tempt readers to educate themselves...

    Inflation is caused only by the central bank; only the central bank can increase the money supply.

    If one does not understand why the Federal Reserve needs to be destroyed, soon, why the U.S. needs a currency backed unit for unit by gold, and why we need to abolish fractional reserve banking, then one understands neither how the central banking system functions nor real world economics.

    If one wants to educate oneself about economic reality, I would start by searching for articles written by Murray Rothbard on the subjects of money, inflation, and the federal reserve, which can be found at mises.org; LewRockwell.com; and others.

  • Report this Comment On July 22, 2008, at 9:21 PM, JPG101 wrote:

    Amazing how it is possible to get so many things wrong in so many different ways. So many utterly unrelated factoids strung into a non coherent analysis.

    Figures Chuck would by GM. Have any Ford also? Shorting Honda and Toyota I presume...

  • Report this Comment On July 23, 2008, at 5:10 PM, SamLBronkowitz wrote:

    Mr. Chuck "Norris" Saletta:

    I agree - never before has the beauty of the federal reserve system been so crassly exploited

  • Report this Comment On July 23, 2008, at 8:53 PM, stockcommander wrote:

    The best the FED can do is to give the American economy a breathing space. Ben Bernanke can not be faulted for the current state of the economy. If you really want to point fingers –Alan Greenspan is probably more at fault than Ben Bernanke. That the American economy was in trouble was evident to a lot of people when Greenspan stepped down. What I find thoroughly amazing is the more or less total lack of adaptability to the current state of the economy by companies like GM that are more or less totally focused on the American market. The devaluation of the dollar – which is something the FED has worked hard to achieve – creates a golden opportunity for American companies that are export oriented.

    Export from America means that the American economy is strengthened – import means just the opposite. From a corporate point of view this may not be true, but it is true for the American economy in general. It is not Ben Bernanke’s fault that some of the largest American companies seems to be totally unable to adapt to the new situation, so maybe it’s time for a change in leadership – but not at the FED.

    America has a totally insane trade deficit, and its not getting better. A strong dollar may make oil cheaper, but in the long run the deeper problems can only be addressed be increased domestic productivity and a competitive export oriented industry.

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