The Bernanke Doctrine
Comment of the Day

December 19 2013

Commentary by David Fuller

The Bernanke Doctrine

Here is a middle section of this good editorial from Bloomberg on the US Federal Reserve’s retiring Chairman:

Bernanke didn’t arrive at the Fed in 2006 intent on revolutionizing central banking. Just the opposite: The economy seemed strong, with unemployment at 5 percent and annual growth of 3.3 percent. The housing bubble, however, was inflating rapidly. The smartest economists, Bernanke included, failed to see that the combination of undercapitalized financial institutions, subprime loans, securitizations and exotic derivatives could produce the lethal mix that crashed the global economy. Bernanke’s Fed was responsible for regulating large banks and home loans, and it failed.

What happened next redeems him. Bernanke recognized that an economy running on credit would succumb unless the Fed fixed broken credit markets, revived consumer demand and avoided deflation. Using his deep knowledge of the mistakes of the 1930s, Bernanke set up one lending facility after another to finance everything from commercial paper to auto loans. He helped persuade Congress to adopt the Troubled Asset Relief Program to bail out hundreds of banks. He made sure dollar loans were available to overseas banks. He brought interest rates down to near zero, and promised to hold them there indefinitely. To make that commitment more credible, he put more of the Fed’s deliberations on the record.

Granted, mistakes were made. Letting Lehman Brothers Holdings Inc. fail was a big one. Bernanke and Treasury Secretary Hank Paulson wanted to make an example of Lehman and end the moral hazard that bailouts cause. That turned a liquidity crisis into a full-blown panic.

By the end of 2009, the emergency had abated, but the economy was still sick. So Bernanke’s Fed got even more creative. With inflation hawks -- Republican lawmakers, conservative economists and even some of his Fed colleagues -- screaming bloody murder, he started the first of three phases of quantitative easing. The Fed bought enormous quantities of Treasury bonds and mortgage-backed securities to depress long-term interest rates and induce investors to shift into other assets. The Fed’s balance sheet grew from $1 trillion in 2008 to almost $4 trillion, where it stands today -- greater than Germany’s gross domestic product.

The policy worked. It energized the stock market, lowered long-term interest rates, supported the interest-rate-sensitive housing and auto markets, and cut unemployment -- not a lot, but enough to quiet many critics, especially once they saw that inflation remained tame.

Bernanke, meanwhile, backed the Dodd-Frank Act’s many financial reforms. He agreed that large banks shouldn’t get taxpayer subsidies in the form of lower borrowing costs because of their “too big to fail” status. To prevent that, he required the largest banks to hold more capital to absorb future losses. He also required them to submit to rigorous stress tests. More recently, the Fed threw its weight behind a stronger Volcker Rule (to limit banks’ proprietary trading) than most observers had expected.

David Fuller's view

Whether you agree or disagree with the above, I recommend reading the editorial in full.

Although I think it is probably an overstatement to say that Bernanke’s Doctrine “maneuvered the U.S. away from another Great Depression”, as Bloomberg’s editorial claims in its second paragraph, the situation was certainly serious.  I have said before and maintain that we would have seen a considerably more damaging shakeout without Mr Bernanke’s policies.  There is also a possibility that the US economy might have then recovered more quickly without the Fed’s involvement, as some have claimed.  We will never know but I suspect the initial damage would have been much worse, at both corporate and social levels, without the Fed’s intervention.

Meanwhile, it could take at least another five years before we can fully assess Mr Bernanke’s policies.  Currently, developed economies show evidence of modest recovery, in line with what historian economists such as Carmen Reinhart and Kenneth Rogoff have forecast after severe credit crisis recessions. 

Stock markets have generally done much better, mainly thanks to a powerful monetary policy tailwind which is likely to persist for at least another year, despite the tapering of quantitative easing (QE) which commences next month.  The Fed has stated clearly that monetary policy will remain very accommodative for at least another year.  The European Central Bank, the Bank of Japan and the Bank of England are following similar policies, as are central banks in most other countries.  

I do not expect stock markets in the USA, UK, Europe and Japan to move higher to the same extent as in 2013, and the action will often be choppier, as we have seen with many other stock markets this year.  However, monetary policy remains very positive and there is no more bullish indicator.  Therefore, I would remain overweight in equities, monitoring price charts in an effort to buy low once steadying becomes evident, and lightening positions or at least using trailing stops when sustained uptrends are clearly overextended on weekly charts, relative to their 200-day MAs.          

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