A year after the onset of the current crisis in August 2007, financial markets remained stressed, the economy was slowing, and inflation--driven by a global commodity boom--had risen significantly. What we could not fully appreciate when we last gathered here was that the economic and policy environment was about to become vastly more difficult. In the weeks that followed, several systemically critical financial institutions would either fail or come close to failure, activity in some key financial markets would virtually cease, and the global economy would enter a deep recession. My remarks this morning will focus on the extraordinary financial and economic events of the past year, as well as on the policy responses both in the United States and abroad.
And ignore your role in creating it. Don't worry, I'll take care of that for you.
History is full of examples in which the policy responses to financial crises have been slow and inadequate, often resulting ultimately in greater economic damage and increased fiscal costs. In this episode, by contrast, policymakers in the United States and around the globe responded with speed and force to arrest a rapidly deteriorating and dangerous situation. Looking forward, we must urgently address structural weaknesses in the financial system, in particular in the regulatory framework, to ensure that the enormous costs of the past two years will not be borne again.
You've done nothing of the kind going forward just as you haven't looking backward. I have no confidence whatsoever that this will change, but perhaps others do. That's for them to decide.
Notwithstanding these significant concerns, however, there was little to suggest that market participants saw the financial situation as about to take a sharp turn for the worse. For example, although indicators of default risk such as interest rate spreads and quotes on credit default swaps remained well above historical norms, most such measures had declined from earlier peaks, in some cases by substantial amounts. And in early September, when the target for the federal funds rate was 2 percent, investors appeared to see little chance that the federal funds rate would be below 1-3/4 percent six months later. That is, as of this time last year, market participants evidently believed it improbable that significant additional monetary policy stimulus would be needed in the United States.
That's because you were willfully ignoring the facts that were staring you in the face - not surprising, given that you were one of the chief architects of the policies that led to the mess.
Nevertheless, shortly after our last convocation, the financial crisis intensified dramatically. Despite the steps that had been taken to support Fannie Mae and Freddie Mac, their condition continued to worsen. In early September, the companies' regulator placed both into conservatorship, and the Treasury used its recently enacted authority to provide the firms with massive financial support.
Both Fannie and Freddie were running with 80:1 leverage ratios, and prime mortgage default rates were projected to head north of 2%. What could possibly go wrong, given that math? (Psst: A 2% loss with 80:1 leverage puts you some 30% underwater - a catastrophic situation that cannot possibly be survived. This forecast was known more than a year in advance of Fannie and Freddie's collapse, and both I and others, using nothing more than published balance sheets and quarterly reports, called both of these firms "zeros" long in advance of their collapse on that basis.)
Shortly thereafter, several additional large U.S. financial firms also came under heavy pressure from creditors, counterparties, and customers. The Federal Reserve has consistently maintained the view that the disorderly failure of one or more systemically important institutions in the context of a broader financial crisis could have extremely adverse consequences for both the financial system and the economy. We have therefore spared no effort, within our legal authorities and in appropriate cooperation with other agencies, to avert such a failure.
You have actually entirely ignored the limits of your legal authority, including most specifically your taking of equity in securities that do not have the formal full faith and credit of the US Federal Government.
Nobody in Congress seems to care, but I do. The fact that there is no "or else" in the Federal Reserve Act (as amended) is likely the cause, as the worst punishment that can be meted out to you would be impeachment (and even that's open to question) or refusal to reappoint you.
In contrast, in the case of the insurance company American International Group (AIG), the Federal Reserve judged that the company's financial and business assets were adequate to secure an $85 billion line of credit, enough to avert its imminent failure. Because AIG was counterparty to many of the world's largest financial firms, a significant borrower in the commercial paper market and other public debt markets, and a provider of insurance products to tens of millions of customers, its abrupt collapse likely would have intensified the crisis substantially further, at a time when the U.S. authorities had not yet obtained the necessary fiscal resources to deal with a massive systemic event.
An event you fostered. Let us not forget that you had supervisory authority over JP Morgan, Bank America, Citibank and others, yet you allowed these institutions to enter into credit default swaps and other instruments with AIG, even though you knew or should have known that AIG had no ability to perform on those obligations. That is, you intentionally abdicated your responsibility during the boom years to supervise these institutions, and now you wish to claim that this was an "unanticipated" problem.
That is a lie.
The two largest remaining free-standing investment banks, Morgan Stanley and Goldman Sachs, were stabilized when the Federal Reserve approved, on an emergency basis, their applications to become bank holding companies.
That too is a lie. These firms survived only because you negotiated a back-door transfer of taxpayer money, free of all obligation, through AIG to these companies. Their application to become bank holding companies also came with exemption requests for BHC leverage limits, which you granted, thus leaving the liability for their continued gambling (and boy have they!) on the taxpayer's back as well.
The failure of Lehman Brothers demonstrated that liquidity provision by the Federal Reserve would not be sufficient to stop the crisis; substantial fiscal resources were necessary. On October 3, on the recommendation of the Administration and with the strong support of the Federal Reserve, the Congress approved the creation of the Troubled Asset Relief Program, or TARP, with a maximum authorization of $700 billion to support the stabilization of the U.S. financial system.
You and Hank Paulson lied about your intentions for that $700 billion dollar appropriation. That this was a knowing lie, in that the intended disbursement changed before it was finally voted up in Congress, is fact, not supposition - it was disclosed by Neal Kashkari during questioning under oath by Congress that The Fed and Treasury had shelved the "bad asset" purchases several days prior to the final vote, but you never informed Congress of your altered intent.
In short, you and Treasury acquired access to that $700 billion under false pretense. In an honest world we would call that theft by conversion, or simple fraud. But we live in a world where regulatory capture and fraud are part and parcel of everyday life in Washington DC.
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.
The Federal Government expanded spending by 15% annualized from the first to second quarters of this year. This resulted in a nominal improvement in GDP from worse than the first quarter to a printed number that was much better, but that nominal print does not change private economic activity; it hides it.
Far more important than this sort of accounting game and its psychological impact is the cost of maintaining the charade. In the second quarter the cost of this scheme was some $400 billion dollars, plus another $250ish in direct costs to support the more than $20 trillion in guarantees and backstops committed.
While 1% per quarter in cash costs against those guarantees sounds quite reasonable and low, it is nonetheless a massive expenditure of public funds that must continue indefinitely until those guarantees are withdrawn. An indefinite extension of these guarantees is not possible as this would result in an addition to federal spending of one trillion annually for the indefinite future - an amount that vastly exceeds any other single federal program and is clearly unsustainable.
But at the root of these support and guarantee programs lie the root of the crisis - your actions, and that of other regulators. Let's examine one of your other statements in this regard:
To be sure, the provision of liquidity alone can by no means solve the problems of credit risk and credit losses; but it can reduce liquidity premiums, help restore the confidence of investors, and thus promote stability. It is noteworthy that the use of Fed liquidity facilities has declined sharply since the beginning of the year--a clear market signal that liquidity pressures are easing and market conditions are normalizing.
Nonsense. Withdraw any material part of the $12 trillion+ in formal guarantees and the more than $20 trillion in formal and informal, and I'll believe you. The Fed has withdrawn none of it and it has urged Treasury to withdraw none of it. As just one example Citibank alone has more than $300 billion of formal guarantees provided by the Federal Government against so-called "assets" that are almost certainly not worth what they are marked at.
Indeed, we know this is the case essentially across the board when it comes to our banking system, as in essentially every case where a bank has failed assets have been shown to be "mismaked" by anywhere from 10-50%. The recent acquisition of Colonial is a prime example - their "asset book" was in fact overvalued in the bank's own view by some 37%, with BB&T re-marking the assets to the market at that level. That you, the rest of The Fed and other regulators have allowed this situation to not only arise but continue to allow it to persist is an outrage - this is out-and-out fraud, it is pervasive, and we are treated to multiple examples of it on virtually every Friday.
In an honest nation every regulator associated with this insanity would have been drummed out of office and indicted for public corruption, bank executives would be in the dock on fraud charges and we would have performed a comprehensive examination of every bank's books to detect the level of intentional falsehood on every bank in the nation by now.
We haven't and I bet we won't until it all comes tumbling down - an outcome that is ultimately assured, simply because "that which can't go on forever, won't."
We've utterly failed to perform the necessary clearing of the credit system of bad assets. Instead you, along with Treasury and Congress, have chosen to paper over those bad assets and hide them. This has prevented you, the FDIC and Treasury from being forced to close these institutions, but it leaves them zombies, stuffed chock full of toxic garbage that they cannot sell (lest they be instantly recognized as insolvent) and are forced to expend precious cashflow maintaining the illusion of "par" value. This was aided and abetted by Congressional pressure applied to FASB - a change made by them quite literally at gunpoint in what was arguably the most outrageous display of institutionalized fraud I have seen in my 46 years on this planet.
While there are many who argue that "the ends justify the means" this is a false argument and a further lie. We have accomplished exactly nothing of long-term positive impact, as without honest marks on these assets institutions cannot freely trade them - that is, there is no liquidity in these assets on the balance sheet and the credit intermediation system remains clogged and non-functional.
Unfortunately all modern monetary systems are credit-based. The importance of this should be understood by you, since you're a monetarist and classic Keynesian, yet you seem to miss the essential point, at least in public. In reality I suspect you're changing your underwear every time you testify before Congress or speak where anyone other than those "in on" the clever scam might question you, lest reality be discovered: The Fed has utterly failed to improve the real velocity of credit circulation and without it they've accomplished nothing. In fact the deflationary forces are winning and will continue to do so until and unless the bad assets are flushed from the system and thus rendered impotent.
Hell-bent and determined to protect those "special bankers" who are you're friends and cronies, not to mention accomplices in creating this mess in the first place, The Bernanke Fed has refused to demand full accountability to market prices on these assets. This is no surprise - but it is also no surprise that with a constrained credit system consumer credit card rates are up dramatically, in many cases to 30% or more and banks are charging upwards of $10 billion a quarter in fees - most of them junk fees such as manufactured NSF charges and similar abuses in a mad dash to cover the cash-flow shortages that are impacting on these so-called "assets" that have gone septic and are poisoning the firm.
There will be no durable economic recovery until this problem is addressed, and that can only happen when those bad assets are marked to the market, their deficiency is recognized and they are able to trade freely at a true market price - a combination of recovery value (if any!) against defaults and ongoing cash flow. That's the definition of a market price, yet you, along with the banks, have continually done your damndest to avoid this discovery, starting with the "Super-SIV" proposal in the fall of 2007 and continuing to the present day.
Although we have avoided the worst, difficult challenges still lie ahead. We must work together to build on the gains already made to secure a sustained economic recovery, as well as to build a new financial regulatory framework that will reflect the lessons of this crisis and prevent a recurrence of the events of the past two years. I hope and expect that, when we meet here a year from now, we will be able to claim substantial progress toward both those objectives.
We could start by locking up everyone involved in creating this mess Ben - including you.
Where We Are, Where We're Heading (2013) - The annual 2013 Ticker
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