Bernanke: Don't take me for granted, boys

By Julian Delasantellis

For this Halloween, it seems that US Federal Reserve chairman Ben Bernanke chose to dress up as Betty "Riz" Rizzo, the young social outcast in the 1978 film Grease.

Riz sings a song of remorse, expressing outward pride but inner shame over being the girl the 1950s boys know they can go to when they want an assured good time:

There are worse things I could do,
Than go with a boy or two.
Even though the neighborhood thinks I'm trashy,
And no good,
I suppose it could be true,
But there are worse things I could do.

I could flirt with all the guys,
Smile at them and bat my eyes.
Press against them when we dance,
Make them think they stand a chance,
Then refuse to see it through.
That's a thing I'd never do.

Picture Bernanke, with signature form-fitting black pedal pusher pants, teased hair, hot pink lipstick, and a tight, "Pink Ladies" girl gang leather jacket, going trick or treating at Wednesday's Federal Open Market Committee meeting, singing a song of his own individual professional conflict between values and popularity:

There are worse things I could do
Than lower an interest rate or two ...

For the third time in the last 75 days, the US Federal Reserve has made a major move to lower interest rates in order to attempt to revive a US economy whose future prospects are looking ever bleaker with each successive economic report.

This move involved a cut of 0.25%, or 25 basis points in money market lingo, in the Federal Funds target rate, to 4.50%; there was also an accompanying 25 basis point cut in the Federal Reserve Discount rate, the interest rate the Fed charges member banks who must borrow from it due to the fact that they have been denied funding at reasonable rates from the private, commercial money markets.

In total, since this current easing rate cycle began on August 17, the discount rate has now been cut a total of 125 basis points, and the Federal Funds rate by 75. US Federal Reserve rate moves usually come in successive series, called cycles, in the same direction, that can last many months or years. There is every indication that due to economic weakness arising from a crippled housing sector, the US is now in the early stages of a new rate cutting cycle, one that we will not see the end of until at least early 2009, perhaps even beyond that.

Unlike the previous Fed move on September 18, when the markets were surprised with stronger than expected twin 50-point cuts of both the Fed Funds target rate and the discount rate, this move was pretty well expected and discounted by the markets prior to the meeting.

In the recent past, during the Alan Greenspan Federal Reserve era, having a predictable Fed was seen as a positive value, something that America's central bank should strive for. There are indications that this policy objective - predictability, or, in market lingo, transparency - is losing favor as a core Fed institutional virtue, and that puts us in the international community of Federal Reserve watchers; indeed, it puts the entire financial world in a wholly new situation.

In an article posted on the Financial Times website, "Fed concern at expectation of rate cut", on October 28, Krishna Guna reported that being a bit too loose with the boys in the financial markets was emerging as a major policy concern with the Bernanke Fed board.

"According to anecdotal reports, there is some resistance among Fed insiders to the notion of a guaranteed rate cut. Many would have preferred to go into the meeting with market odds more evenly balanced, which would give the central bank greater latitude to make its determination without risking market turmoil."

Since at least the opening years of the Alan Greenspan Fed in the early 1990s, the results of the regularly scheduled Federal Reserve meetings have rarely been much of a surprise. Invariably, a few days before the meeting, you'd see stories in the financial media about "Fed insiders" or "highly placed Fed sources" in essence telling the world what the outcome of the meeting would be.

The "Fed insiders" and "highly placed Fed sources" were, of course, Fed officials close to Greenspan; these stories were, in a Washington tradition that probably predates Pierre L'Enfant's arrival in the city to design it, leaks. The leakers did not have to, like Bob Woodward's Watergate era "Deep Throat", meet the reporter in the wee hours in an empty car park; since Greenspan obviously fully approved the procedure, the source probably got some good whiskey and a steak dinner for this valued service to the Fifth Estate.

Greenspan endorsed this dance of the seven Fed veils because he believed that unpredictability carried a cost to the general economy. Unpredictable and unexpected Federal Reserve moves were invariably followed by large concomitant movements in the financial markets. If you are a participant in the markets, whether it be a buyer or seller of stocks, bonds or commodities, your life is made infinitely more complex if you have to provide and plan for regularly expected potential 3-5% moves, in either direction, in your market, rather than more sedate 1% moves.

You can go into the options markets and take out "insurance", buying puts and calls, against extreme market moves, but that costs money, costs that rise along with the projected near-term volatility of the markets. Greenspan believed that the corporate funds utilized to guard - "hedge" - against excess volatility could be better spent on more productive capital investments like plant and equipment.

But as this operational paradigm became a finely honed tradition, an inherent contradiction in the process emerged.

If the markets know, and factor into securities prices, what the



results of a Fed meeting will be prior to the actual meeting, does that mean, in effect, that when the full Federal Reserve Open Markets Committee members gather on meeting day, they will feel that their hands are tied, that they can't act in such a way other than the market expects, for fear of provoking a severe selloff?

Is the tail wagging the dog here? More importantly, in this case, who's the dog and who's the tail?

The Greenspan Fed felt that this was a cost worth incurring, in order to avoid the greater costs of unpredictability. Thus, an entire industry of Fed watchers developed, like Cold War Kremlinologists, in order to read the monetary policy tea leaves, to ascertain the direction and quantity of upcoming Federal Reserve moves so as to profitably position trades in advance of the actual announced decisions.

The Chicago Board of Trade futures exchange actually initiated a commodities futures contract, Federal Funds futures, so that commercial hedgers and punters alike could seek to profit from how the Fed would act.

The Greenspan Fed, and in its early months the Bernanke Fed, never disappointed the markets. Thus, if it is seen that the Fed always follows the markets' lead, then, in essence, it is as if the markets are controlling the Fed, not the other way around. (I wrote about this perception in my September 18 piece, A rate cut with a shoeshine and a smile.)

Bernanke apparently wants to change how the cards in this game are dealt. He surprised the markets with his double-barreled rate cut on September 18, and he found a way to surprise the markets on Wednesday.

The markets did get the dual twenty five basis point rate cuts they had expected, but it was in the post-meeting statement, the booming voice of the monetary gods thundering down from the Olympian heights of their headquarters in Marriner Eccles Hall in Washington, where it can be seen that Bernanke might be trying to make himself a little bit of a mystery to the boys in the markets.

The September post-meeting statement gave the markets every indication, every reason to believe, that there would also be seen a cut at the October meeting, the cut we actually did see on Wednesday.

"Developments in financial markets since the Committee's last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth," the Fed said in September.

But after Wednesday's meeting, it seems that Bernanke batted his eyes, flirtatiously telling the boys that in the future, maybe yes, maybe no.

"Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth."

At first, the markets were puzzled by this coquettish new Fed. The Dow Jones Industrial Average was up over 100 points before the announcement, it quickly dropped to be down 20 points after the market got a chance to read the statement, rallied back to close up 134; for now, at least, the market agrees with Hamlet's mother that "The lady doth protest too much."

This leaves the markets, and the economy, in an entirely new place. The worldwide Fed analysis community is certainly not going to pack up and go away. If the Fed is now placing an equal or greater value on unpredictability over transparency, in order to retrieve the policy initiative it feels it imprudently ceded to the markets, will it then take this thinking to its logical conclusion and someday fail to act in such a way that the economy needs, just so that it can surprise the markets?

It is entirely possible, and widely expected in the markets, that the current subprime mortgage mess will spread and intensify, festering across at least the entire housing and financial sectors. If pride holds Bernanke's hand from cutting rates and providing liquidity when he should, just because the markets called it first, the markets will look on this situation very negatively. A lot of wealth could be destroyed in the markets very, very quickly.

It's not as if pride has never ruled over policy in Washington. Veteran journalist Bill Moyers tells a story that, when he was working as president Lyndon Johnson's press secretary in the 1960s, word came down that LBJ was planning to fire cantankerous, obstreperous FBI Director J Edgar Hoover.

As he thought Johnson wanted, Moyers spread the word to the press; when the story came out before Johnson got a chance to make the official announcement, out of pique, he reversed his decision and reappointed Hoover to another term, where he stayed until his death in 1972.

Maybe we in the markets are taking Bernanke for granted. We should not be treating him like a cheap pickup in a singles bar. We should call him the next day. We should send flowers. Maybe we need take the entire Fed board out to breakfast the day after.

Dr Bernanke, did you just want to be held?

Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at juliandelasantellis@yahoo.com.

(Copyright 2007 Asia Times Online Ltd. All rights reserved.)