Ben Bernanke: Hero or Goat

Morris Segall      Ben Bernanke, business landscape, Capital Markets, credit crisis, economics, economy, government, obama, treasury, trends, unemployment

Ben Bernanke appears to be fighting for his life before Congress where several members from both major parties and one of the independents in the Senate are rejecting his reappointment as Chairman of the Federal Reserve Board for a second four year term.  The opponents of his reappointment blame Mr. Bernanke for aiding and abetting the excesses in the financial system that resulted in its meltdown and taxpayer bailouts of many of its institutions. In their zeal to lash out at the stewards of fiscal and monetary policy during the financial crisis of the past two years, the critics of Ben Bernanke fail to include one of the most culpable parties to the worst financial crisis since the Great Depression and that is Congress itself. From the enactment of the Bank Holding Company Act in 1956 and its subsequent amendments which allowed banks to buy non bank financial entities outside of the supervision of the Federal Reserve System, to the repeal of the Glass Steagall Act which had separated the commercial and non-commercial banking activities of banks in 1999, to the lax oversight of Fannie Mae and Freddie Mac, federally chartered institutions that were the backbone of mortgage securitizations and transactions which fed the lending bubble. For over 40 years the Congress has consistently enacted legislation that enabled banks and other lenders to engage in high risk activities OUTSIDE of the supervision of the Federal Reserve Board. So when the Fed complained that it was losing control of the financial system, Congress did nothing.

In our website article of December 7, 2007, “The Treasury Plan: Is This the Solution?“  we outlined our skepticism of the success of the Treasury plan of then Treasury Secretary, Henry Paulson, to effectively “dance around” the mortgage crisis by adjusting mortgage rates and terms in the hope of forestalling the inevitable losses from mortgage defaults. It was not until March, 2008 that the Federal Reserve forcefully attacked the loan loss problem by swapping Treasury paper for the problem debt held by mortgage lenders. The Fed subsequently expanded Discount Window facilities to both commercial and for the fist time, non-commercial banks like investment banks and brokerage firms so these firms could have liquidity. In fact in our ongoing economic presentations such as the ones  posted on our blog and website,  there is an entire section of slides and commentary entitled “The Government”s Response” to the severe credit crisis. It shows the leadership of the Fed in increasing the money supply, reducing interest rates and expanding its own balance sheet by purchasing the “toxic” assets of the banking system to provide it with liquidity necessary to keep the system afloat.  By most objective scutiny of the Federal Government’s handling of the credit crisis, including our own jaundiced view, if there is a hero in this debacle, it is Ben Bernanke who literally pulled out all the stops to keep the financial system in this country from totally collapsing, particularly after Henry Paulson triggered a system panic by allowing Lehman Bros. to fail. We may not have liked the bailouts of many of these instituions but as we have stated in prior commentaries, the country runs on credit and letting the banking system fail was just not an option.

If one wants to point a finger at the Fed for allowing the credit bubble to build, it needs to be pointed at Alan Greenspan who instead of musing on the illogical low level of interest rates in 2004-05 in the face of the real estate boom should have raised interest rates and loan reserve and capital requirements to slow the creation of credit. Upon succeeding Greenspan in January, 2006 Ben Bernanke’ s Fed started raising interest rates through the spring and into the summer of that year and held those higher rates until the recession began in late 2007.

We and other observers believe Ben Bernanke will be reappointed to another term after this current thrashing. He better be. A rejection of Ben Bernanke AND an ill advised replacing of the Federal Reserve as the nation’s principal regulator of monetary policy and the financial system, would create a loss of confidence in foreign bankers, creditors and traders and would depress our bond markets and exacerbate an already “free falling” U.S. dollar. The President needs to show leadership on this issue and strongly reaffirm his support for the reappointment of Ben Bernanke and not let Congress make him the “goat” of the recession. If Congress wants to assess blame for the financial mess, they should begin by looking in the mirror.

Morris R. Segall, CFA, CIC

Today’s Economic Landscape and What’s on the Other Side

Morris Segall      2009 economy, Capital Markets, economics, GDP, global, government, international, treasury, trends, unemployment

We recently updated our presentation on today’s economic landscape and what’s on the other side with some fresh data.  We hope you continue to find value in our slides:

FASB Waters Down Accounting For Impaired Assets; The Ultimate Bank Bailout

Morris Segall      FASB, Financial Accounting Standards Board, private equity, securitized asset, TALF, treasury

After months of debate about suspending the cardinal principle in accounting regarding reflecting asset value impairment in both the balance sheets and income statements of public financial statements, the Financial Accounting Standards Board (FASB) ignominiously and even in a measure of surprise, voted at its April 2nd Board Meeting to suspend the strict application of “mark to market” accounting for banks. The financial news media has reported on the story since last Thursday with almost universal condemnation and criticism. We wanted to see the text of the FASB’s statement to see exactly what the rule changes were going to be.

Unfortunately, the text of the pronouncement, FSP FAS 157-e, confirms many fears and criticisms of financial analysts, the accounting profession, investors, lenders, portfolio managers, creditors and the lay public. That is the FASB was “buying into” the argument that the illiquid, value impaired securities backing the personal and real estate assets the banks had previously lent on were not really impaired because the asset impairment was due to an illiquidity in the market for such securities which artificially had depressed prices for these securities. The position of the banking industry is that  in reality these securities were  going to be held until maturity so as long as principal and interest were current, hence there was no need to reduce the holding value of these securities to what they believe are distressed market conditions. The pronouncement contrasts forced liquidation valuations from orderly transaction valuations and allows discretion on the parts of managements, with the blessings of their auditors, to ascertain whether the security value impairment is temporary due to distressed market conditions and to declare whether management intends to hold the securities to maturity and not sell them before “recovery of its cost basis”. It further allows holders of these securities to recognize the permanent credit loss component of a security in earnings BUT the temporary impairment of a debt security in “other comprehensive income”. That account is not defined.

So, in what appears to be a total cave from pressure by Congress and the banking industy, the steward of hard accounting principles and standards which govern the integrity of financial statements, has given the banking industry what the U.S Treasury Dept., the Federal Reserve Board, the SEC and the world financial marketplace couldn’t do. It is allowing them to ignore the impact of current market forces on the net realizable values of major classes of assets and concomitantly, the net book value of its capital accounts. Reporters and commentators are now suggesting this shift in accounting treatment of impaired collaterized debt securities will not only abate further bank losses, it will allow banks to actually “write up” valuations on previously written down securities and could actually result in bank profit growth in the first or second quarters of this year. This from a governing board of a profession that some years ago prided itself on the credo. “Anticipate no profit; provide for all possible losses”. This was when auditors and CPA’s were the acknowledged protectors of fair, independent and honest accounting treatment of financial transactions and valuations. Not only does Thursday’s pronouncement liberalize accounting treatment for financial companies, it gives a “pass” to the company’s auditors to approve it without being accused of false and misleading financial statements, the basis of all security class action lawsuits.

In our blog piece of March 5, 2009, “Is There A Plan Here?”, we outlined specific measures we believed actionable that would be effective in stemming the recession and providing an “arms length” and long term solution in cleansing the banks’ balance sheets via a “bad debt bank”. This argument also articulated in our website comment, “The Treasury Plan”, December 7, 2007, recognized the underlying philosophy and theory behind securitized assets. First, these securities were CREATED by the investment and commercial banking industries to provide liquidity behind the funding of hard assets. They were created to be traded. Trading desks were created to buy and sell them at negotiated prices. Asset indices were created to track price and performance. The securitized portfolios were leveraged with derivatives and credit default swap instruments, also traded in negotiated markets. The volume of these primary and attendant instruments exploded into the hundreds of trillions of dollars and were marketed around the world over the past two decades and in particular in the frenzied real estate and consumer spending expansion of the last decade. To now decide or even allow to be decided that these securities were going to be held to maturity flies in the face of financial reality. If these securities were going to be held to maturity they would have been valued similar to private equity or venture capital investments where there is no public market and investors know they are holding an illiquid investment that is not marked to market but whose valuation is determined annually by independent appraisal. Following this theory further, there would have been no reason to mark these securities to market. The banking losses would have been avoided and the Government’s TALF program to purchase these eroded securities from the banks would not have been necessary.

The action of the FASB is an expedient one and is another in a series of public moves to short circuit this recession by avoiding the real and painful long term solutions to sounder finances and more transparency in financial transactions and accounting. The downside of this action will be an increase in distrust of the system, banking and accounting and will lead to fewer high risk transactions in the future. Who will be able to accurately ascertain what these man made paper assets are really worth if we don’t let market forces be that ultimate arbiter?  Ironically, the action of the FASB may hurt the Treasury’s TALF program if investors believe the prices they will have to pay to purchase these assets are arbitrarily too high. Clearly, investors will be skeptical of an individual bank’s asset valuations and net worth and financial analysts and lenders will be uncertain as to the real value of these bank’s investment and creditworthy values. Our response to investors is to “play” the ultimate recovery in financial stocks by utilizing sector ETFs and index funds. That is a sector bet and there is safety in numbers.

Morris R. Segall, CFA, CIC

In the Global Fight Against Recession, Is the U.S. a Party of One?

Morris Segall      bailout, banking system, economy, government, The new Fed actions, their implications and political fallout, treasury

Today the Federal Open Market Committee voted to increase the stimulus to the credit markets by keeping the Fed Funds rate in a 0%-.25% target range. In addition they voted to have the Fed purchase:

• Up to $300 billion of long-term Treasury securities
• Another $100 billion of U.S. Government Agency debt making a total of $200 billion
• An additional $750 billion of mortgage backed securities making a total of $1.25 trillion

In addition the Open Market Committee voted to launch the Treasury’s TALF program to purchase consumer and business asset backed securities. This program will start at $200 billion but could expand to a $1 trillion.

The Fed’s actions are based on what the Open Market Committee states are continued recessionary pressures in the U.S. economy. With today’s actions, the balance sheet of the Federal Reserve is estimated to have expanded to approximately $3 trillion. This compares to assets of less than $1 trillion six months ago. It would seem the Fed is throwing in the towel on a recession bottom in 2009.

This compares to Chairman Ben Bernanke’s testimony on February 14th before the U.S. Senate Banking Committee in which he forecast an end to the recession by the end of this year. Clearly there is some disconnect between the Fed’s current actions and the Federal Reserve Chairman’s outlook.

Indeed, the most recent economic data released this month and recent corporate announcements from several large banks indicate there is some hope the pace of economic and earnings contraction may be slowing. We have communicated to our clients and audiences that we felt the worst of the current recession would be felt in the first quarter of this year. If we and Chairman Bernanke are correct, today’s Fed actions are too much at the wrong time and will have negative consequences intermediate-longer term. We warned in our last blog posting, “Is There a Plan Here?” the increasing concern among international creditors about the future creditworthiness of the U.S. government given the outsized spending of the current bailout programs. It is noteworthy that the Chinese government just last week expressed misgivings about their large holdings of U.S. Treasury debt and further purchases going forward. Today’s massive new spending by the Fed will cause further alarm in international financial circles. While today’s announcement of Fed purchases of long term Treasuries suppressed interest rates on government debt and provided fresh fodder for further stock market gains, it is important to note today’s large decline in the value of the U.S. Dollar in currency future markets and the simultaneous large increase in the price of gold futures in commodity markets.

The Federal Open Market Committee is preoccupied with deflation as a result of the current recession. Yet the price of oil has moved to nearly $50 per barrel from approximately $35 per barrel a month ago. In addition the most recent reports on consumer prices for January and February show an annualized rate of inflation of 2.5% excluding food and fuel and inflation and rates much higher in key non discretionary spending categories. The recent rise in energy and service prices belie a chronic deflationary environment or outlook. The unbridled U.S. government and Federal Reserve spending on the multitude of stimulus and bailout programs has been rejected by our overseas trading and financial partners despite this government’s pleas for more foreign government stimulus spending. These governments are afraid of the inflationary bubbles and sovereign balance sheet erosions that will result from such unfettered spending. So the Treasury Dept. and the Fed plot their own course of uncapped spending as their answer to the current credit and economic dilemmas.

Speaking of dilemmas, President Obama is feeling the heat on what is clearly a botched bailout of AIG and an erosion of confidence amongst economists and politicians in Treasury Secretary Geithner. The public is angry and very stressed over the recession. The economy is President’s Obama’s and the Democratic Party’s problem now and the public wants to see results from the hodgepodge programs the government is implementing. The current scandals regarding executive bonuses and the perceived inadequacies of the Treasury leadership will in our opinion start to erode the President’s poll numbers adding a further difficulty to the current social and economic environment.

Morris R. Segall, CFA, CIC