Wikinvest Wire

On the trail of the real root cause

Tuesday, October 14, 2008

Having long thought that Fed Chairman Ben Bernanke is an exceptionally bright fellow and an excellent writer (if not the best economic forecaster, as seems to be the rule rather than the exception - perhaps even a prerequisite - for someone to have risen so far in his field), his choice of words in today's Wall Street Journal op-ed piece regarding the "root" of the current financial crisis is worthy of note.

The Fed Chief strikes much closer than most to the real root cause of the current problems in noting that it is "a loss of confidence by investors and the public" that has brought us to where we are today, requiring global interventions on a scale never before seen in history with a positive outcome that is still, by no means, assured.

While a huge improvement over the blather about "falling home prices" being at the head of the causal chain, after just a bit of contemplation, "loss of confidence" also seems to fall short of the mark.

Here it is:

We're Laying the Groundwork for Recovery
The necessary policy tools are in place.
By BEN S. BERNANKE

As Americans well know, the challenges we now face in the financial markets and in the economy are both extraordinarily complex and historic in scope. I firmly believe, however, that with the actions policy makers are announcing today, we will be able to meet those challenges.

Our strategy will continue to evolve and be refined, and we will adapt to new developments and the inevitable setbacks. But we will not stand down until we have achieved our goals of repairing and reforming our financial system, and thereby restoring prosperity to our economy.
...
As in all past crises, at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets. This has had cascading and unwelcome effects on credit availability for households and businesses, and on the value of savings. Under these circumstances, steps to restore confidence in our institutions and markets will go far toward resolving the current market stress. Our economy will not be able to function at its best unless and until financial market stability returns. The bold actions taken by the Congress, the Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation and other agencies, together with the normal recuperative powers of the financial markets, will lay the groundwork for financial and economic recovery.
...
I am not suggesting the way forward will be easy. But the tools are in place to respond effectively and with force. These tools will bolster the capital of our financial institutions, restore confidence in their debt, and offer increased access to funding for businesses. Their application, together with the underlying power and resilience of the American economy, will help to restore confidence to our financial system and place our economy back on a path to vigorous growth.
Presumably, if this loss of confidence in financial markets is justified - not just a frightful episode that will soon pass - by the growing understanding that the business model under which the system had previously operated was fundamentally flawed (i.e., that we can't all get rich through rising asset prices - at least not for a long enough time), then, perhaps this "loss of confidence" really isn't the root cause.

Stock prices go up and then when you think they can't go up anymore they go even higher and we all feel rich until they come crashing down.

After the last five or six years, the same can be said about real estate.

Why should investors and the public have any confidence in a financial system that has produced the vanishing wealth of the last decade?

It would have been better to have never been seduced by this wealth at all.

Loss of confidence is not the root cause here.

Loss of confidence is a very rational reaction to the growing realization that the financial system that has been in place for many, many years has fundamental flaws that are in dire need of remedy, a task that seems to get all too little attention as bigger and bigger checks are written in an attempt to preserve the status quo.

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20 comments:

just some guy said...

BB is basically running a confidence game called a Ponzi scheme and the American public are all the targets of the scheme.

From his perspective as a con man, the mark's loss of confidence is the worst thing that can happen.

You and I see it as a scam and so have never been taken in. We know the real problem is that there is no true value (like gold or silver) behind the empty promises of payment by Uncle Sam.

I shudder to think how this will end...

Anonymous said...

"not the best economic forecaster, as seems to be the rule rather than the exception - perhaps even a prerequisite - for someone to have risen so far in his field"

you got that right.

Mary Wallace said...

To my non-economist eye, I believe the root of the problem is:
1) the excessive lending to capital ratio these institutions have been allowed to pursue, unregulated, in the name of profits.
2) the casino style stock market investing. no one invests in GE because GE channels electricity and is a solid company, they invest in GE because its supposed to go up in the next 90 days because of some foreseen changes. Investing has become a guessing game looking to make short term profits.
3) Banks are not assets. Anything purchased in the stock market is not an asset. They are wisps in the wind. They are non-material, non-solid profit machines.
4) the small homeowners and minority homeowners are now being blamed for the huge ponzi scheme cooked up and ravaged by Wall Street gamers. Their share of the troubles we are in are miniscule compared to the problems of massively dangerous over leveraging and casino style shuffling of money products.

Our government would love to blame the little guy, but its the big guy with the guilt on his hands. Why does he still get to keep his huge compensation package and Hamptons estate while the little guy loses? No-income, no asset loans were approved by financial insitutions, who then doles out ungodly amounts of cash substitutes, mortgages.

Its a ponzi scheme

Nostradamus, apparently said...

The term 'bright' to indicate high intelligence is overused and not appropriate for Mr. Bernanke.

Part of being smart or bright is the ability to see trouble before it arrives.

Bernanke may be glib (and, after AG, anyone seems glib), but I dispute the notion that he's bright.

His apparent inability to see the housing troubles on the horizon simply cannot be ignored. Thousands of people with and without advanced finance degrees saw it coming.

The fact he apparently didn't see it coming makes him dull in my book. If, however, he saw it coming but chose to try to cover it up, then he's a liar.

Either way, he does not deserve to be in such a powerful position. The same can be said of his predecessor, A. Greenspan and most other so-called leaders today.

Bernanke and Greenspan were appointed and approved by the leaders we have elected. Thus, in the end, we have only ourselves to blame.

As long as we refuse to hear the truth, we'll get lies and those lies will hurt us.

Ron Paul was screaming bloody murder about all these issues and now, even after he's been proven correct, the masses are still trying to decide between McCain and Obama.

Clearly, there is no hope for the masses. If this hasn't opened their eyes, nothing will.

Nothing.

fresno dan said...

I agree with Nostradamus. I will also point out that Paulson isn't so brillent either. Ask yourself 1 question about our esteemed Treasury secretary: Did he know how Goldman sachs was making money when he ran the place???

DK said...

I think Tim meant "bright" in a kind of academic, intellectual, "I might be hopelessly naive about some things" kind of way........

Tim said...

That's exactly how I meant it DK! Maybe "bright" was the wrong word - how about "booksmart"?

dearieme said...

"the financial system that has been in place for many, many years has fundamental flaws...": I despair at the chumps who simply blame the lamentable W. That is to miss the point on a grand scale.

Greyhair said...

Tim,

I'm totally sympathetic with your position .... your reasoning as to the real root causes. I'm about your age and have lived long enough to watch the slide in values (pun intended) toward money. But my question is, what would you do now? We're in a mess NOW, how do we get out of it? Do we throw the baby out with the bathwater?

I don't think the powers that be have a real choice. Perhaps in the long run effective changes can be made more gradually (including the American public btw). Maybe they will, maybe they won't. If history is a guide they likely won't which guides my investment decisions.

But for the moment, make yourself king of the world. What would you do to get from "here" to your "there"?

Tim said...

Well, you can either heavily, heavily regulate a system like the one we have now (which is probably where we are headed), or you can start over.

Starting over with a currency based on something other than faith in the issuing government (e.g., a basket of commodities or precious metals) would be a good start. Then getting back to reasonable rates of creation for money and credit (e.g., in line with population growth rather than some multiple of it) would also be wise.

Naturally, drastic changes such as these only happen after we've had a much bigger collapse than the one we've just seen.

staghounds said...

The first thing I'd do is to try to make it clear that ANY bailout or inflationary credit scheme is a punishment for prudence and thrift. All they do is buy failure with the savings of the careful.

I'd stop engaging in "speculation with other people's money" by banks via the Federal Reserve system. There's no reason to subsidise ANYONE, but certainly not banks and certainly not to these incredible ratios.

Make the money sound and it will find its own level. Get government out of business, business out of government.

It's just occurred to me that this is generational. The money managers of today all started their careers after the collapse of Bretton Woods, didn't they? They can barely remember, as children, a time when money wasn't automatically debased 5% or so a year, can they? They think that 3% value loss (that's a third in a decade) is a GOAL.

But we as a population want to be ignorant, we want the pretty bad checks.

Oooh, look, racism! Britney Spears! The super bowl!

Greyhair said...

Tim, with all due respect. That is a very ideological answer.

My question is how do you get from here to there? If you were in charge, would you allow a collapse? Would you regulate? Some combination?

My point is that it's all kinds of easy for critics (i.e. Mish Shedlock) to say stuff when you're not the responsible party. But what if you are? How do you reconcile your ideology (the there you want to get to) with the current reality? I really haven't seen that issue dealt with. And for the vast majority of us with investments, this really is a key issue.

Tim said...

Well, I don't have detailed plan. As for collapse versus regulate, I think I'd side with Jim Rogers and just let them all fail, have a few very painful years, and then build it back up in a more sustainable fashion.

From an investment standpoint, it's much more important to be right about what they will do, not what they will not do. As I've long thought, and as demonstrated recently, there are no limits to the amount of money that will be summoned to (literally) "paper over" the fundamental problems.

Anonymous said...

Tim,

Absolutely agree with your view. In the simplest terms, the argument could be posed as follows. You and I have a great plan to solve world hunger that is 99% guaranteed to work. Do we have the right to co-opt greyhair's property without his consent in order to enact it?

Anonymous said...

sorry if miss spell every word, or appear 2 know half of u good ppl. but 1 thing is 4 sure is that after greenspan, 1 of the three marketers had congress get rid of the rules an regs i.e. checks an balances could any of u expect anything else but implosion? as history would tell u, da only way 2 rule ah country is 2 bankrupt it then buy it.

Nostradamus, apparently said...

Greyhair:

Tim gave you an answer but you apparently didn't like it.

The answer is to let the free market return (which means bankruptcy for weak companies and financial turmoil for quite a while) and a gradual return to a sound currency.

It won't be pretty but if you think there's some way out of this mess that is pretty, you're just fooling yourself. You can't have the kind of excess we've seen for the past 30 years and not pay for it eventually. The only question is whether you're willing to pay for it now and get it over with or delay it and pay even more later. 'Reversion to the mean' comes to mind.

You apparently think that's an ideological answer which, to me, it is not. It's simply realistic. (I don't hear either of the mainstream candidates espousing that view or anything even close to it. How is it ideological?)

Again, Ron Paul has laid this out for years. You don't need to ask Tim how to fix it. Just read up on Ron Paul. It baffles me that we look to the very people who caused the mess to clean it up rather than someone like Ron Paul who saw it coming and tried to stop it.

There is no perfect answer to this mess. But, don't let the perfect be the enemy of the good.

Greyhair said...

I never posted what "my position" is. And I'm well aware of Ron Paul's position (which frankly seems to me to be simply the other extreme of the current situation)

My point is that it's pretty darned easy to sit back in our easy chairs and speculate about what "should've" been done. It's quite another to be the responsible party making the decision in the moment that will affect millions. Somehow I think being in that position changes your pov a bit.

My pov is that some combination of regulation and free markets works best. This ratio has gotten severely out of balance since Reagan, and we need "revert to the mean" on that spectrum. Completely free markets based on a gold standard aren't without their booms/busts as well, and they're often more extreme. We'll never get it perfect because, well, we aren't.

Anonymous said...

@greyhair. Check your research on completely free markets. You'll find the freer the market, the more stable it is.

Nostradamus, apparently said...

Greyhair:

You say we'll never get it perfect because we're not perfect. This is the classic "the perfect is the enemy of the good" argument.

Obviously, we won't get it perfect if, by perfect, you mean we'll all live in a Garden of Eden. The best we can apparently hope for with free market captialism is a series of cycles. This is what Ron Paul and others of his ilk admit and accept and it's better than the alternatives such as we have today.

We live in America and we have the Constitution. As such, we should follow the Constitution and not chuck it every time we feel some pain. We can amend it if necessary.

We don't live in a socialistic or communistic system where dictators or central planners run things. At least we're not supposed to according to the Constitution.

It's silly to ask Tim, a blogger, to specify a detailed answer to the financial problems extant when you know full well that those answers exist in the form of Ron Paul.

Tim has mentioned Ron Paul in a positive manner several times and it's obvious Tim believes the lack of a sound money supply is part of the problem. I agree.

That's a great start, especially since none of our so-called leaders seem to agree.

And, I agree with a prior comment that history shows that the cycles are more stable in a free market than in the current hybrid mess we have today and that you propose.

Your hybrid approach is far less likely to succeed (as we now know since that's what we have) than a purist approach. Your approach relies on the goodness and wisdom of the regulators. I'm not interested in that.

I'll take the unbiased hand of the free market over your trust in humans! I also have the advantage of having the Constitution on my side of the argument which, I suggest, you do not.

Again, these arguments have all been made in detail by Ron Paul and his ilk. The web is replete with this information.

If you want specifics:
1) Stop borrowing
2) Stop foreign entanglements
3) Chuck the Fed
4) Return to the gold standard
5) Accept some pain
6) Vastly reduce the size of all governments
7) Vastly reduce the power of the federal government
8) Chuck the income tax

In a nutshell, you only need one rule:

1) Follow the Constitution

Sorry, it's not perfect...

Greyhair said...

Nos ....

I'll only address two of your points as you apparently still don't get mine.

I asked Tim, a blogger, his answer because he also runs an investment newsletter of which I subscribe. As such, he moves beyond a mere "blogger" and into an advisor role. Thus what he thinks is of greater import to me. I also would like to see more "solutions" than simply popping the popcorn and throwing darts. I stand by my comment that it's much easier to be a let-the-market-fail type pundit when YOU don't have to make the decision.

Secondly, you say you would trust "the markets" over human. Guess what. "The markets" ARE humans. And when left to individual devices we tend to indulge our darker sides. OTOH, when groups of people make decisions, hopefully at some distance from the issue, you're more likely to have a better outcome. One of our greatest recent problems is that those who make the decisions have too much at stake.

I totally agree with the title of Tim's blog. But Ron Paul represents the anti-Greenspan, if you will, and I'm not as sanguine as you that this is the magic answer. People a lot smarter than you and I have evolved this system. People who DID have to make the decisions with accountability. The pendulum will swing, and the net result will in the long run be good. If not, none of this discussion really matters anyway.

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