Ben Talks to the FT

Tomorrow is a big ‘at bat’ for our boy Ben Bernanke. He is in front of the Senate Banking Committee. I don’t underestimate these Senators. They are well aware of how quickly the economy has slowed in the past sixty days. They know how bad their home state unemployment and budget picture is.

Greenspan said we “Hit an invisible wall” on July 1st. The past three weeks of numbers show that the wall is anything but invisible. A third and fourth quarter slowdown is now baked in the cake. There is a legitimate question, “Do we face a “double dip?" Should that rare event happen, the fiscal picture would become very cloudy. If we don’t grow, we die.

While the Senators will show the Chairman all due respect I expect some fireworks. I don’t know if there is an approval rating for the Fed. If there were it would be at an all time low. Therefore it is in the best interests our legislators to do a bit of Ben bashing. It makes them look like they are doing something important for the folks back home.

The question that I think (hope) we will hear from the Senators is:

“Okay, we have a slowdown staring us in the face. What is the Fed going to do about that?”

It would be easy for Ben to duck the question by saying:

“The timing and choices regarding monetary policy will be made in deliberation with other Fed members and announced publicly at the time a decision is reached”. 

That would be a bullshit answer. Ben has been telling the press for weeks now what his options are and how his thinking is evolving on QE 2. Last week it was the Wall Street Journal. Jon Hilsenrath clearly was speaking to Bernanke and revealing his thinking. Today we have a big leap across the pond for Ben’s “covert” effort to leak the news of his plans. The FT had an article by Robin Harding. Fed Eyes Looser Monetary Policy. To me it was Ben talking and Robin writing. From the article:

The two simplest measures will be to (1) stop paying interest on bank reserves, encouraging banks to lend the money out instead, or to (2) start reinvesting capital repayments from the Fed’s portfolio of mortgage-backed securities.

I think the FT has quoted from Bernanke’s ‘short list’ of policy options. These would be modest initial steps toward a full-blown QE. These measures will not have a significant economic impact. They will be market friendly. Or at least that will be the intention.

As of July 15th the Fed had $1.13 trillion of Agency MBS in portfolio. That is down from the target of $1.25T. Therefore $121 billion of principal has been paid on the Fed holdings. It is a layup for the Fed to announce that it will re-enter the MBS market to top off its portfolio. This would be more a refinement of existing policy. At least that is how it will be framed. The brokers will love the extra 100b+ in business. It will not move mortgage spreads 5 tics.

The Fed is now paying ¼% on reserves. The theory is that moving the rate to zero would stimulate more lending. I guess that if a bank had some reserves and got zero return it would be forced to buy something like GE commercial paper. That would get those short date CP yields close to zero pretty quick. There is a balance sheet consideration to the banks however. I don’t think this change will make any difference at all. Goodbye to all small savers.

The FT also mentioned something that was new to me. The idea is to change the language the Fed uses. The current language is, “ZIRP for the foreseeable future”. This will be changed to read, “ZIRP until X is achieved”. “X” could be a number of things:

X= Unemployment less than 7%
X= Three consecutive quarters of GDP greater than 3%
X= Inflation greater than 3% YoY.
X= Dow 20,000
X= Bernanke re-grows hair

My point is that the X can be set such that no reasonable person would assume that it would happen at anytime over the next two or three years (or longer). So the real language would be, “ZIRP forever.”

Numbers 1&2 are acts of desperation that will accomplish little. And Ben knows that. A change in the language that results in a ZIRP forever policy will be the death of us. It will just take a few more years to figure that out.

If Bernanke can whisper to the likes of the WSJ and the FT he should be just as open with the Senators tomorrow. I think the American people should know what he has in store. They should not get that message through an interpreter.