The Last Word On Bernanke: FAIL

I have written two Tickers in recent days in which I put forward what I believe is a clear and convincing, if lengthy, case that Bernanke simply can’t be justified for re-confirmation – So Bernanke, You Want To Be Reconfirmed? and The Black Hats Strike Back.

But today, on the eve of Bernanke’s reconfirmation hearing in the Senate Banking Committee, I want to focus on one and only one thing – The Fed’s basic mandate:

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

Ok.

Let’s look at the performance.

We shall first look at the growth of GDP and credit aggregates:

Data is through the latest "Z1" statement showing credit aggregates.

This is The Fed’s performance of its mandate.  GDP growth is in green, credit aggregates in various shades of orange and red, and the debt-to-GDP ratio in light gray on the right scale.

You can see the problem.  "Credit Aggregates" have grown much faster than has GDP.  This is the definition of Ponzi Finance – that is, debt pyramiding or "credit leverage."

This is an intentional violation of The Fed’s lawful mandate to properly manage the growth of credit aggregates (that, by the way, is what they’re really doing – interest rates move in relationship to liqudiity, which governs the growth or contraction of credit aggregates.)  Why?  Because when credit expands faster than GDP over time, as has occurred here, you have an inherently unstable system that with mathematical certainty will eventually melt down.

In order for the debt to be serviced – debt that is growing much faster than GDP – it should be obvious that ever-lower interest rates are required.  When the interest rate "required" to prevent massive default rates from occurring reaches zero, as we have recently seen, The Fed is reduced to the raw printing of money.  This in turn debases the currency which forces risk premia higher – and thus causes real rates to rise (despite The Fed’s desire to hold them at zero.)  If The Fed refuses to allow the market’s demand for higher rates to occur then credit – that is, lending – from other than The Fed is simply cut off as the private credit markets will refuse to accept a below-market rate of interest.  Only through the force of government can that below-market rate be obtained.

This is the definition of a credit lock-up or "seizure."  It is not that there is no credit – it is that the demanded interest rate exceeds what the borrower can afford, because the aggregate debt in the system has reached or exceeded the ability of borrowers to service it.

This is in fact exactly what happened and is a mathematically-certain outcome of The Fed’s failure to discharge it’s mandate, most particularly since the 1980s.

Before someone shouts out that The Federal Government is the biggest cause (which Bernanke has little direct control over, if any control at all), you must look at this chart, which breaks down the components of debt represented above:

Note that the "pinkish" slice is the Federal Government debt, and that it has exploded in the last two years.  But most important to the question of Bernanke’s performance, it is not a huge portion of the whole.

No, the big problems are found in Household and Non-Profit credit and financial instruments, along with general non-financial business credit, all of which are under the direct supervisory control of The Federal Reserve through their interactions with the banks in both regulatory and liquidity management roles.

The credit bubble – the root cause of our problem – is not an abstract thing.  It was created through the willful mismanagement of Federal Reserve Policy during both Alan Greenspan and Ben Bernanke’s time in office.

That mismanagement is a willful and direct violation of Federal Law and must disqualify Ben Bernanke from a second term.

It is that mismanagement that made inevitable the economic pain we have and will suffer.  Attempting to provoke even more credit creation will simply lead to a bigger disaster.

While those in The Senate who lament tight credit among "Main Street" are correct, the solution is not to loosen credit there while leaving "Wall Street" with its extraordinarily-loose lending policies.  Rather, we must tighten Wall Street’s credit by more than we loosen Main Street’s, so the net aggregate credit outstanding contracts but is shifted to productive uses rather than financial engineering and speculation.  The Fed has utterly refused to do this and in fact has promoted and maintained policies that have done precisely the opposite.

Since the cited law has no "or else" embedded in it, despite the presence of the word "Shall", it is incumbent upon The Senate to refuse reconfirmation, as that appears to be the only enforcement mechanism available.

Should The Senate fail to do so we may as well rip up The Federal Reserve Act as currently extant, as it is in fact a legal nullity.