Bernanke's First and Last Term

I've been having an ongoing discussion with a longtime friend (former classmate and colleague) who is an editor of a very well known financial services publication.

My view: Bernanke and the Fed are way behind curve on the economy, and their actions on Dec 11 have led to significant market confusion. The Fed should have lowered the discount rate by 50 basis points yesterday. My friend's view: the Fed is correct, (as they Fed had built up a lot of respect in the past with correct actions and moves), and they can lower the discount rate by 75 basis points in January - making the end point the same.

This morning, the Fed announced that they have been involved in the largest worldwide coordinated response to the worldwide liquidity fear since Sept 11, 2001. The Central banks of England, Canada and Switzerland will essentially work together to ensure that banks have the capital necessary to provide the credit markets with liquidity.

Unfortunately, the Fed completely bungled this announcement and have taken on the appearance of rank amateurs in doing so. As a result, the market has completely lost respect for this group of academics, and the chorus has already began: Bernanke needs to resign.

Yesterday, the Fed missed on three counts to "get ahead of the curve", and each miss was more significant tha the previous. Instead of lowering the discount rate by 50 basis points, they lowered it by 25 basis points. Strike one.

Last August, the Fed surprised the market with a 50 basis point reduction in the Fed funds rate. Many commentators have suggested that current conditions in the credit markets are as bad, if not worse, than conditions were last August. Therefore, the market was expecting another 50 basis point reduction in the Fed funds rate today. Nope - we got 25 basis points.

Strike two. The statement pointed to a concern about rising inflation rather than a faltering economy on the knife's edge of slipping towards a recession. This was the most grievous mistake. Strike three.

So the markets (the Dow) immediately begin a death spiral selloff, and was down by 300 points by the end of the day. Within the first 30 minutes, the financial sectors stocks and housing sector stocks began the plunge. Most interestingly, key tech stocks held up very well in those first thirty minutes. However, within an hour, the tech stocks which had been performing extremely well all year (due to their superior results and execution), began to mirror the slide down, and most were 3%-5% lower by the end of the session. Obviously, as a fund manager, if one side of the portfolio is experiencing a massive slide, you need to begin selling your winners to raise cash, so you sell the most liquid names first.

I guess the worst part of the day was a "Breaking news" announcement from Steve Liesman of CNBC, who came on the air to announce that a confidential source at the Fed had contacted him to say that "the Fed can do more, and an announcement was coming soon."

Huh?

After spending several weeks of trying to wean the markets off of "automatic" rate cuts, and saying that the Fed will react to market conditions as market conditions warrant, the Fed was reacting to the tantrum being thrown by a child (the market).

So what happened this morning?. The coordinated effort announcement. The markets initially took this as good news since it was obvious that they had been working on this coordinated effort for some time. However, as the day progressed questions about this action began to emerge, and the markets began another downward move. The most significant questions related to the execution of the announcement: first a confidential phone call to Steve Liesman at CNBC in an effort to calm the markets, and then the announcement the next morning after the other central banks had been properly and officially consulted about the public announcement. Second, while the announcement focused on easing the ongoing seizure in credit markets, it said nothing about the greater fear of an upcoming recession. And the selling began.

By the end of the day, I heard that Dennis Gartman was openly calling for the resignation of Bernanke.

The market also came to the realization (though this happened almost immediately), that their execution is better characterized as amateur hour – you know, like Sangia (on American Idol). He started out sounding great, but then hit some major flat notes – and then was mocked by everyone.

They cut interest rates – but oh yeah – they left off some key comments about risks increasing on the economy – and they left off the comment about working on a worldwide solution (they didn’t have to provide specifics, just say something else is in the works).
They gave themselves a big black eye this week, and it will take quite some time to heal, and regain the respect of the market. At this point, it looks very bleak, and the market has completely lost respect for these guys.

Conviction about a solution will help with market psychology, but it appears that the Fed is contributing to a recession by being wishy washy and incompetent about the execution.

My friend at the financial publication shared a comment sent to him by a longtime client.

"I think (your publication) assumes that the Fed will get it right. With this regime, I would not make that assumption.

I think that a Fed Chairman with his academic background and all his personal money invested in TIAA CREF (like a paint by number book for investors) is not likely make good practical decisions under this level of stress. And his team seems likewise confused.
The most dangerous day in (Canadian) hospital's intensive care unit is July 1 - (the Canada Day holiday). That is when they turn the newly graduated doctors loose to treat patients independently. The patients are gravely ill and the new doctors are gravely inexperienced. The results are largely predictable.

My bet - the Fed is missing a major turn. This is the first time I think you might be wrong -your line of reasoning is logical as the Fed has never been so incompetent and they have your implicit respect.

I hope you are right that things will turn out fine. They will, but I think not soon. I believe I see a new intern in my ICU and it is Canada Day".

Bottom Line: Led Zepplin is currently on a "comeback" tour. They lead off with the Fed's new theme song: “Dazed and Confused”. Now we have to worry about Fed figures out whether the second song is “Stairway to Recession.” – or was it Heaven?