Saturday, July 19, 2008

Federal Reserve Chairman Ben Bernanke’s Monetary Policy Report to the Senate Banking Committee (Emerson Bluhm)

In his semi annual Monetary Policy Report to the Senate Banking Committee, Federal Reserve Chairman Ben Bernanke spoke about the current troubles in the economy, the future outlook and the FED’s plans to help the economy return to health. With an average of 94,000 jobs lost per month over the last six months, unemployment at 5.5%, home prices falling, rising inflation, soaring commodity prices and trouble at Freddie Mac and Fannie Mae, Bernanke was less than optimistic about the economy over the next year, forecasting extremely slow growth. While he claimed that the U.S. is technically not in a recession by a textbook definition, he acknowledged the hardships many Americans are facing with extremely low consumer confidence, declining wealth, and rising food and energy costs.

According to the Chairman, the housing crisis and rising commodities prices are at the center of the current economic problems. Bernanke told the committee that he believes the Treasury Department’s plan to backstop the Government Sponsored Enterprises (GSEs), Freddie Mac and Fannie Mae, is a step in the right direction to help the housing sector regain his footing. Bernanke expects the housing sector to bottom out by the end of the year and explained that once this happens, he feels the rest of the economy will largely fall into place. As the economy recovers, he believes that the dollar will strengthen. He expects inflation to rise further in the near term but moderate in 2009 as international growth slows and the commodity market cools down but acknowledged that this outcome is highly uncertain. While slowing international growth could hurt U.S. exports that have been vital to U.S. growth, he claimed it would be a net positive if it could help lower commodity prices. Bernanke cited rising demand and a shortage of supply as the reasons for rising oil prices. Several senators asked about the role of speculators in oil prices, to which Bernanke replied that they have had no role in the increase in oil prices and defended their role in the marketplace. Proposals to regulate the futures markets would have no effect on the price of oil.

Treasury Secretary Henry Paulson spoke to the Senate Banking Committee as well, defending the administration’s rescue plan for the GSEs. With Fannie Mae and Freddie Mac now touching 70% of mortgages and representing the only secondary market for mortgages, Paulson and Bernanke both claimed it was essential to provide a capital backstop to these companies to ensure a recovery in the housing market. The rescue plan calls for an 18 month window where the Treasury has unlimited funds to provide liquidity through a line of credit as well as unlimited funds to buy stock in the two companies if they see a need to raise capital. The plan also calls for reform that will give the FED consultative authority to the GSEs in order to reduce systemic risk.

Several members of the Banking Committee expressed their displeasure with the idea of giving the Treasury Department a blank check from taxpayers, questioning why the current $2.25 Billion line of credit would not suffice. Mr. Paulson responded that this $2.25 Billion was set in 1971 when the GSEs had a market capitalization of only $1 Billion. He explained that this was not enough today as “markets have changed but the architecture has not” and told the committee that the authorization to use unlimited funds shows confidence to the market and makes it less likely that he will have to use them. If Congress wants all the funds to be used, they “can make it small enough and it will be a self-fulfilling prophecy”, claimed Paulson who also likened the funds to a bazooka in the Treasury’s pocket. With the entire world watching the current economic situation in the U.S. very closely, Paulson urged a quick passage of the proposals to help restore confidence.

Securities Exchange Commission Chairman Christopher Cox faced many questions from the Committee about their role in enforcing and investigating claims of manipulation in the marketplace. With encouragement from many members of the committee, Cox also explained the SEC’s recent emergency decision to curb naked short selling in the equities of several financial firms. Concerned that short sales may be pushing the financial sector down too far, Cox said the SEC would move to immediately put an end to naked short selling in the GSEs and 17 financial firms for the next 30 days. The SEC is also considering extending this to the entire market. Cox also updated the committee on the SEC’s investigations and prosecutions of investors spreading false rumors to drive down stock prices, charges that he claimed were the first of their kind. He also described a desire to increase regulation of credit rating agencies and require more disclosure of off balance sheet items.

July 15, 2008. Emerson Bluhm.