Samuelson Flunked Bernanke

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

The forecasting proficiency of central bankers is a topical issue. At least, a friend asked if I could help with a list of Federal Reserve Chairman Ben S. Bernanke’s predictions. The list stops in 2008, although he has been no more accurate since then. I sent the list to a few others. To those lucky recipients, I attached Paul Samuelson’s opinion of Ben S. Bernanke. It is the response (below) of one correspondent to Samuelson’s statement that is most telling.

Bernanke has been a Federal Reserve governor since 2002. He was named Chairman in early 2006. He served as chairman of the president’s Council of Economic Advisors from June 2005 until early 2006.

Here we go:

"[T]he recent capital inflow [has shown up in] higher home prices. Higher home prices in turn have encouraged households to increase their consumption. Of course, increased rates of homeownership and household consumption are both good things."

-March 10, 2005

"[I]ncreases in home values, together with a stock-market recovery that began in 2003, have [aided]…[t]he expansion of U.S. housing wealth, much of it easily accessible to households through cash-out refinancing and home-equity lines of credit."

-March 10, 2005

Interviewer: Ben, there’s been a lot of talk about a housing bubble, particularly, you know, from all sorts of places. Can you give us your view as to whether or not there is a housing bubble out there? What is the worst-case scenario if in fact we were to see prices come down substantially across the country?

Bernanke: Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.

-Interview on CNBC, July 1, 2005

"The housing market has been very strong for the past few years…. It seems to be the case, there are some straws in the wind, that housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise but not at the pace that they had been rising. So we expect the housing market to cool but not to change very sharply."

-February 15, 2006

"In 1994, fewer than 5 percent of mortgage originations were in the subprime market, but by 2005 about 20 percent of new mortgage loans were subprime….[T]he expansion of subprime lending has contributed importantly to the substantial increase in the overall use of mortgage credit. From 1995 to 2004, the share of households with mortgage debt increased 17 percent, and in the lowest income quintile, the share of households with mortgage debt rose 53 percent."

-November 1, 2006. In case you are wondering if Simple Ben approved or disapproved of this development, the title of his speech says it all: "Community Development Financial Institutions: Promoting Economic Growth and Opportunity"

"[O]ur banks are well capitalized and willing to lend."

-June 5, 2006

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Some views on derivatives:

Senate Banking Committee Chairman Paul Sarbanes: Warren Buffett has warned us that derivatives are time bombs, both for the parties that deal in them and the economic system. The Financial Times has said so far, there has been no explosion, but the risks of this fast-growing market remain real. How do you respond to these concerns?

Bernanke: I am more sanguine about derivatives than the position you have just suggested. I think, generally speaking, they are very valuable. They provide methods by which risks can be shared, sliced and diced, and given to those most willing to bear them. They add, I believe, to the flexibility of the financial system in many different ways. With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly. The Federal Reserve’s responsibility is to make sure that the institutions it regulates have good systems and good procedures for ensuring that their derivatives portfolios are well managed and do not create excessive risk in their institutions.

-November 15, 2005

"To an important degree, banks can be more active in their management of credit risks and other portfolio risks because of the increased availability of financial instruments and activities such as loan syndications, loan trading, credit derivatives, and securitization."

-June 12, 2006

"[M]any large banking organizations are sophisticated participants in financial markets, including the markets for derivatives and securitized assets. In monitoring and analyzing the activities of these banks, the Fed obtains valuable information about trends and current developments in these markets. Together with the knowledge obtained through its monetary-policy and payments activities, information gained through its supervisory activities gives the Fed an exceptionally broad and deep understanding of developments in financial markets and financial institutions."

[Chairman Bernanke testified before the Financial Crisis Inquiry Commission on November 17, 2009.This was at the beginning of the FCIC’s investigation. Bernanke offered suggestions of what he thought the FCIC should investigate. Among Bernanke’s comments: "I’m a little concerned still about systemic risk that comes from financial products or financial markets that aren’t adequately seen or understood by a banking supervision kind of institutional approach. And I wish you’d comment on that. I mean, nobody really, totally saw the problems with securitization or OTC derivatives."]

"If you have two investment banks doing an over-the-counter derivatives transaction, presumably they both are well-informed and they can inform that transaction without necessarily any government intervention."

-February 27, 2008

"Since September 2005, the Federal Reserve Bank of New York [led by New York Federal Reserve President Timothy Geithner – FJS] has been leading a major joint initiative by both the public and private sectors to improve arrangements for clearing and settling credit default swaps and other OTC derivatives…. I don’t think the system is broken, but it does need some improvement in execution."

-July 10, 2008

[ November 17, 2009, before the FCIC: "So I guess my own view is that if the system had been adequately stable, had strong enough supervision, et cetera et cetera, it could have dealt with this problem or other problems without collapsing." Note: "This" problem: if the crisis was due, which Simple Ben did not concede, to Federal Reserve policy.]

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"At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained"

-March 28, 2007

"While rising delinquencies and foreclosures will continue to weigh heavily on the housing market this year, it will not cripple the U.S."

-May 17, 2007

"We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."

-May 17, 2007

"We have not seen major spillovers from housing onto other sectors of the economy."

-June 21, 2007

"For the most part, financial markets have remained supportive of economic growth. However, conditions in the subprime mortgage sector have deteriorated significantly."

-July 18, 2007

The "expected impact from weaker housing… may flare in the future, today" – in the words of Ben Bernanke – "it is contained."

-July 18, 2007

"Bernanke said [subprime mortgages] were ‘market innovations’ and ‘sometimes there are bumps’ in the new-product road. ‘We’ll see how this works out."

-July 18, 2007

"I’d like to know what those damn things are worth," [CDOs – FJS] Mr. Bernanke said. Until investors "are confident in their evaluations, they are not going to be willing to fund these vehicle."

-October 15, 2007

"It is not the responsibility of the Federal Reserve – nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions."

-October 15th, 2007

"I expect there will be some failures. I don’t anticipate any serious problems of that sort among the large internationally active banks that make up a very substantial part of our banking system."

-February 27th, 2008

"Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."

-June 9th, 2008

[Freddie and Fannie] "…will make it through the storm", "… in no danger of failing","…adequately capitalized."

-July 16th, 2008

[This is the] "most severe financial crisis" in the post-World War II era. Investment banks are seeing "tremendous runs on their cash…. Without action, they will fail soon."

-September 19th, 2008

November 17, 2009 before the FCIC:

MR. BERNANKE: "But I think not withstanding the claims of one or two people out there who are now sort of living on the fact that they – quote – anticipated the crisis [A little jealous, Ben? – FJS], I would still say that the intersection of these things, the "perfect storm" aspect was so complicated and large, that I was certainly not aware, for what it’s worth – and it could just be my deficiency – but I was not aware of anybody who had any kind of comprehensive warning. There are people identified – and the trouble is and particularly in this blogosphere we live in now – at any given moment, there are people identifying 19 different problems, crises."

VICE CHAIRMAN THOMAS "And some of them may be right at some point."

NOTE: It was at this point that Captain Queeg, when testifying in court, grabbed for his steel balls.

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COMMISONER THOMPSON: "So no calamity of this magnitude occurs without there being some early signals that something is going wrong. In the case of this calamity, what were the signals? Why did we -and had we acted on them, might we have averted the disaster?

MISTER BERNANKE: "Well, I don’t know, I have to think about that."

Note: Could not the FCIC have reached its conclusion at that moment? It interviewed a few hundred witnesses and wrote a 500-page summary, but was not the master cylinder identified? – FJS

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The Atlantic, June 17, 2009, Interview with Paul Samuelson – the man who established MIT as a magnet for economics. He wrote the best-selling economics textbook in history. The interview was conducted just before Samuelson died: "The 1980s trained macroeconomics – like… Ben Bernanke and so forth — became a very complacent group, very ill adapted to meet with a completely unpredictable and new situation, such as we’ve had…. I looked up Bernanke’s PhD thesis, which was on the Great Depression, and I realized that when you’re writing in the 1980s, and there’s a mindset that’s almost universal, you miss a lot of the nuances of what actually happened during the depression."

A reply, from a friend who knew Paul Samuelson:

"The biggest surprise here–and perhaps the most damning–is Paul Samuelson’s dismissive comments about Bernanke and his "…very complacent group, very ill adapted…. [that you] miss a lot of the nuances of what actually happened during the depression." That Samuelson, whom I knew when I was at MIT as generally a mild-mannered and kindly gentleman, should have checked Bernanke’s PhD thesis done in Samuelson’s department (for Stanley Fischer, governor of the Israeli Central Bank, but then an MIT Prof.) and then ended up stating such–for him–negative comments about Bernanke is extremely significant."

Frederick Sheehan writes a blog at www.aucontrarian.com