Bernanke's muddled message
The timing of Tuesday's rate cut adds to worries that the Fed chairman is too focused on soothing the stock market.
NEW YORK (Fortune) -- The stock market didn't crash Tuesday, but Ben Bernanke didn't win himself any fans, either.
The Federal Reserve chairman surprised Wall Street Tuesday morning by slashing short-term interest rates by three-quarters of a point, after stocks sold off sharply overseas for a second straight day. U.S. stocks had been set to fall as much as 5 percent. But after the rate cut, the decline was modest, with the Dow Jones Industrial Average and the S&P 500 each closing off around 1 percent.
So a stock market crisis was averted, at least for a day. But the victory came at the cost of another hit to Bernanke's crumbling credibility with economists and investors, who fear that Bernanke - by appearing to intervene at a moment of market distress - is tailoring his message to financial markets he cannot hope to control.
"The markets have to come to grips with reality," says Dean Baker, co-director of the Center for Economic and Policy Research in Washington, D.C. "I think it's right to cut rates," he adds, given the scope of U.S. economic distress, but Bernanke "can't try to prop the markets up."
Tuesday's surprise rate cut came after the worst two-day stock decline in Japan and Hong Kong for more than a decade, and just a week ahead of a scheduled meeting of the Fed's policy-making Federal Open Market Committee.
It's widely understood that Fed policy moves take six to nine months to have any effect on the real economy, says Jeffrey Miller, CEO of investment adviser NewArc Investments in Naperville, Ill. So the rate cuts will help businesses, but not till later in the year. For businesses, "the timing makes no difference in terms of weeks," Miller says.
So why not wait a week? The implications weren't lost on commentators. By acting now, the wags surmised, Bernanke was acting primarily to soothe the markets. Some observers charged that the central bank is bailing out Wall Street at the cost of ignoring its commitment to maintain full employment and fight inflation.
Of course, Bernanke has also been pilloried for being slow to cut rates. CNBC commentator Jim Cramer famously accused him this past summer of being asleep at the switch. No matter what Bernanke does, it seems, someone takes offense.
"This must be the worst job in the world," Miller says of the Fed chairmanship. Bernanke "is being held personally accountable for what is happening in the stock market."
The market's rumblings aside, Miller says an objective study of Bernanke's performance suggests much of the criticism is unfair. For instance, the Fed under Bernanke has been more proactive than under his predecessor Alan Greenspan, Miller says. He says the Fed began cutting rates in this cycle unusually early - when the economy still appeared to be growing at about a 3 percent clip.
Indeed, Miller says that while there is much talk that a U.S. recession is under way, the evidence is more equivocal. Fourth-quarter economic data ranging from jobs numbers to manufacturing surveys suggest growth of about 1.5 percent, he says - certainly below the economy's capacity, but far from a surefire recession indicator.
Bernanke's Fed has also shown a willingness to use unorthodox tactics to keep money flowing through the economy. Take the Fed's Dec. 12 announcement that it was using something called a term auction facility to encourage banks to lend to one another. At the time, the spreads between government bond rates and short-term market rates were at historically high levels, indicating banks were so panicked about possible losses on toxic mortgage securities that they were holding onto their cash rather than lending it out. But since then, spreads have narrowed, suggesting that the term auction facility worked much as Bernanke intended.
Miller says much of Wall Street's distrust of Bernanke stems from the Fed's decision to announce the term auction facility a day after its Dec. 11 scheduled policy decision, rather than laying out the two plans simultaneously. Traders who sold stocks at a loss on the day of the expected 25-basis-point rate cut were miffed to find the next day that they could have avoided some of those losses by holding on, Miller says. "That was badly handled," Miller says of the Fed's communications with the market.
At the same time, the term auction facility - which lets banks borrow from the central bank using a wide range of collateral, including loans that may be impaired - has Baker wondering about Bernanke's avowed interest in transparency. He says bank "secrecy" is part of the problem that investors here will have to confront before the financial industry's mess can be fixed.
"The lesson from the Japanese bubble is own up," Baker says, referring to Japanese banks' failure to promptly write off bad loans made in the country's stock-and-property bubble of the late 1980s. Here, he adds, the term auction facility is potentially delaying the important process of bringing bad loans out into the open. "It's not helping that banks ... can hide losses," he says.
Baker says Bernanke can't be blamed for the housing bubble, which was brewing earlier this decade back when Alan Greenspan was the Fed chief. But Baker says he doesn't understand why Bernanke, who took office in February 2006, failed to warn Americans about the size of the problem. Baker estimates that deflating the housing bubble stands to exact a toll of $4 trillion to $6 trillion on the economy - including perhaps $1 trillion worth of bad mortgage debt on the balance sheets of already stretched U.S. banks. Huge writedowns this month from the likes of Citi (C, Fortune 500) and Bank of America (BAC, Fortune 500) won't be the last, Baker says.