November 23, 2011
Given the way the financial world is holding its collective breath, one might suppose Federal Reserve Chairman Ben Bernanke is cut from the same magical cloth as his predecessor, “Maestro” Alan Greenspan. In earlier times, every word that dropped from the lips of Chairman Greenspan was treated as though it came from the Delphi Oracle given his seemingly inexhaustible ability to fine tune a faltering economy. It was only after he left the central bank that markets realized just how misdirected his loose monetary policy actions were. While still denied by Mr. Bernanke (one of Greenspan’s confederates at the time), most analysts agree that excessive money growth, low interest rates, and a loose regulatory environment contributed to the housing crisis that caused the U.S. and world financial markets to nearly implode.
With the U.S. economy now entering a very slow-growth mode, everyone seems to be clamoring for a savior. Given the obvious failure of fiscal policy actions — not to mention the newfound desire to lower future deficit/debt obligations — the conduct of monetary policy seems to be the only policy game left in town. But could it be that monetary policy is just as failed as fiscal policy? In my opinion, the answer is an unqualified yes for a number of reasons.
Back in 2008 when the Fed started its money-easing campaign, Chairman Bernanke stated that it would revitalize the “real” economy, that is, the output and employment activities that all of us depend upon to provide us the jobs/income needed to prosper. This was done, at least in part, with the cooperation of the Treasury which was undertaking its Troubled Asset Relief Program (TARP). In essence, the Treasury would provide stability to shaky financial institutions by purchasing preferred stock to shore up their net worth positions and the Fed would follow up with a healthy dose of monetary stimulus by driving short interest rates to nearly zero, buy up a wad of their faltering mortgage-backed securities, and inject huge amounts of liquidity into financial markets. Such actions, we were assured, would not only save banks but also give financial institutions the ability to lend funds to those in the real economy (people and businesses) and thereby pull us back from the brink of economic disaster.
All-in-all a pleasant little outlook, but one which we now know was a little better than a perverse Grimm’s fairy tale. While it was certainly true that financial institutions were saved (at least temporarily), the real economy sank like a rock.
With economic growth now stalling out, financial markets are waiting for the next dose of monetary madness to cure our economic ails. But as events have unfolded over the past few years, it should to be abundantly clear that a Keynesian use of monetary policy (with low interest rates to stimulate borrowing and spending) is not working. Loan demands of both people and businesses are quite weak. Further, banks remain hesitant in many instances to provide loans given the uncertain economic outlook and the possibility of loan delinquencies/defaults rising. Just last week, for example, an increase in mortgage delinquencies was reported for the second quarter of this year.
What’s more, consider the possible impact of the Fed’s recently announced decision to keep short term interest rates near zero for the next two years and potentially start purchasing more long-term Treasuries, using returns from those mortgage backed securities they own. If the Fed engages in such actions, the spread between loan rates and the cost of funds banks pay to depositors (for both short and longer term balance sheet entries) will narrow and the ability to turn a decent profit on loans will dissipate.
Over time, stock prices will fall — in fact, banks represent one of the hardest hit sectors right now in terms of the plunge in stock prices — and banks will hit customers up for larger fees and penalties to make up some of the lost profits. As well, banks will be forced to lower expenses to prop up profitability, which is now translating into lowering their employment levels and shuttering some facilities.
This further erodes the livelihoods of people and makes it even more unlikely that the real economy will prosper. As a result, even the Fed’s goal of stabilizing the financial sector is at risk, with the probability of a double-dip recession increasing. Now that’s a combination that has just got to be considered a monumental failure.
Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at Ohio State University-Marion. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion.