President Obama's decision to nominate Fed Chairman, Ben Bernanke for another four year term had pundits chattering, both approvingly and disapprovingly. Those who believe that Mr. Bernanke deserves another term point to his calm under fire and his in-depth knowledge of the great depression as the reason for averting a catastrophe. Detractors point to his previous time at the Fed when he was part and parcel to then Fed Chairman Alan Greenspan's policy of keeping short-term borrowing rates very low for an extended period of time as a prime cause of the housing bubble. There is some truth on both sides of the debate.
We should all be thankful that it was Ben Bernanke who was at the Fed's helm when this crisis erupted. However, he was on board with Alan Greenspan's policy. There is one factor that few pundits seem willing to discuss. That is Wall Street's responsibility in the housing crisis.
Low rates alone did not cause the crisis. Sure, lower rates spurred home buying and put home ownership within the reach of more people, but it was Wall Street "innovation" which permitted borrowers with poor or no credit history to obtain credit. It was "innovation" which permitted 100% (or more) financing and the incredibly stupid pay option ARM. Mr. Bernanke, like investors who purchased packages of these loans, assumed that banks, investment banks, credit ratings services and investors were doing their respective due diligence. That was not the case. Even if the Fed had tightened sooner, we could have had a violent correction, but probably not as violent as have seen. The criticism should be shared by the Fed, FDIC, SEC, FINRA, The Comptroller of the Currency and the GSEs. Regulations were in place, but were ignored.
In spite of all of the aforementioned dropped balls and the shell game known as the "Stress Test" the economy does so signs of improvement. Inventories are being replaced as the worst is over. Auto sales are higher, thanks to Cash for Clunkers and home sales are rising thanks to a tax credit for first time home buyers. These are all positive events. However, just as the economy turned out not to be as bad as some feared, stimulus driven growth should not be considered normal or sustainable.
Here is where Mr. Bernanke can add value. During the Great Depression, the economy did show signs of recovery only to be torpedoed by bad tax and trade policy. Maybe Mr. Bernanke can be the soothsayer warning politicians of what might happen should they choose to make the same mistakes of their 1930s predecessors. He can also set Fed policy to minimize the damage of unwise legislation.
Mr. Bernanke will have his hands full. Taxes will probably increase, a weaker dollar will weigh heavy on food and energy prices and the huge deficits could put upward pressure on interest rates. These are formidable headwinds and could moderate, but not eliminate growth. The U.S. is the most dynamic economy in the world and, in spite what the nouveau smart will have you believe, is the prime long-term driver of global economic growth.
Opportunities abound for those who understand the fixed income markets. High yield buyers have experienced significant, albeit illogical, gains this year. These investors should not become too greedy. Corporate defaults will rise as many junk-rated companies will not be able to refinance maturing debt affordably, if at all. Many regional banks are time bombs and are clearly not too big to fail.
Treasuries have a significant amount of downside price pressure due to the potential for rising rates due to continued large supply of treasuries and rising deficits. The best places in the fixed income market are agency debt on the short end of the curve and high grade corporates (especially large true banks) farther out. Investors who can tolerate time uncertainty of maturity should consider agency-issued mortgage-backed securities, especially GNMA bonds which enjoy the full faith guarantee of the U.S. government.
Any questions, please ask.
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