Hindsight is Great Stuff

That’s what my Dad always told me. It came out whenever I was recounting something that went badly and wishing I had done things differently. The phrase came to embody a sort of move-on-don’t dwell-on-your-mistakes mentality and it has served me well for many decades.

Recently the telecosm is filled with stories about the start of the, “Great Recession”. That relatively brief but very severe financial dislocation probably never would have acquired the superlative, “Great”, had it not been for the great failed recovery that followed.

The spark that lit the fire that burned down global financial markets is pretty well understood to be a massive government intervention in the U.S. property markets. Inspired and encouraged by congressional leaders like Barney Frank, Fanny and Freddie, took a remote corner of the mortgage market called sub-prime and grew it into a $3.5 trillion monster. When the crisis hit they controlled 50% of the market, when the dust settled they owned 90% of it. That risk persists today with 70% of new mortgages carrying the imprimatur of those twin GSEs.
More interesting in my view is what happened after the meltdown.

By January of 2009, the banking system had been stabilized with the implementation of the $475 billion, Troubled Asset Relief Program (“TARP”), signed into law by President Bush in October 2008. TARP was ultimately successful rescuing banks, auto companies and even the United Auto Workers Union.

Tarp produced a net profit of $15.3 billion for taxpayers. By June 2009, the “Great Recession” was technically over.
The financial system was stable but barely functioning as banker risk aversion reached extremes in the face of massive losses and recriminations from Washington. They eventually paid out over $60 billion in federal fines for mistakes in documenting, processing and securitizing mortgages. Banks withdrew from that market and homeowners were left unable to refinance their homes.

Meanwhile, the Federal Reserve had the proverbial monetary pedal to the metal.

Interest rates were taken down to zero. They pumped out trillions in liquidity, buying bonds in a “quantitative easing”. This was helicopter-Ben Bernanke’s idea of dumping cash out of the sky. Except instead of helicopters he marshaled a fleet of 747s. In response, any asset that could be easily leveraged increased in value. Not surprisingly, a stronger stock market, and more profitable banks did nothing for consumer confidence.

Oddly, as we see in the chart nearby, real investment also lagged. If capital was so cheap, why not build that new plant or office building or expand those retail outlets?

What happened to the Keynesian, “animal spirits”?

During the depression analysts worried that government policy might upset, “the delicate balance of spontaneous optimism” underlying that risk-taking bias for action.

Clearly, that optimism was missing in this recovery. We think the Fed was, in part, responsible.

In every FRB action, there is a number and a message. Often the number is less important than the message. This is why bond traders spend time parsing every press release and every public utterance by a Fed board member. In our view Bernanke and later Yellen, misunderstood the messaging part of their actions.

As they kept interest rates at zero and the central bank balance sheet floating above $4 trillion, they were sending a message that they saw economic weakness far into the future. The private sector took that message to heart and curtailed their investment plans.

Understandably, the Business Optimism Index collapsed to lows not seen in 40 years. Confidence did not recover to pre-recession levels until after the election in November 2016. Consumer confidence followed a similar path, only reaching pre-recession levels in 2017.

FDR built confidence in a depressed nation by declaring that, “The only thing we have to fear, is fear itself”.
The Fed only added to the nation’s anxiety by messaging continuing economic weakness.
– Jim Anderson


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