Bernanke: Economy "Far From Being Out of the Woods"

The Chairman of the Federal Reserve, Ben Bernanke, today gave a speech titled Economic Challenges: Past, Present, and Future

The first half of Bernanke's prepared speech revisited the events that led us into the great recession. Ben then reviewed and justified the innovative actions that had to be taken by the Federal Reserve to save the banking system.Overall, nothing new was offered in this portion of the statement, but later on he did provide some insight about the road ahead.

Here are a few excerpts and my comments…

On Housing:

“Wern have yet to see evidence of a sustained recovery in the housing market.rn Mortgage delinquencies for both subprime and prime loans continue torise as do foreclosures. The commercial real estate sector remainstroubled, which is a concern for communities and for banks holdingcommercial real estate loans.”

Plain and Simple: I supposeit's reassuring to hear one of the most respected economists in theworld confirm that housing has failed to gain any recovery momentum. From a bigger picture point ofview…housing is now getting the attention it deserves.

On Jobs andMonetary Policy:

“Some of the toughest problemsrn are in the job market. The unemployment rate has edged off its recentpeak, but at 9.7 percent, it is still close to its highest level sincethe early 1980s. Although layoffs have eased in recent months, hiringremains very weak. More than 40 percent of the unemployed have been outof work six months or longer, nearly double the share of a year ago. Irn am particularly concerned about that statistic, because long spells ofunemployment erode skills and lower the longer-term income andemployment prospects of these workers.

“That said, my bestguess is that economic growth, supported by the Federal Reserve'sstimulative monetary policy, will be sufficient to slowly reduce theunemployment rate over the coming year.”

Plain and Simple:this echoes an observation we have been pointing out for months now.Productivity is high, consumer demand is constrained, and employers havern not needed to add permanent payroll positions. Investment in technologyrn and advances in productivity will permanently eliminate many of thejobs that were lost over the past two years. If you are unemployed orunderemployed, go back to school and re-educate yourself to work withadvances in technology.

By the way…notice Bernanke used thephrase “MY BEST GUESS”. This goes to show you just how uncertainthe economic outlook is….

On Inflation:

“Meanwhile, for the near term, inflation appears to be wellcontrolled. “

Plain and Simple: inflation appears to be well controlled!Aggregate demand will suffer because jobs are not being created. This isrn the beginnings of a downward spiral. Less spending = less jobs = lowerprices = less jobs = less spending = less jobs = lower prices = lessjobs. Inflation is not an issue because aggregate demand is well-belowits potential. The Fed calls this “resource slack”

On “Too Bid to Fail”: 

“Critically, so that we will never again face the unpalatable choice between bailouts and a disorderly bankruptcy that threatens to bring down our financial system, we must bring an end to the belief that some financial institutions are too big to fail. To do that, we urgently need a new resolution regime for large, complex, and interconnected financial firms, similar to that already established for banks. To end too-big-to-fail, the new regime should permit regulators to close a failing firm and impose losses on shareholders and creditors; indeed, I would argue that no financial instrument counted as regulatory capital should be allowed to receive any protection from losses.”

Plain and Simple: whatever branch of the government is given the power to regulate large banking institutions (currently the Fed and hopefully will continue to be the Fed) should be given the ability to close down a failing firm. If the Fed has this ability two years ago, banks and insurance company losses would not have been taken by the US taxpayer…they would have rested on the shoulders of creditors and shareholders.

On the Budget Deficit:

“Two interrelated economic challenges our nation faces: meeting the economic needs of an aging population and regaining fiscal sustainability.”

“The U.S. population will change significantly in coming decades with the combined effect of the decline in fertility rates following the baby boom and increasing longevity. As our population ages, the ratio of working-age Americans to older Americans will fall, which could hold back the long-run prospects for living standards in our country. The aging of the population also will have a major impact on the federal budget, most dramatically on the Social Security and Medicare programs, particularly if the cost of health care continues to rise at its historical rate. Thus, we must begin now to prepare for this coming demographic transition.”

“Inevitably, addressing the fiscal challenges posed by an aging population will require a willingness to make difficult choices. The arithmetic is, unfortunately, quite clear. To avoid large and unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above”

Plain and Simple: we may have avoided the “worst case economic scenario”, but it came at a huge cost to US taxpayers. In the future will all be forced to pay for the government stimulus spending that saved our economy from the “worst case economic scenario”. This means higher taxes and less social spending…including a reduction in education allocations on the budget. The trickle down effects of this economic crisis will last for decades.

In conclusion:

“Ourrn country's competitive, market-based system, its flexible capital and labor markets, its tradition of entrepreneurship, and its knack forinnovation have ensured that the nation's economy has surmounteddifficult challenges in the past. I do not doubt that we can do so onceagain.”

Plain and Simple: This is America. We can doanything! Ben has his pom-poms on….

Overall, Ben continues to demonstrate cautious optimism. He isoptimistic that the “worst case scenario” was avoided, but extremelycautious about getting too excited for the road ahead. This implies weshould not be expecting the FOMC to hike the Fed Funds rate any timesoon. I think Bernanke's opening statement sums up the economicenvironment:

“Fortunately, today the financial crisis looks to bemostly behind us,and the economy seems to have stabilized and is beginning to grow again.rn But we are far from being out of the woods. Many Americans are stillgrappling with unemployment or foreclosure, or both. Cities and statesare struggling to maintain essential services. And, although much of thern financial system is functioning more or less normally, bank lendingremains very weak, threatening the ability of small businesses tofinance expansion and new hiring.”

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