Good Evening: As Thursday dawned, market participants were a little on edge. Yesterday’s FOMC statement was found a bit wanting by most investors, leaving them concerned about not only the Fed’s exit strategy from Quantitative Easing but also Chairman Bernanke’s exit strategy for a successful escape during today’s Congressional hearings on the BAC-MER deal. Those worries proved premature on both fronts, and the U.S. capital markets celebrated with a solid up day for both stocks and bonds. Longer term, however, I wonder if Mr. Bernanke and the Fed can escape political challenges to their independence during the next twelve months.

There were some interesting gyrations in our stock index futures overnight, perhaps due to some position jockeying by the off-hours trading crews ahead of Mr. Bernanke’s testimony. With the Russell indexes facing a large rebalancing tomorrow and with the end of the second quarter next week, our markets may see some choppiness that has more to do with portfolio positioning than with shifting fundamentals. This morning’s economic data were another potential source of volatility, but they more or less offset one another. Initial and continuing jobless claims were slightly worse than had been expected, while the final revision to the Q1 GDP figures was slightly better than the forecasts. Stocks opened with smallish losses as all eyes turned to the Bernanke hearings. “What does Congress have on the Chairman — and can he survive?” were the questions posed on T.V. and on trading desks.

Equities had already reversed their early downticks when Mr. Bernanke’s prepared testimony was released at 10am edt. The nascent rally under way grew legs once it was apparent that Mr. Bernanke had come prepared to defend himself quite vigorously (see below). As the hearings dragged on, it looked less and less likely that Congress would be able to lay a glove on the Fed Chairman, let alone disclose the type of information that might lead to a TKO (Bernanke’s resignation).

Stocks continued to rally, and they went higher still when the Fed released a statement addressing the status of some of the alphabet soup lending programs they’ve been sponsoring (see BAC-MER piece below). One program was closed and a couple of others shrank a touch, and while these moves won’t have much impact on the credit markets themselves, the downshifting nature of the announcement implied the Fed is cognizant of the need for an exit strategy for all the liquidity created by these facilities. This news was quite welcome, since many analysts and investors were disappointed yesterday when the widely anticipated FOMC statement didn’t address these issues at all.

With this morning’s twin concerns about the Fed now addressed, market participants were handed a final bit of good news from the bond market. A seven year note auction was quite well received, capping off a very successful week for the Treasury. The major averages made one final push to the upside in the wake of the auction results, and stocks prices then went mostly sideways for the rest of the afternoon. The final tally left every index with gains of more than 2%, with the Dow Transports (+4.4%) leading the way for the third straight day. As mentioned above, Treasurys also enjoyed solid gains as yields declined between 7 and 15 bps. The dollar weakened a touch and commodities exploited this downtick in the greenback. Led by a very firm energy sector and with some help from the metals complex, the CRB index rose 1.4% today.

Ben Bernanke came out swinging in his own defense today, quelling (for now) fears that his job might be on the line over the Fed’s role in the Bank of America–Merrill Lynch merger. Prior to the hearings, no one really knew if the Committee calling him to the microphone had some real evidence of impropriety or if the politicians were just grandstanding for the voters back home. Luckily for Mr. Bernanke, it was the latter. The most humorous moment came when Mr. Bernanke told those assembled that the Fed “acted with the highest integrity throughout its discussions” (over the BAC-MER deal). Some of the elected officials looked momentarily stumped over the meaning of the word “integrity”, and I thought they would have to turn to their staff flunkies for an explanation.

I bring it up because the hearing itself was a farce. As usual, Congress is focusing on the wrong issue, choosing to overanalyze an aftermath sideshow to the financial crisis when they should be focusing their attention on the root causes of the crisis and how to prevent them in the future. Given his easy money policies that fostered the credit bubble, his advocacy of dismantling the financial regulatory framework, and the general abdication of monitoring lending practices that were allowed to become dangerous under his stewardship, it should have been Alan Greenspan sitting in the hot seat on the Hill — not Mr. Bernanke. Mr. Bernanke was handed this mess by the Maestro, who was aided and abetted by the very Congress that spent the morning grilling his successor.

And, speaking of successors, another unseemly aspect of today’s proceedings lies in just who in the administration leaked the BAC-MER documents to Congress. The prime suspect, who — of course — will have left no fingerprints, is none other than the man who covets Mr. Bernanke’s job. I am speaking of Larry Summers, and if he somehow convinces President Obama to ditch Mr. Bernanke when the current Chairman’s term expires next year, it will be a disaster. Not because I revere Helicopter Ben, mind you, nor because I have a problem with Mr. Summer’s political party. I would shed no tears if Mr. Bernanke were suddenly replaced by a tough, hard money advocate like Paul Volcker (see the fascinating article about this man of character below), but though they share the same party affiliation, Mr. Summers is Mr. Volcker’s polar opposite.

Summers contributed to the current crack up when he championed the abolition of Glass-Steagall while working for President Clinton, and he also pushed for the law that banned the regulation of the very credit derivatives that have wrought so much damage during these past 24 months. In addition to being “part of the problem” that brought us here, Mr. Summers is an active member of the current administration, one who helps set economic policy for the President. I can think of no other potential appointee who would be viewed as a greater risk to the Fed’s independence than Mr. Summers. It’s a prospect that would not sit well with investors, especially our global creditors. Why else would Warren Buffett offer the glowing endorsement he gave Chairman Bernanke yesterday? As someone who knows well the dynamics in the current administration, the Oracle of Omaha knows full well who Mr. Obama would call upon as the next Fed Chair. The risk such a fate might befall Mr. Bernanke in the wake of today’s hearing is why market participants were nervous this morning. His swift dispatch with the proceedings helped both stocks and bonds soar this afternoon.

Again, my beef with Mr. Summers isn’t personal, nor is it political; it is one grounded in ideological common sense. If we are going to have a central bank in this country, it needs to have the independence we preach about to the rest of the world. Thus, while Bernanke dodged a bullet today, the markets rightly fear there is still one out there with his name on it. It may never happen, but if Summers some day replaces Bernanke, investors will likely react by selling bonds and buying precious metals. In the eyes of investors at least, we might as well just mail the keys of the Eccles building to 1600 Pennsylvania Avenue.

– Jack McHugh

U.S. Stocks Gain as Bernanke Defends Actions on Merrill Lynch
Treasuries Rise After U.S. Auctions $27 Billion of 7-Year Notes
Bernanke Defends His Record on Bank of America Talks
A step toward an exit strategy
Volcker Gets Less Than He Wants in Curbing Wall Street Excesses

Category: Markets, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

8 Responses to “Bernanke Dodges Bullet; Markets Celebrate”

  1. [...] Jack McHugh (commentary with links) [...]

  2. Mike in Nola says:

    Good point about Summers. Just think, we could be stuck with someone worse than Ben in charge of an agency that is already out of control. And he couldn’t be fired. What GS has been aiming at for a complete takeover of US financial policy.

  3. Simon says:

    Gold seems to be catching a bid as London opens. It feels a tad soon for another launch at $US1000. The drama will really start when it holds above.

  4. BG says:

    Mike in Nola,

    You are right. I hadn’t really thought about it; but, I think having Summers as the FED Chairman may be even worse!

    I wish they would put Volcker back in there. I know he can not lay down a scorched-Earth policy like he did in the early 80′s; but, I think the whole financial arena is suffering from absolutely no credibility what-so-ever.

    Basically, the masses have decided the whole mess is being internalized and we are just along for the ride, kind of like the fly on the elephant’s back. We-the-people have lost control of this Country. Big talking Obama has already bought into the ruse and hasn’t even been in Office six months yet.

    Nothing materially will change until the crisis is even bigger than the one we had at the end of ’08 if you can believe that. The whole system is full of entrenched players who would put a hit out on you before they would change.

    The US is now an economy that jumps from one bubble to another. That in and of itself prevents any potentially- viable business in the US from ever having a chance in the global marketplace. You can’t make any long-term plans in this kind of environment. It’s absurd to even think you can. There is no stability in input costs, demand or finished goods prices. You might as well go to Vegas and eat the food and forget about it.

  5. leftback says:

    Nice summary. I think you are probably right about Summers orchestrating a leak of the BAC-MER details. I knew that we could make you into a conspiracy theorist if you spent enough time at TBP.

    Whatever we say about Bernanke’s ideas and aims, no-one can argue that his execution has been brilliant at times. I am worried that just at the time that we have all become familiar with his neo-Japanese methods, we may have to adapt to an alternative devil in the shape of Summers.

    Looking at the residue of Summers’ reign at Harvard, I think we should all be afraid. Very afraid.

  6. davossherman@gmail.com says:

    Really good read. I got the idea he was getting tossed under the bus and really wondered whose hands were around his neck. Thanks!

  7. bruerr says:

    Fact from the country: There is NO integrity, in helping large corporations pass their debt, onto people who did not sign for it. None. Zero.

    Acting in such an endeavor, points to a deficit of integrity.

    Ben Bernanke is culpable in seeking to abuse capitalist rule of law: During one down cycle of a capitalist economy, Bernanke and Paulson, sought to remove from Americans, laws, that if left in place, would serve to protect them from the dishonorable practice (of) debt evasion as a corporate method to stay in business. Everything that came after debt evading practices (unloading debt at corporate levels) is fruit from a poison tree. Its non-political, void of business integrity.

    Anyone who think evading debt as a method to stay in business or gain advantage over competitor banks, is a go route, to achieving “utmost integrity” in other business meetings, need to go back and review their financial ethics course work.

    Agreed, Larry Summers is the last person Americans want to see in that office. It would signal betrayal to those who voted for the current President. I strongly disagree with the idea that Bernanke is above reproach and should not be questioned for his role during meetings with bank executives. I think there is merit in questioning what happened, as it does appear to me Ken Lewis was pressured into a deal that started smelling bad as BofA was trying to do due diligence to finalizing the deal. I think there was dishonesty in that environment, and Lewis was lead to believe more value existed initially, than what was true. I do not think John Thain is always an honest broker when under pressure. I think he viewed North Carolina as someone who could be deceived by his NY style of doing business. It is like example Paulson provided: When Mr. Paulson did not want to answer too many questions about what was going wrong, and did not seek to assign blame, in his haste to get money, it turned out he was intent to lie about what he intended to do with the money, so that he could get the money, and then changed course to give banks money… this type of environment does not facilitate “utmost integrity.” It facilitates the opposite. I think there was haste, to pressure Mr. Lewis, when he started learning of some dishonesty in what was initially presented to him, specifically about Merrill Lynch.

  8. bruerr says:

    Congress is right to question this activity and I do not think it is good form to bash congress over this desire to question, where the questions are genuinely focused on what was happening and what our leaders where doing, when pressured by financial circumstances.

    Paulson specifically forbid questioning about wrong doing. When seeking money, he was annoyed like a con man, and did not want to dwell on finding fault. Said the greater urgency was on getting money to consumers directly, to help them. It turned about to be a lie.

    Americans have a right to know what occurred in private meetings involving such actors, and the way that gets done, is by their representatives putting forth questions. In this congress is not grandstanding, as much as they are fulfilling their role to be representative eyes and mouth piece for common Americans who cannot go there and all together at the same time, ask questions, for it would be a logistical problem. Not practical, for Americans to disrupt their own work, go to Washington, and try to get a meeting with Bernanke or Paulson. Americans have to rely on Congress and rather than bash congress, I think it is important to be more helpful and protective of congress, so that they can get the information that Americans might need or want.

    Big Banks have successfully evaded their debt obligations on those who did not sign for it, and have since made material changes in accounting methods. They did this once before during the Savings and Loan problems, again, debt evading, in practice, after dealing in real estate markets.

    If this does not raise eyebrows and cause questions to go forth, from our representatives, something is wrong with our system.