Bernanke Blows Smoke in His Attempt to Blow More Bubbles

Banana Ben Bernanke released a transcript of his scheduled testimony to Congress regarding his plans for removing the trillions he's printed and injected into the system (the appearance was cancelled due to the blizzard hitting DC). In his remarks, Bernanke outlines a few policy tools he plans on rolling out if and when he decides monetary policy needs to be tightened. Since he missed forecasting the housing bubble and the ensuing economic collapse, I'm not sure why anyone would trust him to determine the appropriate time to drain the system in order to prevent hyperinflation. Here's a link to the Bloomberg article on Bernanke's remarks: LINK

Bernanke's first proposal would be to raise the discount rate.  The discount rate is the rate charged by the Fed when banks borrow directly from the Fed. Raising the discount rate is meaningless right now as a tool to regulate systemic liquidity because the banks have plenty of money to lend out in the form of excess reserves. Excess reserves are bank deposits kept at the Fed in excess of reserve requirements. As of 12/31/09, banks had around $1.1 trillion in excess reserves. Here is a graphic portrayal of the amount of excess reserves being kept at the Fed right now:  Excess Reserves.  The banks thus have no need to borrow money from the Fed. As of Feb 3, Discount Window loans were an insignificant $14.7 billion. As you can see, the discount window is not even a source of bank liquidity in comparison to the liquidity the banks already have on deposit at the Fed. Raising the discount rate would be about as useful as taking away ice machines in Antartica. In Banana Ben's own words today: raising the discount rate is “not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signaling any change in the outlook for monetary policy." So why even bother mentioning this unless Banana Ben's intent is to remain consistent with his unstated policy of blowing smoke?

Bernanke goes on to say that he has other tools he can use to drain liquidity and tighten monetary policy when the economic growth warrants those actions. Quite frankly, the way Obama is throwing around Q4 GDP growth of 5.7% as evidence of a strong economy, one would think the time would be now. Of course, anyone who tracks what is really happening in the economy knows better, and so does Bernanke. But, in the fairy tale world of the Federal Reserve and the U.S. Government,  assume Banana Ben will get a chance to unleash his liquidity-draining monetary tools on the system. Let's take a look at why his other tools are useless.

His next tool would be to raise the interest rate being paid on bank excess reserves. The idea would be that banks will be incentivized to keep those reserves with the Fed rather than use them to fund lending. The problem is that those excess reserves have built up to the extent that they have because the banks were bailed out of bad business loans that should have never been made in the first place. Furthermore, given the very poor outlook for any kind of meaningful economic expansion for the foreseeable future, banks will be quite content holding onto that cash and keeping it at the Fed. In fact, Bernanke could probably refrain from paying any interest rate on that money because it's a safe place for banks to keep that cash and avoid the risk of that money not being returned (unlike general business loans, money market funds, commercial paper etc.). Of course, Bernanke being an ivory tower academic and nothing more, is clueless about the nature of this dynamic. But you can see why this policy tool is useless. Would you want to keep your cash in a place where you know you can get it back, or lend money to a real estate developer or hamburger franchiser right now? How about a Ferrari dealer who wants to expand in Ohio? The point is that IF the time comes when the economy offers favorable risk/return lending opportunities to the banks, they will unleash those excess reserves and Banana Ben will have no control using his sleepy excess reserve interest rate tool.

His third policy tool is what is called a reverse-repo operation. The idea behind this concept is that the Fed can sell back the roughly $1.5 trillion toxic assets it purchased from banks to keep them from collapsing, and thereby "drain" that $1.5 trillion in cash from the system. Correct me if I'm wrong, but I believe the Treasury also issued a guarantee against loss to the Fed on those purchases. Here's the problem. We have no idea what value the Fed placed on that $1.5 trillion of crap when it removed the assets from bank balance sheets. The Fed is spending millions to keep us from finding out. In all probability, not only did the Fed overpay for those assets, but the market value of most those assets has likely declined precipitously. The Fed certainly can't force the banks to reload those assets back onto their balance sheet, because it will put the banks in even worse financial condition than when the Fed assumed them. And if the banks could not have disposed of those assets in the market back when this occurred, imagine how ugly the bid side for that toxic crap is now. In other words, the Fed WAS the ONLY buyer back then and IS the ONLY buyer now. See the problem?

So, if my analysis is correct, this leads us back to where we were before Bernanke unveiled his policy ideas to the world: no change in the Fed's monetary policy for the foreseeable future, trillions in excess reserves, zero percent interest rates and a Federal Reserve with no idea how it will, for all practical purposes, remove the trillions it has injected into the system. In his own words, Bernanke stated to today that this policy is warranted "for an extended period of time."