Ben Bernanke Is Finally Right For Being Wrong
On the trading floor, "If you are good, 49 percent of your decisions will be wrong. Even if you are great, something just short of a majority will be losers." Nick Kokonas, Life, On the Line, p. 172
As is well known now, Federal Reserve transcripts released last week confirmed that Fed Chairman Bernanke was caught unaware by the brewing mortgage storm that rocked many of the banks his Fed is charged with overseeing. As Bernanke put it in 2006, "So far we are seeing, at worst, an orderly decline in the housing market." Bernanke went on to note that a cooling of the housing boom was a "healthy thing."
Fed critics from the left and right will doubtless seek to use Bernanke's utterances as weaponry meant to further discredit a Fed Chairman who is expert at always being wrong, but they'd be unwise to do so. Instead, they should use Bernanke's musings to explain in more confident terms why the Fed's presumed regulatory mission is a total contradiction.
First off, Bernanke was right in saying that a slowing mortgage market would be healthy. Far from negative, sector-specific downturns are extraordinarily stimulative because they ensure that no more capital will be destroyed in parts of the economy that no longer need investment. Market signals are precious in this regard in that through rising and falling prices, investors have a better idea of where and where not capital allocation will be rewarded.
What was then unhealthy, and which remains unhealthy, and this helps to explain why the U.S. economy continues to sag, is that the political class would not allow the market correction to run its course. Instead, bailouts of the banks and counterparties impacted by the correction softened the blow of the latter, plus delayed the stimulating migration of capital to business concepts desired by the infinite inputs that comprise what we know as the "market."
Where Bernanke was and continues to be scarily wrong is in his assertion that the Fed, for having failed to foresee just how bad the correction would be, should be given more oversight of the banks whose exposure to faulty mortgage securities imperiled their very existence not long ago. Here Bernanke can perhaps be excused. A Washington pro as evidenced by his ascendance to a job at which he's failed completely, he seemingly believes as all political animals do - with good reason - that to fail in Washington is to fail upward.
Instead, what Bernanke's presumptions about the health of the mortgage market prove yet again is that regulations are a tragic lie. They don't work, and the reason they don't is that no one - and this is even more true for the individuals so lacking in ambition as to want to become regulators - has any kind of consistent knowledge of the future. Regulations, if they are to work, are of course predicated on future knowledge, and as Bernanke once again revealed in the Fed transcripts, he hadn't a clue about what was ahead.
To understand why Bernanke was caught unaware, and why regulators nearly always are, it's necessary to consider how frequently even the best investors are wrong. This is notable too in the certain sense that regulators and government bureaucrats are frequently the individuals who could not get Wall Street jobs, or who lacked the ambition to compete with the brightest minds in finance.
As former expert trader Nick Kokonas notes in the quote that begins this piece, even the great traders are wrong nearly as often as they're right. Kokonas also pointed out in Life, On the Line, that the "saying on the Chicago floors was that only two out of every hundred guys break even their first year; and out of those only one out of a hundred becomes a millionaire."
Looking back at mortgage securities in 2006, as evidenced by the billions hedge fund trader John Paulson made betting against them, a good number of very sharp market minds felt as Bernanke did; that everything was fine. If this is doubted, we need only reference Paulson's now-famous Abacus deal. His counterparties in the trade set up by Goldman Sachs needed Paulson to bet against not because they wanted to, or because they'd even heard of him, but because so great was the demand for mortgage securities at the time that purchasing same wasn't very simple. Paulson's willingness to offer them synthetic exposure allowed them exposure that they couldn't otherwise achieve in the actual markets.
Considering regulations in this light, Fed hubris post-crisis has it seeking more oversight of banks, and then Dodd-Frank is predicated on giving regulators more broadly the power to take control of banks "before" balance-sheet difficulties cause "contagion" in the financial markets altogether. Of course as the years leading up to 2008 reveal in living color, no one, least of all regulators, was aware that something was amiss. Those that did made millions, and in Paulson's case made billions.
To state the obvious, regulators, and this includes the allegedly brilliant academic minds at the Fed, will always be late to problems, thus rendering regulation worthless at best, and tragic at worst for regulations creating a false sense of security that inevitably magnifies in harmful ways the similarly inevitable errors that occur in a marketplace comprised by fallible individuals. Better is it always to limit regulation to something that doesn't even require effort by lawmakers; as in if you fail, you will be allowed to go bankrupt.
What commentators should not do is use Bernanke's now-naïve utterances against him. He was wrong about looming problems in the mortgage markets, but so were many market participants - by definition. And then what commentators should do is use the information gleaned from the Fed transcripts to rail against any and all banking regulations which, by their hubristic presumption not to mention simple logic, are doomed to fail.