The Fed That Never Sees It Coming

By Pam Martens and Russ Martens: January 29, 2015

Alan Greenspan, Former Fed Chairman, Testifying to the House Oversight Committee on How He Got It Wrong, October 23, 2008

Alan Greenspan, Former Fed Chairman, Testifying to the House Oversight Committee on How He Got It Wrong, October 23, 2008

There is growing unease in stock and bond markets around the world that the current Chair of the U.S. Federal Reserve, Janet Yellen, has retrieved former Fed Chair Alan Greenspan’s blinders out of the mothballs in some musty old closet at the Fed, thus setting the U.S. economy up for more epic convulsions.

Yesterday, the Federal Open Market Committee (FOMC) released its policy statement and rattled markets here and abroad overnight. The statement contained a number of economic absurdities. The first sentence argued that “economic activity has been expanding at a solid pace” while a few sentences later we are told “inflation has declined further below the Committee’s longer-run objective.” A solid expansion simply does not correlate with declining inflation in the U.S. and mushrooming deflation among our trading partners.

Later in the statement the Fed tells us that inflation will be heading back toward the goal of 2 percent once “the transitory effects of lower energy prices and other factors dissipate.” There is no evidentiary basis offered to support the idea that the historic collapse in oil prices will be “transitory.” The “other factors” remain vague because to enumerate the other factors – slack demand around the globe creating a monster surplus of supply – would destroy the argument that the oil price collapse will be transitory. (And remember, it’s not just energy prices that are swooning, it’s a broad range of industrial commodities which the Fed conveniently fails to mention.)

Bond markets around the world, including the U.S. Treasury market, think Yellen is full of it. Shortly after the FOMC statement was released, the 30-year Treasury hit an historic record low yield of 2.295 percent. The yield on our longest dated Treasury bond reflects two elements: the long-range outlook for inflation and a perceived safe-haven to weather a looming economic upheaval.

Yesterday, the yield on the 30-year Treasury also represented one more thing: a no confidence vote that the U.S. Fed knows how to read the global tea leaves.

As we reported last week, seven central banks around the globe have recently taken bold actions to cut interest rates or ramp up stimulus to stem the tide of deflation and reignite sagging economic growth. How could it be possible that the U.S. Fed stands alone in a sea of prosperity where its major concern is when it will raise interest rates to dampen demand.

The reality, which the markets clearly understand and are discounting, is that the strength of the U.S. dollar is going to accelerate a decline in U.S. inflation – not an increase to the 2 percent inflation level that the Fed is projecting. When U.S. consumers purchase foreign imports which are priced in currencies which have lost value to the U.S. dollar – which is the case among major trading partners – the price of those imports are lower. This lowers the inflation rate in the U.S. and has the potential to turn the inflation rate negative, i.e., deflation.

Janet Yellen will make her semi-annual appearance before Congress next month. We urge her Congressional questioners to drill down into what the Fed is thinking and seeing that is causing it to make these truly peculiar predictions. Another vital question that should be asked is what the Fed has as a backup plan in case it has gotten everything completely wrong and we have another crash.

To jog Congressional memories about dead-wrong Fed chairmen, we have included below excerpts from the October 23, 2008 hearing before the House Oversight Committee which examined the greatest financial collapse since the Great Depression in 2008. Be sure to catch the statement from Alan Greenspan at the end.

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House Oversight Committee Chairman, Henry Waxman. “The committee will please come to order. Today is our fourth hearing into the ongoing financial crisis. Our previous three hearings focused on the private sector. Our first hearing examined the bankruptcy of Lehman Brothers. We learned that this investment bank failed after it made highly leveraged investments that plummeted in value.

“Our second hearing examined the fall of AIG. We learned that this huge insurance company was brought to the brink of bankruptcy by speculation in unregulated derivatives called credit default swaps.

“Our third hearing, which we held yesterday, examined the role of credit rating agencies. We learned that these firms sacrificed their rating standards–and their credibility–for short-term gains in sales volumes.

“Each of these case studies is different, but they share common themes. In each case, corporate excess and greed enriched company executives at enormous cost to shareholders and our economy. In each case, these abuses could have been prevented if Federal regulators had paid more attention and intervened with responsible regulations.

“This brings us to today’s hearing. Our focus today is the actions and inaction of Federal regulators. For too long, the prevailing attitude in Washington has been that the market always knows best. The Federal Reserve had the authority to stop the irresponsible lending practices that fueled the subprime mortgage market, but its long-time chairman, Alan Greenspan, rejected pleas that he intervene. The SEC had the authority to insist on tighter standards for credit rating agencies, but it did nothing, despite urging from Congress.

“The Treasury Department could have led the charge for responsible oversight of financial derivatives. Instead, it joined the opposition. The list of regulatory mistakes and misjudgments is long, and the cost to taxpayers and our economy is staggering.

“The SEC relaxed leverage standards on Wall Street, the Offices of Thrift Supervision and the Comptroller of the Currency preempted State efforts to protect home buyers from predatory lending. The Justice Department slashed its efforts to prosecute white-collar fraud.

“Congress is not exempt from responsibility. We passed legislation in 2000 that exempted financial derivatives from regulation, and we took too long, until earlier this year, to pass legislation strengthening oversight of Fannie Mae and Freddie Mac.

“Over and over again, ideology trumped governance. Our regulators became enablers rather than enforcers. Their trust in the wisdom of the markets was infinite. The mantra became government regulation is wrong, the market is infallible.”

Former Fed Chair Alan Greenspan: “So the problem here is something which looked to be a very solid edifice, and, indeed, a critical pillar to market competition and free markets, did break down. And I think that, as I said, shocked me. I still do not fully understand why it happened and, obviously, to the extent that I figure out where it happened and why, I will change my views. If the facts change, I will change.”

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