There’s no way to hedge politics
Ben Bernanke in peril and the Volcker crackdown on proprietary trading by banks show two truths of the current dispensation: there is no effective hedge against politics and the reflation trade rests on fragile foundations.
Neither of these realities is particularly good for financial markets and neither is going away any time soon.
Both, too, are utterly related not just to each other, but to the Senate election in Massachusetts which installed a Republican into what had been a Kennedy seat, in the process terrifying Democrats who fear they will be sunk by association with a set of policies perceived to be favoring Wall Street.
In the aftermath, President Obama unveiled a policy authored by former Fed chief Paul Volcker, which is intended to make financial firms get out of the business of using government insurance to underwrite speculative bets; well, er, not all speculative bets, but the bad kind.
At the same time the confirmation of Bernanke is under threat, and he and the institution he works for had to endure the humiliation of seeing Senator Harry Reid issue a statement endorsing him but implying that he’d extracted some sort of undertaking from the central banker to “redouble” his efforts to help those struggling in the recovery.
Whether all of this is good or bad, or even if it has much of an impact, the fact is that both are the result of a financially struggling electorate which is going to strive to control things that they’ve previously been convinced to more or less let alone.
That’s quite a change from a few years ago, when most of us sat around stroking our chins and praising Alan Greenspan, banks and market forces as if they were one and the same. Everyone still agrees that you need banks, a market and a Federal Reserve Chairman, but there is a lot less agreement about how much freedom the three should be given.
This may be just a few politicians getting the vapors, and soon everyone may ignore finance and economics and get back to the Super Bowl and dancing competitions on television, but there is a real possibility that this popular upsurge has legs. Markets famously hate uncertainty, but this is worse: this is uncertainty mixed with hostility.
This does not have to play out one particular way, and this in some ways is the problem for investors. That stocks have been going their merry way higher in recent months while this issue lurked in the background is astounding. There is an extremely high level of uncertainly over how the world will work in coming years.
BRING ME THE HEAD OF, WELL, ANYONE
As for the Volcker Rule, if it works it is probably only fair, but you have to admit that it is also an arrow in the side of the whole reflation balloon which the administration has been pumping up since last year.
Wanting to avoid a Depression but being unwilling politically to take huge swaths of the banking system over temporarily, U.S. policy in essence underwrote the liabilities of the banking system without taking much of it over, leaving it to get on with arbitraging its new guarantee into profits with which to meet its losses and rebuild its capital.
That worked, if by worked you mean prevented big banks from falling over and revived asset markets.
But seeing as how shareholders are impotent, the bankers are continuing to take a huge, and often growing, share of the loot, a fact that is also politically untenable. Fixing that without undermining the recovery of banking and the reflation of markets is not going to be easy.
Bernanke’s plight, and the related effort to impose a new audit and other controls on the Federal Reserve are similarly both understandable and dangerous.
It’s not as if Bernanke and crew didn’t ask for it — first by standing as godfather to the bubble and latterly by buying up mortgages in what amounts to poaching on the Congressional prerogative of doling out money to specific sectors of the economy.
Even so two things stand out. A Fed chief who has been through a bruising political fight to retain office is an impaired Fed chief, both in terms of perceptions of independence and, potentially, real power and will to fight for that independence. Secondly, even if Bernanke was blameless, unemployment is high, former truths look pretty fragile and we can expect politicians to continue to meddle, or, if you like, to represent their electorates more actively.
It’s possible that Bernanke can play scapegoat, resign, and in going protect the Fed. It’s also possible that he is confirmed and stays with little long-term damage.
The underlying trend — call it populism or call it democracy — is not going away.