When the Bernanke Bluff is Called


The stock market fell 27% in a single day. Bank of America suspended ATM payouts and JP Morgan applied for bankruptcy protection. Citigroup defaulted on its bonds and Deutsche Bank shares weren’t allowed to trade on Europe’s stock markets after its shares fell 86% on America’s stock market.

None of this happened on Wednesday. But it would have if anyone believed Federal Reserve Chairman Ben Bernanke’s sworn testimony to Congress. Instead, he was either ignored or called out as a complete liar.

Bernanke made one of the most explosive and dangerous claims a Federal Reserve Chairman could possibly make, and the market didn’t tank. Instead it rallied. It’s crucial to understand why if you want to prepare for the fateful day his lie will be exposed.

Here’s what went down at the Congressional hearing.

Senator Elizabeth Warren asked Bernanke about the fact that the ‘too big to fail’ banks were able to borrow money cheaply because they had the Federal Reserve and government backing them. According to a study, the big banks’ borrowing costs are $83 billion dollars less because of the implicit subsidy. Here’s what Bernanke answered:

‘Well the subsidy is coming because of market expectations that the government would bailout these firms if they fail. Those expectations are incorrect. We have an orderly liquidation authority.’

This is a truly surreal claim. Bernanke is saying he will not bail out banks like Lehman Brothers and Bear Stearns if they fail. Instead, he will try to liquidate their assets, a kind of managed bankruptcy. Remember, the financial crisis really took off when the Federal Reserve tried to do this in 2008 with Lehman Brothers and AIG.

The irony here is so thick it hurts. First of all, the whole purpose of a central bank used to be to save too big to fail banks. It was the financial system’s backup. The idea that a central bank should manage the economy is comparatively recent. Now that the Fed is declaring its original purpose null and void, it’s only left with managing the economy. It’s gone from being a back up failsafe to a central planning authority.

Secondly, Bernanke is clearly bluffing. He wouldn’t hesitate to bail out a failed financial institution. Lehman Brothers and AIG are in the ‘what not to do’ section of the central banker’s handbook. So why is he claiming banks will be allowed to fail?

If Bernanke comes out and says ‘we’ll bail out anyone big enough’, that will increase something called moral hazard. A government guarantee is a license to misbehave at someone else’s expense if things go wrong, but to your benefit while it all goes well. Bernanke can’t be seen encouraging that openly. It must all be implicit. By the time banks need bailing out, no politician will be brave enough to remind Bernanke that he promised not to.

The stock market knows Bernanke is bluffing. It didn’t blink when he gave his remarkable testimony. As Senator Warren pointed out, past experience from the financial crisis proves Bernanke is willing to bail out everyone he can:

Warren: ‘You did not wipe out the shareholders of the largest financial institutions, did you — the big banks.’

Bernanke: ‘Because we didn’t have the tools. Now we could. Now we have the tools.’

Warren: ‘Whatever you’re saying Mr Chairman, $83 billion dollars says that there really will be a bailout for the largest financial institutions if they fail.’

Bernanke: ‘No that’s the expectations of the market, but that doesn’t mean that we have to do it.’

This is a wonderful case of the emperor having no clothes. Nobody believes Bernanke’s sworn testimony. Remember the days when that could land you in gaol?

The thing is, none of his facade does anything to improve the economy. At some point, Bernanke’s bluff will be called. He will have to bail out another financial institution. If he suggests using the ‘liquidation authority’, the stock market will drop out from underneath his feet. Instead, he will step up rescue efforts.

And that leads us to the bigger bluff at hand.

Imagine you bought jewellery for your mistress. There are two ways of doing it. One, you pay cash. The other, you pay by credit card, using the bank’s money. Do you think your wife would care which way you paid if she found out? Explaining that the bank bought the jewellery, not you, probably wouldn’t make a difference.

Bernanke is trying pretty much the same argument he used in testimony to Congress back in 2009. Then, a representative asked him ‘Will the Federal Reserve monetise this debt?’ He replied, ‘The Federal Reserve will not monetise the debt’.

Since then, the Fed has purchased vast amounts of government bonds with money it creates in the process. But because the Fed doesn’t buy the bonds directly from the government, it’s not called ‘monetising’. At least as far as they’re concerned.

Just like with the jewellery for your girlfriend, the banks are playing middle man. The Fed buys the banks’ bonds and the banks buy the new bonds from the government. The end result is the same. The Fed is in all but name monetising the government’s borrowings.

Of course, the banks only do so because they get to skim off a bit of the cream in the process. They earn vast amounts of money for doing something their customers don’t really want or need, while playing their part in a bigger scam. Think of them as Rufus in the movie Love Actually.

Would You Like Your Monetisation Gift Wrapped?
Source: Love Actually

It’s not just government bonds the Fed is buying. Bloomberg reports that the Fed’s latest money printing efforts are ‘effectively absorbing about 90 percent of net new dollar-denominated fixed-income assets…’ That’s 90% of the increase in total US dollar denominated fixed income assets, not just government bonds. The Fed is buying the entire jewellery store. No wonder financial assets are going up in price.

The real fear is that the Fed will have to reverse all these purchases at some point. When inflation takes hold the Fed will have to drain the money it pumped into the economy back out. But doing so involves selling the assets it bought back into the financial markets of the world. Imagine dumping several years’ worth of the US’s fixed income assets onto markets. Interest rates would skyrocket and prices would tumble.

Slipstream Trader editor Murray Dawes has all this figured out, going by his last bunch of trades. He’s heavily short the industry that will suffer if Bernanke makes a mistake and equally long the industry that will profit. But it’s his unique style of trading that he is focusing on in his upcoming video to subscribers. Keep an eye out for it.

Nickolai Hubble.
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Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.


  1. you may have missed the new FED job description passed in 2010, aka dodd/frank.

    many know-it-all type pundits make the same MISTAKE, due to i.g.n.o.r.a.n.c.e.

    or, they are simply part of a v. large disinfo campaign run by a handful of online publishers and their minions.

    you see, after the problems last decade, they actually changed the law about being “too big to fail”.

    maybe in a coupla more years your head will clear and you’ll be able to smell. the. coffee.

    long shot, i know.

    i’m not saying this is “good” or “bad”, just that it is, unhh… truth.
    congratulations on your personal face-omelette!

    slewie the pi-rat
    March 4, 2013
  2. I think what slewie is saying is the same as Kohler today…. that Bernanke will just double down, print, and let the inflation run.

    He can keep seek to contain it by naming his own price and asset bubbling. Buffet indicates that he thinks he can with his latest funny money backed moves (Hutchinson’s Prudent Bear banner reads: Warren Buffett Looks Like a Leading Indicator: When Cash is Trash, Beans are Queens!)

    But I don’t see how it hits the streets effectively enough without street level inflation. If people can’t afford rents they lock them out in the US and I don’t think they can culturally change to do anything else within a medium term. The elite can pass the asset parcels among themselves on extended and pretended funny money but how do you convince the little guy to buy-in and turn it into consumption at this point? You can inflate his debts away (or into something more manageable) only with street inflation and bank balance sheet damage (remember the Fraser government years!). The difference I have with Kohler for Australia and the AUD is that I see higher street level interest rates migrating, ballooning in the carry trade differential manner that we are addicted to, and subsequently flattening us when we make a half arsed attempt to do the orthodox thing in response.

    Maybe the above contention is a wave I would be catching too soon as is usually my style. Interested to hear more. Slewie is about as forthcoming as some old mates on this site….

  3. Kohler’s view is built upon this (and this interest rate level continuing)


  4. my point is that the bernankster sez (to Sen. Warren}:> ‘Those expectations are incorrect. We have an orderly liquidation authority.’

    nickH, the author, claims this is b.s. (“explosive”, “dangerous”, “surreal”) and introduces “what went down” with [Paste} It’s crucial to understand why if you want to prepare for the fateful day his lie will be exposed. {End]


    my point is that theBenBernankster is correct. try reading about the post-crisis dodd/frank law and see for yourself. the law no longer permits “bailing, not failing” at the public trough. PLUS, the FED has a new “committee” to report to, and it is directly connected to the CFR (Council on Fornographic Relations).

    mrHubble seems not to be aware of this.

    during the last US election cycle, many pundits and prognosticators made this same error:> i.e., they did not have their facts straight re the FED under the dodd/frank legislation of 2010.

    some of the more prominent trend-setting publishers such as the agora peeps, peter @Au.seek, tyler @zH, casey, butler, and even mauldin to some extent, all got this wrong GOING INTO THE US ELECTION. and, they appeared to this pi-rat to be humping the election boonies with packs full0’neoCon (Republican) m.o.n.e.y. for their editors, writers, and techs.

    just a coincidence, perhaps, but propaganda IS propaganda, is it not? disinformation IS really, right in front of your eyes.

    try opening them?

    slewie the pi-rat
    March 5, 2013
  5. slewie, agree re Dodd-Frank, we didn’t even need to read it at the outset to realise that we never see that many lines in legislation without there being contrary intent in respect of the legislation vs the prevailing narrative line.

    ps: if I were writing a constitution today, the greatest service I could deliver constituents would be to seek to impose an absolute limit on the number of words in a given piece of legislation; and for the inclusion of a prevailing opening statement in each piece of legislation from which all the following words were lawful only so long as they didn’t contradict, and indeed were explicitly correlated with, that limited opening statement.

    The Fed have already started nudging the “there are concerns” bow on the ship of chatter seeking to turn it (where Fed QE withdrawal chatter was prevailing in public discourse in recent months). Santelli’s recent rhetoric must be a “concern” to them, which in turn should be a “concern” to Santelli if they find it harder to award him a fringe status.


    If the EU stands as it is, the CFR retain control of world government without it. But do they want an EU? Isolated Germnay making a lone stand is something they can deal with – they figure they’ve proved that. There can’t be a disregard for austerity in the Anglo world (assuming Brits leave the Eurozone and Japan is cemented in) while the EU does austerity and keeps traditional restraint on land price inflation. The Nordic countries are under the US’s wing leadership like never before. The periphery ratbags including the basket case Baltics are hanging by threads whether in or out of the EU (Eurodollar austerity or jump ship to debilitating levels of inflation).

    I loved the Rothschild Economist piece on the Tobin Tax just recently simply titled “Bin it”. There’s a fault line for you….

    On ZH, the longstanding link to Stratfor for sewing geo-political misinformation (which they have seen as a credibility achilles heel and tried to tone down recently), and the flirty fishing for the ID’s of financial industry dissenters and anti-semitic type’s, may be as important to them as the narrative misses at critical turnings.


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