Bernanke - It's Complicated!
Get ready for more money to be printed - this time not to subsidize an overly indebted American consumer, but to stem against the credit destruction caused by the Federal Reserve (Fed) itself. Tuesday evening at the International Monetary Conference in Atlanta, J.P. Morgan CEO Jamie Dimon gave a laundry list of changes that have already incurred in the banking system, including
No more Special Investment Vehicles (SIVs)
No more sub-prime, no more "Alt-A" mortgages
No more CDOs
Higher underwriting standards
On top of these changes, the Fed now wants to introduce 300 new regulations. Has anyone at the Fed studied what impact these regulations will have on credit?
A fair question, to which Fed Chairman Bernanke stumbled, "it's Complicated!" He then admitted that no such study has been undertaken and that, indeed, tradeoffs have to be made and that the impact on credit will have to be carefully monitored.
For practical purposes, we believe we should expect more easy money; Dimon is correct that headwinds caused by upcoming regulations, as well as those already introduced since the onset of the financial crisis, are enormous. To keep the economy moving ahead nonetheless, more money may need to be printed than even the Fed expects.
Unfortunately Bernanke misses the obvious: if it is so complicated, make it simple. Keep It Simple Stupid is a paradigm that should not only apply to monetary policy, but also to regulatory policy. In our humble opinion, regardless of regulation imposed, bankers will remain one step ahead of regulators. They simply have greater resources to find loopholes - introducing fancy terms like "macroprudential supervision of financial institutions" won't change that, either.
Regulators should embrace the challenge by working with market forces, rather than over-regulating the system, thereby stifling economic growth. There are simple levers that can be employed. For example, we believe that speculators should not be prevented from making dumb decisions, but processes should be in place that dumb decisions do not cause systemic risks. Such a policy is fairly straightforward to implement by imposing margin requirements on leveraged bets. Add transparency and mark-to-market accounting and you have already achieved a more stable system, with incentives to use less leverage. There are additional measures that can be implemented to force banks to de-leverage their balance sheet should the market, rather than regulators, believe banks engage in behavior that's too risky (e.g. by requiring banks to issue substantial amounts of staggered, long-term subordinate debt; should the cost of refinancing be unattractive, banks need to shrink their balance sheets, but can do so in an orderly fashion).
Some concluded from Bernanke's talk that there is no additional round of quantitative easing, a QE3, in sight. Our view is that the Fed is simply baffled that all the money printed has not worked, and will wait and hope... for now. But because things are so complicated, sprinkling more money on the problem may be the weapon of choice in the not too distant future...