Preventing Another ‘Armageddon’: Bernanke, Paulson, Geithner Warn On Deficits, Regulation Rollback, Populism

Say what you will about Ben Bernanke, Tim Geithner and Hank Paulson (and there’s a lot you could say), they do know a little something about being on the front lines in a battle to stave off economic and financial calamity.

It’s been interesting to watch this year as market observers cheer Jerome Powell’s “plain English” approach to Fed communication. I’ve debated the relative merits of putting a non-economist in charge of the effort to unwind the greatest economic experiment in modern history and smart people can disagree on the extent to which that’s a good idea. But one thing that stands out to me as disingenuous is what I perceive to be a tendency on the part of prominent market pundits to suddenly accept the notion that post-crisis monetary policy has created egregious distortions and likely contributed to all manner of bubbles in risk assets as something akin to gospel after spending years characterizing that notion as something akin to a conspiracy theory.

That rather abrupt about-face seemed to coincide with Powell’s ascension to Fed chair. Suddenly, “plain English” Powell is exactly what the world needs to restore capital markets to their traditional role as price discovery mechanisms and his non-credentials in economics are seen as a feather in his cap, rather than a glaring gap in the CV of a Fed chair (don’t get me wrong, his CV is infinitely more impressive than mine and likely yours, but when it comes to experience that suggests he’s qualified to help unwind a $15 trillion global experiment in Keynesian insanity, I’m just not seeing it).

In short, what I wonder is this: Where were all of the folks who are now praising Powell’s “plain English” assessment on the way to implicitly arguing that monetary policy shouldn’t be conducted on the basis of academic theory, when the skeptics of the world were arguing that the post-crisis policy response was dangerous?

Well, I’ll tell you where they were: They were on Twitter, sarcastically posting charts of G4 balance sheets plotted with the S&P and adding derisive captions that suggested anyone who dared to say the correlation between central bank balance sheets and rising stock prices wasn’t a coincidence, was a conspiracy theorist.

Fast forward to 2018 and somehow, that’s no longer a conspiracy, but rather an unassailable fact of market life and those same Twitter pundits know just the man for the job when it comes to restoring discipline and reversing financial repression: Jerome Powell, a relatable average Joe-type, where “average Joe” means a lawyer worth “just” $110 million.

I say all of that to remind you that before everyone jumps aboard the non-economist bandwagon, don’t forget to whom you owe your good fortune in risk assets over the last decade. You owe that to the economists.

Economists like Ben Bernanke, who, along with Paulson and Geithner, delivered a series of warnings about everything from monetary policy to fiscal policy to regulation in a round-table discussion cited by multiple media outlets on Wednesday. Apparently, the three of them are going to host a summit in September.

“It is important that people focus on the lessons,” Paulson said, adding that he, Bernanke and Geithner “aren’t sure people remember everything they need to remember.”

While they note that some of the reforms put in place by Congress following the crisis have weakened the capacity of the Fed, Treasury and the FDIC to respond to crises (Bernanke said it’s “important we don’t backslide any further on those powers”) they also voiced concerns that loosening reforms designed to keep the banking system from taking too much risk is perilous.

Specifically, the trio caution lawmakers not to get too aggressive when it comes to rolling back Dodd-Frank. Here’s Geithner, recalling what led to 2008:

We let the financial system outgrow the protections we put in place in the Great Depressions and made the system very fragile and vulnerable to panic. One of the most powerful lessons from this crisis should be that you want to work very hard to make sure that your defenses are robust.

Not to put too fine a point on it, but Republican lawmakers, in conjunction with Powell’s Fed are rolling back some of those defenses, Powell’s protestations to the contrary notwithstanding. Listen to this exchange with Elizabeth Warren from Powell’s Tuesday testimony on Capitol Hill:

Big banks are required to take annual stress tests to make sure they aren’t at risk of crashing our economy again. Today, I asked @FederalReserve Chair Powell why the Fed looked the other way when 3 banks failed the test: pic.twitter.com/CpLGSQ1uYV

— Elizabeth Warren (@SenWarren) July 17, 2018

Geithner also criticized the Trump administration’s efforts to neuter Warren’s prized Consumer Financial Protection Bureau:

I think the significant intent to erode and scale back consumer protection is something we are going to live to regret as a country.

We ran the financials of the United States for a long period of time with very weak and very limited protection for the consumer. You get tragic results from that.

Last month, Mick Mulvaney (who you’ll recall was installed last year to “lead” the agency following Rich Cordray’s resignation and the accompanying turmoil) fired all 25 members of the CFPB’s advisory board.

Special criticism was reserved for the anomalous fiscal path the Trump administration has put America on.

Piling fiscal stimulus atop an economy operating at full employment has been criticized by virtually every economist, analyst and government official who is not in one way or another beholden to the President. It is, in short, a terrible idea. It risks overheating the economy, forcing Jerome Powell to hike rates aggressively and puts the U.S. on what Jeff Gundlach recently called “a suicide mission” where rates are rising with deficits.

Gundlach reiterated that point in an interview with Barron’s last week:

The strangest thing is that Congress passed a $280 billion tax cut and spending increases so late in the cycle, and with interest rates rising. It’s like a death wish. The U.S. is taking on hundreds of billions of dollars of debt while raising rates, which means our debt-service payments are going to be under serious pressure to the upside.

In late June, Trump economic advisor and former CNBC personality Larry Kudlow elicited all manner of criticism for misleading the public on national television when asked about the deficit. Here’s the clip:

 

That is a demonstrable, bald-faced lie. Everyone knows the deficit is exploding — that’s the main criticism of Trump’s fiscal policy. The CBO projects the deficit will hit $1 trillion in 2020, two years ahead of previous estimates, and part of the problem is Trump’s tax bill.

“Bernanke criticized the deficit-ballooning tax cuts and spending increases agreed to by President Donald Trump and Congress as ill-timed, noting that they come as the country is at or near full employment”, Bloomberg writes, summarizing, before adding that the former Fed chair “also voiced concern about the longer-term consequences of rapidly rising government debt.”

Invariably, some commentators will point to the fact that QE amounts, on some level, to deficit monetization. Those same commentators will point to fiscal largesse from Democrats. But as Geithner reminds you, fiscal policy is about timing. Here’s what he said:

I think the deficit fever of ’09 through ’13 was mistimed, reducing the amount of stimulus spending that might have helped turn around the economy faster. I say the new complacency about the larger deficits is mistimed, too.

Paulson had this to say:

If we don’t act, that is the most certain fiscal or economic crisis we will have. It will slowly strangle us.

Here’s what that looks like, via a chart from the firm Paulson used to run:

(Goldman)

“Today, when we are growing, this is the time when we need to deal with some of the persistent structural issues that are going to determine our long-term economic competitiveness,” Paulson continues, adding that “we have the fiscal deficit, dealing with immigration, the income disparity and what automation and globalization are doing to wages.”

Again, the critics among you will point to the fact (and it is a fact), that the crisis response increased income disparity by ballooning the value of the assets that are concentrated in the hands of the wealthy. Assets like stocks:

(Deutsche Bank)

But that was a side effect of the post-crisis policy response, not a rationale for implementing it. Bernanke didn’t do what he did because it would exacerbate inequality. He did what he did in order to avert another Great Depression (a period he knows a thing or two about) knowing that one likely side effect would be that financial assets would appreciate, and due to the non-linear nature of the wealth effect (it’s non-linear due to the concentration point illustrated above), inequality would probably increase.

Ironically, most Americans who are swept up in the populist fever embodied by Donald Trump, aren’t aware of the dynamics that have actually led to growing inequality. If they were, they probably wouldn’t support Trump’s tax cuts.

(Deutsche Bank)

The middle class (and especially flyover America), is, however, acutely aware of the bad optics around the Wall Street bailout, something which Paulson takes full responsibility for:

The public was angry; they wanted to see us, if not punish the banks, (then) put limits on bonuses. I was totally ineffective at having the American people understand that what we were doing was for them and not for Wall Street.

But Bernanke reminds you that the kind of sentiment currently festering in America almost always ends in tears.

“Financial crises, particularly big ones, do tend to get followed by a population reaction; that was certainly the case in the 1930s,” he said.

As AP notes, that was “an allusion to the rise of Hitler in Germany and other fascist movements.”

I’ll leave you with what Paulson said about the state of affairs that existed in September 2008.

What we were trying to do was to prevent Armageddon. We were looking at a situation where if we felt we had one more big institution go down, it would have taken the whole system down. We were focused on staving off disaster.