Tuesday, June 19, 2007

The Mind of the Chairman

There is little doubt that the actions of the Fed have a powerful influence on the financial markets. And if the Fed has a chairperson who commands respect, then it behooves all investors to try and understand the mind of that individual.

Last Friday, Ben Bernanke gave a speech that, in my opinion, revealed much of his fundamental perspectives on key aspects of monetary policy. In a speech titled “The Financial Accelerator and the Credit Channel”, Chairman Bernanke described and expanded upon his original 1983 work on the same topic. The speech was most informative on a number of levels, including the his view of non-bank lending.

In the traditional areas of credit creation (specifically bank lending), Bernanke's financial accelerator thesis is useful in “understanding the nature of the monetary policy transmission process.” It is also useful in understanding the Chairman’s view of the current housing slump and how “If the financial accelerator hypothesis is correct, changes in home values may affect household borrowing and spending by somewhat more than suggested by the conventional wealth effect because changes in homeowners’ net worth also effect their external finance premiums and thus their costs of credit.” Given the importance of the US consumer, how the Fed views the impact of the current housing slump on consumer spending should be of great interest to all investors.

Yet, it is Mr. Bernanke’s comments re non-bank lenders that, unfortunately reserved to the next to last paragraph, investors might wish take special note. Chairman Bernanke believes that “non-bank lenders also face an external finance premium” and that “the ideas underlying the bank-lending channel might reasonably extend to all private providers of credit.” In other words, he sees little reason to view the explosion in non-bank sources of capital any differently than bank lending. This could be a big mistake as the Fed could easily underestimate the "financial accelerating" characteristics of this powerful, largely unregulated force of money.

Investment Strategy Implications

The speech is of value to all non-economists if not for anything than as a worthwhile exploration of many of the key concepts that nearly all economists rely on. Since most investors are not practitioners of the dismal science yet markets are heavily influenced by their opinions, a better understanding of how an economist thinks is always of value. It is of even greater value when the speech is from the single most important financial figure in the world and on a subject that is clearly close to his heart.

To view the speech, Click Here

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