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Daily Global Commentary

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Chairman Bernanke, It is Time to Grab the Reins and Lead

Wed, Sep 24 2008, 22:46 GMT
by Asha Bangalore

Northern Trust

Chairman Bernanke, It is Time to Grab the Reins and Lead

With all due respect, Chairman Bernanke, you have led the Fed admirably in the charge against the current financial hurricane in the past thirteen months with numerous innovations and timely measures, but you have to do more now than endorse the Paulson rescue plan. In the past two days, your testimony has noted the need for immediate action to calm markets and prevent a dire economic recession. The world is fully cognizant of this fact and it is widely recognized that a monumental step is necessary to restore calm in the global financial marketplace. The current crisis is of historical importance because of not only its nature and scope but also the fact that the world looks upon leadership from America on various fronts and particularly in economic and financial matters. I am sure you were consulted on the details of the plan and the Fed has a fleet of experts to study and evaluate it. Economic and financial experts of different political persuasions are united in their view that the Paulson plan needs improvement. In addition, members of Congress are not convinced of the merits of the plan. There is no reason for a hasty passage of a faulty plan. The Paulson plan surely did not strike you as the best solution.

Let us accept the premise that a rescue plan in necessary. There are opinions and evidence that the Paulson plan may not be necessary. Hear Prof. Meltzer or read the transcript for a discussion about why a rescue package is not a great idea. Other important insightful comments from Paul Krugman can be found in the same link.

http://www.pbs.org/newshour/past_programs/2008/september.html (video)
http://www.pbs.org/newshour/bb/business/july-dec08/bailouttalk_09-23.html (transcript)

Prof. Meltzer cites the example of Morgan Stanley’s recent deal with a Japanese firm and Merrill Lynch’s sale. Don’t forget what Goldman Sachs obtained from Warren Buffet. This route to resolve the entire crisis is late because markets expect a plan. So, what should be done?

The numerous facilities established at the Fed to obtain funds and the nationalization of Fannie Mae and Freddie Mac have bought the time necessary to examine all other solutions. With all due respect, Mr. Bernanke, declare that a package whose proposals and implications are not thoroughly examined should not be the burden of taxpayers. Of course, you may need to say this in more diplomatic terms. The ongoing debate in Congress, calls from the public to representatives of Congress, and the fact that the press is inundated with critical comments and letters to the editors are examples of the plan’s serious weaknesses. Call upon Congress for a special session to examine the issues carefully with full representation from experts. You have the stature, credibility, and leadership to declare this is as a necessity. It would be a serious lapse of leadership if alternatives and/or improvements to the Paulson plan are not considered. Of the many comments and discussion in cyberspace, here are two. Glenn Hubbard, Hal Scott and Luigi Zingales map out a plan in today’s Wall Street Journal (Let's Get the Bank Rescue Right - WSJ.com). Charles Calomiris of Columbia University has suggestions in “A Matched Preferred Stock plan for government assistance” (FT.com | The Economists’ Forum | A Matched Preferred Stock plan for government assistance#more-186). The bottom line is that a rushed plan with numerous visible faults is not the best solution for taxpayers to shoulder in the name of restoring the functioning of financial markets.

Sales of Existing Homes Continue to Maintain Downward Trend, but Inventory Situation Is Improving Gradually

Sales of all existing homes fell 2.2% to an annual rate of 4.910 million units in August. Purchases of existing single-family homes dropped 1.4% to an annual rate of 4.350 million units, close to the cycle low reading set in June 2008 (4.26 million). Sales of single-family homes appear to be stabilizing around the 4.3 million pace, which can be seen from the fact that sales of existing single-family homes have held in a narrow range between 4.21 million and 4.47 million units in the first eight months of the year.

The good news is that the inventory of unsold existing single-family homes fell to a 10.4-month supply in August from a revised 10.9-month supply in July. The inventory of unsold single-family homes is also down to 10.0 months from 10.4-month mark in July. This trend is encouraging but more is necessary.

The median price of an existing single-family home fell to $201,900 in August from $208,900 in July. On a year-to-year basis, it is down 9.8%, the largest drop in the history of this series (see chart 3). Compared with the peak median price of an existing single-family home in July 2006, the August reading translates to a 12.6% drop (see table 2). The large inventory of unsold homes points to a further reduction in prices in the months ahead.

Deteriorating Outlook for the Euro-zone

A month ago, two of our favorite leading indicators for the Euro-zone economy were pointing to a slowdown but not an outright stop, and we were still hopeful that signs of recovery could be cropping up by the end of this year. One month on, the outlook has deteriorated.

Germany’s Ifo business climate index for September – a poll of around 7,000 firms – deteriorated for the fourth consecutive month, coming in at 92.9 (94.8 in August). The gauge of current conditions dropped to 99.8 (103.2 in August) and the expectations index slipped to 86.5 (from 87.0), its lowest level in 15 years. The overall index is still above the lows recorded in late 2002, the last time Germany was headed into recession. However, as we’ve noted before, the speed of the recent fall is disconcerting. Or, as the Institute stated in its own commentary: “The downward trend…is proceeding in large steps.” It should also be noted that about 60% of the survey’s responses were gathered before last week’s news about the collapse of Lehman and the rescue of AIG. It is therefore highly likely that the business climate index for October will be significantly lower.

The September Belgian National Bank business confidence index (a leading indicator for Euro-zone growth about six months out), released yesterday, dropped to a five-year low, coming in at -14.1 (-5.9 in August). Confidence deteriorated in all sectors, with a notable decline in manufacturing (falling to -15.8 from -5.6 in August). The BNB reported that indicators relating to domestic and export demand “deteriorated considerably.”

Not surprisingly, other business confidence indicators have also been gloomy. French business confidence fell to a five-year low this month, with the main index reading just 92.9, while Italy’s came in at 82.7 – the lowest since September 2001.

Yesterday also brought a slew of flash purchasing managers’ indices from the major Euro-zone economies – and all the news was gloomy. The Markit composite PMI for Germany (combining the manufacturing and services surveys) fell to 48.6 (50.5 in August), with the manufacturing index dropping to 48.1 (49.7 in August), its lowest in eight years, and the services index edging below the growth-contraction mark of 50, coming in at 49.3 (51.4 in August). In France, a slight improvement in the services index helped the Markit/CDAF composite PMI to recover slightly, to 47.7 (46.9 in August), but the manufacturing index saw its sharpest fall in six and a half years, dropping from 45.8 in August to just 43.6. Not surprisingly, the composite PMI for the Euro-zone as a whole fell from 48.0 last month to 47.0, with the manufacturing PMI dropping to a seven-year low of 45.3 (47.6 in August) and the services index stalled at 48.2 (48.5 in August).

All of which confirms our earlier suspicion that the Euro-zone will see a second quarter of contraction in Q3, and significantly increases the risk that Q4 will bring further negative growth. Upcoming data releases to watch include the German Gfk consumer confidence survey for October (due September 25), preliminary German inflation (September 26), Euro-zone September sentiment surveys (September 29) and flash Euro-zone inflation data for September (30th).

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Published on  Wed, Sep 24 2008, 22:51 GMT