Is Bernanke As Dumb As a Fox?

03/26/2008 12:00 am EST

Focus: MARKETS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, editor of the Forbes/Lehmann Income Securities Investor, says the Federal Reserve chairman may have a secret plan for dealing with the current crisis. 

Federal Reserve Chairman Ben Bernanke promised a new era of transparency for Fed policy. So far markets have not liked what they have seen. Mr. Bernanke is accused of following rather than leading and of cutting rates too deeply, thereby inviting the onset of inflation.

But is the chairman perhaps a bit smarter than he is truly transparent? To conduct Fed policy requires a degree of opacity, something Bernanke has by now learned. This is because there is too much capital in the world in the hands of “smart money” managers ready to exaggerate or neutralize any overt policy moves by the Fed. And sometimes the Fed needs to do something that is not only controversial, but also dangerous, e.g. the cutting of the discount rate down to 1% from 2001 to 2004 and its unintended consequences, which action still bedevils investors today.

Now Ben, suppose that the economy is facing recession, suffering a housing inventory glut and a mortgage reset and payment crisis. Meanwhile inflation, the threat everyone thinks should be your number-one concern, is growing. What do you do?

Well, you can do what Alan [Greenspan] did in 2001—drop the discount rate to 1%. This would reduce the reset rates adjustable rate subprime mortgage holders would have to pay. It would also reduce interest costs on their alternative, switching to a fixed-rate mortgage–provided they can still go that route. Bottom line, you would have fewer defaults, fewer repossession additions to the housing inventory and increased confidence that the crisis is over.

What makes such a solution particularly elegant is that Wall Street and the media will scream that you don’t understand what you’re doing and that their “perceived” inflation is going to go through the roof. But, you and I know that the most popular way “smart money” protects itself against inflation is buying a piece of beaten-down real estate like a house or condo. With about two million excess housing units congesting that market, there’s a lot of inventory to be bought by this “smart money” before the housing market gets back to normal.

Now, in order to pull off this hat trick, Ben, you have to look a little dumb—and so far you have been doing a fine job of this. Of course, nine months or so down the road you also have to suddenly get smart and reverse course before “real” inflation does take hold.

That’s when we’ll see if you can do what Greenspan could not. For in life, it’s good to be smart, but it’s even better to be lucky. I hope they’re paying you some big bucks, Ben.

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