The Bernanke Conundrum

EconMatters's picture

By EconMatters

Ben Bernanke gave a press conference after the last Fed decision where he laid out the Fed`s plans for exiting their stimulus program and the market to put it bluntly freaked out with Bonds yields soaring, and all other asset classes selling off sharply. The Fed didn`t like the reaction, especially with bond yields jumping much higher than they ever anticipated, and immediately sent numerous Fed governors to the media trying to talk back the market, again especially bond yields.  



The Definition of a Bubble

The fact that the market would react so dynamically without the fed actually doing anything, and only talked about slowly transitioning from QE purchases in a tapering fashion with a rather drawn out process through the summer of 2014 means the federal reserve has created massive bubbles in several asset classes.

This is the very thing they were lecturing everyone about on how fed policy going forward would be different this time and that they finally learned their lesson after the 2007-08 financial crisis caused by having the fed rates too low for a prolonged period in order to stimulate the housing industry.  




Well not only has the federal reserve kept the fed funds rate too low for far too long a period, but they injected billions and billions of dollars into asset classes with their various outright purchase programs which had the effect of pushing many asset classes several standard deviations beyond their normal sustainable levels through normal market conditions. This is the definition of a bubble all over again!


Further Reading: China GDP To Hit 6.7%

The Conundrum

The catch 22 is that they cannot exit now without markets and asset classes freefalling back to natural sustainable levels, yet markets are at hundred year highs! The real problem is that if they cannot exit now, then they push markets and asset classes even higher artificially to even more unsustainable levels! The drop becomes even more pronounced a la the Tech bubble where stocks trading in the 100`s dropped to zero, silicon valley had their fire sale for property as all the business built up around unsustainable market valuations came crashing back to reality.



The Original Plan

The thought was that, or rather the original hope by the fed, I am sure they thought of it more as a theory was that they would push or support asset prices up until the economy picked up and then the next business cycle would kick in and take over or be able to support asset prices as they withdrew the stimulus. But it has been five years of artificial stimulus and the economy still cannot hold up or replace the fed`s stimulus measures without asset classes falling precipitously.


Further Reading: Oil Myths & Why WTI Is a Short

The Bubble is too Big for Original Plan

Here is the most salient point the bubble is so big now after five years of artificial stimulus that even a robust economy that creates 350,000 new jobs each month, and a GDP of 3.5% cannot replace the offset of the fed removing their stimulus from the markets. Asset prices are going to fall rather hard once the fed leaves as we witness even at the hint of tapering.



This is because asset prices have been inflated for five consecutive years. This has never been done in the history of financial markets.  The fed has outdone every previous bubble they have ever created, and as all asset classes are inter-related, leverage is used, and the correlation of asset classes in greater than ever before in markets. There is no possible exit without causing massive money flow disruptions in financial markets. Every asset class is based upon and relies on the fed stimulus each month like a financial market crack addict.


The Withdrawal Effect

Shoot you cannot even get prescription sleeping aids these days without your doctor lecturing you on the effects of the withdrawal phase. Not receiving $85 Billion each month that finds its way into financial assets is going to create a significant withdrawal phase for markets. The longer the policy continues the more severe the withdrawal phase becomes similar to withdrawal from a highly addictive drug.



Portfolio Expiration is a nice trick, but only addresses a third of the Withdrawal Effect

The talk of just letting the portfolio expire on the fed`s books without them selling these assets into the markets completely misses the point. Yes that will make it worse selling those massive positions, but that is a foregone conclusion that they cannot sell those into the market. It is the stimulus each month during these QE1,2,3,4 programs that being taken away is where there is no way to mitigate or hedge the market withdrawal, i.e., the bubble effect.

When you have Amazon going from a $50 stock to a $310 stock on several years of poor earnings results, an electric car company in Tesla that has a stock price at $130 a share in a boutique market, where low growth companies like Microsoft, Yahoo and Intel are all having ridiculous multiple expansion for dying business models illustrates how valuations are getting really frothy and bubbly in financial markets.


Fed Options & Damage Control

There is a bubble, and I think the fed realizes it and are trying to figure a way out of their predicament. The best way is to take some short-term pain and stick with the program. The worst way is too never stop the program because the bubble gets so big when it crashes it will crash despite the fed`s participation, and given no more bullets the entire system collapses. This results in disaster cleanup mode where after the carnage somebody picks up the pieces and starts all over again trying to construct healthy markets from scratch.


Somewhere between these two options is to intend to stop in the near-term future in a tapering fashion but the markets leave or front-run the fed and correct or price-in the collapse/money flow disruptions on their own in essence breaking the fed`s credibility.


The Bond Vigilantes

This is what the bond market is already starting to do in fits and spurts. But we haven`t seen anything yet by the bond vigilantes. The only thing we have seen so far is an $80 Billion withdrawal from bond funds as investors try to protect principal. Make no mistake we haven’t even begun to experience any vigilantism in bond markets.


When this happens the worst thing the fed can do is try to fight them as the perception that they are out of touch further erodes credibility, and the market becomes panic stricken where normal valuations and previous models go out the window.


The Fed behind the Curve due to Market Appeasement

I think the fed realizes there may be a problem, but I don`t think they have a clue how serious the problem is because they just don`t understand actual market structures these days. These are all economic trained academics and not a single fed member has any actual market experience in the industry.


Academics don`t fully understand financial markets – Underestimate consequences of policy

They have no clue about how leverage is used these days with futures and options, the interconnectedness of assets, and how once the bubble starts receding or losses start in one area of the market they become exponentially compounded because of the advanced financial tools meant to maximize profits on gains.


Well the reverse happens on losses and despite credit default swaps being monitored more closely, i.e., firms probably are not going to sell more credit default swaps than the value of their firm; other lever-able tools and structured trades in the current system are more than enough to create massive losses on the bursting of the Fed QE inflated bubble.


The Federal Reserve just doesn`t understand the magnitude of the unintended consequences of this current QE conundrum that they are locked into. The inescapable fact is that the busting of this bubble, and it will bust at some time, is going to cause massive losses in the financial system.


The question is what if anything can they do to minimize the collateral damage from a known bubble that exits in numerous asset classes, and how to minimally prick or slowly deflate this bubble without ending up in a worse place than you started out at five years ago. This is the Fed Conundrum!

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ebworthen's picture

Bubble part two.

Or bubble part three if you count the .com bubble - or bubble four if you count the interest rate/savings and loan bubble - or bubble five if you count Nixon unhinging the dollar from Gold - or bubble six if you count the military/industrial complex taking over post WWII combined with the corporatocracy pushing for Mom to leave the house and work and farmers and families to leave the farm to let the petrochemical industry take over food production.

Wait, I forgot the offshoring of productive career employment to anywhere but the U.S.A.; I suppose that is the biggest bubble.

toadold's picture

Do you guys remember that video of the rat traps and ping pong balls that was used to illustrate how nuclear fission works?  They spread out a bunch of rat traps with ping pong balls on them. At a low density of rat traps you could throw out a ping pong ball that would trigger a trap and that might  trigger off a couple more.  Increase the density and then you would get a somewhat gradual increase in the  tripping of all the traps. Increase the density some more and when you threw out a ball it was an explosion of ping pong balls and snapping rat traps. You look out the window that is the internet and you see an awful lot of rat traps being set. Financial, legal, military, and etc. Instead of ping pong balls it looks like hand grenades and real rats and God help the innocent and unprepared (of course what is proper preparation these days?)

One dangerous method they used to fight fires was counter fires, they would start a controlled burn in the path of an oncoming fire to remove fuel from the path. It would be ironic to get caught in a financial or law and order counter fire. 

andrewp111's picture

Cyprus was such a controlled burn, done on a test case experiment because Cyprus is too small to cause a chain reaction.

geno-econ's picture

Volker for President !  Even with dementia he is smarter than the current pyramid gangsters. David Stockman for Vice President.  Kyle Bass Chairman of Federal Reserve.  Tyler Sec. of Treasury.  Now you have a ticket with real change

Blue Dog's picture

The problem isn't the market. The problem is the trillion dollar deficit. That's what QE funds.

blindman's picture

the problem is the money system is a negative pressure pump
that is directly draining the liquid in the lake we call
the markets and real economy.
they say we need more debt, negative pressure, to actuate
the draining and pump head or the suction will disappear.
so what?
so they are trying to set up a sort of market/s on the other side
of the hose where all the liquidity is. that this scenario will kill
the markets and economy and people is not their problem. it is their
benefit and exploit and they have made this legal. I just call it
fraud and stealing because that is what it is.
how many times can it be said? fiat money , fractional reserve banking
in the private hands of the central bank has a trajectory which should
not be all that mysterious or complicated. they will STEAL ALL THE MONEY
so let us see ..." we need more debt to cover the astronomical debt and cure
our addiction to fraudulently induced debt." here the opportunity to
transfer the "cost" part of the debt.
it is actually historic and hysterical not to mention horrible
that people allow it or can't comprehend it.

blindman's picture

1.A confusing and difficult problem or question.
2.A question asked for amusement, typically one with a pun in its answer; a riddle.
riddle - puzzle - enigma - mystery
the answer; it is all smoke and mirrors perpetrated by the central
bank and can be dissolved or evaporated in an instant. then people
might see the value of hard assets and important skills and qualities
like integrity, leadership, etc....

disabledvet's picture

no one expected this move...least of all me and i'm long the market. the bottom line is a soaring stock market is your exit strategy. PERIOD. one look at tax revenues says to me "everything is a go." this does not mean the equity space goes higher nor am i betting as such currently (still.) having said that those who believed they could get the Fed to stand in the way of all this by The Taper have been in my view THUMPED. throw in nationwide riots and craziness in the Middle East and i think treasuries really can rally to below 1 percent...with an extra 1000 points on the Dow thrown in "for shits and giggles."

RaceToTheBottom's picture

The FED will do what WS wants them to do.  Everything else is windowdressing

DawgAss's picture

And Bernanke shits all over himself ....AGAIN!

PS Fuck You bernanke

moneybots's picture

"I am sure they thought of it more as a theory was that they would push or support asset prices up until the economy picked up and then the next business cycle would kick in and take over"


The next business cycle did kick in- the problem is that the excesses of the boom have not been cleared out, thus the current business cycle has been left handicapped.  That is the problem with all this financial manipulation.  Pull demand forward artificially, eventually future demand disappears.  Math always catches up, so why manipulate it for POLITICAL PURPOSES in the first place?

Bush Jr. got a housing bubble, to give him a second term and retain a republican congress.  Now republicans are stuck with Obama and wound up with a two year democrat congress majority, as blow-back, when the economy crashed as a result.

otto skorzeny's picture

LOL-assets at "sustainable levels"- like oil at $30 a barrel, 30 year treasuries at 6%, gold at $600 an oz and the Dow at 6000? at that point I would consider breaking open the bank of Sealy to invest in the "markets".

derek_vineyard's picture

japan 40K in 1987

25 years later.............

thats what we need here ( a crash in paper wealth)...we are an aging society , losing our competitive should be discounting this but i forgot we have helicopters.  can i post my exact coordinates and have a drop right on my home?  


moneybots's picture

"Ben Bernanke gave a press conference after the last Fed decision where he laid out the Fed`s plans for exiting their stimulus program and the market to put it bluntly freaked out"


The market didn't freak out.  The financial suppression is a FINANCIAL FRAUD in the first place.  Where do interest rates and the stock market price really belong?  Definitely not where they were at the beginning of May.  It was through blatant FED manipulation, that the 10 year was 1.5% and the DOW was at 15,000.  Manipulated markets ALWAYS blow-back against their manipulators. 

Markets that go up on financial fraud, crash on financial truth.

Aquarius's picture

Both the written Idiom and Money, per se, are measures of humanity. (to measure is a qualitative verbe).

Both have been weighed, measured and found wanting (Daniel)

The FedRes actions both under Greenspan, complicity with the Clinton/Bush Administrations and by open and public promotion of the Iraq invasion, and Bernanke's wealth transfer from productivity to the non-productive Banking System classes which can only be intended to support the continuity of the Project for the New American Century Policy (PNAC) of infinite mass Blood sacrifice, mass genocide and endless War. The Global Cull with a twist; the sweet taste of endless blood of humanity for the "neocons' aka Bolsheviks.

Here is "Economic Theory" in practise: blind utopian faith in obedience and political expediency for the desires of the Master Collective aka  the Banking System; the  true Ponzi schema. The FedRes below screams that it is superior, misunderstood and is doing things for the greater and noble good; your good, while adding more fuel to the fire, under the pan, where YOU sit in the water in a state of false belief, gullibility; betrayed and ready for the sacrifice; your sacrifice. 'Trust us, forgive us; we are fixing it for you and your security' but we can't tell you what we are doing because you are incapable of the high level mathematics in which we have been personally gifted by God'. (roll your eyes and scream out 'Oh, Lordy'. Mathematics are only uselful to describe what exists and not that which does not exist; it is all an imposed allusion by the deluded.)

Philadelphia Fed ‏@philadelphiafed45m

#Plosser: Just because markets like what we are doing now does not mean that it is the best thing in the long run. http://  

The bottom-line is that the USA as we have known it as the great Light of Freedom and Liberty for all has been captured and is being destroyed from the inside; nothing new here. The final moments are already in play; you are now experiencing the Fall of Rome; today is the continuation of the 1917 Bolsehivek Revolution..


The Greatest declarations of humanity ever recorded in written history are contained Declaration of Independence, The Constitution of the United States of America, the Bill of Rights and their premable, essences and contributing intellectual correlations. It is the Supreme Law of the Constitutional Republic known as the United States of America,


The President of the USA today is said to be a Professor of Constitutional Law - if you believe that you will believe anything. The White House spokesman Mr. Carney is said to state that Snowden is not a "dissident". Obviously the White House is not only incompetent, obedient to its masters but also delusional. And it has been reported that the US has a secret Court that over-rules The Supreme Court, and is so secret that its finding in Law are kept as secret. Its victims are then found guilty and incarcerated, executued or assassinated without ever knowing why? A Constitutional Lawyer, I think not. Your President is merely a charlatan.


Is it not clear to you Americans that Your Government is intent on your total suppression? For non-Americans it is clear that your Government is also intent on Global Totalitarianism aka Global Communism; the banner of vile corrupted ideology carried by the demented and twisted pervert Bolshevik, Leon Trotsky, the hero of your embedded "neocons" that are clearly running the United States of America today? Note that before "Clit" Bill Clinton they were referred to by the Pentagon as the "F*&king Crazies". They still are!


Language is the measure and Government and all that hangs and feeds off it, have been found wanting. The Constitution of the USA has been shreaded, yet it still remains, a priori, the HIGHEST LAW of the LAND. There is nothing else but political expedience aided and abetted by the Institutional Economists and unelected bureaucrats and their out-of-control feral supporters that '... hate you for your Freedoms". The US Constitution allows for ALL Laws introduced by Congress, the Senate, the Supreme Court, the NSA Secret Court, and the President to be made null and void, a priori, when found to be not in compliance; Your Constitution is The Supreme Law of Your Land; your Nation.


The War now is of the individual against the "Collective". But there is a larger "collective" in the room (there always is) but this "collective" respects the individual and that is known as humanity; the creation of God.


"In Principle, God created the heavens and Earth." Genesis 1. This is the correct translation of the first line of Genesis 1, from the original /reconstructed Hebraic (Text written/constructed before ~2500 BCE in the original language of the ancient Egyptian sages. Make note, the original Hebrew was the official and sacred language of the Egyptian Temple. Make no mistake, truth always, a priori, survives time.

The bottom line


"Do you wish to know when that day is coming? Watch money. Money is the barometer of a society’s virtue. When you see that trading is done, not by consent, but by Compulsion -- 
when you see that in order to produce, you need to obtain permission from men who produce nothing -- 
when you see that money is flowing to those who deal, not in goods, but in favors -- 
when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you -- 
when you see corruption being rewarded and honesty becoming self-sacrifice -- 
you may know that your society is doomed. Money is so noble a medium that it does not compete with guns and it does not make terms with brutality. It will not permit a country to survive as half-property, half-loot."
-- Ayn Rand Author Atlas Shrugged, P. 385 (1957)

The FedRes role is to support the Government of the USA to conquer the World and to impose Global Communism. Economic Theory is nothing but a faith-based consensual politic agenda which justifies through expediency the rule of force and imposition by those with the guns. The institutional Economists are blind meal-ticket apologists of the priesthood who pay allegiance to those that protect their faith - whatever, that is; it is however not science; as nor is mathematics.

Money is the measure of integrity of the man and State; it has been measured and found wanting. The FedRes and its Economists need to face the Constitution in its orginal essence and format as well as face a Court of real Law founded in the Principles of Science (this does not infer academia).

The edifice that inhabits the former USA, and built out of ignorance must be overcome and you Americans whom we foreignors do not hate, yet envy for your Constitution and Freedoms, deplore you to use your Constitution to right your Nation again and rid yourselves of the disease that has taken possession of your Nation. The whole World is today dependant upon you.

Long Live: Assange, Manning, Snowden, Tice, Drake, Binney, et al < >

Long Live: Humanity.

Long Live: Truth.

It is seen from the outside of the USA that the expectation and the practise is to lie. It has be-come the norm to lie.

Why then do you need Congress? Why do you need Courts? 

Answer: The State needs nothing but guns, murder, genocide and incarceration. Today, the USA has become a State, not an empire. It is not Empire that fails: it is the State that fails as it is a parasite that always kills its host.

References: Rothbard - v. Mises - v Hanyek, et al.

Ho hum

DEVILDOG's picture

benny should end his conundrem and do the world a favor and just shoot himself in his ignorant, academic elitist head by first sticking the gun in his big constantly drooling diarrhea bullshit mouth. TIA.

lunaticfringe's picture

So they never had an exit strategy. In fact, I have read Ben's 2002 speech to the Board of Governors many times. He always ASSUMED he could drop money out of helicopters until the economy caught up. What he never figured was that the failed rule of law could not restore integrity to markets and since nothing has been fixed...

he has simply delayed that which should have taken place beyond Mar. of 2009. Beyond bankers and the elite, and Mr. Obama, there are no beneficaries. This was all political bullshit from the get go.  

Dingleberry's picture

"QEEEE to infinitee...."


Can we make a rap song out of this?


The higher the markets goes up, the further it will fall once the QE drug pushing stops.

With the crash comes collateral damage to the healthy and/or innocents.

This is why (ostensibly) Bernank and Paulson sold the bailout to the unwashed.

Now the bad debt is even worse. To the tune of several trillions (plus leverage).

Go long Orville Redenbacher.

I should note their is one conceivable way out: a serious crisis overseas causing everyone and their brother to pile into the USD or markets. This has happened many times before, coincidentally of course.

DavidC's picture

There was never any sense of capitulation in the markets in 2009, only a sense of hubris at having turned it then (Gordon Brown and his 'Saving the World' comment in UK Parliament for example). And only a sense of capitulation marks the end of a proper bear market.

Heck, in the US markets, there are still daily gaps from the first days of the year that, if one quaintly believes should be filled at some point (as, indeed, I do), are waiting for a BIG drop in the markets to occur.


derek_vineyard's picture

The markets were down hard in 2008/9 and should have stayed down.  Some policy was required, but the actual QE and printing of money is so wrong on so many levels.  QE will become as infamous a moniker as breadlines were in 1930's. 

the parallels with drug addiction are so right on.....morphine can only be taken for a few days before addiction occurs. It is impossible to not be addicted after 5 years.....and the survival rate of morphine addicts and their life expectancies are very low.

Whoever drew that first needle and facilitated the injection should be incarcerated for life and all the main facilitators stripped of all their assets.  My 2 cents.

andrewp111's picture

What if things were really so bad in 2008/9 that the global financial system would have died right then and there if the Fed and the Treasury hadn't done their extraordinary actions? In this case, they bought us 5 years, and possibly more.....but the financial system is still going to die.

My guess is they will do one last ditch effort on a global basis. A new global, all-electronic  currency will probably be implemented as the current order dies. With a single all-electronic currency that cannot be withdrawn from the system, they will imagine that they can control everything and keep the system going indefinately. But they are wrong of course. Something always goes wrong eventually.

otto skorzeny's picture

the original lie about the creation of the Fed to the US people to sell it to them was that it would take the creation of $ out of the hands of the stupid politicians  so they would not screw it up when actually it was just a way of removing the transparency of the process from the public and no one in public office could be held accountable