From the Washington Post

By Ben Bernanke
Sunday, November 29, 2009

For many Americans, the financial crisis, and the recession it spawned, have been devastating — jobs, homes, savings lost. Understandably, many people are calling for change. Yet change needs to be about creating a system that works better, not just differently. As a nation, our challenge is to design a system of financial oversight that will embody the lessons of the past two years and provide a robust framework for preventing future crises and the economic damage they cause.

These matters are complex, and Congress is still in the midst of considering how best to reform financial regulation. I am concerned, however, that a number of the legislative proposals being circulated would significantly reduce the capacity of the Federal Reserve to perform its core functions. Notably, some leading proposals in the Senate would strip the Fed of all its bank regulatory powers. And a House committee recently voted to repeal a 1978 provision that was intended to protect monetary policy from short-term political influence. These measures are very much out of step with the global consensus on the appropriate role of central banks, and they would seriously impair the prospects for economic and financial stability in the United States. The Fed played a major part in arresting the crisis, and we should be seeking to preserve, not degrade, the institution’s ability to foster financial stability and to promote economic recovery without inflation.

The proposed measures are at least in part the product of public anger over the financial crisis and the government’s response, particularly the rescues of some individual financial firms. The government’s actions to avoid financial collapse last fall — as distasteful and unfair as some undoubtedly were — were unfortunately necessary to prevent a global economic catastrophe that could have rivaled the Great Depression in length and severity, with profound consequences for our economy and society. (I know something about this, having spent my career prior to public service studying these issues.) My colleagues at the Federal Reserve and I were determined not to allow that to happen.

Moreover, looking to the future, we strongly support measures — including the development of a special bankruptcy regime for financial firms whose disorderly failure would threaten the integrity of the financial system — to ensure that ad hoc interventions of the type we were forced to use last fall never happen again. Adopting such a resolution regime, together with tougher oversight of large, complex financial firms, would make clear that no institution is “too big to fail” — while ensuring that the costs of failure are borne by owners, managers, creditors and the financial services industry, not by taxpayers.

The Federal Reserve, like other regulators around the world, did not do all that it could have to constrain excessive risk-taking in the financial sector in the period leading up to the crisis. We have extensively reviewed our performance and moved aggressively to fix the problems.

Working with other agencies, we have toughened our rules and oversight. We will be requiring banks to hold more capital and liquidity and to structure compensation packages in ways that limit excessive risk-taking. We are taking more explicit account of risks to the financial system as a whole.

We are also supplementing bank examination staffs with teams of economists, financial market specialists and other experts. This combination of expertise, a unique strength of the Fed, helped bring credibility and clarity to the “stress tests” of the banking system conducted in the spring. These tests were led by the Fed and marked a turning point in public confidence in the banking system.

There is a strong case for a continued role for the Federal Reserve in bank supervision. Because of our role in making monetary policy, the Fed brings unparalleled economic and financial expertise to its oversight of banks, as demonstrated by the success of the stress tests.

This expertise is essential for supervising highly complex financial firms and for analyzing the interactions among key firms and markets. Our supervision is also informed by the grass-roots perspective derived from the Fed’s unique regional structure and our experience in supervising community banks. At the same time, our ability to make effective monetary policy and to promote financial stability depends vitally on the information, expertise and authorities we gain as bank supervisors, as demonstrated in episodes such as the 1987 stock market crash and the financial disruptions of Sept. 11, 2001, as well as by the crisis of the past two years.

Of course, the ultimate goal of all our efforts is to restore and sustain economic prosperity. To support economic growth, the Fed has cut interest rates aggressively and provided further stimulus through lending and asset-purchase programs. Our ability to take such actions without engendering sharp increases in inflation depends heavily on our credibility and independence from short-term political pressures. Many studies have shown that countries whose central banks make monetary policy independently of such political influence have better economic performance, including lower inflation and interest rates.

Independent does not mean unaccountable. In its making of monetary policy, the Fed is highly transparent, providing detailed minutes of policy meetings and regular testimony before Congress, among other information. Our financial statements are public and audited by an outside accounting firm; we publish our balance sheet weekly; and we provide monthly reports with extensive information on all the temporary lending facilities developed during the crisis. Congress, through the Government Accountability Office, can and does audit all parts of our operations except for the monetary policy deliberations and actions covered by the 1978 exemption. The general repeal of that exemption would serve only to increase the perceived influence of Congress on monetary policy decisions, which would undermine the confidence the public and the markets have in the Fed to act in the long-term economic interest of the nation.

We have come a long way in our battle against the financial and economic crisis, but there is a long way to go. Now more than ever, America needs a strong, nonpolitical and independent central bank with the tools to promote financial stability and to help steer our economy to recovery without inflation.

Commodity inflation is evident through the metals markets. The excess liquidity that has been pumped into markets worldwide is driving this inflation.

China in particular, as previously asserted, is one of the largest inflationists. China is also stockpiling commodities and through government stimulus spending driving a massive infrastructure build out.

Price has risen significantly off of the lows from the liquidity crisis forced selling from last year. Now look at the supply of these two commodities.

The underlying problem for the dollar bears is that the short-sellers are most likely speculators, who are not going to hold in the face of technical pressure. They’ll collapse and reverse their trades.

Dubai in of itself, is probably survivable. The problem might be that if a premier commercial real estate debt like Dubai can default, what about the rest of the really dodgy commercial real estate financing out there?

The banks have been hoarding for a reason. Their balance sheets are still vulnerable to commercial real estate financing. We will likely start to find out over the next week just how vulnerable they might be.

Everything seems to be business as usual. The market dips to a technical support, buyers step-up, market goes higher. The problem is that the market wasn’t really expecting a Dubai default. Thus the reflex of buying a technical level is not actually going to be the final say on the matter.

It may be that Central Banks extend liquidity, or not, the debt may be restructured in the debt markets via the banks, or not. The point is that this won’t necessarily resolve before the weekend. Like weekends last year, there will be some negotiating, and the final answer will emerge next week. It may well turn out to be a buy-the-dip, but then again, it may not.

The dollar will likely be crucial. If for whatever reason, there is a dollar spike, that will most likely trigger a sell-off through risk assets, that may spread through markets that are tightly coupled.

INTERNATIONAL. Global stock markets fell sharply Thursday on mounting fears of a debt default by Dubai and tighter lending conditions in China, analysts said.

The dollar edged up from 14-year lows against the yen as renewed risk aversion prompted investors to shed riskier assets, giving pause to broad dollar selling. Gold climbed to a new record high but fell back as the dollar rose.

The Dollar climbed against 14 of the 16 most traded currencies due to concerns over the possibility of a debt default by Dubai, after its attempt to reschedule its debt spurred investors to turn away from the riskier assets and back to the safety of the Dollar and JPY. The recovery in the US Dollar was aided by the fact that most Asian and European equity markets posted losses in today’s trading.

London shed 1.95% to 5,260.05 points in mid-afternoon deals. The market was earlier forced to suspend trading for three and a half hours due to a technical hitch.

Elsewhere, Frankfurt sank 1.91% to 5,692.06 points and Paris plunged 2.04% to 3,730.77 points.

In Asia, Beijing nosedived 3.62%, Tokyo fell 0.62% and Hong Kong closed 1.78% lower.

Chinese shares were also hit by the prospect of tighter banking rules and worries about monetary policy next year.

The reversal of the dollar carry trade could really throw a spanner in the works for risk assets [stocks, commodities, etc] It’s very difficult to know just if there is a vulnerable dollar carry trade, how big it is, and if it’s unwound just where the focus will fall.

I guess we’ll start to find out the answers tomorrow in an abridged trading session.

Nov. 26 (Bloomberg) — European stocks fell the most in seven months and bonds jumped as Dubai’s attempt to reschedule its debt rattled investors seeking higher returns in emerging markets. The dollar slid to a 14-year low against the yen.

Europe’s Dow Jones Stoxx 600 Index retreated 3 percent at 3:29 p.m. in London. The Shanghai Composite Index slumped 3.6 percent, its biggest drop since August, and Brazil’s Bovespa Index slipped 2 percent. Credit-default swaps tied to debt sold by Dubai rose as much as 131 basis points to 571 according to CMA DataVision. U.S. markets are closed today for the Thanksgiving holiday.

Causing problems for equity markets while the US is closed and limited trading on Friday. Might add some volatility.

“Most let us call’ em customers — are alike. You find very few who can truthfully say that Wall Street doesn’t owe them money. In Fullerton’s there were the usual crowd. All grades! Well, there was one old chap who was not like the others. To begin with, he was a much older man.

Another thing was that he never volunteered advice and never bragged of his winnings. He was a great hand for listening very attentively to the others.He did not seem very keen to get tips — that is, he never asked the talkers what they’d heard or what they knew. But when somebody gave him one he always thanked the tipster very politely. Sometimes he thanked the tipster again — when the tip turned out O.K. But if it went wrong he never whined, so that nobody could tell whether he followed it or let it slide by.

It was a legend of the office that the old jigger was rich and could swing quite a line. But he wasn’t donating much to the firm in the way of commissions; at least not that anyone could see. His name was Partridge, but they nicknamed him Turkey behind his back, because he was so thick-chested and had a habit of strutting about the various rooms, with the point of his chin resting on his breast.

The customers, who were all eager to be shoved and forced into doing things so as to lay the blame for failure on others, used to go to old Partridge and tell him what some friend of a friend of an insider had advised them to do in a certain stock.They would tell him what they had not done with the tip so he would tell them what they ought to do. But whether the tip they had was to buy or to sell, the old chap’s answer was always the same. The customer would finish the tale of his perplexity and then ask: “What do you think I ought to do?”Old Turkey would cock his head to one side, contemplate his fellow customer with a fatherly smile, and finally he would say very impressively, “You know, it’s a bull market!”

Time and again I heard him say, “Well, this is a bull market,you know!” as though he were giving to you a priceless talisman wrapped up in a million-dollar accident-insurance policy. And of course I did not get his meaning.

One day a fellow named Elmer Harwood rushed into the office, wrote out an order and gave it to the clerk. Then he rushed over to where Mr. Partridge was listening politely to John Fanning’s story of the time he overheard Keene give an order to one of his brokers and all that John made was a measly three points on a hundred shares and of course the stock had to go up twenty-four points in three days right after John sold out. It was at least the fourth time that John had told him that tale of woe, but old Turkey was smiling as sympathetically as if it was the first time he heard it. Well, Elmer made for the old man and, without a word of apology to John Fanning, told Turkey, “Mr. Partridge, I have just sold my Climax Motors. My people say the market is entitled to a reaction and that I’ll be able to buy it back cheaper. So you’d better do likewise. That is, if you’ve still got yours.”

Elmer looked suspiciously at the man to whom he had given the original tip to buy. The amateur, or gratuitous, tipster always thinks he owns the receiver of his tip body and soul, even before he knows how the tip is going to turn out.”Yes, Mr. Harwood, I still have it. Of course!” said Turkey gratefully. It was nice of Elmer to think of the old chap.”Well, now is the time to take your profit and get in again on the next dip,” said Elmer, as if he had just made out the deposit slip for the old man.

Failing to perceive enthusiastic gratitude in the beneficiary’s face Elmer went on: “I have just sold every share I owned!” From his voice and manner you would have conservatively estimated it at ten thousand shares.But Mr. Partridge shook his head regretfully and whined, “No!No! I can’t do that!”: ‘What?” yelled Elmer. “I simply can’t!” said Mr. Partridge. He was in great trouble.”Didn’t I give you the tip to buy it?”"You did, Mr. Harwood, and I am very grateful to you.Indeed, I am, sir. But –” “Hold on! Let me talk! And didn’t that stock go up seven points in ten days? Didn’t it?”"It did, and I am much obliged to you, my dear boy. But I couldn’t think of selling that stock.”

“You couldn’t?” asked Elmer, beginning to look doubtful himself. It is a habit with most tip givers to be tip takers.”No, I couldn’t.”"Why not?” And Elmer drew nearer.”Why, this is a bull market!” The old fellow said it as though he had given a long and detailed explanation.”That’s all right,” said Elmer, looking angry because of his disappointment. “I know this is a bull market as well as you do. But you’d better slip them that stock of yours and buy it back on the reaction. You might as well reduce the cost to yourself.”"My dear boy,” said old Partridge, in great distress “my dear boy, if I sold that stock now I’d lose my position; and then where would I be?”

Elmer Harwood threw up his hands, shook his head and walked over to me to get sympathy: “Can you beat it?” he asked me in a stage whisper. “I ask you!”I didn’t say anything. So he went on: “I give him a tip on Climax Motors. He buys five hundred shares. He’s got seven points’ profit and I advise him to get out and buy ‘em back on the reaction that’s overdue even now. And what does he say when I tell him? He says that if he sells he’ll lose his job. What do you know about that?”"I beg your pardon, Mr. Harwood; I didn’t say I’d lose my job,” cut in old Turkey. “I said I’d lose my position. And when you are as old as I am and you’ve been through as many booms and panics as I have, you’ll know that to lose your position is something nobody can afford; not even John D. Rockefeller. I hope the stock reacts and that you will be able to repurchase your line at a substantial concession, sir. But I myself can only trade in accordance with the experience of many years. I paid a high price for it and I don’t feel like throwing away a second tuition fee. But I am as much obliged to you as if I had the money in the bank. It’s a bull market, you know.” And he strutted away, leaving Elmer dazed.

What old Mr. Partridge said did not mean much to me until I began to think about my own numerous failures to make as much money as I ought to when I was so right on the general market.The more I studied the more I realized how wise that old chap was. He had evidently suffered from the same defect in his young days and knew his own human weaknesses. He would not lay himself open to a temptation that experience had taught him was hard to resist and had always proved expensive to him, as it was to me.

The Federal Reserve is expressing concern that there might be a tad of speculation going on.

The problem will only become a problem if people speculate that the Federal Reserve [might] will reverse this inflationary policy.