Bernanke in the Hot Seat

 “With all due respect, U.S. policy is clueless….(the problem) is not a shortage of liquidity. It’s not that the Americans haven’t pumped enough liquidity into the market.”

  Wolfgang Schauble, German Finance Minister reacting to QE2

As we saw in the lead up to the G20 meetings in Seoul this past weekend and at the meetings themselves, there is a growing chorus of discontent regarding US economic policies. Direct attacks on the Fed and its Chairman would have been unthinkable at any time in the past 30 years. Thus, while  his predecessors received the utmost in the way of deferential treatment at all times, Ben Bernanke is rapidly becoming the sad-faced “no respect” poster child for economic policies that have so far failed to live up to their advance billing and for the associated growing global economic tensions.

Just ahead of the G20 meetings, Chairman Bernanke penned an article in which he attempted to deliver an overview of the situation and the Fed’s plans for reinvigorating economic activity.  The letter is astonishing in a number of dimensions:

According to Chairman Bernanke, it seems that in spelling out Fed policy and the need for additional stimulus that the Fed intends to get the economy growing by creating false markets (ie higher prices) in the stock bond, and real estate sectors. This is short-sighted, arrogant and ill-considered even before one takes into account the fact that the man was announcing his intentions to the markets with the apparent conviction that the investment professionals who operate within them would heed his financial advice, rather than consider the logical implications of it.

Chairman Bernanke’s piece waxes eloquent, saying that the risk of deflation warrants further strong doses of liquidity: ”……… the need to achieve certain outcomes, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed.” These are all laudable policy objectives, but the point is that nowhere in this article is there any mention of what the risks are of these proposals. For example, some of the second order effects of QE  and ZIRP that we know about today include:

• Liquidity leakage and consequent pressures on markets in other countries, particularly emerging economies;
• Contribution to economic imbalances and unwelcome swings in FX parities;
• Disruption of trading relationships;
• Rapid inflation of input prices and foodstuffs which falls disproportionately on low income population groups and countries and those on fixed incomes;
• Intensification of the Sovereign debt crises in other economies;
• A reverse wealth effect on consumption from the Zero Interest Rate Policy stance that hits retirees and savers.

Chairman Bernanke`s letter fails to mention other key risks of his policies including the possibility of significantly elevated inflation numbers down the road, dangers for the financability of the yawning US fiscal deficit, and a potentially unmanageable downgrading of the United States as guardian of the global reserve currency. Predictably, his explanations also fail to acknowledge the vast solvency problem in the US financial sector that needs to be urgently addressed (in ways that are markedly different from the Fed’s and the FDIC’s  “extend and pretend” approach). Not surprisingly many commentators and observers are starting to mock Bernanke and his policies.

Given the fact that there is general agreement that QE1 has been a failure; these are issues that should make the Fed and Mr Bernanke sit up and take note. As for QE2 it is hard not to observe that since the launch of this policy the stock market has lost 4% of value; bond rates in the Fed’s announced “buying zone” have backed up 40-50 basis points and the economic numbers are still expected to remain soft by the mainstream economists.

On this latter point it also helps to do the math. Even if this round of QE works and raises prices in various asset markets, then the addition to GDP through the wealth effects that Bernanke is staking everyone’s future on, will, under the best of circumstances, only translate into about an extra 0.3 to  0.7 percent of growth. This is peanuts, and certainly not an objective worthy of risking significant disruptions to achieve.

For this and other reasons best dealt with under separate cover, there is now significant opposition being mounted against the Bernanke policies. Not only did Obama and the US delegation get a bollocking from their G20 colleagues over US economic policy last weekend, several prominent FOMC members, including Plosser,  Hoenig and Warsh have spoken out against additional QE, others in the US have cautioned on Fed policy, and this week an number of prominent economists, investors and commentators issued a public letter to the Fed asking it to cease and desist on QE.

The open dissent on the FOMC and the fact that this has been taken into the public domain is extremely noteworthy. Tensions has been building between those in the Fed that regard these policies as the only way out of the Roach Motel and those who want to chart a different course and restore some measure of transparency and sanity to US monetary policy. One immediate outcome of the second alternative, provided that the policies are well thought out and capably executed is that it would defuse the systemic risks and spill-over effects that have been accumulating in the global economy and in international relations as a consequence of ZIRP and QE.

In the present scenario Chairman Bernanke is therefore in an unenviable and weak position: There is growing conflict regarding the path he has charted and what remains of the Fed’s credibility is at serious risk. There are obvious questions to be asked regarding his competencies. His communications style shows that he has little appreciation or understanding of risk and market behaviour. He failed to spot the crisis in its early stages, saying on numerous occasions that it was limited in scope and containable. His policies have not worked and considerable international tension and opposition to his policies and their intent has been building. Not to be overlooked, prior to QE1 he also mislead lawmakers and the markets repeatedly as regards the likelihood of debt monetization by the Fed – ie the willingness of the Fed to run a QE.

In the meantime, there is scant hope of a major near term bounce in the US economy. Five million jobless on the US unemployment rolls will see their benefits run out in the next couple of months. Commodity markets continue red hot. Debt crises in a number of economies are worsening. If the Fed continues to plough on as per its policy announcement we can only expect the geopolitical picture to become even more fraught

 “Honourable Committee Members…….the dog ate my homework”

With this and other depressing information painting the backdrop for his testimony, there is very little good news that Chairman Bernanke will be able to serve up to US lawmakers in February when he is obliged to deliver his semi-annual Humphrey Hawkins testimony regarding Fed Policy. He is presiding over a giant mess that he himself helped create and now cannot get out of.

The Bottom LIne: Barring a major failure of courage and leadership within the FOMC and US Government, and from the Obama Administration  (not exactly a zero probability outcome given the personalities involved)  it is likely, but far from certain, that we could see Ben Bernanke sacrificed on the altar of political expediency or resign. In the meantime the political and economic ructions resulting from QE will continue.

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Recovery Partners Turnaround Clinic – Leaders under Stress

This week we heard from the IMF that the total borrowing requirements of key governments in 2011 will amount to around  $10.2 trillion. The estimate represents a rise of 7% from 2010 and over 27% of the annual GDP of the developed economies. This rollover profile exposes the vulnerabilities in the maturity composition of Sovereign liability portfolios and the likelihood that most Sovereigns will find it impossible to appropriately de-risk their financial exposures by extending term or otherwise executing an imunization strategy. The bottom line is that unless deficit control and the establishment of debt management perfomance benchmarks is adopted as a matter of urgency in many economies,  it becomes very easy to envision the near term onset of another round of severe financial turbulence.

The risk of another shake-up also relates to what is often ignored in these situations: the human dimension. Economists are very good at quoting statistics but notoriously bad at interpreting the emotions, motivations and fears that always lie behind the raw data, and what these might mean in terms of the probable outcomes in a given situation. Recently, we were fortunate to sit down with Dr Jack Muskat, one of the members of our Advisory Board, and interview him on his experience in this area.

Q: Dr Muskat can you tell us a bit about your experience in dealing with organisations and leaders under stress?

JM: Well usually I only like to get involved in situations where there is a high probability of a successful restructuring or exit from crisis. The key indicators for a successful exit from distress are usually all or a combination of the following factors: it is a situation that matters in terms of the dollar amounts; it is politically and economically sensitive; there may be international implications; it might also feature multiple investment parties and in all cases there is a significant debt load. You also have to have the right leadership team in place.

Q: So you are saying if all of these factors are present the odds of turning things around are good?

JM: Not exactly, what I mean is that when all of the factors are present that the odds for a successful crisis management outcome should be good. What I find frequently is that psychological factors erode the odds of turning a situation around. Whether the cause of distress is management weakness, inadequate financial controls, fraud, weak strategy or execution or some external factors; what we usually see in most stress situations is that is that leaders are frequently first caught is a cycle of denial that is  then followed by a cycle of blaming others for the problems. If this goes on for too long the opportunity to successfully turn things around will disappear and failure becomes the only “option”.  I can tell you that the foregoing sequence of events is already in motion in a number of Sovereigns who find themselves under financial pressure.

Q: How so?

JM: It all comes down to the personalities involved. What I have found is that when leaders are under stress it is very common for them to slip into behaviour patterns that are extremely counterproductive. I say this because we use a variety of tools to diagnose the issues and to determine whether the incumbent leadership in a crisis situation is psychologically suited to managing the crisis, stabilizing matters and capable of executing a credible recovery plan.

Q: Can you provide some examples please?

JM: Well you have start from the reality that the leaders in a crisis situation are usually new to these type of events. Typically you don’t find crisis managers working full time leading a company or in a Government waiting for the day when something blows up. The leadership is a crisis is more typically untested and new to the situation. This means three things: (1) there may be feeling of guilt or anger associated with the crisis as they find it difficult to distance themselves emotionally from the situation; (2) there may very well be a competency problem amongst the leadership in that they are incapable of dealing with the issues; and (3) there may be a bandwidth or capacity problem within the organisation as the leadership becomes engulfed in problems that are increasing at a rate faster than its ability to solve them. Alternatively you may find that the peson selected because of relevant credentials has not bothered to properly analyze the crisis and evaluate his prescriptions in the context of what the situation really might require.

Q: What happens then?

JM: This is where the trouble really starts. If you have a leadership in a predicament like that they may react in a variety of ways, all of them counterproductive: (1) they could bury their heads in the sand and refuse to acknowledge the problems or that their preferred way of dealing with them won’t work; (2) they become defensive and attack anyone who looks into how the issues are being  handled with the intention of offering sound advice; (3) they might engage in “magical thinking”, that is, believing that a painless solution is available to them if only they do one simple thing; (4) they might engage in nihilistic thinking, believing that the situation is so bad that it doesn’t matter if it gets worse; (5) they may panic and opt for a destructive course of action; or finally (6) the leadership may engage in all of these behaviours.

Q: Wow, that sounds like it would be impossible to deal with.

JM: It gets worse. If these types of behaviours are present it might also be accompanied by physical symptoms that further detract from the ability of these leaders to make the correct decisions – lack of self esteem, feelings of failure, sleeplessness, poor eating habits, lethargy, withdrawal from social interactions. All of these conditions lead to inertia, poor decision making and a tendency to always be in a reactive mental state. Frequently valuable time and energy is wasted by these type of leaders in diverting scarce resources and attention to issues that are not germane to resolving the actual causes of the crisis. This is usually known as “rearranging the deck chairs on the Titanic”.  We all know how that situation turned out

Q: So how do you handle this and recover the situation?

JM: You have to get the right leadership installed. Our screening techniques allow us to determine if any of these destructive behaviours are present within a leadership group and whether the leadership group has the right aptitudes to deal with the crisis and apply solutions. In a crisis situation the best leader is one that knows how to admit to and correctly prioritize the actual problems, knows that they must urgently identify the best possible advisors, and then is prepared to receive and process advice in order to create a plan to lead the way out of the mess. On top of them being able to then stick to and execute a credible plan, you also want leaders who can frame the situation in such a way as to inspire others to support the crisis management plan. This is important because you want to maximize the likelihood of emerging from the problem. A good example of this is the current leadership in Great Britain. They have a debt crisis there and the new Government has just delivered an austerity budget. However by evoking nostalgic memories of the post-WWII rationing period and the British “stiff upper lip” they have got the British public behind them and that has measurably increased the odds that the debt management plan will work there. The same cannot be said for many other crisis-hit economies, a number of which we at Recovery Partners expect will hit the proverbial “wall” in the near term, barring a change in course.

Q: Thank you for these valuable insights Dr Muskat. It is clear that from what you have said, that the probability of a policy mis-step or other dangerous miscalculation is relativley high in the current environment as it relates to Sovereign Debt in a number of countries.

JM: It certainly does seem so.

Dr Jack Muskat is a management psychologist with over twenty years consulting and business experience with individuals and organizations. He is an acknowledged expert on issues relating to organizational culture and leadership, succession planning, strategic management and corporate distress. Dr. Muskat received his Ph.D. in Applied Psychology from the University of Toronto. He is a member of the Canadian and American Psychological Associations and is a recognized speaker and published author.

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