Tags: Bair | Schonberger | economy | intentional

Sheila Bair on State of the Banking System – Part I

By    |   Thursday, 29 August 2013 02:57 PM

This article and the next one are based on the panel assembled on Aug. 21 by the National Press Club to consider the state of the nation's economy and banking system. The panel consisted of Pimco's Mohamed El-Erian, Stanford economics professor John Taylor and former FDIC Chairman Sheila Bair, now with the Pew Charitable Trusts in Washington. The moderator was Jennifer Schonberger of The Wall Street Report.

The reasons for devoting a few articles to this subject are threefold. First, because the authorities have never done anything to contain the financial crisis, over more than four decades, despite the enactment of a series of landmark bills, each touted in its turn as the ultimate solution.

Second, in my opinion, Bair's commentary is so incoherent that her words require close parsing in order to separate the occasional insightful analysis from the stream of statements that seem to be offered for their presumed effect.

Third, a new episode in the ongoing financial crisis could occur at any time, and this article provides an opportunity to lay down markers for future reference.

El-Erian made a very telling statement that ties the condition of the banking industry directly to the protracted sluggishness of the economy embodied in the New Normal.

He said, "The problem is the mindset. We grew up believing that finance was the next level of capitalism, that somehow you go through agriculture, manufacturing, service and then, if you're really lucky, you get to finance. In fact, the description of my industry changed from 'financial services,' which is this notion that you serve the real economy, to 'finance,' this notion that you're standalone. We need to realize that right now we don't have a financial services industry that supports the economy enough. So we have to go back to genuine drivers of growth instead of this love affair that we had with leverage and debt entitlement, because that's going to just put us into another crisis down the road."

As the conversation continued, Schonberger asked the now-familiar question about whether the state of the economy is squeezing the middle class and fraying the social fabric. El-Erian responded that the powers of the Federal Reserve are such that they can only be employed in an indirect manner, so that they operate on assets markets so as to create a "wealth effect." As asset prices rise, consumers are expected to become more confident and to spend more, thus boosting the economy.

Bair suggested that while it is "not intentional," the result is asset inflation.

This is a prime example of the need to stop the clock periodically when Bair speaks and to ask how she cannot realize that of course the asset bubbles are intentional. One is reminded of an old headline from theonion.com: "American People Demand New Bubble to Invest in."

But when Schonberger followed up by asking what the biggest risk to the economy might be, Bair switched into "insightful analyst" mode and replied that the biggest risk is the "unsustainability" of what is happening as the economy is "going back to leveraged housing finance."

She is right; this is the course the banking committees are pursuing right now.

Bair added that the current policy is not sustainable. The economy needs real goods and services, and cheap interest rates are designed to achieve this, but the result could be another downturn.

The next and last article in this series will examine the effects of unsustainable policies on the banking system, as discussed by Bair.

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This article and the next one are based on the panel assembled on Aug. 21 by the National Press Club to consider the state of the nation's economy and banking system.
Thursday, 29 August 2013 02:57 PM
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