Understanding Bernanke

Every time I hear that Bernanke has offered up some hope of impending recovery I feel the need to scour through the data to find support for his statements. There is, after all, the idea that he sees something that the rest of us don’t. So his testimony today sent me back to the books. Here’s what I found:

• He says that there are signs that consumer sentiment is turning. Well yes. Consumer confidence has ticked up. From extremely low levels to simply very low levels. This is an improvement. Whether we should read that as being the end of the slump I doubt. We need several more months of improvement before we can definitively call the corner. And with unemployment bound to get much worse through the summer last month’s movement could easily be reversed.
• But: anecdotal information supports Bernanke. Wal-Mart recently told analysts that it was seeing a shift in the purchasing habits of its customers. After months of buying only essentials they were returning to the purchase of ‘discretionary items’. People don’t do tis unless they are beginning to think the worst is over.
• Plus: the first quarter GDP data shows that consumption rose 2.2% January through March after having fallen by around 4% during the previous two quarters. If that holds up the recovery cannot be far away. Unfortunately the data also shows that pretty much all that gain was in January, and that by March consumption had turned down again.
• The housing industry is starting to show some life after being trashed for the best part of eighteen months. Life that is if you think that a gentle slope down is much better than a precipitate collapse. Some areas of the country are now seeing a surge in home buying: Sacramento is being most often referenced as an example. The problem is that buyers are flocking to pick up bargains. The flood of foreclosed homes is finally attracting buyers who have cash or credit worthiness. With mortgage rates at extremely low levels this kind of activity will continue.
• But: since the action is mostly bargain hunting, home prices continue to fall. They are now down about 30% on average from their peak and it looks as if we will see another 10% – 15% drop. That implies a further erosion of household wealth and consequently the threat of retrenchment in spending. That would offset the improvement in consumption I mentioned above.
• The credit markets are improving steadily. A key measure of credit market confidence is the London Inter-Bank Offering Rate [‘LIBOR’] which is the rate banks in London lend to each other. It also is the rate used worldwide to set rates on things like mortgages. At the height of the crisis last September LIBOR shot up to record levels signaling that banks were afraid to lend to each other for fear of default. Since then the rate has bumped about as fears of banks failures and the AIG mess kept those fears high. Now, at last, LIBOR has fallen back. Not just to ‘normal’ levels, but to historically low levels. It is now down to less than 1%. In part this is due to the general level of rates being at historically low levels. But it also reflects a return of confidence that the worst of the banking crisis may be over. I don’t agree with that sentiment, but that’s another story.

So, taking all this together it is easy to see why Bernanke can say that things are improving. They are. What he means is that things are getting worse at a slower rate than before, which is a more accurate and more nuanced statement.

The problem is that we are still faced with fragility everywhere we look. Any one of these statistics could turn back and worsen just as easily as it could continue to improve.

As an example: the Federal Reserve Board reported this week that the major banks that it surveys regularly say that, overwhelmingly, they are tightening credit standards. That means they are renewing fewer loans and turning down more customer requests for new loans. This tells me that there are a lot of small businesses who are running short of cash. And there are consumers whose credit cards are getting more expensive. A consequence of this is that later this year we may well see surge in small business bankruptcies along with less consumer buying power. Either would spell the end of any improvement.

Which brings me the the last point: I have said repeatedly that the timing and shape of the recovery depends heavily on the banks being able and willing to fuel it with credit. The health of the banking system is now the critical element in the outlook.

And that’s not good.

Bernanke admitted as much in his testimony, so at least he is not fooled by the leaks from the Treasury Department that say while our banks need capital, they are fine anyway.

But let’s be hopeful: things are not getting worse as quickly as they were late last year.

Now doesn’t that feel better?

Addendum:

Here’s another upbeat note: David Leonhardt at the New York Times passes on this calculation from Larry Summers. US consumers need to buy about 14 million new cars a year to keep up with replacements of those that are worn out or obsolete. But actual car purchasing has now fallen to around 9 million a year. At some point the pressure to buy will outweigh the urge to save or the ability to extend the life of the old cars. So consumers will have to increase their buying. That will end the slump. This kind of calculation can be applied to many forms of goods or services. You can postpone some things only so long. The ‘pent up’ demand that this postponement implies eventually breaks and the economy recovers on the back of a surge in demand.

This is all well and good. It assumes that we are in a typical cycle. It is probably at least partially correct.

My concern remains the availability of credit to finance the car buying etc. Summers expects.

Having said that, the fact that we are even discussing stuff like pent up demand is a positive sign that the more dire fears we all had last year are dissipating.

The recession will end later this year.

Then the hard part begins: shaking out the imbalances that caused the crisis, and stripping the banks of their power.

I have been saying for a while now: the big question is not whether the recession will end, but what will the recovery be like?