Thursday, January 10, 2008

Fed in the eyes of traders and academia

This NY Times article is scary. In short, it tells us that Bernanke and Fed are viewed by Wall Street as way behind the curve ("They know nothing", Jim Cramer) but are highly praised by economists from different universities. The problem here is that academia economists usually understand only economy of the past. They don't understand big changes in economy until those changes are, again, in the past. Examples are plenty: "You can't have both stagnation and inflation" (Keynes), original Phillips curve (and, maybe, modified one as well) etc. Another problem is the main hypothesis of current economic theories: agents (means people) behave rationally. Of course, just looking around you'll see a lot of people behaving not exactly rationally.

Wall Street is different. A lot of people there also have economic education, but they are dealing with current and future state of economy and they know that "agents" are not rational, and they don't pretend to be rational themselves. Just look around, there are thousands of books, articles, blogs teaching investors and traders how to overcome emotions (read: irrationality). In times like now I'd rather trust Wall Street than academics. Unfortunately, according to the article, most of Fed governors are academics.

Today's Bernanke speech is a good example. The whole idea of the speech is that current housing debacle is unexpected. In the real world, as opposed to academia, first signs of trouble were visible in the end of 2006, first real problems on the market appeared in April 2007 (just look at builders charts) and in August 2007 anybody with half a brain could see the biggest financial crisis since, well, Great Depression (that's when Jim Cramer said "They know nothing!"). So, it took Fed professors more than 3 months to understand what Wall Street saw immediately.

The end result: high probability of the big crisis. In the worst case, something like Japan since 1990, and Japan is not out of the woods yet. Of course, current Fed governors and other professors will explain what happened in 2008 later. That's exactly what Ben said in his speech. Oh well. And I thought that Fed just have to do what it was created for: ensure functioning of the financial system, i.e. being lender of last resort. Stable money, by the way, comes second in Fed's mandate. Explaining what happened in the past is not in this mandate.

I don't think we are up to 18 years (and no end in sight) of crisis, like Japan. US economy is much more flexible, it'll recover sooner. But "sooner" might be couple of years or a decade, only time will tell. For the nearest couple of years, it's going to be ugly. I'm accepting suggestions on when Fed's rate is going below 1%. My forecast: January 2009.

On the side note, this link probably explains strange behavior of TCSM noted in my post two days ago.

Idea of this article is borrowed from Jim Cramer. The idea that being from academia and not from Wall Street is the main problem of the Fed was stated (screamed) by Jim Cramer several times, in articles and TV shows.

Full disclosure: at the time of publication author had long position in TSCM. Positions can change at any time.

Disclaimer: This article is not intended as an investment advice. Every person should make her/his own investment decisions based on all available information and advice from her/his own financial advisor.

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