Why Yellen is Wrong on ‘Resilience’

springIn her recent Michel Camdessus Central Banking Lecture, Federal Reserve Chair Janet L. Yellen stressed the importance of resilience in the financial system. Further, she believes she has advanced a new idea here, stressing that “much of the public discussion, which often concerns whether some particular asset class is experiencing a ‘bubble’ and whether policy makers should attempt to pop the bubble” misses the point, because “identification of bubbles [becomes] less critical” as resilience is achieved.

Central bankers in general, she contends (and she cites with favor the Basel III regulatory capital framework in this context) should create countercyclical buffers, so that booms and busts, the creation and the inevitable disruption of bubbles, won’t matter all that much.

Countercyclical Semantics

In that connection, “minimum margin requirements for securities financing transactions could potentially vary on a countercyclical basis so that they are higher in normal times than in times of stress.”

The semantics there are worthy of note. So far as I can tell, what she means is that booms are to be regarded as “normal” and busts are to be re-designated as “times of stress,” which sounds nicer than “times following colossal foul-ups.” After a bust, central banks and the wise Treasury/regulatory officials of the correlated states can ease up on margin requirements, which easing presumably will have a stimulative effect.

During “normal” times, though, when there is no need of stimulus, margin requirements can be increased, to build resilience.

There are obvious objections to this line of thought, and Jeffrey Snider, at Alhambra Investment Partners, makes them well. I’ll seek to expand on some of his thoughts here.

The Chair of the Federal Reserve cannot with any plausibility look upon market bubbles as something exogenous, something that just happens to the earth, like a meteor shower, something from which she and others in her august circles can seek to protect us. The network of central banks that sits atop the world are, collectively and individually, the problem that they affect to solve.

Fourteen Months

It was only 14 months ago, May 2013, that markets suffered a bit of a dip because they became persuaded the Federal Reserve was going to “taper,” slowing its purchase of assets and concomitantly its money creation. This was not a devastating drop in historical terms (the Dow closed at 15,354.40 on May 17th, and at the bottom of this particular slide, June 21, it was at 14,799.40, a fall of 555 points in a little over a month.) Yet it was enough to attract the attention of Yellen’s precursor, Ben Bernanke. He told the world that he understood that what it needed was “a highly accommodative policy … for the foreseeable future.” Everyone breathed a sigh of relief and the rally resumed.

The course of events there offers a bit of a lesson. Quantitative easing was already looking long in the tooth then, and it had come to represent what Yellen now dresses up as a new idea and urges upon her colleagues around the globe, a policy of “accommodation.” The “taper” signaled a desire to be a little less accommodating, the parties that would have been adversely affected signaled (surprise!) that they would then be unhappy, and the Fed chair backed down – yes, we’ll continue to accommodate.

The lesson is quite the opposite of what Yellen seems to think it was. The Federal Reserve’s policies, policies that Yellen has endorsed and continued, haven’t and will not make the system as a whole more resilient.

They, central bankers, are bringing water to the desert so that retirees in Arizona can maintain the same sort of lush grassy lawns they knew and loved in Connecticut. They are doing this in the name of resilience, or in whatever name you want, but it remains hydraulically and ecologically perverse.

We aren’t here to offer advice to policy makers. We’re here to consider portfolio management in a world of portable alpha and alpha/beta separation. Through that prism, Yellen’s speech looks like evidence that the race to the bottom among the currencies of developed nations will continue, as will the need to look elsewhere, especially to the emerging market nations and to real assets within the developed world, for opportunities.


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