Bernanke deconstructed - more volatility ahead?
FED Chairman Bernanke went back to his academic roots, offering a history of the mortgage markets and a view on how they have evolved. He notes that mortgages are rarely made from deposits and that the evolving nature of securitization, the process by which mortgages are packaged and sold, has raised risk. Specifically, Bernanke noted the widening of credit spreads on subprime paper, the falling off of issuance of subprime paper in July and the difficulty dealers have had placing AAA rated paper. In addition, Bernanke noted that “global financial losses (due to subprime problems) have exceeded even the most pessimistic projections of credit losses on those loans.” Given Bernanke’s comments, it not a leap to think the rapid contagion effect from subprime to virtually the entire credit market suggests subprime lenders and securitizers likely knew subprime was on extremely shaky ground - especially in the 2005-2006 issuance period.
One of the most interesting notions raised in Bernanke’s speech was the weighting that updating economic data will be given. Specifically, the FED Chairman noted that , “in light of recent financial developments, economic data bearing on past months and quarters may be less useful than usual for our forecasts of economic activity and inflation.” He said the FED “will pay particularly close attention to the timeliest indicators.” In short, the FED will give more weight to recent data and keep a wary eye on the subprime crisis and contagion effects on the broader economy.
Lastly, Bernanke re-iterated the Richmond Fed’s Lacker’s views that it is not the FED’s job to bail out institutions and investors that have partaken in risky investments.
Overall there is little in this speech the market did not know and the main effect of it may be to create more market volatility around upcoming releases as traders understand the FED will be focusing on these data with an especially sharp eye.