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When Bernanke says don’t worry, it’s time to worry

Federal Reserve Chairman Ben Bernanke said Wednesday a default by Greece won’t have a serious negative impact on U.S. financial institutions. He conceded a Greek default would “no doubt roil financial markets globally,” but that such a default would do little damage to U.S. banks and money-market mutual funds. Billions of dollars worth of complex derivatives would be affected by a default by Greece, and Bernanke would have us believe U.S. firms don’t have a significant piece of that action. Really? This has all the trappings of another gross misdiagnosis from Bernanke.

Such audacious confidence brings to mind Treasury Secretary Timothy Geithner’s “Welcome to the Recovery” op-ed in The New York Times last August, but the reality is that we need look no further than Bernanke’s own history of prognosticating to draw a troubling comparison.

  • Bernanke in May 2007 on the danger posed by the subprime-mortgage market: “Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited.” We all know how that one turned out.
  • Bernanke warning lawmakers in September 2008 about what would happen if they didn’t support the Troubled Asset Relief Program: “You could see a 20% decline in the stock market, unemployment at 9% to 10%, the failure of GM, certainly, and other large corporate failures.” Lawmakers believed Bernanke approved TARP, yet his doomsday scenarios happened anyway. The Dow Jones Industrial Average closed at 10,325.38 on the day TARP was enacted (Oct. 3, 2008). Within two months it had fallen 27% to 7552.29. By March 2, 2009, the DJIA had fallen to 6,763.29, marking a 35% decline since the passage of TARP. General Motors and Chrysler both filed for bankruptcy. Unemployment has thus far peaked at 10.1%.

And now we have Greece. One of the interesting nuggets about Bernanke’s forecast on Greece is the source of his confidence: the financial institutions’ own stress tests. “We have asked the banks to essentially do stress tests and ask, looking at all their positions, all their hedges, what would the effect on their capital be if — i f– Greece defaulted,” Bernanke said. “The answer is that the effects are very small.”

Financial institutions proved during the most recent crisis that even they are sometimes unable to assess their exposure to market disruptions, yet Bernanke turns to these very same institutions for his market intelligence. If analysis of the opaque derivatives market is that easy, then why in the name of transparency does Dodd-Frank mandate derivatives be traded on exchanges or via swap execution facilities? Bernanke must think that aspect of Dodd-Frank is a waste of time since he can just pick up the phone and ask those he is tasked with regulating to accurately assess any possible threats to the market.

Greece may or may not default. But if it does, Bernanke’s track record and bold reliance on questionable data means his forecast will probably be wrong. Again.