In our Schaeffer's Media Outtakes series, Bernie Schaeffer dissects the news, using contrarian analysis to provide a unique take on the market.

"In 2005, Ben Bernanke, now chairman of the Federal Reserve, did his bit to bolster the cosy American myth that house prices were a one-way bet. According to the New York Times he said strong fundamentals were driving the housing market before adding the oft-repeated refrain: 'We've never had a decline in house prices on a nationwide basis' ... The trouble is, by luck or design, the money men have ended up in a strong position. By giving the average American easy access to financing so they too could play the leveraged investment game they have made life tougher for the Fed. If the central bank is too hard-nosed and does not cut rates, it risks collateral damage to homeowners who, sometimes without realising it, were among the headiest speculators of all ... With homeowners poised to discover that high leverage, which boosted their gains during the golden years, has a darker side, Mr Bernanke will not want to pile on the pain. If house price falls accelerate, there is a real risk that homeowners will start rebuilding their savings and cut back on their legendary consumption, which has helped fuel America's strong economic expansion. That concern, along with below-par US economic growth and relatively well-behaved inflation, will give the Fed an excuse to cut interest rates very soon ... Ironically, as housing enters possibly its worst downturn since the second world war, it could be the over-exuberance of homeowners during the boom that ensures a bail-out for Wall Street by forcing the Fed into the rate cut investors are betting on so heavily."
----(The Financial Times "Homeowners may force Fed into action" - 9/7/07)

Schaeffer's addendum: There is no guarantee that an aggressive and rapid rate cut will cure what is ailing our economy. But there is simply no alternative that makes a modicum of sense at this juncture, and in the scheme of things as described in this article the cries of "moral hazard" and "bailing out speculators" and "inflation risk" ring extremely hollow.

Per the piece above, just 2 years ago Bernanke was clearly a believer in the invincibility American housing. Five years ago he was a believer that our economy faced a serious deflation risk. And until only a few weeks ago, inflation was his biggest concern. In other words, he has no more talent for forecasting than does the typical economist, Alan Greenspan included. But Greenspan did not have a tin ear for sensing economic distress and acting to mitigate it. Bernanke has yet to demonstrate the necessary auditory instincts.

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