October 15, 2007
Bernanke's Soft Investor Alert
Posted by Lawrence Cunningham

"How do you value these damn things?" was the most memorable line from Fed Chair Ben Bernanke in remarks tonight at the Economic Club of New York.  He referred to complex financial instruments, responding  to a question from Henry Kaufman. 

The answer amplified a theme from an otherwise studious and sober speech putting current US economic challenges in context.  The formal talk's theme was hidden somewhat by its dryness.  But an important point seemed to be that the sub-prime crisis was not a cause but a trigger of recent deterioration in market functioning. 

The real cause is the proliferation of financial technology manifested in instruments that no one is really sure how to value.  The Chairman politely but firmly criticized investor reliance on rating agencies as a substitute for doing their own risk and valuation assessments.  He emphasized that investors who make bad or ill-informed decisions have, will and should suffer economic losses from doing so.

The Fed's job is limited to promoting stable prices and maximum sustainable employment, he repeated.  It has to take into account the effects that financial markets can have on those goals when setting policy.  But investors have to make judgments for themselves and mustn't expect ex post bailouts from the Fed or other governmental agencies. 

People at my table agreed that the speech itself was a competent if dull account of the present situation and that the Chairman's answers to questions after that showed a vibrant, astute and engaged man commanding historical perspective, economic learning, and good common sense.

Kaufman's question and Bernanke's answer do underscore two points of special interest to me: (1) investors have to do a better job of valuing securities and not rely on ratings and (2) accounting standard setters need to be cautious moving toward "fair value accounting" when valuation of trillions of dollars worth of assets today is an uncertain art at best.

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