Bernanke Learns the Perils of Honesty

Investors who never stopped griping about the cryptic statements of former Federal Reserve Chairman Alan Greenspan may already be getting nostalgiac. In most relationships, brutal honesty (or transparency, as it's known in business-speak) is a double-edged sword, and never was that more apparent than in the swift reaction to Monday's candid comments by Ben Bernanke, Greenspan's relatively straight-talking succcessor at the Fed. In a speech to an international monetary conference, Bernanke took a hard stance against inflation and implied interest rates would continue to rise in order to keep inflation in check, all of which sent stocks tumbling, with the Dow falling more than 2%, or almost 250 points, in the first two days of the week. The harsh reaction wasn't just due to Bernanke's unusually blunt outlook, though certainly the stock market doesn't like higher interest rates, which tend to crimp corporate profits as people are lured to save money instead of spend. It was also that his position on interest rates flat out shocked the markets and there are few things investors dislike more than surprises. The Fed has raised interest rates 16 times in a row, a run that many investors thought would end later this month, considering that there have been signs of a slowing economy. As Bernanke himself pointed out, the housing market is cooling, consumer spending is down because of high energy prices, and jobs aren't being created nearly as quickly now as they had been over the past couple of years. Higher interest rates tend to dampen all three of those barometers of economic strength. So if they are already dampened, the thinking goes, the Fed won't raise rates. But, in the same speech, Bernanke came out swinging against inflation, saying that the Fed would be "vigilant" and that the core inflation rates of 3.2 percent over the past three months and 2.8 percent over the past six were "unwelcome developments." Those levels, Bernanke said, were at or above the high end of what he'd consider good for price stability and long-run growth. Translation: in order to control inflation, the Fed might keep raising rates. Higher rates are also bad news if you're about to borrow money. Technically, the Fed only controls the interest rate between banks lending each other money over night (currently, it's 5%), but that trickles down to the consumer. The cost of buying a house or a car goes up, as does the price you pay for carrying a credit card balance from one month to the next. For example, thanks largely to Fed hikes, the average interest rate for a 30-year mortgage currently stands at 6.6%, according to Freddie Mac, up from 5.7% this time last year. Folks who have adjustable-rate mortgages tend to be especially hard hit, as payments balloon and more defaults follow. On the other hand, if you're a saver, you'll start seeing bigger interest payments on savings accounts, CDs and money markets. To be clear, though, no decision has yet been made about where rates are headed. This week's hoopla is all reaction to Bernanke's reading of the economic tea leaves. The real excitement hits June 28-29, when the next rate hike or hold is announced. One thing is certain; after Monday's performance, fewer people on Wall Street or Main Street will be foolish enough to think they know exactly what Ben Bernanke and the Fed is going to do or say.