A Certain Exit

So tonight
Gotta leave that nine to five upon the shelf
And just enjoy yourself
Groove
Let the madness in the music get to you
Life ain't so bad at all
If you live it off the wall

-Michael Jackson

Exits are a part of life.

Some are very good, such as when venture investors exit their star company at a large multiple of their original investment. Some are very bad, such as the loss of 5.7 million jobs in the last 17 months. And some are simply a part of life, such as the exits of Ed McMahon, Farrah Fawcett, and Michael Jackson. May they rest in peace.

Ben Bernanke's exit began last week. That we know for sure, but what is uncertain is whether we are talking about a strategic exit of the markets by a Fed that has ballooned its balance sheet to ward off deflation and further deterioration of the economy, or his exit from the Fed itself.

In the same week he provided testimony defending his actions regarding the Bank of America/Merrill Lynch combo, Ben announced a pullback of a few recession-induced stimulus programs including the Term Auction Facility (TAF) and the Term Asset-Backed Securities Loan Facility (TALF).

The goal here was not to actually rein in stimulus, as the markets have not relied on these two programs heavily in recent times, but to begin the overall process that will be gargantuan at best.

Since last September, the Fed's balance sheet has grown from around $870 billion to $2 trillion as evidence that "Helicopter Ben" was on the job. This added cash plus other guarantee programs put in place by the FDIC and the Treasury certainly saved us from dreaded deflationary risk, but created the risk of overshooting into inflationary territory.

More important than actual inflation, though, is inflation expectations. Since the days of Paul Volcker the Fed has been rightly credited with killing inflation, thereby allowing more marginal net present value (NPV) projects to become net positive. This is simply fancy finance speak for the so-called �productivity miracle' of the nineties.

Now, should investors come to expect high inflation, NPV analysis will face the high hurdle of an increased discount rate to account for the fact that tomorrow's dollar is worth much less than today's. The productivity miracle will become history, killing thousands of otherwise potentially additive projects gathering dust in the desks of CFOs. Should this happen, no one will be blamed except for Bernanke. (History may even refer to him as Ben Shalom Bernanke as we seem to include middle names for all our mass murderers).

My best guess is that Ben will not let this happen.

Which brings us to his other potential exit.

If he can leave just enough doubt in people's minds regarding the Merrill/BofA merger, perhaps he can give President Obama the out he needs to nominate Larry Summers for the job in January without truly taking any blame.

Personally, I doubt this is his motivation, but I bet a cushy university job looks pretty good to him these days.

Key Developments

The Fed met and left interest rates unchanged as expected. In addition, it reported that the current economic contraction is "slowing" and that the target rate will be kept low for an "extended period." It stated "household spending has shown further signs of stabilizing but remains constrained."

Orders for durable goods rose from the mat slightly in May. Currently standing at an annual pace of $164 billion, activity is about 29 percent below the $230 billion peak in 2006. Activity indices such as this are going through a process of leveling out, but it remains to be seen whether the next move will be toward recovery or a second dip.

Finally, we get to put the first quarter to bed at -5.5 percent. The Bureau of Economic Analysis' final estimate is a full two percentage points lower than their initial assessment. The remainder of 2009 should be closer to zero with the possibility of positive growth later in the year.