Bernanke’s speech on Europe: reading the tea leaves

NEW YORK | Federal Reserve’s chairman Ben Bernanke attended his semi-annual monetary policy report to Congress on Tuesday and Wednesday, insisting that the Fed remains in close contact with European authorities but the alarms of spillover are still on.

“I don’t think they [Europe leaders] are close to having a long-term solution that will solve the problem and until they find those long-term solutions, we’re going to continue to see periods of financial market volatility,” he said.

Mr. Bernanke pointed out that European authorities have both strong incentives and sufficient resources to resolve the crisis, although the last measures taken, such as the recapitalization of Spain’s troubled banks, haven’t prevented Europe’s financial markets and economy to remain under significant stress.

“Moreover, the possibility that the situation in Europe will worsen further remains a significant risk to the outlook,” he warned.

THE FISCAL CLIFF’S NIGHTMARE

But for Wall Street the fear seems to be currently shifting from Europe to the domestic fiscal situation. The biggest nightmare is the so-called fiscal cliff, $600 billion spending cuts and tax hikes scheduled to kick in at the start of 2013 if policymakers don’t agree on the country’s budget. That would endanger the weak recovery and make job creation extremely difficult, leaving unemployment rates above 9 percent. A fiscal cliff would basically put the U.S. back into recession.

“While our analysts are somewhat less worried about the impact of European bank strains, the negative impact of fiscal cliff uncertainty is becoming more widespread,” a Morgan Stanley report stated on Monday.

Mr. Bernanke urged (again) lawmakers to achieve fiscal sustainability in order to avoid the worst. Policymakers pressed him to be more specific in his suggestions. But he wasn’t. Nor did he make any promises of more quantitative easing action, causing broad disappointment among investors.

LIBOR SCANDAL

The Fed is drawing more scrutiny from its critics after the New York Fed released documents showing it was aware that Barclays Plc underreported borrowing costs in 2008. Bernanke underlined that the underreporting of LIBOR was “unacceptable behavior” and the U.S. central bank offered a “substantial response” to address the problem. According to him only had the information that they were “possibly submitting low rates to avoid appearing weak” during the financial crisis.