This is how to make a trillion dollar mistake, from the master of disaster, Captain Carnage.

As you know, commodity prices peaked during the summer and, rather than leveling out, have actually fallen dramatically with the weakening in global economic activity. As a consequence, overall inflation appears set to decline significantly over the next year toward levels consistent with price stability.

They are consistent with deflation, not price stability. Demand didn't moderate, it rolled off the table. Well at least they turned the problem into a nail. Instead of a problematic, but manageable, asset deflation, and a problematic, but manageable, resource inflation - we know have a dangerous, and potentially catastrophic down turn. It's not always good to move all the variables to one side of an equation. But there's more in this speech to fear and loathe.

To ensure that adequate liquidity is available, consistent with the central bank's traditional role as the liquidity provider of last resort, the Federal Reserve has taken a number of extraordinary steps. For instance, to provide banks and other depositories easier access to liquidity, we narrowed the spread of the primary credit rate (the rate at which banks borrow from the Fed's discount window) over the target federal funds rate from 100 basis points to 25 basis points;

He's done this by making the fed funds rate largely fiction. A classic example of breaking the indicator.

Although monetary easing likely offset some part of the economic effects of the financial turmoil, that offset has been incomplete, as widening credit spreads and more restrictive lending standards have contributed to tight overall financial conditions. In particular, many traditional funding sources for financial institutions and markets have dried up, and banks and other lenders have found their ability to securitize mortgages, auto loans, credit card receivables, student loans, and other forms of credit greatly curtailed. Consequently, the second component of the Federal Reserve's strategy has been to support the functioning of credit markets and to reduce financial strains by providing liquidity to the private sector--that is, by lending cash or its equivalent secured with relatively illiquid assets.

Read, a cash for trash program.

Judging the effectiveness of the Federal Reserve's liquidity programs is difficult. Obviously, they have not yet returned private credit markets to normal functioning. But I am confident that market functioning would have been more seriously impaired in the absence of our actions.

How not to think like an economist. The question isn't whether we are better off with these actions, but what the opportunity cost of these actions against some other set of actions is. This, Prof. Bernanke leaves as a class exercise. Note the word "Lehman Brothers" doesn't enter his vocabulary here.

In particular, the Federal Reserve collaborated with the Treasury to facilitate the acquisition of the investment bank Bear Stearns by JPMorgan Chase and to stabilize the large insurer, American International Group (AIG). We worked with the Treasury and the Federal Deposit Insurance Corporation (FDIC) to put together a package of guarantees, liquidity access, and capital for Citigroup. Other efforts include our support of the actions by the Federal Housing Finance Agency and the Treasury to place the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac into conservatorship and our work with the FDIC and other bank regulators to assist in the resolution of troubled depositories, such as Wachovia. In each case, we judged that the failure of the institution in question would have posed substantial risks to the financial system and thus to the economy.

Note the absence of Lehman Brothers. Note that he forgets to mention that Bear was acquired in the spring, and then the Federal Reserve decided to sit and wait... and wait... and wait...

The Federal Reserve has worked to promote financial stability through other means as well, such as strengthening the financial infrastructure. For example, the Federal Reserve Bank of New York has led cooperative efforts to improve the clearing and settlement procedures for credit default swaps and other over-the-counter derivatives.

Even though since this program started Credit Default Insurance has increased in price.

In particular, recent events have revealed a serious weakness of our system: the absence of well-defined procedures and authorities for dealing with the potential failure of a systemically important nonbank financial institution. I

The dramatic expansion of which he's overseen as Fed Chair.

The Federal Reserve is authorized to lend to nondepositories under unusual and exigent circumstances, but such loans must be backed by collateral sufficient to provide reasonable assurance that they will be repaid; if such collateral is not available, the Fed cannot lend.

But he refuses to disclose what makes up 2 trillion of his balance sheet, so we don't really know.

On that basis, the Administration, with the support of the Federal Reserve, asked the Congress for a new program aimed at stabilizing our financial markets. The resulting legislation, the Emergency Economic Stabilization Act (EESA), provides the necessary authorizations and resources to strengthen the financial system and, in particular, to deal with the potential failure of a systemically important firm. Notably, funds provided under the act facilitated the recent government actions to stabilize Citigroup. More broadly, the act allows the Treasury to recapitalize and stabilize our banking system by purchasing preferred stock in financial institutions.

Shorter Bernanke: "We've got a license to print money and hand it to our friends." And lord God did the taxpayer get taken to the cleaners on what little stock we've bought.

However, economic activity appears to have downshifted further in the wake of the deterioration in financial conditions in September. Employment losses, which had been averaging about 100,000 per month for much of the year, accelerated to more than 250,000 per month, on average, in September and October, and the unemployment rate jumped to 6.5 percent in October.

Actually, according to the NBER, all important indicators they follow peaked in June. Monetary policy had already screwed up. The financial acceleration of the problem, it should be noted, is precisely the sort of event that Bernanke the academic warns should not be allowed to happen, a contraction in effective money supply in the face of a down turn. Well, we hired an expert on the Great Depression, and it is working, we might just get one.

The likely duration of the financial turmoil is difficult to judge, and thus the uncertainty surrounding the economic outlook is unusually large. But even if the functioning of financial markets continues to improve, economic conditions will probably remain weak for a time. In particular, household spending likely will continue to be depressed by the declines to date in household wealth, cumulating job losses, weak consumer confidence, and a lack of credit availability.

Read: he still hasn't fixed the credit markets, and even when he does, we still have an ordinary recession to work through.

At the same time, the increase in economic slack and the declines in commodity prices and import prices have alleviated upward pressures on consumer prices. Moreover, inflation expectations appear to have eased slightly. These developments should bring inflation down to levels consistent with price stability.

And even more consistent with deflation.

In practice, however, several factors have served to depress the market rate below the target. One such factor is the presence in the market of large suppliers of funds, notably the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which are not eligible to receive interest on reserves and are thus willing to lend overnight federal funds at rates below the target.

He's still lost control of monetary policy.

The FOMC will ensure that that is done in a timely way. However, that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy.

This from the guy who said we shouldn't get in the way of asset bubbles. Capitalists on the way up, communists on the way down.

Finally, working together with the Treasury, the FDIC, and other agencies, we must take all steps necessary to minimize systemic risk. The capital injections into the banking system under the EESA, the FDIC's guarantee program, and the provision of liquidity by the Federal Reserve have already served to greatly reduce the risk that a systemically important financial institution will fail. We at the Federal Reserve and our colleagues at other federal agencies will carefully monitor the conditions of all key financial institutions and stand ready to act as needed to preserve their viability in this difficult financial environment.

But the risk isn't zero.

This is not going to generate any warm fuzzies on the markets.

1. Banks have an incentive to borrow from the GSEs and then redeposit the funds at the Federal Reserve; as a result, banks earn a sure profit equal to the difference between the rate they pay the GSEs and the rate they receive on excess reserves. However, thus far, this type of arbitrage has not been occurring on a sufficient scale, perhaps because banks have not yet fully adjusted their reserve-management practices to take advantage of this opportunity

Read, they are still too broke to even take free money.

In summary, if you want to grow up to be a widely praised heroic central banker, what you need to learn how to do is be late and wrong about monetary policy with a near oracular consistency, and then tell people that they should be thankful things aren't so much worse.

Will some one please send this man back to academia?