In Fed we Trust: Ben Bernanke’s War on the Great Panic is the first account of the inside details, hesitations and evolving decisions taken in the US by a very small group at the FED and the Treasury through the course of the largest financial crisis and depression since 1929. The book reveal a profile of the present FED chairman renominated this week by president Obama for a second term from January 31, 2010 until 2014, a critical period where diverse scenarios can emerge in America: a truly recovery, a stagflation economy or a double dip recession.
The book written with passion by journalist David Wessel has an empirical support in live coverage of the public events and also in research and inside investigation, particularly about Bernanke’s brain trust, named ironically by the author the “four musketeers” (one of them, Tim Geithner, head of the Federal Reserve Bank of New York at that time, is now secretary of the Treasury of the Obama Administration).
As we learn in David’s book, Bernanke is a different character from his predecessor, Alan Greenspan, called the Maestro. Also a monetarist and a republican, Ben is an academician specialized in the Great Depression of 1929. Most of his reflections about the “errors” of the 1920s and the 1930s inspired in 2002 (his remarks ‘Deflation: Making sure ‘it’ doesn’t happen here’) and 2005 (his book Essays on the Great Depression) his menu of monetary policy in case of a similar event, something he never thought possible until end of 2007. Since he was nominated first time for FED chairman in 2006, Ben got the opportunity to deal live with “it” and keep his promise to Milton Friedman, the monetarist Papa, that FED top staff will never permit again a Great Depression in America.
Just last week, August 21, ate the FED of Kansas City’s Annual Economic Symposium, at Jackson Hole, in his “Reflections on a year of Crisis” he concluded America avoided the collapse. The Fed, unlike in the 1930s, stopped the mutation of the financial crisis and the Great Panic of 2008 in a great depression, in the Great Depression 3.0 (if we consider the Great Global Depressions of 1907/1908 and 1929/33 so far) – that’s his overview. Not as a bystander economic historian but as a real political actor. As David pointed in the last chapter of his book, “It may someday be said, with substantial accuracy, that after some initial hesitation, Ben Bernanke and his team did all they could to defeat the Great Panic. But if the ultimate result is years of painfully slow economic growth and widespread unemployment, they will be judged by many Americans to have failed.”
It seems Obama appreciated Bernanke’s overview: “Ben approached a financial system on the verge of collapse with calm and wisdom; with bold action and outside-the-box thinking that has helped put the brakes on our economic freefall.” He has to be confirmed by the American Senate.
But Bernanke’s analysis of 1929, based in the findings of Milton Friedman and Anna Schwartz (A Monetary History of the United States, 1867-1960, Princeton, 1971), is not consensual in academia – far from that. Ben also never criticized publicly the Greenspan “put” doctrine and the Maestro strategy of fueling bubbles; never dismissed his own theory about the ‘great moderation’ and now he is very cautious in his reflections for the future about liquidity risk management at financial institutions and macroprudential regulatory approach regarding for instance all the so-called financial innovations of the rent-seeking system of the last 20 years, those weapons of mass economic destruction. Obama, this week, was politically bold: “Part of that [new] foundation [for growth and prosperity] has to be a financial regulatory system that ensures we never face a crisis like this again. We have already seen how lax enforcement and weak regulation can lead to enormous wealth for a few and enormous pain for everyone else. And that’s why even though there is some resistance on Wall Street from those who prefer things the way they are, we will pass the reforms necessary to protect consumers, investors, and the entire financial system.”
David, 53, is economics editor of The Wall Street Journal and writes the weekly ‘Capital’ column since January 2001. He works at the WSJ since 1984 and previously worked for the Boston Globe. He shared two Pulitzer Prizes. In FED we trust was published in August first week.
– OBAMA’S OPTION: “As it is often said, the markets not the Senate truly confirm the nomination of a Fed chairman. In the end, Obama looked at the alternatives to Bernanke and concluded, in this case, stability outweighed change.”
– BERNANKE’S DILEMA: “Tighten too soon and we repeat 1937, a double dip recession that would be unwelcome for many reasons — including the fragile financial system. Wait too long and we get inflation, a lot of it. That is the challenge for next four years for Bernanke.”
– MONTESQUIEU BARON “REVISED”: “The Great Panic exposed the powers of the Fed, and many Americans — and elected politicians — were stunned to discover that the Fed had become almost a fourth branch of government.”
– THE TIPPING POINT: “Clearly, Bernanke and Paulson didn’t appreciate just how big the ripples from the bankruptcy of Lehman Brothers would be — that it would, for instance, trigger the run on money market funds. The economy was weakening even before Lehman so all that followed can’t be blamed on Lehman’s bankruptcy, but Lehman’s case did make a bad financial situation worse.”
– BERNANKE’S AUTO-CRITIC FIRST STEP: “The Greenspan doctrine — to which Bernanke subscribed, and indeed one for which he helped provide the intellectual foundation — was that central banks couldn’t and shouldn’t try to pop asset-price bubbles but should instead be prepared to clean up the mess if a bubble bursts. Bernanke has said that, in light of the damage done by the bursting of this bubble, that question needs to be reexamined.”
INTERVIEW by Jorge Nascimento Rodrigues
QUESTION: Through all the crisis process since mid 2007 the White House and an apathetic President delegated, as you referred. W. Bush was a spectator, as you mention in the book. Is this politically acceptable? Is it acceptable to let voters (the citizens) think that fixing recessions and financial crisis is a “technical” problem for professional economists and financiers, for technocrats and not for elected politicians? Are economic or financial crises different from wars or great power politics?
ANSWER: Managing the response to any economic crisis takes both technical expertise and political leadership. President George W. Bush, unpopular at the time, delegated the big decisions to Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, both presidential appointees who were confirmed by the Senate. You’re correct that the president and his staff didn’t play a central role in making decisions. I suspect Bill Clinton or Barack Obama — and perhaps George W. Bush or his vice president, Dick Cheney, earlier in their administration would have played a central role. I can’t say whether this was “acceptable” or not. It’s just a fact that I reported. In war, the president is commander in chief and he has powers that no other person has — including the power to order an attack in defense of the U.S. As I observe in the book, in a financial crisis, at least under current law, neither the president nor the Treasury secretary can create the money needed to defend the economy in a crisis; only the Fed can do that.
QUESTION: Do you think the American politicians sooner or later will change this power derived from the statutory independence of the FED that, in practice, equals the Federal Reserve System to the other three pillars of the modern State (executive, legislative, justice)?
ANSWER: The Great Panic exposed the powers of the Fed, and many Americans — and elected politicians — were stunned to discover that the Fed had become almost a fourth branch of government. One can see the backlash building already. More than half the members of the House of Representatives have endorsed a bill, sponsored by Texas Rep. Ron Paul, who would do away with the Fed altogether, that would expand the authority of the congressional Government Accountability Office to audit the Fed’s monetary policy functions. The Fed strongly opposes this, and my guess is that the Fed will prevail — but will make some compromises that strengthen congressional oversight in some fashion. President Barack Obama’s proposal to renovate the financial regulatory system makes a number of far-reaching proposals: One would require the formal consent of the Treasury secretary before the Fed exercised its power to lend to almost anyone in “unusual and exigent circumstances.” (The Fed got the okay of the Treasury secretary before lending to Bear Stearns and AIG, but it didn’t have to.)
QUESTION: But is it acceptable to give to the Central Bankers a power similar to judges? Was it not clear that Central Banks, using its instrument independence (and in the case of the FED almost goal independence), were in the last 20 years the main engines of bubbles instead of being the guardians against speculation and risks of procyclicality?
ANSWER: The Greenspan doctrine — to which Bernanke subscribed, and indeed one for which he helped provide the intellectual foundation — was that central banks couldn’t and shouldn’t try to pop asset-price bubbles but should instead be prepared to clean up the mess if a bubble bursts. Bernanke has said that, in light of the damage done by the bursting of this bubble, that question needs to be reexamined. At least until the memory of this bubble wears off, I predict central bankers will be more willing to try to let some air out of asset bubbles than they were a decade ago.
QUESTION: Do you think the suggestions from William White (former BIS chief-economist) to “moderate” procyclicality from the FED policy have conditions to go mainstream among politicians and central bankers?
ANSWER: William White’s observations, which seem so strikingly out of step with the mainstream of central banking when he made them, have the virtue of looking prescient now. There’s widespread agreement that too much government policy — bank capital standards, notably — was pro cyclical, and there are efforts underway to change that. So, yes, the mainstream is moving in White’s direction.
QUESTION: Clinton’s confirmation of Alan Greenspan as FED chairman and his political agreement to the repeal of the 1933 Glass-Steagall Act in 1999 were big political mistakes that had long-term effects, finishing in this recent mess?
ANSWER: Greenspan made some mistakes, yes. But at the time Clinton reappointed him, his record was very impressive — and the monetary policy he pursued did help the U.S. avoid deflation and did keep unemployment and inflation low. As I describe in the book, the questions are whether he kept interest rates too low too low (in hindsight, I think the answer is yes), whether he was too reluctant to use the Fed’s regulatory power (I think he was) and whether his conviction that markets are best able to manage risk without government intervention created a climate in which regulation was held in very low regard in Washington (I think so.) The repeal of Glass Steagall, it seems to me, is one manifestation of the deregulatory climate in Washington. But I don’t think it gets too much blame for all the troubles that followed. After all, Bear Stearns, Lehman Brothers, AIG — none of them were conventional deposit taking banks that wandered into the risky business of investment banking.
QUESTION: All these musketeers you mention (the four guys at the FED front end and the shadow ones) aren’t sons of the same ideological father? They haven’t the same group thinking and the same “interconnectedness”? How can they have an innovative thinking to deal with a crisis that shocked the fundamentals of their thought? Pragmatism is sufficient to navigate through the crisis and to exit?
ANSWER: Actually, the Four Musketeers come from very different backgrounds and perspectives: Bernanke was the accomplished academic, Kevin Warsh was the former investment banker and Republican policy wonk, Don Kohn was the veteran Fed staffers and Tim Geithner came from the Clinton administration’s financial-crisis management squad. And, gosh, the Fed has displayed an extraordinary amount of innovative thinking and creativity in response to the crisis. The harder question is whether they didn’t see this coming because they collectively were looking in the wrong places, blind to the dangers lurking beneath the surface. On that score, perhaps one can say they were engaged in group think.
QUESTION: President Obama decision to pick Tim Geithner for Government was a casting error?
ANSWER: Perhaps, although he is looking better now than he did initially. One fact that I didn’t previously appreciate: It is hard to be the Treasury secretary, particularly in a crisis, if you don’t look the part — and he doesn’t.
QUESTION: The musketeers got excessive time to understand the ongoing crisis? Instead of the one-step-at-a-time approach, it would be more effective a bold policy about the zombie-banks and the shadow financial system from the beginning? The Swedish example in the 1990s could be of help regarding bold action just from the first moments?
ANSWER: In a democracy, the politicians almost always wait too long to act, and the cost of the rescue of the financial is larger as a result. That’s true in this case too. It does, however, look like the worst of the Japanese experience — with the zombie banks — has been averted. The stress tests did pave the way for the banks to raise a substantial amount of private capital. That’s a plus. I do worry that Fannie Mae and Freddie Mac, and perhaps AIG, will be more costly, though. The government has a plan for AIG; it’s just taking a long time to execute. It isn’t clear what their plan for Fannie and Freddie is.
QUESTION: Letting Lehman Brothers sink was the critical mistake from the musketeers in all this process?
ANSWER: That’s a hard question. A lot of people would say yes, it was, although some would say that saving Bear Stearns was as big a mistake because it raised expectations that Lehman would be saved. Clearly, Bernanke and Paulson didn’t appreciate just how big the ripples from the bankruptcy of Lehman would be — that it would, for instance, trigger the run on money market funds. The economy was weakening even before Lehman so all that followed can’t be blamed on Lehman’s bankruptcy, but Lehman’s case did make a bad financial situation worse. Bernanke insists to this day that he didn’t have the legal power to lend to Lehman because it had no collateral to offer.
QUESTION: Benchmarking with FDR period in the 1930s, it seems at that time the Administration was more driven by “structural” solutions (like the Acts approved that proved far sighted and with a long-term impact), even if accounting less financial tactical creativity?
ANSWER: Compared to the 1920s and 1930s, the Fed and elected politicians — both Bush and Obama teams — look pretty impressive, so far. They responded aggressively to the crisis, and have kept the mistakes of the 1920s and 1930s in mind. But the story isn’t over yet. Remember that the Depression took a turn for the worse in 1937 because both monetary and fiscal policy was tightened prematurely.
QUESTION: From all the crisis’ stories you wrote about the last two years, which one impressed you more?
ANSWER: The extraordinary rescue of Bear Stearns and then the extraordinary tsunami that followed the bankruptcy of Lehman stand out. I am struck, though, about how much depends on a very small number of people in the government doing the right thing at the right time at a time of crisis. Really, you could count them on the fingers of two hands — and in some cases on the fingers of one hand.
QUESTION: With this nomination of Bernanke for a second mandate from 2010-2014, Obama “links” his own political mandate (2009-2013) to a monetarist (even if pragmatic) that thinks that the monetary policy is the best way to deal with depressions and recoveries. Obama is repeating the same step that Clinton deed nominating Greenspan for a new mandate?
ANSWER: Obama is following in Clinton’s footsteps here, you are right. He is reappointing a pragmatic Republican Fed chairman — because replacing him with a Democrat would do more to unsettle markets and probably raise interest rates at an unwelcome time. As it is often said, the markets not the senate truly confirm the nomination of a Fed chairman. In the end, Obama looked at the alternatives to Bernanke and he concluded, in this case, stability outweighed change.
QUESTION: Would you consider that the major dilemma for FED Bernanke monetary policy will be from 2010 and beyond the following: Tighten too soon (as the Fed did in 1936-1937, in conjunction with a contractionary fiscal policy from government) and you push the economy back into sharp recession, prolonging the Great Depression. Tighten too late and you engineer a new bubble and a larger burst after. And, if we consider the convergence with a huge fiscal deficit (just estimated this week to jump for $9 trillion dollars over the next decade) you risk a hyperinflation à La Weimar situation. Or this last Cassandra scenario is an exaggeration?
ANSWER: Tighten too soon and we repeat 1937, a double dip recession that would be unwelcome for many reasons — including the fragile financial system. Wait too long and we get inflation, a lot of it. That is the challenge for next four years for Bernanke. It requires technical skill, forecasting ability, luck — and political courage because it will require raising rates before the economy feels normal. I don’t think Weimar like inflation is a substantial risk in an era in which central banks around the world are independent of elected politicians and see their job as delivering price stability.