You've Come a Long Way, Ben

I heard a terrific speech last Friday by the Federal Reserve Chairman, Ben Bernanke.

In his address, to a Russell Sage-Century Foundation Conference on the causes and cure of the financial crisis, Chairman Bernanke said just about everything a progressive would want to hear. Read it for yourself and see if you agree.

The financial industry, he said, had been characterized by "high levels of leverage; excessive dependence on unstable short term funding; deficiencies in risk management in major financial firms; and the use of exotic and non-transparent financial instruments that obscured concentrations of risk." In other words, Wall Street went berserk; and markets did not correct themselves. Add a little more invective about Goldman Sachs and Rolling Stone's Matt Taibbi could not have put it better.

As for the regulators, "gaps in the regulatory structure" allowed very large firms and markets "to escape comprehensive supervision." There were "failures of supervisors" and "insufficient attention to the stability of the system as a whole."

Bernanke added that though the immediate losses in the tech bust of 2000 were about the same as the losses in the value of housing -- $7 to 8 trillion -- the crash "resulted in a relatively short and mild recession with no major financial instability," while the sub-prime collapse brought down the entire economy. Why? Because of the massive disguised leverage and related abuses in the shadow banking industry that caused financial markets to grind to a halt.

Bernanke defended the Fed's policy of driving interest rates nearly to zero, including buying securities as necessary from the Treasury and from private financial markets. In pursuing these policies, he has braved attacks by the right and by several inflation-phobic regional Federal Reserve Bank presidents.

So does Bernanke deserve the accolade bestowed in the April Atlantic magazine cover profile by Roger Lowenstein, "The Hero?" Not entirely.

Bernanke certainly gets an A for using monetary policy to keep the economy from collapsing. But if you look at Bernanke over the past ten years, what you see more than anything else is a learning curve on matters of regulation. Lowenstein misses that.

Supreme among those supervisory agencies criticized in his speech that failed to contain escalating abuses was the Bernanke Fed itself.

Bernanke, in his scholarly writings about the failure of the Federal Reserve to head off or cure the Great Depression, emphasized failures of monetary policy. He said not word one about regulatory failures.

"The correct interpretation of the 1920s," he wrote in 2002, "is not the popular one -- that the stock market got over-valued, crashed, and caused a Great Depression. The true story is that monetary policy tried overzealously to stop the rise in stock market prices."

But that view is not only wrong but at odds with the views that Bernanke espouses today. The over-leveraging, conflicts of interest, and regulatory lapses of the '20s were precisely analogous to the market abuses and supervisory corruption that caused the bubble and crash of our own era.

Bernanke also gave a now (in)famous scholarly paper in 2004, in which he spoke of "The Great Moderation," meaning a world of "reduced volatility", low interest rates and plentiful capital. Bernanke utterly missed what was really occurring. Today, he would recognize that "moderation" as a fools' paradise -- the result of the reckless and un-policed creation of leverage by the shadow banking system.

Though Bernanke was determined not to repeat the mistakes of his predecessors once the system crashed in 2008, when he acted to pump in as much money as necessary, it was only later that he learned the regulatory lessons. In the spring of 2009, he was on the side of Larry Summers and Tim Geithner in wanting to prop up large, effectively insolvent banks rather than acting to nationalize them and break them up in the public interest. The Fed also resisted releasing documents on the bailout, whose disclosure was required by Dodd-Frank, until ordered by the courts.

Today, however, Bernanke is increasingly on the side of the regulators in wanting to crack down on abuses in the banking and shadow-banking systems. Which is a very good thing, because the Dodd-Frank bill, which is only a partial solution to those abuses, is under assault from all sides, and so are the other regulatory agencies.

The Republican House, urged on by Wall Street, is trying to gut Dodd-Frank's regulation of derivatives. Thousands of Wall Street lawyers and lobbyists are flooding the zone to undermine the rule-making process necessary to implement Dodd-Frank. Congress is also trying to starve regulatory agencies that have new enforcement responsibilities.

The D.C. Court of Appeals threw out the SEC's first set of rules to implement Dodd-Frank on the ground that the Commission failed to do an adequate cost-benefit analysis. This brand of cost-benefit analysis mainly looks at compliance "costs" of banks. It ignores the cost, running into the tens of trillions, of the collapse itself.

The Fed's actions are not subject to this brand of cost-benefit analysis. Nor is the Fed captive to Congressional actions limiting its enforcement budget, since the place creates money.

It is an odd feeling, certainly, seeing the largely undemocratic Fed, long an agency historically beholden to Wall Street, as an important ally in the effort to clean out the financial system and to prevent the next collapse. I'd be much happier if Congress had passed even tougher legislation, and if President Obama and his Treasury Secretary -- that would be Tim Geithner (!) -- were leading a popular crusade for deep financial reform.

Bernanke, thanks to his baptism by fire in the crisis, has steadily moved from regulatory dove to regulatory hawk. Several of his colleagues deserve credit, too, notably Governor Sarah Bloom Raskin, who prodded the Fed to take an assertive stance pressing for more housing and mortgage relief, and Governor Daniel Tarullo, the Fed's point man on banking regulation.

The Fed remains a deeply undemocratic institution, structurally in bed with the financial industry. But in times like these, we take allies where we can find them. And Ben Bernanke's odyssey deserves our respect.

Robert Kuttner is co-editor of The American Prospect and a Senior Fellow at Demos. His latest book is A Presidency in Peril.