The Collected Works Of Benjamin Bernanke

Federal Reserve Chairman Benjamin Bernanke...ecce homo! The man is so hugely qualified that it was essential for Obama to break off his vacation on its first day to announce his re-appointment. Just couldn't wait!

So, okay, let's take some time to remind ourselves of all the myriad ways that Bernanke both missed the signs of, and continues to enable, the economic meltdown.

What housing bubble?

Days before President George W. Bush nominated him to take the reins at the Fed, Bernanke was already fitting his neck for albatrosses, insisting that the housing boom was not a bubble.

"House prices are unlikely to continue rising at current rates," said Bernanke, who served on the Fed board from 2002 until June. However, he added, "a moderate cooling in the housing market, should one occur, would not be inconsistent with the economy continuing to grow at or near its potential next year."

As Stephen Roach points out in today's Financial Times, Bernanke is a big enthusiast of the bubble economy, and that enthusiasm led to our collective undoing:

On this count, he stood with his predecessor - serial bubble-blowing Alan Greenspan - who argued that monetary authorities are best positioned to clean up the mess after the bursting of asset bubbles rather than to pre-empt the damage. As a corollary to this approach, both Mr Bernanke and Mr Greenspan drew the wrong conclusions from post-bubble strategies earlier in this decade put in place after the bursting of the equity bubble in 2000. In retrospect, the Fed's injection of excess liquidity in 2001-2003, which Mr Bernanke endorsed with fervour, played a key role in setting the stage for the lethal mix of property and credit bubbles.

Roach also points out that Bernanke "was the intellectual champion of the "global saving glut" defense that exonerated the US from its bubble-prone tendencies and pinned the blame" elsewhere, a stance that reflects "a deep-seated denial."

The subprime mortgage crisis is going to be "contained."

Back in March of 2007, Bernanke faced the Joint Economic Committee, with a rosy projection on the housing crisis that was a wee bit more focused on the petals than the thorns.

Although the turmoil in the subprime mortgage market has created severe financial problems for many individuals and families, the implications of these developments for the housing market as a whole are less clear. The ongoing tightening of lending standards, although an appropriate market response, will reduce somewhat the effective demand for housing, and foreclosed properties will add to the inventories of unsold homes. At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency. We will continue to monitor this situation closely.

By July of 2008, Bernanke was "revising and extending" those remarks. By which he meant that "stabilization is expected later this year or early next year." Is it still "early" 2009?

"The Fed blew it -- big time."

Dean Baker, writing for TPM, said that, "The problem in the current situation was not that the Fed did not have the responsibility to prevent the $8 trillion housing bubble that caused this crisis. The problem was that the Fed either did not see the bubble or somehow did not think there would be serious consequences from its collapse."

Just to be clear, this was not a minor error. It was as bad a mistake as you could possibly make on the job. This is like the cook who leaves the stove on and causes the restaurant to burn down. It's comparable to a nurse administering the wrong medicine, not once or twice but hundreds of times, leaving a lengthy trail of illness and death in his wake. The Fed's performance is like a school bus driver who drunkenly heads into oncoming traffic, causing the death of all of his passengers. In short, this is really serious.

But, in the clubby world of high-level Washington no one would ever be so rude as to suggest that Ben Bernanke should be fired for his mistakes. In fairness, his predecessor Alan Greenspan deserves more blame. But Bernanke still could have mitigated the damage even as late as January of 2006, when he took over as Fed chair.

Missing the meltdown

Bernanke continually attempted to portray Wall Street's collapse as an unforeseeable set of circumstances. This week, at the Jackson Hole symposium, Bernanke's story was that in August of 2008, "there was little to suggest that market participants saw the financial situation as about to take a sharp turn for the worse. For example, although indicators of default risk such as interest rate spreads and quotes on credit default swaps remained well above historical norms, most such measures had declined from earlier peaks, in some cases by substantial amounts."

Although Bernanke is correct to say that in August 2008, counterparty risk levels had not yet breached the March peak reached when Bear Stearns nearly failed (although they did very soon afterwards), it's pretty evident to anyone, looking at this chart, that financial market strains had been on a general uptrend since the beginning of 2007. Indeed, the average credit default swap spread on these dealer banks was 13 times higher in August 2008 than it had been in January 2007.

Has the Fed lent "freely against good collateral"? Hardly. Here's Econbrowser's pictorial representation of the Fed's balance sheet from a few months ago, showing a dramatic shift from holdings concentrated in US Treasuries to a mish-mash of mortgage-backed and asset-backed debt, taken on from Bear Stearns and AIG, on which it has already suffered losses of up to US$5 billion.

Keeping AIG counterparties under wraps

Back in late February and early March, when AIG returned to Congress, seeking another huge bailout, members of Congress insisted on knowing the identities of AIG counterparties that stood to gain from another round of taxpayer largesse. Ben Bernanke, along with Timothy Geithner, did everything he could to stand in the way of that disclosure.

The odor of bailouts

At a town hall meeting in July of 2009, Bernanke told a number of frustrated citizens that he had to "hold his nose" over the various bailouts which utilized taxpayer monies. "I was not going to be the Federal Reserve chairman who presided over the second Great Depression," Bernanke said. When the Fed was criticized for being a de facto fourth branch of the government, Bernanke bristled. "That's a tremendous exaggeration," he said, later adding, "I'm answerable to the American people." Really? How does he figure that?

How about that Fed oversight?

Bernanke was publicly insistent that the Fed could handle the role of economic supercop and monitor large financial companies, even though their track record at foreseeing problems was suspect. Yet when it came time to account for the $500 billion that vanished into the gaping maw of various foreign banks, Bernanke pled ignorance:

In response to the global economic crisis, the Fed has injected hundreds of millions of U.S. dollars into foreign central banks in exchange for foreign currency. The swaps represent a radical intervention by the Fed in the global money supply but have barely been covered by the media. They are done without approval from or oversight by the Congress or the White House.

Bernanke, asked by Grayson what the central banks did with the U.S. money, replied: "I don't know."

And who's watching over the Fed, watching your money? Even more clueless people!

Toxic asset alchemy

Was there ever a time, during all the talk about the government buying up "toxic assets" with your money and then attempting to recoup the money by getting banks to snatch them up, that you wondered, "Hmmm. I don't think I'd pay a whole lot of money for something described euphemistically as a 'toxic asset.'" Well, you had reason to wonder!

Bernanke wants government to pay significant premium over current "firesale" prices for troubled assets. Specifically, he wants to pay close to the "hold-to-maturity" price, which he argues is much higher than the mark-to-market firesale price. Bernanke and Paulson believes this is necessary to get banks to participate.

This is a huge boon to banks and will likely hose taxpayers. Why? Because the government will not have time to figure out what the true "hold to maturity" value of these assets is. Instead, it will have to take the word of banks who have every incentive to dump their crap on taxpayers.

Wall Street remains unchastened.

And those various vampire squids are still paying themselves huge bonuses! No one's learned a hard lesson, and Richard Bernstein ably sums up why:

Wall Street has supported both Mr. Greenspan and Mr. Bernanke. Much like a raw material producer thrives on real asset inflation, Wall Street thrives on financial asset inflation's cheaper and more abundant credit. Mr. Greenspan and Mr. Bernanke made sure that the Street was not disappointed regardless of the longer-term detrimental effect on the US economy.

The next Fed Chairman should be more concerned with the stability of the financial sector, rather than with the growth of the financial sector. The next Fed Chairman must be ready, willing, and able to take swift and significant action to protect the security of the US financial system regardless of whether Wall Street deems it appropriate or not. Mr. Bernanke has demonstrated no such aptitude.

Compounding overconfidence

John Carney, channeling Malcolm Gladwell, points out that by simply accepting the "too big to fail" dynamic as reality, Bernanke and the Fed transform themselves from would-be overseers to straight-up enablers. This is "irrational exuberance" writ large, and it is POLICY, now:

Everyone from Fed chair Ben Bernanke to Treasury Secretary Tim Geithner has officially announced that the policy of our government is that we will not allow another Lehman Brothers, which means that the government will do whatever it takes to prevent the collapse of a large, complex, systemically important financial institution.

Not many people seem to understand that this policy makes it almost impossible for banks to competently manage their risk. On the surface, the Wall Street banks benefit from lower borrowing costs thanks to the subsidies from both the explicitly guaranteed debt and the broader implicit guarantee against failure. But because this leaves the financial firms without a market check on their activities, it becomes impossible for them to gauge whether they are taking the appropriate risks and the appropriate level of risk.

So, for instance, we see that Goldman Sachs dramatically increased the amount of risk it takes from day to day last quarter. The market doesn't seem to have penalized them for this additional risk. And why should investors care? They've got the government on their side. Which means that Goldman has no market check on its risk, leaving the firm without outside guidance about the wisdom of its investments. In short, the market penalty on overconfidence is destroyed by the guarantees.

Harbinger of doom

Flash forward to today...

...And, even as we speak, the Southern District Court of New York has ruled against the Fed, insisting that yes, they need to be accountable for their actions:

Manhattan Chief U.S. District Judge Loretta Preska ruled against the central bank yesterday, rejecting the argument that loan records aren't covered by the law because their disclosure would harm borrowers' competitive positions.

The Fed has refused to name the financial firms it lent to or disclose the amounts or the assets put up as collateral under 11 programs, most put in place during the deepest financial crisis since the Great Depression, saying that doing so might set off a run by depositors and unsettle shareholders. Bloomberg LP, the New York-based company majority-owned by Mayor Michael Bloomberg, sued on Nov. 7 on behalf of its Bloomberg News unit.

"The Federal Reserve has to be accountable for the decisions that it makes," said Representative Alan Grayson, a Florida Democrat on the House Financial Services Committee, after Preska's ruling. "It's one thing to say that the Federal Reserve is an independent institution. It's another thing to say that it can keep us all in the dark."

As Dean Baker said today: "It would have been appropriate to mention this issue in a discussion of the case for Bernanke's reappointment." Oh, well! Don't benignly neglect your Martha's Vineyard vacation, Benjamin!