January 30, 2010: Grading the Bernanke Fed
On January 28, 2009, the U.S. Senate voted 70-30 to confirm Ben Bernanke for a second four-year term as Fed Chairman. While this lopsided margin sounds like a resounding endorsement, in fact, it was narrowest in the history of the Fed. Prominent senators on both the right (Jim DeMint (R-SC)) and left (Barbara Boxer (D-CA)) opposed Bernanke’s bid for a second term.
Prior to this vote, the narrowest margin was 84-16 in favor of Paul Volker’s second term in 1983, after what had, up until now, been acknowledged as the worst U.S. recession since the Great Depression. (Unemployment was actually higher in 1983 at 10.8% than the 10.2% peak recorded during 2009).
Why the opposition to Bernanke? To better understand the opposition to Bernanke, let us consider the Fed’s three main areas of responsibility: (i) monetary policy; (ii) consumer protection; and (iii) bank regulation.
The Fed’s monetary policy is driven by a dual mandate: keep inflation and unemployment low. While the Bernanke Fed kept inflation under check, many economists (including this one) think that Bernanke’s “easy-money” policy on interest rates led to excessive leverage, (i.e., borrowing) in the financial system, which not only created the housing bubble but also fueled speculation by investment banks, hedge funds and other financial institutions, leading to the ongoing financial crisis. We now have a 10.0% unemployment rate. Moreover, the Bernanke Fed has more than doubled the size of the Fed’s balance sheet, from about $800 billion before the crisis, to more than $2.25 trillion in the most recent week. While most of this increase was initially for “liquidity facilities” used to provide liquidity to the financial markets during the crisis, the Fed has wound down most of these facilities and replaced those assets with purchases of $1.25 trillion in mortgage-backed securities (MBS) designed to keep mortgage-interest rates low. The Fed now has to craft an “exit strategy” for reducing its balance sheet in order to keep the money supply from exploding and causing double-digit (or worse) inflation. Yet, if the Fed sells the MBSs, which no other entity would purchase during 2009, it risks pushing mortgage-interest rates up by hundreds of basis points. If rates rise while the Fed holds these MBSs, then the Fed will lose hundreds of billions because the market value of the long-duration securities will fall precipitously as rates rise. One can easily arrive at a grade of “F” for Bernanke’s monetary policy.
Next, consider the Bernanke Fed’s record on consumer protection—not a pretty picture. Under Bernanke, the Fed failed miserably in protecting consumers from predatory mortgage lenders, who saddled uninformed borrowers with “teaser-rate” mortgages, option ARMs, subprime mortgages and usurious credit-card loans. It also failed to reign in home-equity loans, which consumers used to turn their homes into piggy banks, paying off credit card balances with cash-out home-loan refinancings. The four largest banks hold more than $400 billion in home-equity loans that, if marked to market values, would be worth pennies on the dollar, wiping out the capital of these systemically important “too-big-to-fail” banks. Again, one can easily arrive at a grade of “F” for Bernanke’s record on consumer protection.
This leads us to the third main area of the Fed’s responsibility—bank regulation. Under the Bernanke Fed, the big Wall Street banks funded lines of credit to the unscrupulous mortgage brokers who originated the toxic home mortgages (subprime, Alt-A, Option ARM, stated income, etc.) that Wall Street securitized and led to the financial crisis. Two of the four largest bank holding companies--$2 trillion Citigroup and $800 billion Wachovia--arguably failed (or had to be bailed out by taxpayers). The Fed is the primary regulator for bank holding companies. Losses at failed banks have pushed the FDIC into insolvency for the first time since the early 1990s, and the banking system is in shambles, with more than a thousand banks in serious danger of failure. The widely publicized “stress tests” of the 19 largest bank holding companies were designed by the Fed and have been roundly criticized as a total fraud. Under Bernanke, the Fed punted on providing liquidity to Bear and Lehman, allowing them to fail, but somehow figured out how to allow Goldman Sachs and Morgan Stanley to become bank holding companies, which saved them from insolvency. In so doing, Bernanke extended the taxpayer safety net to these two investment banks, which were largely responsible for creating the financial crisis. Again, it is easy to arrive at a grade of “F” for the Bernanke Fed’s record on bank regulation.
With grades of “F” in each of the Fed’s main areas or responsibility, it is truly amazing to this economist how 70 U.S. Senators and the President could possibly consider Bernanke fit to serve another term. It just goes to show how, in the world of Washington politics, nothing succeeds like failure.
The financial crisis isn't over. We are looking at either double-digit inflation (perhaps the best case) or a massive double-dip recession (the worst case).
