Making the Fed Less Opaque
Ben Bernanke's idea of an exciting evening—according to David Wessel's new book, In Fed We Trust: How the Federal Reserve Became the Fourth Branch of Government—is to stay at home and do crossword puzzles with his wife. As it happens, a crossword puzzle that ran in the New York Sun in August 2007 provided a milestone in the Fed chairman's odyssey and education.
"Cause of difficulty in understanding Ben Bernanke?" read the clue. The answer: FEDOPAQUENESS.
Thanks to Wessel, the Wall Street Journal economics columnist, a lot of that opaqueness has been cleared up. His book is the best primer yet on the financial and economic events of the last two years. The Fed is so powerful that it has for many years been called "the fourth branch," but Wessel shows how it expanded its powers to meet the current crisis, effectively creating $1 trillion out of thin air to stabilize the financial system. "Most politicians, indeed, most American citizens, had a vague idea that the Fed could move some interest rates up or down," Wessel writes. "But they had no idea that the Fed could—with the push of a button on a computer keyboard—create that much money from nothing and without seeking the approval of Congress or the president."
But there are some mysteries about the last year that even Wessel cannot completely clear up. The first among them is what happened a year ago when the Treasury and the Fed decided they could not rescue Lehman Brothers without the help of a buyer from the outside, and that once Barclays dropped out, one of Wall Street's storied investment houses was finished. The Lehman collapse ushered in what Bernanke describes as a period of "anaphylactic shock" to the global financial system.
Wessel suggests that Bernanke and Treasury Secretary Timothy Geithner, then president of the New York Fed, were more inclined to help Lehman than Treasury Secretary Henry Paulson, who felt burned by the criticism of the government's role in the sale of Bear Stearns to J. P. Morgan earlier in the year. "I'm being called Mr. Bailout," Paulson is said to have declared during the Lehman discussions. "I can't do it again."
We will be hearing soon from Paulson when his book comes out, and he may well have a different take on the matter. But Wessel talked to Paulson's people and reports that Bernanke and Geithner were willing to put up some Federal assistance to help Lehman get acquired by someone, but not over the objections of Paulson. There was an uneasy relationship all along between the Fed chief and the Treasury secretary, Wessel says. "Managing Paulson was like riding a bull," a Fed staffer told him. Geithner is also portrayed as losing patience with Paulson's penchant for unnecessarily drawing lines in the sand when open-mindedness was needed. "Your statement is way out of line!" Geithner supposedly told Paulson, as the Treasury chief repeatedly ruled out a federal role in rescuing Lehman.
Though the book is sympathetic to Bernanke, it does not shrink from finding fault. For example, it portrays him as occasionally overly collegial, waiting for a consensus on his board or on the Federal Open Market Committee (FOMC) when he should have pushed for action. It also faults the Fed chief for not seeing the crisis coming, even as panic spread in 2008. And of course it says he misjudged the consequences of a Lehman collapse. Though Wessel does not directly blame Bernanke for a monetary policy that critics say was "too easy for too long" in the years leading up to the crisis, he quotes Bernanke as admitting that he was slow to recognize that he was facing a large worldwide credit bubble. "The mistake I made was to think about the damage being primarily limited to subprime lending," Bernanke tells Wessel. "After all, the subprime losses involved an amount of money equal to one day's movement in the stock market, and that isn't enough to make a big difference in the economy. But we know now this was a much bigger than subprime lending. It was a credit bubble much more broadly construed."
The mantra that Wessel uses to describe the Fed's actions—"whatever it takes" to avoid a Great Depression—seems apt. In 2002, Bernanke famously told Milton Friedman, whose scholarly work led him to conclude that in the 1930s the Fed helped produce the Great Depression with its tight monetary policies, that the Fed would never again make that mistake. The Fed chairman's own studies of the Depression—"to understand the Great Depression is the Holy Grail of macroeconomics," Bernanke once wrote—taught him the dangers posed not only by tight monetary policies but also the bank failures resulting from a collapse in the value of their assets. Bernanke thus became determined to use the Fed's power in unprecedented ways to avoid the cascading effects of breakdowns in the financial infrastructure.
Journalism may be the first rough draft of history, but historians will long value what Wessel brings to this book: his understanding of the sweeping changes in finance and the rise of the "shadow banking system" over several decades is coupled with a keen sense of the characters and the sequence of policy choices they confronted.
For example, there was the time that Geithner, still at the New York Fed, went to see Paul Volcker, the former Fed chairman, during the Bear Stearns collapse. As he walked in the door, Volcker said to the younger man: "How's your finger?" It was a sardonic reference to the Little Dutch Boy holding back the tides of collapse with his finger in the dike. Of course, Volcker, Geithner, Bernanke, Paulson, and others were only then beginning to understand the force of the tides being restrained.
Now that Bernanke has been renominated for another term, his biggest challenge may lie ahead. He has to guard the Fed's independence, jeopardized in the eyes of many Americans by the series of "politically charged bailouts" of the last year, as Wessel says. And he will have to define—and execute—the "exit strategy" from the Fed's interventions, just as the administration will have to adopt an "exit strategy" from the deficit spending incurred by its spending programs and the collapse of federal revenues in the recession. No doubt there will be unintended consequences flowing like a tidal wave from whatever Congress and the administration do to build a new regulatory, fiscal, and monetary system.
How's your finger, indeed.