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The Investor
Failure Rewarded
The Federal Reserve's purpose, beyond monitoring the money supply, is to ensure the safety and stability of the financial system and to manage systemic risks.
Is there any doubt that the Fed has failed -- spectacularly -- to fulfill these duties?
Ben Bernanke, as the Fed's chairman, should not be allowed to fail on the job without any consequences, as if he were more an economic planner-for-life than a public servant. For that general reason, President Obama should not have commited to reappointing Bernanke for a second term.
There are also more specific charges against Bernanke. Although mainstream economists are right to say that Bernanke's aggressive monetary policies avoided a repeat of Great Depression-style deflation, he should answer for preventable mistakes he made in the wake of the housing crash that threatened regime stability and damaged business confidence.
Bernanke, a Great Depression expert before his public service, himself provided the justification for aggressive monetary expansion. He helped build on the narrative that after the financial crash of 1929, the Fed allowed the money supply to contract rapidly, which led to the steep decrease in investment and output that lasted over a decade. The seminal book in this line of inquiry was Milton Friedman and Anna Schwartz's 1963 A Monetary History of the United States. In 2002, on the occasion of Friedman's 90th birthday, speaking as a Governor of the Federal Reserve, Bernanke admitted the Fed's negligence, apologizing to Friedman, "Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."
And he lived up to that promise. Between August and November 2008, the Fed increased its balance sheet from roughly $900 billion to over $2.2 trillion -- an unprecedented expansion that involved many inventive liquidity programs. Clearly the Fed acted to avoid the specific mistake it made during the Great Depression.
But that does not excuse Bernanke's other, serious missteps along the way. Indeed, although he averted the kind of deflation that kicked off the Depression, he copycatted some of the mistakes that '30s economic officials made. Specifically, his errors lay in measures that increased what Depression historian Thomas Higgs calls regime uncertainty. His Fed misidentified the root causes of the financial meltdown, and failed to stem the contagion early on. More importantly, he aided Treasury Secretary Hank Paulson in the disastrous bailouts, overstepped the limits of his office and the law in dealing with the banks, and undermined the Fed's sacrosanct independence.
John Taylor, a Stanford economist famous for the "Taylor Rule" that describes the Fed's interest rate policy, argues in his 2009 monograph Getting Off Track that Bernanke fundamentally misdiagnosed the cause of the financial panic as illiquid banks when in fact it was counterparty risk -- banks afraid of lending to institutions that might collapse overnight. Instead of massive targeted liquidity programs, Taylor demonstrates, Bernanke should have, early on, taken the feared subprime loans and other toxic assets off of the banks' books or injected equity. In doing so, he could have begun the process of rehabilitating the fragile credit system even before the near-collapse in September.
If only our financial overseers had tried such a structured, calm approach. Instead, the tag team of the Fed and the Hank Paulson-led Treasury, charged with regulating the banks, launched a flurry of ad hoc measures with no regard for precedent, policy continuity, or even the Constitution. Hank Paulson cannot bear all the blame for these terrible false starts and mixed signals. What else would one expect from a former investment banker but to make deals and be overly aggressive?
For the economist Bernanke, however, there are no such excuses. Surely during his studies he must have come across the work of Robert Higgs, and learned his explanation for the failure of private investment throughout the '30s and into the '40s. Higgs's insight on regime uncertainty is that the activist government, in its haste to "do something, anything," confused the private sector as to the rules of the game and ended up discouraging long-term investment, which relies on stable conditions. Higgs drew on the insights of Depression-era economists like Joseph Schumpeter as well as modern econometric studies of investment under uncertain conditions to demonstrate that it was the Hoover and FDR administrations' capriciousness that retarded investment until after WWII.
In his seminal 1997 paper, "Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War," Higgs outlined all of the various property rights encroachments, changes to the tax code, giant spending programs, and threatening promises that FDR's government inflicted on private investors. Although the Bush and Obama administrations have not embraced anything like FDR's anti-market rhetoric -- Higgs presents a 1941 poll that found that 40 percent of businessman believed that the U.S. would become a fascist or at least semi-socialist economic system after the war -- otherwise they have copied FDR's missteps very closely, with Bernanke complicit all the while. A review of the events from the fall of 2008 to today clearly shows a pattern of the Fed introducing all kinds of instability into the economic mix.
The first monumental blow to regime stability was the Fed's inexplicable decision to let the investment bank Lehman Bros. go bankrupt in mid-September when it had already committed to rescuing systemically important financial companies with the Bernanke-blessed nationalizations of Fannie Mae and Freddie Mac just a week earlier, and the Fed-facilitated fire sale of Bear Stearns all the way back in March. The very next day after Lehman's collapse, the feds turned around and bailed out the giant insurance firm AIG to the tune of $85 billion. These inconsistent measures sent a clear signal to the market that the government was not operating according to any set procedure, but instead arbitrarily picking winners and losers.
The panic brought on by their own decision to let Lehman fail provided Bernanke and Paulson with fodder to fearmonger their way into the now famous TARP. The Economist described Bernanke's apocalyptic rhetoric best:
[Bernanke] "told us that our American economy's arteries, our financial system, is clogged, and if we don't act, the patient will surely suffer a heart attack, maybe next week, maybe in six months, but it will happen," according to Charles Schumer, a Democratic senator from New York. Mr. Schumer's interpretation: failure to act would cause "a depression."
The duo didn't stop at words, they also used outrageous antics, such as Paulson getting down on his knees and literally begging Nancy Pelosi to help pass the bailout plan that he, Bernanke, and a few advisors had concocted the night before.
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Robert Rosencrans| 8.26.09 @ 7:34AM
The FED is but another shining example of what occurs when the government practices the art of the monopoly. Absolute power corrupts absolutely and nowhere can the effects of that statement can be seen than in the FED. Add to that the element of dishonest politicians like you have in the Obama White House (And they're certainly not the first group like that in the White House) and you have an ideological raid on the Treasury, financing all types of socialist themes while their friends get rich.
Melvin| 8.26.09 @ 7:39AM
"Failure" but that is what government does best. Everything and everyone that government comes into contact with turns to instant failure.
Government failure is allot like King Midas, instead of turning to gold with the Midas touch, our lives turn to crap with the government touch.
Hell people, we cannot even win a damn war any more.
Indiana Alex| 8.26.09 @ 8:09AM
I believe that The Fed was primarily responsible for the current recession.
Having said that we could do worse. Look to the appointment in NY.
Yosemeti Sam| 8.26.09 @ 9:26AM
Oy, - the cliche of following the money is
just too rich.
How many Democrats on Wall Street have
raked in the money from the bulldozed
'stimulus' legislation - courtesy of the
democrat-controlled Congress?
Ex aedibus| 8.26.09 @ 9:31AM
Although Bernanke is not the best choice, Obama could have done far worse. He could have appointed Paul Krugman as chairman of the Fed.
Mike| 8.26.09 @ 9:40AM
This article is a classic in Monday morning quarter backing. More important than anything Bernanke did or didn't do leading up to the economic meltdown are: (1) the actions of Alan Greenspan (2) deregulation (3) underfunded regulatory commissions (4) regulatory commissions staffed with people of questionable competence. Mr. Lawler writes: "Although mainstream economists are right to say that Bernanke's aggressive monetary policies avoided a repeat of Great Depression-style deflation, ...." There is no although! He, aided by President Bush and Secretary Paulson who fortunately were able to take off their ideological blinders, saved us from disaster. Enough said. With all due respect, I am infinitely more comfortable with Mr. Bernanke in charge of deciding when to unwind current policies than I would be with peanut gallery critics like Mr. Lawlor
Joshua Price| 8.26.09 @ 11:12AM
"His Fed misidentified the root causes of the financial meltdown, and failed to stem the contagion early on. More importantly, he aided Treasury Secretary Hank Paulson in the disastrous bailouts, overstepped the limits of his office and the law in dealing with the banks, and undermined the Fed's sacrosanct independence."
That last sentenced is the only justification needed for not reappointing Bernanke. He was, in my opinion, willing accomplice to Hank Paulson's plan to make Goldman Sachs even stronger by helping weed out some of its competitors.
Josh Price-- theconservativebeacon.net
Louis Jenkins| 8.26.09 @ 11:25AM
Madness: Doing the same thing over and over hoping for different results.
Bob| 8.26.09 @ 12:04PM
What Lawlor recommended was not possible, which leads me to believe he knows little about the banking sector. Lawlor thought the Fed should take the toxic assets off of the balance sheets of the financial institutions. This would have caused a worse financial crisis for these companies because these assets would have to be written down to purchase cost. That would have surely sent these institutions into bankruptcy. These were leveraged on the order of 40 to 1 and AIG was leveraged on the order of twice that. Mark to market accounting was abandoned precisely to prevent this from occurring.
Lawlor clearly doesn't understand the corporate side of this. Yes, Bernanke made some mistakes, but not as many as his predecessors. Instead of bailouts, I would have liked to see prearranged bankruptcies primarily to eliminate promissory contracts to other companies and management. This would have kept the sector relatively stable while the Fed lowered interest rates and pumped capital in to the market. Even now, the banks will not sell their toxic assets because of what it will do to their balance sheets.
Regarding the stimulus bill, this is highly overstated as only 15% of the stimulus money has been spent to date. The housing bubble was obvious to many of us who follow and chart the markets. But Bernanke could have done little to stop it other than to call for re-regulating non-bank financial institutions to keep proper capital reserves and to put instruments like default swaps under scrutiny. Even now, these kinds of instruments are still possible and unregulated.
Joe| 8.26.09 @ 1:41PM
Should we not sue the government on constitutional growns for what Bernanke, Paulson and liberal democrats did. Put them in jail. That is where they belong. And if they want Bush, find he is the one who pick these 2 idiots. So, long as Obama, Pelosi and Reid are there too.
Joe B| 8.26.09 @ 1:46PM
Failure rewarded. No two words better describe the career of Barack Obama.
J.E. Davis| 8.26.09 @ 3:40PM
I really hate it when writers attempt to opine on subjects that are clearly outside their grasp. I like Lawler, but he doesn't understand banking.
J.E. Davis| 8.26.09 @ 3:40PM
I really hate it when writers attempt to opine on subjects that are clearly outside their grasp. I like Lawler, but he doesn't understand banking.
Mike| 8.26.09 @ 4:05PM
Joe B
Actually, the two words better describe Bush.
whyyeseyec| 8.26.09 @ 4:21PM
Scary thought Ex aedibus!!. Paul Krugman would be a disaster too horrible to imagine.
Don`t say things like that outloud anymore. You may give BHO ideas.....
aware| 8.26.09 @ 4:27PM
Has the writer actually read the (and other) Robert Higgs book(s)? He seems to accept the role of the Fed in the economy that Higgs certainly does not.
It is way to soon for the Masters of the Universe to be patting themselves on the back for "saving us from the Great Depression". The day may come soon when they will regret claiming ownership of the "recovery" prematurely.
When the effects of the cures (quantitative easing, fiat money, deficit spending, etc.) finally make themselves felt we may wish we'd taken a depression.
The Bankrupt America| 8.26.09 @ 7:06PM
The American National Debt is growing faster than the debt of any other world nation, it currently owes in excess of $2.7 trillion to foreign governments and other private investors. The debt equates to around 20% of the countries total GDP. This quick hub will give you the low down on who America owes and how much money they owe them, you should perhaps bear in mind that interest payments will make the true figure much higher - so who is profiting from America's overspending? Lets take a look.....
See all 5 photos
1. Japan - $585.9bn
You think that your mortgage is big? Try telling that to the Japanese government, who are owed an astonishing $585.9bn by the American government - a sum which is difficult for any of us to even comprehend. Based on a rough American population estimate of 313 million people, this equates to $1,871 per American citizen. I find it quite frankly astonishing that America's biggest creditor is a country with whom it was at war just half way through the 21st Century.
2. China - $541.0bn
Close behind Japan in the list of creditors is China who are owed some $541bn by America. That is another $1,728 that each American citizen owes to Asia. To think that America owes so much money to a country that it imports so much from is quite frankly economic suicide; Americans are purchasing many of their consumer goods from China, only for China to lend their money back to America and charge them interest on it. Thats like buying a new sofa for $1000, then having the shop lend you back your $1000 but charge you.... say 10% APR on your own cash. Debt is power, and China certainly has a lot of power over America, it is believed that Chinese funding was used to meet the significant costs of the Iraq war. Taking over a country to topple one man that posed no direct threat to world safety was certainly an expensive exercise.
3. United Kingdom - $307.4bn
To be honest, this one suprised me greatly; particularly as the British have racked up significant national debts themselves. I wouldn't be suprised to see the UK calling in this debt in order to pay its own creditors, but this is still a sour debt for American people. America flourished after the first World War because of the huge UK debts that itself owned. It appears that the tables have turned however, and each American citizen now owes the UK $982. Since the population of the UK is about one-fifth of the size of the USA's, I will take a total of $4,910 from five of you please (paypal or cheques accepted).
4. OPEC Nations - $179.8bn
The OPEC Nations, this stands for the Organization of the Petroleum Exporting countries are basically Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, U.A.E. and Venezuala. I don't really understand this one, but I do fidn it rather amusing that the Americans owe Iraq money - having pretty much chosen to blow the place to bits, I suppose it is only fair that they pay the costs of damages. If your kid smashes your neighbours window whilst playing baseball, then you have to pay for the window, same rule applies to global politics it seems. To owe money to Angola, one of the developed world's poorest countries, seems ludicrious. I doubt that America could sink too much further.
5. Caribbean Banking - $147.7bn
America also owes $147.7bn to the Caribbean Banking centres. This debt is basically owed to Bahamas, Bermuda, Cayman Islands, Netherlands Antilles, Panama, and British Virgin Islands. To think that the USA owes so much cash to places with.... well, hardly any money themselves, is perhaps testimony to how low the country has sunk. The good news is that Obama intends to reduce America's debt, so hopefully Americans will no longer face the embarrassment of owing money to a bunch of tiny islands.
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Tim Pruse| 8.30.09 @ 10:49PM
With all due respect, the TARP funding of banks demonstrates one fact more than all others: the Federal Reserve is not controlled by the U.S. Government, let alone We the People, but rather is owned and operated by the Wall Street banks that have controlled it to their benefit since its founding. This ongoing economic crisis (which is headed for worse before a recovery, despite the pollyanish pronouncements of Bernanke and Obama) is related to the continual redistribution of wealth between the productive American people and companies and the parasitic, usurious paper-pushers in Washington and Wall Street. Bernanke is surely complicite, but no more so than anyone else in banking, investment, or government. This country MUST return to fiscal sanity or my generation (I'm 26) and those following will be overcome by our national debt and general financial irresponsibilty. The best solution is not to fire Bernanke, but rather to fire the entire Federal Reserve and return to the Gold Standard and the republican form of government!
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