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August 28, 2009

Bernanke - Take II

Earlier this week, President Obama made it official and reappointed Ben Bernanke for a second term as Federal Reserve Chairman. This wasn't a big surprise and was viewed by many as the safe choice. It would have been tough to switch to a new leader while we're still very much in the midst of volatile economic times.

That's not to say, however, that everyone loves the decision. Bernanke is getting mostly positive reviews from economists for his performance during the financial crisis. But he's also drawing his fair share of criticism. Here's a sampling.

Robert Samuelson thinks that while Bernanke made some significant mistakes, he got it mostly right:

Here is where Bernanke distinguished himself. A student of the Great Depression, and especially of the disastrous effects of bank failures, he went well beyond the standard response of lowering interest rates (the overnight Fed funds rate dropped effectively to zero by December). The Fed created a dizzying array of "liquidity facilities" that substituted more than $1 trillion of Fed credit for retreating private credit. The Fed supported markets for mortgages, money market funds, commercial paper, auto loans and student loans. The strategy was, as [In Fed We Trust author David] Wessel says, to do "whatever it takes" to avoid a complete loss of credit and confidence — a loss causing continuous drops in spending and asset prices (for stocks, bonds, homes) and culminating in depression.
Although there were other actors, the Fed's interventions were decisive in halting the panic. It is an open question whether any other Fed chairman — someone without Bernanke's detailed knowledge of the Depression — would have been so bold in supporting credit markets. Moreover, Bernanke's approach inspired similar moves abroad. After the 1997-98 Asian financial crisis, Time magazine ran a cover story called "The Committee to Save the World" featuring Summers, then-Fed Chairman Alan Greenspan and then-Treasury Secretary Robert Rubin. An updated version might have Bernanke on the cover under the headline: "The Man Who Saved the World."

The Wall Street Journal isn't quite as generous. In their estimation, Bernanke deserves credit for what was done after the crisis blew up. But he also deserves criticism for being largely responsible for creating the problem in the first place:

This commodity spike weakened the economy further in 2008 and contributed to the failures that struck after Labor Day. As economists Anna Schwartz and John Taylor have noted, Mr. Bernanke misdiagnosed as a liquidity crisis what was principally a bank solvency problem. This is one reason his easing did little to stem the panic throughout 2007 and 2008. A steadier monetary hand might well have avoided the autumn panic. But the Bernanke Fed was taken as much by surprise as Lehman Brothers.
All of this history is relevant because the Fed is now back where it was in 2003, albeit with a weaker recovery and more political complications. The test of Mr. Bernanke's second four years will be whether he has the wisdom and political courage to roll back his epic monetary easing before it creates the next set of problems or a new inflation. Everyone loves a central banker when he's flooding the economy with money, at least while the mania lasts. But Mr. Bernanke will sooner or later have to say no to the political class. This is something he has never done, and already there are signs in China and the edges of the dollar bloc of new asset bubbles.

But those criticisms pale when compared to the harsh words John Hussman has for Bernanke in his latest commentary:

Ben Bernanke (like Tim Geithner and his predecessor Hank Paulson), shows no hesitation in diverting the real resources of the American public to defend and compensate the bondholders of mismanaged financial companies who made reckless loans and who should have (and equally important, could have) been expected to write down principal or swap debt for equity as an alternative to receivership. This is not decisiveness. It is timidity and poor stewardship. Worse, the underlying problems are not healed — only band-aided temporarily by a flood of public money.
Unfortunately, the resources used in the recent bailout were not just free money tossed out of a helicopter. Only a partial-equilibrium economist thinks that way. No, this was an allocation of trillions of dollars of real resources that could be spent improving access of poor families to health care, finding cures for life-changing diseases, providing better education, and reversing the crowding-out of productive private investment. A public servant willing to act this carelessly with the resources entrusted to him, and so strongly in defense of fellow bankers, frankly does not deserve the job. Most likely, we will face the same credit issues a few quarters from now, given that the lull in the adjustable-rate reset schedule is near its end. We continue to expect a fresh acceleration of credit losses as we enter 2010. It would be best if we faced these challenges with more thoughtful leadership.

It's good to realize that judging the performance of Fed Chairmen is difficult to do accurately in the moment. Volcker was hated when he was breaking the back of inflation in the early 80s, as it involved brutally painful interest rate hikes. But today he is widely lauded as one of the best Fed chiefs we've ever had. On the opposite end of the spectrum, Greenspan was widely hailed as "The Maestro" — a supposed genius who left the job with great popularity. Yet just a few short years later, many hold him responsible as one of the prime culprits of the financial crisis.

Time will tell how Bernanke is remembered. How he deals in his second term with the inflation threat created during his first term will likely go a long way toward writing the rest of the story.