Ben Bernanke and the financial crisis.
At Princeton, where Bernanke taught economics for many years, he was known for his retiring manner and his statistics-laden research on the Great Depression. For more than a year after he was appointed by President George W. Bush to chair the Fed, in February, 2006, he faithfully upheld the policies of his immediate redecessor, the charismatic free-market conservative Alan Greenspan, and he adhered to the central bank’s formal mandates: controlling inflation and maintaining employment. But since the market for subprime mortgages collapsed, in the summer of 2007, the growing financial crisis has forced Bernanke to intervene on Wall Street in ways never before contemplated by the Fed. He has slashed interest rates, established new lending programs, extended hundreds of billions of dollars to troubled financial firms, bought debt issued by industrial corporations such as General Electric, and even taken distressed mortgage assets onto the Fed’s books. (In March, to facilitate the takeover by J. P. Morgan of Bear Stearns, a Wall Street investment bank that was facing bankruptcy, the Fed acquired twenty-nine billion dollars’ worth of Bear Stearns’s bad mortgage assets.) These moves hardly amount to a Marxist revolution, but, in the eyes of many economists, including supporters and opponents of the measures, they represent a watershed in American economic and political history.
Ben Bernanke, who seemed to have been selected as much for his predictability as for his economic expertise, is now engaged in the boldest use of the Fed’s authority since its inception, in 1913.
Bernanke, working closely with Henry (Hank) Paulson, the Treasury Secretary, a voluble former investment banker, was determined to keep the financial sector operating long enough so that it could repair itself—a policy that he and his Fed colleagues referred to as the “finger-in-the-dike” strategy. As recently as Labor Day, he believed that the strategy was working. The credit markets remained open; the economy was still expanding, if slowly; oil prices were dropping; and there were tentative signs that house prices were stabilizing. “A lot can still go wrong, but at least I can see a path that will bring us out of this entire episode relatively intact,” he told a visitor to his office in August.
By mid-September, however, the outlook was much grimmer. On Monday, September 15th, Lehman Brothers, another Wall Street investment bank that had made bad bets on subprime mortgage securities, filed for bankruptcy protection, after Bernanke, Paulson, and the bank’s senior executives failed to find a way to save it or to sell it to a healthier firm. During the next forty-eight hours, the Dow Jones Industrial Average fell nearly four hundred points; Bank of America announced its purchase of Merrill Lynch; and American International Group, the country’s biggest insurance company, began talks with the New York Fed about a possible rescue. Goldman Sachs and Morgan Stanley, the two wealthiest investment banks on Wall Street, were also in trouble. Their stock prices tumbled as rumors circulated that they were having difficulty borrowing money. “Both Goldman and Morgan were having a run on the bank,” a senior Wall Street executive told me. “People started withdrawing their balances. Counterparties started insisting that they post more collateral.”
The Fed talked with Wall Street executives about creating a “lifeline” for Goldman Sachs and Morgan Stanley, which would have given the firms greater access to central-bank funds. But Bernanke decided that even more drastic action was needed. On Wednesday, September 17th, a day after the Fed agreed to inject eighty-five billion dollars of taxpayers’ money into A.I.G., Bernanke asked Paulson to accompany him to Capitol Hill and make the case for a congressional bailout of the entire banking industry. “We can’t keep doing this,” Bernanke told Paulson. “Both because we at the Fed don’t have the necessary resources and for reasons of democratic legitimacy, it’s important that the Congress come in and take control of the situation.”
Paulson agreed. A bailout ran counter to the Bush Administration’s free-market principles and to his own belief that reckless behavior should not be rewarded, but he had worked on Wall Street for thirty-two years, most recently as the C.E.O. of Goldman Sachs, and had never seen a financial crisis of this magnitude. He had come to respect Bernanke’s judgment, and he shared his conviction that, in an emergency, pragmatism trumps ideology. The next day, the men decided, they would go see President Bush.
On October 3rd, Congress passed an amended bailout bill, giving the Secretary of the Treasury broad authority to purchase from banks up to seven hundred billion dollars in mortgage assets, but the turmoil on Wall Street continued. Between October 6th and October 10th, the Dow suffered its worst week in a hundred years, falling eighteen per cent. As the selling spread to overseas markets, the Fed’s failure to save Lehman Brothers was roundly condemned. Christine Lagarde, the French finance minister, described it as a “horrendous” error that threatened the global financial system. Richard Portes, an economist at the London Business School, wrote in the Financial Times, “The U.S. authorities’ decision to let Lehman Brothers fail will be severely criticised by financial historians—the next generation of Bernankes.” Even Alan Blinder, an old friend and former colleague of Bernanke’s in the economics department at Princeton, who served as vice-chairman of the Fed from 1994 to 1996, was critical. “Maybe there were arguments on either side before the decision,” he told me. “After the fact, it is extremely clear that everything fell apart on the day Lehman went under.”
The most serious charge against Bernanke and Paulson is that their response to the crisis has been ad hoc and contradictory: they rescued Bear Stearns but allowed Lehman Brothers to fail; for months, they dismissed the danger from the subprime crisis and then suddenly announced that it was grave enough to justify a huge bailout; they said they needed seven hundred billion dollars to buy up distressed mortgage securities and then, in October, used the money to purchase stock in banks instead. Summing up the widespread frustration with Bernanke, Dean Baker, the co-director of the Center for Economic and Policy Research, a liberal think tank in Washington, told me, “He was behind the curve at every stage of the story. He didn’t see the housing bubble until after it burst. Until as late as this summer, he downplayed all the risks involved. In terms of policy, he has not presented a clear view. On a number of occasions, he has pointed in one direction and then turned around and acted differently. I would be surprised if Obama wanted to reappoint him when his term ends”—in January, 2010.
Bernanke and Paulson’s reversals have been deeply unsettling, perhaps especially so for the millions of Americans who have lost jobs or defaulted on mortgages so far this year. And yet, for the past year and a half, the government has confronted a financial debacle of unprecedented size and complexity. “Everyone knew there were issues and potential problems,” John Mack, the chairman and chief executive of Morgan Stanley, told me. “Nobody knew the enormity of it, how global it was and how deep it was.” In responding to the crisis, Bernanke has effectively transformed the Fed into an Atlas for the financial sector, extending more than $1.5 trillion in loans to troubled banks and investment firms, and providing financial guarantees worth roughly another $1.5 trillion, making it global capitalism’s lender of first and last (and sometimes only) resort.
“Under Ben’s leadership, we have felt compelled to create a new playbook for the Fed,” Kevin Warsh, a Fed governor who has worked closely with Bernanke, told me. “The circumstances of the last year caused us to cross more lines than this institution has crossed in the previous seventy years.” Paul Krugman, the Times columnist, a former colleague of Bernanke’s at Princeton, and the winner of this year’s Nobel Prize in Economics, said, “I don’t think any other central banker in the world would have done as much by way of expanding credit, putting the Fed into unconventional assets, and so on. Now, you might say that it all hasn’t been enough. But I guess I think that’s more a reflection of the limits to the Fed’s power than of Bernanke getting it wrong. And things could have been much worse.”
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