Savior from depression, or father of coming inflation? Bernanke era ends this week

McClatchy Washington BureauJanuary 27, 2014 

US NEWS FED 7 ABA

Federal Reserve Board Chairman Ben Bernanke speaks at a news conference June 19, 2013 at the Federal Reserve System in Washington, DC.

OLIVIER DOULIERY — MCT

— When Ben Bernanke prepared to lead the Federal Reserve in January 2006, the former Princeton University professor and economic historian confided to colleagues that he hoped he’d be one of the least remembered chairmen of the Federal Reserve.

Eight years later, he’s leaving the post likely to be the most remembered.

Bernanke ends his second four-year term as Fed chairman on Jan. 31, a stretch that to him might have felt like it was measured in dog years. Two years into the job, the financial system unraveled in a near collapse in the summer of 2008.

Already the nation’s leading expert on the Great Depression, Bernanke was determined not to repeat the Fed’s passive response of the 1930s. Instead, he attacked the crisis with aggressive and creative moves designed to keep the economy moving forward at all cost.

“He kept us out of Great Depression II,” said Dean Croushore, an economics professor at the University of Richmond and co-author of a textbook with Bernanke. “What the Fed did at that time (in the 1930s) was follow standard practice in the face of this massive shock to the economy. . . . I think Ben’s greatest contribution is . . . that he was creative, that he thought about the impact of the shock across many dimensions.”

In his memoir, “Decision Points,” former President George W. Bush recalled how Bernanke convinced him that bold steps were needed to arrest an unfolding financial crisis of epic proportions.

“The market had ceased to function. And as Ben had explained, the consequences of inaction would be catastrophic,” Bush wrote. “As unfair as it was to use the American people’s money to prevent a collapse for which they weren’t responsible, it would be even more unfair to do nothing and leave them to suffer the consequences.”

Notwithstanding the bold moves, the financial crisis caught Bernanke and the rest of the economic profession by surprise, no doubt something that’ll remain part of his legacy, too. Bernanke later admitted that he regretted thinking that the housing crisis was an isolated, contained event.

During his confirmation process in 2005, there wasn’t talk of a looming housing crisis or that Wall Street banks had taken on boneheaded amounts of risk. The closest issue to controversy was if Bernanke’s committing to a published inflation target of 2 percent would threaten the Fed’s credibility.

“Before he took the job, I think Ben was really looking to continue the (Alan) Greenspan years. Things looked like they were in pretty good shape,” said Croushore, who maintains a friendship with Bernanke. “He wanted to be one of the least remembered Fed chairs in history. I think the opposite happened and events thrust him into the spotlight where he did not want to be. Talk about being out of your comfort zone.”

In March 2008, Bernanke helped broker an unprecedented fire sale of investment bank Bear Stearns to JP Morgan Chase. Months later, attempts to do the same with Lehman Brothers failed and crisis ensued with a vengeance.

The Fed used powers few knew it had to rescue global insurance giant American International Group. It used those powers to provide short-term financing to a number of U.S. corporations to keep the so-called commercial paper markets afloat. And investment banks changed their legal status to holding companies in order to get Fed life support.

When the panic finally calmed, the Fed on three separate occasions turned to quantitative easing. That practice, never tried before, involved purchasing government and housing bonds to drive investors out of safe returns and into risk-taking such as stocks, which supported economic activity.

The efforts swelled the Fed’s holdings to above $3 trillion, and in December, Bernanke announced that as of this month the Fed would taper back on what had been $85 billion in monthly bond purchases.

Critics contend that the purchases distort the value of stocks and bonds and may lead to a persistently high rate of inflation as the Fed gradually ends its economic support. That could dent Bernanke’s legacy.

“We don’t know and won’t know whether this unconventional policy has created a serious risk until we see how it plays out,” said Martin Feldstein, a prominent conservative economist and Harvard University professor who was on the short list for the Fed chairmanship in 2005.

Feldstein is among those who think Bernanke’s rescue efforts will be his legacy, but that the bond buying threatens it.

“It’s really created more increased risk than increased aggregate demand” for goods and services, he told McClatchy, adding that it “may have helped in 2010” but serves to muddy the outlook today.

Sen. Rand Paul, R-Ky., a frequent Fed critic, agreed.

“His role with the Federal Reserve’s unprecedented actions, such as printing trillions of dollars to pay for government debt, bailing out Wall Street, and leaving interest rates near zero into perpetuity, may have catastrophic consequences for America’s savings, wealth and standard-of-living in years to come,” Paul said in an email to McClatchy.

The bond buying coincided with a period of congressionally imposed fiscal austerity, making it hard to determine if Bernanke’s policies failed to spark more growth or conversely kept growth from being even slower.

Bernanke isn’t much worried about what future historians say.

“I hope to live long enough to read the textbooks,” he quipped during a Dec. 18 news conference, likely his final one.

Turning serious, he suggested his is a two-part legacy.

“The first is that the Federal Reserve has rediscovered its roots, in the sense that the Fed was created to stabilize the financial system in times of panic,” Bernanke said. “The other thing that was . . . largely unique about this period was that we were trying to help the economy recover from a deep recession at a time when interest rates were almost or essentially zero, and that required us to use other methods, most prominently forward guidance and asset purchases, neither of which is entirely new.”

This guidance often came during news conferences, a novelty introduced by Bernanke after decades of secrecy at the Fed. He also reintroduced the English language to Fed statements, his predecessor favoring deliberately vague language.

In his memoir “On the Brink,” former Treasury Secretary Henry Paulson likened a chat with Bernanke to a “graduate school seminar,” calling him “one of the most brilliant people I’ve ever known, astonishingly articulate in his spoken word and in his writing.”

Email: khall@mcclatchydc.com; Twitter: @KevinGHall

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