Bernanke in Denial
Now Ben Bernanke wants better regulation?
The Fed chairman’s speech to the American Economic Association Sunday could be viewed several ways: Ironically, because he was involved in the monetary policies over much of the past decade that stoked the lending fires, yet failed to administer appropriate regulatory constraints over his domain. Or hopefully, because he appeared to be looking forward, with a mind toward what we might be facing in 2010.
The markets were certainly enthused about it, with the Dow starting the year up 155.15 points, or 1.49 percent, in part because his defense of accommodative policy was interpreted as a sign that rates will stay low and money will remain cheap.
The flip side of Bernanke’s conclusion—we need stronger regulation to avoid future crises—is that the Fed’s monetary policy was just fine.
But having watched his entire 10-slide presentation (think: Economics 101 with a political twist), I had a different reaction: fear.
My concern is straightforward: Bernanke doesn’t seem to have learned the lessons of the very recent past. The flip side of Bernanke’s conclusion—we need stronger regulation to avoid future crises—is that the Fed’s monetary, or interest-rate, policy was just fine. That the crisis that brewed for most of the decade was merely a mistake of refereeing, versus the systemic issue of mega-bank holding companies engaged in reckless practices, many under the Fed’s jurisdiction.
For Bernanke to blame weak regulation for the pyramid of bank-concocted, over-leveraged, high fee-producing assets—real loans mixed with a lot of price-inflating hype—is like a Super Bowl coach blaming coaching in general for the failure of his team to win the Lombardi Trophy. There were $1.4 trillion of subprime loans issued between 2002 and 2007, which became $14 trillion worth of mostly toxic assets, which were used as collateral by the biggest banks to borrow much more.
• Charlie Gasparino: 5 Economic Predictions to Bank On It would be more honest of Bernanke to put blame where it’s due. Banks did not merely lend predatorily—they pushed, scooped up, repackaged, and resold loans to a frenzied degree. The repackaging of distressed assets, formerly known as “toxic,” is again a top growth area for Wall Street. Meanwhile, risk at the major banks has increased alongside trading revenues, while consumer-oriented activities continue racking up losses. All this Bernanke missed in his speech and by extension, his future strategy.
Instead, he launched into a lengthy academic discussion of the Taylor rule, an equation used to evaluate how much rates should be lowered or raised to maintain a certain inflation target. Defending Fed rate policy, he advocated the “alternative” Taylor rule that considers forecasted rather than current information to determine rates, which he noted was applied properly.
More slides followed that addressed the housing bubble. The upshot we already know—the most rapid house-price gains were in 2004 and 2005. But, Bernanke insisted, if monetary policy was an important source of price appreciation in the U.S., then it would have also propped up home prices in other countries, which it did. Consequently, he concluded that accommodative policy (low rates) “does not appear to have been inappropriate,” and that “the magnitude of house-price gains seems too large to be readily explainable by the stance of monetary policy alone.”
In other words, the Fed did everything right.
Bernanke discussed how various kinds of mortgage loans, from adjustable-rate to no-documentation ones, exacerbated problems. This was true, but used to further support his argument that “stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been…more effective… than a general increase in interest rates.”
And in case we seek to cast future blame, he warned “monetary policy can be problematic to pop asset bubbles,” that constraining the bubble in 2003 and 2004 could ”have seriously weakened the economy at just the time when the recovery from the previous recession was becoming established.”
In other words, the Fed did everything right—again.
Bernanke has this habit of expounding academic garble to deflect attention from the Fed’s regulatory responsibility for monitoring the banking system. It’s a safer tact, especially when the final Senate vote is still not yet cast with respect to his re-confirmation.
Sure, keeping rates low helps capital flow. But banks first lent cheap capital at exorbitant rates—to subprime borrowers and credit-card users alike—putting the customer economy at a distinct disadvantage to the financial-system players. And today, they are using it for risky trading purposes. Lesson not learned. Problem not solved.
While Time magazine and others gave Bernanke credit for supposedly saving the world from a second Great Depression, all he really did (alongside Geithner and former Treasury Secretary Hank Paulson) was feed capital to a capital-starved banking system, hoping it would find its way to the population, with no plan for stabilizing ongoing credit problems, including rising bankruptcies and foreclosures that lie at the economy’s foundation.
If you build an asset from a loan that defaults, the asset has less value. The Fed merely subsidized that declining value, on Wall Street’s behalf. It did nothing to fix the loans themselves. Still hasn’t. Yet this point—the $6 trillion of Fed loan facilities and guarantees still deployed to buoy Wall Street—wasn’t highlighted in the speech.
Though he spent a lot of time defending past actions, Bernanke spent little on addressing future solutions. He didn’t talk about fixing loans that are still hurting. Or reducing the complexity of the products engineered from these loans. He didn’t talk about reconstructing the banking landscape, a la Glass-Steagall—by separating banks into those that deal primarily with consumer deposits and loans vs. those creating systemic risk.
Certainly, the Fed should not have raised rates or restricted credit during the crisis. Nor should it now. But, it should ensure that credit flows beyond Wall Street’s doors, which hasn’t happened. Hyper-funding the banks wasn’t the only way to stave off doom. In fact, the Fed could have promoted injecting capital directly into mortgages instead, which would have done the trick more cheaply and fairly.
Meanwhile, justifying past monetary policy rather than acknowledging the real-world link between Wall Street practices and general economic troubles suggests that Bernanke will power the Fed down the path of the same old mistakes. Focusing on lending problems is important, but leaving goliath, complex banks to their worst practices (albeit with some regulatory tweaks) is to miss the world as it is.
The Fed is angling to be the most powerful systemic regulator, which is why Bernanke stated that it will go beyond monitoring each firm individually to being “attentive to the stability of the financial system as a whole.” It sounds good, but not if the Fed keeps ignoring problems at individual firms, and systemically.
Once the Senate confirms him, Bernanke will have to do more than just talk about regulation—he will have to start regulating. Otherwise, all these missed problems will be a horrific legacy, and an expensive lesson not learned for the rest of us.
Nomi Prins is author of It Takes a Pillage: Behind the Bonuses, Bailouts, and Backroom Deals from Washington to Wall Street (Wiley). Before becoming a journalist, she worked on Wall Street as a managing director at Goldman Sachs, and running the international analytics group at Bear Stearns in London.