By Vincent R. Reinhart Friday, July 31, 2009
Filed under: Economic Policy, Government & Politics
Federal Reserve Chairman Ben Bernanke’s Summer of Love 2009 Tour took him to Kansas City last weekend. Over the prior week, he had been combative about the Fed’s turf with the Congress and hawkish in the pages of the Wall Street Journal on the removal of policy accommodation. In keeping with the strategy of peeling away different demographic groups, the KC stop was a chance to show his empathy with the PBS set.
A question-and-answer forum is an ideal setting for the gifted teacher and best-selling textbook author. He compared and contrasted nicely with some other stars of popular multi-part PBS series. The chairman was less hunkish than Colin Firth in “Pride and Prejudice” and less cerebral than Jeremy Brett in “Sherlock Holmes.” Rather, he came across much like Derek Jacobi in the “Cadfael”—a good man in a bad time. It is a role well suited to the monkish Bernanke, right down to the tonsure.
The good feeling, however, was practically foreordained by the way that the host, Jim Lehrer, and his colleagues framed the key issue. Over and over, the audience was told how the Fed had to navigate through a “perfect storm,” complete with footage of waves and boats at sea that seemed to come straight from the George Clooney movie of the same name.
Metaphors matter. Calling what has happened over the past two years a “perfect storm” treats problems in financial markets as if they were imposed from outside by a force of nature. It naturally invites an image of the Fed chairman at the helm of a frail craft in a yellow slicker, trying to bring us home against odds stacked by wrathful gods.
This neglects that policy shaped the contours of the financial crisis. In 2007 and early 2008, the triumvirate of Bernanke, Treasury Secretary Hank Paulson, and New York Fed President Tim Geithner failed to identify the solvency problem sucking the lifeblood from our financial system. When pressed by events in the spring of 2008, they set a problematic precedent in coming to the aid of the investment bank Bear Stearns. Thereafter, they were inconsistent in the manner in which they resolved institutions, adding uncertainty in an already uncertain time.
These policy interventions by the Federal Reserve and the Treasury, in addition to being ambiguous as to the scale and scope of the protections offered, created adverse incentives. The management of firms with capital deficiencies had an excuse to postpone painful adjustments. Creditors and short sellers had a reason to test the limits of government intervention by betting on which would be the next domino to teeter. The net effect was to deter private capital from coming into an industry desperately in need of more capital.
Thus, by autumn 2008, public actions helped to dig the capital hole deeper. At that point, our co-captains made statements about the need to pass the Troubled Asset Recovery Program (TARP) and to justify the takeover of the American International Group, which added to uncertainty and damaged confidence. Quite understandably, households and businesses headed for the hills when officials told them that the financial market threat meter was flashing orange and on watch to go to red. That is a problem inherent in the brinkmanship of bailouts: Political salesmanship does not align well with economic stewardship. But that is a problem of human design, not written in the stars.
That is why the metaphor of the perfect storm is inapt. The captain’s action does not influence the height of the waves. Bernanke, in contrast, participated in making and implementing interventions that worsened the financial crisis last year.
Indeed, the rocky reception the Fed has received in recent months from the Congress, including threats to its independence, stems from those decisions last year. Bailouts confused the public about policy intent and threw open the door of the Federal Reserve to political pressures. The Congress is now rightly debating whether the Fed has been sufficiently accountable given that some of its actions look more like fiscal rather than monetary policy.
The pity is that Bernanke has been mostly masterful in the narrower conduct of his job as monetary policy maker, unburdened by the entangling embrace of the Department of the Treasury. The Fed eased policy aggressively when the depth of the downturn became evident and reached deep into the toolkit of unusual policy actions to lessen credit strains in financial markets. Indeed, it is noteworthy that such support of markets has not brought along nearly as much baggage as support of individual firms. Perhaps the conclusion is that the administration and the Congress should be thinking of ways to narrow, not broaden, the Fed’s focus.
In that regard, there is one last irony. The crashing waves that set the backdrop of the community forum appeared to come straight from the movie “The Perfect Storm.” A subtext of the Sebastian Junger book that the film is based upon is the role of economic hardship. The Andrea Gail sailed far from the safe harbor of Gloucester, Massachusetts, in the fall of 1991 toward an evident risk. But its crew was pressed to take such a risk because the United States was amid a sluggish economic recovery after a painful recession. Monetary policy matters in many ways.
Vincent R. Reinhart is a resident scholar at the American Enterprise Institute.
Image by Darren Wamboldt/Bergman Group.
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