On the morning of Nov. 4, two days after the midterm elections, Timothy Geithner was scheduled to fly to Kyoto for a dinner with Asian-Pacific finance ministers. At the last minute, Geithner postponed his trip; there was just too much going on in Washington. The dimensions of the electoral drubbing that President Barack Obama had taken were still sinking in when the Treasury Secretary arrived at the White House to plot strategy at the President's cabinet meeting.
Obama then extended an olive branch to newly empowered Republican leaders, inviting them to meet later in the month. Geithner had no illusion that peace was breaking out. In fact, as he returned to the Treasury Dept. for a private lunch with Federal Reserve Chairman Ben Bernanke, the next political battle was already taking shape.
Bernanke would be the new target.
Bernanke and Geithner, who sat for separate interviews for this story, won't say what they discussed at their Nov. 4 lunch; an official describes the meeting as routine. As the Administration's point man in its dealings with the Fed, Geithner lunches with Bernanke almost every week. The Treasury Secretary says there's one topic that's off-limits: "I don't give him advice on monetary policy for two reasons. One is out of respect for the basic independence of the Fed. The other is because I'm not living and breathing monetary policy every day."
The two had been scheduled to get together earlier that week but waited until immediately after a two-day Fed meeting that began on Election Day—the same session, as it turned out, that put Bernanke in play politically. At the meeting, Bernanke faced down opposition from Kansas City Fed President Thomas M. Hoenig and pushed through his plan for a second round of "quantitative easing"—pumping $600 billion into the economy over the next eight months by buying long-term Treasury debt. The strategy was designed to boost the flagging U.S. economy, bring the unemployment rate down from its painful 9.6 percent level, and prevent a Lost Decade of low growth and deflation similar to what Japan suffered after its real estate bubble burst in 1990.
With the impact of Obama's $814 billion stimulus program fading and Republicans unwilling to spend more, the President was depending on the Fed to prod the recovery. And Fed officials say they felt obliged to act—to try to reduce unemployment they think is dangerously high and increase inflation they fear is dangerously low. With short-term interest rates already near zero, they sought to bring down long-term rates by taking the unorthodox approach of buying Treasury bonds. The move had already elicited protests from German and Brazilian officials, who worried it would drive down the value of the dollar, making their exports costlier in the U.S. Bernanke and Geithner expected further complaints at the Group of 20 summit in South Korea the following week. They didn't anticipate the size of the battle that erupted at home.
The political attacks on the Fed—once the most sacrosanct of government institutions—started slowly, with Tea Party-backed candidates such as Republican Rand Paul, running for the U.S. Senate in Kentucky, campaigning against the central bank. When Bernanke announced round two of quantitative easing (or QE2, as it became known) on the day after the election, the response was swift. Indiana Representative Mike Pence, a conservative bellwether and possible 2012 Presidential candidate, released a statement accusing the Fed of "masking our fundamental problems by artificially creating inflation." A few days later, former Alaska Governor Sarah Palin, the unofficial leader of the GOP's Tea Party wing, posted on her Twitter account that the Fed was planning to "print $ out of thin air."
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