Bernanke Part 2?

Obama’s decision to re-appoint Ben Bernanke as Federal Reserve Board Chairman has stirred up the dust on Wall Street. Opinions vary wildly over whether it is a sound choice. The single point of agreement appears to be the unanimous idea that this is a very significant moment in the history of the Fed and the economy, so whoever gets the job is an equally significant player on the world stage.

My view?

Mediocre decision. I would have preferred a change, but my problem has been to think of a solid alternative acceptable to a wide audience. There are a few names tat spring to mind -Yellen and Geithner being amongst them – but each has potential issues that could marshall opposition. I don’t like it, but Bernanke is going to get a second shot at the job.

He wins by default.

That’s not a good position to find ourselves in.

The central problem is that academic economists are , by and large, incapable of doing practical things like running central banks. Plus most, if not all, of them are tainted by their adherence to the theories that got us into this mess. Bernanke himself, of course, was an academic, which is one reason why he failed so obviously at the task of spotting and proactively dealing with the housing bubble.

Let’s take a look more closely at how to evaluate Bernanke.

It seems to me that there are three major criteria to look at:

1. His performance in the run up to the crisis.
2. His performance during the crisis.
3. His performance as a regulator.

The first two are central banker type issues and obviously the third is regulatory.

In terms of the run up:

I just don’t see how that Bernanke gets a high grade here. He was absolutely part of the problem. He is ideologically committed to the libertarian ‘market-knows-best’ philosophy that led both he and Alan Greenspan to ignore the build up in asset prices. He failed lamentably to control the excesses of the American economy in the face of the glut of money flowing in from abroad. On the contrary he became a leading advocate of the ‘savings glut’ theory that the bubble was a result of ‘excess’ foreign savings coming to America to find a happy and risk free home. Consequently he saw that inflow of speculative cash as a sign of America’s strength not as a signal to rein in profligate debt riddled habits. A worse decision could not have been made.

So in the run up to crisis Bernanke failed at every test. He is schooled in, and continues to advocate, the very theory that failed us. I have yet to see his admission of this failure. I doubt whether we will ever see it. He remains a committed bubble denier. Better yet we should think of him as a bubble blower.

Next, the crisis itself.

Having helped create the mess it was only fitting that Bernanke found himself at the epicenter of the crisis not just in having to deal with extreme monetary policy problems, but also as a regulator and central banker. The Lehman and AIG crises stressed the capability of the Fed to the extreme. That they appear to have been shambolic, to put it mildly, when viewed with hindsight is not exclusively Bernanke’s fault. The US has a fractured and deliberately antiquated regulatory system that has its roots in the 1930’s and still reflects the state of finance back then. One of the great legacies of the Reagan/Bush era is the deliberate underfunding and near abandonment of our regulatory framework – we should be grateful that it worked at all, which I think is due far more to the lower level functionaries than to its leadership. Nonetheless work it did. And the world’s financial markets did not implode totally. Bernanke sat at the table during most of those essential decision making moments, so we have to give him due credit for that.

But: his de-regulatory predilection surely cannot go unblamed. The fact that the regulatory system is so rickety is because influential people like Bernanke believe profoundly in the efficacy of market solutions. Regulation was seen as a hinderance. Perhaps he still harbors those ideological beliefs. If so he is completely disqualified from the job. Obama seems to be willing to take the chance that the worm has turned.

In terms of pure monetary policy I tip my hat to him. The Fed has employed an arsenal of monetary weapons never before deployed. The entire range of conventional and unconventional weapons has been used. The Fed’s balance sheet has been expanded to levels never seen before; the money base has been bloated beyond recognition; and interest rates – the ‘normal’ tool has been held extraordinarily low for a very long time. All this has created a fear of inflation down the road – which as you know I disregard as a current worry – and so Bernanke has sensibly started to lay the groundwork for a safe exit from these crisis driven measures. The Fed’s monetary policy response has been excellent, even though at times it seemed to be a follower rather than leader in innovation – The Bank of England gets the laurels in innovation, although that is a dubious honor – it managed to introduce enough measures on sufficient scale to stave off disaster.

Finally as to his regulatory credentials.

I have already signaled my objections here. Bernanke at heart is a de-regulatory person. His core ideas are all built around opening the financial world up to competition and thus innovation. He is blind both to the use and value of regulation. His record is terrible. The Fed stood idly by as the derivative market exploded into an other-worldly mess of intricate and valueless obscurely constructed deals that ultimately tore the economy down. That was on his watch. His continued view is that deregulation produces benefits that strengthen the economy by shifting or mitigating risk, or by adding value and opportunity for wealth creation. I would endorse that only in so far as the wealth being created was exclusively channeled to the pockets of bankers. The economy at large saw no benefit. On the contrary taxpayers are going to be paying off the debts of the ‘innovators’ for a very long time. All that innovation produced no substantial social benefit, and it came a huge and very real cost to the millions of people who are now unemployed because of the lax regulatory regime Bernanke presided over.

To cap this all off: in the proposed ‘reform’ of financial regulation the administration intends to hand the Fed even greater power, especially in its role as overseer of ‘systemic risk’. Bernanke is not capable of taking on this job. His education and predilection indicate that he is too far embedded in the system to understand it or to be able to withstand the inevitable pressure from the big bankers who will want to water down anything that might restrict their ability to amass personal fortunes. Bernanke is too weak for the role. He is too close to the big banks. So is practically everyone at the Fed, which is why I advocate the construction of an entirely new regulatory body to take on the systemic role.

Lastly: Bernanke actually is campaigning against the creation of a Consumer Protection Agency for finance. This is driven in part by turf wars – the Fed has done a very poor job at overseeing consumer protection so far; and by his ideological objection to all regulation. Neither of these sources of opposition give great comfort that Bernanke is equipped to be a regulator.

Having said all this I am forced to admit that there are few alternatives. Obama may simply be making the ‘best worst’ choice. It would be impossible, though a lot of fun, to appoint a consumer advocate like Robert Reich, but I imagine the bond market would melt down instantaneously. Krugman is intellectually superior but is enjoying life as it is and would be objected to by the big banks [which is a positive credential in my book]. And the rest are all colorless replicas of Bernanke himself: all schooled in the same ideas; all all deeply wedded to Wall Street; and all too immersed in macroeconomics to give the time of day to consumer advocacy.

So we end up making the safe play. Keeping the guy in the seat already. The markets will love that since they crave stability and the devil they know already. Monetary policy will be safe. Regulation will be a shambles. And the risk of another bubble will remain large on the horizon.

This is what comes from group think: lack of choice.

And group think is one of the main reasons we ruined our economy.

At least let’s all hope that Bernanke Part 2 is a lot more dull than Part 1 was. That will be a triumph.