Thursday, December 3, 2009

Changing My Mind on Bernanke

I think it's pretty obvious that I'm a big supporter of the Obama administration, and particularly of the Geithner Treasury. But I'm surprised at how little I find myself caring about whether Bernanke is reappointed. If you had asked me a month ago, I probably would've given Bernanke my full-throated support. The only thing that's changed in the past month is that I started to think more carefully about how Bernanke, personally, has performed. I still strongly believe that the Fed has performed admirably ever since the Bear Stearns failure, opening wide the money spigots and helping to avoid a second Great Depression. In some respects, Bernanke deserves credit for not repeating the mistakes the Fed made during the Great Depression. But let's be honest: no Fed-Chair-worthy economist would have repeated the mistakes of the Depression-era Fed. The Fed, as an institution, is very much in the middle of mainstream economic thought, and no mainstream economist thinks the Fed acted wisely during the Depression. The Fed has seen itself as institutionally-committed to intervening in a financial crisis for a few decades now. What about all those "creative emergency lending facilities" like the PDCF and the CPFF that the Fed implemented, and that Bernanke is always getting so much credit for? Those were in reality designed largely by the NY Fed's Markets Group (headed at the time by William Dudley, who's now the NY Fed President), not Bernanke. More on that later. If you think about it, two of the decisions that Bernanke actually did have significant influence over were in hindsight pretty terrible decisions: 1. The emergency 75-basis point rate cut when Asian and European markets were tanking due to SocGen unwinding rogue trader Jerome Kerviel's trades — that wasted 3 of the Fed's bullets in one fell swoop. Awesome. It's not like the Fed could've used those bullets later or anything. And the emergency rate cut was definitely Bernanke's call. Here's how David Wessel described it in In Fed We Trust (emphasis mine):

"Flexing his muscles as he had rarely done before, Bernanke won the FOMC’s backing for what — for the Fed — was a king-size rate cut: three-quarters of a percentage point, with a strong hint of more to come at the FOMC meeting scheduled for the following week." (pg. 93)
2. The unreal decision NOT to cut rates on the Tuesday after Lehman's failure. Hoocoohanode that the largest bank failure in world history — 13 months into a still-worsening financial crisis, no less — would've had an effect on interbank lending? Yeah, the interbank markets probably didn't need any help on Sept. 16-17, 2008, and the markets definitely didn't need a confidence boost. Or something. I'm reminded of Paul Krugman's description of Greenspan's emergency rate cut after LTCM's failure (from The Return of Depression Economics):
"It is important to realize that even now Fed officials are not quite sure how they pulled this rescue off. At the height of the crisis it seemed entirely possible that cutting interest rates would be entirely ineffectual—after all, if nobody can borrow, what difference does it make what the price would be if they could? And if everyone had believed that the world was coming to an end, their panic might—as in so many other countries—have ended up being a self-fulfilling prophecy. In retrospect Greenspan seemed to have been like a general who rides out in front of his demoralized army, waves his sword and shouts encouragement, and somehow turns the tide of battle: well done, but not something you would want to count on working next time." (pp. 135-136)
Bernanke didn't even ride out in front of his army. Ultimately, I think these two bad decisions raise questions about Bernanke's "feel for the market" — his understanding of market psychology (hugely important), his ability to interpret market signals that are important to Fed policymaking, etc. A Fed Chair absolutely needs to have a good feel for the market. Greenspan, for all his faults, actually did have a remarkably good feel for the markets during crisis-type situations. Does Bernanke? I'm not sure, but I'm skeptical. Bernanke deserves at least some credit for being willing to sign-off on the "creative emergency lending facilities" that took the Fed into uncharted waters. On the other hand, I don't think he (or the other Fed Governors, for that matter) had much of a choice. As I said before, the Fed sees itself as institutionally-commited to intervening to ease a financial crisis, and there were unquestionably intervention-worthy problems in the credit markets in 2007-2008. For example, Bear's failure vividly demonstrated how important it is, in terms of financial stability, for large investment banks to have access to stable sources of liquidity. After Bear Stearns, any Fed Chair would've seen that the sudden failure of a large investment bank could threaten the stability of the financial system. Since the Fed's traditional emergency lending facility (the discount window) isn't available to investment banks, anything the Fed did to address this problem was necessarily going to take the Fed into uncharted waters. So Bernanke didn't have much of a choice on the Primary Dealer Credit Facility (PDCF) — everyone, and I mean everyone, knew that the Fed had to get involved, and the only real way to do that was with something like the PDCF. Ultimately, I'm not against Bernanke's reappointment. I'm ambivalent on Bernanke personally, and I'm rooting for the Senate to confirm Bernanke just so the Obama administration doesn't take a huge hit to its credibility (I'm also rooting for him because it's effectively a done deal now, and everyone likes to root for a winner). Do I wish that the Obama administration had nominated someone other than Bernanke? In retrospect, yes, I probably do. But now that they've re-nominated Bernanke, I don't want to see him get rejected, and then have the administration forced into accepting someone that Chris Dodd "suggests" can easily get confirmed. The devil you know, and all that. To be clear: I don't think Bernanke will be a bad Fed Chair in his second term by any means, but I don't think he'll be a particularly great Fed Chair either.


Anonymous said...

really confusing post here. What happeneded you are generally such a clear writer! Any ideas on who you would have wanted instead of Bernanke then?

Basically you are accusing him of not having done even more ??

Anonymous said...

"But let's be honest: no Fed-Chair-worthy economist would have repeated the mistakes of the Depression-era Fed. ..." - EoC

I'm not so certain this is true. He was pretty aggressive. I think a lot of economists, Fed worthy, sat back and said, "Wow! I don't know if I could have done that." If true, that would possibly add up to them doing a lot less than necessary, which would be repeating the mistakes of the Great Depression.

Bruce Krasting said...

"To be clear: I don't think Bernanke will be a bad Fed Chair in his second term by any means, but I don't think he'll be a particularly great Fed Chair either."

You must be kidding. Ben is going to destroy us. He thinks we can easily finance 100% debt to GDP. He is dead wrong. When we finally find that out it will be too late.

I like O too. I worked hard and paid to help get him elected. This nomination has turned me against him. Why would he have chosen a guy who has been tainted by history and was appointed by Bush?

My forecast from this: 18 months from now we come to understand that QE was a massive mistake that will take ten years to recover from. Ben will ruin the Obama administration.

In 2012 some fool Republican like Jeb Bush will walk in the White House. And guys like you and I will be blaming Ben B for unseating the guy who actually COULD have made a difference.

History will not treat Ben nicely.

Anonymous said...

"The only thing that's changed in the past month is that I started to think more carefully about how Bernanke, personally, has performed."

Welcome to the party, pal.

Anonymous said...

I don't know if replacing Bernanke will make any difference, but I want this guy gone. So he thinks Congress should take money from the poor and elderly and give it to the banks? I think we need to get rid of people like this to send a message. Politicians and bankers don't give a damn about us, unless they are stealing our money. And most of us have reached the point where there is no money left to give.

Anonymous said...

Bernanke makes unpopular decisions but ultimately saves us from a 2nd Depression. And so we are going to thank him by firing him?

Jasper said...

I think some of us look at it that Bernanke presided over a collapse of the financial system and to the brink of a great depression and to reward that record is unconscionable.

That he prevented a total meltdown by throwing trillions towards Wall Street doesn't make up for the failure to foresee or address the imbalances before they threatened our entire economy.

KoWT said...

the -ocracy of it all

we used to be a democracy, then we moved to meritocracy, from there we segued almost seamlessly to a plutocracy, and these days we're at the kleptocracy stage of the festivities...

Unknown said...

As an 'ingenuo': I feel somebody has to change the 'terms of engagement'. Otherwise we meander towards the logical conclusion. And that is what seems to be the root of initial posting: "I'm following the logic." Fair enough. But wouldn't it be nice to break the logjam? To some some extent Obama was elected to do just that, or rather he was elected to do just that. Do we just need to fine tune, or is a sea-change necessary. I read the blogosphere, and I see that the consensus is arriving at the conclusion that a sea-change is necessary.
The question is who/what can deliver it? The debate seems to over Bernanke's 'firefighting' re 'reforming' characteristics.

Tom Davis said...

I'm afraid if not Bernanke then we end up with Larry Summers as Fed chief. Now that's a log ride over Niagara Falls.

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If you're a fan of the Geithner Treasury, I assume that's for political rather than economic creasons. But if you genuinely believe the administration is making good economic policy, and that's why you're a fan, please can you explain? Not trying to ensnare, just looking for reasons as to why I'm wrong or what I missed.

Thank you.

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