Friday, December 18, 2009

In Defense of Ben

In response to my post yesterday castigating Jeff Merkley for his outspoken stand on Ben Bernanke, a few commentators have stated that they may be willing to accept that his actions post-crisis are commendable, but what about his pre-crisis actions? To this I have four responses:

1. The liberalization of the nations banking laws, most notably the Gramm-Leach-Bliley Act, which repealed parts of the Glass-Steagall Act in 1999 and allowed the merger of commerical and investment banks, and that played a major role in the crisis, were done far before Bernanke's time as a public servant. The lack of regulation of collateralized debt obligations is ostensibly under the SEC's purview, not the Fed's so to pin that on Ben is also misguided.

2. The idea that he should have seen the bubble for what it was and 'popped it' basically suggests that he should have had more foresight than millions of investors that controlled investments in the trillions. For if the bubble really was so obvious to everyone, short-sellers should have popped it long before the crisis. Why didn't they? It is easy for a lot of people to look and say, wow housing prices seem too high - but how do you really know, by your gut instinct?

3. In order to 'pop' the bubble Bernanke would have had to raise interest rates to very high levels which would have given us, perhaps less painful, but very real recession and would have hurt main street for which he would have been roundly condemned - 'who is this guy to decide the economy needs correcting when everything is going fine?'

4. The idea that Bernanke needs to look out for consumers and main street represents a misunderstanding of what the Feds role in the economy is: promote full employment and control inflation. During the real estate boom both were just fine, thank you very much. What he has done since the crisis is to do just that, prevent a depression which disproportionately hurts the most vulnerable in society.

I am troubled by the suggestion in general that we want some technocrat in the Fed who feels that they need to be an economic 'oracle' and act on feelings about the future of the economy. What I think is that we need regulations and reforms that control the ability of any one or few financial entities to leverage up so much and to take on so much risk as to pose a threat to the entire financial system should those risk turn out to be too great.

Thus to damn Bernanke for not doing enough to prevent the crisis is unfair. A good thought experiment for those who do is to ask just exactly who would have been better and what exactly would you have had them do? And don't forget that financial innovation, while run amok in other areas, did manage to get credit in the hands of individuals that would not have otherwise have had access - read the working class and the poor. Yes, it got to the point of over-extension, but it was not just the fat cats on Wall Street that were benefitting.


Runner737 said...

Far before? Didn't Bernanke become a Fed governor in 2002? In any case, Alan Greenspan campaigned for the repeal of Glass-Steagall and I've seen no evidence that Bernanke was against the repeal. In fact he likely agreed with most of Greenspan's moves because the Bush White House's MO was to appoint individuals who were philosophically in agreement with them. Bernanke's statements seem to indicate he had the same kind of foresight as Greenspan: and

Of note in November 2005:

SARBANES: Warren Buffett has warned us that derivatives are time bombs, both for the parties that deal in them and the economic system. The Financial Times has said so far, there has been no explosion, but the risks of this fast growing market remain real. How do you respond to these concerns?

BERNANKE: I am more sanguine about derivatives than the position you have just suggested. I think, generally speaking, they are very valuable. They provide methods by which risks can be shared, sliced, and diced, and given to those most willing to bear them. They add, I believe, to the flexibility of the financial system in many different ways. With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly. The Federal Reserve’s responsibility is to make sure that the institutions it regulates have good systems and good procedures for ensuring that their derivatives portfolios are well managed and do not create excessive risk in their institutions.

Yes, the Fed Chairman should have more foresight than the vast majority of investors. Of course, some had more than Ben Bernanke did, but you'd hope to get someone in the Fed who can spot bubbles. Many of those who predicted the crisis did not do so without reason:

If you're too afraid of making tough decisions then don't be the Fed chairman. If he saw the bubble then he should have attempted to inform the general public about the eminent crisis and then proceed to pop/counteract the bubble. You for got about two other Fed duties:

•supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers

•maintaining the stability of the financial system and containing systemic risk that may arise in financial markets

So the Fed shouldn't try to maintain full employment over the long haul? So you laud them for promoting full employment during the boom times, but excuse them for the busts? Obviously, the goal should be to not have busts. We're asking for someone who analyzes the evidence, makes the necessary observations, and has the experience to recognize and counteract bubbles. It shouldn't come down to a 'feeling.' Greenspan and the Fed were warned by individuals like Brooksley Born, Raghuram Rajan, and most notably William White and Claudio Borio through the BIS. Bernanke obviously deserves less blame, but he should be held accountable for his positions on the key issues and actions. At the Fed I want a Fed chairman who is both a capable regulator and vigilant observor of the markets. Bernanke appears to be neither of these and at best good on mop-up duty.

Chuck said...

My problem is not with your defense of Bernanke. My problem is with your harsh attack on Jeff Merkley. In your own words you say you were "castigating Jeff Merkley for his outspoken stand." Outspoken? Good grief! I suggest you read the text of Jeff Merkley's statement on why he would vote no on Mr. Bernanke's nomination. It is on the Senator’s website.

I read Merkley’s statement and it hardly warrants "castigating" the Senator unless your frame of reference is the nutty bubble of current Republican politics or, apparently, OSU's Economics Department. Senator Merkley's comments were not harsh and are much in line with economists such as Simon Johnson of MIT. And Simon bends over backwards to be nice to Mr. Bernanke.

Your arguments "In Defense of Ben" are sadly lacking in weight. For example "The idea that he [Bernanke] should have seen the bubble for what it was and 'popped it' basically suggests that he should have had more foresight than millions of investors, ,". Have you been to the N.Y. Federal Reserve's website and read staff papers written in the months and years prior to the September, 2008 crisis? I believe they were explicitly discussing whether an asset bubble was occurring. They were asking the questions but either getting the answers wrong or failing to act. Paper’s that should have but didn't cited Hyman Minsky!

In your point three, you ask why would Bernanke have stopped the asset price bubble party "when everything is going fine." What? The red lights were flashing for two years prior in the housing market before Wall Street imploded. Such a silly hypothetical could be compared to a teenager saying "why would I have slowed the car down when we were all having so much fun."

You simply are off the mark in your attack on Jeff Merkley's vote. I think you owe him an apology.

Patrick Emerson said...

For the record, this blog has absolutely nothing whatsoever to do with OSU or the OSU economics department. This is my own personal blog which I write on my own time with my own resources. These are simply my opinions everyone, nothing more.

I do not say that nothing could have been done or that everything was handled perfectly. There is a lot I would have like to have happen that didn't. Many miscalculated the risks that financial institutions were willing to take and how degraded the CDO trade became. Indeed, there is a lot to criticize on the part of the Fed, Treasury, the congress, and the executive branch.

What I am saying is that it was not clear that Bernanke is especially culpable. From the point of view of the fed in 2006, there are worries about an asset bubble in housing, but other economic indicators were going well, most notably inflation seemed well in check. In order to cool off the mortgage and securities market would have probably taken fairly significant increase in interest rates so that Treasuries could become once again an attractive place to park capital. This would have hurt small time borrowers more than anyone else and it wold have been hard to defend such a move against cries that the fed were hurting working people and small businesses. Besides, it is not clear that this would have cooled down the CDO market much at all - they were such good revenue generators. And many of us that saw an asset bubble (myself included) thought that it would deflate in a reasonably orderly way - we were wrong. But you would have had to be pretty darn sure that the whole thing was going to explode the way it did to really put the brakes on so hard.

I agree absolutely that in retrospect many comments by Bernanke and others look far to sanguine, but I don't think you can say - see, it was so obvious!

If there is one thing to blame Bernanke for it is probably letting Lehman fail - Paulson and Getihner are probably more directly responsible, but Bernanke let it happen and it was a mistake.

So, that is to say that the claim that Bernanke should have done more in retrospect is pretty obvious, what is less obvious is exactly what he should have done that would have made everything all right.

What is much more clear to me is that there is no one more responsible for rescuing the economy once it started going south than Bernanke. It is hard to imagine another person who would have been so ready to be so bold.

Patrick Emerson said...

Had to do this in two parts:

So there is much to criticize Bernanke for and much that he (and the rest of us) has learned. But Merkeley claims he is not fit for reappointment goes well beyond saying that - and supposes that his heroic acts are outweighed by his prior incompetence. This to me seems absurd.

Besides, it is clear (to me at least - but his own comments have made this clear) that Merkley knows he is not doing anything but making a public statement, if his vote really counted one wonders if he would have been so quick to throw him out. This is why I think it was a calculated populist move on Merkley's part. And, as a nicely cloistered ivory tower academic, populism and politics often rankle.

Finally, I have read the text of Merkley's statement and it is with lines like these that I think he is so far off base:

"Following our economic collapse, it is also apparent that he has not changed his overall approach to prioritizing Wall Street over American families."

I think this statement is simply wrong, you can't protect and promote credit access and economic growth by letting the financial system collapse.

"We need economic leaders who understand that the ultimate goal of economic policies and the key to meaningful economic recovery should be financially successful families, not oversized Wall Street profits."

This is simply unfair. To suggest Bernanke is protecting Wall Street at the expense of Main Street is unjustified and to suggest that Bernanke does not understand economics is ignorant and an unnecessary ad-homonym attack.

I am sorry, but to me this smacks of crass populism.

Runner737 said...

"So there is much to criticize Bernanke for and much that he (and the rest of us) has learned. But Merkeley claims he is not fit for reappointment goes well beyond saying that - and supposes that his heroic acts are outweighed by his prior incompetence. This to me seems absurd."

Suppose he agreed with Greenspan on all his major decisions like the campaign against both Glass-Steagall and the regulation of OTC derivatives would you still feel the same way about Bernanke? It's very likely he did given his statements, but I don't quite understand how good performance during a severe downturn will translate into good performance during the boom times. Bernanke utterly failed in this capacity during the lead up to the crisis and this should be a huge concern. Now this recovery may very well be precarious, so is it not just a tad too early to glorify Bernanke? Critics, some of whom predicted the crisis, have raised valid concerns.

Those who had an idea of what was coming probably would have performed better than Bernanke, but it's impossible to say with certainty that anyone would have performed better than Bernanke, which is the glaring flaw in that argument. Again, I'm sure Bernanke was aware of the direct warnings Greenspan received from Raghuram Rajan and the BIS (Bank of International Settlements) through William White and Claudio Borio. He raised no public awareness and persisted on Greenspan's path. Perhaps, a more astute chairman never would have allowed the financial sytem to get as close to collapse as it did.

Chuck said...

Patrick, a blog does not allow the space to make an adequate case for one's point. The real value of a blog lies in seeing a volume of well thought out concise statements - when a blog is lucky enough to have such.

I believe we have made our statements. I'll end with one final point. Your write "So there is much to criticize Bernanke for and much that he (and the rest of us) has learned. But Merkeley claims he is not fit for reappointment goes well beyond saying that - and supposes that his heroic acts are outweighed by his prior incompetence. This to me seems absurd." At this point you have left economics and have entered cultural anthropology. A statement that not
to retain Bernanke seems "absurd" is nothing more than the cultural perspective of an American professional where incompetence is almost never punished. Lower strata folks in the U.S. however are dismissed at-will for errors. In Japan, Bernanke would have resigned out of honor in spite of a legion of others urging him to remain. But if there is one value in short supply in the U.S. and absolutely missing on Wall Street it is personal honor.

Chuck said...

Today's Washington Post "Fed's approach to regulation left banks exposed to crisis."

Patrick Emerson said...

Yes, and now Paul is dumping on Ben:

But I recommend Davis Wessel's "In Fed We Trust" for a very balanced look at the Fed prior to and during the crisis. He is critical - it is no whitewash - but I think he is pretty fair.

Runner737 said...

Dean Baker offers his suggestions regarding what Bernanke could have done to prevent or curtail the crisis:

Chuck said...

Senator David Vitter submitted Simon Johnson's Doom Loop question to Federal Reserve Chairman Ben Bernanke, as part of his reconfirmation hearings, and received a reply in writing (as already published in the WSJ on-line). All available at Baseline Scenario. Notice Johnson's opinion of the Bernanke's answer.

Fred Thompson said...

Patrick, You are right about Sen. Merkley, at least I think you are. But why should Republicans have a complete monopoly on stupid, ignorant, populist ranters?