Thursday, July 18, 2013

Bernanke's epitaph: "We had to do something"

In his testimony before the US House of Representatives, Fed Chairman Ben Bernanke provided his own epitaph when he observe "we had to do something" in response to the financial crisis.

Remarkably, since the moment he appeared in panic before Congress to testify on the need for TARP, the self-described Great Depression expert hasn't been unable to come up with a better thought through strategy for ending the financial crisis than "we had to do something".

Actually, as Mark Twain would say, you only have to pay taxes and die.  Everything else you do is optional.

Mr. Bernanke's testimony confirmed that either he a) didn't understand that he was dealing with a bank solvency led financial crisis and the solution is adoption of the Swedish Model or b) he understood that pursuing the Japanese Model would not work and he is trying to defend his legacy.

Bernanke's defensiveness can probably be chalked up to the one thing he could plausibly be afraid of: watching his legacy go the same way as that of former Treasury Secretary Tim Geithner, who left while excoriated for his seeming friendliness toward big banks.
The Geithner Doctrine doesn't "seem" friendly to big banks.  It is designed to be friendly to big banks.

The Geithner Doctrine is don't do anything that will harm the profitability or reputation of big and/or politically connected banks (hat tip Yves Smith).
Bernanke has done more than Geithner did, and took on the economic job left undone by a dysfunctional Congress and a distracted president as well. He became a one-man economic Mr Fix-it, not by choice but by necessity.
Mr. Bernanke told everyone who would listen that he is an expert on the Great Depression.  Hence, he was a logical person to lead the response to our current financial crisis.

The one problem as pointed out by Anna Schwartz, Milton Friedman's co-author and a noted expert on the Great Depression too, is that Mr. Bernanke learned the wrong lessons (see here and here) about the Great Depression.

When faced with a bank solvency led financial crisis, ending the crisis requires having the banks recognize upfront their losses on the excess public and private debt in the financial system.

Until banks recognize the losses, monetary policy is not going to end the crisis.

A fact that should be apparent to all as we approach the six year mark on August 9, 2013 of the beginning of the financial crisis.
Now, facing the end of his term, he is fighting an uphill battle to get the credit for the work laid at his door. 
He wasn't often right – in fact, in forecasting, often wrong – but his Fed did more than any other government or private entity to tackle the country's economic problems
That's something.
Your humble blogger would give Mr. Bernanke a significant amount of credit for trying and doing something were it not for one small fact: he didn't use all the tools at the Fed's disposal from the beginning of the financial crisis.

As he testified before Congress, he talked about not being successful at ending the crisis and the need for the Fed to have additional tools if it were to successfully end the crisis.  However, he completely ignores the fact that the Fed has an entire toolkit from its role as lender of last resort and responsibility for bank supervision that he chose not to use.

The Fed could have used both of these tools to end the financial crisis by requiring the banks to recognize their losses upfront on the excess public and private debt in the financial system and protect the real economy and the social contract.

Mr. Bernanke elected not to do so.

He chose to pursue zero interest rate and quantitative easing policies that Walter Bagehot, who invented the modern central bank in the 1870s, said would create economic headwinds that render these policies ineffective.  Turns out Bagehot was right. The economic headwinds existed in the form of the Retirement Plan Death Spiral as both individuals and companies cut back current consumption to fund the shortfall in earnings on retirement assets.

He chose to allow bankers to continue to pay themselves large cash bonuses at the same time the Fed engaged in regulatory forbearance and let the banks transform their non-performing loans through 'extend and pretend' into 'zombie' loans.

He chose to put the real economy into a downward spiral by placing the burden of the excess debt on the real economy where it diverted capital needed for reinvestment, growth and supporting the social contract to debt service.

In his testimony, Bernanke also observed that
Fed didn't have a way to oversee the shadow banking system.
As regular readers know, the inability to see what is going on in shadow banking should have been a less than subtle hint that there was a need for transparency.

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