The Federal Reserve is the most powerful institution in the US economy. It has also become, in recent years, among the most unpopular. The main source of discontent with the Fed is its actions during the financial crisis and Great Recession of 2007–2009, and the slow recovery that followed, actions that have come under fire from both the left and the right. Progressives have attacked the Fed for orchestrating the bailouts of big Wall Street banks and for neglecting the interests of ordinary Americans. Conservatives, meanwhile, have blasted the Fed not just for the bailouts but also for supposedly risking hyperinflation and the debasement of the dollar by keeping interest rates “artificially” low.
Against this backdrop, The Courage to Act, former Federal Reserve chairman Ben Bernanke’s memoir of the crisis and its aftermath, is a persuasive, if self-interested, corrective. The Courage to Act is an unusual memoir. Perhaps because of Bernanke’s famously even-keeled personality (Secretary of the Treasury Timothy Geithner dubbed him “the Buddha of central banking”), his book contains almost no gossip or personal attacks. Nor is it especially revealing about the emotional experience of presiding over what Bernanke has called “the worst financial crisis in global history.” What it offers instead is a surprisingly rigorous discussion of the economics and theory of monetary policy and the management of financial crises, filtered through a blow-by-blow account of Bernanke’s tenure at the Fed.
As that description suggests, The Courage to Act is a somewhat dry book. But it’s also an important one. Bernanke clearly wants the book to be read as a vindication, showing not just why he did what he did, but also why what he did was right. And that’s not an unreasonable ambition—he deserves a great deal of credit for his management of the crisis and of the Fed’s monetary policy in the post-recession years. But what his book also shows, perhaps in spite of itself, is how the Fed’s actions are often circumscribed by ideology and politics, in ways that are damaging to the economy as a whole. It helps us understand why even the most capable technocrats sometimes fall short of our expectations. And since today’s Fed is wrestling with many of the same issues of monetary policy and bank regulation that Bernanke did, his book has as much to say about the present as it does about the past.
Bernanke first came to the Fed as a governor in the summer of 2002, leaving a post as a professor of economics at Princeton, where he had spent much of his career working on the economics of the Great Depression (something that would turn out to be quite useful). He arrived with the economy still recovering from the 2001 recession, and stayed for almost three years. He then served as chairman of George Bush’s Council of Economic Advisers before returning to the Fed as chairman in February 2006. During this time, the economy began growing briskly, unemployment fell, the housing sector boomed, and the chair of the Fed, Alan Greenspan, was being acclaimed as a wizard of central banking. Not far beneath the surface, though, disaster was brewing, in the form of reckless lending and a metastasizing housing bubble. Rather remarkably, with few exceptions, the people in charge of the Fed weren’t really paying attention.
In the public mind, the Fed’s main function is the management of monetary policy—moving interest rates up or down in order to achieve its twin goals of full employment and stable prices. But the Fed is also responsible for supervising and regulating much of the banking system. And during the housing boom the Fed did a shockingly poor job of supervision and regulation. Fed governors like Ned Gramlich did raise questions about the excesses in the subprime lending market, and there were periodic expressions of concern about the possibility of a bubble. But for the most part, the Fed gave banks and other lenders free rein to make whatever kind of loans they wanted, including loans with no attempt to verify borrowers’ income, no-money-down loans, loans to borrowers with poor credit scores, and loans that were all three of these at once. As a result, as the boom progressed, banks made more and more loans that were less and less likely to ever be paid back. And that meant the chances of a serious financial crisis rose precipitously.
This was not inevitable. The Fed had the authority to ban lending practices that it thought were exploitative or reckless. Greenspan could also have spoken out publicly about the danger of a bubble. Yet very little was done until far too late. (The Fed didn’t even require institutions to verify borrowers’ ability to repay their loans until 2007.) Some have ascribed this failure to Wall Street’s capture of regulators, with the Fed seeing banks not as entities to be regulated, but as clients to be helped. But ideology seems to have played an even bigger part. Greenspan’s conviction that self-interest would prevent the banks from imperiling their own existence with bad loans led him, and by extension the Fed, to minimize the risks that were building.
This was compounded by the fact that the Fed did not have a good picture of how those risks would ripple out through the increasingly interconnected financial system, to disastrous effect. Some of this was the result of the government’s balkanized system of banking regulation, which put different financial institutions under the supervision of different agencies. Some of it was the result of the rise of what’s called shadow banking—financial transactions outside the traditional banking system, conducted by hedge funds, mortgage companies, and investment banks, among others. And some of it was simply a failure to connect the dots. When Bernanke took over as chairman in 2006, he had no idea what was coming. Indeed, as late as May 2007, he famously told Congress, “We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.” It was a statement that revealed just how out of touch the Fed had become.
Still, if the Fed’s performance in the years leading up to the financial crisis was dismal (more dismal than Bernanke acknowledges), it redeemed itself, to some degree, by its performance during the crisis. That may sound peculiar, given that the Fed has taken far more flak for its actions during the crisis than for its supervisory neglect. Anger over the bailouts that Bernanke organized helped propel the rise of the Tea Party, Occupy Wall Street, and, eventually, Bernie Sanders’s insurgent campaign. Yet in retrospect, it’s hard to quarrel too much with the job Bernanke did in stemming the crisis and mitigating the damage it wreaked.
Clearly the Fed was too slow to recognize the severity of the crash, and too cautious in its initial response. But once Bernanke awoke to what was happening, he proved willing to do almost anything to keep the financial system—and the economy—from sliding into the abyss. The Fed rolled out a remarkable array of programs and initiatives—many of them new and untested—to keep credit flowing, not just to banks but to businesses of all stripes. Not all of these programs worked as Bernanke had hoped, but their cumulative effect was to make the Great Recession less painful and less severe than it might have been (and it still turned out to be very painful). The Fed’s charter gives it enormous leeway in the way it exercises power, and Bernanke used every bit of it (and then some—a federal court ruled recently that the Fed-organized takeover of insurance giant AIG was technically illegal).
Part of what the Fed did, of course, was help bail out struggling financial institutions, instead of letting them fail. And that’s been the source of much of the criticism of Bernanke. The Fed (and the Treasury Department) were attacked for not simply letting the weakest big banks fail, or, alternatively, for not nationalizing them—taking them over, booting out management, wiping out shareholders, and forcing bondholders to take haircuts. Doing so, the argument goes, would have helped cleanse the system of bad debts. It would have mitigated the problem of moral hazard, whereby banks took excessive risks because they expected protection from the consequences of failure. And it would have been morally just.
Bernanke, not surprisingly, sees things very differently. His academic work on the Great Depression, with its waves of bank failures, convinced him that financial institutions are not just mechanical intermediaries moving money from people who have it to people who want to borrow it. Instead, they play an active and essential part in the provision of credit, which he terms “the financial accelerator.” When that breaks down, it amplifies the damage from an economic downturn. At the same time, financial failures are contagious—the system becomes a vehicle for the transmission of fear and risk aversion. That leads lenders to pull back on credit and call in loans, which forces institutions to raise cash by dumping assets at fire-sale prices, further weakening the system. Panic doesn’t just reflect economic woes, in Bernanke’s view: it worsens them. As he puts it:
I believed then and believe now that the severity of the panic itself—as much as or more so than its immediate triggers (most prominently, subprime mortgage lending abuses and the house price bubble)—was responsible for the enormous financial and economic costs of the crisis.
As a consequence, Bernanke believed that it was the Fed’s responsibility to be the “lender of last resort,” providing credit freely to creditworthy borrowers in order to prevent the panic from spreading, rather than letting otherwise solvent firms go under.
Bernanke was similarly leery of nationalization, which he argues would have been an operational “nightmare.” (It’s also not clear that the Fed had the legal authority to take over large bank holding companies.) Some of this caution was clearly ideological: he says that he was skeptical of the government’s ability to run a bank well. He also feared that nationalization would aggravate the panic, as shareholders and lenders fled from any bank that seemed to be at risk of being taken over. And he believed that the banks were in better shape than many observers did, and that if the panic could be quelled, they would return to reasonable health relatively quickly.
In the event, this was precisely what happened. When the government ran a stress test in the spring of 2009 that showed that the banks, while in bad shape, were not beyond saving, financial markets stabilized, panic started to fade, and within a couple of months the recession was officially over.
The result of all this was that the US financial crisis ended up costing taxpayers surprisingly little, in sharp contrast to most financial crises. Bernanke says that the Fed made 21,000 loans during the period, and all of them were paid back. The Troubled Asset Relief Program (TARP), which was passed by Congress, also ended up not losing any money. It’s certainly true that all of these loans—which were made at below-market rates—were a subsidy to banks and businesses. And it’s galling that these loans meant, in part, that the very companies that had helped cause the financial crisis were able to survive it, even as none of the executives in charge of these firms have faced any real legal consequences for their failures. But as Bernanke correctly argues, the job of a central bank in times of crisis is not to dispense justice. It’s to stabilize the system. And by that measure, the Fed did precisely what it was designed to do.
The end of the crisis in the summer of 2009 was really just the beginning of Bernanke’s work. Even though the economy was no longer officially in recession, it remained extraordinarily weak. Demand was low. Lenders were skittish, making credit hard to come by, and few of those who could get credit were very interested in borrowing or investing. Consumers were dealing with the debt overhang from the bubble and the collapse in housing prices, which had left many of them with underwater mortgages. And there was no obvious replacement for the housing boom, which had driven economic growth in the years leading up to the crash.
Bernanke was unusually well equipped to deal with this problem. In the early 2000s, in fact, he had become famous when he argued, in a discussion of the Japanese economy—which had been locked in a deflationary spiral following the collapse of its own asset bubble—that the Bank of Japan was not, as some had argued, trapped by the fact that interest rates were close to zero (meaning they could not be slashed further). If worst came to worst, Bernanke argued, the Bank of Japan could pump money into the economy by buying long-term assets. Or if it really wanted to get creative, it could engage in a “helicopter drop” of money. The Japanese government could cut taxes, and the Bank of Japan could finance it by buying bonds, which in effect would mean printing money and putting it directly into people’s bank accounts. Bernanke believed that central banks had all the necessary tools at their disposal to combat deflation and jumpstart economic activity. All that was required was what he called “Rooseveltian resolve.”
That sounded great when Bernanke said it. But the story The Courage to Act tells is the story of his discovery that Rooseveltian resolve was easier in theory than in practice. Bernanke seemed to be exactly the right person at the right time. He was someone who understood the need to use monetary policy aggressively to get the economy moving again, and who was willing to push the bounds of convention. Yet in the end, as far as he went, he could not quite bring himself to go as far as he needed to go. And the result was that the post-crisis recovery has arguably been the weakest in American history.
Of course, the idea that the Fed did too little will sound absurd to many, since by historical standards Fed policy was very aggressive. Having slashed interest rates to near zero, Bernanke committed the Fed to holding rates down for as long as it took. He enormously expanded purchases of long-term Treasury bonds and mortgage-backed securities, in what came to be known as “quantitative easing,” in order to help bring down long-term interest rates, encouraging people to borrow and invest. (That also made it easier for homeowners to refinance, lessening their debt loads and putting more money into their pockets.)
In the process, Bernanke quintupled the Fed’s assets from $800 billion to more than $4 trillion. And he persisted in this easy-money policy despite a sharp political backlash. Rick Perry, when he was running for the presidential nomination in 2012, famously called Bernanke “almost treasonous” and said, “We would treat him pretty ugly down in Texas.” Newt Gingrich called him “the most inflationary, dangerous, and power-centered chairman…in the history of the Fed.” Senator Bob Corker accused Bernanke of “throwing seniors under the bus.”
Much of this criticism was simply political posturing, but it also reflected an obsession with the specter of inflation, which haunted everything the Fed did following the financial crisis. And specter is precisely what it was: while Republican politicians and hawkish Fed members constantly fretted that inflation was about to get out of control, it never did. In fact, inflation stayed historically low—in the US it’s been below the Fed’s 2 percent target for almost the entire post-crisis period. But the failure of inflation to materialize never calmed the Fed’s critics, who insisted that “loose” monetary policy would ultimately lead to disaster.
Bernanke, to his credit, did not buy any of this. Indeed congressional Republicans’ ill-informed attacks seem to have driven him out of the GOP. (“I had lost patience with Republicans’ susceptibility to the know-nothing-ism of the far right,” he writes. “I didn’t leave the Republican Party. I felt that the party left me.”) And yet, at the same time, it seems clear that politics and ideology, both within the Fed and outside it, limited the institution’s range of possibilities and made it difficult to contemplate actions more radical than quantitative easing. If expanding the Fed’s balance sheet to $4 trillion didn’t get the economy moving fast enough, it could have taken it to $8 trillion. Or it could have set a higher inflation target—3 or 4 percent—which would have pumped more money into the economy, and encouraged spending and investment (since inflation erodes the value of money that’s just sitting in a bank account). Or it could even have pushed for a “helicopter drop” of money (though that would have required the approval of Congress). The Bernanke who counseled Japan on how to fight stagnation might well have recommended one of these approaches. The Bernanke who ran the Fed ultimately decided against them.
In Bernanke’s defense, the Fed had almost no help from the rest of the government in its efforts to get the US economy moving again. After the stimulus package of 2009, fiscal policy actually became a drag on the economy, rather than a boost, as city and state governments cut spending and President Obama pivoted, needlessly, toward reducing the budget. While debt relief for underwater homeowners could have helped consumers and boosted economic growth, neither Congress nor the Obama administration showed any interest in meaningful debt relief. Indeed, when the Fed offered a proposal for mortgage writedowns, it was reprimanded by Republican congressmen for interfering in “fiscal policy.”
Bernanke is right, then, when he says that when it came to getting the economy growing briskly again, the Fed was “the only game in town.” Even so, that was the Fed’s job, and it’s hard to say it really succeeded. Economies coming out of steep recessions typically see sharp rebounds. Yet the economy has grown more slowly in this recovery than in any other post-recession recovery. Median household incomes are still lower than they were in 2007. The unemployment rate stayed high for years after the crisis, and while it has fallen steeply since, the percentage of the population that’s employed (the so-called employment-to-population ratio) is still significantly lower than it was a decade ago. It’s true that the US recovery has been stronger than that in Europe, which suggests that had Bernanke not been in charge, things would have been worse. But they could also have been better.
Bernanke retired in early 2014. But the fundamental issues that he wrestled with—how to make the financial system more stable; how to use monetary policy to get the economy moving—are still very much with us. In some cases, progress has been made. The hands-off approach to financial regulation that the Fed—and, indeed, nearly all financial regulators—took before the crisis has been replaced by a more rigorous and active approach, thanks in part to the much-maligned Dodd-Frank bill.
The establishment of the Consumer Financial Protection Bureau, for instance, means that there is now a genuinely independent agency whose mission is protecting consumer interests (something the Fed was supposed to do, but never cared much about). Credit card reform has saved consumers tens of billions of dollars in unnecessary fees. The establishment of what’s called the Financial Stability Oversight Council means, in principle, that financial regulators are now looking at broad systemic risk and how the various parts of the system interact with one another. Most important, banks now face higher capital requirements, which means they have more of a cushion for absorbing losses when things go wrong, and they face tougher restrictions on certain types of risky behavior. The Fed, which has the responsibility for setting these capital requirements, has required the country’s biggest banks to carry more capital, in effect making it more expensive to be a bigger bank.
These are meaningful changes. But for Wall Street critics like Bernie Sanders and Elizabeth Warren, they have not gone far enough. They argue that the country’s biggest banks are still too big (bigger, in fact, than before the crisis) and too powerful, and that they should therefore be broken up. That would presumably decrease their influence in Washington and reduce the chances that another TARP-style bailout would be necessary. Bernanke is not as categorically opposed to this idea as you might think he would be. While he ultimately comes down against breaking up the banks, he also says “there is something fundamentally wrong with a system in which some companies are ‘too big to fail.’”
The real question for him is whether, now that Dodd-Frank has given regulators new tools to take over and wind down failing financial institutions, regulators will be able to successfully shut down a big bank without destabilizing the system as a whole. If regulators believe they won’t be able to do so, he concludes, “they should use their authority under existing law to break up or simplify the largest firms.” But we should wait to do that until “other, more incremental options”—like higher capital requirements and better regulation—“have been tried and found wanting.”
That’s not exactly a strong call to action. But it exemplifies Bernanke’s incrementalist, technocratic approach, and his relative indifference to issues of power and influence. In economic terms, it’s not clear that breaking up the big banks will make much of a difference, or that it will make the financial system more stable. (Canada’s banking system, famously, is dominated by five big banks, but has been historically much more stable than ours.) In political terms, though, breaking up the banks would be a powerful blow against the power of finance. But that’s not an issue Bernanke seems all that interested in.
When it comes to the stability of the financial system, then, what we can say is that the system is safer than it was, but still far from safe. When it comes to monetary policy, the picture is similarly mixed. Bernanke’s experience at the Fed offers crucial lessons for policymakers today. One is that monetary policy is not enough—when the economy is struggling, we need fiscal policy, through government spending and/or tax cuts, to give it a boost. Another is that monetary policy would be more effective if politicians and policymakers were less obsessed with the threat of inflation and more willing to tolerate creative policies from the Fed. Perhaps the most important lesson is that ultra-low interest rates are not necessarily inflationary, and are often exactly what a weak economy needs.
While it’s fair to criticize Bernanke for not doing enough to get the economy moving again, he also deserves a great deal of credit for standing firm against the inflation hawks, and for refusing to raise interest rates. (After Bernanke cut the basic rate the Fed controls—the fed funds rate—to 0.25 percent in 2008, he never raised it, and it’s only been hiked once since he left the Fed in 2014.) He could have pushed harder on the gas pedal, but at least he never hit the brakes. And that’s one reason why the recovery in the US, disappointing as it’s been, has still been stronger than in other developed countries.
What’s unclear is how well these lessons have been learned. Today’s Fed, for instance, has been under a lot of pressure to end its “easy-money” policies and start raising rates at a steady clip. With unemployment below 5 percent and inflation close to the Fed target of 2 percent, conventional wisdom has been that it’s time for interest rates to go back to “normal,” lest inflation finally rear up. Indeed, earlier this year, the Fed was preparing to raise rates before a weak jobs report in May derailed those plans, and Fed chair Janet Yellen recently suggested that because of the strengthening economy, rate hikes are likely in the near future.
Yet if you look past the headline numbers, you have to wonder what the hurry is. Inflation is stable. GDP growth in the first half of the year looks to have been around 2 percent. The economy has been creating a reasonable number of new jobs, but the percent of employed Americans between twenty-five and fifty-four is still lower than it was in 2007. Real wage growth has finally started to speed up, but that’s after many years when wages barely grew at all.
Given all this, the fact that some investors and retirees think interest-rate hikes are now necessary is a sign that the old ways of thinking about monetary policy are still powerful. And, sadly, the current presidential campaign has done little to change those ways of thinking, if only because the issue of interest rates has barely been discussed during the campaign. While Hillary Clinton and Donald Trump have said quite a bit about their economic programs, they’ve generally focused on things like infrastructure spending and trade, while saying almost nothing about the Fed.
That’s unfortunate. Monetary policy is, to be fair, an academic, often esoteric, subject. But what The Courage to Act shows is that its consequences are anything but academic—in fact, nothing has a bigger impact on the lives of American workers. The American economy’s failure to grow as fast after the crisis as it did before has cost the US trillions of dollars in lost GDP. It’s kept employment down, and it’s kept workers from earning higher wages, since the only thing that leads to higher wages in today’s economy is a tight job market.
The Federal Reserve, in other words, is too important not to be an issue in this year’s campaign. Because while the economy certainly needs more fiscal stimulus, it also needs a Fed that, while aware of the threat of inflation, is not paranoid about it, and that’s more concerned with economic growth than with getting interest rates back to “normal.” What we need, in other words, is a Fed that understands the one thing Bernanke got unquestionably right: when it comes to raising interest rates, sometimes what a central banker needs most is the courage not to act.
September 29, 2016
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