Bernanke’s Unprecedented Rescue Unlikely to Be Repeated
As Federal Reserve Chairman Ben S. Bernanke shuts the door to his office for a final time in two days, he can say he took actions that were the first or the biggest of their kind in the central bank’s 100-year history. Some will probably also be the last.
Bernanke was the first to devise a monetary policy that focused on lowering credit costs by suppressing longer-term interest rates after the short-term policy rate hit zero. His strategy, involving direct purchases of agency mortgage-backed securities and longer-term Treasury debt, left the Fed with the biggest balance sheet in its history, $4.1 trillion.
He was the first chairman since the Great Depression to use emergency lending powers to rescue businesses in almost every corner of the financial system -- from banks, to corporations, to bond dealers. And he might be the last: Congress, leery of the Fed’s sweeping powers, removed the central bank’s ability to loan to individuals, partnerships and non-bank companies.
“He was incredibly creative in the different steps and programs he took to prevent a free fall of the global economy,” said Kristin Forbes, a professor at Massachusetts Institute of Technology’s Sloan School of Management in Cambridge and a member of the White House Council of Economic Advisers under President George W. Bush. “During a crisis, you have to make decisions with highly imperfect information. He was willing to do that.”
The 60-year-old Bernanke leaves a Fed vastly different from the institution he took charge of on Feb. 1, 2006. At that time, the former Princeton University professor had a few goals. He said naming an inflation target would help boost accountability and policy effectiveness. He also wanted to push power out of the chairman’s office down into the policy-making Federal Open Market Committee, in effect, to dilute some of the mystique his predecessor Alan Greenspan created.
Eight years later, Bernanke achieved those goals. The Fed declared an inflation target of 2 percent in 2012, and the FOMC is more democratic. The Fed chairman encouraged more open debate at policy meetings, allowing colleagues to interrupt the format if they wanted to make a point. Unlike Greenspan, Bernanke voices his policy view last.
Among other Bernanke innovations, central bankers publish their economic forecasts, including their outlook for the policy interest rate they set, four times a year. The chairman holds a press conference quarterly.
The crisis response also transformed the institution in ways that defy any near-term conclusion because nobody knows whether extraordinary actions, like purchasing $1.5 trillion in mortgage debt or creating $2.4 trillion in excess bank reserves, can be retracted, shrunk and unwound successfully.
The Fed is more extended politically as it engages in policies such as suppressing mortgage rates, and the size and influence of its open-market operations have involved it in financial markets as never before.
“The legacy is still open,” said Vincent Reinhart, a former top Fed official and now chief U.S. economist at Morgan Stanley in New York. “We survived. The question is what are the consequences?”
U.S. central bankers meeting today announced a second $10 billion reduction in the pace of monthly bond purchases, bringing them down to $65 billion from an original $85 billion. That means Bernanke’s successor, current Fed vice chairman Janet Yellen, will inherit a balance sheet that is still growing.
Those purchases from Wall Street dealers add to the level of reserves in the banking system, requiring the Fed to plant a huge footprint in money markets to manage them. Yellen’s Fed will need to use new tools such as paying interest on these reserves or pulling them out of the banking system with reverse repurchase agreements. Otherwise, the central bank would have a difficult time stabilizing its policy interest rate as banks dumped reserves into the overnight market. That could lead to higher inflation.
“I think it is very intrusive,” Tad Rivelle, who oversees about $84 billion as chief investment officer for U.S. fixed-income securities at TCW Group in Los Angeles, said of the Fed’s operations under Bernanke. The outgoing chairman’s legacy “will ultimately be negative” as policies used during the crisis and slow recovery lead to future instability, he said.
That instability may be social and political as well as financial, he said. Banks are still wary lenders, so the Fed’s low-rate policies are providing what Rivelle calls “preferential access” to a privileged group of borrowers: the government, corporations and consumers with the highest credit scores.
The bond-buying policy, known as quantitative easing, has helped boost asset prices. The Standard and Poor’s 500 stock index rose 30 percent last year, and home prices rose a projected 11.5 percent in 2013, according to an index tracked by CoreLogic, an Irvine, California, data and analytics company. Yet earnings per hour for private-sector workers have climbed just 2 percent a year on average since 2011 compared with a 3.2 percent gain in 2007, the last year of the previous expansion. Adjusted for inflation, they’ve barely grown at all.
Meanwhile, the Fed’s retreat from quantitative easing is slowing capital flows to emerging markets, roiling local stock markets. The MSCI Emerging Markets Index is down 6.8 percent year-to-date.
The Fed’s rescues under Bernanke also left an expanded safety net around financial institutions and markets that Congress and regulators are busily trying to shrink.
Fed officials, such as Richmond Fed president Jeffrey Lacker, warn that if the perception of government guarantees against financial risk isn’t reduced, it will set the stage for another crisis. Richmond Fed economists estimate that the proportion of the total liabilities of U.S. financial firms covered by an implicit or explicit federal safety net increased by 27 percent over the past 12 years.
Bernanke helped increase the perception of government support by rescuing Bear Stearns Cos. and American International Group Inc. during the crisis. He further contributed to that notion when Goldman Sachs Group Inc. and Morgan Stanley came under speculative attack and he let them convert into banks, which granted them access to backstop credit from the Fed.
The bailouts triggered a backlash, stiffening resolve on Capitol Hill to prevent taxpayer support from helping Wall Street again.
Even one of Bernanke’s predecessors, former Chairman Paul Volcker, was surprised by the actions, which, he said in an April 8, 2008, speech before economists in New York, took the Fed “to the very edge of its lawful and implied powers.”
The 2010 Dodd-Frank Act, the most sweeping rewrite of financial rules since the 1930s, contains the phrase “to end too-big-to-fail” in its preamble, a message to regulators that no bank should be so big and risky that it would have to be saved again. To put a point on it, Congress limited the Fed’s power to lend emergency funds to non-bank corporations to a broad-based facility that could only be accessed by several institutions. The message was that singular bailouts of firms such as Bear Stearns were over.
Bernanke said in a hearing in February that regulators were “moving in the right direction” to end too-big-to-fail with the new tools given to them by the Dodd-Frank Act.
Phillip Swagel, who helped manage the government’s bank bailout fund known as the Troubled Asset Relief Program during the George W. Bush administration, said legislation is only part of the solution.
“We won’t know if too-big-to-fail has been solved until the next crisis,” said Swagel, now an economist at the University of Maryland in College Park. “The tools are there” to take down a troubled bank, he added. “The unknown is the will of the government.”
Among the unresolved questions as Bernanke exits: Can the Fed operate indefinitely with a multi-trillion-dollar balance sheet? Is the flow of credit to the economy constricted with the banking system under intense regulatory scrutiny? Has the economy downshifted to some slower pace of growth that the Fed can’t change?
“This is a Fed that’s intervening in the yield curve, it’s intervening in liquidity markets, it’s intervening in many asset classes,” said Julia Coronado, a former Fed board staff economist who is now chief economist for North America at BNP Paribas in New York.
“The book is still open, the last chapters have yet to be written, and it’s way too soon to say, ‘Ah, this is his legacy,’ because history is the judge, and there’s still a lot of risk.”
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