Tuesday, July 28, 2009

Reappoint Bernanke, But Don't Deify Him

As America, the homeland of immigrants, grew in diversity, its culture came to be secular and commercial. While the Pilgrims, Puritans, Quakers and others landed on the shores of Britain's North American colonies with the hope of attaining grace through freedom of worship, America came to be the land of opportunity, where the pursuit of happiness evolved (or devolved, as the case may be) into making your fortune. Wherever you or your ancestors might be from, the one thing you have in common with all other Americans is a national culture of commerce.

A nationwide economy, especially in a country 3,000 miles wide (and with two other states much farther away), requires a national referee to ensure fair dealing between people thousands of miles apart. Thus, as the economy grew from Jefferson's ideal of yeoman farmers to fulfill Hamilton's much larger vision, the federal government took on the roles of national referee, guardian of the financial system, and promoter of economic growth and full employment.

This has been ever more the case during the economic crisis of the last two years. The federal government took de facto control of the financial system, and became the majority owner of America's largest car company. Front and center in all this governmental activity has been the Federal Reserve, the central bank and also much more. Today, the Federal Reserve is not merely the regulator and lender of last resort for the banking system. It's the ultimate source of credit for much of the economy, providing trillions of dollars of credit facilities that keep the financial system--and thus the economy--above the septic field.

President Obama has to decide soon whether or not to reappoint Ben Bernanke as the Chairman of the Fed, or chose a successor. He should reappoint Bernanke.

There are reasons to question a reappointment of Bernanke. The man has clearly demonstrated that he has feet of clay. He was slow to recognize the severity of the subprime and related crises, and has left unresolved the still highly troubling problem of trillions of dollars of toxic assets held by the major banks. He and his erstwhile compadre, former Treasury Secretary Henry Paulson, bailed out Bear Stearns, Fannie Mae and Freddie Mac; let Lehman collapse; and then gave AIG a blank check bailout that paid its creditors 100 cents on the dollar even though they were consenting adults who voluntarily took the risk of AIG's creditworthiness. Bernanke's and Paulson's decisions to bail out, or not, were seemingly driven by reasons known only to them. That instilled a fear of the unknown in the financial markets that left credit frozen and the economy on the brink of Depression.

But, to Bernanke's credit, he demonstrated the ability to move up the learning curve, a quality greatly needed but not commonly found in senior federal officials. He came to understand that there are vast pools of raw sewage in the financial system and that dramatic action was necessary to keep them from polluting the national economy. He was highly innovative, and the economy seems to have skirted the edge of the septic field.

As has been well-publicized, the Fed's rescue efforts contain the seeds of inflation and asset bubbles. Bernanke and other Fed governors have insisted they can withdraw the accommodative measures instituted in the last 18 months in a timely enough manner to avoid these consequences. Maybe so, maybe not. But could anyone else do better?

Bernanke seems to understand that his butt was nigh deep-fried sixteen times over during the past two years. Having been so thoroughly acquainted with the potential for disastrous and tremendously embarrassing failure, Bernanke is probably running somewhat scared. That's a good trait to have in the most powerful government official next to the President. Bernanke's predecessor seems to have been overly confident of his ability to discern new paradigms and we're still paying the price for that certitude.

Bernanke is reputed to be as a much a listener as a talker. That's a rare attribute in Washington, but valuable. The current economic problems are far from over, and could easily get weirder before they get better. A Fed Chairman who listens, learns and innovates has a good chance of coping.

At the same time, the Fed's powers should not be expanded. Bernanke wants the Fed to address consumer protection issues in the financial markets. The Fed already had its chance and failed. It simply has too many priorities on its plate. Consumer protection would conflict with other Fed responsibilities. If the banks are tottering and need greater profits to beef up their capital, would the Fed institute and enforce potentially expensive consumer protections? Yet, consumer protection is needed. A newly formed, independent consumer protection agency is in order.

By the same token, the Fed shouldn't be the overseer of systemic risk. As we discussed in http://blogger.uncleleosden.com/2009/07/financial-regulatory-reform-we-should.html, controlling systemic risk could conflict with Fed desires to maintain the financial strength of the banking industry. When banks are undercapitalized, the Fed might be tempted to let them take greater risk in the hope of making greater profits and enhancing their ability to raise capital. But that could let the horse out of the barn in terms of systemic risk, and as we know today all too well, risk that's been unleashed cannot easily be corralled. Our pick for the czar of systemic risk: the FDIC. An insurer won't let the insureds run amok.

Thus, reappoint Bernanke. But don't deify him by adding to the Fed's powers. It's the grandest of doyennes in our national culture of commerce and tremendously powerful already. Increasing its powers would complicate its job and exacerbate existing concerns about its lack of accountability. Economic well-being is the archstone of our national culture, and we shouldn't make it dependent on any single regulatory agency.

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