A New Maestro?

By L. Randall Wray

Ok, the media is a poor judge of the performance of the Chairman of the Board of Governors. It seems like only yesterday that it anointed “maestro” status to Chairman Greenspan, right before all hell broke loose and he had to admit that his whole approach to financial markets had been dangerously wrong-headed. Now Chairman Bernanke is awarded with a magazine’s choice as “man of the year”—purportedly for saving capitalism as we know it. More importantly, the Senate is trying to decide whether he deserves reappointment. Usually these votes are little more than a rubber-stamping. Yet, something seems amiss this time around as the Senate Banking Committee voted 16 to 7 for approval—with significant opposition to reappointment. To some extent this is probably a vote of no-confidence for the Administration’s approach to dealing with the financial mess created by three decades of complete mismanagement of the banking system by a succession of Fed and Treasury officials. And, in truth, it would make more sense to fire Timmy Geithner and Larry Summers—who have done far more harm to the economy than has Ben Bernanke.

Let us suppose for a moment that Bernanke had done everything exactly right. Would he deserve accolades? In truth, the job of a Fed Chairman is pretty darn simple. So far as monetary management goes, he has one tool—the overnight interest rate target that is set in meetings of the Federal Open Market Committee. The Chairman has tremendous influence at these meetings, as we know from the transcripts that are released with a 5 year lag. While tremendous significance is believed to surround changes to the Fed’s target rate, in truth the overnight rate has little influence over the economy. As conventional thinking goes, the Fed raises rates in an inflation and lowers them in a recession. When the crisis hit, the Fed should have lowered rates, and did so. By itself, this should have had no impact; and by all accounts it had no impact. Should anyone receive man of the year designation for doing something that any Fed Chairman would have done, and which everyone agrees has virtually no impact?

Better to replace the FOMC with a rule that the overnight rate will be kept at zero from now on, a directive that the NYFed would implement. That would provide a lot more stability to the financial sector—and would go some way toward J.M. Keynes’s “euthanasia of the functionless rentier class”. But that is a story for another day.

In a crisis, the other thing the Fed does is to “provide liquidity”—that is, it lends reserves to prevent bank runs. This has been widely accepted policy since the 1840s and there is no central bank anywhere in the world that would not act as a lender of last resort in the sort of situation Bernanke faced. In fact, Bernanke was a bit slow to the gate on this, and never seemed to fully understand what he was doing. While he should have lent reserves without limit, to all comers, and against any kind of collateral, he played around with a variety of limited auctions, let a major financial institution fail due to lack of access to the Fed’s lending, and demanded good collateral for far too long. If anything, the Fed’s slow learning curve contributed to the crisis. Man of the year? I think not.

Finally, the Fed is supposed to be a regulator of financial institutions—through the thick and thin of the business cycle. Let us suppose a counterfactual: what if Bernanke had been a competent regulator from the time of his appointment? In truth, he consistently and persistently opposed any regulation that might have prevented this crisis, but in that he only followed his predecessor. And most of the damage had been done, with Greenspan at the helm since 1987 and with most of the important deregulation already accomplished by 2000. Clearly Bernanke deserves a grade of D- as a regulator (Timmy proudly earned an F when he testified before Congress that in all his years at the helm of the NY Fed he had never acted as a regulator!). So, he is certainly no worse than a Rubin or a Paulson and by 2005 when he was appointed he would not have had sufficient time or influence to overcome all the damage that had already been done. But a Man of the Year might have at least sounded a warning—rather than continually claiming even through summer 2007 that all was fine and dandy.

Bernanke will win reappointment. He has probably learned a bit as a result of this crisis so he will be a better head in his second term than he was in his first. Much is made of his scholarship that focused on the Great Depression. It is indeed a great advance over the work of Milton Friedman, who claimed the Fed caused the crisis by reducing the money supply. Bernanke also blamed the Fed for the initiation of the crisis, but the prolonged depression resulted because of the failure of financial institutions—which disrupted the relation between banks and their customers. When the bank of a farmer or entrepreneur failed, they were unable to borrow to finance operations—which collapsed production and employment. This is probably why Bernanke wants to prop up Wall Street institutions at all costs, to get “credit flowing again”. What he does not understand is that Wall Street banking has evolved—these are not lenders. They are speculators that serve no useful public purpose. If Bernanke were ever to figure that out, and would start to close down these predators, then he might deserve to be called Maestro.

8 responses to “A New Maestro?

  1. Bernanke has gone from the man who will save us whatever it takes to the guy who did what he could, but it was not enough.The only reason to reappoint him is that there is nobody else on the list that would do much differently.His saving of the big banks did nothing to save the banking function for businesses (or farmers, for that matter). Functional banking is being done directly through the Fed.Ignoring the massive private debt is the most obvious indication that Neoclassicals have no clue.

  2. Nice post! A couple technical points: it's now person of the year, not man of the year. The other thing is the award isn't issued to the best person, but instead the person "for better or for worse, …has done the most to influence the events of the year." source: Person of the Year: 75th Anniversary Celebration (Special Collector's Edition ed.). New York: Time Books. 2002.Maybe it is Gramm, Leech and Rubin who really deserve the credit for most (negative) influence.

  3. The studied, "thoughful" mein notwithstanding, Bernanke is simply at core the most loathesome of maggots. Yes, he will be confirmed, and perhaps rightly so as the quintessential expression of a putrescent system dedicated to the upward transfer of wealth, pre-emptive war, torture and the destruction of countless civil liberties. Snakes like Bernanke make simple analysis of the rot at the very heart of things. In that sense, he does us a service. If it weren't him, it would be some other reptile. Andrei Vyshinsky

  4. Thanks to both of you for comments. As Warren Mosler said in his post on this topic, it would be good to have someone who understand monetary ops in charge. How about Scott Fullwiler, who understands this better than anyone? And so long as the Fed will continue to monkey around with rate targets on the mistaken belief that it can fine-tune the economy, it would be better to have someone who is not an inflation hawk. Hence, even among the mainstream (who do not understand monetary operations), there are better choices than Bernanke. Even Blinder would be better. LRWray

  5. Ignoring the massive private debt while continuous hand wringing over the level of public debt. The Neoclassicals live in the 180 degree universe.

  6. Isn't the Fed responsible for oversight of lending standards? The effects of lax oversight cannot be corrected by interest rate changes. The Fed is the problem. Quis custodiet ipsos custodes. The Congress has abdicated responsibility by the divide and conquer grid lock type of actions that give a free hand to special interests that do not have the best interests of the country at heart.

  7. Disagree. Overly simplistic argument that takes no account of the connection between well street finance firms, main street economics and fed policy.Besides, as another poster has said, the award is for the person who most influences the news. It is NOT an all-round whatta-guy-heckuva-job-well done award. AHven't we just had eight years of that nonsense and isn't it enough?

  8. Hi michigan: Not clear exactly what you want to give Bennie an award for. Influencing the news? The media does not understand monetary ops. (Neither does Bernanke.) Is that award worthy? Give me the fulcrum and I could manipulate the news. (Remember the bubble boy?) If we just want to go for the guy who got the most press, Bernie beats Bennie hands down. So does Paris. Google it. LRWray