Why Bernanke Must Go

By Marshall Auerback

There are any number of reasons why Ben Bernanke should not be reconfirmed, notwithstanding the vote in his favor by the Senate committee last week.

1. Let’s start by using some criteria laid out by Bernanke himself. When first nominated as chairman of the Federal Reserve, Mr. Bernanke promised a greater degree of transparency than his predecessor, but has completely stonewalled anybody seeking to obtain clarification of the events surrounding the credit crisis and more specifically, the role of the Federal Reserve. Any information disclosed would have facilitated a proper assessment of Bernanke’s job performance (which is probably one of the reasons the Fed chairman doesn’t want it released) and, more importantly, would have created a foundation for useful forensic work to prevent recurrences going forward.

Understanding what the decision-making was prior to and during the crisis is key to evaluating Bernanke’s performance and to improving performance in general. Post mortems are standard in sports and medicine. Why not here? And, more importantly, why does Bernanke continue to oppose it? Even the Swiss National Bank has provided a higher level of disclosure and transparency on the banking crisis to its public than has hitherto been agreed by the Bernanke Fed.

2. The Fed chairman claims unique expertise on the grounds of his scholarship of the Great Depression. Few have actually challenged him on the basis of these academic credentials, yet Bernanke holds these out as if they are manifest proof of his appropriateness for the position as head of the Federal Reserve. Ironically, even though Bernanke drew heavily on the work of both Milton Friedman and Anna Schwartz for his own scholarship of the period, Ms Schwartz herself has been enormously critical of the Fed’s conduct both pre-crisis and in seeing providing liquidity as the primary solution. She also warned explicitly against drawing comparisons between the gold standard era Depression and now. Additionally, Bernanke’s reading of the Depression (which is pretty conventional, that the Fed blew it by not providing more liquidity) ascribed little significance to fiscal policy, which has led Bernanke toward wrongheaded “solutions” such as “quantitative easing” and an alphabet soup of lending facilities, none of which did anything to enhance aggregate demand. Consistent with that, the Fed chairman been on the wrong side of fiscal policy, urging the Congress to balance the budget, at least longer term, which suggests that he learned nothing of the fiscal successes of the New Deal.
3. Bernanke’s consistent advocacy of “quantitative easing” perpetuates the silly notion that the Fed has had something to do with the economic “recovery” (a line which Time Magazine had readily embraced in its selection of the Fed Chairman as “Person of the Year”). He has ascribed little importance to the existence of the automatic stabilizers and indeed has persistently fed the misguided notion that the Federal government had limited fiscal resources.

The mainstream belief is that quantitative easing will stimulate the economy sufficiently to put a brake on the downward spiral of lost production and the increasing unemployment. But as Bill Mitchell as pointed out, quantitative easing merely involves the central bank buying longer dated higher yielding bonds in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts: “[QE] is based on the erroneous belief that the banks need reserves before they can lend and that quantitative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates.” In the real world, the creation of a loan and (concurrently) a deposit by a bank are in no way constrained by the quantity of reserves. Instead, the terms set by the central bank for acquiring reserves (which then also affects the rates banks borrow at in money markets) affect a bank’s profit margin on a newly created loan. Thus, expanding its balance sheet can create a potential short position in reserves, and thus the profitability of newly created loans, not the bank’s ability to create the loan.
Banks, then, lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. Even the BIS recognizes this. Unfortunately our Federal Reserve chairman either does not know this (in which case his ignorance disqualifies him for another term in office) or he deliberately misrepresents the actual benefits of QE (duplicity being another good ground for disqualification for a 2nd term). The current incoherence of our economic policy making could diminish if we had a Fed chairman who understood the importance of fiscal policy, rather than one who downplays its significance. Which leads to point 4 below.

4. The Fed chairman continues to demonstrate a tremendous conceptual confusion at the heart of the current crisis, particularly in regard to the banking sector. He actively supported TARP on the grounds that repairing the banks balance sheets would somehow “unblock” credit flows and thereby enhance economic activity. The whole notion of repairing bank balance sheet is a lie and misdirection. The balance sheets we should want to see repaired are household balance sheets. Banks have failed us profoundly. We want them reorganized, not repaired. This will never happen as long as this apologist for Wall Street remains head of the Fed. A world in which the banks are all fixed but households are still broken is worse than what we have right now. Too-big-to-fail banks restored to health are too-big-to-fail banks restored to power. The idea that fixing legacy banks is prerequisite to fixing the broad economy is a lie perpetrated by, amongst others, the Federal Reserve Chairman.
For all of these reasons, Bernanke must go.

7 responses to “Why Bernanke Must Go

  1. >" which has led Bernanke toward wrongheaded "solutions" such as >"quantitative easing" and an alphabet soup of lending facilities, none of >which did anything to enhance aggregate demandI'm not sure I agree with this point. Much of the damage I've seen occur to businesses, especially small to medium sized ones, is that they lost access to affordable credit. This leads to cost saving measures, and lay offs, which decreases demand, makes banks less willing to lend, and businesses less credit worthy. The Fed through TALF and other asset buying programs stepped in and very quickly started to play the role banks used to. So it depends on how you define enhancing, but in my book limiting the credit crunch leads to higher demand than there would be otherwise. Brenanke operates in Washington, were everything anyone says is for political motives. I wouldn't take anything he says in public seriously. He's brought the fed funds rate down to 0, he provided a new lending channel which helped businesses. It is the White House and Congress that needs to step up to the plate now. Bernanke is good enough to keep the job. Most of the public pressure to get rid of him comes from the libertarians. Would his replacement be better whouch would likely be Yellen or Summers?

  2. Tschaff,I don't think Marshall meant it the way you interpreted it. I think he wanted to say that the Fed thought "*the* solution" is programs such as QE, TALF, PDCF etc. PLUS urging the government to reduce deficits. And that is not "the solution". Far from it.

  3. Tschäff above observes:"I'm not sure I agree with this point. Much of the damage I've seen occur to businesses, especially small to medium sized ones, is that they lost access to affordable credit. This leads to cost saving measures, and lay offs, which decreases demand, makes banks less willing to lend, and businesses less credit worthy."Auerbach's point is that lending was always possible to "credit worthy" businesses. Much of what you've witnessed occur with medium sized and small businesses likely would have occurred anyway in these cases under the insane pre-crisis lending standards. Bernanke only can be credited with exascerbating these standards, a goal he's been trying to bring about with all his energy since 2008. Today, banks appear to be lending to those that can manage the loans, its just that many seeking loans today simply can't justify them. In this sense, anyway, there's been a return of reality, but that has more to do with the banks self-interest than any genius of Bernanke's.In my view, Bernanke is just the worst sort of fascist snake. And, to be sure, I'm no libertarian.Andrei Vyshinsky

  4. Tschaff,You have to consider the following: credit is, as James Galbraith has noted, a two-way contract between lender and borrower. You can't just shove taxpayers' money down the banks' throat and expect them to lend if you have no creditworthy borrowers on the other side. The Fed has not supported any policies to sustain/improve final demand, which complicates the efforts to improve the efforts of borrowers to service loans and make themselves more creditworthy. If borrowers can meet their payments, lenders will receive their funds and will return to profitability and be more inclined to lend again. The Fed (and Treasury) proceed from the opposite set of premises and this is fundamentally wrong, in my view.

  5. Ramanan, Bernanke argued for Fiscal Stimulus back in Jan 2008. (http://www.federalreserve.gov/newsevents/testimony/bernanke20080117a.htm). As for more recent calls for reduced deficits, I'm sure he's well aware of what happened when they tried to balance the budget during the Great Depression. The cover story on the current Time Magazine backs me up "Depression scholars — including Bernanke — tend to see the Hoover Administration's approach of balancing budgets and tightening belts during the downturn as a tragic mistake." So I really think that his calls for budget reduction is a political move. I'm sure every economist across the spectrum fear the massive amount amount of pork that will be hard to get rid of once employment recovers and it is socially desirable.Andrei,"Much of what you've witnessed occur with medium sized and small businesses likely would have occurred anyway in these cases under the insane pre-crisis lending standards." This is interesting because how do you judge? After the crisis hit, the spreads on AAA rated asset backed securities were magnitudes above historic norms. My favorite metric for estimating the credit crunch is by looking at the relationship between GDP and commercial paper outstanding with data from the federal reserve's website. The asset backed commercial paper was the hardest hit. If it falls say 40% while business only fell by 15% you know there is something wrong. I know its not the only source of funding, but I think it is representative of the fear and uncertainty that continues to restrict credit economy wide. As other countries have experienced, that fear can be self justifying. "The market can stay irrational longer than you can stay solvent."

  6. Tschaff,Firstly Ben Bernanke had absolutely no idea of why the crisis took place. He kept telling people that everything's fine etc. If you consider the "sectoral balances approach" which is written about a lot here, you will see that the US domestic private sector has been in deficit in almost every year since 1997. A person at his level should know such accounting stuff. The various scholars who write in this blog kept writing about the dangers of this but sadly Bernanke doesnt want to look at it from an accounting perspective. He still believes a money multiplier model, and fiscal sustainability, wants deficits to go to 4%. http://bilbo.economicoutlook.net/blog/?p=6787 I agree with you about the lending programs and acting as the lender of the last resort. I like this paper http://www.newyorkfed.org/research/current_issues/ci15-4.pdf

  7. Ramanan, I agree with all you say. I know that he, unlike most economists is a pragmatist. He knows enough to not mistake his models for reality. I know he didn't see the crisis coming, he thought all the complex derivatives were reducing risk, not causing it. He knows now that the world doesn't work as he thought it once did, and has said as much. We need people from the Kansas City School to run the Fed. 🙂 I don't see that happening any more than Warren Mosler being the next president of the United States. So I think we have to settle for 2nd best. We are lucky to have had Bernanke and not someone like Greenspan.In terms of the Fed's roll in bank regulating. He is rather incompetent. How do you distinguish credit used for 'good' vs 'bad' purposes. Should complex derivatives be banned? Should they be regulated? Should they be FDIC insured? This is the most cutting edge stuff in economics that no one that I know of has all the answers. Economists have been content to say don't think about it, the invisible hand will sort it out. Personally I am nostalgic for the pre-shadow banking days. We had better growth, and all our bright university students did something more productive (but less profitable) with their lives.