The Case Of Ben Bernanke

Last week, most news applauded Obama’s reappointment of Ben Bernanke as the chairman of the Federal Reserve. Of the few commentators who opposed the reappointment, Morgan Stanley Asia's Stephen Roach lists three critical mistakes that Bernanke made leading toward the financial crisis. He argues that Bernanke should not be reappointed because his “pre-crisis actions played an equally critical role in setting the stage for the most wrenching recession since the 1930s.”

First, and foremost, he was deeply wedded to the philosophical conviction that central banks should be agnostic when it comes to asset bubbles. On this count, he stood with his predecessor - serial bubble-blowing Alan Greenspan - who argued that monetary authorities are best positioned to clean up the mess after the bursting of asset bubbles rather than to pre-empt the damage. As a corollary to this approach, both Mr. Bernanke and Mr. Greenspan drew the wrong conclusions from postbubble strategies earlier in this decade put in place after the bursting of the equity bubble in 2000. In retrospect, the Fed's injection of excess liquidity in 2001-2003, which Mr. Bernanke endorsed with fervour, played a key role in setting the stage for the lethal mix of property and credit bubbles.

Second, Mr. Bernanke was the intellectual champion of the "global saving glut" defence that exonerated the US from its bubble-prone tendencies and pinned the blame on surplus savers in Asia. While there is no denying the demand for dollar assets by foreign creditors, it is absurd to blame overseas lenders for reckless behaviour by Americans that a US central bank should have contained. Asia's surplus savers had nothing to do with America's irresponsible penchant for leveraging a housing bubble and using the proceeds to fund consumption. Mr. Bernanke's saving glut argument was at the core of a deep-seated US denial that failed to look in the mirror and pinned blame on others.

Third, Mr. Bernanke is cut from the same market libertarian cloth that got the Fed into this mess. Steeped in the Greenspan credo that markets know better than regulators, Mr. Bernanke was aligned with the prevailing Fed mindset that abrogated its regulatory authority in the era of excess. The derivatives explosion, extreme leverage of regulated and shadow banks and excesses of mortgage lending were all flagrant abuses that both Mr. Bernanke and Mr Greenspan could have said no to. But they did not. As a result, a complex and unstable system veered dangerously out of control.

I thought to myself what would be the risk of not having Bernanke being in charge of the Federal Reserves and whether the outcome would be worse or better given how susceptible investors are to internal changes. The argument that the monetary authorities should not pre-empt the damage of an asset bubble is a valid one. History, including the Great Depression, and Japan’s lost decade, repeatedly demonstrates how monetary tightening in the bull market is damaging to the economy in which speculations are inherently pervasive. Secondly, even if “global saving glut” should not be an excuse for American deteriorating saving accounts during the pre-crisis period, it is, by all means, a true phenomenon, which played a partial role in forming the financial crisis. Asia was not to blame for the crisis; although, the unprecedented accumulation of reserves in foreign currencies inadvertently augmented the US asset price bubble and widened derivative markets. Lastly, it is inescapable that more regulations are knocking on the door notwithstanding if it’s desirable to the Fed’s chairman. I suspect the reforms of banking and financial sectors will take the center stage as health care reform and economic recovery progress. Unless Stephen Roach could point out a better alternative to replace Ben Bernanke, at the moment, the risk appears to supersede the benefit of replacing him.

*A copy of this entry is posted on Transnational Law Blog