Bernanke Forgot About His Role In Causing the Great Recession
Ben Bernanke's column in the Washington Post has to be absolutely infuriating to anyone old enough to remember the events of 2008. In this column, Bernanke lectures the public about the need for the Federal Reserve Board to preserve its independence from Congress, explaining that:
"The government's actions to avoid financial collapse last fall -- as distasteful and unfair as some undoubtedly were -- were unfortunately necessary to prevent a global economic catastrophe that could have rivaled the Great Depression in length and severity, with profound consequences for our economy and society. (I know something about this, having spent my career prior to public service studying these issues.) My colleagues at the Federal Reserve and I were determined not to allow that to happen."
It's nice to talk about the Fed's response to this crisis, but Mr. Bernanke's studies apparently did not tell him the obvious, that allowing an $8 trillion housing bubble to grow unchecked would lead to an economic disaster like what we are now experiencing. He and his colleagues at the Federal Reserve Board either could not see, or did not care about, this huge bubble. As a result, Ben Bernanke has been running around for much of the last year and a half telling us about his knowledge of the Great Depression.
It is worth quickly explaining why a collapsed housing bubble leads to a recession, since the policy people responsible for this disaster have done so much to try to obscure the obvious.
In the years prior to its collapse, the bubble was driving the economy. Bubble-inflated house prices created an unprecedented housing boom. Residential construction peaked at more than 6.0 percentage points of GDP in 2005.
The $8 trillion in bubble housing wealth led to a consumption boom also. This is the well known housing wealth effect that holds that one dollar of additional bubble wealth will cause annual consumption to increase by 5-7 cents. The implication was that an $8 trillion bubble would push annual consumption up by between $400 billion and $560 billion.
When the bubble collapsed, residential construction fell through the floor as builders suddenly realized that we had an enormous housing glut. The drop in annual construction was more than 3 percentage points of GDP, or more than $500 billion. At the same time, when the bubble driven housing wealth disappeared, we lost close to $500 billion in annual consumption.
We had further losses in demand associated with the bursting of a bubble in non-residential real estate. In total, the loss in bubble-driven demand was well over $1 trillion a year. All of it an entirely predictable outcome of the collapse of a housing bubble.
The simple reality is that there is nothing in the Fed's bag of tricks that will allow it to easily replace over $1 trillion in annual demand. In short, the bubble guaranteed the economic disaster that we are now experiencing: end of story.
It is also amusing the Mr. Bernanke at one point turns to the "global consensus on the appropriate role of central banks." Perhaps Mr. Bernanke missed it, but this global consensus doesn't look very good right now. One of the poster children of the global consensus was Iceland. The country was applauded for its independent central bank and its strong record on inflation targeting.
The arrogance of this column is almost beyond belief. This man is incredibly lucky to still have his job at time when millions of other workers have lost theirs as a direct result of his incompetence. A serious news outlet would not have printed such a ridiculously self-serving piece without at least securing an opposing opinion. Of course, Bernanke's piece appeared in the Washington Post.
Ah...but Dean. Bernanke is THE authority on the "Great Depression". That's how he was able the engineer THIS one so perfectly.
C
November 29, 2009 9:33 AM | Reply | Permalink
First, the Fed's independence is far from absolute. It has to go to Congress for new laws if it feels it needs them. It has to work with other regulators, and with Congress and the President, if it is to do its work properly. Both Congress and the President can threaten to abolish it or limit its powers if it does too many things they don't like. That happened when Reagan threatened Volker and many in Congress told Greenspan to shut up after his irrational exuberance remark.
Second, predicting the future is infinitely more difficult than predicting the past. You are correct that both Greenspan and Bernanke have failed big-time. But so has almost everyone else. Roubini and Shiller predicted the collapse but not the most recent recovery. You know who's proven best at the task? Goldman, Sachs and Paulson & Co. I can anticipate the screams of outrage and envy at that observation, but it's true.
You think you can do better, Baker? Prove it.
November 29, 2009 12:01 PM | Reply | Permalink
While I fully agree with this column, let's not forget the role of that brilliant "economist" Alan Greenspan who never bothered to complete his earned PhD in Economics.
My complaint is with Greenspan's effort to manipulate the economy right before the 2000 and 2004 Presidential elections. In 2000 he increased the interest rate to the highest it had been in years just before the election.(Fed Fund rate at 6.5% as of May 2000 where it remained until January 2001 when he started lowering it again.) It is well-known that the condition of the U.S. economy in the year of a Presidential election is one of the most certain determinants of whether the party holding the White House will retain it. This high interest rate had to be a major contributor to allowing the Republicans to get Bush close enough to winning so that they could steal the election in 2000.
Coincidence, not intent, right? Crap.
Greenspan lowered the interest rate to the lowest it had been in years just before the 2004 election (Fed fund rate at 1.50% in August 2004.) Knowing that he had created and extended the housing bubble to assist in the reelection of Bush, started his process of increasing interest rates by 1/4% per month in Sept 2004, when it was too late to effect the economy before the election. That continued until June 2006 by which time Countrywide (then the nation's largest mortgage broker) was having serious defaults. Countrywide finally went public with their default problems in Spring of 2007 when it was already depressing the economy. [See my personal blog on the subject in march 2008 for the dates of changes in fed funds rates 1997 to 2008.]
While there may or may not have been valid reasons for the economic decisions the fed made, the timing was too obvious to be other than political.
If Ben Bernanke wants the fed to be independent of politics, how does he guarantee that politics will be independent of the fed? The fed has clearly been manipulating the economy to manipulate the Presidential elections.
November 29, 2009 12:38 PM | Reply | Permalink
Whine, whine, whine. Blame, blame, blame. You want to see crap? Look in the mirror.
No institution can be independent of politics. Not in a dictatorship, not in a democracy. Not a government institution, not a private institution.
If you want that go live on another planet.
What we're looking for is an improvement in regulatory institutions, GIVEN that we will ALWAYS be facing an uncertain future, GIVEN that people are very often, grasping, greedy, and crooked, GIVEN that they will ALWAYS attempt to use the political system to their advantage.
Bernanke makes some recommendations. Can you improve on them?
November 29, 2009 12:50 PM | Reply | Permalink
It's funny how the bankers who own and run the fed want to be left independent of political considerations - except when they want to change the President to suit themselves.
I think that the Grayson - Ron Paul proposals appear to be an improvement over the current status. The fed is presently a government institution captured by the national bankers. The institution takes no responsibility for its actions except to the bankers themselves yet it has great power over the entire economy. The use of that power certainly needs to be made more publicly transparent, and other agencies need to have regulatory powers that the fed does not want used such as those over consumer financial products.
November 29, 2009 2:11 PM | Reply | Permalink
#1: ALL derivatives must be traded and regulated through a controlled market.
#2: Derivative financial products should be limited to commercial debt and real estate (none of this life insurance bullshit or derivatives based on derivatives). The creation of any derivative should be reviewed and approved by a regulatory authority that allows for comment from interested/concerned parties and provides full disclosure to consumers.
#3: Only the holder of debt can write a swap on the debt and swaps should be limited to the level of exposure. Swaps should also be regulated as insurance.
#4: Commodities should be subjected to the same regulations/oversight (and restrictions) as financial products.
#5: Cramdowns for primary mortgages should be an option available to bankruptcy judges.
#6: etc, etc.
I think at this point, everyone knows what steps need to be taken to fix the economic problems. Sadly, the *real* problem is that those in charge of fixing the economy don't want to actually fix anything.
November 29, 2009 2:13 PM | Reply | Permalink
Obviously, reforms step on toes. Those who will lose can be expected to fight back as hard as they can. Nothing surprising there.
November 29, 2009 3:25 PM | Reply | Permalink
I have 2 recommendations:
1. Abolish the Fed.
2. Step on all spiders
November 29, 2009 4:15 PM | Reply | Permalink
That's icky.
You're supposed to pull their legs off -- one at a time.
November 30, 2009 12:18 AM | Reply | Permalink
Bernanke (About a year ago) "...transparency would be counterproductive..." Counterproductive? I suppose that's true if transparency might put the skids on the fraud and abuse engaged in by the financial sector.
And then the other day, Bernanke informed a Congressional committee that "a return to Glass- would not necessarily lead to stability." Translated - a return to Glass might put the skids on the fraud and abuse presently engaged in by banks.
Is there any doubt for whom Bernanke really works?
November 29, 2009 12:49 PM | Reply | Permalink
The Fed (Bernanke in charge) has one job and one job, only -- the "setting" of interest rates which will lead to low inflation, job growth, and a sound and safe banking system.
Dean Baker's continuing emphasis upon the demand side of the past "bubble" lets the Fed off the hook -- it ain't the Fed's responsibility to prick bubbles.
But it is the Fed's responsibility to maintain a safe and sound banking system. Thus, Fed critics should be emphasizing its willingness to allow a Ponzi-type (see, Minsky) credit scheme to emerge -- that is, the pyramiding of loans that can't be repaid out of earnings but only out of capital gains (the increase of the nominal value of the property securing the loans).
Bernanke may well be a serious student of monetary responses to Ponzi-scheme crashes; he should be but is not a student of the credit policies that lead to these crashes. Thus, he has nothing much to say about what the Fed's policies should have been in the years immediately preceding the Great Depression when the extension of credit (equally to foreign buyers as well as domestic) far exceeded any possibility of its being repaid.
N.B. I recall reading that Bernanke knew so little about the growing credit crisis that after the two Bear Stearns hedge funds went bust in mid-2007, Wall Streeters had to take him aside and give him a seminar which might best have been entitled "What is a CDO?" for all Ben Bernanke knew about what was happening.
November 29, 2009 1:56 PM | Reply | Permalink
Regulators will always be a step or two behind; it's in the nature of things...unless you can come up with a proposal whereby the leading financial wizards at the leading banks and brokerage houses find it more profitable to work for the public interest than their own firms.
November 29, 2009 3:39 PM | Reply | Permalink
Ellen,
I'm not sure how you decided that it is not the Fed's responsibility to prick bubbles. Under the law, it is the Fed's responsibility to maintain full employment, defined as 4.0 percent unemployment.
A completely predictable response to the bursting of a large bubble that is driving economic growth, like the housing bubble, is a long period in which demand is not sufficient to maintain full employment. So, how is it not the Fed's responsibility to prick bubbles when the expected result of failure to do so is a prolonged period of high unemployment?
November 29, 2009 4:51 PM | Reply | Permalink
Maintaining full employment is a Wright Patmanesque type response to the fear that the Fed would act like a Bundesbank -- keeping interest rates high and unemployment high to "protect" the value of the currency through deflation. A reasonable concern in 1946 but not one after 60 years of inflation and a like number of years of banks learning how to maximize income on the interest rate spread designed by the Fed for the former's benefit.
Today "maintaining full employment" is nothing more than a slogan, an excuse friends of the Fed roll out whenever the Fed decides to promote the profits of its real customers -- the banks.
We should be attacking the Fed where it lives and where its responsibilities are incontestable -- its duty (and its failure) to see to the long term health of its patient, the nation's banking system.
November 29, 2009 7:32 PM | Reply | Permalink
Ellen,
The Humphrey-Hawkins Act, specifying 4.0 percent unemployment, was passed in 1978. This is the law. It is not unreasonable to expect the Fed to follow the law that guides their operation.
November 29, 2009 8:59 PM | Reply | Permalink
Was that Paul Volcker I heard chuckling?
October 1978 Humphrey-Hawkins enacted
August 1979 Carter appoints Volcker
June 1981 Volcker raises fed funds rate to 21%
December 1982 Unemployment hits 10.8% (22% of all persons in the workforce had experienced some unemployment in 1982)
November 30, 2009 12:10 AM | Reply | Permalink
Dean, Ellen is clearly making a distinction between types of bubbles. Both the housing, and the Commercial real Estate bubble would fall into her definition of threat to banking system bubbles. She is identifying the characteristic of a bubble that makes it existential threat to the banking system.
I haven't really seen anyone else, including you doing that. That seems important to me. If we are going to be asking the Fed to pop bubbles we should know why they need to be pooped. We can't simply say because we think so and point to a graph. Sometimes their really are fundamental shifts in markets that will permanently raise (or lower) prices.
You need to know what the characteristics of existential bubbles are to know when to act and when not to.
November 29, 2009 8:14 PM | Reply | Permalink
A completely predictable response to the bursting of a large bubble that is driving economic growth, like the housing bubble, is a long period in which demand is not sufficient to maintain full employment.
This really does strike me as an awfully convoluted argument.
November 29, 2009 9:16 PM | Reply | Permalink
Hell, even I know that an economic bubble is (merely) when asset prices deviate from intrinsic values.
November 30, 2009 12:34 PM | Reply | Permalink
Can we just call this situation what it really is: a Depression?
Seriously, just because some asshat decided to define our nation's economic health by how well the bankers are doing doesn't mean that's real. For the vast majority of Americans, the situation is every bit as bad as any depression we've ever experienced.
And if we're keeping score, I think Summers is also somewhat ... forgetful ... of his (far bigger) role is this clusterfuck of an economic disaster as well. He just has the good sense to STFU and lay low.
November 29, 2009 1:57 PM | Reply | Permalink
Bernanke and friends are in their own bubble. They can look out and see the rest of us, but they don't touch, taste or smell the real world.
November 29, 2009 4:17 PM | Reply | Permalink
Well here is something you might have missed. Seems a Brent T. White, a University of Arizona law school professor thinks home owner that are under water should stiff their lenders and take a hike.
Interesting point of view. I was going to blog about this but decided that it fits nicely here.
So all you chumps that got taken by Countrywide Financial and others....just take a walk and stick it to these SOBs that Bernanke wants to protect.
C
November 29, 2009 4:37 PM | Reply | Permalink
Good idea. From a former Wells Fargo loan officer specializing in subprime loans: Rather than making a prime loan to a customer, who actually qualified for one, she (the loan officer) was instructed to and did use various techniques to 'qualify' the A-rep referrals for subprime loans. Her pay was based on commissions and fees from making these loans. In 2004 alone she grossed more than $700,000 in sales commissions. And, needless to say WF made a killing on subprimes.
Seems to me that 'stiffing' the likes of Fargo is a great idea.
December 1, 2009 11:58 AM | Reply | Permalink
I think it is fair & appropriate to point out the many mistakes that the Fed made in the lead-up to the crisis. But don't you think these mistakes were made because the Fed was already too political? It seems to me that giving Congress more power to control the Fed (and influence Fed policy) is a recipe for making things much worse, not better.
Further while it is true that Bernanke and Geithner were complicit in many of the errors that led up to the crash in '08, they did respond pretty well under pressure to avoid a much worse crash. Let's give credit where credit is due.
Reform is badly needed, but I am terrified that in the rush to reform, either the "abolish the Fed" crowd or the "make the Fed part of the executive branch" crowd will get their way, and wreak havoc.
November 29, 2009 5:12 PM | Reply | Permalink
Government is notorious for acknowledging the existence of a problem far too late, finding the wrong solution and applying it in the worst possible manner.
C
November 29, 2009 5:26 PM | Reply | Permalink
Perhaps the Supreme Court could be persuaded to take it?
November 30, 2009 10:54 AM | Reply | Permalink
A sorry lot of comments if I have ever seen one. I believe Baker's point is that Bernanke is just another one of those folks focused on the future, lets sweep the past under the rug. Odd how that seems the best recommendation by those who have skeletons in the closet. Let's see the skeletons before we take the advice of the closet owners.
November 29, 2009 6:48 PM | Reply | Permalink
You miss the essence of the story: Bernanke and others weren't stupid. There was a reason for allowing the housing bubble to persist.
Were it not for the false sense of prosperity provided by the housing bubble, the cost of the Bush tax cuts and the continued deindustrialization and outsourcing of the economy to China and Mexico would have been apparent. Perhaps apparent enough to stop this whole neoliberal wealth transfer in its tracks. Certainly apparent enough to give the Republicans big trouble at the polls.
Oh, and the one thing we don't have is a disaster for the people running the show. They have come out wealthier, more powerful and more profitable. Bernanke didn't fail at his real job, just his tititular one. For Bernanke, it's mission accomplished.
November 30, 2009 2:05 AM | Reply | Permalink
I don't believe Bernanke is craven, just limited.
In his post at Princeton he wasn't one of the pigs struggling at the feed trough.
November 30, 2009 8:36 AM | Reply | Permalink
Quote-th the craven....never more.
C
November 30, 2009 2:10 PM | Reply | Permalink
Courtesy of Cunning Realist, 15 questions the Senate Banking Committee should ask Bernanke this week, but probably won't.
November 30, 2009 9:36 AM | Reply | Permalink
A little discussed topic.
Other voices; other views:
Ridding economics theory of the Fed's stranglehold over it might turn out to be the biggest benefit we as a nation would realize if the Fed's wings were really clipped.
November 30, 2009 11:10 AM | Reply | Permalink