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A Magazine of Ideas

Does Bernanke Really Deserve a Second Term?

Thursday, July 2, 2009

The Federal Reserve chairman’s tenure has been checkered at best. There must be other candidates who could be expected to do a better job.

Speculation that Ben Bernanke might be appointed for a second term as Federal Reserve chairman after his first term expires in January 2010 has to remind one of Washington’s Alice in Wonderland-like quality. For if Bernanke were indeed to be reappointed as Fed chairman, it would mean that in the depths of by far the worst U.S. economic recession in the postwar period, one would be reappointing to the job the very person whose fingerprints, along with those of former Fed chief Alan Greenspan, are all over that recession. It would also validate the skeptical worldview of a former boss of mine who believes that, in Washington, nothing succeeds so well as failure.

Advocates for Bernanke’s reappointment stress his impressive academic credentials as a world expert on the Great Depression and on the Japanese financial crisis in the 1990s. These credentials, they argue, could not be more relevant at this difficult stage in the U.S. economic crisis. They also point to the consummate skill with which Bernanke prevented financial Armageddon in the wake of the Lehman bank failure in September 2008. He did so by imaginatively trebling the size of the Federal Reserve’s balance sheet to shore up those U.S. financial markets that came under enormous stress and by more recently embarking on an unorthodox policy path of “quantitative easing.”

What Bernanke’s supporters happily gloss over is the policy role that he played in both the run-up to and in the deepening of the country’s worst economic recession in the three and half years since he was first sworn in as Federal Reserve chairman in February 2006. They also make no mention of how closely involved Bernanke was with former Secretary Treasury Henry Paulson’s less than successful attempts to promote financial stability through the (correctly) much maligned Troubled Asset Relief Program (TARP). Nor do they mention Bernanke’s involvement with the Lehman debacle.

A second term for Bernanke would validate the skeptical worldview that in Washington nothing succeeds so well as failure.

In rating Bernanke’s overall tenure as Federal Reserve chairman, one might start by asking why he was as passive as he was in 2006 when the worst of the sub-prime mortgage loans were being made under his watch. During that year, a total of around $600 billion in sub-prime mortgage lending, or around one half the final amount of sub-prime lending that was extended, was made on conditions that were materially more lax than earlier vintages of sub-prime lending. Indeed, it became commonplace for banks to extend loans up to 100 percent of the value of the underlying property and to make such loans to borrowers without incomes, without jobs, and without assets.

In considering whether to renew his appointment, it would also seem reasonable to hold Bernanke to account for totally misjudging how serious the bursting of the housing market bubble would be for the overall economy, and how large would be the losses to the financial system from imprudent sub-prime lending. In April 2007, when he first identified that something was amiss with sub-prime lending, he assured Congress that the sub-prime problem would be limited in size and that any fallout would be confined to the housing sector. A few months later he was forced to concede that sub-prime mortgage lending might result in losses to the financial system on the order of $50 billion to $100 billion, only to have to modify these estimates again to something in the ballpark of $150 billion. He did so even though the latest estimates of the eventual overall losses that the U.S. banking system will record as a result of its lending excesses during the boom years now runs to more than $1.5 trillion.

What Bernanke’s supporters happily gloss over is the policy role that he played in both the run-up to and in the deepening of the country’s worst economic recession.

A further strike against Bernanke’s record must be how blinded he was to the need for early and decisive monetary policy action to counter the fallout from the housing market bust. Indeed, it was as late as August 2007 before the Federal Reserve started its interest rate cutting cycle. This was long after it had become apparent to most market observers that large sub-prime losses and a lack of transparency in the newfangled debt instruments were leading to a seizing up of the international banking system. And even when the Fed did begin cutting interest rates, it did so gingerly and it repeatedly underestimated the downside risks to economic growth from the housing market debacle.

In deciding on whether or not to renew Bernanke’s term, President Obama would do well to focus on the record of his full tenure in office rather than only on Bernanke’s relative successes in the nine months after the Lehman bankruptcy. If President Obama were to do so in a dispassionate and deliberate manner, he would find that Bernanke’s full-term performance has been checkered at best and that there must be other candidates who could be expected to do a better job than Bernanke as Federal Reserve chairman.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was managing director and chief emerging market economic strategist at Salomon Smith Barney and a deputy director in the International Monetary Fund’s policy and review department.

FURTHER READING: Lachman wrote “Despite the Doubters, It’s Still Top Dollar” on the likelihood that the Chinese renminbi will eventually replace the U.S. dollar as the world’s preeminent international reserve currency. He also penned “Can the IMF Really Save the World Economy?” and “The World Economy’s Europe Problem.” His article “Don’t Repeat Japan’s Mistakes” warns against the policies Japanese authorities followed during their financial crisis in the early 1990s.

Image by Darren Wamboldt/Bergman Group/Flicker user.