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March 25, 2012
David Warsh, Proprietor


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The Fourth Tool

Eventually we’ll have the Black Box: the record of what policy makers of the Federal Reserve Board were saying to each other as the crisis deepened in 2008, in the course of fourteen tense meetings during the year, six of them unscheduled.  The Federal Open Market Committee releases transcripts of its meetings five years after the fact.

But September 2013 is a long time to wait for a clearer view of the crisis and its aftermath.

So last week Fed chairman Ben Bernanke took another step in constructing a history of events, delivering the first of four lectures to a class of undergraduates at George Washington University.  All the details, including transcripts of the first two lectures, are here.

(Ed:  What was the first step? Bernanke’s testimony to the Congressional Financial Crisis Inquiry Commission.)

The unusual outreach has been billed as a low-budget public relations campaign. But it resembles, too, those extremely low-frequency signals which the US Navy used for many years to keep in touch with deeply submerged submarines . Communication with submarines is difficult because radio waves do not travel well through salt water. So the Navy built a 28-mile-long transmitter in the North Woods of Wisconsin to generate the seriously long radio waves necessary to penetrate the depths until its scientists devised a better way.

Bernanke’s lectures presumably displayed the broad outlines of the book he will write when he leaves office.  (His second four-year term as chairman is up in 2014.)  But they have the easy informality and low-key authority of a man speaking with slides, but not from a text

The first lecture was mainly about panics – not just forgotten panics, but forgotten movies about panics (“How many of you have seen the movie ‘It’s a Wonderful Life?’  No?  Less people are watching Christmas movies than they used to be, I guess.” [laughter]”).  Lender of last resort.

The second lecture was about why the Fed thought it could arrange a soft landing in 2008 after the housing bubble began to deflate. It was thinking about the relatively mild recession that followed the dot.com  crash in 2002, and overlooked the potential for trouble in the largely unmonitored shadow banking system.

Next week comes a description of the unexpected panic, and then, finally, a discussion of the aftermath.  Details are here.

Binyamin Applebaum, of The New York Times, and Jon Hilsenrath (with Kristina Peterson), of The Wall Street Journal, are wonderful reporters, in daily contact with the Fed. To their credit, both filed stories here and here after the first lecture.  But they may have missed the point. Bernanke was trying to tell a different story from the one that’s been told.

Similarly, the hard-working Roger Lowenstein – author of When Genius Failed: The Rise and Fall of Long-Term Capital Management and The End of Wall Street – produced a cover story for The Atlantic (“The Villain” on the Web, “The Hero” in the magazine itself) with plenty of cooperation from Bernanke. (The take-your-pick title is apparently intended to be ironic:  Lowenstein concludes the piece itself, “to a greater extent than he is credited with now, history may marvel that Bernanke has been a success.”)

Bernanke tells Lowenstein to read Walter Bagehot, the nineteenth-century journalist (editor of The Economist) whose Lombard Street: A Description of the Money Market made the classic case for non-invasive governmental oversight of banking.   “Some people don’t understand,” the chairman tells the writer, “fulfilling the responsibility as lender of last resort is what the Fed was created to do. This is what central banks have been doing for three hundred years.”

But Lowenstein skimps on the history of central banking, except for the tired old boilerplate about the First and Second Banks of the United States in the years before the Civil War.  He skimps, too, on the details of the panic, in favor of a theory of why Bernanke was slow to grasp what was happening in early 2008. Lowenstein writes:

[W]hile Bernanke recognized the danger in theory, he did not anticipate the looming crash in home prices…. In 2007, as the subprime mortgage crisis leached into the financial markets, Bernanke’s training failed him.  as a scholar, he had studied how bank failures worsened the depression; as the Fed chair, he didn’t scrutinize the banks closely enough – that is, he overlooked the fact that that dicey mortgage-backed securities made up a sizeable portion of the assets of the biggest banks. “Risk was concentrated in key financial intermediaries,” he told me. “It led to panics and runs. That’s what made it all so bad.  Speaking of government officials collectively, he added, “Everyone failed to appreciate that our sophisticated, hypermodern, highly-hedged, derivatives-based financial system – how ultimately fragile it really was.”

There was, I think, another reason for his blindness:  Bernanke has an academic’s faith in the market’s essential rightness.  He was so skeptical of the idea of mass market folly that in his scholarly writings he referred to bubbles in quotation marks. He was not, like [Alan] Greenspan, ideologically opposed to government intervention,, but he was dubious that anyone could identify, in real time, when markets were off course.

This is precisely the sort of confusion Bernanke sought to combat in lectures when he distinguished among the three principal tools of central banking:  the conduct of monetary policy; bank supervision; and guardian against panics as lender of last resort. Bernanke is talking about the Fed’s role in a panic; Lowenstein thinks he is talking about the conduct of monetary policy. That third lecture should be most interesting.

There will be a lot more of this sort of thing when the Black Box begins to open. Meanwhile, Bernanke’s lectures, deep vibrations from the Fed, amount to a fourth tool of policy. They are a civics lesson.

.                               xxx

President Obama Friday nominated Dartmouth College President Jim Yong Kim, a physician and public health expert, to head the World Bank after Robert Zoellick’s  term expires in June.

Kim’s candidacy, a surprise, is thought to have been advocated by Dartmouth alumnus Timothy Geithner, Secretary of the Treasury.  Kim was among those who in 1987 joined Paul Farmer in the founding , in Haiti, of Partners in Health.

For the first time, there will be some formal competition for the job. A group of African nations has endorsed Ni­ger­ian finance minister Ngozi Okonjo-Iweala. Several South American countries support former Colombian finance minister Jose Antonio Ocampo.

The post has traditionally gone to an American; the US has been the bank’s biggest funder.

Lawrence Summers, of Harvard University, and Jeffrey Sachs, of  Columbia University’s Earth Institute, campaigned for the job.  John Cassidy and Felix Salmon followed their quest to its bitter end.

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