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April 1, 2012
David Warsh, Proprietor


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Bush’s Best Pick

What was that all about?

Over the past two weeks, Federal Reserve Chairman Ben Bernanke has been interviewed  by Diane Sawyer on ABC, appeared on the cover story of The Atlantic magazine, gave four lectures to college students, delivered a major address  on unemployment to the National Association of Business Economists, testified before Congress on the European economic situation,  and, to cap it all, made a short, pithy speech to a Board of Governors conference, Central Banking: Before, During and after the Crisis — all of it with the mild, self-effacing authority that has become Bernanke’s trademark. As Binyamin Appelbaum wrote on The New York Times “Economix”  blog, “Even by his evolving standards, the last seven days have been extraordinary.”

Bernanke’s spring offensive was a way of sounding a provisional all-clear. What happened in 2007-8 – and what didn’t happen then – is now, he said, considered to be substantially understood.  Financial intermediation had evolved by leaps and bounds into a tangle of banks and bank-like organizations (the latter collectively known as the shadow banking system), which regulators discovered that they no longer understood – whose interconnections they had to figure out on the fly.

Speaking of the Fed’s dimly remembered mission as lender of last resort to this menagerie of institutions, Bernanke told his undergraduate auditors at George Washington University,

[R]ather than being some ad hoc and unprecedented set of actions… the Fed’s response was very much in keeping with the historic role of central banks, which is to provide lender of last resort facilities in order to calm a panic. And what was different about this crisis was that the institutional structure was different. It wasn’t banks and depositors. It was broker-dealers and repo markets. It was money market funds and commercial paper but the basic idea providing short-term liquidity in order to stem a panic was very much what [Walter] Bagehot envisioned when he wrote Lombard Street in 1873

And at the Fed conference he said, “There will not be any more large, complex systemically critical firms that have no oversight. Those gaps are getting closed. We won’t have the situation we had before the crisis.”

To get some idea of how close the world came to what would have been a far much more dangerous situation in 2008, it is necessary to cast your mind back to early 2005.  George W.  Bush had been re-elected. “I earned capital in the campaign, political capital, and now I intend to spend it. It is my style,” he told a press conference.

So the initial venture of his second term was an ambitious attempt to turn the government-administered Social Security System into a program based on private investment accounts. But by April the privatization initiative had failed, solidly repudiated by a Congress that the Republicans controlled.

Then on July 1, Supreme Court Justice Sandra Day O’Connor, 75, announced her resignation.  The president quickly named John G. Roberts Jr to replace her. But when Chief Justice William Rehnquist died in September, Bush opted  to replace him with Roberts instead, leaving the O’Connor seat still to be filled. Many persons, including the president’s wife, urged that the distinguished jurist be succeeded by another woman. In early October, with little study beforehand, Bush nominated White House counsel Harriet Miers to the Court. With almost no background in jurisprudence, she soon came to be seen as little more than an able law office manager.

With Miers’s nomination in trouble, Bush’s hand was forced with respect to the Fed. Eighty-five-year-old Alan Greenspan’s full 14-year term as governor had expired (previously he had filled more than four years of another governor’s term); he was serving as chairman month-to month, and planned to retire in the spring.  The search for his replacement, which had begun the previous spring under vice president Dick Cheney, had narrowed to a list of five names, according to Wall Street Journal columnist David Wessel, author of In Fed We Trust: Ben Bernanke’s War on the Great Panic.

They included Bernanke, John Taylor (of Stanford University), N. Gregory Mankiw (of Harvard University), and Stephen Friedman (a former co-chairman of Goldman, Sachs), all of whom had served in policy jobs under Bush; and Martin Feldstein (of Harvard), who had served under Ronald Reagan. Taylor had received “mixed reviews” as the Treasury’s top international officer, Wessel wrote; Feldstein was remembered as “outspoken,” for his advocacy of deficit reduction during the Reagan administration.

The dark horse was Goldman’s Friedman. He performed best in his interview, Wessel was told. But with Miers’s nomination about to be withdrawn, the White House couldn’t afford to gamble with “another surprise, out of the box choice.”

So on October 24, 2005, the president chose Bernanke.

What would have happened in the crisis if the Fed chairman had been a former Goldman Sachs executive, with almost no background in central banking?  It is anybody’s guess.  Friedman’s counterpart at the Bush Treasury Department would have been his former protégé, Henry Paulson, another former co-chairman of Goldman Sachs.

Friedman served as chair of the Federal Reserve Bank of New York throughout the crisis, even after Goldman became a Fed-regulated bank holding company, in September 2009. (He sought and eventually obtained an unusual waiver from the Board of Governors to continue to serve.) Meanwhile, Timothy Geithner, the New York Reserve Bank’s president and chief executive officer, left in January 2009 to become Treasury Secretary in the Obama administration, replacing Paulson.

Almost immediately, Geithner was succeeded at the New York bank by William Dudley, another longtime Goldman executive. A few months later, Friedman resigned as chairman after the WSJ disclosed that he had increased his stake in Goldman the previous December, and again in January, the day after receiving his waiver.

Bernanke became the second university professor to hold a job that had been considered the province of “markets men” ever since the Fed was created, in 1913. (Greenspan, having made his living as a nuts-and-bolts economics consultant to large corporations, was a transitional figure; Arthur Burns, of Columbia University, was the previous, rule-proving professor.) A pre-eminent student of monetary policy in the Great Depression, Bernanke had the advantage of being intimately familiar with various failures by which the Fed, new at its tasks, compounded the events that followed the stock market Crash of 1929.

The two-week flurry of activity just past almost certainly marks the beginning of a new and final phase for Bernanke, whose second term as chairman expires in early 2014, and who is expected then to leave the Fed. (He will be 61 years old).  The great tests of the crisis may be over, but major challenges of banking supervision remain. It was these to which Bernanke called attention in his remarks to the blue-ribbon research conference in Washington.

Some combination of capital ratios, margin requirements, liquidity regulations and dynamic loan-loss provisioning is, as the experts say, almost certainly required; but as Charles Goodhart, Anil Kashyap, Dimitrios Tsomocos and Alexandros Vardoulakis warned in their conference paper, “It is easy to produce combinations of regulations that look sensible but when combined have adverse effects on the economy.”

To which grateful bystanders can only murmur, “Thank you, Harriet Miers, for having been present in order to have been thrown under the White House bus.”

.                                xxxxx

A further sign that change at the Fed is in the works: Daniel Sichel, Bernanke’s principal speech-writer for the past five years, is on the verge of becoming professor of economics at Wellesley College.

He is expected to succeed there the (not very) emeritus serial entrepreneur Karl (Chip) Case, author of a best-selling textbook (with Ray Fair and Sharon Oster, both of Yale); and inventor of an indispensable index of house prices (with Robert Shiller, of Yale).

Sichel is well known for early work on productivity growth and the measurement of intangible capital. But then he is also the author of the point-making  Everyday Products Weren’t Always that Way: Prices of Nails and Screws Since about 1700 as well.  He was distinguished lecturer at the college last year.

Because of the sheer populous-ness of its graduates in economics and finance, the Wellesley economics program may be unique in US collegiate education. But the fact is that undergraduate college professors play an important role alongside their colleagues in research universities in producing as well as curating and communicating economic knowledge.

Sichel’s pending appointment is good news for those who advocate a broader view of leadership in the profession.  Will a college teacher – as opposed to a university professor – ever become president of the American Economic Association?

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