Monday, October 13, 2008

Words and Deeds


When President Bush appointed Ben Bernanke Chairman of the Federal Reserve’s Board of Governors, most economists said that Mr. Bernanke’s scholarly research on the Great Depression well-prepared him for the job.

Mr. Bernanke endorsed economists’ conventional wisdom that the Fed’s inappropriate actions at the Depression’s outset exacerbated the downturn. The Fed maintained a high-interest-rate policy to defend America gold reserves instead of reducing interest rates aggressively to stimulate borrowing and spending. Because of those high interest rates, so the conventional wisdom goes, a run-of-the-mill recession became the Great Depression.

That version of the Depression’s cause became a key ingredient of free-market ideology: Misguided government policy caused the Great Depression. This viewpoint soon became part and parcel of the notion that “Government Can’t.” Or, to paraphrase Ronald Reagan, “Government is the problem, not the solution.” The corollary: Let markets alone; don’t impede them with excess regulation, supervision and control.

President Bush appointed Ben Bernanke to lead the Fed because Mr. Bernanke espoused those free-market principles. These principles motivated Mr. Bernanke to maintain the hands-off stance of his predecessor, Alan Greenspan, an appointee of President Reagan. Mr. Greenspan and Mr. Bernanke took a minimalist approach: They let low interest rates and lax lending standards inflate the real-estate bubble.

As the bubble began to deflate and mortgage-backed securities became the toxic waste that led to the global financial crisis, Mr. Bernanke maintained his minimalist approach. Both he and Treasury Secretary Henry Paulson underplayed the crisis, invoking the doctrine of “moral hazard” to avoid bailing out foolish lenders. Instead of taking a systematic and systemic approach – such as the rescue package originating in Europe on the weekend of October 11 and 12 – Mr. Bernanke and Mr. Paulson proceeded in an ad hoc and haphazard fashion. They organized a bucket brigade instead of clearing a fire line. It was not until the European nations showed the way that they abandoned ideology and fully embraced pragmatic solutions.

What an irony. Economists endorsed Mr. Bernanke because they thought he had learned from mistakes the Fed had made during the Great Depression. Unfortunately, instead of embracing the benefits of an activist Fed that “can and should”, Mr. Bernanke came away with a minimalist free-market ideology that said the Fed “can’t and shouldn’t.” Instead of leading the charge for a robust and systematic response to the crisis, the Fed consistently remained one step behind.

© 2008 Michael B. Lehmann

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