Ben Bernanke’s Thoughts During the Housing Crisis
I recently found my notes from a couple of years ago when I read Ben Bernanke’s book The Courage to Act. I remember hearing that Ben was coming out with a book after he left his position as the Chairman of the Federal Reserve and I bought the book right away on Amazon. I normally don’t buy books that come out right away, but I was too eager. I had to buy this one. I was interested in what was going through his mind during the biggest economic crisis of my lifetime and the biggest one since The Great Depression.
Here are just some of Ben’s thoughts:
“During the last 4 months of 2008, 2.4 million jobs disappeared, and, during the first half of 2009, an additional 3.8 million were lost.”
“In September 2007, once it seemed clear that Wall Street’s financial turmoil could threaten Main Street, we started cutting the target for the federal funds rate. We continued until we reduced the target to near zero and could go no further. From there, we would venture into unchartered waters by finding ways to push down longer-term interest rates, beginning with the announcement of large-scale purchases of mortgage-backed securities. The journey was nerve-racking, but most of my colleagues and I were determined not to repeat the blunder the Federal Reserve had committed in the 1930’s when it refused to deploy its monetary tools to avoid the sharp deflation that substantially worsened the Great Depression.”
I read Robert Rubin’s book In an Uncertain World, Tim Geitner’s book Stress Tests, and Alan Greenspan’s book The Map and the Territory right before Ben Bernanke’s. I had a huge interest in reading these types of economic books because these guys were responsible for overseeing the U.S. economy which has a huge effect on the rest of the world. There is also so much uncertainty because of the complexity of our economic system and all of its moving parts that there is so much to learn on decision making. What was relevant for them yesterday may not be as relevant today, or may not even be relevant at all.
“I agree that more should have been done to help homeowners, although devising effective policies to do that was more difficult than many appreciate.”
Each moving part has a major effect on everyone’s standard of living and their quality of life. You can’t please everyone. A decision in one area has an unintended or maybe even an intended consequence in another. Also, there are so many variables, cause-and-effect relationships, and consequences that any one of their decisions can have on others.
“In making the decisions we made in March 2008, we could not know all that would transpire. But even in hindsight, I remain comfortable with our intervention. The enormously disruptive effect of Lehman’s failure in September, I believe, confirmed our judgment in March that the collapse of a major investment bank — far from being the nonevent that some thought it might be — would severely damage both the financial system and the broader economy. Our intervention with Bear gave the financial system and the economy a nearly six-month respite, at a relatively modest cost. Unfortunately, the respite wasn’t enough to repair the damage already done to the economy or to prevent panic from breaking out again in the fall.
The decisions that the Federal Reserve Chairmen make are much more important to the world when you really think about it because the U.S. economy is so big and vital to trade that the decisions they make don’t just have an effect on only the U.S. economy, but also on the economies across the globe.
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One reason is because the U.S. dollar is the world’s reserve currency and many important commodities such as oil and gold are traded in U.S. dollars. Also, our global economy is so interconnected these days because of globalization that we are seeing a lot more decisions in one country — especially the major developed countries — have a major effect on another one. This puts a lot more pressure on world leaders. After all, most market participants are watching their every move.
“Bear [Stearns] wasn’t too big to fail. It was too interconnected to fail. Bear had nearly 400 subsidiaries, 5,000 trading counter-parties, and 750,000 open derivative contracts… A bankruptcy proceeding would lock up the cash for many other creditors, potentially for years.”
Leaders are faced with no easy options, especially during a financial crisis. Even if they don’t have all of the relevant information they need to make a decision, they must act. Below are some of the more interesting parts I found from Ben Bernanke’s autobiography in his own words. These are what I believed to be some of the more difficult second-order consequences that transpired after the collapse of the housing market and Ben had to try to solve.
1. On the possible unintended consequences of QE and bringing interest rates to zero:
“People tend to think low inflation is a good thing, because it means that they can afford to buy more. But very low inflation — if sustained — also comes with slow growth in wages and incomes, negating any benefit of lower prices. In fact, inflation that is low can be just as bad for the economy as inflation that is too high, as Japan’s experience illustrated.”
“There was virtually zero risk that our policies would lead to significant inflation or “currency debasement”. That idea was linked to a perception that the Fed paid for securities by printing wheelbarrows of money. But contrary to what is sometimes said, our policies did not involve printing money — neither literally, when referring to cash, nor even metaphorically, when referring to other forms of money such as checking accounts. The amount of currency in circulation is determined by how much cash people want to hold (the demand goes up around Christmas shopping time, for example) and is not affected by the Fed’s securities purchases. Instead, the Fed pays for securities by creating reserves in the banking system. In a weak economy, like the one we were experiencing, those reserves simply lie fallow and they don’t serve as “money” in the commend sense of the word. As the economy strengthened, banks would begin to loan out their reserves, which would ultimately lead to the expansion of money and credit. Up to a point, that was exactly what we wanted to see. If growth in money and credit became excessive, it would eventually result in inflation, but we could avoid that by unwinding our easy-money policies at the appropriate time.”
2. Ben justifying his decisions with an analogy:
“You have a neighbor, who smokes in bed… Suppose he sets fire to his house. You might say to yourself… I’m not gonna call the fire department. Let his house burn down. It’s fine with me. But then of, of course, what if your house is made of wood? And it’s right next door to his house? What if the whole town is made of wood?” The editorial writers of the Financial Times and the Wall Street Journal in September 2008 would, presumably, have argued for letting the fire burn. Saving the sleepy smoker would only encourage others to smoke in bed. But a much better course is to put out the fire, then punish the smoker, and, if necessary, make and enforce new rules to promote fire safety.”
3. On Letting Lehman Brothers Go Bankrupt:
“The Fed and the Treasury did not choose to let Lehman fail. Lehman was not saved because the methods we used in other rescues weren’t available. We had no buyer for Lehman, as we’d had for Bear Stearns — no stable firm that could guarantee Lehman’s liabilities and assure markets of its ultimate viability. The Treasury had no congressionally approved funds to inject, as they’d had in the case of Fannie and Freddie. Unlike AIG, which had sufficient collateral to back a large loan from the Fed, Lehman had neither a plausible plan to stabilize itself nor sufficient collateral to back a loan of the size needed to prevent its collapse. And Lehman’s condition was probably worse than reported at the time, according to the bankruptcy examiner’s report in 2010. As we would learn, the company used dubious accounting transactions to inflate its reported ratio of capital to assets.”
4. On the Controversial AIG Bonuses:
“The bonuses [to AIG employees] had been promised, before the bailout, to retain key employees, most of whom had nothing to do with the controversial actions that brought the company to the brink. Many had specialized expertise that was needed to safely unwind AIG’s complex positions and, thus, to protect the taxpayers’ investment in the company. That said, I certainly understood why an unemployed worker or a homeowner facing foreclosure would be outraged. Paying bonuses to employees of a company that had been bailed out by the taxpayers was an injustice that anybody could understand. No wonder people were angry.”
