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Ben Bernanke's Four Failures

09/29/2009 1:00 pm EST


Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Mark Skousen, editor of Forecasts & Strategies, says the Federal Reserve chairman deserves credit for averting a new depression, but he also helped create the crisis.

Federal Reserve chairman Ben Bernanke, who has been reappointed by President Obama, reported last month that the Great Recession is coming to a close, and we have survived the worst financial crisis in a generation.

Wall Street reacted positively to Bernanke’s reappointment, largely because Bernanke shepherded us through the Great Panic of 2008, which could have left us in a depressed state for years. His aggressive and innovative “quantitative easing” kept us from a 1930s-style financial collapse.

But let us not forget the many blunders Bernanke created in his first four years as chairman, and the mess he faces in the future.

His sins of commission are substantial:

1. The worst excesses of the real estate boom and lax subprime lending rules took place on the first two years of Bernanke’s watch. In January 2007, I was at Bernanke’s first major address before the American Economic Association on the subject of “bank regulation.”

The Fed, he pointed out, is in charge of regulating the banks, yet he failed miserably to control their excesses at this critical time. It was a standard, boring speech, except that Bernanke used the words “panic” and “crisis” 37 times. He subconsciously knew what was coming, but did nothing about it.

2. He significantly raised the “moral hazard” problem with financial institutions. “Moral hazard” is a term used [to describe] the willingness of banks, insurance companies, and other financial institutions to take excessive risks—knowing that the government will bail them out if they fail.

It’s a serious danger, and one reason we continue to have lots of bank failures in the United States. Bernanke raised the “moral hazard” risk when he and Treasury Secretary Henry Paulson engineered a rescue of Bear Stearns in March 2008. But then, fearing further “moral hazard” concerns, he and Paulson decided not to bail out Lehman Brothers in September 2008.

They had no idea how big and important Lehman Brothers was in the global banking system. The next week, because Lehman was allowed to fail, AIG suddenly became vulnerable. AIG was deemed too big to fail and subsequently received about $180 billion (almost $2,000 for every American household) in federal assistance.

3. In less than six months, the Fed more than doubled its balance sheet from $800 billion to more than $2 trillion, and has taken on $600 billion worth of Fannie Mae, Freddie Mac, and Ginnie Mae mortgage-backed securities. During this time, the money supply (M2) grew at a double-digit percentage rate.

4. The worst mistake was Bernanke’s call to Treasury Secretary Paulson to insist that the financial crisis was too big for the Fed to handle. Bernanke demanded that Congress and the Treasury get involved. The result has been more than $1 trillion in TARP expenditures and various stimulus packages to create the worst deficits in US history. This year’s deficit is expected to exceed $1.6 trillion.

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