Bernanke back in ... Oy! Plus the 70-30 labor-capital split means other than you think

Today on the podcast, it is baffled Ben Bernanke in for a second term -- What does that mean for the economy, the financial crises, and the competence of the Obama team going forward?

Also. You've heard that consumption is falling from its peak of over 70 percent. There is another, more stable 70 percent figure. The allocation of national income to workers. The 70-30 split of labor to capital has held for a good long time. What does it mean, for your retirement, investments, job prospects?

And finally today, the history note with Hyman Minsky. Nobody saw it coming. Hoo couldda node? If we keep listening to the people who have been wrong, we're not going to get out of confusion, and we just re-upped the king of denial. But Minsky's analysis predicted instability and increasing instability as financing moved to more speculative forms.

First. The six or eight readers of the blog noticed last week that I filed the reappointment of Ben Bernanke under the heading, What a disaster.

Many have applauded. Paul Krugman, fellow Princetonian, comes to mind. Least surprising was the virtually unanimous approval of the Wall Street Chamber of Commerce. On the transcript of today's podcast, far below, is a single-ply roll of the comments.

We did not applaud. We were dismayed and disgusted. Obama put one of hte architects of the disaster back in as head of the rebuilding team. That means as much about the chances of a new approach to financial markets as it does about the competence of the president's brain trust. Fed Chair is THE most powerful seat in government that is not elected. To ratify the status quo of the past thirty years is really, really, really dumb.

We've said our forecast is dependent on policy choices from the administration. This reappointment signals that the progressive policies we anticipated from the new president will not be forthcoming. Shift the scenario to the right to pessimistic.

Maybe we were naive .... No maybe about it. If not progressive, we expected at least pragmatic. If one thing doesn't work, try something else. Well, it didn't work. But the results on Main Street don't matter. Apparently saving the big banks has been translated to meaning we have saved the financial function and saving the financial function of the economy is an essential first step.

The translation is being skewed by the financiers. It didn't work. Low interest rates and easy terms for banks have meant weird stock markets and a new commodity bubble. Credit is not flowing to business or consumers. Bernanke has critically compromised the Fed's balance sheet in the process of creating huge new backstops for speculative finance.

The entire financial sector collapse and market meltdown is a clear defeat for the corporate-run markets. Alan Greenspan's naive expectation that market forces would provide discipline even in the presence of implicit government bailouts fell apart. How much less will Bernanke's ever more elaborate protections for the financial cowboys work?

And to be clear, the choice was not between saving the institutions who caused the mess and doing nothing. A whole range of banking institutions who had not screwed up could have been capitalized and enabled. The banks themselves could have been cut up. As it is, the big banks are subsisting on their toxic securities -- which are still on the balance sheets -- and on the spreads between zero interest from the Fed and the usury they charge retail borrowers. The more successful ones are playing market games with the cheap chips they get from the Fed. None of this comes under the category of the financial system leading the real economy into recovery.

Any semblance of the conservative's free market is a memory in the current disaster. The remnants of that market is trying to regroup on the fringes while the government carries the mail. But if you listen to the business media, as I do, you hear cries of exit strategies, tax cuts and government withdrawal. Basically, their message is "Put out the fire, rebuild the broken parts, and let us play again, because we know what we're doing."

The conservatives and market fundamentalists promised explicitly a rose garden with deregulation, low taxes and trust. The roses have bloomed, been cut, carried off to the Hamptons, and we have the thorns to live in.

We may sound redundant, but we don't see that the point is realized. The markets crashed. The economic system went into crisis. Not because of any government or outside problem, but because of the internal contradictions and the running wild of the capital markets themselves. Rather than give our future into the hands of a hoocouldanode, perhaps we might check out those whose theories and analysis predicted problems.

Continuity in confusion and error is not the kind of continuity that is required.

Others have been less hysterical than Demand Side.

James K. Galbraith wrote in a couple of places recently. Galbraith's The Predator State is competing with Stiglitz' Making Globalization Work as the best economics book of the milenium, so far.

Writing under the head, "Resist False Optimism," Galbraith says.

Ben Bernanke came to the Federal Reserve imbued with academic notions. One of these was that central banks should concentrate on “inflation targeting.” Another was that we were living in a Great Moderation, that efficient financial markets would provide for stable economic growth evermore. ... Mr. Bernanke had to chew and swallow [these ideas]. His merit is that he did so, quickly, when the time came.

In the crisis, he cut interest rates to zero, nationalized the commercial paper market, lent with abandon here and abroad –- and kept the financial system afloat. He deserves credit for this. But President Obama overstated matters when he said that Mr. Bernanke had kept us out of a Great Depression. This remains to be seen.

One challenge will be to overcome fixed ideas on deficits -– ideas sadly shared in Washington.

Keeping big banks alive is not the same as restoring credit flows. Credit will not recover until the housing crisis subsides. Right now, with record inventories, collapsed cure-rates, and a flood of foreclosures we’re far from that. The jobs picture remains grim. Low interest rates alone can’t fix these problems, nor can “quantitative easing.” Mr. Bernanke’s first challenge, going forward, will be to recognize these facts — and his own limited power.

His second challenge will be to overcome fixed ideas on deficits -– ideas sadly shared throughout Washington. Fiscal expansion remains necessary. More is needed, especially to sustain state and local public services. This is no moment for people who are made nervous by a big government debt. With the private sector still flat, the public sector has to grow, or the economy will not.

A third challenge will be to resist deceptive optimism. In July, 2007, Mr. Bernanke was still testifying that our housing problems could be managed. I don’t believe that he didn’t see the impending collapse. But he didn’t want to precipitate it — understandable, but bad policy. He should now beware of cheerleading for a recovery that may, at best, leave millions behind.

Ben Bernanke is smart and capable, honorable and honest. Yet his renomination signals continuity in policy from the late Bush era, through this year and onward. President Obama passed up a chance to reorganize his economic team. When the moment comes that the policy has to change, the task will not be easier, because of this.

Simon Johnson offered this:

Ben Bernanke will be nominated for a second term as chairman of the Federal Reserve. But which Bernanke are we getting? There are at least three.

1. The Bernanke who led the charge to rescue the US (and world’s) financial system after the Lehman-AIG collapse. If you accept that the choice from late September was “Collapse or Rescue,” this Bernanke did a great job.
2. The Bernanke who argued for keeping interest rates low as the housing bubble developed. This Bernanke was part of the Greenspan Illusion – the Fed should ignore bubbles and “just clean up afterwards.” Is that still Bernanke’s view? Surely, he has learned from that experience.
3. Then there is Bernanke-the-reformer. Given #1 and #2 above, shouldn’t he be pushing hard for tough re-regulation of the financial system – particularly those dodgy parts where markets meet banking? But is there any sign of such an agenda, even with regard to recently trampled consumers – let alone “too big to fail” financial institutions?

Most likely, we’re in for another bubble.

Mark Auerback's header was "Woe and Behold" It began

Obama’s decision, announced yesterday, to reappoint Ben Bernanke to a second term as chairman of the Federal Reserve confirms what we already know and fear: This administration’s determination to save the big banks guarantees that we will emerge from this slump with an unreformed financial sector in the hands of the same people who produced the disaster in the first place.

Let’s be honest.It wasn’t Bernanke’s “bold” creative decisions that stemmed the onset of “Great Depression 2.0?; automatic fiscal stabilizers did the actual heavy lifting to stave off the depression — as they always have done since the onset of the New Deal.

Expanding lending to his member banks by progressively accepting more and more collateral helped but the liquidity crisis was caused by the Fed never having understood that requiring any collateral from member banks is both redundant and disruptive in the first place. Bernanke has yet to recognize this, as per his current discussions and policies.

The complete version of the Auerback piece was put up yesterday in cybertime. This and the rest, most of them more positive, again appear at the bottom of the transcript of today's podcast on the blog.

But in case you missed it, our take on this is

What a disaster. Ben Bernanke to be reappointed Fed Chairman

This reveals very deep problems in the Obama program.

Bernanke was chief economist to George W. Bush, from which position he rose to Fed chairman. It is often remarked that we are so lucky to have an expert on the Great Depression in charge when the second Great Depression came knocking.

Bernanke was put in charge not because he is an expert on the Great Depression, but because he values the big banks above all else. He is deep in the pockets of Wall Street. His theory of the Depression is that it could have been avoided if we'd just saved the institutions that caused it. Witness the hundreds of billions of dollars in transfer from the taxpayer to the big banks, the free too-big-to-fail insurance, the many missed calls and predictions, the absence to this day of real help for mortgage holders when their main asset goes down.

Wow.

The Monetarists are alarmed at the unprecedented direct loans and guarantees to specific Wall Street firms. Why? It's just socializing the risk.

But by far the worst element is what it says about the Obama team and Obama's understanding of what is wrong. Sixty years of New Deal protections worked, but there is no inkling to go back to them. Market discipline is out the window when banks are too big to fail, but no move to break them up, only to backstop them. The Fed has arrogated new powers to itself, but apparently with the consent of the Treasury and Administration.

The policy adjustments we had hoped for are clearly not in the cards if this is the preferred path. Boomers look out. You saw your wages stagnate for thirty years. Now you can retire in the Great Recession.

It is no fun saying "I told you so." Half the responses are, "You did? I don't remember." The other half are silent gestures. This post is for the first half.



We went on so long, we're going to abbreviate our discussion of the 70% rule. Not to be confused with the Rule of 8 we presented last week.

One of the more celebrated statistics of the past year has been the fall in the percentage of GDP going to consumption. It had risen to 70 or 71 percent in the debt-fuled consumption boom that corresponded to the boom in housing. Now it is dropping. This, of course, reflects the rising savings rate, or the rising savings rate reflects the reduction in borrowing and consumption from borrowing. (And we've beat the funeral drum for the consumer several times here on Demand Side.)

But below this consumption number is a much more stable statistic -- the returns to labor.

briefly quoting from a newsletter out of the Federal Reserve Bank of St. Louis

The allocation of national income between workers and the owners of capital is considered one of the more remarkably stable relationships in the U.S. economy. As a general rule of thumb, economists often cite labor’s share of income to be about two-thirds of national income—although the exact figure is sensitive to the specific data used to calculate the ratio. Over time, this ratio has shown no clear tendency to rise or fall.

Wage and salary income as a fraction of national income shows a declining trend in recent decades. Having reached a peak of 58 percent in 1970, wages and salaries have declined to only 52 percent of national income in 2003. However, if we consider total compensation—including employer social insurance contributions and benefits—labor’s share has shown very little variation. By this measure, labor’s share of national income has averaged 70.5 percent over the past 50 years and has remained within a narrow range of that average.


... a long-run perspective suggests that it would indeed be unusual for labor’s share to deviate far from its historic value.

—Michael R. Pakko

This clearly does not mean workers wages and compensation has gone up with the rise in total output over the years. Clearly it has not, by the individual. The median wage has more or less stagnated since the 1970s.

The 70 percent has on one hand been divided by a larger and larger workforce, and on the other the division has become more and more unequal.

The implications are not so difficult. If you sat in 1970 and remarked about the stabke 70-30, you might have said, the 30 percent is the most important, because it is investment in capital that is going to finance my retirement. Just as the wage part of the pie is being divided between a larger workforce, when I and the other boomers retire, we will be dividing the capital portion among a big retired population.

You might have predicted that an expectation of rising asset values in such a circumstance might be frustrated, and that an extension of work past normal retirement might be in the cards.

And you would have been right.

Briefly, what would the 70-30 split tell you about the future. That relatively speaking working people will do better. That asset prices will likely not recover and may trend downward. That a bigger pie is better for everyone. If we grow the wage portion, we will grow the capital portion. That retirement plans based on transfers of income from the working to the retired are not so dumb after all, and less dumb than everybody putting their faith in capital assets.

I am not trying to tell you why the 70 percent number is so stable, notice. Because I really do not know. I don't even have a plausible guess. This has been an exercise in accepting it as fact and seeing what it would mean as other, more flexible parameters -- like demographics and consumption -- come up against it.

There is a lot to think about there, but let's move on to the history note, with Hyman Minsky. Minsky's book Stabilizing an Unstable Economy is in my bag nowadays. It is not particularly well written or organized, and the editing is terrible, but Keynes' General Theory is one of the most influential books of all time in spite of its shortcomings. You might think I have fallen in love just because Jamie Galbraith sent me a note, but it is more that I looked again at his Predator State. It is not a polemic against the corporate oligarchy, at least as much as the title suggests, but a very well-rounded expose of economics, both laying bare the real dynamics and exposing much of the conventional wisdom as vacuous and many of the sacred tenets as demonstrably wrong.

But here is Minsky.

The policy of using monetary constraint to control inflation was not a great success in 1969-70. The policy-makers assumed that constraint upon the rate of growth of the money supply would lead to a smooth decrease in business and household spending and that this would remove some of the excess demand that contributed to inflation. In the world in which we live, however, monetary policy does not directly affect demand. It first affects financing and refinancing conditions and the prices of instruments traded in financial markets. Consequently, monetary constraint leads to financial market disruption even though income, employment, and prices continue to increase; before demand is finally lowered, a financial crisis is induced.

...

And here

Every time the Federal Reserve protects a financial instrument it legitimizes the use of this instrument to finance activity. This means that not only does the Federal Reserve action abort an incipient crisis, but it sets the stage for a resumption in the process of increasing indebtedness -- and makes possible the intrudction of new instruments. In effect, the Federal Reserve prepares the way for the restoration of the type of financing that is a necessary, but not a sufficient condition, for an investment boom that is brought to hald by a financial crisis.

...

What we seem to have is a system that sustains instability even as it prevents the deep depressions of the past. Instead of a financial crisis and a deep depression being separated by decades, threats of crisis and deep depression occur every few years. Instead of realizing a deep depression, we now have chronic inflation. In terms of preventing deep depressions, we have done better than in earlier epochs. This is not a trivial gain. But the instability and the deteriorating performance mean that we need to search for something better.

Indeed.

And in terms of quote legitimizing the use of this instrument, I think we have legitimized the use of the credit default swap in all its grotesque applications.

Hang on.













POSTSCRIPT

Brad DeLong said on Project syndicate:

It is here that Obama has lucked out. Ben Bernanke is a very good choice for Fed chairman because he is intelligent, honest, pragmatic and clear-sighted in his vision of the economy. He has already guided the Fed through two very tumultuous years with only one major mistake - the bankruptcy of Lehman Brothers.

Why the Senate Should Confirm Bernanke But Make the Fed More Accountable, Too

http://robertreich.blogspot.com/2009/08/why-senate-should-confirm-bernanke-but.html

from Robert Reich's Blog by Robert Reich

The President did the right thing in renominating Ben Bernanke to be Fed Chair, but the Senate should couple its vote to confirm him with new legislation requiring the Fed to be far more open about its doings.

If you'd have asked me three months ago whether Bernanke would be confirmed, I'd have said no. Congress (and much of the public) is still furious about the bank bailouts, as well they should be. TARP saved the Wall Street but Wall Street still hasn't saved Main Street, which was the publicly-stated purpose of the bailouts. The only clear outcome of the taxpayers' $600 billion rescue package is a return to giant salaries and bonuses on the Street.

But Bernanke at least deserves credit for lowering interest rates, swamping the nation with money, and pushing the Fed to become the nation's banker of last resort. With the big banks sitting it out, the Fed is buying a huge number of mortgage-backed securities (keeping many homeowners afloat, via the intermediaries of Frannie and Freddie); buying securities in which car loans, educational loans, and other consumer loans are bundled; and -- importantly -- signaling its willingness to do more, if necessary. It's become the U.S. Bank.

To the extent the U.S. economy is showing signs of "bottoming out" -- or, more likely, coming to a slow landing on swampy tarmac rather than crashing -- it's partly due to Bernanke's U.S. Bank. Congress knows this, or at least knows whatever Bernanke has been doing seems to be working. Hence, the Senate will confirm.

Yet much of what Bernanke has been doing has been cloaked in secrecy. No one knows exactly what the Fed has bought, from whom, and why. The secrecy is unnecessary. If the Fed is going to continue to be the U.S. Bank, it has to be publicly accountable. This is no argument for direct political control of the Fed. It's an argument for transparency. Congress and the public need to know what the Fed, with the ever-creative Bernanke at its lead, are up to. Never underestimate the power of public knowledge and opinion. Even our least democratic branch -- the federal judiciary -- is not immune to it. And don't underestimate the importance to our economy of knowing who and what is getting Fed assistance, and in what form.

So the Senate should confirm Bernanke, but link the confirmation vote to new legislation that makes the Fed more transparent.


Resist False Optimism
James K. Galbraith

James K. Galbraith, an economist at the L.B.J. School of Public Affairs at the University of Texas at Austin, is the author of “The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too.”

Odds are, Mr. Bernanke’s second term will not be as interesting as his first.

Ben Bernanke came to the Federal Reserve imbued with academic notions. One of these was that central banks should concentrate on “inflation targeting.” Another was that we were living in a Great Moderation, that efficient financial markets would provide for stable economic growth evermore. Ha, and ha-ha-ha. Both of these ideas, Mr. Bernanke had to chew and swallow. His merit is that he did so, quickly, when the time came.

In the crisis, he cut interest rates to zero, nationalized the commercial paper market, lent with abandon here and abroad –- and kept the financial system afloat. He deserves credit for this. But President Obama overstated matters when he said that Mr. Bernanke had kept us out of a Great Depression. This remains to be seen.

One challenge will be to overcome fixed ideas on deficits -– ideas sadly shared in Washington.

Keeping big banks alive is not the same as restoring credit flows. Credit will not recover until the housing crisis subsides. Right now, with record inventories, collapsed cure-rates, and a flood of foreclosures we’re far from that. The jobs picture remains grim. Low interest rates alone can’t fix these problems, nor can “quantitative easing.” Mr. Bernanke’s first challenge, going forward, will be to recognize these facts — and his own limited power.

His second challenge will be to overcome fixed ideas on deficits -– ideas sadly shared throughout Washington. Fiscal expansion remains necessary. More is needed, especially to sustain state and local public services. This is no moment for people who are made nervous by a big government debt. With the private sector still flat, the public sector has to grow, or the economy will not.

A third challenge will be to resist deceptive optimism. In July, 2007, Mr. Bernanke was still testifying that our housing problems could be managed. I don’t believe that he didn’t see the impending collapse. But he didn’t want to precipitate it — understandable, but bad policy. He should now beware of cheerleading for a recovery that may, at best, leave millions behind.

Ben Bernanke is smart and capable, honorable and honest. Yet his renomination signals continuity in policy from the late Bush era, through this year and onward. President Obama passed up a chance to reorganize his economic team. When the moment comes that the policy has to change, the task will not be easier, because of this.

Getting the Recovery Right
Tyler Cowen

Tyler Cowen is a professor of economics at George Mason University. His blog, Marginal Revolution, covers economic affairs.

I was glad to see Mr. Bernanke reappointed but he faces a daunting task. Basically the Fed pumped a lot of liquidity into the economy to sustain the banking system. So far all that new money has not caused inflation because banks have sat on much of it rather than lending it out and stimulating expenditures.

His biggest challenge will come when the economy starts to recover and the new money starts to be translated into inflationary pressure on prices. What will he do?

Will growth fade away once the stimulus money is spent? That will be a hard call to make.

Most likely he will try to withdraw a lot of that new money from the system, so as to keep inflation within a manageable range. That is indeed the right plan but it’s an open question as to whether the Fed gets the timing right. If they withdraw money too quickly, we could see a “double dip” recession. If they wait too long, inflation may rise to unacceptable levels and then the subsequent required monetary tightening could cause a double dip recession as well.

Running the fiscal stimulus makes good prediction much harder. As more of the stimulus spending comes on-line, measured G.D.P. is very likely to rise because there will be more economic activity. But does that change in the numbers represent true sustainable recovery? Or is it a temporary blip that will fade away once the stimulus money is spent? That will be a hard call to make.

Successful execution requires the Fed to have a good sense of exactly when the recovery is coming. Even though the Fed has an excellent staff they’ve been wrong in the past. I don’t give them any more than a 50 percent chance of getting it right.

It is possible that Mr. Bernanke will face an even bigger challenge if our high and rising debt leads to a run on the U.S. dollar. As we’ve seen with our banking sector, such “attacks” can come with very little warning and that probably would lead to a second Great Depression. I don’t think the Obama administration is worried enough about this problem. But Mr. Bernanke is not the one who can solve it, what we need is more fiscal discipline from Congress, most of all on health care costs.

Why Obama Needs Bernanke
Brad DeLong

Brad DeLong is a professor of economics at University of California, Berkeley, and blogs at Grasping Reality with Both Hands.

Ben Bernanke has already guided the Federal Reserve through two very tumultuous years with only one major mistake (although that mistake, Lehman Brothers, really was a beauty). His knowledge of the Great Depression and of crises is exactly what we need, and he’s intelligent, honest, clear-sighted in his vision of the economy and pragmatic. Even if he weren’t the incumbent he would be at the top of the list of candidates. Here’s why.

Since the reworking of the Federal Reserve’s decision-making structure in the Great Depression, on only two occasions — Reagan in 1987 with Paul Volcker, and President Carter in 1978 with Arthur Burns — have presidents failed to renominate a Federal Reserve Chair of the other political party who seeks reappointment. Presidents have renominated chairmen of the opposite party six times — William McChesney Martin twice, Paul Volcker once, Alan Greenspan twice, and now Ben Bernanke.

Financial markets lose confidence if they think the Fed chairman is too much under the thumb of the president to fight inflation.

The reason, I think, that presidents are so willing to reappoint chairmen from the other political party is closely linked to one of the two things that a president seeks from the chairman: the confidence of financial markets.

If financial markets lose that confidence — if they conclude that the Fed chairman is too much under the thumb of the president to wage the good fight to control inflation, or if they conclude that the chairman does not wish to control inflation — then the economic news is almost certain to be bad.

Capital flight, interest rate spikes, falls in private investment spending as businesses find lenders demanding extra insurance in the interest rate against future inflation, a collapsing value of the dollar — all of these are likely should financial markets lose confidence in the Fed chairman.

And if these events should come to pass, the likelihood of an economy strong enough to give a president the running room to accomplish anything is very low.

A Voice for More Regulation
Mark Thoma

Mark Thoma is an economics professor at the University of Oregon and blogs at Economist’s View.

One important challenge Mr. Bernanke will face is to keep the financial sector recovery on track by not raising interest rates too soon, while avoiding inflation by not raising interest rates too late. It will be a difficult balancing act, particularly with the complications that a large budget deficit adds. I’m quite confident Mr. Bernanke is up to the task.

But the most important challenge is how to restructure the financial sector to reduce its vulnerability to a collapse like the one we just experienced. That’s a task that will require both institutional and regulatory change.

The Fed needs the authority to dismantle “too big to fail” financial firms, authority it lacked but very much needed during the crisis.

Some of this the Fed can do on its own, but other parts require Congressional approval. As the financial sector has started to show signs of life, we are already hearing protests against regulation. The most prominent objection is that regulation will stifle new financial innovation (never mind that it was this innovation that helped to cause the predicament we are in).

My worry is that as time passes, we’ll forget how bad things were and the desire to impose necessary new regulation will fade. Here’s where I think Mr. Bernanke’s experience will be crucial. He was there at every step in the development of the Fed’s response to the crisis and he will not soon forget the problems he faced (nor repeat his mistakes), making it more likely that he’ll be a forceful and passionate advocate for new regulation before Congress.

For example, the Fed needs the authority to dismantle “too big to fail” financial firms, authority it lacked but very much needed during the crisis. Mr. Bernanke knows first hand how hard it was to manage the crisis without this authority. He’s also seen the consequences of an unregulated shadow banking sector, and he knows how bad incentives and poor market structures created problems that could have been avoided.

There are two other factors working in Mr. Bernanke’s favor. If the financial recovery goes as I expect, his reputation will grow, giving him the authority he needs to persuade Congress to make needed regulatory changes. And just as important, unlike some past Fed chairmen, he’s been able to articulate complex ideas in ways that legislators seem to understand.

Surprises in Store
Vincent R. Reinhart

Vincent R. Reinhart, a senior fellow at the American Enterprise Institute, is a former director of the Federal Reserve Board’s division of monetary affairs.

President Obama’s decision to reappoint Federal Reserve Chairman Ben Bernanke was a welcome surprise. The news was not in the choice. Chairman Bernanke has done a good job at shepherding monetary policy over the past three and one half years. He got the big decisions right, easing quickly and acting creatively with the Fed’s balance sheet. He also moved incrementally to provide more information about policy makers’ outlook.

The blots on his record relate to decision in crisis management, which were fitful and inconsistent in 2008. But the Fed chairman was part of a team, and it is difficult and probably unfair to apportion responsibility.

The surprise comes from the timing of the announcement, five months before the Fed chairman’s term is up. Leaving the incumbent twisting a while in the wind was probably tempting. A Fed chairman not sure of his job prospects might be less likely to ease his foot off the monetary accelerator, which has been pedal-to-the-metal for some time. Instead, the White House pulled a page from the Robert Rubin playbook of trying to calm the anxieties of financial market participants.

But two more surprises are in store.

First, the White House will likely learn that a Fed chaired by Ben Bernanke will follow a policy uncomfortably tight as the 2012 election looms into sight. Bernanke has espoused a commitment to low inflation over his entire career. He also is a democratic and consultative chairman, so the voices of monetary conservatives among Fed officials will be heard loudly and frequently.

Second, Chairman Bernanke’s surprise will be that the validation of a second term, while no doubt personally rewarding, will not be worth much in the ongoing bureaucratic battle over regulatory powers and the structure of the Fed. The Congress has justifiable concerns about giving the institution more authority, and the competition among the agencies will be fierce.


Calculated Risk

As Fed Governor Bernanke supported the flawed policies of Alan Greenspan - he never recognized the housing bubble or the lack of oversight - and there is no question, as Fed Chairman, Bernanke was slow to understand the credit and housing problems. And I'd prefer someone with better forecasting skills.

However once Bernanke started to understand the problem, he was very effective at providing liquidity for the markets. The financial system faced both a liquidity and a solvency crisis, and it is the Fed's role to provide appropriate liquidity. Bernanke met that challenge, and I think he is a solid choice for a 2nd term (not my first choice, but solid).

By Phil Izzo

Economists, lawmakers, bloggers and others weigh in on President Obama’s decision to reappoint Fed Chairman Ben Bernanke.

* While I have had serious differences with the Federal Reserve over the past few years, I think reappointing Chairman Bernanke is probably the right choice. Chairman Bernanke was too slow to act during the early stages of the foreclosure crisis, but he ultimately demonstrated effective leadership and his reappointment sends the right signal to the markets. –Sen. Chris Dodd, (D., Conn.), Chairman Senate Banking Committee

* The experience that Bernanke has acquired will be invaluable. I don’t mean this to sound like a back-handed compliment, but Bernanke is not the same person today as the one who made the decisions that his critics object to. –Louis Crandall, Wrightson ICAP

* I think it’s good news for the Federal Reserve. It’s good news for the country. It’s a great choice. Chairman Bernanke has done a terrific job in bringing openness to the Fed. He has been bold and creative in dealing with the financial crisis… It was not clear to most people that the crisis was going to be as broad-based, and that the excesses in the financial markets and in lending were as broadly based as they turned out to be. Even at the start, he was willing to consider all options to deal with what appeared to be more a liquidity than a solvency crisis. As it began to become more clear that it was a crisis of solvency and leverage and a classic credit crunch, he didn’t flinch in bringing enormous creativity to bear in mitigating the problem –Richard Berner, Morgan Stanley

* Having a new chairman come in at this late date would put the Fed engineered solution to both the recovery and the exit strategy at risk. The Federal Reserve made a hasty exit from easy money stimulus in the 1930s and we know how that worked out… Mistakes have been made at many regulatory institutions during this crisis, but all the Fed’s mistakes would have been made by any man according to the prudent man rule. Bernanke is a true prudent man who calls them as he sees them, and knows the ins and outs of policymaking… If he can pull off this recovery that still needs nurturing, he could well go down as one of the greatest Fed Chairmen in history. –Christopher Rupkey, an economist with Bank of Tokyo-Mitsubishi

* History shows that uncertainty is the enemy of markets. Much speculation about Bernanke and a possible Summers succession has swirled in market analysis circles. That is over… We wish the reappointed chairman success. Meanwhile we remain vigilant and recognize that, in a globally linked world, financial integration means that no single central bank and no one chairman of it has ultimate and dominant power. Bernanke needs to find a path for coordinated action when the time to remove the stimulus is at hand. –David R. Kotok, Cumberland Advisors

* While America’s head central banker deserves credit for being creative and courageous in orchestrating an unusually aggressive monetary easing programme, it is important to remember that his pre-crisis actions played an equally critical role in setting the stage for the most wrenching recession since the 1930s. It is as if a doctor guilty of malpractice is being given credit for inventing a miracle cure. Maybe the patient needs a new doctor. –Stephen Roach, chairman, Morgan Stanley Asia at FT.com

* As Fed Governor Bernanke supported the flawed policies of Alan Greenspan — he never recognized the housing bubble or the lack of oversight — and there is no question, as Fed Chairman, Bernanke was slow to understand the credit and housing problems. And I’d prefer someone with better forecasting skills. However once Bernanke started to understand the problem, he was very effective at providing liquidity for the markets. The financial system faced both a liquidity and a solvency crisis, and it is the Fed’s role to provide appropriate liquidity. Bernanke met that challenge, and I think he is a solid choice for a 2nd term (not my first choice, but solid). –Calculated Risk

* I am extremely pleased to learn that Ben Bernanke has been nominated for a second term as chairman of the Federal Reserve. We have had an excellent and very close working relationship during the current episode of exceptional challenges for the world economy. The Federal Reserve and the European Central Bank have, together with other central banks, initiated an unprecedented level of close cooperation, which has been key in coping with the present situation. –European Central Bank President Jean-Claude Trichet

* I am delighted to learn of Ben Bernanke’s renomination as Chairman of the Federal Reserve. Since he became Chairman, we have worked closely together, in conjunction with other central banks, and I look forward to continuing that relationship. Ben brings strong leadership to the Federal Reserve at this vital time. It is a long time since we had adjoining offices at MIT. But that experience has stood us in good stead in dealing with the crisis over the past two years.–Bank of England Governor Mervyn King

* Maybe Obama realizes that the really hard part is only just beginning. Unwinding the vast expansion of the Fed’s balance sheet and figuring out how to tighten the screws on the money supply without plunging the country into an another economic contraction will be a tremendous challenge. Why saddle that grief on some up-and-coming Democratic economist? It’s Bernanke’s mess. Let him clean it up. –Andrew Leonard, Salon.com

* [A] benefit of continuity is that it buys you room to maneuver. During the last several months, the Fed has massively expanded its role in the economy to keep credit flowing and prevent the financial system from seizing up. This is unquestionably a good thing… But one side effect has been to create a vocal reaction among bond traders (and their economist-sympathizers), who fear the moves will be inflationary and are constantly pressuring Bernanke to unwind these policies as soon as possible. Alas, doing so while the economy and financial system are so weak would be a horrible, self-defeating mistake–something Bernanke understands. But without Bernanke’s track record and credibility, a new chairman might have to start unwinding the Fed’s balance sheet much sooner to establish his/her anti-inflation bona fides. (Or, put differently, bond investors might actually start bidding up interest rates rather than just kvetching about inflation unless a new chairman sent a hawkish signal out of the gate.) Suffice it to say, the White House has very good reasons for wanting to avoid this outcome. –Noam Scheiber, The New Republic

* Excellent decision. P.S. Don’t let this good news distract you from the much-less-good economic news on Tuesday: CBO and OMB are releasing new budget projections that will show trillions upon trillions of coming deficits. –Donald Marron

* Game theory would have it this is the safe pick, the one that you cannot get into trouble for, even if things go bad later. A new Fed Chair, in the event something went awry down the road would lead bame back to the White House. –Barry Ritholtz, Fusion IQ

Which Bernanke? Whose Bubble?
Simon Johnson
with 33 comments

Ben Bernanke will be nominated for a second term as chairman of the Federal Reserve. But which Bernanke are we getting? There are at least three.

1. The Bernanke who led the charge to rescue the US (and world’s) financial system after the Lehman-AIG collapse. If you accept that the choice from late September was “Collapse or Rescue,” this Bernanke did a great job.

2. The Bernanke who argued for keeping interest rates low as the housing bubble developed. This Bernanke was part of the Greenspan Illusion – the Fed should ignore bubbles and “just clean up afterwards.” Is that still Bernanke’s view? Surely, he has learned from that experience.

3. Then there is Bernanke-the-reformer. Given #1 and #2 above, shouldn’t he be pushing hard for tough re-regulation of the financial system – particularly those dodgy parts where markets meet banking? But is there any sign of such an agenda, even with regard to recently trampled consumers – let alone “too big to fail” financial institutions?

Most likely, we’re in for another bubble.

The Fed will keep interest rates low for the foreseeable future. This will make sense given continued high rates of unemployment in the US economy. But unemployment indicates average economic outcomes – high unemployment is completely consistent with some parts of the financial sector expanding at record rates: this is part of the two-track story.

The big banks have access to large amounts of Fed-provided funding at very low rates. We’ll see this reflected in speculative market activities (think oil).

We’ll also see this in global capital flows (i.e., gross flows, perhaps also net flows – but the new global imbalances may not be so obvious in the pattern of current account surpluses/deficits around the world). The US is increasingly a cheap funding environment, if you are a big player (definition: anyone regarded as an important client by Goldman). Rates now begin to rise in emerging markets, as their economies turn around. The Asia story will be compelling fundamentals and a great carry trade (borrow cheaply in dollars, lend at higher rates in Asian currencies) - and the exchange rate risk is for appreciation against the dollar.

Everyone involved knows this is unsustainable, but also that it can last for a while – and they can get out before everyone else. Or, alternatively, that – as major financial players – they can’t afford to sit on the sidelines (talk to Chuck Prince: what has changed, in ideology, policies, and people at the top since his day?).

Presumably, commodity prices also get dragged up – or perhaps they jump up in anticipation of the Coming Asian Boom? Now this might lead Asian central banks to tighten, but probably not if these economies can continue to keep wage costs under control. And it might lead the Fed to tighten, but probably not as the mantra of focusing on “core inflation” (without food and energy prices) remains intact – however anachronistic it may seem to the rest of us. It’s hard to see Bernanke #2 doing anything different, except perhaps at inconsequential margins.

So then we really bubble – and perhaps we even mistake it for a boom.

When the Big Crash comes, there’ll be another moment of decision: “Collapse or Rescue.” And we know what Bernanke #1 will do. Which is, of course, why this administration is reappointing him – and not seriously reregulating big finance.

By Simon Johnson

The Logic of Reappointing Bernanke
from The Stash by Noam Scheiber

The big news from Martha's Vineyard is that Obama is appointing Ben Bernanke to a second term as Fed chairman. I've explained before why I think this is a good idea--Bernanke has been creative, even highly unorthodox, at precisely the moment when the economy demanded these qualities from the Fed, and when a conservative, by-the-book approach would have likely sent us into a depression. True, Bernanke's Fed didn't exactly distinguish itself on the regulatory side, particularly the consumer regulatory side, during the boom years--the Fed is by statute one of the nation's top consumer financial regulators. But that was the status quo Bernanke inherited from Alan Greenspan in 2006. And there wasn't exactly a ton of time between then and the onset of the financial crisis in 2007 to reorient the institution. (Which isn't to say Bernanke would have if he'd had more time, but still...)

Of course, that doesn't in itself explain why Obama chose to reappoint Bernanke rather than tap a Democratic-leaning economist like Larry Summers, Janet Yellen, or Roger Ferguson--all of whom could have made fine Fed chairmen. To get there, you have to understand the additional importance of continuity at the Fed. It matters in two key ways. First, it just takes a while for financial markets to understand a particular Fed chairman's idiosyncracies and ways of communicating (and, conversely, for a new Fed chairman to settle on the most efficient way of communicating with markets).

The markets have come to trust Bernanke's pronouncements about monetary policy in recent years. But that wasn't always the case. The first several months of his tenure featured a series of misunderstandings--none of them catastrophic, but all less than ideal. The most famous was Bernanke's comment to a congressional committee in April 2006 that the Fed might lay off raising interest rates at some point soon and gauge the state of the economy before resuming. The market interpreted this as a statement of clear intent, when in fact Bernanke meant it literally--he really didn't know whether or not the Fed would take a breather. When Bernanke then inadvertently clarified the statement--through a private, off-hand comment to CNBC's Maria Bartiromo, who subsequently shared it with the world--the markets briefly threw a fit. Not exactly the kind of kinks you want to be working through while trying to recover from the worst financial crisis since the Depression.

The second benefit of continuity is that it buys you room to maneuver. During the last several months, the Fed has massively expanded its role in the economy to keep credit flowing and prevent the financial system from seizing up. This is unquestionably a good thing (see the first paragraph above). But one side effect has been to create a vocal reaction among bond traders (and their economist-sympathizers), who fear the moves will be inflationary and are constantly pressuring Bernanke to unwind these policies as soon as possible. Alas, doing so while the economy and financial system are so weak would be a horrible, self-defeating mistake--something Bernanke understands. But without Bernanke's track record and credibility, a new chairman might have to start unwinding the Fed's balance sheet much sooner to establish his/her anti-inflation bona fides. (Or, put differently, bond investors might actually start bidding up interest rates rather than just kvetching about inflation unless a new chairman sent a hawkish signal out of the gate.) Suffice it to say, the White House has very good reasons for wanting to avoid this outcome.

--Noam Scheiber


The Bernanke Question
Added to cato.org on July 28, 2009
by William Poole

William Poole is Senior Fellow at the Cato Institute and Distinguished Scholar in Residence at the University of Delaware. He retired as President and CEO of the Federal Reserve Bank of St. Louis in March 2008.

Should President Obama reappoint Fed Chairman Bernanke? The case for reappointment is strong in many respects but there is a contrary case that deserves serious attention.

The President and congressional leaders, especially the majority leaders, should logically favor reappointment; the Fed's massive lending relieved the administration and Congress from taking politically difficult steps. The contrary case is that the Fed too readily made expansive use of its powers. Fed lending programs took Congress off the hook and have had the predictable effect of embroiling the Fed in political disputes that compromise its political independence.

Under section 13(3), a 1932 amendment to the Federal Reserve Act, the Fed can make loans to borrowers other than banks "in unusual and exigent circumstances." The Federal Reserve invoked this authority as the legal basis for its emergency loans. The Fed had to decide in a few hours whether to bail out Bear Stearns in March 2008. There was no possibility that Congress could act over a weekend. The Fed confronted the same situation in September 2008, when it decided to bail out AIG. Whether or not these bailouts were wise, they clearly fit the language of section 13(3).

The Fed's other credit programs are different. The Fed also invoked its authority under section 13(3) to justify its Commercial Paper Funding Facility (CPFF). The Fed announced the program on October 7, 2008 and made the first loans about 3 weeks later. Consider also the Fed's buying program for mortgage-backed securities (MBS), which is authorized by section 14 (b) of the Federal Reserve Act. The Fed announced the MBS program November 25, 2008. The first appearance of MBSs on the Fed's balance sheet was in mid-January.

The CPFF and MBS programs should have been authorized by Congress. Congress was not in session in October but could have come back into session right after the election to legislate both programs.

Neither the CPFF nor the MBS program reflected a weekend emergency. The financial crisis called for quick and decisive action, but not immediate action that needed to be decided in a matter of hours. If there was an emergency at all, it was because of congressional unwillingness or inability to act and not because Congress did not have time to act. If Congress were unable to act, because of its concern about the politics of the CPFF program to provide credit to large corporations, should a federal agency make its own decision on what is necessary, committing taxpayer resources amounting to hundreds of billions of dollars? Worse yet, while legislated programs would have been financed by sale of new Treasury securities, the Fed's programs are being financed by monetary expansion — printing money.

The two programs are large. The CPFF reached a peak of $350 billion in mid January, but has declined since. The MBS program is still growing — $545 billion as of July 22, 2009, on its way to an announced $1.25 trillion. All financed, remember, by printing money.

One view is that it is very unfortunate that the Fed found itself in this position, but it did what it had to do given the financial turmoil. A contrary view is that the Fed's responsibility was to make a strong public case that Congress had to act to provide the needed credit. There would have been a public debate about the wisdom of the proposed programs, whereas we know nothing of the internal debates in the Fed.

The Federal Reserve has not explained why assistance to the particular borrowers eligible for the programs — CPFF, MBS and others — are essential to dealing with the financial crisis, whereas loans to other potential borrowers are not essential. To be clear, the Fed's decisions have not been political in a partisan sense, but they do reflect inherently political judgments in the sense that borrower X deserves or needs access to Federal Reserve resources and borrower Y does not. Such issues belong to Congress. The Fed should not have been making these decisions, because doing so would inevitably draw it into political disputes, such as those already seen over disclosure and other matters.

Access to Federal Reserve credit is valuable. It has long been a staple of monetary analysis that monetary policy is a general policy instrument, controlling the aggregate supply of funds in the market through open market operations in government securities. We then rely on private banking and financial markets, and government credit programs authorized by legislation, to make judgments as to which particular borrowers have access to credit and on what terms.

Chairman Bernanke has stretched the emergency authority under Section 13(3) of the Federal Reserve Act beyond recognition and has provided credit to certain non-bank borrowers and not to others. His consultation with Treasury secretaries and congressional leaders is not an adequate substitute for congressional appropriations to finance the federal government's credit activities designed to deal with the financial crisis.

The public wants to keep monetary policy out of politics and understands that financing government by printing money is dangerous. Perhaps the Federal Reserve will be successful in withdrawing the money at the appropriate time, but if not, we have a serious inflation problem in our future. The Fed will face this problem in a weakened political position because of its political decisions in granting credit over the past year.

Given the importance of a non-political monetary policy, which requires central bank independence from everyday politics, and of a reliably non-inflationary policy, Chairman Bernanke does not deserve reappointment.