In The Fed We Trust? Will The Senate Reward The Architect Of The Wall Street Bailout?

Will the Senate vote another term for Ben Bernanke as head of the Federal Reserve? Should it?

Two months ago, Bernanke looked like a lock. But now unemployment is over 10 percent and rising, while Wall Street bankers are stocking up on vintage champagne, ready to celebrate the highest bonuses in history. As head of the Fed, Bernanke committed trillions to bail out the banks while Main Street got left behind. Should the Senate vote to reward him with another term?

Many in the financial press consider Bernanke a hero. (See, for example, the laudatory book by The Wall Street Journal's David Wessel, In Fed We Trust). He's the button-down academic, calm in the midst of the tempests, who—once he (belatedly) figured out that the financial system was headed over the cliff—worked creatively, ceaselessly, making it up as he went along, doing "whatever it takes" to save the day. Denying him another term would seem a good case of no good deed goes unpunished.

Moreover, with the dollar already shaky, Bernanke is one of the few financial stewards who global investors might trust to sell off the billions in junk that the Fed put on its balance sheet without once more throwing the economy over the cliff. If his nomination is questioned, financial barons from London to Shanghai will start rending their garments, and issuing jeremiads about impending doom.

But take another look. In the lead-up to the financial crisis, Bernanke was Sancho Panza to predecessor Alan Greenspan's Quixote, gleefully touting banking deregulation while blind to the dangers of an $8 trillion housing bubble. He celebrated an economy in which incomes of most Americans were declining, household debt was soaring, and inequality reached Gilded-Age extremes. Once named Fed chair, he chose not to exercise the regulatory powers he had to curb predatory lending, police the Wall Street casino, or crack down on the derivatives that Warren Buffett, among others, warned were financial weapons of mass destruction. Instead he scorned the worriers and predicted steady growth—even after the recession began.

When the bubble began to burst, Bernanke was late to recognize it, consistently underestimated its impact, and failed repeatedly to get ahead of the crisis.

It was only when he finally woke up to the spreading panic that Bernanke threw literally trillions into bailing out the banks—but without restructuring them, without replacing many of the folks that caused the mess, without requiring that they lend to Main Street or renegotiate mortgages. Bernanke and Treasury secretaries Hank Paulson and Tim Geithner were the creative architects of a bailout that has resulted in a far more concentrated financial sector, with major financial houses enjoying an explicit guarantee that they are too big to fail, even as they reopen the casino, start up the same games again, and mobilize to fend off any serious regulatory reform.

The Federal Reserve is charged with pursuing price stability and maximum employment. Now we're experiencing the highest levels of unemployment in over a quarter century, and the dollar is in decline. Foreclosures continue, and one in four mortgage holders owe more than they own. Bernanke and Geithner, et al may have staved off a Depression, but we sure aren't ending up where anyone would want to be.

Worse, Bernanke opposes letting Congress or the public know what he did with the trillions in commitments he made to private companies and foreign central banks. The Federal Reserve added over $1.2 trillion to its balance sheet, while taking on trillions more in credit risks off its balance sheet. Who got the money? On what terms? Why did Bear Sterns get saved and Lehman get the shaft? Why take over an essentially bankrupt AIG and pay Goldman Sachs and others full price for the bad bets they made? Why take on $230 billion in toxic Citibank liabilities with no upside for taxpayers?

It is simply inconceivable that in a constitutional republic, the Federal Reserve can commit trillions of dollars to private companies with no vote of the Congress, no review, no audit, no accountability. How can the Senate even judge whether Bernanke merits reappointment without being able to look at his books? That would be like promoting someone with a four-year hole in his resume during which he secretly committed a good portion of the company's capital. Are the senators supposed to vote for Bernanke simply because Wall Street's bankers are pricing yachts again?

Bernanke argues that auditing the Fed's books would represent a "takeover of monetary policy." Since the Fed is supposed to be the sober chaperon that "takes away the punch bowl when the party gets overheated," its independence is highly valued. But Greenspan and Bernanke's Federal Reserve not only didn't take away the punch bowl, it spiked the punch and joined the party. And then in the crisis, Bernanke took the Fed far beyond monetary policy in bailing out private-sector companies—big banks, insurance companies and the like. This may have been heroic, but it can't remain secret. Congress would be utterly irresponsible if it didn't demand an accounting on who got what and why.

Will Congress Demand an Accounting?

But Congress was ready to be just that irresponsible until the last few weeks when the legislators finally got a whiff of just how blind angry their constituents are at a bailout that saved the bankers that caused the mess while working families are still drowning. The first sign of the wake-up came when Democratic leaders began calling for a jobs program to put people back to work. Then the House Financial Services Committee shocked Washington by passing the Alan Grayson-Ron Paul amendment calling for auditing the Fed.

The Financial Services Committee has 71 members. Both parties stock it with vulnerable freshmen and sophomore members who can use the post to rake in contributions from the banks, and thus be in a better position to defend their seats. Yet, in this vote, it was the vulnerable legislators who voted to audit the Fed, while the more secure veterans—including such progressives as Maxine Waters and Keith Ellison—stood with the Federal Reserve against the bill. The vulnerable realized they didn't want to have to defend a vote for keeping the bank bailout secret.

For senators, Bernanke's nomination poses a stark test. Most Republicans are likely to vote against him since they want to pin the financial collapse and the bailout on Obama—air brushing the Bush years out of the historical picture. For Democrats, headed into an election with double-digit unemployment, million-dollar bonuses on Wall Street and record deficits, the Bernanke nomination is a last chance to express their constituents' fury—or be forced to own a bailout that isn't working very well outside of Manhattan.

The Senate Hearings and Questions For Bernanke

The hearing on the Bernanke nomination—now ironically scheduled on the same day as the president's job summit, December 3—can't be perfunctory. Senators must pose tough questions about what Bernanke has learned from the profound errors made when the bubble was building and after it burst. And surely Senate Banking Committee Chairman Christopher Dodd will find it hard to move the nomination until Bernanke agrees to let the Federal Reserve's books be audited, and responds to a serious probe about the commitments made with literally trillions of dollars.

The senators, of course, are tied in knots about health care and have to get up to speed on jobs quickly. So let's help them and their beleaguered staffs out with questions that they might ask Bernanke at his hearing. Those questions might include the following:

• In 1999, you argued that the Federal Reserve cannot identify asset bubbles and should not use interest rates to burst them. As the housing bubble built, the Federal Reserve chose not to use its regulatory powers to limit predatory lending, or demand tighter rating standards on mortgage backed securities. You supported the strategy of "mopping up after" the bubble burst. Do you still think that strategy is sound? How would you act differently in the future?

• When AIG was taken over, the Inspector General of the TARP argues that you needlessly chose to pay off Goldman Sachs and others the full price for the credit default swaps guaranteed by AIG. Yet you defended not regulating derivatives on the ground that they were used only by experienced investors who knew the risks involved and could take the losses. Goldman claims it was fully hedged against its AIG holdings. Why bail out Goldman?

• An institution that is too big to fail is -- under any theory of a market economy -- either a government entity, an entirely regulated utility or too big to exist. Now virtually every major financial institution has a virtually explicit public guarantee against failure. You argue that the Federal Reserve should have the power to monitor institutions that are too big to fail rather than breaking them up. Given the Fed's regulatory record leading into this crisis, why should we have any faith in that notion?

• You've expanded the Federal Reserve's balance sheet by $1.2 trillion. You've lent vast sums to private financial institutions against what you knew was dubious collateral. Others were turned away at the door. You claim that revealing who got what, why, on what terms would constitute a "takeover of monetary policy." What does this have to do with monetary policy? How do you reconcile the Fed's secrecy and powers with the Constitution?

• Here's one from the conservative at the cunningrealist blog [1]

  :

  Forecasts are an important part of the Fed's work,... making predictive ability an essential part of the job description for any Fed chairman. Yet your record of predictions... is questionable at best. Some examples:

  March 28, 2007: "The impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained."

  May 17, 2007: "We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."

  Feb. 28, 2008, on the potential for bank failures: "Among the largest banks, the capital ratios remain good and I don't expect any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system."

  June 9, 2008: "The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."

  July 16, 2008: Fannie Mae and Freddie Mac are "adequately capitalized" and "in no danger of failing."

  Explain this pattern of terrible predictions and forecasts. What do they imply about your ability to conduct policy going forward? Is there some fatal flaw in your economic models or forecasting tools? Are you just winging it?

If you have questions, you'd like Mr. Bernanke to answer, post them here. We'll put them before senators on the committee.