Bernanke

Ben Bernanke and Conservative Economic Sabotage

Zach Carter — Tue, 23 Nov 2010 16:01:39 -0500

The Republican Party's newfound political assault on Ben Bernanke is a grim reminder of the actual conservative economic agenda for the next two years. The midterm elections taught Republicans a destructive lesson: With Democrats in power, the worse the economy gets, the better Republicans do at the voting booth. Economic sabotage is the essential Republican strategy for winning the White House in 2012. They will block every effort to actually improve the economy they can, and make a big show out of criticizing any economic aid they can't block.

The Party's hypocrisy on the economy has been clear for months. They scream about the deficit when a few billion dollars worth of unemployment benefits are at stake, but deficit worries disappear when the $700 billion in Bush tax cuts for the rich are under discussion. When they do muster an economic defense of the Bush regime, it's the line that a recession is no time to raise taxes. This is a fundamentally Keynesian argument—a bad Keynesian argument, but Keynes through and through. And it's the same argument Republicans and conservative pundits deployed to enact the Bush tax cuts back in 2001 and 2003. It's a bad argument because tax cuts aren't particularly effective at stimulating the economy, especially when they target the rich. Unemployment benefits, in fact, would be a staggeringly more efficient mechanism, as former John McCain adviser Mark Zandi has repeatedly detailed.

Which brings us to Ben Bernanke, the most conservative candidate that President Barack Obama could possibly have appointed to head the Federal Reserve. The current Republican uproar against Bernanke shields the fact that he is, in fact, a Republican himself. He was a top economic adviser to President George W. Bush, who appointed Bernanke to the Fed's Board of Governors and eventually to Fed Chairman post. When Obama reappointed him to the job, a handful of Republicans objected on the grounds that Bernanke had approved generous bailouts of financial firms. Nevertheless, a majority of Senate Republicans still voted to reconfirm him—making his reappointment the most popular decision that Obama has made among Republicans. Republicans got their man, and they let him through.

But now Bernanke is taking a beating from conservative pundits and Republican politicians for the Fed's latest round of "quantitative easing." It's not just coming from the crazies, either. Even relatively milquetoast Senators like Bob Corker of Tennessee have threatened to strip the Fed of its mandate to promote full employment. Don't worry about whether people actually have jobs, you nervous Fed ninnies. Just focus on inflation, whatever the economic cost.

The timing of this argument is particularly instructive, since, right now, we are not experiencing inflation. We are, in fact, dangerously close to deflation, as rampant foreclosures continue to drive down home values.

But the Republican assault is not an attempt to fix the economy or even say intelligible things about the economy. It's straightforward political payback. Bernanke is directly contradicting the Republican midterm message, exposing the Republican anti-spending mantra as an economic disaster, and Republicans aren't going to stand for it.

Republicans just convinced a lot of voters that socialist intergenerational thief Barack Obama caused high unemployment with his budget busting economic stimulus. Government spending is the villain-- not the Wall Street excess or predatory lending that Republicans shepherded for eight consecutive years, not even the generous bank bailouts that Republicans approved.

But last week, Bernanke gave a speech emphasizing that the Fed's actions to revive the economy require Congressional help. Quantitative easing is basically an interest-free credit card for the U.S. government, allowing it to borrow money at negative real interest rates in order to spend that money on job-creation efforts. Since already record-low interest rates on Treasury bonds haven't been enough to convince congress that now is the time to borrow and spend, the Fed is driving those rates even lower. But for this credit card to work, Congress has to use it. It has to enact further economic stimulus, spending money to create jobs.

This kind of talk makes Congressional Republicans look stupid. Now it's not just Barack Obama and his anti-colonialist father who support government spending to boost the economy, it's a very high-profile Republican economist, too. Obama can't be a radical socialist when top-ranking Republicans agree with him. And God forbid that Bernanke's recent statements actually create pressure for Congress to do something about jobs. Lowering unemployment means reelecting Obama.

None of this is to say that Bernanke is some kind of liberal savior, or even a particularly good Fed Chairman. He oversaw bailouts that could have been much more effectively designed, to say the least, and he has not been open about those packages with Congress or the public. He's resisted calls for Fed transparency and waged misleading attacks on financial reform legislation.

But he isn't toeing the Republican Party line on Big Bad Government Spending. And Republicans are going to keep hammering him until he does.

Bernanke Admits It: Too-Big-To-Fail Lives On

Zach Carter — Tue, 07 Sep 2010 16:12:25 -0400

Last week, Federal Chairman Ben Bernanke finally acknowledged that his preferred "solution" for ending Too-Big-To-Fail is likely unworkable. When the financial crisis exploded in 2008, top Fed and Treasury officials insisted that they did not have the legal authority to shut down faltering megabanks, leaving them no choice but to resort to massive bailouts. At a critical hearing last week, many of those same officials acknowledged that in at least one case, policymakers had plenty of authority, and actually went to extreme lengths to sidestep it in order to provide a bailout. Even Bernanke now seems to believe that we can expect the same insanity when the next crisis hits.

Bernanke has spent the past two years fighting efforts to break up the largest U.S. financial behemoths. Instead of downsizing dangerous banks, Bernanke, along with Treasury Secretary Timothy Geithner and other figures in the administration pushed to create a new "resolution authority" that allows regulators to unwind megabanks when they fail.

The FDIC has had this authority over boring commercial banks for decades, and it has worked very well, even through the crash of 2008. When these banks get into trouble, the FDIC wipes out their shareholders, kicks out their executives and liquidates the bank without much trouble. The trick is, these commercial banks are usually relatively small, with simple lines of business all housed in the United States. Last week, Bernanke acknowledged that Wall Street megabanks are different. Even when armed with the technical legal authority to shut them down, regulators will be extraordinarily reluctant to actually pull the trigger.

"Let me just be clear: this is not going to be easy to implement," Bernanke said. "I think the one area that's going to take a lot of effort is the international element."

The resolution authority is a U.S. law, but the big Wall Street banks operate all over the globe, making it extremely difficult to coordinate the their liquidation. Former IMF Chief Economist Simon Johnson has been emphasizing this point for years, and has been ignored by Bernanke and Geithner as they insisted a resolution authority would end Too-Big-To-Fail. Now that Congress has adopted their plan, Bernanke wants to emphasize that it will be extremely difficult to actually use:

"One of the banks that we supervise has offices in 109 countries, each one with its own bankruptcy code and its own rules and so on."

What's more, the FDIC's resolution authority doesn't even work on simple, commercial banks if they're big enough. Bernanke should understand this, since it was the Fed who pushed to bailout Wachovia when that bank teetered on the verge of collapse in 2008. The Fed official who demanded that Wachovia be spared was none other than Timothy Geithner, who was heading the New York Fed at the time.

Last week's hearings detailed the bailout negotiations between Geithner and FDIC Chairman Sheila Bair that took place in late September, shortly after Lehman Brothers filed for bankruptcy. Bair wanted to simply shut down Wachovia and limit losses for taxpayers, while Geithner wanted to spare losses for the bank's investors. Ultimately, bair relented to Geithner's demands, declaring a "systemic risk exemption" to the FDIC's ordinary procedures and arranging a merger that would make sure Wachovia's creditors didn't lose a dime, while the Treasury Department altered a decades-old tax rule in order to funnel billions of dollars to Wachovia's shareholders.

It's conceivable that Bair was actually right about the Wachovia bailout—it may have been unnecessary. But whether she was right or wrong about liquidating Wachovia doesn't really matter so far as public policy is concerned. In the Wachovia episode, policymakers were too concerned about the prospective fallout from the bank's failure to roll the dice and let the bank go down—even though they had a proven, codified, decades-old process for doing just that.

Resolution authority works very well with small, simple institutions. And it turns out that small, simple institutions work better than bloated financial behemoths. There is no economic evidence—absolutely none—that megabanks provide any economic benefits that cannot be provided by smaller banks. Our economy doesn't need the massive banks that caused the worst recession since the Great Depression.

The Wall Street reform bill that Congress passed this summer codified several useful new policies. But the top official at the Federal Reserve just emphasized to the public that the job is not finished. Too-Big-To-Fail lives on, and breaking up the banks is the only way to kill it.

Liveblogging Bernanke & Bair

Zach Carter — Thu, 02 Sep 2010 11:23:00 -0400

1:20

All done. Lesson: Break Up The Banks.

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1:00

Most of the discussion surrounding too-big-to-fail at this hearing has dealt with a relatively short period in time: the decision to bailout a firm, and what happened right after that decision.

This is an important part of the issue, but it's by no means the whole story.

Right now, three banks control 55 percent of the mortgage market, while 10 banks control 95 percent of it. Banks this large, with this much control over the financial spectrum are impeding normal market functions. Even if we allowed these megabanks to fail, the current system is fundamentally anti-competitive, and the broader economy pays a significant price for it. Loans are more expensive because banks can force higher prices on the rest of the economy due to their market clout. Those higher prices do not create any economic benefit for the broader economy-- the exact opposite is true. Big Finance is eating away at the real economy, hamstringing businesses, hampering innovation and making people poorer in the process. That would be bad even if policymakers could credibly say they'd allow Citi and JPMorgan Chase to fail. Which they can't.

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12:45

Georgiou just asked her point blank if, given everything that went on in 2008 and 2009, the resolution authority for complex financial institutions is at all credible. Bair said yes. Bair can credibly say yes because she wanted to apply the resolution authority to Wachovia, because she didn't think it would result in a systemic nightmare.

I think Bair is living in fantasy-land here, but unlike every other major player from 2008, she is at least consistent.

But remember, even if Bair was ultimately right that bailing out Wachovia bondholders was unnecessary, its not the whole story.

When it went under, Wachovia was a commercial bank with about $700 billion in assets. Citigroup, Bank of America and JPMorgan Chase all have well in excess of $2 trillion in assets, under dozens of different lines of financial business. They have massive derivatives operations and lots and lots of complex securities trading. From a strictly technical standpoint, these megabanks much more difficult to unwind than a bank that does almost nothing other than accept deposits and extend loans.

And this ignores Bernanke's admission that it will be impossible to unwind banks across international boundaries.

We may not be able to end too-big-to-fail. In the past, the U.S. has chosen to subsidize the creditors of banks much smaller than Wachovia. Since the Reagan era, the top banks have all been given special treatment. But the price and the consequences of subsidizing creditors in the 1980s were vastly smaller than those of the 2008 and 2009 bailouts. Breaking up the banks at least gives regulators a fighting chance to shut down our largest banks when they fail. If breaking them up isn't feasible, the cost of bailing out a $50 billion bank is a lot lower than the cost of bailing out a $5 trillion bank.

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12:30

Holtz-Eakin just made a great point. Prompt corrective action laws lay out a set of binding, concrete steps that bank regulators have to take when banks get into trouble, staring with restrictions on bank activities and, if the bank is unable to raise enough private capital, ending with liquidation. Regulators do not have the discretion to inject taxpayer money into the bank to keep it afloat.

But the stress tests, of course, sidestepped these laws for the 19 largest banks. Treasury injected capital into these banks and ignored the codified process for reining them in.

Bair responded that the stress tests were a commitment to keep banks above the capital thresholds where prompt corrective action would have applied. Geithner said this repeatedly when the stress tests occurred, and it's totally absurd. It requires us to believe that banks really are perfectly healthy, but the government has to inject capital into them anyway. If the banks really were healthy, why on earth were taxpayers asked to stand behind them?

This is, of course, a technical legal note that keeps policymakers out of jail. But as Holtz-Eakin notes, regardless of what happens to policymakers, the signal to financial markets is absolutely clear. When things break down and crisis sets in, the law doesn't apply. Whatever Congress puts on the books, regulators will do whatever they think is necessary to save the system when the system breaks down.

That does not bode well for the new requirements Congress just imposed on regulators for shutting down "systemically important" firms.

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12:25

Bair says she never knew that the IRS was planning to restructure tax code. Also says she was surprised by Wells Fargo's competing offer for Wachovia.

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12:20

Angelides is digging into the dispute between Bair and Geithner (then at NY Fed) over whether Wachovia creditors should have been fully protected.

Bair is not a perfect regulator and she wasn't perfect on Wachovia, but unlike just about everybody else running the regulatory, she actually respected the laws on the books and actually wanted to see creditors and shareholders take losses.

She wasn't totally sold on invoking a systemic risk exception for Wachovia, because she wanted to hit Wachovia's bondholders with losses. It's been clearly established for decades that commercial bank bondholders take a hit when commercial banks fail. Depositors are protected, other creditors have to deal with the consequences of failure, and they've always known that.

Geithner wanted to protect bondholders, and you protect bondholders by either bailing out the bank or by arranging a merger. The systemic risky exemption which allowed the FDIC to act outside some of the prompt corrective action mandates came from Geithner. Bair resisted, but ultimately gave in.

Geithner may actually have been right about bailing out Wachovia bondholders. It may have been systemically critical to shield them from losses (although if it was, it probably wasn't necessary to shield all bondholders from all losses).

There's an obvious lesson to this episode, and there's really no excuse for Geithner failing to learn it, given his role in the mess. Resolution authorities do not work for big banks. Even under the most generous interpretation of Geithner's actions on Wachovia, one has to conclude that in a crisis, big bank investors need to be subsidized, whether there's a legal structure that prevents this subsidy or not.

Let me emphasize this: Geithner was the very person demanding that the resolution authority be ignored for Wachovia. But his policy for ending too big to fail? Expanding the FDIC's resolution authority to new types of financial firms.

Break up the banks.

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11:55

Bair is beginning.

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11:45

Capital requirements only matter if you actually apply firm accounting standards. If you let banks account for their assets however they want to, they don't have to take losses, because they can simply invent profits and erase losses on their balance sheets, irrespective of what's going on in the real world.

This is why stronger capital requirements alone are unlikely to help in the next financial crisis. Bank accounting is generally a flexible enterprise, and regulators allow banks to get away with murder when financial crises hit. This time around, they went so far as to formally reinterpret accounting rules that required banks to account for their assets at their current market value. That sounds crazy, and it basically is crazy, although there are some crazy people who think market-based accounting was actually what caused the financial crisis, not any fundamental problems on Wall Street.

In response to a host of questions about capital requirements Bernanke basically cautioned against getting too aggressive with new standards, and also cautioned against getting too stringent with accounting guidelines. This stuff is hard, you don't want to screw up, but I believe in markets, and mark-to-market accounting is useful, etc.

The problem is, Bernanke's reticence here is fundamentally anti-market. He's saying that if we pay too much attention to markets in a time of crisis, asset prices will go down too much and banks will be in more trouble than they need to be. If we give banks some flexibility on accounting during a crisis, they won't have to take immediate losses, and once asset prices rebound from their panic-driven lows, everything will be okay. It just means that marking to market is good, so long as market prices are high. When market prices are low, we're somehow being unfair to banks by making them recognize those low prices.

But even if Bernanke is right, and there is something fishy about mark-to-market accounting during a financial crisis-- what's the alternative? Letting banks make up whatever asset values they want? That was the plan in 2008, and it's still the plan today, especially on second-lien mortgages, which banks continue to value at hundreds of billions of dollars, even though second-liens are worthless once home prices decline.

Over and over and over again we've heard Timothy Geithner and Alan Greenspan and Ben Bernanke say we need higher capital requirements. But nobody has any plan for actually enforcing those standards.

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11:15

More on the legality of the Wachovia arrangement. There are some loopholes in the prompt corrective action process, and the FDIC did invoke a systemic risk exception so that it didn't have too dump Wachovia's assets at the least cost to the taxpayer.

But Bair was still planning to auction off Wachovia's assets before Treasury changed the tax law to facilitate the Wells Fargo deal. And no matter what happened, if there was even uncertainty about whether Wachovia was solvent, the OCC totally failed to enforce prompt corrective action laws in the run-up to the bank run. There are multiple categories of capitalization, Wachovia was at the highest. When you slip down into weaker categories, regulators are required to take actions which the OCC did not take.

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10:45

Did Bernanke just admit that the Wachovia bailout was illegal? Wallison is now pressing Bernanke on the same liquidity stuff he presented yesterday to NY Fed's Baxter.

The discount window should be able to provide unlimited liquidity to any solvent bank. It's supposed to help deal with bank runs. If the bank can put up collateral, it can get a loan from the Fed, and the run won't kill the bank.

When Wachovia failed in 2008, regulators blamed a liquidity run (as they did for IndyMac and other banks that failed that year). But that's not supposed to be possible. So, Wallison asks, what happened?

"Their liquidity demands were such that they thought they could not meet them even with the discount window," Bernanke said.

Wallison pushed back. Really? They were solvent but they didn't have the collateral to get loans from the Fed?

Then Bernanke half-admits what must have been going on:

"I think there was uncertainty about whether they were solvent or not," Bernanke said.

This is a very big deal, because the regulators had clear, well-defined authority to unwind Wachovia. It wasn't an investment bank like Lehman Brothers, it was a commercial bank like Washington Mutual. Not only that, under prompt corrective action statutes, regulators and a clear, well-defined legal obligation to shut down Wachovia if it was in fact insolvent. In fact, they had a clear, well-defined responsibility to shut down Wachovia before it became insolvent in order to protect taxpayers. Instead, policymakers arranged a complex bailout by abusing the tax code to subsidize Wells Fargo's acquisition of Wachovia.

If Wachovia was insolvent, this was not just reckless policy, it could have been illegal.

There are accountability questions here-- investigations? prosecutions?-- but also systemic regulatory questions. Even if the new resolution authority for megabanks is technically feasible, can we realistically expect policymakers to use it after the Wachovia mess?

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