Friday, February 5, 2010

Ben Bernanke: The Very Model of a Modern Pliant Bureaucrat

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).

Federal Reserve Chairman Ben S. Bernanke was a safe bet to win the Senate’s vote for a second term. “Safe” is what the senators want and Bernanke passed the test. He is not a man inclined to make bold decisions. A former university administrator, his institutional mind will be just as slow to foresee the next financial crisis as it was incapable of forecasting the last.

Despite obvious signs the financial system was about to burst, Congress had no desire to touch Fannie Mae, Freddie Mac, and the banks’ expanding mortgage securitization machine (i.e., derivatives), that made Washington and Wall Street so rich.

Having replaced Alan Greenspan as chairman on February 1, 2006, Bernanke performed according to script. He dismissed the worrywarts. In June 2006, Chairman Bernanke told an International Monetary Fund (IMF) gathering: “[O]ur banks are well capitalized and willing to lend.” In the same month, he stamped his imprimatur on the most destitute sector of the economy: “U.S. households overall have been managing their personal finances well.” In November 2006, he calmed fears about subprime lending. Before an audience promoting community development, Bernanke celebrated the rise of subprime mortgages: from only 5 percent of the market in 1995, 20 percent of new mortgage loans were subprime by 2005. (He did advise “greater financial literacy” for “borrowers with lower incomes and education levels.”)

In May 2007, Chairman Bernanke gave an appraisal one expects from a short-sighted bureaucrat: “[W]e believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”

Bernanke’s specialty is organization. Filing subprime mortgages into a manila folder appealed to the chairman’s tidy mind. John Cassidy discussed Bernanke’s strength in the New Yorker: “In 1996, Bernanke became chairman of the Princeton economics department, a job many professors regard as a dull administrative diversion from their real work. Bernanke, however, embraced the chairmanship…. [Bernanke] bridged a long-standing departmental divide between theorists and applied researchers….” A colleague explained Bernanke’s considerable skill: “Ben is very good at… giving people the feeling they have been heard in the debate….”

Bernanke gives senators the same feeling (with some admirable exceptions, who know Bernanke’s cordial and vague representations are a variant on his predecessor’s, Alan Greenspan). The IMF did not want to hear America’s banks were undercapitalized. The community developers did not want to know subprime lending was an odious racket that was bound to topple. The nation’s most revered economist assured audiences that all was fine.

On December 3, 2009, the Senate Banking Committee held a reconfirmation hearing (prior to the full Senate voting on Bernanke’s second term). The Fed chairman was given great credit for leading the nation through the recent financial crisis. Committee members congratulated Chairman Bernanke for his brilliant restoration of the U.S. financial system.

He was reprimanded, however, for not anticipating the crisis and expressed requisite contrition. Bernanke thought banks should have held more capital and that the banking system had not employed adequate risk management controls. Committee members nodded in solemn agreement.

In truth, the too-big-to-fail banks are bigger, more unstable, and even more undercapitalized than before the bubble burst in 2007. As for risk management tools, Bernanke is full of talk but has done nothing to restrain either the growth of derivatives or to require reserves be held against derivative exposure.

At the December 3 hearing, the Fed chairman stated that he did not see any asset bubbles emerging. This seemed to reassure the senators who ignored the fatuity of even asking his opinion given that he thought banks were well-capitalized in 2006 and did not see the housing bubble.

As night follows day, Bernanke ignores a signal akin to one the derivative markets offered ahead of the 2007 meltdown. Then, there were wide expectations of loan defaults. Investors hedged this risk in the credit-default swap (CDS) market. The CDS market grew from $14 trillion to $42 trillion from January 2006 to June 30, 2007. Any line of business growing at such a rate should alarm bank regulators.

Ben Bernanke, the nation’s leading bank regulator, did not understand that banks could not honor trillions of dollars of claims once the defaults occurred. It was the CDS market that left Bear, Stearns; Lehman Brothers; Goldman, Sachs; and AIG either insolvent or close to it.

Today, galloping derivative growth has moved to interest-rate protection. The fear is of a government bond bubble. Ten-year Treasury bonds yield 3.7% during the greatest money-printing experiment in the nation’s history. Investment managers are protecting themselves against a higher 10-year Treasury yield. (With interest-rate derivative contracts, banks will have to pay the purchasers if rates rise to a specified level.)

During the first six months of 2009, the volume of contracts offering protection against rising yields of Treasury bonds with maturities of 5 years or longer rose from $109 trillion to $150 trillion. When rates rise, banks may once again default on their commitments.

Bernanke aims to please. He told the senators in December 2009 a reevaluation of his zero-percent fed funds rate “will require careful analysis and judgment.” The chairman will raise the rate “in a smooth and timely way.” This paralysis to action fits the stereotype of a municipal data-entry clerk. Bernanke certified his tremulous loyalty when he told an audience on November 16: “It is inherently extraordinarily difficult to know whether an asset’s price is in line with its fundamental value…. It’s not obvious to me in any case that there’s any large misalignments currently in the U.S. financial system.”

Only an apparatchik could believe an economy with zero-percent interest rates is in balance. The purchasers of interest-rate protection (which is not cheap) believe differently, but Ben Bernanke is the man for the Senate. The chairman’s mandate for his second term is to ignore the obvious, deflect attention from the megabanks’ inherent instability, and to accept blame for his ignorance after the deluge.

Frederick Sheehan writes a blog at

Listen to interviews with Frederick Sheehan:

1 - Thursday, February 4, 4:30 – 5 PM EST, on Bloomberg radio with Pimm Fox on his show Taking Stock

2 - Saturday, February 6 with Jim Puplava at Financial Sense. The one hour interview will be posted at 3 PM EST:

3 - Sunday, February 7, 10 -11 AM EST, with Jim Campbell on Yale University radio WYBC – 1340 AM and streaming live at Simulcast on Yale’s Internet channel: