Ben S. Bernanke’s renomination allows him to redefine the Federal Reserve’s mission as he expands its power over financial markets and pulls back on a credit surge the central bank used to keep the economy from collapse, economists say.
Bernanke’s agenda during the next four years will include elevating the Fed’s role in reducing excessive risk in major financial institutions, figuring out how to curtail asset bubbles, and scaling back $1.2 trillion of monetary stimulus.
“He will have the opportunity to permanently change the structure of the Federal Reserve system,” said Vincent Reinhart, a former director of the Fed’s Monetary Affairs Division who’s now a resident scholar at the American Enterprise Institute, a Washington-based research group.
President Barack Obama nominated Bernanke, 55, for a second term yesterday, lauding the Fed chairman for helping “put the brakes on our economic free fall.”
Bernanke, a former Princeton University economist, has already set in place numerous changes since he took over from Alan Greenspan in February 2006. He’s forced more cooperation between bank supervisors and staff economists and steered the Fed toward greater transparency. He’s also made his office more accessible, explaining his actions to the public on the CBS Corp. television program “60 Minutes” and at a town-hall meeting in Kansas City, Missouri.
Volcker’s Legacy
Bernanke has been a steward of former Fed Chairman Paul Volcker’s legacy of establishing a regime of low inflation. His own imprint will be different, however, because he will help make explicit the Fed’s role in assuring financial stability, said Al Broaddus, former president of the Richmond Fed.
Volcker’s “job was to get monetary policy, the true engine of inflation, under control,” Broaddus said. Bernanke’s actions in confronting the credit crisis put the Federal Reserve’s responsibility for financial stability “in strong relief” and “cemented that unwritten mandate,” he said.
Now, the Obama administration is seeking to give the Fed an even larger mission.
The administration wants the central bank to dictate capital, liquidity and risk-management standards at the nation’s biggest financial companies. That proposal has met with congressional resistance.
The Senate Banking Committee “should carefully examine the impact of the Fed’s failures as a bank regulator, how such failures contributed to the financial crisis, and whether Chairman Bernanke’s performance as the chief regulator merits his reconfirmation,” Senator Richard Shelby of Alabama, the top Republican on the panel, said in a statement yesterday.
Ramping Up Role
Bernanke is already preparing to play a larger part in oversight, no matter how Congress rewrites the rules. Fed bank examiners are putting more emphasis on comparing the risks inside one large bank with those faced by other big lenders.
The stakes are high, said Henry Kaufman, president of Henry Kaufman & Co. in New York. Success in overhauling supervision of the financial system would mean “improved economic conditions for an extended period of time,” Kaufman said. Failure would mean a return to “continued volatility.”
The Obama plan also envisions a permanent role for Bernanke’s broadened use of the Fed as lender of last resort. The Board of Governors used emergency powers to rescue American International Group Inc., as well as markets for commercial paper, housing bonds and asset-backed securities. In the process, the Fed’s balance sheet expanded by $1.2 trillion over the past year.
‘Mondustrial Policy’
Regional Fed bank presidents and scholars are divided over the Fed’s direction. John Taylor, an economics professor at Stanford University, is concerned that emergency loans will draw the central bank into allocating credit to politically favored industries, such as housing. Taylor, a former Treasury undersecretary, calls such actions by the monetary authority “mondustrial policy.”
Some investors say such loans add to political pressure to continue extending credit to satisfy interest groups, threatening the Fed’s goal of keeping inflation low.
“What they are doing is not monetary policy,” said Axel Merk, who has moved the $352 million Merk Hard Currency Fund away from dollar assets to avoid inflation. “His credit programs are fiscal policies. They are inviting political scrutiny and jeopardizing independence. It is a very dangerous road to be on.”
‘Intense Financial Crisis’
Others praise Bernanke for averting a global meltdown.
“His biggest legacy for sure will be having designed and implemented a policy for dealing with an intense financial crisis,” said former Fed governor Laurence Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers LLC. “Here is what is amazing: It was ad hoc, yet it looks very good.”
Bernanke’s first test on inflation will be reversing the $1.2 trillion in additional Fed credit his policies created. The challenge will be to maintain the Fed’s credibility for keeping prices stable, while avoiding a premature increase in interest rates that may snuff out an emerging recovery.
The chairman devoted a section of his semiannual testimony before Congress in July to his exit strategy, saying the Fed could neutralize money in the banking system through tools such as interest on reserves, reverse repurchase agreements, or outright sales of securities.
Unemployment Peaking
Traders in federal funds futures see a rising probability of an interest rate increase in March. The federal funds rate has been in a range of zero to 0.25 percent since December.
A March rate rise would occur in the quarter when economists forecast the unemployment rate to peak at 10 percent, according to the median estimate of a Bloomberg News survey. That could add momentum to legislative proposals that would expose Fed policy-making to greater examination.
U.S. Representative Ron Paul, a Texas Republican, has written legislation that would open the Fed’s monetary policy to audits. The measure has 282 co-sponsors in the House, according to Paul’s Web site.
The timing of any tightening move is “is going to be very tricky,” said Julia Coronado, senior economist at BNP Paribas in New York and a former member of the Fed Board research staff.
Much of the criticism of the Fed from Congress stems from its failure to curb asset bubbles. Subprime-mortgage originations jumped to $600 billion in 2006 from $310 billion in 2003, according to estimates by Inside Mortgage Finance. Fed officials were reluctant to raise interest rates to slow down credit growth.
Siding With Greenspan
As a Fed governor in 2002, Bernanke sided with Greenspan and said “monetary policy cannot be directed finely enough to guide asset prices without risking severe collateral damage to the economy.”
He is likely to maintain a preference for what regulators call “supervisory tools.” Yet he’ll also probably remain open to any solution. Even the use of interest rates is back on the table for some officials.
Janet Yellen, president of the San Francisco Fed, said in June, “In certain circumstances, the answer as to whether monetary policy should play a role may be a qualified yes.”
After an eventful four years, investors are now looking to the central bank for stability, said Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., which manages the world’s largest bond fund, in Newport Beach, California.
“Crisis management defined Bernanke’s first term,” he said. “Markets look to Bernanke for policy continuity and, when the time comes, an eventual orderly exit from a complex set of unconventional policies.”
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