The Courage to Gamble

Ben Bernanke’s new book, The Courage to Act, demonstrates throughout its 579 pages the fundamental uncertainty faced by central bankers, Treasury officers, and everybody else when dealing with financial cycles, panics and recoveries.  “But if the last few years had taught us anything, it was that we had to be humble about our ability to detect emerging threats to financial stability,” he writes. 

Indeed, the Federal Reserve has a lot to be humble about in this respect.  It missed the extent and impact of the great housing bubble, and recently, after Bernanke’s book was written, has missed the collapse in oil prices and the current emerging market turmoil. In their large bank stress tests for 2015, they had oil prices going up, getting not even the direction, let alone the magnitude, of this huge credit event, correct. “The [Fed] staff’s forecasts, like those of private-sector forecasters, were as much art as science,” Bernanke reflects.  “The accuracy of both central bank and private-sector forecasting has been extensively studied, and the results are not impressive.”  Although not impressive, they are highly instructive, especially for anyone tempted to think that central banks and governments can successfully manage the unknown and unknowable economic future.

This daunting lack of knowledge notwithstanding, it is true that in a crisis and a panic, you have to act anyway.  Bernanke makes a very good telling of how the Fed and the Treasury were flying by the seat of their pants from disaster to disaster, taking arms against a sea of financial troubles.  “It was a terrible, almost surreal moment.  We were staring into the abyss.”  In “the frenetic autumn of 2008…it seemed the bad news would never end.”

Amid the endless bad news, the Fed did what central banks do when staring into the abyss:  create more fiat money and finance the bust.  As he led these efforts, some of Bernanke’s crisis gambles proved to be great vulture investments, with very risky securities bought for the Fed’s balance sheet at what turned out to be the bottom, although of course that is never clear at the time.

He is right to say that financing the crisis is the principal reason why the Fed was set up in the first place.  “In essence, we did what Congress had intended when it created the Federal Reserve, what Walter Bagehot had advised a century and a half earlier, and what central banks had always done in the midst of panics.”  Bagehot, the father of central banking theory, wrote in 1873 of the need for the Bank of England to lend freely on good collateral to all relevant parties to stem a financial crisis.  Forty years later, in the original Federal Reserve Act, Congress defined providing an “elastic currency” to counter panics as the principal reason to have the Fed.  Under Bernanke, the Fed proved that the currency is now elastic beyond the wildest dreams of its founders.

“For much of the panic,” Bernanke writes, “the Fed alone, with its chewing gum and bailing wire, bore the burden of battling the crisis.”

“Chewing gum and bailing wire”: there is an appealing candor here about how they were making it up as they went along, very uncertain about and surprised by what would happen next, and an attractive lack of posing as the master of events.

In the same vein:

“I was asked what had surprised me the most about the financial crisis.  ‘The crisis,’ I said.”

“At that first FOMC meeting of my chairmanship, in March 2006, my colleagues and I were upbeat.”  At that point, they were at the very peak of the bubble.  The top in house prices was a few months away and the skids were already greased for the terrifying ride down.

“We failed to understand—‘failed to imagine’ might be a better phrase—how those pieces would fit together to produce a financial crisis.”

Later: ”I knew there was plenty of blame to go around, including at the Fed and other regulatory agencies and in Congress.”

“I tried to appear, and in fact be, calm and deliberate, though my insides often churned.”

In general, the book is a clear and readable first-person account, not pompous or arrogant (as many of us perceive the Fed to be), and remarkably unpretentious.  Its sections on Bernanke’s personal life, which are thankfully brief, stress his modest background and his love of his family.  Yet he is also the product of an elite education and an academic ascent, a meritocrat who rose to holding one of the most powerful positions in the world, a man whose decisions had and continue to have global influence, for good or for ill.

Although he attempts and achieves a balanced tone overall, Bernanke has an intense belief in the Fed as a meritocracy of technocrats, and a deeply felt commitment that it must be “independent.”  Such independence is an undemocratic idea, so when Bernanke does display impatience and frustration, it is with the Congress, the democratically elected representatives of the people.  His taste in this matter is clear: “If I could have, I would have stayed as far away from politics as possible.”  “Although I would testify dozens of times…I always disliked it.”  With Congress, “I would consider how I might respond to an economics student…assuming the role of a teacher.” But perhaps the members of Congress considered themselves not his pupils, but his boss—as in the aggregate, they are.

Besides the autobiographical notes, the book has three main parts:

-The period before the crisis—the failure to anticipate the disasters.

-Scrambling to finance the bust—success at elastic currency, with a matching history of TARP bailouts.

-The unprecedented post-crisis monetary experimentation, the so-called “QE” or “quantitative easing.”  In simple terms, this means Bernanke’s $4 trillion bond and mortgage buying gamble.

The panic ended almost seven years ago.  The recession ended more than six years ago.  House prices bottomed over three years ago, and have been rising rapidly.  Yet the Fed’s interventions are still massive.  Its balance sheet is still bloated with over $4 trillion in long-term securities, and it has kept real short-term interest rates negative for years.  “As everyone (including me) appreciated, the latest round of asset purchases was a gamble,” Bernanke writes.  It was and still is.

A key goal of the gamble was to induce asset price inflation.  In this it succeeded, until recently.  Critics “worried that our securities purchases could stoke excessive risk taking in financial markets.”  The critics were correct.  Recall that then-Fed Chairman Greenspan’s gamble in the early 2000s was to promote a housing boom, which got away into a bubble, and ended up stripping him of his “Maestro” status.  Will a similar fate befall Bernanke’s reputation?

How Bernanke’s giant QE gamble ultimately turns out will determine whether in the future he is judged a central banking hero or a bum.  As of early 2016, with global asset price inflation in reverse, financial markets falling, junk bonds cratering, many emerging market countries struggling, and economic growth slowing, at this point the probability of an unfavorable future judgment is certainly rising. Whatever the final judgment, Bernanke was there amid memorable dangers and deeds.  He has written a book of both general and specialist interest, which will be cited in financial discussions for years, especially when the inevitable new crises arrive to surprise his successors.  “I had gotten more than I had bargained for when I signed up for the job,” he writes.  That’s for sure.