Bernanke grapples with Greenspan as Volcker scorns Fed bailouts

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Apr 21: The event was a 2002 conference at the University of Chicago to celebrate the Nobel laureate Milton Friedman's 90th birthday. When Ben S Bernanke rose to speak, he said that the Federal Reserve, of which he was then a governor, had come around to Friedman's view that the central bank's blunders were to blame for the Great Depression. "We're very sorry,'' Bernanke said, prompting laughter. "But thanks to you, we won't do it again.''

Bernanke, a longtime scholar of the 1929-to-1933 panic, now has the unwelcome task of trying to keep a new financial calamity from turning into a full-blown depression. What started as a meltdown in the market for subprime mortgages has turned into a worldwide credit and economic crisis.

Bernanke, now the Fed chairman, has responded with the most-aggressive expansion of the Fed's power in its 95-year history. Since last August, Bernanke, 54, has twice cut interest rates by 75 basis points, made Federal Reserve loans available to investment firms for the first time since the 1930s, lowered the rates at which banks can borrow from the Fed and launched an unprecedented rescue of Bear Stearns Cos, the struggling investment bank. (A basis point is 0.01 percentage point.)

To prevent a wider crisis, the Fed risked the US government's money by lending $29 billion backed by Bear's mortgage-backed securities. The loan was an incentive to JPMorgan Chase & Co to buy the 85-year-old bank.

While Bernanke's attack on the US economic malaise has been fierce, friends say the Fed chairman himself is anything but. "He is very even-keeled, with a pleasant demeanor, a level temperament,'' says Richard Newell, an economist at Duke University who studied under Bernanke at Princeton. "He's not inclined to hit one over the head with the depth of his knowledge -- that makes him an effective communicator.'' Bernanke's rate cuts were followed by the release on March 31 of a sweeping proposal by US Treasury Secretary Henry Paulson to revamp government supervision and regulation of the financial system. Paulson endorsed the Fed's moves to stabilize the economy and proposed the central bank be given a permanently expanded role as watchdog over the entire financial system, including commercial and investment banks, insurance companies, hedge funds and mutual funds.

"The Fed would have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability,'' Paulson told the press.

At a press briefing in Miami on April 7, Paulson said the plan -- which would abolish the Securities and Exchange Commission -- may take several years to implement, and the Democrats, who control Congress, say no quick action is likely. Even so, Bernanke's Fed has already grabbed some of the power the Treasury proposes to give it by inserting itself into the back offices of the investment banks.

"Since we've begun lending to dealers, including the remaining investment banks, we have put examiners on the ground in those firms, and we've established off-site teams that coordinate with them,'' Bernanke told Congress's Joint Economic Committee in testimony on April 2. Bernanke, an academic from rural South Carolina, took office in February 2006 in the shadow of former Fed Chairman Alan Greenspan who held sway at the central bank for 18 years. Bernanke, a Republican, is now well on his way to becoming the most powerful Fed chairman ever.

"One interpretation of the Paulson report is that the Fed is handed any authority to do anything it wants,'' says former Fed Governor Lyle Gramley now a Washington-based senior economic adviser for Stanford Group Co., a wealth management firm in Houston. "It assigns the Fed overall responsibility for any financial institutions that might be a source of systemic risk.''

Former Fed Vice Chairman Alan Blinder says Bernanke's actions are justified. Paulson and President George W Bush have done little to address the mortgage crisis, he says. "The Fed has been extremely creative and is fighting this war almost exclusively by itself.''

The Bernanke Fed may have already seized too much power and has abandoned historical principles, says Paul Volcker who was Fed chairman from 1979 to '87. "The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers,'' Volcker, 80, told the Economic Club of New York on April 8. " A direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time- honored central bank mantra in times of crisis: lend freely at high rates against good collateral. It tests it to the point of no return.''