Ben Bernanke’s memoir is much more than a chronicle of the financial crisis
Ben Shalom Bernanke helmed the Federal Reserve through the financial crisis with which his two terms were coincident. He was appointed by President George Bush in 2006 and reappointed by President Obama in 2010.
This naturally makes his memoir, The Courage to Act: A Memoir of a Crisis and Its Aftermath, an interesting read. President Obama had praised Bernanke as the “epitome of calm”, while referring to the Federal Reserve’s flagship conference at Jackson Hole, where prescient Raghuram Rajan predicted the financial crisis.
The book is Bernanke’s version of events and a defense of the actions of the Federal Reserve during the crisis and in steering the world economy thereafter, and will serve as notes for an economic historian of the future.
Bernanke describes the experience of taking macro policy decisions, working with two US presidents under fire from a fractious Congress and a hostile public. Some policy actions taken at the time remain controversial. For instance, while Lehman Brothers collapsed, Bear Sterns was bailed out by JP Morgan and AIG by the American taxpayer. AIG promptly extended bonuses and golden parachutes for its officials. Taxpayers and the world at large were shocked by the self-seeking behaviour of banks and the immorality of Wall Street.
Bernanke, as a defender of the faith, asserts that the Fed was right to embrace unorthodox monetary policy in an attempt to revive a flagging US economy and stabilise a teetering financial system. Consumer protection received inadequate attention. Decision-making was hampered by lack of cooperation between the overlapping Fed and Federal Open Market Committee (FOMC) bodies. The FOMC was not comfortable with the alphabet soup of lending facilities. The purchase of mortgage-backed securities seemed a market distortion. Since Adam Smith, liberalism decreed faith in the capacity of free markets to allocate resources efficiently. Fear and risk aversion prevent financial markets from serving their critical functions. Bernanke justifies the policy of asset purchases, as, at that time, the US recession was spreading globally. Inflation, an important concern earlier, was declining, as spending plummeted and commodity prices fell. Purchases of securities were critical and controversial, referred to as ‘large-scale asset purchases’, or LSAPs, which the financial world termed ‘quantitative easing’, or QE. The justification of these unorthodox monetary policies is that they subserved the goal of economic revival.
Other central banks followed the lead of the Fed. The Bank of England started purchasing government bonds, as the Fed announced expansion of the QE programme in March 2009. The Bank of Japan, which had pioneered QE earlier in the decade, increased its purchase of government bonds and undertook a range of other programmes to promote the flow of credit. European Central Bank focused on limited asset purchases, focusing instead on increasing its longer-term lending to banks.
Basel II established a sophisticated and complex approach to calculating capital needs at the largest banks, overseen by supervisors, but relying in part on the banks’ own risk models. These rules for determining the amount of capital to be held against each type of asset (never fully implemented in the US) were intended to discourage banks from gaming the system, but did not aim to raise or lower the total amount of capital held. Despite this, at the time of the financial crisis, the banks remained inadequately capitalised. A primary goal of Basel III was to increase capital held by banks, particularly the systemically important institutions whose operations crossed international borders.
The new accord, released in December 2010, called for increased capital requirements in general and for ‘counter-cyclical’ capital buffer to ensure that banks built up their capital in good times, so that they could absorb losses and keep lending in bad times.
This is a memoir worth reading, for understanding the financial crisis and for valuable lessons learnt.
Deepali Pant-Joshi is executive director, Reserve Bank of India, Mumbai. Views expressed are personal