Federal Reserve policy makers appear confident that they have the weapons they’ll need to fight the next financial crisis. Some of their predecessors on the front lines are not so sure.
Ben Bernanke, Timothy Geithner and Henry Paulson all voiced varying degrees of concern about America’s ability to combat another financial meltdown 10 years after they played prominent roles battling the last one.
While agreeing that the banking system is a lot stronger than it was back then, they saw some weak spots in the country’s crisis-fighting arsenal that didn’t exist a decade ago. The trio also decried the nation’s ballooning budget deficits in a joint briefing with reporters.
“We’ve got better defenses against the more mild, typical sets of shocks that happen to economies and financial systems but in the extreme crisis probably less degree of freedom, more constraints than would be ideal,” former Treasury Secretary and New York Federal Reserve Bank President Geithner said.
The U.S. instituted a raft of reforms after the last crisis drove the economy into its worst recession since the Great Depression. Some were designed to fortify the country’s biggest banks and make it easier to shut them down so they wouldn’t have to be rescued by the government if they ran into trouble.
Others though limited the discretionary power of the Fed, the Treasury and the Federal Deposit Insurance Corp. to provide financial institutions with support as lawmakers responded to a public backlash against bailouts and Wall Street.
Fed Vice Chairman for Supervision Randal Quarles acknowledged in April that the tools available to regulators in an emergency had changed. But he told a conference in Washington, “I wouldn’t be too negative about our ability to respond in the future.”
His boss, Fed Chairman Jerome Powell, has voiced confidence in the government’s ability to shut down a failing financial institution in a crisis without having to sink money in it, telling lawmakers in November that no bank is too big to fail.
Geithner, who is president of private equity firm Warburg Pincus LLC, argued that the emergency powers that proved so essential a decade ago are “somewhat weaker” today.
Former Treasury Secretary Paulson agreed, pointing in particular to the limits that Congress placed on the FDIC and the Treasury’s Exchange Stabilization Fund.
“There is some concern there,” said former Fed Chairman Bernanke, who is now a distinguished fellow at the Brookings Institution in Washington, though he also noted that regulators are now more attuned to potential systemic risks.
The former Fed chief, who was nominated by George W. Bush and given a second term by Barack Obama, criticized the deficit-ballooning tax cuts and spending increases agreed to by President Donald Trump and Congress as ill-timed. Bernanke noted that they come as the country is at or near full employment. He also voiced concern about the longer-term consequences of rapidly rising government debt.
“If we don’t act, that is the most certain fiscal or economic crisis we will have,” said Paulson, who chairs his own institute in Chicago. “It will slowly strangle us.”
The enlarged deficits and debt also mean that the government has less room to pump up demand than it did during the last crisis, when Obama pushed through a massive stimulus package, Geithner said.
Publicly-held federal debt now stands at 77 percent of gross domestic product, double what it was in 2007.
The Fed, too, has less scope to act as interest rates are lower, Geithner said. The central bank’s benchmark rate target is now 1.75 to 2 percent. It was 5.25 percent in July 2007.
Bernanke though noted that the U.S. central bank is better positioned to respond than other advanced economies. The European Central Bank, for instance, has a benchmark interest rate of zero.
The former Fed chairman said the U.S. had made “a lot of progress” toward being able to resolve failing financial institutions without having to bail them out.
Paulson basically agreed, with one big proviso. In the midst of a crisis, policy makers may have to provide temporary support so that a collapsing institution can be liquidated over time — even if that proves politically difficult to do.
“It’s nice to have this authority but somebody has got to be prepared to use it and use it in controversial ways,” he said.
Asked if policy makers and politicians would be able to set aside their differences to tackle any future turmoil given the toxic atmosphere in Washington, Paulson replied that the answer is “unknowable.”
But, he added, “it’s the right question to ask.”