How good is your memory? Not many people today have personal memories of the Great Depression some 80 years ago, when thousands of banks closed. It would be natural, you'd think, to have a burning memory of what happened just five years ago when the U.S. banking system was on the brink of a similar collapse. The housing bubble burst. Lehman Brothers went bankrupt. Banks pulled back on lending, investors avoided new bonds and everyone seemed to be stockpiling cash. The economy started to contract by 5 percent to 6 percent annually. Trillions of dollars were knocked off the value of U.S. companies. The public and financial authorities had reason to believe nothing much could be done to avert a rerun of the Great Depression.
George Santayana (and before him the 18th century British philosopher and politician Edmund Burke) had history in mind when he observed that those who can't remember the past are condemned to repeat it. Five years hardly qualifies as "history," so it is unnerving that even supposedly well-informed people have forgotten how we got out of the mess. Last year, for example, the House of Representatives followed the lead of former Texas Republican Rep. Ron Paul (now taken up by his son, Kentucky Sen. Rand Paul) in passing a motion for an audit of the Federal Reserve, as if the Fed had been a cause of our problems.
On the contrary, the Federal Reserve was quite simply our last hope. It was the chairman of the Federal Reserve Ben Bernanke who came to the rescue. Bernanke, a former Princeton professor, was a scholar of the Great Depression, a background that proved critical. Right from his start in 2006, he demonstrated a tough independence. Unconvinced of inflation predictions in 2007, he refused to continue ratcheting up interest rates – and he was proved right. When the crisis hit in 2008, he went way beyond the standard response of a central banker, which would have been to lower interest rates and hope that cheaper credit would somehow work its way to more borrowing, more activity, more jobs.
It hadn't worked that way in the Great Depression. Nobody wanted to borrow because there was no demand for their products and services. Bernanke understood that the full faith and credit of the U.S. government was required for a bailout, so he devised a whole menu of unique liquidity facilities to restore credit and confidence. More than a trillion dollars in lending programs helped troubled financial firms, especially the banks. Debt from industrial corporations was bought up, and distressed mortgage assets were put onto the Fed's books. The Fed's policy sustained money market funds, commercial paper, consumer loans and more. His intervention was decisive in easing the panic.
Bernanke's boldness no doubt stemmed from his intricate understanding of the Great Depression. He literally transformed the Fed into a daring, financial first-responder and an active market participant, rather than limiting it to its traditional role of controlling the money supply. Simultaneously he joined Treasury Secretary Hank Paulson on a visit to Capitol Hill to persuade terrified politicians to embrace the famously massive fiscal injection of the Troubled Asset Relief Program, or TARP. That was a close call, for at that fragile moment financial experts worried that the banks might not open the next morning.
Bernanke rallied both the Treasury Department and other central bankers around the world. He pushed other central banks to pursue expansion. Miraculously, the clogged arteries of the global financial system opened up. He leveraged whatever assets the Congress authorized him to deploy, and almost single-handedly steered the global economy back from the brink. In so doing he was able to secure enough time for the U.S. to stabilize the financial system and begin to heal its economy.
His greatest strength came from the authority endowed by his insight and understanding of the magnitude of the crisis at a time when Washington was in turmoil and the Obama presidency did not enjoy congressional confidence. Not so with Bernanke. He got behind a series of imaginative but untested emergency funding procedures for the banks. He used the Fed's balance sheet both uniquely and aggressively to buy not only short-term Treasury bills but also long-term bonds and mortgages as a way of manipulating prices and forcing policy interest rates down to virtually zero for an unprecedented period. This lowered both short- and long-term interest rates. He also didn't hesitate to suggest that the Fed would do even more if these measures didn't work.
Through it all, Bernanke retained a unique candor. He spelled out the costs and risks of these unconventional policies. He made it clear that the more the Fed had to persist, the more difficult it would be to get the world back into a state of normal balance.
To this day, the Fed has not yet been able to wind down his innovative policies – for good reason. The U.S. economy in the four years since the recession ended has been growing at less than half the rate of any other recession since World War II. We are still living with a real unemployment rate of at least 14 percent, punishing millions of a new "lost generation." Some 37 percent of the unemployed have been out of work for over six months. And we have failed to attain "escape velocity" to return to steady growth.
That is the justification – the imperative in Bernanke's view – for continuing to purchase Treasury and mortgage-backed bonds at the level of $85 billion a month, or a trillion dollars a year. He has managed this "quantitative easing" through three different phases and remains committed to continuing it to keep short-term interest rates at record-low levels at least until the unemployment rate falls to 6.5 percent.
And what did he receive for this from the president of the United States? A back-of-the-hand comment in a recent PBS television interview with Charlie Rose that the Federal Reserve chairman had stayed longer than he wanted or was supposed to. This made it clear that Bernanke's days as Fed chairman were numbered despite his unpredicted triumph. This was all done with just seven months left in his appointed term, thus depriving the chairman of the dignity of making his own announcement and even precluding the decision that he might not want to re-up for another tour of duty after eight exhausting years of the worst economic and financial crisis since the 1930's.
The market naturally reacted to President Obama's statement. The equity market lost hundreds of millions of dollars in the next two days. It was not the send-off that Bernanke deserved. The best the president could muster by way of complimenting this brilliant and courageous man was to describe him as an "outstanding partner" with the White House. Partner? The White House was the critical player here only in the sense that its economic policies had drained the confidence of the business community. (By the way, since the Federal Reserve is an independent agency overseen by Congress, no Fed chairman reacts well to the description of "partner," for it undermines the integrity and independence of the Federal Reserve and its leader.) And the stab in the back was carried out while Bernanke was conducting an important Federal Open Market Committee meeting.
It could be argued that Bernanke has made mistakes. He was perhaps a little loose in implying that the Fed might soon cut back its stimulus efforts. But his remarks were intended to minimize speculative activity that relied on the Fed's buying of these bonds, and calm was soon restored.
History will marvel at the role that he played in his seven tumultuous years, intervening so bravely and boldly in Wall Street in ways never before contemplated. As the only operator in Washington who was capable of juicing up the economy in the short term, there is now a fear that when Bernanke quits there will be nobody in Washington capable of leading us out of the unemployment and underemployment that is devastating millions of Americans.
But he leaves a legacy: Buying bonds without limits to their quantity or duration is now an acceptable policy. The financial markets have also adjusted to having the Fed as a key participant, which is a dramatically different role than that of monetary policymaking.
Bernanke's Fed was quite simply our last hope, preventing an economy from sliding into a financial abyss. Our economy still has a way to go before it regains full strength, but the president's mean-spirited dismissal of perhaps the greatest central banker in our history is yet another indication of an administration that has no clue of how serious the country's current economic condition is. What a shame to have so cavalierly treated the very architect of the policies that saved America from another Great Depression.