On Thursday, Ben Bernanke will appear before the Senate Banking Committee, to begin his reconfirmation process as chairman of the Federal Reserve Board.
Based on committee members’ public statements, Bernanke already appears to have enough votes on his side. But Thursday’s hearing and the subsequent floor debate are an important opportunity for senators to raise important issues about how the Fed will operate moving forward.
This is more than a ritual. Questioning (the monetary) authority and politely insisting on a coherent answer is an important part of our political governance structure – and something that was sorely lacking during the Greenspan era.
There are three possible lines of enquiry that could draw Mr. Bernanke out. These questions could be separate or part of a sequence:
1. Andrew Haldane, head of financial stability at the Bank of England, argues that the relationship between the banking system and the government (in the UK and the US) creates a “doom loop” in which there are repeated boom-bust-bailout cycles that tend to get cost the taxpayer more and pose greater threat to the macroeconomy over time. What can be done to break this loop?
2. Senator Aldrich and the National Monetary Commission explicitly sought to establish a bailout mechanism that would replace the role played by JP Morgan in saving the financial system during the panic of 1907, and Aldrich saw the creation of the Federal Reserve in 1913 as the lynchpin of that system. But this approach has a fatal flaw. As we saw in the 1920s, a lightly regulated financial sector can produce a boom, based on a high degree of debt, that causes major disruption when it crashes and leads to a Great Depression — even if the major banks are (initially) saved. How should we modify the Aldrich system to remove such risks?
3. Mervyn King, governor of the Bank of England, argued in his recent Edinburgh speech that re-regulating the financial system will not effectively reduce its risks. And history suggests that Big Finance always gets ahead of even the most able regulators. Governor King insists instead that the largest banks should be broken up, so they are no longer “too big to fail.” Paul Volcker and Alan Greenspan, in recent statements, have supported the same broad approach. Can you explain why you differ from Mervyn King, Paul Volcker, and Alan Greenspan on this policy prescription?
In the history books, the Bernanke era at the Fed will be divided into three parts. Through September 2008, Bernanke operated in the shadow of the Greenspan legacy: laissez-faire with regard to bank regulation, taken to the point of absurdity.
In the second phase, once the global financial crisis broke in earnest, Bernanke moved with alacrity to rescue the financial system. History will likely judge him as too generous to the bankers at the center of the mess, but the real point person on bank-by-bank bailouts was NY Fed President/Treasury Secretary Tim Geithner. Bernanke will be reappointed because our Worst Crash did not turn (yet) into a Great Depression.
The third phase is for Mr. Bernanke to decide. Will he become a great reformer, like Marriner S. Eccles in the 1930s, leading the charge to rein in the damage that investment banking, writ large, could cause? Or will his legacy be closer to that of George L. Harrison, head of the New York Fed as the stock market crashed in 1929. Harrison led vigorous efforts – sometimes stretching his legal authority to its limits – to save big banks and by the fall of 1930 was congratulating himself that no major financial institutions had failed. At that point, Harrison thought his work was substantially done; sadly, he was very wrong.
By Simon Johnson
A version of this post appeared on the NYT’s Economix this morning and is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.