THE CASE AGAINST BERNANKE / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( RECOMMENDED READING )

The case against Bernanke


By Stephen Roach

Published: August 25 2009 16:02


Barack Obama has rendered one of his most important post-crisis verdicts: Ben Bernanke will be nominated for a second term as chairman of the Federal Reserve. This is a very shortsighted decision. While America’s head central banker deserves credit for being creative and courageous in orchestrating an unusually aggressive monetary easing programme, it is important to remember that his pre-crisis actions played an equally critical role in setting the stage for the most wrenching recession since the 1930s. It is as if a doctor guilty of malpractice is being given credit for inventing a miracle cure. Maybe the patient needs a new doctor.

Mr Bernanke made three critical mistakes in his pre-Lehman incarnation: First, and foremost, he was deeply wedded to the philosophical conviction that central banks should be agnostic when it comes to asset bubbles. On this count, he stood with his predecessor – serial bubble-blowing Alan Greenspan – who argued that monetary authorities are best positioned to clean up the mess after the bursting of asset bubbles rather than to pre-empt the damage. As a corollary to this approach, both Mr Bernanke and Mr Greenspan drew the wrong conclusions from post-bubble strategies earlier in this decade put in place after the bursting of the equity bubble in 2000. In retrospect, the Fed’s injection of excess liquidity in 2001-2003, which Mr Bernanke endorsed with fervour, played a key role in setting the stage for the lethal mix of property and credit bubbles.

Second, Mr Bernanke was the intellectual champion of the “global saving glut” defence that exonerated the US from its bubble-prone tendencies and pinned the blame on surplus savers in Asia. While there is no denying the demand for dollar assets by foreign creditors, it is absurd to blame overseas lenders for reckless behaviour by Americans that a US central bank should have contained. Asia’s surplus savers had nothing to do with America’s irresponsible penchant for leveraging a housing bubble and using the proceeds to fund consumption. Mr Bernanke’s saving glut argument was at the core of a deep-seated US denial that failed to look in the mirror and pinned blame on others.

Third, Mr Bernanke is cut from the same market libertarian cloth that got the Fed into this mess. Steeped in the Greenspan credo that markets know better than regulators, Mr Bernanke was aligned with the prevailing Fed mindset that abrogated its regulatory authority in the era of excess. The derivatives’ explosion, extreme leverage of regulated and shadow banks and excesses of mortgage lending were all flagrant abuses that both Mr Bernanke and Mr Greenspan could have said no to. But they did not. As a result, a complex and unstable system veered dangerously out of control.

Notwithstanding these mistakes, Mr Obama may be premature in giving Mr Bernanke credit for the great cure. No one knows for certain as to whether the Fed’s strategy will ultimately be successful. The worst of the US recession appears to have been arrested for now – a fairly typical, but temporary, outgrowth of the time-honoured inventory cycle. But the sustainability of any post-bubble recovery is always dubious. Just ask Japan 20 years after the bursting of its bubbles.

While financial markets are giddy with hopes of economic revival – in part inspired by Mr Bernanke’s cheerleading at the Fed’s annual Jackson Hole gathering – there is still good reason to believe that the US recovery will be anaemic and fragile. US consumers are in the early stages of a multi-year retrenchment as they cut debt and rebuild retirement saving. The unusual breadth and synchronicity of the global recession will restrain US export demand from becoming a new growth engine.

It would be the height of folly to reward Mr Bernanke for the recovery that never stuck. Yet Mr Bernanke’s apparent reward is, unfortunately, typical of the snap judgments that guide Washington decision-making. In this same vein, it is hard to forget Mr Greenspan’s mission-accomplished speech in 2004 that claimed “our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful”. Eager to declare the crisis over, the Obama verdict may be equally premature.

The Bernanke reappointment is a welcome chance for a broader debate over the conduct and role of US monetary policy. Mr Obama has made sweeping proposals that give the Fed broad new powers in managing systemic risks. I argued in the Financial Times 10 months ago that the Fed should not be granted these powers without greater accountability as required by a “financial stability mandate” – in effect, forcing the Fed to shape monetary policy with an aim towards avoiding asset bubbles and imbalances. Without a revamped policy mandate, it is conceivable that we could face another destabilising crisis.

Ultimately, these decisions boil down to the person – in this case, Mr Bernanke – who is being charged with the awesome responsibility as America’s chief economic policymaker. As a student of the Great Depression, he should have known better. Yes, he reacted strongly after the fact in taking actions to avoid the pitfalls highlighted by his own research. But he lacked the foresight and courage to resist the most reckless tendencies of the era of excess. The world needs central bankers who avoid problems, not those who specialise in post-crisis damage control. For that reason, alone, he should not be reappointed. Let the debate begin.

The writer is chairman of Morgan Stanley Asia and author of The Next Asia to be published next month

Copyright The Financial Times Limited 2009