Monday, November 24, 2008

Bailout Costs

If you are in a mood for schedenfreud, which we aren't particularly today, you might think from the current issue of The New Yorker that poor Ben Bernanke had it coming to him.

Or, that it's only justice that he would just happen to be the chairman of the Federal Reserve when the housing bubble collapsed, taking down Wall Street's house of cards.

Or, that Abudantia, the Roman goddess of money, has a wicked sense of humor:
The other event that changed Bernanke’s career occurred in the summer of 1999, at the height of the Internet stock boom, when he and Gertler were invited to present a paper at an annual policy conference organized by the Federal Reserve Bank of Kansas City. The topic of the conference—which takes place at a resort in Jackson Hole, Wyoming—was New Challenges for Monetary Policy.

Then, as now, there was vigorous debate among economists about whether central banks should raise interest rates to counter speculative bubbles. By increasing the cost of borrowing, the Fed, at least in theory, can restrain speculative activity and prevent the prices of assets such as stocks and real estate from rising excessively.

Bernanke and Gertler argued that the Fed should ignore bubbles and stick to its traditional policy of controlling inflation. If a bubble inflated and burst of its own accord, they said, the Fed could always bring down rates to alleviate damage to the broader economy. To support their case, they presented a series of computer simulations, which appeared to show that a policy of targeting inflation stabilized the economy more effectively than one that targeted bubbles.

The presentation got a mixed reception. Henry Kaufman, a well-known Wall Street economist, said that it would be irresponsible for the Fed to ignore rampant speculation. Rudi Dornbusch, an M.I.T. professor (who has since died), pointed out that Bernanke and Gertler had overlooked the possibility that credit could dry up after a bubble burst, and that such a development could have serious effects on the economy.

But Greenspan was more supportive. “He didn’t say anything during the session,” Gertler recalled. “But after it was over he walked by and said, as quietly as he could, ‘You know, I agree with you.’ That had us in seventh heaven.”
* * *
Bernanke hadn’t said much about regulation before being nominated as the Fed chairman. Once in office, he generally adhered to Greenspan’s laissez-faire approach. In May, 2006, he rejected calls for direct regulation of hedge funds, saying that such a move would “stifle innovation.”

The following month, in a speech on bank supervision, he expressed support for allowing banks, rather than government officials, to determine how much risk they could take on, using complicated mathematical models of their own devising—a policy that had been in place for a number of years. “The ongoing work on this framework has already led large, complex banking organizations to improve their systems for identifying, measuring, and managing their risks,” Bernanke said.

It is now evident that self-regulation failed. By extending mortgages to unqualified lenders and accumulating large inventories of subprime securities, banks and other financial institutions took on enormous risks, often without realizing it. Their mathematical models failed to alert them to potential perils.

Regulators—including successive Fed chairmen—failed, too. “That was largely Greenspan, but Bernanke clearly shared an ideology of taking a hands-off approach,” Stephen Roach, of Morgan Stanley Asia, said. “In retrospect, it is unconscionable that the Fed didn’t really care about regulation, or didn’t show any interest in it.”

The thing is, as John Cassidy also reports, Bernanke at least listened to his critics -- and eventually came to agree with them. Too late, perhaps, but reality eventually did prevail. Bernanke jettisoned the conservative ideology that didn't work and became as much a socialist, in effect, as the circumstances required.

It's been an expensive lesson, however. Bloomberg News estimates $7.76 trillion already has been spent or committed by the FED and Department of Treasury:
The money that’s been pledged is equivalent to $24,000 for every man, woman and child in the country. It’s nine times what the U.S. has spent so far on wars in Iraq and Afghanistan, according to Congressional Budget Office figures. It could pay off more than half the country’s mortgages.
And, you know as well as we do that it isn't over yet.

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