High Hard One

In case you missed it:

What, No Question About the Salahis?

With only a couple of exceptions, Bernanke's hearing today was a frightening abdication of responsibility even by contemporary DC standards. Most of the senators seemed oblivious to the purpose of the hearing, which was to consider an individual's past performance and current suitability for a specific job. Instead there was question after question about the Fed's organizational structure, the federal budget, and bank lending and supervision -- topics that had no place in this type of hearing. Bernanke was cordially invited to opine almost on whatever he wanted, with softball questions on healthcare reform, ATM fees, and financial literacy. I was waiting for one about the White House party crashers. About thirty minutes in, Bernanke knew the score and was comfortable enough to start grinning.

It took almost an hour and a half before anyone bothered to get to AIG. I think the dollar was mentioned once all day. Bernanke's use of the output gap, which currently underpins the largest monetary experiment in history and is the target of important new criticism from the Fed's own researchers? Not mentioned once. Gold? Schmold.

How did my list of 15 questions fare? Jim DeMint read Bernanke's bad predictions verbatim from my question #4. He also asked my question #10 on whether employment should be part of the Fed's mandate. A pitch-perfect, wonderfully caustic Jim Bunning mentioned the TARP Inspector General's recent disclosure about AIG's counterparties, #1 on my list. He also pointed out Bernanke's desire to lower rates even more in 2003, #3 on my list.

Outside of those two senators, almost everyone else was either a waste of time or an embarrassment to their constituents. I was stunned by how little of the public's outrage came through in the tone and substance of the questions. Bunning and Bernie Sanders have now announced holds on Bernanke's nomination, and there's post-hearing chatter that others may join them. Again, if this issue is important to you, I urge you to contact your senators.

Update: DeMint makes it three.

More: Vitter makes it four.

"Fingers In The Wind"

I received this update from a former staffer on the Senate Banking Committee:

Just an anonymous observation, but as a former staffer for one of these Senators, I'll just point out the obvious: most of them have their fingers in the wind right now. They're leaning to confirm BB, because they don't want to be out on a limb, and there's a lot of talk coming from Wall Street that continuity is absolutely necessary to maintain investor confidence, and that BB is critical in this regard. On the other hand, they recognize that the Fed is very unpopular. If they see signs of strong sentiment against the Fed, they may vote against him, but this is all about politics right now.

The word going around is that tomorrow's hearing has suddenly become a lot more important than it was just a few days ago.

Hot Lights, A Pitcher Of Water

With Bernanke's confirmation hearing set for tomorrow morning, there's been a lot of posturing and teeth-gnashing from Congress and specifically from some members of the Senate Banking Committee. With a few notable exceptions, most of this isn't more than an obligatory nod to growing public outrage. But the bottom line is that Bernanke is now a known commodity; what you've seen is what you'll continue to get. That makes any senator voting in favor of his reappointment complicit in whatever happens during the next few years.

If this issue is important to you, contact members of the Senate Banking Committee, especially if you are a constituent. Here is a list of the committee's members, along with contact information. Some suggested questions for Bernanke are here, and send your own as well. I'll try to post some comments after the hearing.

Hooked

All it took was for [U.S. Ambassador] Max Taylor to hold the line in Saigon to keep the Vietnamese military in line, to get the surface stability which Washington required. And once again [in 1965] the Vietnamese had blown it; they aided their enemies in Washington who said they were not worth American lives, and who said they were not a government, and not a nation and not worth fighting for. ... Although they were warned that America would stand for no more, that they could not toy with a great power like this, that American support was becoming more difficult, they did not believe it. They had already learned that the worse things got and the more the Americans threatened them with disengagement, the more the Americans coughed up; that they had sunk the hook deeper into the Americans than the Americans had sunk it into them.

David Halberstam, The Best and the Brightest

Fear Factor

The attempts to short-circuit a basic level of openness and accountability are getting increasingly frantic now. Note the specious claim about the apocalyptic consequences of letting the public see behind the curtain, which only makes you wonder what they're so desperate to keep secret. If the appeal to fear doesn't seem familiar, how about this:

"The Federal Reserve, like other regulators around the world, did not do all that it could have to constrain excessive risk-taking in the financial sector in the period leading up to the crisis."

I half-expected something about how other intelligence agencies also got it wrong. And some unintended hilarity:

[The proposed audit] would serve only to increase the perceived influence of Congress on monetary policy decisions, which would undermine the confidence the public and the markets have in the Fed to act in the long-term economic interest of the nation.

Yes, we wouldn't want to undermine the overflowing confidence and trust the public has in the Fed right now.

For a great explanation of what's at stake, this William Greider article from a few months ago is one of the best I've read. The fundamental issue here isn't monetary policy. It's really about democracy and individual economic freedom.

The GAO can't get in there fast enough.

Rewarding Failure

The Senate Banking Committee has scheduled Ben Bernanke's reconfirmation hearing for Thursday, December 3. It's incredible that we're reconfirming someone who should be on any list of the top ten people most responsible for the credit bubble and current economic situation. As someone who supported Obama last fall based largely on the frightful alternative (a decision that Palin has since proven right) I think reappointing Bernanke was the single worst decision he's made as president. I've been disappointed in Obama's lassitude on Wall Street reform, and I believe a comprehensive, exhaustive audit of the Federal Reserve is crucial to restoring public trust in policymakers and the financial system.

Bernanke's upcoming hearing is not the place for pro forma glad-handling and major kudos on "averting disaster with decisive action." It's a time for sober reflection on the extraordinary commitments an unelected official has made on behalf of every American, and for a caustic examination of his record and what it implies about his ability to conduct policy going forward. There are lots of questions that could and should be asked, but here are some important ones:

1. The TARP Inspector General recently disclosed that the New York Federal Reserve did not believe that AIG's credit-default swap (CDS) counterparties posed a systemic financial risk. In Congressional testimony and elsewhere, you have stated repeatedly that AIG posed a systemic risk based partly on its CDS obligations [source: Bernanke's testimony to the House Financial Services Committee, 3/24/09]. Explain this apparent contradiction. What was your specific role in the decision to pay AIG's counterparties 100 cents on the dollar?

2. On May 5, 2009, in front of the Joint Economic Committee, you said the following about the unemployment rate: "Currently, we don’t think it will get to 10 percent. Our current number is somewhere in the 9s" [source]. In November it hit 10.2%, and many economists predict it will go even higher. This is happening despite enormous fiscal and monetary stimulus that you previously said would help create jobs. What happened after your JEC testimony in May that caused your prediction to miss the mark?

3. It's now widely accepted that loose monetary policy is at least partly to blame for the credit bubble and subsequent crash. You played an important role in that policy. For eight straight meetings of the FOMC, from June 2003 to May 2004, you voted to keep the Fed funds rate at 1%. But transcripts of recently-released FOMC meetings show you wanted the FOMC to consider cutting rates even further. In the August 12, 2003 meeting, with the Fed already at 1%, you said:

Despite the good news, I think it’s premature to conclude that we should not consider further rate cuts, if not at this meeting then at some time in the near future depending on how the data play out. [source: transcript of FOMC meeting on 8/12/03, page 63]

How much worse would the bubble and subsequent crash have been if you had gotten your way? What do your comments in that meeting imply about your ability to correctly time the reversal of the Fed's current accommodative policy?

4. Forecasts are an important part of the Fed's work. Monetary policy by nature depends on forecasts, making predictive ability an essential part of the job description for any Fed chairman. Yet your record of predictions, including the one about unemployment in (2) above, is questionable at best. Some examples [source]:

March 28, 2007: “The impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.”

May 17, 2007: “We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”

Feb. 28, 2008, on the potential for bank failures: “Among the largest banks, the capital ratios remain good and I don’t expect any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system.”

June 9, 2008: “The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”

July 16, 2008: Fannie Mae and Freddie Mac are “adequately capitalized” and “in no danger of failing.”

Explain this pattern of terrible predictions and forecasts. What do they imply about your ability to conduct policy going forward? Is there some fatal flaw in your economic models or forecasting tools? Are you just winging it?

5. Derivatives such as credit-default swaps played an important role in the financial crisis, and they are central to the financial reforms currently being contemplated. During the Senate Banking Committee's hearing in November 2005 to confirm you as Alan Greenspan's successor, you had the following exchange with Senator Paul Sarbanes [source]:

SARBANES: Warren Buffett has warned us that derivatives are time bombs, both for the parties that deal in them and the economic system. The Financial Times has said so far, there has been no explosion, but the risks of this fast growing market remain real. How do you respond to these concerns? BERNANKE: I am more sanguine about derivatives than the position you have just suggested. I think, generally speaking, they are very valuable. They provide methods by which risks can be shared, sliced, and diced, and given to those most willing to bear them. They add, I believe, to the flexibility of the financial system in many different ways. With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly. The Federal Reserve’s responsibility is to make sure that the institutions it regulates have good systems and good procedures for ensuring that their derivatives portfolios are well managed and do not create excessive risk in their institutions.

How did you get it so wrong?

6. An important factor in the financial crisis (and a large part of the ultimate cost to taxpayers) was the implicit government guarantee of the GSEs. In part because of decisions you made, there is now an explicit government guarantee of every large firm on Wall Street. Has moral hazard increased or decreased over the past year?

7. Via the FDIC, the American public now explicitly guarantees the bonds of Wall Street firms where bonuses are surging and individual employees can be paid millions of dollars a year. What is your opinion on the morality of this guarantee?

8. The importance you place on the output gap is well known. You have often cited "excess slack" in the economy to justify loose monetary policy, arguing that a large output gap lowers the risk of inflation. But economists such as Allan Meltzer have noted that there are "lots of examples of countries with underutilized resources and high inflation. Brazil in the 1970s and 1980s" [source]. Moreover, in a new paper dated December 2009 and titled "Has the Recent Real Estate Bubble Biased the Output Gap?", researchers at the Federal Reserve Bank of St. Louis state the following:

Because this (predicted) output gap is so large, several analysts have concluded that monetary policy can remain very accommodative without fear of inflationary repercussions. We argue instead that standard output gap measures may be severely biased by the bubble in real estate prices that, according to many, started around 2002 and burst in 2007.

They conclude with a warning that seems directed at you: "We offer a word of caution to policymakers: Policies based on point estimates of the output gap may not rest on solid ground."

Please comment on 1) Allan Meltzer's point and 2) the St. Louis Fed's research paper. Why do you continue to put such a high priority on the output gap?

9. In a scenario in which unemployment remains uncomfortably high, but the dollar continues to fall and commodities including oil and gold continue to rise, what would the Fed do? At what point do market signals take priority over hard-to-measure statistics like the output gap?

10. The Fed has a dual mandate: maximum employment and price stability. But unemployment is at its highest level in decades. And in early and mid-2008, with oil at $150 a barrel and prices of basic staples skyrocketing, opinion polls showed that inflation was the public's highest concern, even more so than jobs or the housing market [source]. Why has the Fed failed so badly in its mandate? Is employment an appropriate objective for monetary policy? Should the Fed have a single mandate of price stability?

11. In February 2009, Janet Yellen, president of the San Francisco Fed, said that the Fed needed to fight back against the argument that its liquidity efforts would eventually lead to higher inflation and higher interest rates, calling the notion "ludicrous" [source]. Since then, the dollar has fallen precipitously, oil has almost doubled in price, and gold has surged to all-time highs. Do you share your colleague's view on inflation?

12. What does the surge in gold mean to you? At what price level would it begin to worry you, if it doesn't already? Does gold have any impact on the Fed's policy deliberations?

13. Why does the Fed insist on waiting five years before it releases transcripts of FOMC meetings to the public? Shouldn't someone tasked with evaluating your performance and voting on your reconfirmation have access to transcripts from late 2008 and early 2009?

14. Has the Fed ever had an internal debate about how monetary policy contributes to geopolitical tensions via the rising oil prices caused by a falling dollar?

15. Before the financial crisis there was a widespread sense, especially on Wall Street trading desks, that the stock market was strangely resilient. This encouraged excessive risk-taking in various types of assets. Do you have direct or indirect knowledge of the Federal Reserve or any government entity or proxy ever intervening to support the stock market (or any individual stock) via futures or in any other way? If yes, who decides the timing of such intervention and with what criteria? How is it funded? Which Wall Street firm handles the orders, and who sees them before they are executed?

I think the disastrous broad-stroke mistakes Bernanke has already made, in some cases before he became Fed chairman, have pretty much determined his legacy. But depending on what happens in coming years, he could go down as one of the real bad guys in future books on economics. I know some Senate staffers are readers here, so maybe some of the above questions will find their way into the hearing. We'll see who deserves praise for their questions and who hands out major kudos.

The Prosperity Gospel

During the Bush years, I often wondered if there were any misgivings within the evangelical Right about supporting an administration that openly promoted an almost demonic obsession with the material world (Bush: "Go shopping"). Religious issues aren't exactly my bag, but this clears some things up.