Confidence Game

For those not familiar with Vincent Reinhart, he is a well-regarded former senior Fed official. He worked closely with Ben Bernanke; in early 2004, the two presented this important paper in which they wrote, “There seems to be little reason for central banks to avoid bringing the policy rate close to zero if the economic situation warranted.”

Reinhart recently wrote this interesting article about his former colleague. Excerpt:

There has been another casualty caught in the wreckage of Lehman Brothers over the past two years: Financial authorities have surrendered some of their credibility. As a case in point, Federal Reserve Chairman Ben Bernanke has offered three different descriptions of the rationale for not extending unusual support to the investment bank. He first told a congressional committee in the immediate aftermath that “counterparties had had time to take precautionary measures.” Inaction was described a year later in another congressional appearance as an unavoidable calamity, in which “The Federal Reserve fully understood that the failure of Lehman would shake the financial system and the economy. However, the only tool available to the Federal Reserve to address the situation was its ability to provide short-term liquidity against adequate collateral.” That is, the government had an inadequate range of tools to the circumstances. In the past month, however, the Financial Crisis Inquiry Commission was told by the Fed chairman that “any attempt to lend to Lehman would be futile and would only result in a loss of cash.” Evidently, it was not that markets were prepared or that nothing could legally be done. Now we have been told that nothing would work. Recognize that this is not a Rashomon effect, the same events remembered in different ways by different people. Nor is this a refined understanding brought about by unearthed information. This is the same person, at different points in time, characterizing policy makers' thought processes in mid-September 2008. By default, it must be that convenience dictated this sequence of “needn't, couldn't, and shouldn't.” This sequence, unfortunately, is informative of the reliability of future public disclosure.

Since leaving the Fed, Reinhart has both defended and gently chided it. But this is the most strident and direct criticism I've seen from him particularly with regard to Bernanke. While Reinhart is spot-on, he could have noted a specific part of Bernanke's Commission testimony from early September. Bloomberg (my bolds):

Federal Reserve Chairman Ben S. Bernanke said he regretted not saying in congressional testimony shortly after the failure of Lehman Brothers Holdings Inc. in 2008 that the central bank had no authority to save the firm. The testimony at the time “has supported this myth that we did have a way of saving Lehman,” Bernanke said today in response to questions during a Financial Crisis Inquiry Commission hearing in Washington. “I regret not being more straightforward there because clearly it has supported the mistaken impression that in fact we could have done something.” Bernanke made the remarks to explain the disparity between his September 2008 testimony that the Fed and U.S. Treasury “declined to commit public funds to support the institution” and later statements that the government had no option to save Lehman because of inadequate collateral. The Fed decided at the time against saying Lehman was unsalvageable because it may have risked further panic in financial markets, Bernanke said today. “It was a judgment at that moment, with the system in tremendous stress and with other financial institutions under threat of a run or panic, that making that statement might have even reduced confidence further and led to further pressure,” Bernanke said today.

This was a stunning disclosure that deserved far more attention than it got over a Labor Day weekend. Reinhart is right that Bernanke's inconsistent stories were all about "convenience." And the determination of what was "convenient" came from a single unelected official who was guided not by truth, or by the law, but by a subjective assessment of "confidence" made in the context of his own panic-tinged self-interest.

Reinhart also notes the implications for "the reliability of future public disclosure." The next crisis is only a matter of time. Its course and severity will depend largely on the Fed chairman's personal credibility. As the boy who wouldn't cry wolf while Lehman was being devoured, Bernanke has none except for his tragically credible promises to print more money. This is a perilous position for the country to be in.

The deeper issue is obvious: Bernanke has now admitted he purposely misled Congress and the public at a pivotal time in the nation's history. What other truths has he decided we must not know? When the next crisis hits, the financial markets will ask the same question.