Roger Lowenstein has a profile on Ben Bernanke. Some key takeaways

Why the 4% Club Failed

But after talking with the chairman at length (he was generally not willing to be quoted on this issue), I think that, although Bernanke appreciates the intellectual argument in favor of raising inflation, he finds more compelling reasons for not doing so. First is the fear that inflation, once raised, could not be contained. The Fed creates inflation by adding reserves to the banking system (falling interest rates are the market’s way of registering the increasing plenitude of money). If so much money enters the system that wages and prices start ratcheting upward, the momentum can be self-perpetuating. “The notion that we can antiseptically raise the target and control it is highly questionable,” Bernanke told me.

This is something that will fascinating to hear about in the aftermath but it seems to fly in the face not only of what Bernanke himself has said but the history of modern central banking.

Suppose worst came to worst and inflation expectation became unmoored. The Volker Fed tamed them in the 1980s with a recession far less damaging and far more easily recovered from than this one.

A few conjectures are that Bernanke is especially sensitive to creating a new recession that would be his fault as opposed to someone else’s fault, or that there is a fear of the next generation. That the Committee to come later may not have the nerve to do what needs to be done.

Law and Responsibility

According to Greg Mankiw, formerly President George W. Bush’s top economist and now an adviser to Mitt Romney, Bernanke earnestly believes in the democratic process; he thinks disclosure will lead to a more responsible electorate. Perhaps this is why the public vitriol so disturbs him. Bernanke himself eschews hyperbole (he chooses his words with meticulous care) and refrains from personalizing policy differences. In December, he felt compelled to release a letter to Senate leaders in which he distinguished Federal Reserve loans, which have not cost the taxpayers anything or added to the federal deficit, from “government spending”—a simple point, perhaps, but one that is often confused in the public discourse.

Which is an important moral question and one on which I long suspected the Chairman and I were deeply at odds.

From my vantage point the purpose of the democratic process is to check your actions as a public official. It is not your role to check yourself. It is your role to vigorously pursue policies that are in the best interest of your polity.

If your polity choses to vote you out of office or send you to jail or send you to the gallows, then so be it. But, let them do it. “I followed the law” or “I respected the democratic process” is no shield against the consequences of action or inaction.

They Know Nothing!

In 2007, as the subprime-mortgage crisis leached into the financial markets, Bernanke’s training failed him. As a scholar, he had studied how bank failures worsened the Depression; as the Fed chair, he didn’t scrutinize the banks closely enough—that is, he overlooked the fact that dicey mortgage-backed securities made up a sizable portion of the assets of the biggest banks. “Risk was concentrated in key financial intermediaries,” he told me. “It led to panics and runs. That’s what made it all so bad.” Speaking of government officials collectively, he added, “Everyone failed to appreciate that our sophisticated, hypermodern, highly hedged, derivatives-based financial system—how ultimately fragile it really was.”

What is still so shocking to me and I don’t completely understand was the ease at which leading policy officials dismissed those of us who were freaking out.

I mean sure, who would have listened to me personally, but there wasn’t some grand mystery about what was going on. I wrote in late 2007 in response to someone who proposed that Citigroup could survive if it split-up

The problem I see is this: we know that Citi will take more write downs on direct holdings of CDOs. I don’t think anyone on the outside knows for sure whats going to happen when all of Citis SIV rolls back on to the books. On top of that there are looming losses in Credit Card where Citi is heavily exposed as well as non-Agency prime mortgages and HELOCs. This is not even counting what kind of shit storm comes to fruition in CMBS.
. . .

As a side note some people will undoubtly say that Citi has a 5% cushion in SIV losses and all of its CMBS are super-senior. To that I can only say look at Adams Square which went from AAA to nothing and tell me there is no risk in supersenior CMBS.

At this point we were debating whether there was any possible way of saving the largest bank in the world. It wasn’t like we had access to some private stash of information. This was all public and publically discussed on message boards, emails, blogs, the like.

It seemed like this odd situation where financials were trading with positive valuations because of the Fed put and the Fed was saying “Look, no need for a put, the stocks are trading at positive valuations”

Then, of course, Lehman was the aha moment when both sides realized how vast the chasm was.

This is Just Monetary Policy

Amazingly Lowenstien writes and people still seem to believe this

If banks, presently, were to lend all their excess reserves, say in the form of cash, the supply of currency would nearly triple overnight, and the price of a burger would, you can bet, do the same.

. . .

In plain English, Bernanke plans to reward the banks for keeping some of their money inert, which will give him time to unwind the balance sheet gradually. No one knows whether this gamble will work.

At this point I have to ask – maybe I am crazy? Maybe I just don’t get it.

How is paying interest on reserves any different from setting the Fed Funds rate?

In the case of the Funds Rate the Fed commits to printing any and all money necessary to hold the rate at target. That implies that in theory the Fed stands willing to create $10 Trillion in reserves if the banks ask for it.

Now, the banks have reserves but are held back by the interest on reserve policy,

Maybe you can say there are some technical details, such as the in the former case the Fed could simply allow the Funds rate to spike if things were getting too out of control. But, be serious, the Fed could simply “advise” banks that they slow the accumulation of required reserve balances while it reviews the interest on reserve policy.

There is much, much more but I walked away feeling a bit more confident in the asymmetric response hypothesis. That the FOMC has a hard time doing more, but as things improve will not do less.

That’s what we need to make the Kick work.

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