Bernanke spins the crisis

I learned this morning that President Obama has reappointed Ben Bernanke as the Chairman of the Federal Reserve. This is not surprising. Mr. Bernanke has battled the most destructive economic event in several generations, and while far from perfect, his strategy to remedy our condition has produced a leveling off of the worst of the crisis to date.

On Friday, speaking at Jackson Hole, Wyoming, to a global convocation of central bankers, Bernanke attempted to lay out the “lessons” of the past year, but my sense is that he left a good deal out of the speech. Indeed, some feel the speech was too triumphant, but I’m not especially put out by its tone, but rather what it leaves out of the discussion.

Most notably, the Fed Chairman’s summary of why the US government allowed Lehman Brothers to fail – calling its bankruptcy “unavoidable” – is simply false. Lehman’s case was difficult, but no more so than AIG, the large insurer that US financial authorities have bailed out to the tune of $180 billion. If anything, the gallery of failed enterprises bailed out by Washington – from GSEs Fannie Mae and Freddie Mac to General Motors – has demonstrated that there was absolutely nothing “unavoidable” about Lehman’s bankruptcy.

A more likely explanation for why Lehman was allowed to fail is timing and ideology. Lehman Brothers was the first enterprise of what I would call “global systemic relevance” to falter and to do so without a white knight acquirer to save it (remember, Bear Stearns was “saved” earlier via a government-arranged sweetheart deal with J.P. Morgan); therefore, it put the bureaucrats on the spot – they had to make a decision. Unswayed by protestations that Lehman’s collapse would be very bad, the authorities invoked moral hazard and made an example of Lehman. No one at the Fed has invoked moral hazard since.

Overall, I agree with Bernanke’s sense of where we are – things could definitely be worse; however, by papering over his early mistakes and misapplications of ideology, his speech lacks a certain veracity. Bernanke characterizes the “lessons” learned as nothing all that surprising to economic historians such as himself, but judging from his policy responses post-Lehman, I’d say the destruction unleashed by Lehman’s bankruptcy surprised him and most everybody else. If they had had a clue as to what was to follow, they would have never let Lehman die.

I suppose there is a need for central bankers to seem like they’re in control and that they fully understand the financial system, but for a few months last year, the global financial system became unhinged, and we’ll be counting the costs for years in the form of bloated deficits and economic inefficiency. Give Bernanke credit on one front, though – rather than continue to mouth platitudes, he took decisive action when few others were willing to do so. While Federal Reserve policies played a role in the creation of the financial mess, it was not Ben Bernanke’s fault that so many market actors made so many bad decisions over a such long period of time. It was just his bad luck to have the job of cleaning up the mess.