The challenges awaiting Ben Bernanke once he’s approved, as expected, for a second term as Federal Reserve chairman will make the bumpy reappointment process seem like a walk on the beach.
It’s hard to overstate the difficulty of achieving just the right sense of balance and timing Bernanke will need as he begins his efforts to get the U.S. economy standing on its own two feet again.
Bernanke will need to start unwinding government programs that pumped trillions of dollars of liquidity into the economy in a mostly successful effort to open credit markets that shut down following the collapse of the U.S. housing market two years ago.
Meanwhile, he and his fellow members of the Federal Open Market Committee will have to start thinking about raising key interest rates from the zero-range to which they were cut more than a year ago, also in an effort to stimulate economic growth.
These two actions, credited by many with helping to stave off another Great Depression, will have to be accomplished despite a double-digit unemployment rate that isn’t expected to significantly improve for at least another year.
Moreover, the Fed chairman will be making his decisions in an atmosphere of intense political scrutiny.
“I don’t ever remember the Fed having such a difficult set of judgments to make as it does right now. There’s simply no precedent for this,” said Cliff Waldman, an economist for the Manufacturers Alliance/MAPI, a public policy and economics research organization in Arlington, Va.
A short history of the recent financial crisis is necessary in order to illustrate the monumental dilemmas Bernanke will face early in his second term (assuming his approval by the Senate by the end of this week).
A housing bubble created by low interest rates, easy credit, government policies that promoted home ownership, and a banking culture that rewarded big risks pushed home values too high too fast. That environment allowed millions of borrowers to get mortgages they simply couldn’t afford.
When home values collapsed and borrowers stopped paying their mortgages, the big banks that had purchased many of those loans in complicated securities began bleeding money in copious amounts.
In short order, those same banks stopped lending money, and the U.S. economy very nearly seized like a car engine running without motor oil.
To prevent a second Great Depression, Bernanke, one of the foremost scholars of the first Great Depression, “sent in all the troops,” said Waldman.
Specifically, he introduced a dizzying array of innovative and creative methods for keeping credit flowing to various key sectors of the U.S. economy.
The programs, which in effect made the U.S. government the guarantor of trillions of dollars of loans, were put in place to ensure liquidity in the markets for auto loans, student loans, credit cards and mortgages. Each of these lending sectors had essentially frozen following the collapse of Lehman Brothers in September 2008 as banks grew leery of making any loans that might not get repaid.
By introducing these liquidity programs, the Federal Reserve became “the de facto lender” for the entire U.S. economy, Waldman explained.
Now what has emerged is “a kind of uneasy détente,” according to Waldman, in which a near financial crash has been “neutralized by everything the Fed had at its power.”
The question on everyone’s mind – consumers, economists, securities traders, politicians, etc. – is when and how those programs can be dismantled without pushing the economy back into a crisis.
The other side of that question is how long those programs can be left in place before inflation sets in. More than a few skeptics of the Fed’s unprecedented intervention believe all that loose stimulus cash is bound to push prices higher.
Once Bernanke is settled into his second term, the political pressure to start addressing inflation fears is going to be tremendous.Economists such as Waldman believe the most important — and probably the most difficult – thing Bernanke must do is resist the political pressure.
“The Fed’s liquidity programs are the only thing between us and another recession right now. It’s really been the Fed’s monetary policy that prevented a disaster, it really did,” said Waldman. “The worst mistake that Bernanke can make right now is to start pulling the stimulus too fast. If the Fed acquiesces (to political pressure) too fast and raises interest rates and pulls in stimulus too early, that’s the biggest risk of a double-dip recession.”
Several of these “liquidity facilities” are set to expire Feb. 1. But others, notably the $1.25 trillion mortgage-backed securities program in which the Fed buys loans from struggling mortgage giants Fannie Mae (FNM: 0.9869, -0.0131, -1.31%) and Freddie Mac (FRE: 1.17, -0.03, -2.5%), have longer shelf lives, and there is considerable debate over whether to end them, or to extend and possibly even expand them.
Most economists agree that no significant tightening of Fed monetary policy will occur until the labor markets show clear proof of consistent growth. That means several months of improvements in a row, and no one really expects that to happen until the second half of 2010 at the earliest.
The wild card in all of this is politics, always unpredictable.
Just over two weeks ago, Bernanke’s reappointment seemed a lock. Then Republican Scott Brown won an upset victory in the race to fill Ted Kennedy’s Senate seat in Massachusetts and suddenly populist outrage became all the rage at both ends of the political spectrum.
The public’s already healthy disdain for the Fed, generated by a perception that the central bank bailed out Wall Street at the expense of Main Street, turned Bernanke into an easy target for politicians trying to score points with their angry constituents.
And the Fed was already facing calls for reform for failing to act ahead of the collapse of the U.S. housing market, and for failing to properly regulate the various entities that contributed to the bubble that led to that collapse.
Bernanke will have to make all of his decisions within this charged and difficult environment. Will he succumb to political pressure? Vincent Reinhart, a resident scholar at the American Enterprise Institute, a conservative think tank, doesn’t think so.
“I’ll think he’ll do what’s right. He’ll make the right macro choice. But the way the Fed implements policy and the way they explain their policies will be influenced” by the political atmosphere, he said.
Congress has more leverage over the Fed than at any time in recent history, he said, and that will undoubtedly have Bernanke looking over his shoulder.
In short, Reinhart said Bernanke won’t have a lot of time to celebrate his likely reappointment this week. “It doesn’t get better after the Senate votes,” he said.
By Dunstan Prial – foxbusiness.com
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