The Apology of Socrates was written by Plato and Xenophon; with In Fed We Trust: Ben Bernanke's War on the Great Panic – How the Federal Reserve Became the Fourth Branch of Government, David Wessel (published by Crown Business) makes his bid to do the same for Federal Reserve Chairman Ben Bernanke (and Treasury Secretary Tim Geithner, to a lesser extent). While the book doesn't paint the actions of the Federal Reserve as infallible—if anything, quite the opposite—Wessel shows Bernanke and his colleagues' earnestness such that you can't really blame them: they realized they made mistakes and they did their best. The underlying implication throughout the narrative of the financial panic of summer 2007 to winter 2009 is that without Bernanke, it would have been worse.
I must admit, I went into reading this book (my second for the CFA book club) thinking that I would probably only like it if the title was intended to be ironic. Very quickly, its sincerity is evident. Wessel's day job is as a journalist for the Wall Street Journal, and for the most part the book reads like an extended article with an inside view to the Fed's actions over a period of almost two years, plus background of Bernanke and other major players (as well as the Fed itself). And that's fine so far as it goes. But, because of his extensive interviews and insider access to Bernanke and others (as indicated in the Acknowledgments) he almost fully incorporates their view of the world, so that he portrays it not as their opinion, but as the truth.
Chapter 2 explains the early history and development of the Federal Reserve, and it begins with the famous story of J.P. Morgan dealing with the Panic of 1907. Morgan's solution was clean: it didn't prevent problems because nothing can, but it looks a lot closer to the optimal than nearly anything in the episodes of the Federal Reserve from its creation in 1913. That series of failures reached its nadir with the Great Depression, for which Bernanke, then a Fed Governor, apologized to Milton Friedman in 2002. Wessel repeats that quote to end the book. Unwittingly though, Wessel's chapter on the early Fed anticipates the ineffectiveness, and sometimes cluelessness, of the Fed during the recent recession.
I remember when I took economics classes that looked at monetary policy in high school and college, we always learned the Fed had three tools: the reserve requirement, discount lending, and open market operations (fed funds rate). When I started looking at the Fed's website for work (June 2007), those same three showed up as the tools that they themselves claimed. In August 2007, they began to lower the discount rate, in September the fed funds rate. In December, finding that the discount window wasn't as effective as it should be, the Fed began its TAF program, and with that the Fed's tools began to grow from three, to around ten by the end of the next year. What neither Wessel nor Bernanke seem to care about is that when the interest rates were lowered in the fall of 2007, the price of oil (and other commodities) broke out of the cycle they'd been in the past few years, going up in the summer and down in the winter. That fall, prices continued moving up. Oil is an input to the production of nearly everything, so an increase in its price leads to a decline in the aggregate supply in the economy. The Fed's moves didn't do anything to arrest the problems in the financial markets, but they certainly were hurting the rest of the economy at that point. By not even dealing with this question, I remain in the belief that the higher prices hurt consumers, including in their ability to pay their mortgages. I'm open to evidence that this isn't the case, but Wessel presents none.
By January 2008's cumulative 1.25% rate cut in the span of a week, Bernanke seemed like he was panicking, whether the Societe Generale debacle had any influence or not. The brokered deal in March to save Bear Stearns was often invoked later as the precedent by which the market expected Lehman Brothers to be rescued too, six months later. No thought is given to the possibility that this makes the Bear decision wrong, rather than the Lehman decision. Rather than chiding the politicians for not having the will to act strongly between those events (on the scale of TARP), the Fed and Treasury should have used that time to work out more surgical and less costly ways to work on the problems. The financial system is a public good, but no single financial firm is.
TARP is emblematic of perspective Wessel brings. Despite being marketed so deceptively, no real consideration is given to any of the alternatives that were being discussed in September and October of 2008. My feeling at the time was that instead of focusing on assets, focus on liabilities. Even a worthless asset, if backed by equity, doesn't pose much risk beyond its owner. Rather, moves to shore up liabilities, through some kind of insurance or guarantee scheme could have better targeted those entities that were really in trouble. Anyhow, for Wessel and Bernanke and Paulson and Geithner, TARP was (and is) indispensible. The significant drop in the stock market the day the House first rejected TARP is taken as proof that the market believed TARP was necessary too; for a day or week, the market can through a tantrum too—that doesn't make it right. He skips mention of the market making up a lot of that ground the next day, when the bill's passage was in doubt, but acknowledges it went further down as and after Congress did approve it. Frankly, Wessel does no better than anyone else about what the real worst case scenario would look like. To me, any argument that one institution's failure would lead to drastic consequences in every facet of our lives is a case for radical decentralization—political and economic—that should start immediately. TARP did the opposite.
In response to recent propaganda by the likes of Geithner for claiming the success of TARP two years later, I want to share this piece I read last week. I don't agree with all Dr. Pitchfork's politics, but I think his economic analysis is solid. Basically, TARP did nothing to wring the risks from the Too Big to Fail standard out of the system. Since the last "dashboard" in June 2009, financial markets and unemployment are both higher, while the price of oil is little changed. We face the near prospect of further quantitative easing. I'd say the government in all its branches has done too much already.
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