Wessel: The Apology of Ben Bernanke

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.

A Perspective on Modern Parallels

Forgive me for disregarding my own maxim I wrote in the previous post, but I read an article by Bill Croke at The American Spectator online that I want to comment on briefly. The piece is called "Obama as Diocletian", and engages in the practice of finding historical parallels that stretches back at least as far as Plutarch in his biographies nineteen centuries ago. Trying to find common themes in the decline of the Roman Republic and/or Empire with the current American experience is also a well (if not over) used rhetorical trope.

As I've written, Diocletian does appear to represent the beginning of a new era in Roman history in a political sense; culturally, he is at the end of pagan dominance over Christianity. Croke compares Diocletian to Abraham Lincoln for rebinding the empire together; yet, it was Diocletian who conceived what would eventually be the permanent split between East and West that allowed the former to survive the latter by a millennium. I might even say that Diocletian may well be viewed as the first Byzantine emperor. While I certainly agree that his economic policies were onerous, to call them Marxist is inappropriate in two ways. First, there was as much or more redistribution to the wealthy and well-connected in the imperial hierarchy as to the poor (and without any attempt at hiding the fact). The second reason is because Marxism, though evil and wrong, has a foundation in the "science" of economics, and no such knowledge existed in those times.

A century after Diocletian, Theodosius still looks as stable as Augustus. If I didn't know that the Western Empire would fall, I wouldn't think it inevitable; indeed, Orosius
had already witnessed some of the first permanent losses and still didn't expect the Roman Empire would end. While the movement of the Huns into Europe clearly put new pressures on the Teutonic peoples against Rome, there was no reason before the fact to think this would be any different from the movement of those Germans into Europe against the Celts/Gauls one thousand years earlier. The Romans were fighting the Gallic peoples in Italy for much of the fourth and third centuries before the Common Era, and they were fighting the Germans defensively at the end of the second century BCE.

On the other hand, I view the fall of the Roman Republic as much earlier determined than Croke seems to. He refers to the Gracchi as "civically virtuous." I see them as symptoms of the Republic already in decline, about a century before the beginning of Augustus' principate. The spectacular treasure Rome won in 167 BCE from the Third Macedonian War allowed domestic taxes to lapse for generations. As political scientists say today about oil states, there's no representation without taxation. The Roman economy hollowed out for this and other reasons. They were able to stave off total state collapse because, unlike any of the empires that had preceded them, the Romans were very good at incorporating conquered and allied nations into their system. Julius and Augustus Caesar created a new system because the old one had already ceased to be effective; their changes were more revolutionary than Diocletian's because the state of things that preceded them was more problematic.

The war in the Roman mind that was most similar to World War II for the United States was the Second Punic War. There is a difference of extraordinary importance between these two great victories. The U.S. finished the war with half the productive capacity in the world, including likely too much manufacturing, so a relative economic decline was necessary for stability, even though it may look like a decline of much greater significance (I don't know how old Croke is, but I wouldn't be surprised if he grew up in the 1950's and thought that was the normal order of things). The Romans, however, were economically devastated by Hannibal's invasion. Because of the perks of victory, however, they never redeveloped the agricultural capacity that had previously been the base of their economy. Maybe if the Gracchi had been successful, though I doubt this was what they actually understood as their goal.

I think the reason comparisons are made so often between Rome and the United States is that Rome was at one time a republic, as America is. It is necessary to remember, however, that the Roman military was still strengthening while their political liberty was deteriorating. By the time of Diocletian, the parallels to U.S. are merely in being a large and hegemonic world power—in which case any other authoritarian empire in history is no worse a comparison. President Obama and Diocletian have both engaged in fighting wars in Mesopotamia and raised some taxes, but so have numerous other world leaders throughout history—Persian, Greek, Arab, Mongol, etc.—and many of their regimes fell a lot more quickly than Diocletian's. Among the four centuries of Roman emperors, Diocletian probably comes off as a bit better than average in performance; whatever one's opinion of Obama, he and every American president are far superior.

Boeckh: What Goes Up, We Can’t Let Come Down

For my first time at the CFA Society of Chicago Book Club, I read The Great Reflation: How Investors Can Profit from the New World of Money by J. Anthony Boeckh, published by John Wiley & Sons. He describes how the government is trying to recreate the positives of economy that ended when the bubble crashed in 2008, but without recreating the same excesses. The book is divided into three parts.

Part 1 concerns the causes of the recession. Inflation and debt are conventional and hard to disagree with. Then, in Chapter 3, he turns to a theory of "long waves" in economic cycles. While Boeckh doesn't think that such waves are completely controlling of what will happen in the economy, he also doesn't seem to think economies can escape them. He explains a history where economies are in a positive wave for about a quarter century and then a negative wave for a quarter century. Nevertheless, he thinks we've been in a down wave since the early 1970's, that was interrupted in the 80's and 90's, only to continue. He concludes that this wave will continue for at least a few more years. I appreciate the Schumpeterian reasons he cites for cyclicality in the economy, the argument about the timing for the waves sounds a lot like permanent advocates of a market condition talk no matter what reality is saying that he condemns elsewhere.

Part 2 is about how to invest during the period of reflation. As Boeckh discusses each asset class, however, his advice is mainly that which could be given at any time. For stocks, he recommends fundamental analysis, with some help from behavioral and technical insights; obviously, that was no less true a couple years ago, or even decades ago. He said we were at the end of a long bull market in bonds, which is for the most part necessarily true because nominal interests rates have become so low, although he was writing before the last run up in bond prices since May that he didn't seem to expect. He's bearish on the dollar, but every other major currency has problems too. Gold is probably following a similar bubble pattern to that of the 1970's and early 80's. The chapter on commodities is best; while this class may provide decent diversification and inflation protection in the short run, data going back two centuries shows that they horribly underperform. The real prices of wheat, cotton, and copper are down 75% to 85% since 1800 because technology will always allow the supply to rise to meet the demand. Similarly, the real price of real estate tends to appreciate very slowly over time, with the bulk of returns coming from the flow of benefits, be they rental cash flows or the real benefit of living in a house.

Part 3 tries to tie everything together, but without much success. It's easy to say that the U.S. is in at least relative economic decline, because there was a time at the end of World War II when it had a majority of the world's productive capacity. He seems pessimistic about politicians making what he considers the right decisions about the economy; he probably would like the Tea Party movement even though they are for fiscal austerity. He cites a wave theory of politics and the economy; I cannot take this idea seriously as it says that 1933, when FDR came to office, and 1985, when Ronald Reagan was re-inaugurated, were both "conservative" highpoints. In the end, though, he thinks we'll muddle through.

Most of the other members of the book club agreed with me that the book was disappointing. The investment advice was not very helpful, and the economic analysis was either not very rigorous, too tepid in its conviction, or an unfortunate confusion of fact with opinion.