Monday, March 27, 2017

The Courage to Act by Ben S. Bernanke (Book Review #4 of 2017)

The Courage to Act: A Memoir of a Crisis and its Aftermath

2017 has really sapped my heart for reading memoirs related to economics and politics because the discourse and attitude of the current Administration is so hostile toward PhD economists like Bernanke. The current President has a woefully understaffed Council of Economic Advisers (CEA) and National Economic Council (NEC) and one wonders what the consequences may be. Bernanke's memoir made me thankful for men and women like him who were able to make a difference at critical junctures in America's history.

I found Bernanke's memoir to be among the most satisfying I have ever read. I followed the economic crisis closely and I remember all the articles, blogs, and books wondering what Bernanke was thinking and making various policy suggestions. Bernanke appears to have read every single one. The Chairman uses this book to painstakingly address criticisms, explain his thinking and the Federal Reserve's actions, and give context about the politics at the time. He's smart but also down-to-earth. The deeper I got into the book the more sad I became that experts like him may not be at the helm during the next economic crisis.

Criticisms of Bernanke and the Fed during the crisis come in three general categories:
1. The Fed did too little. It should have seen the crisis coming and should have also bailed out Lehman Brothers, etc.
2. The Fed did too much, inventing too many new ways of intervening in the economy and keeping interest rates too low for too long.
3. The Fed needs to pursue other policies, generally. An explicit inflation target or nominal GDP level target or some other explicit rule would be more optimal.

I fall into #3, having been persuaded by the arguments of Scott Sumner, David Beckworth, and others for a Nominal GDP level target. I was pleasantly surprised at how much time Bernanke spent in the book responding to these arguments. He clearly took the time to read their blogs and current reseearch, and think deeply about the issue, and found it worthy of response. (Hopefully David Beckworth will have Bernanke on his excellent Macro Musings podcast soon, I think Bernanke would be open to it.) Bernanke prefers a long-term inflation target but much of the book is his frustration of taking an academic idea and implementing change in a government entity under the scrutiny of Congress that is allergic to change. I think Bernanke hopes his legacy is having moved the Fed on its first steps to move toward such a policy by laying the groundwork of being more transparent with the public in explaining its policies.

Bernanke was raised in South Carolina, 60 Minutes went there for their profile of him in 2009. His father owned a drugstore, he grew up middle class, was friends with blacks and aware of his own Jewish heritage, although his family was not devoutly religious. Bernanke was gifted and wanted to be a writer, he was good enough at math and a mentor encouraged him to go to Harvard. While there, he realized he was woefully unprepared for Harvard mathematics and studied hard to get to a higher level. He discovered economics there as an outlet for making sense of mathematics and having mathematical concepts explained in narrative. Throughout the book, Bernanke comes across as well-rounded in his drawing from various strains of economics along with a knowledge of psychology as well as historical context. He explains the "neoclassical synthesis" to the reader quite well. He returns to Bagehot, Friedman and Schwartz, and other classical works for context and to help him learn from history.

The Chairman harkens back to his criticism of Japan's central bank in their low-inflation period. He advised them to use the same unconventional methods he would be criticized by the #3 crowd above for not trying in the US. He now has the wisdom of knowing that optimal monetary policy is not always politically feasible. Every country has a different system and their central banks are governed by different rules and oversight bodies. So, he regrets the "harshness" of his criticism of Japan.

He recounts his interview with George W. Bush in becoming his selection for the Board of Governors. Bernanke's brief tenure on a school board "counts a lot" in Bush's administration, and he is a pretty easy choice. Bernanke learned a lot from Greenspan and other long-time Fed hands. Bernanke isn't critical of Greenspan, but it's clear he wanted to take the Fed in a more transparent direction and not be seen as the "Maestro" that Bob Woodward had made Greenspan out to be. Bernanke also did not like Greenspan's bottom-up forecasting approach. Bernanke would then chair Bush's CEA and be a familiar name for the President to nominate as Fed Chairman in 2006. His wife cried when he got the nomination because she understood what it meant.

I was in graduate school at the time and I can remember concern that Bernanke was an inflation dove. Bernanke was ever-aware of his public perception as "Helicopter Ben" and learned over time to craft his statements more clearly so as not to be misunderstood. This is in contrast to Greenspan who didn't want any of his words understood. Bernanke prefers an explicit long-term inflation target that can be hit over a number of years. Inflation in any given year can be flexible, if you undershoot one year, you make it up with "catch-up inflation" in others. He finds an explicit inflation target the easiest to explain to the public and argues it would do better to hit the Fed's dual mandate of full employment and low inflation than other methods. It is more politically feasible, he argues, than the NGDP level target.

Perhaps the most difficult part of the book for me is accepting Bernanke's resignation that these ideas were not actually feasible. I think those of us in Group #3 would argue he did not do enough to make his case while in office. Some op-eds might have gone a long way, but they might have been risky in roiling the markets. The book's title is "The Courage to Act," but risk aversion is apparently an essential characteristic of a Fed Chairman.

I have read several chronicles of the 2007-onward financial crisis, but I think this book is the best of the bunch as Bernanke painstakingly retells the entire story almost day-by-day. This is way better than Geithner's memoir. (Bernanke didn't initially want Geithner as Treasury Secretary but was "proven wrong.") Bernanke admits his error in not understanding how mortgage-backed securities and credit default swaps were a ticking time bomb, seeing no reasons why a slow-down in the housing market would bring down the larger economy. He justifies the Fed's decision not to raise interest rates to prick the asset bubble-- one never knows how big the bubble is and why put the rest of the economy at risk for one sector? The Fed instead proposed regular reports on the financial stability of the economy. A lot of smart people in the Fed missed what was going on. Bernanke remembers the Jackson Hole conference where Raghuram Rajan warned of impending doom while the rest of the room was toasting Greenspan's tenure.

Who remembers the BNP Paribas failure that triggered it all? Central banks were eager to assert their role as lenders of last resort in order to stabilize financial markets. One challenge was to convince banks to come to the Fed's discount window. Despite the housing market collapse, a lot of underlying economic indicators like consumer spending still looked strong. Inflation was a nagging concern, as Fed transcripts later showed the FOMC was still worried about inflation while NGDP was falling off a cliff. Bernanke never saw the 2007 Jim Cramer rant but he knew about it-- his wife or others would send him such articles to make sure he knew the craziness outside. Bernanke now regrets his hesitation on fed funds rate cuts, optins instead to implement unorthodox policies like the term asset facility and term auction facility. An inflation targeting policy would have given him more optimal flexilibility in that moment, he argues.

Bernanke's encouragement of "blue sky thinking," thinking about problems as an academic exercise rather than a heated moment in a crisis is something I have since seen and heard repeated in other business books. "In an ideal world, what tools would we have to deal with this?" is a decent exercise to keep notes on for after the crisis. (It is close, however, to Ronald Reagan's joke about economists assuming they have a can opener.) We've long forgotten the Bush tax credits as stimulus. Bernanke recounts those days when firms were looking for Section 13-3 loans, emergency meetings, Maiden Lane, and the Bear Stearns bailout negotiations. Then came the biggest fed funds rate cut since 1982.

Bernanke recalls the details of the Bear Stearns negotiations and is confident Treasury and the Fed did the right thing. They were able to find a buyer with some help-- Bank of America. The run on Lehman Brothers would be worse, would require more capital, and they had difficulties in finding a buyer and were left with few legal options. There were details about the Lehman saga that I did not know, including the difference between British financial laws and US laws causing a problem in finding a potential suitor from the UK. Even AIG would later have collateral to legally secure a loan whereas Bear Stearns did not. Bernanke argues persuasively that given we are a nation of laws, there was nothing in the Fed's power it could do to save Lehman. Interestingly, Bernanke includes a brief bio on Dick Fuld, the CEO of Lehman, with some commentary on his life and choices. I am curious how Fuld feels about a former Fed chairman giving commentary on his life. In the end, as Geithner put it, "all we can do is put foam on the runway," as Lehman imploded.

AIG wasn't even on the Fed's radar until after the Lehman weekend. Late in 2007, I attended a seminar at the St. Louis Fed where President Bullard recalled seeing Bernanke's face on a video conference after learning of AIG's problems. He was "furious." The Fed was already dealing with the potential failure of Fannie Mae and Freddie Mac and the problem of international creditors who thought the GSE's had implicit government backing, a problem that Greg Mankiw and others had long warned about under GW Bush but Congress had ignored. Now, they had to examine the books of an extremely complex international entity whose failure would definitely be felt worldwide. President Bush had given Paulson and Bernanke a free hand to negotiate, but policy specifics like the Trouble Asset Relief Program were a tough sell. Bernanke recalls a few times when FOMC Chairwoman Sheila Baier needed convincing on issues as well. Paulson and Bernanke preferred straight capital injections over purchasing troubled assets, but there was no taste for that in Congress and when the program basically went toward capital injections anyway, Republicans howled about socialism.

Another under-appreciated aspect of the Fed's monetary policy was the coordinated central bank rate cuts. Bernanke was persuasive in getting nations to work together, even though doing so in the face of a global panic seems like common sense, it is difficult in practice. Geithner called Bernanke the "Buddha of central banking," for his calm and rational approach. The non-bullying nature of Bernanke was needed in international rate policy diplomacy. Bernanke's memoir returns to international issues in examining Europe's problem with Greece and the effect that worry over massive sovereign defaults had on markets. Nonetheless, Bernanke criticizes the European Central Bank's policies similar to how he criticized Japan 15 years ago. This seems odd given he spends much of the book explaining the difficulty of doing policy in a political environment; he never acknowledges that the ECB faces the impossible task of balancing the interests of a diverse group of countries.

Once the Fed hit the "zero lower bound," Bernanke had Japan's problem. The Fed had set a floor for the federal funds rate by paying interest on reserves, a move which also garnered criticism from Scott Sumner and others. Bernanke explains why they did not want to reduce the IRR to zero-- it would not affect interest rates much but risk destabilizing the money market. I think Sumner and Beckworth would respond that thinking about monetary policy through the lens of interest rates is the problem in the first place. Bernanke writes that once the Fed hit the zero bound, the Fed needed other "creative ways" to conduct policy and an inflation target would have been the best option but it was "too early" to have Congress go along. He did, however, discuss the feasibility of NGDP targeting with Kohn, Janet Yellen, and others before launching their second round of Quantitative Easing policy (QE2). NGDP targeting was discussed at the November 2011 FOMC meeting but the Committee decided it was too much of a paradigm shift and too hard to explain. Bernanke wanted to call it "credit easing" rather than "quantitative easing" because he wanted to state he was targeting long-term interest rates rather than just increasing the money supply. But QE2's results in improving asset markets proved a "false dawn," precisely because the FOMC was more concerned in overdoing stimulus and unconventional policies. Fed Presidents were eager to raise rates or at least have a concrete plan for a "return to normalcy." It is an economic tragedy that Bernanke spent as much mental energy convincing others the Fed would one day return to normal policy in a smooth, orderly fashion than doing what was necessary to stem the crisis at the time.

The Republicans in Congress made Bernanke's efforts a political issue. Conservative economists were in the media criticizing low interest rate policies, asset purchases, and warning of impending hyperinflation. Bernanke had to defend his actions in Congressional testimony and speaks of the annoyance of always having to defend a fiat currency from Ron Paul. Bernanke doesn't disparage Paul, but shows the weakness of Paul's arguments and points out other areas where Paul seems to lack evidence for his wild claims. It's clear Bernanke doesn't like Rand Paul picking up where his father left off. John Boehner and others in Congress took to bashing Bernanke without bothering to consult him. Senator Shelby filibusters a Fed nominee over base closings in Alabama, etc. Following QE2, the Fed's "Operation Twist" was followed by more GOP Fed-bashing and Texas Governor Rick Perry's "we'd treat him real rough down here in Texas" comment, all of which Bernanke found disturbing. If he could deal with the politics, Bernanke had at least an equal frustration with traders misunderstanding his policies. He'd made it a point to be more transparent than Greenspan, and yet the market seemed to be confusing his messages that the Fed would one day be ready for a return to normal policy with thinking that the Fed was ready to raise interest rates. The ECB's actions and the Greek crisis led to more flights to US Treasuries for safety, pushing down interest rates further.

Some of the regulatory reforms like Dodd-Frank were initially difficult for the Fed to embrace. They did not want to give up their own oversight and education role to the new Consumer Financial Protection Bureau, but Bernanke eventually came around to endorse the CFPB. He writes that Dodd-Frank "does much good," and would not support its repeal. He pushes back on former Fed Chair Paul Volcker's "Volcker rule" and notes that even had Glass-Steagall not been repealed it would not have affected anyone's trades except Citigroup. Bernanke never mentions that Obama was slow in nominating others to vacant Board of Governors positions at a time when Bernanke needed all the help he could get on the FOMC. That was one criticism of Obama I remember from Brad DeLong and other left-leaning economists and maybe one weakness of this book.

Bernanke does give some insight into his home life during the stress. He enjoys both the support and remarkable disinterest of his wife. He enjoys baseball and tells anecdotes from his trips to Nationals games. He closes the book with explicit leadership lessons on doing policy and working with others, much of which is pretty bland. In all, I give this book 4.5 stars of 5. It's a must-read on the financial crisis. It's an interesting read about Fed life. I'm more thankful for Bernanke now.

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