'Preventing Systemic Collapse': Bernanke's Ace-in-the-Hole

After catching a few bits and pieces yesterday of Ben Bernanke's testimony on the subject of the Bank of America (BAC) /Merrill Lynch deal before the House Oversight Committee, it seemed best to let the "professional" bloggers over at the Wall Street Journal do the heavy lifting and go for a nice afternoon hike instead - that turned out to be a good decision.

Here's recap of yesterday's events, first, from the Real Time Economics:

The Fed chairman is used to harsh treatment from some corners — Sen. Jim Bunning (R., Ky.) and Rep. Ron Paul (R., Texas) are two persistent Fed critics — but usually has a few friendly faces in front of him. That wasn’t the case during today’s hearings on Bank of America’s takeover of Merrill Lynch.
...
The onslaught was near universal, but the attacks came on different flanks. Republicans railed against what they perceived as a government imposing its will on business. Rep. Jim Jordan (R., Ohio) kept bringing up the October 2008 meeting where Treasury Secretary Henry Paulson, alongside Bernanke, presented bank CEOs with the TARP capital injections. “Do you see how a reasonable person could reach the conclusion that there, in fact, was this pattern of pressure from the government?”

Hmmm... That sounds kind of interesting.

Actually you can watch the whole thing over at CSPAN, but, one glance down at the elapsed time/total time counter reveals that, at over three hours, it would be a substantial investment of time to find out what happened via that method.

Back to the folks at the WSJ, this time for when the subject of inflation was briefly discussed.

How will the Fed prevent its huge influx of money into the financial system from sparking an inflation outbreak? The question didn’t exactly open the door for new insight from Mr. Bernanke, but we’re sure he was pleased to reiterate to his view that everything would be just fine in the end.

“The money is electronic deposits from banks sitting in the Federal Reserve accounts — they’re not being used, not being loaned, they’re not circulating,” Mr. Bernanke explained to lawmakers who had all sorts of other gripes for three hours.

“They key issue here is, can we unwind this money creation and low interest rates in time to head off inflation when the economy begins to recover?” he said. “We have all the tools we need to do that. We believe we can do that. We will certainly remove that stimulus in time. And we are committed to price stability and we will make sure that it happens.”

You know, next year could turn out to be quite a test for the Fed chairman, assuming he gets nominated for another four year term later this year.

With an economic recovery possibly gathering steam in the fall or next year, energy prices are sure to be on the rise (if the events of spring have taught us anything it is that commodity prices will be bid up in advance of any recovery, real or imagined) and, during the run-up to important mid-term elections, it will be Bernanke's job to do what his predecessor did not do about six years ago - raise interest rates more than a few basis points.

That could turn out to be some test.

Over at the Deal Journal blog they live-blogged the entire hearing, apparently hanging around for the entire three hours. This part looked kind of interesting...

11:45: The questions return to the “threat/no threat” debate. Bernanke say if the Fed wants to remove a CEO, it will do so. Just look at AIG, where the Fed fired the CEO as a condition of the insurance giant’s bail out. But I didn’t threaten to fire Lewis.

11:52: Rep. Cummings: Did you think that Ken Lewis was competent (at time of the Merrill deal)?

Bernanke: That’s not a yes or no answer. (Ben just won’t bite)

High noon: Rep. Clay.: Shouldn’t you have disclosed what you knew about the mounting losses at Merrill to the shareholders and to the broader public.

Bernanke: Again, he punts. “It was up to Bofa to disclose those losses.” Our job was to make sure the system was stabilized.

That preserving "system stability" or "preventing a systemic collapse" argument seems to be a reliable ace-in-the-hole for the Fed Chairman, a virtual "Get Out of Jail Free" card it seems, even though they failed to prevent a collapse last fall.

Aside from committing a crime (and maybe not even in that case), is there anything that this "Get Out of Jail Free" card would not be effective on?

Comments

[CautiousInvestor]

At issue is to what length did Lewis go to commit securities fraud and to what extent did Paulson and Bernanke coerce fraud. There are also a host of issues about fiduciary duty and limits of government power.

From what I have read, BAC and Lewis failed to undertake adequate due diligence prior to committing to the merger with Merrill. Upon learning of the scale of potential losses, Lewis attempted to back-out of the deal by invoking the material and adverse change clause.

This change of heart, though, came to a halt after meeting with Paulson who told Lewis there could or would be a change in the board and management should BAC not go through with the proposed merger. An email from Fed boss Lacker to Bernanke, recounting an earlier discussion between the two, made it clear Bernanke was prepared to tell Lewis should he walk away from the deal management would be replaced in the event of further funding requests.

After reading what has been made available, it is clear the Fed and Treasury shared a marginal view of Lewis and his ability to manage a sprawling enterprise. Yet, in the name of increasing systemic risk, they pressed him to move forward with the merger.........with all parties remaining silent on the known Merrill losses until mid January. On that day the losses were announced along with a bailout package.

Quoting Mish "New York State Attorney General Andrew Cuomo's letter to the SEC and Senate Banking Committee on the Bank of America, Merrill Lynch Merger provides strong evidence of coercion to commit securities fraud by former Treasury Secretary Paulson and Fed Chairman Ben Bernanke, and actual securities fraud by Bank of America CEO Kenneth D. Lewis."

2009 Jun 26 06:37 AM

[prudentinvestor]

All the talk about "systemic collapse" is utter nonsense. Banks have failed before, and after a Friday night change in ownership have continued to function on the following Monday, with the same employees in the same positions doing the same things as on the previous Friday.

Taking over any failed bank, no matter how large, would have been better for taxpayers, as the public subsidy would have been limited to cover that bank's actual losses. Instead, with the current bailouts, the public subsidy is extended to cover the bank's investors as well as its actual losses. Additionally, the moral hazard of bailing out the bank's investors will distort investment decisions and the economy for the forseeable future.

If "systemic failure" were real, GM and Chrysler factories would have been piles of rubble by now. Instead, we have ads about "the new GM". Likewise, we could have been seeing ads about "the new xxxxbank".

2009 Jun 26 08:53 AM

[rogersails]

The current administration's handling of the economic crises is running parallel to the prior administration's handling of 911. A lot of shoot from the hip actions surrounded in secrecy, brushing aside the law for the "greater good" . We will never really know what our world would look like like without these responses, but there will be many years of analysis, and, in the event of a change of administration, full blown witch hunts and a few ceremonial hangings.

2009 Jun 26 10:23 AM

[I do my own thinking]

I agree, and if we all suspend belief in gravity pigs would fly.

The near total lack of understanding of the economic system seems to be pervasive within America, and statements such as yours only provide further proof.

What was done was to avert a near certain cataclysmic ending. It was an absolute necessity and the bitter price for deregulation. Your storybook ending of new improved banks out of ash is a myth, the system would have ended, millions staved and the US dollar would never again be allowed the world currency, period, end of story, over and out.

Word to the wise, ignorance is NOT bliss, it’s what drove Senators to deregulate and there by allow the majors either absorb or squash competition to a point that they are too big to fail. Your idealistic view of pure capitalism has created billionaires, destroyed completion and eliminate startups and so called mom and pops. Welcome to true communism when a few mega giants live off welfare as they encourage the average Joe to devourer anyone that dare attempt to bring back balance or regulation and the beat goes on.

For the record, GM will never be what it was and Chrysler is now Fiat. The systemic risk they presented were to employment. If every auto maker in the world went belly up it still wouldn’t register a blip compared to the systemic damage caused by a collapse of the largest financial center the world has ever known.

Americans need to go back to school because it beats getting schooled by the CEO’s that did.

Above all else, stop listening to Fox business, it’s crap.



On Jun 26 08:53 AM prudentinvestor wrote:

> All the talk about "systemic collapse" is utter nonsense. Banks have
> failed before, and after a Friday night change in ownership have
> continued to function on the following Monday, with the same employees
> in the same positions doing the same things as on the previous Friday.
>
>
> Taking over any failed bank, no matter how large, would have been
> better for taxpayers, as the public subsidy would have been limited
> to cover that bank's actual losses. Instead, with the current bailouts,
> the public subsidy is extended to cover the bank's investors as well
> as its actual losses. Additionally, the moral hazard of bailing out
> the bank's investors will distort investment decisions and the economy
> for the forseeable future.
>
> If "systemic failure" were real, GM and Chrysler factories would
> have been piles of rubble by now. Instead, we have ads about "the
> new GM". Likewise, we could have been seeing ads about "the new xxxxbank".

2009 Jun 26 02:55 PM

[Northstar10000]

Deregulation, you must be complete mental midgets to keep repeating the brain washed tune you have been fed. You can't think on your own to save your lives. The institutions that are in the most trouble were and are the regulated ones. Regulation is not even an issue. Wow such fools we are, just spout the government line. Welcome to Iran you mindless dorks. what could government possibly regulate with any degree of competency in a global economy where governments can't even run a post office. Sounds like the public school system has completely destroyed all thinking.

2009 Jun 27 01:42 AM

[johnbee]

Bernanke is like a General in charge of a great war or a Grand Master of Chess. He must choose who and what he need sacrifice for the overall good and not be interrupted by the little people pawns in the game. Obama is right to let him get on with it and should resist calls by bankers friends to hinder. It is obvious that infaltion will be the main problem at some point but we need get over the deflation threat first.

2009 Jun 27 05:55 AM