Financial Crisis: Bernanke's Blame of External Forces Misses the Point

Ben Bernanke:

Fed Chief Cites Trade Imbalances’ Role in Crisis, by Edmund Andrews, NY Times: Ben S. Bernanke, the chairman of the Federal Reserve, said on Monday that global trade imbalances played a central role in the global economic crisis and warned that the both the United States and fast-growing Asian nations needed to do more to prevent them from recurring.

“We were smug,” Mr. Bernanke said of the United States, saying the American financial regulatory system was “inadequate” at managing the immense inflows of cheap money from China and other countries that had huge trade surpluses.

Though the Fed chairman acknowledged that trade imbalances have declined sharply as a result of the crisis, mainly because trade itself plunged, he warned that American foreign indebtedness will aggravate the imbalances once again unless the United States reduces its soaring federal budget deficit.

There were three important factors in the crisis, global imbalances (Bernanke's savings glut), low interest rate policy by the Fed, and the failure of markets and regulators to provide the checks and balances necessary to prevent the crisis from occurring. The global imbalances combined with the Fed's low interest rate policy led to the massive build up of global liquidity looking for a safe, high return home, and the market and regulatory failures allowed the extra liquidity and the false promise of high, safe returns to concentrate risk in the mortgage markets.

Bernanke focuses on two of these causes of the crisis, global imbalances and regulatory problems (market failures get less attention), but he does not focus on the Fed's role in the crisis at all. So let me say that I hope the Fed is more willing to consider popping bubbles as they inflate than it has been in the past. But that is not the main point I want to make.

The crisis, according to Bernanke, occurred when the excess global liquidity overwhelmed financial markets -- it was too much for either regulators and markets to handle. Think of a hurricane hitting a city that is so strong and powerful that it overwhelms levees and other flood/damage control mechanisms. That's essentially Bernanke's explanation, the shock was too big for the mechanisms we had in place to control the damage. One solution to the hurricane problem is to hope that such large shocks don't happen again and simply rebuild the same defenses as before, and another response is to recognize that such shocks will occur every so often and to build the stronger defensive measures needed to get ready.

Bernanke acknowledges that the defenses, i.e. the regulation of financial markets, need to be strengthened, but he seems to place a lot of emphasis on reducing the size of future shocks (reduce the budget deficit, have Asian countries consume more to reduce imbalances, etc.). I think that is fine, we should reduce the danger as much as we can, but we need to accept that global imbalances are possible, that a shock of this magnitude could and probably will happen again at some point in the future, and we need to make sure that markets don't fail like they did this time (i.e. we need to fix the bad incentives in these markets).

But more importantly, we need to strengthen our regulatory defenses in anticipation of the next big shock. If it's fair to blame the government for not having levees, etc. ready for Katrina; if we insist that the defenses need to be strengthened going forward, then the same argument can be made in financial markets. Despite our best efforts to reduce the chances that a large shock will occur through deficit reduction and higher domestic saving rates, we should expect that global imbalances will rear their head again at some point, and the system cannot be overwhelmed again like it was this time.

For that reason, I'm a bit disappointed in Bernanke's willingness to point fingers at external causes and say other countries must change their consumption habits, or to blame budget deficits, at a time when financial regulation is coming onto the legislative agenda (though he didn't say anything about the exchange rate). Those are important problems and I don't mean to dismiss them, but right now financial regulation is being considered by congress, and it's essential that we get the regulations in place that can withstand the next big shock.

Blaming external forces for the crisis will make it easier for opponents of regulation to blame China and other countries, and that gives legislators an excuse to give in to pressure (e.g. campaign contributions) from the financial industry to go soft on regulatory changes.

Update: Paul Krugman comments on Bernanke's remarks: America’s Chinese disease (not quite what you think).

Comments

[Dave Wrixon:]

I think Bernanke started in office with premise of totally missing the point. He just does not seem to understand that his policies make no sense in a World with a Global Trading System with the Dollar at its heart. His policies might have made sense in the period with which he is familiar assuming that the US almost totally closed it borders and commercial activity was limited to the domestic economy with fixed exchange rates. Let's face it, he is the last of the Dinosaurs.

Oct 20 05:19 AM

[Michael Clark:]

"...he warned that American foreign indebtedness will aggravate the imbalances once again unless the United States reduces its soaring federal budget deficit."

Do you think this means Bernanke will stop buying stocks, bonds, mortgages paid for with federal money that is increasing our federal deficit...?

Talk is cheap. Betrayal of Americans is easy.

Oct 20 05:49 AM

[User 353732:]

Blaming the "other" is the defining trope of totalitarians, terrorists and self anointed victims. It is also the most visible sign of moral and intellectual bankruptcy.
Hitler , Stalin and Mao blamed the "other" which ,of course, inevitably led to concentration camps, gulags and long marches.
Iran, Venezuela,North Korea,Cuba and Islamic terrorists blame the "other" every day and it not only defines them but is the reason for their existence. They live to hate and destroy.
In the US the Regime blames the "other" whether its small business, or Main St or China or India or Russia for its own vast and diverse crimes and predations.

Once, America was the "shining city on the hill" that sought to guide, instruct, inspire and liberate "others". Now, in 2009, the US Regime blames and hates "others" alternating between cowering and whimpering and snarling and frothing. When the Regime is not depressive it is manic, oscillating between imagined persecution by the "other" to egomaniacal and equally imaginary lordship over the "other".

Oct 20 08:03 AM

[Michael Clark:]

"Once, America was the "shining city on the hill" that sought to guide, instruct, inspire and liberate "others". Now, in 2009, the US Regime blames and hates "others" alternating between cowering and whimpering and snarling and frothing. When the Regime is not depressive it is manic, oscillating between imagined persecution by the "other" to egomaniacal and equally imaginary lordship over the "other". "

A desperate governor seeks to galvanize the people against the outside. In fact, we are being galvanized against the governor.

Oct 20 08:12 AM

[john s. gordon:]

yes strengthen the regulatory defenses - more & better regulation please. are you listening congress?
> jack

Oct 20 08:47 AM

[fwi:]

Brilliant comment 353732. Bernanke is blaming the prudent Chinese saver for his out of control money printing? He is like all failed leaders--fighting the last war with 60 year old ideas.

Oct 22 07:46 AM