Hey Ben Bernanke - Just Apologize

Includes: AIG, BAC, GS
by: Rick Newman

It worked for Bill Clinton, Mel Gibson, David Letterman and even dog-abuser Michael Vick. Millions of embattled husbands have done it, finding much relief. Even Tiger Woods is likely to do it sooner or later.

Just say you’re sorry.

Federal Reserve Chairman Ben Bernanke apparently doesn’t think he has anything to apologize for. But lots of others do, and the disagreement threatens not just Bernanke’s future but the standing of the Federal Reserve, with him or without him.

The controversy over Bernanke basically boils down to two issues: The Fed’s low-interest-rate policy in the early 2000s, and the handling of the AIG bailout in 2008 and 2009. On interest rates, the Fed famously drove interest rates very low after the tech bubble burst in 2000, to help limit the pain of a downturn. The Fed began lowering rates at the beginning of 2001 and stuck with that policy until the middle of 2004, bringing rates close to historic lows. “It’s worth asking why the Fed took rates to such ridiculous extremes,” writes Barry Ritholtz in Bailout Nation. “The 2001 recession was fairly mild.” Ritholtz’s conclusion: The Fed was mainly trying to pump up the stock markets and bail out investors who got creamed in the dot-com meltdown.

Those low rates did help boost the markets—and a lot more. Many economists feel that the Fed’s cheap money helped pump up the housing bubble, as borrowers found loans plentiful—whether they qualified or not—and investors seeking higher returns cranked up demand for subprime mortgages and risky derivatives tied to them.

Bernanke has staunchly defended the Fed’s actions during that time. In one recent speech, he presented a detailed technical case for why low interest rates couldn’t have caused the housing boom and bust. He acknowledged that regulators—like the Fed—should have been more vigilant in their oversight of shoddy lending practices, but he absolved the Fed of any larger responsibility for the financial crisis.

Why? Bernanke wasn’t even running the Fed back then. Alan Greenspan was. From 2002 to 2005 Bernanke was one of seven members of the Fed’s Board of Governors, so he had a role in Fed policy. But Greenspan, who was Fed chairman from 1987 to 2006, was most responsible for the Fed’s actions, and critics have in fact fingered Greenspan for his complicity in the crisis. Greenspan himself has even admitted a degree of error.

It would be easy for Bernanke to simply say the Fed made a mistake back then. Blame it on Greenspan, which isn’t just plausible, it’s actually true. Plus, it would be encouraging to hear Bernanke say, “Yeah, we screwed up, and as a result we’ve learned a few really important things that will help us get it right in the future.” Instead, Bernanke sounds like he’s defending an esoteric academic argument where the points go to the most rarified logic. Not in Washington.

AIG is thornier. The Fed had no good options in the fall of 2008, when it launched the biggest (and ugliest) corporate bailout in U.S. history to prevent an earthquake in the financial system. A group of private Wall Street firms failed to rescue AIG, even with the Fed’s help. The Fed’s worries about a depression and other horrifying ramifications of a full-blown AIG collapse appear valid even now. In an urgent and chaotic situation, the Fed decided to effectively take over AIG, along with all of its liabilities and obligations.

Overall, that plan is working, although it will take years to play out. AIG is slowly selling off assets, winding itself down and paying back its government creditors. That’s probably a better outcome than a hasty liquidation of AIG, which would most likely still be roiling credit markets today and driving unemployment a lot higher. But in the midst of this pandemonium the Fed screwed up a few times. First, it agreed to buy out Goldman Sachs (NYSE:GS), Merrill Lynch, Bank of America (NYSE:BAC) and 13 other firms that had derivatives contracts with AIG at 100 cents on the dollar. That favored treatment basically amounted to a gargantuan, $62 billion transfer payment from U.S. taxpayers to some of the world’s richest investing firms—a far better deal than they would have gotten if AIG had declared bankruptcy.

Then the Fed tried to keep the names of the trading partners secret, as if the central bank has the right to dispense taxpayers funds to whomever it chooses, with no oversight. That wasn’t just arrogant, it was also a rookie move—secrets involving such explosive information never keep, not even when they’re classified (which this wasn’t). Finally, the Fed failed to anticipate the galling possibility that AIG, nearly ruined, would still pay multimillion-dollar bonuses to some of the very wheeler-dealers who wrecked the firm. The spectacle of those contractually obligated AIG bonuses turned out to be a transformational moment at which popular rage boiled over and many Americans turned against the entire bailout effort.

These mistakes have now been detailed in reports by Neil Barofsky, the Treasury Dept. special inspector general charged with auditing all the government bailouts. Other AIG investigations continue, which will keep a cloud over the Fed. But the evidence so far suggests that the Fed, dealing with the biggest emergency since the 1930s, made errors of judgment while conducting aggressive battlefield surgery that probably saved the economy. If Bernanke were to simply say that he’s sorry for the back-door bailouts of Goldman et. al. and the other inequities of AIG, he’d earn some goodwill and show that he understands what’s bugging us. He’d also disarm at least some members of Congress who want to transfer some of the Fed’s powers to other agencies, or even to Congress itself (gulp).

The Fed, with Bernanke at the helm, arguably did more than any other part of the government to help avert a deeper catastrophe. Bernanke bridged two administrations, showed ingenuity, took risks and produced results. He also made some mistakes—which are allowed, in awful circumstances, as long as you recognize them later and show some self-awareness and accountability. So far Bernanke hasn’t really done that, which mars an otherwise strong performance. A bit more humility might make him a bona-fide tested leader.

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Disclosure: no positions