In FED We Trust (8 page)

Bernanke found that the gap between medium-grade Baa corporate bonds and supersafe U.S. Treasury bonds widened from 2.5 percentage points in 1929 to 1930 to nearly 8 percentage points in mid-1932. That was more than double the spread recorded during the deep recession of 1920 to 1922. “Money was easy for a few safe borrowers, but difficult for everyone else,” he concluded. Exactly the same was true during the Great Panic, and many of Bernanke’s innovations at the Fed were aimed at reducing that same spread, which widened sharply from about 1.6 percentage points in December 2006 to over 6 percentage points in December 2008.

In the wake of the Depression, Congress made the only substantial changes to the Federal Reserve Act it has ever made. In 1935, it removed the Treasury secretary and comptroller of the currency from the board in Washington, renamed it the Board of Governors of the Federal Reserve System to emphasize its primacy over the district banks, and changed the title of the heads of the regional banks from “governor” to “president.” Even more significant, Congress diluted the power of the regional Fed banks to set interest rates by creating a Washington-dominated committee, the Federal Open Market Committee. All seven governors in Washington have a vote at all times, but only five of the twelve regional bank presidents vote in any one year, serving in a rotation dictated by statute. (The New York Fed president is always one of the five voting presidents.)

That institutional change would prove important during the Great Panic, giving Bernanke the power to act despite the resistance of the presidents of some regional Fed banks. But the broader consequence of the Depression was the nature of received wisdom. Today, the notion that the government should or would stand by as the stock market crashed, credit markets stalled, and the economy tumbled over the abyss seems implausibly bizarre. The public, politicians, professors, and the press have been shaped by searing memories or photographs from the Great Depression, the years in which the unemployment rate rose to 25 percent and the country’s output of goods and services declined by 29 percent over four years. The lasting lesson — taught by economists with views as different as John Maynard Keynes and Milton Friedman, the leading economic minds of the twentieth century — is embraced almost universally by politicians and economic policy makers: government can and should act to prevent such a dangerous downward financial and economic spiral. Indeed, during the Great Panic, the Fed took interest rates to zero, and President Barack Obama signed into law a package of tax cuts and spending increases that amounted to $787 billion in fiscal stimulus over ten years, $185 billion of which was to hit the economy in the first year and another $399 billion in the second year.

This notion of the government’s role was not universal in the 1930s. In his memoirs, Herbert Hoover described tension within his own administration, putting words in Treasury Secretary Andrew Mellon’s mouth that are routinely reported as something Mellon actually said.

Several Fed officials saw the financial debacle unfolding around them much as Mellon did: as an avenging angel sent to purge a slack system and fallen people. George Norris — a lawyer and early overseer of a federal farm-mortgage agency who was president of the Federal Reserve Bank of Philadelphia from 1920 to 1936 — attacked the Fed for interfering “with the operation of the natural law of supply and demand in the money market,” an argument not far from that made by some dissenting Federal bank presidents during the Great Panic.

History has cast Hoover as the do-nothing president who stood firm on conservative principles as the economy crashed and burned, as opposed to his hyperactive successor, Franklin Roosevelt. Hoover wasn’t as callous or delusional as his modern caricature suggests, and he believed in the power of government to do good. Some of the seeds of the New Deal were planted in his presidency as he realized that “volunteerism” wouldn’t suffice, just as some parts of Obama’s recession-fighting policies of 2009 had their beginnings in the Bush years. Hoover created the Federal Home Loan Bank System to rescue savings banks and savings and loans, and to offer sustenance to the beleaguered mortgage market, but Congress watered down his proposals to his bitter regret. He created the Reconstruction Finance Corporation to provide emergency loans to banks, railroads, and other companies. But he was hung up on balancing the budget. He disagreed with, but didn’t fire, Mellon as Treasury secretary. And he did not — despite some of the claims in his 1952 autobiography — see how big a government response it would take to conquer the Great Depression.

But in contrast to the Great Panic, Hoover did not have anyone with Bernanke’s stature at the Fed pushing him to be bolder. Only a minority of Fed officials, Hoover wrote, “believed with me that we should use the powers of government to cushion the situation.”

Bernanke knew this history well. He faulted Hoover for overoptimism and for listening too much to Mellon, among other things, but thought Hoover — a smart, well-intentioned man who was hardly opposed to using the power of government — had been given a “bum rap.” The bigger culprit, he said, was Woodrow Wilson, the father of the Fed, because he had so badly botched the Treaty of Versailles after World War I, which produced the global economic and political conditions that led to the Great Depression.

“After Strong’s death …,” Bernanke said, “the Federal Reserve no longer had an effective leader or even a well-established chain of command. Members of the Board in Washington, jealous of the traditional powers of the Federal Reserve Bank of New York, strove for greater influence; and Strong’s successor, George Harrison, did not have the experience or personality to stop them. Regional banks also began to assert themselves more. Thus, power became diffused; worse, what power there was accrued to men who did not understand central banking from a national and international point of view, as Strong had. The leadership vacuum and the generally low level of central banking expertise in the Federal Reserve System was a major problem that led to excessive passivity and many poor decisions by the Fed in the years after Strong’s death.”

Or as Herbert Hoover put it, the Fed became “a weak reed for a nation to lean on in a time of trouble.” Ben Bernanke was determined that
his
Fed would not be a weak reed. “I optimistically think that, while we could still have financial crises and bad outcomes in the world economy, policy makers know enough now to short circuit the impact before it becomes anything like the severity of the 1930s. Certainly that’s the hope anyway,” he said.

In November 2002, the University of Chicago honored Milton Friedman as he turned ninety years old. Bernanke, then in his fourth month as Fed governor, turned to Friedman and Schwartz and said: “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

A half decade later, faced with the Great Panic of 2008, Bernanke would struggle to keep that promise.

As for J. Pierpont Morgan, the man who saved the nation in the Panic of 1907, the glory of his triumph would be subsumed in the shifting sentiments of the times. When he died at the end of March 1913, the nation was more relieved than sad.

“We may look upon Mr. Morgan’s like again — there were great men before
and after Agamemnon, but we shall not look upon another career like his,” the
New York Times
editorialized on April 1. “The time for that has gone by. Conditions have changed, and Mr. Morgan, the mighty and dominant figure of finance, did more than any other man to change them. …

“The growth in his time was prodigious, and now Wall Street is beyond the need or the possibility of one-man leadership. There will be co-ordination of effort, the union of resources, but Mr. Morgan will have no successor; there will be no one man to whom all will look for direction.”

The
New York Times
editorialist, of course, could not have known about Alan Greenspan.

I
n the morning cold of February 6, 2006, President George W. Bush made his way by armored limo to the Federal Reserve’s Beaux Arts building, only the third time on record that any U.S. president had visited the Fed’s headquarters. The official occasion was the public swearing-in of Ben Bernanke as the chairman of the Federal Reserve, but everyone knew Bernanke’s ascension wasn’t the main event. What really was being celebrated was Alan Greenspan’s departure after nearly nineteen years as Fed chairman, the Maestro. To laughter and applause from the invitation-only crowd, Bush said, with substantial accuracy, “Alan Greenspan is perhaps the only central banker ever to achieve … rock-star status.”

Indeed, Bush gladly would have done what he had four years earlier, and what his father and Bill Clinton had done before him: extend Greenspan’s term as chairman and avoid the search for a successor who would satisfy both financial markets and the president. Bush had plenty of other problems — notably the war in Iraq — and in the years following the September 11 attacks, Greenspan had steered the economy to a place where Bush hardly had to worry about it. But Greenspan was seventy-nine years old, ready to retire and cash in on his celebrity. He rebuffed a quiet White House plea to stay for a while beyond the January 31, 2006, expiration of his term.

BERNANKE’S DASHBOARD
February 6, 2006

So, in front of a crowd that included Greenspan and his predecessor, Paul Volcker, Bush celebrated Greenspan’s successes. The final report card looked impressive. Unemployment was below 5 percent. Inflation was low. The United States had been in recession for only 16 months in Greenspan’s 211-month tenure. The housing bubble had yet to burst. The very worst of the subprime mortgages were yet to be written. The Great Panic was unimagined except by a few Cassandras who were routinely dismissed as cranks.

Bush was not alone in his belief that Greenspan’s time at the Fed had been barely short of magic. During the 2000 presidential campaign, Senator John McCain had quipped that if Greenspan were to die, the smart response would be to put sunglasses on him, prop him up, and keep him in office. Greenspan’s last Federal Open Market Committee (FOMC) meeting had turned into a roast. Richard Fisher, president of the Federal Reserve Bank of Dallas, borrowed from Shakespeare. “I … am but a sprout in the crop of otherwise experienced men and women here … but I’m sure they will agree with me that Henry V’s remarks at Agincourt are appropriate: economists and bankers now asleep shall think themselves accursed they were not here.”
Greenspan responded with a smile, and then said, “I went to school with Henry V. And the last time I spoke to him he gave me a good notion of strategy.” Everyone laughed.

In the 1980s, Greenspan had turned his interest in and facility for understanding the inner workings of the American economy into a successful consulting business when Ronald Reagan’s Treasury secretary, James Baker, and chief of staff, Howard Baker, recruited him to succeed Paul Volcker. Volcker had put the U.S. economy through a wrenching recession and accomplished what most people — economists and ordinary folk — thought impossible: bring inflation from the double digits to below 5 percent. But he was not in favor in the Reagan White House. He was a Democrat, for one thing. “Jim Baker didn’t necessarily want a puppet. He just wanted a Republican,” the
Washington Posts
Bob Woodward wrote in his 2000 celebration of Greenspan,
Maestro
. “It was not a matter of trust, it was a matter of good politics. He also wanted a Fed chairman with a more agreeable temperament. Volcker’s crankiness and his I’m-above-politics air were hard to take.”