Bernanke's Big Bet
Gentle Ben from Dillon, South Carolina, is betting the farm that he has got it right. The farm is us--the people of the United States--and Ben is Ben Bernanke, chairman of the Federal Reserve Board. The bet he has made is that he can stop housing prices from dropping, thereby saving trillions of dollars worth of mortgage-backed bonds and the other strange financial instruments tied to them. So far, not so good on winning the bet.
If bonds and the other financial instruments derived from them collapse in value, the banks that own them collapse and take the whole system down. Then we are looking at the 1929-1933 situation.
All depends on stabilizing the price of housing, since the higher housing prices, the more the bonds are worth. Bernanke believes he knows how to make that happen. The man has long since prepared himself to deal with just this kind of emergency. As a student and teacher of economics, he concentrated on the 1929 stock market and the mistakes that turned the great crash into the Great Depression.
"Without...policy blunders by the Federal Reserve, there is little reason to believe that the 1929 crash would have been followed by more than a moderate dip in U.S. economic activity," he has written. The biggest blunder Bernanke has in mind was the Federal Reserve Board's passive inactivity as the roof was falling in.
Bernanke holds that the Fed should have been pumping money into the financial system by lending to the nation's banks and brokerage houses, thereby enabling these institutions to meet their obligations instead of--as happened--going belly-up on such a scale they took the country down with them. This view is not a crank, idiosyncratic idea the Fed chairman thought up by himself.
His plan derives from a landmark book, A Monetary History of the United States, 1867-1960, by Milton Friedman and Anna J. Schwartz, which threw a new light on the economic catastrophe of the 1930s. Bernanke and other economists followed up on Friedman's and Schwartz's work so he was ready to deal with an impending implosion in which everybody's money vaporizes and the daily life of the country comes to a halt, as we line up in front of the soup kitchens.
Though he spent much of his professional life in the library and the classroom, when the crisis came Ben Bernanke showed he was no dithering academic. Using tools of his own invention and setting precedents some think may come back to bite us, Bernanke has put upwards of half a trillion dollars into the financial system.
To Bernanke, the US economy is a freighter out in the ocean with a leak in its hull through which water (lower housing prices and foreclosures) is rushing. Instead of patching the leak, he is on board with a pump, hoping to bail the water out faster than it is flowing in.
The hundreds of billions he is bailing are intended to make up for losses financial institutions are suffering from the mortgage-backed bonds whose current value is verging toward zero. The banks, reinforced with this new money, were supposed to start lending again, thus pushing up the price of real estate and moving us out of the danger zone.
But it is not happening. Not yet, anyhow. The Wall Street Journal reports that "home prices are falling at an accelerating pace, new data show, while a separate report found a shrinking share of Americans plan to buy a home anytime soon, suggesting more price declines in the months to come."
After all the help Bernanke has given them, the big institutions are still not out of the woods, and now reports are coming in that smaller banks are in serious trouble. People are falling behind on car payments and credit card debt, which has been consolidated and sold as bonds. As consumers default on their payments, these bonds are on their way to the same worthless end as the mortgage-backed bonds ahead of them.
That leaves us with Bernanke's bet and a question hanging in the air. Is he right that the 2008 crisis is close enough to the 1929 crisis to apply the untried and untested remedies of '29 to today's situation?
The Fed can print as much money as it likes, so Bernanke can stuff it down the gullets of the bankers till the cows come home. It may yet work. But while he is doing his stuffing, the rest of us may wish to close our eyes and offer up a small prayer.