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What Will Bernanke Do With His Second Term?

Ben Bernanke has a great opportunity to lead the reform of our financial system. His standing in Washington and on Wall Street is at an all-time high, as a result of his bailout/rescue efforts. He is about to be reappointed with acclaim for a second term as chairman of the Federal Reserve’s Board of Governors. And he has a lot to answer for.

Look, for example, at his speech of May 17, 2007, which discusses some of the problems in the subprime market and contains the memorable line: “Importantly, we see no serious broader spillover to banks or thift institutions from problems in the subprime market; the troubled lenders, for the most part, have not been institutions with federally insured deposits” (full speech; marks in the margin are from an anonymous and careful correspondent.)

Three points jump off these pages.

  1. With the kind of analytical capacity and world view demonstrated in this speech, there is no way that Fed can be regarded as capable of protecting consumers vis-a-vis financial products going forward. The Fed’s claims to that effect undermine their legitimacy and plausibility. They failed consumers completely, and they should reflect deeply on the organizational culture and internal incentives that brought them to this sad point. “Give us another chance” is not convincing; there is too much at stake.

  2. If the Fed is capable of such mistaken views as Bernanke expressed in May, 2007, you must assume that regulation will break down again in the future. Tightening the rules on bank behavior is fine, but the banks will down the road again fool the Fed, other regulators, and perhaps even themselves on the true risks they face. It is therefore essential that our financial system carry much more capital than has been the case in the recent past. We should go back to pre-1935 or even pre-1913 levels (see slide 40 in this presentation). In a New York Times op-ed today, Peter Boone and I call for at least tripling current capital requirements as the right goal (of course, this should be phased in over a few years.)

  3. The intellectual capture of Washington by Wall Street was well underway in May 2007; it is now complete. This is why the banking barons felt no need to show up and show respect for the President on Monday. They have so many of their people (mindset-wise) placed throughout the administration, and the principle of revolving between Wall Street and Washington so well established, that they know: If they ever need another massive bailout, the people standing behind this or any future President will say there is no alternative. That’s why Peter and I also call for a 5 year gap between holding a responsible position on Wall Street and a top job in Washington, and vice versa.  Stop with the political appointment of regulatory “doves” and end the notion that you can go directly from a failing bank to directing efforts to rescue such banks.

Ben Bernanke can play the broad reformist role of Marriner Eccles, chair of the Fed during the Great Depression. Or he can go back to being a cheerleader for the financial sector, following in the discredited footsteps of Alan Greenspan.

This is his choice.