I called Ben S. Bernanke, the former chairman of the Federal Reserve, late in the debt ceiling stalemate. It wasn’t quite finished yet, but it would be soon. This time, at least, the financial system has averted another full-fledged crisis.
But when truly terrible events happen and Congress and the White House are focused on political battles, the Fed often ends up as “the only game in town,” Bernanke said, “the only policymaker that can help a troubled economy.”
Solving the pressing problems of the world is no longer Mr. Bernanke’s responsibility. In 2014, he stepped down as chairman of the Fed after guiding it through the global financial crisis. Now, at the age of 69, he studies at the Brookings Institution in Washington, where he devotes himself primarily to research and writing.
His research, which shows “that banking crises can have potentially catastrophic consequences” and “illustrates the importance of well-functioning banking regulation,” earned him a Nobel Prize in Economics in 2022. That academic work and the changes he made at the Fed changed the way we understand financial news, even if he himself makes less headlines.
Still, Mr. Bernanke said he is still “watching the Fed very closely,” and in an extended interview, he touched on many thorny issues, including bank runs, inflation and threats to financial stability.
At the moment, the banking system seems stable, he said, but you never know. For example, in the summer of 2007, when the global financial crisis began, Mr. Bernanke that he didn’t immediately realize how “devastating” it was going to be. Now, he said, he regrets that it has taken “several months” to “realize the magnitude of the crisis”.
Conditions in the financial system appear to be fairly calm today, he said, but added: “I learned from painful experience that you never say never; it is always possible.”
When he agreed to an open-ended talk, he insisted on one basic rule: He wouldn’t “doubt” the Fed.
“I’ll tell you what I think the Federal Reserve is doing and why it’s doing it,” he said, “but I won’t tell you what I think they should do at the next meeting,” he said.
Observations and recommendations
When Mr. Once Bernanke got rolling, his commentary included the following highlights:
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Further bank runs could be prevented by raising the ceiling for deposit insurance. That insurance “should cover more than $250,000 per account,” perhaps requiring larger bank depositors to “pay some kind of premium” for the benefit. His research, and that of his two fellow 2022 Nobel laureates, Douglas W. Diamond and Philip H. Dybvig, showed that fear of losing money in a weakened bank could cause or exacerbate bank runs like the one earlier this year, and could lead to deep economic stress.
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If the Fed had the regulatory authority that other central banks possess, it wouldn’t have to invoke emergency powers and set up temporary bailouts every time a crisis requires them to hold back shadow banks, including hedge funds, investment banks, private equity funds, money market funds, and of such. These giant institutions perform many of the functions of traditional banks. The Fed is hampered by “a structural flaw that has never been corrected by Congress, which is that the Fed is normally limited to lending to banks and not to other types of financial institutions,” he said.
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Never assume that everything in the financial system is okay. It may not be. There is a need for continuous monitoring and strengthening of systemic regulatory oversight to address major issues. Mr. Bernanke’s research showed that “the financial crisis of the 1930s was a major factor in the Great Depression,” an insight that, he recalls, people “laughed at” when he first wrote about it. “I think it’s become pretty conventional wisdom at this point that a major financial crisis is really bad for the economy.”
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The Fed may need time to bring inflation back to the 2 percent target it helped set, but unlike some writers — including this columnist — he said that target should be maintained. Two percent isn’t an “ideal” number, he said, and during his early academic career he advocated a higher target, of 3 or 4 percent, for Japan. But now U.S. politics and practical realities mean that the 2 percent target should be maintained, he said. “I would think if the Fed announced tomorrow that it would raise its inflation target, it would destroy its credibility,” he said. And any attempt to raise the target could trigger a Congressional action that could have the opposite effect.
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Are we in an AI bubble? Mr Bernanke said it was difficult to identify bubbles as they formed, and to know what to do if one did. “AI stocks are rising despite the overall economic environment being worrying,” he said. “Is that a bubble? It depends on whether AI turns out to be the transformative technology that some people think it will be. Maybe it is, maybe it isn’t.” The problem is that when some bubbles collapse, they can wreak havoc, as the housing bubble did in 2008. Such a collapse can “bring down critical financial institutions and cause huge financial problems.” He added: “If you have a strong and well-regulated financial system, then even if you have a bubble coming down, the system should be able to weather it without huge impact on the economy. “
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Regular press conferences by the Fed Chairman, which Mr. Bernanke initiated and which his successors, Janet L. Yellen and Jerome H. Powell, have expanded, are essential, he said. They are needed not only to convey the messages from the Fed to market specialists, but also to explain what is happening to the general public. At the start of the 2007-2008 crisis, he said, the Fed went to great lengths to bail out big Wall Street firms while supposedly neglecting the little guy. “It was probably impossible, but at least I should have tried to explain why it was important to maintain the stability of the financial system,” he said. “And why it would benefit everyone, not just Wall Street CEOs There is a sense that the Fed is owned by Wall Street, which is simply not true. But if you ask for regrets, I think I should have been a little more active.”
Fiscal and monetary policy
The Fed, he said, had to innovate in those years because the economy was in a serious downturn and needed more help, but the Fed had already cut short-term interest rates to near zero.
In 2011, he said, “we faced a very, very bad situation out of ammunition, in terms of the Fed Funds rate.”
More fiscal stimulus — more spending — might have done the trick, he said. But, he recalled, “Congress was already trying to move into an austerity program, trying to reduce fiscal policy.”
“And so the Federal Reserve was essentially left as the only policymaker in Washington that could do something about this desperately deep recession and all the job losses and costs imposed on workers and their families,” he said. “So we needed a new set of tools.”
At that point in his academic work, Mr. Bernanke formulated the principles of quantitative easing (buying bonds and other securities to lower interest rates over the longer term) and forward guidance (using messages to adjust expectations). These will become permanent fixtures in the Fed toolkit.
Large-scale fiscal stimulus has certainly taken place during the recent downturn in the pandemic, but with inflationary implications, so the Fed has not only raised interest rates but also used its new tools. In a reversal of quantitative easing, it has scaled down the assets it has bought over the years and sent many messages to tighten its belt. At a policy meeting next week, the Fed will assess whether all of these measures are slowing the economy.
The Fed’s job would be easier if fiscal policies were “more cooperative,” he said, but it’s very likely that the central bank will often be “the only game in town.”
A boring investor
Mr. Bernanke has released a stream of books and articles on both obscure and current topics, including a paper in the American Economic Review based on his December Nobel Prize lecture summarizing his life’s work. In May the paperback edition of his book ’21st Century Monetary Policy’ was published, with a new analysis of recent events.
Like many of us, Mr. Bernanke is putting money aside for retirement. A cottage industry of Fed watchers base their investment strategies on what they think the Fed is doing. Mr. Bernanke may be the most sophisticated Fed watcher, but he said he was “a very boring investor.” “I actually have a well-diversified portfolio,” he said. “I’m not trying to pick individual stocks. I don’t base my investments on what I think the Fed is going to do.”
Mr. Bernanke even told me that he was essentially practicing the straight-forward approach that “you advocate in your column.” He added, “I’m definitely not going to advise people to buy meme stocks or do anything out of the ordinary.”
He summarized his approach this way: “The other day you said something like, you know, get your portfolio aligned with your risk aversion and with your liquidity needs.”
I’d say make sure you can pay the bills first. Don’t put money in the stock market that you can’t afford to lose. And invest for the long term.
Based on Mr. Bernanke’s own example, I would add: Think, study, innovate and do all you can to keep the world going. But for your own personal investment, keep it simple.
