Monday, January 25, 2010

A hairy reed or a thin one?

Harry Reid is one of the Senators taking aim at Fed Chair Bernanke. His tepid endorsement and implied support in return for a more helpful Fed is repugnant.

The senators angry at the Fed for not printing more money simply don't get it. The Fed has expanded bank reserves at a very rapid pace. But it is banks that turn reserves into money by lending it. Their loans are redeposited by recipients into bank accounts where the funds are relent again. The process repeats in what is known as the multiplier effect.

The Fed does not create money. The Fed creates reserves which are the raw material for money supply. Interest rate policy is used to assist banks and the public in the expansion or retardation of loan growth and money growth. In this episode, the Fed has done all it can. Short of becoming like China, a bank that tells its banks to whom to lend, the Fed has done all it can. Those that castigate the Fed for not doing enough to grow the money supply are wrong and confused.

In the economic text books it is noted that when it is time to stimulate the economy the Fed's policies are hampered. Its attempts to stimulate are like pushing on a string. That is the problem, not Bernanke or that he has not done his job correctly or prudently. Oddly, those who want him do more are trying to lynch him for his role in in his activist stance under the previous Fed chairman. There is no ideological consistency to this criticism - it's all for political theater.

The view that Bernanke is damaged goods because he served under Greenspan misses the point that it was Greenspan who was the Chairman. No one ever accused Greenspan of sharing too much power. This never ending blaming of Bernanke for advocating low interest rates in the last cycle misses the point too. Low rates did not destabilize the economy. They stabilized it. With good lending practices the damage from low rates would have been minimal. The economy was not undone by 'too much lending' but by lending of a very poor quality and by too much leveraged lending.

It was Congress and it's pushing to extend home ownership- regardless of prudence that was at fault to a large extent. Banks engineered derivatives that were poorly constructed and not understood. that was their own error. A whole industry was set up to remain in denial and to defend the status quo of home loan production.

The SEC was in charge of securities regulation, not the Fed. The Fed's mandate was narrower than the SEC's. Yet the Fed did uncover mortgage irregularities and Greenspan stopped it from pursing those findings. How is that Bernanke's fault?

Perhaps the most amazing thing through all of this is that Greenspan seems to remain as a respected former Chairman despite his key role in all that went wrong while some in Congress have decided to go after Bernanke! The House Financial Services Committee and Senate Banking Committee were in the thick of making wrong policies especially regarding the missions of Fannie Mae and Freddie Mac. Yet these are the committees that have conducted the witch hunt. Read the WSJ Journal Op Ed then re-read this. The WSJ has it all wrong. The Witch hunters have it all wrong.

Bernanke is and was the right man for the job. There is little to blame him for. His innovation and consistency in sticking to the Fed's mission saved the economy. We should seek out those who attack the Fed and explore their ulterior motives. that would be the most productive tact at this point - after reappointing Bernanke, of course.

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