Bernanke defensive but not all wrong

When I heard on the news Monday that Fed Chairman Ben Bernanke had given a speech in which he contended that the Fed played little role in the housing bubble that precipitated the financial crisis, I was appalled. I have been influenced by Stanford economist John Taylor's little book making the case that the Fed's departure from the "Taylor rule" on monetary policy was a big factor in the fiasco, flooding the economy with funny money from about 2002 through 2004, and I still think he has a strong case.

I found all the news stories fairly unsatisfactory, so I found a copy of Bernanke's speech (which included more than a dozen pages of charts and graphs) and read and pondered it. I finally decided he has made a case that the Fed's role was less important than is widely believed. It really was more Fannie and Freddie. Bernanke's most telling datum is a reminder that the bubble began expanding in 1999, well before the Fed's post-9/11 expansion, although the expansion accelerated in 2005 -- and Bernanke acknowledged that the Fed probably played a role in that.

I think this Register editorial, in combination with this blog post, summarizes my thoughts fairly accurately.Bernanke made a case, but still unduly downplayed the Fed's role. And his argument that better regulation would better prevent future crises is ludicrous.

Small progress on the Fed

It is appropriate, as this Register editorial does, to take note of the fact that Ron Paul's bill to audit the Federal Reserve system, which he has introduced since the 1980s, finally got House approval this week. I have often thought that when the founders contemplated the Congress they were establishing that they hoped for a Congress full of people like Ron Paul --devoted to the Constitution and thinking first and foremost of making sure the government abides by its strictures. Instead, we have Congress with one Ron Paul and a few others with something 9of a passing knowledge of the Constitution. Ah, well.

Of course it would be nice if this were a serious preparatory step toward abolishing the Fed instead of something of a symbolic gesture fueled mostly by uncomprehending populist anger at a powerful and mysterious institution. But I'm afraid Jefferson was right when he said the natural order of things is for government to grow and liberty to retreat. We get a little pushback now and then -- this vote, a growing sense of unease with Obama and his kneejerk efforts to expand government in every sphere of life -- and sometimes a little advance for liberty. But even hanging on to the oiberty we have, I'm afraid, is the work of a lifetime.

Some pushback against giving the Fed more power

It's interesting to see that Obama is getting some pushback from Congress on the proposal, as part of the massive financial reregulation proposal, to give the Federal Reserve more power and authority by making it the guardian against "systemic" risk. The WaPo subhead says congresscritters are irked that the Fed didn't do enough to avert the crisis. Didn't do enough to avert? The Fed was a huge cause of the crisis with its loose-money policy after 9/11 and afterward. John Taylor even makes the case that Fed policy was the prime cause, and Tom Woods assigns it a huge share of the blame -- along with other government policies and practices, like pushing banks into giving mortgages to people who were obviously unqualified.

But the Obama proposal is fairly typical of government, where nothing succeeds like failure. Has a government agency with a mission made a little progress toward fulfilling it? Give it more money and power as a reward and incentive to finish the job (sometime in the next milennium). Has it failed utterly? Obviously it needs more money and power (see war on drugs). Of the two rationales, failure is the more effective and the more often used.

In a sane world the Fed would be seen as an inherently destabilizing institution with a buiilt-in bias for creating inflation (when I was in high school a candy bar that costs 75 cents now was a nickel) and abolished forthwith. In Washingtonworld is creates a crisis and is rewarded with more power, the true currency in the Imperial City.

Tom Woods Diagnoses the financial meltdown

I promised a link to my review of Thomas E. Woods' book, "Meltdown: A Free-Market Look at Why the Stock Market Collapsed," and here it is. While he mentions the Community Reinvestment Act and various government mandates to give mortgages to people of marginal (at best) creditworthiness, he pins most of the responsibility on the Federal Reserve's enormous expansion of the money supply after 9/11, and argues that we could get along quite nicely -- in fact much better -- without the Fed. I'm inclined to agree. Best line, I think from the introduction by Ron Paul: To blame the financial meltdown on greed is like blaming a plane crash on gravity.

Fed: The smell of panic

The Federal Reserve's decision to cut the interbank loan rate to a "target" of 1/4-to-zero was in one sense simply an acknowledgment of reality and in another a sign of real panic. They've pumped hundreds of billions of funny money into the banks over the last few months, but so far the impact has been slight at best. Esmael Adibi, whom I talked to yesterday, said at the Chapman economic Forecast meeting last week that since the banks have to pay 5% interest (or whatever they're calling it) on much of the bailout money, they'll have to start lending soon. But so far they haven't exactly been eager to lend. In some ways that's not too bad; the trouble started with an orgy of government-mandated and -induced dubious loans, so it's not surprising and probably a good thing that they're tightening up criteria. And the government has been so haphazard, changing approaches every couple of weeks, that the lending environment is more than a little unsettled.

Anyway, here's the Register's editorial on the move, worrying that the government is setting us up for serious inflation is 2010 and 2011, and setting the stage for another boom-bust cycle. If it were up to me I would get rid of the Fed. A central bank is (and has been from the beginning) an instrument for creating inflation to facilitate government growth rather than for promoting genuine monetary and/or economic stability.

Incidentally, Chapman, which called the recession last December (just validated by the NBER) thinks we'll start coming out of it by the end of 2009, but doesn't expect a very robust recovery.

Market discipline better than regulation

Here's a link to the Register's editorial on the Fed's decision to keep the discount window open to investment banks, which could presage a move to regulate them directly. As Bill Niskanen, chairman of the Cato Institute, told me, this could create yet another industry with the moral hazard of knowing the government is likely bail them out if they make bad moves, because they're "too big to fail," like Bear Sterns. In retrospect, it might have been better to let Bear-Sterns fail rather than bail it out earlier this year. The reason market discipline is more efficient than regulation is mainly due to the knowledge that a business could fail, which tends to concentrate the attention mightily. Sending the message that investment banks won't be allowed to fail is an incentive for riskier behavior -- probably not immediately, but a few years down the road, when lessons (like the 1980s S&L failures) tend to be forgotten.

Bear Stearns crisis makes case for gold

I'm not much of a gold bug, although I certainly can appreciate the case for a gold standard and the critiques of fractional-reserve banking. The current crisis that the government and the Federal Reserve are having so much trouble dealing with -- the fire they are pouring gasoline on -- certainly makes something of a case. Robert Samuelson, in a recent column, explains how convoluted the financing/banking system has become. Mortgages aren't often kept by the institution that issues them, but are "securitized" -- packaged with other loans and sold to inveswtros. The current crisis is likely to affect more of the economy because the system is so convoluted and not the least bit transparent. Without fractional-reserve banking, such convolution would be almost impossible. Bank runs like Bear Stearns couldn't happen, because banks could lend out only on nthe basis of the funds they have on deposit.

The other problem is loss of confidence in the dollar, due largely to thr Fed pumping in more Fed-created money into the economy. The Fed's response? Lower interest rates more so as to pump in even more funny money! It's a quintessentially short-term, not to say desperate approach, that will only make the problems worse in the long run. With a gold standard the government wouldn't be able to manipulate (and more often than not, mismanage) the money supply so irresponsibly.