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Just better than middling

27 January 2014 By Hugo Dixon

How should the world outside America view Ben Bernanke’s legacy? Should it lambast the U.S. Federal Reserve chairman, who retires later this week after an eight-year stint, for failing to predict the financial crisis and being slow to react when it hit? Or should it laud him for pulling out the stops to save the financial system and pep up the U.S. economy after Lehman Brothers went bust in 2008? Or should non-Americans be worried that the process of unwinding Bernanke’s unprecedented money-printing policy will deliver a bad case of whiplash?

The answers to the last three questions are “yes, yes and yes.”

Bernanke’s culpability for the global financial crisis is not nearly as great as that of his predecessor, Alan Greenspan. It was, after all, Greenspan who ignored the dangers of financial deregulation, while being ever-too-ready to respond to any sign of market trouble by dropping interest rates – a policy that encouraged banks and investors to run up excessive risks with borrowed money.

By the time Bernanke took over in February 2006, the global credit bubble – and, in particular, the U.S. subprime housing bubble – was already well inflated. There was no way of avoiding trouble. However, the new Fed chairman could have mitigated the damage if he had had more foresight – say, by pushing for tighter regulation of the financial system.

The bigger criticism, though, is that once the subprime bubble burst in mid-2007, Bernanke was slow to appreciate the severity of the situation. True, he did cut interest rates. But he didn’t realise how losses were going to cascade through the global financial system, nor did he push hard enough for financial institutions to increase their capital and liquidity buffers.

What’s more, Bernanke’s Fed did little contingency planning to prepare for a big U.S. financial institution failing. As a result, when Lehman went bust, threatening to drag much of the global financial system down the plughole with it, there was no plan B.

After that, Bernanke swung into action with many important innovations – working closely with Hank Paulson, then Treasury secretary, and Tim Geithner, first president of the New York Federal Reserve and later Treasury secretary.

Their fire-fighting skills were not perfect. In particular, they were too soft on banks’ investors and employees when bailing them out. But they were right on the big call, which was to provide plentiful liquidity to banks, brokers and money market funds as well as dollar lifelines to central banks around the world. This stopped the crisis turning into a total disaster.

The U.S. bank stress test of 2009, which was accompanied with recapitalisation of weak institutions, was another important step in stabilising the system. It meant America could embark on an economic recovery without being smothered by zombie banks. If only the euro zone, which has delayed a similar stress test to this year, had done the same.

Bernanke’s next gift to America was extremely loose monetary policy. By the end of 2008, the Fed’s interest rates were already effectively zero. But the Fed boss, an eminent student of the Great Depression, knew he had other tools in his kit bag. Indeed, he had been nicknamed “Helicopter Ben” before he ran the Fed for agreeing with Milton Friedman, the founder of monetarism, that dropping dollar bills from helicopters would be an effective method of combating deflation.

Helicopter Ben first used “forward guidance” to indicate that interest rates would stay at record low levels for the foreseeable future. Then he launched an aggressive campaign of “quantitative easing” (QE). This involved going into the market and buying up trillions of dollars of bonds. By driving up the bonds’ prices, their yields plummeted. Investors were thereby encouraged to shift their assets into riskier investments.

The combination of QE and forward guidance undoubtedly helped America recover from the Great Recession. Loose monetary policy was especially important given that U.S. fiscal policy has been contractionary in the past three years.

The United States may not be growing as fast as it did after other recessions. But the economy is roughly 6 percent above its pre-crisis peak. That’s a lot better than the euro zone, which has not engaged in QE and whose economy is still 3 percent below its pre-crisis peak.

Bernanke’s loose money hasn’t just helped America; it has also helped the rest of the world. Just think how desperate the global situation, and especially Europe’s, would be if the U.S. economy hadn’t grown.

That said, QE has risks as well as advantages. The main one is that it can inflate new asset bubbles. Emerging markets have been particularly exposed because hot money from America poured into them in search of higher returns as a consequence of yields at home being artificially depressed.

Now that Bernanke’s Fed has started “tapering” its QE – a process that is expected to continue this week – money is flowing out of emerging markets. This is one factor behind the sharp falls in emerging market exchange rates from Argentina to Turkey last week.

But it’s not the only factor. Many emerging markets are vulnerable because they lived beyond their means and are guilty of poor governance. They are not innocent. What the Fed’s policy has done is give them plenty of rope with which to hang themselves.

So Bernanke’s legacy has definite minuses as well as pluses. That said, on balance, he has been a small net positive.


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