Contrary to this morning’s headlines, we believe Chairman Bernanke’s reappointment this week is still far from certain and may become eerily reminiscent of the first TARP vote. After last week’s confirmation vote for Fed Chairman Bernanke was called off due to insufficient votes, the Administration and Congressional leaders are in the headlines this morning claiming he has the votes now and will be confirmed. Intrade odds for Bernanke’s confirmation bumped higher on the news. But our review of the numbers suggests Bernanke still faces a tough road, virtually all of the undecided Senators must break for the Chairman in order for him to secure reappointment.
Politics and policy from inside Washington
From AEI’s Desmond Lachman:
Bernanke’s sole claim for a second term rests on the masterful and bold way in which he prevented the U.S. economy from falling into the abyss following the Lehman debacle in September 2008. However, this begs the question as to who led us to the abyss in the first place. Throughout 2006, when the worst of the sub-prime lending was taking place, Bernanke was conspicuously silent in sounding the alarm about the dangers of the U.S. housing bubble. Similarly, he was painfully slow in recognizing how severe the fallout from the bursting of the housing bubble would be and he displayed the poorest of judgments in allowing Lehman to fail in as disorderly manner as it did.
If there is one more item that should sink Bernanke’s bid for a second term it has to be his recent statement that the Federal Reserve’s extraordinarily low interest rate policy between 2001 and 2004 contributed little to the creation of the largest U.S. housing market bubble on record. The Senate would do well to ask itself whether the economy’s interests would be best served by again choosing a Fed chairman who seems to have learned so very little from the Federal Reserve’s past monumental mistakes.
This is part three (part one and part two here and here) of my recent email chat with the Nicole Gelinas, author of the wonderful After the Fall: Saving Capitalism from Wall Street and Washington.
Why should capital standards be uniform across different asset types; why is this important?
Consistent capital standards are an acknowledgment of humility. For example, the next financial crisis could come from government debt. Yet governments around the world say for regulatory-capital purposes that sovereign debt is the safest investment imaginable. They said the same thing about highly rated mortgage-backed securities four years ago.
Regulators should allow financial firms and investors to do their own assessments of risk, rather than decree what debt is safe and what is not. Bottom-up risk assessment would protect the economy as a whole. If one financial firm makes a mistake in thinking that a class of securities is perfectly safe, the rest of the system will survive its failure. But if the government makes a similar mistake in one of its universal decrees of safety, the mistake multiplies itself over the entire financial industry.
Consistent capital requiremens would also make ratings agencies irrelevant – a much easier way of “reforming” them than what Washington is trying to do.
You brings up lots of reform ideas that don’t necessarily coalesce into a specific plan. But a common theme seems to be bright, clear rules instead of regulator judgment? Is that right?
Right. Of course, there’s always some human judgment involved. Back in the Eighties, hen-Fed chairman Paul Volcker, for example, used human judgment when he applied old-fashioned margin rules to limit speculative borrowing to the new-fashioned junk bond markets. Investors – and people in the Reagan administration – howled. But Volcker was humble enough to know that neither he, nor the financial industry, was able to predict the future and obviate the need for consistent rules.
The theme of my book is that free-market principles should govern the financial system. How do we make that happen? Big and/or complex financial firms must operate under a credible threat of failure. Lenders to such firms must know that that failure comes through a consistent, predictable, transparent system, in which losses come according to a creditor’s place in the capital structure – not through arbitrary, opaque government bailouts.
How do we make that happen? We must make the economy better able to withstand financial-industry losses. And we do that through everything that I talk about here and in the book. Moreover, we know that this works. It worked from the Thirties until the Eighties, until financial innovation began to evade the regulatory system and thus market discipline.
Do you buy the John Taylor idea that the credit crisis escalation in September 2008 was caused not by Lehman but rather lack of investor confidence in Paulson/Bernanke/TARP?
No, although I do not think that Lehman caused the crisis, either. If our “free market” financial system is dependent on “investor confidence” in the competency of government as it executes arbitrary bailouts, then we’ve got a real problem! I do agree, however, that arbitrary government actions starting in 2008 have prolonged the recovery and made it less robust. The answer to that problem, though, isn’t for the government to perfect its arbitrary actions. It’s to make such actions unnecessary by making the economy safer for financial-firm failures.
Would you have let Lehman fail
Yes. The financial system’s business model was itself a failure. That model was to borrow every last dollar based on Panglossian assumptions multiplied decades into the future. It was fatally brittle even to the slightest wavering in assumptions, and thus worked only in an environment of too big to fail.
When we took that veil of government protection away even for a moment, as we did with Lehman, what was underneath wasn’t pretty. It revealed that a financial system that’s immune from market discipline and exempt from prudent regulations is a system that can destroy the economy.
I hope that Washington learns this lesson, and takes it to heart. If not, the next time the financial system cashes in on its implicit government guarantees, it may overwhelm the government’s ability to bail it out. Markets will work, in such a case – but will exact a cruel economic and social price.
New polling by Rasmussen shows Evan Bayh in danger. Remember, one of the big impacts of the Scott Brown victory was a boost to recruitment. RealClearPolitics has the details:
Indiana Rep. Mike Pence (R) leads Sen. Evan Bayh (D) by 3 points, according to a new Rasmussen poll. Pence, the third ranking Republican in the House, is considering a Senate bid but hasn’t indicated publicly which way he is leaning.
Bayh leads two other Republicans, ex-congressman John Hostettler and State Sen. Marlin Stutzman, but still polled below 50% — not a good sign for an incumbent.
Bayh 44 – Pence 47
Bayh 44 – Hostettler 41
Bayh 45 – Stutzman 33
UPDATE: It now looks like Beau Biden isn’t going to run in Delaware. With Mike Castle in for the GOP, there is a good chance of a Republican pickup of Veep Biden’s old seat.