TOPICS > Economy

Bernanke Faces New Questions Over Role of the Fed

June 25, 2009 at 6:30 PM EDT
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Federal Reserve Chairman Ben Bernanke faced fresh questions from a House committee Thursday over the central bank's role facilitating Bank of America's purchase of Merrill Lynch. Experts discuss the acquisition, as well as the expanding power of the Federal Reserve, with Jeffrey Brown.

JIM LEHRER: We now have confirmation that pop music star Michael Jackson is dead. We’ll have more on that story in a few moments.

But now, Congress asked Federal Reserve Chairman Ben Bernanke tough questions today about his role during the financial crisis. Jeffrey Brown has that story.

JEFFREY BROWN: The key issue before a House Oversight Committee: What part did Chairman Bernanke play in Bank of America’s $50 billion acquisition of Merrill Lynch in the throes of last year’s economic crisis?

In the months after the purchase, it was revealed that Merrill had lost more money than anyone at BofA initially knew. Bank of America CEO Ken Lewis considered walking away from the deal in December, but went through with it after the government provided a financial rescue package.

Two weeks ago, Lewis told the same committee he felt pressured by the Fed to move the deal forward. And internal e-mails from other Federal Reserve employees suggested Bernanke was considering replacing the bank’s management if the deal did not go through.

But today, Bernanke insisted he did not threaten anyone to ensure the deal was completed.

BEN BERNANKE, Federal Reserve Chairman: And they were obligated to make the choice that they believed was in the best interest of their shareholders and the company. I did not tell Bank of America’s management that the Federal Reserve would take action against the board or management.

JEFFREY BROWN: Bernanke was pressed repeatedly by several Republicans on the committee. Indiana’s Dan Burton asked what happened when Ken Lewis considered invoking a clause to exit the deal, known as a MAC, or material adverse change provision.

REP. DAN BURTON (R), Indiana: Is Mr. Lewis lying when he tells this committee that you put pressure on him, along with Mr. Paulson?

BEN BERNANKE: All I know is that I never said that I would replace the board and management if he invoked the MAC.

REP. DAN BURTON: Well, what did you say? I mean, you know, sometimes there’s an implication without a direct order.

BEN BERNANKE: I expressed concerns about the effects of invoking the Mac both on the financial system and on the Bank of America itself. I expressed those concerns, which is appropriate, but it was always his decision whether or not to go ahead and take that decision.

REP. DAN BURTON: Did Mr. Paulson lie when he told Mr. Cuomo that he was acting under your suggestions or orders to tell them that the board would be fired if they didn’t comply?

BEN BERNANKE: I believe he’s modified that statement. I did not tell him — I did not tell Mr. Paulson…

REP. DAN BURTON: What did you tell him?

BEN BERNANKE: I didn’t tell him anything like that.

JEFFREY BROWN: That explanation didn’t convince Utah Republican Jason Chaffetz.

REP. JASON CHAFFETZ (R), Utah: I’m just not buying that. You’re in charge. You have the ability to affect their outcome, to fire them, to let them go. You’re telling them that if they don’t come to the same conclusion as you do that they would obviously, everybody in the room, everybody in the marketplace would know that their judgment was miscalculated.

I think that’s a threat, and I think it’s reasonable for the CEO and the board of directors to take that as a threat. I don’t see any other conclusion. If we were sitting across from the table, you controlled my destiny, that that’s one of the consequences.

BEN BERNANKE: Well, we don’t control his destiny unconditionally. We would have to make a case that he had made decisions that were damaging to the company. And if he had made that decision and the company had prospered, there would be no basis whatsoever for any action.

Assessing the Fed's restrictions

JEFFREY BROWN: Several Democrats raised a different concern: whether the Fed provided financial assistance too easily.

Chairman Edolphus Towns.

REP. EDOLPHUS TOWNS (D), New York: Internal e-mails we have obtained from the Federal Reserve indicates officials there were very skeptical about Mr. Lewis' motives in threatening to back out of the Merrill deal. Fed Chairman Ben Bernanke thought Lewis was using the Merrill losses as a bargaining chip to obtain federal funds.

Was Bank of America forced to go through with the deal, or was this just an old-fashioned shakedown?

JEFFREY BROWN: Dennis Kucinich of Ohio asked why the Fed didn't place more restrictions on the use of government money.

REP. DENNIS KUCINICH (D), Ohio: Ken Lewis came to you with a story that the Fed didn't believe. You were getting advice from your staff and from peers that considerable concessions should be required of Bank of America because of concern about the quality of top management.

And yet you decided to give the aid away without any meaningful changes to Bank of America's corporate management or its compensation policies. How do you explain that, Chairman?

BEN BERNANKE: Congressman, the supervisory process is not a one-time thing. It's an ongoing process. And in our ongoing supervisory process, we have made demands of the Bank of America...

JEFFREY BROWN: All this comes as President Obama has proposed that the Fed become an even bigger player in future bank oversight, an idea that provoked worry from Republicans today.

The committee's ranking member, Darrell Issa.

REP. DARRELL ISSA (R), California: Do you think that federal regulators should pick winners and losers as they go through trying to figure out in a crisis like this who gets to own who or who gets bailout money and who doesn't?

BEN BERNANKE: I think all these interventions are very unfortunate, and they're only made necessary by the extreme circumstances.

JEFFREY BROWN: Next up in the merger investigation, the committee plans to call former Treasury Secretary Henry Paulson.

The Fed's future role

JEFFREY BROWN: Today's hearing just added to the many questions raised about the Fed and its future role. We talk about that now with Martin Baily, who served as chairman of the Council of Economic Advisers under President Clinton. He's now at the Brookings Institution.

And Mark Calabria, who spent six years as a Republican staff member on the Senate Banking Committee, he's now director of financial regulation studies at the Cato Institute.

Welcome to both of you.

Martin Baily, there was some tough questioning in that hearing we just heard. What does that tell you about any prospective future stronger role for the Fed?

MARTIN BAILY, Former Chair, Council of Economic Advisers: Well, the Fed is not popular on Capitol Hill; there's no question about that. That was true before today, and I think after today that will be the case.

I have a lot of sympathy with Bernanke. I think he's a man of integrity. I think he acted very decisively to try to help us get through this crisis, so that I think he's getting a bit of a bad rap here.

But certainly it's going to make it more difficult for the administration's proposal, which is to give more power to the Fed. That's going to be resisted.

JEFFREY BROWN: All right. We'll come back to some of the details, but, first, what did you hear in today's hearing?

MARK CALABRIA, Former Senate Aide, Senate Banking Committee: Well, I want to agree with Martin on that. I think that this will make it more difficult.

But on the other hand, there was no smoking gun. I mean, nothing was presented saying, "You know, here's where Bernanke put pressure on it." You know, a lot of it was the ambiguity.

You know, and that's one of the problems in terms of bank regulation is, you know, the pressure might be implicit. So, you know, for the plus side, I don't think Bernanke made any big mistakes, and I don't think that the committee nailed him down on anything that's going to come back to haunt him.

But on the other side, I mean, he didn't knock it out of the ballpark, either. I mean, he really didn't dispel the sort of suspicions, which is really what he should have wanted to do. That should have been his number-one priority.

JEFFREY BROWN: All right, so let's look at what the Obama administration is talking about. One of the key things is the so-called systemic risk, correct, and the idea is to give the Fed more of a role. Now, what should the role of the Fed be to deal with that?

MARTIN BAILY: Well, I think the things the Fed has done well is monetary policy and trying to keep the economy stable. Maybe they've made mistakes here and there, but in general they've done that very well.

So I think putting them to monitor systemic risk, to really keep an eye on the whole banking system, the whole financial sector, indeed, the whole economy to make sure where we're not getting into another bubble like the one we've gotten into now, I think that's a good role for the Fed.

Where I think it's more difficult is their supervisory role. I'm not sure they did such a good job in supervising these bank-holding companies. And to give them increased authority there and give them all the big banks, I think that's an open question.

I would rather see a system like they have in the U.K. with a Financial Services Authority that does bank regulation. I don't know there's any appetite on Capitol Hill for that.

What we do have to do is to make sure, whether it's the Fed or whether it's given to a separate agency, that we get better regulation of all the banks, but particularly the big banks.

Alternatives to current system

JEFFREY BROWN: All right. Well, start with the larger systemic risk issue and giving the Fed more power to oversee that. Good idea?

MARK CALABRIA: I think it's very problematic. I mean, to me, going out there and essentially having a list of institutions that are going to be bailed out and are too big to fail to me is a signal to the marketplace that, you know, your debt is going to get paid off.

You know, whether the equity shareholders get wiped out or not, that's a different question. But I think the funding costs of these institutions will decline, and they'll get bigger and they'll get more market share. They'll actually more dominate our system, so that concerns me.

JEFFREY BROWN: Let me just be -- let me make sure people understand. So you're saying that the Fed would be, in essence, signaling that they will help these banks or these institutions?

MARK CALABRIA: The caveat would be, whoever the regulator would be, if you ahead of time say, "These institutions are too big to fail and they will be backed," then you're essentially saying to the marketplace that, you know, if you buy the debt of this institution, you're going to be taken care of, which is going to lower the funding costs of the institutions.

And so the question is, will the Fed or any regulator increase regulation sufficiently enough to offset that advantage? I'm very skeptical, you know, because part of the argument -- I imagine it this way.

What we're being told is that the Fed, who had bank-holding company oversight over Citi, over BofA, if we simply extended that same sort of oversight to AIG, we would have avoided it. You know, and I find that a hard argument to believe, because Citi has done such poor shape.

JEFFREY BROWN: Well, but given where we are, is there an alternative? I mean, is there an alternative to the Fed or what kind of system would you have?

MARK CALABRIA: Well, I think it depends on what you want to have. I mean, the number-one reason that I think the administration is positioning the Fed is, the Fed is the only institution besides Congress that has deep pockets and can spend lots of money. So the question is, do you want an institution that can resolve it?

If you want an institution that will resolve it, the FDIC has considerably more experience. They actually resolve institutions. They resolved IndyMac; that went fairly cleanly. You know, they resolved WaMu. They were able to find a buyer.

Those are things that went pretty cleanly. The market disruptions were pretty minimal. So the question always comes down to: Do you think that there needs to be a considerable pot of taxpayer money put in?

If you think that's the case, then there really is no other institution other than the Fed. But if you think that this is a regime to resolve and wind or restructure corporations, then I think the FDIC makes a much better...


MARTIN BAILY: Well, I agree we want to be careful not to create institutions that are too big to fail, and I think we need a resolution authority to deal with these big banks when they get into trouble. So I agree very much on that.

I also think we don't want to give them a special competitive advantage so that, if the cost of funds goes down -- and I agree it probably would -- we would want to offset perhaps by charging them some kind of insurance premium or making them hold more capital so that we level the playing field for all financial institutions.

Now, the idea of giving this regulation to FDIC, I think, would be a mistake. First of all, I think FDIC has done a good job, but not a great job. They did not resolve WaMu very well at all; that did not go well.

And I think they just don't have the experience and the staff and the personnel to really supervise these much more complicated banks that have global reach and global scale. So you'd have to -- either whether you put it at the Fed or some other agency, you've got to have that kind of expertise available.

Distributing power more evenly

JEFFREY BROWN: Is there at the same time some danger of putting too much power in any -- whoever this is -- in this case, the Fed -- too much power in one agency?

MARTIN BAILY: Well, there clearly is a danger of having too much power in one agency. That's certainly something one has got to watch out for, and that's why I'd prefer, really, the FSA, the separate agency for bank regulation.

But we do need regulators that have got the authority, and I think having the deep pockets is helpful when you get into a crisis. So I think the Fed does have that expertise and authority. But it is a danger to put too much power in any one institution. I agree.

JEFFREY BROWN: Is that part of your concern, that there's the -- you know, the Fed remains such a mystery to so many of us, right? There's that. There's the independence question. There's a lot of questions about what it -- and there's all the other things on its plate.

MARK CALABRIA: Oh, very much. And I would say, the one point of agreement here -- several points of agreement is, I would say we should look at the British model, splitting off monetary policy from bank supervision.

I do want to say very strongly, in terms of nonbank financial companies, like AIG, I still think that we can fix the bankruptcy code to the extent that that will work, because I do think you need to take the politics out of it, you need to take the severing of priorities in terms of who's treated how.

And, you know, everybody points out Lehman as a failure, but most of Lehman's assets were sold within four weeks. I mean, most of that was resolved. It's still outstanding, but compared to AIG -- and I would agree with Martin in terms of, well, did WaMu go perfect? But, no, but I would say it went a whole lot better than AIG. And there was an end game.

You know, nobody can tell me what AIG is going to look like in six months or what Freddie and Fannie are going to look like in six months.

JEFFREY BROWN: Just to finish, go back to where we started, looking at that hearing. You guys both have worked in Washington and in the administration on the Hill. All of this now is part of a political football, is it correct? Is that the way to...

MARK CALABRIA: Oh, definitely.

JEFFREY BROWN: Nothing will be resolved here without politics involved.

MARTIN BAILY: Oh, definitely. I do think the Senate particularly has a desire to come out with something which is bipartisan. And I think Shelby and Dodd are going to work towards getting a bipartisan compromise. It's not going to be easy, but I think that's something that they want to do, yes.

MARK CALABRIA: And I would 100 percent agree. I mean, the ability to take two, three weeks of floor time in the Senate on this is only going to happen if you have bipartisan buy-in. And you have a lot of moderate Democrats, I think, Mark Warner, people like that, who I think have some skepticism about continuing bailouts.

So it's not like the House, where you can just jam something through, which I think something will be jammed through in the House, probably on pretty narrow party lines, but you're going to see a real effort, and it's going to take a lot more time, but I think there will be at least a lot of effort made to get a bipartisan product out of the Senate.

JEFFREY BROWN: All right, Mark Calabria, Martin Baily, thank you both very much.

MARTIN BAILY: You're welcome.