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Bernanke Reflects on Fed’s Aggressive Actions

July 27, 2009 at 6:05 PM EDT
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In the first of a three-part discussion, Fed Chairman Ben Bernanke warned that jobless rates may continue to rise and discussed his fears of another Great Depression.
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GWEN IFILL: With that in mind, we asked a nonpartisan organization, Kansas City Consensus, to help us identify area residents with questions for Chairman Bernanke. They were pre-interviewed by NewsHour staff and selected by us. Our staff also helped Jim select questions submitted by our online audience.

Here now is part one of our forum, “Bernanke On the Record” with Jim Lehrer, at the Federal Reserve Bank in Kansas City.

JIM LEHRER: Mr. Chairman, welcome, sir.

BEN BERNANKE, chairman, Federal Reserve: Thank you.

JIM LEHRER: Underlying many of the questions that these folks have are questions that are basic about the Federal Reserve itself. For instance, I’d like for Gwen Bailey to stand up.

Tell the chairman what you told our producer when she talked to you about your questions for the chairman.

GWEN BAILEY, social worker: My name is Gwen Bailey. I’m a social worker with Visiting Nurse Association. And my particular interest is, exactly what is the Federal Reserve? I don’t have a clue what they do, how they impact our lives, and that is why I was very interested to be selected to participate in this forum.

BEN BERNANKE: Gwen, you’ve got a good place to start there. The Federal Reserve is an independent government agency, also called the central bank. It was founded about a hundred years ago.

It was founded actually in the beginning to try to address financial crises. There had been a panic in 1907, and that started the process by which Woodrow Wilson created the Federal Reserve.

So, throughout our 100-year history, we have been very much involved in dealing with financial crises, trying to address situations just like we have now, when the financial markets are in disarray and they’re affecting the economy.

The Fed has some other important functions, as well. We set short-term interest rates in order to try to keep the economy on track. We have a mandate from the Congress to move interest rates up and down as needed to try to promote employment and to keep prices stable, keep inflation low. So monetary policy, moving interest rates around is very important.

We have lots of other things we do, as well. We work with other supervisors to try to make sure the banking system is stable. And we’ve had a lot of work to do on that in the last couple of years.

And many people don’t know: We also do consumer protection. So if you look at your credit card bill, you will see the periodic statement, the structure, the lines, and the way that’s organized was determined by the Federal Reserve. And the Federal Reserve sets a lot of the rules associated with how credit cards can be charged, the kinds of penalties, fees, and so on.

So, broadly speaking, financial stability, trying to keep the financial markets stable, monetary policy, interest rates to move the economy into a higher pace or a lower pace, banking supervision and consumer protection, and so a whole range of financial economic issues.

JIM LEHRER: Thank you, Ms. Bailey.

Just to follow up, Mr. Chairman, when you say independent agency, define “independent.”

BEN BERNANKE: We are an agency of the government, but within the government we need to have some independence from Congress and the administration. And the most important area is monetary policy.

There’s a lot of evidence that, when politicians make monetary policy, you don’t get good results. Politicians have a short-term horizon or they may want the central bank to print money to pay for the government deficit. Either one of those things is going to create a lot of inflation.

What we’ve learned over time — and this is a lot of evidence to support this — is that, when the central bank is allowed to make monetary policy, with the interest, the long-term interest of the economy in mind, without the interference of the administration or the Congress, you get much better results. You get low inflation, and you get good growth.

This has been seen all around the world, so we’re very, very sensitive to this issue. We want to be very sure that when we make monetary policy that we’re doing it in a nonpartisan way, that we’re doing it based on what’s good for the economy, and that we’re not being told what to do by the president or the Congress.

JIM LEHRER: So when you get up in the morning, who do you — who do you go to work for? Who do you feel you’re answerable to?

BEN BERNANKE: I’m answerable to the American people. I was appointed by the president to a 14-year term as a governor, but a 4-year term as the chairman of the Fed. And I was approved, I was confirmed by the Senate. So I obviously go through a political process to be appointed.

But, again, the Federal Reserve governors, the Board of Governors, the seven people who are at the head of the Fed in Washington, are generally professionals, technical people, people who are not lifetime politicians, people who wanted to serve the country using their knowledge in one of these areas that I was talking about, like banking or monetary policy.

JIM LEHRER: When somebody says, “Oh, the Fed is essentially the fourth branch of government,” how do you react to that?

The Fed Requires Independence

Ben Bernanke
Chairman, Federal Reserve
[T]he Fed needs independence in making monetary policy, and that's good for everybody, because it helps keep inflation low.

BEN BERNANKE: That's a tremendous exaggeration. As I said, the Fed needs independence in making monetary policy, and that's good for everybody, because it helps keep inflation low.

But we are very accountable. We have to report regularly and frequently to the Congress. Just this last week, I had to testify -- maybe you saw me on television -- I had to testify before both the House and the Senate explaining our policies, what we're doing, and reporting to the Congress and the American people about our ideas, our decisions, and how they affect the economy.

And, again, we are subject to the appointment process. And Congress can change the rules, as well. So it's not a constitutional-type situation. It's one where our independence has to be won every day, if you will, in that we have to show that we are producing good results and doing so without intervention or interference from other political bodies.

JIM LEHRER: OK, got it. Now, to set the various stages for where we go from here, we have a report by NewsHour economics correspondent Paul Solman.

PAUL SOLMAN: In Missouri, with more Federal Reserve branches than any state in the country, Kansas City, with more fountains than any city outside Rome, where better, we thought, to launch an explanation of the Fed's actions to supply liquidity so the economy can remain afloat?

Economist Nick Perna.

NICK PERNA, Perna Associates: Just like that old metaphor about the Federal Reserve trying to steer a course between inflation and recession. I'm sure you did a segment 20 years ago with a couple of my great old professors from MIT.

PAUL SOLMAN: Indeed, we did. Twenty years ago, we went to sea with Nobel laureates Bob Solow and Franco Modigliani, who gave the image of Fed chairman as boat captains a classical twist.

FRANCO MODIGLIANI, economist, MIT: He reminds me of a famous passage in "The Odyssey" that describes Ulysses trying to negotiate a passage between two rocks.

PAUL SOLMAN: In Homer's epic poem, "The Odyssey," one rock harbored six-headed Scylla. To the economics professors, Scylla symbolized the dangers of inflation, which makes money worth less. Beneath "The Odyssey's" other rock,

Charybdis, a ship-sucking whirlpool, to the economists, symbolic of the downward spiral of recession and unemployment.

ROBERT SOLOW, economist, MIT: A little bit of recession creates a little pressure for more recession. My business is bad; I buy fewer materials; I lay off workers. They can't spend incomes they don't have.

PAUL SOLMAN: Thus, the Fed's job: to steer a steady, sturdy middle course. No wonder the Fed is built to seem so Washington-reassuring.

DONALD KOHN, vice chairman, Federal Reserve: This is the boardroom, where the Board of Governors meets.

PAUL SOLMAN: Don Kohn is current vice chairman of the Fed.

DONALD KOHN: This is also the room where the Federal Open Market Committee meets to discuss monetary policy.

PAUL SOLMAN: And to make monetary policy, which is how the Fed steers, by deciding to draw money out of the economy if inflations threatens, pump money in if, as now, recession is the monster.

BRIAN SACK, executive vice president, Federal Reserve Bank of New York: When the Federal Open Market Committee makes policy decisions, it's the job of the desk at the markets group to actually go out and implement that.

PAUL SOLMAN: The desk is at the stout New York Fed, famous for the five metric tons of gold, more than Fort Knox, tucked underground. "Diehard With a Vengeance" had to re-create the vault. Fourteen floors above the gold, Brian Sack runs the open market desk.

BRIAN SACK: In open market operations, the way we create money is by buying securities.

PAUL SOLMAN: Amazingly, the Fed's usual job for almost a century is as simple as that. To add money to the economy, the Fed buys U.S. government securities -- on this day, $3 billion worth -- and thereby creates new money, Federal Reserves. It's supplying, in Fed speak, liquidity.

BRIAN SACK: Financial firms will be giving us Treasury securities. In return, they'll be getting reserves or just liquid assets that they could use for a variety of purposes.

PAUL SOLMAN: But they're not really anything. I mean, they're just electronic entries somewhere on their books.

BRIAN SACK: Right. Right. Yes, we don't send a truck out with $3 billion in bills.

PAUL SOLMAN: But to financial firms, the reserves are like cash in the vault. The more reserves banks have, the more loans they can make, and in competing to make them, the lower the interest rates they offer. The usual result: more money flows through the economy.

Returning to the water metaphor, however, these were not usual times. That's because what everyone's been calling a perfect storm hit. The economy appeared to be going under. The Fed responded with what seemed like a radical laundry list. It pumped money into the system short term, lowering overnight interest rates dramatically. It loaned money longer term to financial firms in peril. Finally, with Treasury, it gave money to fragile firms directly.

Back in the watery city of fountains, economist Nick Perna.

A Perfect Storm Sunk the Economy

Ben Bernanke
Chairman, Federal Reserve
We really need -- and this is critically important -- we really need a new regulatory framework that will make sure that we do not have this problem in the future.

NICK PERNA: What they did was to provide financial liquidity, not the stuff we're standing in right now. They bought commercial paper, mortgage-backed securities. They bought preferred stock. They made direct loans. They injected hundreds of billions of dollars of funds, of liquidity into the financial system.

PAUL SOLMAN: So 20 years after we first shot them explaining the Fed on Martha's Vineyard where he summers, we asked Bob Solow to return to his steering-the-course metaphor.

And we're using this boat, because we're not going out on the water in this kind of wind. Steering the course between inflation and recession, the Fed drives interest rates down almost to 0 percent, and yet we're still headed into the whirlpool of recession. What happened?

ROBERT SOLOW: Well, think of it this way. In normal winds, the Fed can steer between inflation and recession by making small adjustments. But then, a year or 18 months ago, there weren't normal winds. There was a perfect storm, a really dangerous blow, and a boat like this can't make headway against that. It will get knocked down. So the Fed had to try something dramatically different, way outside its normal procedures, and it did.

JIM LEHRER: Mr. Chairman, first, do you agree with the perfect storm analogy?

BEN BERNANKE: A lot of things happened. A lot of things came together. It created, I think, probably the worst financial crisis certainly since the Great Depression and possibly even including the Great Depression. So, yes, I agree.

JIM LEHRER: What were your worst moments for you personally?

BEN BERNANKE: Oh, the worst moments were back in September. The financial crisis began with Fannie Mae and Freddie Mac, the large housing companies that were taken over by the government. And subsequent to that, a number of very large financial firms came under enormous pressure.

And one of them, Lehman Brothers, an investment bank, failed. Others came close to failure, needed government support, not just in the United States, but around the world, and those were some very long nights I spent on the sofa in my office as we worked to try to keep the financial system running.

JIM LEHRER: Yes. Let's go to a question here from Janelle Sjue about this very thing, the storm, and what Chairman Bernanke and others at the Fed were doing.

JANELLE SJUE: Hi. I'm Janelle Sjue, a Kansas City mother.

I guess I have a couple of short questions. First of all, we've given millions, hundreds of millions of dollars, of tax money to these large corporations, these behemoths. Is that going to be enough to correct the situation?

And, secondly, you know, I'll use the analogy of nature. When a prairie fire burns through, it takes out all the big overgrowth and allows all the small stuff to pop up. Why don't we just let the behemoths lay down and then make room for the small businesses? Thank you.

BEN BERNANKE: That's a great question. The problem we have is that, in a financial crisis, if you let the big firms collapse in a disorderly way, they'll bring down the whole system.

When Lehman Brothers failed, the financial markets went into anaphylactic shock, basically. And it was that shock to the financial system that led to the global recession that began last fall, which was probably the worst one since World War II.

So it wasn't to help the big firms that we intervened. It was to stabilize the financial system and protect the entire global economy.

Now, you might ask, you know, what's the deal? Why are we doing that? It's a terrible problem. It's a problem called the too-big-to-fail problem. These companies have turned out to be too big to allow to collapse, because, again, if they collapse, when the elephant falls down, all the grass gets crushed, as well.

We really need -- and this is critically important -- we really need a new regulatory framework that will make sure that we do not have this problem in the future. And the president, the administration has proposed a system that would include -- and let me just mention two items -- first, that the Federal Reserve would oversee all these major big firms that are, quote, "too big to fail" and would put extra tough requirements on their capital and their activities, what they can do, the risks they can take. That would be the first part.

But the second part is very important. We would modify the bankruptcy code. The problem now is that the bankruptcy code is such that, when one of these firms fails, it's a disorderly mess.

What we need is a system where the government can say, "This firm is about to fail. We can't let it just fail, but we've got -- also, we don't want to prop it up, either. We need an alternative between bailout and bankruptcy."

And that alternative is a system where the government can come in and seize the firm and then unwind it in an ordinarily way, sell off the assets, and do that in a way that does not cause chaos in the financial markets.

We have a system like that already. Right now, the Federal Deposit Insurance Corporation, whenever a small bank or a medium-sized bank is about to fail, it can come in before it fails, grab it, sell off assets, pay off the depositors, and this all happens without causing a huge problem in the financial markets. That's what we need.

And I agree with everyone here. Too big to fail is a terrible situation. We've got to fix that. And I think that's the top priority for policy going forward.

Steering a Middle Course

Ben Bernanke
Chairman, Federal Reserve
We need to have sort of a middle course between credit that is excessively risky, excessively easy, and credit which is so tight that legitimate borrowers can't get credit.

JIM LEHRER: Bill Black, staying on the storm question, has a short question on this. Bill Black?

BILL BLACK, professor, Economics: Bill Black, professor of economics, law and criminology, and former financial regulator, UMKC. If this is a terrible situation and creates this kind of moral hazard, all theory says we need to remove the officers who put us in this situation. When will the Fed begin to remove those officers?

BEN BERNANKE: Well, when we've gotten into situations where companies were actually failing and had to be supported, first, I should say that this was not a Fed operation. The Fed and the Treasury work closely together, so it's been a broader -- and the FDIC has participated, as well.

In those cases where companies were prevented from failing, the shareholders typically lost virtually all their money and we did replace the officers.

Take, for example, AIG. AIG's CEO was fired. The shareholders lost all their money. Bear Stearns, Bear Stearns' shareholders lost all their money, and the company was taken over by another company.

So, you know, in most cases, we have replaced the leadership and we have made sure the shareholders have lost the greatest part of their value.

JIM LEHRER: Got an e-mail, Mr. Chairman. This is from Karl Denninger in Niceville, Florida. The question is, "Since this crisis began with people unable to pay their bills and continues to be marked by this problem, how does expanding credit solve the problem? Isn't that going to be like giving a drunk a bottle of whiskey and calling him cured?"

(LAUGHTER)

BEN BERNANKE: Well, we have a case here of overreaction. It's true to some extent that this crisis was caused by too much credit, credit that was too risky, too easy. That's all true.

But the financial crisis has caused a huge reaction in the other direction. And if you have a small business or you try to get a loan, you know that credit is very, very tight right now.

We need to have sort of a middle course between credit that is excessively risky, excessively easy, and credit which is so tight that legitimate borrowers can't get credit.

The Federal Reserve has been working hard on this in a lot of ways. First, we've cut interest rates all the way to 0 percent, the short-term interest rate, one that we control. We've then worked with banks to try to increase their lending.

And we have a whole set of programs. Let me just talk about one. We have a program that lends to investors who want to purchase consumer or small-business loans from banks. And that puts more money into the system.

And what we've found is that this program has brought down auto loan interest rates. We've helped finance 1.6 million auto loans. It's helped a lot in small-business loans. We've financed about 600,000 small-business loans. And so we have actually intervened in the market to try and get the credit markets working again.

So we had too much credit. It was too risky. It was too excessive. Now we've got to bring things back to sort of a nice middle ground.

JIM LEHRER: Jonathan Kemper, a question?

JONATHAN KEMPER, Banker: I'm Jonathan Kemper. I'm a fifth-generation community banker here in Kansas City.

My question is, you reacted to a perfect storm going in, but I think the judge is going to be how you come out of it, because you talk about these new programs, all these special programs. Are they going to be part of the normal course of business for the Fed going forward?

BEN BERNANKE: No, they won't. That's a good question. We have some programs we've had for a while which are, as you would know, are short-term lending programs to banks when they need liquidity for short-term periods. And that's been around since the beginning of the Fed, and that would continue.

But all the other programs, the special programs we've put together to help in the commercial paper market, to help in the consumer loan market, to help in the mortgage market, all of those will eventually be unwound and be taken away as the normal market processes begin to function again.

We need to do that, because we want to make sure, first, that markets go back to normal, that credit is allocated through the market process, and, secondly, because at some point when the economy begins to recover, we want to make sure that we don't over-stimulate the economy into an inflation.

And so for both of those reasons, we're going to have to unwind, essentially, all of the programs that we've put out.

Too Big to Fail, Too Small to Save

Ben Bernanke
Chairman, Federal Reserve
I was not going to be the Federal Reserve chairman who presided over the Second Great Depression. And for that reason, I had to hold my nose and stop those firms from failing.

JIM LEHRER: Dave Huston, you have a question in the same area.

DAVID HUSTON, plastics distributor: Hi. Welcome to Kansas City.

BEN BERNANKE: Thank you.

DAVID HUSTON: My name's David Huston. I'm a third-generation small-business owner with offices here in Shawnee, Kansas, a suburb of Kansas City, Des Moines, and Omaha.

My question is partly a statement, but also a question. I said I'm very, very frustrated during the past year when I see billions and billions of dollars sent to large financial institutions and of what we were alluding to before.

I'm especially upset when I hear the phrase -- and you used this -- quote, "That company is too big to fail." As a small businessperson, that's very hard to swallow. I feel like a more accurate statement of policy would be too big to fail, too small to save.

My business and thousands of others fall into that too-small-to-save category. Small businesses employ more people than the Fortune 500 companies combined, but I truly believe small business are getting shortchanged by the Federal Reserve, the Treasury Department, and Congress. Am I wrong on that perception?

BEN BERNANKE: It's a great question, tough question, but a great question. Let me go first back to too big to fail, and let me just emphasize that nothing made me more frustrated, more angry than having to intervene, particularly in a couple of cases where taking wild bets had forced these companies close to bankruptcy. Nothing made me angrier than having to do that.

Why did we do it? Because, if that company had collapsed in the middle of a crisis, it could have brought everything down.

In 1929, people think the depression was created by the stock market crash. It wasn't. From 1929 to 1931, it was a normal recession. Then, in 1931, a huge bank in the middle of Central Europe collapsed. And that created a global financial crisis which then made the recession into a Great Depression.

I was not going to be the Federal Reserve chairman who presided over the Second Great Depression. And for that reason, I had to hold my nose and stop those firms from failing.

I am as disgusted about it as you are. And I think it's absolutely critical as we go forward that we put in a new system that will make sure that, when a firm does not succeed in the marketplace, that it fails. That is absolutely critical, and I support that 100 percent.

Now, on small business, I also agree with you. Small business is where the jobs come from. It's where the innovation comes from. It's where the creativity and entrepreneurship in America comes from.

Every big company was once a small company. And so we really have to preserve and protect and strengthen small business. And I'm fully aware of those issues.

We hear all the time about the credit issues for small business. We're doing what we can. As I mentioned, our program to get small-business loans out, we're working with the banks, encouraging them to make loans.

I understand your frustration. I absolutely understand your frustration, and we're working really hard to try to make it better.

JIM LEHRER: Mr. Chairman, as I'm sure you know, there were competing pieces in the Sunday New York Times op-ed section on the question of whether you deserve another term as chairman.

And the negative part was written by -- a piece was written by Anna Jacobson Schwartz. She's an economist from the National Bureau of Economic Research. I'm aware that you know her.

But let me just read you what she said, which relates to this particular question that we're talking about here, is the storm and how the Fed reacted.

Quote, "The Fed delivered plenty of rhetoric about the importance of transparency, yet failed to articulate its own goals. The market was thus bewildered when the Fed rescued certain firms and not others. Mr. Bernanke should have explained the principles behind these decisions. The market could not understand why the Fed rescued Bear Stearns and then permitted Lehman Brothers to die."

"As a consequence, there was volatility in the credit and equity markets and a general sense of turmoil that demonstrated that participants were at a loss to understand the functioning of the Fed."

Your comments, sir?

BEN BERNANKE: My comment is that we tried to save all these big companies, because we knew the implications. We tried to save Lehman Brothers.

The problem is, as I was discussing before, is that we don't have a system. We don't have a structure. All these problems that she was alluding to occurred before even the Congress passed this TARP legislation that created the $700 billion to support failing companies. So we didn't have any tools.

In the case of Bear Stearns and in the case of AIG, by using the Fed's lending authority and other devices, we jerry-rigged up a way of preventing the failure of those firms. In the case of Lehman Brothers, there was just a huge $40 billion, $50 billion hole that we had no way to fill and no money, no authorization, no way to do it, so we had to let it fail. We had no choice.

So I don't -- I regret that it happened, because it created a huge amount of difficulty. And in fact, it just confirms what I've been saying, that if you allow a big financial firm to collapse in the middle of a financial crisis, the consequences for the average person, for the global economy are severe.

What Ms. Schwartz wanted us to do was to state in advance what our strategy was for saving firms. We had no idea which firm was going to fail, and we didn't have a system. We didn't have a structure.

And what I'm saying is, going forward, we need to have what we now have for banks, but don't have for other kinds of financial firms. We need to have a law, a set of laws that allows the government to come in and systemically and in a transparent way wind down a failing financial behemoth, to use the word that was used before, so that it doesn't create damage throughout the system.

So her premise is that we made a conscious decision to let Lehman fail. We did not. We spent the entire weekend with basically 24 hours a day trying to do everything we could to save that company, not, again, because we thought it was deserving, but because we knew what the implications were going to be.

We didn't have the tools to do it. The other companies that were thinking about buying it decided not to buy it. And so we had no choice.

GWEN IFILL: The next part of Jim's conversation with Chairman Bernanke then turned to questions on the state of the economic recovery. That's where part two of our forum picks up tomorrow night. You can watch the entire event right now on our Web site at newshour.pbs.org. A one-hour version, "Bernanke On the Record," will air on most PBS stations. Check your local listings for the time.

And check out Paul Solman's "Making Sense" Web site to play a game where you get to be Fed chairman and see what happens when you make decisions on monetary policy.