When Ben Bernanke became Fed chairman five years ago, no one imagined he would ultimately be criticized by domestic and global leaders and economists and even in a YouTube video gone viral, with 4 million hits.
But that is exactly what happened after he unveiled his controversial Quantitative Easing (QE)2 program.
Bernanke's legacy will be determined by his response to the meltdown that began shortly after he began his term on February 1, 2006. His honeymoon ended with the subprime disaster in early 2007, the onset of a worldwide financial crisis that August and the start of the Great Recession in December 2007.
Bernanke's biggest blunders in dealing with this confluence of unprecedented economic events, the worst since the early 1930s, mainly follow from his underestimation of how bad they were. This may be because he was too close to the situation as a former member of the Federal Open Market Committee when it was run by his predecessor as Fed chairman, Alan Greenspan, and as a former head of the President's Council of Economic Advisors before the economic disaster. … Or perhaps he was too distanced from it with his "ivory tower" background?
In either case, he made five serious misjudgments in 2007-10.
• Grossly underestimating the impact of the subprime crisis. Many signs warned of an impending catastrophe in early 2007. Yet on March 28, 2007, he stated: "The impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained." Later, on May 17, he restated the point, saying, "the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system." Of course, the subprime market proceeded to cripple not only the broader housing market but also the economy and financial system.
• Not cutting interest rates on Aug. 7, 2007. Bernanke's subprime-judgment mistake played itself out in a serious policy mistake at the Federal Open Market Committee's Aug. 7 meeting when he failed to cut the federal funds rate. By continuing to target inflation as the paramount challenge, he ignored the rapidly deteriorating condition of the economy and financial markets. To make matters worse, Bernanke's calendar for that time shows a series of key meetings and calls the next day with Wall Street chieftains, which prompted Bernanke to flip-flop, provide needed liquidity and later issue a new statement conceding the situation's direness. Bernanke's Aug. 7 "rookie mistake" marked the global financial crisis' start.
• Letting Lehman fail on Sept. 15, 2008. The biggest public policy mistake of the financial crisis was the government's decision to let Lehman fail. Despite self-serving claims that the Treasury and the Fed lacked the ability to save Lehman, it appears that a bailout in the $45 billion to $60 billion range could have prevented what may have been a cumulative adverse global impact of more than $1 trillion.
The enormous underestimation of the impact of letting such a globally systemic firm fail was, in my opinion, 75% due to then-Treasury Secretary Paulson and 25% jointly to Bernanke and then-New York Fed chief Geithner. Sept. 15, 2008, the day Lehman filed for bankruptcy, was the nadir of the global financial crisis.
• Lobbying more than 75% of Senate Banking Committee in 2009 to keep his job. Despite his success in getting Obama to nominate him on Aug. 25, 2009, to a new four-year term as chairman, Bernanke seriously underestimated the very negative public and congressional reaction to his handling of the financial crisis.
His calendar showed that he contacted 24 senators, nearly one-fourth of the U.S. Senate, almost all at congressional office buildings, from Aug. 4 to Nov. 30. This included conversations with 18 of the 23 members (more than 75%) of the Senate Banking Committee, which ultimately recommended his confirmation on a 16-7 vote.
My analyses of Fed chairmen's calendars since 1996 had never turned up such unprecedented political contact in so short a time. This was inconsistent with Bernanke's vow before his first Senate confirmation, on Nov. 15, 2005, that he would "be strictly independent of all political influences."
• Prematurely ending the first quantitative easing program on March 31, 2010. Bernanke, perhaps overinfluenced by the increasingly vocal FOMC inflation hawks, again underestimated just how badly the economy and financial markets were doing by prematurely terminating the $1.7 trillion QE1 program.
Despite the recession's official end in June 2009, unemployment remained around 10%, residential and commercial real estate markets were still distressed, and the domestic and global financial crisis persisted.
Bernanke spent too much time articulating an "exit strategy" to appease the hawks and not enough time understanding that things were getting worse, not better. When he finally realized this, he announced the controversial $600 billion QE2 program last November. Had QE1 been continued in this amount for the remainder of 2010, he would have helped the economy more when it needed it and avoided the QE2 criticism. His legacy is now closely tied to whether QE2 will restore the economy to health or backfire and create new inflationary pressures and perhaps the seeds of a future financial bubble.
Bernanke has done some good and innovative things during his five-year tenure, but these five major mistakes made a bad situation worse. Only time will tell whether his legacy will reflect more mistakes than accomplishments.
