Bernanke: The Federal Reserve and the Financial Crisis

Greenspan & Bernanke are predominately responsible for the housing debacle & consequently, the Great Recession. The proliferation of new financial products made its contribution too (velocity). But lets examine the facts:

To counter what Greenspan described as “irrational exuberance (at the height of the Doc.com stock market bubble), Greenspan initiated a “tight” monetary policy (for 31 out of 34 months). A “tight” money policy is defined as one where the rate-of-change in monetary flows (our means-of-payment money times its transactions rate of turnover) is no greater than 2-3% above the rate-of-change in the real output of goods & services.

Greenspan then wildly reversed his “tight” money policy (at that point Greenspan was well behind the employment curve), and reverted to a very “easy” monetary policy — for 41 consecutive months (i.e., despite 17 raises in the FFR, -every single rate increase was “behind the curve”). I.e., Greenspan NEVER tightened monetary policy.

Then, as soon as Bernanke was appointed to the Chairman of the Federal Reserve, he initiated a “tight” money policy (ending the housing bubble in Feb 2006), for 29 consecutive months (out of a possible 29, or at first, sufficient to wring inflation out of the economy, but persisting until the economy plunged into a depression).

The FOMC continued to drain liquidity despite its 7 reductions in the FFR (which began on 9/18/07). I.e., despite Bear Sterns two hedge funds that collapsed on July 16, 2007 & filed for bankruptcy protection on July 31, 2007 (having lost nearly all of their value), the FED maintained its “tight” money policy (i.e., credit easing, not quantitative easing).

Note: Nominal gDp’s (which equals what the FED can control — MVt), 2 year rate-of-change peaked in the 2nd qtr of 2006 @ 12%. Bernanke let it fall to 8% by the 4th qtr of 2007 (or by 33%). It fell to 6% in the 3rd qtr of 2008 (another 25%). It then plummeted to a -2% in the 2nd qtr of 2009 (another [gasp] – 133%).

I.e., Bernanke didn’t initiate an “easy” money policy until Lehman Brothers later filed for bankruptcy protection (& it was one the Federal Reserve Bank of New York’s primary dealers in the Treasury Market), on September 15, 2008. Then the next day AIG’s stock dropped 60%.

By waiting to inject liquidity, risk aversion was amplified, &haircuts were increased, additional and/or a higher quality of collateral was required, liquidity mismatches grew, funding sources dried up, long-term illiquid assets went on fire-sale, a counterparties’ creditworthiness was examined more carefully, all of which lead to runs on financial companies.

I.e., Greenspan didn’t start “easing” on January 3, 2000, when the FFR was first lowered by 1/2, to 6%. Greenspan didn’t change from a “tight” monetary policy, to an “easier” monetary policy, until after 11 reductions in the FFR, ending just before the reduction on November 6, 2002 @ 1 & 1/4% (approximately coinciding with the bottom in equity prices).

I.e., Greenspan was responsible for both high employment (June 2003, @ 6.3%), and high inflation (rampant real-estate speculation, followed by widespread commodity speculation – peaking in July 2008 – Greenspan’s inflection point).

Bernanke then relentlessly drove the economy into the ground, creating a protracted un-employment, & under-employment rate, nightmare.

Unfortunately the Federal Reserve doesn’t gauge the volume and timing of its open market operations in terms of the amount and desired rate of increase of member commercial banks COSTLESS legal reserves, but rather in terms of the levels of the federal funds rates (the interest rates banks charge other banks on excess balances with the Federal Reserve).

By using the wrong criteria (interest rates, rather than member bank reserves) in formulating and executing monetary policy, the Federal Reserve became the bubble’s engine. I.e., the “administered or actual” prices would not be the “asked” prices, were they not “validated” by (MVt), i.e., “validated” by the world’s Central Banks.