A warning from the almost-depression
All during the 2008-09 financial crisis, Americans were told that the government was saving Wall Street not to protect overpaid bankers but to help Main Street avoid a second Great Depression. It was a hard case to make. However valid the logic, it was overwhelmed by infuriating realities — government was pouring tens of billions into the financial system while 500,000 Americans were losing their jobs every month. Naturally, people felt bitter.
Ten years after the financial crisis, Henry Paulson, treasury secretary under President George W. Bush; Tim Geithner, treasury secretary under President Barack Obama; and Ben Bernanke, former chairman of the Federal Reserve Board, are confessing that this political and public relations failure was their greatest setback.
They repeated the message recently at a conference sponsored by the Brookings Institution. The danger is that efforts to stop a financial panic will falter on political objections. Halting the panic requires propping up Wall Street, the purveyors of credit, in some form. Although everyone wants to end the panic, no one wants to be seen helping the institutions that caused or aggravated the crisis.
A paper delivered by Bernanke at the conference illustrates the dilemma. Following other economists, Bernanke identifies two main channels through which the financial crisis weakened the “real” economy of jobs and production: first, a buildup of household debt, used to finance homebuying and consumer goods and services; and second, widespread financial speculation by banks, investment banks and hedge funds.
The housing boom was fated to implode. By itself, this might have triggered a recession, possibly a severe one. But Bernanke and others believe that the popping of the housing bubble by itself would not have caused a recession as destructive as what actually occurred.
The difference, they argue, reflects the side effects of financial speculation: reliance of banks and others on short-term funding and the proliferation of arcane securities. What might have been a serious recession turned into an almost-depression.
The implications are unavoidable. Amazing though it might seem, most economic forecasting models — including the Fed’s model — did not include “much role for credit factors,” Bernanke wrote. Most models “focused on explaining the behavior of the postwar U.S. economy, a period that until 2007 had been without a major financial crisis.”
The models must change, Bernanke says. True. But gains in control may be modest. Forecasting models have repeatedly missed major economic turns, for better or worse. In the 1970s, inflation was underestimated; in the early 1980s, unemployment was overestimated. The models are always playing catch-up.
It is not surprising that the three of them feel vindicated that — in Bernanke’s words — “policymakers’ aggressive actions to end the financial panic on Wall Street were crucial in preventing an even more devastating blow to Main Street.” This may be, but the dilemma remains. How do you protect the system without seeming to reward the guilty?
Robert J. Samuelson writes a column for The Washington Post.