The Bernanke Question

July 28, 2009 • Commentary
This article appeared on Cato​.org on July 28, 2009.

Should President Obama reappoint Fed Chairman Bernanke? The case for reappointment is strong in many respects but there is a contrary case that deserves serious attention.

The President and congressional leaders, especially the majority leaders, should logically favor reappointment; the Fed’s massive lending relieved the administration and Congress from taking politically difficult steps. The contrary case is that the Fed too readily made expansive use of its powers. Fed lending programs took Congress off the hook and have had the predictable effect of embroiling the Fed in political disputes that compromise its political independence.

Under section 13(3), a 1932 amendment to the Federal Reserve Act, the Fed can make loans to borrowers other than banks “in unusual and exigent circumstances.” The Federal Reserve invoked this authority as the legal basis for its emergency loans. The Fed had to decide in a few hours whether to bail out Bear Stearns in March 2008. There was no possibility that Congress could act over a weekend. The Fed confronted the same situation in September 2008, when it decided to bail out AIG. Whether or not these bailouts were wise, they clearly fit the language of section 13(3).

The Fed’s other credit programs are different. The Fed also invoked its authority under section 13(3) to justify its Commercial Paper Funding Facility (CPFF). The Fed announced the program on October 7, 2008 and made the first loans about 3 weeks later. Consider also the Fed’s buying program for mortgage‐​backed securities (MBS), which is authorized by section 14 (b) of the Federal Reserve Act. The Fed announced the MBS program November 25, 2008. The first appearance of MBSs on the Fed’s balance sheet was in mid‐​January.

The CPFF and MBS programs should have been authorized by Congress. Congress was not in session in October but could have come back into session right after the election to legislate both programs.

Neither the CPFF nor the MBS program reflected a weekend emergency. The financial crisis called for quick and decisive action, but not immediate action that needed to be decided in a matter of hours. If there was an emergency at all, it was because of congressional unwillingness or inability to act and not because Congress did not have time to act. If Congress were unable to act, because of its concern about the politics of the CPFF program to provide credit to large corporations, should a federal agency make its own decision on what is necessary, committing taxpayer resources amounting to hundreds of billions of dollars? Worse yet, while legislated programs would have been financed by sale of new Treasury securities, the Fed’s programs are being financed by monetary expansion — printing money.

The two programs are large. The CPFF reached a peak of $350 billion in mid January, but has declined since. The MBS program is still growing — $545 billion as of July 22, 2009, on its way to an announced $1.25 trillion. All financed, remember, by printing money.

One view is that it is very unfortunate that the Fed found itself in this position, but it did what it had to do given the financial turmoil. A contrary view is that the Fed’s responsibility was to make a strong public case that Congress had to act to provide the needed credit. There would have been a public debate about the wisdom of the proposed programs, whereas we know nothing of the internal debates in the Fed.

The Federal Reserve has not explained why assistance to the particular borrowers eligible for the programs — CPFF, MBS and others — are essential to dealing with the financial crisis, whereas loans to other potential borrowers are not essential. To be clear, the Fed’s decisions have not been political in a partisan sense, but they do reflect inherently political judgments in the sense that borrower X deserves or needs access to Federal Reserve resources and borrower Y does not. Such issues belong to Congress. The Fed should not have been making these decisions, because doing so would inevitably draw it into political disputes, such as those already seen over disclosure and other matters.

Access to Federal Reserve credit is valuable. It has long been a staple of monetary analysis that monetary policy is a general policy instrument, controlling the aggregate supply of funds in the market through open market operations in government securities. We then rely on private banking and financial markets, and government credit programs authorized by legislation, to make judgments as to which particular borrowers have access to credit and on what terms.

Chairman Bernanke has stretched the emergency authority under Section 13(3) of the Federal Reserve Act beyond recognition and has provided credit to certain non‐​bank borrowers and not to others. His consultation with Treasury secretaries and congressional leaders is not an adequate substitute for congressional appropriations to finance the federal government’s credit activities designed to deal with the financial crisis.

The public wants to keep monetary policy out of politics and understands that financing government by printing money is dangerous. Perhaps the Federal Reserve will be successful in withdrawing the money at the appropriate time, but if not, we have a serious inflation problem in our future. The Fed will face this problem in a weakened political position because of its political decisions in granting credit over the past year.

Given the importance of a non‐​political monetary policy, which requires central bank independence from everyday politics, and of a reliably non‐​inflationary policy, Chairman Bernanke does not deserve reappointment.

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