Bernanke Empowered

8/8/2019 Bernanke Empowered

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th w a al gula o lawg v s h F al r s v ha ma

h au ho y o fo a ks o a s

ap al a gh l g—jus ash ’s y g o s mo a y pol y h oppos o .

By STEVE MATTHEWS and JOSHUA ZUMBRUNPhotograph by ETHAN HILL/CONTOUR-GETTY IMAGES

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Six months later, when President Barack Obamasigned into law a 2,300-page bill overhauling nancialservices regulation, the super-regulator had been for-gotten. Instead, the Federal Reserve had acquired new regulatory heft, and Bernanke had emerged as themost powerful Fed chairman ever—with more au-thority even than his legendary predecessor, AlanGreenspan, who had chaired the Fed for 18 years.

For all of the heat Bernanke took for failing to seethe gathering credit storm in 2007, lawmakers—with

a few exceptions—have come to ap-preciate the actions he has taken torescue the banking system and theeconomy in the past two years. Hehas pushed interest rates as low asthey can go and vowed to keep themthere until the employment pictureimproves, and he has committedthe Fed’s immense resources to the

goal of preventing the nancial sys-tem from freezing over again.“When the dust settled, Congress realized that Bernanke and the Fed

knew what they were doing,” says Mark Gertler, a New York University economics professor who did research with Bernanke, a former Prince-ton University professor, on the causes of the Great Depression. “Thepower of any Fed chairman is ultimately based on the perception by Congress that he will use it prudently. He has this reputation.”

Under the Wall Street Reform and Consumer Protection Act, knownas the Dodd-Frank law, Bernanke’s Fed gains powers never before housedin one regulator. The central bank remains the supervisor of 5,000 U.S. bank holding companies and 830 state banks. The law gives it new

n November 2009, Senate Banking Committee Chair-

man Christopher Dodd advanced a radical proposal:to create a super-regulator that would take over mostof the bank supervision that had been done by theFederal Reserve System, the Federal Deposit Insur-ance Corp. and other agencies. Dodd had been a harshcritic of the Fed and its chairman, Ben S. Bernanke,declaring in July 2009 that the central bank’s super-

vision of nancial services had been an “abysmal failure.” In January2010, the U.S. Senate approved Bernanke for a second four-year term by a tally of 70 to 30—giving him the most negative votes any nominee hadreceived since the chamber started con rming Fed chiefs in 1978.

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authority to control the lending and risk taking of the largest, most “sys-temically important” banks. Among them: investment banks GoldmanSachs Group Inc. and Morgan Stanley, which became bank holding com-panies in September 2008. The Fed gains authority over about 440 thriftholding companies and will also regulate “systemically important” nonbank nancial rms, including, analysts say, the biggest insurance com-

panies, Warren Bu ett’s Berkshire Hathaway Inc. and General ElectricCapital Corp., the nancial unit of GE.The Fed is now required to look for evidence that practices in the

banking system threaten the country’s nancial stability and, if neces-sary, take action to put a stop to those practices. It’s also obliged underthe law to administer stress tests at the biggest banks every year to deter-mine whether they need to set aside more capital. The law prescribes thatthose banks write so-called living wills, approved by the Fed, that wouldmake it easier for the government to break them up and sell the pieces if they’re su ering from a Lehman Brothers Holdings Inc.–style meltdown.

Bernanke’s Fed will also house and fund a new federal consumer pro-tection agency, although it will operate independently. The Fed will even

have the power to tell U.S. banks how much they can charge merchants when a consumer uses a debit card to buy a suit or a sack of groceries.Regular credit cards will be the responsibility of the new consumer agency.

“There are an enormous number of powers given to the Fed,” says Vin-cent Reinhart, who was the Fed’s chief monetary policy strategist from2001 to 2007. “The Fed has a very powerful and very broad mandate.”

That kind of power was just what Senate opponents of the nancialregulation bill wanted to deny Bernanke, who declined to comment forthis story. “Augmenting the Federal Reserve’s authority risks burdening

it with more responsibility than one institution canreasonably be expected to handle,” Alabama SenatorRichard Shelby, the ranking Republican on the SenateBanking Committee, said at a hearing in July 2009. “Infact, the Federal Reserve is already overburdened withits responsibility for monetary policy, the payment

system, consumer protection and bank supervision.”Shelby also raised the issue of the inherent con ict between the Fed’s role in setting interest rates and its job of bank supervision. “The mixing of monetary pol-icy and bank regulation has proven to be a formula fortaxpayer-funded bailouts and poor monetary policy decisions,” Shelby said.

The Fed’s role as a bank regulator dates to its creationin 1913, in the wake of another nancial crisis: the Panicof 1907. It originally supervised only state banks thatchose to operate under a Federal Reserve charter. Its bank supervisory duties were expanded with the 1933

passage of the Glass-Steagall Act, which, in addition tosplitting apart commercial and investment banks, estab-lished the FDIC to insure deposits and required bankholding companies to submit to audits by the Fed.

One opponent of giving the Fed new regulatory power is former chairman Greenspan. “The additionalpower that the Fed has been given I had not been in fa- vor of,” he told Bloomberg News on July 16. “I do notthink they can actually prevent the next crisis.”



W H i t n e Y c U r t i S / b L O O M b e r G ( t O P ) : d O M i n i c c H A V e Z / L A

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As Bernanke, 56, assumes his new responsibilities,he continues to take bold and unprecedented steps inthe Fed’s traditional areas of responsibility: managingthe money supply and setting interest rates. To res-cue the banking system and stimulate economicactivity, the Fed has for more than two years been

buying bank and government debt, swelling its balance sheet to more than $2 trillion. With the crisis past, the Fed by mid-2010 had

decided to let the securities-buying program winddown, shrinking its balance sheet as the bonds it heldmatured. The Federal Reserve Bank of New York esti-mated in March that more than $200 billion of agency debt and mortgage-backed securities held by the central bank would mature or be prepaid by theend of 2011. Bernanke reversed that decision on Aug. 10. The central bank’s Federal Open MarketCommittee announced it would replace maturing

bonds with longer-term Treasuries, explaining thatthe economy had weakened since June and it didn’t want to add to the problem by driving up interestrates. Buying bonds pushes yields on Treasury noteslower, which forces down mortgage rates and otherlong-term borrowing costs.

The average rate of a 30-year xed-rate mortgagedropped to a record low of 4.44 percent in the weekended on Aug. 12, from 4.49 percent the week before,according to mortgage packager Freddie Mac, which began compiling the data in 1971. The yield on10-year Treasury notes fell on Aug. 16 to its lowest

level in more than 16 months.“The simple option of reinvesting the proceeds of maturing assets will not have a huge impact on thescale of market liquidity,” says Lena Komileva, an

economist at Tullett Prebon Plc, a London brokerage rm. “But it willsend the message that the Fed is still in easing mode, which may create anappetite for risk and borrowing.”

William Ford, a former president of the Federal Reserve Bank of At-lanta who now teaches at Middle Tennessee State University, calls theFed action “a wrong move” that will have little impact except to increasethe losses the Fed su ers on its portfolio of long-term Treasuries wheninterest rates rise. “They are sticking their foot deeper in a liquidity trap,”Ford says. “It will not cause any lending.”

Bernanke’s use of nearly every tool at his disposal to stimulate eco-nomic growth could con ict with his new job as regulator-in-chief, saysformer Fed Governor Lyle Gramley. “If the regulators were to get very tough right away and make major changes in liquidity and capital require-ments, that could be a problem,” he says.

Mark Zandi, chief economist at Moody’s Analytics, says any move by

the Fed to increase reserves against bad debt will hurt economic growth.“The higher the capital ratios, the greater the hit to bank pro tability,credit growth and GDP growth,” he says. “The near-term consequence will be to slow growth.”

Bernanke says his examiners are working with the nation’s -nancial institutions to minimize the economic impact of tougherregulation. “Our message is clear,” he said on July 12 at a meetingof small-business owners. “Consistent with maintaining appro-priately prudent standards, lenders should do all they can tomeet the needs of creditworthy borrowers. Doing so is good forthe borrower, good for the lender and good for our economy.”

Bernanke and his supporters triumphed over the opponents of

expanding the Fed’s regulatory power by exploiting the institu-tion’s historical prestige. “The Fed ended up on top because Dem-ocrats and Republicans can agree that its independence is moresigni cant than that of any other agency,” says John Silvia, chief economist at Wells Fargo Securities and former chief economistfor the Senate Banking Committee.

Bernanke says it’s important that the Fed continue to be thecountry’s main bank regulator because no agency knows the banks better. “Because of its wide range of expertise, the FederalReserve is uniquely suited to supervise large, complex nancialorganizations,” Bernanke told a hearing of the House FinancialServices Committee on March 17.

Were it not for a few peoplelike Bernanke, we would nowbe in a catastrophic depression.Lyle Gramley, fo m F gov o

I’ve neverbelievedthat it’sessential for

the FederalReserve tohave banksupervisionauthority.William Poole, fo m p s , S . Lou s F



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S t e P H e n V O S S

The Fed chief has taken his message to the publicin a series of appearances, including a pro le onCBS TV’s60 Minutes in March 2009 and a half dozenspeeches and question-and-answer sessions. On Aug. 2 of this year, he spoke in his native South Caro-lina to an audience of Southern state legislators, de-fending the Fed’s role in the bailout of big nancial

rms like Citigroup Inc. and insurer American Inter-national Group Inc. “In September and October2008, our nancial system came as close as it hascome since the 1930s to utter meltdown,” he said.

“I am not just talking about the United States butthe entire world. We did what we did—it wasn’tpretty—to prevent the collapse of the global nancialsystem because we knew what e ect that would haveon Main Street, not on Wall Street.”

Bernanke’s supporters see the nancial regulation bill as a gesture of trust in the Fed chief, who has been working with the Fed since 1987, when he began severalstints as a visiting scholar at regional Fed banks. Dodd,66, a ve-term Democrat who is retiring in January, was

one person Bernanke brought around in the months Congress spent wran-gling over the nancial regulation bill. “I have real concerns about how theFed responded at a time they should have been more aggressive,” he says.“But I think Ben Bernanke learned a lot from it and I have a lot of con dencein him today to lead.”

Bernanke also won the backing of Barney Frank, the MassachusettsDemocrat who is head of the House Financial Services Committee, and of Obama, who signed the Dodd-Frank law on July 21.

Former Fed Governor Gramley says Bernanke was just one of many -nancial regulators who didn’t see the buildup of bad debt that broughtthe economy low. “Bernanke has to take his lumps along with everyoneelse who missed the boat,” says Gramley, now senior economic adviser at

Potomac Research Group in Washington. “But were it not for what a few people like Bernanke did to keep us from going over the deep end, we would now be in the midst of a catastrophic depression. So Ben comesout a hero in my book.”

Bernanke saw no catastrophe on the horizon in 2005, when he was serving as head of President George W. Bush’s Council of Economic Advisers, a post heresigned from the Fed Board of Governors to take. Ata brie ng for reporters in August of that year, he wasasked about the rapid rise in home prices. “Housing

prices certainly have come up quite a bit,” he said. “But I think it’s impor-tant to point out that house prices are being supported in very large part by very strong fundamentals.”

Bernanke remained an optimist in the rst year after he was sworn inas Fed chairman, in February 2006. On March 28, 2007, addressing what was by then a collapsing subprime housing market—13.3 percent of such borrowers made late payments in the fourth quarter of 2006—Bernanketold Congress’s Joint Economic Committee, “The impact on the broadereconomy and nancial markets of the problems in the subprime marketseems likely to be contained.”

Bernanke recognized that the Fed’slegitimacy depended on how it wasviewed by the public.Vincent Reinhart, fo m F mo a y s a g s



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Five months later, credit markets seized up. TheFed then began a long chain of actions that Bernanke would later say were necessary to avert nancial col-lapse. “The Fed was slow to appreciate the loss of li-quidity in the global nancial markets,” says ErnestPatrikis, a partner at law rm White & Case LLP and a

former general counsel for the New York Fed. “Oncethe Fed got it, it truly got it. The Fed was creative,pulled out all the stops.”

B

eginning in September 2007, the cen-tral bank repeatedly lowered the fed-eral funds rate, which is the rate banks charge to lend to each other. Itnow ranges from 0 to 0.25 percent.The Fed also cut the interest rate it

charges banks to borrow directly from the Fed, to

0.5 percent in December 2008 from 6.25 percent in August 2007. In March 2008, the Fed directly intervenedto try to still the crisis, lending $29 billion to buy toxicassets from failing Bear Stearns Cos. and facilitate itstakeover by JPMorgan Chase & Co.

By December 2008, in the wake of thenancial chaos triggered by the bankruptcy of

Lehman Brothers, Bernanke’s Fed was ood-ing the nancial system with money.

At the same time that Bernanke was takingemergency measures, he was imposing someregulatory discipline on the banks. Congress

had given the Fed the authority to regulatemortgage lending in 1994, yet Greenspan’s Fedhad never written the rules that banks must fol-low in issuing such loans. In July 2008, the Fed

nally signed o on new rules, and Bernankeannounced that the central bank would enforcethem rigorously. “Far too much of the lending inrecent years was neither responsible nor pru-dent,” he said, adding that “strong, uniformoversight of di erent types of mortgage lendersis critical to avoiding future problems.” Thatsame month, the Fed ruled that mortgage

lenders must verify a homebuyer’s income orassets—a detail that had been neglected in theera of the so-called liar loan.

In the wake of the nancial breakdown, thefocus in Congress was on which agency of gov-ernment should be charged with searching out systemicrisk. During July 2009 hearings by the Senate BankingCommittee, Shelby said the one body that shouldn’thave the job was the Fed. “I believe anointing the Fed asthe systemic risk regulator will make what has proven to be a bad bank regulator even worse,” he said.

William Poole, a former president of the Federal

Reserve Bank of St. Louis, says Bernanke has to deal with the con ict between his bank supervision duties and the orchestration of mone-tary policy. The clash was apparent as early as the 1970s, when the Fed was battling both high in ation and growing problems in the savingsand loan industry, he says. “There was concern about raising interestrates, which would put further pressure on the savings and loans,” says

Poole, who was at the St. Louis Fed from 1998 to 2008 and who is now asenior economic adviser to Palo Alto, California–based Merk Invest-ments LLC. “You don’t want monetary policy decisions to be domi-nated by what’s a side issue.”

Poole’s view isn’t popular among his Fed colleagues, he says. “I’venever believed that it’s essential for the Federal Reserve to have supervi-sion authority,” he says. “I know my Federal Reserve colleagues will re-gard me as a traitor if you publish that. I don’t think it’s essential.”

It was partly to answer this argument that Dodd, in November 2009,proposed the creation of a super-regulator to replace the Fed, the FDIC,the O ce of the Comptroller of the Currency and the O ce of Thrift Su-pervision. The only agency that ended up getting axed was the OTS, whose

responsibilities were divided up among other agencies, including the Fed. While Congress was debating the fate of the Fed’s bank supervisionpowers, Bernanke took to the streets and airwaves to repair the central bank’s image. In March 2009, he agreed not only to sit for an interview with60 Minutes ’ Scott Pelley but also to travel with Pelley to his hometown of

Dillon, South Carolina, where his father and uncle once ran a drugstore.Bernanke talked about the damage the nancial crisis had done to Dillon’seconomy. In July 2009, he made a town-hall-style appearance on PBStelevision in Kansas City, Missouri. In May 2010, Bernanke toured aPhiladelphia shipyard and a Tasty Baking Co. factory in a part of thecity that is being redeveloped. The Philadelphia visit, well covered by local media, had the aura of a political campaign tour. “It was just an S

t e P H e n V O S S / r e d U x

The mixture of monetary policy andbank regulation is a formula fortaxpayer-funded bailouts.Richard Shelby, s a o f om Ala ama



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inspiring morning for me,” Bernanke said afterward.Bernanke chatted with ABC News’s Sam Donaldson

at a June 7, 2010, dinner in front of a live audience. Twodays later, he traveled to Richmond, Virginia, to meet with 20 students at J. Sargeant Reynolds Community College, where he praised job training programs as a

way to help the unemployed.“I call that the summer-of-love tour,” former Fedmonetary policy chief Reinhart says. “He recognizedthe voting public was angry and they were angry at theFederal Reserve. He came out of this recognizing thatthe Fed’s legitimacy depended on how it was viewed by the public.”

Other members of the Fed Board of Governors andthe leaders of the 12 regional Fed banks were also busy in the spring and summer of 2010 defending theFed’s bank supervisory power, particularly its juris-diction over 830 banks with state charters. On May 5,

2010, four regional Fed presidents—Kansas City FedPresident Thomas Hoenig, Minneapolis Fed PresidentNarayana Kocherlakota, Richmond Fed PresidentJe rey Lacker and Philadelphia Fed President CharlesPlosser—traveled to Washington to urge Congressnot to enfeeble the Fed.

They “argued very vociferously” that a Doddproposal then on the table to strip the Fed of supervision of smaller banks would make Fed regulation“too New York–centric,” says Senator John Ensign, aNevada Republican.

Dodd recalls that the regional Fed presidents’arguments resonated with Congress. “The regional banks did a lot of work on this that had a lot of in u-ence in various parts of the country,” he says. “Thatclearly caused some people to change their views.It became a local issue.”

As the July vote on nancial regulation approached,

Bernanke himself pleaded the Fed’s case over and over. From Jan. 1 untilthe vote, he spent at least 35 hours testifying at congressional hearings,meeting with members of Congress and talking to them on the phone,according to congressional records and Bernanke’s personal calendar, which is periodically released by the Fed.

Bernanke dealt with the con ict issue head-on. “The Federal Reserve’s

participation in the oversight of banks of all sizes signi cantly improvesits ability to carry out its central banking functions, including makingmonetary policy, lending through the discount window and fostering

nancial stability,” Bernanke said at the March 17 hearing of the HouseFinancial Services Committee.

Now that the Fed has won the argument over whoshould regulate the banks, Bernanke must answerthose who worry that his newly vigilant agency will throttle the nancial system with new restric-tions, NYU’s Gertler says. “The Bernanke Fed is

acutely aware of the need to strike a balance,”Gertler says. “Some increase in costs from regulatory protection is en-tirely justi able. But the trick is to not overdo it.”

Bank of America Corp. says the section of the law covering debitcards is an example of overdoing it. The law says banks must cap fees tomerchants so that they are “reasonable and proportional to the cost” of the transaction. The Charlotte, North Carolina–based lender inter-prets that to mean it isn’t allowed to make a pro t on such transactions.The bank planned to take a charge of $7 billion to $10 billion for thethird quarter in anticipation of a fee reduction.

Richard Bove, a banking analyst for Stamford, Connecticut–based Roch-dale Securities LLC, says bank regulators have already

done too much. “If they don’t ease up on bank capitalrestrictions and requirements for liquidity, they are go-ing to continue to see declines in money supply, andthat will create another recession,” Bove says. He blames regulators for a contraction in lending. As of mid-August, U.S. banks had cut back credit for 16 of thepast 17 months, according to data compiled by the Fed.

The new regulatory regime will have its own bu-reaucracy. The law calls for the president to name anew Fed vice chairman for bank supervision, who will be subject to con rmation by the Senate and willsupervise a sta of at least 3,000 people. The career

civil servants will be led by bank supervision chief Patrick Parkinson, a Ph.D. economist who joined theFed in 1980. Parkinson, 58, works from an unmarkedo ce building on Washington’s K Street, eight blocks from Fed headquarters. “One of the lessons

we learned from the nancial crisis is that we need higher capital, and better quality capital, especially at the largest institutions,” he says.“There is no doubt we need to be very sensitive about imposing toostrict standards too soon.”

Part of the vice chairman’s job will be to oversee the annual stresstests. Fed bank examiners will subject all banks with $50 billion ormore in assets to the tests. As of June 30, that would have included S

t e P H e n c r O W L e Y / r e d U x

The addi-tional powerthe Fed hasbeen givenI was not infavor of. Ido not thinkthey can

prevent thenext crisis.Alan Greenspan,fo m F ha ma



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J i M b O U r G / c O r b i S

36 U.S.-based rms, compared with 19tested last year, when the cuto was

$100 billion. The Fed sta will look ateach bank’s risk of failure under threeeconomic scenarios: base line—that is, no crisis—adverse and severely adverse. The 2009 tests, formally known as the Supervisory Capital Assessment Pro-gram, resulted in a Fed demand that 10 of the banksincrease their capital cushion by a total of $75 billion.

Big nonbank nancial rms will, for the rst time,have to meet Fed standards for capital reserves. A new council of regulators will designate which nonbank rms are systemically important. Two likely toface Fed examinations are Berkshire Hathaway and

GE Capital, says Christopher Whalen, managingdirector at research rm Institutional Risk Analyticsand a former New York Fed official. “It is thenonbanks that will really go through the wringer,” Whalen says. “With Berkshire Hathaway, it will be a

signi cant annoyance and they will have to report alot of data. GE will have to raise capital levels andhave a more-centralized risk-management regime, which goes against the entrepreneurial, more-decentralized regime that has been their strength.”

General Electric Co. Chief Financial O cer Keith

Sherin says GE Capital isn’t worried about any Fed de-mands. “We feel con dent that we’re going to be able tomeet whatever the requirements are to be well capital-ized,” he said in a July 16 conference call with investors.

Berkshire Hathaway, 29 percent of whose revenuecomes from insurance, declined to comment on thepossibility that it will come under the Fed’s sway.CEO Bu ett, though, has a high regard for Bernanke.“Paul Volcker was essential to this country comingout of that 1979 to ’82 period like we did,” Bu ett toldPBS and Bloomberg Television talk show host CharlieRose in November 2009, referring to the economic

crisis of 30 years ago. “Ben Bernanke was essential tokeeping us from going into the abyss last September.”Now, Bernanke’s job is to lay down sti new banking rules and make

them stick. It won’t be easy, says Edward Kane, a professor of nance atBoston College. “Once the rules are de ned and put in place, then theloopholes will also be de ned,” says Kane, who’s a senior fellow at theFDIC’s Center for Financial Research. “The new system means a new system of getting around the rules.”

Bernanke told Congress on July 21 that the outlook for the economy is“unusually uncertain.” The same might be said for his prospects as thenew master of nancial regulation. ≤

S v m h wscovers the U.S. economy and the Federal Reserve at BloombergNews in Atlanta. [email protected] J shu Zu un covers the Fed inWashington. [email protected] With assistance from Sc l n n in Washington.

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Bernanke Empowered