CERAWeek 2014 - IHS Leadership Forum

In his first major address since leaving the Federal Reserve Board, former Chairman Ben Bernanke delivered the concluding remarks for IHS CERAWeek 2014. In conversation with IHS Vice Chairman Daniel Yergin, Dr. Bernanke discussed his experiences at the Federal Reserve during the financial and economic crises of the Great Recession of 2008-09. He acknowledged that there is always a great deal of political controversy regarding the role of the Federal Reserve. Indeed the Wizard of Oz, by L. Frank Baum, is an allegory about monetary policy-"Oz" being the abbreviation for "ounce" together with the obvious symbolism of the "Yellow Brick Road." He said that Baum was a news reporter with an interest in the 1890s monetary policy.

Dr. Bernanke emphasized the importance of the Fed's independence with three reasons. The system requires specialized knowledge of monetary and economic policy, he said, and an independent institution will have more credibility with financial markets. Lastly, because the Fed is self-financing, it can respond quickly in a crisis without having to wait for Congress to take action.

The Fed was created after the Panic of 1907 to deal with monetary crises. During the Great Depression, the Fed made many mistakes, he said, including an overly restrictive monetary policy that made the Depression worse. In addition, the collapse of banks in the United States and globally created widespread panic and interrupted the flow of credit. He noted that countries that were tied to the gold standard fared much worse than countries that had more flexibility. Similarly in the Great Recession of 2008-09, the Fed had to use the monetary policy option and stabilize the financial system. Initially, it was thought that the housing bubble in 2008 would be similar to the decline in technology stocks that precipitated the mild recession of 2000-01. Economists missed the fact that the decline in house prices would create more financial instability than the stock decline. In addition, because of a failure of supervision within the banking system, banks did not anticipate the extent of their financial vulnerability to the house price decline.

Unlike in the Great Depression, there were no bank runs. But there were runs in the uninsured short-term markets (e.g., the collateralized repo market); and the financial system was heading toward an "abyss" of total collapse. Dr. Bernanke described the dramatic events as they unfolded. In August 2007, the Fed realized that financial problems were quite severe and began taking action. In March 2008, it oversaw the acquisition of Bear Stearns by J.P. Morgan. Then in September 2008, over the "Lehman Weekend," the Fed realized that Lehman Brothers was about to collapse. There were two potential buyers, Bank of America and Barclays. Bank of America wanted a big subsidy to buy Lehman, but there was no money available. And the British central bank would not support Barclay's interest in acquiring Lehman. The two options fell through and Lehman Brothers collapsed.

With other financial firms (such as AIG) on the brink of collapse, Congress soon approved $700 billion to fund the Troubled Asset Relief Program (TARP) for the Fed to use to prevent a widespread financial system collapse. Many in Congress opposed this program. One Senator said he was getting many phone calls from constituents and "about 50% were saying 'no' and another 50% were saying 'hell no.'" However, with the Dow Jones Industrial Index down about 700 points and President George W. Bush supporting the legislation, TARP was passed. Dr. Bernanke called it "the most successful unpopular program in history."

Returning to his roots as an energy economist, Dr. Bernanke said that the unconventional oil and gas revolution was "one of the most beneficial developments if not the most beneficial development since 2008." It has created a meaningful number of jobs, helped reduce the US trade deficit, and improved US competitiveness. Today, the economy is recovering, and although "we are not out of the woods, there are fewer trees." The financial system is in much better shape, he said. Banks are much better capitalized and can support the economic recovery. The housing sector is coming back, mortgage interest rates have been kept low, and the overbuild has been worked off. Dr. Bernanke said he is moderately optimistic about the global economy and concluded that "we have learned a lot, but we have also learned not to be complacent."

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.