The Credit Crisis

Federal Reserve Policies Called "Activist" by Famous Economist

Image Group
Cartoonist Group image
Fed Chairman Ben Bernanke as Santa Ben in a popular cartoon published by Gary Varvel in December 2008.

Federal Reserve Chairman Ben Bernanke will go down in the history books for launching an unprecendented range of unconventional, controversial programs to fight a financial crisis, a recession and slow economic growth.  "Activist bent."  

Shortly after Ben Bernanke was nominated to the Federal Reserve Board by President George W. Bush in 2002, he wrote a paper in which he argued that monetary policy, rather than President Ronald Reagan's supply-side economic policy, was one of the main reasons for the economic boom of the 1980s and 1990s.  In the paper, as Stanford University economist John Taylor recounts in his new book First Principles, Bernanke used one of Taylor's own theories called the Taylor curve to make his point about the importance of monetary involvment in the economy. 

The Taylor curve was devised by John Taylor himself to show the benefit of rules-based policy in monetary decision making as opposed to discretionary policy.  However, Bernanke was using the Taylor rule for something else.  Exactly what became clear when the paper was shown by Taylor to one of the twentieth centuries greatest economists, Nobel laureate Milton Friedman, just before Friedman's death in 2006. 

As Taylor writes in his book, Friedman's reaction was "unequivocal:"  "John, this is exactly what I mean. In this paper you see a policymaker with an activist bent making use of your curve to justify that activism."  Indeed, as Taylor, who served on the Council of Economic Advisers under President George H.W. Bush, points out "in the months immediately before, during, and after the financial crisis of 2008, we saw monetary activism as it never had been seen before in the United States." 

The "activism" included excessive easy money policies, unpopular bank bailouts and economic stimulus and money printing on an unprecendented scale.  By most indicators, the controversial programs have not succeeded as planned in expanding economic growth but have succeeded in adding more than $3.5 trillion in debt to the Fed's balance sheet (see accompanying graph).

It all started in November 2008 when the Fed said it would buy $600 billion in mortgage debt in an effort to funnel credit to the troubled housing sector.  Then, in March 2009, it expanded the program, saying it would buy $1.75 trillion of mortgage debt and government bonds.  The approach became known as "quantitative easing" or "QE."  The goal is to drive down long-term interest rates to spur spending and investment and buoy the stock market.

In November 2010, the Fed launched a second bond-buying program, this time saying it would buy $600 billion in long-term government notes and bonds to drive down long-term interest rates, a practice called "printing money."

Bailout loans
During the financial crisis, the Fed made special loans available to J.P. Morgan Chase & Co. to facilitate its acquisition of the collapsing Bear Stearns.  Later, it provided the credit the government needed to take over insurance giant AIG as it neared collapse.  These loans were later repaid through a series of public offerings staged by the U.S. Treasury Department.  However, some of the offerings had to be delayed due to lack of investor interest. 

Since 2008, the Fed has made dollars available to foreign central banks to lend out to banks in their regions that are short of dollars.  The program is meant to ensure U.S. markets don't suffer from financial turmoil plaguing places like Europe.  By mid-June 2012, foreign central banks had borrowed $23 billion in such loans.

Liquidity programs
During the worst of the financial crisis in 2008 and 2009, the Fed launched a range of special programs designed to funnel credit to struggling sectors, including investment banks, money market funds, and markets for car loans, student loans and other consumer debt.  Part of this was a $44 billion term asset-backed securities loan facility aimed at reviving the securitization market for consumer credit card loans and auto loans. 

Operation Twist
In September 2011, the Fed launched a $400 billion program in which it shifted its portfolio of assets by selling short-term debt and using the proceeds to purchase more long-term debt as part of an exotic effort to drive down long-term borrowing costs for consumers and businesses.  This was one of the Fed's most controversial programs.

In September 2012, the Fed announced it would buy $40 billion a month of mortgage-backed securities and $45 billion a month of long-term Treasury securities, which put it on course to add another $1 trillion to its balance sheet if it maintained the program for one year.  In addition, for the first time, the Fed promised to keep buying until the U.S. job market substantially improved.  This was considered one of the central bank's most ambitious stimulus programs.  "This is a main street policy," Mr. Bernanke said after the Fed's two-day September meeting.  "What we are about here is trying to get jobs going."