Come back, all is forgotten

Vintage Bernanke: Ben Bernanke was slow to catch on to the financial crisis. The Federal Reserve chairman, appointed this week to a second four-year term, didn’t grasp the scale of financial excess. He didn’t read the subprime collapse correctly. Worse still, it looks like he didn’t even read one of his own speeches from 2002.

In October of that year, when he was a member of the Federal Reserve Board of Governors, Bernanke gave a thoughtful semi-academic speech on “bubbles” and monetary policy. The quotes around “bubbles” gave away the tenor of the speech: they are hard to identify and cannot easily be popped.

That was very much the thinking of then-chairman of the Fed, the revered Alan Greenspan. He didn’t think bubbles were something that central bankers could or should do much about.

But towards the end of his 2002 discussion, Bernanke allows for a partial exception: bubbles caused by “the rapid growth of credit”. These are usually caused by “botched financial liberalization”, which leads financial institutions to “take speculative positions” knowing that they will be bailed out if all goes wrong. In his words, “the classic “heads I win, tails you lose” situation.

Sound familiar? It should. That is just what happened over the next five or so years, as the financial system became ever more leveraged. Bernanke even got the market effect right. Under these circumstances, “credit flows rapidly into inelastically supplied assets, such as real estate.”

The governor didn’t like the idea of central banks popping these bubbles. He preferred getting the regulation right in the first place. But “failing that”, the authorities should “intervene and fix the problem when it is recognised”. That is exactly what Bernanke did not do when it was his turn to run the Fed.

It is too late to know why Bernanke forgot, or discarded, his own argument. But it’s not too late for the newly reappointed chairman to study up his earlier works. With commodity and stock prices rising in the midst of a recession – and central banks almost giving away money to banks – it is at least worth considering whether another credit bubble is being inflated. The 2002-vintage Bernanke would know what to do.