In the nearly four weeks since surviving a bruising Senate confirmation battle, Federal Reserve Chairman Ben Bernanke has been navigating a difficult new era of widespread public distrust of the central bank and legislative efforts to curtail its powers.
During that time:
— Bernanke unveiled the Fed’s exit plan for controversial lending and monetary policies it put in place over the past two years to bail out banks and financial institutions. Many on Capitol Hill contend those policies rewarded reckless and greedy behavior by Wall Street executives at the expense of average taxpayers.
— The Fed last Thursday raised the interest rate it charges on short-term loans to banks — a surprise move widely interpreted as a first step toward normalizing lending by increasing the extraordinary rock-bottom interest rates that have prevailed during the economic crisis.
— Bernanke reportedly indicated a willingness to go along with a proposal hatched by the Obama administration and Senate Democratic leaders to essentially strip the Fed of its responsibility for identifying systemic risk in the nation’s financial system, such as the housing bubble that led to the financial crisis. According to The New York Times, the Fed chief had agreed to hand that authority over to a council of regulators headed by the Treasury secretary, but with the Fed as a member.
Bernanke, the urbane former Princeton economics professor who succeeded Alan Greenspan, once enjoyed a soaring reputation as a master in the financial world. But after a populist political backlash to the Fed’s policies during the lead-up to the 2008 financial crisis, President Obama had to apply considerable pressure to salvage his nomination to a second term.
Senate opponents offered a litany of complaints against Bernanke. They accused him of bailing out Wall Street and allowing big bonuses for financiers while doing little to help troubled small businesses. They said he looked the other way when the housing boom got out of control and threatened to take down the economy.
Critics also said the Fed failed to act when it was clear the banking system was becoming overleveraged and that it coddled the giant insurer, American International Group (AIG).
Now Bernanke must fight to restore confidence in his stewardship at the Fed while trying to help lift the country from a deep recession and massive joblessness — and play a key role in imposing tougher regulation on the nation’s financial institutions.
"He has had this red circle painted on his chest," said David Wyss, chief economist at Standard & Poor’s, the rating agency. "It’s going to be difficult for him."
Stocks rebounded from a two-day slide Wednesday after Bernanke told Congress that low interest rates are still needed to support the economy. The Fed chief voiced optimism about a recovery in surveying the economy, according to the Associated Press. He told the House Financial Services Committee he still expects interest rates will remain low for an extended period. Investors want to see low-cost borrowing continue to help revive the economy.
In an effort to improve relations with Congress, Bernanke said the Fed will be more open about its operations, adding that he would support legislation to identify companies that used the Fed’s special lending facilities "after an appropriate delay." A delay in identifying companies taking advantage of the loans would help discourage investors from viewing a company as having financial difficulties, he said.
"Bernanke fiddled while our markets burned," said Sen. Richard Shelby, R-Ala., the ranking Republican on the Senate Banking Committee, during a scathing floor speech in which he suggested Bernanke failed to exercise sound judgment in handling a near-meltdown of the economy.
The Senate’s 70-30 vote on Jan. 28 to confirm him for a second term was a remarkably tepid endorsement of Bernanke — the fewest confirmation votes for a chairman in the Fed’s history.
Bernanke and his supporters conceded that the Fed chairman had made mistakes and miscalculations in the years leading up to the financial crisis. Bernanke said the central bank’s regulatory efforts to deal with the housing bubble were "too late or were insufficient" and that it should have required that banks have more capital. "I did not anticipate a crisis of this magnitude and severity," he said.
But his supporters said Bernanke’s firm hand and extensive knowledge of Wall Street and the financial world was essential to preventing the crisis from turning into a worldwide depression.
"He did a fantastic job once the crisis happened," said Alice Rivlin, a former Fed member. "It was an unprecedented situation. He was calm and sensible and very aggressive."
Some in Congress are pushing for a measure that the Fed fears could compromise its independence from politics — a House-passed amendment sponsored by Rep. Ron Paul, R-Texas, who favors the Fed’s abolition. It would enable the Government Accountability Office to audit the bank’s books, but Fed supporters suspect that would lead to auditing of monetary policy as well.
Even after winning reconfirmation, Bernanke continues to devote a substantial amount of time trying to fend off legislative encroachment, according to Fed insiders.
"The Federal Reserve has been granted, both in law and in political tradition, considerable independence and autonomy," Bernanke said at his swearing-in ceremony on Feb. 3. "In the interest of maintaining public confidence and promoting economic and financial stability, we must continue to protect our independence."
Gaining public confidence is widely seen as crucial in helping the Fed with its challenging agenda. Fed officials’ goals include:
— Strengthening financial regulation via legislation to do away with the concept that some banks are "too big to fail" and therefore can always expect to be rescued with the help of taxpayer funds.
— Steering the economy to a solid recovery while reducing unemployment, no easy task given current forecasts by the Fed, the administration, and independent analysts that point to a slow recovery and persistently high unemployment.
— Pursuing an "exit strategy" from its rock-bottom interest rates and extraordinary crisis-ridden moves to pump cash into the economy without causing inflation.
The Fed’s role in banking regulation remains unsettled, with congressional critics still dissatisfied with Bernanke’s performance during the financial crisis.
In conducting monetary policy, the Fed sets short-term interest rates for the entire economy by influencing the overnight lending rates that banks are required to pay. The Fed also pays interest on money that banks deposit at the central bank. In times of crisis, it pumps cash into the economy through the banking system. And it regulates all national banks and many state-chartered banks.
Bank failures numbered 45 in the fourth quarter and totaled 140 last year. That was the highest annual total since 1990, during the savings and loan crisis. So far this year, 20 banks have failed.
Bernanke has made it clear the Fed does not want to be a super-regulator of financial institutions. A House-passed bill would create a new government council responsible for identifying systemic risks to the financial system, with the Fed serving as its chief "agent" in regulating this area.
A Senate bill being pushed by Senate Banking Committee Chairman Christopher Dodd, D-Conn., would also set up a separate council, but with the Treasury secretary as chairman and the Fed chairman as vice chairman.
The House financial reform bill would allow for an orderly winding down of failing financial institutions, but with no federal bailouts. If financial assistance is required, failing banks could turn to a "Systemic Dissolution Fund" that would be established by assessments on large banks and hedge funds. Dodd’s draft bill would follow that same "too big to fail" principle.
As for the economy, Bernanke’s Fed shows little immediate worry about inflation as it keeps short-term interest rates near zero to fight the worst recession since the 1930s. "It is going to be a very elongated, difficult recovery," said Diane Swonk, chief economist at Mesirow Financial in Chicago.
The Fed’s latest economic outlook for this year projected little improvement in the jobless rate, which it said would average between 9.5 and 9.7 percent. It is now at 9.7 percent. In 2011, the unemployment rate would ease to 8.2 percent to 8.5 percent, according to its forecast.
Mark Thomas, economics professor at the University of Oregon, said a small improvement in the economy’s direction could help Bernanke if it appears lasting. "I think that will generate a lot of positive political spin for him," he said.