Three central bankers: Mandarins of money
- Story of intense exercise in economic crisis management
- Revealing look at central bankers and power they exert
- Among global peers%2C Bernanke first to grasp depth of crisis
Without the unprecedented actions by major central banks after the financial crisis struck five years ago, the world undoubtedly would have plunged into a depression rivaling that of the 1930s.
Nevertheless, the Federal Reserve, the European Central Bank and the Bank of England, acting individually or together, were not able to prevent massive losses by investors, homeowners and businesses of all sizes; nor were they able to head off a deep recession that left millions without jobs.
And by lending hundreds of billions of dollars, euros and pounds to banks to prevent a collapse of the world financial system that would have brought on a depression, they and their governments appeared to be sacrificing ordinary people to save the wealthy.
In The Alchemists, Neil Irwin focuses on these three central banks and their leaders in a time of crisis and poisonous politics. There have been plenty of books about the crisis, many primarily about financial markets and the big institutions that let greed overwhelm any concern about the risks they took. This one is about central banking and in many ways a successor to David Wessel's fine In Fed We Trust, which covered events through the end of 2008.
The book's title refers to efforts in the Middle Ages to turn base metals such as lead or tin into gold or silver. In a sense, central banks can turn the trick because they can, with a government's backing, create money from nothing.
That's a stupendous power but it is hardly unlimited. It is no simple matter for a central bank to figure out how much to create. Financial panics, as crises used to be called, inevitably involve the failure of banks and other financial institutions, which simply supplying more money can't fully offset. And public attitudes and other actions by governments may limit what a central bank can do.
As Irwin explains, too much money can, in an extreme case, create crippling inflation, as occurred in Germany when the head of its central bank pumped up its money supply to help finance World War I.
That inflation and the hyperinflation that followed so damaged Germany that it is the reason the German-dominated ECB has a sole mandate—stable prices—rather than the Fed's dual mandate—stable prices and maximum employment.
Even today with the eurozone in a recession and unemployment at a record high of 12%, the ECB is extremely hesitant to try to stimulate economic activity despite very low inflation.
If a central bank is too niggardly in creating money, as the Fed was in the early stages of the Great Depression, conditions can become unnecessarily harsh for years on end. The fact that Fed Chairman Ben S. Bernanke's academic studies focused on the Depression has been a key reason he has been so willing to use extraordinary measures to keep the current crisis from being much worse in the U.S. than it has been.
Irwin covers all this in his highly readable account of central banking in a time a crisis. The crisis, of course, wasn't just financial -- it was and to some extent still is intensely political.
The Fed can reasonably be blamed for banking regulatory lapses that left financial institutions vulnerable when the housing bubble collapsed. That, plus the deep resentment triggered by the bailouts, caused the Fed to come close to losing all its regulatory powers and having Congress become intimately involved in the Fed's monetary policy debates.
Bernanke and his supporters also had to fight hard in 2009 to get him confirmed by the Senate when President Obama nominated him for a second term.
One of the more interesting sections of the book is Irwin's description of the major lobbying effort by many of the presidents of the 12 regional Fed banks, reinforced by the backing of an association of thousands of smaller community banks, which successfully defended the Fed's turf.
That effort also highlighted the long-standing internal tensions between the powerful Board of Governors, led by Bernanke in Washington, and the regional presidents. Those tensions, as Irwin explains, were deliberately built into the decentralized organization of the Fed to curb the fears in much of the country that bankers in New York and politicians in Washington would dominate the new central bank to the detriment of the rest of the nation.
Bernanke's continuing efforts to spur growth in the face of a subpar recovery and high unemployment has repeatedly been challenged by conservatives—including some Fed officials—who fear supplying so much money to the economy will spark high inflation.
The low point in such claims was reached in 2011 during the fight for the Republican presidential nomination when all the candidates said they would get rid of Bernanke. But Texas Gov. Rick Perry went much further. "Printing more money to play politics at this particular time in American history, is almost treacherous, er, treasonous, in my opinion."
Irwin makes it clear that Bank of England's governor, Mervyn King, and Jean-Claude Trichet, president of the European Central Bank, were far behind Bernanke in recognizing the severity of the crisis.
As in the U.S., there was a failure at both to understand the risks financial institutions were taking, but once the crisis had begun, King and Trichet were reluctant to lower interest rates rapidly as much as they should. Moreover, both men accepted the hard-held view of some political leaders, especially German Chancellor Angela Merkel, that government budget deficits were the primary economic problem facing Europe.
Trichet, though a Frenchman, had a thoroughly Germanic view of the ECB's proper role. King became so focused on deficits that he, in effect, lent his support to the austerity approach of the Conservative Party as it successfully challenged the incumbent Labor government.
And long after the Fed had moved to what is called quantitative easing—adding money to the economy by purchasing Treasury and mortgage-backed securities from private owners—King resisted. Trichet, whose term ended last year, never moved in that direction, nor has his successor Mario Draghi of Italy.
Irwin, a reporter for the Washington Post, began covering the Fed in 2007 just as the crisis began. In a summary section, he says, "the central bankers' judgments were far from perfect, and their mistakes—allowing the collapse of Lehman Brothers, endorsing early fiscal austerity in Britain, moving with such hesitation and delay in the face of the Eurozone crisis—will do lasting damage."
Certainly the collapse of Lehman Brothers, an investment bank, in September 2008 did lasting damage when it caused the world's financial system to freeze. Had the bankruptcy not occurred, the economic history of the past four years might have been far brighter. But was allowing the collapse of Lehman Brothers a "mistake"? No, a group of Wall Street institutions refused to put up the money to keep it alive and the Fed couldn't.
The problem was, Lehman was not just illiquid but insolvent. As Irwin writes, "a loan wouldn't solve its problem, and there was no legal way for Bernanke or [Treasury Secretary Hank] Paulson to hand money over to a private firm. It's not clear that U.S. politicians—from President Bush to Congressional Democrats who were tiring of Wall Street bailouts—would have stood for it anyway."
In short, the Fed had reached the limit of its power.