History’s greatest wrecker of market capitalism gets the Nobel prize. Bernanke was wrong about almost everything he asserted during his tenure as the U.S. Central Bank’s (Fed) chair.
BY DAVID STOCKMAN FOR THE INTERNATIONAL CHRONICLES
Ben Bernanke got the Nobel Prize for his early 1980s work on, well, why banks exist!
That’s right. What all students of banking knew 100 years ago—-that banks are inherently risky because they lend long and borrow short—got gussied up into a fancy theory of “maturity transformation”, and a further claim that the severity of the Great Depression was owing to the failure of maturity transformation in the private banking market.
That proposition, of course, implies that banks and other financial intermediaries are inherently defective and need the helping hand of the central bank to ameliorate their mistakes. Or as Fed and Bernanke fanboy Greg Ip wrote in the WSJ this AM:
In a seminal 1983 paper, Mr. Bernanke showed that the depth and length of the Great Depression was due in great part to financial factors: As the economy contracted and deflation took hold, banks failed, taking with them knowledge about borrowers that had been critical to sustaining credit.
Mr. Bernanke added another crucial insight: Lenders, he noted, dealt with information asymmetry by demanding collateral, such as property, that can be seized if the loan isn’t repaid. If collateral values are falling, even sound banks might not want to lend. The 1930-33 debt crisis was due to “the progressive erosion of borrowers’ collateral relative to debt burdens,” Mr. Bernanke wrote. The usual response of banks was “just not to make loans to some people that they might have…in better times.”
Well, good on them per the last bolded sentence, and bad on the Nobel committee and the modern guild of economic professors for promoting the opposite humbug.
The Great Depression was not caused by “market failures” such as deficient maturity transformation, nor the reluctance of the Fed back in those times to flood the market with fiat credit, as did Bernanke 78 years later. To the contrary, the Great Depression amounted to a vast purge of the credit excesses and bad loans that had been made during the false prosperity of the Great War, exacerbated by the easy credit policies of the Fed during the mid-1920s thru the crash of October 1929.
Yes, commercial bank deposits did shrink by 26% after the crash—-from $46 billion to $34 billion between 1929 and 1933. But that was due to the liquidation of bad loans made during the prior 15 years of unsustainable prosperity. During that period, the US first experienced a credit-fueled economic boom as it became the wartime arsenal and granary of the European Allies; and then another huge leg up during the 1920’s when Wall Street made massive foreign loans, which fueled booming exports and domestic CapEx.
Alas, the party eventually came to an end when these massive foreign loans—upwards of $1.5 trillion in today’s economic scale—which had been taken out by foreign governments and private companies alike could not be serviced.
So Bernanke was half-right, but had the time period upside down: To wit, the culprit was not timid central bank policy during 1929-1933 when the excesses of the prior booms were being necessarily and unavoidably liquidated. Instead, the Fed’s policy error was that it had financed an unsustainable wartime boom during 1915-1919, and then added insult to injury by fueling the foreign lending and stock market bubbles of the 1920s, which came crashing down in 1929—pulling the props out from under the Roaring Twenties.
What didn’t happen during 1929-1933, however, was a too stingy Fed as Milton Friedman and his acolyte Ben Bernanke have insisted. While the money supply (M1) shrank by -7% per year during that period of deep contraction, the Fed’s balance sheet—a measure of its credit support to the financial system—grew by +8% per annum.
What really caused the Great Depression, therefore, was the collapse of the money multiplier, thereby severing the alleged constant relationship between Fed credit (reserve provision) and M1. Yet the money multiplier’s collapse was not evidence of a “market failure”, but embodied a necessary and healthy market purge. After all, when bad loans are liquidated, bank deposit money gets destroyed as well.
In fact, the level of bank deposit money—which is the overwhelming share of M1 in the modern economy rather than hand-to-hand currency—is a passive consequence of bank credit expansion/contraction, not vice versa as implied by Bernanke’s maturity transformation theory. So rather than a sign that central bank intervention is required in the current period, the contraction of bank credit and therefore M1 is evidence of central bank excesses in the prior periods.
Stated differently, the “information asymmetry” ballyhooed by Bernanke is a two-way street: Banks may well over-estimate the credit-worthiness of borrowers on the upside of the cycle just as they possibly under-estimate the profitability of new loan extensions on the downside. But the solution to that true condition is to minimize the purgative of the down-cycle by not fueling lending excesses and reckless risk-taking on the up-cycle.
Indeed, at the heart of Bernanke “market failure” theory is a massive and dangerous invitation to moral hazard. He proved during his tenure in the Eccles Building that a “Bernanke Fed” doesn’t care about the information imperfections of bankers on the upside of the cycle, but only about bailing them out during the downside, thereby depriving the financial markets of their natural modality of financial discipline.
That is, if banks were motivated after the 1929 crash to “just not to make loans to some people that they might have…in better times“, that was Mr. Market doing his job.
When banks don’t make money owing to exaggerated fears triggered by current losses, and thereby suffer periods of declining loan volumes and profits from the “maturity transformation” spread, they become better lenders and more profitable enterprises in the long haul.
Of course, that’s not the lesson that central bankers have promulgated in modern times—nor the narrative peddled by their fanboys in the financial press.
As one of the worst of these, Greg Ip, opined in the recent WSJ piece, central bankers dare not let the value of loan collateral (stocks, bonds, derivatives and real estate) fall. That’s because the genius professor from Princeton chanced to discover that collateral values fell sharply during the Great Depression, thereby causing loans to be called and credits to be liquidated.
Well, mirabile dictu (wonderful to relate)!
Of course collateral values shrank during that period. That’s because they got vastly overstated during the prior booms. For want of doubt just recall that $9 billion of the $16 billion of shrinkage in bank loan books between 1929 and 1933 was owing to margin loans being called on Wall Street.
Do we think that the booming stock values behind these margin loans—tickets to instant riches famously tipped to Joe Kennedy by his shoeshine boy during the top of the stock market boom—were overvalued?
Why, yes we do!
But according to Greg Ip, Bernanke was not about to disappoint the equivalent of today’s shoeshine boys in 2008-2009.
These (collateral boosting) mechanisms became central to the global financial crisis that began just a few months after that (Bernanke) speech. As home prices plummeted, so did the net worth of millions of homeowners, and the capital of countless banks and shadow banks. Mr. Bernanke responded by using every tool available, and inventing several new ones, to prop up floundering financial institutions and cushion the broader economy from bankruptcy and deflation. As a result the recession, though the worst since the 1930s, wasn’t a repeat of the 1930s.
Nonsense. The Great Depression was long-lasting only because Hoover’s protectionism and FDR’s menagerie of interventionist agencies (NRA, AAA, WPA etc.) thwarted the natural recovery mechanisms of the free market.
Yet the Friedman/Bernanke fostered myth that the Great Depression was caused by the Fed’s failure to compensate for the alleged “market failure” of the banking system after 1929 is now stuck in the word processors of the financial press and, therefore, the mainstream narrative about the reckless money-printing policies emanating from the Eccles Building, especially after the 2008 housing bubble collapse.
Beyond his work on financial crises, Mr. Bernanke also long advocated central banks adopt a formal inflation target. Originally a response to the high inflation of the 1970s, Mr. Bernanke also saw targets as a safeguard against the deflation of the 1930s. This interest grew in the aftermath of the crisis when inflation remained stuck below 2%, keeping interest rates near zero as well—robbing the Fed of its ability to boost the economy.
In response, Mr. Bernanke introduced and refined “quantitative easing,” or large scale bond purchases, and in 2012 persuaded the Fed to adopt a formal 2% target. In 2017, Mr. Bernanke proposed a temporary “price level” target under which the Fed, after a period of below 2% inflation, would for a while aim to keep it above 2%.
The Fed adopted a version of that in 2020, just before inflation came roaring back. Today, the Fed is instead battling to get inflation down from too-high levels. With property values soaring in the past year and financial institutions well capitalized, the dynamics of falling collateral values and failing lenders that marked the Depression and the 2007-09 recession appear largely absent. Nonetheless, there are strains appearing, such as in the government bond market. The current situation is “not anything like the dire straits” of 14 years ago, Mr. Bernanke told reporters Monday.
Well, exactly how would Bubbles Ben know? As one wag posted this morning, Bernanke had been wrong about almost everything he asserted during his tenure in the Fed chair, and 2% inflation targeting against the bogeyman of “deflation” is the very worst of his errors.
However, to give a Nobel to Ben “Sub-prime is contained”/”high levels of private debt do not matter”/”banks intermediate between savers and borrowers”/”zero rates and QE” Bernanke for providing “a foundation for our modern understanding of why banks are needed, why they’re vulnerable, and what to do about it” –just as central banks try to undo the post-2008 policy error, and perhaps the post-1980 financialisation and zombification of the economy to boot– is either a slap in the face (“You might reshape the global economy, but you aren’t going to get a prize from us!”) or shows economics, or the Nobel committee, or both are past saving.
We sincerely hope that the latter is not true, but when history’s greatest wrecker of market capitalism gets the Nobel prize, it’s hard to conclude otherwise.
