“Infamy, infamy, they’ve all got it in for me!” That wail from a British comedy spoof of the last days of Julius Caesar now echoes in the private offices of most of the world’s key central bankers.
Former Federal Reserve Board Chairman Alan Greenspan is being blamed for America’s house-price bubble. It seems he kept interest rates too low too long and failed to target asset prices. Never mind that similar bubbles foamed up in Spain, Ireland and Britain, to name just a few countries in which house prices soared and which are far beyond Greenspan’s jurisdiction.
Greenspan’s successor, Ben Bernanke, is being criticized both for being too slow to cut interestrates, and for cutting them so much that he will trigger inflation. His charge sheet also includes an entry alleging that he was too slow to understand the gravity of the liquidity squeeze and too quick to bail out investment banks caught in that seizing up of credit markets. Paul Volcker, Greenspan’s predecessor, is among Bernanke’s critics, and because he is one of Barack Obama’s advisers, there might be an opening at the Fed soon.
Central bankers in Britain, the European Union and elsewhere are also being criticized for not doing enough to ease interest rates, and for not having raised them enough to head off house-price bubbles. So the life of central bankers is not an easy one these days. But they can take solace from an important fact: They will leave the capitalist market system in better shape than it was when they inherited it.
They no longer will distinguish between ordinary commercial banks and investment banks. Many of the former are too big to fail, and many of the latter too interconnected to be allowed to fail. Which is why the generally anti-interventionist Bush administration approved the use of taxpayer money to make it possible for JPMorgan to take over Bear Stearns.
And why the Fed has opened its discount window to investment banks so that they can trade in their illiquid paper for cash.
There is no free credit window. So from now on these once-lightly regulated institutions will have to meet capital and liquidity requirements that the Fed deems appropriate. In essence, we are witnessing a retreat from the age of deregulation that culminated in the 1999 repeal of the 1933 Glass-Steagall Act, ending tight government control of investment banks’ operations. That was largely the work of former Texas Sen. Phil Gramm, now John McCain’s top economic adviser.
We are also about to see major changes in the originate-to-distribute chain. Firms that originated loans — vetted borrowers and approved mortgages — often had an incentive never to say “no.” For one thing, their commissions depended on the volume of loans they originated, rather than the quality of those loans. For another, having sold the loan off to others, they risked no loss should a borrower default.
The protection against these perverse incentives was to be provided by the rating agencies, which would provide investors with a rating of the safety of the securities in which mortgages were bundled. Problem: Like originators, rating agencies get paid only if a deal is consummated. And that takes a high rating, AAA being the best. Say, “Yes, these are lovely AAA-rated bits of paper,” or no fee. The saintly can be trusted to overlook such an incentive, mere work-a-day mortals cannot.
So look for legislation that leaves some risk with originators, and more closely regulates rating agencies.
Finally, the age of go-it-alone central banking is over, in two senses. First, it is now clear that so-called independent central banks cannot cope with major upheavals without close coordination with politicians. Bernanke spends more time than many critics feel he should meeting with congressmen, hungry for photo-ops.
Second, international cooperation will become more structured and intense, although it is unlikely to reach the degree of formalized coordination that some of the finance ministers, departing Washington after their weekend confab, are proposing in an effort to find some role for largely outdated international institutions. Individual national interests will always predominate, but those interests are now seen to include controlling events in other countries.
None of these changes will do much to reduce criticism of central bankers for doing too much too soon, or too little too late when crises occur. Nothing much they can do in the face of such criticism except to hope that the good they have done will not be interred with their bones.
Examiner Columnist Irwin Stelzer is a senior fellow and director of The Hudson’s Institute’s Center for Economic Policy.