Brian Wesbury Weekly Outlook: Second Thoughts on Bernanke’s Nobel Prize

18.10.2022 10:26 - First Trust Global Portfolios Limited

The Nobel Prize in Economics was recently awarded to former Federal

Reserve Chairman Ben Bernanke, as well as professors Douglas

Diamond and Philip Dybvig, for their work on understanding the role

banks play in the economy, especially during a financial crisis.

All three of them have done important work that’s worthy of

recognition. Banks are key parts of the economy that, by assessing

the creditworthiness of borrowers, help channel the savings of

households and companies into productive investment. Bank

failures, in turn, threaten to make it tougher for an economy to direct

savings to where they’re most useful.

However, like many recent Nobels this award seems to ratify

expansionary government policy. Bernanke’s approach to the

Financial Panic of 2008-09 included a massive bailout of the financial

system, monetization of government spending, and a huge

expansion in the Federal Reserve’s balance sheet.

The Bernanke approach did not include fixing mark-to-market (MTM)

accounting, which was the key ingredient that turned a limited

financial fire into a raging inferno that almost burned down the entire

US financial system.

To review, in late 2007 the Financial Accounting Standards Board

(FASB) forced financial firms to use market prices to value securities,

rather than models or cash flow. Within a year, the U.S. was in the

middle of the worst financial panic in a hundred years. This was not a

coincidence.

On the surface, MTM made sense. Markets usually provide

transparent and verifiable prices, so companies couldn’t just make

up numbers. The problem is that market prices often deviate –

sometimes substantially, but always temporarily – from underlying

fundamental value. Since markets are forward looking, MTM

forced financial firms to take hits to capital over something that

might happen in the future but hadn’t happened yet. It was like

forcing homeowners to come up with more capital as a hurricane

approaches because their homes might get destroyed.

This, in turn, created a vicious cycle as capital constraints hurt banks,

undermined the economy and drove asset prices lower, and then

destroyed more capital. In 2008, when markets for even prime

mortgage-backed securities became illiquid, the financial crisis

intensified.

Finally, in March 2009, six months after TARP and QE were put

in place, the stock market was still falling. That’s when Congress

(specifically, Barney Frank) started to twist arms, forcing FASB to

loosen up its rules and allow cash flow to be used when markets were

illiquid. This seemingly small adjustment did the trick. Banks were

finally able to raise new capital, the stock market surged, and the

economy started a long and sustained recovery. This was no mere

coincidence, but Ben Bernanke, as far as we know, has never publicly

discussed it.

We find that odd because Bernanke should be familiar with the

damage MTM can do. Bernanke is a student of the Great Depression

and Milton Friedman won the Nobel Prize for his work on the Great

Depression, as well. In addition to his focus on the money supply,

Friedman also wrote about how a MTM rule in the 1930s caused

many banks to fail. Not coincidently, the Roosevelt Administration

suspended MTM in 1938 and, simultaneously, the Depression ended.

We, and others, including Peter Wallison, have written extensively

about the economic damage done by the MTM accounting rule…

especially to the financial markets. Yet, the Fed, other government

agencies, and academics have ignored it. Apparently, even if you

have solid evidence that TARP and QE really didn’t end the 2008

Panic, you should be ignored. The only narrative allowed is that free

markets caused the crisis and the government saved us.

And now, Nobel Prize or not, the bill is coming due on the “abundant

reserves” monetary model that is the result of Bernanke’s research.

The US has its highest inflation rate in 40 years. True, this didn’t

happen in the aftermath of the 2008-09 crisis, because the M2

measure of money remained more stable. But government spending

surged much more during COVID and Bernanke’s new system

monetized it.

Having some insights into the role banks play in an economy is not

the same as fully understanding the economy. And dismissing the

role of MTM accounting seems intellectually dishonest. We have

second thoughts about anyone who does.

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