The Fed and the Crisis of 2007

In Fed We Trust, by David Wessel, Crown Business, 2009. $26.99, 336 pgs.
Screenwriters take note: this economic crisis will provide material for decades to come. The story of Ben Bernanke, the soft-spoken economist with humble roots in small-town South Carolina, is on its own the stuff of cinema. Bernanke, a Depression scholar, capped a meteoric rise through academia by demonstrating that the Federal Reserve’s Depression-era policies had exacerbated an already bad situation. In 2005, he became Chairman of the Federal Reserve, and two years later, he found himself battling economic meltdown from the heights of the very institution whose failures had been his life’s study.
Bernanke’s remarkable ascent, and his decisions as the world’s most powerful economist, form one strand of David Wessel’s riveting and intelligent, though ultimately premature, new book In Fed We Trust: Ben Bernanke’s War on the Great Panic: How the Federal Reserve Became the Fourth Branch of Government. Wessel’s work is a sweeping exploration of the Fed’s long and checkered history, its actions during the current crisis, and the unprecedented role it now plays in global policy-making.
Grading the Players
Wessel, the economics editor of The Wall Street Journal, deftly explains the basics of monetary and financial theory, providing much-needed background to a system defined by an arcane financial vocabulary. But the real gifts to laymen are the author’s “translations” of public pronouncements by Fed and Treasury officials. Here, he dissects a 2005 speech by Tim Geithner: “‘Low realized volatility in macroeconomic outcomes [Translation: everyone thinks we’ve licked the boom-bust cycle] and low realized credit losses [Translation: even deadbeats are paying their loans]… have worked together to bring risk premia down across many asset prices [Translation: all of which have led prices of stocks and other assets to rise awfully high.].'”
In Fed We Trust also functions as an early report card for the major figures of the current crisis, and Wessel isn’t afraid to mark down. He frowns on Hank Paulson, whose capricious decision-making “didn’t build lasting credibility”, George W. Bush, who was conspicuously absent from most precedent-shattering decisions, and the omnipresent Alan Greenspan, whose misguided “mop-up-after” strategy allowed the housing market to bubble. Wessel’s impressions of Bernanke and Geithner are much more favorable, even as he takes issue with several of the specific choices they made.  The decision to let Lehman Brothers fail, in particular, draws Wessel’s ire, and emerges as one of the most engrossingly bizarre of the entire narrative. In later interviews, Paulson and Bernanke offer changing and contradictory explanations for why the collapse was allowed, and Wessel compellingly argues that the fateful choice  that let Lehman fail triggered “a devastating intensification of the Great Panic.”
The Predictioneer’s Folly
In Fed We Trust is both meticulously and thrillingly reported, and a compelling minute-by-minute, blow-by-blow account of this crisis’s defining moments.  But at the same time, Wessel’s book arrives too early on the scene to be anything but a temporary authority on the subject. Certainly, Bernanke’s mantra of “do whatever it takes” appears to have beaten back far worse economic woes, and the financial system has pulled back from the brink. Wessel’s admiration of the Fed’s work appears justified. But banks remain under enormous pressure, the commercial real estate market is uneasy, and skeptics warn of a coming rapid rise in inflation. And, most importantly, it’s impossible to know, if the actions taken in response to this crisis will eventually bring unforeseen consequences of their own.
Writing about Greenspan’s misguided mid-90’s policies, Wessel observes that “what was clear later was not obvious at the time,” and the reader can’t help but wonder if the same might apply today. Wessel himself knows the limited power of prediction. His last book, titled Prosperity: The Coming 20-Year Boom and What It Means to You, was published in 1998.
Wisely, then, Wessel concludes that “Every time officials at the Treasury or the Fed thought they finally had gotten ahead of the Great Panic, they turned out to be insufficiently pessimistic.” We all hope that Wessel is not being insufficiently pessimistic himself. But after the way this crisis unfolded, it’s hard to believe anyone can say.