Don't give Ben another term

    Even if you agree with Fed Chairman Ben Bernanke's policy choices so far, you can't argue that he was slow to notice, and respond to, the subprime crisis.

    By Desmond Lachman

    Speculation that Ben Bernanke might very well be appointed for a second-term as Federal Reserve Chairman when his term expires in January 2010 has to remind one of Washington's Alice in Wonderland-like quality.

    For if Bernanke were indeed to be reappointed as Fed Chairman, it would mean that, in the depths of by far the worst U.S. economic recession in the post-war period, one would be reappointing to the job the very person whose fingerprints, along with Alan Greenspan's, are all over that recession.

    Bernanke's tenure as Fed Chairman has coincided with the most tumultuous period for the U.S. economy since the Great Depression. If there is one thing that we might have learned from this experience, it is the very high price that the country is now paying for a Federal Reserve that between 2000 and 2006 was totally oblivious to the dangers of the largest housing and credit market bubbles in the postwar period.

    By now, we also should have learned the high price of a Federal Reserve that was painfully slow in reacting to the bursting of those bubbles in 2007 and that lacked any real financial market strategy for picking up the pieces once the bubbles burst.

    In deciding whether or not to renew Bernanke's term, President Obama would do well to ask himself whether, during a four-year tenure as Chairman, Bernanke has consistently shown himself to be early in detecting looming problems. He might also usefully ask whether Bernanke has been sufficiently forceful in staving off those problems as soon as they were identified.

    A useful place for Obama to start would be to ask why Bernanke was silent in 2006 as the housing bubble was continuing to inflate and as the worst of the subprime mortgage loans were being made. During that year, a total of around $600 billion in subprime mortgage lending -- or around one half of all subprime lending ever -- was made on conditions that were materially more lax than earlier vintages of subprime lending.

    It would also seem reasonable for Obama to hold Bernanke accountable for totally misjudging how serious the bursting of the housing market bubble would be for the overall economy. And for how large the losses would be to the financial system from imprudent subprime lending.

    In April 2007, when he first identified that something was amiss with subprime lending, he assured Congress that the subprime problem would be limited and that any fallout would be confined to the housing sector. His highest estimate in 2007 was that such losses would cost the economy about $150 billion. The latest estimate of the eventual subprime-related losses to the U.S. banking system is more than $1.5 trillion.

    Perhaps even more disturbing to Obama should be how blinded Bernanke was to the need for early and decisive monetary policy action to counter the fallout from the housing market bust. Indeed, it was as late as August 2007 before the Federal Reserve started its interest rate cutting cycle.

    This was long after it had become apparent to most market observers that large subprime losses and a lack of transparency in the newfangled debt instruments were leading to a seizing up of the international banking system. And even when the Fed did begin cutting interest rates, it did so gingerly, and it repeatedly underestimated the downside risks to economic growth from the housing market debacle.

    Advocates for Bernanke's reappointment stress his impressive academic credentials as an expert on the Great Depression and the 1990s Japanese financial crisis. These credentials, they argue, could not be more relevant at this difficult stage in the U.S. economic crisis.

    They point to the consummate skill with which Bernanke prevented financial Armageddon in the wake of the Lehman bank failure in October 2008. And they also underscore the highly creative, albeit belated, way in which Bernanke has doubled the size of the Fed's balance sheet and resorted to so-called quantitative easing in recent months to reduce long-term interest rates and keep financial markets adequately liquid.

    But in deciding on whether or not to renew Bernanke's term, Obama would do well to focus on the record of his full tenure in office rather than only on Bernanke's relative successes in the nine months after the Lehman bankruptcy.

    If Obama were to do so in a dispassionate and deliberate manner, he would find that Bernanke's full-term performance has been checkered at best. There must be other candidates who could be expected to do a better job than Bernanke as Federal Reserve Chairman.

    Desmond Lachman is a former IMF deputy director and currently a senior fellow at the American Enterprise Institute.