Bernanke and Paulson: economy's two key crisis managers
The Fed chairman and the Treasury secretary face tough scrutiny as policymakers.
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Institutions. The Bear Stearns collapse hints at the possibility that credit-market turmoil could engulf more financial firms – large and small – this year. Already a number of hedge funds and mortgage companies have failed.Skip to next paragraph
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In its move last week, the Bernanke Fed (with the knowledge of Paulson and other officials) is framing the current meaning of "too big to fail." Bear is not among the dozen biggest financial players, but it is sizable and its tentacles do reach into a range of important markets.
Some finance experts say the Fed and other bank regulators – including the Treasury's Office of the Comptroller of the Currency – should be more wary of the "moral hazard" involved in bailouts. By riding to the rescue, policymakers make Wall Street complacent about managing its own risks in the future.
But many analysts agreed with the application of the too-big-to-fail doctrine Friday. In this case, the Fed extended credit to keep Bear afloat, and urged a rapid buyout of the firm. A sign of the level of distress: The bank J.P. Morgan paid $2 per share Sunday for a company whose shares had traded in the $50s a few days earlier.
In another emergency move over the weekend, the Fed announced a new way that it will loan money to other Wall Street firms under pressure, not just banks.
But the larger point is this: To avoid the need for bailouts, banks and other financial companies need capital in reserve.
Last week, tucked into a larger array of long-term proposals for credit markets, Paulson made a plea for banks to move on this issue.
Interest rates. Low interest rates aren't a magic elixir for an economy where both borrowers and lenders are under stress. But many economists say that recent rate cuts by the Fed can help.
The problem: Others worry that cutting interest rates will fan inflation. The percentage of economists who see Fed policy as "about right" dipped below 50 percent this month in a survey by the National Association for Business Economics. The most frequently cited concerns in the survey were the inflation threat and the idea that lower interest rates might "bail out investors who should have known better."
In recent testimony, Bernanke said he expected consumer prices to rise more slowly than last year's 4 percent pace. But by some measures, bond-market expectations of inflation are edging up. That could pressure the central bank to shift away from efforts to stimulate the economy.
Brian Bethune, an economist at Global Insight says a key measure of money creation – considered the fuel for inflation – has been falling for several months. He says the Fed is right to focus on how to prevent a wider financial meltdown, which, if it occurs, could unleash the opposite problem of declining prices – deflation.
Currency. Paulson is under fire in some quarters for doing too little in his role as official spokesman for the US dollar as it declines – most notably against the euro. "Fixing this mortgage mess is important. But at the same time the Treasury should be working to stabilize and appreciate the dollar," Lawrence Kudlow, a conservative economist who hosts a talk show on CNBC, wrote in a commentary to clients last week.
Many economists say that a weaker dollar, for now, is in the US's interest, since it bolsters the competitiveness of US exports. Others counter that the dollar weakness is inflationary. Much of the rise in oil prices, for example, simply reflects a weak dollar. Conceivably, the US could work with other nations in a bid to firm up the purchasing power of the greenback.
Paulson, like virtually every Treasury secretary, repeatedly affirms that a strong currency is in the US's interest. In a TV interview Sunday, Paulson said that Bush policies and America's long-term strength are "going to be reflected in the dollar."