Fed Chief 's Measured Response to Crisis

Gerard Petti, right, traded on the New York Stock Exchange floor Thursday, when the he Dow dropped sharply but ultimately suffered a small loss.
Gerard Petti, right, traded on the New York Stock Exchange floor Thursday, when the he Dow dropped sharply but ultimately suffered a small loss. (By Richard Drew -- Associated Press)
By Neil Irwin
Washington Post Staff Writer
Sunday, August 19, 2007

As the world's financial markets experienced a wrenching upheaval and markets for home mortgages and many other kinds of debt came to a standstill, Wall Street begged Ben S. Bernanke and the Federal Reserve to do something about it.

On Friday, they did. Wall Street rejoiced when the Fed cut the interest rate on loans to banks and indicated that it would do what it takes to protect the economy from problems in the markets.

But the Fed, chaired by Bernanke, was not as disengaged before Friday as conventional wisdom suggested, and it is not now as eager to take dramatic action as some investors seem to hope, close watchers of the central bank say. Friday's moves were narrowly tailored, and they stopped well short of using all the tools in the Fed's arsenal to ease the crisis, such as lowering a key interest rate that would make it cheaper for consumers and businesses to borrow money.

The Fed's actions, say market watchers and longtime friends of the Fed chief, are consistent with the Bernanke they know: cautious, cerebral, and disinclined to react to the rumor and speculation that are among Wall Street's greatest exports.

"He doesn't want to act precipitously and doesn't change his view on fleeting evidence," said Alan S. Blinder, a Princeton economist and former Fed vice chairman who has known Bernanke for years. "He wants to see real evidence before changing his views about the economy."

Bernanke is betting that the underlying U.S. economy is strong enough to weather the damage. In this view, if he had done more to address the concerns of Wall Street sooner, it would have had the effect of bailing out people who made bad bets and could have worsened the crisis. Crucially, Bernanke does not expect the ups and downs of financial markets to cripple what economists like to call the "real economy" -- the decisions of businesses to expand and hire, for example.

If he is right and the United States does not suffer any significant economic downturn from the recent trauma in the markets, he is likely to be heaped with praise for his level-headed response. It might even gain him some of the mystique that his predecessor, Alan Greenspan, enjoyed.

If he's wrong and the nation falls into recession, he will be "a one-term Fed chairman," as Standard & Poor's chief economist David Wyss put it.

For two weeks, Wall Street whisperers have accused Bernanke of not doing enough to stanch the problems. And in a video clip viewed more than 180,000 times on YouTube, the hyperbolic market commentator Jim Cramer screams that Bernanke does not understand how bad things have gotten.

For the most part, the response from the reserved career academic has been silence. Bernanke has given no speeches and kept a low public profile through the tumult. Behind the scenes, he has been gathering information from Fed staff members, Wall Street contacts and a wide range of other sources. His key collaborators in dealing with the crisis have been Vice Chairman Donald L. Kohn and Timothy F. Geithner, president of the Federal Reserve Bank of New York.

At the Fed's white marble headquarters on Constitution Avenue NW, senior staff members have held multiple daily conference calls with market participants. Bernanke has sent e-mails to top advisers every few hours, exploring ways the Fed might respond. Having already aired various ideas throughout the past two weeks, members of the Fed's policymaking committee decided quickly on Thursday night on the announcements to make Friday morning.

There was no single factor or event that led the Fed to make its move, only a sense that on Wednesday and Thursday the problems in the marketplace had gotten worse and were at risk of turning into a self-reinforcing cycle. A central banker's worst nightmare is an environment in which fearful investors avoid any risky asset, driving prices down further and, in turn, making everyone even more fearful.

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