Fed Chief 's Measured Response to Crisis

"We have little experience with how financial markets behave in situations such as this, given the spread of these structured securities," said Marvin Goodfriend, an economist at Carnegie Mellon University who contributed to a book edited by Bernanke, referring to the complicated new types of debt products that have been particularly affected by the problems in the markets. "The sequence of actions the Fed has taken fits closely with what I would have expected on the basis of what the community of academics and central bankers and economic historians believe."

The way many financial-market participants view it, Bernanke's background in higher education -- he spent most of his career at Princeton and has also worked at the White House and previously at the Fed -- makes him less attuned to financial markets than Greenspan was.

"The Bernanke Fed looks much more academic," said Diane Swonk, chief economist of Mesirow Financial in Chicago. "There are fewer market people there now."

On the other hand, Bernanke has spent a career studying how central bankers respond to crises. He is among the foremost scholars of the Great Depression, a period in which the Fed failed miserably to prevent the nation's economy from collapsing.

Greenspan became a hero to the financial markets in 1987, two months after he became Fed chairman, for his response to a stock market crash. Greenspan assured markets that the Fed would provide liquidity in the wake of the crash, and stocks soon rebounded. Similarly, in 1998, Greenspan cut a key interest rate after Russia defaulted on its debt and a giant hedge fund imploded, threatening to bring down the financial system with it. The markets then stabilized, and the U.S. economic expansion lasted three more years.

Bernanke is trying to balance two competing interests. If he doesn't do enough to calm the markets, businesses might become more cautious and decide to hold off on buying new equipment. Consumers might pull back on their spending. Economic growth would slow down. On Friday, the University of Michigan said that consumer confidence in August hit its lowest level in a year.

But there's the risk of doing too much to soothe the markets, too. If Bernanke moves too aggressively to calm things down, it might result in the bailout of people who made foolish bets, such as those who issued mortgages to borrowers who couldn't afford them. That might encourage investors in the future to take even more irresponsible risks, a problem economists call "moral hazard."

The Fed's moves on Friday attempted to deal with the shortage of liquidity in global markets by letting banks use mortgage loans as collateral with which to borrow cash. It was thus narrowly targeted at the exact markets that are troubled. That reflects Bernanke's attempt to limit the risks to growth without triggering the moral hazard.

If the Fed's policymaking arm lowers its main short-term rate at its Sept. 18 meeting or before, as many analysts think is becoming more likely, it would be a sign that Bernanke and his colleagues believe that the first issue, the threat to growth, has become the greater concern.

"When push comes to shove, they know they have to protect the smooth functioning of financial markets," said Wyss, of Standard & Poor's. "Whatever you say about the Fed needing to focus on inflation, if they don't have control over the financial markets, they don't have any control over the economy, either."