Economy Is 'Leveling Out,' Bernanke Says
With Fed's Role Under Review, Chairman Cites Strength of Its Actions

By Neil Irwin
Washington Post Staff Writer
Saturday, August 22, 2009

JACKSON, Wyo., Aug. 21 -- Federal Reserve Chairman Ben S. Bernanke rendered his most positive assessment of the economy yet in a speech Friday and gave credit in part to his own institution's handling of the worst economic crisis in decades.

The U.S. and global economy "appear to be leveling out," Bernanke told an audience of some of the world's leading economists and central bankers, and "prospects for a return to growth in the near term appear good." He warned, however, that the recovery is "likely to be relatively slow at first," with unemployment declining only gradually.

The idea that the economy is starting to improve was bolstered Friday by a report that sales of existing homes soared 7.2 percent in July to the highest level in two years. Bernanke's comments and the housing news sent Standard & Poor's 500-stock index up 1.9 percent to a new high this year.

But the meat of Bernanke's speech was not about the stabilizing economy, but rather an extensive defense of the Fed's handling of the financial crisis and recession. It is part of a broader effort to shore up confidence in the central bank, which has come under fire in Congress and in public opinion polls for its role in various bailouts.

And it comes as speculation heats up over whether President Obama will reappoint the chairman when his term expires Jan. 31.

"History is full of examples in which the policy responses to financial crises have been slow and inadequate," Bernanke said at the annual symposium sponsored by the Kansas City Fed. By contrast, in the current crisis "policymakers in the United States and around the globe responded with speed and force to arrest a rapidly deteriorating and dangerous situation."

With the recession waning, Bernanke and other Fed leaders are trying to make the case that their actions, including unconventional lending programs and the bailouts of Bear Stearns and American International Group, are part of the reason. He has offered broad outlines of this idea in the last month to Congress (in two days of testimony on Capitol Hill) and to the American people (in a late July town hall-style television broadcast on PBS).

His comments are not merely intended to set the record straight: Congress is looking to remake the financial regulatory system, which could include changes to the Fed's mission and governance.

"He's trying not to be defensive, but to explain why the Fed did what it did," said John Makin, a principal at hedge fund Caxton Associates and participant in the conference.

The question of Bernanke's future increasingly hangs over his public appearances. Obama has several alternatives, including White House economic aide and former Treasury secretary Lawrence H. Summers. But Bernanke enjoys strong support from the financial community and economists, and the conventional wisdom in those circles is that his reappointment is the most likely outcome and Obama's safest choice.

Bernanke has about a 79 percent chance of being reappointed, based on trading Friday on the online betting exchange InTrade.

The annual conference, at a lodge in the shadow of the Grand Tetons, is a gathering spot for the world's leading central bankers and other top economists. Two years ago, ominous clouds were gathering for the world economy, and last year, there had already been a few thunderstorms.

But this year, the economists were trying to piece together how last fall's financial typhoon has altered the financial system, and what they, as policymakers, can do to stop it from happening again.

Bernanke and a Fed colleague, Brian Madigan, argued that the Fed's extraordinary interventions were a logical extension of central banking practices first explained by Walter Bagehot, the 19th century British father of modern central banking.

Bagehot said that central banks should halt panics, an idea that has long been government policy for conventional banks. Bernanke and Madigan said Fed programs to support money market mutual funds, commercial paper and consumer and business lending are an adaptation of that notion for the 21st century.

"Bagehot's dictum continues to provide a useful framework for designing central bank actions for combating a financial crisis," said Madigan, director of the Fed's division of monetary affairs. But, he said, that framework should be used amid "the modern structure of financial markets and institutions."

While speakers were generally cautiously optimistic about the future, many seemed wary of becoming complacent about continuing risks to the economy -- or forgetting the lessons of the last year.

"I am a little a bit uneasy when I see that because we have some green shoots here and there, we are already saying, 'Well, after all, we are close to back to normal,' " said Jean-Claude Trichet, president of the European Central Bank, commenting on a paper presented at the conference. "We know that we have an enormous amount of work to do and we should be as active as possible."

Stanley Fischer, governor of the Bank of Israel and a onetime thesis adviser to a young Ben Bernanke, gave a particularly sharp warning about the risk that world governments will fail to rein in the excesses that created the crisis.

"At this stage, we seem to be taking it for granted that we should go back to the structure of the financial system as it was on the eve of the crisis," Fischer said in a speech. "But we need to be thinking more broadly, including the possibility that some radical restructuring is needed," such as sharply restricting the ability of banks to have large trading operations.

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