Page 2 of 2   <      

After its big move to boost economy, Federal Reserve reflects on its history

These leaders have been a driving force behind the nation's economic policies since the financial crisis of 2008.

"We're not in the business of trying to create inflation," Bernanke said. Rather, he said, the Fed is trying to avoid a further drop in inflation.

In recent decades, the major mission of the Fed has been to manage the money supply to try to stabilize the economy. But when the Fed was founded - the private discussions at Jekyll Island in 1910 were followed by congressional passage of the Federal Reserve Act of 1913 and the creation of the Fed in 1914 - its main mission was to prevent bank panics that had intermittently ravaged the U.S. economy from 1873 to 1907.

In other words, the Fed was a lender of last resort to the banking system long before it was in charge of stabilizing the economy and inflation more generally. After all, when there was a gold standard, there was little ability to expand or contract the money supply.

Bernanke described the breakdown of several key financial markets during 2007 and 2008 - the short-term funding markets that investment banks used to finance their operations, for example - as a 21st-century version of those pre-1914 bank runs.

Those complex securities had "the same structure as a bank, except they didn't have the protections, the guarantees and the oversight that a bank has," Bernanke said. Referring to a series of unconventional Fed programs launched to pump money into various corners of the financial system, he added, "I really think of it as a classic lender-of-last-resort response, adapted for the complexity of the financial system."

To many Fed critics, a central failure over the past three decades has been the perceived willingness of the central bank to take action to prop up financial markets whenever they are faltering, a phenomenon known as the "Greenspan Put," which uses the term for an option that protects against an asset losing value.

The criticism is that by standing in to prevent precipitous declines in financial markets, the Fed made it appear that one could invest without risk - and that this led investors to be overly complacent about risk, which in turn fueled the panic of 2007 to 2009.

Given that his own policies have helped prop up stock prices in the past year, Bernanke echoed the phraseology of some of his critics and referred to the phenomenon, almost sheepishly, as the "Greenspan/Bernanke Put."

Greenspan was unrepentant.

"If in effect the Greenspan Put is the notion which says you're stabilizing the system, then I hope so - that's what we're here for," the former Fed chairman said. "I don't really have an understanding of why that has become a pejorative term. . . . If I understand it, what we're doing is what we should be doing."

Greenspan recalled when, early in his tenure as Fed chairman, the stock market collapsed on a single day in October 1987. The next morning, White House Chief of Staff Howard Baker called. He articulated a single word: "Help!"

During the same period, his colleague Corrigan had a slightly different message for the new Fed chairman: "Okay, buddy, it's all on your shoulders."


<       2

© 2010 The Washington Post Company