Columns

Ben Bernanke has a lot in common with the next president. The pinnacle of his career will mostly involve cleaning up someone else’s mess. When he took over as chairman of the Federal Reserve Bank in 2006, Bernanke stepped into a quagmire so deep and wide that he sometimes has that stunned, wide-eyed look of a drowning man.  

Meanwhile his predecessor, Alan Greenspan, is telling anyone who will listen that it’s not his fault that the economy might slide into a crippling recession and that the nation’s financial system is teetering on the edge of systemic failure. Greenspan is worried about his place in history and the yet-to-be-written books that will trash his record as America’s economic steward.  

Even Paul Volcker, the stern and widely revered Fed chairman who preceded Greenspan and wrestled inflation to a standstill in the 1980s, has lately been wagging his finger at Bernanke for orchestrating the rescue of Bear Stearns and at Greenspan for his Wall Street boosterism that helped to get us in this mess. Recently, Volcker told the Economic Club of New York that our “bright new financial system” had failed the test of the marketplace.  

It was lost on no one that Greenspan had played midwife to the birth of that new system and for years had defended it against criticism and calls for regulation by many in Congress. That of course made Greenspan a hero on Wall Street, and so long as the good times kept rolling he was feted by the media as a financial god. Well, the good times have stopped rolling.  

“We have moved from a commercial bank-centered, highly regulated financial system, to an enormously more complicated and highly engineered system,” Volcker told his audience. Much of today’s financial activities “takes place in markets beyond effective official oversight and supervision, all enveloped in unknown trillions of derivative instruments,” he added. “The sheer complexity, opaqueness and systemic risks embedded in the new markets—complexities and risks little understood by even most of those with management responsibilities—have enormously complicated both official and private responses to this the mother of all crises.”  

Well, that sure doesn’t sound good. How bad are things? If you listened to Bernanke’s testimony before the Senate Banking, Housing and Urban Affairs Committee, you heard him say, “Clearly, the U.S. economy is going through a very difficult period. But among the great strengths of our economy is its ability to adapt and respond to diverse challenges. Much necessary economic and financial adjustments have already taken place, and monetary and fiscal policies are in train that should support a return to growth in the second half of this year and next year.”  

But minutes of the Fed March 18 policy meeting were recently released, and they paint a decidedly darker picture. Some of the policy committee members were predicting a continuation of the drop in housing prices and possibly “a prolonged and severe economic downturn.” In March alone the U.S. economy lost 80,000 jobs, the biggest drop in five years, and the losses are spreading beyond the housing and finance sectors to a wide cross-section of industries. In all likelihood, we are already in a recession. What isn’t known is how long it will last and how deep will it cut.  

The frustration and fearfulness of the Fed rate cutters is nearly palpable. Usually they speak in nearly indecipherable jargon about economic growth, inflation, and what they’re planning on doing with the short-term rates they use to control the flow of money into the economy. Now the Fed is warning that there’s only so much a central bank can do: “Monetary policy alone could not address fully the underlying problems in the housing market and in financial markets.” That is the Fed’s way of introducing the new guiding principle of our economy: Have high hopes, but low expectations. Last week the International Monetary Fund added to those low expectations when it announced that the global banking and financial system would suffer losses of about $1 trillion due to the mortgage crisis and that “systemic risks have risen sharply.”  

In other words, the possibility of a worldwide financial meltdown has increased and despite the current calm we are still deep in the woods. If the IMF estimate is even close to correct, this will make our current problems the most expensive financial crisis in history, according to the Financial Times. The IMF puts the chances of our borrowing binge ending in a worldwide recession at one in four. Some economists are arguing that the losses will be a minimum of $1 trillion and are likely to exceed that if there are unforeseen shocks to the system: Say, for example, a major international bank collapses or the U.S. military attacks Iran or one of the world’s current riots over escalating food prices seriously destabilizes an important country such as Egypt. If you think gasoline is expensive now, you don’t want to think about what $150 a barrel oil will do to the world.  

But even if we leave aside those dire possibilities, there are many current realities that suggest we may soon find ourselves caught up in a rough cycle of financial crises followed by deeper economic downturns. You’ve heard of that fabled “soft landing” of our falling economy? Well, there are a lot of reasons we could lose altitude in a hurry. Consider these sobering facts: Oil now costs $117 a barrel and commodity prices across the board are hitting new highs. Meanwhile, the dollar continues its steady downward retreat. The severe credit crunch in mortgages is now spreading to other segments of the consumer credit market, for example, credit cards and car loans. Without government intervention, nearly two million homes will face foreclosure over the next two years. Most option ARM loans—those adjustable rate mortgages that have low teaser rates and let you pay less than you owe—have not yet adjusted upward. When those loans adjust up to the new higher rates and the lenders demand full payment each month, the other shoe in the mortgage crisis will begin to fall. 

Remember, our high household debt ratio—136 percent of income—means tens of thousands of households are barely able to shoulder the monthly payments even when rates are low. The U.S. economy has lost at least 230,000 jobs since the start of this year. Meanwhile the number of people who stopped looking for jobs because they didn’t think there were any out there rose to 401,000 in March. Consumer spending, the engine of our boomtime growth, is dropping fast.  

It’s enough to keep you awake at night. Unless you’re Alan Greenspan. Mr. Greenspan—who in fairness is not responsible for everything that has gone wrong, just a whole lot of it—recently told the Wall Street Journal that he doesn’t regret a single decision he made while he was chairman of the Fed. Let’s hope that Ben Bernanke isn’t quite so sure of himself.