Review: Fourth branch of government

Federal Reserve Chairman Ben Bernanke recently told an audience at the Brookings Institution that it is “very likely” the recession is over. Markets jumped, politicians began looking less grim and a certain feeling of calm began to spread — at least in Washington. Metastasizing and infecting nearly every corner of America’s economy since 2007, the treacherous hours of crisis have now given way to a feeling that the worst has passed. (Never mind that unemployment rates keep rising.)

Bernanke’s words matter. His actions, as the last year demonstrates, matter more. David Wessel’s In Fed We Trust is an engrossing tale of how Bernanke and a small band of officials at the heart of the government mobilized after missing the warning signs and did whatever it took to haul the country back from the brink of depression. Historians and economists will spend their careers analyzing every twist and turn of the past two years, but Wessel’s book is an essential and timely account that comes as memory — that tricky and contested battleground — begins to fade.

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At nearly every critical juncture, government officials — Bernanke and three others called themselves the “Four Musketeers” — drafted massive new programs, improvised as the markets collapsed and stretched the Fed’s authorities to prop up the economy. Bernanke is a student of the Great Depression, and once he recognized the gravity of the impending crisis, he moved to tackle problems at Bear Stearns, Fannie Mae, Freddie Mac, American International Group, the markets for commercial paper and money market funds — the list goes on.

The book also serves as something of a prologue to the debate now raging in Washington. Members of Congress, the Obama administration, federal regulators, lobbying groups and consumer watchdogs are all massing their forces to define the new rules of the financial game.

The debate has many contours and parochial interests, but a central question is the future of the Fed. In many respects, the near term benefits from a dose of clarity. President Barack Obama has chosen to reappoint Bernanke. Had the economy fared worse, Wessel speculates, the president might have chosen otherwise.

And Bernanke’s immediate task is to devise an exit strategy after committing trillions of dollars to keep the economy going while also curbing inflation.

The institutional and longer-term questions are much more uncertain. Obama has proposed that the Fed become a new grand overseer of risks across the financial system while the central bank would lose its consumer-protection responsibilities to a new agency.

Many in Congress — Democrats and Republicans — have grown highly critical of the Fed and challenge the notion that the central bank should gain power to look out for systemic risks. For some, the Fed simply has failed too many times on too many issues. Why didn’t it better regulate the housing market in the run-up to the crisis? Why didn’t Bernanke and former Treasury Secretary Henry Paulson go to Congress earlier to seek money to support the banking system instead of waiting until after the collapse of Lehman Brothers? Why were interest rates so low for so long?

For others, the Fed’s actions are simply part of a story line of a bigger, more activist government.

At root, the debate swirling in Washington is about accountability. For most of its history, the Fed has sought to avoid politics as it decides to raise or lower interest rates. But as Wessel — the chief economics correspondent at The Wall Street Journal — makes clear, at numerous turning points during the crisis the Fed was the only place to turn and the only institution with the capability to respond. The Fed effectively created a vast new set of tools without any political blessing. With those major efforts have come more frequent calls for new oversight of the Fed.

In one telling moment, after the bailout of AIG, Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, asked Bernanke how he had $80 billion to support the crippled insurance firm. “Well, we have $800 billion,” Bernanke replied. Frank and his colleagues were stunned. The Fed can create money, and it doesn’t need to appeal to congressional appropriators or even the president to do so.

While the Fed has long been called the fourth branch of government, as the book points out, the full power of the unelected bureaucrats at the central bank wasn’t clear until the crisis took hold.

Lawmakers are now shouting the familiar refrain: “Never again.” If only it were so simple. Crises recur and regulatory gaps have a way of yawning over time. Central to Congress’s task is preserving the flexibility of the Fed and the government writ large to respond to crises, while also answering the calls for greater accountability and oversight. Economics and finance, after all, often move much faster than politics.