WASHINGTON — Ben Bernanke, a respected Princeton professor before heading off to Washington, is finding that the nation’s financial markets can be tough graders. But he is also demonstrating that he can be a quick learner.
Going into Tuesday’s meeting, Bernanke was definitely failing to make the grade in the eyes of many on Wall Street. In contrast to Alan Greenspan, who gained rock star status during his nearly two decades at the Fed, Bernanke was seen as too cautious, especially at a time of crisis like the current turbulence in financial markets.
But then with one stroke, Bernanke turned the jeers into cheers. He got unanimous agreement among his colleagues to cut the federal funds rate for the first time in four years and not by the quarter-point that had been expected but by a much bolder half-point.
The bigger rate cut sent stocks soaring with the Dow Jones industrial average soaring by 336.05 points, its biggest one-day point gain in nearly five years.
In the eyes of investors, Bernanke had suddenly gone from a failing grade to doing OK in the handling of his first major test since taking over the top Fed job in February 2006.
Bernanke, whose specialty as an economics professor was monetary policy, demonstrated that he has learned one key thing from watching Greenspan. If you find your policy is wrong, don’t stay wrong too long.
During his long tenure at the Fed, Greenspan on more than one occasion was called upon to suddenly reverse course because of changing economic data. The fact that Greenspan was able to guide the country through its longest economic expansion in history and only endured two mild recessions during two decades was proof of the success of his nimble footwork.
Since the last Fed meeting, Bernanke has shown his own touches of dexterity.
At the Aug. 7 meeting, the Fed generated groans among investors when it seemed to dismiss the emerging problems in credit markets and the deepening housing slump by saying that the risks to growth had only been “increased somewhat.”
In the days immediately following that meeting, financial market instability increased significantly with the announcement by BNP Paribas, France’s largest bank, that it was suspending withdrawals from three investment funds, raising worries about just how far-reaching the fallout would be from rising defaults on subprime mortgages in the United States.
Responding to plunging markets, the Fed first pledged to supply as much money to the banking system as needed to make sure all institutions could meet their obligations. Then the next week on Aug. 17, it cut the discount rate, the interest the Fed charges for direct loans to banks, by a half-point and encouraged banks to use the window as much as necessary to meet their obligations.
However, it left the federal funds rate unchanged at 5.25 percent, where it has been since June 2006. The funds rate is the biggest policy tool the Fed has to influence the economy because it translates immediately into rate changes for millions of consumer and business loans.
Some believed Bernanke was hesitating to use the funds rate because he did not want to be seen as bailing out investors such as hedge funds that made bad bets in such areas as mortgage-backed securities.
For that reason, many believed Bernanke would exhibit the caution he has shown in his 19 months as Fed chairman at Tuesday’s meeting by only cutting the funds rate by a quarter-point. The surprising half-point move was seen by some as evidence that the Fed is more worried about a possible recession, especially after the August employment report showed the economy lost jobs for the first time in four years.
There was certainly growing political pressure on the Fed to act, coming publicly from such Democrats as House Financial Services Committee Chairman Barney Frank.
While the Bush administration has maintained its customary line that it won’t comment on Fed monetary policy because of the Fed’s independence, there is little doubt that Republicans hoping to hold onto the White House did not relish the possibility that the country could be in a recession at this time next year when voters are getting ready to select their next president.
But the major factor governing Bernanke’s decision to opt for the half-point move could very well have been that he wanted to challenge the prevailing view on Wall Street that he was not able to respond with sufficient boldness when the situation called for it.