Page last updated at 16:44 GMT, Thursday, 3 December 2009

The world's most powerful banker is humbled

By Kabir Chibber
Business reporter, BBC News

Federal Reserve chairman Ben Bernanke
Ben Bernanke was first appointed in 2005 by Mr Obama's predecessor

Ben Bernanke's confirmation hearings before the US Senate's banking committee will probably be unlike any seen in recent memory.

The Federal Reserve chairman was reappointed to a second term by President Barack Obama in August, after a tumultuous four years as head of the world's most important central bank.

But, this time, the confirmation process - normally a formality for Mr Bernanke's feted predecessors, such as Alan Greenspan - is tinged with anxiety.

One senator has vowed to block his confirmation, while the chairman has come under attack from politicians on both sides of the aisle. The criticism has been virulent.

What has gone wrong for the world's most powerful banker?

'Profound disgust'

Mr Bernanke was appointed by former President George W Bush in 2006, tasked with following the 18-year reign of Mr Greenspan, whom Gordon Brown that year introduced in London as "the man acknowledged to be the world's greatest economic leader of our generation".

It's going to be quite a spectacle in the Senate
Carl Weinberg, economist

(Both Mr Brown and Mr Greenspan's reputations for economic skill have taken a bit of a battering in the intervening years, but that is another story.)

Despite his Republican credentials, few were surprised when Mr Obama reappointed him, saying that "Ben approached a financial system on the verge of collapse with calm and wisdom, with bold action and outside-the-box thinking that has helped put the brakes on our economic free-fall".

But many have criticised the Fed's response to the financial crisis, the worst since the Great Depression.

Incidentally, Mr Bernanke has written extensively about the underlying causes of the Great Depression as a professor at Princeton.

"Nobody likes the Fed during a crisis," says Carl Weinberg, chief economist at High Frequency Economics.

Senator Bernard Sanders said this week that he would hold up Mr Bernanke's nomination.

"In this country, there is profound disgust at what happened on Wall Street," Mr Sanders told the New York Times. "People want a new direction and people are asking, where was the Fed?"

In practice, this means that the Fed chairman will need the backing of 60 senators to be approved, rather than the usual simple majority of 51.

The criticism from both Democrats and Republicans has been unprecedented for the head of the central bank.

The head of the Senate's banking committee, Christopher Dodd, has previously said he has had "serious differences" with the Fed.

He has proposed stripping the Fed of all his regulatory powers and handing it over to a new authority.

A group called the Progressive Change Campaign Committee has reportedly been spreading an anti-Bernanke petition around well-known economics blogs.

Congress re-election

This is partly down to the fact that many members of Congress are up for re-election in November, according to Mr Weinberg.

"Main Street is very angry at the way the financial crisis has shaken down to them," he says. "It seems that, to people on Main Street, all the attention has gone to the banks and the Wall Streeters."

Mr Obama reappointed Ben Bernanke in August

In the House of Representatives, libertarian Republican Ron Paul has proposed legislation allowing Congress to "audit" the actions of the Fed - including its interest rate decisions.

The House Financial Services Committee surprised many by adding Mr Paul's amendment to the financial overhaul legislation currently being debated.

And Mr Sanders has proposed a similar bill in the Senate.

Mr Bernanke attacked those proposals, writing an editorial for the Washington Post to push for a strong and independent central bank that supervises banks.

Other senators, even those that support Mr Bernanke, have promised an aggressive line of questioning at his hearings.

"It's going to be quite a spectacle in the Senate," Mr Weinberg says.

Too late?

Much of the criticism surrounds the Fed's failure to prevent the crisis.

Mr Bernanke's opponents say he allowed the sub-prime-fuelled housing bubble - started on Mr Greenspan's watch - to build up and then watched while the property market collapsed.

As fear spread and the credit markets froze in 2007, causing the collapse of two of Bear Stearns' hedge funds in July, Fed officials continued to say throughout the summer that it would have no effect on the broader markets.

As the panic started to grow, the Fed began to realise the impact that US homeowners defaulting on their loans was having on banks, and made its first interest-rate cut in four years.

From then on, it seemed that Mr Bernanke was behind the curve.

As stock markets continued to fall and banks stopped lending to each other, the Fed resorted to shock tactics.

It made a surprise unscheduled rate reduction in January 2008 - its first emergency cut since September 2001, as well as its largest since 1982 - in an attempt to get banks lending and restore confidence.

But the reaction was muted, and it appeared the gamble failed. To many, the emperor had no clothes.

The Fed did not appear to understand the extent to which banks had borrowed to invest in risky or toxic derivatives, or how great the loss of confidence in the banking system was.

Draw a line

Most are still angry about Mr Bernanke's inconsistent handling of the US investment banks' domino-style collapse in 2008.

Bear Stearns ended its 85 years as an independent firm in May, selling itself to JP Morgan Chase.

But it was in September that year that the tidal wave began in earnest.

Merrill Lynch and Lehman Brothers were teetering on collapse, and the Fed spent a tense weekend co-ordinating the sale of the former to Bank of America.

But when a deal could not be agreed for Lehman Brothers, the Fed decided to draw a line and let it go.

The collapse of Lehman, the largest bankruptcy in US history, set off shockwaves.

Days later, the Fed was forced to abandon this and bail out the insurer AIG. It is now 80% state-owned, having received a total of $182.5bn of government funding.

The Fed, along with the US Treasury, organised the $700bn bank bail-out plan in October 2008, cut rates to almost zero and has since spent an additional $3tn propping up the credit markets through various emergency lending measures.

The central bank began purchasing mortgage-backed securities, doubling the size of the Fed's balance sheet to more than $2tn in less than a year.

'Major part'

Mr Bernanke's seeming failure to understand the systemic risks to the banking system, or to regulate the complex financial products that almost caused its collapse, still irks politicians.

But so far, he has been unapologetic about his performance.

"The Fed played a major part in arresting the crisis, and we should be seeking to preserve, not degrade, the institution's ability to foster financial stability and to promote economic recovery without inflation," he wrote in his Post editorial.

"The Federal Reserve, like other regulators around the world, did not do all that it could have to constrain excessive risk-taking in the financial sector in the period leading up to the crisis," he added.

"The government's actions to avoid financial collapse last fall - as distasteful and unfair as some undoubtedly were - were unfortunately necessary to prevent a global economic catastrophe that could have rivalled the Great Depression in length and severity."

As of now, there is no risk that Mr Bernanke will be kicked out of his job. There are enough votes from both parties to re-confirm him.

But these are humbling times for the Fed, an institution not normally used to defending itself in public.

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