Jeremy Siegel, Ph.D. The Future for Investors

President Obama made the right choice last month in reappointing Ben Bernanke as chairman of the Federal Reserve. He could have waited until the fall, or even later, but his early reappointment emphatically proclaims that there was no one else in real contention for this critical post.

Larry Summers, the other economist often mentioned for the job, never specialized in monetary policy and serves the Obama administration best as an economic adviser. Bernanke, despite his flaws, is the best candidate for Fed chief.

Fortunately, the chairmanship of the Fed has once again risen above politics. Obama, a Democrat, keeps Bernanke, a Republican, just as Democrat Bill Clinton kept Republican Alan Greenspan. And Paul Volcker, the last Democrat to hold the Fed chairmanship, was reappointed by Ronald Reagan, a conservative Republican.

In his reappointment speech, Obama was right when he said that Bernanke will be remembered for his creative "outside-the-box thinking." Bernanke saw that stemming the crisis was not just a matter of lowering interest rates. Steps had to be taken to improve liquidity and reduce record-high risk premiums. Backing up bank deposits and especially money funds was a necessary first step, but he also implemented new lending facilities that sprung from his studies of the Great Depression. 

Economists know that the failure of the Federal Reserve in the 1930s to support the banks was a major cause of the economic collapse during that decade. Bernanke certainly did not predict the current crisis, but once it was upon us, the Fed chairman implemented the right policies to allow the economy to recover.

Failures During Bernanke's Tenure

Bernanke (like everyone else) is not without faults. The most glaring was his failure to see the financial crisis coming.  Here I blame Greenspan more than Bernanke.  Greenspan, lionized by many as the greatest central banker that ever lived, said nary a word about the housing bubble and the potential threat that subprime securities posed to the banking system. 

By the time Bernanke took the helm of the Fed in 2006, most of the damage had already been done. Certainly Bernanke was as clueless as Greenspan about the dangers looming ahead. But he quickly got in gear once the financial markets began to buckle under the weight of the subprime crisis.

Another disappointment during Bernanke's tenure was his failure to plan for the impact of the Lehman Brothers bankruptcy on the economy and financial markets. Six months before Lehman went under, the Treasury and the Fed bailed out Bear Stearns bondholders and merged the investment bank into JPMorgan Chase. But after the Fannie Mae and Freddie Mac bailouts, Treasury Secretary Henry Paulson didn't want to go down in history as the "bailout secretary," and he decided to let Lehman go. 

But the Fed should have known that if any money market fund owned Lehman paper, it would have to mark that paper to zero when Lehman declared bankruptcy. That would make it likely that the fund would "break the buck" and start a run on the $4 trillion money market fund industry, sparking a full-scale liquidity crisis. Indeed, after Lehman went under, the Reserve Primary Fund broke the dollar, and investors were thrown into a state of panic, fleeing private securities for the Treasury bond market.

During that week, it appeared that Bernanke acquiesced too easily to Paulson’s decisions, particularly the ill-conceived TARP plan for extracting toxic assets from troubled banks. The sight of Bernanke and Paulson floundering in front of Congress trying to explain how they would buy toxic assets was saddening. TARP whipped up anti-Wall Street sentiment in both Congress and the public and led other firms to seek government handouts.

It is ironic that almost a year after the TARP plan was first introduced, virtually no toxic asset has been extracted from the banks. Instead, the Fed put a "fence" around the troubled assets of Citigroup and Bank of America and provided these banks a non-recourse loan for 90% of their value. This policy accomplished the same objective as TARP and did not need Congressional approval. Had this policy been in place from the beginning, much of the Congressional fight about bailouts could have been avoided.

Better a Fixer Than a Forecaster

Given Bernanke's failures, it seems like a better man (or woman) could have been selected for Fed chair. Certainly there were those who predicted some form of financial or housing crisis, such as Nouriel Roubini, Gary Shilling, John Mauldin, and my good friend Bob Shiller. But being able to predict the crisis does not mean that you can prevent it or cure it.

If one looks at economic history, the major cause of the Great Depression was not that the Federal Reserve didn't forecast the stock market bubble or the price deflation that followed, but that it did nothing to stop the banking collapse.

It was a staggering failure of an institution that was particularly created to provide reserves in just such a crisis. The lessons of this failure are burned into the minds of those who study monetary history, and Bernanke was one of this period's best students. 

Bernanke said that he didn't want to preside over the second Great Depression. He has accomplished that and more. And for that reason he is the man of choice for reappointment to the country's most powerful economic and financial post.