Federal Reserve Chairman Ben Bernanke sat down on Dec. 8, 2009 with TIME managing editor Richard Stengel, Time Inc. editor-in-chief John Huey, TIME assistant managing editor Michael Duffy, and TIME senior correspondent Michael Grunwald for a conversation on everything from the state of the economy to the contents of his wallet. Here is an extended, edited transcript of the interview.
TIME: Explain for general-interest readers what it is that you do, and what it is that you've done during the past year that has impinged on their lives, for better, or for worse.
Bernanke: Well, I came to this job as an academic. I was a professor at Princeton University. And, in that capacity, I studied for many years the role of financial crisis in the economy. In fact, I became an expert on the Great Depression of the 1930s. It was a period in which the stock market crashed, and it collapsed the banking system. It was one of the main reasons that the economy was in such deep depression for more than a decade.
In 2002, I came to Washington to join the Federal Reserve as a member of the Board of Governors of the Federal Reserve. The Federal Reserve is the Central Bank of the U.S. It's an agency of the United States government, and it has a number of functions.
One important function is to set monetary policy, which means to change values of the short-term interest rate, to try to steer the economy to full employment and low inflation, to try and use that tool to keep the economy as stable as possible. But the Federal Reserve has some additional very important responsibilities. And one of the most important is trying to preserve stable transformance.
In fact, the Federal Reserve was created in 1913 in response to a severe financial crisis in 1907, with the objective of having an institution that could be a first responder to try to address situations where financial markets were in great disruption, great disarray before the effects on the economy were too great.
Importantly, in the 1930s, in the Great Depression, the Federal Reserve, despite its mandate, was quite passive and, as a result, financial crisis became very severe, lasted essentially from 1929 to 1933. And the effects on the economy we know. So, again, I came to Washington. I initially joined the Board of Governors, which is the group of seven leaders of the Federal Reserve who are appointed by the President, confirmed by the Senate.
I did that job for about three years. I then spent nearly a year in the White House advising the President on economic policy. And then in 2005, he appointed me to succeed Alan Greenspan as the chairman of the Federal Reserve. So, as the chairman of the Federal Reserve I am, essentially, the leader of this institution, and also of the committee that makes monetary policy, such as short-term interest rates, to address unemployment and inflation.
About a little more than two years ago, in the late summer of 2007, the financial sector of the U.S., and much of the world went into a period of significant stress. It was tied to excessive risk taking in much of the private sector. For example, many banks and mortgage brokers made sub-prime loans, which turned out to be bad loans, and those losses affected the banks and their perceived solvency from the perspective of the public and investors. But there were many other investments, also, that were made that were excessively risky, were dangerous, and brought losses to the financial system.
The stress on the financial system was in the fall of 2007, was significant, but not so significant as to threaten the overall stability of the U.S. economy, although it did lead to the beginning of a recession at the end of 2007.
[In response], I took a large number of steps, including cutting the short-term interest [rate], which is making monetary [policy] more supportive of the economy. By cutting short-term interest rates, we provided support for the economy to try and improve economic conditions, try and create jobs, and try to overcome the effects of the crisis. But, unfortunately, things heated up considerably in the fall of 2008.
In September 2008, the two largest housing mortgage companies called Fannie Mae and Freddie Mac, which were government-sponsored enterprises, which hold hundreds of billions of dollars of mortgages, because of the losses they took on the mortgages, they essentially became insolvent, and the government had to take them over.
Following that, there was increasing distress in the financial sector as investors became more and more concerned about the stability of many of the largest financial institutions in the U.S. and Europe. And this broke into a full-blown depression era style financial crisis in September, when Lehman Brothers, a large investment bank, failed and created an enormous wave of fear and uncertainty throughout the financial markets.
At that point, virtually every large financial firm in the world was in significant danger of going bankrupt because of the money being withdrawn quickly from those firms. And we knew, and I knew based on my experience as a scholar, based on my experience as a policy maker I knew that if the financial system, the global financial system, were to collapse in the sense that many of the largest firms were to fail, and the financial sector essentially stopped functioning, that the implications of that for the global economy would be catastrophic, that it we would be facing, potentially, another depression of the severity and length of the depression in the 1930s. And this was not at all hypothetical. And only one firm failed; that was Lehman Brothers.
Shortly after the failure of Lehman Brothers, I was in Brazil at an international meeting, and I had a meeting there with bankers, and I asked them how the Brazilian economy was doing. And they said well, it had been doing fine, but within a week after Lehman Brothers collapsed, it was like a frigid wind descended on the economy in Brazil. And there was an enormous impact almost immediately on their economy, on their ability to raise funds and make loans. And it's astonishing how quickly that one failure spread throughout the world, and created a very severe recession, not just in the U.S., but around the world.
So, we knew that if this crisis was allowed to expand, and to bring down not just one major institution, but 10, or 15, or 20, which seemed very likely at the time, that the consequences for every single person in the world, for every American, would have been extraordinarily dangerous and adverse. It would have had very, very bad consequences for the entire economy.
So, the Federal Reserve, along with the Treasury, moved aggressively to try to stop the crisis. We took a number of measures. The most controversial, and most unpleasant, and distasteful measure that we took was to prevent the failure of the insurance company, AIG. A small portion of that company had been engaged in risky financial bets, which had not been regulated, which had not been monitored appropriately. And because of those risky financial bets, the company was in immediate danger of failing within in hours. And, in doing so, it would have exacerbated the crisis, and probably brought many other institutions to the ground.
The Federal Reserve, by making a large loan under very tough terms to AIG, prevented the failure of that institution, and, therefore, tried to contain the impact of the Lehman Brothers failure on the rest of the global financial system. I'll come back and talk more about AIG, and those things later, but that was just the first step of many that we took to try to stop the crisis.
Subsequently, again, very concerned with the possibility of a global financial meltdown, we worked with Treasury and the Congress to develop a bill that would provide funding that the Fed, the Treasury and other agencies could use to stabilize the financial system, to prevent collapse of the financial system.
This immediately became relevant, because in mid-October, the crisis heated up again to the point that we thought that we were again within days or hours of a collapse of many of the largest financial firms in the world. It was a dramatic weekend. It was Oct. 10 or 11, Columbus Day weekend, when the Finance Ministers and the central bankers of seven of the largest industrial economies had a meeting here in Washington, which, of course, I attended. Usually, those meetings are very scripted and very dry. In this case, there was palpable concern among the participants that the collapse of their financial system might be just days away, and there was a great deal of discussion about how we, collectively, as the policy makers leading those countries could stop the collapse.
In the days that followed, countries all over the world, particularly the advanced industrial countries, took strong measures to prevent the collapse of the financial systems. That included putting capital into banks; it included preventing the failure of large financial firms; it included guaranteeing the debts of financial firms so they could borrow and keep themselves afloat; it included making short-term loans to firms so that they would have the short-term credit they needed to pay off lenders who were withdrawing their funding. And, again, this was the U.S. doing this, but also many of the most important industrial countries around the world simultaneously, including the U.K., Germany, France, Switzerland and others.
The result of this collective global effort over that week was essentially to succeed in stabilizing the global banking system, in that subsequent to that week the fears of utter collapse were largely overcome.
Now, in the following months after that, there were still many, many great difficulties in the financial markets. And the Fed, and other central banks and Treasuries around the world, worked very hard to restore the normal functioning of those markets. For example, following the Lehman failure, there was a run where ordinary investors went as quick as they could to pull their money out of money market mutual funds, which are a common investment vehicle for many Americans. It was very analogous to 100 years ago when a bank was about to fail, and the depositors would go to the bank, they would run and pull their money out as quickly as possible, and then the bank would fail. The money market mutual funds were experiencing exactly the same phenomenon.
The Fed and the Treasury working together provided short-term loans to these funds. The Treasury provided some insurance to depositors, or to investors so they would know they wouldn't lose their money. We stopped the run on the money market mutual funds, and that was an example of how we helped stabilize the situation.
There were many other steps we had to take helping individual institutions, and providing programs for backstop lending to make sure that the key markets in the financial system were functioning again, because for months after Lehman Brothers, the amount of fear and uncertainty in the financial markets was so elevated that these markets were, essentially, not functioning properly, and it took really many months until we had reached the point that these markets had begun to approach a normal state.
Currently, we are in much better shape than we were in the fall of 2008. Most of the financial markets are functioning more or less normally. The stock market has recovered significantly from its lows in March 2009. The corporations are able to borrow through bond issues, for example, or by raising new stock, by selling new stock on the stock market. The banking system has been stabilized, and we no longer fear the collapse of large banks.
But bank lending is still weak. The banks had a near-death experience, they are now lending in a difficult economic environment. We are strongly encouraging them to lend. We have taken a lot of steps to help them raise new capital, so they'll have a basis on which to make new loans. And we are taking a number of steps to try to open up markets through which investors invest directly in various forms of credit, like auto loans and credit card loans. All of these steps are improving the financial situation, but particularly the banking sector, we're still in the convalescent stage.
I think it's important for me to go back to make a couple of general observations about this whole episode. The first is that, again, going back to my own background. I was raised in a small town in South Carolina. My father and his brother ran the town drugstore. This town was a very still remains very economically challenged. It has a high unemployment rate, and my former home where I was raised was recently foreclosed upon. I have a good sense of the difficulties that Americans are facing in this current environment.
As I said, I was a professor. I never worked for Wall Street. I have no connections on Wall Street. In fact, when I first became chairman, I was criticized in some quarters for not being close enough, or knowing enough about Wall Street. So, why did I take these actions?
I didn't take these actions, or the Federal Reserve didn't take these actions because we were trying to help bankers, or trying to help Wall Street. What I understood, and what knowledgeable people all around the world understood, is that the financial system is essential to the functioning of any economy. And that if the financial system had collapsed to the extent to which we believed was very likely in September and October 2008, then no force on earth, no policy, could have prevented the collapse of the entire U.S. economy with long-lasting and extreme consequences for every American. It was because we were concerned about jobs and incomes and the economic well-being of every American that we intervened to prevent the collapse of the financial system.
Now, going forward, we have a lot to do to get the economy back to stability, get jobs created. You can talk as much as you like about the things we're doing there, but we're also going to have to take some very strong steps to make sure that the crisis doesn't ever happen again.
There were, certainly, weaknesses in our financial regulatory system. There were weaknesses in the way that financial regulators supervised the banks and other financial institutions. And the financial institutions themselves made lots of mistakes in terms of their ability to measure the risks that they were taking, and to control them properly. And to make sure we don't ever have a crisis like this again, we need to have extensive reform in the private sector, in the public sector, to eliminate these risks in the future.
You had said that the banks were convalescent still, Mr. Chairman. Can you talk to us a little bit more about what that means?
Well, the banks have been stabilized. They've raised a good deal of capital, so they're in much better shape than they were. They are lending, but they are not lending enough to support a healthy recovery. One important reason for that, is that given their losses, given what they've been through, they're being very conservative in the face of what is still a very weak economy; and, therefore, a sense that many borrowers are quite risky.
As bank supervisors, we have a difficult challenge. We have told the banks very clearly that we want them to make loans to credit-worthy borrowers, where there are borrowers who can repay the loans. It's in the interest of the banks, it's in the interest of the economy, and, of course, it's in the interest of the borrowers for those loans to get made.
But the problem is, of course, that we got into trouble in the first place by banks making loans that couldn't be repaid, so we don't want banks to make bad loans. Therefore, we are trying to work with banks to make sure that they are, in fact, able to make as many good loans as possible, that they have enough capital, that they have enough short-term funding, and that the examiners and the regulators who work with the banks are not unduly restricting the loans that they make. We want to work with the banks to make sure that they balance the appropriate prudence and caution against the need to make good loans for the economy, and for their own profits.
That was an incredibly comprehensive answer.
That was an open-ended question.
I offered to stop. (Laughter.)
No, it was comprehensive, and it was succinct considering the scale of it. I'm gripped by this meeting in October with the ministers of the industrialized nations. And it makes me want to ask, here you are in this job where you're under tremendous domestic political pressure all the time, this week being a pretty good example. But in your real job, when you're really trying to do what you outlined as your goal, can you explain to us where the role of the U.S. really fits into the rest of the world in this particular crisis, and going forward? And how much of your job involves dealing with the rest of the world, and their ministers? And when you talk about regulating the environment better, and getting better controls, how much of that is possible in a globalized economy? In other words, how much of what you can do, and we can do, can be effective in that arena?
Well, the U.S., of course, is the world's largest economy. It's about a quarter of the world's output. It's also home to many of the largest financial institutions and financial markets. With that being said, as you pointed out, we're only part of a global system. You know, economically, we are interdependent with our trading partners in Europe and Asia, for example, and many other countries in Europe, continental Europe, U.K., others, Japan also have large financial institutions. And we have, as you know, a globalized financial system, where transactions can speed around the world at the speed of light. And financial markets and institutions are integrated across borders in a very intimate way.
So, what this means is that economic policy, and financial oversight have to take into account all the international dimensions of that. So, for example, on the monetary policy side, we have worked carefully and closely with other central banks to talk about monetary policy in different parts of the world. In fact, during the heat of the crisis in October 2008, the Federal Reserve and five other major central banks cut interest rates together on the same day, as a sign of how committed we were to cooperating on monetary policy.
It's much more regular and consistent for us to cooperate on financial oversight, because of the fact that our financial markets are so global. And the financial institutions are multinationals with subsidiaries in many, many different countries. So, we work closely with other countries in overseeing these firms.
Typically, a bank which has its headquarters in the U.S. will be the primary overseer will be a U.S. regulator, but we will also coordinate, cooperate, with the regulators in the countries where that bank or financial institution operates. So, we coordinate very closely in that respect. And we also coordinate in terms of regulatory policy.
There are a number of institutions globally where the Federal Reserve typically leads the U.S. effort to work with financial regulators from other countries, and we try to, to the extent possible, establish international standards for how the amount of capital a bank should hold, for example, or how much.
So, except for the issues of self-interest, you're saying there is some consensus in this.
There is consensus. Indeed, there's quite a bit of cooperation and working together, both at the level of central banks, which work together very closely, and finance ministries. And, recently, we've seen cooperation even to the level of Presidents and Prime Ministers, you know, in the G20 meetings that we've had.
So, on a personal level, to what extent do you go that October meeting saying, they're all looking at me. And you're the man.
Well, Secretary Paulson and I represented the U.S. in that meeting. And we certainly wanted to provide some leadership, but we had representatives of seven major industrial countries there the U.S., Canada, Japan, U.K., France, Italy, Germany. I think that's it.
Is there much finger-pointing in a session like this, you caused it, you fix it?
Our main concern was, what are we going to do together collectively to prevent this global financial meltdown? We understood that, given the international nature of the crisis, and the way money flows across borders so quickly, and the fact that the institutions and the markets themselves were transnational, that only a strong cooperative effort would restore the confidence in the financial markets, and stabilize the situation. And, indeed, while it wasn't we didn't literally move at exactly the same time, and in exactly the same way but there was a remarkable amount of coordination between the U.S. and other major industrial countries.
The system worked.
It did work. It was an important first step. I mean, even after we took those steps, the financial markets were in a great deal of stress, and credit at all levels was very much constrained. But it stabilized the situation, and from there, we were able to take a number of steps to both we, and our partners in other countries to get the key markets working again, to get the banks stabilized, and to begin the very difficult process of getting the financial system back on its feet.
What would if you had to look in your sort of negative crystal ball, if you hadn't taken those steps, if everybody had been more timid, if there hadn't been cooperation at the end of the year, and the beginning of this year what would the world economy, and the U.S. economy look like in a specific way? I mean, how much unemployment would there be? How much foreclosure? Sketch that kind of dystopia.
Well, it's very hard for us to know precisely, but we know that in the 1930s, the U.S. went from an unemployment rate in 1929 of about 3% to an unemployment rate in 1933 of 25% of the labor force. There was a decline in GDP in the 1930s, close to a third of GDP, maybe four or five times greater than what we've seen in this recession in the U.S. The stock market fell to 10 or 15% of its initial value, about a third of all the banks in the U.S. failed, and many other countries had even worse depressions. Some had worse depressions than the U.S., Germany being an example, which is why we saw the rise of Hitler in 1933.
So, while it's difficult to know exactly what the outcome would have been, certainly, just judging on what happened after the failure of a single firm, the collapse of the global financial system would surely have led to a far deeper recession, higher unemployment, much greater fiscal cost to the taxpayer, and to rebuild the financial system, and to get the economy moving again. And almost certainly, [we would have had] many, many years of subnormal substandard performance by the U.S. economy, and by other industrial economies, as well. Again, we can't know precisely, but I think if anything, the financial crisis last fall was as severe, and as dangerous as anything we've ever seen, including the 1930s.
There is an irony here that's literary, that here's this man who spends his life distinguishing himself studying economic history. And then one day you wake up and realize that you're at the center of economic history in this really unusual chapter. How do you process that personally? I mean, how does that change how you go from being the academic expert to you're in the arena?
Well, I certainly didn't anticipate when I came to Washington in 2002, I certainly didn't anticipate these events, or how things would evolve. No question about it. And when I became chairman in 2006, I thought that I hoped that my main objectives would be improving the management, communication and monitoring policy.
We were certainly attentive to the risks of financial crisis. Secretary Paulson and I talk frequently to people on Wall Street, and we secured the Federal Reserve. We set up a team of staff drawn from different disciplines to try to identify problems and weaknesses in the financial sector. So, we were certainly aware of the risks of financial crisis, but one as large and as dangerous as this one, I certainly did not anticipate. I wish I had, but I didn't.
Then when the crisis came, you know, rather unexpectedly, a different part of my training and research became relevant, which was to work on financial crises generally, and also on the Great Depression. And I believe very much that that experience, and that knowledge, was very helpful to me in many dimensions of this effort, ranging from I think the most important lesson, there are many lessons, but I think the most important lesson was that we were not going to have a healthy stable economy with a completely dysfunctional financial system. We had to take strong measures to prevent that from happening.
And in the 1930s, the Federal Reserve was quite passive, and allowed the banks to fail, and we know the result of that. So, we were determined that that wasn't going to happen on my watch, on our watch, so we were prepared to take very strong actions to avoid that.
You've been quite forthcoming, I think, in your testimony about saying, there's a lot of things you didn't see, there's some things that we didn't do. If I gave you a kind of do-over to go back as long as you want to say you know what, if we'd seen this, if we'd looked at the sub-prime mortgage crisis. I mean, how could you have handled it, and the Fed handled it better to have a different outcome?
Well, we have, based on the experience of the crisis, we the Treasury and others have made proposals for how the financial regulatory system ought to be reformed and restructured. I'll say a word about that. If we had been in that forum, I think we would have avoided the crisis. So, there were some important lessons.
One was that our regulatory system was too myopic. It was too focused on individual firms, or individual markets, and there was nobody paying attention to the broad overall financial system. So, the Federal Reserve was not entrusted with looking at the whole financial system. We were we had very specific assignments. We were supposed to look at specific institutions. Those institutions did not include many of the firms that had severe problems, like Lehman Brothers or Bear Stearns or AIG. Those were outside of our purview, and since they were outside of our purview, we didn't look at them.
But there were many situations where there was really nobody who was looking carefully at what was going on, and nobody who was looking at how the parts of the system fit together. So, a very important recommendation that we have made is that there be a more systemic approach that is, have some arrangement whereby a regulator, or a group of regulators, has responsibility to look at the system as a whole, and try to identify emerging problems, or gaps in the regulatory apparatus, or weaknesses in individual institutions, as they relate to other institutions, that threaten the integrity of the system as a whole.
We didn't have that. Therefore, nobody paid enough attention to AIG, nobody paid enough to attention to credit and call swaps, nobody paid enough attention to some of the activities of investment banks. You go on, and on, and on. Again, if we had had a more comprehensive overview approach that would have been helpful.
A second key element is the problem too big to fail, and how to address that. So, I just want to be very, very clear that even though the Federal Reserve was involved in rescuing Bear Stearns and AIG, we did that extremely reluctantly, and with it was a very distasteful thing for us to do. We did not do it we were not set up to do it. We were it was very difficult for us to do, but we did it because there was no appropriate mechanism, there was no set of laws that would allow the government to intervene in a situation like that in a way that would allow the firm to fail, but would not have all the negative consequences for the financial system and the economy.
So, we had a situation where there were firms who were literally too big to fail, or too complex to fail, or too interconnected to fail. When they came to the edge of collapsing, we had only two very, very bad choices: we either bailed them out, put taxpayer money at risk, put the Federal Reserve at risk in terms of our lending, or we could let them collapse and have all the hugely negative consequences for the financial system and for the economy.
So, what we did not have, and what we very much need going forward, is a third option, and that option should be a legal framework which allows the government and I think that means, in practice, the Treasury and Federal Deposit Insurance Corporation to intervene when a large complex systemically critical firm is about to fail, and to allow the firm to fail, impose losses on the lenders, the creditors of the firm, the shareholders, fire the management, protect the taxpayer, but be able to do that in a way that protects the system, so that the financial system is protected from the immediate impact of that collapse.
We did not have a system like that in place. I think if we had, we could have dealt with Lehman Brothers and AIG in a much more satisfactory way. We would have avoided many of the problems. And, most importantly, we would have not, in some sense, rewarded failure, which is what happened. In the future, it's important that firms be allowed to fail if they, in fact, take excessive risks, and make bad gambles.
But that mechanism is not in place now.
The mechanism is not in place, and we have asked Congress to address it, and I believe that they will. But until they do, we are really still in a situation where we don't have good options in dealing with potential collapse of a global financial firm.
You had said one of the goals when you came to Washington was the management and communication of the monetary policy. This year you've stepped out a little more than the past Fed chairmen. Are you still convinced that being more communicative about the Fed and the things it does is the right approach?
Yes, I am. And we communicate on multiple levels. I mean, first, we provide a lot of detailed information to the Congress about our financial condition, our balance sheet, our financial transactions, our financial operations, our controls. We provide a great deal of information to the public and to the Congress about monetary policy. For example, we provided detailed minutes just three weeks after a meeting to describe the entire discussion and decisions we come to. All those things provide a lot of information, a lot of transparency, but they're mostly for specialists, people who are particularly interested in the Federal Reserve or monetary policy. And they don't, generally, reach the general public very much except through newspaper stories and the like.
And you're right that, in the past, Federal Reserve chairmen have not generally gone directly to the public. But I felt not only was it an issue of understanding what the Fed was doing, but I believed that a lot of the fear and uncertainty that was apparent in the surveys was the result of the fact that people didn't understand what was happening in our economy, or happening to our financial system. And I thought it would be helpful, as the chairman of the Federal Reserve, as much as possible to go out and talk directly to the public, try to explain what we were doing, why were doing it, what was happening in the economy, what was likely to happen in the future. So, I did that, you know, in the context of 60 Minutes, a PBS Town Hall, and also in speeches in places like Morehouse College and the National Press Club and so on. And just, in fact, a couple of days ago, Monday, yesterday I gave a speech called "Frequently Asked Questions," which was intended to address four sort of basic questions that the general public might be interested in.
So, I think that's important, and I think it may have helped some. It's true that the Federal Reserve faces a lot of political pressure, and is unpopular in many circles. The Federal Reserve's job is to do the right thing, to take the long-run interest of the economy to heart, and that sometimes means being unpopular, but we have to do the right thing.
I think an example I would give you would be in the early 1980s, when the U.S. was suffering from serious inflation, one of my predecessors, Paul Volcker, tightened monetary policy and raised interest rates [to roll] back inflation. The side effect of that action was to create a significant recession, about as bad as the one we're currently experiencing. And that was, of course, extraordinarily unpopular. And one of the things that happened was that people were sending into the Federal Reserve two-by-fours. I'm going to show it to you. Here's an example passed down to me, two-by-fours on which were written some things that weren't so printable, some that were more printable.
I hope that's a printable one.
Yes, this is a printable one. Asking the Federal Reserve to lower interest rates.
Well, save the housing industry. I see.
Save the housing industry. Yes.
I do remember my first home I bought, where the VA loan was 15 1/2%.
It was probably in the '80s.
Yes, well, late '70s, 15-1/2%, so times were different.
That's right. So, there was a very difficult period...
Houses were cheap.
A lot of grief, a lot of unpopularity, but those decisions were the right ones, and breaking the back of inflation was the basis for 20-plus years of growth and prosperity.
Has no one mailed you anything?
No one has mailed me anything, so far, but I don't want to invite that. (Laughter.)
Right now people are sort of looking to you, and to Congress, to kind of break the back of unemployment. And you've talked about how that is really our biggest challenge right now. Do you feel there is anything else that can be done, or has the Fed shot all its bullets, and has Congress shot all its bullets?
Well, the Federal Reserve has been very aggressive on the unemployment side. So, let me just first say that even though the recession may be technically over., in a sense that the economy is growing, it's going to feel like a recession for some time, because unemployment remains very high, about 10%. And even people who have jobs, there are many people who are on short hours, that are in voluntary part-time, or maybe people who are not technically unemployed, only because they stopped looking. So, the labor market is in very weak condition, and we're not going to see a healthy, vibrant economy again until the labor market the job market has recovered. So, that is really an extraordinarily important objective for policy going forward. And, certainly, our job won't be done until the economy is growing again, and jobs are being created.
The Federal Reserve's attempts to address employment issues, we've done several things. Certainly, one of the things is we're using our monetary policy. In December 2008, while the crisis was still in an intense phase, we cut the short-term interest rate that is the measure of our monetary policy almost to zero. The first time that had ever been the case, the Fed had ever done that, in order to provide the maximum amount of support to the economy, and it remains close to zero today. So, that is a very powerful measure.
Having used that tool to its maximum extent, we have then turned to new and innovative tools, things that have never been done before in the Federal Reserve. I'll give you two examples. One, we've purchased about $1 trillion worth of mortgages that are guaranteed by Fannie Mae and Freddie Mac, and the U.S. Treasury. And in doing those purchases, we have succeeded in reducing the national 30-year fixed-rate mortgage rate from about 6-1/2% to about 4.8%. By lowering mortgage rates that way, we have helped to stabilize the housing sector, to help stabilize the housing crisis, and allow people to refinance, to buy homes. And that, obviously, should get construction started again and house prices stabilizing, and people being able to meet their mortgages. That's obviously going to be helpful.
We've also created a program that helps bring credit from Wall Street to support a wide variety of consumer and small-business loans. So, for example, our program allows Wall Street money to come in and support auto loans, credit card loans, student loans, small business loans, commercial real estate loans. By providing that conduit, we are supporting what the banks are doing to get credit flowing into those important sectors.
And I guess a third thing, an additional thing I would mention is that we serve not only as monetary policy makers, but also as bank supervisors. And there we've been sparing no effort, as I talked about earlier, to get the banks able and willing to lend again, to create particularly the small businesses to create the credit that's needed to create new jobs and get employment back on track.
I would mention, in particular, our leadership of the stress tests. In the spring, the Federal Reserve led an effort to evaluate the balance sheets of 19 of the largest banking companies in the U.S., and our report on those balance sheets, along with the FDIC, the OCC, to other banking agencies, our reports on those balance sheets is public, greatly increased the confidence in the banking system, which meant that they were able to go out and raise new capital in the stock market, and many of them have paid back the capital to the government. But by raising new capital, they increased their own capacity to lend. And, as conditions improve, they'll be able to make new loans as well.
So, by keeping interest rates low, including both short-term rates and long-term rates, like mortgage rates, by supporting a flow of credit to small businesses, consumers and the like, that is our primary effort. Those are the tools that we have. We can always do more, if necessary, but those are the tools that we are applying trying to get job growth going again. And we have seen, obviously, the labor market is still very weak, but the last report we saw shows that we're now coming closer to the point where we'll stop seeing job losses and start seeing job gains.
We've talked about a lot of those extraordinary things you've done. But is that it? Like now do we have to because there's still really bad numbers, even your forecasts are like what, 10% [unemployment] this year, 9% going forward, I think like 8% in 2012. Do we just have to kind of now sit back and take it?
Well, the Federal Reserve will continue to see what other policy actions we can take. And we've really been very aggressive, thus far. And the additional steps aren't as obvious or clear as the ones that we've already taken. A lot of the scope now is on the fiscal side of the house. As you know, the government passed a major fiscal program earlier this year, and I think it was just today the President announced a number of individual a package of programs to try to address unemployment. So, [there are] a lot of new initiatives probably coming from the fiscal side.
Did they ask you for your opinion of those before...
Well, our staffs confer frequently with the Treasury and other parts of the Economic Advisory Groups that advise the President. And we often give our views. Our views are solicited. But, of course, they are responsible for their policy choices.
Have you said before, or are you prepared to say now, that a second stimulus, a round of incentives, is a good idea, on the fiscal side?
So, my domain is monetary policy and financial stability. And we have done, of course, a lot of aggressive things to try to support the economy, try to support job creation. I generally leave the details of fiscal programs to the Administration and Congress. That's really their area of authority and responsibility, and I don't think it's appropriate for me to second guess.
You have said that there's a long-term deficit program that needs to be dealt with. You said health care costs ought to be cut back, so it's not like you won't talk at all about the fiscal situation. Regardless of the details, which I understand that you don't want to tell them how to do it, do you think that the fiscal side ought to do something?
Well, let me say this, I think that it's very important that whatever actions that Congress and Administration take on the fiscal side, that they begin soon, or even sooner, to develop a credible medium-term interest strategy for fiscal policy, one that will persuade the markets and the public that over the medium term, the next few years, we will we, as government, we, as a country will be able to bring our deficits down to a level that could be sustained over a period of time. If we can do that, which will increase the confidence of the markets in American fiscal policy, that would give us more scope to take action today, because, again, there would be confidence that we have a way out, a way back towards sustainability.
In your testimony the other day, one Senator talked about here's the money that the federal government takes in, here's what we spend on entitlements. It's basically the same. Everything else we have to borrow for. I mean, there are a lot of people saying that it's not sustainable, as you have said. And they said one of the only solutions is some kind of tax, a sales tax, value-added tax, something other than an income tax. But would you be in favor of any of those alternatives?
So, the way I put this before Congress before is that the one law that I strongly advocate is the law of arithmetic. (Laughter.) That law of arithmetic says that if you are a low-tax person, then you have to you are responsible for finding ways on saving on expenditure, so that you don't have enormous imbalances between revenues and spending. And by the same law of arithmetic, if you were somebody who believes that government spending is important, and you are for bigger and more spending, and bigger programs, then it's incumbent upon you to figure out where the revenues are going to come from to meet that spending. So, again, I think that's, again, Congress' main responsibility.
I have spoken about deficit, and I think deficits are important, because they address broad economic and financial stability. We need to talk about that. But in terms of the specifics about how to get to fiscal balance, that's the elected officials' responsibility.
Do you think Congress is fiscally illiterate? Economically illiterate?
No, of course not. But what they have to deal with is not just a question of understanding. It's a question of making very, very tough choices, and in a political environment, where people understandably are resistant to cuts in programs or benefits, or increases of taxes. So, there needs to be tough choices made, there needs to be leadership. And I don't envy Congress those choices, because they're very difficult ones to make.
Could you make the case in as simple a way possible for why the Fed should have increased regulatory authority?
Well, first, as I said, I think the very important part of a restructured regulatory system would be a way of looking at the system as a whole, a systemic approach that looks holistically at the entire regulatory system. I am not proposing the Federal Reserve to take that job. There have been other proposals made. For example, the Administration has proposed creating a council of regulators that would work together to identify emerging risks in the financial system, would help coordinate the efforts of different regulators, would look for regulatory gaps, and the like. So, I am not proposing, have never proposed that the Fed have responsibility for the broad financial system.
The Federal Reserve's existing authorities include being the umbrella supervisor of large banks. Other regulators may look at the companies which are owned in this banking organization, subsidiaries. The Federal Reserve is supposed to be looking at the company as a whole. And we think that so-called umbrella supervision of these large companies is a critical component of a systemic approach to regulation. So, we already have that authority.
We think the only expansion of authority which we think is appropriate would be to not only banks, but other large financial companies whose failure might pose significant risk to the financial system. That's the extension of responsibility that we think is appropriate.
Now, why the Federal Reserve, and why not some brand-new agency? A couple of reasons. First, these large companies are very complex. They operate in many different markets. They own many different kinds of companies, so an effective regulator of umbrella supervisor of one of these companies must have a wide range of economic and financial expertise. And there is no agency in Washington that has a wider range of financial expertise than the Federal Reserve, which we have to develop as we make monetary policy, analyzing the economy, analyzing how the economy is likely to evolve, monetary policy works in financial markets, so we have a wide range of expertise that makes us the natural supervisor for these large complex firms.
We have, by the way, identified, we are working hard to identify where we came up short before. And we are working hard to restructure our supervisory practice, our regulations, our whole approach to make sure that if we do get this retain this authority that we will do an effective job making sure that these companies are safe.
There's a second very important reason why the Federal Reserve ought to be doing that particular job, which is that the information that we get from being supervisors of these large financial firms, the expertise that we develop in supervising these firms, the authorities, relationships and so on that we develop in supervising these firms are very, very important for us in our role as financial stability in our role in trying to support financial stability. Last fall is a perfect example. We made loans to short-term loans to banks. We helped restore the functioning of critical financial markets.
And some investment banks had to become banks.
Exactly. In fact, when they became banks, their situation stabilized considerably, because the market had good confidence in the Federal Reserve's ability to oversee those companies. Last fall we needed that information in order to do what we did to stabilize the financial system in the fall of 2008, and in 2009. If we did not have that information, the expertise associated with it, those authorities, those relationships, we would not have been able to do what we did. And this is not just a one-time thing. There have been many previous examples of financial crises, or financial problems, where the Federal Reserve, because of its expertise, and because of the knowledge it gains through this supervision, was able to intervene and prevent a bigger problem.
Just the most recent example before this one was following 9/11, when, of course, the financial system was physically badly disrupted. The Federal Reserve led the effort to stabilize and restore the functioning of the financial system. It was our knowledge of the individual institutions, their funding positions, the role they play in the broader system of the companies involved in making payments between banks and other financial institutions. It was that knowledge, and that experience, that allowed us to lead the effort to restore functionality in the financial system relatively quickly.
So, do you have a point of view on the whole post Glass-Steagall era? I mean, should banks and investment banks be separate? Should there be a wall between them?
Well, the Glass-Steagall law enforced separation between commercial banks who make loans to all kinds of customers, and investment banks, who essentially operate in the securities markets.
Was that a good law?
It was repealed. I don't think that if that law had been in place it would have had much effect on this particular crisis. Investment banks manage to go bankrupt through their investment-banking activities, commercial banks manage to go bankrupt through their commercial-banking activities. It wasn't really the case that the combination was the major problem.
With that being said, more generally, there was a lot of financial innovation and change in the last decade or so, and our regulatory system did not keep up. So, credit default swaps are a good example. Credit default swaps were very completely regulated. They got AIG into serious trouble. They create lots of other problems. And one of the important objectives to perform is to better regulate derivatives like credit default swaps, and other kinds of esoteric financial instruments.
So, the general point that innovation and change made it difficult for the financial regulators to keep up with what was happening, that was certainly true. And one of the reasons to have a council, or some systemic oversight, is to have someone responsible for watching what's happening, and to recommend to Congress or to take action, if necessary, to address the implications of new instruments, new practices and new institutions.
I have one more personal question.
You grew up in a small town in South Carolina, modest means, educated, studied money your whole life, studied, been around, now have the job overseeing more money than anybody in the world. You've been an academic and a public servant. You're not a wealthy man by the standards of the people you regulate. Here's a question, it's a populist question that many of our readers would want to know the answer to: Do bankers make too much money?
I think that bankers ought to recognize that the government and the taxpayer saved the financial system from utter collapse last year, and brought the financial system back to a situation where banks could operate something in a way close to where they did prior to the crisis. And in recognizing that, I would think that bankers ought to look in the mirror and decide perhaps that there should be some more restraint in how much they pay themselves, given the what the government and the taxpayer did to protect the system.
But is there any sign that they recognize that?
Not too broadly, no.
And is there any reason to believe that they will? There is a reason they chose to become investment bankers.
Well, I think so, let me first say that the Federal Reserve has instituted policies which we'll be enforcing on banks, which requires them to structure their pay packages in ways that align pay received with the performance given, that do not create excessive incentives for risk-taking and, therefore, don't promote financial instability, like some of the pay packages did prior to this. So, we are going to be looking at that as part of our supervision of banks.
Because, after all, Goldman Sachs and Morgan Stanley did become banks. Right? They became national banks.
They became holding companies because they own banks.
They paid the money back, but they became bank holding companies, so they are regulated in some way by the Fed. Right?
Yes. So, in the longer term, I think if we had these tools to get rid of too-big-to-fail, which I think is an enormous problem. I want to be very, very clear, too-big-to-fail is one of the biggest problems we face in this country, and we must take action to eliminate too-big -to-fail. One of the strongest things we can do to eliminate too-big-to-fail is create this special bankruptcy regime that would allow us to unwind a failing systemic and critical firm in a way that doesn't destroy the financial system. If you have this mechanism, then all banks, not just small ones, would be subject to market forces. And that, in turn, I think, would impose more discipline on pay packages over a period of time. But we don't have that yet. And right now, we have a situation still where the government is either directly or indirectly providing some protection or help to many large financial institutions. And with that recognition, I think that bankers ought to exercise some restraint in their pay decisions.
Are you saying that time for fiscal and monetary stimulus is over? And, if so, what's the downside of pushing even harder?
There are not easy solutions. It's an enormous problem. I think the Federal Reserve one direction that we can go is to continue to encourage the extension of credit, small businesses, in particular, create a lot of jobs, particularly during economic recoveries. And we have lots and lots of evidence and anecdotes suggesting that small businesses are particularly harmed by the tightness of the bank lending standards and unavailability of credit. So, everything we can do, and that the Administration and Congress can do, to support credit extension to all business, but primarily small business, would be a very powerful.
You don't think it's a liquidity problem?
Well, I mean, interest rates are very low, so I think it's going to be a question, first of all, of getting credit flowing again. And the Federal Reserve has got a role to play there. And then, Congress and the Administration will consider possible programs and fiscal policies.
You're definitely not okay with long-term profligacy, but are you okay with them doing something in the short-term?
I think if they do that, it's critically important they clarify the longer-term plan for establishing sustainable fiscal [policy].
There are some economists who think that perhaps this time around the unemployment problem might be different than in previous recessions that came up very fast, or were shed very quickly. Are you among those who think that there might be something more structural about it this time, something about the kind of things America makes now, that it didn't make 10 or 20 or 30 years ago during past recessions, to make unemployment a different problem this time than in previous downturns?
No, I don't see much evidence that the structure of the labor market the job market has changed very much. I think we still can deliver unemployment rates similar to what we saw before the crisis, and as the economy grows, firms are going to have to put people back to work in order to meet the demand for their products. And I expect the unemployment rate to come down over a period of time. We don't, at this point, have any reason to believe that long-term unemployment the unemployment rate will be higher in the long term than it has been in recent years.
What does the chairman of the Fed have in his wallet? And can you show it to us?
My wife just got me a new wallet, because my old one was too raggedy, so I'm glad I got a new one.
How new is that one?
It's just a week old.
Where did you get it?
We want to see the old one.
I don't know where she got it from. I've got a Washington, D.C. driver's license. I've got my American Express card here. I've got a debit card, a Jos. [A.] Bank card, where I get my suits from. And I have a health insurance card. And then I have a variety of other cards, phone numbers, United Airlines, frequent flyer.
How much cash?
And I have (Laughter.)
I have $45, $75, $85... I'm all set.
We have all admired your basketball a couple of years back at the office. And I, for one, said he's got a really good-looking jump shot. Have you played basketball with President Obama?
I have not, and I don't think I'm really in his league, to tell you the honest truth. He's a pretty serious player. [Treasury Secretary Timothy] Geithner is a good player.
Geithner is a good basketball player?
Geithner is a good athlete, in general.
Right, he plays tennis, I know.
He's a very good tennis player. I know he plays with the President.
So, when you're playing in that gym by yourself, why don't you invite the President to shoot 21 with you, or around the world, or something like that?
Well, you know, if I were one of his advisers, maybe I I think this is the independence of the Federal Reserve being exhibited here.
How often do you see the President, either President? You served under two Presidents.
I saw President Bush very frequently, in part, because he knew me very well, because I was his chairman of his Council of Economic Advisers for a while. I see President Obama less frequently, but I have he relies, of course, on his own I'm not his adviser. I'm a separate part of a separate agency, but I have very frequent interactions with his advisers, Geithner, [Director of the National Economic Council Larry] Summers.
Do you find it odd how quickly everyone forgets that you were appointed by the last President, and were on his Council of Economic Advisers?
Have they forgotten yet?
So, I'm a fringe economics type, I'm not personally, but I'm saying a reader picks up TIME Magazine, and they see this and they go, oh, my God, Ben Bernanke, low interest rates caused this whole thing. He's just an extension of that devil man, Alan Greenspan. Low interest rates, this is the whole cause. What's your bullet answer to that?
It's hard to give a bullet answer.
Monetary policy in the early part of this decade was accommodated for good reasons. There was a recession in 2001, there was the jobless recovery, inflation was very low. Keeping interest rates low to get the economy back on track was a reasonable thing to do. I think there are a lot of forces that led to the crisis, a whole range of things were relevant there. I don't think that monetary policy was a particularly important source of the crisis.
That's a good enough answer.
John mentioned earlier, talked about you had a career as an academic. Certainly, by the standards of the people you regulate now, and bankers, you're not a wealthy man. Where do you keep your money? What do you do with your finances?
I have my teacher's pension a little money in Merrill Lynch, and money in the bank. That's about it.
The money in the bank, like cash?
Like cash, checking accounts. And a house, we own a house on Capitol Hill. My ride is a Ford Focus.
What's your interest rate?
That I'm earning?
No, on your house. Do you have a mortgage?
Oh, yes, we refinanced.
Oh, perfect. When?
About 5%. A couple of months ago.
We had to do it because we had an adjustable rate mortgage and it exploded, so we had to.
So, did you get a fixed rate at 5%? I think this might be the most valuable piece of information.
Thirty years fixed rate at a little over 5%.
Well, there you go, from the horse's mouth. Now we know what you really think.
Adair Turner, the chief British [financial services] regulator, said that we've learned that much of what the financial services sector did in the past 10 years has no economic or social value. Do you agree? Did the financial services sector just get too big, and should it be smaller?
Okay. Well, a strong financial system is very important. It allocates capital to new businesses and new industries. It allows for people to invest in a wide range of activities, so it's critically important to have a good financial system. And the evidence for that is that when the financial system breaks down, the system just doesn't function. You see what the impact has had on the economy. With that being said, the financial system is unique to the extent, first, that it is so critical to the economy, and, secondly, to the very, very old tendency to succumb to booms and busts. And, therefore, we do need to have an effective comprehensive financial regulatory system that will essentially allow us to tame the beast so that it provides the benefits, the growth and development without creating these kinds of crisis.
You talked about how, and everybody agrees, that these complex financial instruments that were created for the last 10 years have been more like financial weapons of mass destruction. It always seems like Wall Street is ahead of the regulators. You read now in the business pages of new financial instruments that are being created. Who's monitoring that now? Isn't it possible that they're creating new financial instruments that might have deleterious effects down the road that we don't even know about now?
Well, in principle, the regulators of the institutions are paying attention to what you're doing. If they're doing if they're creating new instruments that create risks for the institution, then the regulator of that institution should be aware of that, and should be, if necessary, preventing it. But to the extent that new instruments created by Institution A may have bad implications for Institution B or Institution C, that can fall between the cracks under our current system. What we need, therefore, is some kind of approach that allows us to look at the system as a whole, and that's this holistic approach to regulation that I've been trying to push here in this discussion.
You mentioned when you were talking about the steps that the Fed has taken to combat unemployment, one of the things you mentioned was buying $1 trillion worth of mortgages. Going back to the immutable laws of arithmetic, and maybe this is a dumb question, but where does that money come from to buy those mortgages?
And how does that unwind? How does that end?
It's such a complicated question.
The most complicated question for the end.
Okay. When the Federal Reserve buys mortgages, it pays for them by creating reserves the banks hold in Federal Reserve. So, as we purchase $1 trillion of mortgages, we've created roughly $1 trillion of reserves that banks hold at the Federal Reserve. The banks, at this point, are just willing to hold those reserves with the Fed, and not do anything with them.
Ultimately, if the economy normalized, and the Fed took no action, the banks would take those reserves, try to lend them out, and they would begin to circulate, and the money supply would start to grow. And then, ultimately, that would create an inflationary risk. So, therefore, as the economy begins to recover, and as we move away from this very weak economic environment, the Federal Reserve is going to have to pull those reserves out of the system.
We have a number of means for doing that, which we have explained to the markets, and the public, and everyone is confident we can do that. And we will do that over time, in order to make sure that as we come out of this crisis, we don't generate inflation at the end. So, the reserves can be pulled out through various mechanisms or can mobilize. And we don't have to do that yet, but when the time comes, we have tools to do that.
And are there lurking dangers in those mortgages that you purchased that we don't even know about now?
Well, the mortgages are guaranteed. The credit, even if they go bad, Fannie and Freddie with the backing of the U.S. Treasury will pay them off, so the Fed is not taking any credit risk by holding these mortgages.
It's comforting for you, but not for the taxpayers. Right?
Well, on the other hand, what's happening is that we earn the interest from those mortgages, and then we remit that interest back to the Treasury, so the money finds its way back to the taxpayer. And, indeed, the Federal Reserve will be paying the Treasury a good bit more money the next few years than it has in the past, because of the interest we're earning on these mortgages we acquired.
On that note, this week we did learn the TARP is going to pay back nearly all of what it was required to from the taxpayer. Looking back a year later, are surprised by that?
Well, we said at the beginning that the TARP money was an investment. It was going to acquire assets, and that most or all might come back to the taxpayer. Right now, if you look at all these repayments from banks, and the fact that the government is sitting on capital gains, as well as other investments, I think it's a reasonable probability that the TARP money invested in financial institutions, that the great majority of it will come back to the taxpayer. So, in the end, we will have stabilized the financial system and avoided this global crisis at not a small amount of money, but relative to the alternative, a quite small amount of money.
Were there days where you woke up and you thought, what am I not thinking of that we could be doing?
We had a philosophy right here, which was what we called blue-sky thinking. And what blue-sky thinking was, was we have a problem, I want everybody to give me just three associations. What can you think of? How can we approach this, what can we do? And we'll worry about getting rid of the silly answers later. So, there's been a lot of creativity here, and I give credit to terrific staff . I think one of the lessons of the depression, and this is something that Franklin Roosevelt demonstrated, was that when orthodoxy fails, then you need to try new things. And he was very willing to try unorthodox approaches when the orthodox approach had shown that it was not adequate.