TIME's Managing Editor Richard Stengel talks with Federal Reserve Chairman Ben Bernanke during an interview in Washington, DC
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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.