Paulson agreed. A bailout ran counter to the Bush Administration’s free-market principles and to his own belief that reckless behavior should not be rewarded, but he had worked on Wall Street for thirty-two years, most recently as the C.E.O. of Goldman Sachs, and had never seen a financial crisis of this magnitude. He had come to respect Bernanke’s judgment, and he shared his conviction that, in an emergency, pragmatism trumps ideology.
Looking back on this period, Bernanke told me, “I and others were mistaken early on in saying that the subprime crisis would be contained. The causal relationship between the housing problem and the broad financial system was very complex and difficult to predict.”
In October, 2002, a few months after joining the Fed, he gave a speech to the National Association for Business Economics, in which he said, “First, the Fed cannot reliably identify bubbles in asset prices. Second, even if it could identify bubbles, monetary policy is far too blunt a tool for effective use against them.” In other words, it is difficult to distinguish a rise in asset prices that is justified by a strong economy from one based merely on speculation, and raising rates in order to puncture a bubble can bring on a recession.
In the glut of paper I could find no unifying or fundamental principle except a certain belief that money was good for rich people and bad for poor people. It was the only point on which all the authorities agreed, and no matter where the words were coming from (a report on federal housing, an essay on the payment of Social Security, articles on the sorrow of the slums or the wonder of the U.S. Navy) the authors invariably found the same abiding lesson in the tale—money ennobles rich people, making them strong as well as wise; money corrupts poor people, making them stupid as well as weak.
Bernanke and Gertler argued that the Fed should ignore bubbles and stick to its traditional policy of controlling inflation. If a bubble inflated and burst of its own accord, they said, the Fed could always bring down rates to alleviate damage to the broader economy. To support their case, they presented a series of computer simulations, which appeared to show that a policy of targeting inflation stabilized the economy more effectively than one that targeted bubbles. The presentation got a mixed reception. Henry Kaufman, a well-known Wall Street economist, said that it would be irresponsible for the Fed to ignore rampant speculation. Rudi Dornbusch, an M.I.T. professor (who has since died), pointed out that Bernanke and Gertler had overlooked the possibility that credit could dry up after a bubble burst, and that such a development could have serious effects on the economy. But Greenspan was more supportive. “He didn’t say anything during the session,” Gertler recalled. “But after it was over he walked by and said, as quietly as he could, ‘You know, I agree with you.’ That had us in seventh heaven.”
In an article Bernanke published in 1983, he showed how the Fed’s failure in the early thirties to prevent banks from collapsing contributed to the depth and severity of the Great Depression—a finding that supported a theory first proposed in 1963 by the economists Milton Friedman and Anna Schwartz. In November, 2002, shortly after joining the Fed, Bernanke appeared at a conference to mark Friedman’s ninetieth birthday, and apologized for the Fed’s Depression-era policies. “I would like to say to Milton and Anna: regarding the Great Depression, you’re right; we did it,” he said. “We’re very sorry. But, thanks to you, we won’t do it again.”
The lexicon of The Wall Street Journal and the business sections of Time and Newsweek turned out to bear a striking resemblance to Genesis, the Epistle to the Romans, and Saint Augustine's City of God. Behind descriptions of market reforms, monetary policy, and the convolutions of the Dow, I gradually made out the pieces of a grand narrative about the inner meaning of human history, why things had gone wrong, and how to put them right. Theologians call these myths of origin, legends of the fall, and doctrines of sin and redemption. But here they were again, and in only thin disguise: chronicles about the creation of wealth, the seductive temptations of statism, captivity to faceless economic cycles, and, ultimately, salvation through the advent of free markets, with a small dose of ascetic belt tightening along the way, especially for the East Asian economies.
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