Focus turns to key role played by Bernanke

Some in Congress are beginning to question the awesome power an unelected Federal Reserve chief wields, writes Denis Stauntonin Washington

TWO WEEKS into the worst financial crisis since the Great Depression, US president George Bush yesterday stepped into the White House Rose Garden to address the turmoil on Wall Street.

"The American people are concerned about the situation in our financial markets and our economy, and I share their concerns," the president said.

Bush, who spoke for less than two minutes and declined to answer reporters' questions, has been largely invisible during the market meltdown. His absence is the more remarkable given the dramatic moves the federal government has made in response to the crisis, starting with the seizure of mortgage giants Fannie Mae and Freddie Mac two weeks ago.

This week, the Federal Reserve rescued insurer AIG with an $85 billion emergency loan, taking an 80 per cent stake in the company.

And throughout the crisis, the Fed has been pumping billions of dollars into the financial markets in an effort to maintain liquidity.

But, unlike the lambasting Bush got for appearing uninvolved when Hurricane Katrina devastated the US Gulf Coast in 2005, this time observers are praising him for taking the right approach to the crisis.

Treasury secretary Hank Paulson and Fed chairman Ben Bernanke have emerged as the key figures in Washington's attempt to contain the catastrophe engulfing Wall Street, leaving both the president and Congress on the sidelines.

Critics argue that Bush is dealing with a storm at least partly of his own making, thanks to the administration's deregulatory policies. But with the turmoil now unfolding, observers said the president's tactic of delegating to Paulson and Bernanke, and staying out of the limelight, was correct given the complex issues at stake and the risk of spooking the markets.

"As large as they are, financial issues are still largely technical in nature and it is appropriate that they are being handled directly by Paulson and Fed chairman Bernanke," said Robert Litan, an economics senior fellow at the Brookings Institution.

Paulson and Bernanke have not only co-ordinated the government's interventions but have played a key role in negotiations between financial institutions in recent days.

The collapse of Lehman Brothers became inevitable last week after Paulson ruled out any federal help for a buyout of the stricken investment bank.

Lehman's imminent demise concentrated the minds of Merrill Lynch executives, pushing that investment bank into the arms of Bank of America.

The treasury secretary initially played tough on AIG too, hoping for a private sector solution to the insurer's liquidity problem. But when no such solution was forthcoming, Paulson and Bernanke reversed course and took control of the company.

Under the terms of the deal, AIG must repay the $85 billion loan within two years - at an interest rate 8.5 percentage points above the London Interbank Offered Rate (Libor). The idea is that AIG should pay off the loan by selling its subsidiary businesses in an orderly fashion but without too much delay.

Paulson justified the apparent contradiction between allowing Lehman to fail while rescuing AIG by arguing that the markets had ample warning that Lehman was in trouble and had time to prepare for its collapse. Like Fannie and Freddie, AIG was simply too big and too intertwined with other institutions to be allowed to go under.

Paulson is a former chairman and chief executive of Goldman Sachs and, before he became Fed chairman, Bernanke was a Princeton economics professor specialising in the Great Depression. So both men are well placed to understand what has been happening in the markets since the larger financial crisis began more than a year ago.

Democrats and Republicans in Congress have been slow to second-guess the treasury and the Fed in the heat of the crisis but there are signs that legislators are now impatient to regain influence over the government's actions.

House financial services committee chairman Barney Frank was surprised this week to learn that Bernanke enjoyed powers dating from the 1930s to use the Fed's $888 billion reserves to make loans to any entity under any terms he believes are economically justified.

"No one in this democracy - unelected - should have $800 billion to dispense as he sees fit," Frank told the Washington Post yesterday.

"It may be that there is so much bad debt out there clogging our system that we may have to have some intervention. But it shouldn't be the unilateral decision of the chairman of the Federal Reserve with the backing of the secretary of the treasury."

Looking ahead to the next steps in dealing with the financial crisis, many in Congress favour creating an equivalent of the Resolution Trust Corporation (RTC), which took assets from failed banks and thrifts following the savings-and-loan meltdown in the early 1990s and sold them off over the years.

The original RTC mostly sold off commercial property, but any body set up to deal with today's troubles would have to deal with complex debt securities that are so obscure and innovative that even financial experts struggle to understand them.

However, Congress, acknowledging that it isn't equipped to lead the way to a solution for the financial crisis and unable to agree on a path to follow, is likely to just get out of the way for now.

One reason, senate majority leader Harry Reid said yesterday, is that "no one knows what to do" at the moment. "When you rush to judgment, you usually make mistakes," said Sherwood Boehlert, a former Republican congressman from New York.

Both Barack Obama and John McCain are promising better regulation of financial institutions and the securities and exchange commission this week acted to restrict short selling.

Saying he would fire the current Securities and Exchange Commission chief Christopher Cox, if elected, Mr McCain said the SEC "kept in place trading rules that let speculators and hedge funds turn our markets into a casino. We cannot wait any longer for more failures in our financial system".

The current crisis has highlighted a culture in Wall Street that rewarded risk by encouraging financial institutions to play a high-stakes game of pass the parcel with potentially toxic debt.

The first move towards cleaning up the regulatory system could come from Europe rather than the US as EU internal market commissioner Charlie McCreevy considers a range of reform proposals. Any action taken in Brussels will make it easier for US legislators to follow suit. - (Additional reporting: Reuters, Bloomberg)