Bernanke, by contrast, had been a college professor for most of his career, and at the time of his appointment to replace the then-eighty-year-old Greenspan, his area of specialization—the Great Depression and what the Federal Reserve had done wrong in the 1920s and 1930s—seemed quaint. Trying to identify the causes of the Great Depression may be the Holy Grail of macroeconomics, but to the larger public, it seemed to have little practical application in a key government position. Any economic crisis of that magnitude seemed safely in the past.
By the summer of 2007, however, America’s second Gilded Age had come shockingly to an end, and Greenspan’s reputation lay in tatters. His faith that the market was self-correcting suddenly seemed fatally shortsighted; his cryptic remarks were judged in hindsight as the confused ramblings of a misguided ideologue.
As a scholar of the Depression, Bernanke was cut from a different cloth, though he shared Greenspan’s belief in the free market. In his analysis of the crisis, Bernanke advanced the views of the economists Milton Friedman and Anna J. Schwartz, whose A Monetary History of the United States, 1867-1960 (first published in 1963) had argued that the Federal Reserve had caused the Great Depression by not immediately flushing the system with cheap cash to stimulate the economy. And subsequent efforts proved too little, too late. Under Herbert Hoover, the Fed had done exactly the opposite: tightening the money supply and choking off the economy.
Bernanke’s entrenched views led many observers to be optimistic that he would be an independent Fed chairman, one who would not let politics prevent him from doing what he thought was the right thing. The credit crisis proved to be his first real test, but to what degree would his understanding of economic missteps eighty years earlier help him grapple with the current crisis? This was not history; this was happening in real time.
Ben Shalom Bernanke was born in 1953 and grew up in Dillon, South Carolina, a small town permeated by the stench of tobacco warehouses. As an eleven-year-old, he traveled to Washington to compete in the national spelling championship in 1965, falling in the second round when he misspelled “Edelweiss.” From that day forward he would wonder what might have been had the movie The Sound of Music, which featured a well-known song with that word for a title, only made its way to tiny Dillon.
The Bernankes were observant Jews in a conservative Christian evangelical town just emerging from the segregation era. His grandfather Jonas Bernanke, an Austrian immigrant who moved to Dillon in the early 1940s, owned the local drugstore, which Ben’s father helped him run; his mother was a teacher. As a young man, Ben waited tables six days a week at South of Border, a tourist stop off Interstate 95.
In high school, Bernanke taught himself calculus because his school did not offer a class in the subject. As a junior, he achieved a near-perfect score on the SATs (1590), and the following year he was offered a National Merit Scholarship to Harvard. Graduating with a degree in economics summa cum laude, he was accepted to the prestigious graduate program in economics at the Massachusetts Institute of Technology. There he wrote a dense dissertation about the business cycle, dedicating it to his parents and to his wife, Anna Friedmann, a Wellesley College student whom he married the weekend after she graduated in 1978.
The young couple moved to California, where Bernanke taught at Stanford’s business school and his wife entered the university’s master’s program in Spanish. Six years later, Bernanke was granted a tenured position in the economics department at Princeton. He was thirty-one and a rising star, admired for “econometrics” research that used statistical techniques and computer models to analyze economic problems.
Bernanke also demonstrated political skills as his intellectual reputation grew. As chairman of the Princeton economics department, he proved effective at mediating disputes and handling big egos. He also created a series of new programs and recruited promising young economists such as Paul Krugman (who happened to be his ideological opposite). Six years later Bernanke was recruited to succeed Greenspan.
Up until early August 2007, Bernanke had been enjoying his tenure at the Fed, so much so that he and Anna had planned to take a vacation that month and drive to Charlotte, North Carolina, and then on to Myrtle Beach, South Carolina, to spend time with friends and family. Before heading south, he had to see to one final business matter: the Federal Open Market Committee, the Fed’s powerful policy-making panel, which among its other responsibilities sets interest rates, was scheduled to meet on August 7. On that day, Bernanke and his colleagues acknowledged for the first time in recent memory the presence of “downside risks to growth,” but decided nonetheless to keep the Fed’s benchmark interest rate unchanged at 5.25 percent for the ninth consecutive meeting. Rather than try to boost economic activity by lowering rates, the committee decided to stand pat. “The committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected,” the Fed announced in a subsequent statement.
That, however, was not what Wall Street wanted to hear, for concerns about the sputtering economy had investors clamoring for a rate cut. Four days earlier financial commentator Jim Cramer had exploded on an afternoon segment of CNBC, declaring that the Fed was “asleep” for not taking aggressive action. “They’re nuts! They know nothing!” he bellowed.
What the Fed’s policy makers recognized but didn’t acknowledge publicly was that credit markets were beginning to suffer as the air had begun gradually seeping out of the housing bubble. Cheap credit had been the economy’s rocket fuel, encouraging consumers to pile on debt—whether to pay for second homes, new cars, home renovations, or vacations. It had also sparked a deal-making frenzy the likes of which had never been seen: Leveraged buyouts got larger and larger as private-equity firms funded takeovers with mountains of loans; as a result, transactions became ever riskier. Traditionally conservative institutional investors, such as endowments and pension funds, came under pressure to chase higher returns by investing in hedge funds and private-equity funds. The Fed resisted calls to cut interest rates, which would only have thrown gasoline onto the fire.
Two days later, however, the world changed. Early on the morning of August 9, in the first major indication that the financial world was in serious peril, France’s biggest bank, BNP Paribas, announced that it was halting investors from withdrawing their money from three money market funds with assets of some $2 billion. The problem? The market for certain assets, especially those backed by American mortgage loans, had essentially dried up, making it difficult to determine what they were actually worth. “The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly, regardless of their quality or credit rating,” the bank explained.
It was a chilling sign that traders were now treating mortgage-related assets as radioactive—unfit to buy at any price. The European Central Bank responded quickly, pumping nearly 95 billion euros, or $130 billion, into euro money markets—a bigger cash infusion than the one that had followed the September 11 attacks. Meanwhile, in the United States, Countrywide Financial, the nation’s biggest mortgage lender, warned that “unprecedented disruptions” in the markets threatened its financial condition.