Ben Bernanke was Time's Man of the Year in 2009 for supposedly saving the world economy from Armageddon.  He's also the most powerful man in the world.  Now King Bernanke wants more power.  If he hasn't already sowed the seeds for the Great Depression II, with even more power, it is all but inevitable.

Many people blame Bernanke for the housing price bubble, claiming that Fed policy was too loose over the last 10 years.  The cheap money went into speculation in the housing market.  There is some truth to this, but I think overall loose money is fine, as long as it doesn't cause inflation.  So I think this criticism is unfair.

Bernanke defends his monetary policy in a recent speech on monetary policy here.  However, he blames the housing price bubble on failure of regulation.  If only we had been more vigilant about preventing banks from making bad loans, this whole problem could have been avoided:

Stronger regulation and supervision aimed at problems with underwriting practices and lenders' risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates.

....

The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter. The Federal Reserve is working not only to improve our ability to identify and correct problems in financial institutions, but also to move from an institution-by-institution supervisory approach to one that is attentive to the stability of the financial system as a whole. Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets. We have further strengthened our commitment to consumer protection. And we have strongly advocated financial regulatory reforms, such as the creation of a systemic risk council, that will reorient the country's overall regulatory structure toward a more systemic approach. The crisis has shown us that indicators such as leverage and liquidity must be evaluated from a systemwide perspective as well as at the level of individual firms.

Of course, the housing price bubble was caused by both easy money and lax regulations.  But the biggest problem, which he conspicuously omits, was the involvement of government sponsored entities (GSE) in the housing market: Fannie and Freddie, FHLB, and FHA inflated the market recklessly.  They made lots of money while things went well, and investors in their bonds continued to pour money in, knowing that they had an implicit taxpayer guarantee backing them up if things went bad.   (And the Obama administration will continue to support the GSE bonds for at least the next 3 years.)  Certainly private banks contributed as well, but without the government involvement, the bubble would not have been so huge, and certainly the taxpayer would not be on the hook for losses when it popped.  (Private banks were similarly protected through FDIC.)

Asset bubbles happen.  In fact, some economic theorists think they are inevitable as economies flourish, and wealthy investors seek higher yielding assets with their excess funds.  The problem is not the bubble, and the problem is not when the bubble bursts.  The problem is when the taxpayer has to foot the bill.  This is fundamentally the problem with GSEs.  If not for them, the housing bubble would have hurt much fewer people, and certainly would not have left a bill for generations of taxpayers.  For example, the tech bubble of 2000 did not have long lasting consequences except for relatively few rich investors and unwise speculators.

The stock market crash of 1929 is another example, and is often considered to be the cause of the Great Depression.  However, most economists now agree that the depression was caused not by the crash, but by the government's strict adherence at the time to the gold standard, along with overly tight monetary policy by the Fed.  Bernanke is a student of the Great Depression, and contributed important research showing how the failure of banks worsened the depression as a result of impaired lending, upon which the economy depends. The only people hurt in the stock market crash, for the most part, were wealthy investors and speculators.  The average person was not directly hurt, and certainly they were not responsible for losses suffered by the victims of the crash.

The story today is very different.  Because of Freddie and Fannie, and FHA, and FHLB, and more recently the opening of the Fed discount window and purchases of MBO's, the US taxpayer is responsible for any losses.  These could total in the trillions, and generations of taxpayers will be paying for it.  For this reason especially, Bernanke should stop the bailout.

Bernanke is committed to avoid the mistakes of the past.  Easy money is important in a recovery - this most of us agree.  However, he goes a step further: the banking system must be rescued at all costs, even if the cost is in the trillions of dollars.  However, this is the wrong conclusion.  The bad banks must be allowed to fail, because even though that will cause temporary pain, the cost of keeping the zombies alive ultimately will be far greater.

Bernanke concludes that fundamentally the problem is bad regulation - loose lending standards.  This is really scary, because he is really arguing for more powerful government control over banking.  But even the FBI was aware of widescale fraud and abuse in 2004, and did nothing.  There is no reason to believe that a regulatory agency will do any better.  It's ridiculous to think that a 'Systemic Risk Council', presumably staffed by brilliant economists and Nobel prize winners and otherwise well-qualified political appointees could ever detect legitimate 'systemic risks', much less do anything about them until it's too late.  Government doesn't work this way and never will.  In fact, financial regulation can't work, as explained here.  These types of agencies ultimately will make bad decisions that enrich themselves at the expense of the average person.

This speech is simply an attempt at another huge power grab.  Regrettably, he will probably get what he wants from a Congress that is all too eager to have its own influence on powerful new agencies.  They will continue to back reckless and economy-busting policies with taxpayer money.  The result will be huge deficits, an unpayable debt, hyperinflation and a bankrupt government. The man who is now being credited with preventing the Great Depression II will actually have caused it.