The Corner

A Heckuva Good Flip-Flop

In politics — especially on the campaign trail — key issue flip-flops are usually quite damaging. That’s not necessarily the case in monetary policy. Fed head Ben Bernanke had a whopper of a flip-flop nearly two months ago. But it was a very positive flip-flop for financial markets, the economy, and maybe even the sinking fortunes of the Republican Party.

Earlier this week, Wharton school finance lecturer Ken Thomas shed some light on the Fed chair’s flip-flop. Using the Freedom of Information Act, Thomas was able to unearth Bernanke’s calendar of phone calls and meetings during the height of this summer’s credit seize-up. By piecing together a logical narrative, he discovered that a day after the Fed’s August 7th decision to keep rates steady, and maintain their focus on inflation worries, Mr. Bernanke received a phone call from Wall Street powerhouse and former Clinton Treasury Secretary, Citigroup’s Robert Rubin.

Markets were already in disarray from the credit seize-up that started in mid-July. And while Thomas does not know the actual content of the Rubin call, subsequent calls and events strongly suggest that Bernanke rapidly changed his mind and steered the Fed towards a series of massive money additions to the banking system and a half point discount rate cut. All of which led to a shock and awe, liquidity-adding 50 basis point drop in the Fed funds rate on September 18th.

According to the Bernanke logs, the 5pm Rubin call on August 8th was followed by a 7:30am next day breakfast with Bush Treasury man Henry Paulson, and an 11am meeting with legendary mortgage expert Lou Ranieri. (Ranieri pioneered mortgage backed securitizations, the very bonds that were collapsing as a result of the subprime mortgage virus that had already begun infecting the financial system.)

At 2pm later that same day, the Fed chair also met with Ray Dalio, head of Bridgewater, the 4th largest US hedge fund, as well as other hedge fund magnates. At 4:30pm, Mr. Bernanke was on a conference call with his fellow FOMC members, undoubtedly to discuss a 180-degree Fed change of heart.

In fact, over the next few weeks, Bernanke participated in no fewer than thirty-five separate conference calls with fellow Fed operatives — a complete departure from the chairman’s earlier style of not having conference calls.

As we know now, the Fed started pouring in new liquidity Friday August 10th with a major announcement. On August 17th they slashed their base discount rate for member bank loans by 50 basis points, and of course a month later, slashed their overnight target rate.

As Mr. Thomas notes, no one can be sure if this narrative is correct, simply because there is no available record of what was actually said during these calls and meetings. But it seems pretty clear that Robert Rubin started a chain reaction with his call back on August 8th. This was only one day after the Fed’s hold-the line policy decision that so disappointed financial markets and intensified the credit turmoil that many people feared would spillover into the economy and lead to recession.

Essentially, the academic Mr. Bernanke became a hands-on market participant through his contacts with Rubin, Paulson, the hedgies, and others. His learning curve efforts to reach out to savvy financial market players put him in touch with the real world. Basically, Bernanke embarked on a 5-week journey that shook world credit markets out of their financial panic and started the healing process that continues to progress right up to this very day.

Most folks would agree that while far from being completely solved, the credit crunch is easing. And of course, the stock markets have rebounded dramatically with the Dow hovering near its all-time 14,000 high. Stock markets all around the world have recovered. And the outlook for economic growth, though still uncertain, is nonetheless much brighter than it was back on August 7th when the Fed first turned its back on the emerging credit crisis.

Without question, Bernanke made a mistake in early August. But this is a case where his flip-flop was a very positive move, one that enhanced his credibility in U.S. and world markets.

Larry Kudlow is the author of JFK and the Reagan Revolution: A Secret History of American Prosperity, written with Brian Domitrovic.

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