The one-year anniversary of the end of the financial world as we knew it has come and gone. Yet, quite remarkably, the financial world as we knew it is still here—absent a few laggard investment banks and several million jobs.
While regulatory proposals flutter in the wind, big banks have reconstituted themselves, and profits and bonus pools have returned. In numerous articles and books, banking and government leaders applaud themselves for having staved off a crisis that could have been worse. Many of these accounts give us second-by-second depictions of sweat dripping from furrowed brows as tough decisions were made. And, as if to validate these histories, Ben Bernanke has been nominated to serve another term as chairman of the Fed, certifying that his tenure is one of glory gained by defeating the crisis rather than glory lost because of responsibility for its onset.
Yet as we appear headed to reinforce the Fed as the center of all economic power, there are enormous questions that remain, and Bernanke needs to answer them at his upcoming Senate confirmation hearings. The scope of authority now claimed—and sought—by the Fed makes these confirmation hearings more important than any I can recall. The performance of the Fed over the past several business cycles gives me enormous pause. We should enter these hearings with an agnostic view about Bernanke's suitability and an understanding that he carries the burden of proving his case. This may be the one genuine opportunity to plumb the depths of lessons learned—or missed—about the economic catastrophe.
Here are nine questions Bernanke needs to answer before he wins another term.
1. How does the Fed define economic success? If the Fed is to be the macro giant that it seeks to be, we must understand whether its metrics for success focus on GDP growth, job growth, household median income growth, inflation moderation, or some other data.
2. What industrial policy does the Fed see best fitting our macro goals? We cannot deny we now have an industrial policy, given the enormous Fed intervention in particular market sectors. So is the Fed now explicitly promoting a revitalization of our manufacturing sector, or is the apparent atrophying of that sector something that the Fed will tolerate through a policy of benign—or malignant—neglect? Does the Fed believe that a service-sector-driven economy can survive and thrive? Does the Fed believe that the trade policies that have led to the out-migration of our manufacturing sector truly generate the mutual gain that traditional "comparative advantage" theory suggests, or is it time to take a hard look at trade theory, just as we are re-examining much of the "rational market" theory that underlay other policies of the past decade.
3. How do we define and measure systemic risk? If the Fed wishes to be granted the authority to be the regulator of risk, it better be able to explain how it measures it.
4. Has the Fed found the analytical error that permitted it to believe throughout 2008 that the crisis was contained and would not jump from the sub-prime sector to the entire financial system? If we cannot locate that analytical error, how can we possibly begin to spot systemic risk in the future?
5.Has the Fed examined why it permitted the avalanche of debt to course though the financial system without one of its own analysts observing that the risk of default was not reflected in the market's pricing of risk? If the credit analysis within the Fed was as faulty as it was at the banks, we must all take a hard look at the analytics we are relying upon.
6.What bank structure will best accomplish the macro goals the Fed defines? Do we desire a market dominated by several institutions that are openly "TBTF"—too big to fail—or are we going to reverse the implicit and explicit federal guarantees of the past year and cut loose the major institutions? And if we are to cut them loose, how will the market be persuaded that they really are on their own, and the Fed will not rescue them next time, too?
7.Does the Fed stand by the notion that asset bubbles are better dealt with after the fact than during their creation? Does this view, which the chairman has articulated with some frequency, doom us to the incessant cycles we have lived through over the past decade?
8.Does the Fed still have faith in "self-regulation," the concept that was used to justify the decay that set in throughout the regulatory apparatus in Washington?
9.What governance structure is appropriate for the Fed, given its new authority? Does the interconnectedness of the Fed and the banking community create an overwhelming conflict of interest, now that the Fed is so central to financial questions beyond the scope of mere monetary policy?
Many questions also remain about specific transactions connected to the fall of Lehman and the bailout of AIG. But much more important are the policy questions I have listed above. These must be examined in a most serious manner, for these macro policy questions will determine the course the Fed takes not only in the relative calm that usually prevails, but also when the economy and the markets break down, as they inevitably will.