The house that Ben built

CHARLOTTE, N.C.—In 1945 the grandparents of Federal Reserve Chairman Ben Bernanke bought a small tract of land on East Jefferson Street in Dillon, S.C., a town near the North Carolina border that—then as now—had less than 10,000 people. They paid $750 for the lot. The grandparents, Jonas and Pauline, were prudent and well educated: Pauline trained to become a physician at the University of Vienna. Jonas Bernanke, a pharmacist, had opened Jay Bee Drug Company on Dillon’s Main Street in 1941. Within a few years, the Bernankes had built a large brick home on the property. In 1960, Jonas sold the house to his son, Philip, for $22,000. Philip raised the future Fed chairman in that house.

The brainy young Bernanke (he scored 1590 out of 1600 on his SAT) went off to Harvard (summa cum laude) and then to the Massachusetts Institute of Technology for his Ph.D. His parents worried about his going north and losing his Jewish roots. For centuries, South Carolina has kept a thriving Jewish community: As early as 1700, the state had a significant Jewish population and was the first place in America to elect a Jew to public office. In 1800, over 2,000 Jews lived in South Carolina—more than any state in the nation. A friend eventually convinced Ben’s parents “there were Jews in Boston” and they sent him to New England.

Dillon, the textile and tobacco town Bernanke left behind, fell on hard times. Global forces beyond the control of Dillon’s hard-working and thrifty residents shut down the area’s textile plants and tobacco farms. At the height of the Great Recession, which took place on Bernanke’s watch, Dillon’s unemployment hit 15 percent.

In some ways, the drama of Bernanke’s departure and Dillon’s decline is playing again on a much larger stage. This time it’s the American economy that’s a tangled mess as Bernanke himself—who will end his second four-year term as Fed chairman next January—prepares once more for the exits. And as we enter what will likely be Bernanke’s last year as Fed chairman, questions about the 59-year-old’s legacy arise: Have his policies saved America from bankruptcy, or made matters worse? If they have made matters worse, who will be left to clean up the mess he leaves?

The answer to the first question depends on whom you ask. Donald L. Kohn became the Kansas City Federal Reserve Bank governor in 2002, the same year Bernanke became a Fed governor. Then President George W. Bush appointed them both, and Kohn served through 2010, during the worst of the financial crisis and Bernanke’s first years as Fed chairman. He gives Bernanke high marks, saying he’s “done a superb job given the challenges he’s faced. I predict historians will look favorably on his tenure.”

The Wharton School’s Jeremy Siegel also gives Bernanke a good grade for the way he’s handled the financial crisis. “On the whole, I’d give him an A,” Siegel told me. “I support the quantitative easing he has done. It’s prevented a much worse financial crisis.”

Quantitative easing is the central bank’s practice of buying assets from financial institutions with newly created money. Central banks use this technique when interest rates—the primary lever a central bank can pull—are already at or near zero.

Bernanke first embarked on a series of quantitative easing strategies in 2008. Because the Fed had already lowered interest rates almost to zero, a frenzy of home building, buying, and selling drove prices up. When the bubble the Fed helped create burst, the financial markets panicked. Banks stopped lending money. Capital markets froze. No longer able to lower rates, the Fed bought $800 billion in mortgage-backed securities in a desperate attempt to provide liquidity to the crashing housing market.

A second round of quantitative easing—QE2—began in November 2010, when Bernanke announced a decision to buy $600 billion in Treasury bonds. In September 2012, Bernanke announced QE3: The Fed would buy $40 billion in mortgage-backed securities per month through at least 2015. Finally, in November, Bernanke announced what some call QE-Infinity: The Fed will purchase Treasury securities at the rate of $45 billion per month with no end date in sight. Bernanke said on Nov. 12 that the Fed would continue the purchases and would keep interest rates low until the unemployment rate fell below 6.5 percent, or long-term inflation projections rose above 2.5 percent.

Even Bernanke supporters swallowed hard at his most recent pronouncement. Siegel, for example, told me, “I’m concerned about the focus on the unemployment rate. He has elevated a measure that involves a lot of subjectivity.” Siegel refers to the fact that much of the recent drop in the unemployment rate is the result of discouraged workers leaving the workforce altogether.

Robert L. Pollock, writing in The Wall Street Journal, places blame both for the slow recovery and the massive growth in U.S. debt in the past four years directly at Bernanke’s feet. He said that “to the extent that the United States finds itself in a precarious financial situation, Bernanke shares much of the blame. Simply put, there is no way Washington could have run the deficits it has in recent years without the active assistance of a near-zero interest rate policy.”

Conservatives deride the practice as “printing money,” saying the inevitable consequence is inflation, possibly hyperinflation. Japan resorted to quantitative easing in the early 2000s to prevent deflation in that country. Economists say it worked at preventing deflation, but it doomed the Japanese economy to more than a decade of stagnation.

That Bernanke would follow this path is no great surprise. In 2002, when Bush appointed him to the Fed, the U.S. economy struggled under the twin blows of the technology bust of 2000 and the aftermath of 9/11, in 2001. Inflation, which had been falling since 1990, was near zero—below zero according to some models. Deflation seemed a real possibility. In 2002 Bernanke gave a speech to the National Economists Club in Washington that laid out what has come to be called the Bernanke Doctrine: “Sustained deflation can be highly destructive to a modern economy and should be strongly resisted.”

Bernanke continued on the Fed until 2005, when he resigned to serve a short stint as chairman of Bush’s Council of Economic Advisers. It was a post many thought was an audition for the Fed chairmanship. Conservatives took comfort in Bernanke’s open appreciation of Milton Friedman, the 20th century’s leading conservative economist. Friedman advocated free markets, minimal government intervention, and “monetarism,” the small, steady, incremental expansion of the money supply. Friedman stood against the dominant Keynesian orthodoxy, which advocated a much larger role for the government.

But a growing number of conservative economists say Bernanke has left Friedman behind, and it was his 2002 Bernanke Doctrine speech that should have been the first clue.

“He is not a monetarist,” said Jeff Herbener, a professor of economics at Grove City College. “His views have become decidedly more Keynesian, and his policies are counter-productive.”

Herbener believes that Bernanke has not only failed to help the country’s economic situation, he has made it worse by keeping interest rates low and increasing the money supply dramatically—not incrementally, as Friedman advocated—in order to buy assets. Artificially low rates reduce the incentive of young families to save and squeeze the interest income of retirees. They also create an incentive to borrow more than is prudent. That ease of borrowing is the main reason the housing market overheated in 2008.

Not only does Bernanke’s strategy of increasing money supply—“printing money”—increase the likelihood of inflation, it has also dramatically increased the amount of monetary assets under government control. “The state is an inefficient allocator of resources,” Herbener said. “The best economic policies reduce the amount of resources in the command of the state.”

Bernanke’s current quantitative easing plans will add $1 trillion per year to the amount of assets under government control, bringing the total to $5 trillion by the end of 2014.

In early 2008, the government had only about $1 trillion in assets on its balance sheet. By buying up assets and bailing out the companies who own non-performing assets, the Fed has disrupted the economy’s natural cleansing process, Herbener said. “Market economies are excellent at displacing bad entrepreneurs with good entrepreneurs. The good assets of bad entrepreneurs get reallocated by natural market mechanisms to good entrepreneurs,” he said. “One of the reasons the recession was as long as it was and the recovery has been so slow is that the government has interrupted that process.” Bailouts and buy-backs allow good assets to remain in the hands of bad entrepreneurs. The result is that these assets fail to reach their full productive potential.

But what about the argument that the situation was so dire in 2008 that without an immediate and massive government intervention, the economy would have fallen into not just the Great Recession but a second Great Depression? Herbener doesn’t buy it. “Just screaming ‘fire’ and running for the exits is not an argument. The burden of proof is on those who make those claims,” he said. “And so far they have failed to make the case.”

Herbener says Bernanke and the Fed should have let the global markets, not the U.S. government, provide liquidity and solve the crisis. The U.S. government is big, but Herbener says “the world markets are huge by comparison. It is simply implausible that the world markets would not have done a better job of responding to the financial crisis, of providing liquidity and re-allocating assets, than the U.S. government did.”

But for the foreseeable future, thanks to the policies of Ben Bernanke, massive amounts of assets that in years past would have been in the private sector will be in government hands. Jeremy Siegel and liberal economists such as Paul Krugman think this will not be a problem. “We will grow our way out of the current situation,” Siegel said. “There are currently no signs of inflation, and if the signs show up, the Fed will act.”

Former Fed Governor Kohn agrees. “I do not fear inflation in the medium-term, defined in the next few years,” he said. “There’s enough slack in the U.S. and global economies to keep wage and price pressures in check.”

Others remain unconvinced. George Melloan is a former editor of The Wall Street Journal’s editorial page and the author of The Great Money Binge: Spending Our Way To Socialism. He believes the nearly 2,000-point run-up in the Dow Jones Industrial Average at least partly reflects what he calls “asset inflation,” which he defines as an increase in price that reflects a “cheapened dollar, not an increase in their real worth.” In addition to the rise in stock prices, he also points to the double digit rise in farm prices coming at a time when farmland itself has been less productive because of “crippling drought” gripping much of the nation. “How could drought-stricken farms be gaining value so rapidly,” he asks, “other than through inflation generated by cheap credit?”

Melloan says the danger of the current situation is that it produces a “wealth illusion, the belief that pricier assets make one permanently richer. Illusions are dangerous. Eventually, painful reality intervenes.”

Grove City’s Herbener is also skeptical that inflation is under control. “Predicting with that kind of precision what inflation will be two years or more in the future seems implausible, at best,” he said. Nonetheless, Herbener is willing to make a qualified prediction about The House That Ben Built: “We may not be headed for a collapse. It could end up being just a slow and steady decline. It’s virtually certain that without dramatic monetary reform, Bernanke’s policies are leading us into an era of inflation. And despite what people are saying about the troubles we’re in now, I can promise you that double-digit inflation will be worse.”

It will be especially worse for taxpayers and homeowners, who will eventually have to make good on Bernanke’s bonds and will not have the luxury of selling when the market is high and buying back in after it crashes. That’s why even some members of the Fed’s Open Market Committee (FOMC) are quietly calling for a pullback in quantitative easing. The Dow Jones Industrial Average set a record high on Feb. 19, closing above 14,000. But the next day the FOMC released the minutes of its January meeting, reflecting the divided minds of the Fed governors. Over the next two days, the Dow fell nearly 200 points. On Feb. 25, the Dow saw another 200-point fall. On the same day, the market’s volatility index, sometimes called the “fear index,” jumped 34 percent. The next day, Feb. 26, Bernanke delivered his semi-annual testimony before Congress, saying quantitative easing would continue. That stabilized the stock markets and underscored his influence.

Bernanke’s second four-year term ends next January, and two-thirds of economists polled in February by USA Today believe he will step down at the end of his term. Former Fed Governor Donald Kohn says that means it will “be up to the next chairman to lead the exit from these extraordinary polices to avoid the inflation pressure building up.” Bernanke himself has been as tight-lipped about his future as he has been in public pronouncements as Fed chairman. Those close to him think he will end up at a think tank or university.

One thing is sure: He won’t be returning to the home Jonas and Pauline Bernanke built in Dillon, S.C., in the 1940s. In the 1990s, the last Bernanke to live in the large brick house on East Jefferson Street sold it. And in 2009, the house Ben Bernanke left all those years ago went into foreclosure.

Today, as his Bernanke Doctrine and long tenure as chairman are causing some to call the modern Federal Reserve “The House That Ben Built,” many pray that bit of local history doesn’t repeat itself on a national economic scale.

Inside The House That Ben Built

1921 ‣ Jewish immigrants Jonas Bernanke, 30, and his wife Pauline, 25, arrive at Ellis Island from Poland.

1945 ‣ The Bernankes pay $750 for a tract of land in Dillon, S.C.

1953 ‣ Grandson Ben Shalom Bernanke is born in Augusta, Ga.

1960 ‣ Bernanke’s father Philip buys home in Dillon from his father Jonas and moves the family there.

1975 ‣ Bernanke graduates from Harvard.

1996 ‣ Bernanke becomes chairman of the economics department at Princeton.

2002 ‣ President George W. Bush appoints Bernanke to Federal Reserve Board of Governors.

2005 ‣ Bernanke leaves the Fed to become chairman of Bush’s Council of Economic Advisers.

2006 ‣ Bush appoints Bernanke to 14-year term on Federal Reserve Board of Governors and four-year term as its chairman.

2009 ‣ President Barack Obama announces he will appoint Bernanke to a second term.

January 2014 ‣ Bernanke’s current term as chairman ends.

Buying in bulk

Quantitative easing (QE) is the practice where a central bank buys assets from financial institutions using money it creates. In 2010 the Federal Reserve began an open-ended purchase of mortgage-backed securities—known as QE1. QE2 followed in 2010 and QE3 began in 2012. Under Bernanke as chairman of the Federal Reserve, quantitative easing plans will add $1 trillion per year to the amount of assets under government control, bringing the total to $5 trillion by the end of 2014.