Jeannine Aversa: Wounded Bernanke wins second term – but at what cost?

The anti-bailout anger that eroded Bernanke's support in the Senate on Thursday night produced the most "no" votes ever on the confirmation of a Fed chairman. That could have lasting impact on the central bank's ability to manage the economy without regard to the political winds. To shore up his support, Bernanke made the rounds with congressional leaders, meeting privately with senators, including majority leader Harry Reid and Dick Durbin, the number two Democrat leader in the Senate, in the days leading to the 70-30 confirmation vote. Bernanke was in the awkward position of having to lobby for his own job and defend the Fed against efforts to strip it of some of its regulatory authority. Those meetings alone raise at least the perception of a Fed co-dependency with Congress. What, if any, assurances did Bernanke give lawmakers about interest rates and other Fed policies? Allan Meltzer, of Carnegie-Mellon University in Pittsburgh and author of a history of the central bank, says: "We don't know what Bernanke agreed to do in those meetings, what he promised. The Fed's job is to be independent, and the Fed isn't doing that." The Fed often must make decisions, such as raising interest rates to keep inflation in check, that are unpopular with individuals and companies. Its role in bailing out Wall Street banks to prevent a broader crisis angered the public, too. That's why economists say the Fed's political independence is essential to its mission. Its interest-rate policy can have huge consequences, affecting everything from large companies to a home buyer's ability to get an affordable loan, to the price of cereal. Any influence from the political arena risks compromising the Fed's credibility. Keeping rates too low for too long could unleash inflation and trigger another speculative bubble like the one in housing that plunged the US into a recession in the first place. Senate opposition to Bernanke intensified after Republican Scott Brown's upset victory in the Senate race in Massachusetts. That jolted congressional Democrats and led some to reconsider their support for Bernanke. His critics cast him as a symbol of the Wall Street bailouts. Kenneth Thomas, a lecturer in finance at the University of Pennsylvania's Wharton School, says: "This is a perfect example where the world of politics collides with the world of economics, and the result is not good." If the Fed were to lose credibility on Wall Street and from investors around the globe, it would fan inflation pressures and send up interest rates, choking the US – and global – economic rebound. Bank industry lobbyists say Congress's increased scrutiny could lead the Fed to weigh the political consequences of its regulatory actions. "They will be more aware of the political forces," says Scott Talbott, chief lobbyist for the Financial Services Roundtable, a trade group whose members include the largest banks. Bernanke's confirmation comes as Congress is writing an overhaul of financial regulations aimed at avoiding another financial crisis. A House of Representatives bill would remove its power to oversee consumer protections and subject it to a congressional audit. A Senate bill would create a single banking regulator that would strip the Fed of its supervision of bank holding companies, such as Citigroup, Goldman Sachs and JPMorgan Chase. Even Bernanke's supporters worry about the long-term consequences of his nomination fight. It sends "the message that the Federal Reserve and its monetary policy decisions are under the thumb of Congress," says Democratic senator Chuck Schumer, who voted for Bernanke. The Fed wasn't always independent. The US treasury secretary used to serve on its board. Congress changed that in 1935. And past Fed chairman have battled with Congress and presidents. Some lawmakers called for Paul Volcker's to go when the country was gripped by soaring inflation and high unemployment in the late 1970s and early 80s. President Lyndon Johnson was so angered by a Fed rate increase that he feared would make it too expensive to expand social programmes and fight the Vietnam War that he ordered staff to find a replacement for its chairman William McChesney Martin. But Martin refused to yield and didn't back down on the rate increase. He became the longest-serving Fed chairman ever. President Harry Truman also tried to influence the Fed to keep rates low. He summoned the Fed's policy-making committee to the White House, the first and the only president to do so. Bernanke himself may have hurt the Fed's independence by involving the central bank in deciding to bail out some Wall Street banks but not others, such as Lehman Brothers. The Fed's involvement began in 2008 with its financial backing of a deal letting JP Morgan take over ailing investment house Bear Stearns. But the biggest of all bailouts was for insurance giant American International Group (AIG). Eventually, government lifelines to the company would total some $182 billion (113bn). The Fed provided a $60bn line of credit to AIG. "The Fed sacrificed its independence long ago," says Meltzer.