Wednesday, February 14, 2007

For Bernanke, Capitol Hill's No Easy Street

News Analysis
February 14, 2007

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For Bernanke, Capitol Hill's No Easy Street

The Fed chief returned to give upbeat news on the economy to lawmakers. Wall Street cheered, but Dems remain skeptical

Ben Bernanke had little trouble winning the heart of the stock market on Valentine's Day. Shortly after the Federal Reserve chairman began his two-day testimony to Congress, the Dow Jones industrial average climbed to a new all-time trading high (see, 2/14/07, "Dow Hits New Record after Bernanke Speaks"). While Wall Street and economists cheered, lawmakers on Capitol Hill would prove trickier to satisfy.

A year into his chairmanship, Bernanke returns to Washington for his semiannual remarks backed by new credibility. The economic "soft landing" his Fed outlined in previous testimony and policy statements has been borne out in recent data releases. In Bernanke's Feb. 14 comments before the Senate Banking Committee, the no-longer-so-new Fed chief solidified his role as a plain-speaking central banker with modest policy goals.

Improved Performance

Bernanke used straightforward English to describe an economy with moderate growth, gradually cooling inflation, and some early signs of stability in the housing market. He answered senators' questions for more than two hours on such topics as entitlement spending, corporate regulations, and trade deficits, but largely steered away from offering fiscal policy prescriptions.

In short, Bernanke hit his marks, but he still has his work cut out for him. "He's established his credibility," says Peter Rodriguez, a Darden Graduate School of Business economist and one of Bernanke's former students. "Now it's onto making himself known for deeper changes."

The Fed chief's market-boosting performance was particularly notable in light of his earlier missteps. In Bernanke's first policy meeting as chairman, the Federal Open Market Committee surprised hopeful traders with hawkish language and an interest-rate hike. Later, the meeting minutes and Bernanke's Apr. 27, 2006, congressional testimony sent Wall Street conflicting signals. When Bernanke went on to tell CNBC reporter (and BusinessWeek columnist) Maria Bartiromo the markets had misread him, investors were in uproar.

"A Little Inadequate"

These days, Bernanke may have found a balance between transparency and too much information. "Since the [2006] second quarter, he's done a fairly stellar job of communicating the Fed's position to the market and of guiding the FOMC's outlook on growth and inflation," says Michael Englund, chief economist at Action Economics. For now, the Fed intends to remain on the sidelines, Bernanke made clear in his Feb. 14 testimony, but higher-than-expected inflation could prompt further rate hikes.

In the question-and-answer session that followed Bernanke's testimony, members of the Senate Banking Committee pressed the Fed chief for his views on a variety of issues outside of monetary policy. Some of the harshest questioning came from Senate Banking Committee Chairman Christopher Dodd (D-Conn.), who asked the Fed chief about deceptive lending practices. Bernanke said regulators were considering the issue—a response Dodd criticized as "a little inadequate."

Bernanke gave lawmakers greater detail on some of their other concerns. He reiterated his recent warnings on the rising costs of entitlements like Medicare, expressed support for opening foreign markets, and said China needs to do more to improve its currency policy. However, he stopped short of giving legislators specific policy advice. "Perhaps one of the things Bernanke is trying to do here is keep the testimony today on topic," says Conrad DeQuadros, senior economist at Bear Stearns (BSC).

As Good as Your Data?

The Fed chairman's clear syntax and reluctance to venture beyond monetary policy put him in stark contrast with legendary predecessor Alan Greenspan, the famously cryptic "maestro" whose support for President Bush's 2001 tax cuts likely helped get them enacted. Some economists say avoiding matters of fiscal policy, though a laudable goal, may be easier said than done for Bernanke. "You now have a Congress that's conditioned to get the Federal Reserve chairman to talk about almost anything," says Alan Blinder, a Princeton economist and former vice-chairman of the Federal Reserve.

The new Democratic majority in Congress could pose other challenges for Bernanke. Some analysts expect the Fed chief to receive a grilling in the Feb. 15 Q&A session with the House Financial Services Committee, chaired by Barney Frank (D-Mass.). Meanwhile, it may take time to get a fresh set of congressional leaders to support one of Bernanke's key goals, publicly announced inflation targets (see, 11/7/05, "The New Fed"). "You have to develop new relationships," explains Stephen Cecchetti, a professor at Brandeis International Business School.

On the other hand, Bernanke's reputation on Wall Street may only be as good as the latest readings on the major indexes, other economists observe. Bernanke's emphasis on transparency may earn him favor from economics professors and foreign central bankers, but "it doesn't mean a thing to Wall Street," says Nobel laureate Paul Samuelson. "Wall Street wants him to be very transparent-on their side."

Inflation Wariness

Bernanke's biggest challenges are probably still to come. So far, he has shepherded the economy through a housing slowdown and volatile oil prices, but he has yet to face a large-scale financial crisis. "He gets a good grade for basically taking a stable situation and managing it well," says Johns Hopkins economist Laurence Ball. Sooner or later, unforeseen circumstances may force Bernanke to prove his mettle.

Inflation remains a possible concern. The Fed's forecasts for core inflation this year remain above Bernanke's stated comfort zone of 2%. With the housing market apparently stabilizing, some economists wonder what the catalyst could be for a drop in inflation—other than interest-rate hikes. At the same time, a sudden spike in oil prices could slow economic growth and drive inflation higher in a dangerous combination.

For now, investors are applauding Bernanke as an able and highly qualified successor to the maestro: The Dow finished at an all-time closing high on Feb. 14. "He deserves a good pat on the back," says Jeff Kleintop, chief investment strategist at PNC Wealth Management. But facing a skeptical group of lawmakers in the second and final leg of his February testimony, Bernanke may get a far different reception.

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