Pater Familias

A VOICE FROM 1873. An article in yesterday’s New York Times by Edmund L. Andrews is headlined: “Fed Chief Shifts Path, Inventing Policy in Crisis.” and continues in the text that: “Mr. Bernanke [Ben Bernanke, the Chairman of the Federal Reserve Bank] is inventing policy on the fly.” The policy change was in connection with a Fed bailout of Bear Stearns. The novelty in the policy is that the Fed is buying a different kind of security than is its custom: “In a move that would have been unthinkable until recently, the central bank agreed to accept potentially risky mortgage-backed securities as collateral.” Kids, from another point of view, what the Fed is doing — even the acceptance of potentially risky collateral — is in accordance with the traditional role of a central bank. In 1873, Walter Bagehot wrote LOMBARD STREET, which set forth his concept of the role of a central bank (the Bank of England for Bagehot; now in the United States, the Federal Reserve Bank). Bagehot argued that in a credit crisis, the central bank should act as the Lender of Last Resort. Meyer Burstein in MONEY summarized: “Bagehot showed a fine appreciation of what has come to be the accepted doctrine of central bank behavior during a domestic crisis of liquidity: namely to stand ready to purchase broad ranges of securities, damping cumulative speculative forces feeding an internal drain.” Burstein noted that Bagehot wanted the Bank of England to lend on a very broad base of collateral, which is what the Fed has just done.

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