Whether the Fed chief and other central bankers were partly to blame or not, it fell to them to step up to the plate and save the West from banking oblivion.
They were forced to make a rapid series of agonizingly expensive and unpopular decisions—each time knowing that, if they put one foot wrong, they’d be professionally crucified on Capitol Hill, which operates with 20/20 hindsight.
So, you could argue that the central bankers have a motive for revenge. But they like to be known for their detached calm, systematic, evidence-based approaches to policy.
So, last Sunday, Ben Bernanke spent two hours trying to prove to fellow economists in Atlanta that low interest rates were not the main cause of the housing bubble. Yes the Fed should be open to raising rates against future bubbles, but his big policy conclusion was stronger regulation.
If the Fed chairman’s speech didn’t worry investors, his timing is interesting. Ben Bernanake now flies to Switzerland for a meeting with the world’s other central bankers.
Saturday’s invitation from the Bank of International Settlements specifically questions whether banks—using cheap money—are returning to the aggressive behavior that prevailed during the pre-crisis period.
Alan Greenspan might call it "irrational exuberance." But for Bernanake—having triggered a stock market rally, a hugely profitable dollar carry trade and record bonuses—it’s fair to assume his response will be … regulation. (Separately, the FDIC will discuss on Tuesday charging higher insurance rates to banks who reward "aggressive behavior.")
So what would tough, new international rules might look like?
Well, the Basel Committee’s already put some on the table. Two percentage points to capital ratios for "too big to fail" banks would force some Irish players into raising six times their market caps in fresh equity, according to Barclays Capital.
It adds that loan-to-deposit ratios at 100 percent could mean either a massive contraction in main street lending—or leave some banks chasing around to boost their cash deposits by up to 50 percent.
For main street America, higher savings rates would be a great structural change for retiring cash-rich baby boomers—and welcome relief for America’s other hard hit savers.
The obvious problem, however, for Bernanke & Co is that tough new rules like that would also effectively force banks to pull cash out of the economy—when we badly need them to lend more.
The quid pro quo could only be that the government replace that liquidity—the Fed keeping rates low and buying up Treasury bills.
Fannie Mae and Freddie Mac might already be about to pick-up from the Fed's trillion dollar-plus spending in the mortgage market. But that could prove a sideshow as the Fed's balance sheets blows to even more mind boggling proportions.