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Bernanke's response to sell-off wins kudos

The Fed chairman's calmness before a House panel is seen as helping to stabilize markets.

March 01, 2007|Joel Havemann | Times Staff Writer

WASHINGTON — With his message to the markets not to panic, Federal Reserve Chairman Ben S. Bernanke in effect signaled Wednesday that the central bank would again stand ready to try to head off any major financial crisis, analysts say.

Bernanke told the House Budget Committee the day after Tuesday's global stock sell-off that the economy was in good shape and that the Fed was monitoring the markets. Stock market operations "seem to be working well," he said, adding that "there's a reasonable possibility that we'll see some strengthening of the economy sometime in the middle of the year."

Analysts saw his words and calm body language as an apparent signal that the Fed would be ready to provide cash or other support in case Tuesday's plunge escalated into a meltdown that threatened the global financial system. That would continue a practice under Bernanke's predecessor, Alan Greenspan.

Under Greenspan, the Fed had provided financial support to ease the effect of several crises, including the 1987 stock market crash, the 1997 Asian financial crisis and the 1998 collapse of hedge fund Long-Term Capital Management.

The 1987 market crash, which greeted Greenspan two months into his term and drained the stock market of about one-fifth of its value in a single day, was widely thought at the time to be a precursor of recession. But the former Fed chairman, beginning to establish his reputation for working miracles, avoided what seemed to be inevitable by guaranteeing to temporarily pump enough money into the economy to keep it from collapsing.

That policy became known as the "Greenspan put" because it implied that investors didn't have to buy so-called put options in markets to cushion themselves from a tumble. In today's context, such a safety net could protect the economy from the growing woes in the sub-prime mortgage market.

But it could also backfire by encouraging big investors such as hedge funds to take undue risks, knowing that they or the financial system would be bailed out in the end, some experts say. Many analysts said Tuesday's market sell-off was primarily the result of a realization that investors globally were taking outsized risks with their money.

Most analysts and investment advisors agreed that Bernanke's demeanor helped to minimize the risk that Tuesday's stock sell-off would snowball.

Nariman Behravesh, chief economist at research firm Global Insight, said Bernanke's stance -- soothing, but with no explicit promise of injecting new money into the financial system -- was just right for the situation.

"We're a far cry from 1987, when the Fed was facing a 23% drop in the markets in just one day, with another big drop to come four or five days later," Behravesh said. Tuesday's 416.02-point drop in the Dow Jones industrial average was a much smaller 3.3%.

"Bernanke exudes calm. He plays the role well," said Mark Zandi, chief economist at Moody's Economy.com. "He's clearer than Greenspan and articulates his points in clear terms."

Zandi said the global economy was much more complicated now than in the 1987 crash, and that not even the U.S. was powerful enough to steer it single-handedly.

"In times past, the genesis of crises was overseas," Zandi said. "Now most imbalances are of our doing -- the trade and budget imbalances. In past crises, we've been a safe haven for the world's money, but now if capital flows out of the United States because other markets seem more secure, we'll have a whole different set of problems."

Ironically, Greenspan's use of obscure language, which contrasts sharply with his successor's more common touch, may have contributed to the immediate problem facing Bernanke.

"When you get this far away from a recession," Greenspan told a Hong Kong business conference over the weekend, "invariably forces build up for the next recession, and indeed we are beginning to see that sign."

Greenspan seemed to be predicting a recession around the corner -- except that he turned around and said, "It's very precarious to forecast that far into the future -- six to eight months is a very long time."

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joel.havemann@latimes.com

Times staff writer Molly Hennessy-Fiske contributed to this report.

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