What does it mean for the Federal Reserve Board to show leadership in a crisis? Judging by Wall Street's recent clamor for lower interest rates, it would appear that it can mean only one thing: The Fed should come to the rescue, no matter how much the disaster is of Wall Street's own making. That's the perception of how things worked under former chairman Alan Greenspan, who slashed interest rates after the stock market crash of October 1987, orchestrated a bailout for the Long-Term Capital Management hedge fund in 1998 - and pursued what looks, in hindsight, like an overly accommodating policy toward the housing boom of the last few years.
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Like his predecessors, Mr. Greenspan faced a dilemma: Economics says that government should let the market deal out condign punishment to those who make bad business decisions; but if too many people have to pay for their mistakes all at once, it can wreck the economy. An art of central banking is to prevent panic without appearing to guarantee bailouts.
Events of recent weeks suggest that the housing sector has been bubbling on easy credit and that Wall Street, which eagerly underwrote the subprime boom, did not learn the right lessons from previous meltdowns. Or, as Mr. Greenspan's successor, Ben S. Bernanke, put it in a careful but clear speech on Friday, "Some increase in the premiums that investors require to take risk is probably a healthy development on the whole, as those premiums have been exceptionally low for some time."
Mr. Bernanke has approached the subprime mortgage crisis with considerable common sense. In mid-August, he spoon-fed billions of dollars worth of short-term credit into the banking system to prevent a sudden collapse. Beyond that, he has remained calm, notwithstanding the pleadings of talking heads on CNBC and gyrations in the stock market. Mr. Bernanke made it clear that he "stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets" but "it is not the responsibility of the Federal Reserve - nor would it be appropriate - to protect lenders and investors from the consequences of their financial decisions." The Fed is aware of the risks to the overall economy and ready to cut rates if data show that's necessary. But with revised second-quarter figures showing that the economy grew at over 4 percent, Mr. Bernanke is clearly not quite convinced that the time is right to bathe Wall Street's wounds in a fresh supply of cash.
In short, the chairman's speech delivered a much-needed admonition to the financial community, without ruling out a rate cut if the interests of the country as a whole require it. Through the crisis of the moment, he is keeping his eye on the long-term health of the U.S. dollar. For a man in Mr. Bernanke's position right now, that is a pretty fair definition of leadership.