Decision Time for Bernanke

Ben Bernanke is having a tough time deciding whether or not to put his foot on the economic gas pedal or step on the brake, so he's doing a bit of both.

Federal Reserve Chairman Ben S. Bernanke’s efforts to stoke a U.S. economic recovery may be undermined by the central bank’s other goal of restoring the banking system to health.

The Federal Open Market Committee, at the conclusion tomorrow of a two-day meeting, will probably maintain its assessment that “tight” bank credit is impeding growth. Lending contracted for five straight weeks through Sept. 9, a drop that in part reflects Fed orders to banks to raise more capital and toughen lending standards, analysts say.

A failure to restore the flow of bank credit carries the risk that the economic recovery will be slower than the Fed anticipates, or even that the U.S. lapses into another recession, economists say. That would make it more likely the Fed will keep its main interest rate close to zero for a longer period.

“They would be absolutely delighted if banks went out and raised a lot more private capital and then began to lend more,” said former Fed Governor Lyle Gramley, now senior economic adviser with New York-based Soleil Securities Corp. “Until that happens, the Fed has to continue to try to encourage economic growth through easy money.”

The reason why the banks don't raise a lot of private capital and do more lending is that if they do the payoff is likely to get hammered by Congress and get their pay cut. This is where the game-playing and political posturing by Congress is really causing problems. If you are a banker, why take the risk? If it works out, you get hammered. If it does not, you get worse. You can't win.

In the meantime, Bernanke tells the banks to tighten their capital and lending practices, and has to keep things moving with the near zero policy on the discount rate. All the while GDP continues to shrink and unemployment grows.