By Calev Ben-David and Rich Miller
Dec. 22 (Bloomberg) -- Bank of Israel Governor Stanley Fischer likened Bernard Madoff’s alleged $50 billion fraud to the global financial crisis: in both, sophisticated investors missed warning signs that something was awry.
“You get into a way of thinking,” Fischer, who’s been a student of the world economy for the past quarter century as an academic, banker and policy maker, said in an interview at the central bank’s Tel Aviv offices. “You get into a way of accepting things that people do.”
Investors who placed their money with Madoff were lulled into complacency by his consistent returns, while those who piled into mortgage-backed securities were aided by AAA ratings that proved as flawed as forecasts of rising house prices.
Fischer, who advised Federal Reserve Chairman Ben S. Bernanke on his doctoral thesis at the Massachusetts Institute of Technology in 1979, said the U.S. economy has yet to feel the worst from the financial turmoil.
“This is going to be tough,” Fischer, 65, said. “The worst of the real side is yet to come.”
St. Louis-based Macroeconomic Advisers forecasts that the U.S. economy will shrink at a 6.5 percent annual rate this quarter and a further 4.2 percent in the first quarter of next year.
Fischer, who was first deputy managing director at the International Monetary Fund during the 1997-98 Asian financial crisis, saw a risk that today’s turmoil creates a deflationary spiral in the U.S. and world economies, in which prices, wages and demand all fall.
Present Danger
“It’s a danger at the moment,” the central banker said, adding, “We’re not there yet.”
U.S. consumer prices dropped a record 1.7 percent in November, though Fischer pointed out that was mainly due to falling energy prices.
Whether deflation takes hold will depend on how successful Bernanke and other policy makers around the world are in reviving their economies, he added.
Watching his former student from a corner office in the bank’s drab, off-white building in downtown Tel Aviv, Fischer said Bernanke was putting the lessons he learned analyzing the Great Depression to work.
As the crisis deepened, the Fed chairman launched programs aimed at getting credit flowing in the economy, including providing a backstop for the $1.7 trillion commercial-paper market that companies use to finance their day-to-day operations.
Student of Depression
“Bernanke’s work was on the collapse of the credit mechanism during the Great Depression,” Fischer said. “So he’s much more keenly aware of that as a critical factor than almost anyone else.”
The Fed last week cut the main U.S. interest rate to as low as zero and shifted its focus in trying to resuscitate the economy to the amount and type of debt it buys. The moves were reminiscent of those taken by the Bank of Japan in the early part of this decade as it struggled to end the deflation gripping that country’s economy.
Fischer argued that Bernanke stands a better chance of succeeding than did Japan. Not only has the Fed chairman focused his efforts on reviving credit flows, he also moved more quickly to cut rates to near zero.
President-elect Barack Obama also looks likely to be much more aggressive than the Japanese government in using fiscal policy to turn the economy around, Fischer said.
An Obama adviser, who spoke on condition of anonymity, said last week that Obama may ask Congress for a stimulus plan of about $850 billion.
Japan Comparisons
The actions “are on a completely different speed and scope than was attempted in Japan,” Fischer said. “If there’s a critical difference, it’s that.”
He said the Bernanke Fed has also begun to act in a small way as lender of last resort for the world economy by setting up currency swap lines with more than a dozen other central banks to provide them with dollar liquidity.
Following a career as an academic, policy maker and banker in the U.S., Fischer became governor of the Bank of Israel and a citizen of the country in 2005. Born in Zambia, he studied at the London School of Economics and earned his doctorate in economics at MIT.
While Fischer isn’t a native Hebrew speaker, he insists on conducting all public business in his adopted language. While the bank’s headquarters are in Jerusalem, Fischer usually works Thursdays in Tel Aviv, the country’s financial center.
After spending 19 years teaching at the University of Chicago and MIT, Fischer joined the World Bank in 1988 as chief economist. He later went on to the IMF as the second in command before becoming vice chairman of Citigroup in 2002.
Inflation, Peace
Fischer is the author of a variety of books on economics, including “Indexing, Inflation and Economic Policy,” published in 1986. He also edited a number of books, among them “Securing Peace in the Middle East,” which came out in 1994.
As Bank of Israel chief, Fischer has presided over the strongest run of economic growth in Israel’s sixty-year history. The shekel gained as much as a third against the dollar, ending a 30-year tradition among Israelis of linking the prices of homes and services to the U.S. currency.
Outside his office, on Lilienblum Street, black-market money changers openly bought and sold dollars during the 1980s as inflation surged. Consumer prices rose 4.5 percent this November from a year earlier, down from 5.5 percent in October. Inflation reached almost 500 percent in 1984.
Rate Reductions
While Israeli economic growth has outpaced most of the developed world this year, growing at a 2.3 percent annual rate in the third quarter, Fischer has cut the bank’s benchmark rate four times in the past 10 weeks to a record low 2.5 percent to buttress growth.
He said IMF has to assume a bigger role in helping to manage global crisis, though it needs more cash to do so. The fund lent more money last month than it did in the past five years combined, to economies as diverse as Iceland and Pakistan.
“Because global capital flows have increased enormously, its financing looks small relatively to the current needs of the situation,” Fischer said.
He voiced hope that China would follow the lead of Japan and pledge to provide some of its currency reserves to the IMF, perhaps in return for a bigger voting share at the fund.
Editor: Daniel Moss, Brendan Murray
To contact the reporter on this story: Calev Ben-David in Jerusalem at cbendavid@bloomberg.net;
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