As the government’s efforts to save the financial system from impending ruin reached a high-water mark Friday, economists took a step back and offered tentative assessments of the Federal Reserve’s conduct through this year-long crisis.

By and large, they say, the central bank, in conjunction with the Treasury Department, has responded appropriately to an unprecedented stream of crises, and has likely warded off a truly monumental meltdown.

[Ben Bernanke]
Bernanke

To be sure, it is far from clear that the worst has passed, and much uncertainty surrounds the outlook, particularly given the lack of detail in the government’s sweeping rescue plan. Still, economists say there are plenty of reasons to be hopeful.

“The way the financial markets were heading threatened to create the sort of permanent damage to the financial system we saw in the 1930s,” when the Fed reacted passively to failing banks, said Dana Johnson, chief economist with Comerica.

“To head off the potential damage… it was appropriate to do everything in [the Fed’s] power” to avoid a similar outcome, he said. Johnson views the Fed’s historic initiatives as a “magnificent reaction” to what policy makers have confronted.

Industry group the Business Roundtable said in a statement that Friday’s actions were “appropriate and timely,” and it argued for a “comprehensive” review of the nation’s financial regulatory structure.

Tyler Cowen, an economics professor at George Mason University, said Fed Chairman Ben Bernanke and Treasury’s Henry Paulson “have been making good decisions, relative to a very bad starting place.” Given the nature of the troubles, the two officials started in a “very unfortunate position,” so “it’s very hard to second guess particular decisions,” he said.

One Federal Reserve veteran sees the Fed’s response throughout the crisis as entirely appropriate, but less dramatic than others. Indeed, for CarnegieMellon Tepper School of Business economics professor Marvin Goodfriend, a former Richmond Fed top economist, “the central bank has always had at its disposal two broad policies.”

One is very well known and understood. Monetary policy aims to control inflation and influence growth via the control of short term interest rates, he said. Then there’s the less understood and codified credit policy, which has come into play as the Fed’s extended loans to various parts of the financial system. He reckons officials will need to think about and explain more fully this part of their arsenal, and that illuminating this issue will feature prominently in central banking analysis as the crisis is resolved.

Still, not all are happy with the path charted by the Fed and Treasury. Former St. Louis Fed president and current Cato Institute scholar William Poole said in an interview he believes the Fed did the right thing when it bailed out Bear Stearns last spring and granted an emergency loan to AIG this week, and it was correct in letting investment bank Lehman Brothers go into bankruptcy.

But moves to support the money market funds in a fashion similar to what’s afforded bank deposits, along with mechanisms to gather up and dispose of bad securities — that’s a bad thing, Poole said. He reckons the money market fund support will unnecessarily drive risk-taking in a competitive sector of the market, now that fund managers know their investors will be bailed out in the event of bets gone sour.

But the bigger problem is the plan to buy stricken assets from banks. “The euphoric market reaction to this vague idea doesn’t make that much sense to me,” Poole said. The government will have an extremely difficult time finding appropriate prices for the troubled securities and is likely to be saddled with the absolute dregs of the financial system that will prove very expensive to unload, he said.

“I don’t think it’s possible to do it right,” Poole said, and “when the costs become obvious there will be a whole lot of finger pointing.”

[Henry Paulson]
Paulson

Poole also argued it’s entirely possible that the resolution mechanism may not even be needed, and that the recent string of bank failures may well be coming to an end.

Others worried about the risks the Fed’s balance sheet may be facing, although some central bank officials have sought to downplay such fears. They can even point to the $29 billion in securities the Fed acquired as part of the Bear Stearns bailout, which thus far have not lost value.

The American Bankers Association was also negative on the most recent Fed and Treasury actions, saying that they “will undermine the role of banks during this credit crisis and [have] the potential to have an extremely negative impact in the future.”

Still, those views do not appear to hold dominate sway among economists. CarnegieMellon’s Goodfriend said the nation has been “quite fortunate” in having Bernanke at the Fed’s helm, with his academic career so heavily based in understanding the lessons of the Great Depression. “No one could have expected him to do better,” Goodfriend said. –Michael S. Derby