In discussing parallels between the Great Depression of the 1930s and the Great Recession that defined his term as chairman of the Federal Reserve System, Ben S. Bernanke quoted Mark Twain: “History doesn't repeat itself,” he said, “but it rhymes.”
During a far-ranging discussion at Columbia University in May to accept the 2016 George S. Eccles Prize for Excellence in Economic Writing, Bernanke noted that the first-blush similarities between the two economic cataclysms seemed remote. The financial crisis of the Depression era was triggered by a retail run by bank depositors, a danger unlikely to recur thanks to today’s FDIC insurance on bank accounts. The economic morass that began spreading in 2007, on the other hand, seemed far more complex, with its catalyst of subprime mortgage-based derivatives and interconnectivity of the global financial system.
In The Courage to Act: A Memoir of a Crisis and Its Aftermath (W. W. Norton & Co., 2015), the book for which he won the Eccles award, Bernanke said he was determined not to repeat the do-nothing stance of his predecessors, which he believes significantly deepened the Great Depression. He stressed that all the actions taken by the Fed were aimed not at bailing out bankers and shareholders but at keeping the financial system and thus the broader economy functional.
“Economists tend to think in an abstract way,” he said, “but I tried to recall my roots.” As a teenager, Bernanke stocked shelves in his father’s pharmacy, worked construction, and waited tables near his hometown of Dillon, South Carolina. “I went into economics because it was interesting, but also because I believed it could be a tool for making people’s lives better,” he said.
The format of the Columbia visit involved a discussion with Glenn Hubbard, dean of the business school and a long-time colleague who appears as a player several times in his book. (Bernanke expected Hubbard to get the nomination as Fed chief when he was named instead.) Hubbard began by paraphrasing a question posed by the Queen of England about the recession: “Why did nobody see it coming?”
“What we didn’t recognize immediately was the vulnerability of the system to a run of short-term funding,” explained Bernanke, who is known for his scholarship on the 1930s. “This crisis involved a 21st century electronic panic by institutions,” rather than depositors lining up at bank doors. “It was an old-fashioned run in new clothes.”
The Fed responded by providing liquidity to the financial system through a variety of programs. It also lowered short-term interest rates, beginning in 2007 when inflation was still a concern and the recession was little more than a rumor. The intent was to try to offset the effects of the deepening financial panic on output and jobs. But as rates plunged from a 2006-era high of 5.25 percent to effectively zero by 2008, and as the first bank failures began piling into the multi-car collision that ensued, “the space to cut rates alone was not adequate,” Bernanke reflected. “We would venture into uncharted waters.”
Efforts included large-scale purchases of mortgage-backed securities and Treasuries, so-called quantitative easing. The Fed also invoked its emergency lending powers to provide critical funding to the troubled financial system and to help avoid the collapse of Bear Stearns, AIG, and other large firms. “We did what central banks are supposed to do,” Bernanke said. “We provided liquidity.”
Starting in 2009, the Fed moved into its phase of restoring confidence in the financial system by stress-testing the balance sheets of large banks. Results on individual institutions were made public, and those that lacked adequate assets were required to raise capital or accept high-interest government funds with strings attached.
“We Are Safer Now”
Although he expects another economic crisis will inevitably hit, Bernanke said the United States has developed far more adequate tools to fight the next big financial crisis, including new authorities for resolving a large, failing financial institution without taxpayer bailouts or a destabilizing impact on the broader financial system.
“Probably the greatest change” since 2007, said Bernanke, “has been a mental shift among regulators. We now take a more systemic view of the financial system as a whole. And reforms have made the system more stable, including the fact that banks must hold far more capital.”
Bernanke, who now spends his time as a distinguished fellow in residence at the Brookings Institution, suggested that many of the tools developed for the Great Recession “likely will go back on the shelf” when the economy returns to normal, and “monetary policy once again will consist mostly of changing short-term interest rates.” And the one-time head of the Fed is more than okay with that more modest stance.