The Federal Reserve and the Financial Crisis Kindle Edition

In March 2012, former Federal Reserve Chairman Ben S. Bernanke delivered a series of lectures to an audience of students and faculty at George Washington University, in Washington DC. The four lectures that Mr. Bernanke gave was a summarized history of the Federal Reserve system, how it came into being, and why it was needed. Mr. Bernanke's book is very short, 134 pages including index, and yet, it's brevity, and the sharpness of the picture which Mr. Bernanke paints of the Fed's mission and history makes it essential reading for anyone wanting to voice an opinion about the American financial system and its near collapse in 2008. I would include every member of Congress and their principal aides; every senator and their principal assistants; every committee chairman and committee chief of staff; every newspaper publisher and media executive, editor, and staff writer; and every media commentator.It should also be required reading in every high school and college or university course teaching the basics of American government and political economy. The subject is as fundamental as knowing and understanding the American form of constitutional government. It is that important.Because his book is the product of lectures that Mr. Bernanke gave, lectures that were transcribed and edited for separate publication apart from his appearance before a university audience, he does not go into extensive detail about the Fed's history, its powers and responsibilities, and the existential threat to the American economy that was blunted only because the Federal Reserve was able to marshal the resources needed to rescue the American banking system from the consequences of the nation's leading bankers' excessive risk-taking that led to the collapse of the home mortgage market, a collapse that collectively threatened to tank the American economy as a whole. That we came away from the experience with a deep and painful recession instead of an economy-destroying depression is a tribute to Mr. Bernanke's and his colleagues' indefatigable efforts.Mr. Bernanke begins with a description of a central bank, what it is, and how it operates central banks, he says, are government agencies that stand at the center of a country's monetary and financial system. Historically, they have helped to guide the development of their modern financial and monetary systems, and they play a major role in economic policy. Every major country has a central bank, whether it is the Fed, the Bank of Japan, the Bank of Canada, the Bank of England, the European Central Bank, which acts as the central bank for the European Union, the 17 European countries that share the euro as their common currency, and so on.Central banks, broadly speaking, have two principal missions or functionalities, of which the first is achieving macroeconomic stability; Mr. Bernanke says that macroeconomic stability includes achieving stable growth in a country's economy, avoiding big swings, meaning drastic upturns and downturns of the national economy that in the past have led to uncontrolled inflation and rampant speculation when an economy is going up, and when it is going down, severe economic distress caused by contraction of credit leading to loss of jobs, bank runs, and business failures. That, essentially, was the history of the American economy between 1836, when then-President Andrew Jackson destroyed what was then America's central bank, until 1913, when newly-elected President Woodrow Wilson, ironically, himself elected on the Democratic ticket, signed legislation that had been in the works for more than a decade, thus creating the Federal Reserve system, and giving the American government for the first time in its history the ability to take counter-cyclical measures to ameliorate the worst consequences of the boom-and-bust business cycles that had previously destroyed tens of thousands of previously stable and business-worthy banks and business firms that had to close their doors because they lost access to credit at affordable interest rates through no fault of their own. The consequence of those business failures inevitably meant that tens of millions of bank and business customers lost their jobs, their savings, and frequently, their homes and their farms.It is that loss of bank and business liquidity that brings us to the second reason why we have central banks; they are the lenders of last resort who are able to provide emergency loans at reasonable rates to banks and business firms who suddenly find themselves cash-poor at critical moments because their financial reserves are tied up in business loans and mortgages, in the case of banks, and business inventory and other illiquid assets that cannot be disposed of by their owners without taking drastic losses of value if they have to be sold in distress sales, typically bankruptcy auctions forced mergers, mortgage foreclosures, and the like. Before 1914, an American bank's liquidity was only as good as the amount of cash it had on hand to pay off any depositor who might be concerned about the safety of his account with that bank. In the parlance of the times, when crowds of bank customers lined up at the teller window demanding their deposits back, the term that was used was 'a bank panic' because it was fear and aversion to risk that drove depositors to demand their money back, lest the bank shutter its business before they could get their money out. The so-called 'panics' had the effect of economic earthquakes that sent shockwaves out to any and all banks, businesses, and commercial customers with whom the banks had business dealings. Banks under siege by crowds of panicky depositors would soon run out of money, and the only way they could raise money would be to call the loans that they had written to their customers, and to withdraw funds on deposit in the large city banks with whom they had been transacting business to facilitate the purchase and sale of agricultural products and commodities, raw materials, and other goods and services in distant cities and states.Mr. Bernanke mentions in his first lecture a British journalist, Walter Bagehot, who articulated the fundamental rationale for making the central bank 'the lender of last resort'. Bagehot reason that in times of financial panic, only a relative few business firms were actually insolvent, but in a cash, or near cash economy, a stable business would always need credit to cover its payment obligations, and even if the firm has sufficient assets to cover its debts, those assets might not necessarily be readily convertible to cash. If the firm had to do so, typically it would take a drastic loss, thereby jeopardizing its economic health. Bagehot's dictum was that in times of panic, a bank should always loan money to a business firm if that firm's collateral was good. The customer pays a slightly higher interest rate for the privilege of borrowing emergency funds, but on balance it preserves the value of the collateral against a forced sale.Mr. Bernanke then goes on to give what amounts to a thumbnail sketch of the economic history of the United States with respect to the six bank panics and the ensuing business failures leading that occurred between 1873 in 1914. The Panics of 1893 and 1907 proved to be particularly severe because of the increasingly industrialized character of the American economy as compared with the decentralized, agrarian economy that was prevalent before the Civil War. In 1893, five hundred banks closed their doors; in 1907, fewer banks failed but those that did were larger.Another problem that Mr. Bernanke discusses was the gold standard. In certain conservative quarters, gold is the ultimate commodity of value going back to ancient times. The problem is that in the modern world, gold is one of many indicators of value, but tying a nation's currency to the value of gold makes it inflexible, and having to transport gold from one place to another, whether in coin or bullion, great severe logistical problems, not to mention risk of loss from theft or natural disaster.Mr. Bernanke goes on to describe the essential structure of the Federal Reserve system, consisting of a central headquarters in the nation's capital, Washington DC, but overseeing a system of 12 Federal Reserve Banks, each of which services a particular district or region within the continental United States. Through a series of charts and graphs, Mr. Bernanke describes what happened during the 1920s through the end of World War II, and he notes that during the Fed's first 35 years of existence, the Fed was dominated by the old economic thinking, and it did not use its powers either to develop and guide economic policy, nor did it fulfill its function as lender of last resort. Consequently, the depression that we suffered during the 1930s was much more severe than it needed to be.In his second lecture, Mr. Bernanke brings the Fed into the post-World War II world. This was the period of the Cold War, where the United States used its economic clout as a cudgel against the Soviet Union. United States was now using its economic and industrial prowess in a strategic effort to offset and undermine the Soviet Union's military advantages in manpower and arms production. That effort eventually proved to be successful when the Soviet Union could no longer compete with the United States economically.Mr. Bernanke concludes his second lecture by describing the Fed's efforts to control and thereafter eliminate inflation from the American economy. The Fed's raising of interest rates caused a great deal of short-term pain, but ultimately the efforts of its then-chairman, Paul Volcker, proved successful. What came afterward has been called, 'The Great Moderation', in which the peaks and valleys of economic activity occurring between 1984 and 2006, as represented by changes in the interest rates charged to member banks, tended to remain quite consistent over time. That consistency was also reflected in the Consumer Price Index as it existed between 1986 and 2007, reflecting a relatively low level of volatility.But, the Great Moderation's extended stability and low inflation came at a hidden cost, which Mr. Bernanke makes clear to the end of his second lecture. For those making higher incomes, price stability and low inflation made finding productive investments for rising incomes difficult to find. Additionally, wealth generated elsewhere in the world found its way into the American economy looking for better investment opportunities than were available in its countries of origin. That new money found its niche in the American housing market, particularly for single-family homes, wherein prices of existing houses trebled between 1980 and 2007. That housing bubble was facilitated and accelerated by the mortgage finance industry's use of residential home mortgages to create new forms of investment through collateralization and sold as bundled obligations to investors seeking higher returns, whatever the risk. These were entirely new instruments whose complexity and opacity defeated any form of reasonable analysis, and bad mortgages were bundled with the good so that no one could objectively determine whether the bundled mortgages, or any particular tranche within them, would be likely to default. The banking industry itself appeared to drop all pretense of reviewing mortgage applications to determine whether prospective borrowers would be capable of repaying their loans. As the buying mania got higher, properties would be 'flipped', passing from buyer to buyer to buyer, and increasing in paper value with each turnover.In addition to the housing market, the securities industry developed other types of opaque and exotic financial instruments that were far too complex to be understood. It became common knowledge that newly-minted PhD's in mathematics and physics sought and found employment not in their areas of scientific expertise, but rather in the financial services industry crafting algorithms in which highly sophisticated mathematics played a central role in designing these new types of investments.The securities industry itself, in the form of the rating companies, like Standard & Poor's, had an insurmountable conflict of interest because they were being paid by the securities issuers to bless their products with a AAA rating, the highest and safest rating available.From a regulatory standpoint, Mr. Bernanke makes clear that government agencies charged with the administration of the securities and banking laws were both outgunned and outmaneuvered by both outdated laws that parceled out different regulatory responsibilities among a number of different government agencies, each with a different regulatory focus, no common plan, and perhaps worst of all, no common understanding of what was happening to the economy as a whole. Intermediate steps that could have been taken along the way that would have thwarted some of the worst abuses were not taken either because the agency staff lacked the resources to do its job thoroughly, or lacked the political will to buck politicians in Congress who wanted to keep things just the way they were.In the end, it was for the banking and financial services industry, to borrow Sebastian Junger's apt description, 'the perfect storm'. Mr. Bernanke goes on to tell us how the Fed was able to deflect the worst aspects of the financial crisis. But it was also clear that the American economy came perilously close to a fiscal calamity that could have equaled or exceeded the disaster of the 1930s. In the end, it was the Federal Reserve that would handle the deluge, or it was nothing at all.Mr. Bernanke has written a much longer book on the subject of the financial crisis in which he goes into much greater detail. That longer book will be the subject of a future review. But this one, short as it is, makes its point clearly and cogently, and for that reason should be as widely disseminated as possible.

As a close news follower of the past financial crisis, I feel quite fascinating about the role and capacity of Fed. For example, from where Fed comes up with the 85 billion dollars to buy treasury bonds and other securities every month? I find this timing book answers all of my questions about Fed and much more. This book gives a good account of the original of Fed, the Great Depression (the deflection age), the inflation in the 1970s, the Great Moderation, and finally the 2008 financial crisis and aftermath.After reading the book, you will have a good appreciation of what is bank run, why you need a bank of banks (Fed or central bank), what is the difference between fiscal policy and monetary policy, why deflation is not good (as a layman, we tend not to think inflation is good), how Volcker attacked the 1970s inflation, why Greenspan is a great moderator, what caused the housing bubble, what happened behind the scene of last financial crisis, why Lehman Brothers went bankrupt while others got rescued, why bailout AIG is so controversial, why "too big to fail" is a real problem. Believe it or not, Bernanke also briefly talked about Fed's exiting strategy from the expanded balance sheet.For people against any form of bailout, thinking it as money printing, as injecting inflation that is a distorted form of taxation, I suggest them to pay more attention to what happens after the clash of 1929. How a financial crisis in Wall Street can easily becomes a problem in Main Street. The way I see it, a properly injected inflation is an action of depressing existing asset in favor of promoting labor force. So whether the inflation is that bad, it probably depends on whether it properly promotes labor market.Compared to another book I read recently - "The Creature from Jekyll Island", I feel Bernanke's simple and straightforward lecture about Fed is much readable. But in case you need a counter viewpoint, Jekyll book might provide a good resource. I like the large amount of historical information on that book. But its promotion of gold standard and emphasizing inflation as stealing taxation without counter balancing the impact on labor market, make me believe it can not be a serious economy work.

Great lectures, these lectures are a perfect starting place for understanding Fed and the GFC (they can be freely accessed on Fed's website, along with sides and transcripts, so it's not necessary to purchase this book). But the book is poorly printed with zero top margin. Two sides of the paper also have different textures.

Chairman Bernanke is a good communicator. I wish my economics professors had been half as good. He gives a lucid explanation of the evolution of central banking in advanced economies, and the history and functioning of the Federal Reserve, America's central bank. He discusses the Fed's dual roles as "lender of last resort" and it's role as the maker and implementer of US monetary policy. It is in the latter role that the Fed has been most controversial over the years, but Bernanke skirts most of that and other controversies surrounding the Fed. In discussing the Fed's role in responding to the 2007-08 financial crisis, Bernanke actually takes that skirting a step further. He denies that government policies had anything to do with that crisis, which he says arose out of problems in the private sector. That point is at least debatable, if not laughable, given the government's significant role in creating and expanding the sub-prime mortgage market. But Bernanke is a loyal trooper and follows the party line. So, if you want to learn about how the Fed came to be and how and why it functions as it does, this book will be informative and an easy read. If you want to learn about the causes of the 2007-08 economic crisis and the rightness or wrongness of government's responses to it, look elsewhere.

It is short and succinct, well written. This book is not polemical. It deals with a practical situation and describes it effectively. Whilst one might disagree with the policies and/or the supervision of the Federal Reserve over the megabanks in the United States or otherwise this book is well worth reading. It is a good illustration of less is more. It also deals with what actually happened and contains plenty of data. Of course one must not allow oneself to be the subject of regulatory capture through reading Chairman Bernanke's words but this book does allow us to see how Banks avoided regulation in certain areas. It touches upon how megabanks are effectively subsidised by the taxpayers without actually saying it. It explores, to some extent, how high risk has been and still is effectively subsidised by tax payers and touches upon how this may be avoided. A good read if the subject is of interest to you.

A short and enjoyable read on the Financial Crisis and Bernanke's views on the origins and functions of the Federal Reserve and central banks in general. I suspect it provides a useful primer to the more in-depth 'The Courage to Act' which I also intend to read. The book is the transcripts of a series of lectures given by Bernanke and as such it is interesting that even a lucid, highly competent academic and leading central banker has caught the 'virus' of starting too many sentences with 'So...'.

Ben tries to make things accessible. He doesn't quite get there. Despite defining all terms in the ealier chapters, the later chapters are still overwhelming with jargon.I very much enjoyed the first half laying out his personal story and the introduction to monetary policies.

Very much a theoretical overview for Economists of different issues.

excellent brief presented central bank role in a modern market economy