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economy lab

U.S. Federal Reserve chairman Ben Bernanke testifies about monetary policy before the House Financial Services on Capitol Hill in Washington on February 29, 2012.JONATHAN ERNST

Course: The Federal Reserve and Its Role in Today's Economy, George Washington University (Washington)

Guest Lecturer: Ben S. Bernanke

Lecture Title: "The Federal Reserve's Response to the Financial Crisis"

Date: March 27, 2012

Three lectures down, one to go (on Thursday)!

Good thing, too. Today's class was a little dull, at least for anyone who has read the book and watched the movie. But some of this could be on the exam! So here's a capsule version of Prof. Bernanke's telling of the financial crisis:

  • Fannie and Freddie got too big, and didn’t keep enough capital. There were many things that were missed before the financial crisis, but the “danger” posed by the housing agencies wasn’t one of them, Prof. Bernanke said. The Fed and other warned repeatedly that something should be done. But Congress refused to do anything about it.
  • Wall Street went nuts creating exotic financial products lined to housing. Eventually, investors lost faith. The value of all this junk was only the equivalent of a day’s worth of trading, Prof. Bernanke said. However, no one knew who held it. Presto: classic bank panic, only on a global scale.
  • Prof. Bernanke has a “deep dark secret.” Group of Seven and Group of 20 meetings are “usually a terrible bore.” (Go easy professor. You’re not exactly Paul Giamatti today!) However, the G7 meeting in the autumn of 2008 was anything but boring. Ministers and central bankers ripped up the script and pledged to ensure no big financial institution failed. The trick worked. Market pressures eased. Prof. Bernanke says global coordination doesn’t get the credit it deserves for arresting the crisis.
  • Pages 52 and 53 of Prof. Bernanke’s slides provide graphic evidence for the Fed’s case that its policies avoided a repeat of the Great Depression. For 15 months or so, the stock market and industrial production were tracking the same path as in 1929-30. But this time, the Fed did its job. Stock markets and industrial production reversed course when the Fed and the Treasury came to the rescue.


Why were so many banks willing to sell such crappy financial products?

Firms were too confident that housing prices would keep rising, Prof. Bernanke said. As long as prices climb, mortgage-backed securities were a good bet because homeowners could renegotiate terms. Also, there was a lot of Asian and European demand for highly rated financial assets. The "ever-clever" bankers on Wall Street figured out a way to create more of what those Europeans and Asian were looking for.

How do you decide who is too big to fail, who isn't?

Good question, Prof. Bernanke says, but he wants to set one thing straight: the Fed hates that some firms are too big to fail and he desperately hopes that new financial regulations will ensure that no big bank is bailed out ever again. "It would be a great accomplishment to get rid of too big to fail," he said. During the financial crisis, the Fed and the Treasury had to make judgment calls. Bear Stearns was saved because it had a buyer in JPMorgan Chase. In retrospect, Lehman Brothers "probably was too big to fail," but the Fed was blocked by law from helping an insolvent company – and Lehman was broke. "If we could have avoided that, we would have done so," Prof. Bernanke said. Authorities now are bent on keeping banks from becoming too big. For example, the Fed will no longer approve a bank merger that would create a financial institution that could be considered too big to fail.

"Two o'clock. I'll see you Thursday to talk about the aftermath of the crisis. Thank you."

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