By Rodney Sullivan, CFA
The Federal Reserve and the Financial Crisis. 2013. Ben S. Bernanke.
Reviewed by Marc L. Ross, CFA
It is fitting that The Federal Reserve and the Financial Crisis should be published in the centennial year of the institution. Adapted from a series of four lectures given by Ben Bernanke at George Washington University in March 2012, the book is a good primer on the workings of the central bank throughout its history, including its role in the recent financial crisis. Concepts are introduced with clarity, and the prose is straightforward. The book is appropriate for students of central banking, and experienced readers will find it a worthwhile account of the historical record for what it both does and does not reveal.
Each lecture builds on the preceding one. The book begins with the formation and objectives of the Federal Reserve, moves on to the bank's role in the Great Depression, the post-World War II era of economic growth, and the Great Moderation, proceeds into a fairly robust discussion of the Great Recession and the Fed's response to it, and concludes with a review of ongoing policy provisions in the wake of the crisis.
A running theme is the bank's dual mandate of macroeconomic stability and financial stability. Throughout the book, Bernanke, the Fed's 14th chairman, defends its record, but not without humility. A student of the Great Depression, he lays bare the bank's policy blunders during that period, which only seemed to aggravate the economic downturn. As to the recent financial crisis, he readily acknowledges its complexity and discusses areas where the central bank could have done a better job.
Although Bernanke neither cheerleads nor apologizes for the institution, he does admit to the Fed's flawed monetary policy during the Great Depression and its more recent shortcomings in regulation and supervision. Each "siloed" regulator had a specific remit but failed to communicate regularly with the other regulators and also failed to see the bigger picture and the confluence of events.
The discussion falls short in Bernanke's response to the question of the Fed's role in the housing boom of the first half of the past decade. Calling the issue controversial and complex, he rejects ascribing the sustained run-up in house prices to the central bank's increasingly easy money policy. To buttress his argument, Bernanke cites the examples of the United Kingdom, where tighter monetary policy failed to prevent a boom, and the eurozone, where Spain experienced a housing boom and Germany did not, despite their being tethered to the monetary policy of the same central bank. Although housing dynamics may well vary across countries, his response does not fully resolve the question.
Bernanke's assertion that the global nature of the financial crisis received too little attention is odd. The troubles of such banks as Royal Bank of Scotland (RBS) and Northern Rock and of the economies of Iceland and Ireland are well known, as are the Fed's efforts to ease dollar funding through the extension of swap lines. He discusses the latter topic as well as the coordinated efforts of central bankers to assuage roiled markets.
The tools at the Fed's disposal both during and after the financial crisis of 2007-2009 were novel yet consistent with its mandate. Because uncertainty and risk were broadly dispersed, the central bank had to invoke special powers available for exigent circumstances under the Federal Reserve Act. In so doing, it was able to lend funds to such nonbank entities as broker/dealers, foreign governments (dollar swap lines), and AIG (AIG). Though unprecedented, these actions accorded with Walter Bagehot's principle of lending freely to provide liquidity in the event of panic.
Designating an institution "too big to fail," Bernanke maintains, was not an establishment of a doctrine but, rather, the least bad decision to make in extraordinary circumstances. Noting the ongoing challenge of an orderly wind-up of failed institutions, he recognizes the importance of the Federal Deposit Insurance Corporation's process in this regard and emphasizes the need for cooperation among governmental agencies in order to anticipate and deal with future financial crises.
Monetary policy is not a panacea. The intensity and duration of the housing crisis and a somewhat muted economic recovery are continuing challenges that the central bank is addressing in collaboration with other governmental agencies. Regulation needs to focus on the bigger picture. Several efforts are already under way, including such initiatives as the Financial Stability Oversight Council and the Consumer Financial Protection Bureau.
Even if The Federal Reserve and the Financial Crisis offers little that is new for the experienced market observer, it nonetheless provides a useful tutorial on the workings of an institution in its most difficult hour. For that reason alone, it makes an important contribution to the historical record.