Bernanke lectures on financial crises patterns

Having an individual, a company or a central bank willing to lend to banks is crucial in responding to financial panics,Former chairman of the Federal Reserve and former economics department chair of the University Ben Bernanke said in a lecture Tuesday.

“Lender of last resort activity is a critical tool to stopping bank runs,” Bernanke said.

Bernanke used the 1907 financial panic as an example, explaining that there was no central bank to deal with it as the Federal Reserve had not yet been instituted. A private citizen, J.P. Morgan, worked with his colleagues to respond to the panic, and Bernanke noted that Morgan employed essentially the same tools used by central banks.

However, the private sector’s response to the panic was not entirely successful and the economy suffered accordingly, he said.

“It is striking, though, in this case because Morgan was slow to respond, the panic actually got much worse and spread to most of the country,” Bernanke said.

In contrast, the response to the 1914 panic was more efficient because the treasury utilized its power to create emergency currency, Bernanke said. An act of Congress allowed for the printing of up to 500 million dollars. He explained that the treasury in 1914 quickly and aggressively printed currency to lend out to the troubled banks of New York City so that they could pay their depositors, and this prevented the banks from collapsing.

“The difference here was the very rapid, very comprehensive lending,” Bernanke said. “No banks failed and there was no recession that followed.”

Bernanke explained that while the most recent financial crisis of 2007-09 involves a more sophisticated, globalized context, the comparison between 1907 and 2007 is still valuable because the crises are conceptually similar.

Most financial panics share some common fundamental characteristics, Bernanke said. For example, what triggers a financial panic is often small. While the financial panic of 1907 was one of the sharpest recessions in the history of the U.S., Bernanke noted that the 1907 panic had a trigger which was amusingly trivial.

Another common feature is the lack of liquidity in financial markets, Bernanke said, explaining that a liquidity crunch is when, because of the runs of the banks, nobody has any money.

More fear and more panic then ensues due to a phenomenon Bernanke referred to as ‘contagion,’ meaning the panic spreads to entire system through interconnections between financial institutions.

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“Contagion can happen because of common risk factors,” Bernanke said. “Runs accelerate into a panic.”

Such financial crises have big impacts on the economy because they can lead to an adverse feedback loop, with panics giving way to economic decline, he explained.

Looking at the current state of the global economy, Bernanke said that while the U.S. recovery is not as strong as we would like, the main weakness is still in the global economy.

The Chinese slowdown, Bernanke noted, is an inevitable part of its transition from a top-down, semi-centrally planned economy to a more organic, market-driven economy.

“But it’s been surprising that emerging markets besides China seem to not have adapted to that as well as we thought they might,” Bernanke added.

Bernanke also noted that the GDP of the U.S. has reached levels even higher than its pre-crisis peak, while the Eurozone has not yet recovered its pre-crisis levels. This has to do with differences in monetary or banking policies, Bernanke explained.

The lecture, titled “A Historical Perspective on the Financial Crisis,” was sponsored by the Bendheim Center for Finance and took place in McCosh Hall 50.