Chairman Ben S. Bernanke
At the Fourteenth Jacques Polak Annual Research
Conference, Washington, D.C.
November 8, 2013
The Crisis as a Classic Financial Panic
I am very pleased to participate in this event in
honor of Stanley Fischer. Stan was my teacher in graduate school, and he has
been both a role model and a frequent adviser ever since. An expert on financial
crises, Stan has written prolifically on the subject and has also served on the
front lines, so to speak--notably, in his role as the first deputy managing
director of the International Monetary Fund during the emerging market crises of
the 1990s. Stan also helped to fight hyperinflation in Israel in the 1980s and,
as the governor of that nation's central bank, deftly managed monetary policy to
mitigate the effects of the recent crisis on the Israeli economy. Subsequently,
as Israeli housing prices ran upward, Stan became an advocate and early adopter
of macroprudential policies to preserve financial stability.
Stan frequently counseled his students to take a historical perspective,
which is good advice in general, but particularly helpful for understanding
financial crises, which have been around a very long time. Indeed, as I have
noted elsewhere, I think the recent global crisis is best understood as a
classic financial panic transposed into the novel institutional context of the
21st century financial system.
1 An appreciation of the parallels between
recent and historical events greatly influenced how I and many of my colleagues
around the world responded to the crisis.
Besides being the fifth anniversary of the most intense phase of the recent
crisis, this year also marks the centennial of the founding of the Federal
Reserve.
2 It's particularly appropriate to recall,
therefore, that the Federal Reserve was itself created in response to a severe
financial panic, the Panic of 1907. This panic led to the creation of the
National Monetary Commission, whose 1911 report was a major impetus to the
Federal Reserve Act, signed into law by President Woodrow Wilson on December 23,
1913. Because the Panic of 1907 fit the archetype of a classic financial panic
in many ways, it's worth discussing its similarities and differences with the
recent crisis.
3
Like many other financial panics, including the most recent one, the Panic of
1907 took place while the economy was weakening; according to the National
Bureau of Economic Research, a recession had begun in May 1907.
4 Also, as was characteristic of pre-Federal
Reserve panics, money markets were tight when the panic struck in October,
reflecting the strong seasonal demand for credit associated with the harvesting
and shipment of crops. The immediate trigger of the panic was a failed effort by
a group of speculators to corner the stock of the United Copper Company. The
main perpetrators of the failed scheme, F. Augustus Heinze and C.F. Morse, had
extensive connections with a number of leading financial institutions in New
York City. When the news of the failed speculation broke, depositor fears about
the health of those institutions led to a series of runs on banks, including a
bank at which Heinze served as president. To try to restore confidence, the New
York Clearinghouse, a private consortium of banks, reviewed the books of the
banks under pressure, declared them solvent, and offered conditional
support--one of the conditions being that Heinze and his board step down. These
steps were largely successful in stopping runs on the New York banks.
But even as the banks stabilized, concerns intensified about the financial
health of a number of so-called trust companies--financial institutions that
were less heavily regulated than national or state banks and which were not
members of the Clearinghouse. As the runs on the trust companies worsened, the
companies needed cash to meet the demand for withdrawals. In the absence of a
central bank, New York's leading financiers, led by J.P. Morgan, considered
providing liquidity. However, Morgan and his colleagues decided that they did
not have sufficient information to judge the solvency of the affected
institutions, so they declined to lend. Overwhelmed by a run, the Knickerbocker
Trust Company failed on October 22, undermining public confidence in the
remaining trust companies.
To satisfy their depositors' demands for cash, the trust companies began to
sell or liquidate assets, including loans made to finance stock purchases. The
selloff of shares and other assets, in what today we would call a fire sale,
precipitated a sharp decline in the stock market and widespread disruptions in
other financial markets. Increasingly concerned, Morgan and other financiers
(including the future governor of the Federal Reserve Bank of New York, Benjamin
Strong) led a coordinated response that included the provision of liquidity
through the Clearinghouse and the imposition of temporary limits on depositor
withdrawals, including withdrawals by correspondent banks in the interior of the
country. These efforts eventually calmed the panic. By then, however, the U.S.
financial system had been severely disrupted, and the economy contracted through
the middle of 1908.
The recent crisis echoed many aspects of the 1907 panic. Like most crises,
the recent episode had an identifiable trigger--in this case, the growing
realization by market participants that subprime mortgages and certain other
credits were seriously deficient in their underwriting and disclosures. As the
economy slowed and housing prices declined, diverse financial institutions,
including many of the largest and most internationally active firms, suffered
credit losses that were clearly large but also hard for outsiders to assess.
Pervasive uncertainty about the size and incidence of losses in turn led to
sharp withdrawals of short-term funding from a wide range of institutions; these
funding pressures precipitated fire sales, which contributed to sharp declines
in asset prices and further losses. Institutional changes over the past century
were reflected in differences in the types of funding that ran: In 1907, in the
absence of deposit insurance, retail deposits were much more prone to run,
whereas in 2008, most withdrawals were of uninsured wholesale funding, in the
form of commercial paper, repurchase agreements, and securities lending.
Interestingly, a steep decline in interbank lending, a form of wholesale
funding, was important in both episodes. Also interesting is that the 1907 panic
involved institutions--the trust companies--that faced relatively less
regulation, which probably contributed to their rapid growth in the years
leading up to the panic. In analogous fashion, in the recent crisis, much of the
panic occurred outside the perimeter of traditional bank regulation, in the
so-called shadow banking sector.
5
The responses to the panics of 1907 and 2008 also provide instructive
comparisons. In both cases, the provision of liquidity in the early stages was
crucial. In 1907 the United States had no central bank, so the availability of
liquidity depended on the discretion of firms and private individuals, like
Morgan. In the more recent crisis, the Federal Reserve fulfilled the role of
liquidity provider, consistent with the classic prescriptions of Walter
Bagehot.
6 The Fed lent not only to banks, but,
seeking to stem the panic in wholesale funding markets, it also extended its
lender-of-last-resort facilities to support nonbank institutions, such as
investment banks and money market funds, and key financial markets, such as
those for commercial paper and asset-backed securities.
In both episodes, though, liquidity provision was only the first step. Full
stabilization requires the restoration of public confidence. Three basic tools
for restoring confidence are temporary public or private guarantees, measures to
strengthen financial institutions' balance sheets, and public disclosure of the
conditions of financial firms. At least to some extent, Morgan and the New York
Clearinghouse used these tools in 1907, giving assistance to troubled firms and
providing assurances to the public about the conditions of individual banks. All
three tools were used extensively in the recent crisis: In the United States,
guarantees included the Federal Deposit Insurance Corporation's (FDIC)
guarantees of bank debt, the Treasury Department's guarantee of money market
funds, and the private guarantees offered by stronger firms that acquired weaker
ones. Public and private capital injections strengthened bank balance sheets.
Finally, the bank stress tests that the Federal Reserve led in the spring of
2009 and the publication of the stress-test findings helped restore confidence
in the U.S. banking system. Collectively, these measures helped end the acute
phase of the financial crisis, although, five years later, the economic
consequences are still with us.
Once the fire is out, public attention turns to the question of how to better
fireproof the system. Here, the context and the responses differed between 1907
and the recent crisis. As I mentioned, following the 1907 crisis, reform efforts
led to the founding of the Federal Reserve, which was charged both with helping
to prevent panics and, by providing an "elastic currency," with smoothing
seasonal interest rate fluctuations. In contrast, reforms since 2008 have
focused on critical regulatory gaps revealed by the crisis. Notably, oversight
of the shadow banking system is being strengthened through the designation, by
the new Financial Stability Oversight Council, of nonbank systemically important
financial institutions (SIFIs) for consolidated supervision by the Federal
Reserve, and measures are being undertaken to address the potential instability
of wholesale funding, including reforms to money market funds and the triparty
repo market.
7
As we try to make the financial system safer, we must inevitably confront the
problem of moral hazard. The actions taken by central banks and other
authorities to stabilize a panic in the short run can work against stability in
the long run, if investors and firms infer from those actions that they will
never bear the full consequences of excessive risk-taking. As Stan Fischer
reminded us following the international crises of the late 1990s, the problem of
moral hazard has no perfect solution, but steps can be taken to limit it.
8 First, regulatory and supervisory reforms,
such as higher capital and liquidity standards or restriction on certain
activities, can directly limit risk-taking. Second, through the use of
appropriate carrots and sticks, regulators can enlist the private sector in
monitoring risk-taking. For example, the Federal Reserve's Comprehensive Capital
Analysis and Review (CCAR) process, the descendant of the bank stress tests of
2009, requires not only that large financial institutions have sufficient
capital to weather extreme shocks, but also that they demonstrate that their
internal risk-management systems are effective.
9 In addition, the results of the
stress-test portion of CCAR are publicly disclosed, providing investors and
analysts information they need to assess banks' financial strength.
Of course, market discipline can only limit moral hazard to the extent that
debt and equity holders believe that, in the event of distress, they will bear
costs. In the crisis, the absence of an adequate resolution process for dealing
with a failing SIFI left policymakers with only the terrible choices of a
bailout or allowing a potentially destabilizing collapse. The Dodd-Frank Act,
under the orderly liquidation authority in Title II, created an alternative
resolution mechanism for SIFIs that takes into account both the need, for moral
hazard reasons, to impose costs on the creditors of failing firms and the need
to protect financial stability; the FDIC, with the cooperation of the Federal
Reserve, has been hard at work fleshing out this authority.
10 A credible resolution mechanism for
systemically important firms will be important for reducing uncertainty,
enhancing market discipline, and reducing moral hazard.
Our continuing challenge is to make financial crises far less likely and, if
they happen, far less costly. The task is complicated by the reality that every
financial panic has its own unique features that depend on a particular
historical context and the details of the institutional setting. But, as Stan
Fischer has done with unusual skill throughout his career, one can, by stripping
away the idiosyncratic aspects of individual crises, hope to reveal the common
elements. In 1907, no one had ever heard of an asset-backed security, and a
single private individual could command the resources needed to bail out the
banking system; and yet, fundamentally, the Panic of 1907 and the Panic of 2008
were instances of the same phenomenon, as I have discussed today. The challenge
for policymakers is to identify and isolate the common factors of crises,
thereby allowing us to prevent crises when possible and to respond effectively
when not.
1. See Ben S.
Bernanke (2012), "
Some Reflections on the Crisis and
the Policy Response," speech delivered at "Rethinking Finance," a conference
sponsored by the Russell Sage Foundation and Century Foundation, New York, April
13. For the classic discussion of financial panics and the appropriate central
bank response, see Walter Bagehot ([1873] 1897),
Lombard Street: A
Description of the Money Market (New York: Charles Scribner's Sons).
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2. Information on the
centennial of the Federal Reserve System is available at
www.federalreserve.gov/aboutthefed/centennial/about.htm
.
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3. The Panic of 1907
is discussed in a number of sources, including O.M.W. Sprague (1910),
A
History of Crises under the National Banking System (PDF), National
Monetary Commission (Washington: U.S. Government Printing Office), and, with a
focus on its monetary consequences, Milton Friedman and Anna Jacobson Schwartz
(1963),
A Monetary History of the United States, 1867-1960 (Princeton,
N.J.: Princeton University Press). An accessible discussion of the episode, from
which this speech draws heavily, can be found in Jon R. Moen and Ellis W.
Tallman (1990), "
Lessons from the Panic of 1907 (PDF),"
Federal Reserve Bank of Atlanta,
Economic Review, May/June, pp. 2-13.
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4. See Charles W.
Calomiris and Gary Gorton (1991), "The Origins of Banking Panics: Models, Facts,
and Bank Regulation," in R. Glenn Hubbard, ed.,
Financial Markets and
Financial Crises (Chicago: University of Chicago Press), pp. 109-74.
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5. As discussed in
Bernanke, "Some Reflections on the Crisis" (see note 1), shadow banking, as
usually defined, comprises a diverse set of institutions and markets that,
collectively, carry out traditional banking functions--but do so outside, or in
ways only loosely linked to, the traditional system of regulated depository
institutions. Examples of important components of the shadow banking system
include securitization vehicles, asset-backed commercial paper conduits, money
market funds, markets for repurchase agreements, investment banks, and mortgage
companies.
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6. See Bagehot,
Lombard Street, in note 1.
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7. For a more
comprehensive discussion of recent changes in the regulatory framework, see
Daniel K. Tarullo (2013), "
Evaluating Progress in Regulatory
Reforms to Promote Financial Stability," speech delivered at the Peterson
Institute for International Economics, Washington, May 3.
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8. See Stanley
Fischer (1999), "
On the Need for an International Lender of Last
Resort,"
Journal of Economic Perspectives, vol. 13
(Fall), pp. 85-104.
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text
9. For example, see
Board of Governors of the Federal Reserve System (2013),
Capital Planning at Large Bank
Holding Companies: Supervisory Expectations and Range of Current Practice
(PDF) (Washington: Board of Governors, August).
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10. For a more
detailed discussion, see Daniel K. Tarullo (2013), "
Toward Building a More Effective
Resolution Regime: Progress and Challenges," speech delivered at "Planning
for the Orderly Resolution of a Global Systemically Important Bank," a
conference sponsored by the Federal Reserve Board and the Federal Reserve Bank
of Richmond, Washington, October 18.
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통일 전후 독일 경제 상황과 독일 통일이 한반도에 주는 함의 (2014.02)
