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Bernanke Stresses That ‘Creativity’ Helped Staunch Financial Crisis

Speaking to the Center for the Study of the Presidency and Congress last night, Federal Reserve Chairman Ben Bernanke went back to his academic roots. The longtime Princeton economic historian, who specializes in the study of the Great Depression, cited the “passivity” of policymakers during the 1930s as central to letting bank runs become a nationwide economic failure.

[P]olicymakers must respond forcefully, creatively, and decisively to severe financial crises. Early in the Depression, policymakers’ responses ran the gamut from passivity to timidity. They were insufficiently willing to challenge the orthodoxies of their day….A key turning point, in the United States, came with Franklin Roosevelt’s commitment to bold experimentation after his inauguration in 1933. Some of his experiments failed or were counterproductive, but [some decisions] helped arrest the descent of the U.S. financial system and set off a strong, albeit incomplete, recovery.

He argues that this crisis could have been as bad as the last one, were it not for advances in monetary policymaking. The statement reads not just as an appreciation of Roosevelt’s eventual decision to leave behind the gold standard, but as a counter today’s criticism of Bernanke’s more activist Fed. Senators such as Richard Shelby (R-Ala.) have hit Bernanke with withering criticism for failing to prevent the crisis before it occurred and to act until after the markets started seizing, being too generous in bailing out faltering banks, and then stretching the Federal Reserve’s mandate and policy operations far, far beyond their historical and possibly statutory limits.

But in this speech, Bernanke reinforces the point that — regardless of what he did not do before the markets went south — he acted with necessary strength and “creativity” once the crisis hit:

[O]ur traditional tools, developed in an earlier era, were of little use in addressing panic in the shadow banking system or in the money market mutual fund industry. So, we engaged in what I call “blue sky thinking” — generating many ideas. Most were discarded, but, crucially, some led to the development of new ways for the Federal Reserve to fulfill the traditional stabilization function of central banks.

Notably, Bernanke also addressed the repurchase agreement market in the news this morning:

In the shadow banking system, loans, instead of being held on the books of banks as was virtually always the case in the 1930s, were packaged together in complex ways and sold to investors. Many of these complex securities were held in off-balance-sheet vehicles financed by short-term funding. When the housing slump shook investors’ faith in the values of the loans underlying the securities, short-term funding dried up quickly, threatening the banks and other financial institutions that explicitly or implicitly stood behind the off-balance-sheet vehicles. This was a new type of run, analogous in many ways to the bank runs of the 1930s, but in a form which was not well anticipated by financial institutions or regulators.

That might read as a bit of financial gobbledygook, but the point is simple: Policymakers now understand the financial crisis as, essentially, an old-fashioned bank run in the under-regulated “shadow” banking system, comprised of financial institutions that are not registered as banks. And how those banks are monitored and regulated is crucial to financial stability now.

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