Right Thinking From The Left Coast
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Systemic Risk for a Trillion, Alex

From the people who brought you the first great depression, and helped with this recession, comes the likelihood of more authority.  Yes, the Federal Reserve may be the new grand regulator to monitor risk.

As is always the case with government screw-ups, and government backed screw-ups from the so-called private institutions like the Fed, those who helped bring about the mess ALWAYS get rewarded with more power. Nope, there will be no regulation or oversight for the worst offenders, because they are the ones looking out for us. Now if you want to think I’m exaggerating a little in blaming the Fed for the first depression, and what may turn out to be a long and drawn out stagnant pain fest for the modern era, I bring you Bernanke’s view of the cause of the first depression.

Bernanke’s speech in 2002 honoring Milton Friedman

For practical central bankers, among which I now count myself, Friedman and Schwartz’s analysis leaves many lessons. What I take from their work is the idea that monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful. The best thing that central bankers can do for the world is to avoid such crises by providing the economy with, in Milton Friedman’s words, a “stable monetary background"--for example as reflected in low and stable inflation.

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

Bernanke’s reasoning behind the first depression was bad monetary policy, which started the downturn, and how the Fed stood by and let the banks fail via banking runs, but what’s also important to note is back then the banks already had a solution to prevent such havoc regarding banking runs, and the market did ok on monetary policy too, and it actually worked until the Fed came around and took over monetary policy and crisis management.

Before the creation of the Federal Reserve, Friedman and Schwartz noted, bank panics were typically handled by banks themselves--for example, through urban consortiums of private banks called clearinghouses. If a run on one or more banks in a city began, the clearinghouse might declare a suspension of payments, meaning that, temporarily, deposits would not be convertible into cash. Larger, stronger banks would then take the lead, first, in determining that the banks under attack were in fact fundamentally solvent, and second, in lending cash to those banks that needed to meet withdrawals. Though not an entirely satisfactory solution--the suspension of payments for several weeks was a significant hardship for the public--the system of suspension of payments usually prevented local banking panics from spreading or persisting (Gorton and Mullineaux, 1987). Large, solvent banks had an incentive to participate in curing panics because they knew that an unchecked panic might ultimately threaten their own deposits.

In the modern day with an already expanded Fed that’s grown over the decades as a reward for the pain they helped cause in the first depression, we now see the results of a Fed that had loose monetary policy for too long during the housing bubble, years of rules and regulations that brought about bigger banks who will always survive because we bail them out at the expense of the small ones, and along with bad government policy with the everyone deserves a house mentality, well here we are. Yes, the bankers have their share of the blame, and we get to see it all over the news, and we get the reminders to thank God the government and Fed are here to save us.

If you are skeptic like me though, don’t worry, in this era of swelling government intervention with such vast power in the hands of a few, surely someone will monitor the Fed. Well, maybe not. If you have not already seen the discussion between Democratic congressman Alan Grayson, and the Inspector General for the Federal Reserve Elizabeth Coleman, I suggest watching it. Try to count how many times Grayson asks her where all that money went. I mean no big deal if there aren’t any answers, she’s only the Inspector General for the Fed. Also, notice what is missing. A packed room full of reporters, angry crowds, and congressional leaders looking for that photo op. Anyhow who cares, what’s a few trillion among friends with zero oversight? There’s no risk in that.

Posted by on 05/28/09 at 10:13 PM in • Permalink

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