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Analysis

The cauldron of crisis

by George Hoguet

The cauldron of crisis

‘Courage is grace under pressure.’ So wrote Ernest Hemingway, author of Death in the Afternoon, a book about the ceremony and traditions of Spanish bullfighting.

The most interesting sections in former Federal Reserve Chairman Ben Bernanke’s memoir, The Courage to Act – A Memoir of the Crisis and Its Aftermath, are not those describing the formulation and execution of policies designed to save the American financial system and avoid another Great Depression – though these are gripping.

Rather, they are his reflections on the structure and weaknesses of the US financial and regulatory system, the relevance of history, the American political system, and the discipline of economics. For example, ‘Sound monetary policy, I knew, can support a healthy economy – but it cannot create one. In the long run, the economy’s ability to produce a rising standard of living for future generations depends on people having opportunities to acquire both economically valuable skills and the perspective that comes from a broad education. Nothing else matters as much.’

This book is a riveting, moving memoir, and a testament not just to Bernanke’s analytical and leadership skills, but also the efforts of countless nameless Federal Reserve, US Treasury and other government agency officials who laboured under frightening and chaotic conditions both tirelessly and frenetically to prevent a global financial meltdown.

Hard work and determination

It is also a testament to the plasticity of the American system. Bernanke, who grew up in small town South Carolina and attended Harvard College almost by accident, rose to the second most powerful office in the land on the basis of analytical insight, hard work and determination, and civic engagement (he was elected twice to a local school board). Anyone wanting to know how and why US decisions were made during the global financial crisis should read this book.

Bernanke divides the book into three sections – Prelude, The Crisis, Aftermath. The first describes Bernanke’s personal history, intellectual evolution and research on the ‘financial accelerator’ and Great Depression. His research impressed on him the need to forcefully deploy monetary policy during recessions, to act decisively to preserve financial stability, and to think ‘outside the box’ when confronted with extraordinary circumstances. For Bernanke, excessive reliance on wholesale funding by banks and a ‘shadow banking system’ that had become too large and complex were important causes of the crisis.

This section also covers Bernanke’s tenure as a governor of the Federal Reserve and as chairman of the Council of Economic Advisors. For Bernanke, Greenspan’s thinking ‘was idiosyncratic and less conceptual than I was used to’. Bernanke argues throughout for the institutionalisation of policy formulation and for an explicit inflation target.

Multiple financial crises

Bernanke devotes large chunks of the second section to multiple crises: Bear Stearns, Fannie Mae and Freddie Mac, Lehman Brothers, AIG, Washington Mutual, Citibank, Wachovia, passage of the Troubled Asset Relief Program, and a severe recession that led to 10% unemployment.

In this cauldron, Bernanke and his colleagues executed a strategy with four main elements: lower interest rates; emergency lending aimed at stabilising the financial system; rescues (coordinated when possible with the Treasury and Federal Deposit Insurance Corporation) to prevent disorderly failure of major financial institutions; and stress-test disclosures of banks’ condition.

Lest we forget, US government interventions were massive: $182bn in support for AIG; $350bn in commercial paper purchases; $700bn in TARP funds; $600bn in swap lines, $3.5tn in quantitative easing – for openers!

Bernanke’s discussion of the decision to let Lehman Brothers fail is one of the most striking in the book. The author is at pains to suggest that there was no other alternative, arguing that there was no buyer for Lehman, and that it had insufficient collateral to qualify for an emergency loan under Section 13 (3) of the Federal Reserve Act. He then suggests Congress would never have acted to recapitalise major financial firms absent the failure of some large firm and the associated damage to the system. In this sense, ‘a Lehman-type episode was probably inevitable’.

Under a microscope

The third section discusses macroprudential regulation, QE, Dodd-Frank, Federal Reserve communications policy, and countless other topical debates. It also describes what it’s like to be relentlessly pilloried by political opponents and to have one’s every utterance put under a microscope.

Bernanke was against nationalising the banks, feels that the Obama stimulus was too small, argues that Dodd-Frank ‘does much good and stands as a remarkable achievement’, and laments the evolution of his chosen political party.

Throughout the book there are reflections on the many personalities and institutions Bernanke dealt with throughout the crisis. One may not agree with all the decisions that were taken (such as the failure to impose losses on some senior debtholders of financial institutions). But this is an important book, of interest to future historians, and written by an exceptionally able, thoughtful, and courageous public servant.

George Hoguet is Global Investment Strategist in the Investment Solutions Group of State Street Global Advisors.

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