The Courage To Act: A Memoir Of A Crisis And Its Aftermath

Ben Bernanke  “The Courage To Act: A Memoir Of A Crisis And Its Aftermath”,  W.W.Norton, 2015, 583 pp.

In 2006 Ben Bernanke replaced Alan Greenspan as chairman for the Federal Reserve, just a year before the 2007 bursting of the housing bubble and the beginning of the Great Recession.  This, his personal memoir, recounts the actions of the Fed between his 2006 appointment and retirement in 2014, when Janet Yellen replaced him.  As the Great Recession progressed, it is apparent that we are fortunate that Bernanke had dedicated much of his school life to the analysis of the 1930s Great Depression.   He makes a compelling case that in 2007 and 2008, the world economy came very close to collapse, and only novel efforts by the Fed (cooperating with other United States and foreign government agencies) saved us from an economic catastrophe greater than the Great Depression.

This book clearly describes how Federal Reserve policy making is under unrelenting public and political scrutiny.  Rapidly changing communications technologies—first, twenty-four-hour cable television, then blogs and Twitter—seem not only to have intensified the scrutiny but also to have favored the strident and uninformed over the calm and reasonable, the personal attack over the thoughtful analysis.  The deepest frustration is with the government dysfunction itself.  The founders had designed a system to be deliberative; instead, it is paralyzed.  Too often the system promotes showboating, blind ideology, and malice.  Nothing productive can be done until all the wrong approaches are tried first. (Pg. 536)

My Notes:

Pg. 33:  In his school years, Bernanke became a Great Depression buff in the way that other people are Civil War buffs, reading not only about the economics of the period but about the politics, sociology, and history as well.  Prior to Milton Friedman and Anna Schwartz’s analysis of the Great Depression, the prevailing view was summarized in Galbraith’s 1954 book The Great Crash, 1929, that the Depression was triggered by the speculative excesses of the 1920s and the ensuing stock market crash. Friedman and Schwartz showed that the collapse of the money supply in the early 1930s, rather than the Great Crash, was the more important cause of the Depression.  The sharp decline in the money supply hurt the economy primarily by inducing a severe deflation (falling wages and prices).  Prices in the US fell by nearly 10 percent per year in 1931 and 1932.  This violent deflation in turn led households and firms to postpone purchases and capital investments in anticipation of lower prices later, depressing demand and output. Moreover, the international gold standard, which created a monetary link among countries tied to gold, spread America’s deflation and depression abroad.

However, Bernanke wondered whether the collapse of the money supply and the ensuing deflation, as severe as it was, could by itself explain the depth and length of the Depression.  Unemployment in the US soared to 25 percent in 1933, from less than 5 percent before the 1929 crash.  It did not fall below 10 percent until the eve of the US entry into WWII, even though the deflation occurred mostly prior to 1933.  It seemed to Bernanke that the lack of credit after the collapse of the banking system had to have played a significant role in the slump as well.  More than 9,700 of the nation’s 25,000 banks failed between 1929 and 1933.

Pg. 44:  Despite not having a central bank, the US established a national currency—the greenback—in 1862, eventually replacing a system in which private state-chartered banks issued their own currency.  And in 1873, the country returned to the gold standard, which had been suspended during the Civil War.  However, the country during the period without a central bank could not respond to the recurring bank runs and financial panics that buffeted the economy, including major panics in 1837, 1857, 1873, 1893, and 1907.

Pg. 47:  The Fed board consists of seven members, appointed by the president and confirmed by the Senate to staggered fourteen-year terms.  (The long overlapping terms of members were intended to give the Board greater independence from political pressure, although this effect is diluted in practice because Board members almost never serve full terms.)  A new term opens every other year, and new members can be appointed to open seats at any time. 

Pg. 48:  To improve the performance of monetary policy, FDR’s reforms created a new body, the Federal Open Market Committee (FOMC) to oversee the Fed’s buying and selling of government securities, the primary tool through which the Fed determined short-term interest rates and influenced the money supply.  The FOMC includes nineteen people—the seven Board members and the twelve Reserve Bank presidents.

In 1975, Congress set explicit objectives for monetary policy, directing the Fed to pursue both maximum employment and price stability.  These two objectives constitute the Fed’s so called dual mandate.

Pg. 90:  House prices rose 15 percent in 2005, on top of a 16 percent increase in 2004.  Robert Shiller, who correctly predicted both the dot-com stock bubble and the housing bubble, attributed the housing bubble largely to psychological factors rather than low interest rates.  He noted that house prices began to accelerate rapidly in the US around 1998, well before the Fed’s 2001 rate cuts.  Sharp increases in house prices occurred at about the same time in other countries, in spite of having more restrictive monetary policies than the US.

Pg. 92:  Another factor driving US home prices was a tidal wave of foreign money that poured in  These inflows—largely unrelated to our monetary policy--held down longer term rates, including mortgage rates, while increasing the demand for mortgage-backed securities. 

Pg. 96:  The fragmentation of financial regulation and the allowed shopping for more lenient regulators did not help.  (In March 2007, the subprime lender Countrywide Financial, by switching the charter of the depository institution it owned, replaced the Fed as its principal supervisor with the OTS, after the OTS promised to be less antagonistic).  In 2005, only about 20 percent of all subprime mortgages were made by banks and savings institutions under federal supervision.  Another 30 percent of subprime loans were made by non-bank subsidiaries of federally regulated institutions.  The remaining 50 percent of loans were originated by independent mortgage companies chartered and supervised only by the states.

Pg. 102:  Subprime lending was widely seen as the antidote to redlining—and thus a key part of the democratization of credit.  It helped push the US homeownership rate to a record 69 percent by 2005, up from 64 percent a decade earlier. 

Pg. 106:  Bad subprime mortgage loans would ultimately expose the vulnerabilities of a fragile financial system.  US house prices would plunge more than 30 percent from the spring of 2006 to the spring of 2009 and would not begin a sustained recovery until early 2012.  Mortgages seriously delinquent or in foreclosure would soar from just under 6 percent in the fall of 2005 to more than 30 percent at the end of 2009. 

Pg. 205:  Congress had added Section 13(3) to the Federal Reserve Act in 1932, motivated by the evaporation of credit that followed the collapse of thousands of banks in the early 1930s.  Section 13(3) gave the Fed the ability to lend to essentially any private borrower.  At least five members of the Board needed to certify that unusual and exigent circumstances prevailed in credit markets and the borrower’s collateral had to be sound enough that the Fed could reasonably expect full repayment. 

Pg. 215:  Bernanke does not agree that size alone—Too Big To Fail (TBTF) -- was the problem at Bear Stearns, rather it was TITF (To Interconnected To Fail) that was the problem.  It had 5,000 trading counterparties and 750,000 open derivatives contracts.

Pg. 227:  Both Fannie and Freddie started out as federal agencies, Fannie during the Great Depression, in 1938, and Freddie in 1970.  However, both were later converted by Congress to shareholder-owned corporations—Fannie in 1968 and Freddie in 1989.  Although legally private, Fannie and Freddie were regulated by and maintained close ties to the federal government, were exempt from all state and local taxes, and had a line of credit from the Treasury.  This status effectively privatized profits and socialized losses.

Pg. 286:  Ultimately the US government would make investments and loan commitments totaling $182 billion to prevent AIG from failing.  However, the government did recouped all that it invested in AIG, and had a $23 billion profit.

Pg. 293:  Barney Frank proposed that Monday, September 15—the day between Lehman’s failure and AIG’s rescue—be designated ‘Free Market Day.’  ‘The national commitment to the free market lasted one day, Barney said, It was Monday.’

Pg. 409:  The Fed’s response to the Great Recession had four main elements: lower interest rates to support the economy; emergency liquidity lending aimed at stabilizing the financial system; rescues (coordinated when possible with the Treasury and the FDIC) to prevent the disorderly failure of major financial institutions; and the stress-test disclosures of banks’ condition.

 Pg. 409:  After the Fed interest rate had been pushed down to zero and could go no further, the Fed ventured into large-scale purchases of mortgage-backed securities.  Bernanke was determined not to repeat the blunder the Fed had committed in the 1930s when it refused to deploy its monetary tools to avoid the sharp deflation that substantially worsened the Great Depression.  Even as the financial panic subsided in 2009, the recession would deepen into the worst economic downturn since the Great Depression.  Unemployment would peak at 10 percent in October 2009.  A quarter of homeowners would owe more on their mortgages than their homes were worth.  Lenders had begun 1.7 million foreclosures in 2008 and would initiate 2.1 million more in 2009 and 1.8 million in 2010.  On March 9, 2009 the Dow Jones hit bottom, closing at 6,547, a near twelve-year low.

Pg. 509:  The debt ceiling law in the US is a historical accident.  Until WWI, when Congress approved spending, it routinely authorized any necessary issuance of government debt at the same time.  In 1917, for administrative convenience Congress passed a law that allowed the treasury to issue debt as needed, so long as the total debt outstanding remained below a permitted amount.  In effect, Congress separated its spending decisions from its borrowing decisions.  At some point it dawned on legislators that approval of the debt ceiling could be used as a bargaining chip.  The debt limit is not about spending and taxing decisions themselves, rather, it is about whether the government will pay the bills for spending that has already occurred.  Refusing to raise the debt limit is not analogous to a family cutting up its credit cards.  It is like a family running up large credit card bills and then refusing to pay.  As Congress continued this game in 2011, Standard and Poor’s downgraded US government debt to one notch below the top AAA rating—citing, among other factors, the prospect of future budget brinkmanship.