Central Banking after the Great Recession: Lessons Learned, Challenges Ahead

2. A Conversation with Ben Bernanke

2 A Conversation with Ben Bernanke Liaquat Ahamed and Ben Bernanke 5 Two weeks before the end of his eight-year term as chairman of the Federal Reserve, Ben Bernanke was interviewed by Liaquat Ahamed, a Brookings trustee and author of the Pulitzer Prize–winning Lords of Finance: The Bankers Who Broke the World. As Glenn Hutchins noted in introducing the conversation, Ahamed’s book was about the mistakes that central bankers made during the Great Depression. The story of Ben Bernanke’s tenure is about the steps the Federal Reserve took to avoid another Great Depression. An edited transcript of the conversation follows. AHAMED: The way you handled the financial crisis in 2008 will clearly go down as one of your signature achievements. You’ve said somewhere that the playbook that you relied on was essentially given by a British economist in the 1860s, Walter Bagehot.1 His dictum was that in a financial crisis, the central bank should lend unlimited amounts to solvent institutions against good collateral at a penalty rate. How useful in practice was that rule in guiding you? BERNANKE: It was excellent advice. This was the advice that’s been used by central banks going back to at least the 1700s. When you have a market or a financial system that is short of liquidity and there’s a lack of confidence, a panic, then the central bank is the lender of last resort. It’s the institution that can provide the cash liquidity to calm the panic 1. See http://research.stlouisfed.org/publications/es/09/ES0907.pdf. 02-2608-1 ch2.indd 5 3/11/14 9:56 PM 6 A Conversation with Ben Bernanke and to make sure that depositors and other short‑term lenders are able to get their money. In the context of the crisis of 2008, the main difference was that the financial system that we have today obviously looked very different in its details, if not in its conceptual structure, from what Walter Bagehot saw in the nineteenth century. And so the challenge for us at the Fed was to adapt Bagehot’s advice to the context of a modern financial system. So, for example, instead of having retail depositors standing in line outside the doors, as was the case in the 1907 panic, in the United States we had runs by wholesale short‑term lenders like repo lenders or commercial‑paper lenders, and we had to find ways to essentially provide liquidity to stop those runs. So it was a different institutional context, but very much an approach that was entirely consistent, I think, with Bagehot’s recommendations. AHAMED: Now in addition to lending to institutions, you intervened in markets. Is there a sort of similarly pithy dictum, a Bernanke rule that you can come up with about when the Fed should intervene in markets and when it shouldn’t? BERNANKE: If we’re talking about the crisis period, I would say that all the interventions we did fit under the Bagehot heading. For example, the commercial‑paper facility that we set up was essentially designed to prevent a run on this particular form of financing. It was a different institutional structure, but it was, again, essentially the same Bagehot rule being applied in a different institutional context. So while the analogies between what we did and the run on the savings and loan in It’s a Wonderful Life are not always obvious, there was, in fact, a very close parallel. Now we have done other interventions, with our asset purchase program , for example, but that I would call those the monetary policy part of our response. AHAMED: The crisis began in August of 2007, when there was a problem with a fund run by a French bank.2 And if you trace through it, it actually continued until the spring of 2009. So that was a long time. And despite major intervention after Lehman, despite the Troubled Asset Repurchase Program (TARP), you still had a run on Citibank, 2. See http://www.nytimes.com/2007/08/10/business/worldbusiness/09cnd-eurobank. html?_r=1&. 02-2608-1 ch2.indd 6 3/11/14 9:56 PM A Conversation with Ben Bernanke 7 you still had a run on Bank of America. Why did it take so long to get it under control? BERNANKE: It was not a continuous crisis of equal intensity for the entire...