Bernanke on the Financial Crisis: Interventions Prevented Cataclysm

The head of the world's most powerful central bank did not mince words in his evaluation of the actions by central banks, governments and other policymakers during the global financial crisis.

"In the current episode, in contrast to the 1930s, policymakers around the world worked assiduously to stabilize the financial system," U.S. Federal Reserve Chairman Ben said in speech Thursday at the Center for the Study of the Presidency and Congress in Washington. "As a result, although the economic consequences of the financial crisis have been painfully severe, the world was spared an even worse cataclysm that could have rivaled or surpassed the Great Depression."

Inaction in the 1930s Worsened the Great Depression

The key failing of 1930s policymakers concerned their inability to fully appreciate "the importance of a healthy financial system for economic growth" and the timidity of their response to the financial crisis, Bernanke said. What's more, some policymakers even viewed the financial and economic crisis of the 1930s as desirable to rid the financial system of excesses that had built up during the 1920s.

"Indeed, the treasury secretary at the time, Andrew Mellon, believed in the tonic effects of weeding out weak banks and famously advised President Herbert Hoover, 'Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate . . . . It will purge the rottenness out of the system,'" Bernanke said.

In 2008 and 2009, Intervention Averted a Calamity

The Fed made no such mistake of indifference or timidity early in the crisis this time, Bernanke said. Effective policy responses during the Great Depression took place after three to four years of financial crisis and economic contraction. Bernanke cited President Franklin D. Roosevelt's actions declaring a bank holiday upon taking office in March 1933 and severing the link between the dollar and gold as helping to end the descent of the U.S. financial system. "In our own time, policymakers acted sooner and with greater force than in the 1930s," Bernanke said.

He cited the quick authorization by the U.S. Congress of the $700 billion Troubled Asset Relief Program, as "far from perfect legislation," but a move that "was essential for preventing an imminent financial collapse." Further, along with the Fed's interest rate reductions, Bernanke cited the central bank's unprecedented (for the U.S.) program to purchase long-term securities as essential to keeping credit markets functioning, and the bank stress test -- a program similar to Roosevelt's bank holiday in 1933, in his interpretation -- as critical to banks' ability to attract capital.

"Critics had warned that the stress test could backfire, but as it turned out, the release of the results last May helped restore confidence in banks, and many institutions have since been able to raise capital from investors and repay the capital the government had injected," Bernanke said.

Global Crisis Requires a Global Response

Another lesson policymakers learned from the Great Depression was that an international crisis requires an international response, Bernanke said. Often thought of as an American event, the Great Depression was, in fact, global, he said, but post-World War I grievances and disputes over debts and reparations had prevented the international coordination needed to check the financial and economic plunge.

By contrast, this time, policymakers worked together. In October 2008, in an unprecedented action, six central banks -- the Federal Reserve, European Central Bank, Bank of England, Swiss National Bank, Bank of Canada, and the Central Bank of Sweden -- acted together to cut short-term interest rates. Days later, major central bankers announced comprehensive plans to stabilize their banking systems, and the Federal Reserve, aware of dollar-induced turmoil, established "temporary liquidity swap lines that enabled 14 central banks around the world to calm their markets by lending dollars in their jurisdictions," he said.

Later, the Fed would create several new facilities that were able to restore the flow of credit that's critical for American businesses by supporting various credit markets.

The Fed's Actions: Is the Jury Still Out?

University of Connecticut history professor J. Garry Clifford's adage, "Don't study a public policy action or an event in history until everybody has been dead for 20 years" -- certainly applies in this case. Scholars, public policy professionals and others will be evaluating Bernanke's actions, as well as the actions of other central bankers and policymakers, both leading up to and during the financial crisis, for decades, as more information becomes available. In other words, it's nearly impossible to determine the long-term impact of the Fed's actions now.

Further, in the short-term, many worry that the Fed's and other central banks' actions will result in a significant rise in inflation in next few years. That concern is hardly baseless. But the global financial system was close to collapse a year and half ago. Given what could have happened, a little inflation beats a return to the barter system any day.