Lessons Learned? Comparing The Federal Reserves Responses .
Lessons Learned?Comparing the Federal Reserve’s Responsesto the Crises of 1929-1933 and 2007-2009David C. WheelockThe financial crisis of 2007-09 is widely viewed as the worst financial disruption since the GreatDepression of 1929-33. However, the accompanying economic recession was mild compared withthe Great Depression, though severe by postwar standards. Aggressive monetary, fiscal, and financialpolicies are widely credited with limiting the impact of the recent financial crisis on the broadereconomy. This article compares the Federal Reserve’s responses to the financial crises of 1929-33and 2007-09, focusing on the effects of the Fed’s actions on the composition and size of the Fedbalance sheet, the monetary base, and broader monetary aggregates. The Great Depression experience showed that central banks should respond aggressively to financial crises to prevent a collapseof the money stock and price level. The modern Fed appears to have learned this lesson; however,some critics argue that, in focusing on the allocation of credit, the Fed was too slow to increasethe monetary base. The Fed’s response to the financial crisis has raised new questions about theappropriate role of a lender of last resort and the long-run implications of actions that limit financiallosses for individual firms and markets. (JEL E31, E32, E52, E58, N12)Federal Reserve Bank of St. Louis Review, March/April 2010, 92(2), pp. 89-107.The financial crisis of 2007-09 is widelyviewed as the worst financial disruption since the Great Depression of1929-33. The banking crises of the GreatDepression involved runs on banks by depositors, whereas the crisis of 2007-09 reflected panicin wholesale funding markets that left banksunable to roll over short-term debt. Althoughdifferent in character, the crisis of 2007-09 wasfundamentally a banking crisis like those of theGreat Depression and many of the earlier crisesthat preceded large declines in economic activity(Gorton, 2009).Table 1 reports information about every U.S.recession since the Great Depression of 1929-33—more specifically, the periods designated as eco-nomic contractions by the National Bureau ofEconomic Research (NBER). The recent recessionbegan in December 2007, according to the NBER.Although their Business Cycle Dating Committeehas not officially identified the end of this recession, many economists believe that it ended inthe middle of 2009; thus, the data used for thisrecession span December 2007 through June 2009.In terms of duration, decline in real grossdomestic product (GDP), and peak rate of unemployment, the recent recession ranks among themost severe of all postwar recessions.1 However,1The recession of 1945 was marked by a sharp, but short-liveddecline in output as industries sharply reduced the production ofwar material at the end of World War II.David C. Wheelock is a vice president and economist at the Federal Reserve Bank of St. Louis. The author thanks Michael Bordo, Bob Hetzel,Rajdeep Sengupta, and Dan Thornton for comments on a previous version of this article, which was presented at the conference “The Historyof Central Banking” at the Bank of Mexico on November 23, 2009. Craig P. Aubuchon provided research assistance. 2010, The Federal Reserve Bank of St. Louis. The views expressed in this article are those of the author(s) and do not necessarily reflect theviews of the Federal Reserve System, the Board of Governors, or the regional Federal Reserve Banks. Articles may be reprinted, reproduced,published, distributed, displayed, and transmitted in their entirety if copyright notice, author name(s), and full citation are included. Abstracts,synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank of St. Louis.F E D E R A L R E S E R V E B A N K O F S T. LO U I S R E V I E WMARCH/APRIL201089
WheelockTable 1Key Macro Performance Measures Across U.S. RecessionsDuration (months)Real GDP:Decline peakto trough (%)Unemployment:Maximum valueduring recession (%)CPI:Change peakto trough 09*The current recession end date has not yet been determined by the NBER; data are through 2009:Q2.the recent recession was mild compared with theeconomic declines of 1929-33 and 1937-38. Forexample, real GDP fell 36 percent during 1929-33,and the unemployment rate exceeded 25 percent.Moreover, the price level, measured by the consumer price index (CPI), fell by 27 percent. By contrast, the CPI rose 2.76 percent between December2007 and June 2009.Monetary, fiscal, and financial policies arewidely credited for limiting the impact of thefinancial crisis of 2007-09 on the broader economy.In nominating Ben Bernanke for a second termas chairman of the Board of Governors of theFederal Reserve System, President Obama creditedBernanke with helping to prevent an economicfreefall.2 Chairman Bernanke (2009c) has alsocited “aggressive” policies for insulating the globaleconomy, to some extent, from the financial crisis.2The White House press release (www.whitehouse.gov/the Of-the-FederalReserve/) provides the text of the president and Bernanke’s remarks.90MARCH/APRIL2010Bernanke noted that, in contrast, monetary policywas “largely passive” during the Great Depression.This article summarizes the Federal Reserve’sresponse to the financial crisis of 2007-09 andcompares it with the Fed’s response to financialshocks during the Great Depression. First, thearticle describes the Fed’s actions as the recentcrisis evolved. Initially, the Fed focused on making funds available to banks and other financialinstitutions, but used open market operations toprevent lending to individual firms from increasing total banking system reserves or the monetarybase. As the crisis intensified, the Fed drew onauthority granted during the Depression to provide emergency loans to distressed nonbank firms.The Fed also lowered its target for the federalfunds rate effectively to zero and eventually purchased large amounts of U.S. Treasury and agencydebt and mortgage-backed securities. The articleshows the effects of these actions on the Fed’sbalance sheet, the monetary base, and broadermonetary aggregates.F E D E R A L R E S E R V E B A N K O F S T. LO U I S R E V I E W
WheelockThe Fed was considerably less responsive tothe financial crises of 1929-33. It neither lent significantly to distressed banks nor increased themonetary base sufficiently to arrest declines inthe money stock and price level. The article discusses alternative explanations for the Fed’s failureto pursue a more aggressive policy during the GreatDepression. It also examines the impact of the Fed’sdoubling of reserve requirements in 1936-37, whenofficials feared that a large increase in excessreserves posed a significant inflation threat.The next section summarizes the Fed’sresponse to the crisis of 2007-09 and examines itsimpact on the composition and size of the System’sbalance sheet, the monetary base, and the growthof broader monetary aggregates. Subsequently, thearticle describes the Fed’s actions in response tothe financial shocks of the Great Depression, againfocusing on the effects of the Fed’s actions on themonetary base and broader monetary aggregates.Finally, the article compares the Fed’s responsesto the crises of 2007-09 and 1929-33 and highlightsmistakes made during the Great Depression thatthe Fed did not repeat during the recent crisis.THE FED’S RESPONSE TO THECRISIS OF 2007-09The Initial Phase:August 2007–February 2008The recent financial crisis began with thedownturn in U.S. residential real estate markets.Beginning in early 2007, a growing number ofbanks and hedge funds reported substantial losseson subprime mortgages and mortgage-backed securities, many of which were downgraded by creditrating agencies. The crisis first appeared in interbank lending markets in early August, when theLondon Interbank Offered Rate (LIBOR) and otherfunding rates spiked after the French bank BNPParibas announced that it was halting redemptionsfor three of its investment funds (Brunnermeier,2009). The Federal Reserve sought to calm markets by announcing on August 10 that “the FederalReserve is providing liquidity to facilitate theorderly functioning of financial markets” and noting that, “as always, the discount window is availF E D E R A L R E S E R V E B A N K O F S T. LO U I S R E V I E Wable as a source of funding” (Board of Governors[BOG], 2007). Subsequently, on August 17, theBoard of Governors voted to reduce the primarycredit rate by 50 basis points and to extend themaximum term of discount window loans to 30days. Then, in September, the Federal Open MarketCommittee (FOMC) lowered its target for the federal funds rate in the first of many cuts that tookthe rate essentially to zero by December 2008.3Financial strains eased somewhat in Septemberand October 2007 but reappeared in November. OnDecember 12, the Federal Reserve announced theestablishment of reciprocal currency agreements(“swap lines”) with the European Central Bankand Swiss National Bank to provide a source ofdollar funding in European financial markets.Over the next 10 months, the Fed establishedswap lines with a total of 14 central banks.On December 12, the Fed also announced thecreation of the Term Auction Facility (TAF) to lendfunds directly to banks for a fixed term. The Fedestablished the TAF in part because the volumeof discount window borrowing had remained lowdespite persistent stress in interbank funding markets, apparently because of a perceived stigmaassociated with borrowing at the discount window.Because of its anonymity, the TAF offered a sourceof term funds without any of the associated stigma.4As of December 28, 2009, the Fed had provided 3.48 trillion of reserves through TAF auctions.Rescue Operations, March-August 2008Financial markets remained unusuallystrained in early 2008. In March, the FederalReserve established the Term Securities LendingFacility (TSLF) to provide secured loans ofTreasury securities to primary dealers for 28-dayterms.5 Later in March, the Fed established the3The St. Louis Fed provides a timeline of Federal Reserve andother official actions in response to the financial crisis(http://timeline.stlouisfed.org/index.cfm?p home).4The Fed’s htm) describes theTAF and other credit and liquidity programs instituted since 2007.5Primary dealers are banks and securities broker-dealers that tradeU.S. government securities with the Federal Reserve Bank of NewYork on behalf of the Federal Reserve System. As of February 17,2010, there were 18 primary d02.html).MARCH/APRIL201091
WheelockPrimary Dealer Credit Facility (PDCF) to providefully secured overnight loans to primary dealers.The PDCF, a temporary facility, expired onFebruary 1, 2010.Because not all primary dealers are depositoryinstitutions, the Fed invoked authority underSection 13(3) of the Federal Reserve Act, whichpermits the Federal Reserve to lend to any individual, partnership, or corporation “in unusualand exigent circumstances” if the borrower is“unable to secure adequate credit accommodations from other banking institutions.” Such loansmust be “secured to the satisfaction of the [lending] Federal Reserve Bank.”6 Section 13(3) waswritten into the Federal Reserve Act in July 1932(and amended by the Banking Act of 1935 andFederal Deposit Insurance Corporation Improvement Act of 1991) out of concern that widespreadbank failures had made it difficult or impossiblefor many firms to obtain loans, which depressedeconomic activity.7 The Fed made 123 loans totaling a mere 1.5 million in the four years after thesection was added to the Federal Reserve Act in1932.8 Section 13(3) was not used again until 2008,when it became an important tool in the Fed’seffort to limit the financial crisis.Shortly after Section 13(3) was used to createthe PDCF, the Federal Reserve Board again invokedSection 13(3) when it authorized the FederalReserve Bank of New York to lend 29 billion toa newly created limited liability corporation(Maiden Lane, LLC) to facilitate the acquisition ofthe distressed investment bank Bear Stearns byJPMorgan Chase. Bear Stearns was heavily investedin residential mortgage-backed securities, highlyleveraged, and relied extensively on overnightloans to fund its investments. Bear Stearns facedimminent failure when the firm’s creditors suddenly refused to continue to provide funding6See “Federal Reserve Act—Section 13: Powers of Reserve n13.htm) for the textof this section.7Bernanke (1983) argues that bank failures increased the cost ofcredit intermediation during the Depression and shows that bankfailures help explain the decline in economic activity.8See Fettig (2008) for a short history of Section 13(3) and FederalReserve lending to non-bank firms or see Hackley (1973) for a moredetailed history of Section 13(3) and other lending programs.92MARCH/APRIL2010(Brunnermeier, 2009). Because of Bear Stearns’large size and interconnections with other largefinancial institutions through derivatives tradingand loans, the Federal Reserve determined that“allowing Bear Stearns to fail so abruptly at atime when the financial markets were alreadyunder considerable stress would likely have hadextremely adverse implications for the financialsystem and for the broader economy” (Bernanke,2008a).9The PDCF—and especially the Maiden Laneloan—marked significant departures from theFed’s usual practice of lending only to financiallysound depository institutions against good collateral.10 Former Federal Reserve Chairman PaulVolcker (2008) contends that the Fed’s financialsupport for the acquisition of Bear Stearns byJPMorgan Chase tested “the time-honored centralbank mantra in time of crisis: ‘lend freely at highrates against good collateral’ to the point of noreturn.” Certainly nothing like this support wasprovided or even contemplated by the Fed duringthe Great Depression.11In July 2008, the Federal Reserve Board onceagain authorized loans to non-bank financialfirms when it granted the Federal Reserve Bankof New York authority to lend to the FederalNational Mortgage Association (Fannie Mae) andthe Federal Home Loan Mortgage Corporation(Freddie Mac) if necessary to supplement attempts9Maiden Lane acquired 30 billion (face value) of mortgage instruments from Bear Stearns. JPMorgan Chase provided a 1 billionloan to Maiden Lane and agreed to take the first 1 billion of anylosses on its portfolio. As of January 7, 2010, the net portfolio holdings of Maiden Lane were valued at 26.7 billion, and the outstanding principal amount of the Federal Reserve Bank of New Yorkloan to Maiden Lane was 28.8 billion (data source: Federal ReserveStatistical Release H.4.1, Factors Affecting Reserve Balances,Table 4; hwartz (1992), however, notes that the Fed made sizable discountwindow loans to both Franklin National Bank and ContinentalIllinois Bank before their failures in 1974 and 1984, respectively,as well as to many smaller banks that bank supervisors had identified as being in weak financial condition. The Federal DepositInsurance Corporation Improvement Act of 1991 sought to limitdiscount window borrowing by failing banks.11However, following the stock market crash in 1929, the FederalReserve Bank of New York extended loans to New York City banksto enable them to absorb stock market loans held by securitiesfirms. The Fed also offered support through commercial banks toissuers of commercial paper following the failure of Penn CentralCorporation in 1970 (Schwartz, 1992).F E D E R A L R E S E R V E B A N K O F S T. LO U I S R E V I E W
Wheelockby the U.S. Department of the Treasury to stabilizethose firms. The Fed was not called on to lend toeither firm, however, and the Treasury Departmentplaced both Fannie Mae and Freddie Mac underconservatorship in September 2008.Rescue Operations, September 2008–May 2009The financial crisis intensified during thefinal four months of 2008. Lehman Brothers, amajor investment bank, filed for bankruptcy onSeptember 15 after the failure of efforts coordinated by the Fed and Treasury Department to finda buyer for the firm. Subsequently, the Fed hasbeen widely criticized for not rescuing LehmanBrothers. Allan Meltzer (2009), for example, arguesthat allowing Lehman Brothers to fail was “a majorerror” that “deepened and lengthened the currentdeep recession” (Meltzer, 2009a,b). ChairmanBernanke (2008b), however, has stated that “thetroubles at Lehman had been well known for sometime, and investors clearly recognized that thefailure of the firm was a significant possibility.Thus, we judged that investors and counterpartieshad time to take precautionary measures.” Furthermore, by law, the Federal Reserve is not permitted to make unsecured loans and, accordingto Chairman Bernanke (2009c), the available collateral at Lehman Brothers “fell well short of theamount needed to secure a Federal Reserve loanof sufficient size to meet [the firm’s] fundingneeds.” Hence, the firm’s failure was unavoidable (Bernanke, 2009c). Nonetheless, ChairmanBernanke has also stated that “Lehman provedthat you cannot let a large internationally activefirm fail in the middle of a financial crisis” (CBSNews, 2009).Within hours of the Lehman bankruptcy, theFed was forced to confront the possible failure ofAmerican International Group (AIG), a large financial conglomerate with enormous exposure to subprime mortgage markets through the underwritingof credit default insurance and other derivativecontracts and portfolio holdings of mortgagebacked securities. Fed officials determined that“in current circumstances, a disorderly failureof AIG could add to already significant levels offinancial market fragility and lead to substantiallyF E D E R A L R E S E R V E B A N K O F S T. LO U I S R E V I E Whigher borrowing costs, reduced household wealth,and materially weaker economic performance”(BOG, 2008a). Hence, on September 16 the Fedagain invoked Section 13(3) of the Federal ReserveAct and made an 85 billion loan to AIG, securedby the assets of AIG and its subsidiaries. Thus,in the span of two days, the Fed confronted thefailure of two major financial firms. Neither firmwas a depository institution and thus could notobtain support through the Fed’s normal lendingprograms. In the case of Lehman Brothers, FederalReserve officials determined that they could notprevent the firm’s failure and concentrated ontrying to limit the impact on other financial firmsand markets. However, in the case of AIG, Fedofficials determined that a rescue of the firm wasnecessary to protect the financial system andbroader economy, and they therefore called onemergency lending authority granted underSection 13(3).The Lehman bankruptcy produced immediatefallout. On September 16, the Reserve PrimaryMoney Fund announced that the net asset valueof its shares had fallen below 1 because of lossesincurred on the fund’s holdings of Lehman commercial paper and medium-term notes. Theannouncement triggered widespread withdrawalsfrom other money funds, which prompted theU.S. Treasury Department to announce a temporary program to guarantee investments in participating money market mutual funds. The FederalReserve responded to the runs on money fundsby establishing the Asset-Backed CommercialPaper Money Market Mutual Fund LiquidityFacility (AMLF) to extend non-recourse loans toU.S. depository institutions and bank holdingcompa
Federal Reserve Bank of St. Louis Review, March/April 2010, 92 (2), pp. 89-107. nomic contractions by the National Bureau of Economic Research (NBER). The recent reces sion began in December 2007, according to the NBER. Although their Business Cycle Dating Committee has not officially identified the end of this reces -
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Le genou de Lucy. Odile Jacob. 1999. Coppens Y. Pré-textes. L’homme préhistorique en morceaux. Eds Odile Jacob. 2011. Costentin J., Delaveau P. Café, thé, chocolat, les bons effets sur le cerveau et pour le corps. Editions Odile Jacob. 2010. 3 Crawford M., Marsh D. The driving force : food in human evolution and the future.
