Read Online In FED We Trust by David Wessel - Free Book Online Page B

about the safety of banks prompted runs in which depositors pulled out their money. Runs, or even the anticipation of them, forced banks to sell securities or call in loans to raise cash. Dumping assets at the same time other banks were doing so pushed down the market price of virtually all assets, generating losses that actually caused banks to fail. “Thus, expectation of failure, by the mechanism of the run, tends to become self-confirming,” Bernanke wrote. The words could have been used to describe Bear Stearns or Lehman Brothers.
“T HE F INANCIAL A CCELERATOR”
    In seeking to understand why the economy had a disturbing tendency toward growth spurts followed by recessions, panics, and depressions, many economists discounted the financial markets as a sideshow. They believed that financial markets reflected and predicted what was going on in the underlying economy but weren’t an independent driver of the business cycle. It was a reflection of much of the profession’s amazing proclivity for assuming away reality at times and understating the importance of institutions. Ben Bernanke didn’t see the world as they did. The health of banks and other financial institutions and their attitude toward lending was a major driver of thebusiness cycle — and could amplify the impact of Fed policies on the economy, he said. He called it “the financial accelerator,” and the Great Depression became his leading case study. His research on this subject provided the lens through which he would later view the Great Panic.
    Beginning with an article published in 1983 in the prestigious
American Economic Review
and in subsequent research, Bernanke emphasized banks’ role in the economy, employing concepts that later brought Nobel Prizes to Joseph Stiglitz and George Akerlof for their insights into the functioning of markets when one side has more information than the others.
    Bernanke, among others, contended that banks and other financial intermediaries were “special” because they did more than funnel money from savers to borrowers; they developed expertise in gathering information about industries and borrowers and maintained ongoing relationships with customers. “The widespread banking panics of the 1930s caused many banks to shut their doors,” Bernanke told a 2007 audience. “Facing the risk of runs by depositors, even those that remained open were forced to constrain lending to keep their balance sheets as liquid as possible.” The economy, thus, was denied the benefits of banks’ unique knowledge and ability to discern the creditworthy borrower from the less desirable. Stingier banks inhibited consumer spending and capital investment and made the Depression worse. His determination to avoid repeating that mistake drove Bernanke during the Great Panic to do
whatever it takes
to resuscitate the financial system.
    The other way that financial disturbances exacerbated the rest of the economy in the 1930s, Bernanke said, was through the creditworthiness of borrowers — and, particularly, through the value of the collateral that they could offer as a way to assure lenders that a loan would be repaid. Bernanke viewed the collapse of home prices during the Great Panic primarily through this lens: a decline in the value of American families’ best collateral would inevitably make it harder for them to borrow. This reading of economic history also led him to press earlier and harder than Paulson did for the government to take steps to avoid “preventable foreclosures” and reduce the size of mortgages that exceeded the value of the homes on which they were written.
    In his dissection of the Fed’s mistakes in the 1930s, Bernanke also cited the Fed’s misreading of interest rates as a gauge to the availability of credit.
    At times of panic and uncertainty, bankers and others rush to the security of the safest securities, especially the debt of the U.S. Treasury. This pushes down the interest rate that the Treasury