Introduction
17:56, a media teacher who has worked with for a long time sent a WeChat message: Nobel Prize in Economics , can you give us a post? I thought to myself, is it because I also wrote an Nobel Prize review last year, and I will make another one this year? It turned out that it was Bernanke that won the award - for its "research on banking and financial crisis". I understand. I have read a lot of Bernanke's books, so I'm still familiar with them (One Book per week 050 | How to understand Fed ?; One Book per week 044 | Bernanke's new book: "21st Century Monetary Policy")! The Chinese version of its new book "21st Century Monetary Policy" should be launched this year. This article is excerpted from part of the manuscript, reviewing the process of the US financial crisis in 2008 and the rescue process of the Federal Reserve in the Bernanke era. For your reference (the full text has been uploaded to Knowledge Planet).
Once you find that your neighbor’s house is on fire, the most urgent thing is to put out the fire together, rather than accuse your neighbor of being careless. Because once the fire spreads, your own house will be difficult to protect. This is Bernanke's reflection on the great crisis in "The Courage of Action" and the three "Fire-fighting Captains" in "Fire-fighting" and also a warning to decision makers. From the peak of housing prices in July 2006 to the bankruptcy of Lehman in September 2008, panic continued to spread, and the liquidity crisis spread from subprime mortgage loan to the entire wholesale financing market, swallowing up the capital of financial institutions. Policy makers need to balance the moral risks arising from intervention too early and the systemic risks arising from intervention too late. It was not until the "BNP Paribas shock" in August 2007 that Bernanke realized the seriousness of the situation. The Federal Reserve's firefighting operations began to continuously break through traditional frameworks and strengthen cooperation with regulators such as the Treasury Department and federal deposit insurance company (FDIC), but the panic spread faster than expected. Reflection on the big crisis and rescue behaviors during the crisis have reshaped the US financial system of , , meaning "the end of an era."
collapse: From liquidity impact to financial crisis
because it involves real estate, it can only be published in the form of pictures Fire extinguishing: surpassing the "Baizhihao Rules"
The Federal Reserve's fire extinguishing action is the fastest (Figure 3). After the BNP Paribas incident, Bernanke began to study the possibility of an emergency rate cut before the regular meeting on September 18. Donald Kohn, a veteran of the Federal Reserve and vice chairman of the board of directors, was worried that early rate cuts would aggravate investors' panic and suggested a 0.5 percentage point cut at regular meetings. On September 18, the regular meeting announced a 0.5 percentage point reduction in the federal funds rate, from 5.25% since July 2006 to 4.75%, which also started a new round of interest rate cuts. At that time, some hawk members of FOMC were opposed. They prefer to drop by 0.25 percentage points. Because at that time, the fundamentals of the US economy were still strong, the unemployment rate after the season was lower than 5%, and the rise in crude oil prices began to attract attention to inflation. In hindsight, it was not until July 2008 that the US inflation rate peaked (CPI grew by 5.6% year-on-year, and the core CPI growth rate was 2.5%. Figure 3: "Fire-fighting Operation" jointly carried out by the US government
Source: Bernanke et al., 2019, p.182, the author draws
According to the "Bage Zhihao Rules" (Bagehot rule), when liquidity shock occurs, the Federal Reserve should play the function of "lender last" but charge a punitive interest rate. This is why the discount window is set up. Taking into account the stigma, while cutting interest rates, the Federal Reserve continues to compress the spread between the discount rate and the federal funds rate (from 1% to 0.25%) to alleviate borrowers' concerns. The effect of "opening the door to welcome guests" is not ideal. To this end, the Federal Reserve has surpassed the "Bai Zhihao Rules" and creatively implemented two tools: the Term Auction Facility (TAF) and the central bank liquidity swap (LSL). The former is an upgraded discount window, which not only extends the loan term, but also replaces the fixed punitive interest rate with market-oriented auction rates.Foreign banks' branches in the United States are unable to handle deposit insurance business for depositors, and are more likely to be runs and have a higher demand for asset liquidity. At the same time, the problem of overseas US dollar liquidity shortage is also serious. Central banks' liquidity swap tools are established for this - central banks can borrow US dollars from the Federal Reserve using their own currencies as collateral and then lend to their own financial institutions, which can also indirectly alleviate the liquidity pressure on the United States. Since January 2008, the Ministry of Finance has also implemented some conventional tax cuts (size $150 billion), but has not increased its spending.
In order to save Bear Stearn , the Federal Reserve played the edge of the law. Article 13 (3) added to the Federal Reserve Act in 1932 authorizes the Federal Reserve to issue loans directly to any individual or business as long as the consent of 5 or more members of the Federal Reserve Board of Directors is granted “in exceptional and emergency situations”, “with satisfactory assurance” and proof that the debiter cannot obtain funds through other channels. These restrictive provisions are intended to protect the interests of taxpayers, because any loss will reduce the profits paid by the Federal Reserve to the Treasury Department and increase the fiscal deficit. In order to bypass the restrictions, the Federal Reserve created a special purpose institution (SPV) called "Maiden Lane". By injecting capital into "Bayer Stearn" and then purchasing Bear Stearn's 30 billion shares held by JPMorgan Chase , indirectly achieving the purpose of rescuing Bear Stearn. On March 11, the Federal Reserve announced several new liquidity management measures. In addition to increasing the currency swap quota, more importantly, the establishment of a new Term Securities Lending Facility (TSLF). Through TSLF, the debiter can use mortgage-backed securities or "other private brand mortgage-backed securities" as collateral, borrow Treasury bonds from the Federal Reserve, and then use treasury bonds as collateral to raise funds in the repurchase market. On the one hand, it alleviates the pressure of liquidity and asset selling of institutions, and also helps guide funds to flow to the real economy sector. On March 16, the Federal Reserve Board approved the establishment of the Primary Dealer Credit Facility (PDCF). Primary dealers can borrow from the Fed like commercial banks, with a wider range of qualified collateral than TSLF. After resolving the Bear Stearns risk, the market ushered in a brief calm. sub-loan mortgage asset prices rebounded slightly, the credit spread between non-sub-loan ABS and banks no longer hit a new high, and the liquidity pressure in the interbank market has also eased. The double impact of
Lehman and AIG completely frozen the liquidity of the money market. Traders were unable to perform their financial intermediary functions. The Federal Reserve could only act as the "dealer of last resort" and play its financial intermediary functions (Figure 4). The fire-fighting operation has entered the final stage of attack. After the main reserve funds fell below their face value, in order to provide liquidity to money market funds and commercial paper markets, the Federal Reserve established Commercial Paper Funding Facility (CPFF) and Asset-based Commercial Paper (ABCP) Money Market Fund Liquidity Tool: the former can directly lend to borrowers (including foreign banks); the latter first provides reserves to the bank, and then the bank purchases commercial paper held by money market funds. The effect was immediate, and no more money market funds fell below their face value.
Figure 4: The function of the Federal Reserve as the "optimal trader"
Source: Perry Merlin, 2011, "New Lombard Street"
In the early rescue operations, in order to control the FFR, the Federal Reserve needed to keep the amount of reserves unchanged (reserve-neutral), so Treasury bonds were sold while issuing loans. This is reflected in the Fed's balance sheet, which is actually just a change in the asset structure - increasing loans to financial institutions and reducing Treasury bonds of equal scale. This is a stopgap measure. The upper limit of the size of the Federal Reserve's loan is the size of the Treasury bills it holds. Under the framework of adequate reserves, the Federal Reserve's function of managing liquidity will also be limited when there are no Treasury bills to borrow. So, when House Financial Services Committee Chairman Barney Frank asked Bernanke where the Federal Reserve found $85 billion to lend to AIG, Bernanke said: "We have $800 billion."Frank looked shocked and didn't understand why the Fed had so much money to dominate. This figure corresponds to the size of the Federal Reserve's balance sheet before the crisis.
After Lehman went bankrupt, the lower limit of the federal funds rate target dropped rapidly to zero. The Federal Reserve launched a new "flooring mechanism" to maintain interest rate targets. The scale of treasury bonds that can be loaned has shrunk by nearly half. In order to better play the role of a final trader, the Federal Reserve had to expand its balance sheet to increase liquidity to financial institutions and key currency markets (Figure 5).
Figure 5: Federal Reserve Asset Structure (2008-2010)
Data Source: Cleveland Fed, Oriental Securities Wealth Research Center
After rescuing AIG, Bernanke knew that the Fed's capabilities were limited, so he discussed with Paulson , Geithner and others to seek the authorization of Congress to implement TARP. The plan was led by the Ministry of Finance. After long debates and repeated repeated times, it was finally passed in Congress in early October. It is mainly used to inject capital into systemically important financial institutions such as banks and AIG. At the same time, in order to alleviate the dilemma of the consumer credit market, the Federal Reserve once again activated the Term Asset-backed Securities Loan Facility (TALF) to support borrowing from the Federal Reserve on mortgages with credit card loans, student loans, auto loans and small business loans.
After the Obama administration took office in early 2009, the $750 billion Economic Recovery Act was quickly introduced. After Geithner took over Paulson as Treasury Secretary, he began to conduct a "stress test" on banks to estimate capital gaps in extreme cases, with the goal of distinguishing "good banks" from "bad banks" and reducing a comprehensive run caused by information asymmetry (Gethner, 2015). The test results released in May 2009 were better than expected. Of the 19 largest financial companies surveyed, nine have enough capital to deal with the shocks, while the remaining 10 need a total of $75 billion. Since then, the cost of default insurance for financial institutions has dropped rapidly, and the private sector’s information on investment banking has been restored. At the end of 2008, the liquidity situation in the non-mortgage loan assets and wholesale financing markets began to improve. In early 2009, the liquidity situation in the wholesale financing market had recovered to before Lehman's bankruptcy. The recovery of credit for non-mortgage loan assets was slightly slower and did not fall within 1 standard deviation of the historical mean until the second quarter of 2009 (Bernanke, 2018). At the same time, the US economy bottomed out and started a long recovery. The Federal Reserve has carried out three rounds of QE under its forward guidance on zero interest rates to lower long-term interest rates and support economic recovery.
From BNP Paribas to the post-Lehman era, the US government has continuously enriched its fire extinguishing toolbox and comprehensively used international policies, housing policies, monetary and fiscal policies, as well as systemic financial policies (liquidity plans, guarantee plans and capitalization strategies) to respond to the crisis. The Federal Reserve has continuously broken through the traditional policy framework and created a number of liquidity tools to inject liquidity into institutions and markets in a targeted manner, rebuilding confidence, and quickly put out the fire after Lehman went bankrupt. But the "compliance book" is not only the Federal Reserve, but also the Treasury Department and the FDIC. In addition to strengthening cooperation within the administration, Congress needs to “ensure that crisis managers have the tools they need before things get really bad.”
responded immediately: the best time to extinguish the fire
The positive feedback characteristics of the financial market endogenous instability. Just as Buddhists view death, "the fire will eventually come." Keeping this lesson in mind, putting the first flame out when it appears is more important than predicting when a fire will happen. This is how to minimize costs. Even Bernanke, who spent his life studying the Great Depression of , could not predict the crisis in advance.
The wave of subprime mortgage defaults triggered by the collapse of the real estate market is the fuse of the big crisis, but the spread of panic is the real reason for the evolution from liquidity shock to financial crisis. Before the outbreak of the subprime mortgage crisis, subprime mortgage loans accounted for only 1/7 of all housing mortgage loans, and floating interest rate subprime loans with higher default rates accounted for only 1/12 of them. Even if all floating interest rate subprime mortgages are defaulted, banks still have enough capital to digest.However, subprime mortgages are also the carrier of panic, gradually spreading to high-quality mortgage loans, non-mortgage loan assets and short-term wholesale financing markets, destroying the credit of counterparty. Coupled with the amplification effect generated by leverage , it most leads to financial deleveraging and the contraction of the real economy.
This is what Gary Gordon calls the "E. coli effect" - after knowing several burger contamination incidents, some consumers will reject all meat food instead of trying to figure out which stores and which meat foods in which areas are contaminated. During the financial panic, the asset pricing mechanism fails. In the case of information asymmetry, lenders will "one-size-fits-all" believe that all collateral will have problems, thus requiring a higher risk premium and discount rate. Individual rationality leads to market irrationality, which is what Kindleberger describes as the process from "fear" to "collapse". The economic recession brought about by the 2008 financial crisis was second only to the Great Depression from 1929 to 1933. Both are related to the real estate market, but if the spread of panic can be interrupted in time, the economic recession may be reduced. There are two representative narratives in
from the financial crisis to the economic crisis. The first category of narratives focuses on stages I and IV, focusing on the real estate market, bank credit and resident balance sheet channel ; the second category of narratives focuses on stages II and III, focusing on the liquidity issues of the wholesale financing market and asset securitization market. Bernanke called the first category "balance sheet channel" and the second category "panic channel". Which channel is more explanatory to the Great Depression? If the panic in Phase I did not spread, will the Great Recession still occur?
Mian and Sufi (2010; 2014) and Ku Chaoming (Koo, 2014; 2018) are representatives of the balance sheet channel. During the crisis, the market value of US real estate evaporated by $5.5 trillion. This directly deteriorates the household balance sheet . As mortgage lenders are concentrated in the low-income class with a higher marginal consumption propensity, the bursting of the housing price bubble has also aggravated the gap between the rich and the poor, reduced consumption expenditure, and dragged down the pace of economic recovery. In terms of experience, before Lehman went bankrupt, U.S. automobile spending fell by 9% year-on-year from January to August 2008, furniture spending fell by 8%, and renovation spending fell by 5%. After Lehman went bankrupt, total consumer spending continued to shrink.
Bernanke is the representative of the panic channel (Bernanke, 2018). According to the four stages of the crisis evolution, Bernanke selected 72 economic indicators, used the factor to analyze the method, and isolated 4 factors from it, and then integrated into balance sheet factors and panic factors. Bernanke found that except for residential construction, the panic factor has significant explanatory power on economic trends (GDP, production, consumption, employment), and must be higher than the balance sheet factor. Based on this, Bernanke believes that the deterioration of residents' balance sheets and deleveraging have intensified the process of dragging down the economic recovery, but the depth of the economic recession is mainly determined by panic in the wholesale financing and asset securitization market. The meaning of the policy is: the best strategy for extinguishing fires is to act quickly before the fire spreads. So, before the launch of QE1 in March 2009, the Federal Reserve first targeted bailout of financial institutions and created a series of liquidity convenience tools to provide liquidity to key credit markets. Bernanke said such policies could be called "credit easing" (CE).
In a speech at London School of Economics (LSE), Bernanke pointed out the difference between QE and CE: "The goal of (Japan) quantitative easing policy is to increase the amount of bank reserves...the asset-side loans and securities structures are accompanied. In contrast, the Federal Reserve's credit easing policy focuses on the combination of loans and securities held and how this asset composition affects the credit status of households and businesses." (Bernanke, 2009) Therefore, QE focuses on the central bank's liabilities and balance sheet size, while CE focuses on the asset structure, with the aim of improving the financing liquidity of counterparty parties. In pure CE policy, the size of the reserve and central bank balance sheet remains unchanged.
Bernanke is deeply affected by Friedman , and believes that the cause of the Great Depression is that the Federal Reserve is unwilling to provide liquidity during the credit tightening because it is worried about inflation or moral hazard. The difference between the two is that Friedman is more concerned about bank credit, while Bernanke is more concerned about it, especially the wholesale financing market. This is because, over the past half century, the importance of banks in the US financial system has continued to decline, and the importance of the money market has become more prominent. The quantity and quality of qualified collateral are the key to the liquidity of the multi-level financial system. The II and III of the 2008 financial crisis were the liquidity crisis caused by inter-institutional runs in the money market.
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