Reminiscent of the Great Depression, the insecurity of the current recession has Americans in a "Great Panic." In response to the economic panic of 1907, President Woodrow Wilson created the Federal Reserve (Fed) in 1913 to stabilize the American economy and to mitigate future crises. The central bank of the United States, the Fed, was designed to provide a safe, flexible monetary system for the country by keeping prices stable and interest rates low. Now, nearly a century later, the American people depend on the Fed to lift the nation out of imminent catastrophe amidst a global recession.
Wessel opened with a characterization of the man behind the Fed: Ben Bernanke. A "nice, Jewish boy" growing up in the small town of Dillon, South Carolina, Bernanke was notoriously smart and a champion speller. After high school, he planned to go to a local state university until Kenneth Manning, a graduate of Harvard, convinced Bernanke to attend his alma mater. Bernanke was a start student at Harvard, winning the prize for the best undergraduate economic thesis. He went on earn a Ph.D. in economics at MIT and then took up a teaching post at Stanford. In his professional life, Bernanke became a leading student of the Great Depression. He concluded that both the failure of the banks and the Fed's stinginess with credit were significant contributors to the economy's collapse. Appointed as Chairman of the Fed by President George W. Bush in February 2006, Bernanke promised to continue the legacy of his predecessor Alan Greenspan. He pledged to increase transparency and elevate the presence of the institution over the Chairman. As the global financial system tottered on the edge of collapse in the wake of Lehman Brothers' collapse, Bernanke took extraordinary steps to stabilize the financial system. With his great knowledge of the Great Depression, Bernanke turned out to be the ideal candidate to confront America's worst economic slump in decades.
The Federal Reserve building is a physical metaphor of America's financial strength. Other countries have found security in the building's immense and grandiose structure, many of which store their gold in its vaults. Three years ago in a period of economic prosperity, very few people aside from the usual naysayers, predicted an economic downfall. In September 2007, when problems in banking and housing arose, the Fed dismissed them as isolated and "contained." September 2008, shook the foundation of trust in the Fed as an economic stabilizer. As Wessel described, everything went wrong at once. Three institutions --AIG, Lehman Brothers, and Merrill Lynch-- were on the brink of collapse, and Bernanke began to realize the modern economic system was built on the faulty assumption that overall housing prices don't fall.
A question central to discussions surrounding the collapse of the American economy was why didn't Bernanke detect signs of disaster looming in the future? Following Greenspan's mantra: "when in doubt, leave the market alone," Bernanke focused on interest rates and left bank supervision to others. In addition, while some banks were simply greedy, many were oblivious to the irresponsible risks they were taking. Wessel argued that failure of imagination prevented a clear view, no one saw how interconnected the system was and how it could implode all at once.
Wessel also discussed the reasoning behind the critical decision to let Lehman Brothers fail. Bernanke knew the firm was in trouble, but neither he nor other key players could find a private sector purchaser of Lehman without offering federal guarantees. Bernanke and Secretary of the Treasury Paulson already faced criticism for having bailed out Baer Sterns months before. There was also concern that bailing out another financial firm would create what economists call moral hazard by failing discourage other institutions from negligent risk-taking. The consequent messy collapse of Lehman Brothers, a prominent financial institution, had several unforeseen effects. First, though Bernanke assumed investors expected the bankruptcy, the collapse shocked financial institutions around the world. Who was next, they wondered? Was any institution safe?
Finally, Wessel concluded with comments on the current condition of the United States economy. He compared the American economy with a person who is recovering from a heart attack: the patient is out of intensive care but is still very weak and highly susceptible to further damage. The economy is still suffering from a high and rising unemployment, slow growth, and many troubled financial institutions. Wessel asserted that the Fed cannot be naive in assuming nothing else can fail in our economy. Ultimately, Wessel argued, the United States needs an ability to avoid the Hobson's choice of bankruptcy or bailout if large firms declare bankruptcy in the future and safety nets in place to prevent economic recession of this magnitude from occurring ever again.
Drafted by Stephanie Grow, PAGE
Edited by Kent Hughes, PAGE