Bernanke's Financial Crisis 101: Four Questions

Yesterday the chairman of the Fed, Ben Bernanke, gave a lecture to students of Morehouse College on the financial crisis. Bernanke provided an introduction to the crisis by posing and answering four questions in light of the four questions that children supposedly asked during passover. Fortunately the folks at Bloomberg recorded this lecture, and I watched it on YouTube. Here are my notes from the talk:

I've broken the notes down into the four questions Bernanke posed, with my synopsis of the answers he provided.

1. How did we get here?

There are many videos and explanations of this one, so you probably know this already. Basically, foreigners started lending U.S. banks lots of money, so much that banks and financial institutions (fints) had a hard time finding reliable people to loan this foreign money to, and began loaning money to unreliable people. The housing bubble just made fints even more willing to loan to unreliables, and package unreliable loans in ways which made them seem like safe investments. Basically, we as a nation were making lots of loans to unreliable people.

2. What has the Fed been doing about this?

Well, first, they cut the overnight loan rate to 0%, and plan to keep it low for a while. They also agreed to make short term loans to banks (this in turn mkes banks more willing to give out mortgages). They used "targetted lending" to help markets outside of banking (commercial paper, basically a short term loan, is an example of a market the Fed helped out succesfully). The Fed is also issuing programs to help ordinaries like us get credit, and finally it is buying securities in the open market. Basically, the Fed is doing quite a bit to help out! And it should .After all, this IS their job...

3. Could the Fed's actions lead to an inflation problem?

Bernanke didn't actually answer this question. Instead, he basically said that inflation isn't necessarily a bad thing. Bernanke noted that the Fed wants to maintain an inflation rate of 2%, and that currently inflation is below this. He also pointed out that deflation is a bad thing (is often an indicator of a struggling economy). My conclusion from this is Bernanke does think there will be an inflation problem, especially since he's trying to calm people down about it.

4. Why did the Fed and Treasury act to prevent the bankrupcy of Bear Sterns and AIG?

Bernanke first pointed out that he is very much in favor of letting troubled companies go bankrupt. But, because AIG is connected to the health of so many institutions, letting AIG fail would also force many other companies to fail. Furthermore, this could cause a global panic, which is never good in economics. 

Bernanke said that in order to avoid a situation like this in the future, the "rules of the game" need to change. First, all large financial institutions like AIG need to have federal oversight. Second, we need a system to deal with the failure of large fints. This would basically be the equivalent of the FDIC for large companies. I think that this is a very good idea.

So there you have it. I thought the talk was very understandable, and fun to hear. Hopefully these notes were informative, if not incredibly fun, to read.