Chinese title: 金融的本质 - Bernanke’s Four Lectures on the Federal Reserve

English title: The Federal Reserve and the Financial Crisis

Author: Ben S. Bernanke (US)

Publication Year: 2014-4

ISBN: 9787508644097

Notes:

The main cause of the 2008 financial crisis was this: financial institutions were overconfident in their own risk-management capabilities, everyone firmly believed housing prices would keep rising, banks assumed mortgage loans could easily be resold, and international clients had enormous demand for “safe” assets. As long as housing prices rose, originating subprime residential mortgages was a highly profitable line of business.

When housing prices fell, the blow to the financial system should have been comparable to a decline in one class of stocks, and should never have spread so widely. What actually let the crisis spread was the derivatives behind housing credit. Fannie Mae and Freddie Mac did not lend directly to homebuyers; instead they bought loans from banks, securitized the housing credit, and sold it to investors. Clearly, such securities — a mix of good and bad — were not easy to find a market for, so investment institutions very cleverly packaged the housing credit into securities of various credit ratings and issued them. The AAA-rated securities were sold quickly, leaving the riskier ones. Insurance companies such as AIG also ran insurance businesses underwriting this kind of security. By buying the credit derivatives they offered, these securities could obtain a AAA rating. These operations did not improve the quality of the assets underlying the securities; on the contrary, they created the conditions for risk to spread throughout the entire financial system.

Over the long run, the gold standard could maintain the stability of the currency’s value and keep the inflation level stable, but over the short run (roughly five or ten years), inflation or deflation showed up a great deal. That is because under the gold standard, the total amount of money in the economy changes with factors such as the volume of gold mining.

In 1934, after the deposit insurance system was established, the number of bank failures per year gradually fell from thousands to zero. Even if a bank failed, ordinary customers could get their money back, so they had no incentive to run on the bank again.

The Federal Reserve-Treasury Accord signed in 1951 meant that the US government explicitly acknowledged for the first time that the Federal Reserve should operate independently. Today countries around the world have reached a consensus: an independently operating central bank is better than one led by the government, and it need not heed short-term political pressure.

A key event that ultimately led to the 2008 crisis was the sharp rise in housing prices.

These housing mortgages were distributed across different securities and flowed through different markets, and no one knew who would suffer the losses. This brought great uncertainty to the financial markets.

If a system contains some enterprises that are “too big to fail,” then that system certainly has certain fundamental flaws. Being rescued because of its size is very unfair to other enterprises. Moreover, it encourages these large companies to take excessive risks.