Federal Reserve Chairman Ben Bernanke said Tuesday that U.S. government intervention during the financial crisis prevented a “total meltdown” in the U.S. economy that could have rivaled the Great Depression. In the third of four lectures to students at George Washington University, Bernanke also said that there is something “fundamentally wrong” with a system in which some banks are “too big to fail,” but insisted that the government was “helpless” to help Lehman Brothers, which collapsed at the height of the crisis.
Bernanke’s lectures are part of campaign to increase the public visibility of the Federal Reserve — traditionally, a secretive and opaque institution that focuses on esoteric economic policy — as well as counter critics who say that the government had no business intervening in the private markets and should have let failing institutions go bankrupt. (Also on Tuesday, Bernanke sat down with Diane Sawyer for an interview with ABC News.)
For Bernanke, the series is something of a return to his roots: for more than two decades he taught economics at NYU, Stanford and Princeton, specializing in the history of the Great Depression. Throughout the lectures so far, Bernanke has advanced a two-fold argument explaining the policy errors the Federal Reserve made that exacerbated the Great Depression. First, the Fed failed to use monetary policy to prevent deflation and an economic collapse. Second, the Fed did not adequately carry out its responsibility as “lender of last resort,” even as thousands of banks failed. “The Fed did not fulfill its intended mission” during the Great Depression, Bernanke told the students.
On Tuesday, Bernanke sought to apply those lessons to the recent financial crisis. “Without the forceful policy response that stabilized the financial system in 2008 and early 2009, we could’ve had a much worse outcome in the economy,” Bernanke said, adding that without strong government intervention the financial system could have faced a “total meltdown.”
In particular, he singled out financial giant AIG, which held complex insurance contracts known as credit default swaps protecting Wall Street banks from a decline in the value of mortgage backed securities.
“The failure of AIG, in our estimation, would have been basically the end,” Bernanke said. “Because AIG was interconnected with many other parts of the global financial system, its failure would have had a massive effect on other firms and markets. We were quite concerned that if AIG went bankrupt, we would not be able to control the crisis any further.”
“Over time, AIG has stabilized,” he added. “It has repaid the Fed with interest and made progress in reducing Treasury’s stake in the company.”
Bernanke made clear that the government did not want to intervene in private markets so forcefully, but only did so to prevent greater damage to the financial system. He characterized the choice as the lesser of two evils. Moving forward, Bernanke said there has to be a “safe way” for a company like AIG or Lehman Bros. to fail without bringing down the global financial system. “I’d like to emphasize that what we had to do with Bear Stearns and AIG was not a recipe for future crisis management,” he said dryly. “There is something fundamentally wrong with a system in which some companies are, quote, ‘Too big to fail.”‘
In the case of Lehman Bros., Bernanke said while it was certainly “too big to fail,” the Fed was “helpless” because unlike AIG, the bank didn’t have any collateral and was “insolvent.”