How good is your memory? Not many people today have personal memories of the Great Depression some 80 years ago, when thousands of banks closed. It would be natural, you'd think, to have a burning memory of what happened just five years ago when the U.S. banking system was on the brink of a similar collapse. The housing bubble burst. Lehman Brothers went bankrupt. Banks pulled back on lending, investors avoided new bonds and everyone seemed to be stockpiling cash. The economy started to contract by 5 percent to 6 percent annually. Trillions of dollars were knocked off the value of U.S. companies. The public and financial authorities had reason to believe nothing much could be done to avert a rerun of the Great Depression.
George Santayana (and before him the 18th century British philosopher and politician Edmund Burke) had history in mind when he observed that those who can't remember the past are condemned to repeat it. Five years hardly qualifies as "history," so it is unnerving that even supposedly well-informed people have forgotten how we got out of the mess. Last year, for example, the House of Representatives followed the lead of former Texas Republican Rep. Ron Paul (now taken up by his son, Kentucky Sen. Rand Paul) in passing a motion for an audit of the Federal Reserve, as if the Fed had been a cause of our problems.
On the contrary, the Federal Reserve was quite simply our last hope. It was the chairman of the Federal Reserve Ben Bernanke who came to the rescue. Bernanke, a former Princeton professor, was a scholar of the Great Depression, a background that proved critical. Right from his start in 2006, he demonstrated a tough independence. Unconvinced of inflation predictions in 2007, he refused to continue ratcheting up interest rates – and he was proved right. When the crisis hit in 2008, he went way beyond the standard response of a central banker, which would have been to lower interest rates and hope that cheaper credit would somehow work its way to more borrowing, more activity, more jobs.
It hadn't worked that way in the Great Depression. Nobody wanted to borrow because there was no demand for their products and services. Bernanke understood that the full faith and credit of the U.S. government was required for a bailout, so he devised a whole menu of unique liquidity facilities to restore credit and confidence. More than a trillion dollars in lending programs helped troubled financial firms, especially the banks. Debt from industrial corporations was bought up, and distressed mortgage assets were put onto the Fed's books. The Fed's policy sustained money market funds, commercial paper, consumer loans and more. His intervention was decisive in easing the panic.
Bernanke's boldness no doubt stemmed from his intricate understanding of the Great Depression. He literally transformed the Fed into a daring, financial first-responder and an active market participant, rather than limiting it to its traditional role of controlling the money supply. Simultaneously he joined Treasury Secretary Hank Paulson on a visit to Capitol Hill to persuade terrified politicians to embrace the famously massive fiscal injection of the Troubled Asset Relief Program, or TARP. That was a close call, for at that fragile moment financial experts worried that the banks might not open the next morning.
Bernanke rallied both the Treasury Department and other central bankers around the world. He pushed other central banks to pursue expansion. Miraculously, the clogged arteries of the global financial system opened up. He leveraged whatever assets the Congress authorized him to deploy, and almost single-handedly steered the global economy back from the brink. In so doing he was able to secure enough time for the U.S. to stabilize the financial system and begin to heal its economy.
His greatest strength came from the authority endowed by his insight and understanding of the magnitude of the crisis at a time when Washington was in turmoil and the Obama presidency did not enjoy congressional confidence. Not so with Bernanke. He got behind a series of imaginative but untested emergency funding procedures for the banks. He used the Fed's balance sheet both uniquely and aggressively to buy not only short-term Treasury bills but also long-term bonds and mortgages as a way of manipulating prices and forcing policy interest rates down to virtually zero for an unprecedented period. This lowered both short- and long-term interest rates. He also didn't hesitate to suggest that the Fed would do even more if these measures didn't work.