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Not All Financial Crises Are Alike!

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Abstract

The United States has experienced many financial crises, but the Great Depression, the prolonged thrift crisis of the 1980s, and the most recent Great Recession stand out. In this paper, the focus is on the differences the three crises exhibited in terms of the economic environment leading up to each crisis, the effects on financial institutions and financial markets, and the policy responses and how those responses evolved. The post-World War I macro environment leading up to the Great Depression was radically different than either the inflation environment of the 1970s and early 1980s or the housing collapse and role that subprime lending played in the Great Recession. Additionally, the financial institution failure experience was different in all three crises, as were the regulatory and legislative responses that followed. Perhaps most striking are two important differences. In the Great Depression, many very small rural banks failed. In the 1980s, the first round of failures hit mainly thrifts followed by largely smaller regional and community banks. In the Great Recession, the nation’s largest institutions were the main ones affected. Second, the runs on the institutions were also significantly different.

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Notes

  1. See James (2012)

  2. Discount rates were coordinated but set individually by the Reserve Banks, and there was no requirement that they be the same.

  3. See Friedman and Schwartz (1963), Meltzer (2005). See Feinman (1993) for a history of reserve requirements.

  4. See Eichengreen (1989), and Bernanke (1983) for example.

  5. For a contrary view on the role of the discount rate see Calomiris and Wheelock (2011).

  6. See http://useconomy.about.com/od/grossdomesticproduct/p/1929_Depression.htm and

    http://2012books.lardbucket.org/books/theory-and-applications-of-macroeconomics/s11-01-what-happened-during-the-great.html

  7. Calomiris and Wheelock (2011) argue that some aspects of Fed policy were triggered by concern about inflation and the buildup of excess reserves in 1936 and 1937. Furthermore, they suggest that the Fed had lost control over the monetary base though discount rate and open market operations due to the Treasury having gained control through legislation in 1933 and 1934 of the power to set the price of gold, and hence control the size of the monetary base.

  8. For a complete discussion of this crisis and its costs, see Kane (1989b).

  9. See FSF/CGFS Working Group (2009)

  10. See the FOMC Statement, http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040630/default.htm . The reasons are discussed more fully in the meeting’s minutes: http://www.federalreserve.gov/fomc/minutes/20040630.htm

  11. This frustrated the Fed’s efforts to dampen the economy and Alan Greenspan called this lack of responsiveness of interest rates to Fed policy a “conundrum” in his congressional testimony. See “Greenspan (2005).

  12. Frame and White (2005) indicated that part of the reason for the shift was to get Fannie Mae’s debt off the federal budget. See also Financial Crisis Inquiry Commission and United States (2011).

  13. Its stock was originally held only by the Federal Home Loan Banks and thrifts.

  14. In other words, they were prohibited from participating in the primary market as mortgage originators.

  15. “Lower quality assets,” means loans that have credit characteristics that make them potentially worth less as assets than loans with better credit characteristics. This arises directly from lowered lending standards. Again, whether standards have been lowered has nothing to do with whether they were followed.

  16. To be fair, it is also well documented that the government-sponsored enterprises (GSEs) were willing partners in doing so. Pinto (2011) has provided an exhaustive list of GSEs aggressive behavior and much has been documented as well in Morgenson and Rosner (2011).

  17. See Eisenbeis et al. (2007).

  18. For discussions on the fiscal deficit see Auerbach (1997) and Reinhart and Rogoff (2009).

  19. See Chinn (2005), Scott (1999), Mann (1999) and Goldberg and Dillon (2007).

  20. See Bernanke, Bertaut, DeMarco, and Kamin (2007).

  21. For a discussion of China’s exchange rate policies and global imbalances, see U.S. Treasury (2007), Bernanke (2005) and (2007).

  22. See Auerback (2006)

  23. See Cecchetti, Fender, and McGuire (2010) and Fackler (2008).

  24. This argument is emphasized in Obstfeld and Rogoff (2009).

  25. This section draws heavily on Eisenbeis and Herring (2015).

  26. Five of the programs were established under the emergency provisions of Section 13(3) of the Federal Reserve Act which granted the Fed the authority to lend to various nonbank entities but only in unusual and exigent circumstances. Once those conditions were no longer met, the programs were terminated.

  27. Reportedly some were leveraged as high as 52 to one.

  28. To the extent the FDIC did not pay covered depositors immediately for any losses, small depositors were not fully protected in present value terms (Kaufman and Seelig 2002)

  29. See White (1985) and Weiher (2001).

  30. Cook (1978) details the timing of rate changes and provides historical detail on the administration of the ceilings and bank and thrift deposit payment flow patterns throughout the 1970s.

  31. There have been many detailed discussions of the causes and nature of the thrift and banking crises, so this discussion is admittedly brief and omits much in terms of the depth of analysis and understanding that now exists for that period. See for example Kane (1989), Benston et al. (1990) and FDIC (1997)

  32. Benston and Kaufman (1997)

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Authors and Affiliations

  1. Cumberland Advisors, Sarasota, FL, USA

    Robert A. Eisenbeis

  2. Loyola University Chicago, Chicago, IL, USA

    George G. Kaufman

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  2. George G. Kaufman
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Correspondence to Robert A. Eisenbeis.

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Eisenbeis, R.A., Kaufman, G.G. Not All Financial Crises Are Alike!. Atl Econ J 44, 1–31 (2016). https://doi.org/10.1007/s11293-016-9483-9

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