Bernanke says Fed’s response to crisis prevented deeper slump

March 27 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said the central bank’s aggressive response to the 2007-2009 financial crisis and recession helped prevent a deeper slump.

The Fed’s “forceful policy response” probably averted “much worse outcomes,” Bernanke said today in Washington in the third of four lectures to undergraduates at George Washington University. “In terms of economic consequences, the Great Depression was considerably more severe than the recent recession.”

The lectures are the latest effort by the Fed to explain its actions to the public as it comes under scrutiny by critics in Congress and on the campaign trail. Representative Ron Paul, a Texas Republican who is seeking his party’s presidential nomination, today criticized the Fed for its aid to the European Central Bank.

Today’s talk focused on the Fed’s response to the crisis. In the previous one, Bernanke examined its roots, including the boom and bust in home prices and the Fed’s failure to recognize vulnerabilities in the financial system.

Following the bankruptcy of Lehman Brothers Holdings Inc. in 2008, the central bank flooded the financial system with liquidity, expanding its balance sheet to $2.3 trillion by December of that year from $900 billion in September.

Recession Deepens

Even as the crisis ebbed, the recession deepened, with gross domestic product shrinking at an 8.9 percent annual rate in the fourth quarter of 2008, the worst quarter in 50 years. The unemployment rate rose to 10 percent in October 2009, the highest since June 1983.

The threat of a second Great Depression “was very real,” Bernanke told the class.

The financial system came under pressure in the summer of 2007 as the market for subprime mortgage bonds began to collapse, and by August the Fed responded by cutting the interest rate it charges on loans to banks borrowing at its discount window.

The Fed lowered its benchmark interest rate in a series of cuts, to 3 percent in January 2008 from 5.25 percent in August 2007. Yet in March 2008, the crisis intensified with the collapse of Bear Stearns Cos., the fifth-biggest U.S. securities firm, prompting the Fed to intervene and help JPMorgan Chase & Co. acquire the bank.

Lehman Brothers Fails

That didn’t end the crisis. In September 2008, Lehman Brothers filed the largest bankruptcy in U.S. history after the central bank and U.S. Treasury declined to intervene. One day later, the Fed made an $85 billion loan to American International Group Inc. to avert the collapse of the New York- based insurance company.

Bernanke defended the central bank’s bailout of AIG. Its failure “would have had a massive effect on other financial firms and markets,” Bernanke said.

“The rescue of AIG prevented even greater shocks to the global financial system,” Bernanke said in slides. “Over time, AIG stabilized. It has repaid the Fed with interest and has made progress in reducing Treasury’s stake in the company.”

Bernanke has used his lecture series to defend the central bank’s track record during the housing crisis and to criticize the gold standard.

Town Hall Meetings

During the last three years, Bernanke has given television interviews and appeared at town hall-style meetings. He toured a Philadelphia shipyard and a Tasty Baking Co. cupcake factory in 2010 and last year traveled to El Paso, Texas, to speak to soldiers at Fort Bliss. He also began holding press conferences in 2011, after each of the Fed’s four two-day policy meetings.

His lectures to 30 students are streamed live on the central-bank’s website and on Afterwards, it will be posted on the Fed’s YouTube page.

Bloomberg News

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