Ten years have passed since the worst moments
of the global financial crisis and the devastating
recession that followed.
Now that you have the luxury of doing research,
you've stepped back to look at why was it
so bad and what can we learn from that.
In your paper for the Brookings Papers on
Economic Activity, you distinguish between
the causes of the crisis in the first place
and the failure of economists to foresee how
deep the recession would be once the housing
bubble burst.
Your paper really focuses on the latter one.
So what do we know about why it was so hard
to foresee the depth of the recession?
I mean, after all, it was in the spring of
2008 that forecasters at the Fed and elsewhere
were predicting a recession, but not one nearly
as deep as the one that followed.
No that's right, there were really two forecasting
errors made.
One was identifying the crisis itself.
Many people saw aspects of it coming.
Robert Shiller talked about the housing bubble,
Alan Greenspan talked about risk-taking, but
nobody saw how widespread and devastating
the crisis itself would be in terms of financial
markets and financial institutions.
But the second forecasting error, the one
you were alluding to, is the effect of that
crisis on the broader economy.
And there was a lot of reason to be worried
about that, and policymakers, including many
of us at the Federal Reserve, were quite worried
about it.
We knew from history -- the Great Depression,
for example, where I've done a lot of my academic
research, was a situation where the collapse
of financial markets was a major contributor
to the depth of the Depression.
Likewise, we know that, historically, big
financial crises are often followed by long
and deep recessions.
But that being said, the formal models that
we were using at the Federal Reserve and that
other forecasters were using did not pick
up the depth of that reaction.
So, to give you an example, the Fed's staff, which are really the best macro forecasters
around, even after the crisis was getting
into its worst stages, saw unemployment rising
only to, say, seven percent, when in fact
we know that, in 2009, unemployment hit 10
percent.
So, they were underestimating how bad the
impact of the crisis on the economy was going
to be.
So with the benefit of hindsight, why was
the Great Recession so deep and severe?
Well, as my research suggests, I think the
critical element was the fact that there was
a financial panic.
A panic, you know, in the 1930s, a panic would be depositors
lining up to take their money out of banks.
Now, we have deposit insurance now, so we don't have runs on banks as we did many years ago,
but there were other kinds of runs.
So, for example, investment banks, which held
all types of credit, financed themselves with
lots of short-term funding like the so-called
repo market, commercial paper, other types
of uninsured, short-term funding.
And there was a run, a panic, analogous to
the 1930s, but in electronic form rather than
people lining up on the street.
That pulled the funding away from these firms,
forced them to dump credit, forced them to
stop making new loans, and so the cost of
credit, the availability of credit, plumetted.
It was that credit supply shock, I think,
that was the most devastating aspect of the
crisis in terms of the real economy.
So the housing bust starts the problem, but
the housing bust alone doesn't explain how
deep the recession was.
Yeah, the decline in house prices obviously
had important effects.
It lowered consumer wealth, it made people
less willing to spend, and ultimately, the
collapse of the mortgage market was the thing
that triggered the panic, the run on financial
institutions.
My claim would be that, without that run,
the housing bust would not have had nearly such deep
effects on the economy.
So as you know, there are people who argue,
some quite vociferously, that the failure
of policy in this episode was that we didn't
spend enough time and energy helping homeowners,
that we didn't use more government money to,
maybe, buy up mortgages from people who were
underwater and refinance them, and so forth.
And that, had only that been done, we would
have been spared a lot of the pain.
What's your take on that?
Well, first, I think it's not quite accurate
to say that nothing or little was done for
homeowners.
The Treasury, which ran these operations,
did provide programs of various kinds that
ultimately helped millions of homeowners refinance
their mortgages or modify their mortgages
to stay in their homes.
But it's also true that millions more were
not helped for a couple of reasons.
One was the fact that Congress was very tight
on the purse strings on helping homeowners,
partly for political reasons.
The other was that there were a lot of logistical
problems in trying to do it.
If you're helping homeowners, you rely a lot
on servicers who have the capacity to modify
the mortgages and restructure the mortgages.
In practice, the servicers were overwhelmed
and they couldn't handle the thousands and
thousands of mortgages that were there.
So, a lot was done.
It would have been great if a lot more had
been done, it would have saved a lot of people
a lot of distress, so I certainly agree that
it was a shame that not more was done.
That being said, I don't think that that was
the reason that the recession was so deep.
The Treasury made some trade-offs, and they
said, given how much money Congress is going
to allow us to have, where can we best put
that to work?
And they decided that, for example, a tax
cut that broadly reduced tax burdens for consumers
across the country would have a better chance
of restoring employment and getting the economy
going again than putting yet more money into
the housing situation.
So if I'm reading your paper as a policymaker,
a Fed chair or a Treasury secretary a decade
from now, what lesson do you want me to draw
from the research that you've been doing?
Well, the basic lesson is that a financial
panic, which disrupts the supply of credit,
can be very, very damaging to the broader
economy.
Retrospectively, as the Fed and the Treasury
and the FTIC were trying desperately to stop
the panic and bring it under control, there
was a lot of debate about, why are you doing
this?
Some folks were saying that the Fed was helping
out its friends on Wall Street and not paying
enough attention to the U.S. economy.
Well, in fact, of course, what we were trying
to do was prevent more damage to the U.S.
economy by trying to stabilize the financial
system.
That was the motivation.
My research suggests, in fact, that if we
had let the financial panic continue and get
even worse, the damage to the U.S. economy
could have been even much worse that it actually
was.
Looking forward, what this suggests, is that
we need to make sure that our system is sufficiently
capitalized, has enough liquidity, has enough
safeguards, so that a panic like this becomes
very unlikely in the future and, moreover,
if a panic does occur -- and probably we can't
guarentee that there never will be another
panic, someday there will be -- that policymakers
have appropriate tools to respond to put out
the fire as quickly as possible in a more
systematic, predictable, and effective way
than we had to deal with the crisis in 2008
when we were using whatever tools we could
come up with to try to stop the panic.
In many ways, the work you've done for BPEA
is a sequel to the work you've done as an
academic.
But when you were working as an academic,
you were understanding the Great Depression
and the responses of people who are no longer
with us.
This time, you're doing research on a period
where you were pretty central to the policy.
How does that feel?
What's it like to be researching your own
decisions in hindsight?
You know, I'm trying to understand the mechanisms
by which the crisis affected the economy,
and this was something where I felt, as a
policymaker, while we did have some information,
some idea, some historical examples to look
at, that we didn't have enough quanitative,
rigorous analysis to help us understand how
the developments in the financial markets
were going to affect the economy.
And so, as a policymaker, I saw that gap.
Now that I'm back in a more research-oriented
mode, it's a chance to try to think about
this at more leisure, and I hope to contribute
to more policymaking in the future.
Thank you very much for your time.
Thanks Dave.
