when it appears, we will see what it does. in the meantime, we will do everything we can to figure out what we need to compete with that capability. it will no longer just be china, once they feel -- when the russians are fielding that feels the platform, others will feel it. t's the capen't, the technology, not any particular country that has it. gentlemen, closing thoughts? >> thank you again for telling the story. the air force is in good shape. excited about what they do. they're proud of who they are. hey believe what they do personally and in the view of the nation. they're motivated and strong. doing the job as well as they can. the job from here is they need do the things they need to do

that. not distracted. that's what i need to hear more than anything else. when i go out to talk to the airmen, i don't say how do we weapon or a better airplane. i get questions about retirement plan and sequestration. it's all of the details of money. i don't want them to worry about that. we'll do all we can to take care of them in that regard. the nation is not going to let in those ways. we'll come to agreements that make sense over time. on theed to keep focused job. because they're incredibly good at that. >> yeah, the -- thank you all and happy holidays. chief says.the there's been a lot of variables paying out over the course of the year. a number are still left to play out that are bigger than that. pledge to the airmen that i see around the air forces, we decisions that we

can as quickly as we can, as we can to gety as the air force back to new normal in and out of uniform could focus on the osition to get past the decisions we shouldn't have to deal with that have been voiced of the budget and political uncertainty. we're looking to see some of and variables play out some of the things that are unfixed become fixed so we can start planning what the air look like for the future and give a sense to airmen what their role is in that air force. again, thank you all for doing that. have a great holiday. >> you too. >> thanks. >> there was a reference to that

briefing to debra lee james. confirmed by the senate to the air force secretary. she was among the number of executive d nominations being considered in a two-day long legislative end on that came to an earlier this afternoon. the senate is back in sunday at 1:00 p.m. eastern. the ominations remain on agenda. ann patterson for assistant of state for near eastern affairs and jay johnson for homeland security secretary. votes on the nominations are not expected to take place until late afternoon monday. the last week be in session until next year. some of the items waiting for budget and thehe 2014 defense programs. the house voted on those bills his week before gavelling out for the winter recess. live coverage of the senate on c-span 2. >> this is a train depot in depot, the oldest building here in plains. if you can imagine, in 1976, the bustle of all of the

activities here in the campaign. and ave tables and desks phones going off and letters area. in and out of the s. rosen was here helping to run this campaign from the small building. roslyn carter used during the run for the governor. it's a way to get the word out volunteers going door-to-door, shaking out literature, and spreading the word. method so effective it helped them get elected to the presidency. program on first lady roslyn carter on our slash first an.org ladies. nd monday, we'll start our encore presentation of first adies season two, edith roosevelt to grace coolidge. >> today at the white house, president obama met with newly mayors to discuss jobs

and the economy. here's the president speaking to that ers shortly before meeting began. >> it's a great pleasure to welcome not only some of the the outstanding mayors of country. but also folks who are representing, you know, incredible cities, world class be es, that are going to central to america's economic growth and progress for years to come. 2 2i always said mayors don't have partisan. they are every day accountable of concretely delivering all the services people all across the country. reason that we think about mayors, we think about

folks getting stuff done. outstanding group of mayors-elect.nd they have a shared vision. critical hubs in which we're creating jobs, bringing businesses, seeing startups and develop, make sure for the gateways opportunities are people from -- from the surrounding areas, the regions,ng states, the and in many case, the world, because i think you've got a lot populations that towards diversity and dynamism of the city. although we have seen terrific in our cities as we have across the country over the millions of years, created about businesses investing in manufacturing, making an extraordinary comeback. is we still have a deliver a to do to

vision we all share which is an america where if you work hard, can make it. what that means is is that my this meeting of is to immediately set up a partnerships with all of the mayors here. here we get a clear sense of what the vision is and how we try to deliver services, how we can make sure that our kids are best education possible. we are ake sure that creating the platforms, the nfrastructure for jobs to succeed. and jobs to be created, usinesses to succeed in these cities. how we make sure the ransportation dollars and how it maximizes the economic development and hopefully it and rush hourtion traffic i suspect is something that some of you have heard from your constituents about.

how we make sure there's a safety net there that is not place where people can stay over the long term. by rather is a mechanism have had some bad luck to get back on their feet and get back into the workforce. the federal level, there's some things we can do to help the mayors if we, in fact, the budget deal completed and out of the senate. can get away for the first ime in a couple of years for the constant brinksmanship and crisis governance that we've hill.p on capitol that impedes growth and makes less sses and investors certain about wanting to put their money in it. so that would be an important achievement. that's something that the federal government can do to help mayors. not in this hat's

budget that needs to be passed is ui, unemployment insurance. 1.3 milliontentially people who during chrys malice time are going to lose their unemployment benefits at a time it's very difficult for a lot of folks to find a job. and that's not just bad for for those and families, its's bad for our economy and for our cities. if they don't have the money to pay the rent or be able to buy food for the families, that has an effect on demand and and it could have an effect generally. have said onomists failing to extend unemployment is going to have a grade on economic growth for next year. things 's some basic that we can do just to create a better economic environment for outstanding mayors. there are some areas, for minimum raising the wage that could have a tremendous boost in a lot of the

ities where there are a lot of service workers. and do some of the critical work for all of us every single day. but oftentimes still find themselves just barely above overty or in some cases, below poverty. i want to explore ideas with them. them luck, you can see a binds group, but whatf them together is a commitment to helping people succeed in this country. and so i want to congratulate ll of them and i'm looking forward to over the next three ears for me, working with them for the benefit of their constituencies. many of them may end up being around for 20 years. so they'll have other presidents to work with. but thank you so much for coming in. >> are you concerned that -- >> are you concerned -- >> the -- >> thank you, guys. >> on the next "washington

table ," a round discussion about federal gun policy. on the anniversary of the hooting at sandy hook elementary school in connecticut. ur guests are tom major with manger cities and richard stannick of the sheriff's followed by a look at the two-year budget deal followed by the house next week headed to the senate next week. we're joined by david lauder. washington journal is live every morning at 7:00 a.m. on c-span. >> let me be very clear. delicate very diplomatic moment. and we have a chance to address of the most e pressing national security oncerns that the world faces today with gigantic implications conflict.ential of we're at a cross roads. we're at one of those really points in history.

lead to an ld enduring resolution in international concerns. the other path could lead to ontinued hostility and potentially to conflict. i don't have to tell you these stakes. >> this weekend on c-span, secretary of state john kerry on not ouse members should impose additional sanctions against iran as talks continue n freezing parts of iran's nuclear program. watch saturday morning at 10:00 eastern. 2, book tv, dick cheney and his long-time reiner gist jonathan talk about the former vice president's history with heart advances in ecent cardiology at 11:00. history 3's american tv, a look at the free former american men and slaves who fought for the union, sunday. >> george washington university hosted a forum, friday, on the

system. reserve next, one of the discussions from that event. this panel talks about the history, eserve's including its handling of the more recent 2008 financial crisis. little more than an hour. michael. you, nd welcome, everyone, to this onference commemorating the centennial. i'm pleased and privileged to moderate this discussion. two of the leading cholars and commentators on central banking and the global inancial system but two of my favorite authors, i must say. ahmed is the author of a truly wonderful book which

called "the mmend lords of finance." world.kers who broke the which is about the global andral bankers of the 1920s 1930s and how they were unable o avoid the global economic catastrophe that occurred. this book -- you could say won the trifecta. 2010 pulitzer prize for history. he 2010 council on foreign relations, and the 2009 financial times goldman sachs best business book of the year. a professional investment manager for a number of years. he worked at the world bank. the board of n trustees at the brookings institution, the new america the general philosophy, and also serves on the state department's foreign affairs policy board. departmen affairs board. he will speak first followed by simon johnson, who is a

professor of entrepreneurship for school of management and the author of many works. my favorite being 13 bankers. which is best book contributed to the financial crisis. if you don't read any other books for the next few months, they are tremendous. professor johnson is a senior fellow for international economics here in washington. he's a very well known blogger on the baseline scenario and "new york times" in october in 2007 and 2008. he served as chief economist of the international monetary fund. so i will invite mr. ahmad and professor johnson to provide opening remarks and then there

will be an opportunity for colloquy and an opportunity for questions from the audience. without further adieu. >> i should speak from here. >> thanks. so i'm going to talk about history. and i'm going to talk about what the fed did in 1929 to 1933 and compare it to what the fed did this time around. some background. there were a the lot of parallels between the two decades. so 2000s were early similar to the 1920s. in both cases they were boom

times characterized by enormous sense of confidence about the future. there were new technologies in the 1920s with automobiles and radio. in the 2000s it was the internet. investors persuaded themselves that we entered an era of prosperity. at the same time in both cases, policymakers were struggling with major. in the '20s it was between europe and the u.s. as europe was trying to rebuild itself after the first world war. and the 2000s it was much more the imbalance between hash sha and the u.s.

imbalances led to too much credit creation. in both cases, the credit creation did not lead to. but instead in various ways, the credit creation led to bubbles. in the 1920s it was in the stock mark market. in the 2000s it was in real estate. in both cases as they always do, the bubbles burst. in both cases, although the mechanisms varied, we got banking crisis. in the 2000s there was a direct link because wangs were involved in real estate lending. in the 1920s there was a debate at the role of the stock market crash of 1929 played in the subsequent bnking crises. but we got a bursting bubble and

we got banking crises. in the 1930s they were conventional run. and you remember all those grainy black and white pictures of people lining up outside banks to take their money out. in the 1930s they introduced insurance. so this time around we didn't get that a retail run of banks, but we got a wholesale run on -- we got a run on the wholesale funding of financial institutions. both banks and so-called shadow banks like money market funds. so that's the leader. now the consequences were very different. and in part because the fed reacted very differently in both cases. so let me talk a little bit

about what the fed did in '29. in 1929 immediately after the crash the new york. fed injected $100 million in liquidity in the next few days, which would be the equivalent to injected about $40 billion. which is modest, but it actually played a very important role. it also encouraged the new york. banks to take on broker loans. a the lot of the leverage in the u.s. stock market was financed by broker loans chrks came from nonbank institutions. they pulled their money out and the fed encouraged the new york banks to take on these loans. and the total loan is about $8

billion, which was a very substantial percentage of the capitalization of the new york stock exchange. and thirdly they cut rates from 6% to 2.5% over the next nine months. so so far so good. they did exactly the right things. it wasn't completely smooth because they entered into a big fight with the federal reserve board. the new york fed took these decisions on its own. federal reserve board tried to veto them and you the got a bureaucratic tussle between the two institutions, which the new york fed essentially won in the short run. after the first nine months, essentially the middle of 1913, the fed stopped easing for all

intents and purposes. for the next two years sat on its hands. that was very unfortunate because throughout 1913 thae rejected the idea of more open market operation. that was unfortunate because starting at the end of 113 we got the first of a series of bank runs. so late 1913 we got one bank run. we then got. another one in 19 -- in the summer of 1931. we then got another one in the fall of 1931 and that continued through until the massive bank run in '32 just at end of 1932

just after roosevelt was elected. the consequence of these bank runs was to cause the -- let's just take u.s. bank lending. bank lending was about $50 billion in an economy that had a gdp of $100 billion. bank lending fell 40%. so bank lending went from $50 billion to $30 billion. that more than anything else is what converted a depression, a bad downturn into u.s. into a massive depression where we got over 25% unemployment. so why did fed make so many mistakes? it was created to act as a lender of last resort.

after the 107 crisis new york bankers recognized that the u.s. financial system needed a lender of last resort. it had relied until then on collective action either through the clearinghouse or most famously in 1907 with j.p. morgan got everyone together. and they realized these arrangements weren't going to work anymore and they needed an institution. so the principle that the fed's job should be to act as lender of last resort. so why did it it fail? i think there are five reasons. first, the fed began with

completely the wrong view of what a central bank should be. it sort of viewed itself as a passive reserve for the banking system. and it failed to understand that when banks start accumulating access reserves, one of jobs of the fed is to offset that. the view within the fed at that time was that if banks take the decision to accumulate reserves, then they are making the best decision for their own purposes and is not the job of the fed to counteract this. so there was no focus on the money supply. there was no focus on the credit. they view eed themselves as essentially providing -- acting as a passive resident vary of reserves. by contrast by 2008, the fed

completely did the opposite. it it increased the balance sheet from a trillion to $2 trillion within the first few weeks because banks were accumulating access reserves afraid to lend to each other. the fed realized that it it had to offset this by injecting reserves back into the system. secondly the fed was in its infancy. there was constitutional weakness. when the fed was first created, it was sort of a hybrid organization that had always been historically great suspicion about having centralized power in the united states. this is the reason why the second bank of the united states

was closed down by andrew jackson and the first proposal for a central bank that emanated after the 1907 crisis was for a si single central bank. a single unit ri central bank. they didn't call it it a central bank, but essentially that was it. and that was rejected by the democrats who said we do not want to have so much power concentrated in one institution. so instead a senator came up with an alternative plan which was to have multiple central banks. a series of reserve banks around the country that would act as many central banks to the banks within the their territory. and the idea there is that you would actually not have the same concentration of power.

when it was finally submitted to woodrow wilson, he thought that you needed some coordinating mechanism. they established the federal reserve to act as a cap start to the whole thing. the board was viewed at the time as a sort of regulatory agency that was supposed to oversee the operation of the regional reserve banks. so there was considerable confusion about what authority lay with the regional reserve banks and what authority lay with the federal reserve board. that confusion became a major problem during the great depression. the federal reserve bank of new york had a much more activist view of what it thought it

should do. the federal reserve board -- a second problem was that wilson thought that it was not a good idea to put bankers on the federal reserve board because after all if you were creating a regulatory agency to oversee banks, if you put too many bankers on the board, they would be captured by the industry. so he put in a lot of people who knew nothing about banking. small town businessmen, some political acts. so the federal reserve board was characterized by -- was a remarkably inept institution in 1929. this has always been a challenge in any sort of regulatory regulation of the financial industry and remains a challenge

today, which is how much do you rely on bankers to police heez regulations and how much do you rely on insiders on outsiders. so the 1930s the first problem was a fight between the federal reserve board and the new yorkers and the reserve bank of new york. you also got competition among the reserve banks. in 1931 the federal reserve bank of new york started losing gold because britain had just left the gold standard. and whereas the federal reserve bank of chicago had access gold reserves so it offered to swap

from gold with the federal bank of chicago and the federal reserve bank of chicago turned them down because they wanted to hang on to gold just in case there was a run on the federal reserve bank on their federal reserve. so these constitutions acted in uncoordinated and often competitive way. the third problem in the 1930s was the gold standard. at the time, countries and the whole financial system relied -- the fundamental reserve asset was gold. so under the federal reserve act, federal reserve banks had to hold 40% of their liabilities in the form of gold. the remainder they could hold in the form of commercial paper.

interestingly enough, they weren't allowed to hold government bonds as an asset against their liabilities because this would be -- this would be viewed as a form of deficit -- of monetary financing the deficit. so in 1931 when britain left the gold standard, there was a run on the dollar, there was a run on gold reserves in the united states. actually the united states had very large access reserves of gold. but because the commercial paper market had dried up, there was almost an artificial shortage of gold because they could -- they either had to hold gold or commercial paper. that led to the federal reserve tightening in 1931. they raised rates from 1% to

3.5% the in the middle of the great depression. so the third reason was the gold standard. since we have moved to exchange rates, no one now tries to -- no one except countries within the euro targets their exchange rate. so that was less of a factor this time around. fourth reason was that the fed found itself bound too rigidly by its own rules. access to the fed window was restricted to members of the federal reserve. that's 65% of the banks in this country were not members of the federal reserve system. and they accounted for about 25%

of the deposits. and they had no access to the fed window. so when the run began, the ability of the fed to act as lender of last resort or the willingness of the fed to act as lend lender of last resort to this group of banks, the fed just refused to do so. in addition, the federal reserve act had very strict stipulations on what collateral they could accept. they could only accept self-liquidating paper. they couldn't accept government bonds, there was a whole series of assets they couldn't accept. again, this time around, the fed was much more expansive in its

view of what types of institutions it was willing to lend to. so it lent to investment banks who were converted into commercial banks. it was very inventive in the types of ways that it lent financial system including and it had a very expansive view of the collateral it was willing to accept. finally and the fifth reason is that the fed had a very limited perspective on what it meant to be lender of last resort. they took the view that it was not their job to bail out bankers from the consequences of their bad decisions and only

when it was very obvious were they willing to step in. the problem is in a great depression the distinction between liquidity and solvency starts dissolving. and as a consequence, their ability to lend to most institutions in trouble were severely hampered. the consequence was that then we thought 25% unemployment this time around we got. 10% unemployment. and we essentially got about a third of the great depression. i suppose one of the interesting questions to ask is there was a view that if only the fed had acted improperly, we would have avoided the great depression. we have actually just seen an experiment where the fed has done almost exactly what a

central bank should do in crisis. and we didn't get a great depression, but we got a third of a great depression. and i think we've illustrated that there are limits. even under the best circumstances central bank acting vigorously as lend er of last resort and easing monetary policy very rigorously cannot avoid a major downturn after a financial crisis. thanks. [ applause ] >> my name is simon johnson. i'm a professor at m.i.t. thanks very much, art, for this opportunity to participate in such an interesting conference. i'm going to talk about bailouts. a short history of bailouts. and i think i'm going to agree

with pretty much everything that was said about the history of the fed, but i might put a somewhat different spin on certain aspects including how we could look at the economic and financial prospects going forward. now i absolutely and completely agree that the main. point, that mistakes were made in the 1930s by the federal reserve system that were avoided in the last few years by the board of governors under the leadership of ben bernanke. we did, as a result of the policies, from the fall of 2008 policy of the federal reserve we did have a less bad outcome than we would have otherwise. i'd like to recognize another author and commend a third book from art's list. david wes sl in the front row. his book is a really inciteful

account of the the thinking inside the federal reserve and how they applied the lessons of the 1930s once the financial crisis became. but here i thinkhere, i think i were simply we made mistakes in the past, we've learned the lesson from that history, we're not going to do it again and people should keep reading and rereading the book to make sure they don't do it again, that would be fairly straightforward, but unfortunately, it doesn't stop there. both the last 100 years and very importantly the date that preceded the foundation of the federal reserve and what we've seen around the world many, many times indicated strongly that while providing a backstop, a set of safeguards you might call it liquidity provision in some instances, might call it a bailout, and i hope we discuss those terms throughout the course of the day, but providing

that kind of support has a significant effect on people's incentives. the technical term you're all aware of is moral hazard, meaning you're less careful when you have a high degree of insurers or downside protection, and this is not a small problem. and i'd like to speak directly at that issue, addressing three sub headings. one is about political legitimacy, the second is about the new york fed, and the third is about cultural capture and what that means. so, the key issue that i would suggest the federal reserve had at its beginning and has now, perhaps will always have, is one of political legitimacy. every modern monetary system in a market economy is a partnership between the public sector and private sector. public saying is what you can use as money, what is legal tender. they are in many instances, such as this one, providing what we

call a monetary base, and the private sector is allowed or encouraged to build a system of credit and money on that basis. you might like that or not like it. that's also a great debate to have, but that's the system which we've been operating for a long time. now, there are reasons to be uncomfortable about the terms of that public/private partnership, and this is a big part of the debate in the run up to 1913, including after the crisis of 1907. there was a realization that the private insurance mechanisms, which have been relied on in u.s. markets to that time, would no longer be sufficient going toward, and therefore the government should play a greater role, at least in some urgent situations and perhaps more broadly in managing the availability of credit. now, that, obviously, was a controversial conclusion.

people on the left felt that they did not want to seed excessive power to the bankers, although new york bankers or what they called then, what we call now wall street. they didn't want to put this power, this authority of government in private hands. the private sector people, understandably, felt strongly they didn't want to seek too much to the public sector. and we ended up with this very strange hybrid that perhaps what was not so strange in its day, there were other public-private mixes, including the bank of england and european structures. all those structures have changed completely. all other major central banks, to the best of my knowledge, and most nonmajor central banks, are government institutions now. we have retained this hybrid public-private partnership.

so who decides when you have a crisis or whether you have a crisis? who should provide, who should receive what kind of support, in retrospect, you can see the story in the 1920s, 1930s, i agree with liaquat's version. you can see where some support could have been provided and wasn't and read the work of ben bernanke, i think, which is superb and may well end up getting the nobel prize for exactly these kinds of insights, but in realtime, when the events are unfolding, who should get support and who shouldn't? and on what terms? of course, walter badget identified this problem, it's not specifically american, it's not specific to the different versions of the financial system we've seen over the past 100, 200 years. we have absolutely, repeatedly

experienced various forms of panic, and the right way to deal with a panic is, as badget said, to lend freely against good collateral. but what's a panic? which -- who's insolvent and who's merely, who has mismanaged their business in an inappropriate fashion and brought distress upon themselves and, of course, had a big spillover effect on the rest of the economy, because that's what banks and the credit system can do, much more than private enterprises, so who's responsible for what went wrong, and who is merely a victim of the circumstances overcome by events, completely, they were completely conducting business in a responsible manner and all of a sudden circumstances have turned against them. and i would stress to you, this is not a hypothetical, academic, or historical question. don kohn, who is also in the

front row, former vice chairman of the fed, i think you'll hear from him later today. don kohn and i are both on the systemic advisory committee of the fdic, and we had a public meeting on wednesday, and you can review the tape. there was a fascinating discussion there of what the so-called orderly liquidation authority, created by dodd-frank, will actually mean in practice. it will not, by the way, mean liquidation. i think we established that on wednesday, whether it will be orderly is another matter. i guess it is in authority. we will find the people responsible in the heat of crisis.

very hard to do. who do you trust? this is where the new york fed comes in, and the history of the federal system, i think, is intertwined both -- you have to tell the story of the board and the development of the board and the reformers of the 1930s that brought us the current board of governors structure and the new york fed. the crisis, the epicenter was in new york, jpmorgan, the man, saved the day with his resources. benjamin strong was his point man on deciding who to open and who should stay open and who should be shut. benjamin strong became the first president of the new york fed. it made complete sense in that public-private compromise moment. and as liaquat said, it's not the case the new york fed had all the power or the new york fed was calling all the shots, it was a much more complicated and dysfunctional structure. i think everyone ended up feeling that way in the 1930s, and the reforms are reforms put

through, i don't think it would ever be undone, but this central role of the new york fed is the eyes and ears of the federal reserve system with regard to the heart of finance on wall street in new york, that role has remained today, and if you look at who's on the board of the new york fed, who remains on the board, these are people who are central characters on wall street and friends in the nonprofit sector. who has had the financial and literal capability of deciding who's in, who's mismanaged their business and who has run out of liquidi liquidity. this is now changing at the board of governors, but up until

2008, analytical wisdom, in quotation marks, of the federal reserve of this issue was concentrated on the new york fed. and that leads to the third point, which is the, i would agree the most disturbing and uncontroversial, both perhaps historically and certainly going forward. and that is the issue of both cultural capture. who you know, who you talk with, who you hang out with, your friends, your immediate business counterparties, your associates, those are people who help you form a view of the world, both in general terms, is this a reasonable idea, would this policy work, and also the spur of the moment. when circumstances turn against

you, who do you call to understand what's really going on? most of us know a very limited number of people in those heightened, intense situations. we rely on a small set of people to guide us through the circumstances, and we tend to share their view of the world. and i'm afraid what happened, in my view, in the run up to 2008, is that over a fairly long period of time, but increasingly in the 1990s and 2000s, people who were powerful in washington, but also powerful, influential in the new york fed, became increasingly convinced that the way modern finance had become organized was superior and

perhaps essential to the well functioning of the rest of the economy. in the vernacular, i guess it's called, drinking the kool-aid. they drank the kool-aid, became persuaded, they were captured by the view of wall street as modern, as efficient. my book on this topic did not win the goldman sachs book of the year award. i have no idea why, but we lay out the argument and there's plenty of footnotes and historical references if you'd like to look at it. we're saying, plainly, that wall street captured too much of official thinking, not only through the political connections and the campaign contributions and so forth, those are important, capitol hill, absolutely important part of this, but also,

unfortunately, through the way the federal reserve sold this problem and thought about it, particularly under mr. gree greenspan, but also the early years of mr. ber knananke. there's a shift under way, i believe, of the federal reserve system away from the new york fed towards the board of governors in washington. and i think that's entirely appropriate. but what we learned in this crisis, going back to the point, we learned the federal reserve actually has much more power to stabilize, to intervene, to save than we thought previously, much more than i demonstrated it was able to do in the 1930s. now, we don't know where this episode ends exactly, and i would also stress despite those

interventions, we still had a huge crisis, the worst recession since the 1930s, more than 8 million jobs lost, and we're struggling to recover over five years later. so this is not a panacea, but it is a pretty good deal of powerful players on wall street. for management, for creditors, what exactly is going to be handled differently going forward? who's going to decide who's saved and who's not saved? does the political legitimacy -- i want there to be a federal reserve. i think we've benefitted, i think the way the fed has evolved and operated, makes sense and the alternatives are worse. but will the fed retain its political legitimacy? will you trust the fed going

forward? the federal reserve act is an act of congress. it can be overturned by congress. we have to believe that the fed has sufficient critical distance from the financial sector, from the banks, from the nonbanks, from the shadow banking system. whatever you want to call them, whoever gets in trouble next time, we have to trust that the fed will get it right. we have to believe they can sort out solvency and liquidity problems. we have to believe they are not just handing out overly generous bailouts. i hope they can do it. and it's not just about the fed, it's about the fdic, it's about treasury, perhaps it's about other parts of the regulatory apparatus also, but mostly it's about the fed. i wish the fed well. i admire many of their

achievements over the past 100 years, but i'm emphasizing to you that it is not gone well in recent years for deep structural, political, perhaps cultural reasons. and this problem has not, unfortunately, yet been fixed. thank you very much. [ applause ] >> would you like to have a few remarks in response to professor johnson? >> you know, i -- simon, essentially, said we don't actually -- the rules of the game are unclear. and that is true, and maybe they'll always be unclear, and i like his point, which is that where the rules get set has a

very important, big impact on the political legitimacy of the fed. so, let's take top. top was economically a very successful program. we saved -- it was very efficient. we injected a certain amount of capital, and we essentially after a point stopped the run on the financial system. it was first it was incredibly politically unpopular. secondly, the big question became, well, if you're going to bailout financial institutions, why aren't you bailing out other

debtors? and we've never really properly resolved that. you ask the treasury at the time why couldn't we have used some of the tarp money to help limit the degree of foreclosures. they'll come up with sort of very complicated answer of why it was so difficult, but i think it undermined the political legitimacy, so i think for simon's fundamental point, which is how these rules operate has a very important effect going forward. i couldn't agree more. >> one question i'd like to throw out to both of you, and this follows up on both of your remarks, and i think it goes to sort of what the fed's role has been during the crisis and what it might be during the next crisis, so just to throw out some round numbers, the fed's balance sheet, as you mentioned, was less than a trillion when

the prices started, and most of it, about 80% or more of it, consisted of treasury bills. the last count i've seen, the fed's balance sheet now is, i think, approaching $4 trillion, and a very big chunk of the assets they bought were mortgaged-backed securities, both issued by fannie mae and freddie mac and also by the so-called private label issuers, which were the wall street banks themselves. it's hard to get precise numbers, but perhaps there might be a trillion and a half or so of mortgage-backed securities on the fed's balance sheet, which is about roughly 20% or more of the mortgage-backed security market. very large portion of that market. in response -- and, of course, as we know, next week could bring a change, but right now every month the fed has been buying $45 billion of treasury

bills, $40 billion of mortgage-backed securities. as this occurred, what's been interesting to me is the number of both academic commentators and financial industry participants who have begun to talk about the fed, not simply as lender of last resort, but as market maker of last resort, and the argument has been made that effectively the fed was the market maker of last resort, because nobody else during the crisis would have touched these mortgage-backed securities. they were viewed as opaque and toxic and nobody knew what they were worth, and so the fed became the market maker of last resort, and there are commentators, both academic and in the industry, who argue that's exactly the role the fed should play, when the markets become ill liquid, the fed should step in as market maker of last resort. so i'd like each of you maybe to respond to two questions. one is, is it fair or unfair to say at least with regard to some

assets, the fed really moved from lender of last resort to market maker of last resort, or something approaching that role, and what would it mean if the fed actually did become something like the market maker of last resort for ill liquid markets during crises, what would be the implications of that? >> let me try. i think the why do we need the fed to be -- why do we need a lender of last resort, and essentially, the idea is that in a panic, or in that everyone heads for the door and you need an adult in the room to say, listen, you guys, calm down. you're all getting too worried about things and we can see through this trough and we can

see that things eventually will get to a better level, and so we're going to counteract what each individual, private institution, is doing. so that was the origin of the bank of england becoming the lender of last resort. they would step in when everyone else was heading for the door. that was transmitted, or that was translated into lending to institutions or lending to banks, but it needn't been, and it seems to me the idea that the fed should step in and act as the adult in the room, when markets that are critical are severely dysfunctional, it's not a great leap to go from the fed is being the lender of last resort to institutions to the

financial system, to the fed is intervening in financial markets. i think there's always been a challenge in its capacity as lender of last resort/market maker of last resort, which is how specific should it be? should it lend to individual institutions, or should it lend to the market as a whole? and i'm not sure i sort of have all those arguments in my head, but that's -- it lends to individual institutions when it worries about contagion effects. so i'm not too worried about the idea of the fed being market maker of last resort. i think i would distinguish that from the notion that the fed's balance sheet is very large and has become a big portion of,

let's say, the mortgage market. i don't think that was in its capacity of market maker of last resort, but really the decision was to try to influence long-term rates, and it wanted to select which long-term rates of influence and mortgage rates because they have such a pervasive impact on the economy, became one of the targets they were aiming for. we were not in a panic. we were in a panic in 2009. by 2010, '11, the financial panic was over, but the fed took the decision the way to get the economy going was to try to get long-term mortgage rates down. and there are, you know, there are pluses and minuses for that. pluses are that we did get mortgage rates down and probably helped to get housing restarted. the minuses are that allowing

one institution like that to play such a big role in a financial market is sort of distortionary. and i suspect one of the reasons why they are trying to all this talk about tapering is because they realize the costs are now beginning to outweigh the benefits. >> so, friedman schwartz history emphasized the monetary contraction in the 1930s and ben bernanke's academic work, which has just made famous, switches from the monetary side to the credit side of what happened in the financial system, and i think the policies that have been pursued were absolutely an application and continuation of that and addressing the point liaquat made, concern about the 1930s, which is they didn't understand what was the role of the central bank. what would happen when reserves built up. the goal should be to keep credit functioning, make it possible for credit worthy

people to borrow and the fed has followed that logic in a reasonable way. they are lending, they are making loans, they are lending. i hope that's not, but here's the problem, art, which is the deal from the 1930s, much more than from 1915, the deal was provide this lender of last resort role in return for regulation. regulation that was not entirely run by the fed as a canopy, ecosystem of regulators in the united states, but that's the quid pro quo. that broke down, regulation broke down, did not function, okay, in the run up to 2008. now we have a new regulatory system, substantially remade, on some key aspects, including the central role of the fed. the fed's the lender of last resort and it is the systemic regulator. if anything is systemic importance to bring down the system, it's the fed's job to get ahead of that.

now that's the right way to do it. it's also an incredible responsibility and a very difficult task, and the legitimacy is going to be much harder for the fed to say that was the fault of the officer of supervision or something. next time it's the fed's responsibility when it goes down, and that's a completely reasonable price tag for this enormous lending power, much larger than existed under the gold standard. like i said, belief in the gold standard and thoughts how that should operate at the central bank, that's all gone. they can make this up on the fly now, good and bad. that's where the political legitimacy comes in. >> more of a question, then we'll open to the audience, my own personal view as to why the lender of last resort has morphed into a market maker of last resort is that the banks themselves have morphed, right, that was a decision we made and by allowing banks to become very large, they are no longer simply

credit intermediaries. now, in fact, they are market intermediaries, and so i think the fed could no longer really separate as mr. ahamed said, banking institutions versus supporting the financial markets, the two became intertwined, and one sort of interesting question, one reason that we didn't do mortgage write downs, principle relief, help to home owners, that the biggest banks were sitting on $400 million of second mortgage liens that would have had to be wiped out. the first liens, which have been securitized, but they were holding the second liens, so that would have been an uncomfortable write down to look at. but as you say, the fed is now, the systemic regulator, but is one of the problems that in a sense in order for the fed to

take that role on, and as you say to act perhaps a little differently the next crisis, do they have to sort of think about how do we convince the larger financial institutions perhaps to adopt a more prudent size, perhaps, than they have going into the last crisis? >> well, you know, the question of how is not the question. >> sure, sure. >> they have plenty of legal authority, and i would emphasize, and i think this is something very clear at the meeting on wednesday, that under dodd-frank, the legislation is quite clear that all financial firms must be resolvable under bankruptcy. the so-called orderly liquidation authority is a backup in case by mistake we find out that institutions we thought could go bankrupt actually can't go bankrupt, because it would cause some sort

of awful contagion. but, which of the large, complex financial institutions of today could actually go bankrupt, go through ordinary bankruptcy procedure, as we amended, without that causing massive spillover effects to the money market funds, commercial paper market, global interactions, through the derivatives market. the answer to me, again, see review of the tape on wednesday, we had the experts in the room, the answer to me is, none, zero of these banks could do that. dodd-frank says, under those circumstances, the authorities, meaning the fed, should take steps to change something about their size, complexity, structure, whatever it is the fed has determined is the problem for bankruptcy. so, the legal authority is there. the tools are readily available through ordinary supervisory mechanisms.

the question is, when will the board of governors of the federal reserve system act in this matter? >> mr. ahamed, do you think the fed is comfortable taking on this role of saying we'd actually like to see the financial structure change to avoid a repeat of what we had in 2008 and not as it pertains drastically, but changed toward a more fail-safe type of structure than it had in 2008? >> i'm probably the wrong person to ask about the fed. i mean, my impression is that whenever i've spoken to either people in treasury or the fed, their performance would have been not to have the voel con rule, but more to focus on capital. essentially, to try to prevent a crisis by raising capital requirements.

and i'm not an expert in this, but it seems to me, broader, simpler regulations are better than sort of very intrusive regulati regulations, so i've always been a fan of increased capital requirements. >> can i invite questions from the audience? i see one back there. >> congress has asked that the federal reserve define what it will do with 13-3, if the fed hasn't defined that, it's dragging its feet. what's interesting is, i think members of congress see 13-3 as a kind of bailout mechanism. the issue is that shadow banking, money market funds and the like, as gary gordon has so eloquently written, are forms of

money, so we now have a banking system that has a lender of last resort and congress pressuring the fed to limit the lender of last resort for shadow banking, basically. of course, i can write a check against my money market fund. it's a bank by any other name. so if you were the federal reserve, how would you respond? >> so, this is a great question. the question about 13-3, emergency powers of the federal reserve, and there are two views out there, one is from gordon and also phil dudley, the new york fed has spoken in favor of extending the safety net. the other idea, which is more mainstream among federal reserve people and other people working on this issue is that we should reform money market funds so they are no longer regarded as being as good as money, and the most obvious way to do that is to float the net asset value, so remove the illusion that a dollar in the money market fund

is as safe as a dollar in your bank account, and maybe there are other measures that should be taken, as well, but i think the question is absolutely right, there is a tension right now between an obvious source of vulnerability and what the fed is empowered to do, perhaps, and certainly feels comfortable doing, with regard to providing the safety net. if you're in that safety net, this was the deal from the 1930s, the deal is, if you're in the safety net, you're going to be regulated, you have to be careful. the point i'd say, perhaps i've been spending too much time with mr. volcker, but he does impress this upon everyone, you need multiple fail safes. it's like nuclear power, has to be used with great, great caution. capital may be the right way to go, but the bosel committee, oh

dear, didn't get it quite right, and the risk weights used in the main focus, the risk weights that we use are problematic, what is a low risk weight asset in the european context? sovereign debt. what is the only thing we know about the current european context, sovereign debt is not free, so these issues continue to play out. >> i think we have time for one more question before we adjourn. anymore questions from the audience? yes. >> i was interested in your comment about how the structure of the federal reserve system is unique in that many other central banks don't have this hybrid structure, and i wondered if you could comment on what you think the advantages or disadvantages of that are and feelings on congress, as you said, the federal reserve act could be opened up. i'm curious to know what you

think about that structure and looking back on that. >> well, the -- in -- when the fed was created in 1913, the bank of england is a private institution. the government had no role. the governor was chosen from the board called the court, still called the court. there was a bunch of private bankers and it was almost a hereditary position. >> very confidence almost. >> exactly. france had private shareholders and being a share holder from france was considered a great mark of social prestige. so there's always been these hybrid things, hybrid constructions. the -- i think the hybridness of

the fed was much greater in the 1930s, because the federal reserve banks had much more power and their boards were -- federal reserve banks are essentially cooperatives of banks, and the board was a regulatory mechanism. i get the impression, and i'm not -- since 1930, since the banking act of 1935, a lot of power has shifted to the board, but there's still residual, as simon mentioned, considerable amount of authority in the federal reserve banks, particularly new york, and their boards are still largely private sector participants, and in the case of the new york fed, a lot of people from wall street.

what role that -- what role did they play in the decision making, i don't really know, but ultimately, all central banks have tended -- central banks have always had on their boards financial market participants, and so it's not surprising that there is an element of hybridness, even if there isn't a legal element of hybridness. >> one tiny anecdote to add to that, jamie dimon was a member of the board of directors of the new york fed in early 2008 when jpmorgan chase acquired stearns with financing provided in part by the federal reserve. he remained on the board of the new york fed, despite the nature of that transaction. and when i raised the matter with -- and i don't know any other organization, private,

public, or nonprofit in the united states, where the, let's call it, optics of such a situation would make people comfortable, or where this would actually be allowed to happen. when i raised this matter with the new york fed and with the board of directors, sorry, with the federal reserve board, i actually had a petition on the internet on this issue, to have mr. dimon resign, and i got a meeting with the chief council, 35,000 signatures does not get you a meeting with the governor, but does get you a meeting with the chief council, just for reference. and there are -- the answer that i got, i'm afraid i have to summarize as the rules that govern the rest of american society do not apply to us. there's a very problematic reaction when you remember the essential political nature of this institution and what i'm

afraid is that the fragile nature of its political legitimacy. >> i'll make the closing comment on this issue, which seems to me the fed has sort of been between silla, we tried very hard to create a fed that would not be subject to political control and manipulation, and countries like argentina, you see what happens when central banks are subject to political manipulation, but we tried to offset that with much more private sector influence and private sector influence, but the problem is, you fall into the other trap then of being subject to too much industry influence, and i think that's been a continuing struggle with the fed, how do you actually remain balanced on the high tension wire, right, between the two threats, and i think the other thing about the new york fed in 2008, steven friedman, who was the former chairman and still a director of

goldman, was on that board, remained on that board even after goldman became a bank holding company, which technically wasn't allowed, and in addition brought significant amounts of stock after goldman became a bank holding company. that was not the proudest day, in my opinion, for the federal reserve system. >> he was required to resign. >> eventually. >> from the new york fed, but i agree. >> it took awhile. >> it did. >> yes? >> i was going to ask whether the boards of the federal reserve banks have decision making authority over what they do, because you get the impression when you talk to the federal reserve that the boards are sort of almost advisory boards and that they have no policy making authority. >> well, so i have raised this question with the new york fed and others, and, of course, they do have separate advisory boards, so there are plenty of advisory groups. the board is a separate entity,

and these are freestanding, independent, or particular kind of corporations, so they are responsible for appointing the president of that bank. now, the rules have changed. the class-a directors, the bankers representing the bankers can no longer participate in the choice. it's up to the class-b directors, who are chosen by banks to represent members of the public. think about that in modern american context, and the class-c directors, who are the class-c directors in new york? people afraid to come to the bankers. who get all the money from the banks. so, you know, this does not look good. the supervision is run from the federal reserve board, no question, in washington. what is the engagement of the regional feds, including new york, in the perception, the application, how the social context of these relationships, outsiders cannot determine, so you have to worry about the optics, you have to always care about the optics. the technology

that we do possess now of destroying at sea. >> automatically disappear? i think so. welcome back. i'd like to begin the next session, which features don kohn and fred wessel. for fed watchers, don really needs no introduction, although david might. don is an important historic figure in the fed, having spent more than 40 years in the system. most recently as vice chairman.

he was mentioned by president obama as a candidate to replace chairman bernanke, in fact. don is now at brookings. i'd like to acknowledge don for the role he played here at g.w. in helping us establish the paul volcker scholarship. he played a major role, and he helped us actually honor and pay tribute to paul volcker in this very room, and it was a successful event, don, in large part, due to you, so thank you for that. also joining us is david wessel, "the wall street journal," and david, for readers of "the wall street journal," david also needs no introduction. he's been with the journal for 30 years, and the capital columnist for ten, david? ten or so. he's written a best selling book, as you've heard, "in fed we trust." did you go with the whole title of that, david? the whole title is interesting, in fact, "in fed we

bernanke's great war of 2009." thank you very much for both joining us today and look forward to this. thanks, david. >> thank you very much and thanks for doing this. i thought what we might do here is reflect a little on the lessons of history that liaquat and simon discussed, that influenced you while you were in the midst of avoiding the great depression, or likely you avoided two-thirds of it. but i be at the federal reserve. you got your ph.d. at the university of michigan in 1970 when a lot of people were wearing long hair, smoking dope and protesting the vietnam war. you ended up at federal reserve bank of kansas city. >> where no one was wearing long hair, smoking dope and protesting the vietnam war. >> what led you to do that? why in god's name did you stay

at the federal reserve for 40 years? >> so what led me to the federal reserve was an interest in public policy that i had probably from childhood in hearing debates around participating in debates around the dining room table, but certainly while i was at the college of worcester and did my undergraduate work. this had application to public policy. and that figuring out economics and doing it right and applying it to helping shape the economy, shape the way people made money and shape the way economies worked could make people better off if it were done right. i became as an undergraduate fascinated with public poll system university of michigan at that time had a reputation as

being deeply involved in public policy, a tract between ann arbor and washington was well worn. i never had gardner ackley as a teacher because he left michigan and was head of the council of economic advisors. so there was a public policy application there. and a natural place to apply that was the federal reserve system. the federal reserve bank of kansas city had a reputation then as it does now as having a very good small, relative to new york, research department with high standards, with good access to the policy makers, to the director of research and the president of the bank before fomc meetings. it was a great place to go and

begin practicing economics as public policy. >> how did you happen to come to washington? >> several of the people that i joined kansas city fed at the same time i did ended up coming back to the board of governors in the next few years. >> you mean on the staff? >> on the staff of the board of governors, right. they kept calling and saying this is a really neat place. would be great to have you come back and join. i think at some point i saw that there were tremendous advantages to kansas city, but if you wanted to be near the center of policy making then washington, d.c., the federal reserve board staff was the place to be. >> i wanted to ask you a little bit about the conversation lee atkins simon had. as you taught me, to large extent the federal reserve is returning to its roots.

that in 1907 we had a financial panic that directly led to the creation of a central bank. the idea they were going to deal with inflation and unemployment was not central then. i'm sure everybody at the fed has been taught that the fed screwed up in the '20s and '30s, and the fed screwed up in a different way in the '70s when we allowed inflation to get out of control. what role did that have navigati navigating sloals. >> ben bernanke was chairman of the federal reserve. having studied the great depression brought his experience, his study, his thoughts about what to do to avoid that again to our deliberations. >> explicitly?

i remember reading in milton freeman in a 1930 board meeting -- >> there was only a little of that. simon concentrated his studies on the credit side. he wooed to say about franklin roosevelt i disagree franklin roosevelt tried. famous phrase whatever it takes and his openness to experimentation throughout of the idea of decision making under these very difficult circumstances. you don't know how things are going to turn out. you have no idea what's going to work and what isn't going to work. i think a study of the depression and history of the fed and the, what we brought to that meant we were going to do whatever it took to avoid the great depression. he helped shaped the decision-making machinery to get

us to that end. >> of course, the financial crisis didn't arrive on a rocketship from mars. it wasn't an act of god. it was preceded by a lot of developments in the economy. in the financial system that as simon pointed out, the federal reserve was in part charged with supervising. while i don't think there is any substantial question that it could have been worse, i want to ask you about whether it could have been better in a minute. there is a question whether it might have been avoided had the federal reserve done something different in the ten years before? >> i think there were a number of regulatory -- there were a number of mistakes made. first and foremost by the private sector who were buying and selling securities they didn't understand. credit rating agencies were giving ratings that were totally unjustified.

on securities that had very little history and there was no -- they weren't warning people, hey, we're taking a guess here. we don't know how this is going to turn out under certain tale events. i think the cops weren't on the beat. not only the credit rating agencies weren't on the beat, but the regulators weren't on the beat, as well as we could have been. the fed bears some responsibility for that, absolutely. on the consumer side, famously ned gramlich started raising issues. how is it going to work, et cetera. so that never got followed up. the whole atmosphere from the late '90s to the early 2000s was financial liberalization and the advantages that deregulation was having, creating new

instruments, spreading the availability of credit to new folks that hadn't had it before, subprime loans are a good example of that. this wasn't just a d or an r situation. certainly in the clinton administration this was supported. you remember president bush had the ownership society, encouraging people to climb on the ladder of wealth through acquiring homes. the whole thought was the financial system is working better, they created a bunch of new instruments, these helped to distribute risk. sure, there are risks and problems out there, but i don't think no one really foresaw the kind of collapse that happened. we took some steps ahead of time, but part of the -- one i can clearly recall is commercial real estate lending. the federal reserve and the other agencies saw that small

and medium banks in particular, regional banks were doing a lot of commercial real estate lending to developers and whatnot. they really didn't have the risk controls on that, but part of the problem was the structure regulation in the u.s. so to get new guidance out required all these agencies to agree. the office of thrift supervision was very difficult to bring along on that and the thing got watered down. it took a while to get that guidance out. interestingly, there was huge blowback from the political system. what do you mean telling the banker in my district that he can't make loans to this developer that i play golf with with every sunday? so i think the political dimensions are important here. >> but the whole argument for having independent central bank when it comes to monetary policies that the central bank can do things that the

politicians can't or might not even support, it doesn't seem to quite work that way on regulation. >> so i do think though, independence, there's been a bifercation. there's lots of history over time, over countries, independence of monetary policy is essential, a high degree of independence is essential within a democratic system, a democratic accountability to maintain price stability. i think when you get on the other side, on the regulation supervision side, there isn't that history. it's complicated in the u.s. because of the balkanized regulatory structure. you need to get lots of people together. regulation has effects on the distribution of wealth, on distribution of credit and things like that that often

isn't in an independent agency. so the degree of independence is different on that side. good metric for that, indicator for that is the gao can audit everything the fed does but monetary policy. so the gao audits supervision, regulation, payment systems, all kinds of things, but not monetary policies. so the congress itself in the late '70s when they set the gao up -- >> government accountability office. >> right. recognized that there was a different degree of independence on either side. i think this is, becomes an interesting and difficult issue going forward because as the previous panel was noting, there is now more responsibility for overall financial stability. and an expectation that the federal reserve and it can't be just the fed. it's got -- the fed doesn't have enough tools to do it by itself, but the other agencies and the

fed together need to take away the punch bowl in a credit sense. in a financial stability sense on that side of the house as the party gets going. the people drinking the punch aren't going to be happy. it's not been tested out. the macroregulation requires independence maybe not equal to the monetary dependence but something like it. >> the new york thread was captured by the big banks. you never worked at the new york fed. you could be an independent gauge. was that part of the problem? did alan greenspan's regulatory philosophy play a role? >> i don't think that was a root call of the crisis. i'm not sure simon would own up

to having said that, but it was close. i think the crisis had many root causes. part of it was just complacency over a couple of decades. we had several decades of growth, two mild recessions, all this financial innovation which looked like a decent idea at the time. i think everybody got a little too relaxed. not just the new york fed or not just the board of governors or the fdic or occ or anyone else. i think it was part of what was going on. >> so it was mindset rather than looking out for the profits of their friends. that would be -- >> i think that was primarily, yes. >> you agree alan greenspan didn't lean against that wind? >> that's right. to some extent, the new york fed and tim geithner, the president of the new york fed recognized

that the system was changing and that it needed closer oversight and some fixing. he initiated before the crisis efforts to make the derivatives markets more robust, more transparent. he saw that there were problems and there are speeches that he made noting there are problems. i think part of this, taking a step back, this is about the evolution of the financial system from a bank-centered financial system to one in which has banks and nonbanks and the nonbank piece of it, the securities markets, the securitization markets or p markets, how that stuff is financed becoming more and more important over time. i think to a considerable extent, the regulatory system, oversight, did not evolve with the evolution of the system. the legal basis for oversight did not evolve with the

evolution of the system. i think the new york fed saw actually some of these, some of the weak points, but the legal authority, the political backing, the general recognition wasn't there. >> the new regime basically says that we're going to give the fed more systemic oversight. we are going to create this financial stability oversight council so that at least the regulators have to get in one room once in a while. and we are going to talk a lot about this thing called macroprudential, which is hard to define. i get the gist of it is if there's too much lending going on or too much excess, that somewhere there is a dial you can adjust to avoid this so that you can preserve the monetary policy, interest rates, for as to steer the economy. two questions. one is, is there any chance that this could actually work?

it sounds good. >> yeah. i think is there a chance it could work. whether it's 100%, i'm not sure. let me amend what you said a little bit. too much credit is one issue, but also how the credit is being made and how the lenders are. among the problems, chief among the problems leading up to the crisis wasn't just too much credit in the mortgage housing sector that rouletted in overbuilding and overpricing of houses, it was being financed through a system that, a financial system that was increasingly leveraged. a lot of that leverage was occurring outside the banking system. so outside direct control of the federal reserve. the system was increasingly

financing these long-term securities with very short term overnight borrowing. you had more maturity transformation, more leverage. when the prices of the underlying assets came down, there wasn't a cushion to absorb those losses. people said i'm not sure where the prices are going to stay, are going to rest, so therefore, i'm going to be much more cautious about who i'm lending to, who i'm funding and these funding markets. the interbank market in the fall of '07 spreading even into the secured rp market in the winter of january, february, march of '08 when bear stearns came down and the securitization markets and the commercial paper and asset-backed commercial paper markets certainly through part

of this, but really after lehman came down. so the panic was there from august of '07, but it kept in s intensifying and it systems didn't have the cushion to reassure people we can take losses, but we'll be viable. hopefully macroprudential policy will see not only the growth of credit, but the reliance on short term wholesale funding for long term assets and take steps to deal with that. for example, higher capital requirements is one thing that some fed board members have talked about. should we have higher capital requirements on people who are funding themselves short? liquidity requirements. if you've got a lot of short term funding you have to hold short term assets to absorb the

cut-off of your funding. the basel committee has another requirement coming. margin requirements off the banks so that -- off the banks markets like rp markets that aren't necessarily on the banks' books. try to make them less pro cyclical. i think there are a bunch of things you can do in the banking sector to try to control the leverage but outside the banking sector. >> we talked earlier about the peculiar structure of the federal reserve which has its historical roots. in the uk they, confronting the situation you described, they set up two committees. one does monetary policy and one does financial policy. apparently there weren't enough brits to staff both of them so they recruited a canadian to run the whole operation in europe in a financial policy committee. so what's your early experience

there? does it seem like a good approach? do we know? >> i like the approach. the monetary policy committee is basically being given the responsibility for price stability and subject to that growth and expansion. the financial policy committee has been given a clear mandate to maintain financial stability. so there are different mandates. for sure, the policies, and therefore different accountability, for sure the policies interact. what the financial policy committee does affects how monetary policy is transmitted to the economy and how the monetary policy is carried out affects the financial stability characteristics of the uk economy. and the chancellor in his remit to both the monetary policy committee and financial policy committee has told both of them they need to talk to each other more. there are three members that be overlapped. there is more discussion between

the two committees. in fact, when the monetary policy committee did what the u.s. has done, put in forward guidance keeping interest rates at zero until the unemployment rate in the uk, at least until the unemployment rate got below 7%. they said if this has financial stability implications in those adverse implications, you the financial policy committee have tried to address those adverse implications through other things like bearing capital requirements, but that hasn't worked, tell us. that will knock out the 7% unemployment rate. that means every time the financial policy committee meets, last two times we met since that policy was put in play, we had to have a discussion. do we think the monetary policy is creating financial stability issues? if so, how would we address

those? have we tried everything we can try? what do we need to say to the monetary policy committee? so there's a lot of conversation back and forth between those. but i like the separation. i like the fact that there's another set of eyes on the financial stability piece of it that can then advise the monetary policy committee and do so on a very public way. so what we would say to the monetary policy committee, first the monetary policy committee, but as soon as the monetary policy committee made its decision it and we reveal what it told it and how it responds. the past couple of times we told it, we're not worried. we think there are other things we could do if we were worried. in the future i think it fosters a much more transparent and open dialogue between the financial stability and the monetary policy. >> let me switch to monetary

policy for a moment. i loved the formulation that the fed gets credit for preventing 2/3 of the great depression. why not 3/4? why not 85%? with the benefit of hindsight, and once the crisis hits, we talked about what the fed might have done to reduce the risk of it. once it hits, now that you know everything that you know, was the fed aggressive enough? were there things that you had, if you had to do them over again you would do differently? >> no. i mean, yes, i think we were aggressive as we could be given the circumstances and the law. given in those circumstances and law i don't think there is anything major i would have done differently than we did. on the monetary policy side we began easing policy right in the fall of 2007. when we could see, even though

the economy hadn't peaked yet. the nbr calls the peak in december, but our forward-looking policy said well, we can see there's disruption, particularly in thor in bank market. we think that's going to disrupt the flow of credit to households and businesses, financial conditions are tightening. we need to offset that with monetary policy. we began easing in several steps. by the time we got to january, it was clear the nbr calls the peak in december. anybody looking at the economy knew things were deteriorating even in early december. by the time we got to january, it was a very bad situation. the markets were much more disrupted. the economy was clearly on a downward track. we eased very aggressively in january in two steps.

i think for 125 and 150 basis. it was unprecedented amount of easing. one between the meeting and at the meeting. when we saw the situation deteriorate we moved aggressively. interestingly, we talked about the depression as a lesson. the other thing in my mind in that period was japan. so there had been a conference at woodstock, vermont in '99, i think, or 2000. one of -- about the japanese stuck at the zero lower balance. >> interest rates can't go below zero, prices are falling and the economy is bumping along. >> right. one of the lessons drawn from that conference, and there were a couple of papers there saying if you get into a situation where that might happen, go fast, go aggressively. try to head off the situation. the more aggressive policy is, the more likely you won't get to

the zero lower balance and if you do get there you'll be there briefly. we were looking not only at depression, but at the japanese experience. we went pretty aggressively there. i think the other -- then of course after lehman we got to zero pretty fast and started buying securities. we can return to that separately. the other aspect is the liquidity aspect. as was discussed last time, one reason for founding the federal reserve was to head off the kinds of panics that happened. there are quotes from robert owen. one of the sponsors, senator owen was one of the sponsors of the fed. the federal reserve act. and others saying, i think carter glass quotes and others saying, once we get this thing in place or now that this is in place, there won't be panics any more because people will know that there is someone there to

act as lender of last resort to head off the panic. it's clear that that didn't work. not only in the '30s but in 2008. i think part of the issue was this business of so much migrating to the nonbank financial sector. that used to be thought of as a plus. you had banks, nonbanks. >> chairman greenspan once referred to it as a spare tire. the tire is flat. >> exactly. the spare tire is flat. all the tires were flat at the same time. >> and there was the fed trying to pump air in a tire with a hole in it. >> exactly. >> i'm sort of convinced the essence of monetary policy is picking the right simplistic cliched metaphor at the right time. >> that doesn't come back to haunt you later. >> true. the trouble is the wrong simplistic metaphor can do great damage. >> right. i think part of the problem, one reason we couldn't head off the

panic is because 13-3, the section of the federal reserve act that authorizes lending to individuals, partnerships and corporations that was referenced in the last session, that can't be activated until there is already a crisis. >> 13-3 says under circumstances -- >> unusual and exegen circumstances -- >> the fed can lend to almost anybody as long as they have good collateral. >> to the satisfaction of the reserve bank. it also says credit is not available from other banks institutions. you have to make a finding that you can't get credit from somewhere else. of course, that section hadn't been used since the 1930s. >> that was the lever you pulled at bear stearns. >> a couple of days before bear stearns then pulled really hard after bear stearns and even harder after lehman.

the private sector couldn't anticipate that would come into play. there was great reluctance to use it. a certain chairman of the federal reserve testified about a week before it was activated that, yes, it was there, but boy, it would be a big deal to do it and have all kinds of adverse moral hazards, things. i was careful not to say no. i know never to say never, particularly about something like that in the middle of a crisis. i didn't say you guys can count on it if it gets bad we'll do it. i think partly 13-3 was to be used once the crisis began. so it couldn't head off the panic. >> i assume it didn't occur to you in 2000 let alone 1990 you wouldn't be watching the federal

reserve when interest rates hit zero in 2008. the only question is will they go up in 2015 or '16. almost a decade of zero interest rates. that forced the fed to innovate, to do this business quantitative easing. would getting stuck at zero, would have buying more sooner eased the economic pain? >> i think it's hard to tell. certainly the case that i and others at the federal reserve did not anticipate, although we knew this would be a slow movement out of this recession. that credit was constrained, particularly for real estate and when you think about when we started buying in late 2008, early 2009, constrain for a whole variety of uses.

but i thought that as the banking system and the financial system was rebuilt that credit would become more widely available and that the zero interest rates and the negative real rates subtracting 2% expected inflation would stimulate a lot of demand. i did not anticipate that we would go through so many years of slow growth. would doing more in 2009/2010 have helped? maybe a little. i think part ly certain balance sheets needed to be rebuilt, things needed to come together, other obstacles needed to be overcome. certainly i didn't anticipate the fiscal restraint that would be in place in 2012 and particularly 2013. so other things happened that were hard to anticipate.

whether pushing down long-term rates even more earlier probably it moves in the right direction. would it have avoided four years of tepid growth? not quite sure. >> what is your judgment of the efficacy of quantitative easing? >> i think it's helpful. it's been helpful with long-term interest rates. when we undertook it initially, i think it had two effects. one was directly affected those interest rates by buying the securities, but secondly waits a powerful signal that we were concerned, we were worried and we were on the job and we were going to do things to keep interest rates low and keep the economy going. the signaling part of that has been shifted really to the forward guidance piece of federal reserve and other central bank policies. i think once the forward

guidance is in place, the actual quantitative easing probably less effective than it was when it played kind of a dual role initially. >> one of the effects of quantitative easing isn't the pluming that pushes down interest rates but convince ed everybody the fed will keep the interest rates it controls low a long time. >> the fed was saying that. >> right. now they switched to we are going to say that with more forceful language. the second part is -- >> i do think even having that forward guidance in play we've got a little bit of a test this summer about what happens when the forward guidance is in play but the federal reserve led people to think that the probabilities were high, that they were start to reduce the volume of purchases. interest rates went up pretty substantially. partly because people took that

as a signal. once again, the division between forward guidance and qe wasn't as stark and as tight as the chairman and the committee thought it was, but also i think just the interest rates rising because the term premium rose and just the qe effects were going off. and we've seen that that had some effect on mortgage markets, probably had some effect on other markets and construction. so took a little bit of the steam out of rise. i would say the tests this summer suggested sort of we got a little test of the counterfactual. suppose they hadn't been doing it. looked like it was -- >> in that context, the economy is better, but not good. we still have 7% unemployment. the fed seems to be on track if not in december but january

beginning to scale back quantitative easing. why scaling it back if we are far away from anything like a normal healthy full employment economy? >> i'll say what i think the fed thinks. >> then tell me what you think. >> there is discomfort in the sense that the portfolio could grow almost without limit, not having any limits on it. there is discomfort in the potential financial stability effect so our people becoming exposed to an unexpected rise in interest rates because there's more maturity transformation. people are borrowing short at low rates and lending longer and becoming more levered or taking risks they don't understand? i think there's some legitimacy in those discomforts. there are other discomforts i'm

less sympathetic to. there are people inside the federal reserve that worries about what happens to their balance sheets when interest rates start to rise. >> they'll be paying fed is a public institution. it's not a profit-making institution. the congress and fed and administration shouldn't look at it that way. what they did they did to accomplish the goals they were given in legislation. the fact they are making a bunch of money now, might lose a bunch of money later is irrelevant. you can argue about what they're doing relative to the goals they were set. >> do you think it's a good time to start tapering.

>> i hate doing these predictions of the fed. >> it's not a prediction. it's a judgment of whether it's a good thing to do. that's easier. >> it is easier, i guess. assuming the judgment's any good. i can see the argument dancing around here. i can see the argument that there is more emphasis on the forward guidance. that's an easier tool to use. it's much more like the old fed funds. i like the fact that they've gone to economic conditions for forward guidance. >> if they said we'll keep interest rates low until the economy meets this condition as opposed to six months or 12 months? >> i think a problem with that is they tried to summarize that condition in one metric, the up employment rate. now they are kind of backing away and saying that -- >> would you vote to taper