What critics of Ben Bernanke’s Nobel Prize failed to see

Of course, Bernanke was the regulator of the US monetary system as chairman of the Federal Reserve System and the Fed’s Open Market Committee which sets policy rates. His key insights from his study of the Great Depression were that bank failures contributed to, prolonged and sustained the economic crisis, rather than being one of the many products of the crisis. This informed their decision to provide plenty of liquidity in the wake of the financial crisis that gripped the Western world following the subprime crisis and the 2008 collapse of investment bank Lehman Brothers. Bernanke provided a large additional dollop of liquidity through very low rates and ‘quantitative easing (QE)’, an appropriately opaque name, from a regulatory standpoint, to keep dollar printing machines running non-stop. With this created money, the Fed recapitalized banks by buying their assets off their books — capital adequacy is measured as the ratio of capital to risk-weighted assets, and when you reduce the denominator, you get the new value. Improve the ratio even without adding capital. ,

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Conservatives like to blame Bernanke for making too much money and thus, creating conditions for inflation that prove difficult to contain. Some blame him for the misery caused by emerging markets, the so-called taper tantrums that follow his statement of intent to launch. Why anyone guilty of slashing bond purchases in 2013, the instrument of QE, creating inflationary conditions and emerging market turmoil, should be rewarded with the Nobel Prize, ask critics.

There are two reasons for this: one, if the ocean of liquidity on which all economies eventually float had not opened, there would have been another Great Depression, and not the Great Depression that materialized; And, secondly, Bernanke is being rewarded for his insight into banking, not his role as a regulator.

Diamond and Diebwig presented a mathematically rigorous explanation for the predominance of banks, in the context of their actions of maturity change and delegated monitoring of credit utilization. Maturity change is jargon to make long-term loans from short-term deposits that depositors can recall at short notice. Delegated monitoring is what banks do when they examine a loan application for repayment capacity and monitor the use of the loan to ensure that the money borrowed is being used for which The loan was sanctioned for Because banks perform these two functions, the cost of credit intermediation is reduced, both for savers and those who save to generate more money, investors who take out loans. Imagine that there were no banks and each saver had to do a risk assessment of each potential borrower before and after handing over their savings, and from thousands of small savers with short time horizons to lend to each seeker of capital. Had to make contact. The transaction cost of raising even a small loan would be enormous for both the saver and the borrower.

Now, there is an inherent risk in the maturity change: If all the savers ask for their deposits back at the same time, there will be a run on the bank and it will liquidate all the assets rapidly or quickly enough to meet all the demands. will be unable to finish. Regulation is the only way out: deposit insurance, the lender of last resort, the central bank playing that role, and the buffer of capital. In extreme events, the government can provide capital, as it did during the financial crisis that began in 2008. Banking is inherently counterproductive to laissez faire: without a regulator, bank failures would be as common as they were, indeed, before. The Great Depression and the Institution of Regulation.

Bernanke conducted detailed empirical analysis to establish that the banking crisis was a sustained and prolonged Great Depression, rather than the failure of the banks due to the economic crisis. A banking collapse had two effects: one, which other economists had already noted, was to reduce the reserves of money; Second, more importantly, the bank went away as well as the banking relationship associated with it, eroding delegated monitoring, and thus, increasing the cost of credit intermediation, the supply of savings and the supply of credit at this high cost. Demand reduced both.

Better regulation is also possible by understanding the basic function of banking. For example, it is necessary to recognize the disciplinary impact of deposits – depositors can score a run on an unsustainable bank – while bondholders who provide additional Tier 1 capital cannot. Therefore, the regulator strikes a balance between depending on the capital buffer and discipline by the depositors, while deciding how much capital the bank should hold.

The world’s major banks are much safer today than they were at the start of the 2008 financial crisis, thanks to regulatory measures implemented after the crisis. Still, it will not do anything to dampen regulatory vigilance as economic tensions mount and the global economy is on the verge of recession. The Nobel Prize in Banking Economics underscores that message.

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