The financial-economic crisis explained: the analysis of Ben Bernanke

Ben Bernanke, President of the Federal Reserve, America’s central bank, analysed the crisis of 2008 as “a classic financial panic attack”.

In essence, Bernanke distinguishes two aspects of the crisis: the triggers and the vulnerabilities.
Under triggers (the events and causes that sparked off the crisis), for example, Bernanke classifies the system of subprime loans, the housing price bubble in the United States and the excessive indebtedness of public authorities and in some cases also the public. But Bernanke immediately adds that reasons of that magnitude never would have caused a financial crisis of that amplitude without the vulnerabilities, the structural shortcomings of the financial system and the way the regulation and supervision of that system functioned. ”Both the subprime crisis and the housing bubble were relatively small compared with the disproportionate effect they had on the system”, noted Bernanke.

According to Bernanke, the vulnerabilities of the financial system are many and varied. They express themselves in the (excessively) high leverage (equity in relation to the balance sheet total) of a number of financial institutions, in their over-dependence on short-term financing, in shortcomings in their risk management and also the occasional overuse of exotic and opaque financial instruments. But they also came to light through gaps in supervision, which meant that key players in the financial system escaped proper control. Because this supervision also tended to be microprudential (directed at institutions) rather than macroprudential (focused on the financial system), the risk of contamination also escaped attention until it was too late. These vulnerabilities, Bernanke argues, strengthened the triggers for the global financial crisis from which the world is now recovering.

Bernanke notes that the vulnerabilities were often linked to the use of techniques of shadow banking, essentially a system that functions as a bank, but does not enjoy the same level of supervision. With the help of the excessive use of techniques such as securitisation and an over-dependence on money market funds, for example, shadow banking created asset backed commercial paper conduits (ABCP) or investment banks to finance illiquid assets with short-term money. These shadow banks escaped the prudential regulation that applied to banks.

“This worldwide flight from the regular financial system”, Bernanke now says, “was bad for the financial system.”

Furthermore, in certain cases risk management and control systems did not always seem to keep pace with the degree of financial innovation, Bernanke notes. As a result, a number of large financial institutions were not able to monitor their risks properly, which meant they were not adequately diversified. They were also barely able to verify the quality of certain underlying assets in their investment portfolios. Supervisors also failed in their duty, sometimes because they focused too much on the health of markets and individual banks, and not on the health of the system.