[MUSIC] Part of what determines how dangerous crises are is what policy makers do and are able to do in response to that. Why not talk about some of the most important dimensions of financial capacity that again are ultimately critical in determining how bad these things have to be or how bad these things can be. This is a picture, of a bank in China in 2014 that was experiencing a classic run. I think it was a, sort of a slow walk at that time. People were concerned the bank was not stable. And what this bank did which is the typical response in financial panics, is to stack a bunch of money in the window. To try to illustrate to the depositors they didn't need to rush to withdraw their funds because there is plenty of money there for them. And this is important because you if you want to think about how you break panics. And how you reduce the risk that panics end in terrible damage to economies. You have to figure out a way to build a firewall to put enough money in the window. So that people don't have the incentive to run, to rush to protect themselves individually. But what determines a countries ability to do that? That's determined by a bunch of things that are dimensions of financial capacity. This is a picture that shows the decline and then the gentle rise in the level of public debt in the United States, as a share of the economy over time. And you can see, in the decade before the crisis, the level of borrowing to GDP rose modestly. That came down as a result of a bunch of fiscal rumors in the United States, then it started to rise a bit. But by the early stage of the crisis, a modest surplus in the budget turned into a deep deficit. This is important to note because your degrees of freedom, your ability to act to protect people in a crisis depends a lot on whether you have the ability to mobilize resources quickly in response to the potential losses. Another thing that is important to the degrees of freedom governments and central bank have is what's the central bank's credibility? How confident are people that the central bank is a prudent manager about the risk of inflation. And the US went into the crisis with a high degree of central bank credibility. The central bank had delivered a long period of relatively low and stable inflation. Another dimension of capacity is how large is your financial system relative to the size of your economy? And the US had a relatively small banking system as a share of our economy. You can see on that list of financial systems that banks as a share of our economy were at the lower end of size. And that matters a lot too because you wanna think about the resources you have against the potential risk of loss in banks. You think about the challenge of stabilizing a failing financial system, it depends on how large is that system relative to the scale of your resources. Those were a few things about the degrees of freedom we had that related to our financial strength. But part of our degrees of freedom related to the authority we had and we went into this crisis with very weak, very inadequate financial authority. Fire fighting authority, relative to the system, and relative to the challenge, and relative to the crisis. So we had no standing authority at the Treasury, the FFED, or the FDIC to inject capital into weak banks. The FDIC had lots of ability to wind down a failing bank safely, but no, or a very weak authority to wind down the kind of complicated bank, or investment bank institutions that were the center of this crisis. The Fed had a standing authority like all central banks in the discount window to lend money, to commercial banks. And the FDIC and the Treasury had some emergency authority. The FDIC had deposit insurance, could guarantee deposits against losses up to $100,000. But it didn't have authority to guarantee or had not used authority to guarantee other source of funding that are critical to banks and bank holding companies. It has this emergency authority that was called the systemic risk exception, used very rarely. And Treasury had a tool called the Exchange Stabilization Fund that had I think never been used in the context of an American financial crisis. It had only been used to help mitigate the risks of emerging market financial crises. These tools were very weak and very inadequate to the nature of the risk we faced in the US financial system on the eve of the crisis. Here's a way to illustrate it. This is a stylized representation of the scale of the financial system. And you can see, in the box in green, the scope of deposit insurance. And you can see a sort of softer, more implicit sense of support for the other source of fundings that banks rely on. But the rest of the American financial system, depicted in red, was outside the scope of those basic safeguards. Those basic safeguards we put in place after the Great Depression, to reduce the risk of financial crises. So, what that meant is that the vast bulk, or the substantial majority, of credit, or risk, or financial activity that's relevant to how the economy functions in other institutions in the funding markets. Were left outside of the types of safeguards available to central banks and governments to mitigate the risks of runs and panics. So just to emphasize it, on the eve of this crisis, our financial capacity as a country was very, very strong. But our tools, our fire-fighting authority, our emergency authority were very weak and very inadequate. And that added up to being very important to the degrees of freedom we had into the choices we made. And that in turn was critical to the magnitude of the damage caused by this crisis. [MUSIC]
