Former chair of the Fed speaks about 2008 crisis
Janet Yellen, former chair of the Federal Reserve Bank, spoke to IBS alumni about the economy after the 2008 crisis.
Former Chair of the Federal Reserve Bank Janet Yellen cautioned against the deregulation of governmental oversight of banks in the wake of the 2008 financial crisis, as well as the politicization of the Federal Reserve during a speech Saturday to a crowd of International Business School alumni and other community members.
Yellen, who chaired the Federal Reserve from 2014 to 2018 under the Obama and Trump administrations, was the keynote speaker for Brandeis International Business School's 25th anniversary celebration weekend.
She previously served as the vice chair of the Federal Reserve System, chaired the Council of Economic Advisors under the Clinton administration and was a business professor at the University of California Berkeley, among other positions.
Yellen spoke in conversation with Prof. Stephen Cecchetti (IBS), the Rosen Family Chair in International Finance at IBS.
An independent Federal Reserve creating monetary policy is of the utmost importance to maintaining low, stable inflation and good economic performance, Yellen told attendees. The Federal Reserve, created in 1913 as a “lender of last resort” in response to numerous banking runs, has traditionally been an apolitical institution run independently of government policy. Yet despite this long-standing rule, the Trump administration has attempted to assert more political power over the Federal Reserve by demanding the lowering of interest rates amidst the present economic slowdown, Yellen said.
Yellen and three other past chairs of the Federal Reserve — Alan Greenspan, Ben Bernanke and Paul Volcker — wrote an opinion piece in the Wall Street Journal defending the apolitical nature of the Federal Reserve. Referencing this opinion piece, Yellen said, “We feel strongly that monetary policy works best for the benefit of society at large, for [the] economic well-being of Americans when it’s made in this way.”
Politicizing the Federal Reserve, she said, would be a “grave mistake.” Markets tend to perform poorly when politics are brought into the mix, such as in the context of the Trump administration’s ongoing trade war with China. The trade war has weakened the global economy as businesses put their investments on hold in the face of economic uncertainty, Yellen said.
If the Federal Reserve were politicized, “we would have policy decisions that are motivated by the President’s electoral interests and may [boost] the economy in the runup to the election and then have high inflation later. They would eventually force a downturn and the economy would become more cyclical and would have lower performance,” Yellen told the Justice Saturday.
Yellen also spoke in depth about the actions taken by the Federal Reserve and governments in the wake of the 2008 financial crisis, and the impact of those decisions on the United States government’s current relationship with big banks.
At the outset of the financial crisis, The Federal Reserve and the Department of the Treasury made loans to large firms against good collateral, assets that serve as security for a loan. They also bought millions of mortgage-backed securities from the companies Fannie Mae and Freddie Mac, which buy mortgage loans and package them into securities, after the government took control of their finances. The government has held control of Fannie Mae and Freddie Mac for the past 11 years, but the Treasury Department recently put out a plan to re-privatize the companies, according to a USA Today article.
While the Federal Reserve does not normally lend companies taxpayer dollars, tax dollars were the main source of funds for the loans to Fannie Mae and Freddie Mac, as well as for the 2008 bailout of big banks and investment banks such as Goldman Sachs and the American International Group.
Cecchetti then asked if the United States economy is safer today than before the financial crisis. Yellen responded that with the passage of the Dodd-Frank Act in 2010, the U.S. saw large improvements in regulating its banking system. The Dodd-Frank Act’s reforms included increasing the liquidity threshold for banks, which would require banks to keep more spare liquid assets, or cash, on hand; and requiring them to undergo stress-testing — computer simulations to test a bank’s ability with its current levels of capital to withstand a financial crisis.
Dodd-Frank also addressed shadow banking, one of the main culprits behind the financial crisis. Standalone investment banks like Bear Stearns and Lehman Brothers operated as shadow banks, meaning that they worked outside of the scope of regular banking regulations. Shadow banks operate like regular banks, and have runs that trigger panic among investors because of a lack of liquidity in case of failure. The failure of shadow banks and subsequent investor panic was one of the main causes of the 2008 financial crisis. Though Dodd-Frank has enabled the Federal Reserve to more easily identify and oversee shadow banks, the practice is still a problem and needs further oversight, Yellen said.
Thanks to these reforms, mortgage lending is now safer, Yellen said, but the American economy is still vulnerable in many of the same ways that caused the crisis because of holes in Dodd-Frank.
Yellen told the Justice that she views insufficient regulation of shadow banking, “an absence of tools to address rapid credit growth … [and] the loss of [the] ability of the Fed to make emergency loans to non-banks like they did to AIG and Bear Stearns” as vulnerabilities in the U.S. government’s oversight system.
To avert another crisis, Yellen said, the United States needs to emulate other countries’ financial stability councils, which stop potentially destructive market bubbles from forming. While the United States has a Financial Stability Oversight Council, established under Dodd-Frank, the council has almost no power because of deregulation.
Despite the problems with Dodd-Frank and deregulation of governmental oversight measures, Yellen does not see a financial crisis in the immediate future.
“I think that if the economy turns down, there will be a lot of bankruptcies that will make the downturn worse. I don’t think that will cause a financial crisis, so I’m not worried about a financial crisis now,” Yellen told the Justice.
The event carried a bittersweet undercurrent, though, with the announcement of the Rachel McCulloch Endowed Scholarship, in memory of the late Brandeis economics and IBS professor. McCulloch was the director of IBS and founded its Ph.D program, according to a June 22, 2016 BrandeisNOW article announcing her death.
Yellen, a good friend of McCulloch’s from their time as the only two female faculty in Harvard University’s economics department in the early 1970s, extolled McCulloch’s accomplishments when announcing the scholarship.
“Rachel was a distinguished economist who made enormous contributions to the field of international economic policy. She weighed in on virtually all of the major trade policy debates of our times, the future of the World Trade Organization, the impact of trade on income inequality” and many other important trade policy decisions, Yellen said.
She continued, “Rachel’s work reflected wisdom and good common sense. She knew all the issues in the literature, but also was endowed with an uncommon policy acumen, someone whose advice was sought by policymakers and prominent think tanks, because she got the answers right.”
At the event’s conclusion, IBS Dean Kathryn Graddy presented Yellen with the Dean’s Medal in recognition of her contributions to the field of economics.
“Professor Yellen has set the highest possible standard for what it means to succeed as an economist. But even more importantly, there is no public figure that I know that has demonstrated more integrity, intelligence, and leadership,” Graddy said.
IBS’ 25th anniversary celebration weekend included a variety of panels and workshops geared toward IBS alumni in attendance, such as “Cybersecurity” and “The State of Asset Management,” as well as a celebration in Boston.
—Editor’s Note: Justice Editor Natalia Wiater and News Staff Writer Nancy Zhai work for IBS. They did not edit or contribute to this article.