Lessons Learned from the Financial Crisis

The Federal Reserve Bank of St. Louis launched its inaugural “Dialogue with the Fed: Beyond Today’s Financial Headlines,” an evening discussion series for the general public, on Sept. 12, 2011. Julie Stackhouse, senior vice president of Banking Supervision and Regulation, discussed “Lessons Learned from the Financial Crisis.” Her presentation was followed by a panel discussion and audience question-and-answer session featuring William Emmons, assistant vice president and economist, and Mary Karr, senior vice president and general counsel. St. Louis Fed President James Bullard gave welcoming remarks.

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In her presentation, Stackhouse looked at the Fed’s roles and responsibilities, including its response in the aftermath of the attacks of 9/11, when the Fed stepped in to stop the panic in the financial markets and then stepped out when the crisis passed. The Fed repeated and expanded these actions a decade later during the financial crisis. Stackhouse discussed the beginnings of the most severe financial crisis since the Great Depression in 2008 and examined one of the primary factors leading up to the crisis: the housing bubble and its causes and ramifications. These causes included the growth of private-label mortgage securitization, increased subprime mortgage lending and homeowners using their homes as mechanisms for generating cash. As housing prices began to fall, financial market panic started in September 2008. Stackhouse then detailed how the Federal Reserve provided liquidity to both stem the panic and prevent an economic collapse, in addition to actions taken by the U.S. government and the FDIC. Though the actions of regulators and the federal government clearly ended the panic in the financial markets, they could not avoid the Great Recession, and Stackhouse outlined lingering problems that included housing market weakness and a high national unemployment rate.

Stackhouse concluded with three main lessons learned from this crisis:

• High levels of debt, uncertain ability of borrowers to repay debt and an expectation that housing prices will always increase (among other factors) created a comfort level that was misguided.
• Spreading risk outside of the insured banking system and use of “insurance” policies such as credit default swaps did not result in risk diversification. Risk needs to be understood across all parts of the financial system–banks and nonbanks.
• The Dodd-Frank Act provides a means to do so. Choices made in the short-run may have long-run consequences that need to be carefully considered.