Lessons Learned from the Financial Crisis: Three Main Lessons Learned

In the St. Louis Fed's first Dialogue with the Fed event, Julie Stackhouse takes a look at the issues that lie ahead for U.S. economic growth and highlights three main lessons learned from the financial crisis.

Presentation (PDF)

• Part 1: Welcoming Remarks | James Bullard (8:40)
• Part 2: Responses to the Pre-Event Survey | Julie Stackhouse (2:41)
• Part 3: A Brief History of the Federal Reserve and the Fed's Responses to Past Crises (7:25)
• Part 4: The Beginnings of the Most Severe Financial Crisis since the Great Depression (10:07)
• Part 5: The Housing Bubble and Its Ramifications (9:53)
• Part 6: The Federal Reserve as a "First Responder" to the Crisis (9:37)
• Part 7: Avoiding a Financial Collapse, but not the Great Recession (8:18)
• Part 8: Lessons Learned from the Crisis (7:21)
• Part 9: Question-and-Answer Session (26:26)

Transcript:

Julie Stackhouse: So what lies ahead? Certainly, and this just takes a look at forecasters. The question, and Jim mentioned it at the beginning of the program tonight, is what's going to happen with economic growth? And there is uncertainty that's out there. Not only uncertainty in terms of what's happening in the United States, but uncertainty caused by those European countries that are experiencing their own challenges. We would like to maybe ring fence our country to say that we don't have to worry about what's happening in places like Europe, but unfortunately we can't. We are tied economically to other countries. We have money market mutual funds that invest in European financial institutions. We have banking organizations that hold debt of European countries, as much as they hold debt of ours. And so, all of these are tied together as financial markets work through and try and understand the implications.

Also what lies ahead is clearly government spending. And, again, I think this is one where I probably get many questions that I don't understand it. How can there be proposals to yet stimulate the economy through government spending when we've got a big long-term problem? And we've got several countries labeled here, and we've taken a look at projections for what the debt levels are. And quite honestly even before we get to the very expensive times for Medicare and Social Security, you'll see that U.S. is not in a good position and needs a very credible plan for reducing its federal deficit.

What Chairman Bernanke and others have said though is that a credible plan to reduce the deficit needs to be established and it needs to be followed. That doesn't necessarily preclude though short-term actions that help support a strong economy. And that's what Congress will wrestle with in the days ahead. How does it come up with the expected $1.5 trillion in government spending cuts over the long term due by Nov. 23, while at the same time ensuring that so much is not withdrawn from the economy that we end up in a situation, the worst of which would be recession.

Bill Emmons is going to cover this next month, so there's my plug for that.

Chairman Bernanke and Jim Bullard, I could have put the Jim Bullard quote up here. I'm sorry I didn't do that. Now I won't get any extra credit. (Laughter) No cookies, so there I go. That's my lunch tomorrow. Chairman Bernanke at his Jackson Hole speech did point out though that not all is bad. As we look at the growth in the economy, it's not the robust growth we want to see. I think though the important side of it is that today growth has continued and although it may be a long process to get us back to where we were, you know, several years as we look forward at some of the fundamentals, the fact is, the economy continues to grow, and importantly the underlying strength to ensure that employment ultimately comes down is there.

So now what have we learned? I've given you the story. What have we learned? What do you need to take away? You guys are really young. These are really important lessons for you because heaven forbid we do not want to repeat these lessons yet again.

So this first lesson, I'd like to tell you this is the first time we saw it, but I saw this during the energy crisis when I was working as an examiner in Oklahoma. And I saw it during the ag crisis when I was working as an examiner in Kansas and Nebraska. Too much debt that does not have a clear ability to be repaid and is dependent on an asset, typically land, going up in price, is a recipe for disaster. We like to think that values will always increase over time. We need to begin to think that they might not. And importantly, taking on debt needs to be done with a conscious understanding that it can be repaid even if there is some blip in the normal, ordinary income sources. And, again, I think that is one of those lessons that has been learned and relearned. It was a lot harder to see this time around because the risk was so spread over the financial system. But underlying it all is you've got to be able to repay your debt, particularly when that's a big debt on your balance sheet.

The second thing is this idea of spreading risk. So I'm often asked, okay, "Why didn't you guys see it at the Federal—You should have seen this." And maybe in hindsight we should have seen it. You know, I think we do look at ourselves and say, "could we have seen this?" Well, our regulatory structure was not built to see this. And shame on us for doing that. I supervised banking organizations. The Securities Exchange Commission oversaw investment banking organizations. The rating agencies were still somewhere else. We all had our little pieces. And what we didn't do, or what we didn't have the understanding of was that sometimes you need to look across the pieces, and you need to see the relationships, the interrelationships.

One of the things that Dodd Frank has done is create something called a Financial Stability Oversight Council. It's a group of individuals, key players in the financial system, whose purpose is to understand and define when financial risk is occurring. It's a tall order. Can you really see it before it happens? That is the expectation for this group.

This group also has a special responsibility and that is that we learned that not all risk is in banks. It's easy to say banks and it's often said in the media. But a lot of times the risk is in financial institutions that aren't banks, be they insurance companies like AIG, or be they investment houses like Lehman Brothers. What the Financial Stability Oversight Council is charged with doing is finding the next player, the next organization, could be a morphing of something that exists today, that has that same capability of introducing unnecessary risk. And if it does, if it defines it, if it labels it as systemically important, it has the promise of being supervised by the Federal Reserve going forward. Our examiners will be responsible in the future for those organizations.

So some major changes and major lessons learned from the financial crisis.

And finally I would just offer that the choices made in the short run have to be thought through in terms of their long-run consequences. As I look back at housing, I remember too, and for most of us, owning a home was the American dream. And, in fact, for many it was sort of the concept for how I will build wealth for my retirement. And I think what we probably missed is that we operated with an assumption that prices would always go up. And if in fact building wealth for retirement is the goal, there might have been other choices that would have been more certain than investing in a home. Investing in a home is important because it's your place to live. It's the promise of what you want as an individual and it's something that you can afford. And, again, I think as we look back it's a simple lesson, but probably one that we looked over a bit too quickly.