[MUSIC] This is a talk about how to fight financial crisis. It's about the cause and the craft of fighting financial crisis. It's important, of course, because they're devastatingly damaging. They cause lots of damage. They happen around the world. They happen with pretty appalling frequency. And the craft of what you do about them is very underdeveloped, certainly relative to magnitude of the cost and the damage they impose. So why is this important and why do we do this so badly? As I said these things happen around the world with pretty appalling frequency. I'm gonna show you a little map of how these happen over time. This map shows a century of financial crisis. And if you watch it, you watch it carefully, you'll see that they happen obviously to different countries over time. And the map distinguishes between the relatively modest crisis and the acute systemic crisis, like the crisis of the Great Depression or the crisis of 08, 09. So watch, as you look at it watch the frequency by country, cuz you'll see something really important, which is it's not just that these happen all the time around the world. The really severe ones happen to your country, to the same country very rarely. And that happens to be fundamental to why these things end up to being so damaging and why they are sort of so hard to manage. These scenes of devastating human costs in the middle of our panic in the fall of away when things are falling apart around us. We were having a debate about whether we should go to Congress to get more authority to fight the fire. And we're sitting in my office, the New York Fed, around a conference table on a speaker phone with the Secretary of the Treasury and the Chairman of the Federal Reserve. And we're debating. We were trying to make the case. It was time to go to Congress to get authority. Cuz the Fed was out of ammunition and one of my colleagues, Meg McConnell, from the New York Feds said at that point. She put the speaker phone on mute, and she said, tell the secretary of the treasury that if you don't get the authority now, we're gonna have shanty towns and bed lines across the country. So here's a little picture of the devastation from the Great Depression. In the average, the Great Depression took ten years to get back to the pre-crisis levels of output. In the typical, in the systemic banking crisis, sometimes it takes longer than that. And in two thirds of the major systemic crisis in the last century, unemployment never returns to the pre-crisis level. So these things are just terrible. This is a picture of bank runs in the Great Depression, and here's a picture of the shanty towns that Meg worried about, Meg warned about bread lines, soup lines. So another way to look at the cost is just look at the effects of the fall in employment across countries. These pictures show the crisis in the big five economies over the last century. So you can see the great depression is the U.S. line, you can see Sweden, which is a longer more damaging path. And you can see Japan which is shallower losses but extended over a much longer period of time. Here's two other Scandinavian countries, or Nordic countries, also against the Great Depression. And here is a picture of the U.S. against Spain in their major crisis, before the European crisis, more recently. Ken Rogoff and Carmen Reinhart have written that in this history of financial crisis, this tragic history of financial crisis, unemployment typically rises seven percentage points over five years of job losses. Output typically falls more than 9% of GDP during two years of the decline. Government debt almost doubles. House prices fall by about a third. Equity prices fall by about half. And this is important, the direct fiscal costs of the financial rescues typically exceed 10% of GDP. Steven Pinker is famous for describing or showing how the incidence of death by homicide and war has declined dramatically over the period you see. If you look at the picture on the right in contrast, we're not getting better at limiting the losses and financial crises. Stark contrasts between, lots of areas where you can see measurable progress in the long arc of history in reducing incidence of disease. But again look at the contrasting record in financial crises. So we should be able to do better. These lectures are divided into three parts. The first is about the common causes of financial crises. Then second is about the financial crisis of 08 and 09, what we did, and the strategy we adopted, what we achieved with that strategy. What we missed, what we got wrong, what challenges still remain. And the third is about how to think about what we learned from this crisis and what that should tell us of how we respond to future crises. I wanna start with this quote by Hyman Minsky, the economist who said in talking about what produces this risk of financial crisis, he said stability breeds instability. His basic point is it take s long period of relatively stable outcomes to produce the conditions that make you vulnerable to crisis. And I'll explain a little bit of the intuition behind that using the metaphor of a flood. This is a stylized map of a flood plain, and the lines show how far inland, the more frequent the more mild five year flood occurs. And how far inland the more devastating floods happen, which happen with less frequency. And here is another way to show it, a little stylized picture of how to show it. So you can see in the 100 year flood, it wipes out a lot of economic activity, building wealth incurs a lot of loses. Then over time as you go back to the more modest floods, memory recedes, people start building more. They feel more confident they can build certainly in the margin of the less frequent flood. And as the memory fades, people willing to take more risk to borrow more, to build more, to invest more until you get washed out by the next cataclysm. I say this because it's important to remember what the role of memory has in financial crises. If your memory is dominated by a relatively benign period of economic activity. When things were going well, when unemployment was coming down, when incomes were rising and when house prices were going up, then the natural human view is to project that forward. If your memory is of the recent experience with cataclysmic financial crisis, you're gonna need more risk averse longer. But memory tends to fade over time. Kindleberger tells his history of financial crises, manias, panics, and crashes. And this is sort of stylist arc of that pattern. All crisis are different but they all follow this basic arc of mania over confidence. Exuberance creates the risk of panic. Panic produces crash in economic activity, Great Depression like outcomes. [MUSIC]
