The Federal Reserve, the European Central Bank and the Swiss
National Bank have jointly announced an expansion of liquidity measures
to combat the global financial crisis triggered by the U.S. subprime
The Federal Reserve will increase to $75
billion the amount auctioned biweekly to eligible depository
institutions. Its Open Market Committee will let primary dealers pledge
AAA/Aaa-rated asset-backed securities, in addition to already eligible
residential- and commercial-mortgage-backed securities and agency
collateralized mortgage obligations, in Schedule 2 Term Securities
Lending Facility auctions. Earlier, the Bank of England announced a new
"special liquidity scheme,"which enables banks to offload certain
mortgage-backed securities in exchange for Treasury bills for up to
three years. The aim is to get money flowing to support needed economic
Yet, many "free market" purists oppose such
policies. Conservative sage George Will has even called it "socialism."
Such critics would do well to read the late capitalist guru and Nobel
economist Milton Friedman's criticism of the Federal Reserve's "inept"
failure to act when the economy was sliding into the Great Depression.
Friedman's monumental "A Monetary History of the United States,"
written with Anna Schwartz, makes the now standard interpretation of
what made the "great contraction" so severe. It was not the downturn in
the business cycle, trade protectionism or the 1929 stock market crash
that plunged the country into deep depression. It was the collapse of
the banking system during three waves of panics over the 1930-33
period. Some 9,000 banks closed during those years, wiping out one
third of the nation's money supply.
The failure of the Bank
of the United States on Dec. 11, 1930, the largest bank to collapse in
U.S. history, was the result of the unwillingness of the Federal
Reserve and the private Clearing House banks to save it. The shock it
sent through the system was what today's Fed Chairman Ben Bernanke
wanted to avoid by heading off the collapse of Bear Stearns.
the weeks after the failure of the Bank of the United States, the New
York Fed made open market purchases from two other major banks to head
off runs. But this was not the kind of vigorous policy the Federal
Reserve as a whole was willing to embrace.
recounts, "In 1930, New York strongly favored expansionary open market
operations, but after the middle of the year was unable to persuade
either the other Bank governors. ... or the Board in Washington."
President Herbert Hoover lamented, "I concluded [the Federal Board] was
a weak reed for a nation to lean on in a time of trouble."
Fed's failure led to creation of the private National Credit Corp., a
bank cooperative to extend loans using collateral not ordinarily
acceptable. This effort failed. Next came the government's
Reconstruction Finance Corp. in January 1932 with the authority to make
loans to banks, other financial institutions and railroads as a
substitutes for a Federal Reserve that was refusing to do its job. No
advocate of Big Government, Mr. Friedman could nevertheless declare
"that different and feasible actions by the monetary authorities could
have prevented the decline in the stock of money — indeed, could have
produced almost any desired increase in the money stock."
So why did the Fed fail to do what it was originally established to
do, protect the financial system? Mr. Friedman cites the attitude of
its governors: "They tended to regard bank failures as regrettable
consequences of bad management and bad banking practices, or as
inevitable reactions to prior speculative excesses, or as a consequence
but hardly a cause of the financial and economic collapse in process."
Mr. Friedman called this a "confused and misguided" attitude, though
one often voiced again today — and with more justification.
financial turbulence is different than what hit the country in the
1930s, but the principle remains valid. The government has a
responsibility to take action to shore up the financial system when it
threatens to implode. Mr. Friedman took his thesis beyond the Great
Depression when he cited with favor how the British Panic of 1825 was
combated. "We lent it," said Jeremiah Harman on behalf of the Bank of
England, "by every possible means and in modes we have never adopted
before; we took in stock on security, we purchased Exchequer bills, we
made advances on Exchequer bills, we not only discounted outright, but
we made advances on the deposit of bills of exchange to an immense
amount, in short, by every possible means consistent with the safety of
Today's Federal Reserve and other financial
authorities are trying to be just as creative and responsible in
heading off the Panic of 2008.