The Psychology of Ben Bernanke: The Great Depression was caused by the Federal Reserve. Was he Talking About the current Great Depression that is Sprouting Under his Watch? Lessons From the Great Depression: Part XIII. The Federal Reserve.

Federal Reserve Chairman Ben Bernanke this week once again mentioned that the Federal Reserve was “strongly committed” to financial stability and is considering options like keeping the lending facilities open to primary dealers. In short, they are going to continue to bailout banks and Wall Street firms while Americans get the shaft. This is an important statement and the futures markets are now tenuous of any rate rises this year. After all, we are now firmly in a bear market with the three big index players, the DOW, S&P 500, and NASDAQ down 20+% from their recent peaks.

It is crucial to understand the psychology of Ben Bernanke in order to understand his motives in the current economic crisis. Bernanke is a student of the Great Depression and much of his belief is that the Federal Reserve was a main (if not primary) cause of exacerbating the problems at that time. He feels they didn’t react quickly and strongly to stem the economic collapse that soon followed. Yet many Americans aside from pop culture and what is the hot item at Wal-Mart don’t really have a sense of history. For example, many think that the Great Depression was purely caused by one bad month in October. That is not true, the bottom didn’t hit until years after. Also, many forget that we had a massive real estate bubble that occurred in the early to mid-1920s with Florida real estate looking similar to what is occurring again in the coastal states in particular, California and Florida.

The Federal Reserve was initially envisioned as a lender of last resort. Economic busts and depressions were very common in the past. The idea was to have a central authority who would be able to step in during these moments of crisis to inject some liquidity to prime the pump and get the system going again. But make no mistake, it was designed to be used as a very last resort only when things got absolutely horrific.

Now shift to today. Officials say we aren’t in a recession so how is it possible to have the Federal Reserve bailing out one specific investment bank in Bear Stearns, exchanging U.S. Treasuries for questionable mortgages, and lowering rates even though consumer inflation is running rampant? The futures market isn’t even sure whether Bernanke will lower rates given the malaise with our economy. Take a look at the current job losses this year:


This is not a sign of a healthy economy. If we are to parse the above employment data even further, we quickly will realize that we are losing better paying jobs in financials and construction while loading up with lower paying service and government jobs. The current Fed Chairman muFtst feel given the radical actions being taken that we are on the precipice of another major recession or Great Depression. After all, why intervene so extensively and aggressively if problems in the economy were only minor? We are standing on a house of cards that can no longer continue the obvious façade of being solvent. No time in our nation’s history have we been in so much debt. The way many of the banks and lenders book revenues is absolutely optimistic in thinking we are at the bottom. In fact, many are saying we will have a second half recovery yet they aren’t specific about where this will come from.

The fact that lenders are being inundated with REOs and foreclosures is only another form of wealth and money destruction. If a lender had a mortgage booked at $500,000 on their books that is now defaulted, they now have to go through the expenses of marketing and selling the home or note. What if they can only get $300,000 for the home in the current market? In that instance, $200,000 just evaporated in thin air. And we haven’t even started the commercial real estate burst. How are people going to spend now that credit is more restrictive and people are losing their jobs? Even the almighty Las Vegas is feeling the pinch:

“(Telegraph UK) Casino owners in Las Vegas have been warned that America’s economic slowdown had left the gambling mecca facing “its most severe downturn ever”.

Challenging the resort city’s traditional boast that it was virtually recession-proof, shares in companies that operate casinos have dipped to new lows this week.

With casino owners plunging into heavy debt and even bankruptcy, industry experts have warned that the world’s gambling capital faces the toughest economic challenge in its history.”

I imagine it would be hard to plunk down $500 on Roulette if you knew your family back home needed that money for fuel and food, which of course is rising just as quickly as the Las Vegas thermometer.

To understand Ben Bernanke it is also useful to examine the former chairman Alan Greenspan. The former chairman Alan Greenspan was known for his convoluted responses and ability to keep people guessing about his next move. He received much praise during the boomtime but now is on a mission trying to revise history to preserve what little is left of his legacy. Alan Greenspan was the champion of adjustable rate mortgages which are now the bane of the entire housing economy.

Yet understanding who Alan Greenspan grew up with also helps to frame the psychology of his monetary philosophy. During the 1950s Greenspan got to know Ayn Rand, the novelist and philosopher and this relationship would last until her death in 1982. Greenspan also wrote for Rand’s newsletter and wrote a few essays for her book on capitalism. This is important to understand because Rand’s ideals show up in much of her work including one of her most popular novels Atlas Shrugged. Rand advocated the following:


-Laissez-faire capitalism

She rejected socialism, altruism, and religion. In reading Atlas Shrugged, you can see her disdain towards politicians and respect for survival of the fittest in business through her characters. If the former Fed chairman did believe in objectivism and the philosophy that Ayn Rand advocated, Alan Greenspan lost his way in the last few years of his tenure. For one, lowering rates to prop up the economy is not survival of the fittest. Using the Fed as a promotional tool for politicians would have Rand turning in her grave. And this would lead us to Bernanke and his views and philosophy.

This is part 13 in our Great Depression series:

1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from the Past and How will the Housing Decline Impact You?

2. Lessons From the Great Depression: A Letter from a former Banking President Discussing the Bubble.

3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the Roaring 20s.

4. The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part IV: Where do we go After the Housing Crash?

5. Business Devours its Young: Lessons from the Great Depression: Part V: Destroying the Working Class.

6. Crash! The Housing Market Free Fall and Client #10 Contagion.

7. Winston Smith and the Bailouts in Oceania: Lessons from the Great Depression Part VII.

8. Sheep Back to the Slaughter: Lessons from the Great Depression Part VIII: All the Change and Bear

Market Rallies.

9. A Bubble That Broke the World

10. The Sham of our Current Unemployment Numbers

11. Understanding the Impact of Asset Deflation and Consumer Inflation.

12. Is the DOW now Tracking with the California Housing Market?

Destiny Sometimes Finds You – The Coming Economic Collapse

For a person who has studied the Great Depression in great deal, it must appear as a weird sense of destiny for Ben Bernanke to confront the current economic climate. Here he is, this is our 1929 and Bernanke is going to have the chance to put his theory into practice. One of Bernanke’s great heroes is the famous economist Milton Friedman. Bernanke in November 8 of 2002 at a conference honoring the 90th birthday of Friedman had a chance to say a few words:

“I can think of no greater honor than being invited to speak on the occasion of Milton Friedman’s ninetieth birthday. Among economic scholars, Friedman has no peer. …

Today I’d like to honor Milton Friedman by talking about one of his greatest contributions to economics, made in close collaboration with his distinguished coauthor, Anna J. Schwartz. This achievement is nothing less than to provide what has become the leading and most persuasive explanation of the worst economic disaster in American history, the onset of the Great Depression – or, as Friedman and Schwartz dubbed it, the Great Contraction of 1929-33.

… As everyone here knows, in their “Monetary History” Friedman and Schwartz made the case that the economic collapse of 1929-33 was the product of the nation’s monetary mechanism gone wrong. Contradicting the received wisdom at the time that they wrote, which held that money was a passive player in the events of the 1930s, Friedman and Schwartz argued that “the contraction is in fact a tragic testimonial to the importance of monetary forces.”

Ironically somewhere from the 1913 inception of the Federal Reserve the idea started to emerge that the Fed was not simply a lender of last resort, but also a method of controlling markets. It is without a doubt that the Fed has now morphed into an agency beyond its initial scope. And recently with comments from Hank Paulson, it would appear that they want to increase powers even further. The irony of the current situation is a large part of blame falls on the shoulders of the Federal Reserve. They are the culprit here and not the solution. This bubble could have been stymied long ago by raising rates and ensuring that lenders had adequate capitalization to make the ridiculous loans they were making.

Bernanke is now allowing the Fed to exchange horrific mortgage paper for liquid Treasuries and has also slashed rates once again to historical lows. He is finally putting that Friedman theory to work. But this is beyond monetary policy here folks. To think that an economy as global as we currently are, as heavily in debt as we are, and as irresponsible financially as we have been would be solved by a few rate cuts is Fed hubris. Look where we now stand. Bernanke must be thinking, “okay, we’ve bailed out an investment bank, we’ve lowered rates at a historically unprecedented level, we’re exchanging good paper for junk which is new, and why isn’t the economy moving like I had predicted?” Let us see what else Bernanke had to say:

“… Before the creation of the Federal Reserve, Friedman and Schwartz noted, bank panics were typically handled by banks themselves – for example, through urban consortiums of private banks called clearinghouses. If a run on one or more banks in a city began, the clearinghouse might declare a suspension of payments, meaning that, temporarily, deposits would not be convertible into cash. Larger, stronger banks would then take the lead, first, in determining that the banks under attack were in fact fundamentally solvent, and second, in lending cash to those banks that needed to meet withdrawals. Though not an entirely satisfactory solution – the suspension of payments for several weeks was a significant hardship for the public – the system of suspension of payments usually prevented local banking panics from spreading or persisting. Large, solvent banks had an incentive to participate in curing panics because they knew that an unchecked panic might ultimately threaten their own deposits.

It was in large part to improve the management of banking panics that the Federal Reserve was created in 1913. However, as Friedman and Schwartz discuss in some detail, in the early 1930s the Federal Reserve did not serve that function. The problem within the Fed was largely doctrinal: Fed officials appeared to subscribe to Treasury Secretary Andrew Mellon’s infamous ‘liquidationist’ thesis, that weeding out “weak” banks was a harsh but necessary prerequisite to the recovery of the banking system. Moreover, most of the failing banks were small banks (as opposed to what we would now call money-center banks) and not members of the Federal Reserve System. Thus the Fed saw no particular need to try to stem the panics. At the same time, the large banks – which would have intervened before the founding of the Fed – felt that protecting their smaller brethren was no longer their responsibility. Indeed, since the large banks felt confident that the Fed would protect them if necessary, the weeding out of small competitors was a positive good, from their point of view.”

It is the case that during the Great Depression there were many smaller banks that failed. This was partly due to the fact that we had a much more localized economy back then. That is, if you wanted a mortgage you went to your local bank. Your business normally catered to your small niche. That is now not the case. We are a mega serviced oriented society. One of my loans for a home was completely done without a face to face meeting. The loan originated in one state and was for a property in another. That lender is now out of business. Doesn’t impact the local economy here in Southern California but I bet it impacts the economy in their neck of the woods. This is the new reality. We have mega banks that consume a large portion of the market so the idea that measuring the coming bank collapses in sheer number is a poor indicator of distress. Many of these mega banks are the equivalent of 1,000 small banks.

So the Fed right now is fighting the 21st century banking problem with theories suited for a market in the 1930s. This is why the Fed is now being exposed as a paper tiger. They can do nothing in such a large global marketplace aside from helping a few select friends. To think they can convince everyone that they somehow have the Midas touch is absurd. The mystique that once reigned at the Fed with Greenspan is completely shattered. Bernanke thinks the Fed has the ability to stop any panic or in today’s case, any recession:

“In short, according to Friedman and Schwartz, because of institutional changes and misguided doctrines, the banking panics of the Great Contraction were much more severe and widespread than would have normally occurred during a downturn. …

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

Best wishes for your next ninety years.”

You got that right Ben. You did it alright. Forget the Great Contraction absurdity. It was the Great Depression. They’d probably like to call what is happening today as a “market reshuffling” but we are in a recession. This softening of the language is pure propaganda and setup to downplay the magnitude of our current problem. The housing crisis is the worst even dwarfing the speed of drops from the Great Depression. Personal debt is at the highest ever. Job losses are mounting. Yet they want you to believe that this is a minor correction. Those that believe in the 2nd half recovery might as well believe that monetary policy alone will get us out of this mess. $500 billion in pay option loans are set to recast and foreclosures are at record highs, the destruction of wealth will continue. That is what faces us in the 2nd half.

Chairman Bernanke, what do you call a theory that doesn’t work?

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11 Responses to “The Psychology of Ben Bernanke: The Great Depression was caused by the Federal Reserve. Was he Talking About the current Great Depression that is Sprouting Under his Watch? Lessons From the Great Depression: Part XIII. The Federal Reserve.”

  • Felix Salmon over at Seeking Alpha wrote a few days ago on the arrogance of banking ‘models’, i.e., those formulaic models they used to justify their lending practices. Of course these models became essential when you operate across
    the country and enjoy the ‘synergies’ of all the acquisitions and mergers that allowed a small S&L to become a WAMU or Countrywide. You simply don’t have the manpower or local expertise to use ‘judgement’ on the borrowers ability to pay you back. You must rely on FICO scores and valuation models to assess the loan and not even that if you can bundle them up and sell them to UBS, Merrill Lynch etc. But now we have reached the end of the line. The bit players are all gone. Only the giants are left and they are giants with clay feet. As they wobble we are transfixed. It’s like looking at the World Trade Center Towers on 9/11. Back then, watching it live on TV, the two network anchors were talking as a live shot of the New York skyline showed the South Tower dissolve into a column of dust. I blinked and then shouted for the anchors to shut up because an unbelievable event just happened and they didn’t yet know it! Everything they were saying had just become irrelevant. So here we are with a financial 9/11 taking place and the Kudlow’s and other talking heads telling us what the FED should do but as a wag put we’ve come to the point where the remaining institutions are ‘not too big to fail’ but ‘too big to save’!

  • Huh. Seems like the large banks are the ones in trouble today, while the smaller credit unions appear to be safer. Or is that not true? It doesn’t seem safe to put ones money at say BofA or WaMu right now. Anyone want to hand over their retirement money to Lehmans or Merrill?

    Great article Doc!

  • Another great post Dr HB!!!!!

    The financial 9-11 took place in cognito around 10/2007 ..

    The MSM will never report what we see here. (never again).

  • The Federal Reserve just makes a mess worse.

    A bad recession in 1920 and they stayed out. Recovery within 2 years. !930 recession and they got involved. Recession ended by World War 2.

    Japan 1990 recession. Their Fed and government gets involved. Doesn’t end for fifteen years.

    Our recession will not end till at least 2015 with the fed and government involved.

    Housing prices in Japan went up crazy amount like our. The rest of Japan went up like the United States. But housing prices went a lot more in six cities like ours in California, Arizona, Nevada and Florida. Japan housing went down big the first five years every where. Then for the next 10 years it was a gradual slide.

    It look likes we will have the same big drop the first five years (till 2011-2012 option arm loans), then a gradual slide till 2015 as the econmy goes bust in 2009.

  • I wanted to share something with everyone that relates to this story and might give further explanation into the mess we are currently in. I read an article over at Bloomberg that quoted Morris Davis, a former senior economist with the Federal Reserve and now a real estate professor at some University making a massive mistake. It related to explaining the effects of mortage rates and mortgage payments. The error bothered me so much that I emailed the author.

    The email is below…

    Hello Sharon,

    I just wanted to point out something out of your article dated 6/27/08 titled “Homes Less Affordable as Prices Fall, Rates Rise, Zillow Says.”

    Your article reads, “Changes in mortgage rates have the biggest impact when those rates are near the historic lows they are now, Davis said. If interest rates were at 1 percent and rose to 2 percent, house prices would have to drop 50 percent to keep a buyer’s house payment the same.” I know that your only quoting someone else saying this but this is simply flat out wrong.

    I’ll give you an example, if someone purchases a home for say $500,000 with a 1% 30 year fixed loan they pay $1608.20 (this is only principal and interest). If the rate would go up to 2% AND the loan amount drops 50% to 250,000 then their payment is $924.05 which is far from the $1608.20. In order for their payment to be equivalent to the $1608.20 and the rate going up to 2% the loan amount would have to go down only 12.98% to $435,100.

    You might get a few emails but I thought I would point this out to you. I seriously hope this is just a misprint because there is no way a senior economist for the Federal Reserve should make a mistake like this.

  • Here’s something really scary. Anyone remember Gary Condit? The California congressman whose career ended when his very young mistress was found murdered in Rock Creek Park. Well he’s living in Arizona now and was in the news for losing a libel lawsuit against Dominic Dunne. That isn’t what caught my eye. This was what I found interesting. He is being sued by Baskin-Robbins, the ice cream retailer, for mismanagement of two stores he ran in Arizona. Think about it. A veteran US Congressman, cast lose from Washington, where he made economic policy for the largest economy in the world, was unable to succeessfully sell ice cream in the desert! This, I’m afraid, is probably, typical of the denizens of our Congress and we have two of them running for president.

  • Well written, once again. I think it is obvious to any man that choses to see what the magnitude of the situation is, qualitatively. No man truly can quantify the gravity of the predicament facing us in the near or long term. An most have a vested interest in keeping the masses from the truth, so we will continue to receive an attempt at mass confusion and inundation of suedo-facts, deceptions, and flat out lies. If everyone invested in commodities, only the first to the party will be able to steal from all the rest–we can’t all go out and rob each other’s house every night. No one gains there. Contraction is a death spiral, and only WalMart wins for a while. When the golden goose has bled dry, it will be too late.

    Anyone have a plan?

  • “Anyone have a plan?”

    Internationalize yourself I have. Open a bank account in in a foriegn country with a history of good banking stewardship ie Switzerland, Austria, and believe it or not recently Panama. You need to be able to get wealth out of the US dollar as currency controls will eventually be imposed as the dollar collapses. Buy a crib in another country. We all agree there is going to be chaos here as the financial system implodes better to watch via satellite then out your living room window. Buy physical gold and store it in a secure location outside of the US. The US government has made gold ownership illegal in the past, google “FDR gold confiscation”. Use bear funds or short vulnerable companies yourself as the stock market has a long way to fall from here over the next few years. Those are just a few ideas however they require some capital to put into action. No capital then just deal with it as it comes.

  • Michael LittleBig

    Being from Ohio I was struck by the phrase” Cleveland is the foreclosure epic center”
    As I read, looks like 1.5 million foreclosures with 2.5 million in the process.
    This foreclosure/credit crisis has many sides that are all interconnected. What blew my doors off, is the fact that federally chartered savings bank( Countrywide CA; Washington Mutual WA; Am Trust OH) are not legally bound by federal consumer banking regulations, because there are none. These types of banks they operate with absolute impunity. They have no accountability to anyone. Their federal supervisor, the Office of Thrift Supervision has no authority to protect a borrower from unethical actions by a federally chartered savings bank. However by using the shield of secrecy (which is now labeled privacy); the OTS does protect the bank. The States have no authority over federal banks. This is verified by the fact that two States are now suing Countrywide, and if they win, new and bold case law would be established. I look for more State to join this lawsuit parade which will march on for years.
    It does appear that nothing has changed since the last savings and loan crisis other than it is much worse. We see on the horizon where the Banks maybe violating TILA (truth in lending act) by freezing HELOCs. The list of unethical lending operations keeps growing like a ship without a rudder. Personally, I would agree with the many that say this foreclosure /credit crisis is only the very tip of the iceberg. If this current crisis was the Titanic, then the politicians would be on the lifeboats waving goodbye to the women and children who were left on the decks of the sinking USS Economy.

  • Gimme a Break!

    The FED, acting as bartender, gives out free booze to the bankers

    The FED caused 3 depressions in the 30’s, (google how their flood & retraction of currency correlates precisely with Corp failure & unemployment)

    The Federal Reserve Bank is privately owned

    The FED owes its duty to private shareholders!

    FED precipitated 1.5 quadrillion dollars in fake derivatives!

    The FED wants the USA to collapse! The FED is NOT part of the US Gov!

    Once the USA collapses, they buy up assets for pennies

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