According to Mr. Friedman, the Great Depression did not occur primarily as a result of the stock market crash of the 1930s but mainly because of the lack of intervention of the Federal Reserve. When the Bank of the United States in New York crashed on December 11, 1930, he says that the Federal Reserve should have intervened and flooded the country with liquidity and hastened to ensure that no more failures took place. Instead, they were silent observers of an imploding economy and persisted with a lackluster monetary policy. Mr. Friedman with a fellow economist Anna Schwartz, argues (on the basis of their research and empirical evidence) that the falling out of speculative investments led to the stock market crash. But, the crash was in no way the cause of the Great Depression, state the researchers.
The Fed apart from creating policy is also ‘the Lender of last resort’ and is supposed to fulfill its role in the event of liquidity constraints. Back then, the Fed sat pretty rather than take action.
What’s happening today?
Thus far, the Fed seems to be following Mr. Friedman’s advice. When Bear Stearns was ready to keel over, the Fed extended a $30 billion line of credit to JP Morgan to help it buy the firm. Countrywide, which was one of the largest mortgage lenders was sold to Bank of America after mounting losses from sub prime investments. Financial problems at the government-sponsored mortgage giants Fannie Mae and Freddie Mac, which own or guarantee nearly 50% of all US mortgages forced the Treasury to take them over on September 7, 2008. A week later, Lehmann Brothers filed for bankruptcy and Bank of America bought Merrill Lynch. A couple of weeks after, the Fed rescued AIG with a package of $180 Billion and later, also bailed out Citigroup (35% Fed stake now). And then we have TARP, which Congress approved in 2008 to lend $700 billion to banks that are in danger of failing.
While Mr. Friedman did approve of government intervention in troubled times, I’m sure even he would have shuddered at the mess that the Fed has gotten itself into today. Today’s economic shambles is a result of shoddy economic policies. Those policies drove the housing market bubble to expand beyond ridiculous proportions and financial firms driven by greed concocted funky financial instruments which were marketed and sold to other firms and for a while all was fine. It’s important for people to understand the consequences of greed. If the Fed steps in every single time, the critical lessons will not be learned and the next business cycle will see another bubble inflate and burst after a while. Here’s hoping we get out of this mess pronto.
