Research Topics

Nicola Matthews, University of Missouri–Kansas City, presents the main findings of her research on the Fed’s lending practices following the global financial crisis of 2008. Applying Walter Bagehot’s principles, she finds that the Fed departed from the traditional lender-of-last-resort function of a central bank by lending to insolvent banks without good collateral--and below penalty rates. Most of the Fed’s emergency facilities lent at rates that were, on average, at or below market rates, with the big banks the primary beneficiaries. The Fed went beyond aiding markets to effectively making markets. Reform, Matthews concludes, is the only solution.

The Low and Extended Lending Rates that Revived the Big Banks

Walter Bagehot’s putative principles of lending in liquidity crises—to lend freely to solvent banks with good collateral but at penalty rates—have served as a theoretical basis for thinking about the lender of last resort for close to 100 years, while simultaneously providing justification for central bank real-world intervention. If we presume Bagehot’s principles to be both sound and adhered to by central bankers, we would expect to find the lending by the Fed during the global financial crisis in line with such policies. Taking Bagehot’s principles at face value, this paper aims to examine one of these principles—central bank lending at penalty rates—and to determine whether it did in fact conform to this standard. A comprehensive analysis of these rates has revealed that the Fed did not, in actuality, follow Bagehot’s classical doctrine. Consequently, the intervention not only generated moral hazard but also set the stage for another crisis. This working paper is part of the Ford Foundation project “A Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis” and continues the investigation of the Fed’s bailout of the financial system—the most comprehensive study of the raw data to date.

This paper reviews the key insights of Hyman P. Minsky in arguing why finance cannot be left to free markets, drawing on the East Asian development experience. The paper suggests that Minsky’s more complete stock-flow consistent analytical framework, by putting finance at the center of analysis of economic and financial system stability, is much more pragmatic and realistic compared to the prevailing neoclassical analysis. Drawing upon the East Asian experience, the paper finds that Minsky’s analysis has a system-wide slant and correctly identifies Big Government and investment as driving employment and profits, respectively. Specifically, his two-price system can aid policymakers in correcting the systemic vulnerability posed by asset bubbles. By concentrating on cash-flow analysis and funding behaviors, Minsky’s analysis provides the link between cash flows and changes in balance sheets, and therefore can help identify unsustainable Ponzi processes. Overall, his multidimensional analytical framework is found to be more relevant than ever in understanding the Asian crisis, the 2008 global financial crisis, and policymaking in the postcrisis world.