PrestoPundit

ECONOMIST DAVID HENDERSON

Posted by PrestoPundit on 10/20/2008

explains what caused the current crisis.  Quotable:

On a September 23 White House conference call, the chairman of President Bush’s Council of Economic Advisers Ed Lazear told listeners that what really led to the belief in a bailout was credit market conditions the previous Thursday, September 18.

Credit markets, he said, had frozen. I asked him how he could make strong conclusions about the future of the economy based on data from a day or two. His answer was that the negative returns on short-term Treasuries were scary.

Presumably, Bernanke’s–and Paulson’s–fear was that people looking at negative interest rates will want to pull their money out of banks. In our fractional reserve banking system, each dollar pulled out of the system stands behind multiple dollars of deposits. The result could be a substantial decline in the money supply. That is what happened when the bank runs started in October 1930 and lasted into 1933.

But there are two huge differences between now and then.

First, in September 2008, the FDIC was insuring deposits up to $100,000 (and now, under the bailout, up to $250,000), thus making a bank run unlikely. Second, the Federal Reserve knows that it is the lender of last resort. It already has the power it needs to prevent a contraction of the money supply.

Now, though the US government has put itself even more in the role of central planner of credit markets, do not be surprised if the financial crisis lasts for years rather than for the few months it likely would have lasted had the Feds stayed out.

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