Charles P- Kindleberger

David Warsh: The science of U.S. financial panics


Some professors find a second wind when they stop teaching.  Norman Maclean wrote A River Runs Through It after he retired from the University of Chicago, in 1973. Fifteen years later, he published a sequel, Young Men and Fire.   Samuel Hynes, of Princeton University, has a hit on his hands with The Unsubstantial Air: American Fliers in the First World War – at 90!  Charles P. Kindleberger published Manias, Panics, and Crashes: A History of Financial Crises after becoming emeritus at the Massachusetts Institute of Technology in 1976 and then kept writing for another twenty-five years.

Meet Elmus Wicker, economic historian, of Indiana University.  Since his retirement, in 1993, Wicker has published three slim, dense, but thoroughly accessible and strangely graceful books, each about 150 pages long.  Any one of them would be easy to overlook, but together they represent detailed portraits of three of the four signal events in the monetary history of the United States since 1867.

They are The Banking Panics of the Gilded Age (Cambridge University Press,  1996); The Great Debate on Banking Reform: Nelson Aldrich and the Origins of the Fed (Ohio State University Press, 2005); and The Banking Panics of the Great Depression (Cambridge, 2000). What’s missing?  Only a narrative of the fourth such episode, the banking panic of 2008. As Wicker has written:  “The recent financial crisis came as a total surprise. I never expected to see a reoccurrence in my lifetime.” Neither did anyone else.

That’s why a substantial fraction of the small community of economists who take seriously the historical perspective on central banking traveled to Bloomington, Ind.,  in rolling hills 40 miles southwest of Indianapolis, for a day-long conference last month to honor the 88-year-old Wicker.

Ellis Tallman, of Oberlin College and the Federal Reserve Bank of Cleveland, who, with Eric Leeper, of Indiana University, organized the conference, recalled,  “I ran into Elmus at an economics conference in 1995 or so. I asked him why he was attending, since I’d been told he had retired. He replied, ‘Ellis, retirement means doing only what you like to do.’” Wicker clearly enjoyed the proceedings. “Rarely [otherwise] does anyone recognize your presence [in the field],” he said.

Speakers included Charles Calomiris, of Columbia University; High Rockoff, of Rutgers University; Richard Sylla, of New York University; Gary Gorton, of Yale University’s School of Management; Jeremy Atack, of Vanderbilt University; Mary Tone Rodgers, of the State University of New York at Oswego; George von Furstenberg, of Indiana; James Boughton, of the International Monetary Fund; Gary Richardson, of the Federal Reserve Bank of Richmond; David Wheelock, of the Federal Reserve Bank of St. Louis; Will Roberds of the Federal Reserve Bank of Atlanta; and Al Broaddus, former president of the Richmond Fed.

Wicker was born in 1926, in Lake Charles, La. He graduated at  18  from Louisiana State University, received a master’s in 1948 there and spent the next three years as a Rhodes Scholar at Queens College, Oxford. John Hicks, already famous as a mathematical economist, was his tutor. Wicker received his Ph.D. from Duke University in 1956.

By then he was teaching at Indiana University and there he remained for the next 40 years, a legendarily demanding teacher who led the movement to establish an honors college and helped launch a second good department of economics in Bloomington, at the business school.  Wicker to students, circa 1969: “If some of you don’t flunk this examination, I’ll swim to Moscow and back!”  Voice from the rear of the hall, “Why back?”

Throughout, Wicker’s intellectual journey has closely paralleled the joint project of Milton Friedman and Anna Schwartz, whose landmark book, A Monetary History of the United States 1867-1960, called attention to the banking panics of the 1930s. So little-noted had these been in the tumult of the onset of the Great Depression that they were all but forgotten until 1962, when Friedman and Schwartz assigned great significance to the collapse of banking and credit.

Wicker’s first book, Federal Reserve Monetary Policy 1917-1933 (Random House). appeared in 1966. Its concluding chapter: “From Easy Money to the Collapse of the Banking Mechanism: 1932-1933.” For the next  15 years, he conducted a kind of siege warfare against strict monetarist interpretations of the Great Depression.  A colleague arranged an introduction to Schwartz, a National Bureau of Economic Research associate of sterling reputation.  She and Wicker became mutual admirers. A money and banking textbook, written with his friend Boughton, never saw a second edition, but by then the ever-closer attention Wicker paid to the events of the early '30's had begun to pay off.

The galvanizing event, Wicker later wrote, was discovery on a library shelf of John McFerrin’s “remarkable but largely neglected” study of Caldwell and Co., the largest investment banking house in the South, whose failure in 1930 precipitated runs on 120 banks in four states.  The collapse of this “Morgan of the South” turned out to be far more important than New York’s unfortunately-named Bank of the United States, a commercial bank serving a mainly immigrant population to whose failure Friedman and Schwartz had attached great significance.

Wicker published two journal articles based on his discoveries, but not until retirement was he able to set down his reinterpretation of the events of the  '30s's  in book form. His verdict?  It was complicated – far more complicated than the simple story of Fed ineptitude that Friedman and Schwartz had given their readers to believe.

By then, however, Calomiris and Gorton, working together, had raised a new set of questions about the possibility that the Fed had helped turn an ordinary recession into a deep depression.  They argued in a 1991 paper that the nature of banking panics had fundamentally changed after the Fed was created to take over responsibilities previously shouldered collectively by the banking industry itself.

Hence Wicker’s second book, a close look at panics in the period governed by the National Banking Acts of 1863 and 1864, culminating in the Panic of 1907. His conclusion, “The New York Clearing House bungled a once-and-for-all opportunity for effective voluntary action to forestall banking panics and thereby ward off the establishment of a government central bank, voluntary action failed, and government intervened to fill the vacuum.”  The third book, an examination of the political debate through which the Fed was put together, follows naturally in turn.  A fourth manuscript, an examination of the Fed’s attempts to pop stock market bubbles, as in the poorly-timed tightening of 1928, awaits a publisher.

Wicker’s books are expensive -- $130 if you wanted to buy all three. I wish someone would put them together in a single paperback edition, perhaps with some new material and a foreword by one of the younger scholars. It would make a readable tour of banking history for the general reader, with enough theory thrown in to understand something of economists’ disagreements about the facts. It would give the most energetic and scrupulous critic of Friedman and Schwartz some of the visibility he deserves. More important, it would broaden understanding of what happened in 2008, by putting those events where they belong – in historical perspective.

David Warsh, a longtime financial journalist and economic historian, is proprietor of Boston-area-based

David Warsh: Deconstructing the Great Panic of 2008



Lost decades, secular stagnation -- gloomy growth prospects are in the news. To understand the outlook, better first be clear about the recent past. The nature of what happened in September five years ago is now widely understood within expert circles. There was a full-fledged systemic banking panic, the first since the bank runs of the early1930s. But this account hasn’t yet gained widespread recognition among the public. There are several reasons.

For one thing, the main event came as a surprise even to those at the Federal Reserve and Treasury Departments who battled to end it. Others required more time to figure out how desperate had been the peril.

For another, the narrative of what had happened in financial markets was eclipsed by the presidential campaign and obscured by the rhetoric that came afterwards.

Finally, the agency that did the most to save the day, the Federal Reserve Board, had no natural constituency to tout its success in saving the day except the press, which was itself pretty severely disrupted at the time.

The standard account of the financial crisis is that subprime lending did it. Originate-to-distribute, shadow banking, the repeal of Glass-Steagall, credit default swaps, Fannie and Freddie, savings glut, lax oversight, greedy bankers, blah blah blah. An enormous amount of premium journalistic shoe leather went into detailing each part of the story. And all of it was pieced together in considerable detail (though with little verve) in the final report of the Financial Crisis Inquiry Commission in 2011.

The 25-page dissent that Republican members Keith Hennessey, Douglas Holtz-Eakin and Bill Thomas appended provided a lucid and terse synopsis of the stages of the crisis that is the best reading in the book.

But even their account omitted the cardinal fact that the Bush administration was still hoping for a soft landing in the summer of 2008. Nearly everyone understood there had been a bubble in house prices, and that subprime lending was a particular problem, but the sum that all subprime mortgages outstanding in 2007 was $1 trillion, less than the market as a whole occasionally lost on a bad day, whereas the evaporation of more than $8 trillion of paper wealth in the dot-com crash a few years earlier was followed by a relatively short and mild recession.

What made September 2008 so shocking was the unanticipated panic that followed the failure of the investment banking firm of Lehman Brothers. Ordinary bank runs – the kind of things you used to see in Frank Capra films such as "American Madness" and “It’s a Wonderful Life”– had been eliminated altogether after 1933 by the creation of federal deposit insurance.

Instead, this was a stampede of money-market wholesalers, with credit intermediaries running on other credit intermediaries in a system that had become so complicated and little understood after 40 years of unbridled growth that a new name had to be coined for its unfamiliar regions: the shadow banking system – an analysis thoroughly laid out by Gary Gorton, of Yale University’s School of Management, in "Slapped by the Invisible Hand'' (Oxford, 2010).

Rather than relying on government deposit insurance, which was designed to protect individual depositors, big institutional depositors had evolved a system employing collateral – the contracts known as sale and repurchase agreements, or repo – to protect the money they had lent to other firms. And it was the run on repo that threatened to melt down the global financial system. Bernanke told the Financial Crisis Inquiry Commission:

As a scholar of the Great Depression, I honestly believe that September and October of 2008 was the worst financial crisis in global history, including the Great Depression. If you look at the firms that came under pressure in that period… only one… was not of serious risk of failure…. So out of the thirteen, thirteen of the most important financial institutions in the United State, twelve were at risk of failure within a week or two.

Had those firms begun to spiral into bankruptcy, we would have entered a decade substantially worse than the 1930s.

Instead, the emergency was understood immediately and staunched by the Fed in its traditional role of lender of last resort and by the Treasury Department under the authority Congress granted in the form of the Troubled Asset Relief Program (though the latter aid required some confusing sleight- of-hand to be put to work).

By the end of the first full week in by October, when central bankers and finance ministers meeting in Washington issued a communique declaring that no systemically important institution would be allowed to fail, the rescue was more or less complete.

Only in November and December did the best economic departments begin to piece together what had happened.

When Barack Obama was elected, he had every reason to exaggerate the difficulty he faced – beginning with quickly glossing over his predecessor’s success in dealing with the crisis in favor of dwelling on his earlier miscalculations. It’s in the nature of politics, after all, to blame the guy who went before; that’s how you get elected. Political narrative divides the world into convenient four- and eight-year segments and assumes the world begins anew with each.

So when in September Obama hired Lawrence Summers, of Harvard University, to be his principal economic strategist, squeezing out the group that had counselled him during most of the campaign, principally Austan Goolsbee, of the University of Chicago, he implicitly embraced the political narrative and cast aside the economic chronicle. The Clinton administration, in which Summers had served for eight years, eventually as Treasury secretary, thereafter would be cast is the best possible light; the Bush administration in the worst; and key economic events, such as the financial deregulation that accelerated under Clinton, and the effective response to panic that took place under Bush, were subordinated to the crisis at hand, which had to do with restoring confidence.

The deep recession and the weakened banking system that Obama and his team inherited was serious business. At the beginning of 2008, Bush chief economist Edward Lazear had forecast that unemployment wouldn’t rise above 5 percent in a mild recession. It hit 6.6 percent on the eve of the election, its highest level in 14 years. By then panic had all but halted global order-taking for a hair-raising month or two, as industrial companies waited for assurance that the banking system would not collapse.

Thus having spent most of 2008 in a mild recession, shedding around 200,000 jobs a month, the economy started serious hemorrhaging in September, losing 700,000 jobs a month in the fourth quarter of 2008 and the first quarter of 2009. After Obama’s inauguration, attention turned to stimulus and the contentious debate over the American Recovery and Reinvestment Act. Summers’s team proposed an $800 billion stimulus and predicted that it would limit unemployment to 8 percent. Instead, joblessness topped out at 10.1 percent in October 2009. But at least the recovery began in June

What might have been different if Obama had chosen to tell a different story? To simply say what had happened in the months before he took office?

Had the administration settled on a narrative of the panic and its ill effects, and compared it to the panic of 1907, the subsequent story might have been very different. In 1907, a single man, J.P. Morgan, was able to organize his fellow financiers to take a series of steps, including limiting withdrawals, after the panic spread around the country, though not soon enough to avoid turning a mild recession into a major depression that lasted more than a year. The experience led, after five years of study and lobbying, to the creation of the Federal Reserve System.

If Obama had given the Fed credit for its performance in 2008, and stressed the bipartisan leadership that quickly emerged in the emergency, the emphasis on cooperation might have continued. If he had lobbied for “compensatory spending” (the term preferred in Chicago) instead of “stimulus,” the congressional debate might have been less acrimonious. And had he acknowledged the wholly unexpected nature of the threat that had been turn aside, instead of asserting a degree of mastery of the situation that his advisers did not possess, his administration might have gained more patience from the electorate in Ccngressional elections of 2010. Instead, the administration settled on the metaphor of the Great Depression and invited comparisons to the New Deal at every turn – except for one. Unlike Franklin Delano Roosevelt, Obama made no memorable speeches explaining events as he went along.

Not long after he left the White House, Summers explained his thinking in a conversation with Martin Wolf, of the Financial Times, before a meeting of the Institute for New Economic Thinking at Bretton Woods. N.H. He described the economic doctrines he had found useful in seeking to restore broad-based economic growth, in saving the auto companies from bankruptcy and considering the possibility of restructuring the banks (the government owned substantial positions in several of them through TARP when Obama took over). But there was no discussion of the nature of the shock the economy had received the autumn before he took office, and though he mentioned prominently Walter Bagehot, Hyman Minsky and Charles P. Kindleberger, all classic scholars of bank runs, the word panic never came up.

On the other hand, the parallel to the Panic of 1907 surfaced last month in a pointed speech by Bernanke himself to a research conference of the International Monetary Fund. The two crises shared many aspects, Bernanke noted: a weakening economy, an identifiable trigger, recent changes in the banking system that were little-understood and still less well-regulated, sharp declines in interbank lending as a cascade of asset “fire sales” began. And the same tools that the Fed employed to combat the crises in 2008 were those that Morgan had wielded in some degree a hundred years before – generous lending to troubled banks (liquidity provision, in banker-speak), balance-sheet strengthening (TARP-aid), and public disclosure of the condition of financial firms (stress tests). But Bernanke was once again eclipsed by Summers, who on the same program praised the Fed’s depression-prevention but announced that he had become concerned with “secular stagnation.”

The best what-the-profession-thinks post-mortem we have as yet is the result of a day-long conference last summer at the National Bureau of Economic Research. The conference observed the hundredth anniversary of the founding of the Fed. An all-star cast turned out, including former Fed chairman Paul Volcker and Bernanke (though neither historian of the Fed Allan Meltzer, of Carnegie Mellon University, or Fed critic John Taylor, of Stanford University, was invited). Gorton, of Yale, with Andrew Metrick, also of Yale, wrote on the Fed as regulator and lender of last resort. Julio Rotemberg, of Harvard Business School, wrote on the goals of monetary policy. Ricardo Reis, of Columbia University, wrote on central bank independence. It is not clear who made the decision to close the meeting, but the press was excluded from this remarkable event. The papers appear in the current issue of the Journal of Economic Perspectives.

It won’t be easy to tone down the extreme political partisanship of the years between 1992 and 2009 in order to provide a more persuasive narrative of the crisis and its implications for the future – for instance, to get people to understand that George W. Bush was one of the heroes of the crisis. Despite the cavalier behavior of the first six years of his presidency, his last two years in office were pretty good – especially the appointment of Bernanke and Treasury Secretary Henry Paulson. Bush clearly shares credit with Obama for a splendid instance of cooperation in the autumn of 2008. (Bush, Obama and John McCain met in the White House on Sept. 25, at the insistence of Sen. John McCain, in the interval before the House of Representatives relented and agreed to pass the TARP bill. Obama dominated the conversation, Bush was impressed, and, by most accounts, McCain made a fool of himself.)

The fifth anniversary retrospectives that appeared in the press in September were disappointing. Only Bloomberg BusinessWeek made a start, with its documentary “Hank,” referring to Paulson. The better story, however, should be called “Ben.” Perhaps the next station on the way to a better understanding will be the appearance of Timothy Geithner’s book, with Michael Grunwald, of Time magazine, currently scheduled to appear in May. There is a long way to go before this story enters the history books and the economics texts.

David Warsh is proprietor of, economic historian and along-time financial journalist. He was also a long-ago colleague of Robert Whitcomb.