11
Modern Crises: Perspectives from History
In any time period, a financial crisis starts in a chaotic way, and modern-era crises (when central banks are present) create even greater confusion than the panics of the National Banking Era. When discussing the Panic of 2007– 8, former Treasury secretary Tim Geithner (2014, 119) wrote, “At the start of any crisis, there’s an inevitable fog of diagnosis.” This fog is thicker and more widespread in the modern era. In modern crises, the timing of key events differs from the typical sequence observed during the US National Banking Era, when there was no central bank. Modern-era financial crises invariably involve expectations that the central bank or the government will intervene in markets in some way, and, as a result, runs on short-term debt do not necessarily start right away. Firms and households wait to see what will happen. At the beginning, shortterm debt holders suspect that one or more financial institutions may be insolvent. Some financial institutions may in fact be bankrupt, closing their doors. Banks have liquidity problems because there are usually slower large withdrawals (a silent run) but not sudden mass runs. There is no suspension of convertibility by banks. Some banks cannot get loans in interbank markets. But it’s not clear that the events are a systemic crisis. Without an explicit run, the central bank and other public authorities are not sure the events are a crisis, and so policy makers wait to see what develops. Households and firms wait too. When events finally begin to spiral out of control (e.g., Lehman), there is a mass run prompting the government to act. No one is sure what to do. Some counsel that (any) proposed responses will foster “moral hazard” and authorities advocate standard responses to address those problems that might make sense long before a crisis hits but are not appropriate during a crisis.1
