CFP Special Advisor and former Assistant Secretary for Economic Policy at the Treasury Department, Professor Phillip Swagel, has written a new paper on the Legal, Political and Institutional Constraints on the Financial Crisis Policy Response. Read the full paper.
The paper is part of a symposium on the financial crisis that will appear in upcoming edition of the Journal of Economic Perspectives.
The story of the financial crisis response can be told through the lens of evolving legal and political constraints. In late 2007 and early 2008, while policymakers recognized weaknesses in the system, they believed that conventional monetary and fiscal responses such as Fed lending and a modest fiscal stimulus would suffice to buoy the US economy while the imbalances that had built up during the housing bubble were resolved. By the time of the Bear Stearns bailout in March 2008, the usual methods were clearly perceived to be inadequate, and the Fed was making discretionary choices to invoke authority reserved for “unusual and exigent” circumstances to respond to the potential collapse of a nonbank financial firm. In September 2008, the Fed’s ability to use this discretionary authority had reached its limits, and the imminent risk of financial crisis led to the Troubled Asset Relief Program. The advent of the TARP capital injections facilitated a program of guarantees by the Federal Deposit Insurance Corporation to support bank funding, undertaken with existing legal authority but in an extraordinary way. Together, these actions reassured market participants that the US financial sector would not collapse and marked the beginning of the stabilization from the crisis.