WASHINGTON POST: …Next, Bernanke provides instructive numbers to explain why the financial system was so vulnerable. Years ago, banks dominated the system and got their funds mainly from household and business deposits. These were largely immune to panic because most were government-insured. But in recent decades, a “wholesale” market for funds had developed consisting of the spare cash of corporations, pension funds, wealthy individuals and others. These uninsured funds were lent to banks and other financial institutions for short periods, often overnight. By late 2006, wholesale funds totaled $5.6 trillion, exceeding insured deposits of $4.1 trillion. It was the abrupt withdrawal of these funds that drove panic and threatened the financial system with collapse.
Finally, Bernanke convincingly argues that this financial panic — and not defaults on subprime home mortgages — was the crux of the crisis. Subprime loans represented about 13 percent of outstanding home mortgages, he says. Though they triggered the crisis, their losses alone could have been absorbed by the financial system. The real economic damage, he contends, stemmed from the chaotic side effects of the mortgage write-downs: fears of more losses in other types of loans (credit card debt, auto loans); falling bond prices as financial institutions dumped “toxic” securities; and the flight of wholesale funds from banks, investment banks and others (much of their cash went into U.S. Treasury securities).
Thus battered, the financial system became comatose. It no longer provided credit where it was needed. The calamitous chain reaction for spending, production, jobs and confidence followed. The “financial turmoil,” writes Bernanke, “had direct consequences for Main Street.”… (more)
