The Nobel Prize Committee awarded Ben Bernanke the Nobel Prize in Economics for his research on the importance of banks and the dangers of a bank run. In the financial crisis from 2007, Bernanke, as head of the US Federal Reserve, probably prevented the economic collapse thanks to his knowledge.
The fact that the Nobel Prize Committee awarded the American Ben Bernanke the Nobel Prize in Economics for his research on the importance of banks and the danger of a bank run, gives a special meaning to an episode from 2008. At that time, Bernanke, as head of the US Federal Reserve, saved the AIG bank, which had gotten into trouble as a result of the financial crisis. This had lost more than 60 billion dollars within three months and threatened to take the entire financial system into bankruptcy. The Fed kept the bank alive with billions in loans.
In 2010, the Huffington Post reported that Bernanke overruled several Fed analysts who would have preferred to let AIG go bust on that decision. Critics accused him of saving the bank was unnecessary.
By honoring Bernanke for his research before and after he was Fed chairman, the Nobel Committee is siding with the majority of Americans, who praise Bernanke’s decision to have prevented worse – most notably a bank run.
To understand why a bank run worries economists so much that they would rather bail out billions of dollars to troubled banks than risk their bankruptcy, a look at history helps.
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Anyone who is familiar with the images of desperate bank customers during the global economic crisis from the end of the 1920s, who crowded in long queues in front of bank counters, knows the desperation that a bank run writes on people’s faces: Many investors lose their entire savings in the process.
That often doesn’t have to be the case. A bank run is an example of a situation where all people do what makes sense for them, but in doing so creates problems for themselves and everyone else. This is because banks store only a small portion of their customer’s money in their branches. They lend a good part to house builders and companies, for example, or invest it in a fixed amount.
If the customers of a bank withdraw their money according to their normal habits, there are enough reserves for everyone. But if numerous people want to withdraw a lot of money from a bank at the same time, they will eventually exhaust their reserves. Except for the first customers, everyone else gets nothing.
If people fear that the bank could go bankrupt, the development picks up dangerous momentum: everyone wants to be the first to withdraw their money and therefore come to the bank immediately. There are long queues, like in the pictures of the global economic crisis.
Eventually, the bank paid out all of its available money to the people. If it has firmly allocated its remaining funds elsewhere, it can no longer pay its costs and goes bankrupt. If people storm not just one bank, but all of them, they bring down the entire financial system and with it the global economy.
A bank run can happen for no reason. Like a self-fulfilling prophecy, he then lets institutes collapse because of untrue rumours.
As understandable as people’s craving for their savings in the face of rumors of bank problems may be, politicians are therefore keen to avoid a bank run.
Experts recognized the importance of Bernanke’s decisions as early as 2009: “Time Magazine” named Federal Reserve Chairman Ben Bernanke the most influential person of 2009. But the future of the 56-year-old at the head of the Fed is open.
Normally, a bank run remains extremely unlikely. Even during the pre-Christmas period, when people withdraw large amounts of cash for gifts, the banks have enough in stock for everyone. The withdrawals usually only become critical when customers fear bankruptcy of a bank and want to withdraw their money while this is still possible. Even during Germany’s hyperinflation in the early 1920s, investors were quick to withdraw money to spend before its value fell even further.
German savers don’t have to worry about their money anyway. In order to strengthen people’s trust in the banking system, the Federal Republic of Germany is demanding deposit insurance from banks: Banks must fully protect their customers’ money up to an amount of 100,000 euros. Most savers therefore do not need to worry about their savings.
During the financial crisis from 2007, the then Chancellor Angela Merkel (CDU) and Finance Minister Peer Steinbrück (SPD) repeatedly emphasized the stability of the German banking system: They wanted to strengthen people’s trust in the banking system and thus prevent a bank run.
In his research, Bernanke, who received the Nobel Prize together with the Americans Douglas Diamond and Philip Dybvig, highlighted the importance of banks for a functioning economy and their problems, which also led to the crisis after 1929. He showed what dangers a bank run poses for companies and why, in his opinion, this should be prevented. Diamond and Dybvig also researched the importance of banks in the 1980s.
On the one hand, argues Bernanke, the problems in the banks have tightened the money supply, which is why people and companies have been spending less and economic output has fallen. In addition, they no longer provided the important links between borrowers and lenders that households, small businesses, and farmers in particular used to finance purchases and investments. Credit became more expensive or was simply unavailable. So people bought less, companies made less or went bust. All of this turned the “severe but not unprecedented downturn of 1929 and 1930 into an extended recession,” writes Bernanke in an essay from 1983.
Bernanke’s research is important for today because it explains his actions during the financial crisis: with low key interest rates, he ensured that banks always made cheap money available to people and customers never worried so much about their savings that they stormed banks. In the opinion of many experts, he thus prevented an even worse crisis than in the 1930s.
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