Question

Why did the Federal Reserve allow the Bank of United States to fail in​ 1930? A. The Fed was prohibited from aiding the bank because its assets were concentrated in real estate. B. The Fed did not want to be viewed as rewarding the poor business decisions of the​ bank's managers. C. The Fed was unable to obtain the approval of the U.S. Treasury for its purchase of the​ bank's toxic assets. D. The​ bank's managers refused to abide by Fed rules governing the use of Fed loans. Why did the Federal Reserve allow Lehman Brothers to fail in​ 2008? A. The Fed did not have the legal authority to assist an investment bank. B. By the time the Fed understood the extent of the trouble at Lehman​ Brothers, it was much too late to act. C. The Fed believed that Lehman Brothers had found a suitable buyer and would recover. D. The Fed feared that assisting Lehman Brothers would increase the extent of moral hazard in the financial system. Contrast the​ Fed's actions following the failure of the Bank of United States with its actions following the failure of Lehman Brothers. A. The Fed aggressively intervened following the 1930 failure but remained largely inactive for several years following the 2008 failure. B. The Fed intervened aggressively following the 2008 failure but remained largely inactive for several years following the 1930 failure. C. The​ Fed's actions following both failures were the​ same; it aggressively intervened with assistance

Answer 1

Answer: 1. B. The Fed did not want to be viewed as rewarding the poor business decisions of the​ bank's managers.

2. D. The Fed feared that assisting Lehman Brothers would increase the extent of moral hazard in the financial system.

3. B. The Fed intervened aggressively following the 2008 failure but remained largely inactive for several years following the 1930 failure.

Explanation:

1. In 1930 when the Great Depression was at it's early stages, the Central Bank could have done some things that would have reduced it's impact on the world but they remained passive and did little. One of the reasons was that there was a lack of cohesion between the Fed Districts and some of the directors subscribed to the "liquidationist" which meant that companies that engaged in adverse financial decisions be allowed to fail to as to prune the financial system and make it better. This contributed to the failure to help the Bank of the United States.

2. The Fed did not want to be seen as aiding Moral Hazard when they refused to bail out the Lehman Brothers in 2008. The Lehman Brothers had engaged in very risky transactions that brought it to ruin in 2008 and the Central Bank did not want to encourage the precedent of saving Banks that did so. Moral Hazard is when a risky action is engaged in by a company or person because they will not pay for the risk if things go awry. For example, a person with car insurance might drive more recklessly because they know that if the car crashes, the insurance will cover it. This is what the Fed did not want to encourage. A situation where Banks would engage in risky actions knowing that the Fed would back them up.

3. In the 1930s during the Great Depression, the Fed did not do enough to stem the depression because there was not coordination amongst the districts. They could not agree on a way forward and so did little. They even admitted their failure when in 2002, a member of the Board of Governors called Ben Bernanke said they could have done more.

In 2008 though, the Fed stepped in to help the economy get back on track. They reduced Interest rates and poured money into the economy through various ventures that helped the American public amongst others. Their actions ensured that the 2008 financial crises did not last as long as the Great Depression.