WASHINGTON — The financial turmoil is so severe that a top Federal Reserve Board official resurrected a word Monday that has not been used to describe markets for more than a century: "panic."
In a speech to the Council of Institutional Investors, Fed Gov. Kevin Warsh said the pervasive uncertainty about the financial sector means the current downturn cannot be viewed as a run-of-the-mill recession.
"The depth and severity of this downturn are due, I believe, to a more profound panic phenomenon," he said. "Market participants wonder whether the forms of financial intermediation and functions of financial institutions — long connecting savers with investors — will be implemented in a manner that will enhance, or reduce, economic well-being. Some are questioning the efficacy of the remaining vestiges of the existing financial architecture and remain uncertain of the timing, efficacy and policy preferences for the financial architecture that will ultimately emerge."
As a leader of an organization that tends to err on the cautious side, Warsh's description of the "Panic of 2008" was striking. It was, of course, the Panic of 1907 that helped create the Fed.
Distinguishing a panic from a recession is important, Warsh said, because the former makes it even more important for policymakers to make the right decisions. "Panics are threatening to economic well-being," he said. "Panics take even less kindly to, and often result from, uncertainty. And panics place a greater burden on the deftness of policy responses than recessions alone."
To reduce uncertainty, he said, government leaders should stand by the deals they cut with financial institutions.
"Fidelity to the rule of law … suffers its greatest blow when the governing authorities are unwilling to uphold their end of the bargain," he said.
Donald Kohn, the central bank's vice chairman, expressed the same sentiment last week. "Firms might hold back on accepting government help if they saw the cost of meeting the conditions as greater than the benefit of assistance or if they were concerned that the conditions might change in an undesirable way after the assistance had been accepted," he said in a Friday speech at the College of Wooster. "Such hesitance could impede the effectiveness of government programs and slow the recovery of jobs and income."
Congressional leaders have been criticized for trying to recoup bonuses paid to executives at American International Group Inc. This political threat has raised the possibility that investors will be less willing to work with the government, but their participation is crucial, especially for the Fed's Term Asset-Backed Securities Loan Facility, which was begun last month to revive liquidity in several consumer sectors.