Bigger than Penn Central: The Financial Crisis of 1970 and the Origins of the Federal Reserve's Systemic Guarantee.

The Federal Reserve's reaction to the Penn Central bankruptcy in 1970 marked a pivotal moment in American financial governance history. This paper delves into the Fed's extraordinary measures to avert a widespread financial crisis following the resulting collapse of the commercial paper market. We outline the crisis's progression, highlighting Penn Central's increasing troubles and the subsequent emergency actions by the Fed, led by chair Arthur Burns in mid-1970. A key focus of our analysis is the financial environment of the 1960s, marked by the growth of complex, intertwined, and increasingly global short-term credit systems, which introduced a new type of systemic risk. We argue that the Penn Central crisis represented the Federal Reserve's initial major intervention in response to this emerging systemic risk, expanding its traditional role as a lender of last resort to individual banks to a broader responsibility as a stabilizer of the entire financial system. The Fed pursued this new systemic guarantee by using moral suasion, encouraging banks to increase lending, and providing structural support to reinforce financial system stability, thereby establishing a new precedent in central banking history. Our study also explores the consequences of the crisis. Despite the successful management of the Penn Central crisis, this paper raises crucial questions about the potential moral hazard and the extensive impact of the Federal Reserve's landmark actions. We contend that reassessing the 1970 Penn Central crisis is essential for a better comprehension of the structure of American financial market governance and the Fed's evolving role in handling subsequent crises, including the Great Financial Crisis of 2008. [ABSTRACT FROM AUTHOR]