CNBC Guest Blog

During the lecture, one of the students asked Professor Romer why it had been so difficult to see this recession coming – “why the great surprise?”

“One of the things I thought I knew in the postwar period is business cycles were caused by the Fed tightening and then that caused a recession, and then the Fed loosened and it was over, she replied. ” Not this time. “This is just a whole other animal.”

The second reason, she added, was “the international ramifications.” Through the summer, many people thought that while “the U.S. went down,” the rest of the world would not. That turned out to be wrong….We didn’t realize how interconnected our financial institutions were, but I think that’s probably the main source of the surprise.” In other words, that once much-vaunted decoupling between the United States and the rest of the world fed what proved to be a dangerous complacency.

Professor Bernanke focused in on fixing regulation so that the Great Recession – or worse – does not happen again. It was clear that he is more than preoccupied with what he called “the Too Big to Fail problem” (read AIG, Citigroup). Too-big-to-fail “reduces market discipline and encourages excessive risk-taking.” In fact, there is a perverse incentive “for firms to grow in order to be perceived as too big to fail” – meaning that they can take more risks because they know they will be bailed out.! The answers, he said, were much more intensive regulation that envelops the entire enterprise and eliminates any “gaps” that allow “risk-taking to migrate from more-regulated to less-regulated sectors”.

One could almost read into Professor Bernanke’s words a novel solution to the “Too Big to Fail problem,” which is to make regulation so intrusive — and indeed so irritating — as to discourage firms from reaching for that august status of too big to fail!

He also put firmly on the table the idea of what he called “macroprudential” regulation, which would be looking not at individual firms but at “systemic risks” – such as – just to take an example that happens to come to mind — the hyper-growth of subprime mortgages. Here, too, one might read into his words a substantial shift in Fed policy: Perhaps regulators should, after all, do something about bubbles before they get out of hand.

One of the most intriguing parts of Bernanke’s lecture was his suggestion that the much-debated mark-to-market accounting might actually need some tinkering. The reason? Its undesirable trait of encouraging “procyclical tendencies” – which is central bankese for helping to drive values up higher than warranted and then slamming them down farther than appropriate.

He became a little more explicit. Mark-to-market, he said, is “one of the things that tends at times to increase the severity of ups and downs in the financial system and in the economy.” He said is definitely against “any suspension of mark to market…. But, in periods like this, when some markets don’t’ even exist or are highly illiquid… the numbers that come out can be misleading.” Or, he added, “not very informative, at best.”

“Guidance,” he said, is definitely needed to “financial institutions and to the investors about what are reasonable ways to address the valuation of assets that are being traded – if traded at all, — in highly illiquid, fire-sale type markets.”

Professor Summers made clear – perhaps in a nod to that worry that bothers Chinese Premier Wen, along with others – that he does not like deficits. “When I left Washington eight years ago, people were debating what to do when there was no more federal debt,” he dryly observed. “ That is hardly our problem today.”

But there is no choice, according to his economics textbook , to a very big stimulus today. For, as he said, “the crucial problem is a broad shortage of demand” and investment. For the longer term, he said, picking up on Professor Bernanke’s core argument, the United States has to move away “from foreign debt-financed growth.”

Professor Summers did so go far as to talk boldly about “the next economic expansion.” He didn’t put any date on it, but he, with great conviction, did tell all students in the “Economics of the Great Recession” course that “there is one enduring lesson in the history of financial crises: they all end.”

One can be sure that the three professors hope that this recession will end soon enough that this course does not need to be offered next year. Or, if it is, only as a small seminar.

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Daniel Yergin, CNBC’s Global Energy Expert, is chairman of Cambridge Energy Research Associates an IHS company and author of The Prize: the Epic Quest for Oil, Money, and Power, now in a new edition.

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