The Committee to Save the Banks put on a clinic in their ongoing effort to defend their choice to save the banks in 2008/2009 rather than the real economy.  In their tenth anniversary interview, they took throwing jello against the wall to see what would stick to new heights.  This is required because everyone knows Goldman and JP Morgan need the US, but the US financial system is designed so it doesn’t need Goldman and JP Morgan.

Geithner: This is the central dilemma for policymakers in a crisis, which is that everybody’s instinct is to let the thing burn, because it seems just to let it burn. It seems fair. Good for future incentives, good for moral hazard. Better at preventing future crises. But if you let the thing burn to the point the system collapses, you’re going to be left with hundreds of millions of innocent victims. And it is very hard for people to understand, completely understandably, that what feels unjust and immoral in the context of breaking a panic is the most just thing to do if your interest is trying to prevent the economy from mass unemployment or a decade of breadlines across the country like what happened in the Great Depression. And it’s a it’s a hard thing for people to appreciate or think in part because, you know, we hadn’t had a major financial panic in 75 years. There was no living memory of what the risks were in letting a panic burn  go too far. And that’s in some ways, it’s the central reason why these things are so terrible, because the natural human political instinct around fairness and justice collides with what is necessary and effective to protect the most people.

Instinct?

Was there ever any reason to doubt the policymakers who responded to the Crash of ’29 and the Great Depression wouldn’t have redesigned the financial system to save the real economy and let the panic burn itself out in the financial system?  No!  As I have shown in the earlier posts, this is exactly what these policymakers did.  They redesigned the financial system so it couldn’t collapse.

Going into the acute phase of the financial crisis everyone knew this.  They understood firms like Goldman and JP Morgan need America, but America’s financial system is designed to withstand a financial crisis and does not need firms like Goldman and JP Morgan.

Of course, the Committee to Save the Banks couldn’t be bothered using the financial system as it was designed.  Instead, they headed off to save Wall Street.

Paulson: OK, Kai, I want to say one other thing that I think added to the confusion in all of this, which was that when we were designing a program, you know, we had all known how in the United States of America, government ownership is an anathema. There’s a red line. And we all knew that putting capital would be a problem if it were drawn broadly. So, you know, I had argued and I really believed at the time that we could free up the banking and the interbank lending and free up capital by buying illiquid assets from the banks. OK. We had believed that. And if I had believed something different, I’m not sure we could have gotten TARP. I’m not sure the Republicans ever would have voted for it. But I, in good conscience, went forward, made the case. But then when we were up at Congress, and we’d seen the situation continue to get worse when we were up there. We’d seen two of the biggest bank failures in U.S. history with essentially WAMU and Wachovia going down and what happened in Europe. We needed to change. And I remember going to President Bush and saying, “You know, the situation changes, we’re going to have to recapitalize the banks.” And, I mean, he basically was very courageous. He said, “You got to do whatever you got to do to to save the economy.” But it was, like, holy moly, you know, you’ve told the whole world you’re going to buy illiquid assets. What do you do? I said, “Well, you know, we’ve got to change.” And so we changed right there. The last thing I will say, and this isn’t to justify the program or not, but you’d be surprised when I go and talk to average Americans and they’re angry about not punishing the banks, many of them also believe we gave like $700 billion to Wall Street. They don’t recognize that all the capital that went into the banks and in the insurance companies came back, plus almost $50 billion. Now that’s not to justify or not justify it, but that’s another source of confusion.

Paulson lobs a handful of jello at the wall with his observation government ownership is anathema as this statement implies the government is going to own the banks for a long period of time.  As the Savings and Loan Crisis showed, there was no reason to “own” the banks for a long period of time.  As the US, Swedish and Icelandic governments have shown, it could easily have let the insolvent banks stay afloat, systematically closed each one and subsequently put the good assets into private hands.

Paulson then lobs another handful of jello by saying “we’re going to have to recapitalize the banks”.  No you don’t.  By design, the banks could continue to make loans to support the real economy.  They might not be able to hold those loans on their balance sheet, but that is a different issue.  One there were plenty of buyers (insurance companies, pension funds, hedge funds, ….) to solve.  By design, the banks that were viable after realizing all of their losses on their bad assets should have been allowed to remain open and forced to retain all of their pre-banker bonus earnings until their book capital had been rebuilt to some regulatory minimum.  The non-viable banks should have been closed.

Going for the trifecta in jello throwing, Paulson then trots out the claim TARP was a success since it made money.  It is highly selective accounting myth TARP was a success.  According to the Wall Street Journal,

The financial crisis cost the U.S. economy some $6 trillion to $14 trillion in lost output, and ended only after the government promised aid worth an estimated $12.6 trillion.

$50 billion doesn’t remotely repay the cost of the Wall Street caused financial crisis to the US economy.

Since deposit insurance made the taxpayers the silent equity partner of all the insolvent banks, TARP was completely unnecessary.  With or without TARP, the taxpayers were on the hook.  TARP succeeded in one way:  it saved Wall Street from the consequences of its actions.

Bernanke: Well, I was going to say that prior to Lehman, there was a wide variety of views among economists about how serious a collapse of the financial system would be for the broader economy. And given my background studying depression, I was on one end of saying, no I think this is very serious…. Yeah, certainly among academic economists, anyway, I had a much more concerned viewpoint that I was again, because of my historical work, I thought that this could be very serious, and I went to Congress and I said if we allow the financial system to collapse, you know, unemployment is going to do this and so on. It turns out that even I, who was at the end of the most extreme among standard economic views, I underestimated the impact. So I think, you know, I think even though we were very, very concerned, I think, you know, as we saw after the fact, and we saw how quickly the economy deteriorated in the last part of 2008, you know, I think the stakes were even higher than we understood at the time.

With his comments, Bernanke confirms how unfit he was for the role as Chairman of the Federal Reserve.  He managed to study the depression and missed how the financial system was redesigned to protect the real economy.  It did this by using deposit insurance and a lender of last resort to prevent the collapse of the financial system.  He managed to study the depression and miss the role of automatic stabilizer programs (programs Professor Krugman says worked as designed and meant the recession associated with the Great Financial Crisis wasn’t too severe).  Yes, the names of those insolvent Wall Street banks would change, but there was never a moment when the payment system would have failed or loans not continued to be made.

Of course, you couldn’t expect an Economist to be aware of the 1980s Savings & Loan Crisis which showed the redesigned system worked in the US.  Of course, you couldn’t expect an Economist to know how Sweden in the 1990s used a similarly designed financial system to handle a financial crisis.

Geithner: I think the three big things. There’s many of them. I think three big things are we, as a country, allowed the financial system to outgrow the protections we put in place after the Great Depression and leave ourselves on the eve of the crisis with a very fragile, dangerous system. The second thing is that we went into the crisis, we’ve said, with very weak tools for protecting the country from a panic. It took a long time, and it took too long, and it took too much damage to remedy that failure. And although with that authority, you know, we did a set of very innovative, very powerful things and I think produced dramatically better results than is true for most countries caught up in financial crises. You know, we are still left with a terribly damaged economy, deep scars, huge loss of confidence in public institutions. And, you know, we didn’t, the country got caught up in a little fever of austerity too prematurely.

The financial system outgrew the Great Depression protections because Wall Street managed to gain control over the process by which the SEC set disclosure requirements.  The Transparency Label Initiative remedies this problem.

The tools for addressing the panic weren’t weak.  Transparency is the only tool that ends a panic and the Committee to Save the Banks didn’t want to use it.

As for the results the Committee produced, a good argument can be made the rise of populism is the direct result.  Perhaps more importantly, crises era programs like zero interest rates and quantitative easing created tremendous inequality.  This inequality might have been acceptable, but even the economics profession cannot find any evidence these programs worked (remember as Krugman said, it was the automatic stabilizer programs).

Paulson: But the biggest regret I’ve got is that the life is going to be much more difficult for any regulator sitting in the seats facing another crisis because what we did was so unpopular.

It wasn’t just unpopular, it was wrong.  Rather than use the financial system to protect the real economy, the Committee to Save the Banks used the real economy to protect Wall Street.

Bernanke: Well, I didn’t foresee the panic. I mean, I didn’t appreciate that the problems in the mortgage market, the subprime market, were going to cause a loss of confidence in the broad financial system and lead to a panic. Now I think if I had foreseen it, I would have had more credibility. But I don’t think I could have, you know, materially averted what actually happened.

This comment is truly stunning, but further reveals how unfit Bernanke was to run the Fed.

It is a matter of public record I foresaw the crisis.  It is a matter of public record I explained BEFORE the acute phase of the financial crisis hit how to avoid this occurring.  It is a matter of public record I said the policies being pursued by the Committee to Save the Banks would not address the underlying problems in the global financial system or restore confidence in the global financial system.  

I think in terms of things that I could have done differently, I agree with Hank that, you know, we were so focused, I remember trying to deal with some of these situation — it felt like a one-arm juggler with so many balls in the air and trying to focus on my daily tasks and the challenges. And you know, again the communication, trying to help people understand against their instincts that, you know, allowing the banking system to collapse was not going to be something that would be irrelevant to their lives, that it was going to have an effect on, you know, on jobs, on mortgages, on incomes in a really big way. And the history of financial crises, a graduate school classmate of mine, Ken Rogoff, Rogoff and Reinhart, wrote this book, “This Time Is Different,” about, you know, the history of financial crises, and they are very consequential and have big impacts on the economy.

The book by Rogoff and Reinhart was fundamentally flawed and every trained economist should have been able to identify its biggest flaw.  The authors looked at financial crises pre-Great Depression and made assertions about the impact of financial crises post-Great Depression.  Of course, for their statements to be true they assumed there was no change in how a financial crisis could be addressed.

Hmmm….

Everyone knows this assumption is false as policymakers redesigned the financial system in the 1930s.  Their redesigned meant future financial crises could be handled differently.  Just look at how Sweden and Iceland handled their crises and the speed with which a self-sustaining recovery was started.  This redesign was so significant it rendered pre-Great Depression data irrelevant for making predictions about the impact of post-Great Depression financial crises.

Of course, you couldn’t expect a self-proclaimed Great Depression scholar sitting on the Committee to Save the Banks to know or act on this fact.  Doing so would have meant containing the financial crises in the financial system and protecting the real economy.  It would have meant Goldman, JP Morgan and the rest of the Too Big to Fail banks would not exist today (of course, much smaller banks would have emerged from their charred remains).  It would have meant bankers going to jail for their misbehavior behind a veil of opacity.

Instead, the Committee to Save the Banks saved Goldman, JP Morgan and their fellow Too Big to Fail banks and threw the real economy under the bus.