Ten years after they undermined capitalism in America, the Committee to Save the Banks got together to defend their action.  The Committee is made up of Ben Bernanke, Tim Geithner and Hank Paulson.  Their action was to bailout Wall Street and the 1% rather than use the financial system as it is designed to contain a financial crisis and protect the real economy.

In a lengthy interview defending their actions,

The three men who helped shepherd the U.S. through the 2008 Great Recession are worried that the country and Congress have not learned the right lessons from the last financial crisis — and may not have the tools to weather the next one.

It is quite apparent from the actions the Committee took they did not learn the right lessons from the last financial crisis (aka the Great Depression).

For example, everyone understood the central lesson from the Great Depression:  Specific banks like Goldman Sachs and JP Morgan need the US;  The US does not need any currently existing specific bank.

This lesson was reflected in the reforms passed during the Great Depression.  These reforms included deposit insurance.  Deposit insurance protected the payment system from collapse.  When combined with the Fed acting as a Lender of Last Resort, insolvent banks could continue in operation indefinitely as the taxpayers became the insolvent banks’ equity partner.

This has significant implications for how to handle a financial crisis.  It allows all the bad debt in the financial system to be written down to the greater of what the borrower can afford to repay or a third party will pay for the collateral.  It allows the losses on this bad debt to flow through to the book equity of the banks.  It allows viable banks (those that can still generate earnings after recognition of their losses) to continue in business.  It allows viable banks to retain pre-banker bonus earnings until their book capital has been rebuilt.  It allows the government to close non-viable banks and transfer their assets to new institutions.  It allows the government to pursue bankers for breaking the laws.

Of course, the Committee to Save the Banks ignored this central lesson.  Instead, it saved specific currently existing banks.  Instead, it foamed the runway for the banks so they didn’t have to write down the bad debt in the financial system.  Thereby forcing the damage of the financial crisis unto the real economy.  Instead, it prevented bankers from being pursued for their misbehavior by creating the concept of Too Big to Jail.  Instead, it made the real economy dependent on the financial regulators preventing another financial crisis.  There is no reason to think the financial regulators are fit for this purpose as they did not see the Great Financial Crisis coming or take steps to prevent it.

I’ll let the Committee to Save the Banks describe how they view the results of their handiwork.

“I think the reforms were, on the whole, quite constructive,” Bernanke said. “The banking system is stronger. Oversight is better. The tools are mostly better, although some of the tools we used during the crisis were taken away. So it’s not an unambiguous improvement, but overall I think the system is stronger.”

Forgive me, but where is the objective evidence to support this statement.  Banks are still opaque.  Nobody, and this includes the regulators, knows what is hiding on and off their balance sheets (if you want to disagree with this statement, you’ll have to explain how the regulators were caught unaware of the JP Morgan’s London Whale).

Thank goodness some of the tool the Committee used during the acute phase of the Great Financial Crisis have been taken away.  With luck, it will force the next set of financial regulators to use the financial system as it is designed and not save specific banks.

But he also warned that “the enemy is forgetting that as time passes and the memory of this gets further in the rear-view mirror, you know, then you’ll start hearing from Congress and from the banks: ‘You know, well, this is going to constrain lending. We should really start undoing all of these things as soon as possible.’”

Bernanke statement reflects why a dependence on regulators and regulations doesn’t work to prevent a financial crisis.  Both enforcement and the regulations themselves are subject to change.  Think of a pendulum swinging from cosmetic enforcement to light touch.

Our financial system was designed not to be reliant on the financial regulators.  It does this through using the combination of caveat emptor (buyer beware) and transparency.  The latter provides the necessary information so investors can assess the risk of any investment.  The former provides an incentive not to have more exposure to any investment than the investor can afford to lose.  Together, they result in market discipline.  Unlike financial regulators, market discipline is always on.

However, banks are not currently subject to market discipline because they are opaque.  They don’t qualify for a label from the Transparency Label Initiative because they do not disclose the information necessary so an investor could know what they own.