“The real key isn’t about whether what I say is true, but whether you believe it. From start to end, the direction of narrative is not guided by the tongue, but by the ear….” “Invisible Planets” Hao Jingfang |

Since the acute phase of the global financial crisis began, the narrative conjured up by the Committee to Save the Banks (Paulson, Geithner and Bernanke) has dominated the crisis response.  Unfortunately, their narrative wasn’t true.

This is very unfortunate because it led to numerous policy decisions that were good only for the bankers while being dreadful for the real economy and democracy.

For example, the Too Big to Fail banks had to be bailed out.  These banks were clearly insolvent in 2008.  However, unlike Lehman, they were in no danger of closing overnight.  Why?  The combination of deposit insurance and access to a lender of last resort.  Deposit insurance made the taxpayers the silent equity partner of each insolvent bank.  The lender of last resort meant the banks had access to funding.  With this combination, these banks could have continued to operate and support the real economy for years until the banking regulators were ready to close them.

I doubt I am the only person to recognize how this combination can be used during the acute phase of a financial crisis.  In fact, I suspect this was well known in the 1930s as it was the promise of deposit insurance that got the Fed to perform its lender of last resort function after the 1933 bank holiday.

Wouldn’t you think this fact would also be known by macroeconomists?  Even if it was, they were never going to speak out against the Fed.

Why?  The damage it would do to their career.

The Federal Reserve is a very large employer of macroeconomists.  Saying the Fed’s financial crisis response narrative was BS would have made it highly unlikely a macroeconomist would be invited to work for the Fed (either on its staff or as a consultant).  This in turn would limit a macroeconomist’s opportunity for lucrative consulting contracts from the private sector and may even play a role in their tenure case.

So even IF macroeconomists knew the Fed’s narrative was BS, they acted as if they believed it.  To this day, they still act like they believe it.

A macroeconomist pushed back against the idea the profession is cognitively captured by the Fed or the narrative was false.  The argument presented was we will never know what would have happened if the banks hadn’t been bailed out.

Of course, this straw man argument reveals a lack of understanding of the 2009 stress tests. The stress test proved the combination of taxpayer guarantee and lender of last resort meant insolvent banks could continue operating indefinitely.

Regular readers will recall the Treasury said the banks could withstand financial armageddon.  The Fed said to ensure this is true the Treasury would put up as much money as the banks needed.

It was the statement by the Fed bank investors responded to.  They knew giving $25 or $50 billion to a bank with a balance sheet in excess of $1 trillion wasn’t going to plug the hole in the bank’s balance sheet.  But here was the Fed saying the taxpayers would put up all the additional money that was needed.

With the taxpayers on the hook and the Fed committed to acting as a lender of last resort, the banks were able to ride out the rest of the acute phase of the financial crisis without any additional injections (exactly as I observed they would be able to without going through the bailout BS).