Protecting Banks at All Costs Still Mission of the Committee to Save the Banks
As we approach the tenth anniversary of the 2008 acute phase of the Great Financial Crisis, the Committee to Save the Banks is recounting the lessons its members learned for why it is important to bailout the banks and lie about their financial condition.
Tim Geithner, who along with Ben Bernanke and Hank Paulson make up the Committee observed,
One of the most powerful lessons from this crisis should be that you want to work very hard to make sure that your defenses are robust… We let the financial system outgrow the protections we put in place in the Great Depression and… made the system very fragile and vulnerable to panic.
The Information Matrix shows why the financial system was designed based on transparency and why the growth of the opaque sectors made the financial system fragile and vulnerable to panic.
Information Matrix
| Does Seller Know What They Are Selling? | |||
| Does Buyer Know What They are Buying? | Yes | No | |
| Yes | Perfect Information | Antique Dealer Problem | |
| No | Lemon Problem | Blind Betting | |
If you were going to create a financial system, which quadrant would you want almost all of the transactions to occur in? Almost everyone says the Perfect Information quadrant. It is the only quadrant where economic theory suggests resources are properly allocated.
However, if you are Wall Street, where would you want most of the transactions to occur? Wall Street prefers the Blind Betting quadrant. Wall Street knows it makes much more money selling opaque, high margin investments than it does selling transparent, low margin investments.
Wall Street also knows investors like a good story. It is necessary to get investors to buy or sell. Some of these stories involve securities in the Perfect Information quadrant where the investor can Trust, but Verify the story. Other of these stories involve securities in the Blind Betting quadrant where investors have to Trust Wall Street and the valuation it puts on the securities. Naturally, when these stories are called into doubt, there is no information to support a higher price for these opaque securities other than zero. Investors recognize this and “panic”. They want to get their money back. The race to do so is the “run” associated with financial crises.
By choosing disclosure so investors could know what they own, the FDR Administration tried to prevent financial crises by forcing transactions into the Perfect Information quadrant. It didn’t work because the SEC was vulnerable to being captured by Wall Street.
So did the Committee learn this lesson and insist on the creation of the Transparency Label Initiative? Did the Committee insist there be an investor funded Initiative that labels investments where investors could know what they own? Did the Committee insist the Fed only invest in banks through its discount window lending or securities through its open market transactions where there was a label so as not to put taxpayer money at risk blindly betting?
No!
The Committee expressed concern the Dodd-Frank Act would restrict the ability to bailout the banks again. As Bloomberg reported,
The former Fed chairman said the U.S. had made “a lot of progress” toward being able to resolve failing financial institutions without having to bail them out.
Paulson basically agreed, with one big proviso. In the midst of a crisis, policy makers may have to provide temporary support so that a collapsing institution can be liquidated over time — even if that proves politically difficult to do.
“It’s nice to have this authority but somebody has got to be prepared to use it and use it in controversial ways,” he said.
Asked if policy makers and politicians would be able to set aside their differences to tackle any future turmoil given the toxic atmosphere in Washington, Paulson replied that the answer is “unknowable.”
But, he added, “it’s the right question to ask.”
It is a myth the government could wind down a Too Big to Fail bank. Consider the government could not do this in 1984 when Continental Illinois with under $50 billion in assets failed.
The answer to the question of would Congress approve temporary funding is YES! As the Committee to Save the Banks successfully demonstrated, Congress will always approve funding if the Treasury Secretary and Fed Chair say there is reason to believe doing so will prevent a second Great Depression.
So have no fear, the Committee to Save the Banks preferred bank bailouts are alive and well.
Of course, bailouts are totally unnecessary.
By design, the combination of deposit insurance and the Fed as a lender of last resort means the Too Big to Fail banks cannot collapse overnight. They can be put on life-support indefinitely. While on life-support (as shown by the Savings & Loans in the mid- to late 80s), they can continue to make loans and operate the payment system for the benefit of the real economy.
What it takes to get Congress to bailout the banks is the Treasury Secretary and Fed Chair to lie and say a bailout is needed. It happened in 2008. There is no reason to think in the absence of transparency it won’t happen again when the next financial crisis occurs.
Please note, bringing transparency to the banks and requiring them to disclose their current exposure details ends the need for bailouts.
Why?
Market discipline. When banks disclose their current exposure details, investors can exert discipline to restrain the risk-taking by the banks. This has many benefits including ending the risk of contagion as banks will only has as much exposure to each other as they can afford to lose. Furthermore, investors can exert discipline to have the banks recognize the losses on their exposures.
Of course, the Committee to Save the Banks doesn’t champion transparency. In fact, it seeks to preserve the opacity of the banks and future bailouts.
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