Why Has So Little Changed Since Lehman Failed in 2008?
The Financial Times’ Martin Wolf looked at the response to the Great Financial Crisis and discovered the problem with Committee to Save the Banks’ response to the crisis.
Have politicians and policymakers tried to get us back to the past or go into a different future? The answer is clear: it is the former.
The problem is if you are going to go back to the past, you have to choose a past that is demonstrably better for society and the economy.
And the first tell the Committee had not chosen a better past was its decision to save the banks. This decision completely disregarded the fact during the Great Depression the banks were redesigned so they could protect the real economy from a financial crisis by absorbing the losses on the excess debt in the financial system.
This was achieved through deposit insurance. The existence of deposit insurance meant existing banks like JP Morgan and Goldman need the country they are headquartered in (the US in this case), but the country they are headquartered in (the US in this case) does not need the existing banks named JP Morgan and Goldman. This is true for other countries and their banks too.
With deposit insurance in place, the taxpayers become the insolvent banks silent equity partner. As a result, insolvent banks can continue in operation supporting the real economy until such time as they are closed by financial regulators (the US Savings & Loans confirmed this during the 1980s). This is true even after the insolvent banks recognize their losses on the excess debt.
Instead of using the banks to protect the real economy, the Committee to Save the Banks’
chief aim of post-crisis policymaking was rescue: stabilise the financial system and restore demand. This was delivered by putting sovereign balance sheets behind the collapsing financial system, cutting interest rates, allowing fiscal deficits to soar in the short run while limiting discretionary fiscal expansion, and introducing complex new financial regulations. This prevented economic collapse, unlike in the 1930s, and brought a (weak) recovery.
The Committee to Save the Banks’ response to the financial crisis did not prevent an economic collapse like the 1930s! This is an entirely false narrative put forward by the Committee to justify its actions. In reality, the economic collapse was prevented by the automatic stabilizer programs put in place during the 1930s and expanded on in the 1960s! (but don’t just take my word for it, it took Nobel prize winner Paul Krugman a decade to discover this).
By making the decision it did, the Committee guaranteed a miserable experience for many. It placed the burden on debtors and the real economy to carry the excess debt in the financial system.
The Committee effectively returned us to the early 1930s before deposit insurance was adopted. A time when populism and all of its dangers was on the ascendency.
Faced with the disconnect between the Committee’s self-serving narrative and the rise of populism, Mr. Wolf looks for why something of substance that would have prevented the rise of populism wasn’t done.
To his credit, he finds
A more likely cause of inertia is the power of vested interests. Today’s rent-extracting economy, masquerading as a free market, is, after all, hugely rewarding to politically influential insiders.
Unfortunately, he pretends he is outside of the club of politically influential insiders. In reality, he is an insider to this club.
Consider his list of what he refers to as “good ideas” that should have been adopted. Naturally, restoring transparency or the Transparency Label Initiative doesn’t make the list even though we have regularly discussed the need for both since the acute phase of the crisis began.
What makes the list of “good ideas” is higher bank capital requirements. Regular readers know I have debunked this as a good idea by pointing out bank capital is an easily manipulated, meaningless accounting construct (for those readers not familiar with my background and why this observation is true, I was trained in bank examination at the Fed and helped to write what became the Basel I capital requirements while working for a Too Big to Fail bank).
In making his list, Mr. Wolf chose to support the politically influential insiders club.
Why?
Because he is limiting his list of what he calls “good” ideas to ideas the insider’s club considers acceptable.
Transparency and the Initiative aren’t acceptable as they fundamentally change the financial system and provide a better future for people.
Transparency ends Too Big to Fail and Too Big to Jail. Transparency forces policymakers and regulators to use the banks as they are designed to protect the real economy. Transparency makes the banks the servant of the real economy rather than its rent-extracting master.
Of course, this is not what the politically influential insiders club wants.
So Mr. Wolf continues to act as a barrier to change by choosing not to talk about transparency and the Initiative.
The rise of populism is his legacy too!
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