Debunking the Committee to Save the Banks’ Narrative
Ten years ago the Committee to Save the Banks (Paulson, Bernanke and Geithner) began offering up a false, self-serving narrative to justify bailing out the banks to the detriment of the real economy. Today, the NY Times posted another op-ed by the Committee that needs to be debunked.
Like all Wall Street created stories, this one starts with an element of truth before the falsehoods begin.
Ten years ago, the global economy teetered in the face of a classic financial panic, the most dangerous type of financial crisis.
True.
In a financial panic, investors lose confidence in all forms of credit, retreating to the safest and most liquid assets, like Treasury bills.
False. It is true investors lose confidence. It is false they lose confidence in all forms of credit. What they lose confidence in is the value of opaque securities. A very big and important difference.
When investors lose confidence in opaque securities, they run to transparent securities like Treasury bills.
The seeds of the panic were sown over decades, as the American financial system outgrew the protections against panics that were put in place after the Great Depression….
True. As shown by the Information Matrix, transparency is the single preventative for panics.
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 | |
Behavioral economists have shown people like a good story. This is true whether the investment Wall Street is telling them the story about is in the Perfect Information quadrant or in the Blind Betting quadrant.
The key difference between investments in the two quadrants is in the Perfect Information quadrant investors can Trust, but Verify Wall Street’s story. In the Blind Betting quadrant, opacity (the absence of the necessary information) prevents investors from being able to verify Wall Street’s story.
Whether the story can be verified or not results in a vastly different response when Wall Street’s story is called into doubt. In the Perfect Information quadrant, the story can be verified and the doubt dismissed. In the Blind Betting quadrant, the story cannot be verified. Not only is the doubt not dismissed, but the logical follow-up question arises: is the investment worth anything? This too cannot be verified. Investors recognize this and, as behavioral economics suggests, naturally panic. The result is a classic financial panic as investors “run” to get their money back.
Unfortunately, in the decades before the acute phase of the financial crisis, Wall Street captured the process by which the SEC set disclosure requirements. As a result, Wall Street was able to sell the opaque securities at the heart of the financial crisis.
Financial innovations, like subprime mortgages and automated credit scoring, helped millions to buy homes, but they also facilitated unwise risk-taking by lenders and investors.
True. Financial innovation is Wall Street’s way of describing its opaque securities. These opaque securities did help millions to buy homes. The opaque securities made this possible because investors could not assess the true risk of these mortgages.
It is also true investors engaged in unwise risk-taking. Investors should know when they are purchasing opaque securities. Investors should limit their exposure to opaque securities to what they can afford to lose knowing they are likely to suffer a 100% loss of capital from the purchase of the opaque security.
The Committee then moves on to praise the new powers given to financial regulators under the Dodd-Frank Act. This Act and these new powers are totally worthless. Even the Committee agrees on this point as it observed,
Even if a financial crisis is now less likely, one will occur eventually.
Why will we have another financial crisis? Because of the failure to restore transparency to the financial system. As shown by the Information Matrix, if you move virtually all the transactions in the financial system into the Perfect Information quadrant, you don’t get financial crises. You only get financial crises when you allow Wall Street to sell a critical mass of opaque securities.
As always, the Committee to Save the Banks wraps up its narrative with the following observation.
The paradox of any financial crisis is that the policies necessary to stop it are always politically unpopular.
False. The most effective, lowest cost method for stopping a financial crisis is transparency. Transparency happens to be very popular politically with everyone other than Wall Street. Why? Because it results in Wall Street being held responsible.
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