George Soros and Rob Johnson wrote an editorial that brilliantly illustrates why it was and still is important to have the right narrative for the financial crisis.

The Committee to Save the Banks (Paulson, Bernanke and Geithner) provided the false, but dominant narrative.  Their narrative was the banks needed to be saved and it was reflected in their choice of the Japanese Model to respond to the crisis.  Under this model, banks are protected from losses and it is the real economy that has to adjust.  The adjustment the real economy makes to having the burden of excess debt placed on it is stagnation.  Stagnation the Committee tried to overcome with fiscal stimulus and accommodative monetary policy.  In do so, they created a host of other problems like a dramatic growth in inequality.

A decade later, the authors are still wrestling with this false narrative.

At that time, we and our colleague Robert Dugger argued that a much more effective and fair use of taxpayers’ money would be to reduce the value of mortgages held by ordinary Americans to reflect the decline in home prices and to inject capital into the financial institutions that would become undercapitalised. Because equity could support a balance sheet that would have been 20 times larger, $700bn could have gone a long way toward restoring a healthy financial system.

The authors recognize the Swedish Model is the way to respond to a financial crisis.  Under this model, banks are required to recognize their losses on the excess debt in the financial system upfront.  This protects the real economy and allows it to continue to grow.

However, the authors are trapped by the save the banks narrative.  They too want to inject capital into the financial institutions so they can continue to lend.

Injecting taxpayer funds as equity capital into the banks is never necessary.  As a result of the Great Depression, the financial system was redesigned in the 1930s to support choosing the Swedish Model.  Part of the redesign was creating the combination of deposit insurance and the lender of last resort.  Together, they allow an insolvent bank to continue operating and making loans to the real economy until such time as it either becomes solvent again or is closed by the regulators (see US Savings & Loans in the 1980s).

But that isn’t the only place the authors are trapped by the save the banks creditor friendly narrative.

We did recognise a problem with our proposal: providing relief to over-indebted mortgage holders would have encountered resistance from the many homeowners who had not taken out a mortgage.

Iceland demonstrated how to handle this problem.  Mortgage debt was written down to the greater of what the borrower could afford to pay or an independent third party would pay for the property.  Doing this has two benefits.  First, the borrower doesn’t receive some sort of equity windfall.  They effectively have zero equity in the house, but now face payments they can afford to make.   Second, it keeps property prices higher than any other alternative.

Despite being trapped by a false narrative, the authors recognized the cost of pursuing the wrong response to the financial crisis.

We believe a critical opportunity was missed when the balance of the burden of adjustment was tilted heavily in favour of creditors relative to debtors in the response to the crisis and that this contributed to the prolonged stagnation that followed the crisis. The long-term social and political ramifications of this missed opportunity have been profound.

While you cannot go back and change the policy response.  The authors could take a step towards assuring the response will do no further damage.

That step would be supporting the Transparency Label Initiative and restoring market discipline on both bankers and policymakers.