It has been a decade since the acute phase of the Great Financial Crisis.  Yet it appears macroeconomics has learned nothing over the last ten years.

Peter Diamond offered the latest example of this lack of learning and showed a Nobel prize doesn’t grant immunity from PhD economist Derp by observing

Avoiding another Great Depression was the number one priority … The only way to do that was to rescue the banks, and they did that.

The lack of learning starts with “avoiding another Great Depression”.  Regular readers know this was part of the Committee to Save the Banks’ false narrative.  But the fact Mr. Diamond repeats it strongly suggests the macroeconomics profession didn’t bother to investigate if this was actually a possibility.

Even a cursory investigation would have shown it wasn’t a possibility.

Why?

Because the policymakers in the 1930s took steps to ensure it would not happen again.

These steps included creating automatic stabilizer programs.  Programs that Professor Paul Krugman said did more to reduce the severity of the recession than the economic stimulus package enacted by Congress.

The lack of learning by macroeconomists also includes the statement “the only way to do that was to rescue the banks”.  The steps the 1930s policymakers took eliminated the need to ever rescue the existing banks.  They did this by adopting deposit insurance.

Deposit insurance virtually eliminated retail depositor runs.

More importantly it ended a problem the Fed or any central bank has as a lender of last resort.  According to Walter Bagehot’s dictum, a lender of last resort is suppose to lend to solvent banks against good collateral at high rates.  The problem the Fed had in the 1930s  was determining if a bank was solvent or not.

Deposit insurance takes care of this problem.  Deposit insurance removes the risk of lending to even an insolvent bank with dodgy assets by transferring the risk of loss on the central bank’s loans to the taxpayer backed deposit insurance fund.  [The central bank isn’t limited to the initial collateral it receives in exchange for a loan.  It can request new and/or additional collateral.]

The FDR Administration adopted deposit insurance to get the Fed to use its lender of last resort function.  Freed from the risk of loss, the Fed was willing to provide all of the liquidity any bank that was reopened after the 1933 national bank holiday needed.

In 2008, there was no question the Fed could provide all the liquidity needed.  Particularly after the deposit guarantee was extended to cover much of the previously uninsured wholesale funding at the large banks.

Not only could the Fed provide all the liquidity needed, but the US Savings & Loan Crisis in the 1980s had shown the combination of deposit insurance and a lender of last resort allowed insolvent banks to stay open indefinitely and continue to support the real economy.  The only time these insolvent institutions closed was when the regulators closed them.

Deposit insurance had one more important benefit.  It redesigned the financial system so each bank needed its host country; but the host country didn’t need any specific bank.

The idea of rescuing the existing banks was BS from the very beginning.  Something I would have expected the macroeconomics profession to have discovered in the last decade.