As the Committee to Save the Banks continues its tenth anniversary of the acute phase of the Great Financial Crisis tour, they have fully committed themselves to the narrative what they did in bailing out the banks was justified.  Why?  Because in their view it is hard to tell during a crisis if banks are encountering problems because of a shortage of liquidity or because they are truly insolvent.  Of course, this argument is complete BS and ignores how the US and global financial system is actually designed.

Regular readers know Paulson, Geithner and Bernanke deliberately undermined the social contract by choosing to save the bankers and the 1% rather than the real economy, borrowers and the 99%.  Since they made this decision, they have continued to offer up one easily debunked narrative after another to justify this terrible decision.  This difficulty determining if banks are facing a liquidity or solvency crisis is just another example of throwing jello against a wall and hoping something will stick.

In case you think I am being unfair, let me ask one question.  Do you think in the 1930s policymakers would not have addressed the issue banks can go out of business either because they have legitimate solvency issues or because bank runs force them out of business?

Of course they addressed this issue.  They didn’t fail to recognize one of the lasting impressions of the Great Depression was people rushing to take their money out a bank.  Ending this was a top priority for policymakers in the 1930s.

So what did they do to stop this happening again?

Shortly after the national bank holiday in 1933 they introduced deposit insurance.

With the introduction of deposit insurance, came two significant benefits.

First, it ended retail bank runs.  By simply keeping the amount of money you had at any bank below the government guaranteed amount, you had no reason to worry about the financial condition of the bank(s) you did business with.

Second, it made it possible for the Fed as the lender of last resort to extend credit to insolvent banks.  In effect, the deposit insurer guaranteed the Fed could not lose money lending to an insolvent bank.  This was important because from 1929 through March of 1933  the Fed was reluctant to act as a lender of last resort because it feared making loans to insolvent banks.

Said another way, in 1933 policymakers took the question “were banks facing a problem because of liquidity or insolvency” permanently off the table.  And by using deposit insurance, the policymakers allowed insolvent banks to continue to be closed when the regulators got around to it.

The Savings & Loan Crisis in the 1980s demonstrated the robustness of this financial system design.  Insolvent Savings & Loans continued in operation supporting the real economy for years until they were closed.  Please note, even though they were insolvent, these firms continued to make loans.  This is important because it confirms there was no reason for the BS about the need to recapitalize the banks via the taxpayers or the banks wouldn’t be able to lend.

In 2008, policymakers knew extending deposit insurance to the unsecured bank debt holders would end any run on what became known as the Too Big to Fail banks.  In fact, it is generally agreed the acute phase of the financial crisis ended when this occurred.

Unfortunately, the Committee to Save the Banks went beyond what was needed.  They took it upon themselves to lie about the condition of the banks.  The lies took the form of the stress tests.  Tests which Ben Bernanke acknowledged the government did not have access to the information it needed to know if the banks’ claims to solvency were true or not.

Of course, the choice made by the Committee to Save the Banks would not have been possible if the banks disclosed their current exposure details.  With this information, the market would have known which bankers were solvent and which were insolvent.