Former Fed chair Paul Volcker recently offered up his view that “we are in a hell of a mess in every direction”.  This mess is the direct result of the response to the Great Financial Crisis lead by the Committee to Save the Banks (Hank Paulson, Tim Geithner and Ben Bernanke).

Of course, the Committee members would say this isn’t true and besides you cannot know how an alternative response to the Great Financial Crisis would have worked out.  Of course, like their response to the crisis, this too would be wrong.

Why can I say they are wrong when you cannot re-run 2008?

Because you can compare the Committee’s response to the Paul Volcker lead response to the 1984 failure of Continental Illinois.

His handling of Continental Illinois resulted in a series of policy responses that would be used again and achieve the identical outcome during the acute phase of the Great Financial Crisis.  First, deposit insurance was extended to cover previously unsecured wholesale funding.  This included a Treasury program guaranteeing money market mutual funds.  This extension of “deposit insurance” ended bank runs by institutional investors.  Second, a financial regulator declare Continental Illinois solvent.  In 2009, the Fed did the same for all the Too Big to Fail banks.  In both cases, this calmed the financial markets that were worried about contagion to the other large banks.  In the case of Continental Illinois, the financial regulator didn’t even bother with the theatrics of a stress test.

What was dramatically different between Continental Illinois and the Great Financial Crisis was the outcome for the bank’s management and the investors in the banks.  In the case of Continental Illinois, its management lost their jobs and the investors in its shares lost 100% of their investment.  During the Great Financial Crisis, both the bankers and the investors in the Too Big to Fail banks were protected from losses of this magnitude.

And how was this different outcome for bankers and investors achieved?

Virtually every program pursued beyond what was necessary to handle Continental Illinois was done to protect the bankers and save investors in these banks.  Examples of these programs include TARP (the Troubled Asset Relief Program) the proceeds of which were used to bailout the banks.

Of course, in saving the banks, the Committee to Save the Banks threw the real economy and borrowers under the bus.

By design, these banks were suppose to absorb the losses on debt in excess of what the borrowers could afford to repay.  In its effort to save these banks, the Committee forced the burden of this excess debt onto the real economy and borrowers with predictable negative consequences for both.  The former slowed down and the latter went into foreclosure (or possibly worse, became debt zombies that made partial payment on their loans).