For the last decade, I have been pointing out funding guarantees ended the acute phase of the Great Financial Crisis.  The vast majority of programs adopted after the extension of the funding guarantees were done solely to save the existing banks.

Funding guarantees were first done in 1933 to end the run on the banks in the US*.  This took the form of deposit guarantees.  Funding guarantees were expanded from retail to wholesale funding in 1984 to end the run on Continental Illinois.

The use of extended funding guarantees in 2008 was not limited to the US.  It was done globally.

In another “How I saved the world from financial disaster” book, Kevin Rudd, the Australian prime minister during the acute phase of the crisis wrote:

We were sitting on the edge of a crisis of confidence which could turn into a [wider] run on one or another of the banks when they opened for business on Monday.

So what to do?

Why an unconditional deposit guarantee of course!

The response of Kevin Rudd’s government over the weekend of 11 and 12 October was informed by policy options mostly well prepared by the Treasury and the Council of Financial Regulators.

Decisions reached that weekend were taken against the backdrop of the Reserve Bank of Australia’s drastic 100 basis point cut in the cash rate target (on the Tuesday), lousy national accounts data for the June quarter, slumping equities markets (locally and globally) and the move by Ireland (on September 30) to make explicit guarantees over deposits and interbank funding.

The Irish angle was paramount, as Rudd explains: “The rest of the international community began to follow suit, led by the British, as funds began to flee to London-based Irish banks in order to obtain the security of the newly announced sovereign guarantee from Dublin.”

By this point, the Rudd government’s then-reliance on a yet to be legislated system of deposit insurance (announced back in June) lacked any relevance among the mass market, and a clear-cut guarantee on bank deposits was needed.

In one misstep, Rudd had (at the beginning of the month) ruled out a guarantee.

Rudd finally announced the deposit guarantee for all Australian banks and credit unions on the Sunday morning, the 12th of October.

This averted the otherwise imminent announcement by Suncorp that it would accept a low-ball takeover from ANZ. The guarantee also served to terminate, for a time, further rumour-mongering on the names of banks in strife.

* In 1933, the FDR Administration declared a national bank holiday to stop the bank runs.  The Administration noticed the Fed was not acting as a lender of last resort.  The Fed explained its inaction by pointing out the difficulty in determining if a bank is suffering from illiquidity or insolvency.  If it was insolvency, the Fed risked not getting the money back it lent to the bank.

To end this problem, the Administration promised to and did introduce deposit insurance.  Deposit insurance guaranteed the Fed would always be repaid.  It did this by putting the Fed’s secured loan ahead of depositors in liquidation.  The deposit insurance fund (aka the taxpayers) took on the risk of loss if the bank was insolvent.

With the issue of is it illiquidity or insolvency eliminated, the Fed acted as a lender of last resort the way it was designed to do.