Save the Banks, Save the Economy?

Paul Krugman has an excellent column this morning hitting many of the same themes we discuss in our new book. As he puts it:

In the end, the story of economic policy since 2008 has been that of a remarkable double standard. Bad loans always involve mistakes on both sides — if borrowers were irresponsible, so were the people who lent them money. But when crisis came, bankers were held harmless for their errors while families paid full price.

And refusing to help families in debt, it turns out, wasn’t just unfair; it was bad economics. Wall Street is back, but America isn’t, and the double standard is the main reason.

In some of the early reviews of our book, our argument is caricatured as saying we should have let the banks fail and we should have saved homeowners. We do not make such an extreme claim. In fact, we commend both Ben Bernanke and Tim Geithner for some of their policies that were directed at stopping dangerous runs in the banking system. We agree that bank runs threaten the payment system and the entire economy, and policies should be undertaken to prevent such runs.

The problem we have with the Geithner view of the world is that it is far too extreme — it is a “save the banks, save the economy” view which has been thoroughly discredited in both the United States and Europe. The fact that Geithner still adheres to this view despite all the evidence to the contrary is truly remarkable.

The problem with the economy in 2008 and 2009 is not that banks are not lending enough. It’s absurd to argue that we need more bank lending when demand is collapsing throughout the economy.

Here is the passage from our book that speaks on this issue:

When a financial crisis erupts, lawmakers and regulators must address problems in the banking system. They must work to prevent runs and preserve liquidity. But policy makers have gone much further, behaving as if the preservation of bank creditor and shareholder value is the only policy goal. The bank lending view has become so powerful that efforts to help home owners are immediately seen in an unfavorable light. This is unacceptable. The dramatic loss in wealth of indebted home owners is the key driver of severe recessions. Saving the banks won’t save the economy. Instead, bolstering the economy by attacking the levered-losses problem directly would save the banks.



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12 Responses to Save the Banks, Save the Economy?

  1. MRJoyce on May 19, 2014 at 10:58 ami

    My idea, in 2009, for fixing the economy was what I liked to call the “buy ‘em and burn ‘em” plan: the US Gov’t should spend a trillion dollars or so to buy up derelict or run-down properties and destroy them. This would have pumped much-needed funding into the RE industry (and into the hands of derelict property owners), supporting housing values and aggregate demand, and therefore also MBS values, and therefore also CDO values, etc. It would also have caused an enormous short squeeze on the likes of GS, DB, Magnetar and their ilk. Maybe even caused a little inflation. All good results. It might also have saved the banks, as they were leveraged to housing values, too.

    Geithner and his crew saw things differently.

    When something that seems obvious is nonetheless deemed politically impossible, it is usually instructive to remember that, before the Gov’t can ever do anything, first they have to want to. I believe that, in fact, they did what they intended to do, exactly as they intended, and they got the intended results. The only real question is, why were these the results they wanted?

  2. Ken Duncan on May 19, 2014 at 3:25 pmi

    I just finished reading your book. It is a great piece of work. Congratulations.

  3. csissoko on May 19, 2014 at 3:48 pmi

    What you’re missing is that the recent “save the banks” approach to emergency lending (as distinct from the “save the banking system” approach which has a long pedigree), means that the banks don’t need to work with borrowers to find the best outcome for the economy. Which as Brad DeLong points out is what should have happened:

    Because the TBTF banks know that Treasury has their backs, they are no longer incentivized to work with debtors or to worry about the long term performance of the economy and those to whom they lend.

    The current Panglossian financial theory is that it’s the government’s job to deal with long-term economic performance and the private sector bankers don’t need to worry themselves with such matters. 2008 was just a sign of what happens when such nonsense gets institutionalized.

    More on this view of the crisis here:

  4. theyenguy on May 19, 2014 at 6:51 pmi

    You write But policy makers have gone much further, behaving as if the preservation of bank creditor and shareholder value is the only policy goal.

    Yes Yes Yes, that is exactly what happened.

    You write further, This is unacceptable. The dramatic loss in wealth of indebted home owners is the key driver of severe recessions.

    Well so what! The Fed is comprised of bankers not homeowners, and was singularly concerned.

    You write further, Saving the banks won’t save the economy. Instead, bolstering the economy by attacking the levered-losses problem directly would save the banks.

    The Fed hasn’t been concerned the least about levered-losses, banks have been generating all kinds of leveraged loans of late, in fact they have started up with the CLOS again.

    In my blog, I have consistently written that with the Banking System having Excess Reserves the likelihood that the banks will be integrated with the US Fed and be known as the government banks or gov banks for short.

    I suggest that you and your readers consider looking through the spectacles of The economy of God, which the Apostle Paul presents in Ephesians 1:10, that Jesus Christ is the mastermind of the economy of God; that is that He is responsible for designing, maturing and completing all things economic in every paradigm and age. And that He built the very end of age of credit and age of currencies, with little regard for the worker and employment. He has had the greatest regard for the investor and investment gain; with the reason being He wanted to perfect moral hazard.

    The age of currencies, was fathered by Milton Friedman with his Free To Choose Manifesto, and the age of credit was fathered by Ben Bernanke with his QEs, Mario Draghi with his LTRO1, 2, and OMT, and Hiroki Kuroda, with this Abenomics. Each genius provided his own credit stimulus for trust in risk on investing; these birthed and defined the investor as the centerpiece of economic activity. Their provision of credit centered on providing seigniorage, that is moneyness, for investment gain, and very little for recovery from the Great Recession, and have resulted in peak moral hazard.

    Beginning the week ending May 16, 2014, an unwinding of the Euro Yen Currency Carry Trade, that is EURJPY in Ireland, EIRL, Greece, GREK, Italy, EWI, and a derisking out of the European Financials Debt Trade, EUFN, has terminated all liberal things worthy of trust, such as a university education, home buying, and fiat wealth investing, which have been based upon monetary policies of democratic nation state governance and schemes of credit provided for investment gain.

    Out of soon coming economic chaos, people will come to trust in new monetary and economic policies of regional economic governance and schemes of debt servitude to establish regional security, stability, and sustainability, where the debt serf will become the centerpiece of economic activity.

    • David Chittick on May 20, 2014 at 8:43 ami

      Last I knew Kuroda pitched for the Yanks.

      • Larry Signor on May 20, 2014 at 4:02 pmi

        Spectacular catch!

  5. dax on May 20, 2014 at 7:00 ami

    Obviously it was unfair to help the banks and not those in debt. But that’s doesn’t mean helping those in debt makes things fairer, because that might (and in fact would) have disadvantaged others. If you wanted to be fair, you wouldn’t have helped either the banks or debtors. You would have let the banks fail, you would have let debtors who couldn’t pay for their loans to lose their houses, you would have used deposit insurance to indemnify those who lost money up to the appropriate limit, you would have had the federal government create new banks so people could deposit their money. Any other solution, by changing the rules, would have been unfair, and what the federal government actually did was most unfair.

  6. Anon on May 20, 2014 at 11:16 ami

    “In some of the early reviews of our book, our argument is caricatured as saying we should have let the banks fail and we should have saved homeowners.” The headline of this NYT piece is an excellent example of such a caricature:

  7. Prof Fairchild on May 20, 2014 at 11:48 ami

    Excellent book brings recent data and wisdom of the ages to the issue. Wish you had included more about the RTC, created under Bush I to address the problems created by S&L reckless lending in the 1980′s

  8. DeDude on May 20, 2014 at 1:25 pmi

    The biggest problem was a misunderstanding that saving the banks require saving the banksters. The banks should have been saved the same way GM and Chrysler was. Government take over, leadership fired (for their obvious incompetence), loses carried by share and bond holders before a dime of government money is put into them.

  9. brian fotzpatrick on May 20, 2014 at 5:40 pmi

    You are missing the point. Under the no unintended consequences hypothesis, the economic collapse was the object of tbe housing crisis, in the works since Carter, and every subdequent Democratic president, force fed (like s Peking duck) sub prime loans on the banking complex. The subsequent world crisis creating the troubled wsters that make for good fishing in America’s drive for empire. For more see The Dark Side 1&2

  10. Davor on May 21, 2014 at 1:25 ami

    This is where the dogma of private capital is at its worst. If something is too big to fail, government should take it under administration, paying some minimal price to the current owners, firing all the executives without severance packages (set laws so that they have rights as in bankruptcy), stabilize and bail out the firm, and sell it on open market. So, such company is saved, cost to the taxpayers isn’t too extreme (selling price should cover most of the bailout, maybe even result in profit), owners would know that they aren’t shielded in case of bad decisions, but will lose everything, and executives would know that they can forget about their golden parachutes. So, economy saved, those in positions have clear incentive against the same behavior, and no matter how bad government management compared to private one is, it’s still cheaper than current bailout strategy.
    In effect, bankruptcy procedure, but one initiated and executed by the government.

    If it’s not too big to fail, than let it fail.