“Nobody has found an email from a (big bank) CEO saying, “Go ahead, roll the dice. If the worst happens, we’ve always got the Fed.” Political scientist Jeffrey Friedman points out that 93% of the banks’ housing assets were Triple-A or government guaranteed, when the government’s own capital rules invited them to hold riskier, higher-yielding mortgage assets…

…Would large, complex and opaque banks exist if their creditors didn’t assume they were implicitly guaranteed by government in a general crisis? Probably not. And presumably nobody would argue that an implicit government guarantee wasn’t crucial in enabling Fannie and Freddie to scoop up Chinese surpluses and channel them into U.S. subprime….. We may regret that we don’t have a 19th-century banking system, where government takes no responsibility for panics and runs, and giant banks aren’t a global norm. We don’t. Let’s stop lying to ourselves about this. Let’s also notice something else: The big profits taxpayers made on the 2008 bailouts came about after Washington stabilized a financial system Washington did much to destabilize.”, Holman W. Jenkins, Jr., “Bank Bashing, the Modern Nero’s Fiddle”, The Wall Street Journal

Opinion

Bank Bashing, the Modern Nero’s Fiddle

Dodd-Frank and a rash of bank prosecutions have done nothing to make banks safer or more productive.

Photo: Getty Images

By Holman W. Jenkins, Jr.

Received wisdom about the 2008 financial crisis has not been faring well lately.

Peter Wallison, a scholar at the American Enterprise Institute, demonstrates in a new book that the subprime housing boom was fostered mainly by federal housing politics and policy, not by the rampant “deregulation” that many have imagined out of whole cloth.

Another revelation: The New York Fed staff, as we belatedly learned last year, prepared an analysis showing that Lehman at the time of its collapse was theoretically solvent after all—was suffering only a liquidity shortage. Which should not be surprising in retrospect, given that Lehman was stuffed with the same kind of assets that other institutions were stuffed with, which taxpayers bailed out at a nifty profit.

OK, what about “too big to fail”? Nobody has found an email from a CEO saying, “Go ahead, roll the dice. If the worst happens, we’ve always got the Fed.” Political scientist Jeffrey Friedman points out that 93% of the banks’ housing assets were Triple-A or government guaranteed, when the government’s own capital rules invited them to hold riskier, higher-yielding mortgage assets.

Would large, complex and opaque banks exist if their creditors didn’t assume they were implicitly guaranteed by government in a general crisis? Probably not. And presumably nobody would argue that an implicit government guarantee wasn’t crucial in enabling Fannie and Freddie to scoop up Chinese surpluses and channel them into U.S. subprime.

But otherwise TBTF is a culprit more in intuition than in evidence.

The key factors in 2008 were: a housing correction that alone would have been a ho-hum day in the U.S. economy, followed by a global panic due to uncertainty about how the U.S. government would treat financial institutions that held vast piles of now-illiquid but hardly worthless mortgage derivatives.

A sensible postcrisis response would have focused on housing reform plus bringing order to the government’s lender-of-last-resort responsibilities. Bank managements would have kicked themselves for not recognizing the risks entailed in the above-mentioned mortgage derivatives.

Instead, TBTF has been the be-all of postcrisis policy making. Banks have been shaken down for billions in settlements for selling Fannie and Freddie subprime loans they demanded. They’ve been criminalized for paperwork shortcuts in the resulting foreclosure tsunami, though the result was no material injustice to borrowers.

The 2010 Dodd-Frank law has certified various large institutions as “systemically important,” as prelude to burying them in costly regulation ostensibly for safety purposes but partly to divert lending to politically favored sectors. This hasn’t helped the economy. It probably hasn’t done much to make the financial system safer.

Worse, the law treats the efforts by the Federal Reserve and Treasury to calm the last crisis as the ultimate crime not to be repeated. You would think, judging from the anti-bailout rhetoric, we’d somehow conditioned our top-heavy financial system no longer to need a government liquidity backstop. (We haven’t.)

GE recently announced it would incur considerable expense to get rid of its profitable financial arm. The reason is not just heightened regulatory molestation, but the discovery that being in the banking business exposes GE to financial destabilization created in Washington. In a New York courtroom, a judge is seriously entertaining the question of why AIG was subjected to extortionate bailout terms in return essentially for the same guarantee that would soon be extended to GE, Morgan Stanley, Citigroup, Bank of America and the money-market fund industry pretty much gratis.

We may regret that we don’t have a 19th-century banking system, where government takes no responsibility for panics and runs, and giant banks aren’t a global norm. We don’t. Let’s stop lying to ourselves about this. Let’s also notice something else: The big profits taxpayers made on the 2008 bailouts came about after Washington stabilized a financial system Washington did much to destabilize.

Too big to fail is a regrettable condition but Dodd-Frank has changed very little except to inhibit a quick and effective response to the next global panic. And since a bigger panic is coming as the result of the unpayability world-wide of a great deal of government debt, it might be helpful to rethink the last experience.

Posted on June 2, 2015, in Postings. Bookmark the permalink. Leave a comment.

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