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Home Publications Blogs Beat the Press Washington Post Confuses Saving the Financial Industry with Saving the Financial System

Washington Post Confuses Saving the Financial Industry with Saving the Financial System

Saturday, 30 March 2013 08:37

The Washington Post published excerpts from reporter Neil Irwin's new book, The Alchemists: Three Central Bankers and a World on Fire, under the headline, "three days that saved the world financial system." The headline is seriously misleading since it may cause readers to believe the world somehow would have lacked a financial system if the central bankers in Irwin's story had not succeeded in their efforts.

This is not true. Had a financial collapse actually been the outcome, the central banks had the ability to take over failed banks and restart the system. (This is what the FDIC does all the time.) We would most likely see something similar to what Argentina experienced when it defaulted on its debt in December 2001 and broke the link of its currency to the dollar or what Cyprus is seeing today.

Presumably banks would be shut for a relatively short period of time until the regulators could do some preliminary workarounds. Then people would only be allowed access to a limited portion of their deposits, as is now the case in Cyprus. This situation might persist for weeks or possibly months as more money would gradually be freed up for withdrawal.

If Argentina is viewed as the model, this situation would likely lead to a sharp downturn, but then a quick bounce back. By the summer of 2003 Argentina had made up all of the ground lost in the downturn. It was growing rapidly at the time and continued to grow rapidly until the world recession brought growth to a standstill in 2009.

Source: International Monetary Fund.

While the immediate hit from the financial collapse would have almost certainly been worse than what Europe and the rest of the world saw in the immediate wake of the initial euro zone crisis, the euro zone and world economy would almost certainly be much better off today if the central bankers had simply allowed the system to collapse. (This assumes that they are as competent as the economic policymakers in Argentina.)

In this sense, the heroes in Irwin's book can be seen as saving the bankers, who would have been wiped out in a financial collapse, but not really doing much to benefit the rest of society.

Comments (7)Add Comment
Don't Destroy the Village to Save It: Mega Banks are Too Big To Fail for a Reason
written by Last Mover, March 30, 2013 12:21
It's good to know that Neil Irwin has taken lessons learned from Vietnam and applied them to the financial industry. America cannot continue to destroy the financial village in order to save it.

Mega banks provide the same essential role in American society as villages did in Vietnam, providing vital economic services like asset bubbles, massive unemployment and outright theft of mortgaged homes from the American people themselves.

To casually allow their failure and government takeover is not to selectively destroy bad apple firms that dominant the industry while saving the system as claimed by Dean Baker.

Mega banks are like infrastructure, forming the foundation of capitalism itself. They cannot be separated from the likes of road, electric, water and communications infrastructure. When one goes down, they all go down.

Mega banks must be protected from failure at all costs -
especially systemic costs - in order to guarantee that the cost of failure is passed on to customers to the last dime, leaving them unscathed and healthy to inflict more costs to society in the future.

It's the American way. The bigger they are, the softer they fall.
Where are the mythbusters when we need them?
written by Perplexed, March 30, 2013 3:44
How is it possible that, right in the midst of all our "brilliant economists" and "superb investigative reporters" that this myth and cover-up have persisted for so long? Banks are nationalized quite frequently throughout history and there are very few fatalities of any sort associated with these nationalizations. Watching this unfold under the cover provided by most economists, politicians, and "newspeople" was extraordinary. 1st an entire industry is involved in a massive counterfeit fraud that leads to (or seriously exacerbates) an enormous "bubble" that ultimately vaporizes nearly $8Trillion of mostly middle class wealth. Then unprecedented public resources are used to save the fortunes of wealthy investors from bearing any losses from the disaster! No one is held to account, and then the 15% of population forcibly unemployed or underemployed are forced to absorb a $5Trillion+ ($6Trillion? $7Trillion) output gap with trivial (relative to their losses) compensation.

When will the economists who acquiesced in this cover-up start explaining to the public what really happened here? When will they explained that it was $30Trillion of public money and guarantees that "saved" the financial system? When will they explain that nationalization (and the same $30Trillion in commitments and funding) would have protected the public interest whereas the alternatives used instead protected private interests at a huge cost to the public? When will they explain that wiping out the debts of these failed institutions would have reduced the cost to the public (and especially the middle class who owned very little of it) of dealing with this crisis? When will they explain that purging these institutions of the criminals that conducted and benefited from the fraud would have been the best thing to do to protect the "public interest," When will they explain how it would have be easy to restore and implement regulations that would have protected the public interest had the banks been nationalized? When will they explain that, had the government taken over these institutions from the criminals operating them, these criminals would not have been in a position to extend their criminal behavior through a massive mortgage foreclosure fraud campaign that resulted in millions of fraudulent foreclosures?

When will they explain that, had the government prosecuted the mortgage fraudsters instead of leading the cover-up, the evidence of the magnitude of the fraud would have come out in the process? The courts could have then come up with a method to allocate the losses of a massive criminal fraud among the real estate owners, mortgage investors, and the public at large. Instead they chose to allocate 100% of the losses to the real estate equity holders (up to the amount of their equity and any other life savings), and only then would the "investors" (many of which were now banks which were in on the fraud from the start) be subjected to any loss of their "investment"?

When will they explain that had the banks been nationalized and saved with public funds, they could then have been broken up and sold to private investors; and that all of the gains would then accrue to the public instead of the private, bailed out, investors.

When the arsonist is viewed as having saved the structure from total loss because he helped drag out the fire hose (for a huge fee), we have been pretty thoroughly hoodwinked. Ponzi and Maddoff are amateur pick-pockets in comparison.
Cyprus Now? US Ever?
written by Union Member, March 30, 2013 9:37
We would most likely see something similar to what Argentina experienced when it defaulted on its debt in December 2001 and broke the link of its currency to the dollar or what Cyprus is seeing today.

Slightly off topic but our fearlessly adversarial press should demand of every public official - from Obama to Bernanke on down - that they go on record as to whether FDIC protected savings accounts could ever, under any circumstances, be taxed or confiscated or tampered with in any way, financial crisis or no financial crisis.

written by skeptonomist, March 31, 2013 11:40
Apparently Argentina may not be as far out of the woods as Dean thinks; Felix Salmon
claims that they are likely to default in 2013. I can't judge that claim (except that any prediction by an economist is subject to severe discount), but it may be that Argentina has been extended aid and credit partly on the hope that its creditors will eventually get some compensation. If that hope is finally denied Argentina may have problems in the future.
Vultures Circling Overhead
written by JP, March 31, 2013 5:13
The Argentina default goes back a long time. The suit is being brought by 2nd degree owners who bought up the bonds from those who would not accept Argentina's offers for a discounted byback.
For a reliable source of info regarding what is happening in Baja EEUU I rely on Otto at IncaKolaNews. He's not fond of Argentina as a place to put your money but even less fond of some of the predatory practices called "good business" by the vultures up here in the north.
Worth reading?
written by Chris Engel, April 01, 2013 3:19
Is Irwin's book even worth reading? I find some of his work at WonkBlog to be good, but he often parrots the line of neoliberals without providing context or adequate rebuttals.
Financial Industry vs. Financial System
written by The Form of the Good, April 01, 2013 7:56
Dear Dean,

Given your thesis here, how would this tie in with bank size--that desire to end too big to fail. Would smaller banks in this instance make such actions as nationalization of banks more logistically feasible, in addition to spreading the risk or limiting the contagion?

Or is bank concentration a benefit here?: taking over one big bank vs. a multiplicity of them?

But thanks for the clarification on the industry vs. the system.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.