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Bank Crises and Solutions Should Be At Least Somewhat Related

economyblog.ncpa.orgJuly 26, 2012

By Bob McTeer

My first crisis was the Maryland S&L Crisis in 1985. Its primary lesson for me was that there was little or no connection between its cause and the supposed lessons learned. That lesson continues to stand the test of time.

Briefly, Ohio had an S&L crisis that involved state-chartered, but privately insured, institutions. Soon people realized that Maryland also had state-chartered, privately insured, S&L’s. Without any evidence of problems either with the S&L’s or the insurer, but just because of the similarity to the situation in Ohio, a silent run began in Maryland. It grew until we had to close 122 institutions and import examiners from banking supervisors from all over the country to examine and reopen them one by one.

When you drain a lake, you find a few old tires and other rubbish at the bottom. The examiners found some irregularities in a few (very few) of the largest closed institutions. It was debatable whether they would have eventually led to serious problems, but it was clear that they didn’t cause the crisis at hand. Yet, the lesson learned by most was that it was a crisis caused by corruption.

I would submit that the primary cause of the recent banking crisis was the making of subprime mortgage loans that shouldn’t have been made and the securitization and sale of those loans in mortgage-backed securities. That was the cause of the crisis even though other factors—too much debt, leverage, too little capital, underpriced credit default swaps, and perhaps the structure of bonus plans that encouraged excessive risk taking, and more—added to the severity and scope of the crisis. Yet, these collateral factors have received all the attention in the post-crisis finger pointing and the drafting of the Dodd-Frank legislation.

The sub-prime loans were mostly not made by traditional commercial banks and their securitization was done by Wall Street investment banks; yet, the commercial banking system has been, and continues to be vilified, for the sins of a few, mostly others. Many or most of the 8,000 plus commercial banks were holders of the AAA-rated MBS’s and were thus victims of the crisis, not the villains.

What set me off is the recent blame pointed to the absence of Glass Steagall and recommendations to restore it. This is the second crisis wrongly blamed on Glass-Steagall, the first being the Great Depression, which gave rise to it. When its demise was debated several years ago, there was general consensus among economists that the combination of investment banks and commercial banks had nothing to do with the Depression. Now, once again, its restoration is touted as a cure for another crisis it had nothing to do with creating.

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