The Financial Crisis and the Second Great Depression Myth
By Dean Baker
All knowledgeable DC types know that the TARP and Fed bailout of Wall Street banks five years ago saved us from a second Great Depression. Like most things known by knowledgeable Washington types, this is not true.
Just to remind folks, the Wall Street banks were on life support at that time. Bear Stearns, one of the five major investment banks, would have collapsed in March of 2008 if the Fed had not been able to arrange a rescue by offering guarantees on almost $30 billion in assets to J.P. Morgan. Fannie Mae and Freddie Mac both went belly up in September. The next week Lehman, another of the five major investment banks did go under. AIG, the countryís largest insurer was about to follow suit when the Fed and Treasury jury-rigged a rescue.
Without massive government assistance, it was a virtual certainty that the remaining three investment banks, Goldman Sachs, Morgan Stanley, and Merrill Lynch, were toast. Bank of America and Citigroup also were headed rapidly for the dustbin of history. It is certainly possible, if not likely, that the other two giant banks, Wells Fargo and J.P. Morgan, would have been sucked down in the maelstrom.
In short, if we allowed the magic of the market to do its work, we would have seen an end to Wall Street as we know it. The major banks would be in receivership. Instead of proferring economic advice to the president, the top executives of these banks would be left walking the streets and dodging indictments and lawsuits.
This was when they turned socialist on us. We got the TARP and infinite money and guarantees from the Fed, FDIC, and Treasury to keep the Wall Street crew in their expensive suits. All the politicians told us how painful it was for them to hand out this money to the wealthy, but the alternative was a Second Great Depression.
Itís not clear what these people think they mean, but letís work it through. Suppose that we did see a full meltdown. The commercial banks that handle checking and saving accounts and are responsible for most personal and business transactions would then be under control of the FDIC.
The FDIC takes banks over all the time. This would be more roadkill than it was accustomed to, but there is little reason to think that after a few days most of us would not be able to get to most of the money in our accounts and carry through normal transactions.
Credit conditions would likely be uncertain for business loans for some time, as in fact was the case even with the bailouts. Mortgage credit would have been provided by Fannie Mae and Freddie Mac, as has been the case since September of 2008.
One item deserving special attention in this respect is the commercial paper market. This is the market that most major businesses rely upon to meet regular payments like payroll and electric bills. When he was lobbying Congress for the TARP, Federal Reserve Board Chair Ben Bernanke said that this market was shutting down, which would in fact be disastrous for the economy.
What Bernanke neglected to mention was that he unilaterally had the ability to support the commercial paper market through the Fed. In fact he announced a special lending facility for exactly this purpose, the weekend after Congress approved the TARP.
It is also worth ridiculing people who say the government made a profit on its bailout loans. Itís true that most loans were repaid with interest. However these loans were made to favored borrowers (Wall Street banks) at far below the market interest rates at the time.
The Congressional Oversight Panel commissioned a study on the subsidies involved in just the first round of TARP loans. The study put the subsidies at a bit more than 30 percent of the money lent out, implying bank subsidies of almost $80 billion from just this small segment of the bailout. Adding in other loans and various implicit and explicit guarantees would certainly increase this number considerably.
But suppose we hadnít opened the governmentís wallet and instead let the banks drown in their own greed. Would we have faced a decade of double digit unemployment?
From an economic standpoint there would be no reason for concern. We know from the last Great Depression, the key to recovery from a period of weak demand is to have the government spend lots of money. We eventually got of the Great Depression by spending huge amounts of money on World War II. To get the economy jump-started this time we could have had massive spending on education, child care, rebuilding the infrastructure and making the economy more energy efficient. As Paul Krugman has repeatedly joked, if we need a political rationale for this spending we can say it is necessary to protect the United States from a Martian invasion.
Of course as a political matter, such massive spending could prove a tough sell given the present day politics. But that is a political argument, not an economic one.
Since we would be in uncharted water following this sort of collapse, no one can with a straight face claim they know how the politics would play out. We can separate out three camps.
First we have the folks who would like the government to spend enough to restore full employment, but argue the political opposition would be too great. These people have a coherent second Great Depression story, but based on politics, not economics. The bad guys would have forced us to endure a decade of double digit unemployment if we didnít rescue Wall Street.
Then we have the people who donít like government spending and would oppose efforts to boost the economy back to full employment. These people are saying that we would have faced a second Great Depression if we didnít rescue Wall Street because they would have insisted upon it.
Finally, there are Washington Very Serious People types like the Washington Post editorial page, who would go along with restarting the economy but only if accompanied by sharp cuts to programs like Social Security and Medicare. These people are hostage takers who are saying that if the country didnít bailout Wall Street, they would force it to endure a second Great Depression, unless it eviscerated essential programs that working people need.
So the long and short is that we only need to have worried about a Second Great Depression if the bad guys got their way. And most of the people who warn about a Second Great Depression were on the list of bad guys. The prospect of a second Great Depression was not a warning, it was a threat.
Next week I will explain why this downturn has been so long-lasting. The reason is actually far too simple for most economists to understand. As a result, there continues to be widespread confusion about the nature of the downturn.