The First Bank Run of the Non-Bank Bank Era | HughHewitt.com | 09.29.08

According to a late night email from the House GOP leadership, floor debate on the financial rescue bill may begin as early as 8am Eastern Time and will be limited to three hours.  So the House will almost certainly be discussing the bill by the time this column is posted.

No one needs to be told that this is unpopular legislation.  As of early last week, Rasmussen found a large plurality of Americans (44 percent) opposed to it, with only 25 percent in support. Opinion was moving against the proposal, and probably still is.

Among Republicans in the country as well as in Congress, skepticism has been particularly strong. GOP voter anger about overspending in Washington set the stage for the party’s losses in the 2006 elections. As early as summer of the year before, pollsters were picking up the dissatisfaction among Republicans nationwide with Congressional excesses, dissatisfaction that continues today. Until recently the House GOP caucus remained in denial about this anger in the base.  They aren’t now, which is one reason they put the brakes on the deal last Thursday.

Gallup reports that Barack Obama’s role in the crisis is viewed with greater approval than John McCain’s.  McCain’s actively constructive involvement combined with Obama’s aloofness may be the reason. McCain is positioned as a participant, and the American people are not happy with any of the participants.

Despite all this, fearing a meltdown of the global financial markets and its impact here at home, many, perhaps most, Republicans in Congress will support the bill. And they will be right to do so.

The seizing up of financial markets is not exclusively or even most importantly a problem for Wall Street.  Despite all the talk of bailouts of big banks and excessive salaries to their CEOs, Wall Street is nothing more than a go-between for those around the world who have money and those who can put it to constructive use – including every credit card and mortgage holder and every small and growing business in the United States.

It is not true that the current crisis and the proposed legislation are without recent precedence.  In the Savings & Loan bailout of the late 80s, the US government intervened to protect the integrity of the US and global banking systems.  The big difference is that the S&L crisis fit within the framework of the old banking system.

Since then, the US in particular has seen the rise of the so-called non-bank bank.  Unique in the world, most borrowing and lending for consumers and small businesses in the United States ultimately flows through the bond markets rather than staying on the balance sheets of the issuing bank. The bundling of consumer debt and mortgages and selling it both helps lower interest rates and expand credit access of borrowers and diversify the risk of lenders.  But, as we’ve learned in the past few months, this market diversification does not mean that we have escaped risks to the system as a whole.

What we are seeing today is the first bank run of the non-bank bank era.  Its cause is NOT what Congressional Democrats were peddling last night – the wages of deregulation.  As the Wall Street Journal editorial page has pointed out, deregulation has facilitated greater diversification, and the financial institutions that have taken the most advantage of it are the soundest.

Rather, as with most bank runs, among the primary causes is government actions, in this case the Fannie Mae and Freddie Mac fueled rush into sub-prime debt together with an historically long stretch of Federal Reserve decreed historically low interest rates.  In their successful resistance to the Fannie and Freddie reforms and regulations proposed by the Bush Administration and John McCain in 1995 and since, Barney Frank and Chris Dodd are the current mess’ creators.  They are also among the leaders of those pointing fingers at “the ideology of deregulation and unfettered markets.”  Every goat needs a scapegoat.

Still, if this were twenty years ago or earlier, whenever a banking crisis arose, the FDIC or the S&L equivalent would step in, taking very similar actions to the kind involved in today’s bill and no one would say much.  These institutions were in place to deal with panics and to keep them from spreading.  Now, for the first time, we are confronting an old-style panic in the new-style system, a system for which the old institutions were not designed.

Fed Chairman Ben Bernanke has written that bank panics produce a collapse of the money supply, as banks become less willing to lend against reserves.  What he and Treasury Secretary Henry Paulson have proposed and Congress appears ready to enact is an updating of vehicles for keeping such a collapse from occurring.

At a party several years ago for an aged Milton Friedman, Bernanke toasted Friedman, saying that, thanks to Friedman’s work linking money supply and economic growth, panics and recessions would never again produce a depression.  Today Congress is poised to confirm Bernanke’s prediction.

Clark S. Judge is managing director of the White House Writers Group and was a special assistant and speechwriter to President Reagan.