Senseless Panic: How Washington Failed America

From 1980 through 1991, some 3,000 banks and thrifts with today’s equivalent of $3.5 trillion of assets failed, including many of the largest in the country. Yet, the public's confidence in the banking system held and financial panic was averted. Contrast this result with the global financial panic that hit in the fall of 2008 and threatened to push the world into an economic depression.

In SENSELESS PANIC: How Washington Failed America (Wiley; June 2010; $24.95; 978-0-470-64036-4; Hardcover), author William Isaac, who headed The Federal Deposit Insurance Corporation (FDIC) during the financial crisis of the 1980s, describes what was different about the 2008 crisis that allowed the failure of a comparative handful of institutions to nearly shut down the worldwide financial system and proposes sweeping reforms to prevent future crises. He also challenges Congress to get it right this time instead of rushing to enact meaningless election-year reforms designed to placate an angry public still reeling from the massive taxpayer bailout of Wall Street.

Isaac, one of the foremost authorities on banking regulation, provides a riveting inside account of how regulators were able to navigate the treacherous economic and banking waters in the 1980s without creating a financial panic, identifies the misguided policy “fixes” put into place during the 1990s that directly led to the banking crisis of 2008, and then examines the reasons why this crisis developed into what he calls the “Senseless Panic of 2008.” Isaac, who strongly opposed enactment of the TARP bailout program and helped defeat it during its first vote in Congress, also discusses how TARP was poorly conceived and administered and how it did far more harm than good.

Isaac notes that the U.S. economy was in relatively good shape when the subprime mortgage crisis erupted in 2007. Consumer spending, GDP growth, consumer confidence, job creation, and other vital signs of the economic health were all positive and inflation and unemployment were low. So why did the economy falter so rapidly? It was the federal government’s actions that let a manageable situation deteriorate into a full-blown disaster, Isaac explains.

“The panic of 2008 was not created by resolving firms like Bear Stearns in a non-disruptive manner,” Isaac says. “The panic was caused by the schizophrenic manner in which the government handled various troubled firms, bailing out creditors and even shareholders and then giving big haircuts in the next transaction and back and forth. This behavior confused and rattled the markets.” 

For example:

• Why didn’t the government issue a temporary guarantee of Fannie Mae and Freddie Mac’s liability in order to restore confidence in them during the crisis? Until the government takeover of Fannie and Freddie, their preferred stock was considered to have almost as little risk as U.S. government securities. But the government wiped out preferred stock, which sent shock waves throughout the world and added fuel to the conflagration in the financial system.
• Why was Lehman Brothers allowed to go into bankruptcy in the middle of a worldwide financial crisis? The Lehman failure reinforced the perception that there was no coherent and consistent plan in place to keep things from spinning out of control.
• Why couldn’t existing bank creditors be persuaded to join in a rescue plan for AIG, particularly if the government had agreed to limit the risks? Why were the existing bank creditors of AIG bailed out and not required to give something in return?Isaac also offers critical policy measures for preventing the next financial crisis, such as reinstituting some of the Glass-Steagall Act provisions; consolidating and improving bank and thrift supervision; increasing capital, reserve, and liquidity requirements; eliminating procyclical rules; strengthening the SEC and the FDIC; and creating a FDIC-style resolution process could be used to address the failures of non-bank financial behemoths.

SENSELESS PANIC is an insightful analysis of what went wrong with the nation's banking system and a blunt indictment of United States fiscal and regulatory policies.