Stockman (5) Main Street Banks

In his book The Great Deformation, David Stockman argues that the Main Street Banks were not at risk during the GFC. The Treasury and the Fed had claimed that if they had not acted, business pay rolls would be skipped and ATMs would go dark. This was a false panic.

The Main street commercial banking system was well insulated from the contagion on Wall Street. They held about $2 trillion of residential mortgages, but these were mostly prime quality, and they stayed in the loan book, rather than being sliced and diced into tradable securities. Any losses would be charged to loan reserves, not sold at fire-sale prices on the crashing market for securitised paper. Most of their business loans occupied the senior slot, or the highest ranking, in the borrowers business. The risk of less was modest.

The heart of the false panic was rooted in the money market mutual funds sector. Total short-term deposits at the time of the crisis had reached $3.8 trillion, so the run on these funds was scary. In practice, the run amounted to little more than movement of cash between different types of money market funds. The money flowed out of the funds that operated in commercial paper into the government only money market funds. The rest went into CDs and other band deposits, so the money remained in the banking system, not under the mattress.