Keith Hennessey, Douglas Holtz-Eakin vote to remove phrases “Shadow Banking”, “Interconnectedness”, “Deregulation” from FCIC Report.

Why, oh why, can’t we have better Republicans thinking about the financial system?

So the Financial Crisis Inquiry Commission (FCIC), the bipartisan panel created to study and issue a report on the financial crisis, imploded. The four Republican appointees – Peter Wallison, Keith Hennessey, Bill Thomas and Douglas Holtz-Eakin – have decided to go it alone and issue their own report Wednesday. Politico, and the Wall Street Journal have more.

This will no doubt play into a “Democrats say one thing, Republicans say another thing, who can really tell?” narrative, but what is leaking out of the Republican worldview on the financial crisis is disturbing. Shahien Nasiripour, Financial Crisis Panel In Turmoil As Republicans Defect; Plan To Blame Government For Crisis, catches this gem:

During a private commission meeting last week, all four Republicans voted in favor of banning the phrases “Wall Street” and “shadow banking” and the words “interconnection” and “deregulation” from the panel’s final report, according to a person familiar with the matter and confirmed by Brooksley E. Born, one of the six commissioners who voted against the proposal.

“I think a number of us had really pulled for” bipartisan consensus, said Born, a Democratic commissioner who famously tried to regulate certain derivatives as head of the Commodity Futures Trading Commission. “But this action by the Republicans indicates they have decided to go their own way.”…

Hennessey and Holtz-Eakin, for example, have missed about half of the commission’s meetings since [early August], according to a person familiar with the panel’s activities.

Oh. My. God.

I did an interview for the Atlantic Business section about the shadow banking system with Perry Mehrling last year, who has now written a fantastic book about the subject, The New Lombard Street. Gary Gorton has written an influential paper, “Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007”, about this topic which is now also a fantastic book. Banks have well known problems, and one thing we’ve learned from the crisis is that you can provide maturity transformation – function just like a bank, have bank runs just like a bank – without hanging a sign with the word “bank” on your storefront.

How to deal with this, how to fully understand it even, is crucial to understanding the crisis and the way forward.  Here’s Gillian Tett covering a fascinating (and detailed) report by the Federal Reserve Bank of New York Staff Reports titled “Shadow Banking.” Every person I know interested in this topic is reading it, trying to understand the complicated nature of the topic;  the idea that the GOP would think this new crucial report shouldn’t be covered because of its name and topic is really disturbing.

Even if you think this narrative is overplayed it needs to be discussed and examined. That they would vote to not even use the words says all you need to know.

For fun, Keith Hennessey, October 17th, 2008, What caused this financial mess? (my bold):

Some of these large financial institutions were so big and so interconnected with other institutions, that their failure would create a domino effect. This is what we call “too big to fail”, which should more precisely be called “too big and interconnected to fail suddenly”.

Liquidity – Banks normally loan money to each other for short periods of time. But now Large Bank doesn’t want to lend to Big Bank, because Large Bank fears Big Bank might be insolvent and not be around to pay them back. So Large Bank charges Big Bank more (a higher interest rate) for this short-term borrowing. We have seen this in dramatic fashion as the interest rate that banks charge either, called the London Interbank Offerer Rate (LIBOR) has spiked up. Large Bank may shorten the term of their lending – being willing to loan to Big Bank overnight, but not for 30 days. In an extreme case, Large Bank may not lend at all to Big Bank. To oversimplify, banks don’t trust each other enough to lend. This breakdown in trust/confidence among large financial institutions is a core problem in our financial system. [Shadow bank run.]

I wonder if Hennessey is going to scrub his blog of words he doesn’t think are appropriate for describing the financial crisis – like “interconnected” – in the government report he is writing.

Krugman also comments.