“Major Strausser Has Been Shot. Round up the Usual Suspects”

—Claude Rains in Casablanca

“Casablanca”1 may have had a script fashioned on the fly, but some of its lines were epic. Unfortunately, rounding up the usual suspects has just been applied to the colossal failure of two banks, supported by their auditors very recently under current regulatory practices with a clean bill of health. How refreshing, to learn this after their prior equity holders were wiped out due to disastrous portfolio by their senior bank managers.

The continuing failure to write and administer proper financial regulation

The two usual “suspects” are the FED and the regulatory structure constructed after the disasters of 2001 and its recurrence of 2007-2009. Let’s get to the basics. Long ago, Milton Friedman told the JEC that his recommendations of a continual percentage increase in the money supply was not “theory.” It was practical advice to the FED not to behave as a counter-cyclical Central Bank. He argued for a stable monetary anchor. Instead, he told the Congress that the proper role of a Central Bank was to constantly focus on inflation and not to try to predict cyclical shifts in macro-economic behavior.

This FED, however, repeatedly shows itself to be politically astute at the expense of being a reliable monetary institution. It dramatically lowered interest rates to provide stimulus to an economy deeply troubled by Covid. Now, with the hindsight that the passage of time provides, many FED WATCHERS have told the FED that it was much too late in changing its zero-rate interest policy and got badly behind the curve in suppressing inflation. A poignant example of what Professor Friedman always warned us about once again. In theory, of course it would be a wonderful exercise if the FED could predict cyclical turning points and the appropriate lags in monetary policy so that the macroeconomy could avoid the ups and downs of the business cycle or the advent of a One-Off material shock like a pandemic. The evidence of that ability has yet to appear.

One might have supposed that the lessons of sending Bear Stearns into the arms of J P Morgan or subsidizing AIG’s failed portfolio management in 2008 might have changed the behavior of our Central Bankers—or that the monumental failure to bail out Lehman Brothers after the painful examples above—might have taught the FED and the Treasury about being late to the party. Sadly, regulatory “cures” such as Sarbanes-Oxley or Dodd-Frank were not good mentors to our regulators either.2 Those disasters were swept under the rug in the zeal of the Congress to fine-tune financial regulations that led to such poor results by external supervisors to monitor the financial sector of the economy. But again, we see that external monitoring is not timely and that auditing can be a paid-for service of “blessing” a client. KMPG was the auditor of both SVB and Signature Bank who gave these failed banks their approval. No doubt it was well paid for those efforts. Shades of 2008, once again depending on the auditing profession to miss the forest for the trees and get well paid while doing it.

Cardinal Talleyrand: Déjà vu

After Casablanca, my favorite reference is Talleyrand’ 1830’s summation of the French Bourbon rule leading up to the French Revolution. The witty Cardinal remarked, “They learned nothing and forgot nothing.”

We now hear the same nonsense from the Administration as it bails out unsecured demand depositors by creating a special provision to accept at face value the collateral of mid-term Treasury Bonds and Agency Debt taken on by the portfolio manager wizards. Those well paid managers thought they were maximizing shareholder value buying longer term debt with all the ‘fast money’ their depositor clients were taking in from Venture Capital. Monetary floods caused by FED-promoted zero interest rates seem wonderful until we see the damage caused at a later date. ‘Bourbonitis’ is a political virus for which our clever pharmaceutical manufacturers have not yet discovered a preventive vaccination. By the way, the disease is bi-partisan.

Bank Runs, Nash Equilibrium and Monetary Policy

The learning deficit in political economy is as long standing as the mordant humor of “Round up the Usual suspects.” Tax payers and voters should truly ask whether their governors in Congress and the Regulation Derby are doing the right job. And, it wouldn’t hurt for voters to be cynical over their answers or about the cost of bailouts.3

The monitoring process takes time and a random event intervenes to find the patient already suffering a fatal attack well before the monitoring process discovers and prevents the fatality. One wonders if the blame game will triumph over learning to be alert to the consequences of timing interest rate changes to perceived changes in macro-economic conditions. Some evidence of sales of equity stock awards by the managers at SVB prior to the huge bank runs that triggered their collapse will no doubt stimulate political accusations. Attempts to avoid such situations in the future would be more welcomed than current comments of our politicians. That is a minor lesson. The bigger lesson that surely will be too soon forgotten is how monetary policy can underwrite imprudent portfolio management.


  1. “Casablanca,” Warner Brothers, [1942] []
  2. As covered in my book, “Disorganized Crimes,” [2013]. []
  3. Diamond DW, Dybvig PH [1983]. “Bank runs, deposit insurance, and liquidity”. Journal of Political Economy91 {3}: 401–419. It is not to denigrate their contribution but to morn that our Congress and our bank regulators don’t seem to grasp the real lesson. The FED generally is late to the cyclical ups and downs of the economy, but so are the regulators. The Nobel citation is also humorous. “Their discoveries improved how society deals with financial crises”. Really? []

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