This is the Second Supply-Side Disaster: The First One Was 1990

07/22/2009 05:12 am ET | Updated May 25, 2011

Every time the Republican Party drives another nail in its coffin, you can almost hear Democrats mutter "never kill a man who's committing suicide."

It's painful, really. We're watching the spectacle of a rump party, abandoned by its rank-and-file, casting about for some magic words to bring back the glory days.

Meanwhile, it refuses to believe its core beliefs caused the problem--supply-side economics, especially.

This is sad, because so many Republicans are intelligent, educated patriots, and many of them really did believe supply-side economics worked. And many others were willing to give it a chance.

The proof being in the pudding, of course, it's now almost impossible to defend supply-side's deep tax cuts and minimal regulation, the result being that Republicans are without much belief system. The best the so-called "base" can do is double down and claim supply-side wasn't really tried.

This is like fanatics claiming the mountain didn't move because someone, somewhere, had insufficient faith--thus providing a reason to hunt down and punish the traitor.

The hope of the Republican base seems to be that the country will eventually forget that supply-side economics proved its harshest critics to be perfectly correct--that its real aim is to create a disaster, one that forces the government to shrink until America is more to the liking of the John Birch Society.

But what most Americans have never known is that the country was well on its way to that disaster in the late 1980s, when Reagan's supply-side tax cuts created what then seemed to be huge deficits, while lax financial regulation left most of the nation's banks insolvent.

The result was a secret bailout of the banks--still an official secret to this day--that George H.W. Bush began, and Bill Clinton finished.

That bailout could be kept secret because it was a lot smaller than the recent scandal; most banks just had too little regulatory capital, although a few very large banks, like Citibank and Chase Manhattan, were in serious danger of collapse, and only survived thanks to much quiet maneuver. Things were so bad that Citi's then-chairman, John Reed, offered to sell the bank to Sandy Weill, only to be turned down--Weill thought the deal too risky. Citi was eventually saved by the Saudis; Weill stepped in later. We know how that turned out.

In the event, the solution was ingenious. The Fed drove the Funds rate down, but kept Treasury yields 3 percentage points higher. Then the federal bank examiners came around, took the chairman to lunch, told him the bank was insolvent--no secret to the chairman--and mentioned that if he borrowed at the Funds rate and bought Treasuries, the bank would be solvent.

Banks all over the country took the plunge. This was why it was almost impossible, in the early 1990s, to borrow money. It triggered a steep recession, and home prices collapsed for almost a decade. But the system survived.

In other words, supply-side economics almost gave the Birchers what they wanted in 1988-92, but they were thwarted by a President who put country before party, or even himself.

And he paid the price; the bailout was a major reason Bush 41 was abandoned by the right wing of his own party. Plus, Wall Street poured out treasure against him, partly to elect Bill Clinton, and partly to avoid a possible President Dan Quayle, who could be trusted to go to the supply side; his parents, and Marilyn Quayle's parents, were both on the John Birch Society board.

Clinton and Robert Rubin, for all the second-guessing heaped on them now, finished the rescue, straightened out America's finances, and gave us eight years of prosperity. They even put Social Security's finances on a sound footing, since by law, federal budget surpluses are invested in US Treasuries, and deposited in the Social Security Trust Fund.

Then George W. Bush came along, made a deal with the people who'd betrayed his father--so much for W's promise to bring integrity back to the Oval Office--and threw everything in a cocked hat.

The chain of events that followed doesn't require repetition. Still, we have to admit that while we may have avoided the worst, the Republican Party's right wing--call it the John Birch Society, or what you will--did much of what they'd set out to do; we're well into the third year of their disaster.

Luckily, the common sense of the American People prevailed in the last election--said pudding being to nobody's taste--and we've been spared the spectacle of a Treasury Secretary Phil Gramm insisting the country should just let Mr. Market make everything better. Instead, we've got adults in charge.

What they're doing doesn't wow everybody: Many think the Obama plan just papers over a lot of big problems, when what's really needed is a new, FDR-type regulatory foundation.

But at least they're doing a lot of the right things: If Senator McCain had won, we'd probably still be in a sickening market plunge, and right wing Republicans would be telling us it was all Bill Clinton's fault.