Economist Charles Calomiris examines the puzzling pervasiveness of dysfunctional banking, and argues that bank crises are often the predictable result of political bargains, and that these bargains are structured by a society’s fundamental political institutions.
July 14, 2014 By Charles Calomiris and Stephen Haber
Why are banking systems unstable in some countries – but not in others? Charles Calomiris and Stephen Haber use the examples of the United States and Canada to reveal how a mix of politicians, bankers and other interest groups make financial crises more likely to occur
Ken Dryden’s triumphs as goalie for the Montreal Canadiens — five Vezina Trophies; five Stanley Cups — are remembered today almost as keenly by almost as many Canadians as way back in the 1970s when he achieved them.
Afterwards, he went into politics, as a Liberal, and made it into the cabinet. He lost his seat in 2011.
Ever since, Dryden’s abiding goal has been to make Canada a better place.
Politicians here and elsewhere have made their name by attacking bankers’ greed, other countries’ mistakes, globalisation, deregulation, central bankers’ blindness, too loose monetary policy, you name it-except usually themselves. There is no denying that these issues matter and contributed to inflaming the 2008 crisis. All sorts of new ideas on how to make the system safer are constantly being suggested and many being implemented- increasing capital requirements; (forlorn) attempts to restrain bankers’ bonuses; ring-fencing retail and investment banking; abolishing proprietary dealing (the Volker rule); increasing competition; or setting up proper resolution regimes for ‘ too big to fail’ banks…
We get the banking systems we deserve or, more precisely, that our political systems choose. The US has had 12 systemic banking crises since 1840, while Canada has had none. In some cases, therefore, the outcome of political bargaining is stability and in other apparently not dissimilar cases it is instability. Better awareness of how the political forces work might lead to superior bargains. But this informative book does not leave the reader optimistic. It is hard to shift bad political equilibria…
Dodd-Frank has enshrined bailouts while pretending to get rid of them.
From Charles W. Calomiris and Stephen H. Haber’s new book “Fragile by Design: The Political Origins of Banking Crises and Scarce Credit”:
It is challenging to assemble a winning coalition of like-minded people able to overcome the opposition of those that already control banking policy. Crises may mobilize constituencies for change, but powerful interests often succeed in using the crisis to strengthen their power. That was the result in 1913, when the Federal Reserve was founded to facilitate the operation of a fragmented banking system rather than to address the structural problems of unit banking. In the 1930s, instead of addressing the vulnerability of the banking system to agricultural income fluctuations and unit banking—the primary sources of bank failures in the preceding years—bank regulatory reforms further protected small, rural banks by instituting federal deposit insurance and new regulatory limits on bank consolidation. The regulatory reforms of 1989-91 wound down insolvent savings and loan associations and tinkered with regulatory capital requirements without actually constraining banks’ and [government-sponsored enterprises’] abilities to undertake risk at public expense. In fact, banks made ample use of the new capital-requirements framework to build the hidden risks that revealed themselves in the 2007-09 subprime crisis. As of this writing, the reforms introduced in the wake of that crisis have done little to end the subsidization of housing risk, to prevent banks from continuing to abuse the same system of capital regulation to hide risks in the future, or to prevent too-big-to-fail bailouts. Indeed, Title 2 of the Dodd-Frank bill enshrined and institutionalized those bailouts while pretending to get rid of them.
“[The book] is a tour de force analyzing why banking, credit availability and banking crises vary so dramatically across countries.” The authors “make a persuasive case that among economically developed democracies, the U.S. has been uniquely prone to banking crises due to populist political influence since the early 19th century on the banking system.” — Eric Grover, principal at Intrepid Ventures
The mortgage market in Carney country is enviably dull – as is the broader financial system
Tim Geithner’s memoir, published last month, tells us of his life as a firefighter: constantly on call to extinguish a fresh blaze. His baptism of fire, as it were, was in the Mexican financial crisis of 1994: he gained more firefighting experience when called out to Thailand – followed in short order by South Korea then Russia. There was a period of recuperation until the mother and father of all conflagrations broke out close to his fire station. From his experience of these blazes, he warns us to keep a close eye out for any signs of flames and to apply overwhelming jets of water at every opportunity.
But there are many things wrong with this analogy. The fires in question are not natural phenomena, like hurricanes and earthquakes. They are the product of human agency – even more so than bush fires. And, although Mr Geithner has noticed that wherever he goes the same group of arsonists has been there ahead of him, he has nothing but disdain for “old testament moralists” who think it might be better to let some buildings and their occupants burn.
In addition, the stuff used to douse the fires is not cold water but a stream of liberal credit – precisely what set the blaze alight in the first place. Better, perhaps, to limit access to matches and petrol, and to construct firebreaks. Perhaps the problem is one for the police as well as the fire service. Handcuffs might be as useful as the fire hose.
A different account of the origins of financial crises is to be found in a recent book by Charles Calomiris and Stephen Haber. They begin with an obvious question, which Mr Geithner has not thought to ask. Why are financial crises common in the US, and even more so in its southern neighbour, Mexico, but almost unknown in Canada? . . .
Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, by Charles Calomiris and Stephen Haber, combining their scholarship of banking and political institutions, is a book full of fertile ideas, instructive histories of the evolution of a number of banking systems, and provocative interpretations of the co-dependency between banks and governments.