Politics, Banking and Where It Goes Wrong

Article excerpt

In "Fragile by Design," Charles W. Calomiris and Stephen H. Haber look to understand why some countries are so much more prone to crises than others.

Fragile By Design. The Political Origins of Banking Crises and Scarce Credit. By Charles W. Calomiris and Stephen H. Haber.570 pages. Princeton University Press. $35.

Five years after the drama that began in 2008 -- the failure of one bank after another, the decline in the stock market and the freezing up of finance -- we still cannot seem to agree about the causes of the crisis. There are some who like to pin all the blame on the corrupt business practices of Wall Street and the greed of bankers. Then there are those who think it was just one more example of the sort of irrational mass hysteria that gives rise to boom-and- bust cycles in financial markets. Still others focus on the inherent characteristics of banks that seem to make them especially vulnerable to investor panics -- the fact, for example, that their loans and investments cannot be liquidated in a hurry, while depositors can withdraw their cash with the click of a mouse.

In their brilliant new book, "Fragile by Design," Charles W. Calomiris of Columbia University and Stephen H. Haber of the Hoover Institution at Stanford take a wholly different approach. Why, the authors ask, are some countries so much more prone to crises than others? Why, for example, has Argentina had four in the last 40 years and Australia none? Why have the United States and Canada -- two countries that have a common culture and similar legal arrangements, and that share a fundamental belief in a tempered free- market capitalism -- had such different experiences with their banking industries? Since 1840 the United States has had 12 systemic banking crises and Canada has had none. The authors have a very simple answer: It all has to do with politics.

Mr. Calomiris and Mr. Haber argue that politics are baked into the banking business. On the one hand, the government sets the legal framework under which banks operate, regulates what they do and, most important, arbitrates the fraught question of how the losses among various contending interests -- borrowers, depositors, bond holders, shareholders and taxpayers -- are to be shared when a bank goes under.

On the other hand, the government often finds itself in a somewhat equivocal position when it comes to banks. For it is itself a big borrower and always in need of financing. Where better to turn to than the banks? In many countries, banks were originally licensed during the 17th and 18th centuries precisely so that financially pinched governments could raise money -- the two most notable instances being the Bank of England and the Banque de France. To this day banks remain not only a tempting source of cheap funding for governments but also, increasingly, vehicles for channeling politically motivated loans at subsidized rates to important constituents and special interests. There is ultimately no way of getting politics out of banking.

The focus on politics helps enormously in understanding the history of banks, as the examples of the United States and Canada show. In the United States, because of its federal structure, banking policy ended up largely in the hands of the states. As a consequence, it was political elites at the state level, typically small-town merchants and farmers, that came to dominate. The result, for most of American history, was a fragmented system of tiny banks that were highly vulnerable to local downturns and subject to frequent panics. …