Historical Banking Crises and the Rules of the Game
December 7th, 2009
Attended an interesting talk today: “Historical Banking Crises and the Rules of the Game” by Professor Charles Calomiris, Columbia Business School. Sporadic notes below. See also this Weaving History thread on Financial Crises.
Notes
- One crisis with 20 different explanations. Need to sort these out a little.
- If banks are uninsured then in a recession banks cut their supply of loans
- Banks are facing losses, need to bulk up their balance sheet and can do it either by raising equity or cutting supply of loans. Former is hard so do the latter.
- Crisis aren’t just inherent to human nature or capitalism. “Crisis propensity reflects politically determined rules of the banking game that are conducive to crises:”
- industry setup that determines exposure of banks to risk
- absence of decent (effective and incentive compatible) central-banking (NB: 2 isn’t a big problem w/o 1)
- subsidization of risk by govt policies
- Panic = moments of severe sudden withdrawal that threatened the system. Observable variable: collective action by NY clearing banks
- In US (19th and early 20th c.): 1857, 1873, 1877, 1893, 1907 [ed: missing at least 2 and may have got wrong I think]
- All of 6 crises in US post civil war were all preceded by 50% increase in liabilities and 7% drop in stock market
- Britain: 1825, 1836, 1847, 1857, 1866 then none for over a century
- Solvency crisis: -ve net worth of failed bank > 1% of GDP
- 140 examples since 1978
- Rare in past: 4 in 1873-1913
- Australia: 1893 (10%)
- Argentina: 1890 (10%)
- Norway: 1900 (3%)
- Italy: 1893 (1%)
- Literature has converged in last 20 years to agree that safety-net provision on balance increases instability (rather than reducing it)
- Crucial reform in 1858 in UK following 1857 crisis. BoE would no longer intervene in bills market. In 1866 made good on this promise when largest bill discounter went bust (Overend and Gurney)
- Crisis origins:
- Loose money: CBs, flat yield curve … (but note not enough for a crisis on own)
- Housing subsidies delivered by leverage. F&F have $1.6 trillion out of $3 trillion total subprime. $350 billion cost on F&F alone.
- Huge buy-side agency problems
- Lots of buy-side people buying poor quality material for clients facility by big race-to-the-bottom at ratings agency
- Prudential regulation failure
- Everyone smart knew there was a subprime crisis in mid-2006.
- Long-term regulatory reforms
- Micro-prudential reform: focus on measurement of risk
- Credit rating agency reform
- Resolution policy/TBTF Problems
December 24th, 2009 at 5:47 pm
I’m curious whether the talk went into reasons behind the problem with safety-net provisions other than allowing lenders to “push the envelope” (i.e., use the safety net to take on more total risk, thus keeping their own risk constant). The problem is definitely more than even that very big reason, IMLO (In My Layman’s Opinion
.
When I can’t afford to responsibly buy a house myself, or build in a geologically unsound area (e.g., New Orleans), etc., why should I be taxed to pay for others to do so? Many of us in the States have realized that there’s little incentive to increase income under our progressive tax scheme (which punishes increases in income, keeping us ambitious poor from accumulating wealth). Thus, bank equity (and overall economic well-being) is suppressed…right?
I am also curious about reasoning given for the need for a strong central bank under industrialization.
As I mentioned, I am not an economist, so please forgive any misuse of technical terms.
Thank you.
January 12th, 2010 at 1:49 pm
The problem with the safety-net provisions is the one you identify: that it results in “moral-hazard” for banks (and depositors). The banks can take on more risk than they would have done otherwise as that risk isn’t just borne by them but also by other participants in the system (whoever is contributing to the deposit insurance fund), and, perhaps more importantly, depositors don’t need to monitor banks as closely because the deposits are insured.
The second question you raise about the impact of progressive taxation is much more complicated. Obviously, taxation has some negative impact on incentives. However, it provides for public goods, insurance (through health and unemployment provision) and some basic redistribution (there’s some, fairly weak evidence, on the relationship of inequality and growth …). Where a trade-off is made here is necessarily a complex question, and the answer will depend heavily on one’s preferences regarding the structure of society as well as one’s beliefs on matters such as the role of luck versus effort in life outcomes!