Fragile by Design

Fragile by Design: The Political Origins of Banking Crises and Scarce Credit

CHARLES W. CALOMIRIS
STEPHEN H. HABER
Copyright Date: 2014
Pages: 624
https://www.jstor.org/stable/j.ctt5hhpfs
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  • Book Info
    Fragile by Design
    Book Description:

    Why are banking systems unstable in so many countries--but not in others? The United States has had twelve systemic banking crises since 1840, while Canada has had none. The banking systems of Mexico and Brazil have not only been crisis prone but have provided miniscule amounts of credit to business enterprises and households. Analyzing the political and banking history of the United Kingdom, the United States, Canada, Mexico, and Brazil through several centuries,Fragile by Designdemonstrates that chronic banking crises and scarce credit are not accidents due to unforeseen circumstances. Rather, these fluctuations result from the complex bargains made between politicians, bankers, bank shareholders, depositors, debtors, and taxpayers. The well-being of banking systems depends on the abilities of political institutions to balance and limit how coalitions of these various groups influence government regulations.

    Fragile by Designis a revealing exploration of the ways that politics inevitably intrudes into bank regulation. Charles Calomiris and Stephen Haber combine political history and economics to examine how coalitions of politicians, bankers, and other interest groups form, why some endure while others are undermined, and how they generate policies that determine who gets to be a banker, who has access to credit, and who pays for bank bailouts and rescues.

    eISBN: 978-1-4008-4992-5
    Subjects: Finance, Political Science, Economics

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. PREFACE
    (pp. ix-xii)
  4. SECTION ONE No Banks without States, and No States without Banks
    • 1 If Stable and Efficient Banks Are Such a Good Idea, Why Are They So Rare?
      (pp. 3-26)

      Everyone knows that life isn’t fair, that “politics matters.” We say it when our favorite movie loses out at the Academy Awards. We say it when the dolt in the cubicle down the hall, who plays golf with the boss, gets the promotion we deserved. We say it when bridges to nowhere are built because a powerful senator brings federal infrastructure dollars to his home state. And we say it when well-connected entrepreneurs obtain billions in government subsidies to build factories that never stand a chance of becoming competitive enterprises.

      We recognize that politics is everywhere, but somehow we believe...

    • 2 The Game of Bank Bargains
      (pp. 27-59)

      Every reader of this book doubtless has at least one bank account. Most of us give little, if any, thought to the security of those accounts or the solvency of the banks where they are located. This complacency is an outcome of a rather complicated set of institutional practices that have been hammered out over the past four centuries. Without those practices—which are enforced by governments—there would be very good reasons to lie awake at night worrying about our money, because a bank is, by design, a potentially unstable enterprise.

      This instability arises because the normal functioning of...

    • 3 Tools of Conquest and Survival: Why States Need Banks
      (pp. 60-83)

      Every nation-state has some form of government-chartered bank. Communist states have them. Democracies and autocracies have them. Even the sleaziest kleptocracies have them. The one exception proves the rule: Somalia, from 1990 to 2011, had no chartered banks. By then, however, it had ceased to be a functioning state; before its political collapse, it too had chartered banks.¹ Even states without armies—Costa Rica, for example—and those that do not tax the income, wealth, or consumption of their citizens—like Kuwait—still have chartered banks.²

      Why are banks so essential to statehood that they are more ubiquitous than armies...

    • 4 Privileges with Burdens: War, Empire, and the Monopoly Structure of English Banking
      (pp. 84-104)

      Visitors to contemporary London cannot fail to note its stature as a world financial capital. It is the home base for more than 500 banks, including a number of global giants such as NatWest, HSBC, and Barclays. It hosts one of the world’s most active stock markets and some of its oldest and most important insurance companies, such as Lloyd’s of London. Britain’s imposing central bank, the Bank of England, has operated continuously in London since 1694. The British financial sector employs 4 out of every 100 British workers. It accounts for 10 percent of British national income, a contribution...

    • 5 Banks and Democracy: Britain in the Nineteenth and Twentieth Centuries
      (pp. 105-150)

      Britain’s Game of Bank Bargains had been played in the eighteenth and early nineteenth centuries by a very small sliver of the population, one that was not particularly concerned about the effects of government policies on the ability of common people to obtain bank credit. After the end of the Napoleonic Wars, however, that elite group gradually lost control of the game.

      Changes in the technology of warfare, beginning in the Napoleonic Wars and accelerating in the decades leading up to World War I, induced changes in Britain’s narrowly defined suffrage rules, which dated from the fifteenth century. A series...

  5. SECTION TWO The Cost of Banker-Populist Alliances:: The United States versus Canada
    • 6 Crippled by Populism: U.S. Banking from Colonial Times to 1990
      (pp. 153-202)

      Understanding how outcomes vary in the Game of Bank Bargains is a central purpose of this book. Each country’s rules of the game differ, as do the specific identities of the players and their stakes in the game. Governments always get their share of the benefits from playing the game, and the coalitions that forge a winning bargain with the government split the remainder.

      The United States is no exception to this general principle. From the time of the Revolutionary War through the early nineteenth century, the dominant coalition was composed of political elites in both federal and state governments,...

    • 7 The New U.S. Bank Bargain: Megabanks, Urban Activists, and the Erosion of Mortgage Standards
      (pp. 203-255)

      The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, by knocking down the last barriers to interstate banking, marked the demise of the unlikely coalition between unit banks and agrarian populists. The United States was now finally in a position to have a banking structure that was not fragile by design: instead of tens of thousands of unit banks that could not spread risk across regions, it could have a more stable system consisting mainly of larger banks, each with hundreds or thousands of branches. Within a few years of the passage of Riegle-Neal, those possibilities were realized in...

    • 8 Leverage, Regulatory Failure, and the Subprime Crisis
      (pp. 256-282)

      In the previous chapter we explore how an unlikely coalition of mega-banks and urban activist groups took shape over roughly two decades prior to 2007, and we show how that coalition came to control American housing-finance policies. One secret of its success was its ability to draw in other unlikely partners, such as the managers and shareholders of Fannie Mae and Freddie Mac, a number of large mortgage originators such as Countrywide Financial, and influential politicians on both sides of the aisle.

      One of the principal accomplishments of that coalition was to bring about a dramatic decline in the underwriting...

    • 9 Durable Partners: Politics and Banking in Canada
      (pp. 283-328)

      Citizens of the United States, much like the British character Ruth in the movieThe Girl in the Café,often make fun of our purportedly dull neighbors to the north. Canadians don’t seem to mind too much. After all, dullness can be a blessing. During the 2007–09 financial crisis, hundreds of banks failed in the United States, and the Federal Reserve and treasury had to marshal massive quantities of taxpayer dollars in loans, guarantees, and bailouts to prevent the collapse of still more—including some of the very largest. Canada’s banks, however, never came under severe pressure and never...

  6. SECTION THREE Authoritarianism, Democratic Transitions, and the Game of Bank Bargains
    • 10 Mexico: Chaos Makes Cronyism Look Good
      (pp. 331-365)

      Our theoretical framework for understanding the structure and performance of banking systems within autocratic political systems incorporates a number of principles. First, there can be no banking system without a stable government. Second, centralizing authoritarian governments can expropriate their banking systems with ease, which tends to make their banking systems smaller than those of democracies. Third, authoritarian governments and bankers can align their incentives by forming a rent-generating partnership. The experience of Mexico illustrates every one of these principles. Since 1997, Mexico’s transition from a centralized authoritarian state to a fledgling democracy has had a dramatic impact on the political...

    • 11 When Autocracy Fails: Banking and Politics in Mexico since 1982
      (pp. 366-389)

      Mexico’s bankers had always been wary of the Partido Revolucionario Institucional (PRI). They knew that the bargain that they had struck with the party was little more than an alliance of convenience. That wariness proved to be well founded. In 1982, President José López Portillo expropriated the banking system with the stroke of a pen. For the next nine years, the banking system basically existed to finance federal government deficits, to channel credit to state-owned firms, and to provide finance for politically crucial producer and consumer groups based on criteria other than economic viability. The economy went into a tailspin....

    • 12 Inflation Machines: Banking and State Finance in Imperial Brazil
      (pp. 390-414)

      Every country has a claim to fame. Large, diverse countries like Brazil have more than one. Soccer, coffee, and samba come to mind. So does inflation. Over the past two centuries, Brazil’s average rate of inflation has been among the highest of any country in the world. At its peak, in 1993, it hit a staggering 2,477 percent per year.

      Brazil’s inflation rate has waxed and waned over time. As figures 12.1 and 12.2 show, inflation was significant throughout the 1820s, in the early 1890s, and from the mid-1950s to the mid-1990s. It was relatively weak from 1830 to 1889...

    • 13 The Democratic Consequences of Inflation-Tax Banking in Brazil
      (pp. 415-448)

      An overarching theme of this book is that political circumstances define the nature of the Game of Bank Bargains, which in turn, defines the types of banks that can arise in a society. Chapter 12 shows that the persistently weak, autocratic government of colonial and imperial Brazil gave it a small and unstable banking system. To the extent that nationally chartered banks existed, their main function was state finance, which they performed primarily by levying an inflation tax.

      In this chapter, we review the downfall of Brazil’s royalty and the rise of democracy. The transition was not smooth. The Old...

  7. SECTION FOUR Going beyond Structural Narratives
    • 14 Traveling to Other Places: Is Our Sample Representative?
      (pp. 451-478)

      Economic analysis is all about determining causation. Economists want to understand the structure that connects observed facts. Structural models in economics seek to clearly identify the fundamental sources of shocks in the economy and explain how those shocks elicit the observed behavioral responses of individuals, corporations, governments, and bankers.

      To see how useful structural thinking can be, consider the confusion that results from its absence. The 2007–09 U.S. subprime crisis provides an example. Reporters typically listed contributory causes, and some of the assembled lists were extraordinarily long. But some of the items on those lists were symptoms of the...

    • 15 Reality Is a Plague on Many Houses
      (pp. 479-506)

      In chapter 2, we present a framework for thinking about the connections between different sets of political preconditions and the extent to which banking systems achieve abundant and stable bank credit. We show how banking systems arise from a process of political bargaining that we call the Game of Bank Bargains. That game is one in which parties with diverging interests come together to form coalitions that determine what sorts of banks will be created and how they will function. The historical narratives in this book demonstrate the usefulness of those categories by showing how the logic of bargaining applies...

  8. REFERENCES
    (pp. 507-548)
  9. INDEX
    (pp. 549-570)
  10. Back Matter
    (pp. 571-572)