Fragile by Design

Calomiris and Haber’s “Fragile by Design”

The Political Origins of Banking Crises and Scarce Credit

(or Too Much to Know About Banking)

Banking and its political connections are far more complex than I had imagined. This is for many purposes the most interesting history book that I have read. This is the only history of political institutions I know with a sense of what can happen—what situations are stable. Most other history elaborates many situations while neglecting issues of their stability. As Archimedes nailed statics, the authors nail the political situation that can persist at least for a while. It does not provide a theory adequate to predict the future, but does show what political institutions are possible, how they relate to culture, all thru the perspective of banking institutions.

I feel a lack of attention to a very basic question that has nagged me since I was kid: Why banks? There are several functions I will collect here; the authors assume that all the readers know all of this: (in short: its where the money is)

for depositors:
- An alternative to the mattress—usually safer
- A way to earn interest.
- You can mail a check.
for borrowers
- for entrepreneurs
  - loans for adventures or gambles that some idea or plan will prove profitable. This makes sense since the entrepreneur may simply not know those with money (depositors or bank stock holders).
- Ordinary business people:
  - Turn collectables into money now.
- home buyers, car buyers, etc, (collateral)
  - buy now, pay later.
- for governments
  - sort of like for entrepreneurs but instead of ideas, exigencies of national consequence such as defense or (alas) aggression.
  - There is a separate regulation function here which needs to be addressed.
for stock holders
- Sort of like depositors but with more exposure to success of bank. Stock holders gain by bank profits and loose from bank losses. Depositors do not gain thru bank profits yet may loose thru excessive bank losses.
for bankers
- a job
- an obligation to:
  - be wise and give the appearance of wisdom,
  - to judge a borrower’s idea’s, competence and honesty,
  - appear well off, but not too well off.
for the government
- inflation tax
- exigent expenses
  - war
  - graft
  - social spending
for citizens and state
- a more prosperous economy.

There is a widely agreed upon idea that banks are to make loans to governments because the government needs the money, and to individuals and institutions because of interest and tolerable risk.

This vastly understates the relationship between banks and governments. That subject fills the book and is baroque. The book is more specifically about coalitions of the powerful, which defines government.

As I Read

L 300: The authors introduce their term “The Game of Bank Bargains”.

L 315: They promise to explain The Game and its rules—the players and the politics. The laws of the state are not the laws of The Game. The Game includes making the laws of the state.

L 424: Quote:

What is it about American political institutions that generates incentives for bankers and populists to search one another out and forge such powerful coalitions? (coalitions for lowering banking prudence regulations)

I suspect that it is partly a bank’s desire to make the populace into stake holders with equity in homes—thus proponents of property rights.

L 691: The Authors recount the ways that governments and banks are tied together.

L 831: The authors consider a regime with “absolute power” yet in a context of property rights where the money of potential bank investors is safe if they choose not to invest. This is realistic if those investors are foreign or if those assets are otherwise concealed. Bank assets in the form of international credits might mysteriously become useless but physical gold would retain its value.

This section is a good overview of the rôle of money in power politics.

L 953: This section especially relies on implicit banking rules that most educated people might guess are in place but for which I have no collective name. Nor do I know where to find such rules set down. I recognize the rules as I hear them enumerated as likely necessary. Banking axioms?

Throughout the word “rent” is used in the pejorative sense of “rent-seeking”. Several recent dictionaries lack this sense.

L 973: Quote:

Repressed banking systems are far from optimal, but they may be the best that the societies that create them can do under the political circumstances. The authors speak here of autocratic political systems. This is a summary of the reasoned analysis of banking in an autocratic state. Boiled down even further: Autocratic systems fail to benefit from competition within the state; too many decisions are made by fiat rather than upon merit.

L 1051: The authors contrast Liberal and Populist positions. Quote:

In the liberal conception of democracy, unless there are institutions that allow minorities to veto majorities, mass suffrage can, paradoxically, undermine the very goal of democracy—the existence of a free and just society. I do not recall seeing this idea spelled out clearly before. I wonder how broadly it is held, or even contemplated. Quote:

... they [the populists] believe that the function of voting is to allow society to divine the popular will and that satisfying the popular will is a moral imperative: it is inherently right and should be respected by government and embodied in social policy. This is certainly a contrast.

L 1110: Concerning the negatives of deposit insurance:

Doing so puts them [coalition of Bankers and Populists] in a position to ask for a government bailout in the short run and deposit insurance in the longer term. Both measures transfer the losses associated with debt forgiveness away from banks and onto taxpayers. I am confused here. The banks have no money to loose; that is why they cannot pay their depositors. There are certainly losses that are shifted to taxpayers. ‘Forgiveness’ seems like the wrong word. I thought that forgiveness was when someone who has money is forgiven the obligation to pay someone else. Is not a bank that falls back on deposit insurance thereby dissolved? Or is it like chapter 11 bankruptcy? Yes, with deposit insurance the bank can be less cautious in its risks and consequently yield bigger profits to its shareholders.

L 1926 Circa 1800: Quote:

Despite the high profitability of investment, the lack of credit meant that a manufacturing firm started by a tinkerer or inventor could grow only as fast as its owner could plow profits back into the firm. The government had granted the Bank of England monopoly rights and credit came at monopoly prices.

L 1970: Here begins portrayal of the Scotch banks.

L 2278: I must complain here that the authors have lapsed into banking jargon that sends me too often to the web to decipher. Quote:

In the nineteenth century, therefore, England’s merchants and manufacturers had to make do with a second-best option: a market in London for discounting bills, whose most important participants were the Bank of England, the country banks, the goldsmith banks, and independent “bill brokers.” Although this system provided increased access to credit in remote areas, it was inherently unstable as well as inefficient when compared to a system of large, nationwide banks. Small banks could not easily diversify their risks across geographic regions or across different types of borrowers; neither could bankers easily shift funds within the system in order to head off runs. The system was inefficient at channeling financial resources from locations of surplus deposits (relative to lending opportunities) to locations of surplus loan opportunities relative to deposits; it relied on a series of bilateral exchanges to accomplish that goal. In addition, the small goldsmith banks and country banks could not exploit scale economies in administration and accounting. Hitherto the book has been remarkably clear as to why things were as they were. Here there are too many moving parts for me to follow.

L 2820: Quote:

¹¹⁰

This is the only example of informal English I have noticed in the book. Well done.

L 3152: The author’s telling of early US politics hangs together as no other telling in my experience.

L 4162: The narrative is for about now (2014). I am waiting to see if what macroeconomic issues the authors raise.

L 4276: Quote: “Those individuals [US tax payers] were effectively subsidizing everyone else, but most of them did not understand the game as it was being played, or even realize that the house had dealt them in.”

L 4339: The authors are gradually showing their biases in their English. I share those biases.

L 4539: The author’s make clear that most arrangements between banks and states amount to disguised transfers.

L 4734: I had wondered in 2008 whether Freddie Mac had known what sorts of packages they were buying. The authors quote contemporaneous e-mails indicating that they knew well but instructions from above said to go ahead. Quote: “These warnings appear to have fallen on deaf ears, because politics was driving decision making.” Greenspan saw the problem and complained at length. He was ignored. He was not alone in speaking out.

L 4848: Quote: “Seiler [a government economist] concluded that much of the government’s subsidy to Fannie and Freddie was passed to their own stockholders rather than to homeowners in the form of lower mortgage interest rates.” Even Nader complained! I do not recall agreeing with even Nader’s rhetoric before. This off-the-books transfer reminds me of the Enron situation. Both republicans and democrats learned those tricks.

L 6690: The authors present Mexico as authoritarian. I think they are right. Their description of the coalitions is coherent and convincing. I would however be curious like to hear a presentation from the house historians, compatible, of course, with the uncontested external signals. I feel I am understanding a level of cause and effect that is absent from traditional histories.

L 7168: The authors speak of “Mexico’s organized labor movement”. I wonder what fraction of the laborers felt represented. This exceeds the resolving power of the author’s perspective.

L 7952:

Because the Brazilian population never had to be mobilized en masse to fight in defense of the state, a significant pressure that favored the expansion of the franchise in other countries was absent in Brazil. In the United States, by contrast, the existence of a heavily armed yeomanry was essential to the survival of the colonies in the seventeenth and eighteenth centuries, and thus even before independence American farmers had wrested the right to vote for colonial assemblies from the English government, many decades before English citizens obtained similar rights. That is a connection I had not made.

L 8159:

In 1850, the parliament passed a law precluding free access to land. The law specified that if a landowner could not provide documentation showing that his land was acquired through inheritance or grant, the land was forfeited and returned to the government for future sale. The law sounds like you could buy land for it would immediately be forfeit. In that case who would the government sell it to?

L 8800: One continuing question about the power of the elites: The authors say that their power was the threat to leave the country—with their wealth. What was the form of their wealth besides Brazilian land which they could not take? Profits from previous decades of agricultural activity, deposited in foreign banks, is a real possibility.

L9208:

Such a reader might argue that stable and efficient banking might foster democracy rather than vice versa, or that some unobserved factor might be causing both democracy and a stable, efficient banking sector. From my perspective this hardly matters about establishing cause and effect. We can all think of several cultural properties that support democracy. Any of them provide a suitable proxy for democracy in my mind.

L 9247: The authors argue well that government safety nets destabilize banking due to its encouragement of dangerous banking behavior. I like deposit insurance because I don’t have the time to consider my bank’s prudence. Bank surveillance is a new function that is needed but how do we pay the surveyors? The solutions I can imagine fail for a variety of conflicts of interest. Idea futures??

L 9844: The authors make some interesting points about the limits to the libertarian goals for banking. Here is a crude summary: Government is where the power is. Banks are where the money is. Money is power. That’s the root of the connection.

For the topic at hand this book does better at proposing reasons for events that seem coherent to me.

How does cell phone money fit into this picture?