Top critical review
132 people found this helpful
Big achievements...and big flaws
on March 29, 2014
Calomiris and Haber tackle a very ambitious project here. They seek to do three things. First they offer a concise survey of the history of banking. Second, they advance a theory to explain why some countries have had much more stable banking systems than others. Third they attempt to use this theory to explain the recent financial crisis in the U.S.
In my opinion, they succeed brilliantly in most of the historical summary. They do a respectable job of advancing a theory of banking stability. Unfortunately they do a terrible job when they try to shoehorn the recent financial crisis into this theoretical framework. This is less surprising than it appears at first glance. Good historical analysis is always hardest to do with relatively current events.
Everyone's views about banking regulation are grounded in their personal opinions about economics and politics. I will not attempt to hide my opinions here but I hope to write a review that will be useful to potential readers of the book whether or not they share my opinions.
Good summaries of banking history are hard to find and this one is superb for the most part. The authors are excellent writers. They present their ideas in an articulate and engaging way. They avoid unnecessary jargon and build their theory in a clear and systematic way. They make effective use of analogies and often turn a memorable phrase. That said, there is enough detail and repetition here to limit the book's appeal to a mass audience.
The book's central thesis is that stable banking systems require democracy but not too much democracy. Those political systems that contain institutional checks on the populist tendency to expropriate the assets of the banking industry are the ones that have been the most stable. The U.S. is not seen as having passed this test. Governments and banks are seen as necessarily needing each other and co-evolving.
One of the strengths of the book is that the authors assume that everyone should be expected to act in their own interests given the incentives in place. No one is scapegoated and fixable problems are seen as residing in institutions and traditions rather than individuals or groups of individuals.
A central theme here is that, for most of American history, the instability of American banking has stemmed from a very durable political alliance between unit (single location) bankers and agrarian populists. This prevented the geographic diversification and the economies of scale that produced more stable banking systems in some other countries (notably Canada which is discussed in some detail).
So far so good. There is enough good stuff in what I have already described that almost anyone with a deep interest in the topic could profit from reading the book. In my opinion, the authors badly bungle the part where they analyze the recent financial crisis. This matters a lot because it is the very thing that creates most of the interest in the topic.
In the 1990's Calomiris and Haber maintain that mega-banks and the GSE's replaced unit bankers on the business side of a new result in "the game of bank bargains." They wanted the ability to branch and merge freely and use much more leverage. Again, so far so good.
The thing comes off the rails when they describe the other side of the new political coalition in the new "bank bargain." This they consider to be urban activist groups like ACORN seeking lower credit standards for their constituency of low income voters. The problem is that the arcane details of CRA banking regulations never were remotely comparable to the old agrarian populism when it came to turning out the vote. William Jennings Bryan got nominated for president three times on agrarian populism and every high school history student is still being taught about his "Cross of Gold" speech more than a century later. That is how potent and emotional a political issue the old agrarian populism was.
Contrast that with public knowledge about CRA. Try and find a low income voter today who even knows his Congressman's name. Then take that group and consider what percentage know his position on CRA regulation. I think 1% might be a good estimate and even that group might not vote on this single issue.
Calomiris and Haber put a lot of stock in the public hearings about CRA issues and bank mergers. Those hearings happened but they were just political theatre where everyone got to posture for their own political base. Those hearings were window dressing for a predetermined result. In reality none of the big financial institutions was EVER significantly frustrated by CRA. The real political bargain was between big financial institutions and Democratic and Republican political incumbents. The relevant payoff wasn't in votes or even cheap credit. It was in huge campaign contributions and lucrative consulting and lobbying jobs for the incumbents of both political parties.
A key point to remember is that most big financial institutions loaded up on much more exposure to risky mortgage debt than they were required to. When you get a ticket for going 100 MPH on the interstate it won't work to blame it on the 45 MPH minimum speed. They did it because they wanted to, not because they were forced to by low income voters acting through ACORN.
Why did they want to? Because top financial executives were hired, fired, and compensated based on their ability to show short term profits while taking on long term debt. Risky mortgage debt carried the highest interest rates and was therefore the most profitable in the short term. Top executives could, and sometimes did make tens of millions of dollars in a single year this way. They got to keep most of that money whether or not their companies later blew up and whether or not their companies were later bailed out. And if they wouldn't play that game they were at risk of being replace by someone who would.
That is the key perverse incentive in this story. That is the thing CRA regulated institutions had in common with the GSE's. And that is the thing they both had in common with AIG and Lehman and Bear and Countrywide and all the other non-CRA regulated institutions that got caught up in this. And that is the thing they all had in common with the European banks that got caught up in their own housing bubble and financial crash without CRA or Fannie or Freddie in their countries.
Calomiris and Haber do a lot of good work on historical analysis of banking in other countries but they are strangely silent on the housing bubble and financial crisis in many European countries. This is a big omission in a book that purports to discuss the most relevant foreign banking cases.
Why do they not even discuss the role of perverse incentives in executive compensation? Well, executive compensation is not much regulated by the government. The idea that a key perverse incentive that could not be blamed on government might arise in the marketplace seems to be genuinely beyond their imaginations. That is a big flaw in an otherwise fine book.