From 1980 or so onward, however, that system gradually broke down, partly because of bank deregulation, but mainly because of the rise of “shadow banking”: institutions and practices — like financing long-term investments with overnight borrowing — that recreated the risks of old-fashioned banking but weren’t covered either by guarantees or by regulation. The result, by 2007, was a financial system as vulnerable to severe crisis as the system of 1930. And the crisis came.
Banking systems without deposit insurance are subject to runs. The modern banking system did not have deposit insurance on wholesale funding and as we found out, was subject to a run.
The solution to our problem is thus either having a system of deposit insurance for wholesale markets or….well, the only other alternative is to insist that there should be no wholesale funding.
And while I\’m well aware of things like moral hazard, not having wholesale funding looks like a much, much, more expensive proposition in the form of wealth not created.
Still, nice to have a Nobel Laureate on the liabilities tax side rather than the Robin Hood Tax side, isn\’t it?