You describe in the book how the ability to witness a bank run in person can affect the psychology behind the public’s (and the government’s) reaction to it. How is it different now that bank runs take place electronically and via phone rather than on the streets?
In a pre-deposit insurance bank run, people would line up at their banks to withdraw their cash. Everyone would see the lines and understand that this was a crisis. But still it took over a century in the U.S. before this problem was solved with deposit insurance, which by the way was a populist mandate. Everyone—except the American people—opposed deposit insurance because it was supposed to create “moral hazard.”
Things are worse now because the bank run of the recent crisis was not observed by outsiders. Most people did not observe it and have no idea what happened. This compounds the problem because it leads to effects being mistaken for causes. The run resulted in about $1.2 trillion being withdrawn from dealer banks, which then had to sell assets causing bond prices to plummet. Plunging bond prices caused losses for many firms, many of which failed. The failures were observed, but not the cause. So, the popular narratives focused on bad greedy bankers and other superficial explanations.
Okay, but you can’t be saying that “bad greedy bankers” played *no* role in the crisis, right? That issues like mortgage fraud, lax underwriting, misrepresentations by mortgage lenders to the GSEs, things like the Magnetar and Abacus cases and other items that we’re still picking through should be minimised?
If greedy bankers cause crises, we would have a crisis every week. The Quiet Period from 1934 (when deposit insurance was adopted in the US) until 2007, during which there were no systemic crises, is not explained as being due to non-greedy bankers. What, then, caused bankers to suddenly become greedy? In every crisis in history, it happens that fraud is uncovered. Partly this is due to the fact that everyone asks for their money, and sometimes it cannot be produced (as with Madoff). Other times it is the heightened scrutiny of the financial system that reveals these problems.
I am not saying that these problems are unimportant. But I am saying that an explanation of the recurrence of systemic financial crises throughout the history of market economies cannot be explained by greed or fraud, etc. These are not explanations of crises and they are not the central problem. We are talking about systemic crises: that is crises in which the entire financial system is at risk. In Bernanke’s testimony before the U.S. Financial Crisis Inquiry Commission, he said that 12 of the 13 largest financial firms in the US were about to fail. How exactly does greed cause that, but it did not during the Quiet Period?
But you also write, for instance, that historically many bank runs have started after credit-driven land price and real estate booms. It seems like mandating more prudential lending standards would help — if not prevent future bank runs, then make them less frequent or less severe.
I don’t think that will help. It is an inherent feature of private economies that they cannot create riskless debt. What is the proposed lending standard, that banks are only allowed to make riskless loans? The fact is that the economy needs and wants private bank money—short-term bank debt. Such debt cannot be completely riskless.
Bank runs, and thus financial crises, are inevitable in a system of fractional reserve banking. And we do indeed have to have FRB because we need to have maturity transformation.
So we\’re stuck with the idea that we will have financial crises. And it\’s got sod all to do with neoliberalism, the greediness of bankers or any of the other fashionable nostrums.