The Past Speaks

Financial historian John Turner has published a great blog post comparing the lacklustre response of policymakers to the 2008 financial crisis to the bold reforms Britain imposed in the aftermath of the 1825-6 banking crisis.

Speaking of the Lehman Brothers crisis, Turner remarks that

To find a British banking crisis of comparable magnitude we must go back as far as 1825. The UK has actually suffered surprisingly little banking instability in the intervening years. Even events which historians have traditionally classified as banking crises pale into insignificance when compared with the devastation of the 1820s.

Turner points out that effects on the real economy of the 1825-6 crisis were similar to that of the Lehman Brothers collapse. “GDP fell by more than 5.9% in 1826, a figure not dissimilar to the collapse in UK GDP in the year following the Lehman debacle.”

The government of Lord Liverpool acted quickly, decisively and radically in 1826. But the governments of Gordon Brown and David Cameron have acted slowly, indecisively and conservatively whenever it has come to the reform of the banking system. Despite parliamentary enquiries, the Independent Commission on Banking and the Turner Review, we have not seen a radical reform of the banking system; rather we have witnessed a tinkering with the pre-crisis regulatory regime.

The 1826 legislation resulted in stable banking as bank shareholders were unlimitedly liable for their bank’s debts. This constrained banks from taking excessive risk. After the global financial crisis of 2008, there has been no radical reform of banking and no attempt to make shareholders have more “skin the game” in the form of substantially higher capital, which would act as a check on excessive risk taking.

In my view, to understand the why governments in Britain, the United States, and other countries have failed to implement the obviously remedy (i.e., increasing the capital requirement for banks and forcing key players to have “more skin in the game”) we need to draw on public choice theory. To put it more bluntly, we need to ensure that there aren’t corrupt ties between the banks and the regulators. There is a revolving door connecting the regulators and the banks.

I recommend that everyone interested in this issue have a look at  Anat R. Admati and Martin F. Hellwig. The Bankers’ New Clothes: What’s Wrong with Banking and What to Do About It. Princeton: Princeton University Press, 2013. There was a recent EconTalk podcast that deals with this issue as well.

Here’s some speculation: Lord Liverpool’s administration was able to implement banking reform because its key personnel were landed aristocrats who weren’t expecting to get jobs with JPMorganChase after they left office.