[amazon_link id=”0691155240″ target=”_blank” ]Fragile by Design: The Political Origins of Banking Crises and Scarce Credit[/amazon_link] by Charles Calomiris and Stephen Haber is a fascinating exploration of the relationship between banking and politics, and raises some important questions. The bulk of the book is a series of historical narratives looking at the banking history of several countries – the US, UK, Canada, Mexico and Brazil. These histories are seen through the prism of the tight connection between finance and politics, in what the authors call the Game of Bank Bargains.

They argue that banking is inherently political because it is by design potentially unstable – pooling the money of many individuals to make loans to other people –  and depends on the enforcement of certain property rights by legal and political authorities to navigate the conflicting incentives. Three property rights challenges follow: the need for mechanisms to reduce the risk of government appropriation of banks’ assets (either outright, or through regulation, or by printing fiat money); mechanisms to protect depositors and shareholders from the banks’ managers channeling resources to themselves; and mechanisms to prevent borrowers from defaulting. Stability requires finding a balance between the conflicts of interest. It is rare – Canada is the exceptional case, having experienced no systemic crises since 1840 in contrast with the dozen in the US. Populist democracies and more autocratic governments make different types of political deal but both fail to balance the competing interests. Achieving a stable democracy with robust defences against populism is clearly a tricky tightrope act.

The historical narratives are very interesting and do underline the importance of the political context in shaping the banking system. As the final chapter points out, the narrative explanations do offer insights that general theoretical explanations of the financial crisis can not. The general theories fall into one of three categories: inherent structural mismatch of funds and the resulting liquidity risk; inter-connections between banks that give rise to spillovers and domino effects when one bank is in trouble; and the inherent operation of human nature with periods of over-optimism and myopia alternating with pessimism and retrenchment (the Kindleberger and Minsky version). What no general theory can do is explain the contrasting historical paths of the different countries. “The decisive influences determining whether the threats highlighted by these three theories will result in banking crises are political…. The extent of safety nets and prudential regulation are choices made by politicians, and in making those choices they are generally motivated by maximizing what is good for their own short-run political futures, not what is socially desirable in the long run.”

This seems completely persuasive to me. One gap in the book, however, is the part played by the globalization of finance and how that is related to the combination of national politics and international agreement. The historical narratives are entirely focused on the domestic politics of each country. However, globalization has obviously changed the political economy dynamic, even if only by making national politicians feel they face new constraints on their choices. The big global investment banks and the shadow banking sector are surely a key part of the story.

I do like the way the book ends: “As [amazon_link id=”0140437886″ target=”_blank” ]George Bernard Shaw said,[/amazon_link] ‘The reasonable man adapts himself to the world; the unreasonable man persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.’ Meaningful reform in a democracy depends on informed and stubborn unreasonableness.”

[amazon_image id=”0691155240″ link=”true” target=”_blank” size=”medium” ]Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (The Princeton Economic History of the Western World)[/amazon_image]   [amazon_image id=”0140437886″ link=”true” target=”_blank” size=”medium” ]Man and Superman: A Comedy and a Philosophy (Penguin Classics)[/amazon_image]