Banking Crises, Credit, and Political Institutions Stephen Haber Stanford University Presentation at ASOBANCARIA Medellín, Colombia April 4, 2013
Caveat Lector All of the material in this presentation is the result of work that I have coauthored with a number of distinguished colleagues. Stephen Haber, Noel Maurer, and Armando Razo, The Politics of Property Rights (Cambridge University Press 2003); Stephen Haber, Douglass North, and Barry Weingast, Political Institutions and Financial Development (Stanford Press, 2008); and most especially Charles Calomiris and Stephen Haber, Fragile by Design: Banking Crises, Scarce Credit, and Political Bargains (Princeton University Press, forthcoming). ---Buy our new book!
Lets start with the facts: Systemic Banking Crises are Endemic
Scarce credit is not randomly distributed (note the relationship between stable democracies and credit provision)
Exactly how many crisis-free, abundant credit countries are there, and what do they have in common? Singapore Malta Hong Kong, China Australia Canada New Zealand Half of these are small island or city states. The other half are democracies, two of which have liberal (anti-populist) constitutions.
How many high crisis, low credit countries are there--and what do they have in common? High crisis, very low credit: Chad, Democratic Republic of the Congo High crisis, low credit: Argentina, Bolivia, Brazil, Cameroon, the Central African Republic, Colombia, Costa Rica, Ecuador, Kenya, Mexico, Nigeria, the Philippines, Turkey, and Uruguay How many of these 16 countries have been stable democracies since 1970? Only 2: Colombia, Costa Rica.
What pattern is suggested? Non-democracies are systematically less likely to have stable banking systems that allocate credit broadly.
But, we should not think that democracy is a silver bullet
We therefore want to understand two patterns 1. Why does there seem to be a relationship between autocratic government and weak banking systems? 2. Why are some democracies more prone to banking crises than others?
The key to the answer: In order for there to be a banking system, three property rights problems have to be mitigated 1. Majority shareholders, minority shareholders, and depositors must be protected from expropriation by the government. 2. Depositors and minority shareholders must be protected from expropriation by majority shareholders. 3. Majority shareholders, depositors and minority shareholders must be protected from expropriation by debtors.
Solving these property rights problems is difficult, because they require the government (which has inherent conflicts of interest) 1. Governments simultaneously borrow from banks and regulate them. 2. Governments enforce debt contracts but need the political support of debtors 3. Governments distribute losses in the event of bank failure, but they need the political support of depositors
Autocracies can solve these property rights problems, but at a cost 1. Compensate shareholders for expropriation risk by creating barriers to entry that raise their rates of return. 2. Low levels of competition among banks creates weak incentives to search out new borrowers. 3. The threat of expropriation of depositors by bankers creates weak incentives for depositors to invest their wealth in banks. 4. The net effect is that most lending is insider lending.
A classic case: the banking system of Porfirian Mexico 35 30 The Mexican Banking Industry, 1897-1913 Number of Banks 25 Assets as % GDP 20 15 10 Deposits as % Assets 5-1897 1898 1899 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 Source: Anurio de Estadística Fiscal, 1912-13.
The structure of this system was highly uncompetitive Structure of the Mexican Banking Industry 90% 80% BLM Banamex 70% 60% Market Shares 50% 40% 30% 20% 10% 0% 1896 1899 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 1912
Bank shareholders earned rents 2.50 Ratio of Market to Book Values (weighted average), Mexican Banks 2.00 1.50 1.00 0.50 0.00 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 Source: Maurer and Haber 2007.
And the banks mostly lent to their own directors Percent of non-government loans made to banks own boards of directors: Banamex 1886 to 1901 100% Mercantil de Veracruz 1898-1906 86% Coahuila, 1908 72% Durango, 1908 51% Mercantil de Monterrey, 1908 31% Nuevo León, 1908 29%
But the entire system was fragile to the identity of the parties in control of the government Ratio of Bank Assets to GDP, Mexico, 1897-1929 35% 30% 25% 20% 15% 10% 5% 0% 1897 1898 1899 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 1914 1915 1916 Haber, Razo, and Maurer 2003. 1917 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929
Why democracy, by itself, is not a solution: the problem of populism Democracy helps solve the problem of expropriation of the banks by the government But what is to keep debtors from voting for cheap credit and debt forgiveness? A smart banker can see this coming, and hence has an incentive to form a coalition with those debtors--against everyone else.
A classic example: the U.S. banking system from the 1820s to the 1980s
Technology and inflation killed this bizarre system
But American political institutions replaced one bizarre system with another We support the NationsBank acquisition of BankAmerica because they will make credit work for low and moderate income people and they will work with the community institutions. --George Butts, President of ACORN Housing, from his testimony to the Federal Reserve Board in support of the acquisition of BankAmerica by NationsBank, July 9 1998.
The curious coalition between megabanks and activist groups
These deals could only work if special purpose banks (Fannie and Freddie) were required to buy these loans
The nature of American political institutions required them to apply the same lending standards to everyone and anyone
The outcome is well-known
Why are Canadian political institutions so different from those of the U.S.?
Implications for Canada s governmentbanker partnership 1. Banking policy in Canada was centralized in the national government; while banking policy in the US was historically left to the states. 2. Canada has an unelected upper house of parliament that is not subject to term limits 3. In Canada populist banking proposals were always beaten back: Canada has had a system of a few large banks since 1817. 4. But an elected lower house means that Canadian banks cannot extract rents the way the cartelized Mexican banking system did. Bank charters are renewed every five years (ten years previously).
Takeaways 1. There is no getting politics out of bank regulation. Politics is baked in, and that explains why few countries achieve abundant and stable bank credit. 2. Positive change is possible, but only within the constraints imposed by a society s political institutions. (e.g., The USA cannot chose to have the Canadian banking system). 3. To learn more See Calomiris and Haber, Fragile by Design (forthcoming).