Big Banks, Baby!
By Staff News & Analysis - April 10, 2013

Why Canada Can Avoid Banking Crises and U.S. Can't Since 1790, the United States has suffered 16 banking crises. Canada has experienced zero — not even during the Great Depression. When it became a British colony, the majority of Canada's population was of French origin — and the French inhabitants hated the British government. It turns out Canada can thank the French for their stable system, according to a paper by Columbia University's Charles Calomiris, presented at the Atlanta Fed's 2013 Financial Markets Conference. – Wall Street Journal

Dominant Social Theme: If we can build them big enough, they won't fail.

Free-Market Analysis: Are we really supposed to believe that only large statist institutions can provide economic stability? That's what this article argues, anyway.

It is curious that it appears at a time when the US government is trying to dismantle its biggest banks, with legislators crying out that such banks have too much power and not enough risk.

Into the fray steps this academic paper arguing that bigger is better. It is not a new argument. After the famous Crash of 1987, the comparisons between Canadian and US banks were circulated, with many commenting approvingly about the bigness of the Canadian scale.

The conclusion to be reached, apparently, is that banking is a different business than any other and ought not to subject to the market's Invisible Hand for fear of destabilizing the larger economy. Here's more on this argument:

To keep the colony firmly within the Empire, British policymakers steered toward a government structure that would limit the power of the French-majority while also giving Canada more and more self-government. The eventual result was a highly-centralized federal government which controlled economic policy making and had built-in buffers for banker interests against populist forces, the paper argues.

That anti-populist political system — known in political science as liberal constitutionalism or liberal democracy — is a key ingredient in Canada's stable banking track record, Mr. Calomiris contends in his paper, which is a summary of a much longer book he's written with Stephen Haber due out in September. That's because this kind of political system makes it difficult for political majorities to gain control of the banking system for their own purposes, the authors contend.

Populist democracies like the U.S., on the other hand, tend to create dysfunctional banking systems because a majority of citizens gain control over banking regulation that steers credit to themselves and to their friends at the expense of the citizens that are excluded from the banking system, he said.

The contrast between the U.S. and Canada was part of Mr. Calomiris broader argument that dysfunctional banking systems — which are by far the norm rather than the exception around the world — are the result of political factors.

This last paragraph is especially revealing. Calomiris is blaming politics for destabilizing banking. This is a most anti-economic argument but nonetheless it is one that can be expected in the 21st century … as globalists struggle for justifications to protect their franchise. It is anti-economic because economists presumably will argue for market forces when it comes to building better economies and facilities of free-market enterprise.

Instead of explaining how the Invisible Hand of competition can help discipline and regulate the banking industry, Calomiris explores the issue using a diametrically opposed idea. He believes that it is politics that renders a banking system unstable because certain citizens steer credit to themselves at the expense of others.

At the same time, Calomiris is also promoting Canadian banks, with all their government affiliations, as a much superior model. Actually, this sounds like a technocratic argument. Calomiris is disapproving of politics, but not regulation.

"Smart economists with their regulatory ideas are sort of dead on arrival," he said. "Political coalitions will decide — not whether you've got the right VAR model — [but] whether a banking system is going to be set up with rules that will lead it to be stable and have abundant credit or not."

You see? Smart economists will approach the big table of banking with "regulatory ideas" but they will be dead on arrival. Politics will triumph over technocracy. The smart guys will lose out to the venal.

We do live in an Age of Sophistry. Solutions to the profound questions of the day are not, in fact, so difficult to discover. Competition – the Invisible Hand – is the only way to structure societies fairly and sustainably.

But academics like Calomiris are always available to provide another narrative. It is not competition that will discipline the market but "smart guys" with the right regulations.

There are perhaps a lot of reasons why Canadian banks have not suffered from the same sort of crises that supposedly have afflicted US banks. But we highly doubt it is "bigness" and associated governmental relationships that are among them.

After Thoughts

Competition is the cure. Do you think Calomiris gets around to mentioning that?

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