Banking sectors are defined not by their capital ratio and balance sheets, let alone their ability to generate various forms of financial products, some of which are so complex and exotic they are “sliced” and “diced” in various permutations to be sold to other banks and economic agencies. The root of banking or financial crises lies not in their numerous forms and shapes, but the politics of regulations. Charles W. Calomiris and Stephen H.Haber argue quite compellingly that American banks are built on weak foundations.
The political and regulatory sectors are all open to lobbying and influence-peddling. The sum total of these ‘intrusions’ are some 14 banking crises since 1840, with the largest banking and financial crisis happening in 2008. Since political influence had inordinately shaped the banking sector, some banks become “too important to fail,” (TITF) in the words of former British central banker Mervyn King, invariably, also “too important to jail.”
Canada, on the other hand, has not had any banking crisis since the 19th century, despite sharing a common language and border with America. The glaring contrast shores up the argument of the authors that there is something intrinsically wrong with the banking sector in America. But, banks also failed due to the failure to observe ‘macro-prudential’ factors.
Since the end of the Cold War, China has become the major economic producer in the world. Together with India, it has also introduced millions of surplus labor into the capitalist system, thus, depressing wages of people across the world. The world, in other words, has been operating according to the “China price.” When central banks in the West further resort to “inflation targeting” to manage the economy of the respective countries, the surplus savings in the entire financial and banking system becomes flush with money, thus, dragging the interest rates down to zero, if not negative.
When interest rates are unattractive, companies and consumers alike will shift their money to investing in properties and physical assets, thus, triggering a rise in property values. Consumers that are attracted to such quick returns, including, banks, will all converge on this sector, which in turn paves the way to a sub-prime crisis. The burst of the housing bubble will lead to a sharp fall in their prices.
Indeed, once deflationary pressures set in too quickly in the US, Japan, Europe and elsewhere, the entire banking sector is are caught in this financial midriff. While their high over-headwould impel them to seek any kind of marginal profits, banks are also operating in a sector of diminishing returns. “Fragile by Design,” has powerful explanatory currency. But, unless and until, it takes the Asian surplus savings and labor into the equation, it cannot completely account for the frequency of financial crises.