Posts this month
A blog on financial markets and their regulation
After the crisis, it is common for regulators to hold forth about the relative merits of different regulatory systems, but I was surprised to find Bernanke expound his thoughts about presidential and parliamentary systems of government. The Financial Crisis Inquiry Commission has released transcripts of a closed door session on November 17, 2009 with Ben Bernanke.
The problem was – well, to give you a broad perspective, around the world, the United States was the only country to lose a major firm. Everywhere else, countries were able to come in, intervene, prevent these failures.
And I think, politically speaking, this is one place where the parliamentary system probably worked better because the prime ministers and the parliamentary leadership were able to get together over the weekend, make decisions, and on Monday morning, able to take those choices. And, generally speaking, the central banks, although they were involved in Switzerland and other places, in finding solutions, were not leading the efforts to prevent the collapse of these institutions.
But in the United States, as you know – of course, we don’t have the political flexibility for the government – quote, unquote – to come together and make a fiscal commitment to prevent the collapse of a firm. And so basically, we had only one tool, and that tool was the ability of the Federal Reserve under 13(3) authority to lend money against collateral. Not to put capital into a company but only to lend against collateral. That, plus our ingenuity in trying to find merger partners, et cetera, was essentially all — that was our tool-kit. That’s all we had.
Bernanke is absolutely right that the parliamentary governments of Europe were able to act faster than the US. Where I would disagree is whether this was a good thing or not. The failure of the US Congress to pass the first version of TARP (assuming for a minute that it was a failure) was relatively minor compared to the hasty and catastrophic decision of Ireland to guarantee all the liabilities of its insolvent banks. All Irish citizens must be wishing that they had a US like system of checks and balances to prevent such a stupid decision being made so quickly and secretly.
The world’s oldest democracy, Iceland, was saved from Ireland’s disastrous fate only by the action of its president to allow the people to vote directly on the whether the government should assume the Icesave liabilities. The President’s declaration on that occasion is worth recalling:
Following the passing by the Althingi of the new Act on 30 December, the President has received a petition, signed by about a quarter of the electorate, calling for the Act to be subjected to a referendum.
It is the cornerstone of the constitutional structure of the Republic of Iceland that the people are the supreme judge of the validity of the law. Under the Constitution, which was passed on the foundation of the Republic in 1944, and which over 90% of the nation approved in a referendum, the power which formerly rested with the Althingi and the King was transferred to the people. It is then the responsibility of the President of the Republic to ensure that the nation can exercise this right.
It has steadily become more apparent that the people must be convinced that they themselves determine the future course. The involvement of the whole nation in the final decision is therefore the prerequisite for a successful solution, reconciliation and recovery.
In the light of all the aforesaid, I have decided, according to Article 26 of the Constitution, to refer this new Act to the people.
Now the people have the power and the responsibility in their hands.
What Bernanke seems to gloss over is that a decision to bail out a large bank is not a technocratic decision with an objectively optimal answer; it is an inherently political decision with massive redistributive consequences. It takes money away from one group of taxpayers to protect a group of bank depositors and creditors. This is not a decision to be made behind closed doors.
On the other hand, where the decision is essentially technocratic in nature, normal checks and balances do not stand in the way of a government that confronts a crisis. In nineteenth century England, the amount of notes that the Bank of England could issue was laid down by statute and the government did not have the powers to waive this requirement. That did not prevent governments from “suspending the Bank Act” in emergencies. For example during the crisis of 1857, the Prime Minister and Chancellor of the Exchequer wrote to the Bank of England as follows:
The discredit and distrust which have resulted from these events, and the withdrawal of a large amount of the paper circulation authorised by the existing Bank Acts, appear to Her Majesty’s Government to render it necessary for them to inform the directors of the Bank of England that if they should be unable in the present emergency to meet the demands for discounts and advances upon approved securities without exceeding the limits of their circulation prescribed by the Act of 1844, the Government will be prepared to propose to Parliament, upon its meeting, a Bill of Indemnity for any excess so issued.
Her Majesty’s Government are fully impressed with the importance of maintaining the letter of the law, even in a time of considerable mercantile difficulty; but they believe that, for the removal of apprehensions which have checked the course of monetary transactions, such a measure as is now contemplated has become necessary, and they rely upon the discretion and prudence of the directors for confining its operation within the strict limits of the exigencies of the case.
The British parliament passed the Act of Indemnity a month later and the suspension lasted for another 11 days. Most of the period of suspension was therefore without any statutory authority at all and depended entirely on the confidence of officials that parliament would act as promised. Such confidence in turn follows from the belief that the suspension of the Act was something that most reasonable people would agree with.
I believe that there is merit in constraining the ability of a handful of people to act secretly and hastily to bail out the financial elite. The checks and balances of the US constitution should be seen as a strength and not as a weakness. For the same reason, it is a good idea to separate bank supervision from the central bank. It makes it harder to cover up supervisory failures by using the vast resources of the central bank to bail out a failed bank.