Fragile by Design is James Madison for depressives—and he’s even a protagonist. Charles Calomiris and Stephen Haber argue that states are essential for banking systems (and vice versa) and that rent-seeking bargains drive their joint structure. No mere reverse Panglossians, Calomiris and Haber demonstrate that bargains change with the underlying social forces—sometimes even for the better.
In the authors’ accessible form of game theory, wealthy elites need to park their cash and obtain loans for their enterprises. The state’s executive needs bond buyers to finance wars. The larger public wants to borrow cheaply for current consumption. Each has an incentive to weaken (and for the executive, to expropriate) the others. Madison anticipated these incentives in Federalist 10:
[T]he most common and durable source of factions has been the various and unequal distribution of property. Those who hold, and those who are without property, have ever formed distinct interests in society. Those who are creditors, and those who are debtors, fall under a like discrimination. A landed interest, a manufacturing interest, a mercantile interest, a monied interest, with many lesser interests, grow up of necessity in civilized nations, and divide them into different classes, actuated by different sentiments and views.
This struggle plays out across the centuries. The 2008 collapse turned grand theoretical economic models like Keynesianism, monetarism, and rational expectations into gods that failed, and the focus shifted to comparative institutional histories. The authors’ prodigious research across countries and time recalls Carmen Reinhart and Kenneth Rogoff’s This Time Is Different: Eight Centuries of Financial Folly (2009), although Calomiris and Haber believe that political systems, rather than debt, are the problem.
The Bank of England, created in the wake of the Glorious Revolution of 1688, is usually apotheosized as the first modern central bank. Here, it represents an oligarchic coup against absolute monarchy: Commercial banks within the charmed circle received support while country banks outside it often failed. Industrial Revolution entrepreneurs were forced to self-finance, slowing their expansion and delaying the industrial takeoff.
The authors exaggerate the banking clique’s power: King William III—whom the Glorious Revolution brought to power, thus launching the second Hundred Years’ War with France (1689-1815)—wanted war funding even more than the oligarchs did, and he happily traded residual absolutist claims for cash. The bank, facing gigantic financing strains, became a serial defaulter on gold payments over the course of the long war. Struggling to fulfill its primary war finance mission, it had little desire to fund high-risk, high-tech Industrial Revolution startups. Calomiris and Haber argue that the credit system opened up in the wake of pressure created by the national mobilization for the French revolutionary wars, but they downplay the post-Napoleonic peace dividend, which gave the Bank of England the flexibility to protect a broader public in credit crises.
In decentralized America, local elites played on populist sentiments to promote easy money—and resist competition from money center banks. In a 30-year national career, Madison was against a central bank before he was for it—before he was against it, before he was for it. The Father of the Constitution also fathered a quarter-millennium of credit bubbles, inconsistent regulation, and banking collapses. The party really got underway when Andrew Jackson fueled a giant land, cotton, and slave bubble by destroying the Second Bank of the United States (the era’s central bank) and then triggered a global depression by suddenly demanding federal land payments in gold or silver.
Later generations also pursued populist-sounding regulations that entrenched and bailed out local elites. Far from stabilizing the financial system, the Federal Reserve, as created in 1913, limited the power of the relatively responsible New York banks over nonmoney center banks. Early 20th-century state branch banking restrictions and deposit insurance funds prevented larger banks from competing with local banks on the basis of safety. When local banks failed in the Great Depression, the same interests created the Federal Deposit Insurance Corporation (over Franklin Roosevelt’s fierce resistance) to put the federal taxpayer on the hook towards the same end.