Thread: he idea that U.S. bank runs and failures of the 1930s and before "proves" that bank deposits are "subject to runs and require regulation" is a good example of the parochialism that's all too common among U.S. economists, which blinds them to some obvious facts.
https://twitter.com/gchodorowreich/status/1526463154326315008
First of all, the runs on and failure of so many U.S. banks wasn't simply a consequence of their reliance upon demand deposits: plenty of banks in plenty of other places relied on such deposits, without insurance or other props, without being failure prone.
Nor did banks fail because their depositors simply panicked, as naive accounts (including Diamond and Dybvig's Nobel Prize-winning theory) assume. Banks seldom failed because depositors ran on them: most often, depositors ran on them _because_ they were failing.
Why were so many U.S. banks in trouble in the 20s and 30s? Most were rural banks; they got into trouble when agriculture went into a severe post-WWI slump, having lent heavily to farmers who couldn't keep up their loans owing to collapsed farm product prices.
"Why didn't the banks diversify their loan portfolios?" Great question--I'm so glad you asked. The answer is that most couldn't, because unit banking laws, which were the norm back then, kept them from having branches. Nor could loans be "sold" then as they often are now.
So most U.S. bankers were bound to be heavily invested in their local communities. If the economies of those communities lacked diversity, so did their banks' portfolios. Shocks to a single sector, if not a single industry or crop, could have devastating consequences.
Even sufficient knowledge of different _states'_ experience should warn researches against a tendency to attribute bank runs and failure to demand deposit banking, without digging deeper, as a number of more careful economic historians have done.
Their findings suggest that branch banking tended to strengthen the banking systems in which it was allowed, not just by improving the diversification potential of branch banks themselves, but also by disciplining unit banks they competed against. jstor.org/stable/10.1086…
But it's only by looking at the experiences of other nations that the uniquely failure-prone nature of U.S. banks becomes apparent. The difference is why, until the 1980s, few other nations felt obliged to implement deposit insurance to prop-up their banking systems.
And some that did didn't do it because their banks were failure prone: alt-m.org/2021/11/15/an-…
There's an alternative to the "inherently unstable" theory of banking that ought to be taken more seriously, because it's easier to square with the facts. It's the theory that banking systems aren't inherently unstable at all: instead, they're rendered so by bad regulations.
I've mentioned laws against branching as a cause of instability. But they are just one of many examples of regulations that can undermine instead of enhancing bank safety. I reviewed many others in this 1989 article developing the "bad regulations" theory: cato.org/cato-journal/f…
More recently Charles Calomiris and Stephen Haber defended a similar view at great length: amazon.com/Fragile-Design…
This alternative perspective turns the OT's understanding that "demand deposits are subject to runs and require regulation" on its head: it submits instead that "demand deposits are subject to runs _because of_ (misguided) regulation."
Those who find this alternative hard to swallow should at least be willing to consider the historical evidence closely, with both it and the now conventional view in mind, before reaching a verdict. And in so doing they shouldn't just consider U.S. experience.
Instead, they should contrast it with that of other countries, and Canada especially, because of its proximity, and because it once shared a common currency with the U.S. They should also compare pre-1845 English (dumb regs) experience with that of pre-1845 Scotland (wise regs).
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