Institutional change in lending

Who lends?

The declining share of deposit money banks in total credit lending indicates increasing diversification and specialization of capital markets. Organizations that are not deposit money banks include credit unions, money market funds, pension funds, insurance agencies, brokerages and other securities firms, financing companies, venture capital firms, hedge funds, and, at the lowest-tier of the financial structure, payday and other short-term, small amount lending.

Another way of interpreting the share of deposit money banks in total lending is as a share of lending that is not insured or supervised by the government. This is a bit misleading because there are public and private forms of insurance available to these organizations. Credit unions are insured by the National Credit Union Administration (NCUA, the equivalent of the FDIC), while most brokerage houses are insured by the Securities Investor Protection Corporation (SIPC), which has many of the same features as the FDIC. These programs insure depositors against losses; they do not include safety and soundness oversight. As such, the non-deposit money bank share is a reasonably good approximation of the amount of activity taking place outside the purview of public supervision.

The share of deposit money banks in lending is an important institutional relationship for a national financial system. Data for this is collected in the US by the Federal Reserve and other agencies, and the Bank of International Settlements has put together a national cross-sectional, time-series dataset that can be found online ( In the United States, this share rose from the 1940s until the 1970s, peaking below 60% before decreasing from the mid-1970s until today. It dropped substantially during the S&L crisis, as many hundreds of savings institutions but also commercial banks failed. The shares for the US, Australia, and Canada are presented in the figure below.


I include Australia and Canada for the reason that the three countries share similar geographical, historical, and institutional characteristics. They are large, demographically-heterogenous, continental-sized economies that are former British colonies, and so have legal systems based on English common law. Natural resource extraction and trade are essential components of their economic growth. Their experiences with financial crises, however, are somewhat different. For instance, the US has seen two banking crises in the last thirty years (S&L and 2008), while Australia experienced a banking crisis in the early 1990s (when a couple of government-owned savings institutions failed and several other institutions), but was largely spared from the 2008 crisis. Canada has seen periodic but isolated failures of banking organizations, but was also spared from the 2008 crisis. In effect, only the US experienced a ‘systemic crisis’ during the last three decades, which was in 2008. This disparity is even more remarkable in light of the fact that in all three countries, property markets underwent an incredible boom leading up to the 2008 crash.

A institutional model of financial crises

The issue of who lends is vital when considering why some countries are more prone to financial dysfunction than others. Charles Calomiris and Stephen Haber have argued in their book Fragile by Design that the frequency with which a country experiences financial crises is a result of how its fundamental political institutions distribute power between competing groups in society. In the US, historically, populists have exerted a level of influence over the structure of banking markets due to the alliances they have formed with local bankers. In Canada, however, the federal government has insulated the banking sector from populist influence and created a more stable framework that allows its few, very large banks to control much of the lending markets while also providing abundant and cheap credit. The US, by contrast, ranks comparatively low among high-income countries in providing affordable credit (witness the lack of affordable and government-insured borrowing options for low-income Americans in poor neighborhoods and cities).

The conceptual model–the Game of Bank Bargains–that Calomiris and Haber offer is a good counterargument to explanations of financial crises that invoke ‘speculative euphoria’ or ‘banker folly’ or other aspects of human behavior. Their argument has its limits, though. For example, they spend a great deal of time repeating the conservative bugaboo about the 2008 crisis that Frannie Mae, Freddie Mac, and the Community Reinvestment Act of 1970 distorted lending incentives and caused a deterioration of underwriting standards during the housing bubble. They also suggest that community activists teamed up with mega-bank interests to push through the financial liberalization reform program of the 1990s in exchange for greater lending to urban minorities. I think in doing so they alienated a number of readers who might have been inclined to use their model but were put off by the polarizing and discredited notion that the victims of the 2008 crisis–urban minorities–were responsible for the crisis.

This is obviously a shame, because I think it is crucial that we have a more informed conversation about how financial markets and specific banking organizations are used by the state to advance the state’s interests as well as to advance parochial or regional interests. Nonetheless, it is possible to use their model of interest group collusion to tell a different story about the 2008 crisis and why credit is allocated the way it is. The central process in that story is the transformation of legal foundation of the banking sector and the change in contractual relations between households, the financial sector, and the state. I’m going to outline this story and emphasize its geographical component.

A brief application/reinterpretation of the Game of Bank Bargains

At the end of the S&L crisis, the surviving, well-capitalized financial organizations were able to take advantage of (1) a buyer’s market in distressed financial assets, and (2) an appetite for regulatory reform at the national level, aided by an accommodative Federal Reserve Board. The S&L crisis affected mainly (obviously) savings institutions in the south and southwest states. The surviving banks were money center and investment banks in New York and other northeast financial centers, as well as the so-called super-regionals. For a more in-depth review of this period, I suggest you read a working paper by Gary Dymski entitled “Genie out of the Bottle: The Evolution of Too-Big-to-Fail Policy and Banking Strategy in the US.”

Suffice it to say that the type of organizations that were poised to reap the benefits of the post-S&L environment very much shaped the nature of the legal reforms of the 1990s. That is, the reforms included repealing intra- and inter-state branching restrictions, removing separations between investment and retail activities, and repealing size limitations. Less talked about consequences of these reforms include that the role of the Federal Reserve took on greater importance. For example, under the Riegle-Neal Act of 1994, the Fed was charged with approving mergers-and-acquisition (M&A) activity, while the organizational model of choice for accomplishing M&A activity was the bank holding company. It so happens that the bank holding company is supervised by the Federal Reserve.

An even less talked about event during this period, which likely had a strong effect on the nature of bank strategy, was the experience with Long-Term Capital Management. Without getting too deep into the details, the collapse of Long-Term in 1998 was marked by an incredible intervention by the Federal Reserve, which organized a private sector bailout by leaning on Long-Term’s creditors. Some of the lessons of that experience were: the Fed was willing to drastically intervene to prevent the failure of what it considered a systemically important institution; the use of complex instruments such as derivatives would continue as a risk management mechanism; and, a highly connected firm could be successfully resolved in the event of a crisis. I suspect the experience of Long-Term was on the minds of decision-makers at the Fed and elsewhere in the upper echelons during 2008 (it had only been a decade, after all).

So, who is at the table of the Game of Bank Bargains in the 1990s? The table is populated by New York investment and money center banks, super-regionals, the Federal Reserve, and various senators and administration officials representing those organizations. I think it is fair to say that there was nothing inevitable about this particular group advocating for the particular package of liberalization reforms. It seems quite opportunistic, in fact. The group’s identity reflect the survivors of a crisis in the housing finance and commercial property sectors in the 1980s and their strategic considerations.

Was there a viable alternative to their view of the ideal financial landscape? Not really. The savings association industry was in a shambles, and community, consumer, and housing advocates had made major gains in the reforms passed during and immediately after the S&L crisis (notably by imposing as much of the costs of the S&L resolutions on the industry itself). Their continued efforts were stymied by the George H.W. Bush administration. There doesn’t seem to be much in the way of any advocacy for a greater role of public options in banking, such as state banks (in the style of the Bank of North Dakota) or perhaps a postal savings system during this time.

So the legal foundation of the financial sector was radically altered between the early 1990s up to the early 2000s. The preferred organization for consolidation was the bank or financial holding company, the preferred regulator was the Federal Reserve, and the preferred solution to the bank profitability crisis witnessed in the 1980s was the removal of geographic barriers in banking markets. Another implicit element of the Game of Bank Bargains in this instance was the too-big-to-fail issue. The bailouts during the S&L crisis demonstrated the possibility that market mechanisms could be used to resolve failed assets, while the government emphasized its willingness to intervene directly into markets to prevent disruption. The effect of these reforms was actually, as shown in the figure above, to narrow the government’s zone of control over lending–new intermediaries popped up in the interstices between the big banks, which themselves were executing more trades and lending outside of their chartered, depository units.

The Bank Bargain of the 1990s was truly a new contract between a quasi-governmental agency (the Federal Reserve) and a collection of large institutions (many of which were already embedded within international financial markets) for control over the credit allocation process. It was guided by an ethos of liberalization that had been brewing before the S&L crisis, and in fact could arguably be seen as having instigated the crisis or at least made it worse (for instance, by deregulating interest rates under DIDMCA of 1990 and Garn-St. Germain Act of 1982).

Bottom line

One of the lessons for institutional change in lending, which is how I started this post, is that the choice of organization actually matters very much. Different types of organizations face different strategic considerations and observe specific locational distributions. Additionally, types of organizations fall more or less within the state’s influence. The Bank Bargain of the 1990s sought, given the ideological climate of the time, to limit the zone of control. One of the points I picked up on reading Calomiris and Haber’s account of the banking stability of Canada is that the state endeavored to maintain or increase the domain of lending covered by its preferred organizations (its large chartered banks) as new technologies and innovations arose. The example of REITs in the US (which precipitated a crisis during the 1970s, see Hyman Minsky’s Stabilizing an Unstable Economy) shows that while REITs were eventually legitimated, they remained an industry operationally separate from the chartered and regulated system.

These are only some preliminary thoughts, but I think they provide good support for a more thorough comparative analysis of the politics and institutions of credit allocation. The US, Australia, and Canada, I suggest, are excellent candidates for such an analysis. The conceptual model by Calomiris and Haber could be reapplied by adding the spatial perspective–the location of organizations, their structure, strategies, the competitive environment–and also by reframing the issue as the extent to which a country manages (and wants to manage) the quality of its lending.


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