Key Moments
Peterson Academy | Dr. Charles Calomiris | The History of Financial Crises | Lecture 1 (Official)
Jordan PetersonKey Moments
Financial crises aren't accidental bugs but 'adaptive' political choices stapled to desirable societal goals like democracy, innovation, and privacy. This suggests we're choosing to risk crises for other benefits.
Key Insights
From 1980-2010, the world experienced its most severe period of banking crises, with real economic activity falling by about 6% during such events.
The median cost of distress for banks during a banking crisis, requiring government bailouts, is approximately 16% of GDP.
Hyman Minsky and Charles Kindleberger's theory posits that human behavior oscillates between massive greed and fear, leading to predictable crisis cycles.
Statistical evidence shows commonalities in banking crises, such as unusually high loan growth before collapse and the presence of generous government deposit insurance.
The lecture posits that financial crises may be 'adaptive' because they are linked to politically beneficial activities like rent extraction, geopolitical competition, and fostering innovation through risk-taking.
Deposit insurance, statistically proven to make banking systems riskier, has spread globally since the 1970s, with over 160 countries adopting it by the 1990s, and this trend has not reversed.
The puzzle of recurring financial crises
The period between 1980 and 2010 was marked globally by an unprecedented severity of banking crises. These events are not merely statistical anomalies; they lead to significant economic disruptions, with real economic activity declining by about 6% during a banking crisis. Furthermore, the cost of resolving these crises, often through government bailouts, can be substantial, with a median cost of 16% of GDP. This recurring pattern, despite its high economic cost, presents a fundamental puzzle: why do societies continue to experience financial crises? This lecture series proposes approaching crises not as external shocks but as consequences of inherent societal choices, urging a look in the mirror to 'know thyself' and understand the underlying motivations.
Defining and understanding asset value declines
A financial crisis is defined as a sudden decline in the value of an important asset, which could be land, stock, sovereign debt, or currency. These declines are typically driven by a sudden change in risk perception or expected revenues, or often a combination of both. When an asset, representing a claim on future revenues, is perceived as riskier, its value falls because the required rate of return increases. This shift in perception, whether about risk or future earnings, is central to understanding asset price collapses and their disruptive impact on current economic activity and income.
Behavioral cycles vs. institutional patterns in crisis
Two main theories attempt to explain the recurrence of crises: the behavioralist view, notably by Minsky and Kindleberger, suggests that human nature swings between irrational greed and fear, making crises inevitable. Alternatively, the historical particularist view argues that each crisis is unique, rendering learning from past events impossible. However, empirical research and narrative evidence point to discernable commonalities. For instance, banking crises often coincide with rapid loan growth and extensive government deposit insurance, while exchange rate collapses are linked to unsustainable fiscal and monetary policies. This suggests a middle ground: crises share common features, but not all are identical, implying that learning is possible, though its limitations remain a key question.
The 'adaptive' nature of financial crises
A controversial yet central argument is that financial crises might be 'adaptive' in an evolutionary sense, not because the losses are desirable, but because the crisis event is 'stapled' to things society implicitly wants. These include the functioning of democracy, which often involves rent extraction and rewarding specific political coalitions; geopolitical competition where nations take risks to survive or gain advantage; the process of innovation and learning about new technologies and markets, which inherently involves uncertainty and risk-taking; the concept of privacy, which enables fraud but also entrepreneurship; and discretionary fiat money regimes managed by central banks. These factors, despite their potential to provoke crises, are politically advantageous or essential, leading societies to accept or even promote the risk of crisis.
Political and geopolitical drivers of risk subsidies
Domestic political systems often incentivize risk-taking through subsidies designed to achieve specific outcomes for winning coalitions, such as mortgage insurance for veterans. This 'rent extraction' can make political systems function but increases financial fragility. Geopolitically, nations compete for trade and market share, sometimes compelling them to take significant risks to avoid a worse outcome, like losing territory or market dominance. This was evident in early modern Europe, where countries like France and Britain took on significant financial risks to compete with established powers. The drive for survival and competitive advantage can thus make risk-taking, and by extension the potential for crisis, a politically adaptive strategy.
Innovation, privacy, and the trade-offs of learning
Crises can arise from the need to learn about new technologies and markets. The development of Florida in the 1920s, for example, involved massive risk-taking to understand market potential and infrastructure needs. Similarly, the 1920s US stock market boom was tied to innovation. Avoiding such risks would mean avoiding learning and technological advancement. Furthermore, the privacy that enables fraud, like that seen in the Florida land boom, also underpins desirable aspects of market economies, such as decentralized information and entrepreneurship. While fraud is an undesirable consequence, the privacy that allows it is considered essential for a dynamic economic system.
The role of monetary policy and fiat money
Fiat money regimes, managed by central banks, are a significant source of oscillating risk perceptions. Monetary policy that is too loose can temporarily suppress risk perceptions, leading to asset bubbles, while tight policy can rapidly increase them. The period from 2002-2007, for instance, saw a dramatic decline in perceived risk in stock and bond markets, directly linked to excessively loose monetary policy, which culminated in the 2008 crisis. While reforms to central bank policy are possible and some economists advocate for more systematic approaches, discretionary monetary policy remains popular. The structure of a democracy often favors the status quo of discretionary policy, despite its role in exacerbating crises.
Deposit insurance: a global risk subsidy
A prime example of an 'adaptive' political choice is the widespread adoption of deposit insurance. Despite strong empirical evidence showing that deposit insurance makes banking systems riskier by removing depositor discipline, it has become nearly universal, with over 160 countries adopting it by the late 1990s. This trend, initiated in the US in 1933 and spreading globally from the 1970s onwards, shows no sign of reversal. Economically, deposit insurance is a subsidy for banking risk, and where risk is subsidized, more of it occurs. The persistence of this policy suggests it serves a political purpose that outweighs its negative economic consequences from the perspective of those making policy decisions.
Historical examples: Rome and early modern Europe
The lecture delves into historical case studies to illustrate these concepts. The Roman banking panic of AD 33, for instance, was triggered by usury laws and land-holding requirements that became binding as interest rates rose, restricting credit and causing land values to fall. These regulations, understandable from a political perspective of rewarding elites and preserving the empire's stability, had costly economic consequences. Similarly, the Mississippi Bubble in France (1720) and the South Sea Bubble in England (1720) exemplify how mercantilist regimes, seeking to catch up with established powers, utilized new institutional innovations like chartered companies and privileged banks. John Law's Mississippi scheme, while ultimately overextended, was rooted in a sophisticated understanding of these modern financial tools, demonstrating that crises often stem not from lunacy but from pushing understandable, adaptive policies too far.
A taxonomic approach to understanding crises
Instead of viewing all crises as identical or entirely unique, the course proposes a middle ground: a taxonomic approach. This involves asking a common set of questions about each crisis to identify underlying patterns and causal factors, such as predictability, asset price booms, and political risk subsidies. This allows for the classification of crises based on which dimensions—like international competition, domestic rent-seeking, or monetary policy—are most influential. This structured analysis, moving beyond hindsight bias to an ex-ante perspective, helps understand why similar situations with different political equilibria can lead to vastly different outcomes, even between neighboring countries like England and Scotland, or the US and Canada, illustrating the persistent lack of learning due to differing political landscapes.
Mentioned in This Episode
●Companies
●Organizations
●Concepts
●People Referenced
Common Questions
Dr. Calomiris defines a financial crisis as a sudden decline in the value of some important asset, such as land, stocks, sovereign debt, or currency. These declines are typically linked to a sudden change in risk perception or expected revenues, often both, making assets appear riskier and thus decreasing their value.
Topics
Mentioned in this video
An economist who, along with Charles Kindleberger, proposed an influential theory of financial crises based on human behavior oscillating between massive greed and fear.
An economist who, along with Hyman Minsky, proposed an influential theory of financial crises based on human behavior oscillating between massive greed and fear.
A famous economist from the 1970s who advocated for improvements in monetary policy to reduce risk oscillations, some of which were implemented.
Author of a book on the 1929 stock market crash, criticized for his 'superiority thinking' and historical inaccuracies.
A Scottish schemer and central character in the Mississippi Bubble. Described as extremely creative and understanding of new financial innovations, but who took his ideas too far by trying to fix market prices.
President who initially opposed deposit insurance in the 1932 election due to state-level failures, but ultimately signed federal deposit insurance into law.
Mentioned in the context of Roman macroeconomic policies, where interest rates were generally low and credit abundant during his time.
Dictator of Mexico around 1900, whose regime (the Porfiriato) is discussed as an example of political equilibrium that fostered economic success despite being inhospitable in some ways.
Mentioned in the context of common features across crises (Mexican crisis of 1994-1995) and as an example of an early 20th-century political regime with a banking system collapse.
Mentioned in comparison to the Mexican crisis, highlighting similarities between its 1983 experience and Mexico's 1994 crisis.
Mentioned with its 2010 crisis having similarities to the East Asian crisis.
Mentioned as an example of a country lagging behind in early 18th-century global competition, needing to take risks to catch up. Later, the location of the Mississippi Bubble.
Mentioned as an incumbent global competitor in the early 18th century, which other nations like France and Britain were trying to catch up to.
Mentioned as an incumbent global competitor in the early 18th century, which other nations like France and Britain were trying to catch up to.
Mentioned as an incumbent global competitor in the early 18th century, which other nations like France and Britain were trying to catch up to.
Discussed as an example of a place that experienced new, unknown risks in the 1920s land market due to new technologies and speculative dreams, involving substantial fraud.
Compared with Scotland regarding banking system stability, with England being more crisis-prone in the 18th and early 19th centuries. Also the location of the South Sea Bubble.
Compared with England, Scotland is highlighted as having a much less crisis-prone banking system in the 18th and early 19th centuries.
Compared with the United States for its banking system's stability, noting that Canada has not had a banking crisis since it started chartering banks in the 1800s.
The setting for the 33 AD banking panic, where regulations were geared towards sustaining the empire and its political elite rather than economic growth.
Cited as an example of a government program that subsidizes mortgage risk for veterans, allowing 100% mortgages at artificially low rates.
The US central bank, responsible for determining the amount of dollars, but which has made significant monetary policy errors, such as from 2002-2006 and 2021-2023.
An example of a bank granted monopoly rights by a sovereign in the early modern era, reflecting new institutional tools for centralized power.
An example of a company granted monopoly rights by a sovereign to organize trade with a certain region in the early modern era.
Described as a technology for central banks to create currency, which, despite leading to monetary policy errors and risk oscillations, is widely adopted as the best available technology.
A series of programs and reforms in the United States, including the beginning of residential mortgage subsidies in 1934.
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