chapter  5
44 Pages

Banking crises and the rules of the game CHAR leS W . C A lOM IRIS

The author thanks conference participants, Allan Meltzer, and Joseph Mason, for helpbul comments on earlier drafts of this chapter.

5.1 Introduction Pundits, policy makers, and macroeconomists often remind us that banking crises are nothing new, an observation sometimes used to argue that crises are inherent to the business cycle, or perhaps to human nature itself. Charles Kindleberger (1978) and Hyman Minsky (1975) were prominent and powerful advocates of the view that banking crises are part and parcel of the business cycle, and result from the propensities of market participants for irrational reactions and myopic foresight. Some banking theorists, starting with Diamond and Dybvig (1983), have argued in a somewhat parallel vein that the structure of bank balance sheets is itself to blame for the existence of panics; in their canonical model, banks structure themselves to provide liquidity services to the market and thus create large liquidity risks for themselves, and also make themselves vulnerable to self-­fulfilling­market­concerns­about­the­adequacy­of­bank­liquidity.­The­theoretical modeling of banking theorists, like the myopia theory of Minsky, is meant to explain prevalent banking fragility – a phenomenon that any blogger can now trace at least as far back as ad 33, when Tacitus (Book VI) tells us that the Roman Empire suffered a major banking panic, which was quelled by a large three-year interest-free loan to the banking system by Emperor Tiberius.1 There is, however, at least one obvious thing wrong with all these arguments that purport to show how myopia, business cycles, and inherent bank liquidity transformation can explain the historical constancy of banking crises: in fact, the propensity for banking crises has not been at all constant over time or across countries. Banking crises have not regularly and consistently accompanied business cycles. In fact, banking crises have been much more frequent in some eras than in others and much more frequent in some countries than in others. The differences across countries and across time are dramatic, as this paper will demonstrate.