fighting financial crises
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Three were very serious events. So we can study the experience of multiple panics occurring in the same system. Of course, many casually dismiss the past as irrelevant, but how else do we learn if not from history? With respect to financial crises, it really is, as Marx put it, a case where “History repeats itself, first as tragedy, second as farce.” The reality is that financial crises have occurred throughout the history of market economies. There is a common root problem: short-term debt. Short-term debt is necessary for the economy to work, but it is vulnerable to runs. This is clearest to see during the National Banking Era. Second, this period is particularly interesting because there was no deposit insurance and no central bank, and so expectations of possible future central bank interventions during a crisis are not an issue. During modern crises, firms and households expect the central bank or government (Treasury) to intervene by, for example, issuing blanket guarantees against bank debt, nationalizing the banks, bailing out banks, and so on. In most modern crises, there are bank runs, but they come later in the sequence of events than we observe in the earlier period, as people often wait to see what is going to happen. This makes modern crises very difficult to study. Because of the public’s expectations about interventions, some conclude that the interventions themselves are the problem. And further, because delays in actions by authorities can take place earlier or later in the event sequence, it may appear that crisis events have nothing in common. In that circumstance, researchers and regulators seize on idiosyncratic aspects of each crisis and miss the essential common features. Third, crises typically do not happen frequently enough for there to be a learning process about how to fight them or to develop some clarity about the nature of a financial crisis. Lessons from fighting previous crises are lost. Without multiple observations, crises are attributed to all sorts of factors. That’s why Bagehot is still invoked. Our view is that by studying a period that avoids these modern complications but exhibits the same short-term debt problems, we can distill the essence of fighting crises. We can state some common principles or guidelines for fighting crises. And it is important to note that crises during the National Banking Era cannot be due to “moral hazard” or “too big to fail,” so some clarity about the underlying cause of a financial crisis can be gleaned. During the crises of the US National Banking Era, banks would suspend convertibility of deposits into cash, that is, banks would refuse to repay amounts in depositors’ checking accounts. Suspension was an intervention meant to disrupt widespread liquidity drains from the banking system. Suspension was always illegal, but it was tolerated as necessary to save the bank-
