Behind the Game of Bank Bargains
Everything you wanted to know about banking but were afraid to ask


‘Everyone knows that life isn’t fair, that ‘politics matters,’” Charles W. Calomiris and Stephen H. Haber write in their new book, Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (from which we ran an adaptation here). “We recognize that politics is everywhere,” they continue, “but somehow we believe that banking crises are apolitical, the result of unforeseen and extraordinary circumstances, like earthquakes and hailstorms.” That’s simply not true, Calomiris and Haber argue: “The politics we see operating everywhere else around us also determines whether societies suffer repeated banking crises . . . or never suffer banking crises.” Fragile by Design will make you skeptical of the “version of events told time and again by central bankers and treasury officials,” and critical when that version is “repeated by business journalists and television talking heads.” The authors talk with National Review Online’s Kathryn Jean Lopez about the book, banking, morality and politics, Canada, fatherhood, and even Game of Thrones.


Kathryn Jean Lopez: Is the “Game of Bank Bargains” anything like Game of Thrones? Why do you set things up this way?

Haber: Well, there are a lot fewer beheadings in the Game of Bank Bargains than in Game of Thrones, and none of the protagonists in our book are 15-year-old monarchs with antisocial personality disorder. More seriously, the point of explaining bank regulation as a game in Fragile by Design is to get across the idea that laws and rules are not produced by robots programmed to maximize social welfare. They are the outcome of strategic actions of interested parties — a game, as it were — and those strategic interactions can produce unlikely alliances that work against the interests of society as a whole.

Let’s take the United States in the 1990s as an example. There was a strategic alliance that consisted of banks that were in the process of merging and activist groups. The activists supported bank-merger applications, and in exchange the banks directed hundreds of billions of dollars in mortgage credit through the activist groups. In order to make this alliance stable, the megabanks and the activists had to draw the housing GSEs [government-sponsored enterprises], Fannie Mae and Freddie Mac, into the partnership. Fannie and Freddie agreed to purchase the loans that the megabanks had made to satisfy their activist allies, and in return received the right to back their portfolios with paper-thin levels of capital. Each of the three players in this game had a strategic objective — to further its own interests. The one group that did not have a seat at the table as the game was being played was taxpayers, who were presented with the bill when the game was over.


Lopez: Is there a danger you downplay morality in banking?

Calomiris: Policy in banking, as in all things, should be morally defensible. As James Madison recognized, however, moral achievements of government are largely the consequence of the quality of rules that govern a society, not the inherent virtues of its citizens. Laws, he reminded us, are not fashioned for angels, but rather to govern the affairs of flawed human beings. Most important perhaps, good laws and regulations predictably occur more in societies whose rules of political engagement make it harder for groups of citizens to use the government as a means of taking advantage of other citizens.


Lopez: Do taxpayers have any control over this, a real role to play in banking and financial reform beyond praying the money is real?

Haber: They absolutely do! The laws that govern the banking system are passed by our elected representatives. Obviously, the average taxpayer is not going to become an expert on the arcane details of bank regulation. But taxpayers can apply a simple heuristic: There are no free lunches. When a government official promises a subsidy, taxpayers should ask, who is ultimately going to bear the cost of that subsidy? When a government official promises a subsidy and implies that no one is going to bear the cost, taxpayers should grab hold of their wallets.

Taxpayers might keep the following example in mind: Americans were told that the mortgage giants Fannie Mae and Freddie Mac should receive a range of special privileges that subsidized their operations, because those subsidies were passed on in the form of reduced costs of homeownership. Everyone was getting a free lunch. This turned out to be false on two counts. First, a large body of research has shown that the majority of the subsidy was captured by Fannie and Freddie’s stockholders and managers, not homeowners. Second, when Fannie and Freddie failed in 2008, they had to be bailed out at enormous taxpayer expense. Housing subsidies turned out to be a very expensive lunch.