Alexander Field (and Santayana) on Financial Regulation

As some in policy circles advocate unilateral financial disarmament, I think it is useful to think about what history tells us about the financial crisis of 2008, which seems to have already receded in people’s collective consciousness. Here I turn to Alexander Field’s new volume on the Great Depression, A Great Leap Forward. From Chapter 10, “Financial Fragility and Recovery”:

The regulatory or policy failure was not simply or primarily a matter of interest rate policy. Rather it was a failure to control, or really be interested in controlling, the growth of leverage. …

…This is understandable from a political-economic perspective. In the boom period, higher leverage combined with riskier lending engendered vastly increased financial sector profits and compensation and both the means and motivation to lobby effectively against government regulation, which stood in the way of the continued operation of the money train. That is how we got to where we are.

There is thus a strong case that lax regulatory environments contributed to the onset of both the Great Depression and the recession of 2007-09 and that the well-designed rules are necessary to reduce the likelihood of future crises. In part it is a matter of fairness. Citizens should not be faced with the choice of either saving the creditors and employees of financial institutions that are too big or too interconnected to fail from the consequences of their risky behavior or enduring serious declines across the economy in output or employment.

Once the economy goes into recession, of course, it is too late. . . .

So, as efforts proceed to enable financial capture of the Consumer Financial Protection Bureau [1] and the defund implementation of Dodd-Frank [2], we should remember “Progress, far from consisting in change, depends on retentiveness. When change is absolute there remains no being to improve and no direction is set for possible improvement: and when experience is not retained, as among savages, infancy is perpetual. Those who cannot remember the past are condemned to repeat it.”

The book also debunks the notion that rapid technological innovation necessarily induces rapid growth. As Field documents, TFP growth during the 1930’s was actually quite rapid (see also [3]) Demand was the missing ingredient.

This post originally appeared at Econbrowser and is posted with permission.