Fatalistically Flawed: A Review Essay on Fragile by Design, by Charles W. Calomiris and Stephen H. Haber

• Published date: 01 March 2015
• Date: 01 March 2015
• DOI: http://doi.org/10.1111/1468-2362.12060
• Author: George Selgin

REVIEW

Fatalistically Flawed: A Review

Essay on Fragile by Design,by

Charles W. Calomiris and

Stephen H. Haber

George Selgin

Center for Monetary and Financial Alternatives, The Cato Institute,

Washington, DC, USA.

Calomiris, Charles W.,and Stephen H. Haber (2014), Fragile by Design: The Political Origins of

Banking Crises & Scarce Credit. Princeton, NJ: Princeton University Press.

I. Introduction

Not long ago a colleague of mine, who works regularly wi th legislators, attended a

conference at which the lunch speaker, a famous economist, began by tel ling

everyone why governments regulate financial instit utions. The reasons the economist

gave consisted of various (supposed) financial-market fa ilures. Said the colleague

International Finance 18:1, 2015: pp. 109–128

DOI: 10.1111/1468-2362.12060

© 2015 John Wiley & Sons Ltd

to me later: ‘I just wanted to stand up and shout, “That’s got nothing to do

with it!”

I relate this becausesome readers may otherwise fail to appreciate the importanceof a

work whose chief revelation is that financial legislation—and consequently the general

structure of financial systems—are shaped by politics. My colleague did not need to be

told, but others, including many economists, evidently do.

In Fragile by Design: The Political Origins of Banking Crises & Scarce Credit, Charles

Calomiris and Stephen Haber tell them. Banking arrangements, they argue, are ‘not a

passive response to some efficiency criterion but rather the product of political deals

that determine which laws are passed’(pp. 13 and 38).

1

What is more, the laws

such deals give rise to are, more often than not, detrimental to bank safety and

soundness. In few words, banking instability has its roots, not in any fragility inherent

to commercial banking, but in deals struck between governments and various interest

groups.

Fragile by Design is at once an alternative interpretation of the history of banking

and a contributionto the debate on the causes of the recentcrisis. Though other reviewers

have tended to focus their attention on the latter contribution, many of Fragile by

Design’s most important insights, as well as many of its more serious flaws, are

independent of its take on the subprime crisis. It is to those insights and flaws that I

wish to draw attention.

II. Daring Histor y

In a passage that ought to be emblazoned on every monetar y economist’s laptop, John

Hicks (1967, p. 156) observed that ‘Monetary theory is less abstract than most economic

theory; it cannot avoid a relation to reality,which in other economic theory is sometimes

missing. It belongs to monetary history, in away that economic theory does not always

belong to economic history’.

What goes for monetary theory goes for theories about banking, because there is no

separating the two. Unlikemost other works on banking instability, Fragile by Design takes

Hicks’observation seriously. By doing so, it exposes the parochialism, if not the sheer

ignorance of history, upon which most conventional wisdom about banking instability

rests.

At the heart of this wisdom lies the claim that commercial banking systems a re

inherently unstable. As Nobel Laureate Robert Lucas put it in a series of lectures he

gave during and after the 2008 crisis, ‘a fraction al reserve banking system will always

be fragile, a house of cards’(Lucas 2011). ‘Even a superficial acquaintance with the

basic facts of banking h istory’, Calomiris and Haber obser ve, reveals an obvious

1

Where parenthesescontain page numbers only, the referenceis to Calomiris and Haber (2014).

110 George Selgin

© 2015 John Wiley & Sons Ltd