The Trouble With “Financial Stability”

“I have never understood why Financial Stability should be an objective of public policy,” writes a pseudonymous London Banker in the course of an excellent post on the subject. “One strength of the US banking system from the 1930s to the 1980s was that failures were dealt with quickly and certainly. Foreclosed properties had to be sold by banks within two years of repossession, leading to a quick and certain reallocation of assets from failed borrowers to new owners. The FDIC swiftly and mercilessly shut down failed banks. New owners – often buying at distressed prices – were encouraged to invest in making the assets productive and profitable. It was this simple recycling from failed managers to better managers that was largely behind the short recessions and strong recoveries during this period of American economic history. With forbearance now institutionalised at all levels of the US economy, we are seeing Japanification instead of recovery. And it is even worse just about everywhere else where dominant banks are much more influential.”

What’s ironic about the current state of affairs is that this was all conventional wisdom in the United States at the time. Throughout the 1990s, the American powers that be thought the problem in Japan was that they had to stop propping up banks with regulatory forebearance and start deploying monetary stimulus to ensure that real resources weren’t going idle. Then when our own financial system saw tumbling property prices lead to banking problems, the powers that be went and did exactly what they’d spent a decade criticizing Japan for – focusing central bank activity on propping-up banks up while paying scant attention to idling of workers and real resources.