The Crisis in American Banking.

The Crisis in American Banking forced me to think about the yardstick by which to measure an academic book. It struck me that the appropriate criterion is "opportunity cost"; will the reader learn enough from Crisis to justify the opportunity cost of time spent? Unfortunately, the target market of the book is unclear; it is, therefore, difficult to answer this question.

Crisis contains six conference papers and an editor's introduction. In the introduction, White promises that the book offers a fresh perspective on banking issues, a perspective informed by insights from public choice and Austrian economics. He says that the common thread running through each of the essays is that poorly designed policies--such as branching restrictions and mispriced deposit insurance--are responsible for U.S. banking woes. The policy implication is that government shouldn't meddle in the banking sector. If the book's target audience is professional economists with an interest in banking, I doubt that these insights will strike the prospective reader as fresh. However, several of the essays could prove useful pedagogical tools in an undergraduate banking course.

In the first essay, White answers the question, "Why is the U.S. Banking Industry in Trouble?" He traces the trouble to bad loans, in turn, attributed to a combination of regional shocks, misguided monetary policy, increased competition from other credit suppliers, and badly crafted government regulation. White weaves his arguments--together with statistical evidence--into a credible call for narrow banking. On the whole, the essay gives a good overview of the recent plight of the banking industry, though Boyd and Gertler, in a similar essay in the NBER Macroeconomics Annual 1993, do a better job. They offer much more data and analysis as well as an interesting set of discussant comments that differentiates the economic and finance perspectives on banking.

In the next chapter, "Public-Sector Deficits and Private-Sector Performance," Roger Garrison presents the Austrian view of budget deficits. To Austrians, deficits have different negative effects on the economy at different times; hence, it is misleading to interpret the absence of an empirical link between deficits and a single variable, say interest rates, as proof that federal red ink does not matter. Moreover, Austrians hold that the overarching evil of deficits is that they increase the level of uncertainty with which economic agents must cope. In particular, agents must deal with uncertainty regarding how the deficit will be financed. They must also wonder whether taxes will be raised, and, if so, by how much. These additional uncertainties complicate economic decision-making and induce serious resource misallocation. Garrison's essay provides good background on the Austrian perspective for anyone writing about fiscal policy. The problem is that the essay has very little to do with the crisis in American banking. Admittedly, the author tries to make the connection, but I think most people who worry about deficits do not do so because they fear banking repercussions.

Thomas Havrilesky contributes the third paper in the book, "An Empirical Analysis of Public Choice Aspects of the Savings and Loan Disaster." He analyzes the factors influencing big bank and S&L PAC contributions and concludes that, for 1985-1987, when the House and/or Senate considered several bills crucial to the banking and thrift industries, a congressman or senator's voting behavior determined how much industry PAC money he obtained. Havrilesky takes this as evidence that banks and S&Ls controlled legislators like marionettes and, with fiery rhetoric, declares that this sort of monkey business allows industry problems to mushroom at taxpayer expense. I found Havrilesky's regressions interesting but not persuasive enough to warrant his incendiary prose. Evidence that PACs contribute to legislators who cast sympathetic votes does not, by itself, establish the "capture" Havrilesky alleges.

Richard Salsman's essay, "Bankers as Scapegoats for Government-Created Banking Crisis in U.S. History," the fourth chapter in Crisis, is the most interesting contribution to the volume. He starts with the premise that the potential for market failure in free banking has been wildly exaggerated. Acting on these exaggerated fears, government has ratcheted up the level of bank regulation over the past 100 years. In each case, intervention and "reform" have led to a host of new problems that later served as justifications for more government meddling. Through all these episodes, politicians have blamed bankers for any and all banking woes. In a particularly piquant example of scapegoating, Salsman quotes Senator Wheeler of Montana, who, responding to the hemorrhage of bank failures in the 1930s, reasoned that "[t]he best way to restore confidence in the banks would be to take these crooked presidents out of the banks and treat them the same way we treated Al Capone when he failed to pay his income tax." Put another way, crooked bankers, not the Federal Reserve, as Friedman and Schwartz would later document, bore the ultimate responsibility for the demise of one-third of the country's banks. Salsman's insightful discussion contains many lessons for the current health care debate; it should be required reading for policy makers inclined to blame all health care problems on the insurance and pharmaceutical industries.

Walker Todd and Gerald O'Driscoll, in their essay "Deposit Insurance Reform is not Enough," allege that troubles in the banking sector run much deeper than the effects of mispriced deposit insurance. Government meddling, in their view, is so pervasive and insidious that deposit insurance reform alone will not go far to correct industry troubles. Instead, Todd and O'Driscoll advocate "scorched earth" banking reform; they want to scrap most of the existing framework for bank regulation and reintroduce market mechanisms on a widespread scale. Though the essay addresses the history of and problems with deposit insurance nicely, it fails to deliver on the promise--stated explicitly in the title--to tackle issues broader than deposit insurance alone. For example, the authors call for a return to classical lender of last resort doctrine under which the Fed would lend only on good collateral to banks with liquidity problems. Todd and O'Driscoll could have explored this important topic further, especially given recent evidence that the discount window has become a sop to failing banks. The interested reader should see Anna Schwartz's excellent essay on discount window abuse in the September/October 1992 issue of the Federal Reserve Bank of St. Louis Review.

George Kaufman closes the book by musing on "The Diminishing Role of Commercial Banking." He establishes the economic rationale for banking, documents the sources of banking sector decline, and places this decline in historical perspective. To Kaufman, the decline and fall of the banking industry does not, by itself, merit great concern. Technological change may be inducing resource reallocation to more efficient methods of intermediation. However, to the extent that bad policy is driving the reallocation, remedial action is in order. The principal virtue of Kaufman's essay is his clear approach to the subject. He neatly divides the issues into those the reader should worry about and those he should not. This essay, by itself, would be excellent supplementary reading in an undergraduate class.

In sum, The Crisis in American Banking holds that government is the problem rather than the solution for the U.S. banking industry. Although several of the essays are interesting, overall the book does not offer enough new material to justify the investment for a professional economist interested in banking. The editor could have improved the book by including an essay on the theoretical and historical case for free banking as an anti-government theme pervades the collection of papers. In addition, I would have enjoyed some back-and-forth, perhaps, a look at discussant comments. This is not to say that Crisis lacks an audience. If properly introduced to public choice economics, Austrian economics, and free banking, students in an undergraduate money and banking or financial institutions class could learn much from reading The Crisis in American Banking as a textbook supplement.

Mark Vaughan The Milken Institute for Job and Capital Formation