Dan Snow's History Hit - A Short History of Bank Collapses

Episode Date: March 21, 2023

Looking back at the past few weeks, it seems like banks are collapsing left, right and centre; but what exactly does this mean for us? Are these inconsequential blips on the financial radar, or will they herald the beginning of a major banking crisis? On today's episode, Dan is joined by Charles Read, who teaches economics and history at the University of Cambridge, to walk us through why these collapses happen, whether they can be predicted, and what their repercussions are.Produced by James Hickmann and edited by Dougal Patmore.If you'd like to learn more, we have hundreds of history documentaries, ad-free podcasts and audiobooks at History Hit - subscribe to History Hit today!Download the History Hit app from the Google Play store.Download the History Hit app from the Apple Store.

Hello everyone, welcome to Dan Snow's History Hit. Banks are collapsing. Banks are under pressure. Is this a full-blown banking crisis? I didn't have it on my 2023 bingo card, and I'm not happy that it's come up. But as ever, we're going to provide you with historical context for banking crashes. A lot of banks out there have crashed with sometimes limited repercussions and other times pretty gigantic ones. The man to tell us all about it is Charles Reid. He's been on this podcast before. He came up to talk about a previous book in which he talks about how government policies can cause a borrowing crisis. That was well-timed because the British government caused a borrowing crisis in the autumn, the fall of last year. In the first half of March 2023, Charles published a new book. This was a book about how

rapid interest rate rises caused financial crises and banking collapses over the last 200 years in Britain. The following day, Silicon Valley Bank collapsed, thanks in large part to the Fed's rapid tightening of interest rates. So I begged Charles to write his next book about something happy and positive and constructive. If you want to check out his book, it's called Calming the Storms. He's got some solutions and recommendations about how to prevent financial crises in the future. As for the one we might be in at the moment,

well, it's fingers crossed, really. Charles Reid teaches economics and history at the University of Cambridge. It's great to have him back on the podcast talking about banking collapses. Enjoy. T-minus 10. The Thomas bomb dropped on Hiroshima. God save the king. No black-white unity till there is first and black unity.

Never to go to war with one another again. And lift off, and the shuttle has cleared the tower. Charles, thank you very much for coming back on the podcast. Thank you very much for having me. Charles, what is a bank? Why do people need banks? Why don't they just put... I find myself thinking of this particularly at times.

Why not just put your money in a huge metal box with a lock on it? Well, banks have a vital function in the economy. So the purpose of banks, the banking system, the wider financial system, is to turn savings in the economy into investment. So the problem with putting your money, say, under your mattress in a safety deposit box, going to Gringotts in Harry Potter and putting it in a vault is that that's not really investment. That's just squirreling it away in a way that it doesn't aid productive investment. So what a bank, the banking system, a wider financial system does is it turns those savings into investment. So the bank takes deposits from savers and it lends that or invests that in, say, businesses that invest to build a factory,

an office, and those factories and offices employ people, those firms employ people and that's how you get economic growth. Investment helps produce economic growth. So a properly working banking system is vital to getting economic growth in an economy. This is where we have this idea of a kind of ratio between money that they actually got in their basement and then the money they loan out. What is that ratio? And is that why banks collapse? Because the money they've got written in their spreadsheet is not necessarily in their account at any one time. So a bank doesn't work by having all the deposits is taken in sitting in a safe in the back of the room. That's not how it works. They work in that they lend a lot of that money out.

And what's regarded as a safe ratio varies over time. One of the causes of the 2008 crisis was that they didn't have that much in terms of equity buffers. So it's also what do they owe to depositors against their assets? And the remainder is the equity owned by the shareholders. And the effect buffer gets too little. It means that if the assets owned by a bank suddenly fall sharply, that bank is insolvent quite quickly. So banks need to have liquid reserves, so a certain amount of readily available cash to meet demand from depositors to withdraw money from the bank. They also need to have an equity buffer owned by the shareholders, which ensures that if the value of their assets falls, they don't become insolvent, they don't become bust. So those two things are very important. But they're not the only thing

that banks need to keep an eye on in order to remain stable. So right, when times are good, bankers say to regulators, you guys, stop making us have a quarter of a sort of notional amount of money that we're lending out. Stop making us keep that in our actual basement, right? The temptation is to just keep lending more money and assume that no one's actually going to come and demand their savings back. Yes. In boom times when banks are doing well, there's always pressure on regulators to try to relax the rules. And you can see that in America, for example, during the Trump administration, there is a desire to roll back some of the banking reforms imposed after the 2008 crisis. Likewise, in the U2K, there's a lot of talk about Big Bang 2. And some people have got quite worried

that if that involves too much deregulation of the banking sector, some of the risks which were exposed in the 2008 crisis might come back. However, the problem is that regulators don't have all the answers to banking crisis. So because of the nature of the 2008 crisis, they very much focus on liquidity risk and also the risk of not having enough equity buffers. But as the collapse of Silicon Valley Bank recently has shown, those are not the only things a bank has to be worried about. And getting back to basics, whether it's the early Italian bankers, bancorruptoi, that they would smash their market stall, wouldn't they? They'd say that was it. They were broke. To the kind of 18th and 19th century banks in the UK that seemed to just go bankrupt a lot. I mean, there were lots of banking failures in the past. And that was just because lots of savers were turning up at the same time and being like,

we want our savings right now, buddy. And the bank couldn't make that work. Is that because it had loaned money out, it couldn't get that money back in quick enough? Exactly. So in the mid 19th century, certainly in Britain, there were very frequent banking panics, banking crises, bank runs, everyone running to the bank and demanding their money back. There was a banking crisis in Britain in 1825, in 1837, in 1839, 1847, 1857, 1866, at least once a decade. You can see almost there's a cycle going on there. And that cycle actually continued in other countries until the present day. But in Britain, for just above a century, banking crises disappear between 1866 to 1973. Almost completely made

banking crises disappear. They didn't make banks disappear, but banks were very important to the British economy. But banking crises almost completely disappeared. So much so that in a 1960s film, which is still very popular, the original Mary Poppins movie, there is a scene about her bank run on an Edwardian British bank. Somebody overhears that the bank

is not going to give the two pence back to one of the children of the family Mary Poppins works for. And all the depositors overhear that and they go, the bank's not giving that person their money back. Well, I'm worried that they're not going to pay my money back. So I'm going to ask for it all and get it all out. And then this bank run descends on the bank. But the thing is, that's a fantasy scene, because in reality, in the 1960s, this hadn't happened in Britain for a century. And that scene is just as much was a fantasy as a time as the scene in Mary Poppins, where there's a tea party floating in

the air on the ceiling, or the scene where they jump into a chalk pavement picture and have an adventure in a cartoon world. That scene is just meant to be as fantastical as unlike reality of 1960s Britain or Edwardian Britain as those other scenes. But instead, we've seen crises reappear in British history since the 1970s. So in the past, they were very common. Some countries did get rid of them for quite significant amounts of time. But weaknesses in the banking sector, financial crises appear to be coming back, particularly in British financial history. Why did Britain manage to put its turbulent 19th century banking history behind it? What happened?

Firstly, I suppose the answer to that question is partly why were there so many crises in the middle of the 19th century? And that is in part because central banks and the banks did not understand interest rate risk. So the Bank of England used to keep interest rates as low as possible for as long as it possibly could. And then when a crisis appeared, or what would trigger the crisis is when the Bank of England suddenly had to raise rates in order to stop running out of reserves or keep within its own regulations. The Bank of England's lending rate would hit a record level. This occurred in 1847, 1857, and then 1866, when new highs were achieved. And then after the crisis, they would put interest rates back down to a very low level.

And just as the collapse of Silicon Valley Bank has shown, rapid rises in interest rates can make banking systems unstable. And is that because much of what the bank has invested in with our money are low-yielding bonds, things, instruments from a previous era, from a time when interest rates are very low. So those things aren't very valuable at a time when interest rates are quite high. So the bank is unable to meet its obligations to its investors or the people that want to get their money out of it. Exactly. The bank either goes insolvent or even before it goes insolvent, the fear that it could become insolvent is enough to trigger a bank run, which causes it to run out of money in hand,

so it becomes illiquid, or might cause it to have to fire sell its assets, and that might make the value of its assets go down even further, so it becomes insolvent. And that's exactly what happened to Silicon Valley Bank. It announced that it had to fill a hole in its balance sheet. And that was enough to trigger the fastest bank run in world history on some metrics. Because they admitted, they said, look, guys, we need $2 billion, don't we? Because we've got a bit of a hole in our balance sheet, but it'll be fine. Can everyone please buy shares up to the value of $2 billion? And everyone went, no, we don't have money back now. And we're going to sit outside the bank branch with a big sack to put our money in as

quickly as possible. And so what you're seeing there is very old. It's a classic case of a 19th century bank run following an interest rate hike. People like you are sitting there drinking your whiskey, smiling at the TV of an evening. I'm not happy when banking collapses happen. I mean, the purpose of my most recent book is to try to find ways of preventing them and look at history to look at see why did they go away in the late 19th century. So I don't think, oh, great, that is a banking crisis. I think, well, that's a great failure, both for policymakers and people involved in public discourse such as myself, because these are avoidable, preventable. They're caused very much by the same factors as previous banking

crises were. And indeed, Britain did basically get rid of systemic banking crises for just over a century of its history. And it should be possible to do that again in the future. One of the ways, Dinger, is that as we saw in the legislation that followed the 2008 crisis, which was then watered down by Trump and the Republicans, is as well as the various tests around how much money you're holding, the ratios and things, you can also check a bank's exposure to interest rate rises. Is that the kind of thing you're talking about? So I think the regulations brought in after 2008 are very important. Regulators can't produce the entire solution in that regulators are always like the generals who are fighting the last war. On some of the metrics which came under scrutiny in 2008, Silicon Valley Bank wasn't

doing badly. It didn't buy a load of rubbish assets. It bought what it thought and what regulators rewarded it for thinking some of the safest, so US government debt. But what had been ignored in that regulatory push since 2008 was interest rate risk. What if interest rates suddenly rise? What if short-term lending rates suddenly rose above long-term lending rates, which occurred in the past few months? Essentially, Silicon Valley Bank was borrowing short-term, using short-term interest rates and lending long, as in buying this US government debt. And the point is interest rate rises make the price of bonds fall. So the yield or the interest rate moves inversely to the price of a bond. And long dated bonds are particularly sensitive to that because a lot of

the price of the bond is very strongly related to the interest rate. So interest rates rises made it more difficult for or more expensive for Silicon Valley banks to attract funds at the same time as interest rate rises were making the value of what it had bought invested in fall. And essentially, that's what made it collapse. But looking at the risks associated with that is not how regulators have been looking at it and also central bankers are far more interested in looking at how monetary policy impacts inflation and that's a very important thing that they've forgotten to consider what's the impact of monetary policy on financial stability

and what the consequences of monetary policy are for financial stability and potential financial crises in the future. You listen to Dan Snow's History, we're talking about financial crises. More coming up. I'm Professor Susanna Lipscomb and this month on Not Just the Tudors from HistoryHit, I'm dusting down my magnifying glass to investigate some of history's most notorious murders and brutal crimes. Was Amy Dudley pushed down a flight of stairs to her death? Was it a quarrel, or was the brilliant playwright Christopher Marlowe actually murdered? And what's the truth about the Hungarian noblewoman

who allegedly killed hundreds of young women? Join me for not just the Tudors from History Hit, wherever you get your podcasts. I'm Matt Lewis. And I'm Dr. Alan Orjanaga. And in Gone Medieval, we get into the greatest mysteries. The gobsmacking details and latest groundbreaking research. From the greatest millennium in human history.

We're talking Vikings. Normans. Kings and popes. Who were rarely the best of friends. Murder. Rebellions. And crusades. Find out who we really were by subscribing to Gone Medieval

from History Hit, wherever you get your podcasts. And you've been on this podcast before, and you've said to me, the thing that you want to avoid at all costs are banking failures, are banking collapses. Tell me, with your vast knowledge of history, why are they particularly bad? Banking collapses or recessions, which are associated with banking collapses and banking panics, produce much worse consequences than recessions which don't have banking collapses. So for example, a recession which didn't have a banking collapse is the early 1990s in Britain. An example of one where there was was 2008. In the early 1990s, the economy bounced back and continued its previous growth path. The economy dipped and then bounced back quite quickly. Compare that to 2008,

where the British economy shrank, but then it sort of stopped growing. The last 15 years have been the worst 15 years in UK economic history for growth in the last 200 years. You have to go back to the late 18th century to find a period so bad. And that is the effect of having a banking crisis. Because banks, if there's a banking crisis and banks run into problems or disappear, that's like the system having a heart attack. So you stop getting savings being converted to an investment, the economy grows a lot less. where you have a banking collapse or banking panic, recessions are longer, recessions are deeper, and recovery takes longer to happen and is much slower when it does happen. Economists think that half, if not more than half, of the blame for basically having no growth in Britain since 2008 can be attributed to the fact that there was a banking panic, a banking collapse in 2008. So you really want to avoid that. There's also a political problem as well, in addition, in that

people don't like their growth. If there's a period of short term, down term, people tend to be quite forgiving of politicians. Voters tend to be quite forgiving of politicians. But if you come to a long drawn out thing, people get very frustrated and they try to vent their frustration by voting for extremist parties. And as several economic historians before have found, banking collapses are associated with an increase in extremist voting. And I think you can quite clearly see that across the world since 2008. Trump in America, the rise of the far right in Europe, and in Britain, the rise of UKIP. Charles, is it not infuriating?

These banks, you talk about Hartzaks, you talk about, I mean, these things are essential to our lives, our economy, the future of liberal democracy. And bankers, in my experience, can be pretty loose dudes who just charge around on private jets having a good time. Why do we find a situation where the future of all these essential pillars of our civilization are in the hands of these bankers? That seems inherently quite

dangerous. It is quite dangerous, but politicians have even greater power in their hands. Politicians can't say there will be growth, but they can even greater power in their hands. Politicians can't say there will be growth, but they can destroy economy quite quickly and cause financial panic quite quickly. But I think the way to think about this is that the financial sector, just like any other sector, needs proper regulation. Partly that regulation is to make sure they preserve a good enough equity buffers. But I think it's also important that the macroeconomic environment remains stable for bankers to make sensible decisions. So rather than having very low rates followed by a sudden rise to a new record rate, and then it goes back to low rates for a decade, and then suddenly goes back to very high rates,

rate, and then it goes back to low rates for a decade, and then suddenly goes back to very high rates, having this much smoother adjustments to interest rates. So lots of small adjustments to interest rates, which aren't so quick, so prompt, but not necessarily rapid changes to interest rates. And that's how banking crises disappeared in Britain in the late 19th century. There was a change in interest rate policy, change in monetary policy at the Bank of England. And those lessons have more or less been thrown away in the last 50 years, which is why banking crises have returned in British history. So yes, it might be frustrating that we've handed all this power to bankers, but that's why we need to regulate the banking sector properly, as well as produce a macroeconomic environment which helps banks work properly and help give banks the incentive to focus on what's really their key role in the economy, which is to help recycling savings into investment. So there's many things wrong with the structure of the British banking system,

in that banks use far too much of those savings that depositors are leaving with them on giving loans to buy very, sometimes quite artificially inflated house prices. And in reality, if we want growth, that money shouldn't be going into mortgages to push up housing prices ever higher and higher. Instead, more of that money should't be going into mortgages to push up housing prices ever higher and higher. Instead, more of that money should be going and being invested in British industry. Likewise, the decline of the UK stock market is partly because UK domestic investors no longer want to invest in UK domestic firms. They want to use their money to buy stocks in other countries. And the result of that is that bankers now joke that British shareholders and British stock market investors

are some of the people who least want to buy UK investments in the entire world. So something has gone wrong, structurally gone wrong in the British banking system, in that this is no longer really a banking system which takes deposits from UK investors and recycles that into investments in UK firms and UK industry. This has been something which has been decades in the making. But there has been a profound shift in what the City of London does. And the question mark is, is the City of London doing the best job it could for the British economy and long run economic growth? And I think that is a big question that politicians and regulators and central bankers need to think about very seriously over the next

decade. Why are bank crashes contagious? Is it because when the first one or two crashes, that is indicative of a very challenging environment for banks? Or is it because of sentiment? Everyone starts panicking, a regional bank goes down in the States, and now we're all worrying about our own bank wherever we are in the world? Well, I think it's both. So the initial banks in the banking crises had problems. It could be because they haven't kept enough in terms of equity buffers. It might be because interest rates make them fall over. But then that damages sentiment. And then you get an extreme scenario of everyone runs on every bank and wants to get their money out and the system becomes very unstable. So this is why we want to prevent banking crises. And this is why

policymakers need to spend a lot more time thinking about how to prevent financial collapses. Because the other problem with when a banking collapse happens is what do you do? So if you bail out a bank, if the US government, for example, has stepped in to protect the deposits of Silicon Valley Bank, if you do that, it produces something that economists call moral hazard. So if the bank thinks, oh, well, if we go bust, if we can keep the profits when times are good, but somebody else will pay the losses. The taxpayer will pay the losses when things go wrong. And you don't want to incentivize that sort of behavior. So the best thing to do is to ensure that crises don't happen in the first place. You don't get the first banking collapses, which set off the line of dominoes, which causes a much bigger banking panic and banking collapse. The way you do that partly

is through good regulation. I put my emphasis on good quality. So it's not the quantity, it's not how big the rulebook is, but whether it's really dealing with risks in the system. And also creating a stable macroeconomic environment. So central bankers need to understand the impact of monetary policy changes, the impact of interest rate changes on the stability of the financial system better. That's why it's important both to prevent the first banking collapses, which might trigger panic and cause a wider banking failure. But it's also important that we try to prevent that before we get into the situation, even the first few banks falling of the first few dominoes of that process.

Well, as you said, create that moral habit is very difficult because then people know that they can behave however they like and someone will step in and bail them all out. That is infuriating to voters and you are caught in great danger of merely exacerbating a problem, postponing it rather than dealing with it. That's essentially how policymakers in late Victorian Britain were thinking. So Walter Badgett is famous for arguing that bank language should become a lender of last resort, but it should be the lender of last resort to the banking sector, but only at penalty interest rates, i.e. charging very high interest rates in order to punish banks for being imprudent. But he actually thought, okay, this is what you do when you're in a mess. But he also thought that there are things that the Bank of England should be doing

when times are good in order to make it less likely that you get a banking collapse in the first place. And those things are greater reserves, but also a more stable monetary policy system and a more stable macroeconomic environment. That's what he really thought would reduce the propensity of the banking collapses, which could trigger a full-blown banking panic and banking crisis to occur. And people have taken the lender of last resort out of this thinking, which is the, okay, if you're in a terrible situation, this is what you do, but not really looked at what he was thinking about how to prevent crises. And that's the sort of thinking that my book tries to highlight and promote that we should be thinking about how should we prevent crises in the future by creating a more macro

economically stable environment and a regulatory system which focus more squarely on the risks the banking sector faces, including interest rate risk. Thank you very much indeed, Charles. You better tell everyone what your book is called. My book is called Calming the Storms, the Cary Trade, the Banking School and British Financial financial crises since 1825 and basically the book explains why were there so many crises in victorian britain why did these crises go away for a century and why have they come back in britain since the 1970s the answer the book gives is you have to understand interest rates and interest rate risks and it's many of the same mechanisms that the book explores

are the same mechanisms which caused Silicon Valley Bank to fail recently. Thank you very much indeed, Giles, for coming on at such short notice. Thank you.