Financial History’s False Lessons

TOULOUSE – If history punishes those who fail to learn from it, financial history does its punishing with a sadistic twist – it also punishes those who learn from it too enthusiastically. Time and again, financial crises have reflected the weaknesses of regulatory systems founded on the lessons learned from previous crises. Today’s crisis is no exception; nor will the next one be.

The post-war system of financial regulation was founded on three supposed lessons from the 1930’s. First, we thought that the main reason why banks fail is that depositors panic, not that the main reason depositors panic is that banks are in danger of failing.

Like the view that running away from lions provokes them to eat you, there is a grain of truth in the view that banks fail because depositors panic. But it is a small grain, and one on which the average uninsured depositor, like the average tourist in a game park, would be ill-advised to rely. In fact, many panics happen for a good reason. Even in the 1930’s, most banks failed as a result of bad management and illegal activity, as is true today.

Second, we thought that the depositors prone to panic would always be small depositors – households and small firms – rather than corporations or professional investors. We now know that this is wrong, but there was never any serious reason to believe it.