Playing the Game of Bank Bargains

I am beginning a new series on economics focusing on income and wealth inequality, which may last for a couple weeks. This first post (originally written in 2014 as preliminary work for a thesis research project that ended up simply not happening) does not deal directly with income inequality; instead, I discuss the political economy of banking, reviewing a book and a journal article on the topic. Next week’s post will make clear the relationship of the content in this post with income inequality.

In this essay, I review Dr. Ertürk’s essay “Breakdown of the capacity for collective action: The leitmotif of our times” and Dr. Calomiris and Dr. Haber’s book Fragile by Design; The Political Origins of Banking Crises and Scarce Credit. All of these authors look at the problem of systemic instability in the banking system and ask why it is present. When their thoughts are considered together, they bring new enlightenment to the question but raise new questions that should be addressed with discussing how the banking system functions and how the American banking system could be reformed.

According to Dr. Ertürk’s essay (which uses a Marxist framework), one of the problems faced by capitalists is coordinating amongst themselves how to handle needs for the perpetuation of the capitalist economic system. While they are capable of coordinating the labor of the masses to create the products society needs, coordinating amongst themselves to create and sustain the resources needed to sustain this economic system is not so easy. The capitalist state exists to resolve this problem; it coordinates collective action of the capitalists to meet these needs, and prevents free-riding by beneficiaries, thus ensuring that these needs are met.

According to Dr. Ertürk, the activist state that emerged in the United States after the 1930s served this function well, providing a number of “goods” necessary for the capitalist economy to function. In the case of banking and finance, it provided regulations that prevented actors from behaving in a systemically destabilizing manner, ensuring that the financial system ran smoothly. The costs to the wealthy associated with this regime (taxes, lost opportunities due to regulation, etc.) were simply part of the costs of maintaining the system that was still quite profitable, and, thanks to the state’s programs, would remain so. But as time went on and many of the poor, empowered with citizenship, demanded that the activist state create programs for their welfare while passing off the costs to the wealthy, the capitalists became disenchanted with the activist state, and saw to its dismantling in the 1980s and 1990s.

While the capitalists may have rid themselves of the burden of maintaining the activist state, they reintroduced the problem that the activist state was created to resolve: coordinating the collective action of the capitalist class to meet the needs of their economic system. Returning to the example of banking and finance, this need manifested in financial crises. Prior to deregulation, the state, via regulatory oversight, ensured that agents in the financial system did not act in a manner that would create systemic instability; this was a “good” that all players in the financial system benefited from. After deregulation, this “good” was no longer being maintained by anyone, so it disappeared. Both Dr. Ertürk and Dr.’s Calomiris and Haber emphasize that myopia on the part of actors in the financial system does not sufficiently explain the reckless and destabilizing behavior of agents in the financial system. Their behavior is best understood as being the consequence of the “rules of the game” of the market in which they are playing. Dr. Ertürk put it well: “What arguably made profit seeking banks stray from their enlightened self interest by taking on excessive risk was the economic imperative market discipline imposed on them”. In other words, if bankers wanted to survive competition, they had no choice but to behave recklessly, grabbing the short-term benefits of risk taking that the market demanded, and hold fast when the inevitable consequences of reckless risk taking en masse came home to roost.

Dr. Ertürk then describes how the inability of the capitalists to come together and coordinate their collective action to serve their enlightened self-interest—in not only banking and finance but in other important issues—has become “the leitmotif of our times.” This observation—that capitalists seem to be trapped in a suboptimal Nash equilibrium—is very puzzling in banking and finance when considered in light of the model that Dr. Calomiris and Dr. Haber present in their book. According to them, banking system stability and efficiency are the products of the rules of banking produced by the “Game of Bank Bargains,” which is played by all stakeholders in the banking system. The rules of the game—including those rules that are legal, regulatory, or informally understood—determine the outcomes of the banking system, and those rules are determined by politics. Political coalitions form, and those coalitions that are able to garner enough power are the ones with the ability to write the rules the banking system will obey. The authors then proceed to describe what banking systems are produced by coalitions formed by different combinations in banking stakeholders.

Dr. Calomiris and Dr. Haber’s model reminds me of a game called Nomic. In Nomic, the players not only play the game but also participate in writing the rules, typically by a democratic process of proposing and voting for rule changes to the game (though alternatives, such as “despotism,” do exist). While no one ever really “wins” a game of Nomic (some games played via e-mail have been ongoing for decades), a player could still consider herself to be “winning,” and they certainly have a stake in what rule changes are made. An unfavorable rule change could change a player’s status from “winning” to “losing” with the stroke of a pen. Similarly, in the “Game of Bank Bargains,” the stakeholders both play the game and write the rules, and every stakeholder will want to see that the rules are written in such a way that his interests are served.

The rules of the game at present, along with the coalitions that exist, are dependent on how the game has been played in the past; this is the historical context that the authors of the book utilize and implore readers to consider. Likewise, the strategies employed by various stakeholders—when both forming coalitions to write the rules of the game and when playing the game as it stands—are dependent on the rules of the game at present, the nature of the political institutions that determine how rules are created (which is its own set of rules that exists above those created by the “Game of Bank Bargains”), and are informed by how the game has been played in the past. One then reaches the main conclusion of the book: banking system efficiency and stability are determined by the “rules of the game” created by political coalitions of banking-system stakeholders, which are formed by the nature of a country’s political institutions.

This raises interesting implications for Dr. Ertürk’s “leitmotif.” Supposedly, capitalists are faced with a problem of collective agency—that is, coordinating their collective action to solve a common problem facing their economic system. In the case of banking, the current “rules of the game” in the United States result in an unstable baking system; the winning strategy, when playing the game, is to disregard one’s own enlightened self-interest in favor of short-term self interest that introduces systemic instability. But there does exist a set of rules that would align the short-term and enlightened self-interest of bankers, one that would allow for centuries of banking system stability (according to Dr.’s Calomiris and Haber, the Canadian banking system is such a system), perhaps even granting the bankers oligopoly rents. This system could be attained if the existing rules governing banking are changed to those that would foster stability and efficiency. This begs the question: why is an alternative set of rules not favored?

Dr. Calomiris and Dr. Haber would respond that the reason why an alternative set of rules isn’t adopted is because the existing coalition with the power to change the rules doesn’t favor them. But one asks why again, and discovers a missing piece in their book’s framework: how does a stakeholder in the banking system know when they are “winning the game?” This is not a trivial question. There could be a number of competing metrics that a stakeholder may use to determine whether they are “winning.” For example, do the “haves” in an economy care about their share of the national wealth, or their nominal wealth (which are not necessarily the same thing)? Which metric informs their decision making? Dr. Ertürk notes a case of competing metrics: capitalists today are pursuing short-term self-interest at the expense of their enlightened self-interest. But they supposedly have the power to change the rules of the game to a set that would favor their enlightened self-interest (granted they form the right coalition). Why do they choose not to?

Answering this question, which focuses on the motivation of the players of the game, could be a valuable addition to the model set forth in Dr. Calomiris and Dr. Haber’s book. As it stands, their model is a recipe guide for different banking systems; combine certain stakeholders in a certain environment, and you get a banking system that behaves in a certain way. It does not describe the chemistry that guides the interactions of the stakeholders and explain why they combine the way they do and why they create a certain banking system. Yet this is the crux of the issue.