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Source: The post is based on the article “Is Every Bank Too Big to Fail? – US government rescue culture will hurt the global financial system, then growth and living standards everywhere” published in The Times of India on 28th March 2023.
Syllabus: GS 3 – Economy
Relevance: About the US’s changing attitude towards rescuing banks and its implications
News: Bank runs in the US have caused global economic shocks and it increases the burden on the government for its rescue. This has been caused by the easy money policy adopted by the US.
What is easy money policy of the US?
In the last few decades, the easy money policy of the US, made the US market five times larger than the world economy.
The market in the US was so deeply interconnected that the failure of even a midsize bank had global impacts.
This easy money era was shaped with low interests and the state’s responsibilities to rescue banks and other economic institutions from crisis.
Even in the present bank runs, the easy money era is being followed. For instance, central banks are tightening monetary policy due to the inflation and the government is opting to rescue those which failed.
This rescue mechanism has turned US from a minimalist state towards maximalist.
How has America grown from a minimalist state to maximalist?
Before the Civil War: America in the pre-1929-era was a minimalist state. In those times, economic rescues adopted by the government were rare and were also not controversial.
America in had limited government intervention and no central bank. Trust in those times was kept at personal level not at institutional level.
During the American Industrial Revolution: Even during the industrial revolution, the government restrained in intervening into rescuing the economic institutions. This resulted in strong productivity and higher per capita income growth.
During the 1960s-70s: By this time also, people were against government rescue of the economic institutions.
During the 1980s: Free market ideology spread worldwide during this period. It also saw the rise of rescue cultures. Continental Illinois became the first US bank to fail.
FDIC extended unlimited protection to Continental depositors of the bank just as it recently did for SVB depositors.
During the 1990s: The first preventive rescue came in the late 1990s. The Fed organised support for Long Term Capital Management in order to avoid the threat of a systemic financial crisis.
Post-1990s: The US government in 2008 and 2010 attempted a larger rescue. It rescued big Wall Street banks in 2008.
And in 2020, the government took preemptive measures to rescue everyone including individuals and companies of all sizes, including those lacking solid collateral.
The Fed and Treasury combined spent trillions of dollars in loans and bailouts to thousands of companies across finance and other industries at home and abroad.
What are the implications of adopting maximalism?
Maximalism has led to a massive misallocation of capital and a surge in the number of zombie firms.
In the US, total factor productivity growth fell from 2% between 1870 and the early 1970s to 0.5% after 2008. This maximalist culture, instead of re-energizing the economy, is destabilizing the global financial system.
Hence, the government intervention eases the pain of crises but over time lowers productivity, economic growth and living standards.