In the acknowledgements to The Shifts and the Shocks (which I am currently reading) Martin Wolf has stated that friends like Mervyn King encouraged him to be more radical than initially intended, and I suspect, as I read Chapter 4, “How Finance Became Fragile,” that this was one of the chapters that was affected by such comments. In particular, I see a contradiction between the initial framing of financial fragility which focuses on Minsky-like inherent fragility, and the discussion of regulation. Was this a crisis like that in the U.K. in 1866 or in the U.S. in the 1930s, or was this an “unprecedented” crisis that was aggravated by the elimination of legal and regulatory infrastructure that limited the reach of the crisis in 1866 and the 1930s? I am troubled by Wolf’s failure to take a clear position on this question.
Because Martin Wolf understands that the government intervention due to the crisis was “unprecedented” (at 15), I had always assumed that he understood that the nature of the 2007-08 crisis was also unprecedented. He appears, however, to be of the opinion that this crisis was not of unprecedented severity. Martin Wolf really surprised me here by taking the position that: “The system is always fragile. From time to time it becomes extremely fragile. That is what happened this time.” And by continuing to treat the crisis as comparable to the 1930s in the U.S. or 1866 in the U.K. (at 123-24).
His treatment of how regulation played into the crisis could be more thorough. He concludes that “the role of regulation was principally one of omissions: policymakers assumed the system was far more stable, responsible, indeed honest, than it was. Moreover, it was because this assumption was so widely shared that so many countries were affected.” (at 141). Wolf is undoubtedly aware of the many changes to the legal framework that protected the U.K. financial system in 1866 and the U.S. financial system in the 1930s that were adopted at the behest of the financial industry in both the U.S. and the U.K. (Such changes include the exemption of derivatives from gambling laws, granting repurchase agreements and OTC derivatives special privileges in bankruptcy, and the functional separation of commercial banking from capital markets.) Is the argument that these changes were not important? or that these changes fall in the category of omission by regulators? Given the preceding section of this chapter, it would appear that he believes these changes were not important, but given the conclusion of the chapter, I am not so sure.
In the conclusion, Wolf takes a somewhat more aggressive stance than he does in the body of the chapter: “The crisis became so severe largely because so many people thought it impossible.” (at 147). So maybe the crisis is unprecedented compared to 1866 and the 1930s. (In 1866 at least the possibility of financial collapse seems to have been recognized.) He also adds two more points to the conclusion that I didn’t see in the body of the chapter: the origins of the crisis include “the ability of the financial industry to use its money and lobbying clout to obtain the lax regulations it wanted (and wants)” and the fact that “regulators will never keep up with” the ability of the financial industry to erode regulation (at 147).
Thus, once I reached the conclusion of the chapter, it was no longer clear that Wolf views this crisis as primarily an example of inherent fragility. He has laid out the argument for how the financial industry successfully removed the legal and regulatory protections that were in place in 1866 and the 1930s. So this is my question for Mr. Wolf: Was the crisis itself “unprecedented” in the course of the last two centuries of Anglo-American financial history, or was this just a Minsky moment like many that have come before?