(Bloomberg Businessweek) -- One of Jamie Dimon's daughters called him up from school with a question more than a decade ago: “Dad, what's a financial crisis?” The billionaire who runs JPMorgan Chase & Co. tried to put her at ease. “It's the type of thing that happens every five to seven years,” he told her, he later testified to the Financial Crisis Inquiry Commission. She asked him on the phone why people seemed so surprised by the calamity. In Washington, when he told this story, he said we shouldn't be.
That's because the history of banking is, at least in part, a kind of horror story that keeps repeating itself.
Back during the Venetian Renaissance in the 14th and 15th centuries, the business was so fragile that a rumor of someone withdrawing cash was enough to send depositors into a panic. For Amsterdam bankers in 1763, it was a grain deal with Russians at the end of wartime that helped stir up crisis. This year, angst about losses on bond investments and large uninsured deposits helped trigger two of the biggest US bank failures ever. The problems are old, and the system is delicate: We let banks make long-term investments, including loans and bonds, while taking deposits from customers who can demand them back whenever they want.
Deposit insurance, central bank backstops and regulation make panics less likely. Even so, banking and financial crises are “as much rooted in human nature as in any particular legal, economic or political system,” says Kenneth Rogoff, the Harvard University economist who wrote a bestselling history of financial crises, , with Carmen Reinhart. “After a crisis, regulations inevitably become tighter, but then as memories fade, regulations often relax. And whatever rules regulators design, over time financiers will eventually find creative ways around them.”
In Fort Worth, students who'd taken a class on financial history at Texas Christian University sent messages to their professor, Stephen Quinn, when Silicon Valley Bank collapsed. They couldn't believe that the bank runs they'd studied were happening again. “It's a delight,” he says. “Not that I want panics.” He also heard from his mother-in-law, who wanted to know if she should pull her money out of her bank, too. For most people in the US today, deposit insurance up to $250,000 makes that kind of move unnecessary. But above that amount, the basic logic of bank runs is powerful and unforgiving—if you suspect your money might be in trouble, why wait?
Almost a century ago, during the Great Depression, about 9,000 banks failed in the US alone. Between 1340 and 1500, according to Luciano Pezzolo at Ca' Foscari University of Venice, few major banks in the city “avoided a bitter end.”
Dimon's fatherly advice aside, experts say calamity doesn't always have to be part of the system. Besides guaranteeing deposits, regulators can watch how bankers manage their books and invest their assets. Canada manages to have “wonderfully boring” banks, says David Singer, who studies crises and heads Massachusetts Institute of Technology's department of political science. “The recipe for stability is to have well-capitalized, risk-averse banks,” he says. A well-capitalized bank is something like a homeowner with a lot of equity: It has a financial cushion to absorb losses on the value of its assets. “But banks won't naturally gravitate toward such behavior. They need thorough and steady regulation that doesn't ease up when the economy is humming.”
That can be easier said than done. Bankers are adept at finding new ways to squeeze out profits that can eventually get them into trouble. For example, in the early 2000s, Wall Street's financial engineers figured out how to make risky mortgages look like safe investments. “Often, regulators do not know of such loopholes in real time; therefore unknown risks are mounting in the shadows, until a crisis hits the system,” says Haim Kedar-Levy, a professor at Ben-Gurion University of the Negev who wrote .
Natacha Postel-Vinay, who teaches a class on financial history at the London School of Economics and Political Science, says failures won't be inevitable when the right incentives for bankers are in place. Some new rules clawing back bonuses in the event of trouble have helped make sure executives have skin in the game when they take risks with depositors' and investors' money. But, she adds, “we're far from the overhaul of corporate governance that would be needed to tackle the problem.”
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