My Amazon Review of James Grant's "Bagehot: The Life and Times of the Greatest Victorian"

The Oracle of Lombard Street

I knew Jim Grant in the late 1980s and early 1990s when he was chronicling the commercial real estate debacle of that era is his eponymous “Grant’s Interest Rate Observer”. Grant, the author of several books, has turned his excellent wordsmithing to write the biography of the mid-19^th Century editor of the “Economist”, Walter Bagehot. During the financial crisis of 150 years later, Bagehot’s “Lombard Street” dictum during a crisis of lending freely at a penalty rate against good collateral was widely quoted by central bankers, most notably by the then Fed Chairman Ben Bernanke. According to Grant Bernanke got the lend freely part right, but it was at low rates against less than stellar collateral.

Grant’s Bagehot is very impressive. A polymath country banker who married James Wilson’s daughter, the founder of “The Economist.” On Wilson’s death Bagehot succeeds Wilson as editor. From that post Bagehot wields great influence in Britain’s Liberal Party becoming a key adviser to William Gladstone who would become Chancellor of the Exchequer and later Prime Minister. Bagehot cut his teeth during the 1866 Overend Gurney bank failure that froze the London money market, then the largest in world. London had three times the deposits of New York and eight times the deposits of Paris. In the teeth of the crisis the Bank of England violated its statutes and intervened in the market to stop the bank run.

In 1873 Bagehot wrote “Lombard Street,” his primer on central banking. Grant is sympathetic to his main critic Bank of England Director Thomson Hankey, who argued that to have the central bank be the lender of last resort you create an environment that large banks are too big to fail. We live with that to this day.

There is far more to Bagehot than central banking. He wrote “The English Constitution” and commented on all sorts of developments including his belief that the South would win the Civil War. Grant has written a worthy biography of this truly eminent Victorian.

The full Amazon URL appears at: https://www.amazon.com/review/R38KJVAABISATI/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Mervyn King's "The End of Alchemy: Money, Banking and the Future of the Global Economy"

Fixing the Banks

Mervyn King, the former governor of The Bank of England, has written a very readable book on the interaction of money and banking on the global economy. He offers his insights as a practical banker and a serious economist for the way forward from the financial crisis of 2007-09 that we are still reeling from.

Although he discusses a host of topics relating to how people make decisions in practice compared to how economic theory suggests they behave, the problems of the fixed exchange rate regime within the European Union, and the difficulties of making policy within a framework of competing nations; I will focus on two issues that he raised.

The first is his suggested reform for the banking system. His reform is a modified “Chicago Plan” of the 1930s which called for 100% reserves. Under that regime bank deposits would be matched with cash and short term government securities. Hence no risk and no potential for bank runs. In contrast the current system is based on fractional reserves where banks hold a small portion of their deposits in reserves and lend out the balance. This process is King’s alchemy where short   maturity deposits are transformed into long term assets. In the jargon of economists this process is called “maturity transformation.” 

This system is inherently unstable because the cash is not there to pay off depositors if they want all of their money at once. To deal with this contradiction the central bank acts as a lender of last resort to meet the demands of anxious depositors. This gives rise to the issue of “too big to fail.” King’s compromise is to turn the central bank into a “pawnbroker for all seasons.” Under his proposed system banks must hold sufficient reserves, liquid assets and discounted long term assets to meet all deposit and short term borrowing liabilities. The discounted assets would be valued at a “normal times” value with an appropriate “hair-cut”  to allow for risk and those asset could be pawned at the central bank should the need arise. Any lending above this threshold would have to be funded by additional equity and long term liabilities. Thus depositors would feel secure that their money be there when they needed it.

All this is fine and good, except there would be very little incentive for banks to make risky loans. Why is that bad? It is bad because new businesses, new ideas and new construction have to be funded if the economy is going to achieve the growth that most of us desire. To undertake King’s reforms we would need new institutions to undertake those risks. King is silent on this question.

The other issue that King raises that I would like to discuss is that the universal answer to all financial crises is to throw central bank money at it. We have been doing this for nine years. The problem that King rightly raises is that if the problem is structural rather than liquidity, throwing money at the crisis will delay solving the structural imbalances. To King’s mind central bankers in this environment may set interest rates too high to permit growth, but too low to allow for a structural adjustment.

The issue in the West is that savings are too low, while in the East consumption is too low. For example in order for the U.S. to cure its chronic trade deficit the savings rate has to rise and consumption has to fall, while China’s huge trade surplus has to be cured by higher consumption and lower savings. Politically asking people to reduce consumption is a hard sell so the easy way out is to keep interest rates low that works to keep consumption up.

All told Mervyn King has written an important book that will play a significant role in the ongoing debates over banking reform and monetary policy. He also offers a well done primer on current thinking on monetary policy that is accessible to the lay reader.

For the full Amazon URL see:
https://www.amazon.com/review/R2QKZ627F6QZRL/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Roger Lowenstein's "America's Bank: The Epic Struggle to Create the Federal Reserve"

The Making of the Fed

The “money question” is as old as the Republic. In “America’s Bank” Roger Lowenstein tells the story as to how the United States in 1913 brought into being its first central bank since 1837. Recall that the Second Bank of the United States came to an end when President Andrew Jackson refused to renew its charter. This triumph of Jacksonian Democracy would come back to haunt the Democrats who supported the creation of the Federal Reserve.  

To be sure there were panics and crashes in those intervening years, but absent a central bank the U.S. still grew to become the largest economy in the world. What triggered the need for a central bank was the Panic of 1907 which nearly brought the economy to its knees and it required the rescue of a bankers syndicate led by one James Pierpont Morgan. In response to the panic, Congress passed the Aldrich-Vreeland Act which authorized the Secretary of the Treasury to issue emergency currency and it established a National Monetary Commission to investigate the causes of the panic and to recommend policy changes. Unlike the 2008 financial crash Congress acted first with the Dodd-Frank Law and then created a financial inquiry commission whose work is already forgotten.

It here where we begin to see the leading players involved in the creation of the Fed. First and foremost is Rhode Island Senator Nelson Aldrich who chairs the commission, studies European central banks and becomes convinced of the need for a central bank in the U.S. Next is Paul Warburg, a German immigrant and scion of the Warburg banking family who worked for their U.S. affiliate Kuhn Loeb. He is rightfully called by most historians and Lowenstein as the father of the Federal Reserve as he becomes the most knowledgeable and tireless advocate for a central bank.  It is Warburg and Aldrich who organize the famous Jekyll Island bankers’ retreat where all of the essential elements of the Federal Reserve Act are written in secret. Sometimes transparency isn’t such a good idea.

After the Democrats sweep the 1912 elections Republican Aldrich is moved to the sidelines and the new key players are President Wilson who deftly works around his party’s Jacksonian traditions and Representative Carter Glass of Richmond, Virginia, who though a Jacksonian becomes the leading advocate for a central bank. Glass would later as a Senator, be the coauthor of the Glass-Steagall Act separating commercial banking from investment banking. Lowenstein spends a great deal of time dealing with both Wilson’s and Glass’ maneuverings to bring about passage of the act. He tells a good story especially in regard to how the U.S., in deference to its Jacksonian traditions, doesn’t have one central bank but rather a national board with 12 district banks.

I have a few quibbles with this otherwise wonderful book. First he doesn’t’ really tell us why there is a district bank in Richmond, Virginia, perhaps it is Carter Glass’ hometown or why there are two district banks in Missouri. Is it because the Speaker of the House Champ Clark was from Missouri or was it out of concern with supplying credit to agriculture in the Midwest? Finally, although he mentions it in passing, he doesn’t really go into how successful the pre-Fed Aldrich Vreeland Act was in the summer of 1914 in supplying needed cash to the banking system after the outbreak of World War 1. Remember although enacted in 1913, the Fed did not open its doors until December 1914. Friedman and Schwartz note in their “Monetary History…” that the use of Aldrich-Vreeland money in 1914 did a far better job in protecting the banking system than what the Fed did in 1930-31. 

For the full Amazon URL see:

https://www.amazon.com/review/RNFCDSOKADSJH/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv