Are parliamentary systems better in managing financial crisis?

FCIC has closed operations after submitting its controversial report. While closing shop, it has released a huge library of closed- door interviews, videos and documents.

JR Varma in his superblog points to transcript of the testimony held with Bernanke. Bernanke says US was the only country/democracy where a firm failed (Lehman). In rest of the democracies firms were saved. Why? He thinks it is US Presidential system which does not allow the US government to act quickly. Hence, Fed was the only option:

The problem was – well, to give you a broad perspective, around the world, the United States was the only country to lose a major firm. Everywhere else, countries were able to come in, intervene, prevent these failures.

And I think, politically speaking, this is one place where the parliamentary system probably worked better because the prime ministers and the parliamentary leadership were able to get together over the weekend, make decisions, and on Monday morning, able to take those choices. And, generally speaking, the central banks, although they were involved in Switzerland and other places, in finding solutions, were not leading the efforts to prevent the collapse of these institutions.

But in the United States, as you know – of course, we don’t have the political flexibility for the government – quote, unquote – to come together and make a fiscal commitment to prevent the collapse of a firm. And so basically, we had only one tool, and that tool was the ability of the Federal Reserve under 13(3) authority to lend money against collateral. Not to put capital into a company but only to lend against collateral. That, plus our ingenuity in trying to find merger partners, et cetera, was essentially all — that was our tool-kit. That’s all we had.

Though Prof Varma thinks this was not really a weakness. It is actually a strength where you have these checks and balances and don’t give powers in hands of selected few.

I believe that there is merit in constraining the ability of a handful of people to act secretly and hastily to bail out the financial elite. The checks and balances of the US constitution should be seen as a strength and not as a weakness. For the same reason, it is a good idea to separate bank supervision from the central bank. It makes it harder to cover up supervisory failures by using the vast resources of the central bank to bail out a failed bank.

Takes you to the debate held by Economist on role of central banks going forward.

We keep having debates in India on this. Many have said that India should move to a Presidential system like US as it does away with plethora of parties and helps serve democracy better. This blog does not understand political science so not  much thoughts on it.

But this linkage of a certain form of governance with economics is really interesting. Bini Smaghi of ECB  criticised the US for letting Lehman fall. He said this is a problem with democracies as you want public approval before bailout but that would take time. US made the same mistake earlier as well. In 2007 Fed’s 13 (C) helped and in 1995 it was foreign exchange stabilization fund.  Otherwise, things could have been much worse:

At our last meeting, in October 2008, shortly after the collapse of Lehman Brothers, I examined the problems facing modern democracies in making decisions that require citizens to make short-term sacrifices for long-term gains. Lehman Brothers was left to go bankrupt, with devastating effects on the global economy because the US Congress – under pressure from voters a few weeks before the election – refused to provide the US administration with the funds necessary for the rescue.

It was not however the first time that the American people reacted that way. In 1995, at the time of the Mexican crisis, the US Congress refused to disburse funds to support the IMF’s USD 50 billion programme. The US administration found in the labyrinth of the budget a foreign exchange stabilisation fund that did not require Congressional approval to use on that occasion. The facts have shown that without that intervention Mexico would have been hit by a severe crisis which would also have overwhelmed the United States.

However, even in Europe it was as bad. Firms may have not failed but it went through a severe crisis exposing the EMU model. The policymakers did not act quickly and this made both cost and severity of the crisis worse. Most Europeans economies have parliamentary system barring Cyprus.

It seems that the people, their democratically elected representatives, and institutions operating in that context, sometimes need to ‘see’ the crisis approaching in order to realise the dangers and take the decisions necessary to tackle them. This is particularly the case in societies which are based on economic stability, such as Germany, and which are not used to managing crises, especially those of a financial kind. In the global world in which financial markets move rapidly, there is a risk that the reaction times are too slow and that people may sense a crisis looming when in fact it has already hit. To prevent such a risk we need great leadership by those who govern, and we need institutions to convince people to look beyond the short term and take account of the impending crisis. Alternatively, automatic defence mechanisms are needed which permit a rapid addressing of problems before a crisis breaks out.

So it is not as if Parliamentary system was better.  They may have saved big banks from failing (leading to a bigger moral hazard issue) but could not act quickly in case of Greece, Ireland etc.

Fascinating stuff. Till now you wondered about whether central banks should be made responsible for financial stability as well. Now you are also thinking of changes to be made in democratic governance set-ups to help act on the crisis faster. This involves a much higher macro-level thinking and action…


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