Great Expectations, Financialization, and Bank Bailouts in Democracies

• Author: Jeffrey M. Chwieroth,Andrew Walter
• Published date: 01 July 2020
• Date: 01 July 2020
• DOI: http://doi.org/10.1177/0010414019897418
• Subject Matter: Articles

https://doi.org/10.1177/0010414019897418

Comparative Political Studies

2020, Vol. 53(8) 1259 –1297

© The Author(s) 2020

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DOI: 10.1177/0010414019897418

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Article

Great Expectations,

Financialization, and

Bank Bailouts

in Democracies

Jeffrey M. Chwieroth1

and Andrew Walter2

Abstract

Accelerating financialization and rising societal wealth have meant that

democratic governments increasingly provide bailouts following banking crises.

Using a new long-run data set, we show that despite frequent and virulent crises

before World War II, bank bailouts to protect wealth were then exceptionally

rare. In recent decades, by contrast, governments have increasingly opted for

extensive bailouts—well before the major interventions of 2007–2009. We

argue that this policy shift is the consequence of the “great expectations”

of middle-class voters overlooked in existing accounts. Associated with the

growing financialization of wealth, rising leverage, and accumulating ex ante

financial stabilization commitments by governments, these expectations are

suggestive of substantially altered policy preferences and political cleavages.

Since the 1970s, when severe banking crises returned as an important threat to

middle-class wealth, this “pressure from below” has led elected governments

to provide increasingly costly bailouts with no historical precedent.

Keywords

political economy, globalization, economic policy

1London School of Economics, UK

2The University of Melbourne, Victoria, Australia

Corresponding Author:

Jeffrey M. Chwieroth, Department of International Relations, London School of Economics,

Houghton Street, London WC2A 2AE, UK.

Email: j.m.chwieroth@lse.ac.uk

897418CPSXXX10.1177/0010414019897418Comparative Political StudiesChwieroth and Walter

research-article2020

1260 Comparative Political Studies 53(8)

A decade after the global financial crisis, agreement on appropriate policy

responses to banking crises remains elusive despite an apparent political con-

sensus on the need to eliminate bailouts and end “too big to fail” (Binham,

2017). Furthermore, many experts doubt that measures adopted since 2008 to

limit taxpayer-funded rescues will achieve this objective (Admati & Hellwig,

2013; Bernanke et al., 2019; King, 2016). Meanwhile, elected governments,

most recently in Italy, continue to implement costly bailouts regardless.

The commonplace explanation that bailouts are the consequence of pres-

sure from financial sector interests is not the whole story (Barofsky, 2012;

Johnson & Kwak, 2010).1 We argue that the emergence of “great expecta-

tions” among a large segment of society regarding financial stabilization has

been a critical but overlooked factor driving long-term changes in govern-

ment responses to banking crises toward increasingly extensive and costly

bailouts. This evolution in the policy expectations of households and voters

has been driven by three interrelated developments: the financialization of

wealth, the democratization of leverage, and accumulating ex ante govern-

ment policy commitments to financial stabilization. These developments

have increasingly linked the interests of middle-class households2 to finan-

cial markets and thereby broadened and intensified their effective demand for

protection from the fallout from crises.

Utilizing a new data set that codes policy responses for 58 democracies in

112 systemic banking crises since 1848, we provide the first statistical analy-

sis of government policy responses to banking crises over such an extended

time frame and a large sample of systemic crises. Our findings are consistent

with the claim that the wealth effect has generated a rising tendency toward

bailouts. They relate to other studies suggesting that deepening ties to asset

markets now challenge, if not supplant, those with the labor market as the

dominant economic cleavage in politics (Ansell, 2014; Callaghan, 2015;

Harmes, 2001; Langley, 2014). They also extend work emphasizing how this

“democratization of finance,” often associated with a new policy narrative of

individual self-responsibility for embracing and managing life cycle risks,

has a tendency to disappoint (Erturk et al., 2007; Langley, 2009). Voters

strongly resist the idea that they should accept personal responsibility for

wealth losses in an era of great expectations.

Our findings are inconsistent with the argument that “democratic gov-

ernments, constrained as they are by links of electoral accountability, are

more cautious in implementing costly policies that are ultimately shoul-

dered by taxpayers” (Rosas, 2009, p. 4).3 This claim overlooks the dynamic

forces we identify that have weakened the democratic constraint on bail-

outs. Great expectations effectively place modern governments under a

very different standard of democratic accountability by requiring them to

Chwieroth and Walter 1261

compromise minimizing taxpayer liability in systemic banking crises in

favor of bailouts aimed at wealth protection. They thus raise doubts con-

cerning the general claim that democratic institutions promote fiscal cred-

ibility (North & Thomas, 1973; North & Weingast, 1989).

In the next section, we elaborate our argument. We then present the new

data set and the results of our statistical analysis. We conclude by considering

the implications for how we can understand evolving political cleavages.

Banking Crises and Policy Responses in

Democracies

We can conceptualize policy responses to banking crises as mapping onto an

abstract continuum ranging from no government intervention to complete

government socialization of all banking sector losses. We label the first pole

of this continuum the Market pole and the second the Socialization pole. Both

poles are ideal types and in practice policy responses often fall between them,

approximating what Rosas (2009) summarized as “Bagehot” and “Bailout”

(Figure 1).

A “Bagehot” model conforms with Walter Bagehot’s (1873/1962) doctrine

of crisis resolution, which called for central banks to provide lender of last

resort facilities (LOLR) to solvent banks by “freely advancing on what in

ordinary times is reckoned a good security” (p. 97). Such lending should be

unlimited but at “penalty” interest rates in return for good collateral, to ensure

that the government was not subsidizing banks in need.

Bagehot defined bank solvency in reference to “ordinary times” to indicate

that the LOLR is needed only when there is some uncertainty about solvency

and implies the possibility of taxpayer loss (Goodhart, 1999, pp. 347–352).

LOLR support diverges from the pure Market pole in that it involves policy

intervention to prevent ordinarily solvent and illiquid banks from failing. It

places the burden of permanent insolvency on banks, their shareholders and

related creditors rather than on taxpayers and thus can also entail enforcing the

closure of insolvent banks, forcing write-downs of banks’ nonperforming

loans (NPLs), permitting their recapitalization by private investors, and pro-

tecting few if any depositors.

Pure Pure

Market Bagehot Bailout Socialization

Responses Responses Responses Responses

Figure 1. Conceptualizing policy responses to banking crises.