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monica prasad’s mortgage paper

Given my recent concern with the politics of mortgages, Monica Prasad was nice enough to share a working paper called “The Credit/Welfare State Tradeoff: A Demand-Side Theory of Comparative Political Economy.” You can read it here. She gave me permission to give public comment and critique. I am not in political economy, nor am I am expert in banks or financial regulation, so take that into account as you read the comments.

Let’s start with the paper’s main motivation: Traditional political economy can’t explain the fact that (a) the US has more banking regulation than Europe and that (b) a modest amount of deregulation resulted in more bad consequence in America than in  Europe. Existing theories focus on the evolution of industry and the institutions they set up, resulting in states that regulate industry and tax incomes in different ways (“varieties of capitalism,” VoC). Prasad’s alternative is that economies are best understood as agglomerations of firms who are subject to regulations pushed by adversarial interest groups.

Prasad’s main critique is that these traditional theories would predict that America would have pretty lax regulation of banks, when you actually have more regulation of banks than in Europe. I don’t see this observation as a stunning take down of the VoC view. Maybe banking is an outlier and the typical American firm is still more regulated than in Europe. If you look at the Index of Freedom, often used as a basic measure of economic liberalization, the US still does better than most countries. Yes, it’s from a partisan think tank, but it’s ranking seem plausible to me. I think I need an argument about why banking somehow shows a problem with our understanding of what counts as a liberal country, or why we should care about an exception like banking.

Ok, but it still is a pretty important question: banking is more regulated in America, why? Monica’s argument boils down to an issue of state formation. The US was created by land expansion. Farmers and settlers needed credit  So when banks went bust, they demanded tougher regulation. This observation also leads to a solution to (b). Since everyone is using tons of credit, bank turbulence will have have a bigger impact. This raises Prasad’s last point: Why do people need so much credit? It’s because they need income support because we have a thin welfare state. Prasad proves the first point with a sketch of the origins of bank regulation, they second point is shown with a regression showing a negative correlation between welfare state benefits and household debt in a panel of OECD countries.

I am not enough of an expert on American state formation to judge this argument, but it does have some appealing attributes. For example, the modern American regulatory state was set up by agrarian populists who were pretty angry at Wall Street. That’s not quite the case for the European welfare states, which have a different history. It also provides a natural explanation of how we arrived at a state where home equity is a central feature of personal finances, which is not the case in Europe.

My critiques are the following. First, I’m a little surprised at the centrality of banking in the paper’s framing. Maybe the paper would be best framed as the interesting and dangerous alliance of agrarian politics, credit expansion, and welfare state support. A hard core VoC’er might say that either banking is exceptional (which it is) or that state building through land development is exceptional (which it is), but that other parts of the economy fit the VoC model. Second, to make the broader political economy point, I think I need some discussion of how interest group access to the state is radically different in Europe than in America, and how that would result in a systematic difference in regulation across industries.

Overall, a stimulating paper. Outside my area, but I learned quite a bit.

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Written by fabiorojas

December 24, 2010 at 12:04 am

3 Responses

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  1. The U.S is also notable for its large number of (often unstable) small banks, the famously stable Canadian system is concentrated in a smaller number of large banks with more diversified holdings. Populist politics may have something to do with that. Deposit insurance was actually opposed by FDR, we have it because of the influence of small banks (it initially only covered small deposits) on an Alabama senator.

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    teageegeepea

    December 24, 2010 at 2:58 am

  2. [...] the rest here: monica prasad's mortgage paper « orgtheory.net « How Significant Mortgage Role Can Be While Buying A New Home Avail Mortgage [...]

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  3. [...] substitute for the welfare state. I haven’t read the actual paper to know if he is cited, but Monica Prasad evidently agrees with him in attempting to explain why America’s banking system is so heavily [...]

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