The Economist - USA (2020-07-25)

54 TheEconomistJuly 25th 2020

1

I

n renaissance italythe first modern

bankers realised that they could get away

with keeping only some of the gold that

was deposited with them on hand, and

lending out the rest. In most countries

banks have dominated lending to house-

holds and firms ever since. America has

long been different, though. Yes, banks

have played a big role in economic devel-

opment: John Pierpont Morgan was the

muscle behind the railways rolled out from

coast to coast during the 1880s and a cen-

tury later Citibank was helping America Inc

expand abroad as globalisation took off.

But capital markets have played a mighty

role, too. Today that is truer than ever,

which in turn helps explain the stunning

scope of the Federal Reserve’s response to

the latest economic crisis.

How banks are defined in America has

changed over time. Between 1933 and 1999

commercial banks were legally required to

be separated from investment banks, a

quintet of which dominated America’s cap-

ital markets and were regulated differently.

But all these firms had elements in com-

mon. They held only a fraction of their as-

sets as reserves and they borrowed short-

term to make long-term loans or hold long-

term securities. That exposed them to

runs. Economic history is littered with the

tombstones of banks that were felled when

markets for illiquid securities seized up, or

depositors rushed to withdraw their funds.

Most of these crises inflicted severe

economic pain, not least the subprime fias-

co of 2007-09. After it the phrase “too big to

fail” entered the modern lexicon—and the

popular perception of leviathans pulling

the strings of the world’s biggest economy

took hold.

This portrait of utterly dominant and

dangerous banks exaggerated their impor-

tance and today looks out of date. Banks

have become safer—including the invest-

ment banks, most of which are now part of

big banking conglomerates. And they are

being upstaged by a new wave of innova-

tion in capital markets that has changed se-

curitisation and debt issuance and led to

more direct lending by other financial

firms. As a result banks’ corporate lending

as a share of gdp, for example, has stagnat-

ed at about 12%, even as they have rebuilt

their strength and America Inc has in-

dulged in a borrowing boom (see chart 1).

Banks’ stagnation and their risk aver-

sion has had consequences for how central

banks respond to crises. In 2007-09 the

Federal Reserve had to intervene in capital

markets, but went to much greater lengths

to prop up commercial and investment

banks. Earlier this year, however, banks

went relatively unscathed as capital mar-

kets seized up. Rather than acting as a lend-

er of last resort to banks, the Fed became

marketmaker of last resort, intervening in

credit markets with a total size of about

$23.5trn. The scale of the Fed’s intervention

surpasses any other in its history.

Shadow banking

Putting the capital into capitalism

NEW YORK

The Fed has underwritten financial markets like never before. That is because

banks still play second fiddle to capital markets in the provision of credit

Pulling ahead

United States, non-financial business debt*

% of GDP

Source:FederalReserve *Excludingmortgages

1

40

30

20

10

0

19102000908070601947

Bank loans

Non-bank loans

and securities

Finance & economics

57 Whycopperandgoldare shining

57 Antgoestomarket

58 Theperksofvirtualcash

59 Buttonwood:Chapter 11

60 Free exchange: Real-time danger

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