Jefferey Frankel recently pointed out that, "Senator Bernie Sanders has proposed breaking up the banks into little pieces.  It is the centerpiece of his campaign for the Democratic presidential nomination.   The goal is to make sure that no bank is too big to fail without endangering the rest of the financial system.   That would require quite a sledge hammer.  The American banking system historically featured thousands of small banks.   But having thousands of small banks did not prevent runs on depositary institutions in the United States 1930s."

I would just add that it also did not prevent runs on depository institutions throughout the volatile 19th century.  During that century, we had a system of unit banks since branching was restricted for all federally chartered banks and most state-chartered banks.  In fact, by 1920, we had some 30,000 banks operating in the country.  By 1920, the state of Nebraska had a bank for every 1,000 people!  What did all this emphasis on small banks accomplish?  Not much in terms of stability:  The U.S. suffered major banking panics regularly throughout the 19th century and into the early 20th century (8 systemic crises between the 1830s and the creation of the Federal Reserve).  What about our Canadian neighbors?  Zero.  

So what's the difference?  Why did the U.S. have such regular upheaval while our northern neighbors avoided it?  Renee Halton does a good job of describing the differences in this paper, but the main idea can be found in  O.M.W. Sprague's classic analysis of American banking (done on behalf of the National Monetary Commission).  Sprague argued that the unit banking structure was the main flaw in the United States; Canada had no such restrictions on branching.  

While there were obviously many factors other than branching at play in America's long history with financial instability, we should be careful about longing for a return to the small unit banks of the past.  

There are many reasons to object to the effort in modern (well, post 1940s) economics to enlist Adam Smith as an early co-author on the First Fundamental Welfare Theorem (FWT), but one reason is that Smith would object on ethical grounds to the utilitarian basis of the FWT.  

Modern welfare economics is based “more or less explicitly on utilitarian ideas, even when economists deal only with the idea of Pareto efficiency.”[1] By contrast, Smith was opposed to the consequentialist ethic of his teacher Frances Hutcheson, and was “deeply opposed to utilitarianism.”[2]  The seemingly few economists who have paid attention to Smith's overall intellectual project know that he focused on the propriety of one’s actions rather than on their consequences; they might also know that he described his ethical system as “pretty exactly” in line with Aristotle’s virtue ethical system.

Smith's goal was to examine how the virtue ethics approach might apply to commercial society.  McCloskey (2008, p.58) wrote, "Smith, in sharp contrast to his great contemporaries in ethical theorizing, was a virtues man, a half-conscious follower of Plato and Aristotle and therefore of Aquinas, and also of the Stoics…in emphasizing a system of multiple virtues—and indeed precisely five of the seven Aquinian virtues. That is to say, he was indeed the last of the former virtue ethicists.”  

Smith’s concept of the invisible hand clearly does not imply nor does it anticipate the First Welfare Theorem, despite claims to the contrary.  Nor, I would submit, is his normative ethical approach consistent with the utilitarianism on which the FWT is based. Perhaps someday we can rescue Smith from his "followers."



[1] Hammond, Peter J. , “Utilitarianism, Uncertainty and Information” in Utilitarianism and Beyond, Amartya Sen and Bernard Williams (eds), Cambridge University Press (1982), pp. 85-102. 

[2] Fleischacker, Samuel.  On Adam Smith's Wealth of Nations: A Philosophical Companion. Princeton University Press (2005).

McCloskey, Deirdre, "Adam Smith, the Last of the Former Virtue Ethicists," History of Political Economy (2008)

I had no idea such a thing existed, but the guys at Marginal Revolution linked to the website a few days ago.  It includes what looks like a terrific set of Bentham's texts.  Here's a bit about Bentham and the UCL project:

"Even for those who have never read a line of Bentham, he will always be associated with the doctrine of Utilitarianism and the principle of `the greatest happiness of the greatest number'. This, however, was only his starting point for a radical critique of society, which aimed to test the usefulness of existing institutions, practices and beliefs against an objective evaluative standard. He was an outspoken advocate of law reform, a pugnacious critic of established political doctrines like natural law and contractarianism, and the first to produce a utilitarian justification for democracy. He also had much to say of note on subjects as diverse as prison reform, religion, poor relief, international law, and animal welfare. A visionary far ahead of his time, he advocated universal suffrage and the decriminalisation of homosexuality.

By the 1820s Bentham had become a widely respected figure, both in Britain and in other parts of the world. His ideas were greatly to influence the reforms of public administration made during the nineteenth century, and his writings are still at the centre of academic debate, especially as regards social policy, legal positivism, and welfare economics. Research into his work continues at UCL in the Bentham Project, set up in the early 1960s with the aim of producing the first scholarly edition of his works and correspondence, a projected total of some seventy volumes!"

One of President Wilson's cabinet secretaries on Secretary of State William Jennings Bryan:

"I discovered that one could drive a prairie schooner through any part of his argument and never scrape against a fact or a sound statement."  

Today, President Obama hit the nail on the head about the so-called strict constructionists who have suddenly changed their tunes regarding Justice Scalia's replacement:

"I am amused when I hear people who claim to be strict interpreters of the Constitution suddenly reading into it a whole series of provisions that are not there."

This, of course, is in response to the ridiculous arguments from Senator McConnell and many of the Republican candidates for the presidency.  And it should not matter what one's politics are or how one views President Obama - he's right on this one. I'm no constitutional scholar, but I do recognize the difference between the words "may" (which does not appear here) and "shall" (which does):

"[The President] shall nominate, and by and with the advice and consent of the Senate, shall appoint ambassadors, other public ministers and consuls, judges of the Supreme Court..."

John Nichols is correct to label these efforts an "egregious assault on the basic premises of the Constitution and on the system of functional governance that is supposed to extend from it."

From The Economist:

"Economic history may well be dead as a subject studied in independent academic departments, as it was at universities in the 1970s. But as a subject that is needed as part of the study of economics and the making of public policy, economic history is—and should be—very much alive."

From an interesting new experimental study of the role of a watchful god on human cooperation:

“Deterring oneself from the pursuit of self-interest because of the risk of punishment from a watchful supernatural eye would seem to reduce an individual’s evolutionary fitness, and should thus be eliminated by natural selection,” Johnson wrote. “However, even if such beliefs are false and costly, they may have generated net benefits: to individuals, by steering them away from selfish behavior that risked retaliation in increasingly transparent and gossiping human societies; and/or to groups, by increasing the performance of the group as a whole in competition with other groups.”

This notion of how cooperation among strangers emerges is, of course, an old and intriguing question.  As in many cases, it's helpful to turn to the old Scottish moral philosopher for some anticipation of these results.  Adam Smith (the author of much more than the narrow "invisible hand" idea for which he is mostly known - see Gavin Kennedy's website for lots on this) wrote some fascinating things about moral rules, as described in this article from the Stanford Encyclopedia of Philosophy:

"[Smith] also says that it adds to the sacredness we attribute to moral rules to see them as laws of the Deity, and to the importance of morality as a whole to see it as a way of “co-operat[ing] with the Deity” in the governance of the universe (166). And he shows how a belief in an afterlife may be necessary if we are to see the universe as just, which in turn is important if we are to maintain our commitment to the value of acting morally (168–70). In all these ways, but especially the last, he anticipates Kant's moral argument for belief in God, without ever quite insisting that there is a God. At the same time, he makes clear that any religion that gives priority to ritual or creed over morality is baleful, and poses one of the greatest dangers to a decent and peaceful society (TMS 176–7; cf. WN 802–3)."

From the New York Fed's "Crisis Chronicles" on the 1873 crisis:

"Railroads fueled much of the economic growth in the United States at that time, but they required that a great deal of upfront capital be devoted to risky projects. The panics of  1837 and 1857 can both be pinned on railroad investments that went awry, creating enough doubt about the banking system to cause pervasive bank runs."

And here is a nice overview of crises from 1873-1933.