Banking always involves political economy,
as professor Mark Rose observes, or as we might more precisely say, political
finance. This is the central lesson of Rose’s Market Rules.
The book nicely shows how banking and politics have been constantly intertwined
in the United States over the 50 years beginning in the 1960s, as much bigger
banks have been created and the banking system has consolidated. (Although today
there are 5,477 banks and savings associations in the United States, in 1950
there were 19,438.)

The book’s anecdotes of forceful personalities of American
banking history, both those in the business and those in government during the
times it covers, are engaging, at least to those of us in the trade, and fun to
read. In addition, its theme has much broader application than the text
suggests: namely to all countries in all times. As banking scholars Charles
Calomiris and Stephen Haber have concluded, all banking systems reflect deals
between bankers and politicians, which they call “the Game of Bank Bargains.”
The study of this idea in their book, Fragile by Design—The
Political Origins of Banking Crises and Scarce Credit
(2014), covers a
number of countries in detail and a long history going back to the 17th century.
This gives us a wider framework in which to view the arguments and events
related by Rose and reinforces his local variations on the theme that banking
is politically entwined.

However, unlike Fragile by Design, don’t
read Market Rules for economic or financial concepts or for
careful economic or financial arguments. They aren’t there. Likewise, don’t
read it for theoretical insights into politics or banking systems. Its
discussion of political finance is journalistic, with a left-of-center slant.
The book displays a pronounced bias against markets and competition, repeatedly
dismissing them as “market talk.” “Citing markets” is characterized as a
“rhetorical obsession.” There is throughout a positive bias for governments and
for government control.  Discussing the financial crisis bailouts, for
example, Rose reflects that “For that moment at least, government authority and
prestige were in the ascendance”—just the way he likes it. Still, the book’s
rendition of banking debates and developments is interesting and useful,
describing how the economically critical banking sector evolved over five

A more balanced view of banks and governments than the book
conveys would stress that both banks and governments are made up of human
beings, and that both demonstrate the aspirations, insights, and achievements
always mixed with the failures, mistakes and hypocrisy natural to mankind. We
should not be surprised that these same attributes appear in their interaction
and the deals they make with each other. Moreover, both banks and governments
often make big mistakes at forecasting the economic and financial future and
cannot know what the long-term results of their own actions will be.

We naturally observe this mix of strengths and weaknesses in
all parties in the course of banking history. Nothing human is perfect, or even
close. The pursuit of profit, subject to competition and innovation, will on
average get much better economic results for the people than will the pursuit
of bureaucratic power using the government’s monopoly of force and coercion.
Rose is right, however, that in banking we always find some combination of the

Market Rules brings out in what remarkable fashion banking times and ideas change, and how what seems like a great issue at one point, becomes difficult to remember at some later point. In discussing the Hunt Commission, appointed by President Richard Nixon to consider how to improve the American financial system, the book says:

Hunt and his commissioners determined not to explore in detail the boldest question of all, which is whether the nation needed a separate and distinct group of S&Ls [savings and loans] and another group of separate and distinct commercial banks.

That was the boldest question of all?
It seems hard for us to believe, but in 1970, the S&Ls were a political
force to be reckoned with. They had their own powerful trade association, the
U.S. League for Savings, and their own cheerleading regulator, the Federal Home
Loan Bank Board. Those names are probably unfamiliar, because both have long
since disappeared and been merged into the respective banking organizations. Of
course, at the time of this debate, the 1980s collapse of the S&L industry
was more than a decade in the future.

The Hunt Commission did propose numerous reforms, but
“criticism of Hunt’s report arrived hard and fast,” Rose relates. One of the
commissioners arose “to denounce the ‘blurring of distinctions between
financial institutions.’” “Blurring of distinctions” hardly sounds like a
stirring battle cry, or even a clear thought, but since it really meant
“protect me from competition,” it was.

A similar thought arose in the 1990s: “Large and small
bankers alike feared that insurance companies like State Farm would purchase a
thrift [S&L] charter and use it to offer bank services.” In Rose’s phrase,
this was a “horrifying prospect.” By now, State Farm has operated its S&L,
which is called State Farm Bank, for two decades. I have an account there. It
doesn’t seem too horrifying.

Another big battle of past years was that over the then well-known
“one-quarter point.” To any readers under the age of 50: does that mean
anything to you? Probably not. The context is that in the 1960s and 1970s, the
U.S. government practiced national price fixing for the interest rates that
banks and S&Ls could pay on deposits. The point of this 1930s idea was to
limit competition, so that deposit banking was a cartel with the government as
cartel manager. The “quarter point” meant that the price fixing rules allowed
the maximum rate the S&Ls could pay to be 0.25 percent higher than what
commercial banks could pay their depositors.

As the book relates, “Insiders knew the government’s ability
to determine interest rates paid to savers by its official name, the Federal
Reserve’s Regulation Q,” commenting that it was “curiously named.” So it was,
but famous in banking at the time. I well remember an old banking lawyer
explaining to me that “Reg Q,” as it was called, was a permanent and
unchangeable part of the American banking system. A bad prediction, as it
turned out, since Reg Q has now disappeared from the memory of all but financial
historians. Nonetheless it was a big deal in its day.

The book further explains: “In 1966, President Johnson and the Congress approved the Interest Rate
Control Act, which authorized S&L executives to pay a higher rate of
interest to savers than banks paid them. Nervous S&L officers had urged
this action.” Rose does not
mention that they had urged it because the government’s interest-rate fixing
had brought on the Credit Crunch of 1966. “Federal Reserve officers in turn
approved a 0.25 percent differential.” Then S&Ls were “passionate in
defending the regulation…as a vital protection to their firms and to American
home construction.”

Passionate? Vital? A quarter-point? Reg Q? Times change.

One of the most instructive examples of intertwined finance
and government is the history of Fannie Mae and Freddie Mac. Fannie and Freddie
played a large role in inflating the disastrous housing bubble of the 2000s.
The most important thing about them is that they were government-sponsored,
government-promoted and government guaranteed, while having their stock
privately owned—a fundamental conflict which turned out to have bankrupting
results. Fannie and Freddie were known by the acronym, “GSEs,” for
“government-sponsored enterprises.” In 2008, they also became majority government-owned.

But in its less than one-page treatment of them, Market
 describes Fannie and Freddie as “privately owned firms,” without
mentioning their GSE status or the tight political connections and political
clout they enjoyed in their glory days. Fannie was a Washington bully,
including attacking the individual careers of those who dared to criticize or
oppose them, and inspired genuine fear. James Johnson, its 1990s CEO and a
highly influential political insider and operator, presided over a huge
institution which seemed at the time an unstoppable colossus, both financial
and political. Although he is a most impressive example of its main thesis, he
rates not even a mention in the book.

Many other interesting characters do appear. Featured roles
are given to James Saxon, William McChesney Martin, Wright Patman, Walter
Wriston, Arthur Burns, Bill Simon, Hugh McColl, Don Regan, Gene Ludwig, Robert
Rubin, Phil Gramm, Sandy Weill, Paul Volcker. If you are interested in
political finance but you don’t know who all these gentlemen are, you should.
Also appearing is a whole series of U.S. presidents from John Kennedy on.

Of everybody in this history, my favorite is James Saxon,
the comptroller of the currency from 1961-1966, who on Rose’s telling got the
whole ball rolling of introducing more competition into a financial system
previously designed to suppress competition.

“Saxon, often intemperate in his public language,” Rose
writes, “asserted that investment bankers’ control of revenue bonds constituted
a ‘full-fledged monopoly.’” To be exact, it was an oligopoly, but of course
Saxon was basically right.

“In March 1964, Saxon told members of the Senate Banking
Committee that the Federal Reserve’s regulation of the interest rates that
banks paid savers amounted to price fixing.” Rose comments primly,
“Presidential appointees did not speak in that fashion about the Federal
Reserve.” My reaction is, “Saxon was absolutely right!”

Being right may not be popular: Saxon “had thrown
state-chartered bankers into a more competitive environment, which they
resisted.” And Saxon had “encouraged powerful enemies” who demanded his ouster.
Rose does not like him either and writes with satisfaction of how President
Lyndon Johnson declined to reappoint him in 1966, so that “Saxon returned to
anonymity.” Like we all do, but it seems to me he had a great run.

In conclusion, as this book illustrates with lots of
examples, political finance it is.

When my successor as president of the Federal Home Loan Bank
of Chicago asked me for advice, I told him, “Remember that this job is 50
percent banking and 50 percent politics.” That seems to sum it up.

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