The banking crisis that began in August 2007 shocked markets and precipitated the Great Recession. To fully explain the banking crisis, one must account for its timing, severity, and global impact. One must also confront a startling historical contrast. If we define “banking crisis” to mean bank failures and system losses exceeding 1 percent of a country’s gross domestic product (GDP), we find that in the period 1875-1913, a period of marked expansion in international trade and capital flows comparable to the last three decades, there were only four banking crises worldwide.1 By contrast, in the period 1978-2009, a period of much more extensive bank regulation, central bank intervention, government protection of depositors and other bank creditors, and government control of mortgage markets, about 140 banking crises occurred worldwide. Of these, 20 were more severe than any crisis from the earlier period of 1875-1913, in terms of total bank losses as a percent of GDP.Leading financial economists such as Charles Calomiris have argued that a necessary condition for a banking crisis is government policy that distorts the micro-incentives of banks. Likewise, University of Chicago scholar Richard Posner has argued the banks that got into trouble during the recent crisis were simply taking “risks that seemed appropriate in the environment in which they found themselves.”
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