The Economist: The financial system passes under the control of the state

The relationship between finance and the state has changed, and now banks are a threat to the state, analysts at The Economist say. Recent events show a trend towards increased state control in the banking sector. The financial crisis of 2007–2009 and subsequent shocks hastened this shift.

Banks are suffering significant losses, and there is debate about better protection for bank deposits. State dominance is evident in areas such as deposit insurance, emergency lending, and asset quality regulation. Government intervention in banking is expanding, which raises concerns about the private sector’s ability to assess risk.

Government backing and extensive regulation can distort incentives and risk pricing. While it may be comforting to have the government’s support during crises, such actions can create future problems. Changes implemented during times of crisis tend to become permanent, and there are concerns about the further expansion of the state’s role. Deposit insurance, which was initially resisted by President Franklin Roosevelt, has now been extended retrospectively to protect depositors.

Emergency lending is another area where the state’s influence is increasing, with relaxed rules and penalties imposed by central banks. Regulation of asset quality is also subject to policy preferences, as seen in the mortgage market, where government-backed institutions like Fannie Mae and Freddie Mac dominate. The recent rules introduced to make housing more affordable have further compromised the compensation for risk undertaken by these institutions.

The increasing state control in Western systems blurs the line between explicit government direction in lending and the social contract of the Western system. The growing state influence threatens the role of the private sector and can lead to misguided interventions in the banking sector.