Emil Verner on Banking Crises, Credit Booms, and the Rise of Populism

Episode Summary

Executive Summary: Emil Verner argues that most bank failures are rooted in deteriorating solvency, not pure liquidity runs. Drawing on new U.S. historical bank data and cross-country crisis evidence, he finds that weak fundamentals, rapid credit growth, and asset losses usually precede panics. He extends this logic to policy, financial crises, and populism, emphasizing recapitalization and borrower relief over a run-centered narrative.

Main Topics: Why bank failures matter (Priority: 5/5): Verner explains that banking crises disrupt payments, credit intermediation, growth, and political stability, making them central to macroeconomic analysis and policy design. Liquidity vs. solvency in bank failures (Priority: 5/5): The interview contrasts Diamond-Dybvig-style self-fulfilling runs with a fundamentals-based view in which asset losses and insolvency are the main causes of failure. Historical U.S. bank failure evidence (Priority: 5/5): Using a newly assembled dataset on most U.S. banks from 1863 onward, Verner and coauthors find failures are usually preceded by worsening balance sheets, rising loan losses, and weaker funding profiles. Cross-country crisis evidence (Priority: 4/5): A companion paper shows that severe macroeconomic downturns arise mainly when banking crises involve large asset losses and weak capitalization; panics often amplify but do not originate crises. Policy implications for regulation and crisis response (Priority: 5/5): Verner favors stronger solvency buffers, better capitalization, and targeted debt relief over an exclusive focus on liquidity regulation, deposit insurance, or central-bank backstops. Financial crises and populism (Priority: 4/5): He links debt crises to political backlash, arguing that unresolved private debt burdens can fuel populist movements, illustrated by Hungary’s foreign-currency mortgage crisis.

Key Arguments: Most bank failures are predictable from weak fundamentals, especially declining solvency, not random runs on healthy banks. Runs are typically a symptom or proximate trigger, but the root cause is usually asset losses that leave banks insolvent or near-insolvent. Historical U.S. bank failures show a gradual deterioration over several years, with rising loan losses and shrinking equity buffers before failure. Banks that grow rapidly are more likely to fail later, suggesting risky credit booms sow the seeds of crisis. In the cross-country evidence, large asset losses are necessary for severe macroeconomic damage from banking crises; panics mainly amplify already-bad conditions. The 2023 banking turmoil, including SVB, is better understood as a solvency/risk-management failure than as a textbook Diamond-Dybvig run. Policy should prioritize higher bank capital, monitoring credit booms, and recapitalizing banks in crises rather than relying mainly on liquidity support. Debt crises can drive populism because they intensify conflict between debtors and creditors over who should bear the burden of adjustment.

Data Points: U.S. historical and modern bank sample: Over 38,000 banks - Size of the bank-level dataset used in the Failing Banks paper Bank failures in dataset: Over 5,000 failures - Number of failures observed across the long U.S. sample Historical coverage: 1863 to 1941 - National-bank historical sample in the U.S. dataset Modern coverage: Late 1950s to present - Call-report-based modern sample in the U.S. dataset National banks’ share of commercial banking assets: About 40% to 70% - Coverage of national banks in the historical U.S. system Pre-failure balance-sheet deterioration: 8 to 10 percentage points - Typical drop in equity-to-assets in the five years before modern bank failure Asset recovery rates before FDIC: Below 60%, often mid-50s percent - Historical recovery rates on assets of failing banks before 1934 Cause-of-failure attribution to runs: Less than 2% - OCC receiver classifications of bank failure causes Cross-country sample: 46 countries - Scope of the Banking Crises Without Panics paper Historical coverage for cross-country study: Since 1870 - Time span for the international crisis analysis Hungary foreign-currency mortgages: Two thirds - Share of mortgages originated in foreign currency before the GFC in Hungary Debt-service shock in Hungary: 50% or more - Rise in monthly installments after currency depreciation and Swiss franc appreciation Bank-stock decline before Bear Stearns failure: About 60% - Aggregate U.S. bank stock losses before major 2008 crisis events Panic narrative example: 1984 panic without widespread failures - Example cited to show runs can occur without systemic insolvency Populism literature reference: 800 general elections - Referenced prior study linking financial crises and far-right populism

Pivotal Quotes: "bank failures are actually quite predictable based on these weak fundamentals" — Emil Verner: Explaining the central finding of the Failing Banks paper "runs on otherwise healthy banks are not a common cause of failure" — Emil Verner: Summarizing his rejection of the pure Diamond-Dybvig interpretation as the main driver of bank failures "the banking system is often already very impaired" — Emil Verner: Describing how panics often occur after large asset losses and near-insolvency

Implications: Listeners should view bank runs as usually a symptom of deeper solvency problems, not the main cause. For policy, that means stronger capital, better credit-boom oversight, and borrower relief may matter more than ever-larger liquidity backstops.