Bank bailouts during the financial crisis increased awareness for the power that the financial sector holds over national governments. In her recently published book “The Power of Inaction”, Cornelia Woll, Professor of Political Science at the Science Po in Paris, compares bank rescue schemes in different countries. The general perception of bailout regimes is that the costs imposed on the industry vary depending on how strong the state versus the lobby industry is. Woll presents an alternative explanation, where the collective inaction of the financial sector critically shapes the design of bailout packages in favor of the industry. On 14 May, she presented her results in a SAFE Policy Center Lecture at the House of Finance.
Woll outlined that a common explanation for why bank bailouts happened is the high influence the financial industry has on politics. Another view is that governments wanted to prevent the spread of systemic risks across the financial sector. According to Woll, differences in bank bailouts between countries crucially depend on how banks collectively play out the power they have on politics at the time of near collapse. In order to analyze variations in bank rescue schemes, Woll compared how governments in different countries cooperated with the financial industry when setting up the respective scheme. The countries analyzed were the United States, the United Kingdom, Germany, France, Ireland and Denmark.
First, Woll compared Ireland with Denmark – two small, bank-based, open economies. Denmark managed to get a positive outcome of its bank rescue scheme, despite the failure of nine Danish banks. This positive result was due to the fact that the Danish bank rescue scheme was set up as a public-private arrangement, the “Danish Private Contingency Association”. Denmark bailed in senior debt and actually let banks go bankrupt, Woll argued. The state negotiated the rescue scheme with the banks which led to a collective action in the public interest. On the contrary, the Irish government decided not to rely on the industry. The result was an excessive protection of banks and a rather incoherent rescue strategy which led to a sovereign debt crisis.
Subsequently, Woll compared France and Germany – large open economies with reliance on bank funding. France had a positive outcome of its rescue packages (except for the case of Dexia). Woll attributes this success to the collective action taken by the state and banks. In France, a “cartel” was set up that provided a coordinated public-private liquidity funding and a collective acceptance of recapitalization. In Germany, there were some attempts to involve the financial industry in the design of the rescue packages but not as strong as in Denmark or France. Germany is now expecting large write-offs. Her last comparison looks at the US and the UK which have largely a market based funding for their economies.
Woll’s conclusion was that when the financial sector “succeeded” in remaining collectively inactive, like in the UK or Ireland, it imposed the highest commitments on the government and, thus, on the taxpayers. In Woll’s view, the collective inaction of the financial industry is a sign of its power which ultimately affects the question of how the public and private sectors share the cost burden of bank bailouts. Asked about the lessons for the Banking Union, Woll argued that the often heard argument that the close relationship between national supervisors and national champions needs to be severed does not take into account the positive social capital that long-standing personal relationships can have for negotiations in crisis situations where the acceptance of collective responsibility is sought.