The evolution of bank bailouts: two centuries of variation, selection and retention

Abstract

Why has the policy of state-backed bank bailouts emerged as the de facto global response by governments to crises involving systemic bank risk? This question has salience in the context that while bank bailouts solve an immediate problem of systemic risk, they create another set of problems almost as significant. Bailouts involve largescale socialization of private losses, are politically toxic, ideologically contrary to market norms, and economically costly to the state. For these reasons many commentators view the policy to be neither optimal nor desirable, yet it has nonetheless been institutionalized in all modern financial systems. In this paper I argue that the global diffusion of bank bailout policy over the past two centuries is an example of institutional evolution. A process of variation, selection and retention has winnowed down initial variation in responses to possible financial sector collapse to one policy, a state-backed guarantee to bail out the financial system. Understanding the past is a prerequisite for gaining insight into possible futures. Consequently, historical study of bank bailouts will contribute to understanding the future evolution of systemic banking crises by providing insight into the evolution of institutional resilience.