We begin by looking at whether our data support the theory that commercial banks and investment banks faced different sets of incentives and whether this difference in incentives led the former to less selective underwriting decisions. This claim has assumed renewed political relevance after Paul Volcker’s recent focus on the necessity to divorce commercial and investment banking once more. We find no support for the theory that commercial and investment banks behaved differently if they underwrote sovereign bonds.
Of course, the actual fact that we usually do not find any difference between commercial and investment banks will not indicate that banks most importantly didn’t face conflicts of interest. We discuss this matter by looking at the partnership between reputation and conflicts of interest and relate our findings to modern theories of signalling and certification, which claim that reputation interacts with market structure. We find that prestigious underwriters who may have been tempted to overprice poor securities refrained from doing this, presumably in order to avoid damaging their reputation. Despite contemporary focus and outrage with allegedly anomalous underwriting fees, we find no evidence that banks misrepresented the securities they underwrote and sold them to the general public at inflated prices while pocketing extra fees. Basically, we find no proof "banksterism" searching for international sovereign bonds. As the case for banksterism becomes less convincing, the case for misfortune – meaning an urgent shock or unpredicted policy errors when coping with that shock – becomes more plausible.
The fact that people find no proof systematic misbehaviour for investment and commercial banks will not indicate that the regulatory reforms implemented in the 1930s weren’t warranted. However, it can mean (in fact it is a significant finding) that the state motivations for them lacked empirical validity. We believe that is information to ponder at the same time when regulatory responses to the subprime crisis are being considered.
Relevance to today?
A far more fundamental question is if the discipline at work through the 1920s also operates today. The irony of the historical experience is that, while we find no proof misbehaviour, contemporaries were convinced that banksterism was the root cause of the crisis. Regarding today’s crisis, some observers have expressed their doubt on the validity of arguments suggesting that concerns for reputation or worries of losing market shares played a job in mitigating those conflicts of interest (see, for example, Acemoglu 2009). If that is correct, future research must realize why size and reputation, that have been once moderators of bad behaviour, no more operate in the manner they used to.
Calomiris, Charles W (2009), “The Subprime Turmoil: What’s Old, What’s New, and What’s Next”, Journal of Structured Finance, 15: 6-52, Spring.
Flandreau, Marc, Norbert Gaillard, Ugo Panizza (2010), “Conflicts of Interest, Reputation, and the Interwar Debt Crisis: Banksters or MISFORTUNE?”, HEID Working Paper No. 02/2010, February.