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Great expectations: government intervention during a financial crash is rarely rewarded by voters

If you think a bailout is going to occur during a crisis, or even a recession, you might take on more and more risk.
- Professor Jeffrey Chwieroth
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Sign Of The Times - Foreclosure Jeff Turner

Ordinary people’s fortunes are increasingly dependent on the performance of the financial industry, a development that has transformed our politics. Professor Jeffrey Chwieroth’s latest book charts this change and explains why all mainstream political parties now share at least one thing in common.

The financial industry, once largely restricted to keeping customers money safe or issuing them loans, has grown exponentially since deregulation occurred in the 1980s.

Modern finance, which offers an array of complex investment products, mortgages, pension funds and near-infinite ways for consumers to borrow money, is now relied upon by many to create wealth and provide security.

Professor Chwieroth of the Department of International Relations has spent much of his career researching the politics of money and finance. His book, The Wealth Effect, co-authored by Andrew Walter from the University of Melbourne, takes a long lensed view on how the expansion of the financial industry has changed our politics.

“In the past fifty years or so economies have seen big shift away from some of the old industries like manufacturing, towards the financial sector. Growth has often come from finding new ways for greater numbers of people to invest or borrow money.”

The book analyses a range of democracies over the past 200 years, and focuses on Brazil, the UK and the US.

It demonstrates how the financial industry and financial markets have become integral to the economic health of these nations, particularly the prospects for the middle-classes. As citizens have come to acquire and rely on financial assets, they have also come to expect the government to protect their wealth from the vicissitudes of the economic cycle.

Professor Chwieroth says: “If you think a bailout is going to occur during a crisis, or even a recession, you might take on more and more risk, confident the government will act as a kind of insurance mechanism for your assets and step in to rescue you.”

Rather than  more limited interventions to protect almost all bank account savings, such as that introduced by the Labour government during the aftermath of the financial crisis, Professor Chwieroth says it is a broader set state interventions, such as guarantees for bank liabilities  and recapitalization of banks in distress, that gave people this confidence.  

“These interventions will stop asset prices from falling below the level that would have been dictated by a market in freefall, and prevent even larger massive drops in house prices, for example. When buying a house, this means people are more likely to borrow more than they ordinarily would.”

Government policy to support the financial industry is now so well-established, and runs across party lines, that governments no longer receive credit from voters when they intervene. Voters merely expect them to act in this way in a crisis, and often punish them in the following election anyway, as happened in many democracies in the aftermath of the 2008/9 financial crisis. This is because asset prices still fall with the interventions, even if less than they would have done.

“Governments might say that you would be much worse off if we hadn’t intervened, but most people can’t understand or engage with this kind of counterfactual reasoning. They can’t imagine how much worse off they’d be without this government intervention, so it just becomes normalised and governments don’t get the credit.”

In the UK and the US, which are due to hold elections in 2019 and 2020, Professor Chwieroth expects there will be little debate on the principle of government support for protecting household wealth in times of crisis.

“Whether you look on the left or the right, the idea of protecting private wealth is generally accepted. This is why in the US, for example, you see much more emphasis on the culture wars and identity issues in politics. Parties have to differentiate themselves in other ways.”

The trend for building up private assets has also been bolstered by the gradual erosion of state support, particularly since the 1980s, in the US and the UK.

“Relatively speaking, the social security safety net and state support available to citizens is now much less robust than it once was. Meanwhile, costs of services have risen precipitously.  Education and healthcare are examples of this. This compels individuals grow their private resources to protect themselves.”

The rolling back of the state may also be about to change. As the centre-left parties gear up for the next election, there is much discussion about how public education and healthcare can be supported, for example, by abolishing university tuition fees and cancelling student loans, or creating a universally available public healthcare service in the US. 

Like government intervention in the financial industry, these policies run counter to the free-market principles that have been so dominant in recent decades.

“Most individuals seem unable to accept substantial risk, or incur losses when they invest or borrow money.  And I don’t see many signs that this culture is likely to change soon.”

Behind the article

The Wealth Effect: How the Great Expectations of the Middle Class Have Changed the Politics of Banking Crises by Jeffrey M. Chwieroth and Andrew Walter was published in March 2019 by Cambridge University Press.