Financial crises are traditionally analyzed as purely economic phenomena. The political
economy of financial booms and busts remains both under-emphasized and limited to
isolated episodes. This paper examines the political economy of financial policy during
ten of the most infamous financial booms and busts since the 18th century, and presents
consistent evidence of pro-cyclical regulatory policies by governments. Financial booms,
and risk-taking during these episodes, were often amplified by political regulatory stimuli,
credit subsidies, and an increasing light-touch approach to financial supervision. The
regulatory backlash that ensues from financial crises can only be understood in the context
of the deep political ramifications of these crises. Post-crisis regulations do not always
survive the following boom. The interplay between politics and financial policy over these
cycles deserves further attention. History suggests that politics can be the undoing of
this bidding war the SSC paid bribes to politicians from members of the House of Commons on up ( Carswell, 1993 ). By the time the conversion was approved by parliament SSC’s stock had more than doubled.
This episode saw a general increase in optimism and in speculation that sent stocks of SSC and other companies soaring. The rise of the SSC coincided with the advent of new joint-stock companies which had also flourished in the stock market. These so-called “bubblecompanies” included many speculative, deceptive, and ludicrous schemes. The literature is abound with
troubling. In contrast to the late 1990s equity bubble, companies in the U.S. continue to buy back stock on aggregate ( Figure 21 ), and global IPO and merger and acquisition activity remain below previous cyclical highs ( Figure 22 ).
Figure 19. Risky Credit Issuance—Trends in Absolute and Relative Terms
Source: Author’s estimates, Dealogic, AFME, SIFMA
Figure 20. Annual Sovereign Debt Issuance for First Time Issuers
Source: Guscina and others (2014) , Deologic
Figure 21. U.S. Net Stock Issuance
Source: Author’s estimates, Haver
In the aftermath of the global financial crisis, the issue of how best to identify speculative asset bubbles (in real-time) remains in flux. This owes to the difficulty of disentangling irrational investor exuberance from the rational response to lower risk based on price behavior alone. In response, I introduce a two-pillar (price and quantity) approach for financial market surveillance. The intuition is straightforward: while asset pricing models comprise a valuable component of the surveillance toolkit, risk taking behavior, and financial vulnerabilities more generally, can also be reflected in subtler, non-price terms. The framework appears to capture stylized facts of asset booms and busts—some of the largest in history have been associated with below average risk premia (captured by the ‘pricing pillar’) and unusually elevated patterns of issuance, trading volumes, fund flows, and survey-based return projections (reflected in the ‘quantities pillar’). Based on a comparison to past boom-bust episodes, the approach is signaling mounting vulnerabilities in risky U.S. credit markets. Policy makers and regulators should be attune to any further deterioration in issuance quality, and where possible, take steps to ensure the post-crisis financial infrastructure is braced to accommodate a re-pricing in credit risk.