The people’s flag is deepest red | FT Alphaville

The people’s flag is deepest red

Here’s a fun — and highly timely — bit of political science to ponder, just as legislators in the US and UK are limbering up for a big push on financial regulation, and markets wonder just how far they will go.

A new academic paper argues that booms and busts historically give political power to the parties and policies of the Left:

Financial cycles of boom and bust are as old as finance itself—a fact that has led some observers to infer that human nature may be a fundamental cause of financial cycles. But “politics” also influences financial cycles by way of government policies and regulations. I argue that policies and regulations vary predictably with the partisan character of the government, creating a partisan-policy financial cycle in which conservative, pro-market governments preside over financial booms while left-wing governments are elected to office after crashes.

Drawing on 27 banking busts in the developed world since 1970, Lawrence Brosz makes the case for a ‘partisan-policy financial cycle’. As he goes on:

My working hypothesis is that a partisan-policy financial cycle exists in which conservative governments preside over financial booms, funding budget deficits with foreign borrowing and deregulating financial activities in line with their pro-market ideology. When the crash ultimately occurs, voters reassess their support for right-leaning governments, making it more likely that left-wing governments will be in office after financial crashes. Once in power, left-wing governments pursue policies to unwind the financial excesses of their predecessors and oversee the broad re-regulation of financial activities. In short, the political orientation of the government is both a “cause” of pre-crisis policies and a “consequence” of financial crises.

A tip of the hat to The Monkey Cage.

As we said — the argument’s time has come.

Senate Democrats debate their giant financial reform bill soon, while SEC v. Goldman becomes ever more Democrat vs Republican. Britain’s Liberal Democrats have surged in the polls in the meantime — and they’re the most bank-bashing mainstream party.

Not bad for an outfit that last took power in 1906. America also faces key mid-terms in November. If Brosz is right, we can expect a few more leftward shifts, in so far as the recovery remains uncertain worldwide.

In what’s perhaps a presage of things to come, the Republicans have started to drop outright resistance to Democratic financial reform, according to the American Banker.

This would imply quite a few political risks ahead for banks concerned with the effect of regulation on their balance sheets; or for derivatives markets — or, indeed, for the Cassandras of sovereign debt.

After all — scratching our heads for a counter-argument to Brosz’s paper, we did think of one objection: that voters turn to right-wing politicians in fiscally hard times, given their propensity to cut, cut, and cut some more.

Not a lot of academic evidence to cite on this idea, though. So, could left-wing leaders in the US and the UK pull off the full set of financial reform and make fiscal cuts as their deficits mount?

Ah, well. At least this lot of leftists haven’t followed their French Revolution ancestors in proposing a modern-day Law of the Maximum. Yet.

Related links:
Britain’s Conservatives go for the Fitch vote – FT Alphaville
Britain’s Labour party banks on, er, bank regulation – FT Alphaville
Our Pecora moment – The Baseline Scenario
The Red Flag (song) – Wikipedia