Surviving Large Losses: Financial Crises, the Middle Class, and the Development of Capital Markets

Abstract

Financial disasters often have long-range institutional consequences. When financial institutions—banks, insurance companies, brokerage firms, stock exchanges—collapse, new ones take their place, and these changes shape markets for decades or even generations. Surviving Large Losses explains why such financial crises occur, why their effects last so long, and what political and economic conditions can help countries both rich and poor survive—and even prosper—in the aftermath. Looking at past and more recent financial disasters through the lens of political economy, the authors identify three factors critical to the development of financial institutions: the level of government debt, the size of the middle class, and the quality of information that is available to participants in financial transactions. They seek to find out when these factors promote financial development and mitigate the effects of financial crises and when they exacerbate them. Although there is no panacea for crises—no one set of institutions that will resolve them—it is possible, the authors argue, to strengthen existing financial institutions, to encourage economic growth, and to limit the harm that future catastrophes can do.