Financialization, wealth, and the changing political aftermaths of banking crises

Households face two politically salient risks associated with financial instability. The first risk, which has existed for perhaps centuries, is associated with the indirect effect of systemic banking crises on employment and income flows. The second risk arises from the direct effects of crises on asset prices and thus household wealth stocks. Historically, the second risk mainly affected only a small wealthy elite. We argue that the rapid expansion and financialization of middle class wealth since the mid-twentieth century mean that many voters now have “great expectations” regarding government responsibility to protect their wealth. The political risks of financial instability for incumbent governments have thus increased sharply, especially when institutional constraints hamper their ability to respond to voters’ new expectations. We show that the probability of incumbent governments facing significant institutional constraints retaining office after systemic banking crises has indeed fallen sharply in recent decades compared to the pre-1945 period.