kent nickell
Well-known member
An interesting analysis of the new nature of bank runs. Traditionally since the Great Depresstion bank runs were seen as being caused by worried depositers taking their money out of banks leading to a banking crisis. This was largely averted by the creation of deposit insurance.
But now banks get their money (liquidity) from more than just depositers including commercial paper issued by various firms. Also some of these firms get their financing from the markets rather than by loans from the banks.
So when markets do badly, then commercial paper tends to dry up. This hurts the banks directly as a source of their liquidity and also the firms look to banks to get money from previously established but unused credit lines. The firms (financial and non-financial) may not even need this money but they will draw it out because they worry about the solvency of the bank. These relatively new products of liquidity production thus cause a run on the bank that is not covered by deposit insurance.
Some of these firms are investment banks that with the repeal of the Glass-Steagall Act in 1999 were able to engage in a wider range of financial product activity. This was a classic example of giving too much free rein to the financial industry thinking that any abuses would be essentially self-regulating and not fully appreciating the risk.
This problem has been magnified by a loss of confidence in the rating agencies that rate the various commercial papers as to their safety and a fairly high level of nontransparency in this market leading to further uncertainty and loss of confidence. Since many of the producers of commercial paper did not take in actual deposits they were not under as much regulatory scrutiny.
Especially after the Lehman bankruptcy in Sept 2008 the whole financial system was viewed as being at risk further drying up these credit markets. This led to massive federal efforts to back the commercial paper market.
Federal Reserve Bank of Boston by Judit Montoriol-Garriga and Evan Sekeris, March 2009
A Question of Liquidity: The Great Banking Run of 2008?
Link: http://www.bos.frb.org/bankinfo/qau/wp/2009/qau0904.pdf
But now banks get their money (liquidity) from more than just depositers including commercial paper issued by various firms. Also some of these firms get their financing from the markets rather than by loans from the banks.
So when markets do badly, then commercial paper tends to dry up. This hurts the banks directly as a source of their liquidity and also the firms look to banks to get money from previously established but unused credit lines. The firms (financial and non-financial) may not even need this money but they will draw it out because they worry about the solvency of the bank. These relatively new products of liquidity production thus cause a run on the bank that is not covered by deposit insurance.
Some of these firms are investment banks that with the repeal of the Glass-Steagall Act in 1999 were able to engage in a wider range of financial product activity. This was a classic example of giving too much free rein to the financial industry thinking that any abuses would be essentially self-regulating and not fully appreciating the risk.
This problem has been magnified by a loss of confidence in the rating agencies that rate the various commercial papers as to their safety and a fairly high level of nontransparency in this market leading to further uncertainty and loss of confidence. Since many of the producers of commercial paper did not take in actual deposits they were not under as much regulatory scrutiny.
Especially after the Lehman bankruptcy in Sept 2008 the whole financial system was viewed as being at risk further drying up these credit markets. This led to massive federal efforts to back the commercial paper market.
Federal Reserve Bank of Boston by Judit Montoriol-Garriga and Evan Sekeris, March 2009
A Question of Liquidity: The Great Banking Run of 2008?
Link: http://www.bos.frb.org/bankinfo/qau/wp/2009/qau0904.pdf